nep-com New Economics Papers
on Industrial Competition
Issue of 2008‒10‒21
twenty-two papers chosen by
Russell Pittman
US Department of Justice

  1. Mass Customization with Vertically Differentiated Products By Oksana Loginova; X. Henry Wang;
  2. Optimal Collusion under Cost Asymmetry By Miklos-Thal, Jeanine
  3. A Model of Quality Ladders with Horizontal Entry By Pedro Rui Mazeda Gil; Paulo Brito; Óscar Afonso
  4. Linking Reputations: The Signaling and Feedback Effects of Umbrella Branding By Miklos-Thal, Jeanine
  5. Cash Breeds Success : The Role of Financing Constraints in Patent Races By Schroth, Enrique; Szalay, Dezsö
  6. Negotiating remedies : revealing the merger efficiency gains By Cosnita, A.; Tropeano, J.P.
  7. Are There Waves in Merger Activity After All? By Dennis L. Gärtner; Daniel Halbheer
  8. Interconnecting Differentiated Networks By Alexei Alexandrov; ;
  9. Entrepreneurial Innovations in Network Industries By Pehr-Johan Norbäck; Lars Persson; Joacim Tåg
  10. Platform Competition, Compatibility, and Social Efficiency By Ramon Casadesus-Masanell; Francisco Ruiz-Aliseda;
  11. Net Neutrality and Investment Incentives By Jay Pil Choi; Byung-Cheol Kim;
  12. Incentives to Invest and to Give Access to Non-Regulated Next Generation Networks By Duarte Brito; Pedro Pereira; João Vareda
  13. Decomposing the Congestion Effect and the Cross-Platform Effect in Two-Sided Networks: A Field Experiment By Catherine Tucker; Juanjuan Zhang;
  14. Estimating a Model of Strategic Store Network Choice with Policy Simulation By Mitsukuni Nishida; ;
  15. Competition vs. Regulation in Mobile Telecommunications By Johan Stennek; Thomas TangerŒs;
  16. Quantifying the Benefits of Entry into Local Phone Service, By Nicholas Economides; V. Brian Viard; Katja Seim
  17. Who thinks about the competition? Managerial ability and strategic entry in US local telephone markets By Avi Goldfarb; Mo Xiao;
  18. Pricing and Multi-Market Contact in the Cable TV Industry By Robert Seamans; ;
  19. Service-sector competition, innovation and R&D By Gustavsson Tingvall, Patrik; Karpaty, Patrik
  20. Digital Rights Management and Technological Tying By Jin-Hyuk Kim; ;
  21. Joint Bidding in Infrastructure Procurement By Antonio Estache; Atsuhi Iimi
  22. Bidder Asymmetry in Infrastructure Procurement: Are There any Fringe Bidders? By Antonio Estache; Atsuhi Iimi

  1. By: Oksana Loginova (Department of Economics, University of Missouri); X. Henry Wang (Department of Economics, University of Missouri);
    Abstract: We analyze a duopoly game in which products are initially differentiated in variety and quality. Each consumer has a most preferred variety and a quality valuation. Customization provides ideal varieties but has no effect on product qualities. The firms first choose whether to customize their products, then engage in price competition. We show that in equilibrium either both firms customize, only the higher quality firm customizes, or no firm customizes. Even if customization is costless, the firms might not customize. This happens when the quality difference between the firms is small. We explore how the total welfare changes with the fixed cost of customization. Interestingly, the relationship is not always monotonic. Contrasting with the situation when customization is not feasible, both consumer surplus and total welfare are higher when one or both firms customize.
    Keywords: customization, horizontal differentiation, vertical differentiation
    JEL: D43 L13 C72
    Date: 2008–09
  2. By: Miklos-Thal, Jeanine
    Abstract: Cost asymmetry is generally thought to hinder collusion because a more efficient firm has both more to gain from a deviation and less to fear from retaliation than less efficient firms. Our paper reexamines this conventional wisdom and characterizes optimal collusion without any prior restriction on the class of strategies. We first stress that firms can credibly agree on retaliation schemes that maximally punish even the most efficient firm. This implies that whenever collusion is sustainable under cost symmetry, some collusion is also sustainable under cost asymmetry; efficient collusion, however, remains more di¢ cult to sustain when costs are asymmetric. Finally, we show that, in the presence of side payments, cost asymmetry generally facilitates collusion.
