nep-com New Economics Papers
on Industrial Competition
Issue of 2006‒08‒26
nineteen papers chosen by
Russell Pittman
US Department of Justice

  1. E-commerce and the Market Structure of Retail Industries By Onsel Emre; Ali Hortacsu; Chad Syverson
  2. Quantifying the Benefits of Entry into Local Phone Service, By Nicholas Economides; V. Brian Viard; Katja Seim
  4. The Doubtful Profitability of Foggy Pricing By Eugenio J. Miravete
  5. Retail Prices and Facility-Based Entry into the Telecommunications Market By David Gabel; Carolyn Gideon
  6. Evaluating Wireless Carrier Consolidation Using Semiparametric Demand Estimation By Patrick Bajari; Jeremy T. Fox; Stephen Ryan
  7. The Incentive for Vertical Integration By Nicholas Economides
  8. Two-sided competition of proprietary vs. open source technology platforms and the implications for the software industry1 By Nicholas Economides; Evangelos Katsamakas
  9. Pricing of Complementary Goods and Network Effects* By Nicholas Economides; V. Brian Viard
  10. Strategic Product Pre-announcements in Markets with Network Effects By Jay Pil Choi; Eirik Gaard Kristiansen; Jae Nahm
  11. How Do Incumbents Respond to the Threat of Entry? Evidence from the Major Airlines By Austan Goolsbee; Chad Syverson
  12. Competing technologies in the database management systems market By Tobias Kretschmer
  13. Incompatibility, Product Attributes and Consumer Welfare: Evidence from ATMs By Christopher R. Knittel; Victor Stango
  14. Indirect Network Effects and the Product Cycle: Video Games in the U.S., 1994-2002 By Matthew T. Clements; Hiroshi Ohashi
  15. Effects of Industry Concentration on Quality Choices for Network Connectivity By Mark A. Jamison;
  16. The Welfare Consequences of ATM Surcharges: Evidence from a Structural Entry Model By Gautam Gowrisankaran; John Krainer
  17. Competition Policy in Indonesia By John Malcolm Dowling
  18. Patents, Price Controls and Access to New Drugs: How Policy Affects Global Market Entry By Jean O. Lanjouw
  19. The Economics of Open-Access Journals By Mark McCabe; Christopher Snyder

  1. By: Onsel Emre (University of Chicago); Ali Hortacsu (University of Chicago and NBER); Chad Syverson (University of Chicago and NBER)
    Abstract: While a fast-growing body of research has looked at how the advent and di®usion of e- commerce has a®ected prices, much less work has investigated e-commerce's impact on the number and type of ¯rms operating in an industry. This paper theoretically and empirically takes up the question of which producers most bene¯t and most su®er as consumers switch to purchasing products online. We specify a general industry model involving consumers with di®ering search costs buying products from heterogeneous-type producers. We inter- pret e-commerce as having created reductions in consumers' search costs. We show how such shifts in the search cost distribution reallocate market shares from an industry's low- type producers to its high-type businesses. We test the model using data for two industries in which e-commerce has arguably decreased consumers' search costs considerably: travel agencies and bookstores. We ¯nd evidence in both industries of the market share shifts predicted by the model. Interestingly, while both industries experienced similar changes, the speci¯c mechanisms through which e-commerce induced them were di®erent. For travel agencies, the shifts re°ected aggregate changes driven by airlines' reductions in agent com- missions as consumers started buying tickets online. For bookstores, on the other hand, industry-wide declines in small book stores re°ected aggregated market-speci¯c impacts, evidenced by the fact that more small-store exit occurred in those local markets where consumers' use of e-commerce channels grew fastest.
