Advantages and Disadvantages of Monopolies

A business becomes a monopoly when it is the only supplier to which buyers can turn. The diamond company De Beers, for example, was a monopoly for most of the 20th century. De Beers could dictate prices because there were no competitors undercutting them. That is one of the major advantages of a monopoly, but there are negative effects of a monopoly too.

Becoming a Monopoly

Even for a new business, achieving a monopoly is not impossible. There are several ways to achieve a monopoly or a near monopoly.

  • Control a scarce resource: Standard Oil, for example, became a monopoly in the late 19th century by achieving near-total control of the American oil industry.

  • Intellectual property: If a pharmaceutical company develops a drug to cure cancer or Parkinson's disease, it can patent it and have a monopoly.

  • Be the first: Facebook's social network has its problems, but with so many people using it, it keeps people interested. Companies that have tried to clone Facebook have not made headway in luring people away.

  • Become a brand name: Walt Disney is a classic example. The company he built does not have a monopoly on making movies, but it has a monopoly on movies with the Disney brand, and that brand has a standing few studios can match.

  • International alliance: If you become the only importer for, say, a new food from Japan, that gives you a monopoly.

  • Government assistance: If the government makes you the sole manufacturer of tanks, for example, you are in a monopoly position.

Monopolies may not be permanent. Generic drugs eventually compete with the original. Brand name movies or TV shows inspire knockoffs. Governments can always renegotiate contracts.

Pros of a Monopoly

If you are skilled or lucky enough to turn your company into a monopoly, you will see some definite benefits. Most obviously, you can set any price the market will bear. As long as enough customers are willing to pay your price, you can charge what you like.

If your product is not something your customers need to have, skilled advertising may convince them to pay your price anyway. Nobody needs diamonds, but De Beers worked for decades to convince consumers that diamond rings were the only acceptable engagement jewelry. The company created a demand that kept prices artificially high.

Other Advantages of a Monopoly

Price control is only one of the benefits your company can see if you achieve a monopoly.

  • Monopolies generate high profits. You can pour those profits into added capital investments. A software company, for example, can use profits from its intellectual property to develop new proprietary software.

  • As you grow, you can enjoy economies of scale, increasing your output and decreasing the cost of production per unit.

  • You can use your monopoly profits as a loss leader. That enables you to offer other goods or services that are not profitable but build customer loyalty or brand reputation.

Negative Effects of a Monopoly

If you are in a monopoly situation, it is important to keep in mind the negative effects of a monopoly and guard against them.

  • Governments often break up monopolies, believing competition is better for consumers. The federal government broke up Standard Oil. It also broke up AT&T, which once controlled the landline market.

  • Consumers often hate monopolies. Drug companies that raise prices on patented drugs overnight often look like villains exploiting people's need for lifesaving medicines.

  • Becoming a monopoly can make you lazy. With no competition, it is easy to stop worrying about cutting costs or running an efficient operation.

  • Change often catches monopolies unaware and unprepared. IBM ruled the personal computer market for years, but when new companies offered alternative products, IBM could not adapt. IBM eventually left the industry.

  • Even if you have a monopoly in the U.S., manufacturers in other countries may enter the industry.

References

About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com