How and Why Companies Become Monopolies

In business a monopoly is 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 monopoly status is not easy to do, so how and why do companies do it?

Key Takeaways

A monopoly exists when a company has little to no competition and can therefore set its own terms and prices, allowing it to become highly profitable.
While monopolies are both frowned upon and 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 are several ways to monopolize a 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.

A History Of U.S. Monopolies

How to Create a Monopoly

There are many ways to create a monopoly. Interestingly, most of them rely on some form of assistance from the government.

Exclusive Government-Granted Rights

Perhaps the easiest way to become a monopoly is by the government granting a company exclusive rights to provide goods or services. The East India Company, to which the English government granted exclusive rights to import goods to England 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; it even had the power to levy taxes and direct armed forces.

Nationalization

Nationalization, a process by which the government itself takes control of 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.

Intellectual Property Ownership

Copyrights and patents are two other ways in which assistance from the government can be used to create a monopoly or near-monopoly. Because the government has laws in place to protect intellectual property, the creators of that property are given monopoly power over things such as ideas, concepts, designs, storylines, scripts, songs, and even short melodies.

A good example of this comes from the world of technology. 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.

Control of Resources

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 that breakup. De Beers Consolidated Mines Limited also used access to a scarce resource—in its case, diamonds—to create a monopoly.

Mergers and Acquisitions

Mergers and acquisitions are another way to create a 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.

In addition to John D. Rockefeller’s Standard Oil Company, Andrew Carnegie’s Steel Company (later known as U.S. Steel), the American Tobacco Company, and International Harvester were famous American monopolies. The U.S. Postal Service is a centuries-old government-created monopoly.

Why Monopolies Are Created

While governments usually try to prevent monopolies, in certain situations they encourage or even create them. 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. For example, imagine 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 copyrights and patents, governments are seeking to encourage innovation. If artists and inventors had no protection for their work, all of their time, effort, money, and originality spent writing books and plays, recording songs, and conducting the research and development to create new drugs to combat disease would be wasted when someone else uses an artistic work without payment or steals an idea and creates a competing product at a lower cost.

The Downside of Monopolies

While monopolies are great for companies, they are often not so great for both the consumers who buy their products and would-be business rivals. Their drawbacks include:

High Prices

Consumers purchasing from a company that enjoys a monopoly often find they are paying unjustifiably high prices for inferior-quality goods.

Poor Service

Monopolies tend to give short shrift to customer service because the consumer can’t go elsewhere. For example, if your water pressure is low or spotty, you don't have the option of using another water company to help you take a shower and wash your dishes.

In 1974 the U.S. government brought charges against the American Telephone and Telegraph company (AT&T), known as “Ma Bell,” under the Sherman Antitrust Act, citing it as a telecom industry monopoly. AT&T was broken up into smaller, regional “Baby Bell” companies in 1984.

Competition Hurdles

Monopolies can make it impossible to start a new business, which is why the U.S. Department of Justice and the Federal Trade Commission are tasked to approve the mergers of larger companies. If they disagree with a merger, they can challenge it in court.

Just one example of many is the legal decision to block the 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, in effect a monopoly.

A proposed merger between Kraft Foods and H.G. Heinz raised similar concerns, but in that case the government did not oppose it. The merger eventually took place in 2015, creating the Kraft-Heinz Company (KHC). However, according to 2019 reporting in The New York Times, it did not prove all that successful. Sales and profits slumped, and the merger led to numerous shareholder lawsuits.

What Is the Difference Between Monopolies and Oligopolies?

A monopoly exits when one company and its product dominate an entire industry. There is little to no competition, and consumers must purchase specific goods or services from just the one company.

An oligopoly exists when a small number of firms, as opposed to one, dominate an entire industry. The firms then 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 late 1800s many monopolies existed in the U.S. Company owners included John D. Rockefeller (oil), Andrew Carnegie (steel), and Cornelius Vanderbilt (steamboats). These men, to name but a few, dominated their sectors, crushed small businesses, and consolidated power. However, they also made these industries more efficient, which resulted in the growing industrial strength of the U.S. and its rise to global power in the 1900s.

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

Monopolies during the Gilded Age were known as “trusts” and initially supported by the government. It wasn’t until the Sherman Antitrust Act was passed in 1890 that the government sought to prevent monopolies.

In the immediate years after the act was passed, very few cases were brought alleging violation of it, and most of them were unsuccessful because of narrow judicial interpretation of what constituted a violation. However, presidents Theodore Roosevelt and William Howard Taft used the act with considerable success in the early 1900s.

What Is the Difference Between a Monopoly and Perfect Competition?

Under a monopoly only one firm offers a product or service. Because it experiences no competition, it can set its own prices. Barriers to entry are high.

In a perfect competition market there are many sellers and buyers of an identical product or service. Because the firms compete against each other, the market sets prices and barriers to entry are low.

The differing circumstances result in differing profits in the short run, with those for companies in a monopolistic market much higher than those for perfect competition companies.

The Bottom Line

While monopolies created by government policy 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 desires and conditions that create monopolies will continue to exist. Accordingly, the battle to properly regulate them, giving consumers some degree of choice and businesses the ability to compete, will continue to be fought.