ANTIT R U S T

The Case of Duopoly

Industry structure is not a sufficient basis for imposing regulation.
By Erwin A. Blackstone, Temple University
Larry F. Darby, Darby and Associates
and Joseph P. Fuhr, Jr., Widener University

T
he economic literature is filled with different theories analysis, empirical research, and experimental research. None
of oligopoly and duopoly ranging from perfect collu- support the proposition that duopoly, per se, is tantamount to
sion to cutthroat price competition. However, many market failure and sufficient grounds for remedial government
policymakers speak as if concentrated industries are actions. Simply stated, duopoly is not always undesirable.
automatically bad and therefore expect government to take
action based on market structure alone. Some people have Theoretical research | The economic theory of market con-
branded concentrated industries as “cozy duopolies” and thus duct and performance under duopoly market structures is
condemn them based on structure without examining any subsumed in a larger literature focused on the economics of
empirical evidence on industry conduct and performance. “few sellers” or oligopoly. The economic literature addressing
In this article we examine duopolies: what factors may be the relationship between market structure, conduct, and per-
important for competition in these markets and whether these formance is voluminous. It is generally inconclusive and lamen-
markets can achieve desirable market outcomes. While this tably bereft of guidance for policymakers faced with decisions
article focuses on duopolies—markets in which market shares about what, if any, elements of market conduct should be
are exhausted (or nearly so) by two firms—the discussion can be constrained by the power of the state.
applied easily to somewhat less concentrated markets, including The problem is not a paucity of theory or modeling efforts. To
other oligopoly markets. the contrary, there are literally thousands of theoretical models of
oligopoly/duopoly behavior. The problem is the lack of a model
that predicts firm behavior in particular contexts and does so
The Problems with Market Structure with sufficient accuracy and reliability to warrant its being used
The principle rationale for the regulation of market structure as the basis for policy decisions about whether, how, and under
is too few competitors, which reduces consumer welfare. The what circumstances the government ought to intervene and
relationship between market structure and market conduct has impose economic regulation.
been explored in different types of studies, including theoretical Further, some economic models suggest that even duopolists
can produce equilibria approaching, or at, the competitive equi-
Erwin A. Blackstone is professor of economics at Temple University. librium. The Bertrand model, in which each duopolist sets price,
Larry F. Darby (deceased) was a Federal Communications Commission can produce almost the competitive equilibrium if the products
economist and founder of the telecom consulting firm Darby and Associ-
ates. Joseph P. Fuhr, Jr. is professor of economics at Widener University. are close substitutes. The Cournot output-setting model requires
All three are affiliated with The American Consumer Institute. relatively few oligopolists to achieve close to the competitive out-

12 | Regulation | Winter 2011‑2012

Illustration by Morgan Ballard

put. Finally, the contestable market theory claims that if both University of California, Berkeley economist Carl Shapiro like-
entry and exit are free or unimpeded, even a monopolist would wise writes:
produce the competitive output.
Before embarking on the analysis, it is best to provide the reader with
The conclusions of formal models provide clear warnings
a word of warning[:] … there is no single theory of oligopoly…. I do
that they are not intended to be public policy tools. For example,
not expect oligopoly theory … to give tight inter-industry predictions
Kennedy School professor F. M. Scherer wrote in the first edition
regarding the extent of competition or collusion.
of his popular industrial organization textbook:
After 40 years and thousands of articles in journals of law or
Economists have developed literally dozens of oligopoly pricing theo- economics, Nobel economist George Stigler concluded, “No
ries—some simple, some marvels of mathematical complexity. This one has the right, few the ability, to lure economists into read-
proliferation of theories is mirrored by an equally rich array of behav- ing another article on oligopoly theory without some advance
ioral patterns actually observed under oligopoly. Casual observation indication of its alleged contribution.” That admonition applies
suggests that virtually anything can happen. a fortiori today. Again, from Scherer, “The most that can be

