Dominant position Market power and Market definition Prof

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Dominant position, Market power and Market definition Prof. Ioannis Lianos Faculty of laws University

Dominant position, Market power and Market definition Prof. Ioannis Lianos Faculty of laws University College London

Market power and the limits of competition law • Article 101 TFEU: collusive practices

Market power and the limits of competition law • Article 101 TFEU: collusive practices (market power a non indispensable element of the offence) – Restrictions of competition by object (no need to prove market power) – Restrictions of competition by effect (market power facilitates the finding of an infringement of Article 101 TFEU) • Article 102 TFEU: abuse (also unilateral practices) of a dominant position – Dominant position= “substantial market power over a period – of time” (para. 10) • Commission Guidance on its enforcement priorities for exclusionary abuses under Article 102 TFEU: http: //eurlex. europa. eu/Lex. Uri. Serv. do? uri=OJ: C: 2009: 045: 0007: 002 0: EN: PDF 2

Dominance • Dominance is a key legal concept in EU competition law • “Any

Dominance • Dominance is a key legal concept in EU competition law • “Any abuse by one or more undertakings of a dominant position within the internal market or in a substantial part of it shall be prohibited as incompatible with the internal market in so far as it may affect trade between Member States” • “A concentration which would significantly impede effective competition, in particular by the creation or strengthening of a dominant position, in the common market or in a substantial part of it shall be declared incompatible with the common market. ” • “The dominant position thus referred to (by Article [82]) relates to a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market by affording it the power to behave to an appreciable extent independently of its competitors, customers and ultimately of its consumers. ” 3

Market power • Dominance is not a concept in economics, but is closely related

Market power • Dominance is not a concept in economics, but is closely related to the economic concept of market power • Market power is the ability of the firm to set and maintain price above the competitive level of prices/marginal costs marginal revenue 4

Implications of market power • Outcome with market power is less efficient - deadweight

Implications of market power • Outcome with market power is less efficient - deadweight loss (and possibly cost inefficiency) • Also raises distributional concerns 5

Market power and dominance • Key determinant of market power is how sensitive or

Market power and dominance • Key determinant of market power is how sensitive or responsive is a firm’s demand to changes in its own price and rivals prices – the elasticity of the firm’s demand • A firm with relatively inelastic demand (not very sensitive to price) is very likely to be able to profitable maintain high margins and prices this a firm that economists typically consider as having substantial market power • A firm with relatively inelastic demand is also able to “behave to an appreciable extent independently of its competitors, customers and ultimately of its consumers”, as its demand is not very responsive to changes its own price and the prices of rivals • Legal concept of dominance is equal to the economic concept of substantial market power 6

Measuring Market Power I Margins? • As market power is the ability to raise

Measuring Market Power I Margins? • As market power is the ability to raise price above the competitive price or marginal costs, one way of measuring market power is to measure margins § The Lerner index illustrates the link between margins (market power) and elasticity • Margin = -1/ε, where ε is the elasticity of demand for the firm Elastic demand, smaller margin Less elastic demand, higher margin 7

Margins: problems • While the margin an appealing way to measure market power, there

Margins: problems • While the margin an appealing way to measure market power, there a number of problems and issues that need to be borne in mind • Fixed costs – any firm that has some fixed costs (such as investment in plant, R&D, etc. ), needs to earn a positive margin over marginal cost in order to recover these fixed costs • Margins may vary significantly over the economic cycle, so low margins may reflect the current depressed level of demand rather than a lack of market power • A firm may have high margins because it is more efficient than others in the industry. Alternatively, if a firm has market power then it may have higher costs and not be as efficient as it would be if it had no market power 8

Measuring market power II Market definition Why define markets? • In reality closeness of

Measuring market power II Market definition Why define markets? • In reality closeness of competition is a spectrum: the world is not neatly divided up into market “boxes” • Outside competition law economists do not typically “define markets” – so why do it for competition policy? • A simplification (versus including all possible substitutes, however distant, in our considerations) • A shortcut to understanding the most important competitive constraints on a company/product • This is reasonable and pragmatic: but always a simplification of reality, and the choice of cut-off point between products “inside” and “outside” is inherently arbitrary 9

