Economic Analysis of an Oligopoly Market Structure free essay sample

In this article Michael Baker discusses the livelihood of small retailers in a market subjugated by the financially dominant oligopolies, Woolworths and Coles. While the small independent retailers in direct competition with Woolworths and Coles provide some competitive respite for consumers, as they encourage competitive pricing, albeit predatory pricing, it is clear that Woolworths and Coles control the supermarket industry in Australia, in the formation of a duopoly. It is evident that Woolworths and Coles engage in predatory pricing in an attempt to eliminate independent retailers from the market. This article discusses recent efforts made by the Australian government and the Australian Competition and Consumer Commission to reduce predatory pricing and, thus, encourage competition in the marketplace in an attempt to relieve the financial strain that would undoubtedly be felt by consumers if the Woolworths/Coles duopoly ruled the marketplace without the presence of independent retailers. It is clear that these strategies enforced by the government and the ACCC to aid small retailers are not working, as predatory pricing still exists. What is also evident is that several strategies enforced are in contradiction of each other, as some are enforced to protect small retailers, while others increase foreign competition in the supermarket industry, which is certain to negatively impact small retailers and encourage the formation of an oligopoly, or future monopoly market structure. An example of this is the government initiative to allow foreign entrants into the retail market five years, instead of 12 months as is currently standard, to develop land purchased in Australia. This provides an opening for international retail chains, such as Walmart, to enter the market, allowing them more time to establish multiple locations across Australia. This is destined to have a negative impact on shopping centre retailers, in particular small independent retailers, as international retail chains, such as Walmart, have freestanding locations, encouraging consumers to destination shop where they can purchase everything in the one store. In the ge of convenience, this is a very appealing concept to consumers, and is certain to detract from the business of shopping centers and, thus, small retailers. In addition, large retailers, such as Woolworths and Coles, will also be affected by the introduction of international retail chains into the Australian market, as this will detract from their market share. 1b. Justification of topic Woolworths and Coles duopolistic structure is evidenced through their dominant presence in the industry, relating to the characteristic syno nymous with an oligopoly market structure, having few firms in the industry. The fact that there are only two main firms indicates that this is a duopoly. Woolworths and Coles are present in almost every Westfield shopping centre across Australia, as well as independently, close to access to public transport. The National Association of Retail Grocers of Australia reported that Woolworths and Coles comprised a 79% share of the market (AAP, 2007). High barriers to entry, in particular financial barriers, including set up costs, distribution and advertising, are also evidence that this is an oligopoly market structure. In addition to this, mutual interdependence, whereby Woolworths and Coles are constrained in their competitive activity, and the use of heavy advertising as a means of attracting more market share in avoidance of price competition, also indicate the oligopolistic nature of this industry, as do large economies of scale. 1. Economic Analysis *For the purpose of the discussion Walmart has been used as an example throughout. Duopolies occur largely because of the existence of barriers to entry in an industry. In this instance, the major barrier to entry is financial. Large set up costs, distribution and operating costs, as well as advertising costs exist for any firm considering challenging a duopoly. In addition to this, barriers to entry exist in the form of controlling resources. Woolworths and Coles would have agreements with farmers to supply exclusively to them, in exchange for the firm purchasing all of their quality produce. Woolworths and Coles are also more likely to be able to purchase products, including fruit and vegetables, for a cheaper price than small, independent sellers, as they are purchasing in bulk. According to McKenzie (2002) No major supplier, no matter how big or powerful they are, can afford to be offside, or out of favour, with Coles or Woolworths. Economies of scale give Woolworths and Coles an advantage over smaller retailers because, as a result of their large scale production, they are able to produce at a lower average cost, allowing them to sell goods to consumers at a lower price. This competitive pricing eventually forces smaller firms out of the market, as they are unable to match the predatory pricing, due to a lack of economies of scale. Because Woolworths and Coles generally have homogenous products, they rely on a heavy use of advertising, in order to avoid competitive pricing with each other. Oligopolies tend to