Potential competition as a competitive constraint
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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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Potential competition as a competitive constraint

Mats Bergman

Uppsala University & Södertörn University College

Mats Bergman

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

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


  • 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

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

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

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

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

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

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

Mats Bergman

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

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

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

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

  • 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

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 =

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  • Entry is deterred if Entry profit ≤ 0

  • Solve for the P0 that makes Entry profit = 0

Mats Bergman

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

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

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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