Address to ACCC Conference 29 July 2004 My Assignment The pricing - PowerPoint PPT Presentation

Access Pricing, Innovation, and Effective Competition William G Shepherd Address to ACCC Conference 29 July 2004

My Assignment The pricing of Access to promote 1. innovation, fairness and efficiency How to tell if downstream competition is 2. really effective Deregulation: when can controls be 3. removed safely?

The Main Goals, Most Important First: � Innovation and Technological progress. New products and production methods are adopted quickly. � X-efficiency. Internal business efficiency in minimising costs and managing long-run investment decisions. � Fairness in Distribution. There is fairness in the patterns of wealth, income and opportunity

Other Important Goals � The Competitive Process Itself. Competition provides values of open opportunity and rewards to extra effort and skill. � Allocative Efficiency. Resources are allocated among markets and firms in patterns that maximize the value of total output. Price equals long-run marginal cost and minimum average cost. � Freedom of Choice. Individuals have wide choice in buying goods, choosing jobs, and starting businesses.

Poor Innovation and Efficiency by Monopolies and Dominant Firms … U.S. Instances of Poor Innovation AT&T in the 1950s-1970s, doing poorly on 1. exchange technology, optical fibers, and just about everything else; IBM in the 1960s (as Thomas Watson, Jr., IBM’s 2. head, openly admitted); Eastman Kodak (it excluded Berkey in the 1970s, 4. and Kodak was slow to go into digital since 1990); and Microsoft’s quality of technology and software has 5. been mediocre ever since its lucky rise around 1980.

Cont’d Sloth and Disarray in Leading U.S. Firms US Steel in 1910s-1940s, 1. General Motors in the 1950s-1980s, 2. Xerox in the 1970s-1980s, 3. IBM in the 1980s, 4. Boeing in the 1980s-1990s, 5. Kodak in the 1990s,…. 6.

The Schumpeterian Competitive Process: “Creative Destruction” A dominant form exploits and abuses market power, yielding 1. inefficiency and retarding innovation. Soon it is invaded from outside and ousted by an innovating 2. firm, which quickly becomes the new dominant firm. It imposes the same abuses, inefficiency, and loss of 3. innovation. Soon it too is invaded and ousted; so the process goes on… 4. Note: The market is always changing, always inefficient, but creating powerful innovation. This Schumpeterian competition is dynamic and out of disequilibrium. It’s the opposite of static neoclassical perfect competition But: it requires quick entry and rapid ouster.

Criteria for Fully Effective Competition Enough competitors: At least 5 reasonably 1. comparable rivals. Competitive parity: no single dominant firm, 2. with 40% of the market or more Entry by new competitors must be relatively 3. easy to do so

Long-lasting Dominance in selected U.S. Industries (other than in franchised utility sectors) Name of Dominant Firm and Years of Dominance Length of Dominance Market (approximate) (approximate) Eastman Kodak amateur film 1900 - 1990s 90 years IBM main-frame computers 1950s - 1990 40 years (continuing?) General Motors automobiles 1930 - 1985 55 years Alcoa aluminum 1900 - 1950 50 years Campbell Soup canned soup 1920s - continuing 70+ years Procter & Gamble detergents 1920s - continuing 70+ years Kellogg cereals 1920s - 1990s 60+ years Gillette razors 1910 - continuing 85+ years

The Criteria Got Increasingly Cluttered during the 20 th Century During 1900-1920: focused on Dominant firms (Standard 1. Oil, American Tobacco, International Harvester, DuPont, USSteel, AT&T,…) and on Market Imperfections The 1930s: Oligopoly theory and real concentration ratios. 2. In 1940, J.M Clark’s “workable competition,” with some 10 3. criteria. But they’re not practical. From 1956 on: Joe Bain stressed entry barriers, at the 4. edge of the market. But there are many sources; especially price strategies. In 1982, Baumol’s group proposed “contestability,” to 5. displace competition itself.

