Downstream Competition Research Articles

Bottleneck co-ownership as a regulatory alternative

This paper proposes a regulatory mechanism for vertically related industries in which the upstream “bottleneck” segment faces significant returns to scale while other (downstream) segments may be more competitive. In the proposed mechanism, the ownership of the upstream firm is allocated to downstream firms in proportion to their shares of input purchases. This mechanism, while preserving downstream competition, partially internalizes the benefits of exploiting economies of scale resulting from an increase in downstream output. We show that this mechanism is more efficient than a disintegrated market structure in which the upstream natural monopoly bottleneck sets a price equal to average cost.

A Careful Examination of the Live Nation-Ticketmaster Merger

As great admirers of The Boss and as fans of live entertainment, we share in the popular dismay over rising ticket prices for live performances. But we have been asked as antitrust scholars to examine the proposed merger of Live Nation and Ticketmaster, and we do so with the objectivity and honesty called for by The Boss’s quotes above. The proposed merger has been the target of aggressive attacks from several industry commentators and popular figures, but the legal and policy question is whether the transaction is at odds with the nation’s antitrust laws. One primary source of concern to critics is that Ticketmaster and Live Nation are two leading providers of ticket distribution services, and these critics argue that the merged entity would have a combined market share that is presumptively anticompetitive. We observe, however, that this transaction is taking place within a rapidly changing industry. The spread of Internet technologies has transformed the entertainment industry, and along with it the ticket distribution business such that a reliance on market shares based on historical sales is misleading. A growing number of venues, aided by a competitive bidding process that creates moments of focused competition, can now acquire the requisite capabilities to distribute tickets to their own events and can thus easily forgo reliance upon providers of outsourced distribution services. If self-distribution is an available and attractive option for venues, as it appears to be, then it is unlikely that even a monopolist provider of fully outsourced ticketing services could exercise market power. Ultimately, a proper assessment of the horizontal effects of this merger would have to weigh heavily the emerging role of Internet technologies in this dynamic business and the industry-wide trend towards self-distribution. The second category of arguments by critics opposing the merger rests on claims that vertical aspects of the transaction would produce anticompetitive effects. Indeed, Ticketmaster’s and Live Nation’s core businesses are in successive markets, and thus the proposed transaction is primarily a vertical merger, but there is broad agreement among economists and antitrust authorities that vertical mergers rarely introduce competitive concerns and are usually driven by efficiency motivations. This wealth of academic scholarship, which is reflected in current antitrust law, has not - from our vantage point - been properly incorporated into the public dialogue concerning the proposed merger. To the contrary, critics articulate concerns, including the fears that the merger would lead to the leveraging of market power and the foreclosure of downstream competition, that are refuted by accepted scholarship. Moreover, there are a number of specific efficiencies that, consistent with economic and organizational theory, are likely to emerge from a Live Nation-Ticketmaster merger and would be unlikely but for the companies’ integration. For these reasons, we submit this analysis in an effort to inform the debate with current economic and legal scholarship.

Can Naked Exclusion Be Procompetitive?

Antitrust scholars have argued that exclusive contracts have anticompetitive, or at best neutral effects, if no efficiencies are generated. In contrast, this paper shows that exclusive contracts can have procompetitive effects, provided buyers are imperfect downstream competitors and contract breach is feasible. In that case, an efficient entrant is not necessarily foreclosed through exclusive contracts but induces buyers to breach. Because breaching buyers have to pay expectation damages to the incumbent, the downstream profits they obtain when breaching must be large enough. Therefore, the entrant needs to set a lower wholesale price than absent exclusive contracts, leading to lower final consumer prices and higher welfare.

