Business environments run the gamut from purely competitive to near monopolistic conditions. Most environments are a hybrid and have both highly competitive and monopolistic elements.
The post examines the occurrence of natural monopolies, which are rich in projects and where many PMs work. Projects in a monopoly environment have different drivers – drivers that can be informed starting with a good understanding of the natural monopoly graph.
What Is a Natural Monopoly?
A natural monopoly occurs when there is a confluence of economies of scale, high capital investment required, and well-defined customer demand. In a natural evolution, a first mover builds volume through investment and being first to market, reducing cost and pricing over time, constructing barriers for competitors, and eventually supplying all that the market needs.
While economies of scale can be the typical barrier to entry by competitors, other barriers can include:
- unique industry affiliation
- special geographical location
- unique raw materials, or unique access to them
- proprietary technology
- special process advantages
Whatever it is, it needs to not only give a firm an advantage to lead the market, but to actually ‘corner’ it so that it is not economical or desirable for another firm to enter the market.
In reality, almost no market is entirely prone to natural monopolies. On the other hand almost every market has some monopolistic tendencies. For example, a railroad has seemingly insurmountable economies of scale and access to railroad networks that cannot be duplicated, but it does have competition from trucking, air freight, and other delivery services. And at the other end of the scale, even in the construction industry, known in many ways for a ‘pure’ competitive environment, firms can develop regional dominance via scale, processes, and branding.
The Natural Monopoly Graph
What are the mechanics of a natural monopoly? It is very different from a basic supply and demand graph.
The natural monopoly graph at right illustrates the uniqueness of the occurrence of Long Run Average Cost (LRAC) and consumer Demand (D).
- Long Run Average Cost (LRAC) – When economies of scale are at play, the LRAC will decline as the quantity produced declines. For example, capital deployed can produce 50 units at a cost of $20, or 165 units at a cost of $10. The graph shows that cost decreases rapidly with large initial capital investments, and once that capital is in place, the reduction in cost flattens.
- Demand (D) – The downward sloping Demand (D) line in the natural monopoly graph illustrates the variation in how much product consumers desire to buy at a given price. For example, it shows that at a price of $20, consumers are willing to buy a quantity of 135 units of the product, but at a price of $10, they are willing to buy 165.
In the case of a natural monopoly, there is an ideal point – $10 and 165 units – where market demand and efficient production intersect. If only one producer can achieve that level of output and realize those economies of scale, they will have a natural monopoly.
The barrier to entry for a competitor, which explains the occurrence of the natural monopoly, is that it would never be attractive for a competitor to invest the capital to build the scale needed when the market equilibrium is already established.
How can a company become that natural monopoly? Usually they start with first mover advantage and build capability and competitive barriers from there.
Strategic Implications of Natural Monopolies
The reality of markets is that they run the gamut from purely competitive markets to natural markets, with many flavors of hybrid, or oligopolistic, markets in between. The following are some markets that have natural monopoly characteristics:
- Railroads – The high fixed cost of procuring land and placing tracks along routes creates a natural monopoly situation with high barriers to entry.
- Utilities – Similarly, electric, gas, and telephone utilities consist of an infrastructure that is prohibitive to duplicate.
- Operating Systems – This is a little different. While there is investment up front, it is more the benefit of standardization to consumers that makes a natural monopoly desirable.
- Networks – Like utilities and operating systems, there is a combination of the infrastructure and the standardization that create the network effects that turn networks into natural monopolies, such as Facebook.
- Proprietary technologies – In many industries, including pharmaceuticals, software, and systems, control of the technology by either patent or other barriers to imitation can create natural monopoly situations.
Do natural monopolies last forever? I would say not! Think about the equally natural occurrence of business life cycles, where businesses grow, stabilize, and eventually decline. Nothing lasts forever; there is no ‘perpetual motion machine’! Regulation can control natural monopolies, but also can perpetuate them.
There are, however, many situations in between, where businesses have localized monopolies, temporary monopolies, or near monopolies. For example, a stone quarry in a particular location may command control of a rare resource and thus enjoy strong, if not monopolistic, control in the local market.
Natural Monopolies and the Management of Projects
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So what might all of this mean for a project manager? Here are some things to consider:
- Project drivers – The drivers when the business is in the growth stage are very different that when in the growth and mature stages (not to mention the startup and decline stages). Projects in a natural monopoly will have different drivers behind “Why are we doing this?” simply because there are different business drivers.
- Risks – Risks also are different if you understand that the business is a natural monopoly. There could be the risk of regulation effecting operations and competitive advantage, the risk of ‘gold plating’ where product and service quality is sufficient, or even the risk of deregulation that could bring in more competition and weaken the monopoly.
- Disciplined execution – This may be a challenge if there is a lack of discipline due to the absence of competition.
- Scheduling – Depending on the stage of development, scheduling may be urgent and require an agile approach, if in the growth phase, or may be much looser and self-regulated in the case of the mature phase.
- Triple constraint – PMs will need to be mindful of different tradeoffs for a natural monopoly among cost, quality, and schedule.
When managing a project for or involving a natural monopoly, it pays to have this perspective and plan accordingly.
This post covered what a natural monopoly is, examples of natural monopolies, underlying factors that are drivers of projects, the fundamentals of the natural monopoly graph, strategic implications of natural monopolies, and considerations for managing projects in natural monopoly environments.
As with anything related to project management and strategy, it pays to take a strategic perspective in managing projects – in this case for a natural monopoly business.
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