Winter 2011‑2012 | Regulation | 13

Antitrust

hoped for is a kind of soft determinism; predictions correct on tion. Indeed, the contrary is frequently suggested. There is much
the average, but subject occasionally to substantial errors.” In support for a modified Schumpeterian hypothesis that some
summarizing his review of the literature and long litany of the market power is needed to assure the optimal rate of technical
assumptions and outcomes of dozens of oligopoly models, Sha- progress. The literature is vast and complex and not given to
piro calls attention to the forgoing caveat and then concludes, easy summary, but it is fair to say that market concentration,
“What we are most in need of now are further tests of the empiri- market rivalry, and technological opportunity are the key driv-
cal validity of these various theories of strategic behavior.” ers of innovation.
There seems to be consensus on what might be characterized
Empirical research | If economic theory is unhelpful as a guide as “competitive oligopoly” wherein competition between a few
to policy on oligopoly, so too is the body of empirical research dominant firms provides the spur and their oligopoly status
linking duopoly structure with anticompetitive conduct and provides the reward necessary to compensate for, and incentivize,
performance. Two chapters in Elsevier’s Industrial Organization risk taking. Thus, in the words of Georgetown law professor and
Handbook, one by MIT economist Richard Schmalensee and economist Howard Shelanski:
the other by Stanford economist Timothy Bresnahan, expressly
The comparative performance benefits of oligopoly over monopoly
consider empirical studies of the relationship between market
for technological innovation also have empirical support. It is well
structure, market conduct, market performance, and consumer
established in the economic and competition policy literature that
welfare. Readers are hard-pressed to come away from the chap-
the link between market structure and innovation is much less
ters with any categorical or even roughly generally applicable
predictable…. But there is reasonably good evidence that neither
conclusions that might be used to inform policy in, say, the
monopoly nor perfect competition is particularly beneficial for invest-
broadband communications context.
ment in research and development or deployment of new technology.
Efforts to link market structure with market conduct and
performance in matters related to prices and the price-setting
process have not been notably successful. Thus, Oxford econo- Experimental research | The behavior of oligopolists in general
mist Donald Hay and Oriel College (Oxford) provost Derek Mor- and duopolists in particular has been the subject of consider-
ris, in their popular industrial organization textbook, offer this able interest and analysis by experimental economists who
conclusion to a lengthy review of empirical efforts to establish undertake to simulate market behavior with economically
these linkages: motivated and constrained lab participants. A recent survey
article by Max Planck Institute scholar Christoph Engel iden-
[T]he relationship between industrial structure and price setting over
tifies more than 150 published papers in recent years dealing
time remains very unclear…. [I]t is difficult to avoid concluding that,
with one or more different experiments designed to test the
if any such links do exist, they are far from obvious and unlikely to be
market behavior (mainly price and quantity of output) of oli-
powerful…. Industrial structure may have an important influence on
gopolists—almost always duopolists—under a large and very
price procedures … but it does not seem to play a central role in the
diverse array of circumstances. This review of the literature
pattern of price changes that develops through time.
found experiments covering more than 500 different parameter
Similarly, there has been a notable lack of success in estab- constellations.
lishing a relationship between market structure and profits. It is difficult in a short space to do justice to such a detailed
Early studies of structure and performance relationships iden- review of such a comprehensive and diverse literature, but the
tified links between concentration and profitability. The main main results are easy to state:
thrust of subsequent analysis and results has been to call into
question the validity of the early studies. This analysis insists ■■ Duopoly behavior is highly circumstantial.
that concentration is only one of several variables (including ■■ Performance varies along a continuum bounded by perfect
growth rates, diversification, buyer concentration, techno- competition and perfect monopoly, but not in predictable
logical change, conditions of entry, degree of regulation, cost ways.
conditions, capital intensity, and numerous others) influencing ■■ Many of the experiments had indeterminate outcomes.
profits and that there is no reliable one-to-one link between ■■ Many of the results were weak and not significant statisti-
concentration and profit. A major analytical problem is that cally.
the causal relationships between structure and profits and ■■ A surprising number of the outcomes were inconsistent with
other variables are not clearly established either in theory or by received theory and, indeed, with economic intuition.
observation. Thus, any correlation between structure and profit
does not imply causation.
Empirically validated relationships between market struc- Evidence from Sectors Served by
ture and innovation are even more tenuous than for pricing Two Dominant Firms
practices and profits. The literature provides no support for Duopoly is quite common in the general economy. In the small-
believing in general that concentration is a barrier to innova- est markets, local businesses are often near-monopolies, with