Using Forward Contracts to Reduce Regulatory Capture

A fully unbundled, regulated network firm of unknown efficiency level can undertake unobservable effort to increase the likelihood of low downstream prices, e.g., by facilitating downstream competition. To incentivize such effort, the regulator can use an incentive scheme paying transfers to the firm contingent on realized downstream prices. Alternatively, the regulator can propose to the firm to sell the following forward contracts: the firm pays the downstream price to the owners of a contract, but receives the expected value of the contracts when selling them to a competitive financial market. We compare the two regulatory tools with respect to regulatory capture: if the regulator can be bribed to suppress information on the underlying state of the world (the basic probability of high downstream prices, or the type of the firm), optimal regulation uses forward contracts only.

Recent EU Case Law Developments: Article 102 TFEU

During the period covered, the European Commission and Courts have followed their traditional approach in the application of Article 102 TFEU (abuse of dominant position). For instance, they have continued to apply the ‘margin squeeze theory’ to cases where inputs controlled by dominant firms are essential for downstream competition or must be provided pursuant to regulatory obligations. Some cases may however generate debate. For instance, one judgment reaffirms the appropriateness of a form-based approach, and another raises the difficulty of striking a balance between the interests of IP rightholders and their generic competitors. The increasing use of the commitments procedure, with possible negative consequences for the development of clear precedents and any jurisdictional control, is also to be noted.

Do Firms Invest in Forecasting Efficiently? The Effect of Competition on Demand Forecast Investments and Supply Chain Coordination

We study the effect of downstream competition on incentives for demand forecast investments in supply chains. We show that with common pricing schemes, such as wholesale price or two-part tariffs, downstream firms under Cournot competition overinvest in demand forecasting. Analyzing the determinants of overinvestment, we demonstrate that under wholesale price contracts and two-part tariffs, total demand forecast investment can be very significant, and as a result, the supply chain can suffer substantial losses. We show that an increased number of competing retailers and uncertainty in consumer demand tend to increase inefficiency, whereas increased consumer market size and demand forecast costs reduce the loss in supply chain surplus. We identify the causes of inefficiency, and to coordinate the channel with forecast investments, we explore contracts in the general class of market-based contracts used in practice. When retailers' forecast investments are not observable, such a contract that employs an index-price can fully coordinate the supply chain. When forecast investments are observable to others, however, the retailers engage in an “arms race” for forecast investment, which can result in a significant increase in overinvestment and reduction in supply chain surplus. Furthermore, in that case, simple market-based contracts cannot coordinate the supply chain. To solve this problem, we propose a uniform-price divisible-good auction-based contracting scheme, which can achieve full coordination when forecast investments are observable. We also demonstrate the desirable properties for implementability of our proposed coordinating contracting schemes, including incentive-compatible and reliable demand forecast information revelation by the retailers, and being regret-free.

On the role of revenue-sharing contracts in supply chains

The supply chain coordinating role of revenue-sharing has, to date, been examined only in static models. With downstream competition, the central conclusion in these models is negative: revenue-sharing cannot, except in degenerate form, achieve coordination. Incorporating dynamics, by allowing inventory carryover in discrete time, this paper establishes a foundation for revenue-sharing contracts in aligning incentives.

Anti-competitive effects of resale-below-cost laws

We show that resale-below-cost laws enable producers to impose industrywide price-floors to retailers. This mechanism suppresses downstream competition but also dampens upstream competition, leading to higher prices. Price-floor may be more profitable for producers than resale price maintenance contracts and, while resale price maintenance may have ambiguous effect on welfare, price-floors always harm welfare. Retailers' buyer power appears as a key element for a price-floor to work out.

Outsourcing suppliers as downstream competitors: Biting the hand that feeds

In this paper, we highlight an aspect of supplier opportunism in the outsourcing paradox that has largely been ignored by extant research – the supplier as a direct competitor of the buyer firm. In light of this paradox, we offer a game-theoretic framework in which we identify conditions under which firms could alleviate or mitigate this outsourcing problem. Our results show that apart from transaction costs, firm-level capabilities (both ordinary and dynamic) play important roles in determining the make only, buy only, or make-and-buy options a firm could exercise in countering the threat of the supplier as a potential competitor in the downstream marketplace.

