Day 2 Session 4

The design of processes of

economic regulation
Jeremy Turk

Requirements of the analysis of markets

A system based on the comprehensive analysis of
markets rather than concentration on specific
offences
A method of identifying when ex ante regulation is the
correct approach because competition is not
generally effective
A process that can be applied uniformly across the
EU in order to ensure a level playing field
An approach based on economic logic and objective
market circumstances
The ability to ensure that current and prospective
cases are treated fairly and in a non-discriminatory
manner
A workable concept of market power

Significant Market Power (Dominance)

A Provider will be deemed to have SMP if, either
individually or jointly with others, it enjoys a position
of economic strength affording it the power to behave
to an appreciable extent independently of
competitors and customers

Where a Provider has SMP in a specific Relevant

Market, it may also be deemed to have SMP in a
closely related market, where the links between the
two markets are such as to allow the market power
held in one market to be leveraged into the other
market, thereby strengthening the market power of
the Provider

An NRA SMP Programme

An National Regulatory Authoritys programme to
control SMP should include four activities:
1. Define Relevant Markets in terms of
product/services, customer groups,
retail/wholesale and geography/route.
2. Analyse each Relevant Market, to determine
whether any providers have Significant Market
Power (SMP)
3. Issue decisions as to providers having SMP in
a Relevant Market
4. Impose regulatory obligations on those
providers identified as having SMP

The European Union process

Identify possible
competition issue

Define relevant
markets

Assess market power

Identify dominant
operator
Produce list of
markets liable to
ex ante
regulation

Consider ex ante regulation

High and nontransitory entry

barriers

Lack of medium tern

tendencies to effective
competition
Inadequacy of
competition law

Consider
competition policy
remedies

The definition of relevant markets

Market definition is central to both US and EU
approaches. In EU it is part of a comprehensive
analysis of markets intended to identify where ex
ante regulation may be required.
Regulatory authorities have attempted to set in place
formal processes that can yield objective analysis
dependent on economic reasoning and the facts of
the situation
The importance of market definition is bolstered by
the structure, conduct, performance view of
markets and market power

The SSNIP test - concept

Regulators need to look at markets in terms of the
possibility that market power may be used to
disadvantage consumers
The SSNIP test takes the market is the smallest
collection of products that a hypothetical monopolist
would find worth monopolising
The ideas of consumer product substitution and
elasticity of demand lie behind the test
The SSNIP test: a Small but Significant and Nontransitory Increase in Price would it be profitable?
In practice, the supposed effect of a 5-10% price rise
over a period of one or two years in inducing
switching to alternatives

The cellophane fallacy

In an early case in the US, Dupont argued that cellophane
was not a relevant market since at prevailing prices there
were high cross-elasticities of demand with other
packaging materials
The US Supreme Court failed to recognise that both a high
own-price elasticity and the identification of effective
substitutes merely reflected the existence of exploited
market power potential
A monopolist will already be charging a price higher than
the competitive price so a test for market that relies on
further raising the price will be bound to fail.
The SSNIP test should begin with the competitive price
but what is it?
The possibility of the cellophane fallacy is a major
practical threat to the usefulness of the SSNIP test in
defining markets

The SSNIP test an example

A: Basic product at issue

B: Enhanced alternative

C: More basic alternative

C

vc

vc

vc

10

1000

5000

13

800

5600

1100

5500

11

700

4200

13

900

6300

1200

6000

-800

+700

+500

A monopolist of A would lose 800 by raising price by 10%

A monopolist of A+B would lose 100 by raising the price of A by 10%
A monopolist of A+C would lose 300 by raising the price of A by 10%
A monopolist of A+B+C would gain 400 by raising the price of A by 10%

The SSNIP test defines the market as A+B+C

The role of market definition

Although market definition is necessary to calculate
market shares, these market shares may be unreliable as
well as, in themselves, revealing little about the process of
competition
There is a difference between defining the market for a
very specific purpose and defining an exhaustive list of
mutually-exclusive markets
Often, specific abuses can be analysed by considering the
market power of the abuser directly
A formal process including the SSNIP test approach
will not produce an all-purpose set of markets
Such lists of markets cannot be applied in any jurisdiction
Information may not be available (reliable elasticities and
the competitive price)
Market definition requires a variety of approaches that
maximise the use of what information is available

The European Union process

Identify possible
competition issue

Define relevant
markets

Assess market power

Identify dominant
operator
Produce list of
markets liable to
ex ante
regulation

Consider ex ante regulation

High and nontransitory entry

barriers
Lack of medium tern
tendencies to effective
competition

Inadequacy of
competition law
Consider
competition policy
remedies

From economics to regulatory decision

Is competition effective?
The structure, conduct, performance approach: market
power is ultimately determined by market structure but
indicators of conduct and performance may be important
information
Are existing prices and quality the competitive prices and quality?
Are costs as low as possible?
Is profitability too high?

