Introduction to competition

analysis

Jennifer SkilbeckJuly 2007

for National Training Workshops

Outline

Basic concepts• To whom does it apply?• Market definition • Market structures• Structural v behavioural issues

Guidance

(1) Advice will normally be provided by

national regulatory authorities

(2) Further assistance may be obtained from the websites of other competition authorities’ which will have broadly similar provisions.

To whom does competition law apply?

Business? Charities? Utilities? – gas, electricity, water,

telecoms, airlines Nationalised industries? State purchasers? Eg defence,

health

It is a policy decision

• In some jurisdictions competition laws apply to “undertakings” “engaged in an economic activity”

regardless of their legal or regulatory status

• In others only to “enterprises”: “carrying on a business for gain or

reward”

Market definition

The law: a relevant market comprises products and services that are

“…interchangeable in terms of characteristics,use,prices.”

Why define the relevant market? (1) dominance

• “Dominance” is only a meaningful concept in relation to the goods and services with respect to which a firm is “dominant”

Why define the relevant market? (2)agreements

An agreement can only be anti-competitive with respect to other actual or potential goods and services, and they represent the market we are seeking to define

Market definition: general

• It will vary according to the investigation

• A market is defined in terms of Product or service; and Geographic scope

• It also covers The demand side; and The supply side

Market definition: outline

1. Product and geographic market generally

2. Product market1. Demand side2. Supply side

3. Some specific tools for market definition1. Elasticities2. SSNIP test & cellophane fallacy

4. Geographic market5. General observations and examples

The “relevant market”

• Product market eg electricity for domestic

consumption, electricity for industrial consumption, laptop computers, all computers

• Geographic market eg “the world”, Mozambique,

Botswana, Maputo, Gaborone – even a small village

Each case must be considered individually:

• The product market must be considered according to:

• Demand side substitutability• Supply side substitutability

Product market definition: demand side

SIMPLE EXAMPLES:• There may be only one airport

in the capital • There is only one Microsoft• There may be only one

telecoms supplierIn each case: no obvious

substitute

… product market definition:demand side

HARDER EXAMPLES

Some pharmaceuticals – some imperfect substitutes

Some soft drinks – some imperfect substitutes

Are trains and buses substitutes?

In the hard cases…

• Consider what would happen if the price of the product was raised

• If it would lose significant sales there are substitutes…

• …and those substitutes are in the same market

Supply side market definition: example

• Still mineral water may be in a different market from sparkling water from the demand side, but manufacturers can easily produce both, so manufacturers of still water only

could not raise prices, even if there was no substitute for the consumer.

So still and sparkling water are both in the same market.

“Tools” of market definition (1)

• There are some obvious methods, based on Usual conventional market

definitions Consumer surveys Observations made by the alleged

dominant firm Miscellaneous market research

“Tools” of market definition (2)

• There are techniques for measuring substitutability: difficult to apply, but, at least.. may inform thinking

• It is best to use a variety of approaches

Tools: measuring elasticity

• “Elasticity”: the percentage change in demand following a specified percentage change in price

• “Cross-elasticity”: the percentage change in demand following a percentage change in the price of another product eg gas and electricity, mobile phones and fixed lines

Elasticity (continued)

• If there is a large change in demand from a specified change in price demand is “elastic”

• If a small change it is “inelastic”

The SSNIP test

“A small but significant non-transitory increase in price”

• This is simply a way of formalising the test for substitutability: can the supplier profitably increase price by a “SSNIP”, usually, 5%?

• If “yes”, then the supplier is in a market of its own because there is not enough price elasticity

The “cellophane fallacy”

• The SSNIP exercise can only be carried out hypothetically, because

If the firm has market power it will already have raised prices until the point where a further price increase will be unprofitable. It will wrongly suggest substituability.

(it is called “cellophane” because of a US case concerning cellophane cooking paper).

The “real” SSNIP test

• Would the supplier/the market be able to sustain a price (5%) above the competitive level?

• That cannot be tested from actual observation

The geographic market (1)

• The geographic market definition is usually obvious. The same principles of substitutability apply:

eg if a local newspaper raised its price, the consumer would not choose to buy the local newspaper from another region, but…

The geographic market (2): example

• If a manufacturer of electronic goods in one country raised its prices, distributors would look to suppliers overseas, but

• A consumer buying the same goods would operate in a smaller geographic market

Market definition: some general observations (1)

• The market definition will be different depending upon the precise issue, in particular whether buyers are consumers or intermediate purchasers.

• The market definition is ultimately a matter of judgment.

• It is generally unavoidable to begin with an “intelligent appraisal” and then consider the appropriate tools

Market Structures

• Markets may be more or less concentrated One player has a 70% share and

15 have 2% each One player has 50% and two have

25% each Four players have 25% each

Herfindahl-Hirschmann Index: HHI

• This is a measure of concentration: sum the squares of each market share:

• Eg1: 50+25+ 25=3850• Eg2: 25+25+25+25=2500• EG3: 10 firms 10% each: HHI=1000

• Eg1 more concentrated than Eg2. Eg3 not concentrated

The HHI: rule of thumb

• Less than 1000: competitive

• 1000 to 1800: moderately concentrated

• Over 1800: highly concentrated

Ease of market entry

• Technological factors• Consideration of the future• Spare capacity• Network advantages• Switching costs• High investment costs• Fashion

Examining market structure

• Past trends in market shares• Cost of gaining market share• Minimum efficient scale of

operation• Cost of exit/failure• Regulatory/planning/licensing

restrictions• Vertical integration

Behavioural issues

• Likely response by incumbents to new entry

• Establishing a reputation• Buyer power: nb intermediate

markets

Thank You

For more informationwww.monckton.com

andjskilbeck@monckton.com