Dogma Premise # 10

Competition keeps markets effective even when there are only 2-3 competitors because the profit motive is constant, regardless of the number of competitors.

Check any Economics textbook and you’ll read the same thing: when just a few firms dominate a market, competition is reduced, and to the extent that the firms compete, they do so on factors other than price.  As a result, prices in a market dominated by an oligopoly of firms are consistently higher than in a competitive market.

Markets that are not competitive are less efficient, and fail to deliver all kinds of economic benefits that are delivered in a free market.  For example, the rate of innovation can slow.  But worst of all, prices are higher than they would otherwise be, which is essentially an “Oligopoly Tax” on every item sold.

So why is it that people are not alarmed at the market concentration that has emerged in most industries?

One reason is that market concentration is frequently hidden behind a plethora of brands.  Many people do not realize, for example, that the following brands: A&W, Barq’s, Canada Dry, Dasani, Fanta, Hi-C, Hires, Minute Maid, Nestea, Odwalla, PowerAde, Sprite, Tab, and thousands of other brands are all really just Coca Cola drinks.  And Pepsi owns most of the rest.  So a market that appears to be competitive, is in fact just divided into a large number of geographical and demographic customer segments that mostly do not compete with each other.  For example, although Coca Cola owns three brands of root beer (A&W, Barq’s, and Hires), there won’t be any price competition between the three -- instead, each one will be targeted at a different demographic market segment.

Another reason that the anti-competitive nature of concentrated markets is hard to notice is because firms in a concentrated market DO compete -- they compete on marketing, they compete on packaging, they compete on services (e.g., free installation), they go to war with different product features, but they do not compete on price.  So all this furious and sometimes high profile competition (e.g., The Pepsi Challenge), is largely smoke and mirrors.  Consumers are offered different colors, different scents, different packages, different styles, different brands  -- anything, but just the basic functional product at a lower price.

It sounds like a conspiracy theory, but it’s not.  All corporate managers are taught in MBA school that sustaining high pricing and avoiding “destructive competition” is the key to profitability.  The best way to sustain high prices is to reduce competition, so they find ways to do that.  The simplest and most common way to eliminate competition is simply to buy all the competitors, as Coke and Pepsi have done.  Companies that pursue this strategy are called “acquisitive,” and they enter competitive markets with a predefined plan to “roll up” the market, which means to concentrate it through acquisitions, and then reap oligopoly profits, which are more than enough to pay the costs of the acquisitions.

The leaders of the firms in a concentrated industry all know that price competition harms the profitabilty of all firms, and they carefully avoid it.  These firms worked very hard to reduce the competition, and frequently paid a lot of money to reduce the competition, so it would be nonsensical for them to destroy the benefits.  Serious price competition only happens when an upstart firm manages to break into the market and disrupt it.  Large firms know all kinds of tricks to prevent this (it is called “creating entry barriers,” and you can read all about it in Michael Porter’s classic, Competitive Strategy.  Or just go to Wikipedia, it’s all there.

In other words, concentrated industries appear to be competitive, and they engage in limited forms of competition. But the primary benefits of competition -- efficiency, innovation, and low prices -- suffer badly in an oligopoly.  To the extent that innovation occurs, it is more likely to revolve around how to create new market barriers to protect the market from new competitors, rather than ways to provide a better product for a lower price.

So although it is sometimes said that the profit motive will sustain competition even in highly concentrated markets, the basis of competition in concentrated markets may be severely limited. If the few rivals set up a plethora of brands that mimic the appearance of market-generated choice, the true objective is more likely to be price discrimination than price competition, and actual competitive threats that might drive innovation and efficiency are minimized.

Dogma Premise 11

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