How and Why Companies Become Monopolies

[ ] 16/04/2019

Investopedia defines a monopoly as, “a situation in which a single company or group owns all or nearly all of the market for a given type of product or service.” Without any meaningful competition, monopolies are usually quite profitable. While companies constantly jockey to increase market share, achieving true monopoly status is not easy to do. How and why do companies become monopolies?

How to Create a Monopoly

There are many ways to create a monopoly, and most of them rely on some form of assistance from the government. Perhaps the easiest way to become a monopoly is by the government granting a company exclusive rights to provide goods or services. The British East India Company, to which the British government granted exclusive rights to import goods to Britain from India in 1600, may be one of the best-known monopolies created in this manner. At the height of its power, the firm served as the virtual ruler of India with the power to levy taxes and direct armed forces.

In a similar manner, nationalization (a process by which the government itself takes control over a business or industry) is another way to create a monopoly. Mail delivery and childhood education are two services that have been nationalized in many countries. Communist countries often take nationalization to its most extreme, with the government controlling almost all means of production.

Copyrights and patents are another way in which assistance from the government can be used to create a monopoly or a near monopoly. Because the government has laws in place to protect intellectual property, the creators of that property are given monopoly power over things like ideas, concepts, designs, storylines, songs or even short melodies. A good example of this comes from the world of technology, where Microsoft Corp’s (MSFT) copyright of its Windows software effectively gave the firm a monopoly on what amounted to a revolutionary new way for computer users to navigate and manage their on-screen activities. (To read more, see: Make Money on Your Intellectual Property.)

Having access to a scarce resource is another way to create a monopoly. This is the path taken by Standard Oil under the leadership of John D. Rockefeller. Through relentless and ruthless business practices, Rockefeller took control of over 90% of the oil pipelines and refineries in the United States. While the government eventually broke up the monopoly, it took several tries and nearly 20 years to do so. Chevron Corporation (CVX), Exxon Mobil Corp. (XOM) and ConocoPhillips Co.(COP) are all legacy companies resulting from the breakup of that monopoly. De Beers Consolidated Mines Limited also used access to a scarce resource—diamonds—to create a monopoly. (To learn more, see: J.D. Rockefeller: From Oil Baron To Billionaire.)

Mergers and acquisitions are another way to create a monopoly or a near monopoly even in the absence of a scarce resource. In such cases, economies of scale create economic efficiencies that allow companies to drive down prices to a point where competitors simply cannot survive.

Why Monopolies Are Created

While governments usually try to prevent monopolies, in certain situations, they encourage or even create monopolies themselves. In many cases, government-created monopolies are intended to result in economies of scale that benefit consumers by keeping costs down. Utility companies that provide water, natural gas or electricity are all examples of entities designed to benefit from economies of scale. Imagine, for example, the cost to consumers if 10 competing water companies each had to dig up the local streets to run proprietary water lines to every house in town. The same logic holds true for gas pipes and power grids. (For related reading, see: Are monopolies always bad?)

In other cases, such as with the government policies that govern copyrights and patents, governments are seeking to encourage innovation. If inventors had no protection for their inventions, all of their time, effort and money spent writing books, recording songs, and conducting the research and development to create new drugs to combat disease would be wasted when another company who steals the idea is able to create a competing product at a lower cost.

The Downside of Monopolies

While monopolies are great for the companies that enjoy the benefits of an exclusive market with no competition, they are often not so great for the consumers that buy their products. Consumers purchasing from a monopoly often find they are paying unjustifiably high prices for inferior-quality goods. Also, the customer service associated with monopolies is often poor. For example, if the water company in your area provides poor service, it’s not like you have the option of using another provider to help you take a shower and wash your dishes. For these reasons, governments often prefer that consumers have a variety of vendors to choose from when practical.

However, monopolies can be equally problematic for would-be business owners as well, because the inability to compete with a monopoly can make it impossible to start a new business. It’s an age-old-challenge that remains relevant today, as can be seen by the legal decision to block a merger of Sysco Corp (SYY) and U.S. Foods Inc. on the grounds that bringing the two largest food distributors in the country together would create an entity so large and powerful it would stifle competition. The proposed merger between Kraft Foods (KRFT) and H.G. Heinz (HNZ) raised similar concerns, although the merger was eventually permitted to take place.

The Bottom Line

While monopolies created by government or government policies are often designed to protect consumers and innovative companies, monopolies created by private enterprises are designed to eliminate the competition and maximize profits. If one company completely controls a product or service, that company can charge any price it wants. Consumers who will not or cannot pay the price don’t get the product. For reasons both good and bad, the desire and conditions that create monopolies will continue to exist. Accordingly, the battle to properly regulate them to give consumers some degree of choice and competing business the ability to function will also be part of the landscape for decades to come. (For related reading, see: Economic Basics: Competition, Monopoly and Oligopoly.)

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