Assessing Retail Competition David Loomis Illinois State University
Overview n Market Characteristics n Standard Measures of Market Competitiveness n A Model of Customer Switching n Alternative Market Share Measures - AMS and NMMS n Lessons from Telecommunications
Characteristics of a Perfectly Competitive Market n Many buyers and sellers who are price takers n No barriers to entry or exit n Mobility of factors of production n Perfect information n Profit-maximizing firms
Characteristics of Network Industries n Customer is attached to a fixed network n Network maintained by regulated entity (may also be default provider) n Customer must be linked with a provider during new connect n Purchases automatically recur unless the customer switches
Characteristics that Impact Market Share Measurement n Passive Demand n Presence of a Default Provider n Imperfect Information
Unique Characteristics of Electric Markets n Inelastic Demand n Peak Characteristics n Transmission Constraints n Properties of Electricity
Standard Measures of Market Competitiveness n Structure –Size and number of competitors n Conduct –Pricing and marketing strategies and behavior n Performance –Profitability
Structure Measures n Regular Market Share (unit/revenue) n Alcoa (1945) - Judge Learned Hand stated that 90% of a market "is enough to constitute a monopoly; it is doubtful whether 60 or 64 % would be enough; and certainly 33 percent is not." n Herfindahl Index - Merger Guidelines n If H is over 1800, "highly concentrated." If , "moderately concentrated." Under 1000,"unconcentrated."
Passive vs. Active Demand n Network Industries - provider decision once, continues until switch n Other Markets, active choice of brand for each purchase
Implications for Market Share n Traditional analysis implicitly assumes active demand n Total Market Share overemphasizes past decisions n Extremely affected by how decision is introduced
Model n Two stage - searching and switching n H - shopping cost n W - incumbent brand equity n E - effort expended to switch
First Stage - Shopping n n Customer will shop if [P I -E(P C )]q i > H + W + E n n So customers shop with higher usage than n n q i > (H+W+E)/(P I - P I ) = q x
Second Stage - Switch n n Customer will switch if [P I -P C ]q i > W + E n n So customers switch with higher usage than n n q i > (W+E)/(P I -P C ) = q s n n Usage M.S. is less than # of customer M.S.
Active MS and New Move MS n AMS describes real-time decisions, but is difficult to measure. n NMMS approximates AMS when customers can choose during new-connect Entire Customer Base Movers Shoppers switchers switchers
New Move Market Share n Easy to measure: supplier choices of new connects are easily observable n Reflects decisions during an active choice time n Real Time measure showing current activity n Highlights the importance of operational details (sign-up procedures)
Lessons From Telecommunications n Success Case – Long Distance n Failure Case - Local
Lessons from Long Distance n Market share for the incumbent may fall slowly and take a long time to decline to competitive level n Access charges were discounted to competitors n Competitive state may mean only a few large providers n Short run excess profits may earned by incumbent – attracts entry
Local Market Share Graph
Lessons from Local Telecommunications n Barriers to entry is the single most important factor in determining competition n All competition is local n Mere presence of competitors is insufficient
Conclusions n Traditional Market Share measures do not accurately reflect current decisions n Active Market Share is a better approach, but is hard to measure n New Mover Market Share approximates AMS and is easy to measure n Barriers to entry must be monitored
References n Loomis, David G. and Eric Malm, Active Market Share: Measuring Competitiveness in Retail Energy Markets, Utilities Policy, Vol. 8 No. 4, n Loomis, David G. and Eric Malm, The Devil in the Details: An Analysis of Default Service and Switching, 20th Annual Advanced Workshop on Regulation and Competition, May 24, 2001.