Market definition – economic principles • Hypothetical Monopolist Test (HMT) – finding the smallest

Market definition – economic principles • Hypothetical Monopolist Test (HMT) – finding the smallest market worth monopolising – Small but Significant Nontransitory Increase in Price (SSNIP): year-long 5 -10% price increase above competitive levels, all other prices (for both substitutes and complements) being equal Start with the identification of the first candidate market along the product and geographic dimensions 10

Cont’d • Demand-side substitutability – Identify ‘functional’ substitutes on the basis of product attributes

Cont’d • Demand-side substitutability – Identify ‘functional’ substitutes on the basis of product attributes and intended uses – Screen out inconvenient (ie, too expensive) ‘functional’ substitutes • Supply-side substitutability • Credible within a year (2/3 years for potential entrants) – If at full capacity, ‘opportunity cost’ given by the profit margin on existing production – Current prices are a proxy for post-entry prices – re, risk that the SSNIP is reversed to deter entry 11

The “hypothetical monopolist” test takes a candidate market and asks whether a monopolist over

The “hypothetical monopolist” test takes a candidate market and asks whether a monopolist over that market would want to raise price by 5%-10% (i. e. higher profit margin on remaining sales more than compensating for lost sales to rivals) Yes: market is correctly defined (monopolist would have strong market power) No: monopolist would be constrained by other products: widen market Start narrow and work outwards: Is it profitable for a hypothetical monopolist over Coca Cola to raise price 5 -10%? NO >> market is wider than Coke: is it profitable for a monopolist over all brands of Cola to raise price 5 -10%? YES >> Define market for Coca Cola Discussion Case Study 1 NO >> market is wider than cola: is it profitable for a monopolist over all fizzy drinks to raise price 5 -10%? NO >> market is wider than fizzy drinks: continue to widen YES >> Define market for all fizzy drinks YES >> Define market for all Cola flavoured drinks 5 -10% is essentially arbitrary 12

Implementing the SSNIP test • Critical inputs to answering this question: • Elasticity of

Implementing the SSNIP test • Critical inputs to answering this question: • Elasticity of demand: Elasticity just means “responsiveness” - so the elasticity of demand for cola with respect to price is simply how much the demand for cola would change in response to a small increase in the price of cola (with everything else constant) Ø To what extent will customers switch away if the price increases? • Margin: Margin (profit per unit sold) is also important, because it determines the implications for profit of the output changes implied by this elasticity: if I lose 10 customers by raising price, at a low margin that may be worth the benefit of the price increase, but at a higher margin it may be better to avoid these lost sales Ø How do profits I lose on departing customers compare with profits I gain on those who stay and pay a higher price? 13

Aftermarkets • Consumers buy a durable (primary) good and a consumable (secondary) good over

Aftermarkets • Consumers buy a durable (primary) good and a consumable (secondary) good over the lifetime of the former – Quantity of the latter reflects intensity of usage – Gate-keeper role for the producer of the durable product ie, patent protection over specification for secondary product – the two products in practice constitute a tie - risk that prices for secondary products are above competitive levels • ‘System’ markets • • Consumers take into consideration combined cost over lifetime of the durable good, based on expected intensity of usage Competition for primary product protects exploitation in the specific aftermarket • Case 22/78 Hugin [1979] ECR 1869 (the relevant market as defined with respect to a brand, not a product) • Case T-30/89 Hilti AG v Commission [1991] ECR II-439 14

Bundles • Contrary to aftermarkets, each complementary product can be purchased and used in

Bundles • Contrary to aftermarkets, each complementary product can be purchased and used in isolation, in principle – eg, triple-play • If not, pure bundle (not very different from a tie) – Is there a market for the individual (bundled) component? • Are there other seller of the individual component? • Otherwise, mixed bundle, where the bundled price is typically cheaper than the sum of individual prices • Separate market for the bundle? – Reverse cellophane fallacy – Genuine transaction economies – ie, customer acquisition, billing and customer care 15

