How to sustain monopoly power

    Monopoly power can be achieved in a number of ways:

- Economies of scale, if sustained over a sufficiently large range of output, give big

firms a cost advantage over smaller competitors. Eventually, this could result in

just one firm serving the market (single-firm monopoly). More usual is the

situation where a few firms dominate the industry.

- Government policies such as provision of a patent, nationalisation or regulation,

create monopoly situations. For example, until recent times, private buses were

prevented from competing with the state-owned bus monopoly in many

European cities.

- Ownership of know-how can confer market power even in the absence of specific

legislation and economies of scale. This know-how could embody organisational,

marketing or financial procedures, as well as technological leadership.

- Ownership of natural resources – such as oil, diamonds, uranium, etc., where the

number of producers is limited by physical constraints.

    Monopoly profits act as a beacon to potential entrants to the industry. If they

succeed in gaining entry to the industry, monopoly profits will be competed

away. Strategic management textbooks advise firms on how to protect and insulate

themselves from potential entrants. Hence a paradox of the market system:

profit maximisation drives firms to seek to acquire monopoly power; at the same time

this self-same drive for profits attracts new entrants and makes monopoly power hard to sustain.

    The way in which market power can be sustained, once it has been acquired,

needs careful attention. Many firms fail to sustain market power. In Britain, GKN,

Courtaulds and British Leyland, and in Germany, AEG and Mannesman, are examples of once great companies which survive in much diminished shape or have

fallen by the wayside. Sustaining market power involves three primary elements:

- Architecture. The network of relational contracts written by or around the firm.

Companies such as IBM and Marks & Spencer exemplify strong architecture in

that they have established a structure, a style, a set of routines, which motivate

employees and suppliers. These routines resulted in exceptional corporate results

over many years and through many changes in the economic environment.

- Reputation. Relevant in markets where quality is important, but verifiable only

through long-term experience. Examples include car hire, accountancy services

and international hotel chains. In these markets, reputations are costly and difficult

to create but, once established, can generate substantial market power.

Reputation is bolstered by advertising and development of brand names.

- Innovation. Development of product differentiation and patents, as already

noted, are a source of market power, but many types of innovation are not protected

by patent. The key issue is how to protect a specific innovation in a

world where innovations – from software to personal stereos to cream liqueurs

 - are difficult and expensive to protect through legal measures. The most powerful

means of protection usually is to combine innovation with architecture

and reputation, much as, say, Microsoft combines its constant innovation with

sedulously created marketing and distribution.

    Architecture, reputation and innovation together give a firm what Professor John

Kay has termed distinctive capability, which in the long term sustains its monopoly

power.

  Market power can also be preserved by strategic entry-deterrent measures such as

1. setting price deliberately below the profit-maximising level in order to reduce

the attractiveness of the industry to outsiders, 2. concealing profit

figures for monopolised parts of its business – a common practice in the case of

subsidiary operations of large companies, 3.below-cost selling, predatory pricing

and dumping, and 4. deliberate over-investment in capacity and extension of

product range.

    To sum up, what matters in terms of exercising market power is the firm’s

ability to earn above-average profits while keeping potential new entrants out of

the industry. If entry is not too costly and cannot be deterred, even a 100 per cent

market share may leave the incumbent firm with little market power. A high firm

concentration ratio will signal market power only if it is accompanied by a low

degree of contestability.