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

Prof. Jordi Gual, IESE Business School2 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 School3 The economics of relevant antitrust markets The hypothetical monopoly principle The hypothetical monopoly principle when fixed costs are important

Prof. Jordi Gual, IESE Business School4 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 School5 The hypothetical monopoly principle (II): the mark-up A monopolist would raise price p by: where  is the elasticity of demand and mc marginal cost Several firms acting jointly will face a residual demand: 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 residual demand

Prof. Jordi Gual, IESE Business School6 The hypothetical monopoly principle (III): measurement The elasticity of residual demand 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 School7 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 School8 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 School9 Defining markets in telecoms: conventional issues (I) Product/Service markets Fixed/Mobile Mass/Business Geographic definition

Prof. Jordi Gual, IESE Business School10 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 School11 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 School12 What is different about telecoms? Wholesale/retail Networks Bottlenecks Bundles –The case of mobile call termination Product/service innovation

Prof. Jordi Gual, IESE Business School13 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 School14 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 School15 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 School16 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 School17 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 School18 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