Why does the government intervene
in markets to maintain competition?
Why might a government
intervene to
encourage competition
or prevent monopolies &
mergers?
To encourage technological
innovation & dynamic
efficiency
To contribute towards
improved efficiency
To ensure effective price competition
between suppliers
What is a
cartel?
An agreement between
competing firms to control
prices or exclude entry of a
new competitor in a market.
It is a formal organization of
sellers or buyers that agree to
fix selling prices, purchase
prices, or reduce production
using a variety of tactics.
The 4 pillars of competition policy in
the UK and EU
Antitrust & cartels
Market liberalisation
This involves the elimination of agreements
that seek to restrict competition including
price-fixing and other abuses by firms who
hold a dominant market position (defined
as having a market share in excess of forty
per cent).
Liberalisation involves introducing fresh
competition in previously monopolised
sectors such as energy supply, postal
services, mobile telecommunications and
air transport.
State aid control
Merger control
Competition policy analyses examples of
state aid measures to ensure that such
measures do not distort competition in the
Single Market
This involves the investigation of mergers
and take-overs between firms (e.g. a
merger between two large groups which
would result in their dominating the
market).
Main Roles of the Regulators
Regulators are the rule-enforcers and they are
appointed by the government to oversee how a
market works and the outcomes that result for both
producers and consumers.
The EU Competition Commission is an
important regulator of business activity in
the single market. The main UK regulators
(namely the Office of Fair Trading and the
Competition Commission) merged in 2014
as part of a competition reform by the new
coalition government to create the
Competition and Markets Authority
(CMA).
Regulators:
Monitor and regulate prices
• Aim to ensure that companies do not
exploit their monopoly power by
charging excessive prices.
• Look at evidence of pricing behaviour
and also the rates of return on capital
employed to see if there is evidence of
‘profiteering.’
• Recently the EU Competition Commission
made a ruling on the ‘roaming’ charges of
mobile phone operators in the EU and
enforced a new maximum price on such
charges.
Regulators:
Ensure standards of customer service
• Companies that fail to meet specified
service standards can be fined or
have their franchise / license taken
away.
• May also require that unprofitable
services are maintained in the wider
public interest e.g. BT keeping phone
booths open in rural areas and inner
cities; the Royal Mail is still required
by law to provide a uniform delivery
service at least once a day to all
postal addresses in the UK.
Regulators:
Open up markets
• Encourage competition by removing
barriers to entry.
• This might be achieved by forcing the
dominant firm in the industry to allow
others to use its infrastructure network.
• A key task is to fix a fair access price for
firms wanting to use the existing
infrastructure. Fair both to the existing
firms and also potential challengers
Regulators:
The surrogate competitor
• Regulation can act as a form of surrogate
competition – attempting to ensure that
prices, profits and service quality are
similar to what could be achieved in
competitive markets.
• Fear of action by OFT and other regulators
may prevent anticompetitive behaviour
(i.e. there will be a deterrent effect)
The key role of competition authorities
around the world including the European
Union is to protect the public interest,
particularly against firms abusing their
dominant positions - A firm holds a
dominant position if its power enables it to
operate within the market without taking
account of the reaction of its competitors
or of intermediate or final consumers.
Anti-Trust Policy - Abuses of a
Dominant Market Position
A firm holds a dominant position if
its power enables it to operate
within the market without taking
account of the reaction of its
competitors or of intermediate or
final consumers.
Competition authorities consider a
firm’s market share, whether there
are credible competitors, whether
the business has ownership and
control of its own distribution
network (achieved through vertical
integration) and whether it has
favourable access to raw
materials.
Holding a dominant position is not
wrong if it is the result of the firm's
own competitiveness against
other businesses! But if the firm
exploits this power to stifle
competition, this is an anticompetitive practice.
Anti-competitive
practices are designed
to limit the degree of
competition inside a
market
Predatory pricing
Also known as
‘destroyer pricing’
When one or more firms deliberately sets
prices below average cost to incur losses for
a sufficiently long period of time to eliminate or
deter entry by a competitor – and then tries
to recoup the losses by raising prices above the
level that would ordinarily exist in a competitive
market.
Vertical restraint
Exclusive dealing: when a retailer undertakes to
sell only one manufacturers product. These may be
supported with long-term contracts that “lock-in” a
retailer to a supplier and can only be terminated by
the retailer at high financial cost. Distribution
agreements may seek to prevent instances
of parallel trade between EU countries (e.g. from
lower-priced to higher priced countries).
Territorial exclusivity: This exists when a particular
retailer is given the sole rights to sell the products of
a manufacturer in a specified area.
