1. How can markets become more contestable?

2. By the end this lesson you will be able to…
Explain how markets can become more contestable?
Differentiate the level of contestability between markets and what determines it using industry examples
Explain using a diagram the implications of contestable market theory on firms in the industry
Evaluate contestable markets

3. Making Markets More Contestable
A2 Economics Revision
Making Markets More Contestable
Main approaches
De-regulation - i.e. reducing statutory barriers to entry to liberalise a market
Tougher competition laws acting against predatory behaviour by existing firms / tough rules against cartels
The changing nature of technology – which has brought down entry costs in some markets (an increase in capital mobility)

4. Examples of increased contestability in UK markets
A2 Economics Revision
Examples of increased contestability in UK markets
Free newspapers e.g. Metro
Radio stations in the digital age
Low cost airlines (Ryanair and EasyJet et al)
Cross channel transport
Domestic Clothing Industry - (Matalan, TK Max and Primark)
Food retailers and the market for organic products
New entrants in mail market
New entrants into online gaming
Telecommunications
Voice over internet (Skype)
New entrants into fixed line market (e.g. Talk-Talk)
New entrants into health care
Contestability in broadband market
Fitness franchises
Deregulation of chemists – to allow supermarkets into the sector
Deregulation of gas, electricity co’s

5. Deregulation of markets – increased contestability
A2 Economics Revision
Deregulation of markets – increased contestability
From postal services, to telecommunications and the suppliers of your electricity and gas, many markets have become more contestable in recent years
This affects the conduct and behaviour of rival firms within each market

6. Competition in Postal Services
A2 Economics Revision
Competition in Postal Services
In 2006 the Royal Mail lost its monopoly due to the regulator, PostComm opening up the Postal Market
A number of new entrants including TNT are now competing for services to collect and sort mail – although most of the new suppliers rely on the Royal Mail to deliver to consumers.

7. Back to the airline industry…
A2 Economics Revision
Back to the airline industry…
To what extent is entry and exit in the market 'costless'?
How would you describe the market structure of the low cost airlines industry?
Looking at the pricing strategies of each company in this market, is there evidence that fierce competition is succeeding in driving prices down as we might expect in a perfectly competitive market structure?
What response are the traditional airlines making to the impact of the low-cost carriers? (The quote and link below may be of help in pointing you in the right direction).
Added these slides back in as didn’t cover them in the first lesson

8. A2 Economics Revision
Competitive response
Today, major airline carriers are judged according to their "low-cost" label. As a result, the biggest impact of Low Cost Carriers (LCCs) on business travel might soon lie in the reactions of traditional airlines. To fight back against the cheap fares advertised by LCCs, major carriers have adopted two parallel strategies:
First, they have focused on the quality of their service (their line is, in short: we do not skimp on service).
Second, they have launched low fares of their own to meet the LCCs in the price war.
This has been understood more quickly in the UK than anywhere else in Europe. For companies, the issue of "low-cost carriers" is "out of date". The focus is now about leveraging traditional airlines low fares. Large German and Dutch companies are also heading in this direction. Potential cost cutting is likely to grow in the months ahead. Major savings opportunities await companies, providing they are able to take full advantage of them."
Source: Quote taken from What benefits do low-cost carriers really bring to business travel in Europe?, a 'White Paper' report from Carlson Wagonlit Travel [PDF, 260 KB]
Added these slides back in as didn’t cover them in the first lesson

9. To what extent is entry and exit in the market 'costless'?
A2 Economics Revision
To what extent is entry and exit in the market 'costless'?
As Baumol comments, no market entry or exit is completely costless but the key principle is the how far an entrant would suffer damage as a result of entering and subsequently leaving the market. This is where the work you did on 'micro-markets' above will be relevant.
How would you describe the market structure of the low cost airlines industry?
Looking at the pricing strategies of each company in this market, is there evidence that fierce competition is succeeding in driving prices down as we might expect in a perfectly competitive market structure?
What response are the traditional airlines making to the impact of the low-cost carriers? (The quote and link below may be of help in pointing you in the right direction).
Added these slides back in as didn’t cover them in the first lesson

10. Open Skies…! March 2008
The new Open Skies agreement between the European Union and the United States.
Currently, only British Airways, Virgin Atlantic, United and American Airlines are legally allowed to offer direct flights from Heathrow Airport to the US.
But after the deregulations of transatlantic air travel, the market will at last be open to competition from challengers.

