Market Power and Dominance

As a practical matter, most of the concerns of competition authorities (and telecommunications regulators promoting a competitive market) are focussed on established telecommunications operators that have market power. Firms without market power are simply not able to cause serious problems in the economy or in the sector. If they raise their prices above market levels, for example, they will simply lose customers and profits.

This section discusses the related concepts of market power, significant market power and market dominance.

Market Power Defined

In general, market power is defined as the ability of a firm to independently raise prices above market levels for a non-transitory period without losing sales to such a degree as to make this behaviour unprofitable.

Factors frequently considered in determining whether a firm has market power include:

• Market Share
• Barriers to Market Entry
• Pricing Behaviour
• Profitability
• Vertical Integration

Market share can be measured in several ways, including monetary value, units of sales, units of production and production capacity. Market share alone can be an inaccurate measure of market power. However, it is unlikely that a firm without significant market share will have sufficient market power to behave anti-competitively on its own. Therefore, market share is usually a starting point in determining market power.

Assessment of barriers to entry is also important. The extent to which established suppliers are constrained by the prospect of new market entry is a key factor in whether the established suppliers have market power.

Pricing and profitability are other factors relevant to a determination of market power. The existence of true price rivalry is inconsistent with a finding of market power. Price competition that consists of "follow the leader" behaviour is consistent with the exercise of market power by the price leader.

The profitability of existing suppliers in a market can also be indicative of the extent of true price competition. Excessive profitability typically indicates insufficient price competition and the exercise of market power in setting prices.

Finally, vertical integration is relevant to an assessment of whether a firm that enjoys market power in one market is able to extend its power into upstream or downstream markets. In telecommunications, incumbent operators that are vertically integrated (e.g. that provide local access as well as long distance or international services) can often use their market power in the local access market to competitive advantage in the long distance and international markets. They may abuse their market power, for example, by inflating local access prices (including interconnection prices) and using the surplus revenues to subsidise rate cuts to their competitive long distance or international services.

Significant Market Power

A related concept is that of "Significant Market Power" (or SMP). This is a relatively arbitrary measure of market power utilised in European Commission competition analysis. A number of the European Commission's Open Network Provision (ONP) directives permit the imposition of additional obligations on operators that have SMP. In its July 2000 package of proposed policy reforms the Commission proposed to change its approach, and to focus more on traditional measures of market dominance. Nevertheless, since the SMP approach is frequently referred to, we will discuss it here.

Article 4 of the European Commission's Interconnection Directive states that "an organisation shall be presumed to have significant market power when it has a share of more than 25% of a particular telecommunications market." The article imposes an obligation on organisations with SMP to "meet all reasonable requests for access to the network including access at points other than the network termination points offered to the majority of end-users".

The 25% SMP threshold is not fixed in stone. The Directive permits national regulatory authorities to determine that organisations with less than 25% market share have significant power; and to determine that organisations with market share greater than 25% do not have significant market power. In making such determinations, regulators are directed to take into account factors such as:

• the organisation's ability to influence market conditions
• turnover relative to the size of the market
• control of means of access to end-users
• access to financial resources
• experience in providing products and services in the market

Characterisation of an organisation as having SMP does not necessarily lead to a finding of market power or dominance on the part of that organisation. The SMP designation is simply a trigger for the application of additional obligations under the various ONP Directives.

Market Dominance

Market dominance is a more extreme form of market power. The definition of market dominance varies significantly in the laws and jurisprudence of different countries. In general, however, two factors are key in the determination of market dominance. First there must usually be a relatively high market share (usually no less than 35%, often 50% or more). Second, there must normally be significant barriers to entry into the relevant markets occupied by the dominance firm. (See the EC’s definition of Market Dominance in Box 1-3.)

Box 1-3:

Market Dominance: A European Commission Definition

A position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained in the relevant market by affording it the power to behave, to an appreciable extent, independently of its competitors, customers and ultimately consumers (United Brands v Commission, ECR 207).

Other definitions exist. The UK office of Fair Trading has said that describing an operator as dominant raises the implication that it possesses more market power than any of its competitors. The European Court of Justice has found that there is a presumption of market dominance, in the absence of evidence to the contrary, if a firm has a market share consistently above 50%. As is the case for market power generally, market dominance is not a matter of market share alone. However, some commentators have suggested that a market share in excess of 65% is likely to support a finding of dominance.

Economics of Market Failure

Market failure has become an increasingly important topic. There is a clear economic case for government intervention in markets where some form of market failure is taking place. Government can justify this by saying that intervention is in the public interest. Basically market failure occurs when markets do not bring about economic efficiency.

Government intervention occurs when markets are not working optimally i.e. there is a sub-optimal allocation of resources in a market/industry. In simple terms, the market may not always allocate scarce resources efficiently in a way that achieves the highest total social welfare.

Examples of Potential Market Failure

There are plenty of reasons why the normal operation of market forces may not lead to economic efficiency.

Public Goods

Public Goods not provided by the free market because of their two main characteristics

• Non-excludability where it is not possible to provide a good or service to one person without it thereby being available for others to enjoy

• Non-rivalry where the consumption of a good or service by one person will not prevent others from enjoying it

Examples: Street lighting / Lighthouse Protection, Police services, Air defence systems, Roads / motorways, Terrestrial television, Flood defence systems, Public parks & beaches.

Because of their nature the private sector is unlikely to be willing and able to provide public goods. The government therefore provides them for collective consumption and finances them through general taxation.

Merit Goods

Merit Goods are those goods and services that the government feels that people left to themselves will under-consume and which therefore ought to be subsidised or provided free at the point of use.

Both the public and private sector of the economy can provide merit goods & services. Consumption of merit goods is thought to generate positive externality effects where the social benefit from consumption exceeds the private benefit.

Examples: Health services, Education, Work Training, Public Libraries, Citizen's Advice, Inoculations

Monopoly

Few modern markets meet the stringent conditions required for a perfectly competitive market. The existence of monopoly power is often thought to create the potential for market failure and a need for intervention to correct for some of the welfare consequences of monopoly power.

The classical economic case against monopoly is that

• Price is higher and output is lower under monopoly than in a competitive market

• This causes a net economic welfare loss of both consumer and producer surplus

• Price > marginal cost - leading to allocative inefficiency and a sub-optimal equilibrium.

• Rent seeking behaviour by the monopolist might add to the standard costs of monopoly. This includes high (possibly excessive) amounts of spending on persuasive advertising and marketing.

• Libenstein's X-inefficiency may also result if the monopolist allows cost efficiency to drop. An upward drift in costs because of a lack of effective competition in the market-place can lead to consumers facing higher prices and a reduction in their real standard of living

Externalities

What are the potential market failures arising from externalities?

The social optimum output or level of consumption diverges from the private optimum.

The main problem is the absence of clearly defined property rights for those agents operating in the market. When property rights are not clearly defined, market failure is likely because producers & consumers may not be held to account.

Don't forget that positive externalities can also justify intervention if goods are under-consumed (social benefit > private benefit)

Inequality

Market failure can also be caused by the existence of inequality throughout the economy. Wide differences in income and wealth between different groups within an economy leads to a wide gap in living standards between affluent households and those experiencing poverty. Society may come to the view that too much inequality is unacceptable or undesirable.

Note here that value judgements come into play whenever we discuss the distribution of income and wealth in society. The government may decide to intervene to reduce inequality through changes to the tax and benefits system and also specific policies such as the national minimum wage.