Vertical restraint
Quantity discounts: Where retailers receive
larger price discounts the more of a given
manufacturer's product they sell - this gives them
an incentive to push one manufacturer's products
at the expense of another's.
A refusal to supply: Where a retailer is forced to
stock the complete range of a manufacturer's
products or else he receives none at all, or where
supply may be delayed to the disadvantage of a
retailer.
Collusive practices
These might include agreements
on market sharing, price-fixing
and agreements on the types of
goods to be
produced.
Price Fixing & the law
UK competition law now
prohibits almost any attempt
to fix prices - for example,
you cannot:
• Agree prices with competitors or agree to
share markets or limit production to raise
prices.
• Impose minimum prices on different
distributors such as shops.
• Agree with your competitors what
purchase price you will offer your suppliers.
Price Fixing and the Law
Cut prices below cost in order to force a
weaker competitor out of the market.
Under the Competition
Act 1998 and Article 81
of the EU Treaty,
cartels are prohibited.
Legal Collusion – Horizontal
Cooperation between Businesses
Development of improved industry
standards of production and safety which
benefit the consumer – a good recent
example is joint industry standards in
Europe for mobile phone chargers
Legal Collusion – Horizontal
Cooperation between Businesses
Information sharing designed to give better
information to consumers
Research joint-ventures and know-how
agreements which seek to promote
innovative and inventive behaviour in a
market. The EU has introduced a “R&D
Block Exemption Regulation” for this
Market Liberalisation
• The main principle of EU Competition Policy
is that consumer welfare is best served by
introducing competition in markets where
monopoly power exists.
• Frequently, these monopolies have been
in network industries for example transport,
energy and telecommunications.
• In these sectors, a distinction must be made
between the infrastructure and the services
provided directly to consumers using this
infrastructure.
State Aid in Markets
• The argument for monitoring state aid given to private
and state businesses by member Government is that
by giving certain firms or products favoured
treatment to the detriment of other firms or products,
state aid disrupts normal competitive forces.
• Under the current European state aid rules, a
company can be rescued once.
• However, any restructuring aid offered by a national
government must be approved as being part of a
feasible and coherent plan to restore the firm’s longterm viability. Government aid designed to boost
research and development, regional economic
development and the promotion of small businesses is
normally permitted.
Merger Policy in the UK and the
European Union
• There is a natural tendency for markets to
consolidate over take through a process
of horizontal and vertical integration.
• The main issue for competition policy is whether
a proposed merger or takeover between two
businesses is thought to lead to a substantial
lessening of competitive pressures in the
market and risks leading to a level of market
concentration when collusive behaviour might
become a reality.
Merger Policy in the UK and the
European Union
• When companies combine via a merger, an acquisition or the
creation of a joint venture, this generally has a positive
impact on markets: firms usually become more efficient,
competition intensifies and the final consumer will benefit
from higher-quality goods at fairer prices.
• However, mergers which create or strengthen a dominant
market position can, after investigation, be prohibited in
order to prevent ensuing abuses. Acquiring a dominant
position by buying out competitors is in contravention of EU
competition law. Companies are usually able to address the
competition problems, normally by offering to divest (sell or
off-load) part of their businesses. For example, in 2007, the
UK Competition Commission decided that BSkyB would be
forced to sell some of its 17.9% stake in ITV.
Privatization
• Sale of state owned shares in companies
(more relevant recently)
• Contracting out of services previously
provided by the state, aka compulsory
competitive tendering, e.g. in school
cleaning, refuse collection etc.
• Selling of individual state assets
• Deregulation
Why were firms privatized?
• Improve efficiency: nationalised industries were accused of
X-inefficiency – the profit motive after privatisation would
ensure this would be eliminated.
• Improving the quality and range of services: the profit goal
and the ‘discipline of the market’ would ensure this, as to
attract customers producers would have to provide a range of
high quality goods.
• Lower prices: these would result from competition.
• Widening of share ownership: if more of the labour force
become shareholders, it is likely that they won’t view the
company owners as capitalists who are opposed to them.
• Revenue raising: the sale of state owned assets and shares
delivered a one-off boost to government revenue and thus a
reduction in public sector borrowing.
• Global competition: new companies would be strong and
efficient enough to compete on a global scale.
Has privatisation been successful?
• Raised government revenue - £90bn between 1979 and
1997.
• Loss making firms began to make a profit.
• Previously state owned firms are no longer such a
burden – only postal services and rail networks still really
receive funding from the government.
• Led to huge losses in the coal, steel and telephone
sectors.
• Desire for wide shareholder ownership among the
population has not been achieved to a significant extent.
