PU006
Disruptive
Innovation and
Competition Policy:
Friend or Foe
Pre-University category
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Summary
The phenomenon of disruptive innovation brings about radical changes in markets and
with it, poses new challenges to competition policy. Disruptive innovation can enhance
competition by making markets more dynamic. It also keeps incumbents on their toes
due to the increased possibility of being supplanted by new entrants. On the other hand,
disruptive innovation can directly and indirectly obstruct competition. Disruptive
innovation can directly enable incumbents to further entrench their market power.
Additionally, it allows potential disruptive innovators to drive out and supplant an
existing monopoly. Indirectly, disruptive innovation compels to incumbents to employ
anti-competitive measures to curb the growth of a disruptive innovator. Being a doubleedged sword, disruptive innovation and competition policy can complement as well as
displace each other.
In view of the benefits and challenges brought about by disruptive innovation, this essay
will argue that Singapore competition policy needs to remain relevant, in order to
harness the benefits and mitigate the challenges of these disruptive innovations. Before
proposing new measures, this essay will evaluate the relevance of existing approaches
towards anti-competitive practices. This essay will then propose frameworks to
strengthen and promote disruptive innovation. Furthermore, this essay will consider
other challenges borne out of disruptive innovation that can impede pro-disruptive
innovation competition policy.
(206 words)
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Chapter 1: Singapore Competition Policy and Disruptive Innovation
1.1 Singapore Competition Policy
Singapore competition policy aims to ensure competition in markets by prohibiting anticompetitive practices, abuse of dominant position and anti-competitive Mergers and
Acquisition (Competition Act). Since "anti-competitive activities is likely to result in
higher prices, lower quality, and/or less choices of products and services for
consumers" (CCS, 2015), one important purpose of the Competition Commission of
Singapore (CCS) is to protect consumer welfare. Also, by ensuring a competitive
environment, CCS promotes a business environment conducive to disruptive innovation.
1.2 What is Disruptive Innovation?
Innovation refers to improvements in quality of products, service or business models. A
disruptive innovation is an innovation that brings about drastic changes to product,
service or business models, thereby resulting in radical changes in existing market
dynamics 1 . Disruptive innovation has positive effects on economic welfare and
efficiency.
1
The term "Disruptive Innovation" was originally coined by Clayton Christensen. However, a broader
definition is employed to comprehensively analyze the effects on competition.
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In terms of welfare, disruptive innovation can meet new and neglected consumer
demand (Christensen et. al., 2015). By creating new products and services, disruptive
innovation can lead to a greater variety for consumers.
At a firm level, disruptive
innovation improves the efficiency of business models, thus enabling them to operate at
a lower cost.
Furthermore, disruptive innovation can bring about new market opportunities. Platforms
such as the internet have enabled disruptive innovations through the "sharing
economy"2, improving efficiency in areas where innovations have languished in the past
by translating excess capacity as an opportunity for profit-making. One such example is
the mobile app Uber, which links drivers to commuters. Moreover, innovations in
general are integral for productivity growth, which spurs long-run economic growth.
2
In a sharing economy, the creation and production of goods and services are based on the sharing of
resources.
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Chapter 2: Effects of Disruptive Innovation on Competition
2.1 Enhancing competition
As competition policy ultimately aims to improve contestability and consumer welfare, it
would seem that disruptive innovation complements competition policy to a large extent.
Disruptive innovation intensifies competition by forcing incumbents to be on their toes
as disruptive innovators will compete directly with their own consumer base. This is
because disruptive innovators might have a substantial edge in terms of the quality of
the product, its cost of production, or the strength of the business model in reaching out
to consumers more effectively. For instance, Apple's introduction of the iPhone
transformed the mobile market drastically by marketing a relatively more attractive
product as compared to the existing phone models by incumbents such as Sony, Nokia
and Samsung. This resulted in intensified competition as incumbents sought to maintain
market share by producing similar phone models.
Furthermore, the nature of disruptive innovation can thwart the success of incumbents'
traditional strategies aimed at preventing entrance, such as predatory pricing, capacity
expansion, exclusive dealing and product proliferation. This is because disruptive
innovation displaces the incumbents' products, services and business models such that
lower prices do not necessarily make incumbents products more appealing. This
complements the aim of competition policy to raise competition through contestability, in
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particular, to reduce artificial barriers to entry (BTE) that "perpetuate their dominant
positions in ways unrelated to competitive merit." (Section 47, Competition Act)
2.2 Roadblocks to competition
While it might seem that disruptive innovation complements competition policy, a closer
examination will lead one to draw a different conclusion pertaining to the impacts of
disruptive innovation. Disruptive innovations can directly entrench the market power of
the innovator, leading to lessened contestability. It could also indirectly result in
reactionary anti-competitive measures by other firms to limit the growth of the disruptive
innovator.