    Date: 2005–10
  2. By: Nicholas Economides (Stern School of Business, NYU); V. Brian Viard (Graduate School of Business, Stanford University); Katja Seim (Stanford University)
    Abstract: See #46
    JEL: D43 K23 L11 L13 L96
    Date: 2005–11
  3. By: Nicholas Economides (Stern School of Business, NYU)
    Abstract: Trinko, a local telecommunications services customer of AT&T, sued Verizon for anti-competitively raising the costs of AT&T, Verizon's rival in the market for local telecommunications services. Pursuant to the rules of the Telecommunications Act of 1996, AT&T was leasing parts of the local telecommunications network (unbundled network elements, "UNEs") from Verizon at "cost plus reasonable profit" prices. The Supreme Court held that Trinko's complaint failed to state a claim under § 2 of the Sherman Act, and dismissed the complaint. I argue that the Court drew in- .correct inferences from its AsPen Skiing decision. The Court also missed a key vertical leveraging issue in Trinko. The opening of competition mandated by the Telecommunications Act of 1996 challenged Verizon's traditional monopoly in the local telecommunications services market. By raising the cost and/or decreasing the quality of the service of rivals in the retailing services market, Verizon aimed to preserve that monopoly. As a result of these efforts, rivals suffered a disadvantage. Yet Verizon also caused retailing rivals to lease a lower number of unbundled network elements and thus incurred a revenue sacrifice. Therefore the actions ofVerizon in raising the costs of retailing telecommunications services rivals are an indication of. liability according to the. "sacrifice principle" proposed in the Government's brief in Trinko, according to which a defendant is liable if its conduct "involves a sacrifice of short-term profits or goodwill that makes sense only insofar as it helps the defendant maintain or obtain monopoly power," even though the sacrifice principle defines a stringent condition for a finding of liability.
    Date: 2005–11
  4. By: Eugenio J. Miravete (University of Pennsylvania)
    Abstract: This paper studies whether competition may induce firms abandoning deceptive pricing strategies aimed to profit from mistaken choices of consumers. The empirical analysis focuses on the pricing practices of early U.S. cellular firms, both under monopoly and duopoly. Foggy tariff options are those that are dominated by another option or a combination of other tariff options offered by the firm. I also define a measure of fogginess of non-dominated tariffs based on the range of airtime usage for which they are the least expensive option among those available. Results indicate that firms offer more dominated tariff options in a competitive market than under monopoly. While markets are profitable, perhaps because they grow or because firms collude, the use of foggy tactics is not frequent. However, if the market is more mature, or if firms do not cooperate, thus reducing the return to their investment, then they commonly turn to foggy pricing.
    Keywords: Nonlinear Pricing; Foggy Strategies; Co-opetition
    JEL: D43 L96 M21
    Date: 2004–10
  5. By: David Gabel (Queens College); Carolyn Gideon (Tufts University)
    Abstract: There is growing sentiment that rate rebalancing to eliminate cross subsidies between local business and local residential telephone markets is necessary to induce efficient entry in the residential market. If the elasticity of supply with respect to the relative prices for business and residential local service is high in both the local business and local residential markets, then the efficiency gains from rebalancing may be large. Alternatively, other factors related to differences in characteristics between business and residential local telephone markets, such as lower costs, lower elasticity of demand, and greater willingness-to-pay for quality or redundancy in the business segment of local telephone may be more important determinants of entry. In this paper we simultaneously measure the elasticity of supply in the business market with regards to the price of business services relative to the price of residential service, using entry, economic and demographic data a the wire center level. We find that business entry is driven by market demand and cost characteristics, and that the effect of cross subsidies in prices on entry is less clear.
    Date: 2005–10
  6. By: Patrick Bajari; Jeremy T. Fox; Stephen Ryan
    Abstract: The US mobile phone service industry has dramatically consolidated over the last two decades. One justification for consolidation is that merged firms can provide consumers with larger coverage areas at lower costs. We estimate the willingness to pay for national coverage to evaluate this motivation for past consolidation. As market level quantity data is not publicly available, we devise an econometric procedure that allows us to estimate the willingness to pay using market share ranks collected from a popular online retailer, Amazon. Our semiparametric maximum score estimator controls for consumers’ heterogeneous preferences for carriers, handsets and minutes of calling time. We find that national coverage is strongly valued by consumers, providing an efficiency justification for across-market mergers. The methods we propose can estimate demand for other products using data from Amazon or other online retailers where quantities are not observed, but product ranks are observed. Since Amazon data can easily be gathered by researchers, these methods may be useful for the analysis of other product markets where high quality data are not publicly available.
