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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

Potential competition as a competitive constraint

Mats Bergman

Uppsala University & Södertörn University College

Mats Bergman

main points
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
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
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

reduced potential competition a concern
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
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
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
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

implication of linkages
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

iv theoretical foundations
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
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
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
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
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

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

Mats Bergman