Some oligopolies began as monopolies, gradually becoming oligopolistic after new firms struggled to become established. Others emerged out of a competitive environment after big firms vanquished or absorbed their rivals. The major causes of oligopoly are mergers and barriers to entry.
Economies of Scale
Technical efficiency sometimes requires enormous plants and massive equipment, which can act as major barriers to entry. Economies of scale cause an industry to gravitate into a natural monopoly when only a single firm of considerable size relative to market demand is able to produce at a low cost. An industry tends toward the oligopoly mold if economies of scale are less formidable.
An offshoot of technological advance in the last century was pressure for ever larger plants (e.g., steel, railroads). Substantial entry barriers may exist if new technology (e.g., robotics) mandates huge operations. Existing firms with established product lines may be able to activate new technologies so rapidly that new firms cannot get a toehold in the industry. It is possible, however, for large amounts of old capital to be an anchor that keeps established firms from keeping pace with upstarts that adopt the latest technology. For example, U.S. steelmakers have had problems in recent decades because most American steel plants are ancient, while their competitors in Japan, Korea, and Germany operate modern equipment in newer facilities.
Recent technological advances have probably been relatively less favorable to huge firms than to smaller ones. For example, cable TV has diluted the oligopolistic power of major networks (ABC, CBS, and NBC), and recent entries in computers have gained on established giants like IBM. Some disadvantages of large firms may have been partially offset by computerization and improved communications, but in the 1980s and 1990s, U.S. employment growth has been most rapid in smaller firms. Increasing numbers of people now work at home, being linked to their employers primarily through computer modems, FAX machines, and cellular phones. This trend probably favors small operations over large ones.
Strategic barriers may also impede entry. For example, firms may pool research and development efforts while excluding outsiders, or frequently change models, or advertise excessively. Product differentiation is often a major entry barrier. Extravagant marketing may intimidate potential entrants with tight budgets; trying to combat established competitors' marketing outlays raises the minimum efficient scale of production for new entrants. Alternatively, an oligopoly may market numerous versions of a basic good (e.g., cereals, cigarettes, or over-the-counter drugs) or offer retailers huge discounts for preferential shelf space (Coke and Pepsi), leaving little space in retail outlets for potential rivals.
Another strategy to bar entry occurs when mature industries and their unions lobby to erect legal import quotas and tariff walls against foreign competition. Textiles, apparel, automobiles, agriculture, and steel are all industries with protection from foreign competition. Established industries often succeed in having laws tailored as hidden entry barriers. This is an international game. For example, mandatory safety standards make it more costly to ship vehicles between countries. Curiously, some Japanese cars cannot be imported into the United States for reasons of safety, while most American autos must be retooled before export to meet Japanese safety standards.
Oligopolies also arise through merger because combining two firms may be a less rocky path for growth than using retained earnings, sales of new stock, or borrowing. However, recent takeovers by corporate raiders highlight certain pitfalls of merger as a path for growth: (a) top managers of takeover targets fear for their own job security, and (b) communities often become embroiled in merger battles when a target firm is a major employer that provides a town's economic lifeblood. Laws and court decisions making it harder for firms to close plants and aimed at inhibiting corporate takeovers have recently begun to appear on the landscape.