The economics of Article 82 reform

1. The economics of Article 82 reform Dr Helen Jenkins, Managing Director February 8th 2008

2. Outline (I) • what is market power? • from form- to effects-based tests for abuse • critique of the guidelines on loyalty rebates • practical issues in applying the methodology • Microsoft

3. What is market power? The ability to maintain price above the competitive level • no entry by competitors • no switching by customers • must be able to maintain price > marginal cost (P > MC) over time The ability to exclude competitors • significant impact on market price and conditions • ability to foreclose • requires barriers to entry

4. Differentiated product power Appreciable effect (Chapter I) Dominance (Chapter II, mergers) Super-dominance Monopoly Market power is a matter of degree

5. Is the company dominant? No No case to answer Yes • Thou shalt not • price below variable cost • offer loyalty rebates • tie products Special responsibility The current ‘form-based’ approach • ‘The successful competitor, having been urged to compete, should not be turned upon when he wins’ • US Judge Learned Hand in Alcoa (1945)

6. Guidelines open the way for effects-based tests • dominance is not a binary state, and the degree of dominance matters for assessing abuses • a significant proportion of the market or of customers need to be affected by the alleged abusive behaviour • to assess exclusionary behaviour, the stated benchmark is the exclusion of an ‘as efficient’ competitor

7. The ‘as efficient competitor’ • the AEC is a central concept in the guidelines • setting benchmark for when it is OK for a competitor to be excluded • in liberalising markets there can be justifications for weakening this benchmark (eg, adjusting for scale) • notably, the AEC concept does not enter the assessment of loyalty rebates • comparison there is between the MES of competitor and the ATC of Domcoregardless of the level of cost at the entrant’s MES

8. Potential situations Scenario 1: Ci > P > Ce • where the entrant is more efficient than the incumbent • can pricing below cost exclude this more efficient rival? Scenario 2: Ce > P  Ci • the ‘traditional’ situation, where scale effects reduce the incumbent’s cost • abuse in this situation ruled out by the guidelines (mostly)

9. Two-sided markets and consumer welfare What is normal competition? What enhances welfare? Commission’s view Alternative view Downloading is a barrier OEMs do not want to load multiple media players Content providers do not want to multi-format Single media player is more efficient? OEMs often happy to pre-load more and/or downloading is easy Costs more to multi-format, but critical mass of users is small Can sustain multiple media players, even if WMP is ubiquitous How should it be chosen? Relevant to consider if there is a foreclosing effect

10. Market shares of media players(unique users) (%) Source: European Commission decision of 24.03.2004 relating to a proceeding under Article 82 of the EC Treaty. (Case COMP/C-3/37.792 Microsoft), data for years 1998–2002; WebSiteOptimization (2007), ‘Apple's iTunes Player Climbs Streaming Media Charts’, March, data for years 2003–07; and Oxera analysis.

11. Use of multiple media players • according to Microsoft Fact Sheet (2006), significant increase in the number of media players pre-installed (in addition to WMP) • EU increased from 1.4 per user in 2004 to 3.2 in 2006 • USA increased from 3.2 per user in 2004 to 3.7 in 2006 • average number of media players per user increased from 2.1 in 2004 to 2.6 in 2006

12. Streaming media player time per person (minutes) Source: WebSiteOptimization (2007), ‘Apple's iTunes Player Climbs Streaming Media Charts’, March, and Oxera analysis.

13. www.oxera.com Contact: Dr Helen Jenkins +44 (0) 1865 253 035 helen.jenkins@oxera.com