11. British Airways faces £250m threat to profits as open skies era takes off – March 2008
The sweeping away of restrictive rules that govern transatlantic air travel could cost British Airways £250 million a year in lost profits.
From tomorrow, BA, which is reeling under a torrent of criticism for the chaos that has surrounded the opening of Terminal 5, its new base at Heathrow, will face increased competition on its most lucrative routes as the “open skies” era begins.
The agreement allows any European carrier to fly to any American city, effectively smashing the Heathrow cartel. To this end, on Sunday Continental, Delta US Airways and even Air France will muscle in on transatlantic services from Britain's largest airport. This is expected to drive down air fares, particularly in business class.
The arrival of new carriers at Heathrow is a particular threat to BA, which controls 40 per cent of the airport's slots and is the largest transatlantic carrier.
Airlines make almost no money on transatlantic economy fares but reap large profits from business and first-class passengers. BA is thought to make as much as 60 per cent of its profits from its Heathrow-to-New York operations alone.

12. Barriers to entry in the aviation industry
A2 Economics Revision
Barriers to entry in the aviation industry
(1) Availability of take-off and landing 'slots'
(2) Necessity of entering a new route on a large enough scale to achieve acceptable cost levels
(3) The costs of leasing new fleets of aircraft
(4) Securing an air operator’s licence from the EU
(5) Contracts with ground-handling companies
(6) Retaliatory behaviour by rivals (e.g. an expansion in flight frequency, cuts in fares)
(7) Overcoming existing customer loyalty achieved by companies who have exploited first-mover advantage on specific routes

13. The Low Cost Airline Model (low cost carriers)
A2 Economics Revision
The Low Cost Airline Model (low cost carriers)
(1) Use of the Internet to reduce distribution costs
(2) Maximise the utilisation of the aircraft assets
(3) Direct sell only via the net
(4) Ticketless travel
(5) No free airline food
(6) Use smaller airports - cheaper to fly from
(7) One kind of aircraft: Commonality maximises efficiency in the recruitment and training of staff

14. MP3 player music downloads…

15. Spotify approved for i-phone

16. Music Artists Recording companies Apple Consumers
What are your interests?
Do you value contestability in the music industry?
Recording companies
You discover talent and enter into exclusive recording and distribution contracts with artists to promote them in return for royalties on their music
e.g. Sony, Warner Music, EMI, Universal
What are your interests?
Do you value contestability in the music industry?
Apple
You are the major online retailer of digital music
What are your interests?
Do you value contestability in the music industry?
Consumers
What are your interests?
Do you value contestability in the music industry?

17. Spotify UK Government What are your interests?
Do you value contestability in the music industry?
Spotify
What are your interests?
Do you value contestability in the music industry?

18. Barriers to Contestability
A2 Economics Revision
Barriers to Contestability
No market is perfectly contestable – there are always some barriers!
Existing firms can engage in predatory behaviour to make entry more costly to new rivals
Raising rivals’ costs
Vertical integration means that some firms act as component suppliers to other firms in their industry – they have control over the supply-chain (also known as vertical restraint)
The use of import tariffs to increase the relative prices of overseas output
Reducing rival’s revenues – “bundling”
A monopoly can use profits in one market to boost market power in another (cross-subsidisation)

19. Bundling – Anti-Competitive Behaviour?
A2 Economics Revision
Bundling – Anti-Competitive Behaviour?
Product bundling is a marketing ploy of giving away a relatively cheap product with a relatively expensive one to attract customers
Bundling can have the effect of tying the consumer to both products
This is particularly prevalent in computer manufacturing where the product comes with specific items of software already pre-loaded

20. Banking Where are the opportunities to skim or hit and run?
Barriers to entry?
Brand loyalty
Marketing
Legal
Financial
Barriers to exit?

21. Evaluating Contestable Markets
A2 Economics Revision
Evaluating Contestable Markets
There are no perfectly contestable markets
What matters is the degree of competition / contestability
The idea is that what matters is not so much competition within a market, but rather competition for a market.
What also matters is the threat of entry of new suppliers – but this may not be enough to affect the behaviour of existing firms
The absence of competition in a market over a long period of time does not necessarily suggest a lack of contestability
Structural changes in costs in different industries can change the degree of contestability
Contestability may force existing firms away from profit-maximising behaviour (e.g. towards sales-revenue maximisation)

22. Normal Profit Contrasted with Profit Maximisation
A2 Economics Revision
Normal Profit Contrasted with Profit Maximisation
Revenue
If the monopolist charges the profit-maximising price, then - if the market is contestable – the firm will be vulnerable to hit and run entry
The only way the monopolist can avoid this happening is to set the price equal to average cost, so that there are no supernormal profits to act as an incentive for entry MC
ATC P1 P2 AR MR
No one in the industry has any advantage over anyone else Q1 Q2
Output (Q)

23. Implications of contestable market theory
A2 Economics Revision
Implications of contestable market theory
The number of firms in an industry is irrelevant in terms of economic efficiency
Abnormal profits attract new entrants driving down prices and ensuring economic efficiency
All markets (excluding natural monopoly) can be efficient so long as they are contestable
Shifts the emphasis of government competition policy away from number of firms towards reducing barriers to entry in an industry
Potential competition may be more important for economic efficiency than actual competition