European Oil Company Behavior in 1996

1. Oligopolistic theory predicts collusion and price stability under certain conditions. What evidence is there that this has broken down and why has it happened?

An oligopoly is defined in terms of the number of firms participating in an industry and the degree of interdependence that exists between those firms (Miller, 1995, p. 297). A small number of major firms, together with a high level of interdependence between these firms, characterize an oligopoly. With respect to the issue addressed in this question, the conditions than permit an oligopoly to develop also are important. The facilitating conditions for an oligopoly are economies of scale, barriers to entry, product differentiation and advertising, and oligopoly by merger. For an oligopoly to develop, substantial economies of scale must be possible, barriers to entry must be high, and product differentiation must be feasible. Merger is not always essential for the creation of an oligopoly; however, the feasibility of horizontal merger with an industry can facilitate the development of an oligopolistic industry.

Three important developments occurred within the British petroleum market that caused the conditions for oligopoly to breakdown or at least to become severely stressed. These same factors also were at work in the wider European market, although their development was more rapid in the narrower British market ("Big is beautiful," 1996, p. 1B). First, the demand for petroleum at the retail level declined

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opolistic competitors in the petroleum industry could largely ignore price competition (Miller, 1995, p. 299). The breakdown in some of the oligopolistic characteristics of the petroleum industry that allowed the supermarkets to enter the retail petroleum market, however, shattered the interdependent character of the industry, which in turn allowed the new entrants into the market to emphasize price competition (Weston & Barrie, 1996, p. 2). The price-oriented marketing strategy of the supermarkets demanded that Esso and other petroleum companies follow suit. In the short-term (and perhaps in the medium-term), Esso and other petroleum companies cannot maintain traditional levels of profitability while engaging in price competition. To maintain the required operational efficiencies at refineries, production must occur at levels that are insupportable by demand from the firm's retail outlets. In the short-term, thus, Esso and other refiners must sell some of their refinery output at discounted prices to the supermarkets. This action, in turn, places further competitive pressures on the firm's own retail outlets. The long-term solution for the petroleum firms is to reduce refinery capacity, which means that the number of firms

Category: Foreign - E