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2.2.1 Direct Roadblocks
In the same way that disruptive innovation enhances competition, it can also change
competition dynamics by entrenching the innovator with substantial market power.
Firstly, an incumbent monopoly firm can attempt to hinder competition by reaping
economies of scale 3 in order to drive out and deter existing and potential rivals
respectively. This is exemplified by the success of Wal-Mart, a retailer in the United
States which employed a disruptive business model of discount retailing, that was able
to drive out smaller rivals due to the sheer scale of its operations (Laseter et. al., 2003).
Secondly, disruptive innovation empowers a firm to drive out and supplant an existing
monopoly. The implication is that a market structure characterized by monopoly power
and stymied competition remains as the key feature of the market. As such, far from
encouraging competition between firms, disruptive innovation merely replaces a
monopoly with another. This monopoly can then create its own barriers to entry such as
patenting disruptive innovation, which further limits contestability of the market.
3
EOS refers to cost savings enjoyed by firms due to increased production.
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2.2.2 Indirect Roadblocks
A comprehensive understanding of the impact of disruptive innovation on competition
requires one to analyze the behavior of firms in response to potential radical products
and services. Disruptive innovation does not necessarily incentivise competition
because incumbents can seek rent-seeking measures to rein in on disruptive innovation.
These measures include imposing regulations on disruptive innovators and startups.
One pertinent case study in the Singapore context is the response to transport phone
applications such as Uber and Grab. Taxi companies such as ComfortDelGro seek to
impose legal measures pertaining to safety on these new applications (Lee, 2015). This
also reveals that there are limitations to which current competition policy is able to
ensure a truly competitive business environment.
Additionally, cooperation between startups and incumbents can lead to anti-competitive
practices such as licensing agreements or Mergers and Acquisitions (M&A). A less
competitive economy would be a consequence as such practices could stifle the growth
of a disruptive innovation that could have had upended the market, thus resulting in the
entrenchment of the incumbent's market power. This also removes the incentive of
incumbents to innovate, and to be more attentive to consumer needs.
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Chapter 3: Mitigating challenges and a way forward
In view of the benefits and challenges brought about by disruptive innovation, Singapore
competition policy needs to remain relevant, in order to harness the benefits of these
disruptive innovations and to mitigate the challenges. It could be argued that under the
purview of the Competition Act, abuses of monopoly power in limiting contestability is
already preventable. Rather, the broader concern for Singapore's competition policy
should focus on how to strengthen disruptive innovation against anti-competitive
practices. Before proposing new measures, this essay would evaluate the relevance of
existing approaches towards anti-competitive practices.
3.1 Relevance of existing approaches: the Rule of Reason
The Rule of Reason is "a legal approach ... to evaluate the pro-competitive features of a
restrictive business practice against its anticompetitive effects in order to decide
whether or not the practice should be prohibited." (OECD, 2002). Viewed from the
perspective of innovation, the rule is a cost-benefit analysis of the increased market
power of a firm, comparing the benefits of increased innovation by the firm and the
costs imposed on consumers.
The rule can be argued to be relevant because there is a possibility that disruptive
innovations can originate from existing companies. As demonstrated by the inverted-U
relationship between competition and innovation (Aghion et. al., 2005), excessive
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competition leaves little resources for firms to invest in Research and Development
while the lack of competition disincentivises firms to stay competitive and efficient via
their innovation investments. As such, by adopting the Rule of Reason, competition
policy can promote efficiency within existing firms as incumbents pursue disruptive
innovation in their own business models and markets.
However, disruptive innovation often occurs outside of incumbent firms as incumbents
have little incentive to pursue disruptive innovation (Christensen, 1997). As such, the
nature of disruptive innovation places limits on the applicability of this rule. This calls for
a new approach to disruptive innovation.
3.2 Strengthening and promoting disruptive innovation
3.2.1 A proposed framework for dealing with disruptive innovation
Competition policy needs to focus on protecting potential disruptive innovation from
incumbents attempt at inhibiting its growth, such as patent lawsuits or the enforcement
of copyright law. Such an abuse of regulations can force start-ups with potential
disruptive innovation ideas to reassess the opportunity cost of pursuing their potential
disruptive innovation idea. This might cause them to sell their ideas to incumbents,
engage in M&A or even exiting the market. As such, this essay proposes a framework
towards dealing with M&As and protecting potential disruptive innovation.
