1. Toulouse, Nov 29, 2007Mats Bergman1 Potential competition as a competitive constraint Mats Bergman Uppsala University & Södertörn University College

2. Toulouse, Nov 29, 2007Mats Bergman2 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

3. Toulouse, Nov 29, 2007Mats Bergman3 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 %

4. Toulouse, Nov 29, 2007Mats Bergman4 Surveys Gilbert, 1989, JEP Kwoka, 2001, Case Western Res. Law R (focus on airline markets) Bergman, 2002, available at www.kkv.se/rapporter www.kkv.se/rapporter Kwoka, 2006, in Issues in competition law and policy

5. Toulouse, Nov 29, 2007Mats Bergman5 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

6. Toulouse, Nov 29, 2007Mats Bergman6 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)

7. Toulouse, Nov 29, 2007Mats Bergman7 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

8. Toulouse, Nov 29, 2007Mats Bergman8 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”

9. Toulouse, Nov 29, 2007Mats Bergman9 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

10. Toulouse, Nov 29, 2007Mats Bergman10 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

11. Toulouse, Nov 29, 2007Mats Bergman11 Intertemporal linkages YesNo Easy entryActual entry effective Intermediate entry costs Pot comp effective Actual entry effective? Costly entryPC and AE ineffective

12. Toulouse, Nov 29, 2007Mats Bergman12 IV. Theoretical foundations 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 Size of effect

13. Toulouse, Nov 29, 2007Mats Bergman13 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

14. Toulouse, Nov 29, 2007Mats Bergman14 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: P M = 125, P PC = 105, P AC = 100 –Effect of actual entry may be estimated to ≈5 % –Effect of pot. competition may be overlooked

15. Toulouse, Nov 29, 2007Mats Bergman15 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

16. Toulouse, Nov 29, 2007Mats Bergman16 8.27; 8.37. Svitzer is a 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

17. Toulouse, Nov 29, 2007Mats Bergman17 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 =

18. Toulouse, Nov 29, 2007Mats Bergman18 Entry is deterred if Entry profit ≤ 0 Solve for the P 0 that makes Entry profit = 0 →

19. Toulouse, Nov 29, 2007Mats Bergman19 Assume ½Q(P D -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 P M = P D + F/Q - ½ (P D -C) k = 0 means that P M → ∞ (for inelastic demand) (unconstrained monopoly pricing) 0<k<1 gives a P M that falls as k rises (pricing constrained by pot. competition)

20. Toulouse, Nov 29, 2007Mats Bergman20 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

21. Toulouse, Nov 29, 2007Mats Bergman21 A richer model Hall, Royer, Van Audenrode, 2003, “Potential competition and the prices of network goods: Desktop software”, manuscript