If competition is not effective which suppliers have market

power?
Is one player dominant?
Is there collective dominance?
Do many players have small amounts of market power
for example, as the result of product differentiation?

Monopoly, market power and competition

One
decision
maker
Monopoly
Market
Power

One decision
maker can act
independently of
other competitors
Dominance

Interdependent competitors
must consider reactions of other
competitors
Oligopoly
Monopolistic
competition

Limited independence of
competitors because each has
distinctive products

Effective
competition

No competitor has
significant market power

Perfect
competition
Number of competitors

No competitor can affect the

behaviour of any others

Criteria for assessing effectiveness of

competition
Similar information is required to assess competition
and to identify dominance
Indicators of the extent of competition in the relevant
market:

Rate of growth
Technological advances and degree of innovation
Number of potential competitors
The degree of price competition
The development of prices over time
The degree of competition on quality
The degree of differentiation of products
The extent to which the consumers are satisfied with the
service choices, quality and price

Criteria for identifying SMP 1

Market position of provider
Market share and market concentration. High and stable market
shares do not always indicate that a Provider has SMP: the historic
position and current trends are also relevant
Overall size of the Provider
Easy or privileged access to capital markets and financial resources
Strength of brand and brand loyalty
Strength of distribution network
Experience in the marketplace
Length of time the Provider has been in a strong position
Absence of potential competition
Economies of scale
Economies of scope e.g. bundled products or services
Vertical integration
Ability of the Provider to influence market conditions especially
prices

Criteria for Identifying SMP 2

Ease of market entry by others
Entry barriers related to control of infrastructure by a
provider, in particular control of the means of access to end
users; control of other infrastructure not easily replicated; or
brand strength of existing providers;
Control of transit services by a provider;
Utilization of excess capacity. If a provider has significant
excess capacity, this may result in an entry or growth barrier
to others. In the event of an increase in demand in the
market, the provider can increase production without major
investment and thus prevent new providers entering or
winning market share;
Product diversification/bundling of products;
Degree of vertical integration of provider;
Size of distribution and sales network of provider;
Technological advantages or superiority.

Criteria for identifying SMP 3

Demand-side factors
Countervailing buying power
Switching costs and lock-in effects:
If there are restrictions or costs for End Users changing Provider,
this increases the opportunity for a Provider to gain SMP
Such restrictions may be practical, technical or financial, or may
arise because the End Users have greater confidence in existing
and well-established Providers rather than new Providers and will
not risk switching

End Users' access to information:

For End Users to make an effective choice between Providers in
a market (in initial purchase or switching), they need information
to compare offerings.
Use of complicated price structures, bonus and discount
arrangements etc. restricts the opportunities for effective End
User choice and may contribute to strengthening a Provider's
power in the market.

Profitability
Market power tends to give rise to profits that are higher
than the normal
In competitive markets investment opportunities with
positive Net Present Value should not persist indefinitely
But excess profits are difficult to identify
What is the appropriate asset base?
Allowing for inflation
Taking into account rapid technological development
Taking into account and valuing intangible assets

How should riskiness be assessed and rewarded?

Cost of capital should take into account non-diversifiable risk
Actual high returns may reflect upside returns on risky projects that have
an ex ante expected returns equal to the cost of capital

Profitability analysis was carried out in the UK Competition

Commission investigation of the Movies on Pay TV and
Skys high profitability is consistent with other evidence
showing a lack of effective competition

The regulator as competition authority

Identify possible
competition issue

Define relevant
markets

Assess market power

Identify dominant
operator
Produce list of
markets liable to
ex ante
regulation

Consider ex ante regulation

High and nontransitory entry

barriers
Lack of medium tern
tendencies to effective
competition
Inadequacy of
competition law

Consider
competition policy
remedies

Assessing markets as requiring ex ante

regulation
The fact that a market is not effectively competitive
does not mean that ex ante regulation is necessary;
ex post competition law may be adequate
A key issue is whether competition can be expected
to become effective in the near future
And competition remedies (including structural
remedies) may be able to enable this by removing
strategic behaviour
Ex ante regulation should attack persistent or
permanent market failures or regulatory objectives
that are not achieved by competition

Three criteria test for ex ante regulation

In order to identify markets that are susceptible to ex
ante regulation, the EU has developed a 3 criteria
test:
The presence of high and non-transitory barriers to entry.
These may be of a structural, legal or regulatory nature.
The existence of markets whose structure does not tend
towards effective competition within the relevant time
horizon.
The application of competition law alone would not
adequately address the market failure(s) concerned

In the absence of these criteria, competition law

should prove sufficient but NB: this is in the context
of the nature and power of EU competition law

EU markets susceptible to ex ante regulation

2002
Retail Level

Wholesale Level

1.