    JEL: L1 C1
    Date: 2006–08
  7. By: Nicholas Economides (Stern School of Business, NYU)
    Abstract: This paper evaluates the incentive of firms to vertically integrate in a simple 2X2 Bertrand model of two substitutes that are each comprised of two complementary components. It confirms that all prices fall as a result of a vertical merger. Further, we find that, when the composite goods are poor substitutes, producers of complementary components are better off after integration. Thus, at equilibrium, each pair of complementary goods is produced by a single firm (parallel vertical integration). In contrast, when the composite goods are close substitutes, vertical integration reduces profits of the merging firms and is therefore undesirable. Thus, at equilibrium, all four products are produced by independent firms (independent ownership). The reason for the change in the direction of the incentive to merge is that, as the composite goods become closer substitutes, competition between them reduces prices (in comparison to full monopoly) thereby eliminating the usefulness of a vertical merger in accomplishing the same price effect. We also find that, for intermediate levels of substitution, firms producing complementary components prefer to merge only if the substitute good is produced by an integrated firm. Thus, for intermediate levels of substitution, both parallel vertical integration and independent ownership are equilibria. When the demand system is symmetric, total surplus is higher in parallel vertical integration, for all degrees of substitution among the products, even for the case when the goods are close substitutes and parallel vertical integration is not the equilibrium outcome. Thus, the market provides less vertical integration than is optimal from a social surplus maximizing point of view.
    Keywords: Mergers, vertical integration
    JEL: L1 D4
    Date: 2005–01
  8. By: Nicholas Economides (Stern School of Business, NYU); Evangelos Katsamakas (Fordham University)
    Abstract: Technology platforms, such as Microsoft Windows, are the hubs of technology industries. We develop a framework to characterize the optimal two-sided pricing strategy of a platform firm, that is, the pricing strategy towards the direct users of the platform as well as towards firms offering applications that are complementary to the platform. We compare industry structures based on a proprietary platform (such as Windows) with those based on an open-source platform (such as Linux) and analyze the structure of competition and industry implications in terms of pricing, sales, profitability, and social welfare. We find that, when the platform is proprietary, the equilibrium prices for the platform, the applications, and the platform access fee for applications may be below marginal cost, and we characterize demand conditions that lead to this. The proprietary applications sector of an industry based on an open source platform may be more profitable than the total profits of a proprietary platform industry. When users have a strong preference for application variety, the total profits of the proprietary industry are larger than the total profits of an industry based on an open source platform. The variety of applications is larger when the platform is open source. When a system based on an open source platform with an independent proprietary application competes with a proprietary system, the proprietary system is likely to dominate the open source platform industry both in terms of marketshare and profitability. This may explain the dominance of Microsoft in the market for PC operating systems.
    Date: 2005–10
  9. By: Nicholas Economides (Stern School of Business, New York University); V. Brian Viard (Graduate School of Business, Stanford University)
    Abstract: We discuss the case of a monopolist of a base good in the presence of a complementary good provided either by it or by another firm. We assess and calibrate the extent of the influence on the profits from the base good that is created by the existence of the complementary good, i.e., the extent of the network effect. We establish an equivalence between a model of a base and a complementary good and a reduced-form model of the base good in which network effects are assumed in the consumers’ utility functions as a surrogate for the presence of direct or indirect network effects, such as complementary goods produced by other firms. We also assess and calibrate the influence on profits of the intensity of network effects and quality improvements in both goods. We evaluate the incentive that a monopolist of the base good has to improve its quality rather than that of the complementary good under different market structures. Finally, based on our results, we discuss a possible explanation of the fact that Microsoft Office has a significantly higher price than Microsoft Windows although both products have comparable market shares.
