Product innovation
Non-price competition in oligopoly may also take the form of product innovation whereby rival firms attempt to gain a larger slice of the market by constantly seeking to improve the quality and/or style of their existing products, or by developing entirely new products. This innovation usually has to be backed by extensive research and development(R&D), and has the effect of causing rapid obsolescence of consumer durable goods, a renewable source of demand and certain decline for those firms unwilling or unable to engage in such innovation. Most car manufacturers, for example, are constantly in the process of changing the design and other features of particular models so as to generate new demand, and the few large firms that dominate the pharmaceuticals industry are locked into a perpetual struggle to develop new and better drugs.
This process fits well with the writings of Joseph Schumpeter (1883-1950) who took a long-run, dynamic view of monopoly to argue that over time it would be far more efficient than perfect competition. He argued that the static method i.e. taking a point in time approach, of comparing perfect competition with monopoly, overlooked the likelihood of technical advances which may lower costs and prices as output expands. Although Schumpeter’s analysis relates specifically to monopoly, it is appropriate to apply it to contemporary oligopolistic markets.
Schumpeter identified two main reasons why monopolies would be more innovative than competitive industries: firstly, because of the earning of long term supernormal profits, the monopolist would have greater access to the funds necessary to finance inevitably expensive research and development programmes which are the basis of most innovation; and secondly, the monopolist would have a far greater inducement to undertake R&D in the first place – in highly competitive markets, any technical advantage gained by one firm would only permit the earning of high profits to be made for a relatively short period of time, as new entrants and existing firms copy the innovation and bid any abnormal profits away; the monopolist however would be the sole beneficiary of technical advance and would thus be able to reap the benefits of lower costs and higher profits indefinitely.
However, empirical evidence on the subject suggests that whilst smaller firms, i.e. those not possessing substantial monopoly power, tend to undertake little R&D, no clear, positive relationship between the amount of R&D spending and company size exists beyond a certain minimum size of enterprise.