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Firstly, CCS has to consider that traditional models using static analysis such as the
SSNIP test 4 are arguably inadequate in examining M&A aimed at curbing disruptive
innovations, which have more dynamic than static effects on market power. This is
because the "emphasis on static price effects resulting from business transactions" has
resulted in "relatively poor attention to effects on innovation." (BIAC, 2015)
Secondly, competition policy can consider the following criteria when deciding whether
a M&A should be permitted: 1) Whether it promotes disruptive innovation by existing
firms? 2) Whether it discourages potential entrants to pursue disruptive innovation in
this market? Complementing this effort, in cases where CCS permits M&A such as
Seek Asia's acquisition of JobStreet Singapore (Leong, 2014), it should place certain
conditions and requirements to its business behavior. Such conditions can include
allowing an acquired disruptive innovator to develop its innovations independently from
the operations of the acquiring firm for a suitable period of time. Additionally, if deemed
in the public interest, the CCS can require the input of the original innovator in the
development of an acquired disruptive innovation. This could help protect competition
and disruptive innovation in the market by curbing abuses of increased market power.
Protecting potential disruptive innovation from other anti-competitive measures by
incumbents is imperative. Firstly, CCS can consider allowing the SMEs and innovators
to decide the amount of time needed to be protected from anti-competitive practices, if
they so wish to. Secondly, CCS should arguably protect potential disruptive innovation
on a case-by-case basis, if it deems it to be in the consumer's interest.
4
SSNIP is a test to determine whether a firm has significant market power.
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3.2.2 Approaches towards regulations
The traditional scope of competition policy which deals with firm-based anti-competitive
measures should also be expanded to look into the effects of regulations on competition
and disruptive innovation. These effects include the imposition of artificial BTEs that
make it difficult for innovators to break into the market. While it could be argued that
unnecessary, rent-seeking regulations could be put in place to protect incumbents as
evident by the influence of business lobbyists in the US, this is less of a concern in
Singapore where politics is largely independent from business. The focus of the CCS
should then be on policymakers implementing well-intentioned policies that might inhibit
competition and disruptive innovation.
CCS can pursue competition advocacy, which involves explaining the positive effects of
competition for consumers to policymakers and identifying the detrimental effects of
regulations on competition. This ensures that policymakers take into account of
competition effects of proposed regulations before implementing them.
Additionally, the CCS needs to acknowledge the balance between the socio-economic
goals of existing regulations and the imperative of achieving a competitive market. To
balance these two competing goals, CCS can collaborate with policymakers to find
ways in which regulations can be modified to lessen restrictions on disruptive
innovations without neglecting legitimate regulatory aims.
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For instance, regulations that aim to protect access to limited resources can have the
unintended consequence of creating oligopolies that engage in anti-competitive
practices, inhibiting the positive effects of disruptive innovation. One example is the
telecommunications industry in Singapore, whereby an oligopoly exists as a result of the
limited frequency spectrum. Disruptive innovations such as Skype and Whatsapp
messages and internet calling services have undercut the profits of these oligopolies.
This is because consumers choose to use such platforms as compared to traditional
forms of communication, namely text messages and phone calls. However, these
oligopolies can abuse their market power to circumvent the effects of disruptive
innovation on their profits. Furthermore, in the context of the telecommunications
industry, the oligopolies have the ability to control access to these disruptive innovations.
As a result, oligopolies can impose measures aimed at covering up their profits,
including attempts to change mobile data plans (Chee, 2014) to charge users for using
these services. CCS can encourage policymakers to consider imposing net neutrality,
which prevents telecommunication companies from restricting access to disruptive
innovation.
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3.3 Other considerations: Equity
Internationally, there has been pushback against disruptive innovations in the taxi
industry such as Uber (Straits Times, 2016). Such political backlash reveals that equity
concerns pertaining to the income and standard of living of parties affected by disruptive
innovation can impede a pro-disruptive innovation competition policy. In such instances,
compensation policies should be considered to advance competition policy aims.
However, in the context of Singapore, the equity issue pertaining to the taxi industry is
different from many countries. In fact, disruptive innovation is beneficial to taxi drivers
because they "benefit from having superior apps that match taxis to passengers more
efficiently, increasing their potential pool of customers." (Low, 2015) This implies that
incumbent taxi companies, not the drivers, are the ones whose revenue, in the "form of
maintaining a large fleet of taxis that are rented out to licensed cab drivers", will be
adversely affected. Businesses, by their very nature, run the risk of obsolescence as
they need to carry the risk of failure against stronger competitors in the first place.
Instead of seeking to impose regulations on disruptive innovations, taxi companies
should preferably evaluate competitive survival strategies.
In sum, the CCS should approach equity concerns regarding disruptive innovation and
competition on a case-by-case basis. CCS should also determine if equity concerns
really exist or are merely used by incumbents as a veneer to entrench existing business
interests, as evident from the local taxi industry case study.
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Chapter 4: Conclusion
In conclusion, this essay proposes two main approaches towards the effects of
disruptive innovation. Firstly, by re-assessing existing approaches, a new framework is
proposed to better deal with M&A and protect potential disruptive innovation. Secondly,
competition policies should focus on the competitive effects of regulations. This enables
competition policy to remain critically relevant in the face of changing market dynamics
brought about by disruptive innovation.
2486 words
[Including references, footnotes, tables, appendices, charts but excluding headers]
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References
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