When Monopolies Make Sense

Competition can’t simply be understood in terms of market share, and neither can monopolies.

Every company is a monopoly of something somewhere. Within the four walls of its shop, any firm could be the “only provider” of a product or service. Any person could have a monopoly on the sale of ice to eskimos, but it probably wouldn’t be worth very much.

Monopolies are predicated on ‘relevant product’ and ‘relevant market’:

• A high street store has a monopoly within its four walls on the sale of all goods. But unless it is a large department store like Macy’s or Selfridges it is unlikely to have a monopoly on the whole block or street.
• A firm may have a monopoly over the provision of a certain type of good over a much larger area. It may be the only “Apple authorized reseller” in a city. It may be the only legally licensed cannabis dispensary. Or it may only be profitable for one provider of a very niche product to survive in a place at any given point in time.

When people think about monopolies being bad, they are almost never considering all types of monopolies, just some. But the existence of such a wide array of varied monopolies forces us to confront that there may be many types — both problematic and not — and industry structure has been ignored for far too long in the regulation of monopolies.

Different types of monopolies exist in the world today:

1. Serial monopolies — industries in which one might expect one character after another to rule the roost. These are industries in which all consumers will always opt for the single ‘best in class’ producer of a product at any point in time.
2. Creative monopolies — companies in industries with products so advanced, superior or preferable to anything that any competitor is able to produce. Typically creative monopolies are temporary, although because large monopolies should have big budgets available for advanced research and development, they are also capable of remaining relevant, profitable and monopolistic over time through technological progress. Vertical integration and a broad product ecosystem can also tie users to a particular provider even in the absence of artificial barriers to exit or inflated switching costs.
3. Artificial monopolies — kept afloat by governmental policy: almost always ostensibly instituted for social reasons, although this is often questionable. From the “systemet” in Sweden (nationalised liquor stores) through to ’natural monopolies’ like railways, as well as patent systems, artificial monopolies draw their strength from law.
4. Coercive monopolies — where the actual or implied use of illegal force is used to deter, diminish or destroy competition.
5. Obscure monopolies — where a company is unknown or unrecognised, operating quietly and without attention, it may make huge profits. Consider something like glitter manufacturing. These monopolists follow the Deng Xioping school of thought: “Observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership”

Where there is corruption and/or extreme regulatory capture by special interests, the line between artificial and coercive monopolies may become blurred (for instance, in many former parts of the Soviet Union).

In a free economy where prices are a function of supply and demand, and a world in which businesses are driven by profit (assured by directors’ fiduciary responsibilities to shareholders), we should expect competition to emerge in any market where individuals are able to identify that super-normal profits are or could be made.

In serial, creative and coercive monopolies we worry a lot about incumbent monopolists engaging in anti-competitive behavior that deters would-be challengers from entering markets. And in artificial monopolies, politicians and civil servants take the opposite stance, worrying specifically about the emergence of would-be challengers to their rule. Any one or combination of these four monopoly types is effective at deterring competition, but only ever through reputation. And obscure monopolies are secured by their lack thereof.

The fact that all monopolies are effectively therefore reputational monopolies suggests that game and deterrence theory hold important insights for both sustaining and challenging incumbents.

In the context of monopolies, reputations may be established and maintained through:

1. Fighting hard (creative behavior: innovating, experimenting, investing)
2. Fighting dirty (coercive behavior: threats, disruption, legal challenges, predatory pricing, etc.)
3. Multiplier effects (external reinforcements: regulator alignment, perceived or actual political backing for a monopoly, strong financial backers and support, powerful parents and affiliated third-parties).

Entrepreneurs face two choices. They are defined by their willingness to either (a) find or create new markets from scratch, or (b) face up to the reputation of incumbents.

Good monopolies

Serial monopolies

Some industries and problems will, absent intervention, naturally and optimally only be supplied or solved by a single serially monopolistic provider at a time.

Social networking is a great example of a serially monopolistic industry: once monopolised by MySpace, the insurmountable incumbent was replaced by a new power with a superior value proposition: Facebook.

Assuming all industries are best served by fragmented entities ignores that monopolies may harbour network effects which benefit consumers.

Would we really be better with three or four or a thousand social networks, of which everybody were present on only some, and everybody were forced to check all those they were a member of to make sure they hadn’t missed any messages? Or would society be better served by a single social network? Which would carry greater utility? And which is more useful for reaching people, finding people, and connecting with friends?

Similarly, do we really want to open 5 or 6 taxi apps to find the best deal to get from A to B? Do we really want to wait longer because not all drivers are hooked up to the same central system?

Serial monopolies tend to:

1. occur naturally (without explicit anti-competitive behavior)
2. operate efficiently (as in the examples above); and
3. generally collapse over time through social pressure alone.* e.g. when backlash against a particular provider occurs in response to a specific issue… be it profit-motivated fake news propagation, an unfortunate affiliation with the spread of extremist content, a particularly concerning security breach, or a brand-destroying privacy scandal.*

Unregulated markets result in collapses and explosions. But like a ball swinging from a tether, these oscillations stabilise over time as market participants become wise to their drivers: consumers, producers, and intermediaries alike.

Regulatory interventions on the other hand result in opportunities for rent-seeking, they upset future expectations in such a way that lessons learned are disbelieved, and they render future lessons unbelievable.

Monopolies that increase competition in adjacent markets

Revisiting taxi-apps, consider for a moment that the current approach of segregated apps like Uber, Lyft, and MyTaxi, each with their own database of partner drivers, could be improved.

By building in parallel a shared driver dispatch ‘backbone’ that would send drivers to jobs fed to it by any taxi app that called the API, a greater number of consumer-facing apps may emerge, each with their own differentiated branding and unique user offering.

New market entrants would build atop the ‘backbone’ to guarantee an initial pool of drivers in place for their launch, and likewise consumers ought gravitate towards apps known to use the platform because they would be tapping into a common pool containing the largest number of drivers anywhere (resulting in quicker pickups, and potentially improved pricing).

Here we have imagined yet another monopoly, but one whose net effect seems to be a transfer of surplus to consumers, and new entrant app developers, at the expense of heavily venture-backed incumbents like Uber.

Monopolies which create competition in adjacent markets typically centralise information, matchmake market participants, and act to reduce transaction costs, thus enabling exchange to occur where it would otherwise fail to take place.

Time-limited monopolies that incentivize big-bet investment

Patents, protected and guaranteed in law, are an institutionalised form of time-limited monopoly designed to provide inventors with ‘first-dibs’ right to exploit breakthrough new technologies they conceive.

By providing protection against having expensive research and development (R&D) efforts ripped off by free-riding competitors, patents protect firms who choose to invest in R&D. Patents incentivize investment, and prevent scientists from being bankrupted by competitors who excel at manufacturing, but choose to invest nothing in advancing the frontiers of science. Certain types of R&D, such as drug discovery, require billions of dollars of investment, and without guarantees that firms will be able to exploit the fruits of their labour, we risk reducing investment in new research and development to socially suboptimal levels.

---

If you found this article interesting, please check out HASH, a platform for real-time modeling and simulation, which aims to enable anybody to capture the complex adaptive systems we see around us. If eliminating information failure is a mission that excites you, we’re also hiring.