• Contracting out of public services such as hospital
cleaning and court security has led to a decline in quality.
Energy
• Real prices of gas and electricity fell in the
1990s – similar in telecommunications.
• But – major oil price rise in 2008 and rise in
gas prices – believed to be due to tacit
collusion amongst the big six suppliers.
• Energy companies – some consumers are
not aware that theirs isn’t the cheapest or
they can’t be bothered to switch suppliers –
customer inertia.
• Many domestic consumers overpay on their
energy bills.
Water
• Water bills have risen significantly since
privatisation in 1989.
• OFWAT was able to reduce customers’ bills on
average due to large efficiency improvements in
1999.
• OFWAT prevented regional water providers from
raising prices more than 18% from 2004-5, due to
efficiency gains they thought could be made.
Rail
•
•
•
•
Not as successful – collapse of Railtrack.
Regulated rail fares rose in real terms since 1997.
Standard of service worsened for several years after privatisation.
BUT more recently there have been improvements to track
infrastructure as investment has begun to pay off.
• More trains are now arriving on time.
• There has been a lot of investment via the government for rail
infrastructure, although this is set to decrease in the next few years.
Regulation of privatised
industries in the UK:
Regulation
• Telecoms – regulated by OFTEL
• Make the firm act as if they
(Office of Telecommunications)
which was replaced by OFCOM
were in a competitive market
(Office of Communications) in
• Once there is competition the
2003.
regulator has to consider
• Gas – OFGEM (Office of Gas
and Electricity Markets),
price
formerly OFGAS (Office of Gas
Supply).
• They will seek to reduce
• Electricity – OFGEM, formerly
barriers to entry and exit
•
•
OFFER (Office of Electricity
Regulation).
Water – Office of Water Services
(OFWAT) and the Environmental
Agency.
Railways – ORR (Office of the
Rail Regulator) and the Strategic
Rail authority.
Price capping
RPI-X
This takes the retail price index (measure of inflation) and subtracts a factor
‘X’, which is determined by the regulator.
X represents the efficiency gains that the regulator has determined can
reasonably be achieved by the firm.
It does give the firms the opportunity to plan investment programmes and
estimate with some accuracy their revenue streams.
This method was once used to regulate British Telecom:
• Between 1997 and 2002 the price formula for telecoms was RPI – 4.5%
• E.g. if RPI inflation was 8%, BT would be able to raise its prices by 3.5%
RPI + K
Uses the RPI and adds ‘K’, which represents the additional capital spending
that a firm has agreed with the regulator is necessary.
This is used by the water regulator to determine regional prices for water
companies. The ‘K’ factor is different for each company, depending on how
much they are required to spend to maintain and improve their quality of
service.
Advantages of price capping
• Firms are allowed to keep any profits they
make if they improve efficiency to a
greater level than the regulator deemed
was reasonable.
• Because the ‘X’ or ‘K’ factor is in place for
5 years, firms can plan ahead and know
that they will not be penalised for making
further efficiency gains.
Criticisms of price capping
• Setting the figure for X and K is difficult.
• The firm needs to provide accurate information about its costs
to the regulator – it may not do so.
• If X is set too high then the company will have insufficient
funds to invest and the standard of service will fall.
• If X is set too low then excessive profits will be earned – these
profits are often used to invest in other areas which the
regulator can’t control to make even more profits.
• Length of time – if X is set for too long then changes in market
conditions cannot be taken into account.
• If it is too short and there isn’t enough of a time scale it will be
difficult for companies to plan ahead with long term
investments.
• Sometimes the regulator and the regulated industry have built
up a close relationship, with the regulator being less strict on
the firms under its control – this is often referred to as
regulator capture.
Performance targets
• Regulator can set performance targets that it
will then monitor.
• These may be based on improvements in the
quality of service or reductions in the number
of customer complaints.
• This may be supported by a system of fines
should the firm fail to meet the
targets/rewards if the firm meets them.
• This has been used to monitor train-operating
companies in the UK and to help determine
future price increases.
Judging the effectiveness of
regulation
• The impact on real prices to customers.
• Levels of competition in the industry.
• Employment and productivity levels in the
industry.
• The quality of service.
• Investment levels in the industry.
• How far has the regulator been able to adapt
to changes in market conditions and
technology.
• Comparing a firm to the rest of the industry.
UK Competition policy
Competition policy as set out in the Competition Act of 1998 and the 2002 Enterprise
Act (the latter two policies):
• Competition policy in the UK is less rigid than in the US generally.
• Policy is therefore more linked to individual cases.
• This was embedded in UK legislation from legislation in the
1940s.
• Since then, legislation has been tightened through a Sequence of
Acts.