Some Main Market Imperfections… Consumers May Exhibit Irrational Behavior. Some or 1. many of them may have preferences that are poorly formed, unstable or inconsistent. They may behave like “captive customers”. Producers May Exhibit Irrational Behavior. Some or 2. many of them may have limited or inconsistent decision- making abilities. They may pursue goals other than pure profit maximizing. There may be large Uncertainties, which interfere 3. with rational and consistent decisions by consumers and/or producers Lags may occur in the decisions and/or actions of 4. consumers or producers. That may permit firms to take strategic actions which prevent competition and/or beneficial outcomes.

More Market Imperfections … Consumer loyalties may exist, often instilled or 5. intensified by advertising. This can prevent objective choices by consumers. The segmenting of markets may be accentuated and 6. exploited. Then the large producers may use price discrimination strategically to extend and sustain their monopoly power. Differences in access to information, including 7. secrecy. Superior knowledge can let some firms gain excess profits without having superior efficiency.

Even More Market Imperfections … Barriers against new competition. New entry may be 8. blocked or hampered by a variety of conditions which raises entry barriers (more coming). Transactions costs and excess capacity may be large. 9. They may occur naturally or be increased by firms’ deliberate actions. Internal distortions in information, decision-making and 10. incentives may cause x-inefficiency and distorted decisions. E.g., misperceptions and conflicts of interest between share-owners and managers, and between upper and lower management groups. These problems in large, complex organizations include bureaucracy, excess layers of management, and distorted information and incentives.

JM Clark’s Criteria for “Workable Competition” (1940) Extent of standardization of the product 1. Degree of seller concentration 2. Method of selling price 3. Extent of market intermediation (e.g., by brokers, 4. salesmen) Extent, type and quality of market information 5. Spatial distribution of consumers and producers 6. Responsiveness of actual supply to production 7. Pattern of long-run costs 8. Pattern of short-run costs 9. Flexibility of capacity variation 10.

Some Causes of Entry Barriers… Exogenous Causes: External Sources of Barriers Capital Requirements. Large capital-intensive firms require big 1. funding. Economies of Scale , from both technical and pecuniary causes. 2. They require entry at larger sizes. Absolute Cost Advantages . There are many possible causes 3. (higher wage rates that entrants must pay, past investment in low- 4. cost technology, etc.). Product Differentiation . Varying features, brands, etc. 5. Sunk Costs: any cost which are incurred by an entrant but which 6. cannot be recovered upon exit. Research and Development intensity . It requires entrants to 7. spend heavily on the creation of new technology and products.

More Barriers Causes … High durability of firm-specific capital (“asset specificity”). It 7. imposes high costs for creating narrow-use assets for entry; and high losses if the entry fails. Vertical integration . It may require entry to occur simultaneously at 8. two or more stages of production. That raises the costs and risks, and hence the barriers. Raising Rivals’ costs . An incumbent may take actions which 9. require a prospective entrant to incur extra costs. Switching Costs. Purchasers of complex systems may have to 10. invest in training and associated equipment. Special Risks and uncertainties of entry . New Firms may face 11. higher degrees of risk, raising their costs of obtaining capital. Gaps and asymmetries of information . Entrants may inherently 12. lack crucial information about market conditions. Formal, official barriers set by government agencies or 13. industry-wide groups . Examples are exclusive utility franchises, bank-entry certification, and foreign trade duties and barriers.

Even More Barriers Causes… II. Endogenous Causes: Voluntary and strategic sources of barriers Pre-emptive and retaliatory actions by incumbents. 1. These are extremely numerous and important. They may include selective price discounts, even to very low levels, so as to prevent or punish entry. Excess Capacity . If the incumbent holds substantial excess 2. capacity, it is a basis for sharper retaliation and an immediate displacement of the entrant’s sales Selling expenses, including advertising . This increases the 3. degree of product differentiation Segmenting the Market . This creates distinct market areas 4. and makes new across-the-board entry more difficult.

Still More Barriers Causes … Patents. They may provide exclusive control over critical 5. or lower-cost technology and products. That can directly exclude entry. Exclusive controls over other strategic resources . 6. These may exclude entrants from the superior ores, favourable locations, specific talents of personnel, etc., that they need in order to compete on even terms. “Packing the Product Space”. This may occur in 7. industries with high product differentiation and varieties of products, such as the US cereals industry. Secrecy about crucial competitive conditions. Secrecy 8. about key conditions which would permit entrants to compete fairly may block that entry.