Open Access and Dynamic Efficiency

In our model, production of a final good requires access to an excludable resource owned by an integrated firm. The quality of the resource depends on an investment by the owner and impacts the downstream demand curve. Under open access, the owner must share the resource with downstream competitors at a regulated tariff. We show that quality exceeds the monopoly level, and increases with the number of competitors, if the access tariff is set according to a principle we call revenue neutrality. Our results contradict the notion that dynamic efficiency must be sacrificed for gains in static (allocative) efficiency. (JEL D21, D43, D45, L24, O34)

Vertical Bargaining and Countervailing Power

We study the existence of countervailing buyer power in a vertical industry where the input price is set via Nash bargainings between one upstream supplier and many differentiated but competing retailers. In case one bilateral bargaining fails, the supplier still has the ability to sell to the other retailers. We show that the capacity of these other retailers to react in the final market has a dramatic impact on the supplier’s outside options and, ultimately, on input prices and welfare. Under downstream quantity competition, we find either no or opposite support to the hypothesis of countervailing power on input prices, as the retail industry becomes more concentrated. With price competition, we find a case for countervailing power, but its existence depends on the degree of product differentiation and on the ability of competing retailers to react to a disagreement.

Chicken, Stag, or Rabbit? Strategic Factor Markets and the Moderating Role of Downstream Competition

Scholars of the resource-based view have developed rich theories of strategic factor markets and pointed to the important implications that the existence of such markets has for firm performance. The prevailing approach in these studies has been to look at the structure of the strategic factor markets themselves, highlighting asymmetries in information or resource complementarity as sources of strategic factor market rents. In contrast, the structure of the downstream markets of the resource-acquiring firms has not been tied explicitly to their participation in upstream (strategic factor) markets. This paper fills that research gap by developing a game-theoretic model of how firms interact in both upstream and downstream markets. It shows that resource-acquiring firms with downstream monopoly power may earn rents on a strategic factor market, as soon as the price of the resource is below its value. However, if firms face strong competition in their output markets they will earn average rents of zero even though the equilibrium price of the resource will generally always be below its economic value. Finally, and most surprisingly, a firm may lose rents from its access to a strategic factor market if it operates in a downstream oligopoly market where tacit collusion is the normal state of affairs.

The Strategic Value of Quantity Forcing Contracts

We explore the strategic value of quantity forcing contracts in a manufacturer-retailer environment under both adverse selection and moral hazard. Manufacturers dealing with (exclusive) competing retailers may prefer to leave contracts silent on retail prices, whenever other aspects of the retailers' activity remain nonverifiable. Two effects are at play when moving from retail price maintenance to quantity forcing. First, restricting screening possibilities may increase retailers' rent. Second, such a restriction affects downstream competition. This latter effect may justify using quantity forcing contracts and, more generally, shed light on a novel source of contractual incompleteness. (JEL D82, D86, L14)

Market Structure, Countervailing Power and Price Discrimination: The Case of Airports

We study bargained input prices where up and downstream firms can choose alternative vertical partners. We apply our model to bargained airport landing fees where a number of interesting policy questions have arisen. For example, what is the impact of joint ownership of airports? Does airline countervailing power stop airports raising fees? Should airports be prohibited, as an EU directive intends, from charging differential prices to airlines? Our major findings are (a) an increase in upstream concentration or in the substitutability between airports always increases the landing fee; (b) the effect of countervailing power, via an increase in downstream concentration, depends on the competition regime between airlines and whether airports can price discriminate: airline concentration reduces the landing fee when downstream competition is in quantities, but if downstream competition is in prices only where airports cannot discriminate. Furthermore, only in a specific case (Bertrand competition, uniform landing fees and undifferentiated goods) will lower fees pass through to consumers. (c) With Cournot competition, uniform landing fees are always higher than discriminatory fees, while the reverse is true with Bertrand competition. We also look at the incentives for airport expansion which raise quantities of passengers paying a given landing fee, but alters the nature of airline competition, which changes the landing fee.

