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Monopoly, Merger and Cartel -- Three Key Issues in Competition

Hu, Tzu-Shun Senior Specialist, Taiwan FTC Vientiane, Lao PDR 7-8 March 2006

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Market StructureHighly Competitive High Degree of Market Power

Perfect CompetitionFarmingStocksCurrencies

Monopolistic CompetitionRestaurantsSmall BuildersSolicitors

OligopolySupermarketsBanksElectrical Goods

MonopolyGas WaterElectricityTele-communications

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Give me answers , please. Which market structure(s) do you prefer?

why? Well, different people have different answers:

if your are consumers, you prefer… if you are …

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Money! Money!Monopoly!

Monopoly!

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Monopoly and Competition: Which One is better?

Diverging views: The libertarian view The innovator view

Question 1

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The libertarian view:

Adam Smith(1723-1790)

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Milton Friedman

the anonymous free market is a guarantee for political freedom

government interference brings us on the road to serfdom

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Joseph A. Schumpeter (1883-1950)

The innovator view:

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Why should there be anything wrongwith monopoly?

The performance of large firms with respect to R&D is much better than those of small firms

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Price

L(S)MC

Output

L(S)AVC

L(S)ATC

Shut down

CE

q3 q2

Competition

q1

Short run profits

Long run equilibrium

min LAC

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Long-run equilibrium 1. Pareto efficiency (P = MC)

2. Productive efficiency

3. Allocative efficiency

Given a set of alternative allocations and a set of individuals, a movement from one alternative allocation to another that can make at least one individual better off, without making any other individual worse off

Min LAC

Minimum efficiency scale

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BA

Quantity

AR

MR

MC

Pm

QC

PC

Qm

C

Lost Consumer Surplus

Deadweight Loss

Because of the higherprice,

consumers loseA+B and producer gains A-C.

Income transferP

Monopoly

Social welfare =Consumers’ surplus + producers’ surplus

Social welfare = public interest

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Disadvantages 1. Higher price, lower production

2. Deadweight loss ( P > MC)

3. Rent seeking

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P

Quantity

MR

AR

MC

Q*

P*

Rent seeking

The social costs of monopoly are unfortunately often much higher than the DWL.

Every producer has an incentive to establish a monopoly.

He is willing to spend the monopoly profits (at least some of it) to bring him in that position.

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Advantages

1. Economies of scale (or scope)

2. Ability of innovation

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A firm may be monopolist (dominant) for several reasons:1.The firm may have an exclusive licence.2.The firm is natural monopoly.3.The firm has operated more efficiency than its competitors.Note:1.monopoly (dominance) is not per se illegal.2.competition authority will be concerned only if the firm

misuses its market power to deter entry of potential competitors or to substantially lessen competition

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1. Excessive pricing2. Predatory pricing selling at below

cost for the purpose of driving out competitors

3. Refusals to deal 4. Price discrimination a practice wh

ere by a firm charges different customers or classes of customers different prices for the same good for reasons unrelated to costs

5. Exclusive dealing requiring a retailer or distributor not to sell products competing with the supplier's products

6. Tie-ins 7. Third line forcing requiring

purchasers of one product to purchase other products from named suppliers

8. Territorial restrictions the retailer or distributor may not resell outside of a defined territory

9. Customer restrictions the retailer or distributor may only deal with specified customers

10. Resale price maintenance minimum price at which the product may be resold to customers

Types of Misuse of Market Power(Abuse of A Dominant Position)

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Do you want to your enterprise is as large as Microsoft?

Yes, but how can I let my enterprise grow up? Internal Growth External Growth

Question 2

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Growth of Firms

Internal Growth

External Growth (Merger)

Vertical Merger

Horizontal Merger

Conglomerate

Types of Merger

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Horizontal Merger ： two competitors combine

Primary

Secondary

Tertiary

New Mobile Manufacturer

Mobile Manufacturers

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Vertical Merger ： one company acquires a supplier/customer

Primary

Secondary

Tertiary Retail Stores

Manufacturer

Vertical Merger Backwards – acquisition takes place towards the source

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Primary

Secondary

Tertiary

Dairy Farming Co-operative

Cheese Processing Plant

Vertical Merger Forwards – acquisition takes place towards the market

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Conglomerate ： two firms from different industries combine

