Two can be an awkward number, as many a prom-goer can attest. That also is true in markets with only two producers. Managers of such firms face difficult choices, and so do their customers. When they make any major decision, they must always consider how their one competitor is going to react.
Large passenger aircraft constitutes just such a market. The U.S.-based Boeing and Europe’s Airbus are the only producers with any significant market share. As competitors, they each must think several steps ahead when deciding whether to spend billions on a new plane. The profitability of such investments always depends on what the other firm does.
Airbus recently celebrated the first flight of its new A380 jumbo jet. Boeing made a decision some time ago not to develop a new plane that would directly compete with the A380. Instead, Boeing is concentrating efforts on its 787 Dreamliner and announced large sales of this model to Air India and Air Canada as the new Airbus taxied out.
Boeing’s first-quarter 2005 earnings, however, were down 14 percent on current business. Orders for passenger 747s — as opposed to cargo versions —have dried up. With many major airlines facing financial difficulties, how these two firms will fare over the next five to 10 years is not at all clear.
Economists call these market situations “duopolies,” and they are a specific subset of oligopolies, which refer to markets with more than a single producer but in which the number is still very small.
In duopolies, the two producers are not the only ones who must think strategically — their customers must also. A large airline may see particular advantages to the new A380. However, it also realizes that it would suffer if Boeing lost so much business to Airbus that the U.S. firm went out of business.
If Boeing bit the dust, Airbus would be a monopolist with much more power to raise prices. Airlines want to get the best plane for their money, but they also want to see that at least two competing aircraft suppliers remain in business.
This dilemma is not limited to the airlines. It has been true for railroads and locomotive builders for more than a century.
Right now there are two locomotive builders, General Electric and EMD, which was until recently the Electromotive Division of General Motors.
EMD introduced the modern diesel-electric locomotive just before World War II. From the 1940s into the 1970s, it dominated the locomotive market. During that time the railroad industry as a whole was highly fragmented, with dozens of railroads dominating in specific geographic regions. Those dozens of railroads could buy from one dominant engine producer — EMD — or from a few declining ones such as Alco and Fairbanks-Morse.
General Electric, which had manufactured electric locomotives and supplied generators and electric motors to diesel-electric locomotive manufacturers, decided to jump in and compete with EMD. It purchased rights to a British-designed diesel engine and began building locomotives in head-to-head competition with EMD.
GE had deep pockets and could finance this sort of venture. Early GE locomotives were not as good as those from EMD. But railroads bought some anyway because they did not want EMD to end up with a monopoly as minor diesel-electric manufacturers gave up.
Over time, the quality and performance of the GEs improved. Moreover, the engineering and managerial sclerosis inherent in monopolies infected EMD. Many of their designs in the 1970s and 1980s were not particularly good, and by the 1980s, GE started to outsell EMD. EMD reacted to the competition with better design and more aggressive pricing. GE still leads, but now both firms are viable and the sector is competitive.
In the meantime, mergers among the railroads resulted in four large companies dominating the industry. Now, four very large railroads are buying from two locomotive manufacturers. The locomotive manufacturers don’t want to see further consolidation among railroads. The railroads don’t want to see either EMD or GE go out of business. So both sides need to think beyond the short-term profits of any particular deal and consider the longer-run implications.
One historical irony: A century ago, there were also just three major steam locomotive manufacturers — Baldwin dominated, while the smaller Alco and Lima provided some degree of competition. (Westinghouse and GE made a few specialized electric locomotives.) But all three steam locomotive firms bobbled the transition from steam to diesel-electric technology, and all three went out of business.
Duopolies affect consumers too. Some Americans complain about European government subsidies to Airbus, but with the demise of Convair, Douglas and Lockheed as jetliner manufacturers, it is clearly in the interest of consumers worldwide to avoid a monopoly in aircraft production. Consumers don’t get bills upfront, but in the long run, they bear the cost of a monopoly.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.