CRESSE SYMPOSIUM ON COMPETITION POLICY: PROCEDURES, INSTITUTIONS, INTELLECTUAL PROPERTY RIGHTS INTRODUCTION

THE COMPETITION AND REGULATION EUROPEAN SUMMER SCHOOL AND CONFERENCE (CRESSE) is an informal network of academics and professionals with an interest in competition policy and sectoral regulation. It was initiated by Yannis Katsoulacos (Athens University of Economics and Business) in 2005 and has since grown to become an important event in the competition and regulation annual conferences calendar, with the continuous support ofMassimoMotta (EuropeanUniversity Institute, Florence), Patrick Rey (University of Toulouse) and David Ulph (University of St. Andrews). The objective is to provide a forum in which the latest research in the areas of competition and regulation is presented and discussed. CRESSE Conference themes have been ‘Abuses of Dominance’ (2006), ‘Competition and Regulation in Network Industries’ (2007), ‘Competition Policy: Procedures, Institutions, IPR’s’ (2008) and ‘Advances in the Analysis of Competition Policy’ (2009). Presentations in the two-day annual Conference include 3–5 invited papers and a limited number (typically 25%–30%) of papers selected from those submitted following a call in the major IO journals. The annual CRESSEConference is held in early July inGreece, the institution responsible for its organization being the Athens University of Economics and Business. CRESSE also organizes an annual summer school in which visiting faculty from a large number of European and U.S. universities provide high quality training topractitioners of competitionpolicy and sectoral regulationwhowish to be up to date with new economic literature and recent legal developments. It is also active in disseminating research in the areas of competition policy and regulation and in contributing, through the organization of special policy sessions and round tables, to public debates on specific policy issues. The annual CRESSE Conference typically has two keynote lectures (the Jean-Jacques Laffont Lecture and theCRESSEConference PolicyLecture),

RETAIL PRICE REGULATION AND THE OPTION TO DELAY

ABSTRACT**** Résumé en fin d’article; Zusammenfassung am Ende des Artikels; resumen al final del artículo. : This paper examines a two-period model of an investment decision in a network industry characterized by demand uncertainty, economies of scale and sunk costs. In the absence of regulation we identify the market conditions under which a monopolist decides to invest early as well as the underlying overall welfare output. In a regulated environment, we consider a monopolist who faces no downstream (final good) competition but is subject to retail price regulation. We identify the welfare-maximizing regulated prices when the unregulated market outcome is set as the benchmark. We show that if the regulator can commit to ex post regulation – that is, regulated prices that are contingent to future demand realization – then regulated prices that allow the firm to recover its total costs of production are welfare-maximizing. Thus, under ex post price regulation there is no need to compensate the regulated firm for the option to delay that it foregoes when investing today. We argue, however, that regulators cannot make this type of commitment and, therefore, price regulation is often ex ante – that is, regulated prices are not contingent to future demand. We show that the optimal ex ante regulation, and the extent to which regulated prices need to incorporate an option to delay, depend on the nature of demand uncertainty.

Level Playing Fields in Regulated Network Industries: Cost-Based Access Pricing, Depreciation, and Capacity Choice

We investigate cost-based access pricing in regulated network industries. Building on recent progress in the accounting literature, we show that a regulator must choose a particular depreciation schedule, namely, relative replacement cost depreciation in order to prevent the network provider from playing manipulative games with the cost-based access price. We then show that the network provider is put at a strategic disadvantage if the regulator sets the access price equal to long-run incremental costs and the downstream market is symmetric. This result may be understood by looking at strategic interaction in the downstream market where both firms are better off if they behave “softly”. If the regulator sets a low access price, he commits the downstream competitor to price aggressively. Then, the entire burden of softening competition must be borne by the network provider. Finally, since consumer prices are decreasing in the access price, we conclude that the regulator faces a tradeoff between low consumer prices and a level playing field on the downstream market.