avoid competitive pricing at all costs, as the worst case scenario of this is a price war, which generally cannot be escaped, resulting in one survivor, who goes on to become the monopolist. It is evident that Woolworths and Coles are mutually interdependent, whereby each of the firms pricing strategies relate to, and depend on, each other. It is for this reason that it is suspected the duopolies are engaged in collusion, where the two firms arrange to coordinate their pricing strategies in order to maximize profits. (See Fig. 1) The increased opportunity for large retail chains, such as Walmart, to enter the Australian supermarket industry, due to the recently enacted proposal allowing foreign retailers up to five years to develop land purchased in Australia, is destined to have a negative impact on Woolworths and Coles, as well as on small independent retailers. The presence of Walmart in Australia would severely affect small independent retailers across many industries, taking away from their market share, and building a stronger oligopoly market structure. As Walmart is designed to be a destination shop, where you can find everything you need in the one store, it provides goods from all industries, including food, hardware, giftwares, sporting goods and pharmaceuticals. Small chemists and giftshops would feel the impact of Walmart most strongly, because of their inability to compete with Walmarts price strategy, due to their lack of economies of scale. In addition, stores such as Rebel Sport and Bunnings may also be negatively impacted by the recently enacted legislation, as consumers are forever seeking convenience, and may be more likely to shop at a mega-retail chain where they can find everything they need. This move is likely to drive many small independent retailers out of the market, creating an even stronger oligopoly market structure, and freeing up greater market share for Walmart, allowing the firm to more effectively take on Coles and Woolworths. It is quite certain that Walmart would be prepared to operate at a loss for several years in Australia (see Fig. 5), in order to gain greater market share from Woolworths, Coles, and independent retailers. Walmarts economies of scale and scope and the firm’s ability to overcome the financial barriers to entry involved in taking on Woolworths and Coles, ensures that it would have the means to do this. The result of Walmart building strength in the supermarket industry would severely compromise Woolworths and Coles duopolistic position. The eventual result of this would be an oligopoly market structure between Woolworths, Coles and Walmart. (See Fig. 2). This would likely result in Walmart reducing it prices in order to gain an initial share of the market, which would lead to Woolworths and Coles lowering their prices on related products in order to protect their market share. This would be demonstrated diagrammatically as a kinked demand curve, which illustrates the presence of a non collusive oligopoly. It also shows that as price falls, quantity increases slowly, therefore, demand is relatively inelastic. (See Fig. 3) If this occurred, the industry would be characterised by sticky pricing. The effect on the supermarket industry, as a result of the increased supply, due to Walmarts presence in the industry, and virtually identical demand is seen diagrammatically in Figure 4. While an oligopolistic environment, with a rigid price structure is likely to be the case if Walmart enters the Australian market, the slight possibility of price wars is also worth consideration. If Woolworths and Coles engage in competitive pricing with Walmart, in order to defend their current market share, this could result in price wars between the oligopoly, potentially resulting in a monopolistic market structure (see Fig. 6), with one dominant supermarket controlling the industry. 2. Conclusion The recently enforced legislation allowing foreign retailers five years, rather than 12 months, to develop land in Australia, may see a dramatic change to the duopolistic structure of the Australian supermarket industry, currently dominated by Woolworths and Coles. While the presence of an international retail giant, such as Walmart may benefit consumers in the short run, the distant and slight, yet considerable, possibility of price wars between Walmart, Coles and Woolworths could have a severe impact, resulting in the formation of a monopoly. Consumers will not be the only place in which this market structure will negatively impact, as small independent retailers will also be affected by this move, slowly being eradicated from the market, due to inability to compete, resulting in a loss of jobs. In essence, the most extreme outcome of the newly enacted legislation would be a monopoly market structure, in which the only party benefiting would be the monopolist or, similarly, the firm with the largest financial capacity to engage in price wars to the end. Alternatively, this legislation could benefit the Australian public, with a more competitively priced environment, while at the same time negatively impacting small retailers. Only time will tell if the enforcement of this legislation will have a positive or a negative outcome for the Australian economy.