    Keywords: horizontal collusion; cost asymmetry; optimal punishments; side payments
    JEL: L13 L41 C72
    Date: 2008
  3. By: Pedro Rui Mazeda Gil (CEMPRE and Faculdade de Economia, Universidade do Porto); Paulo Brito (Instituto Superior de Economia e Gestão and UECE, Universidade Técnica de Lisboa); Óscar Afonso (CEMPRE and Faculdade de Economia, Universidade do Porto)
    Abstract: We develop a multi-sector model of R&D-driven endogenous growth that merges the expanding-variety with the quality-ladders mechanism. The mechanism of expanding variety provides the flow of new firms (new product lines), whilst the mechanism of quality ladders provides the accumulation of non-physical capital (technological knowledge). The aim is to explore the view that, from the perspective of the households, wealth can be accumulated either by creating new firms or by accumulating capital, in a setting with no population growth. Differently from the standard expanding-variety literature, we allow for entry as well as exit of product lines from the market, view the creation of new product lines as a product development activity without positive spillovers, and postulate an horizontal entry mechanism that takes explicitly into account dynamic second-order effects. We perform a detailed comparative steady-state analysis and characterise qualitatively the local dynamics properties in a neighbourhood of the interior balanced-growth equilibrium. The model produces specific results with respect to the impact of changes in the entry-cost parameters and the fiscal-policy variables both in the aggregate growth rate and in the market structure and industry dynamics in steady state. We also conclude that the transitional dynamics is characterised by a catching-up effect, with an empirically reasonable speed of convergence under standard calibration.
    Keywords: endogenous growth, firm dynamics, transitional dynamics
    JEL: O41 D92 C62
    Date: 2008–10
  4. By: Miklos-Thal, Jeanine
    Abstract: This paper develops a theory of umbrella branding as a way to link the reputations of otherwise unrelated products. I show that while umbrella branding can credibly signal positive quality correlation, there are no equilibria in which umbrella branding either fully reveals high quality, or signals negative quality correlation. Finally, whenever umbrella branding signals perfect positive quality correlation, firms that already produce high quality products have stronger incentives to invest in developing further high quality products than firms that are currently inactive or produce low quality products.
    Keywords: reputation; umbrella branding; brand extensions; quality signaling
    JEL: M31 L15
    Date: 2008
  5. By: Schroth, Enrique (Faculty of Economics and Business, University of Amsterdam); Szalay, Dezsö (Department of Economics, University of Warwick)
    Abstract: This paper studies the impact of financing constraints on the equilibrium of a patent race. We develop a model where firms finance their R&D expenditures with an investor who cannot verify their effort. We solve for the optimal financial contract of any firm along its best-response function. In equilibrium, any firm in the race is more likely to win the more cash and assets it holds prior to the race, and the less cash and assets its rivals hold prior to the race. We use NBER evidence from pharmaceutical patents awarded between 1975 and 1999 in the US, patent citations, and COMPUSTAT to measure the effect of all the racing firms' cash holdings on the equilibrium winning probabilities. The empirical findings support our theoretical predictions.
    Keywords: Patent Race ; optimal contract ; innovation ; financial constraints
    JEL: G24 G32 L13
    Date: 2008
  6. By: Cosnita, A.; Tropeano, J.P.
    Abstract: This paper contributes to the economic analysis of merger control by taking into account the efficiency gains for the design of structural merger remedies when the competition authorities do not observe the magnitude of efficiency gains. We show that whenever divestitures are necessary, the Competition Authority will need to extract from the merging partners their private information on the merger’s efficiency gains. For this we propose a revelation mechanism combining divestitures with two additional tools, the regulation of the divestitures sale price and a merger fee. We show that an optimal combination of both instruments is effective: the most efficient merged firms are claimed to pay a merger fee while the less efficient divest asets at an upwards distorted sale price.
    JEL: L41 D82 K21
    Date: 2008
  7. By: Dennis L. Gärtner (Socioeconomic Institute, University of Zurich); Daniel Halbheer (Institute for Strategy and Business Economics, University of Zurich)
    Abstract: This paper investigates the merger wave hypothesis for the US and the UK employing a Markov regime switching model. Using quarterly data covering the last thirty years, for the US, we identify the beginning of a merger wave in the mid 1990s but not the much-discussed 1980s merger wave. We argue that the latter finding can be ascribed to the refined methods of inference offered by the Gibbs sampling approach. As opposed to the US, mergers in the UK exhibit multiple waves, with activity surging in the early 1970s and the late 1980s.
    Keywords: MergerWaves; Markov Regime Switching Regression Model; Gibbs Sampling
    JEL: G34 C32 C11 C15
    Date: 2008
  8. By: Alexei Alexandrov (Simon Graduate School of Business, University of Rochester); ;
    Abstract: I examine interconnection decisions of differentiated firms. I find that previous results that firms never interconnect enough do not hold. In a Hotelling model consumers may suffer from interconnection, and firms may interconnect when it is not socially optimal. The firms interconnect too much when the network effects are steeper - this makes firms compete much less aggressively after interconnection, raising prices for consumers and profits for firms. Price and profit rise results holds under quality and installed base asymmetries, or only some firms in the industry interconnecting. More dimensions of differentiation make interconnection less attractive.