14 | Regulation | Winter 2011‑2012

competition limited by spatial considerations. Monopoly and crews and maintenance and repair of aircraft are facilitated by
duopoly are quite common in small- to medium-sized commu- such a policy.
nities and in rural areas in particular. Service provision is often The duopoly also competes to a great extent in developing
limited to one or two suppliers in such industries as medicine, new and improved airplanes. For example, Airbus was the first to
legal services, specialized retail, motor fuel, etc. These markets make extensive use of composite materials in the 1970s, and in
illustrate the impact of market size, which limits the number the 1980s it was the first to introduce “fly by wire” census. Boeing
of sustainable competitors. was the first to “launch a full-sized commercial aircraft with com-
A small number of sellers—duopoly in particular—is also com- posite wings and fuselage.” The companies devote a substantial
mon in regional and national markets. We have identified various percentage of their revenues to research and development. Airbus
duopolies and the effectiveness of rivalry in them. Specifically, we in particular has been highly innovative as it has tried to increase
have searched for evidence of market failures sufficient to warrant its market share. It has also been a relatively low-price firm. It is
substantial government involvement in constraining or obligat- clear that competition is strong in this market.
ing market behavior. What we found was that these oligopolies
were often characterized by innovation and competition. Below Transparent adhesive tape | The transparent adhesive tape
are some of our findings. industry has long been dominated by 3M’s Scotch brand, with
a market share in excess of 90 percent as late as the early 1990s.
Carbonated beverages | The carbonated beverage industry is Up to that time, 3M Co. sold only Scotch-brand tape, not offer-
essentially a duopoly with two firms, Coca-Cola Co. and Pep- ing retailers private-label tape that could be sold under the
siCo Inc., controlling about 75 percent of the market. In spite retailer’s label. Typically, private-label products are lower-priced
of such high concentration, the two firms compete vigorously and more profitable for the retailer than the branded product.
in a variety of ways. LePage’s 2000 Inc. entered the market in the 1980s, offering
Coke and Pepsi engage in substantial non-price rivalry, includ- both a “second brand” and a private-label tape to compete with
ing advertising and competing for product placement and celeb- Scotch. By 1992, LePage’s had gained 88 percent of private-label
rity endorsements. Especially intense rivalry occurs as the two tape sales and 14.1 percent of overall transparent tape sales. In
firms try to become the exclusive seller in restaurants, universities, response, 3M began offering private-label tape and a “second”
and other such venues. They also compete through introducing brand tape, Highland. The competition offered by LePage’s was
new varieties of soft drinks and through promotions to retailers clearly instrumental in increasing retailer and consumer choice.
or directly to consumers. For example, between 1997 and 2004, The rivalry between LePage’s and 3M provides clear benefits to
Coke and Pepsi introduced 22 new brands. society. Had the rivalry provided by LePage’s not been a “thorn in
Concerning price competition, one study concludes that a the side” of 3M, there would have been no reason for 3M to have
merger of the two firms would raise prices by between 16 and engaged in the behavior it did. Indeed, 3M’s actions to stifle the
17 percent, suggesting the advantage of duopoly. The price per- competition from LePage’s in the form of bundled rebates show
formance of the carbonated beverage market over time has been the advantages of duopoly and the desirability of maintaining
good. The Consumer Price Index (base of 100 in 1967) for the such rivalry.
category of non-alcoholic beverages, which includes carbonated
beverages as an important component, was 169 in 2009. That is Sports | Professional sports leagues for most of their history
far below the 214 for all consumer items or the 215 for all food have been monopolies. However, when a new league emerged
and beverages. This means that the real price of such beverages in a given sport, the duopoly resulted in intense competition
declined by about 21 percent over the 1967–2010 period. Further- for players, coaches, and fans.
more, PepsiCo in 2011 decided not to raise prices in spite of ris- In most cases, the incumbent league would act as a cartel prior
ing input prices, choosing to cut earning estimates, presumably to the entry of a competing league. Team owners would establish
because of stiff competition. rules and other institutions to protect themselves from compet-
ing for players. Contract reserve clauses (which bound players
Aircraft (mainframe) manufacturing | The mainframe air- to their teams even after their contracts expired), the entry draft,
craft manufacturing industry is a duopoly between U.S.-based and the lack of free agency for players, coupled with the lack of
Boeing Co. and Europe-based Airbus SAS, a division of the players’ unions until the 1970s, kept players’ salaries below mar-
European aerospace firm EADS. The duopoly exhibits a high ket value. But this cozy arrangement would be disrupted when a
degree of competitive behavior in spite of difficult entry in part competing league would form. Players suddenly had an option of
because of learning-by-doing economics. teams to play for, and bidding wars would break out for the top
The two companies engage in vigorous rivalry to obtain the players. For example, in 1966, just before the American Basket-
business of the airlines. Airline orders tend to be large and infre- ball Association was formed, the incumbent National Basketball
quent, so it is important to compete vigorously to try to get the Association median salary was $20,000; by 1971 the median sal-
contract. Further, airlines generally want to have the same plane ary had risen to $90,000.
because it is usually efficient and less costly to do so. Training of The emergence of new leagues also benefited fans. New

