Firms in oligopolistic industries rely heavily on non-price weapons such as advertising and variation in product characteristics as marketing strategies. They view price-cutting as a dangerous tactic because it can initiate a price war that may have disastrous consequences in the long run. In contrast, alternative strategic weapons such as advertising and product differentiation are looked at as less risky ways of attracting customers and diverting them away from competitors.
Non-price competition through such devices as selling efforts, model changes and product differentiation is a characteristic of oligopolistic rivalry in the absence of significant price competition. An oligopolistic firm has, no doubt, strong reasons to support and maintain its existing relations within its industry, primarily for avoiding reaction of rivals to unstable situations. Yet it has strong reason to build a defensive position for itself as a protection against possible changes.
A firm seeks to protect itself from actual and potential competition through product differentiation. Product differentiation is achieved by using brand names and by incurring large selling costs. It is a form of non-price competition in which essentially similar products are offered for sale with relatively small quality differences.
By using such devices as brand names, advertising, or styling differences a firm will not only be more secure against any attacks on its sales from other companies, it will also be in a position to charge higher prices than other firms do for similar products.
Advertising and other sales effort enable an oligopolist to achieve a relatively inelastic demand for its brand. This is the fundamental reason for all types of product differentiation. It enables the seller of the branded product to raise its price above that of others without losing many customers. As a result its profit, instead of falling, may rise.
Product differentiation makes the way for various forms of non-price competition. The most obvious form is, of course, advertising and other sales promotion efforts. When the differentiation is largely by brand name rather than in the product itself oligopolistic firms are required to spend huge amounts on advertising.
Thus a circular chain of cause-and-effect is set up:
1. Oligopolistic pricing policies eliminate or greatly diminish price competition, leading to;
2. Product differentiation, which, in its turn, induces;
3. Frequent model and styling changes and huge selling costs. The result is;
4. Rapid market obsolescence of durable goods, causing manufacturers to produce;
5. New models and introduce styling changes to enable rich consumers to keep up with or outpace the Joneses by acquiring the latest and fanciest products.
By spending money on advertising a firm attempts to shift the demand curve for its product to the right and thus increase its market share. Advertising also makes the demand for a firm’s product more inelastic. An aggressive-cum-effective advertising campaign can make it possible for a firm to sell more at the same price.
Firms can use advertising to differentiate their products from those of their competitors and customers may be induced to stick with a particular brand name even though the products of all firms in the industry are much the same. For example, various brands of beer are quite similar, but they are not identical (since they are made available in different bottles and cans). In oligopoly, once any firm has increased its advertising expenditures, no single firm can reduce them to their former size without losing sales. This point may now be explained and illustrated.
Large Advertisement Budget as a Dominant Strategy:
In practice an individual firm may spend a large amount on advertising even though its profits might have been higher with a smaller advertising budget. So a prisoners’ dilemma situation is encountered. If each firm believed that its profits would fall if its rival spent more on advertising, it might feel that a large advertisement budget was in its own interest even though its profits would be larger if everyone agreed to spend less on advertising. Such a situation is illustrated in Table 24.11.
Here large advertising is the dominant strategy for both firms even though both would enjoy higher profits (Rs. 4 million rather than Rs. 1 million) if both fixed small advertising budgets. The solution appears in the upper-left corner of the matrix. It is a Nash equilibrium.
The most important single factor influencing an oligopolist’s profitability is the quality of its products and services relative to those of its rivals. In the short run, better quality enhances profits because the firm is able to charge premium prices. In the long run superior quality leads to both a gain in market share and an expansion of the relevant market. Therefore, despite short-term costs associated with improved quality, in the long run, they may be offset by economies of scale.
Of course, any or all attempts to improve product quality is not worthwhile. It is important for an oligopolist firm to evaluate carefully whether the prospective benefits outweigh the costs. Oligopolists generally achieve quality advantages first by innovations in product (and service) design and subsequently by product and process improvements.
Market share and profitability are strongly related. A business unit’s return on investment is directly related to its share of the market. This relationship may be spurious in part since market share and profitability are likely to reflect other factors, such as management skills or luck. But even when a wide variety of other market and strategic factors are taken into account, market share still seems to have a positive impact on profitability.
The reason is that businesses with high market shares tend to enjoy economies of scale. In addition, businesses with large market shares are survivors and firms do not survive unless they are profitable. Profitability depends on reputation (goodwill) which is an intangible asset. And in case of merger (acquisition) bid, a price is attached to goodwill. If firms cut prices in order to boost sales a price war is inevitable and no firm gains in the process. But product differentiation is a better strategy because it gives a firm a long -term and, at times, a special advantage over its rivals.
Product differentiation can be achieved in three other ways:
(i) By supplying goods according to the attributes of the goods mentioned in advertisement (so that the buyers feel that they are getting their money’s worth).
(ii) Giving prompt after-sales service (which is so important in case of durable goods).
(iii) Maintaining proper quality of the product(s) offered for sale.
(iv) The opportunity to return an unsuitable product which helps to build company goodwill and customer loyalty.
All these factors help reputation building, which is so important because it leads to repeat purchases and thus to stability and expansion of market share. Customers go to the same seller again and again, which leads to market protection in the short run and expansion in the long run. By reputation building a company can cultivate brand loyalties to ensure that sales are increased or at least maintained. The significance of product differentiation is that it widens the parameters of competitive action. It enables dominant firms in oligopoly compete against one another in quality rather than on the basis of price alone.
New Brand Competition:
Oligopolists often vary their product characteristics even as they conduct advertising campaign in order to differentiate their products from those of their rivals. In this way they can also manipulate the demand curves for their products. Changes in product, like other competitive tactics, often result in retaliatory moves by competitors.
Successful changes in design or quality tend to be imitated by competitors (who may lag behind to some degree) and they can prove to be expensive. The automobile industry has been engaged in intense competition of this type for years together and the annual cost of model changes is very high indeed and, at times, prohibitive, i.e., beyond the capacity of small (laggard) competitors.
In oligopoly product differentiation constitutes a more effective and powerful competitive strategy than price competition. The reason is that price cuts can be quickly and completely matched by competitors and this often leads to destructive price war. But a successful advertising campaign or the introduction of an innovator product is less easily imitated.
Moreover, whereas price competition lowers firms’ profitability, product differentiation tends to preserve and even enhance profits. In particular, the establishment of product uniqueness may allow firms to command premium prices over competitors’ offerings.