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Oligopoly 351

The strategic approach extends the single-firm point of view by recogniz-

ing that a firm’s profit depends not only on the firm’s own actions but also on

the actions of competitors. Thus, to determine its own optimal action, the firm

must correctly anticipate the actions and reactions of its rivals. Roughly speak-

ing, a manager must look at the competitive situation not only from his or her

own point of view but also from rivals’ perspectives. The manager should put

himself or herself in the competitor’s place to analyze what that person’s opti-

mal decision might be. This approach is central to game theory and is often

called interactiveor strategicthinking.

The outline of this chapter is as follows. In the first section, we describe

how to analyze different types of oligopolies, beginning with Michael Porter’s

Five-Forces model. Next, we introduce the concept of market concentration, as

well as the link between concentration and industry prices. In the following

section, we consider two kinds of quantity competition: when a market leader

faces a number of smaller competitors and when competition is between

equally positioned rivals. In the third section, we examine price competition,

ranging from a model of stable prices based on kinked demand to a descrip-

tion of price wars. Finally, in the fourth section, we explore two other impor-

tant dimensions of competition within oligopolies: the effects of advertising

and of strategic precommitments.

OLIGOPOLY

An oligopolyis a market dominated by a small number of firms, whose actions

directly affect one another’s profits. In this sense, the fates of oligopoly firms

are interdependent.To begin, it is useful to size up an oligopolistic industry along

a number of important economic dimensions.

Five-Forces Framework

For 25 years, Michael Porter’s Five-Forces model has provided a powerful syn-

thesis for describing the structures of different industries and guiding com-

petitive strategy.^1 Figure 9.1 provides a summary of the Five-Forces framework.

The core of Porter’s analysis centers on internal industry rivalry: the set of

major firms competing in the market and how they compete. Naturally, the

number of close rivals, their relative size, position, and power, are crucial.

(The following section looks closely at the notion of industry concentrationto

measure the number and sizes of firms.) Entry into the market is the second

most important factor in sizing up the industry. We have already seen that free

(^1) The Five-Forces model is examined at length in M. E. Porter, Competitive Strategy: Techniques for
Analyzing Industries and Competitors(New York: Simon & Schuster, 1998).
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