    Keywords: calibration; monopoly; network effects; complementary goods; software; Microsoft
    JEL: L12 L13 C63 D42 D43
    Date: 2005–11
  10. By: Jay Pil Choi (Michigan State University); Eirik Gaard Kristiansen (Michigan State University); Jae Nahm (HKUST, Hong Kong)
    Abstract: It is a widely adopted practice for firms to announce new products well in advance of actual market availability. The incentives for pre-announcements are stronger in markets with network effects because they can be used to induce the delay of consumers’ purchases and forestall the build-up of rival products’ installed bases. However, such announcements often are not fulfilled, raising antitrust concerns. We analyze the effects of product pre-announcements in the presence of network effects when firms are allowed to strategically make false announcements. We also discuss their implications for consumer welfare and anti-trust policy.
    JEL: L1 D8
    Date: 2005–09
  11. By: Austan Goolsbee (University of Chicago); Chad Syverson (University of Chicago)
    Abstract: This paper examines how incumbents respond to the threat of entry of competitors, as distinguished from their response to competitors’ actual entry. It uses a case study from the passenger airline industry—specifically, the evolution of Southwest Airlines’ route network—to identify particular routes where the probability of future entry rises abruptly. When Southwest begins operating in airports on both sides of a route but not the route itself, this dramatically raises the chance they will start flying that route in the near future. We examine the pricing of the incumbents on threatened routes in the period surrounding such events. We find that incumbents cut fares significantly when threatened by Southwest’s entry into their routes. This is true even after controlling in several ways for airport-specific operating costs. The response of incumbents seems to be limited only to the threatened route itself, and not to routes out of nearby competitor airports where Southwest does not operate (e.g., fares drop on routes from Chicago Midway but not Chicago O’Hare). The largest responses appear to be restricted to routes that were concentrated beforehand. Incumbents do experience short-run increases in their passenger loads concurrent with these fare cuts. This is consistent with theories implying incumbents will try to generate some longer-term loyalty among current customers before the entry of a new competitor. We examine evidence relating this demand-building motive to frequent flyer programs and find suggestive evidence in favor of this notion. There is only weak evidence that incumbents increase capacity on the routes.
    Date: 2004–12
  12. By: Tobias Kretschmer (London School of Economics)
    Abstract: In this paper, we study the dynamics of the market for Database Management Systems (DBMS), which is commonly assumed to possess network effects and where there is still some viable competition in our study period, 2000 – 2004. Specifically, we make use of a unique and detailed dataset on several thousand UK firms to study individual organizations’ incentives to adopt a particular technology. We find that there are significant internal complement effects – in other words, using an operating system and a DBMS from the same vendor seems to confer some complementarities. We also find evidence for complementarities between enterprise resource planning systems (ERP) and DBMS and find that as ERP are frequently specific and customized, DBMS are unlikely to be changed once they have been customized to an ERP. We also find that organizations have an increasing tendency to use multiple DBMS on one site, which contradicts the notion that different DBMS are near-perfect substitutes.
    Keywords: Database software, indirect network effects, technology adoption, microdata
    JEL: L86 O33
    Date: 2005–10
  13. By: Christopher R. Knittel (University of California, Davis); Victor Stango (Dartmouth College)
    Abstract: Incompatibility in markets with network effects can either benefit or harm consumers. Incompatibility reduces consumers’ ability to “mix and match” components offered by different sellers, but can also be associated with changes in product attributes that might benefit consumers. In this paper, we estimate the effects of incompatibility in a classic hardware/software market: ATM cards and machines. Our empirical model allows us to measure the indirect network effect relating the value of ATM cards to ATM availability. It also allows us to measure the effects of incompatibility as measured by ATM fees. Our sample contains a relatively discrete move toward incompatibility after 1996, when banks began to impose surcharges on non-customers using their ATM machines. We provide estimates of the partial equilibrium effects of increased incompatibility on consumer welfare, finding that ATM fees ceteris paribus reduce the indirect network effect associated with other banks’ ATMs. However, a surge in ATM deployment accompanies the shift to surcharging and in many cases completely offsets the reduction in welfare associated with higher fees. This suggests that welfare analyses should consider the interaction between incompatibility and changes in product attributes.
