Market Power and Dominance

As a practical matter, most of the concerns of competition authorities (and telecommunications regulators promoting 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 discuses 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, which 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 which 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 at finding of market power or dominance on the part of that organisation. The SMP designation is simply a trigger for the application ofadditional obligations under the various ONP Directives.

Market Dominance

Market dominance is 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.

Box 1-4:
Market Dominance: A European Commission Definition

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 tot 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.

Essential Facilities

The concept of essential facilities is important to the application of competition law in the telecommunications sector. In the sector, an essential facility is generally defined as one which has the following characteristics:

• It is supplied on a monopoly basis or is subject to some degree of monopoly control
  
• It is required by competitors (e.g. interconnecting operators) in order to compete
  
• It cannot be practically duplicated by competitors for technical or economic reasons.

Definitions of essential facilities have been developed by a number of national regulations and multilateral agencies.

Box 1-5:
Essential Facilities – WTO Definition

The complete WTO Regulation Reference Paper is reproduced in Appendix A. The Reference Paper indicates when and how signatory countries must ensure essential facilities are provided to competitors.

The phrase "bottleneck facility" is sometimes used as a synonym for "essential facility". However, the term "bottleneck" puts the emphasis on the facility being a necessary part of a communications link, the supply of which is restricted, rather than on the ability of competitors to replicate the facility.

Essential facilities mean facilities of a public telecommunications transport network or service that:

• are exclusively or predominately provided by a single or limited number of suppliers
  
• cannot feasibly be economically or technically substituted in order t provide a service

Common examples of essential facilities are network access lines (local loops) and local exchange switching. Local loops are the circuits between a customer's premises and the first "node" or exchange which connects the customer with the PSTN. It can be seen that in many countries, local loops fall within the definition of essential facilities because they are:

1. required by competitors in order to compete for the business of end customers
   
2. predominantly supplied by the incumbent
   
3. technically or economically difficult to substitute, at least on a widespread basis

A telecommunications operator that controls an essential facility often has both the incentive and the means to limit access to the facility by competitors. It becomes a matter of public interest to ensure that essential facilities are available to competitors on reasonable terms. Without such access, competition will suffer, and the sector will operate less efficiently than it could.

Consider, for a example, how much more efficient it is to have a variety of different ISPs, international operators and other telecommunications service providers use the same network access lines and local switches to reach subscribers in a locality. This is far more efficient than having each operator construct network access lines to serve the same locality.

The determination of which telecommunications network resources constitute essential facilities has great practical importance. Too narrow a definition can impede competition by preventing competitors from being able to obtain necessary network components on appropriate terms. Too broad a definition can stimulate uneconomic entry or provide insufficient incentives for competitors to invest in and develop alternative network infrastructure.

Various approaches to defining essential facilities are discussed in later chapter of this course. That section considers which facilities an incumbent operator should be required to unbundle and provide to competitors, the balance of this course illustrates the use of the concept of essential facilities in competition policy as it applies to the telecommunications sector.