What Is a Natural Monopoly?

A natural monopoly is a type of monopoly that exists due to the high start-up costs of conducting a business in a specific industry. A company with a natural monopoly might be the only provider or 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.

Understanding Natural Monopolies

A natural monopoly, as the name implies, becomes a monopoly over time due to market conditions and without any unfair business practices that might stifle competition. 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 an unfair market advantage through coordinated price fixing or increases.

Instead, natural monopolies occur 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. Manufacturing plants, specialized machinery, and equipment are all fixed assets that might prevent a new company from entering an industry due to their high costs.

Key Takeaways

  • A natural monopoly is a type of monopoly that exists due to the high start-up costs of conducting a business in a specific industry.
  • A company with a natural monopoly might be the only provider or a 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.

Why Natural Monopolies are Allowed

Natural monopolies are allowed when a single company can supply a product or service at a lower cost than any potential competitor, and at a volume that can service an entire market. Since natural monopolies use an industry's limited resources efficiently to offer the lowest unit price to consumers, it is advantageous in many situations to have a natural monopoly.

For example, the utility industry is a natural monopoly. The utility industry provides water, sewer services, electricity, and energy such as natural gas and oil 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.

Also, society can benefit from having utilities as natural monopolies since multiple utility companies wouldn't be feasible since there would need to be multiple 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. However, the industry is heavily regulated to ensure that consumers get fair pricing and proper services.

Another example of a natural monopoly is a railroad company. The railroad industry is government-sponsored, meaning their natural monopolies are allowed because it's more efficient and 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. However, 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.

A natural monopoly usually exists when it's efficient to have only one company or service provider in an industry or geographic location.

Regulating Natural Monopolies

Companies that have a natural monopoly may sometimes exploit the benefits by restricting the supply of a good or service and inflating prices. For example, a utility company might attempt to increase electricity rates to recuperate losses following a storm that damaged electrical lines and poles. Regulations are established to protect the public from any misuse by natural monopolies.

In most cases of government-allowed natural monopolies, there are regulatory agencies in each region to serve as a watch-dog for the public. 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.