With this duopoly in the news again I thought it timely to look at an older post explaining duopolies- also added a ONENEWS report on the matter.
The supermarket duopoly in New Zealand (Foodstuffs and Woolworths NZ) has been in the news lately and I thought about explaining the strategy of companies in this market structure. Part of the NCEA Level 3 and the CIE A2 economics courses look at market structures – monopolistic, oligopoly, duopoly, monopoly, and monopsony. A duopoly refers to two firms in a market whilst an oligopoly has a small number of firms but greater than two. Therefore we can say that Oligopoly and Duopoly are very similar market structures and they can co-ordinate their behaviour to exploit the market by lowering competition which in turn leads to greater profits for all.
Bernard Hickey from The Spinoff made some salient points about the Commerce Commission report on the duopoly:
- Foodstuffs and Woolworths NZ have been protected by 150 covenants that stop competitors getting access to the best locations for supermarkets.
- Their profits are at least twice as much as is normal for the international supermarket sector,
- The beneficiaries of these super profits have blamed global forces – eg bad harvests, limited global supply for high prices. Aotearoa had the fifth most expensive groceries in the OECD and households spent the fifth most per capita per week on groceries in 2017.
- Profits on the supermarket sector’s $22b worth of sales each year are around double what they would be if the market was properly efficient and competitive.
- Both Foodstuffs and Woolworth NZ use their buying power to shift costs and risks back onto suppliers, while also threatening to pull suppliers’ products and blocking them from supplying the other group.
- NZ needs to look at what Joe Biden is doing – limiting market power in certain industries – technology, meat-packing, airlines and pharmaceuticals.
The Commerce Commission said
“We consider that the New Zealand market could sustainably accommodate at least one more large-scale rival, and that reducing current constraints on entry and expansion would help to facilitate this. In the long term, actual entry or expansion is likely to be the greatest driver of competition”
How do duopolies exploit the market?
Using the example of the supermarket duopoly Foodstuffs and Woolworths. Each company has two options – high price or low price. Obviously if they both price low they stand to be worse off and if they price high they are both set to gain. The outcome and payoffs are illustrated below:
Maximax – riskier strategy
A maximax strategy is one where the player attempts to earn the maximum possible benefit available. This means they will prefer the alternative which includes the chance of achieving the best possible outcome – even if a highly unfavourable outcome is possible. This strategy, often referred to as the best of the best is often seen as ‘naive’ and overly optimistic strategy, in that it assumes a highly favourable environment for decision making.
In this case, for both food providers, the aggressive maximax strategy is $140m from a low price and $120m from a high price, so a low price gives the maximax pay-off.
Maximin – conservative strategy
A maximin strategy is where a player chooses the best of the worst pay-off. This is commonly chosen when a player cannot rely on the other party to keep any agreement that has been made – for example, to deny.
In terms of the pessimistic maximin strategy, the worst outcome from a low price is $100m, and from a high price is $70m – hence a low price provides the best of the worst outcomes.
Again, lowering price is the dominant strategy, and the only way to increase the pay-off would be to collude and increase price together. Of course, this requires an agreement, and collusion, and this creates two further risks – one of the food companies reneges on the agreement and ‘rats’, and the competition authorities investigate the food companies, and impose a penalty.
Nash equilibrium, named after Nobel winning economist, John Nash, is a solution to a game involving two or more players who want the best outcome for themselves and must take the actions of others into account. When Nash equilibrium is reached, players cannot improve their payoff by independently changing their strategy. This means that it is the best strategy assuming the other has chosen a strategy and will not change it. For example, in the Prisoner’s Dilemma game, confessing is a Nash equilibrium because it is the best outcome, taking into account the likely actions of others.
For more on Duopoly view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.