15 Abuse and dominance

Firms can become market leaders through innovation, cost reduction, efficiency or taking advantage of economies of scale. The development of a market leader is not a problem in itself as it shows competitiveness, reduces consumer prices and increases product performance. However, market leaders face the choice of maintaining the status quo, innovating and allowing competition or taking advantage of their position through anti-competitive practices.

Abuse of dominance relates to the practices where a dominant firm exercises its market power to distort the competitive process, exploiting consumers and excluding competitors. Firms could engage in two types of abusive practices: exploitative or exclusionary.

Some of the exploitative abuse practices could be excessive pricing, having high prices not justified by higher costs, and the other could be unfair trading conditions which allow firms to impose terms to exploit customers or suppliers, for example tying sales of one product to another. Exclusionary practices, as their name implies, rely on preventing competitors from acting. Some examples are predatory pricing, where a firm sets a price below cost to eliminate competition, exclusivity contracts denying suppliers or consumers the right to trade with anyone else, or refusing to trade with other competitors, limiting their access to inputs.

Taking one of these actions does not necessarily entail abuse of dominance, as it will depend on its effect on competition. Therefore, competition authorities are careful when handling cases like this, as immediate reactions could disincentivise innovation or prevent efficiency gains. Think about what would have happened if competition authorities disallowed computer manufacturers from providing operating systems. Although it limits consumers’ choice, an already uploaded operating system assists consumers in getting a computer to work without requiring higher knowledge.

In this section, we have only talked about markets from a static perspective. In the following section, we will consider dynamic efficiency, which changes the way abuse of dominance and market power are analysed. 

Activity 5: Regulation of dominant firms

Timing: 10 minutes

Watch the following video by famous British economist John Kay about the importance of regulating dominant firms.  

Download this video clip.Video player: Video 3: How should competition authorities regulate dominant firms?

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Transcript: Video 3: How should competition authorities regulate dominant firms?

PRESENTER

How should competition authorities regulate dominant firms? Professor Sir John Kay.

JOHN KAY

We need to think of the way the world has changed. When companies were producing iron and steel or cars or whatever, it's very clear what the market was. What's the market in which Facebook are operating? Well, they're a monopoly of being Facebook. They're competing in a social media market in which there are many different kinds of providers providing different things.

I don't think that traditional analysis of monopoly is very helpful. That doesn't float. Indeed, it drives you towards the realisation that some of these companies are very profitable. The profits they earn are economic rents. And there isn't competition driving these profits down. That might be a reason for regulation.

On the other hand, the shelf life of these kind of monopolies tends to be very short. For example, we think of Facebook as having a monopoly. We kind of forget that before 2008, there was another company doing the same kind of thing, which was called Myspace. And they didn't do it as well as Facebook did. And there were also, interestingly, more because they were owned by the Murdoch empire, they were more interested in making money out of it than Facebook have actually turned out to be.

And that meant that Facebook displaced Myspace, and Myspace doesn't exist anymore. All of these companies I've been talking about were founded relatively recently, whereas the companies you had in the middle of the 20th century were mostly companies that had been around for a long time. The life of companies is now much shorter than it was.

Now, what we do need to do, as a matter of competition policy, is to stop these companies preventing competitors taking their place. And we've made mistakes in that kind of way. For example, we let Facebook buy WhatsApp, Instagram, et cetera, companies that might have become equally large competitors to these incumbent companies, and we let them be bought.

I think we shouldn't have done that, but I think we'd be wasting our time and energy if we went into trying to break up Facebook or Google. They have to keep up being good at these things. And if they don't, they will disappear pretty rapidly. People easily forget that Nokia were once the largest manufacturer of mobile phones in the world. Where are they now? Well, they're a minor subsidiary of Microsoft who eventually bought them. And that goes on.

And Netscape introduced the first internet browser. They disappeared when better, better browsers like Google's appeared, and so on. We need to keep these markets being competitive. But by competitive, I mean allowing lots of entry and preventing incumbents getting in the way of these entrants. That's more sensible policy, I think, than breaking established companies up.

We need to have regulation to stop new competitors being taken out of the market. That really is what we need. And we need to be very careful about advocating regulation in a lot of these areas, because regulation typically gives a big advantage to incumbent firms which have the political clout, which have the scale to employ regulatory experts and departments and the like.

We just have to look at the financial sector, actually, where regulation is very heavily influenced and captured by existing firms in the market. And it's very effective, actually, in keeping new firms out or making life very difficult for firms. Just look at how hard people have found it to break into the banking market, even though everyone hates their banks.

End transcript: Video 3: How should competition authorities regulate dominant firms?

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Video 3: How should competition authorities regulate dominant firms?

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Considering the neoclassical theory, consider why it is important to regulate firms and how dominant firms can affect the market 

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