Access pricing and investment: a real options approach

This paper examines a three-period model of an investment decision in a network industry characterized by demand uncertainty, economies of scale and sunk costs. In the absence of regulation we identify the market conditions under which a monopolist decides to invest early as well as the overall welfare generated by this decision. In a regulated environment, we consider a vertically integrated network provider that is required to provide access to downstream competitors and compare two distinct access pricing methodologies: the Efficient Component Pricing Rule (ECPR) and the Option to Delay Pricing Rule (ODPR). We identify the welfare-maximizing access prices using the unregulated market output as a benchmark and show that optimal access regulation depends on market conditions (that is, the nature of demand) with two possible outcomes: (i) access prices that provide a positive payoff to the incumbent, that is, provide a positive compensation to account for the option to delay; and (ii) access prices that yield a zero payoff to the incumbent. Moreover, unlike the earlier literature that argues in favor of an ECPR-type methodology to account for the interaction between irreversibility and demand uncertainty, we find that, except under very specific conditions, an access price that accounts for the option to delay value is welfare-superior to the ECPR.

Regulating Next-Generation Fixed Access to Telecommunications Services

This paper considers a central issue in telecommunications regulation. What rules, if any, should regulators put in place to provide incentives for timely and efficient investment in NGA while, at the same time, preventing monopoly abuse - either by taking monopoly rents from end users or harming downstream competition? We focus on the regulatory environment in the EU in attempting to answer this question. But the proposals we make are equally relevant to the rest of the developed world. There is a range of both active and passive remedies which regulators might use. We argue that, while passive remedies are important in enabling infrastructure-based competition, active (bitstream) remedies will be important for preserving competition in the supply of retail, NGA-based, products, In particular bitstream offers access seekers a way of reaching customers nation-wide at the same time as the national fixed incumbent for a relatively modest investment. This is especially important when competing for the revenues of multi-sited businesses. To regulate bitstream products effectively regulators might specify the price regulation principles which would apply to operators found to have significant market power (SMP) in NGA supply in advance of any market definition and SMP assessment. To enable timely and efficient investment in NGA regulators should allow access providers to provide distinct NGA-based bitstream products to meet the needs of different segments of the end-user market and to then charge for these products at the wholesale level so as to reflect their value to end users rather than their costs. But regulators also need to put in place competitive safeguards. These might require access providers with SMP to supply all access seekers, including its own downstream retail business, on equivalent supply conditions and prevent them from exerting a price squeeze on access seekers. Access providers with SMP should also provide a price regulated bitstream product to replace unbundled local loops. Transition measures are also important in moving from competition based on copper access to competition based on NGA access. Here we argue that regulators should allow incumbent fixed operators to shut down their copper networks; remove obligations on access providers to offer legacy wholesale products at greenfield sites where they want to supply FTTH; and not require access providers to compensate local loop unbundlers for any shortening of economic asset lives as a result of closure of the copper access networks. Instead they should give reasonable minimum notice of such closures so as to allow an orderly transition to competition in an NGA world.

Hicks-Marshall Conditions and Defining Antitrust Markets for Intermediate Goods

Appropriate definition of the relevant market for intermediate goods is often critical in antitrust inquiries. We combine the well established “Hicks-Marshall” conditions of derived demand for inputs with “critical loss/critical elasticity of demand” and upward pricing pressure analyses to yield important insights into the appropriate definition of antitrust markets for inputs and the competitive effects from a merger. We show that solely examining demand substitution possibilities for direct customers of an input can lead to the wrong market definition. Although several decisions in antitrust cases have qualitatively addressed some of the Hicks-Marshall conditions, a systematic application of critical loss analysis in conjunction with Hicks-Marshall conditions can provide greater insights for delineating relevant markets for inputs. We illustrate how reasonable ranges for key parameters relating to the ability of firms to substitute to other inputs and to adjust to downstream market conditions will often be sufficient to define antitrust markets in practice. In addition, we combine upward pricing pressure analysis with the Hicks-Marshal conditions to illustrate when merging input suppliers will not have an incentive to increase prices because of downstream competition.