    Keywords: network effects, interconnection, oligopoly, product differentiation
    JEL: D43 L15
    Date: 2008–10
  9. By: Pehr-Johan Norbäck (Research Institute of Industrial Economics (IFN)); Lars Persson (Research Institute of Industrial Economics (IFN)); Joacim Tåg (Research Institute of Industrial Economics (IFN))
    Abstract: In this paper, we study entrepreneurial innovations in an industry characterized by network effects. We show that the presence of network externalities tends to make the entrepreneur prefer sale to entry. Moreover, we also show that the incentive to innovate for entry decreases when network effects become stronger, whereas there is an increase in the incentive for innovation for sale. Moreover, we show that increasing the degree of industry-wide standardization furthers the goal of increasing entry by entrepreneurs. However, this may come at the cost of reducing the research intensity by reducing the bidding competition among incumbents over the innovations of entrepreneurs.
    Keywords: Entrepreneurship, Entry, Compatibility, Innovation, Network Effects, Standardization.
    JEL: D40 L10
    Date: 2008–09
  10. By: Ramon Casadesus-Masanell (Harvard Business School); Francisco Ruiz-Aliseda (Universitat Pompeu Fabra);
    Abstract: In their seminal 1985 paper, Katz and Shapiro study systems compatibility in settings with one-sided platforms and direct network effects. We consider systems compatibility when competing platforms are two-sided and there are indirect network effects to develop an explanation why markets with two-sided platforms are often characterized by incompatibility with one dominant player who may subsidize access to one side of the market. Specifically, we model competitive interaction between two platform providers that act as intermediaries between developers of platform-based products (applications) and users of such products. We show that the unique equilibrium under platform compatibility leads to higher profits than the symmetric equilibrium under incompatibility. Notwithstanding, incompatibility naturally gives rise to asymmetric equilibria with a dominant platform that captures all users and earns more than under compatibility. Our model allows a detailed analysis of social efficiency, and we show that entry by developers is socially excessive (insufficient) if competing platforms are compatible (incompatible). We conclude that while society would be better off if platforms were compatible, the quest for market dominance by competing platform providers prevents them from agreeing to a common standard.
    Keywords: Two-sided Platforms, Incompatibility, Network Externalities, Market Dominance, Tipping, Pricing Structure
    JEL: L11 L15 L40
    Date: 2008–10
  11. By: Jay Pil Choi (Department of Economics, Michigan State University); Byung-Cheol Kim (School of Economics, Georgia Institute of Technology);
    Abstract: This paper analyzes the effects of net neutrality regulation on investment incentives for Internet service providers (ISPs) and content providers (CPs), and their implications for social welfare. We show that the ISP's decision on the introduction of discrimination across content depends on a potential trade-off between network access fee and the revenue from the trade of the first-priority. Concerning the ISP's investment incentives, we find that capacity expansion affects the sale price of the priority right under the discriminatory regime. Because the relative merit of the first priority, and thus its value, becomes relatively small for higher capacity levels, the ISP's incentive to invest on capacity under a discriminatory network can be smaller than that under a neutral regime where such rent extraction effects do not exist. Contrary to ISPs' claims that net neutrality regulations would have a chilling effect on their incentive to invest, we cannot dismiss the possibility of the opposite. Classification-JEL: D4, L12, L4, L43, L51, L52
    Keywords: Net Neutrality, Investment (Innovation) Incentives, Queuing Theory, Hold-up Problem, Two-sided Markets, Vertical Integration
    Date: 2008–09
  12. By: Duarte Brito (Universidade Nova de Lisboa); Pedro Pereira (Autoridade da Concorrência and IST); João Vareda (Autoridade da Concorrência and Universidade Nova de Lisboa)
    Abstract: We analyze the incentives of a telecommunications incumbent to invest and give access to a downstream entrant to a next generation network. We model the industry as a duopoly, where a vertically integrated incumbent and a downstream entrant, that requires access to the incumbent's network, compete on Hotelling's line. The incumbent can invest in the deployment of a NGN that improves the quality of the retail services. Access to the old network is regulated, but access to the new network is not. If the innovation is drastic, the incumbent always invests in the NGN, but does not give access to the entrant. If the innovation is non-drastic and if the access price to the old network is low, the incumbent voluntarily gives access to the NGN. If the innovation is non-drastic, there is no monotonic relation between the access price to the old network and the incumbent's incentives to invest. A regulatory moratorium emerges as socially optimal, if the innovation is large but non-drastic. We also analyze the case where both firms can invest in the deployment of a NGN.