Winter 2011‑2012 | Regulation | 15

Antitrust

leagues would compete for market share locally and nationally,

Figure 1
resulting in innovations. In many cases, the new league would
adopt rule changes or other product improvements in an effort Real Wireless Local Monthly Bill
to make their version of play more exciting. For example, the (Indexed 1988 = 100)
ABA introduced the three-point shot, a more free-wheeling style
$120
of play, and a multi-colored Railroad
basketball, whereas the upstart
Airline
American Football League introduced the two-point conversion 100
Trucking
to professional football. Also ofPrivate
benefit
businessto fans, new leagues often
place teams in cities that the incumbent league had ignored, or 80
else prompts the incumbent league to do so. For example, the

Dollars
incumbent National Football League expanded to Dallas and 60
Minneapolis when it believed that the AFL was going to place
teams in those appealing markets. The rivalry between the 40
leagues led to product improvements and more cities with teams,
showing the competitive advantages of a duopoly. 20
It was during periods of league duopoly that innovation and
competition flourished. Appropriate public policy may well be 0
highly skeptical about mergers from duopoly to monopoly. ’88 1990 1995 2000 2005 2010

Physicians | Unbeknown to most people, the physicians’ required more spectrum, the evidence suggests that the original
services industry is a duopoly. There are two groups of fully duopoly had been competitive. To demonstrate this, we can
licensed physicians, Medical Doctors (MDs) and Doctors of compare the price decline during the duopoly to the latter period
Osteopathy (DOs). The existence of osteopathic physicians, when additional providers entered the market.
who currently comprise 6 percent of all physicians, has pro- Using the annual data available from the business association
vided substantial benefits to society. The group has filled mar- of wireless providers, CTIA, we determined that the average wire-
ket niches not satisfied by MDs. less phone monthly bill, adjusted for inflation, fell by 61 percent
Specifically, MDs emphasized specialization during the 1960s from 1988 to 1996— a decline of 11 percent per year. In contrast,
and 1970s, neglecting general or family practice. This void pro- during the subsequent period when several more wireless pro-
vided an opportunity that DOs exploited. They also practiced in viders began offering service, the average wireless monthly bill,
rural areas and small towns where MDs were scarce. DOs have adjusted for inflation, fell just 2 percent per year. (See Figure 1.)
countered the power of MDs in dealing with insurance com- Over the earlier period, geographic coverage of cellular service
panies, supported some health initiatives that MDs opposed, and other dimensions of quality also improved greatly.
pioneered continuing education, and accepted applicants who The decline in prices reflects, to a large extent, the economies
were discriminated against by MD schools. of scale and possibly learning-by-doing achieved by these net-
More recently, DOs countered the restriction of output of works under duopoly. These economies of scale resulted in reduc-
MDs. MDs were concerned about an impending physicians tions in per-unit costs for the industry. Because of competition
surplus in the 1970s and 1980s, and encouraged their medical between the two wireless providers, these cost reductions were
schools to keep the number of graduates constant at about passed along to consumers in the form of lower prices. Therefore,
17,000. Osteopaths took advantage of that policy and increased effective competition can be achieved with a very small number
their output from 1,724 in 1986–1987 to 2,535 in 1995–1996. of providers.
Had there not been this competition, the current shortage of phy-
sicians would have been more severe. This underscores that even
a small competitor in a duopoly can compete and benefit society. Antitrust Considerations
The Federal Trade Commission and the Antitrust Division of
Cellular telephone services | On April 9, 1981, the Federal the Department of Justice, which are tasked with enforcing
Communications Commission decided that wireless telecom- federal antitrust laws, have recognized the importance of exam-
munications services would operate as a duopoly, with one ining conduct and performance in an antitrust investigation
license going jointly to the incumbent local Bell Telephone and do not base public policy solely on industry structure. This
companies (the “B” license) and the other to a competitor (the policy was formalized in the recently adopted New Horizontal
“A” license). The FCC later revised that policy, auctioning off C, Merger Guidelines, which raised the Herfindahl-Hirschman
E, and F licenses between 1994 and 1997. This opened up the Index thresholds for various levels of market concentration.
nation to competition between several cellular carriers. Specifically, the revised merger guidelines raise the “unconcen-
While the latter increase in competition provided consum- trated” boundary from an HHI of 1,000 to 1,500, essentially
ers with more choices and the ensuing explosion in subscribers implying that a market with about seven firms will be consid-

