What Is a Monopoly Business? (Types and Advantages)
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When a business dominates its market segment and operates without competition, the way it functions can change. Businesses that establish monopolies can dictate prices and generate significant profits, while consumers might suffer from limited choice. Learning about business monopolies can help you understand this important concept and realize the advantages and drawbacks of a monopoly situation. In this article, we explain what a monopoly business is, discuss different types of monopolies, and outline the pros and cons of a monopoly.
What is a monopoly business?
A monopoly business is one that holds a substantial majority of the market share within its industry. They're businesses that don't face significant competition from other companies. Because of this lack of competition, businesses that establish monopolies might behave in different ways than other companies. A business can establish a monopoly in several ways, such as by inventing a novel product category, securing exclusive rights to operate in a region, or controlling a natural resource.
Monopolies can have negative effects on customers, such as increased prices and reduced choices. When a single business controls an essential product and doesn't face any competition for market share, it can raise prices without risking significantly reduced sales. Lack of competition might also lead a business that holds a monopoly to become complacent and stifle innovation. Monopolies can exist on a local level, such as when a single entity controls the entire supply of a product within a town, or on a national level, where utility companies might hold exclusive rights to resource distribution.
Types of monopolies
There are several distinct types of business monopolies. Here are some prominent ones:
A legal monopoly forms when a single company secures the sole legal right to produce a product or provide a service. This can come in the form of patents, in which a company with a novel idea for a product files for the exclusive rights to that design. Competitors are unable to enter the market because it may be illegal to produce a similar product. An example of a legal monopoly is a pharmaceutical company that researches a new drug, patents its chemical makeup, and wins the rights to be the sole producer.
A natural monopoly exists in industries where the barrier to entry for new companies is so high that it's only logical for a single company to operate in that sector. This often occurs with public utilities like electricity or water supply because it isn't practical for two competing electrical companies to install separate infrastructure like power lines all over a country. Instead, natural monopolies allow a single entity to deliver essential services.
State monopolies occur when the government uses legislative means to establish a monopoly on business within a particular sector. The most extreme forms of a state monopoly might exist in communist countries where the state dictates business across most industries. State monopolies are often companies that provide a public good, such as the postal service or hospitals. State monopolies usually control prices and manage operations in industries that are critical to the health of a country.
Unnatural monopolies occur when a private enterprise wins a monopoly in a particular industry due to government legislation or legal action. These monopolies can occur under corrupt governments, where a head of state might favour a single company and make it difficult for competitors to operate. An unnatural monopoly can also occur if a firm wins a government contract to be the exclusive producer of a particular product.
An oligopoly is not technically a monopoly because it occurs when a few powerful companies control an industry. These companies might coordinate their operations to dictate prices and control production. Some oligopolies help stimulate healthy competition, while others might stagnate innovation. An example of an oligopoly is telecom companies, which offer similar prices and limited options to consumers.
Pros of business monopolies
There are several benefits that companies and consumers gain from monopoly situations. Here are some pros of monopolies:
When a business establishes a monopoly, it faces limited competition, which can help it operate freely. The business can save money on advertising and marketing because it isn't essential to distinguish its product from competitors. They might not encounter difficulties hiring and retaining talent because there are no rival companies that can persuade high-achieving employees. Lack of competition might allow a business to experiment and spend more money on development and growth rather than focusing on competing for market share.
A monopoly business has significant control over the pricing of its goods or services because it doesn't have any opposition to compete for customers. This can allow the business to establish stable prices for goods rather than constantly changing rates according to demand and the rates of the competition. Price stability can help consumers budget their spending or feel comfortable making purchases on a regular schedule. Price stability also allows companies to achieve their targets for net sales and profits and forecast future earnings.
When a business has a monopoly, it can attract new investors and raise capital as necessary. Investors might choose to purchase shares in a monopoly business because they feel confident that it can consistently generate revenue and maintain market share. If a monopoly can bring in new investors, it can generate more earnings for shareholders and raise money for research or expansion. The stock of natural monopoly businesses, such as utility companies that generate consistent revenue, might be less volatile than that of other businesses.
Research and development
Because many monopolies are secure and profitable, they might be comfortable investing more of their earnings into research and development (R&D). This can lead to new discoveries or innovations which can benefit both the business and consumers. Some pharmaceutical companies have monopolies on the production of certain drugs due to patents, and they invest some of their earnings into scientific research that can help produce new drugs to better serve patients.
Monopolies can be more efficient than competitive industries. This is because a single large entity usually produces products at a lower cost than several competing smaller businesses. This might reduce waste and lead to lower prices for some products. In the case of utility companies, it's far more efficient for a single entity to control production and distribution than for several businesses to compete.
A business that holds a monopoly can afford to subsidize certain loss-making aspects of its business to provide customers with better service. For example, because telecom companies hold a monopoly or oligopoly and earn significant revenue, they can afford to install new fibre optic internet cables and provide service to rural areas. On its own, serving these areas might not be profitable, but because the government grants telecom companies certain privileges in return for providing critical infrastructure, it becomes a worthwhile expense.
Cons of business monopolies
There can be several negative aspects to business monopolies to consider. Here are some cons of business monopolies:
Some businesses that hold a monopoly exercise extreme control over the price of the goods they produce and might exploit the lack of competition to charge consumers high rates. If a business is the only participant in a market, they don't require to adjust their prices to win market share from the competition. This can become even more severe if the monopoly company controls an essential good or service.
Business monopolies can become extremely powerful entities and have negative effects on a community or even a country. A business that establishes a monopoly might spend money lobbying government representatives to enact legislation that stifles competition or benefits the company at the expense of others. For example, a monopoly might use its control of a product to influence political leaders, dictate policy, or exploit workers and consumers.
When the only producer of a product is a monopoly, consumers have limited possibilities to choose from because there are no substitutes. They can purchase the product at whatever rate the business dictates, or they can go without it. This limited choice often means that consumers settle for a product that might be substandard.
Some businesses that hold a monopoly can become complacent and cease to innovate. This can eventually lead to the business being usurped by new products or market entrants. If competing companies don't challenge a business, it might be difficult to recognize what drives company success and make bold plans for the future.
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