This section covers the following topics:
Defining Market Power
Market power is:
The ability of a firm to raise prices above competitive levels, without promptly losing a substantial portion of its business to existing rivals or firms that become rivals as a result of the price increase. [1]
Market power is only damaging if the firm concerned abuses its power. Should a firm with market power raise prices above competitive levels, this can dampen consumer demand, generate efficiency losses, and harm the public interest.
In addition, firms with significant market power or dominance may be able to implement a range of strategies to reduce competition, and enhance their position in the market.
Testing for Market Power
The starting point in looking for market power is the competitive price level. Pricing above the marginal, or incremental, cost of a service cannot be regarded per se as evidence of market power. In real world markets the competitive price level will often be higher than incremental cost. In industries with high fixed costs, such as telecommunications, prices must include mark-ups over incremental costs for firms to break even across their whole business.
Regulated prices may also be an inappropriate starting point for detecting market power, as they may differ from competitive price levels. For example, in many countries prices for certain “basic” telephone services are set below their economic cost, to meet universal service goals. In these circumstances market power cannot, and should not, be inferred by comparing any given firm’s price to the regulated price level.
For a finding of market power, the price increase must be sustainable. Firms may be able to temporarily increase prices above competitive levels, for example due to opportunistic behavior or based on innovation. However, in the absence of market power, such price increases are unsustainable. True market power requires that the firm be able to profitably implement the price increase for a significant period of time.
A high market share does not necessarily infer market power. Firms may gain high market shares through means other than market power. A firm’s market share may increase, at least temporarily, due to a successful new invention or better customer service.
Alternatively, a firm may have a high market share for historical reasons. For example, incumbent telecommunications firms were once monopoly franchises in most countries and have high market shares as a result. As competition emerges, an incumbent's market share cannot guarantee it the ability to charge prices higher than its competitors.
Market share in itself is neither necessary nor sufficient for market power. Firms with high market shares may be constrained from raising prices by a range of factors, including:
- Competition from other suppliers already in the market
- The potential for competition from new entrants, and
- The “countervailing power” of customers in the market, for example their willingness to do without the service if the price increases.
Several quantitative measures exist that can help to assess whether a firm may have market power. These indexes include measures of market concentration (such as the Hirschman-Herfindahl Index), and measures of price such as the Lerner Index.
Dominance and Significant Market Power (SMP)
The mere fact that a firm possesses dominance or Significant Market Power does not by itself imply abuse of that dominance or market power. However, such firms can raise prices above competitive levels, and may be able to hinder competition.
There is no universally accepted definition of dominance. In general, a firm is considered to be dominant based on its market share. In some jurisdictions additional factors are also considered in assessing dominance. For example the European Commission also takes into account:
- Firm size,
- The role of any essential facility,
- Any technological advantages, or privileged access to financial resources,
- The strength of the countervailing power of consumers,
- Economies of scale and scope,
- Barriers to entry,
- Product differentiation,
- Potential competition, and
- The type and availability of sales channels.
The European Commission introduced the concept of Significant Market Power to bring an element of ex ante regulation to competition policy in telecommunications. The concept of SMP has since been adopted in other jurisdictions.
The European Commission defines Significant Market Power as the ability of a firm to act independently of competitors and customers.
Under the European model, firms that are found to have SMP are subject to additional ex ante regulatory obligations. This allows telecommunications regulators to impose ex ante regulatory obligations on firms with SMP, such as:
- Obligations to align interconnection prices with costs,
- Accounting separation requirements, and
- Mandatory publication of reference interconnection offers.
Endnotes
[1] See Robert Pitofsky, "New Definitions of Relevant Market and the Assault on Antitrust", Columbia Law Review, 90(7), 1990. Having a dominant market share, however, is not sufficient for being able to exercise market power.
RELATED INFORMATION
Barriers to Entry
Essential Facilities