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Potential competition as a competitive constraint

Potential competition as a competitive constraint. Mats Bergman Uppsala University & Södertörn University College. Main points. Empirical studies suggest that potential competition is effective, but less so than actual competition

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Potential competition as a competitive constraint

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  1. Potential competition as a competitive constraint Mats Bergman Uppsala University & Södertörn University College Mats Bergman

  2. Main points • Empirical studies suggest that potential competition is effective, but less so than actual competition • It makes sense to distinguish between “pure” potential competition and (actual) entry in competition law cases • Pure potential competition is only effective if there is a linkage between current imcumbent actions and entrants’ expected future profits • The SW/A case report is very good – but the discussion of the linkage could be richer Mats Bergman

  3. I. Empirical studies of potential competition • Morrison & Whinston, 1987, JLE: 1.5 % lower prices (≈ 1/3 of the effect of 1 actual entrant) • Bergman & Rudholm, 2003, JIE: 4-8 % lower prices (≈ of the effect of 1 actual entrant) • Goolsbee & Syverson, 2005, 2006, NBER: 13 % lower prices (≈ ½ of total effect of 1 actual entrant) • Savage & Wirth, 2005, J Reg E: 15 % lower prices when entry probability increases from 3 to 42 % Mats Bergman

  4. Surveys • Gilbert, 1989, JEP • Kwoka, 2001, Case Western Res. Law R (focus on airline markets) • Bergman, 2002, available at www.kkv.se/rapporter • Kwoka, 2006, in Issues in competition law and policy Mats Bergman

  5. II. Potential competition in competition law • Reduced potential competition is a concern • Mergers between “adjacent” monopolies or dominant firms • Joint ventures • Reduced actual competition is not a concern, because of potential competition Mats Bergman

  6. EU cases MSG Media Service (M469) (Prohibited) Ahlstrom/Kvaerner (M1431) (Abandonned) EDF/EnBW (M1853) (allowed w remedies) ENI/EDP/GDP (M3440) (Prohibited) Telia/Telenor (M1439) (allowed w remedies) Air Liquide/BOC (M1630) (allowed w remedies) Omya/Huber (M3796) (allowed w remedies) Deutsche Bahn/English Welsch & Scottish Railway (M4746) (allowed w remedies) Reduced potential competition a concern Mats Bergman

  7. Mergers allowed due to strong potential competition • CHC Helicopter Corp/Helicopter Services Group, UK, 2000 • See also Ex post evaluation of mergers, OFT, 2005 • FTC vs. Promodes SA Mats Bergman

  8. What do the merger guidelines say? • US 1984: Explicit discussion of difference between “harm to "Perceived Potential Competition"” and “harm to “Actual Potential Competition"” (Ch. 4.1) • US 1992/1997: No explicit discussion (“deter or counteract the competitive effects of concern”) • EU’s horizontal merger guidelines discusses potential competitors (at 58-60) • Distinguishes between “likely entrants” and “potential entrants that constrain active firms” Mats Bergman

  9. III. Two types of effects • (Pure) potential competition • Potential competition constrains current behaviour, because current action (price) affects the likelihood of entry • AKA “entry deterrence” or “limit pricing” • Requires a “linkage” between incumbent’s pre-entry actions (prices) and entrant’s post-entry profit • Entry probability + effect of actual competition • No effect now, but likely in the future Mats Bergman

  10. Without linkage Pre-entry price unconstrained by potential competition Monopoly price prior to entry Entry-decision based on post-entry duopoly price only Entry into large/profitable markets With linkage Pre-entry price constrained by potential competition Entry-deterring price prior to entry Entry-decision based both on pre- and post-entry prices Entry into large/profitable markets Implication of “linkages” Mats Bergman

  11. Mats Bergman

  12. IV. Theoretical foundations Size of effect • Contestable markets • Entry deterrence based on • Capacity commitments (Dixit) • Learning-by-doing (Spence) • Cost signalling (Milgrom & Roberts) • Long-term contracting (Aghion & Bolton) • Switching costs (Klemperer) • Classic or dynamic limit pricing (ad hoc) • “Chicago-style” models, focusing on lack of credibility/sub-game perfection Mats Bergman

  13. V. Methods for assessing potential competition • Large number of markets • Estimate entry probability; regress prices on estimated entry probability • Identify markets where a particular firm is/not a potential competitor; estimate impact on price • One or a few markets • Engineering approach to estimate entry costs, the link between entry deterrence and entry probability and the optimal price structure of the incumbent • Example: Hall et al, 2003, applied to Microsoft’s Windows + Office Mats Bergman

  14. The risk of flawed empirical inference • Inference from empirical data may be flawed if potential competition is not accounted for • How to disentagle effect of actual entry and potential competition? • Example: PM = 125, PPC = 105, PAC = 100 • Effect of actual entry may be estimated to ≈5 % • Effect of pot. competition may be overlooked Mats Bergman

  15. VI. Comments on the SW/A merger • Entry analysed in Ch 7; main focus on the likelihood of actual entry • Potential competition as a competitive constraint analysed in parts of Ch 8 (8.27 – 8.37, also 8.38 – 8.83) • An industry mainly consisting of a number of monopoly (relevant) markets and two duopoly markets • Potential competition clearly relevant Mats Bergman

  16. 8.27; 8.37. Svitzer isa potential entrant into Adsteam’s ports; Adsteam is not a potential entrant into Svitzer’s ports • No explicit discussion of what constitutes the linkage between current incumbent actions and entrant’s future profit • Implicitly, long-term contracts with customers and customers’ ability to sponsor entry Mats Bergman

  17. A simple model of potential competition • The entrant can capture some of the surplus available at current prices: • “Linkage revenue” = • Entrant’s cost = • Entry profit = Mats Bergman

  18. Entry is deterred if Entry profit ≤ 0 • Solve for the P0 that makes Entry profit = 0 → Mats Bergman

  19. Assume ½Q(PD-C)-F is negative. Then entry will not occur and incument’s pricing will be constrained by potential competition for positive k. Specifically: • k = 1 gives PM = PD + F/Q - ½(PD-C) • k = 0 means that PM → ∞ (for inelastic demand) (unconstrained monopoly pricing) • 0<k<1gives a PM that falls as k rises (pricing constrained by pot. competition) Mats Bergman

  20. Implications for the case • If Adsteam is the constraining potential competitor for Svitzer the merger will have adverse consequences, even though A would not actually have entered in equilibrium • The constrained monopoly price is likely to be higher than the duopoly price; hence it makes sense to analyze the possibility of entry at prices lower than the current price • A more explicit analysis of the intertemporal linkage (or “linkage revenue”) would make sense Mats Bergman

  21. A richer model • Hall, Royer, Van Audenrode, 2003, “Potential competition and the prices of network goods: Desktop software”, manuscript Mats Bergman

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