How and Why Companies Become Monopolies

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? 

Key Takeaways

• A monopoly is a company that exists in a market with little to no competition and can therefore set its own terms and prices when facing consumers, making them highly profitable.
• While monopolies are both frowned upon as well as legally suspect, there are several routes that a company can take to monopolize its industry or sector.
• Using intellectual property rights, buying up the competition, or hoarding a scarce resource, among others, are ways to monopolize the market.
• The easiest way to become a monopoly is by the government granting a company exclusive rights to provide goods or services.
• Government-created monopolies are intended to result in economies of scale that benefit consumers by keeping costs down.

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A History Of U.S. 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.

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.

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.

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 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.

The U.S. government brought charges against telephone company, AT&T, under the Sherman Antitrust Act in 1974, citing it as a monopoly. The company was broken up into smaller, regional companies in 1984.

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.

The block was based 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.

Monopolies FAQs

What Is the Difference Between Monopolies and Oligopolies?

A monopoly is when one company and its product dominate an entire industry whereby there is little to no competition and consumers must purchase that specific good or service from the one company. An oligopoly is when a small number of firms, as opposed to just one, dominate an entire industry. No one firm dominates the market or has more influence than the others. An oligopoly allows for these firms to collude by restricting supply or fixing prices in order to achieve profits that are above normal market returns.

How Did U.S. Monopolies Affect the Economy in the Late 1800s?

In the 1800s, many monopolies existed in the U.S. that cornered most of the industry. These included John D. Rockefeller and his monopoly on oil, Andrew Carnegie and steel, and Cornelius Vanderbilt and steamboats. These men, to name but a few, dominated their sectors, crushed small businesses, and consolidated power. However, they made these industries more efficient, which resulted in growing the industrial strength of the United States, helping propel it to the global power it would become in the 1900s.

Why Were Few Court Cases Won Against Monopolies During the Gilded Age?

At the time, monopolies, or trusts as they were known, were supported by the government. It wasn’t until the Sherman Antitrust Act was passed in 1890 that the government sought to prevent monopolies. Even when the Act was passed, there were very few cases brought up in violation against it, and most of them were not successful, because of very small windows of judicial interpretation of what constituted a violation.

What Is the Difference Between Monopoly Versus Perfect Competition?

Under a monopoly there is only one firm that offers a product or service, experiences no competition, and sets the price, thus making it a price maker rather than a price taker. Barriers to entry are high in a monopolistic market. In a perfect competition market, there are many sellers and buyers of an identical product or service, firms compete against each other and are, therefore, price takers, not makers, and barriers to entry are low.

Companies in a monopolistic market can earn very high profits in the short run, profits that are higher than normal market returns. In a perfect competition situation, companies cannot earn high profits in the short run, as they are price takers, not makers.

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 businesses the ability to function will also be part of the landscape for decades to come.