Market Definition in the Telecoms Industry

1. Market Definition in the Telecoms Industry Prof. Jordi Gual IESE Business School Barcelona-Madrid Brussels, 16 September 2002

2. Outline • The economics of relevant antitrust markets • Defining markets in telecoms: conventional issues • What is different about telecoms? • Concluding remarks Prof. Jordi Gual, IESE Business School

3. The economics of relevant antitrust markets • The hypothetical monopoly principle • The hypothetical monopoly principle when fixed costs are important Prof. Jordi Gual, IESE Business School

4. The hypothetical monopoly principle (I): definition • The set of services whose provision, if in the hands of a single entity, could profitably be restricted • Also known as the small but significant (5 or 10%) non-transitory increase in price test (the SSNIP test) • Why is it reasonable? • Position of individual firms computed relative to an aggregate which gives full control • Gradual addition of substitutes • Relative to the competitive benchmark Prof. Jordi Gual, IESE Business School

5. The hypothetical monopoly principle (II): the mark-up • A monopolist would raise price p by: where e is the elasticity of demand and mc marginal cost • Several firms acting jointly will face a residualdemand: how demand falls when firms coordinate price increases, taking into account the reaction of excluded products • The price increase that these firms can achieve depends on the elasticity of the residualdemand Prof. Jordi Gual, IESE Business School

6. The hypothetical monopoly principle (III): measurement • The elasticity of residualdemand depends on: • the extent to which the excluded are products good substitutes • and how aggressive their producers are • In the absence of quantitative information: • demand substitutability • supply substitutability Prof. Jordi Gual, IESE Business School

7. The hypothetical monopoly principle with fixed costs • With fixed costs may not be sustainable for the industry • If the fixed costs are technically based: compute the average mark-up which covers industry fixed costs • If the fixed costs are strategic (continuing “sunk” investments in R&D and brand) • the static mark-up does not capture dynamic efficiency • substitutability is driven by relative product performance and not price Prof. Jordi Gual, IESE Business School

8. Outline • The economics of relevant antitrust markets • Defining markets in telecoms: conventional issues • What is different about telecoms? • Concluding remarks Prof. Jordi Gual, IESE Business School

9. Defining markets in telecoms: conventional issues (I) • Product/Service markets • Fixed/Mobile • Mass/Business • Geographic definition Prof. Jordi Gual, IESE Business School

10. Defining markets in telecoms: conventional issues (II) • In theory, based on the hypothetical monopoly test • In practice, focus on demand substitutability and similarity of competitive conditions • Need to recognize explicitly supply substitutability Prof. Jordi Gual, IESE Business School

11. Outline • The economics of relevant antitrust markets • Defining markets in telecoms: conventional issues • What is different about telecoms? • Concluding remarks Prof. Jordi Gual, IESE Business School

12. What is different about telecoms? • Wholesale/retail • Networks • Bottlenecks • Bundles • The case of mobile call termination • Product/service innovation Prof. Jordi Gual, IESE Business School

13. Bundles of telecom services • Varying degrees of complementarity in demand and scope economies in supply • The hypothetical monopoly principle does not work: • Strong complementarities => low own-price elasticity for individual services => narrow markets • Enlarging the product set may lower market power • When enlarging the product set, prices should not be kept constant • Stand-alone services make sense when: low complementarity and independent supply Prof. Jordi Gual, IESE Business School

14. The case of mobile termination: the regulatory approach • Insufficient incentives for price competition • due to CPP • no offsetting factors • observed high margins • Market delineation: call termination in each network due to low demand and supply substitutability • Introduction of regulation Prof. Jordi Gual, IESE Business School

15. The case of mobile termination: the antitrust approach • Determine the relevant market • Examine the nature of demand relationships without considering competitive conditions • Examine the alternative sources of supply • Assess the degree of competition in the previously defined markets • Impose regulation in the relevant markets if competition is insufficient Prof. Jordi Gual, IESE Business School

16. Product/service innovation • In parts of the industry, fixed costs are sunk and related to strategic competition in service or product innovation • A broader concept of substitutability is needed: • between technologies that can satisfy similar consumer demands • between suppliers that own assets which could lead to the alternative technologies Prof. Jordi Gual, IESE Business School

17. Outline • The economics of relevant antitrust markets • Defining markets in telecoms: conventional issues • What is different about telecoms? • Concluding remarks Prof. Jordi Gual, IESE Business School

18. Concluding remarks • Need to pay more attention to supply substitutability • Systems of services as relevant units of market analysis • Need to redefine the competitive benchmark in the presence of fixed costs • Absence of competition in an individual service should not determine market definition Prof. Jordi Gual, IESE Business School