Two-sided markets • The middle-man facilitate the interaction (often aimed at carrying out a

Two-sided markets • The middle-man facilitate the interaction (often aimed at carrying out a transaction) between different sets of customers • Members on each side decide to ‘get-on-board’ on the basis of an expectation that those on the other side will do the same – chicken-and-egg coordination failure The platform is a match-maker 16

Cont’d Classic examples are: • credit cards, where users want a card that is

Cont’d Classic examples are: • credit cards, where users want a card that is accepted ubiquitously, and merchants do not want to lose business by not offering to their client the convenience of being able to pay with a particular brand of credit card • online marketplaces (eg, auction sites): where both sellers and buyers are keen to be active in thick and liquid markets • heterosexual dating clubs/internet sites: where both genres want to maximise their chances of a happy match • game consoles and Application (App) stores: where users wants a variety of compatible games (Apps) and game (Apps) developers do not want to waste their energies developing a game (App) for a proprietary platform unless it is expected to attract many potential clients 17

Indirect network externalities • Feedback loop: a decision of a member to join the

Indirect network externalities • Feedback loop: a decision of a member to join the platform on side A will benefit members on the other side B; and vice versa, in the sense that to the extent that side B becomes more attractive, thanks to the new affiliation on side A, this will in return increase the utility of joining side A in the first place • Platform ‘internalise’ externalities in order to solve chicken-and-egg problem by setting the structure of prices (membership and transaction fees on both sides) – ie, as opposed to their overall level 18

SSNIP? • Prices on each side not necessarily reflective of underlying costs • Indirect

SSNIP? • Prices on each side not necessarily reflective of underlying costs • Indirect network externalities constraint pricing power – ie, feedback loop can be negative • SSNIP applied to the overall level of prices, whilst allowing the platform owner to optimise the structure thereof • On the other one, indirect network externalities might trigger ‘winners-take-all’ dynamics 19

Scale economies with first movers advantages: brands, network effects Scale economies can act as

Scale economies with first movers advantages: brands, network effects Scale economies can act as an entry and expansion barriers even if not underpinned by sunk costs • Brand loyalty will increase customer acquisition costs for the entrant – absolute cost advantage – strategic use of brand building ads campaigns; loyalty rebates; brand proliferation • Network effects might ‘tip’ the market in favour of the incumbent – ie, even if inferior to an alternative platform with the same scale – customers are uncertain whether to affiliate with the new platform in case it failed to achieve a critical mass – Is this FMA insurmountable? Many examples of successive monopolies show customers have a strong taste for variety – unless there are switching costs such as having to learn from scratch – eg Qwerty keyboard – re, compatibility among proprietary standards 20

The use of quantitative techniques • Herfindahl-Hirschman index (HHI): the sum of the squares

The use of quantitative techniques • Herfindahl-Hirschman index (HHI): the sum of the squares of market shares – higher if market structure is less symmetric – When firms set quantities and products are homogenous, HHI is proportional to industry profitability • Price correlation analysis: prices co-variation in line with the law of one price – False positives: common input cost shock; common increase in disposable income – False negatives: co-variation but only in the medium/long term – Natural experiments: geographically limited market test • Pricing pressure indices 21

Quality • Can quality be used to define markets? • Could the well-known SSNIP

Quality • Can quality be used to define markets? • Could the well-known SSNIP (small but significant, non-transitory increase in price) test be replaced with a SSNDQ (small but significant, nontransitory decrease in quality) test? • Would we ever want to do that in the first place? • Are there situations in which the SSNIP test would yield an incomplete or inaccurate result because it focuses on price, and in which the SSNDQ test would yield a more accurate result? 22

Innovation Commission Dow/Dupont (2017) • First, the assessment of innovation competition requires the identification

