What Is a Natural Monopoly?
A natural monopoly is a type of monopoly in an industry or sector with high barriers to entry and start-up costs that prevent any rivals from competing. As such, a natural monopoly has only one efficient player. This company may be the only provider of a product or service in an industry or geographic location. Natural monopolies can arise in industries that require unique raw materials, technology, or similar factors to operate.
Key Takeaways
- A natural monopoly is a type of monopoly that arises due to unique circ*mstances where high start-up costs and significant economies of scale lead to only one firm being able to efficiently provide the service in a certain territory.
- A company with a natural monopoly might be the only provider or product or service in an industry or geographic location.
- Natural monopolies are allowed when a single company can supply a product or service at a lower cost than any potential competitor but are often heavily regulated to protect consumers.
Understanding Natural Monopolies
A natural monopoly becomes a monopoly over time due to market conditions and without any unfair business practices that might stifle competition. It generally happens when there are high start-up costs or powerful economies of scale that come with conducting a business in a specific industry. These barriers can prevent potential competitors from entering the market.
There are two main factors that can lead to this type of monopoly:
- When a company takes advantage of an industry's high barriers to entry to create a moat or protective wall around its business operations. The high barriers to entry are often due to the significant amount of capital or cash needed to purchase fixed assets, which are physical assets a company needs to operate.
- When producing at a large scale is so much more efficient than small-scale production, that a single large producer is sufficient to satisfy all available market demands. Because their costs are higher, small-scale producers can simply never compete with the larger, lower-cost producer.
The natural monopoly of a single large producer is also the most economically efficient way to produce a good or service in question. This is not due to large-scale fixed assets or investments but can be the result of the simple first-mover advantage, increasing returns to centralizing information and decision-making, or network effects. An example is electricity transmission where once a grid is set up to deliver electric power to all of the homes in a community, putting in a second, redundant grid to compete makes little sense.
Some monopolies use tactics to gain an unfair advantage by using collusion, mergers, acquisitions, and hostile takeovers. Collusion might involve two rival competitors conspiring together to gain unfair market advantage through coordinated price-fixing or increases.
Special Considerations
There are regulatory agencies in each region to serve as a watchdog for the public when it comes to government-approved natural monopolies. Utilities are typically regulated by the state-run departments of public utilities or public commissions.
The U.S. Department of Transportation has broad responsibilities for the safety of travel for railroads while the U.S. Department of Energy is responsible for the oil and natural gas industries.
Keep in mind, though, that no equivalent agencies in the U.S. have been empowered to similarly regulate tech and information monopolies, nor are they governed as common carriers, though this may be a trend in the future.
Just because a company operates as a natural monopoly does not explicitly mean it is the only company in the industry. The company might have a monopoly in one region of the country. Cable companies, for example, are often regionally-based, although there has been consolidation in the industry creating national players.
Advantages and Disadvantages of Natural Monopolies
Advantages
One of the benefits of natural monopolies comes from the use of an industry's limited resources efficiently to offer the lowest unit price to consumers. They can serve a good purpose when a single company can supply a product or service at a lower cost than anyone else, and at a volume that can service an entire market.
Society can benefit from certain natural monopolies. For instance, multiple utility companies wouldn't be feasible since there would need to be many distribution networks such as sewer lines, electricity poles, and water pipes for each competitor. Since it's economically sensible to have utilities operate as natural monopolies, governments allow them to exist. But the industry is heavily regulated to ensure that consumers get fair pricing and proper services.
Disadvantages
One of the main drawbacks to natural monopolies is that it cuts out the competition and takes away choice from consumers. This means that customers can only get certain goods and services from one provider.
Having a natural monopoly in place bars other potential players from entering the market. This is due to the high startup costs associated with doing business.
Because there is only one player in the market, regulation may be an issue—especially when it comes to monopolies that aren't approved or run by the government. As such, entities may abuse their power, increase prices, and provide poor quality customer service.
Pros
Provide goods and services at lower costs than rivals
Economically sensible
Cons
No competition
High startup costs and barriers to entry
Lack of regulation may lead to abuse of power, higher pricing, and poor customer service
Examples of Natural Monopolies
Companies that have a natural monopoly may sometimes exploit the benefits by restricting the supply of a product or service, inflating prices, or exerting their power in damaging ways other than through prices.
Under the common law, many natural monopolies operate as common carriers, whose business is recognized as having risks of monopoly abuse but allowed to do business as long as they serve the public interest. Common carriers are typically required to allow open access to their services without restricting supply or discriminating among customers and in return are allowed to operate as monopolies and given protection from liability for potential misuse by customers.
The following are some industries that have natural monopolies:
- Utility Industry: This is a natural monopoly. The utility monopolies provide water, sewer services, electricity transmission, and energy distribution such as retail natural gas transmission to cities and towns across the country. The start-up costs associated with establishing utility plants and the distribution of their products are substantial. As a result, the capital cost is a strong deterrent for potential competitors.
- Internet Providers: A service platform might use its monopoly power over information, online interactions, and commerce to exercise undue influence over what people can see, say, or sell online. Regulations over natural monopolies are often established to protect the public from any misuse by natural monopolies.
- Telephone Companies: Companies that provide landline services are required to offer households within their territory phone service without discriminating based on the manner or content of a person’s phone conversations and are in return generally not held liable if their customers abuse the service by making prank phone calls.
- Railroads: The railroad industry is government-sponsored, meaning their natural monopolies are allowed because it's more efficient and in the public's best interest to help it flourish. Further, the industry can't support two or more major players given the unique resources needed, such as land for railroad tracks, train stations, and their high-cost structures.
More modern examples of natural monopolies include social media platforms, search engines, and online retailing. Companies such as Meta (formerly Facebook), Google, and Amazon have built natural monopolies for various online services due in large part to first-mover advantages, network effects, and natural economies of scale involved with handling large quantities of data and information. Unlike traditional utilities, these types of natural monopolies so far have gone virtually unregulated in most countries.
How Do Natural Monopolies Work?
A natural monopoly is a monopoly where there is only one provider of a good or service in a certain industry. It occurs when one company or organization controls the market for a particular offering. This type of monopoly prevents potential rivals from entering the market due to the high cost of starting up and other barriers.
How Is a Natural Monopoly Different From a Regular Monopoly?
As the name implies, a natural monopoly exists naturally. Market forces allow one player in the market to become the only player in a certain industry without stifling the competition. Regular monopolies, on the other hand, are created when a company controls the market by eliminating the competition. This happens when a key player buys up the supply chain and buys its rivals. Monopolies may lead to the removal of substitute products and services, higher prices, and low-quality products.
What Are Some of the Most Common Types of Natural Monopolies?
The most common types of natural monopolies include those found in the telecommunications center, the utility industry, oil and gas companies, and the railroad industry.
The Bottom Line
Monopolies can be both a boon and a blessing to consumers and the market in general. Unlike regular monopolies, natural monopolies occur because market forces shape the industry to the point where there is only one key player that offers a specific good or service to the public. Even though this type of monopoly is allowed to exist, the barriers for potential rivals to enter the market can be high. Some of the most common examples of natural monopolies include utilities and railroads.