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Why should mergers occur?Motives

Cost SavingsExternal growth may be cheaperthan internal growth – acquiring an underperforming or young firm may represent a cost effective method of growth

Managerial RewardsExternal growth may satisfy managerial objectives – power, influence, status

Shareholder ValueImprove the value of the overall business for shareholders

Asset StrippingSelling off valuable parts of the business

Economies of Scale(Scope)The advantages of large scale production that lead to lower unit costs

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EfficiencyImprove technical, productive or

allocative efficiency

Synergy The whole is more efficient than the sum

of the parts (2 + 2 = 5!)

Risk Bearing– Diversification to spread risks

Control of Markets-- Gain some form of monopoly power– Control supply– Secure outlets

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Competition restraint Horizontal -- might directly reduce competition significantly ( lessen the number of firms, increase market power, and may make conspiracy)

Vertical -- possibility of cut-off supply to the competitors

Conglomerate -- deep pockets, internal cross-subsidization, may facilitate predatory pricing

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BA

Quantity

AR

P2

Q1

P1

Q2

Cost-saving

Deadweight Loss

P

AC1

AC2

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Merger control Criterion

Economic Benefit > Competition Restraint (cost-saving) ( deadweight loss)

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“What shall I do about it? They say this is no concerted practice but their way to greet each other!“

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“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Adam Smith, The Wealth of Nations (1776)

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Why Investigate Concerted Action:The Monopoly Problem

A monopolist creates artificial scarcity of its product by producing less and selling it at a higher price than if it faced competition.Firms, by entering into horizontal or vertical agreements, may be able to collectively exercise monopoly power, thereby doing the same harm to competition and consumers as a monopolist.

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Concerted Action

Horizontal Agreement(Cartel, Collusion)

Vertical Agreement

Types of Concerted Action

Price Fixing HardBid Rigging CoreMarket Division Cartel

TyingExclusive dealingResale Price Maintenance(RPM)

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How Horizontal Agreements May Benefit/Harm Competition

Benefit 1. Economies of Scale 2. Economies of Scope 3. Sharing or spreading of risk.

Harm 1. International Cartels -- DRAM Cartel -- Graphite Electrodes Cartel -- Lysine Cartel -- Vitamins Cartel

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How Vertical Agreements May Benefit/Harm Competition

Benefit 1. Lowering transaction costs. 2. Assuring a steady supply of key input. 3. Eliminating negative externalities. 4. Getting around another company’s exercise of market power. 5. Preventing “free riding”.

Harm1. Eliminating competition through “foreclosure”.2. Raising barriers to entry or “raising rivals’ cost.’3. Creating distributors’ or manufacturers’ cartels.

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Exemption1. unifying the specifications or models of goods for the

purpose of reducing costs, improving quality, or increasing efficiency;

2. joint research and development on goods or markets for the purpose of upgrading technology, improving quality, reducing costs, or increasing efficiency;

3. each developing a separate and specialized area for the purpose of rationalizing operations;

4. entering into agreements concerning solely the competition in foreign markets for the purpose of securing or promoting exports;

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5. joint acts in regards to the importation of foreign goods for the purpose of strengthening trade;

6. joint acts limiting the quantity of production and sales, equipment, or prices for the purpose of meeting the demand orderly, while in economic downturn, the market price of products is lower than the average production costs so that the enterprises in a particular industry have difficulty to maintain their business or encounter a situation of overproduction; or

7. joint acts for the purpose of improving operational efficiency or strengthening the competitiveness of small-medium enterprises.

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New Policies for Cartels

The Need for International Cooperation Bilateral Agreements • Arrange Comparable economies • Imbalance of interest if large with small economy Regional Integration

FTA negotiations in many regions; some involve common competition rules as a longer-term objective.

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Leniency Program : To encourage a member of a cartel to confess and implicate its co-conspirators with first-hand, direct“insider” evidence about their clandestine meetings and communications, an enforcement agency may promise a smaller fine, shorter sentence, less restrictive order, or complete amnesty (immunity).