Innovation Commission Dow/Dupont (2017) • First, the assessment of innovation competition requires the identification • • • of those companies which, at an industry level, do have the assets and capabilities to discover and develop new products which, as a result of the R&D effort, can be brought to the market. Innovation space: The R&D players do not innovate for all the product markets composing the entire crop protection industry at the same time. They also do not innovate randomly without targeting specific spaces within that industry. When setting up their innovation capabilities and conducting their research R&D players have specific discovery targets. The spaces where innovation competition takes place are thus broader than an individual downstream crop protection market, but are nonetheless small. The Commission will both consider metrics of innovation taking place at industry level, as well as innovation taking place in spaces consisting of groupings of crop/pest combinations, areas where the parties’ activities overlapped 23

Beyond relevant market? 24

Beyond relevant market? 24

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The multi-sided structure of the search engine market Source: Pollock, R. (2010), Is Google

The multi-sided structure of the search engine market Source: Pollock, R. (2010), Is Google the Next Microsoft? Competition, Welfare and Regulation in Online Search. , Review of Network Economics 9(4), 1 -29.

The “search neutrality” narrative • • “Search engines have become the Internet’s gatekeepers and

The “search neutrality” narrative • • “Search engines have become the Internet’s gatekeepers and are arguably as essential a component of its infrastructure as the network itself. Google’s overwhelming dominance of search and search advertising, coupled with its ability to arbitrarily penalise rivals and systematically favor its own services, makes the need for search neutrality particularly pressing “ Google determines the exact placement of its own services independently of the ranking algorithms it uses to determine the relative placement of all other results

Relevant market • market for general Internet search • Limited demand substitutability with •

Relevant market • market for general Internet search • Limited demand substitutability with • Specialised search services • Social networks • Other online services • No distinction between mobile and static devices • market for comparison shopping services • • Comparison shopping services are specialised search services that: (i) allow users to search for products and compare their prices and characteristics across the offers of several different online retailers (also referred to as online merchants) and merchant platforms (also referred to as online marketplaces); and (ii) provide links that lead (directly or via one or more successive intermediary pages) to the websites of such online retailers or merchant platforms Limited substitutability with online retailers as they do not offer users the possibility to purchase a product directly on their websites and online retailers do not offer the possibility to compare their own offers for the same or similar products on the websites of other online retailers Limited substitutability with merchant platforms as they serve a different purpose: they are considered as business partners, not competitors No SSNIP test needed 28

Dominance? Market power? • A stable hierarchy • High market shares • Barriers to

Dominance? Market power? • A stable hierarchy • High market shares • Barriers to entry and expansion • High capital expenditure • Relevance of scale • Direct network effects • Indirect network effects • No countervailing buyer power

Unequal treatment and leveraging • Google positions and displays more favourably, in its general

Unequal treatment and leveraging • Google positions and displays more favourably, in its general search results pages, its own comparison shopping service compared to competing comparison shopping services • Single monopoly profit? NO • (332) A system of undistorted competition can be guaranteed only if equality of opportunity is secured as between the various economic operators • (334) Article 102 of the Treaty and Article 54 of the EEA Agreement prohibit not only practices by an undertaking in a dominant position which tend to strengthen that position, but also the conduct of an undertaking with a dominant position in a given market that tends to extend that position to a neighbouring but separate market by distorting competition. • [Case 311/84, Centre belge d'études de marché - Télémarketing (CBEM) v SA Compagnie luxembourgeoise de télédiffusion (CLT) and Information publicité Benelux (IPB), EU: C: 1985: 394; Case C-333/94 P, Tetra Pak v Commission, EU: C: 1996: 436; Case T- 228/97, Irish Sugar plc v Commission, EU: T: 1999: 246; Case T-201/04, Microsoft v Commission, EU: T: 2007: 289. ] • (339) No need for actual effects 30

Digital Value Chains and Economic power • Data Missing market? IP holders Compulsory licensing/FRAND/SEP

Digital Value Chains and Economic power • Data Missing market? IP holders Compulsory licensing/FRAND/SEP Component manufacturers Original Equipment Manufacturers (smartphones, tablets, PCs) Competition law Search engines Content providers Antitrust exemption for news? Network neutrality Networks/Internet Service providers End users Feedback loop • • Different ways of public action (competition law, net neutrality, compulsory licensing, regulation) EU and US approaches may diverge Countervailing power along the value chain and/or state intervention? 31