Access to the public telephone network at a fixed

location for residential customers.

8.

Call origination in the public telephone network provided at a

fixed location.

2.

Access to the public telephone network at a fixed

location for non-residential Customers.

9.

Call termination on individual public telephone networks

provided a fixed location.

3.

Publicly available local and/or national telephone

services provided at a fixed location for residential
customers.

10.

Transit services in the fixed public network.

4.

Publicly available international telephone services

provided at a fixed location for residential customers.

11.

Wholesale unbundled access (including shared access) to

metallic loops and sub-loops for the purpose of providing
broadband and voice services.

5.

Publicly available local and/or national telephone

services provided at a fixedlocation for non-residential
customers.

12.

Wholesale broadband access.

6.

Publicly available international telephone services

provided at a fixed location for non-residential
customers.

13.

Wholesale terminating segment to leased lines.

7.

The minimum set of leased lines.

14.

Wholesale trunk segments of leased lines.

15.

Access and call origination on public mobile telephone

networks.

16.

Voice call termination on individual mobile networks.

17.

The wholesale national market for international roaming on

public mobile networks.

18.

Broadcasting transmission services, to deliver broadcast

content to end users.

[Note that markets are often referred to by the numbers assigned to them under the EC Recommendation (e.g., the mobile termination
market may be referred to as Market 16).]

Source: ITU

EU markets susceptible to ex ante regulation

2007
Retail level
1. Access to the public telephone network at a fixed location for residential
and non-residential customers (Previously 1+2)

Wholesale level
2. Call origination on the public telephone network provided at a fixed
location (Previously 8)
3. Call termination on individual public telephone networks provided at a
fixed location (Previously 9)
4. Wholesale (physical) network infrastructure access (including shared or
fully unbundled access) at a fixed location (Previously 11)
5. Wholesale broadband access (Previously 12)
6. Wholesale terminating segments of leased lines, irrespective of the
technology used to provide leased or dedicated capacity (Previously
13)
7. Voice call termination on individual mobile networks (Previously 16)
NB Developing countries where mobile telecommunications is preeminent may have concerns about dominance in retail mobile markets
and be less concerned about local loop unbundling

Retail markets and competition in Bahrain

TRA and Batelco conclusions regarding the level of competition in the
relevant markets defined in the August 2007 Consultation
Competition assessment
#

Market
TRA

Batelco

Fixed access narrowband connections and domestic

calls originating on fixed lines - non-residential
customers

Not competitive

Prospectively competitive

Fixed access narrowband connections and domestic

calls originating on fixed lines - residential customers

Not competitive

Prospectively competitive

All international calls made from a fixed location to

Zones 1 countries (GCC countries), Zone 3 countries
(USA, Australia, UK, FR, etc) and Zone 4 countries
(Others)

Zone 1: Not competitive

Zone 3 & 4: prospectively
competitive

Effectively competitive

3b

International calls made from either a fixed or mobile

phone to Zone 2 countries (South Asian countries)

Effectively competitive

Effectively competitive

Mobile services, including mobile originated

international calls to Zones 1, 3 and 4 countries

Prospectively competitive

Effectively competitive

Internet access from a fixed location

Not competitive

Prospectively competitive

Leased line services (domestic and international

leased lines)

Not competitive

Effectively competitive

Wait and see - ex post competition policy

Ex post regulation
The principle here is to wait until there is evidence of wrong-doing
before taking action
The approach generally taken under competition law
Consistent with the general legal principle of innocent until proven
guilty
Minimally invasive and avoids the law of unintended consequences

Ex post remedies include:

Directions
Tell the offending operator to cease the offending activity
Impose corrective actions e.g. monitoring and reporting, structural
separation

Fines

Issues with ex post regulation:

Investigations can be time-consuming and evidence difficult to gather
Conclusions and remedies may be too late to prevent entrants from
being driven out of business