Market Power 101 Phil Weiser Aspen, Colorado Sunday, April 29, 2007

Three Important Concepts Monopoly Power Price Discrimination Vertical Integration

1.What Is Monopoly Power? Two Conceptions –Power to raise prices without losing so many customers as to make price hike unprofitable. Substantial, Non-transitory Increase in Price test Merger Guidelines set level of 5% over two years –Power to exclude competitors

Why Care About Monopoly Power?

How Determine Whether A Firm Possesses Monopoly Power? Define the Relevant Market and Analyze Its Dynamics –Geography –Product Example –XM/Sirius Two Key Lessons –It is reasonable to believe that tech savvy consumers—who will switch to other alternatives if prices rise—will protect lazy shoppers. –Entry barriers matter a lot.

Antitrust v. Regulation on Monopoly Power Antitrust does not view monopoly power itself as evil to be avoided—rather, like IP, it sees the pursuit of monopoly as motivator of innovation. Antitrust only views acquisition or maintenance of monopoly power through “unfair competition” as problematic –Mergers that enhance monopoly power; collusion (price fixing); or predatory practices Whereas antitrust works in conjunction with market, regulation substitutes for market, seeking to regulate prices or industry practices directly and before-the-fact (ex ante) through prescriptive regulation.

Natural Monopoly Regulators long viewed certain industries as “natural monopolies” because the total average cost continued to decline with each customer served—i.e., no diminishing returns to scale. Fearing that the market would allow “cutthroat” and wasteful competition, regulators embraced a system of regulated monopoly and closely regulated entry and exit (as well as prices). Part of the justification for a regulated monopoly was that these high fixed cost industries—like electricity and telecom— were “network” industries.

2. Price Discrimination Offering different prices to different classes of consumers. Perfect price discrimination would bring about same output as perfect competition.

Good or Bad? Efficiency Aspect –it enables producers to increase output without sacrificing monopoly rents paid by customers with highest willingness to pay. Potential Equitable Downside –if the beneficiary of price discrimination is large, sophisticated consumers—say, big businesses—they may enjoy volume discounts whereas smaller consumer pay more. –NOTE—one response to this state of affairs is arbitrage, wherein a firm or a cooperative buys in bulk and resells the product to smaller consumers, enabling them to benefit from the volume discount. Negative Aspect –If producers can isolate and identify customers by willingness to pay, they may be able to exercise market power selectively—by raising prices (say, as to radio advertisements) for those consumers who enjoy no substitutes for advertising on radio. Administrative Challenge –Kahn’s observation that efforts to develop price ceilings might be theoretically correct, but administratively impossible.

3.Vertical Integration Network provider (distributor) “participates”—either through ownership or contract—in applications market (services or content). Over time, the attitude towards vertical integration—both from antitrust and regulation—has changed.

How To Judge Vertical Relations? Internalization of Complementary Externalities (ICE) –A platform monopolist can, in principle, reap the relevant rents from pricing access to the platform (only “one monopoly profit”) –A platform monopolist has the incentive to encourage more efficient applications on its platform, thereby increasing the value of the platform and available rents to it. Exceptions to ICE –Price regulation of platform (AT&T attitude toward CPE) –Application could substitute for platform (MSFT case)

Different Business Strategies Different network (or platform) providers will adopt different strategies toward complementors (or application providers). –Modularity—Palm, Microsoft Xbox, Linux, Comcast DVR –Vertical Integration—Microsoft, Apple, and cable television. The motivation for vertical integration may often reflect benign reasons—i.e., consistent with ICE—such as the value of hand-in-glove coordination (or other transaction cost-related reasons).

Questions?