Managerial Economics - The Strategy of Collusion in an Oligopoly Market - Essay Example

?Managerial Economics The term oligopoly has its origin from the combination of two Greek words. They are ‘Oleg’s’ and ‘Pollen’. The former means ‘a few’ and the latter means ‘to sell’. Thus, the term ‘oligopoly’ in business means a situation when the number of companies selling a particular product or service in the market is very few. In other words, oligopoly can be termed as ‘competition among the few’. Admittedly, oligopoly has a large number of specific characteristics which encourage the companies to exhibit collusive behaviour (Fershtman & Pakes 2000). The first important characteristic of oligopoly is interdependence. It happens because when the number of firms is few, any change in the price or quality of the products by one company will have an immediate and direct impact on the other companies. When this happens, it is highly likely that the rivals will immediately respond with similar or more aggressive changes. Thus, in oligopoly, companies remain in constant vigil about the actions and reactions of their opponents (Bolotova et al 2005). Also, companies will hesitate to adopt any such tactics to gain market share because the rivals will immediately respond with similar strategies (ibid). When this happens, it seems that most of the companies start giving more attention to advertising and selling costs. As other strategies will not work, companies try to increase their advertisement in order to achieve maximum sale. Similarly, companies will start reducing selling costs so that profits can be maximised. Yet another important feature is price rigidity. In an oligopoly system, prices often remain rigid because firms are afraid of making changes because of the price-war (Liu & Serfes 2006) Another important point to be mentioned here is the importance of strategy. To illustrate, in oligopoly, it is highly necessary for firms to be careful about their own strategies because they cannot act independently. It is highly necessary for them to decide when to collude with their rivals and when to compete with them. Also, it is highly necessary to be careful while raising or lowering the prices. Admittedly, these features lure the companies to collude in order to reduce uncertainty and also to enjoy monopoly and higher profits. These firms often engage in various forms of collusion, ranging from overt collusion, covert collusion, and tacit collusion. Overt collusion occurs when firms openly engage in agreements like trade associations. Covert collusion is kept hidden in order to hide the results of the collusion. Thirdly, tacit collusion is the result when all firms in an oligopoly act in concert even without the existence of an agreement. One of the most notorious cases of collusion is the lysine price-fixing conspiracy. It took place in the mid 1990s, and various companies from various countries were involved. They were Archer Daniels Midland from the US, Japan companies named Ajinomoto and Kyowa Hakko Kogyo, Korean companies named Sewon America Inc. and Cheil Jedang Ltd. These companies colluded to raise the price of an important animal feed additive called lysine. It is seen that these companies, through the price-fixing, managed to raise the price of the product by 70% (Liski & Montero 2006). Thus, it becomes evident that the cartel helped the companies to raise their profit through gaining monopoly (ibid). It is found that in a perfect market, it is not possible for companies to collude easily because the decisions of a few companies will not impact the market as a whole. However, in an oligopoly market, the collective decision taken by a few companies will have significant impact on the whole market. This will give the companies monopoly and increased profits. Very similar is the case of the beer companies Heineken, Grolsch, and Bavaria, which made a price-fixing deal in Holland, monopolising beer distribution. In fact, these companies collectively controlled 95% of the Holland beer market (Brue & Mcconnell 2006, p. 210). Through collusion, they increased the beer price for many years till 2007. In the same year, a number of companies including Siemens, Alstrom, Areva, Schneider, Fuji, Hitachi, Mitsubishi Electric, Toshiba, and Japan AE Systems were caught for price-fixing that lasted for more than 16 years. All those years, the companies managed to fix the prices for gas-insulated switchgear (ibid). From history, it becomes evident that companies in oligopoly markets tend to collude for various purposes. The first purpose is price fixing. The companies decide to fix a price as seen in the above two cases and enjoy increased profits. Another important area is allocation of territories. It is seen from studies that at times, companies reach a collective agreement regarding the territories for each of the members in the agreement. This will help reduce various costs including advertisements and other campaigns. In addition, companies do not need to worry about reduced price from competitors. Another important area is the establishment of common sales agencies. It is possible for companies to make cartels to do activities like bid rigging, allocation of customers, adjustment of total industry output, deciding market shares and so on. The first negative impact on the company comes when there is a breakdown in the agreement in the long term. When there is collusion, companies will cut down expenses on advertisement, research and development, and all other ways of ensuring market share and profit as there is high degree of security achieved through retaining monopoly. However, it is reported that there is a high degree of chances for organisations to deviate from collusive agreements during ‘boom’ times, and when this occurs, there arises a price war (Stroux 2004, p. 164). When this price war occurs, companies realise that they have lost all the competitive advantages other than the collective monopoly they enjoyed (ibid). Thus, in total, it becomes evident that most of the time, companies utilise the strategy of collusion in an oligopoly market where the number of companies selling a particular product is very few so that they are collectively able to influence the whole market. In such situations, the companies face a lot of issue like total interdependence, price rigidity and inability to take decisions regarding future pricing and output. In addition, they are forced to adopt aggressive advertising and other publicity campaigns. As a result, the companies in such a situation tend to show colluding behaviour so that they can collectively control the whole market and enjoy higher profits through various activities like price fixing, and territory separation. References Brue, S. L & Mcconnell, C. R. (2006) Essentials of Economics. Tata McGraw-Hill Education. Bolotova, Y et al. (2005) ‘The impact of collusion on price behaviour: empirical results from two recent cases’, The Third Annual International Industrial Organization Conference. Atlanta, Georgia, April 8-9 [online] available at http://www.agecon.purdue.edu/staff/connor/papers/Price_Dispersion_IIOC_03-27-05.pdf [accessed 14 Jan 2013]. Fershtman, C & Pakes, A. (2000) ‘A Dynamic oligopoly with collusion and price wars’. The RAND Journal of Economics, 31 (2), pp. 207-236. Liu, Q & Serfes, K. (2006) ‘Market segmentation and collusive behaviour’. International Journal of Industrial Organization 25, pp. 355–378. Liski, M & Montero, J. P. (2006) ‘Forward Trading and Collusion in Oligopoly’, Journal of Economic Theory 131, pp. 212 – 230. Stroux, S. (2004) US and EC Oligopoly Control. Kluwer Law International. Netherland. Read More