One frequently asked question is: ‘what ultimately leads to a monopoly?’ Economists have identified a few factors that individually or in combination enable a firm to acquire monopoly power. Let us discuss these factors one by one:
i) Exclusive Control over Raw Materials:
Acquiring control over the essential raw materials acts as an entry-barrier for potential entrants and thus, helps in sustaining monopoly power of the incumbent. The potential entrants may procure raw materials from foreign markets but that may not be a feasible alternative, since this option involves licence fees, tax considerations, cost of transport, etc., which may enhance total cost to a certain level that is not competitive.
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A substantial cost advantage for the existing monopolist precludes entry of potential entrants because of a threat that post-entry competition would not allow the new entrants to earn positive profit because a cost efficient incumbent is already there.
ii) Economies of Scale:
When a single firm manufactures a large quantity of a particular product, economies of scale helps to reduce the cost of production per unit of output. This benefit is obtained especially where factors of production (machines, raw materials etc.) are indivisible.
As a result, variable costs as well as the fixed cost reduce with an increase in the scale of operation. By lowering the cost of production, a firm can offer the products at a cheaper price than its rivals.
This raises entry barriers. Generally this is considered to be an early-mover advantage, because the firm that comes first into the business gets time to enhance market share and can thereby exploit scale economies.
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But no firm can enjoy scale advantage permanently and sustain monopoly power because in future, advanced and sophisticated technologies may enable a new entrant to reduce average cost of production and thus, threaten the existing monopolist, which uses outdated technology.
iii) High Capital Requirement:
Requirement of large amount of capital may also restrict new entry. In some industries like automobiles, iron and steel, oil refining, etc., huge capital is required for setting up plants. Likewise, in industries like pharmaceuticals and electronics, heavy investment is required towards research and development.
High requirement of investment acts as an entry barrier, not only because capital is a scarce resource, but also due to the risk involved in post-entry losses. Since investment is irreversible, any decision taken in this regard must be appropriate, particularly where a huge amount is involved in order to avoid heavy losses.
iv) Product Differentiation:
Product differentiation acts as a strong entry barrier, when the incumbent has created a preference among the target group of customers for his “unique” product or brand image through various promotional campaigns. Such barriers are more effective in case of sensitive items (e.g., baby food, medicine etc.) and also for premium products (e.g., high-valued wristwatch, branded diamond, etc.).
v) Patents, Trademarks and other Legal Barriers:
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Legal barriers help to protect the monopoly position of the incumbent. For example, a patent offers the holder exclusive right to make use of, or sell, his invention within a stipulated period of time.
If any potential entrant tries to make use of or sell the same idea, processor system without permission of the patent-holder within that time span, then it is considered as violation of the Patent Act and thus punishable by a court of law.
A copyright, another legal barrier, prohibits copying of an original work without permission from the appropriate authority. It is specially applicable to the publishing industry. Sometimes, the Government sets legal barriers and enjoys monopoly over certain areas, e.g., oil production, gold mines, etc.
vi) Market Size and Minimum Efficient Scale:
In some cases, total demand of a particular product in a market is so small that it does not allow more than one player to operate. If more than one player intend to coexist in the same product field, total demand will be distributed among them and it may so happen that none of them will attain Minimum Efficient Scale (MES). As a result, small size of market along with high MES constraint can also be regarded as a strong entry barrier.
Let us explain this point with the help of a numerical example. Suppose, the total market demand of a particular product is 10,000 units. Presently, one firm is enjoying monopoly and MES of the firm is 9,000 units.
Such a situation is very favourable for the existing monopolist and it would be very risky for any new firm to enter that industry. This is because it would be extremely difficult for the new firm to sell at least 9,000 units, which is the MES, in order to reduce average cost to the lowest possible level.
vii) Strategic Barrier:
A monopolist may exercise ‘limit pricing’ or may hold excess capacity, to discourage new entry. For limit pricing, the monopolist keeps prices of the product abnormally low, which indicates that this business is not feasible for the potential entrants to operate in.
Sometimes, the monopolists intentionally maintain excess capacity to make the potential entrants feel that the incumbent can quickly increase output by utilising its full capacity to meet any additional demand for the product in the market.
viii) Causal Ambiguity:
Sometimes, the superiority of a brand among its rivals can clearly be recognised but the technical knowledge as well as the synergetic effect responsible for that ‘superiority’ of that brand are obscure and partially understood.
It creates an ambiguity among rival firms over the specific process or technical know- how that contribute such ‘extra’ value addition, because no algorithm, formula or set of rules can be validated to explain the creation of this ‘extra’ value to that particular brand.
In many cases, even the production managers may not be able to express properly what actually makes their brand better than that of their rivals’. It is believed by the strategists that causal ambiguity can work as a powerful impediment for the new or the potential entrants and ensures sustenance of monopoly power of the incumbent.