    Date: 2004–10
  14. By: Matthew T. Clements (University of Texas); Hiroshi Ohashi (University of Tokyo)
    Abstract: This paper examines the importance of indirect network effects in the U.S. video game market between 1994 and 2002. The diffusion of game systems is analyzed by the interaction between console adoption decisions and software supply decisions. Estimation results suggest that introductory pricing is an effective practice at the beginning of the product cycle, and expanding software variety becomes more effective later. The paper also finds a degree of inertia in the software market that does not exist in the hardware market. This observation implies that software providers continue to exploit the installed base of hardware users after hardware demand has slowed.
    Keywords: indirect network effects; penetration pricing; software variety
    JEL: C23 L68 M21
    Date: 2004–10
  15. By: Mark A. Jamison (University of Florida);
    Abstract: I examine the effects of market concentration on connectivity in network industries. Using Cournot interactions for a duopoly, each network chooses quantity, quality for communications within the provider’s own network (internal quality), and quality for communications between the provider’s network and other networks (external quality). I find that large networks choose higher internal quality than do small networks and large networks choose higher internal quality than external quality. I also find that providers prefer flexible technologies that allow them to simultaneously choose outputs and qualities. Small networks prefer higher external quality than internal quality except when they make credible quality commitments before choosing output and have higher marginal operating costs than large networks. Networks choose identical external quality unless they have exogenously determined customer bases.
    Date: 2004–10
  16. By: Gautam Gowrisankaran; John Krainer
    Abstract: We estimate a structural model of the market for automatic teller machines (ATMs) in order to evaluate the implications of regulating ATM surcharges on ATM entry and consumer and producer surplus. We estimate the model using data on firm and consumer locations, and identify the parameters of the model by exploiting a source of local quasi-experimental variation, that the state of Iowa banned ATM surcharges during our sample period while the state of Minnesota did not. We develop new econometric methods that allow us to estimate the parameters of equilibrium models without computing equilibria. Monte Carlo evidence shows that the estimator performs well. We find that a ban on ATM surcharges reduces ATM entry by about 12 percent, increases consumer welfare by about 35 percent and lowers producer profits by about 20 percent. Total welfare remains about the same under regimes that permit or prohibit ATM surcharges and is about 17 percent lower than the surplus maximizing level. This paper can help shed light on the theoretically ambiguous implications of free entry on consumer and producer welfare for differentiated products industries in general and ATMs in particular.