• Less formal agreements are also covered by the legislation (as
seen in the table above).
• The conduct of policy was entrusted to two agencies: the Office
of Fair Trading (OFT) and the Competition Commission (dissolved
in 2014)
• Replaced by the Competition and markets authority
Office of Fair Trading (OFT)
•
•
•
•
•
•
•
Dissolved 2014
Superseded by The Competition and Markets Authority (CMA)
The OFT played a role in investigating the four different inquiry types
listed above.
The OFT had preliminary responsibility for investigating a proposed
merger, and then has the power either to impose sanctions directly or to
refer the market to the Competition Commission for a full investigation.
The OFT can also investigate any firm thought to be abusing market
power locally or nationally – it has to investigate whether the firm has a
dominant position.
The OFT will look at the contestability of the market the firm is operating in
and whether it is engaging in anti-competitive policies – for example in
2006 OFT required London Underground to allow other free newspapers
to be distributed, other than Associated Newspapers Ltd’s ‘Metro’.
The OFT is responsible for making markets work well for consumers. We
achieve this by promoting and protecting consumer interests throughout
the UK, while ensuring that businesses are fair and competitive.
The mission statement of the OFT
states:
The OFT is responsible for making
markets work well for consumers. We
achieve this by promoting and protecting
consumer interests throughout the UK,
while ensuring that businesses are fair and
competitive.
The possible results of an OFT
investigation are:
• Enforcement action by the OFT’s competition and consumer
regulation divisions.
• Referral of the market to the Competition Commission.
• Recommendations for changes in laws and regulations.
• Recommendations to regulators, self-regulatory bodies and
others to consider changes to their rules.
• Campaigns to promote consumer education and awareness –
this has happened on numerous occasions, having found that
the problem with the market lay in the way consumers
understood its workings, and not with the market itself.
• A clean bill of health – this indicates that the OFT may not find
anything wrong with the market – for example a multi-million
pound investigation into price fixing in the supermarket
industry was stopped in 2010.
EUC = European Commission.
An example of where the EUC has intervened where there are restrictive
practices is in the airline industry. BA was fined £90m for participating in an
air freight cartel – fuel and security surcharges were rigged over six years
(1999-2006) – airlines fined €799m in total.
The EU traditionally left such matters to individual member states unless
there is an appreciable effect on trade between members.
Since legislation in 1987 and 1992, however, the number of cases has
increased.
However, between 1991 and 2006 only 19 out of 2,700 mergers were
disallowed – the EUC still wants firms to benefit from economies of scale.
Contracting out:
• A situation in which the public sector places activities in
the hands of a private firm and pays for the provision.
• The public sector issues a contract to the private firm for
the supply of some good or service.
• E.g. waste disposal, where a local authority may issue a
contract to a private firm for the supply of some good or
service.
Competitive tendering:
• A process by which the public sector calls for private firms to bid
for a contract for the provision of a good or service.
• The contract would be announced and firms invited to put in
bids, specifying the quality of service they are prepared to
provide and at what price.
• The local authority would then be in a position to look for
efficiency in choosing the most competitive bid.
Public Private Partnership:
• An arrangement by
which a
government service
or private business
venture is funded
and operated
through a
partnership of
government and
the private sector.
• The most common
partnership model
is the Private
Finance Initiative
(PFI).
Private Finance Initiative (PFI):
•
•
•
•
•
•
•
A funding arrangement under which the private sector designs, builds,
finances and operates an asset and associated services for the public
sector in return for an annual payment linked to its performance in delivering
the service.
This was launched in 1992 as a way of trying to increase the involvement of
the private sector in the provision of public services.
This established a partnership between the public and private sectors.
The public sector could get involved with such a venture in order to secure
wider social benefits, perhaps through reductions in traffic congestion, and
this would not be fully taken into account by the private sector.
In other cases, the private sector may undertake a project and sell the
services to the public sector, often over a period of 25-30 years.
Most PFIs are regarding transport and local government (42% in the first ten
years of the scheme).
For example projects involving London Underground were signed in 2003,
and there was also a PFI with the Channel Tunnel Rail Link in 2000.
Private Finance Initiative (PFI):
• The aim of the PFI is to improve the financing of public sector
projects – introducing a competitive element to the tendering
process and enabling the risk of the project to be shared between
the public and private sectors.
• Criticisms:
• The price of borrowing may increase if the public sector would have
been able to borrow on more favourable terms than commercial
firms.
• The competitive element may mean that the private sector may have
less incentive to give due attention to health and safety issues as
compared to the public sector.
• A balance between efficiency and quality of service is hard to
achieve.