A market controlled by a handful of firms is known as an oligopoly. For example, as of early 2011, most desktop computers ran on either the Microsoft Windows or the Apple Mac operating system. Two airline companies, Boeing and Airbus, dominated the long-range airplane market. In oligopolies, unlike in a monopoly where one firm dominates a market, the marketing and operational strategies of the oligopoly firms are linked together.
The characteristics of oligopoly markets include high barriers to entry, a limited number of firms and pricing power. The barriers include size, product complexity, high initial costs, government regulations and limited distribution abilities. For example, it is difficult and expensive to build an airplane, or to get computer users to switch their applications and files over to a new operating system. When a limited number of firms operate in a market, these firms can raise prices to pass on raw materials and other cost increases to their consumers, thus maintaining or even increasing profit margins.
The number of companies in a market affects the behavior of each company. In an oligopoly, increased sales by one company has an impact on the others. For example, if a company increases sales at existing prices, the sales of the other companies are usually reduced. If sales increase because of discounts and other price promotions, it is possible that the market size increases because more buyers come in attracted by the lower prices. Price promotions can also take away market share from the other companies, who will then be forced to respond by reducing prices, increasing promotional efforts or cutting costs to maintain profits.
A price war in an oligopoly helps nobody because it reduces the overall price and profit levels. Sales and profit growth strategies, therefore, should be based on other factors, such as product quality, customer service level and more efficient operations. While price reductions by one company are likely to be matched by others in an oligopoly, price increases might not be matched because the other companies would attempt to gain market share. Regulatory agencies do not permit collusion in an oligopoly, where a small number of companies get together to carve up markets and set prices to maximize profits.
Managers of oligopolies must anticipate the actions of peers because their strategies are interdependent. For example, during a recession, if the firms do not simultaneously lower their production levels, supply might outpace demand, which could lead to lower prices and consequently lower profits for everybody. This means that managers must know their competitors’ businesses, and be generally trusted by the other oligopoly firms to act in their mutual best interests.