    JEL: G21 L13 L5
    Date: 2006–08
  17. By: John Malcolm Dowling (School of Economics and Social Sciences, Singapore Management University)
    Abstract: The Indonesian economy was dominated by the government in the decades of the 1970s and 1980s through its control of major mining, manufacturing and agricultural activities. Hill (2000) estimates that as much as 40% of non-agricultural GDP was accounted for by government entities in the late 1980s There were still a lot of government corporations up until the late 1980s and early 1990s and governmental control over the banking system was still substantial. Non-financial state owned enterprises (SOEs) contributed 14.5% of GDP in the late 1980s. They also accounted for another 9% of gross domestic investment which rose to 15.7% over the period 1990 –1997 (World Bank, 2000). Three SOEs are of particular note that dominate the sector in terms of revenue and assets are Pertamina (monopoly in oil and gas with diversified holdings in hotels, an airline and office buildings); PLN and PTTelkolm (monopoly in power and telecommunications industry respectively). The SOEs also employ a significant percentage of the labor force (25% according to data from the Indonesia’ Statistics Office). This strong role of the state was derived from the historical break with its colonial past under President Suharto and the distrust of “capitalists”. There was also a need for the Suharto regime in the three decades when he ruled to maintain control of enough industries to maintain its base for extortion and corruption. There was only a gradual and delayed shift toward export promotion and away from import substitution. This was partly the result of lobbying by entrenched interests that were making monopoly profits from new protected industries and corrupt officials that were operating the customs and port facilities. It also had to do with the control of key allocation and production agencies like Bulog and Pertamina. The decline in oil prices in the mid-1980s put pressure on the government to develop a more competitive economic environment which was reinforced by the growing integration of economies in Southeast Asia in conjunction with commitments to the ASEAN Free Trade Agreement. Policy measures focused on trade barriers. Tariffs were lowered and some import monopolies and import licenses were converted to tariff equivalents. There were also reforms in banking and the regulation of foreign direct investment. However, these reforms were partial in nature. Several banks remain under government control and policy required domestic partnerships for foreign direct investment (FDI) approval (see Dowling and Yap (2005) for further details. Nevertheless, despite these shortcomings in the policy environment, there was a measurable improvement in competition and economic efficiency, particularly in the manufacturing sector. Pangestu et al (2002) show that there was a decline in the level of industrial concentration and that the size distribution of firms has become more equal over time. There was also a decline in the prevalence of dominant firms therefore enhancing competition and reducing monopoly power. Finally, there was less stability in market shares after 1990, a development which reflects greater competition1. The evidence of enhanced competition over the decades of the ‘80s and’90s is much less compelling in other sectors of the economy, including agriculture, services, infrastructure and some parts for manufacturing and mining sectors. There are a number of examples that can be cited to support this conclusion including the cement industry (where there were high tariffs on imports, restrictions on number of distributors and allocation of markets) as well as gas distribution, telecommunications and electricity (where an opaque regulatory framework prohibited a level playing field from developing as new entrants came into the market). Furthermore, in the telecoms sector the government remained the majority shareholder in PT. Telkom and Indosat.
    Date: 2005–09
  18. By: Jean O. Lanjouw
    Abstract: We consider how patent rights and price regulation affect whether new drugs are marketed in a country, and how quickly. The analysis covers a large sample of 68 countries at all income levels and includes all drug launches over the period 1982-2002. It uses newly compiled information on legal and regulatory policy, and is the first systematic analysis of the determinants of drug launch in poor countries. Price control tends to discourage rapid product entry, while the results for patents are mixed. There is evidence that local capacity to innovate matters and that international pricing externalities may play a role.
    Keywords: patent, drugs, access, market entry, price control
    JEL: D62 D4 K2 K10 I11 I18
  19. By: Mark McCabe (Georgia Institute of Technology); Christopher Snyder (Dartmouth College)
    Abstract: Previous research modeled academic journals as platforms connecting authors with readers in a two-sided market. This research used the same basic framework also used to study telephony, credit cards, video game consoles, etc. In this paper, we focus on a key difference between the market for academic journals and these other markets: journals vary in terms of quality, where a journal's quality determined by the quality of the papers it publishes. We provide a simple model of journal quality. As an illustration of the value of the model, we use it to address issues that have arisen in the recent debate concerning whether, in the Internet age, journals should become \open access" (freely available to readers, financed by author rather than subscriber fees). Among other issues, we examine (a) whether open-access journals would tend to publish more articles than traditional journals, moving further down the quality spectrum in order to boost revenue; (b) whether journal quality affects the profitability of adopting open access; and (c) whether submission fees or acceptance fees are better instruments to extract surplus from authors.
    Keywords: Open access, academic journal, two-sided market, quality
    JEL: L14 L82 D40 L31
    Date: 2004–11

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