16 | Regulation | Winter 2011‑2012

ered unconcentrated, whereas the previous threshold was more
than 10 firms. The “highly concentrated” range now begins
Conclusion
with markets of fewer than four firms instead of the previous We have found nothing of consequence to support a case for
number of between five and six. regulation based only on market structure. Common sense
What is most noteworthy about the guidelines is that they suggests that such regulation should be based on a thorough
consider market structure only as a “guide,” recognizing that a consumer-welfare-oriented cost-benefit analysis of the con-
certain structure by itself is not necessarily bad. That is, all the duct and performance of markets and of the well-known infir-
facts must be taken into consideration. Furthermore, the anti- mities of government efforts to manage competitive processes.
trust authorities, as well as the courts, have recognized the rule It is important to note that policies that maximize the num-
of reason in dealing with monopoly. The structure of monopoly ber of competitors are not necessarily congruent with policies
alone does not constitute the need for regulation or antitrust that will lead to greater willingness and ability to compete or
remedies. Thus, facts concerning not only structure but also incentivize firms to invest. The reasons are well known and
conduct and performance are used to decide public policy for a related to the relationships between the burden of fixed costs,
monopoly and the same criteria should be employed with duo- optimal scale, size of the market, and the number of competi-
polies and concentrated oligopolies. tors sustainable in the long run. Where there are substantial
Illustrative of the concern about duopoly is the now-abandoned economies of scale (that is, where minimum efficient firm size
proposal to merge baby food maker Beech-Nut, a division of Mil- is large relative to the size of the market), where fixed costs
not Holding Corp., with H. J. Heinz Co. The merger would have are a substantial part of total cost, and where marginal cost
joined the large, efficient Heinz plant with the well-regarded Beech- is low and below average cost, government should have very
Nut brand name, yielding a firm that could compete with industry little impact on the number of competitors. Its role should be
heavyweight Gerber Products Co., which held a 60 percent market limited to permitting as many as feasible, but it cannot force
share at the time the merger proposal was announced in 2000. long-term existence of more competitors than dictated by the
Federal authorities moved to block the merger because it would relationship between the size of the market and the structure
result in a duopoly. Freed from the would-be competitor, Gerber’s of cost. With respect to the number and concentration of
share of the baby food market rose to roughly 80 percent by 2008, sellers, markets trump regulation. While consumers are in
while Beech-Nut’s fell to 11 percent and Heinz’s to just 2 percent. general made better off with more choice, it does not follow
This strongly suggests the merger denial was undesirable. that government attempts to force an increase in the number
Other evidence from the antitrust experience also suggests of options will in turn increase welfare in instances where the
that duopolies or highly concentrated industries often compete economics of cost and demand warrant otherwise.
intensely. The rivalry between Intel and Advanced Micro Devices Most economists would agree that the behavior of a given
in computer chips has been so intense that the FTC and Euro- oligopoly or duopoly is indeterminate. That is, multiple out-
pean Union have investigated and challenged Intel’s behavior. comes, ranging from those associated with monopoly to perfect
Again, even a duopoly with a dominant firm can have substantial competition, are possible. Our work suggests that neither theory
rivalry. Additionally, the fact that most collusive agreements nor empirical evidence supports the notion that duopoly or high
involve markets with a few firms suggests that, absent such agree- concentration is per se undesirable. Thus, sound public policy
ments, competition can be substantial in these markets. should be based on empirical evidence and not rhetoric.
Pociask. ConsumerGram, The American Consumer ■■ Market Structure and Innovation, by Morton
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versity Press, 1982.
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Oligopoly Experiments,” by Christoph Engel. Max
Economics, Vol. 72, No. 3 (1958). Viola Chen. Journal of Competition Law and Econom-
Planck Society, 2006.
■■ “A Tale of Two Doctors,” by Erwin A. Blackstone. ics, Vol. 6, No. 2 (2009).
■■ Industrial Economics and Organization: Theory and
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Evidence, by Donald A. Hay and Derek J. Morris.
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■■ “Theories of Oligopoly Behavior,” by Carl Sha-
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■■ “To Regulate or Not to Regulate: Where Is the
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Schmalensee and Robert Willig. Elsevier, 1989.
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Winter 2011‑2012 | Regulation | 17