Identifying competition problems in cases where competition is for the market

1. Identifying competition problems in cases where competition is for the market Matthew BennettDirector of Economics, OFT Please Note: The views expressed are personal and do not necessarily reflect those of the OFT.

2. Context • In normal markets if we see: • Monopoly providers within a product. • High barriers to entry to a product. • Significant and durable profits in a product. • We might see all the key identifiers of a unilateral competition problem, but… • Need to examine whether competition is taking place for the market rather than in the market. • However, does competition for the market imply that competition authorities should never be concerned?

3. Structure • Talk will focus on aftermarkets, but should be taken in a wider context – issue in all markets where the competition is for the market rather than in the market. • Network effects, switching costs, two sided markets • Why competition authorities may be cautious before intervening on the basis of a standard competitive analysis. • What type of issues may still exist even when there is competition in the primary markets. • What types of indicators can authorities use to identify whether these issues are likely to exist and hence whether intervention may be required.

4. Aftermarket • Razor blades - Naïve analysis would indicate: • Single firm producing cartridges. • High profits in cartridges. • High barriers to entry. • Then would infer that we have a competitive based on only these indicators. • However we know that razor blades are an aftermarket for razors. • In these types of markets ex-ante competition forconsumers may replace ex-poste competition for consumers. • Thus are there ever any cases for intervening?

5. Waterbed effect • Primary Market • Secondary Market • Profits made in the secondary market. • Each sale in primary market is more valuable. • Competition in the primary market pushes firms to subsidise consumption to the value of the profits they make in the secondary market. • Is the waterbed effect complete? • To what extent does completeness depend on consumer rationality? • To what extent does completeness depend on primary market competition? • If complete waterbed should we intervene? Price Pm A Pc A Pm Primary Demand Secondary Demand Q m Q c Q m Q c Primary Quantity Secondary Quantity

6. Types of consumer harm • Imperfect pass-through. • Non-rationale (naïve) consumers. • Allocative (in)efficiencies. • Dynamic incentive to innovate. • Distribution concerns.

7. Imperfect pass-through. In general we don’t expect full pass through. However there is a relative lack of clear theoretical or empirical evidence on this. Would expect level of pass through to be related to level of competition. Implies diminishing returns from intervention w.r.t. competition Naïve consumers. When consumers are systematically naïve firms may exploit this. Underestimate secondary demand and have profit exploited twice. Extent to which the additional secondary market profit is competed away depends on primary competition. Again… diminishing returns from intervention w.r.t. competition. Types of consumer harm:Pass-through and naïve consumers

8. Types of consumer harm:Allocative (in)efficiency • Primary Market • Secondary Market • Prices above or below costs result in allocative efficiency losses. • People who value the aftermarket good above cost don’t buy it. • People who don’t value the primary good at the cost level buy it. • This creates two dead-weight loss triangles instead of one of normal market. • In big markets the dead-weight losses can be substantial. • UK CC estimated hat PPI losses were between £361-485m depending on demand assumptions. Price Deadweight loss to consumers Pm Deadweight loss to society Pc Pm Primary Demand Secondary Demand Q m Q c Q m Q c Primary Quantity Secondary Quantity

9. Dynamic concerns: Are there dynamic issues regarding innovation being hampered by the existing model of competition? Is secondary market innovation subverted to primary market innovation? Possible vicious circle: No new products => No consumers pay attention to secondary market => No incentive to innovate => No new products Distribution concerns: Generally cross subsidisation is efficient. But are there limits on how much are we willing to allow? What happens if the cross subsidisation is particularly income regressive? We care in Article 81(3), i.e. benefits have to be same relevant market. Distribution may not be primary concern, but an exasperating factor. Types of consumer harmDynamic and Distribution concerns

10. So what types of behaviour would suggest investigating? • May only want to intervene if firms are in a position where they have an ability to harm consumers. (i.e. consumers can’t/don’t take actions to protect themselves). • If consumers pay attention to the total life time cost of the product/service then any adverse ‘aftermarket’ practices will result in consumers switching away from the primary market. • If consumers can easily moderate and change their behaviour in the aftermarket then firms won’t be able to harm them through adverse practices on the aftermarket. • May only want to intervene if the practice is having a negative effect on at least some consumers. • Even if there is an ability to harm consumers firms may not be exploiting this ability. Thus don’t intervene if there is no evidence of harm to at least some consumers.

11. Some first thoughts on identifying aftermarket cases to investigate Existence of ability to exploit consumers Actual consumer exploitation (effect) • Screen One • Screen Two • Screen Three Does consumer behaviour in primary market constrain firms’ practices in the secondary market Does consumer behaviour in secondary market constrain firms’ practices in it? Is there consumer detriment due to lack of constraints in secondary market? No/Fail No/Fail Yes/Fail A deeper analysis of the case is likely to be warranted. • Yes/Pass • Yes/Pass • No/Pass Practice is unlikelyto be a priority Practice is unlikelyto be a priority Practice is unlikelyto be a priority

12. Conclusions • Analysis of ‘aftermarket’ type markets are subject to two ‘errors’: • Assuming competition problems in areas where there are no harm to consumers. • Assuming no competition problems in areas where there is harm to consumers. • In markets of these type, a closer analysis is likely to be warranted if all the following is true: • Consumers do not base purchasing decisions on the total life-time price. • Consumers find it difficult to moderate or learn from their actions in the secondary market. • There are large, non-cost, related cross subsidies flowing from primary market to secondary market. • Further academic work on importance of waterbed effect?