It’s April and spring, and it seems that crocuses and examples of oligopolistic behavior are busting out all over.
Last week’s example was Iraq announcing a 30-day suspension of oil sales.
This week’s example was Continental Airlines announcing a fare increase and being left “twisting slowly in the wind” (to use a Nixon-era phrase) when its competitors failed to follow.
Once again, the key lesson is that it isn’t easy being an oligopolist. Being one of only a few sellers can provide special opportunities to make profits. But the best strategy to follow isn’t always clear, and mistakes can be costly.
Producers in a highly competitive sector, such as agriculture, don’t face the same sort of pricing challenges. Farmers are classic price-takers. One farmer’s output is not large enough to move the market price down, if she decides to sell, or up, if she holds back.
Farmers decide whether to take today’s price and sell or wait for a better price at some time in the future. Waiting involves costs, such as storage and interest, and the risk that prices will drop rather than rise. But the choice is clear, sell today or wait for another day.
A pure monopolist also faces simple choices. If you’re the only producer of a product you have to know what it costs you to produce additional units. You also need to know something about demand for your product.
But you don’t have to worry about what your competitors will do in response because, by definition, you don’t have any competitors.
The oligopolist, in contrast, must fret about what his oligopolistic cohorts will do. When Saddam Hussein decided to stop selling oil, and no other exporting nation followed, he may have scored political points with some of his own citizens or with Arabs in other countries. However, curtailing sales when other producers do not is a shot in one’s own economic foot.
Continental Airlines did essentially what Saddam did in taking unilateral action without consulting its competitors.
Iraq announced its decision in terms of a quantity limitation and Continental as a price increase, but price and quantity are two sides of the same coin for monopolists and oligopolists. They can’t raise prices without selling less and vice versa.
Prior consultation might have been prudent for Iraq, but would have been illegal if done by a U.S. firm such as Continental. The Sherman Antitrust Act of 1890 and subsequent amendments clearly outlaw oligopolists such as airlines, media firms, auto or steel producers or construction contractors from getting together to agree on limiting output and raising prices.
That’s why there’s a lot of winking and nodding between oligopolists and why they need to play arcane “games” of the type first postulated by John Nash, subject of the Oscar-winning film, “A Beautiful Mind.”
Oligopolists also illustrate the sorts of “signaling” actions described by Michael Spence, co-winner of the economics Nobel last fall.
If an oligopolist’s fortune depends on what actions others take and he is prohibited from talking directly to them, there are several strategies you can follow.
When an oligopolistic industry has one clearly defined leading firm, the best game may be to follow the leader.
Think back to the 1950s and 1960s. GM would announce prices for its new cars at the time they were unveiled each fall. Ford would announce very similar increases a day or two later. Chrysler and the minor produces such as American Motors and Studebaker would follow a day or two after that.
Similarly, whenever U.S. Steel announced new prices for its product line, Bethlehem, Armco, Inland and other steel firms would follow a short time later with very similar increases.
They knew that if they all moved together, relative market share would not change. Total steel usage might drop as a reaction to higher prices, but this was generally minor. Once the big gorilla in the industry moved, it was stupid for the smaller competitors not to act. Not raising to match the industry leader left money sitting on the table.
In sectors when there was no equivalent to U.S. Steel or GM, strategies were more complicated. The contemporary airline industry is like this. Continental’s aborted price rise is typical.
With no clear leader, some aggressive or financially pressed firm decides to take the lead and raise prices. It hopes that other firms will follow. If they do, market shares do not change, and everyone makes more money.
The danger is that other firms will not go along. In that case, you have increased prices and your competitors don’t. You face the prospect of losing lots of customers to the competitors that stood pat. You are left high and dry, twisting slowly in the wind.
Over the past decade, airline strategies have varied. Under Robert Crandall, American Airlines often tried to play the price-leader role.
Sometimes it succeeded, but other times competitors, including Northwest, failed to go along and AA had to retreat in disarray.
Life isn’t easy when you control a good chunk of the market, but not all of it.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.