    Keywords: Next Generation Networks, Investment, Access, Regulation
    JEL: L43 L51 L96 L98
    Date: 2008–10
  13. By: Catherine Tucker (MIT Marketing); Juanjuan Zhang (;
    Abstract: This paper highlights how the provision of information about user participation can serve as a strategic marketing tool for firms seeking to grow two-sided exchange networks. A two-sided exchange network is a business model (such as Ebay or Craiglist) where revenue is generated from persuading people to buy and sell items through that particular exchange. It is not immediately clear whether broadcasting information about the number of sellers will grow further seller participation. On the one hand, a strong rival presence may dissipate payoff (a ``congestion effect''). On the other hand, a large number of rivals may signal high buyer demand (a ``cross-platform effect''). We use field experiment data from a B2B web site that brings together buyers and sellers of used equipment and real estate. Before each seller made a posting request, the web site randomized whether to disclose the number of buyers and/or sellers, and the exact number to disclose. We find that when presented together with the number of buyers, a larger number of sellers makes sellers less likely to list their products, indicating a negative congestion effect. However, when the number of sellers is presented in isolation, its negative impact on entry is significantly reduced, indicating a positive cross-platform effect. Higher buyer search intensity amplifies the moderating role of demand uncertainty. The results suggest that information on the number of users can be an effective tool to grow two-sided networks but should be used strategically. A network can attract more users by advertising dense competition when demand is not transparent, especially in search-intensive markets.
    Keywords: Network Effects, Local Networks, Stability, Option-Value
    Date: 2008–10
  14. By: Mitsukuni Nishida (Department of Economics, University of Chicago); ;
    Abstract: Competition among multi-store chains is common in the retail industry. This paper proposes a general model of strategic store network choices by two chains. Unlike previous work on store network choice, it allows chains to choose not only which markets to open its stores but also how many stores to open in a market, internalizing the effects among their own stores on profits. To deal with the huge number of possible combinations of strategy profiles in their network choices, I exploit the lattice structure of the game. I show that a chain's trade-off between costs and benefits from clustering their stores in a market (within-market effect) can be either positive or negative to ensure existence of an equilibrium, thereby providing a way to freely estimate the effect from data. I apply the technique to market-level data from the convenience store industry in Okinawa, Japan. Integrating the model with revenue allows welfare interpretation of results. I find that the within-market effect is negative and as large as the business stealing effect, reduction in revenues due to presence of a rival chain store. The estimated structural model allows us to perform policy analysis. In particular, this paper considers how significantly the zoning regulation introduced in Japan in 1968 affects chains' store network choices. A counterfactual experiment of eliminating the current zoning regulation shows that in the new equilibrium chains would increase the number of their stores. Total surplus is also expected to increase, due to increase in aggregate sales and aggregate profits. The impacts of a hypothetical horizontal merger among two chains on product variety measured by the number of stores and economic welfare are also evaluated.
    Keywords: entry; retail location; supermodular game; zoning regulation; merger
    JEL: L13 L81 R52
    Date: 2008–10
  15. By: Johan Stennek (Gothenburg University); Thomas TangerŒs (Research Institute of Industrial Economics);
    Abstract: This paper questions whether competition can replace sector-specific regulation of mobile telecommunications. We show that the monopolistic outcome may prevail independently of market concentration when access prices are determined in bilateral negotiations. A lighthanded regulatory policy can induce effective competition. Call prices are close to the marginal cost if the networks are sufficiently close substitutes. Neither demand nor cost information is required. A unique and symmetric call price equilibrium exists under symmetric access prices, provided that call demand is sufficiently inelastic. Existence encompasses the case of many networks and high network substitutability.
    Keywords: network competition; two-way access; mobile termination rates; entry; collusion
    JEL: L12 L14 L51 L96
    Date: 2008–09
  16. By: Nicholas Economides (Stern School of Business, NYU); V. Brian Viard (Graduate School of Business, Stanford University); Katja Seim (University of Pennsylvania)
    Abstract: Local telecommunications competition was an important goal of the 1996 Telecommunications Act. We evaluate the consumer welfare effects of entry into residential local telephone service in New York State using household-level data from September 1999 to March 2003. We address the prevalence of nonlinear tariffs by developing a discrete/continuous demand model that allows for service bundling and unobservable provider quality. We find that the average subscriber to the entrants' services gains a monthly equivalent of $2.33, or 6.2% of her bill, in welfare from competition. These gains accrue primarily from firm differentiation and new plan introductions rather than from price effects.
    Keywords: Entry, Nonlinear Pricing, Telecommunications, Discrete/Continuous Demand
    JEL: D43 K23 L11 L13 L96
    Date: 2007–12
  17. By: Avi Goldfarb (Rotman School of Management, University of Toronto); Mo Xiao (Eller College of Management, University of Arizona);
    Abstract: This paper examines how manager and firm characteristics relate to entry decisions in US local telephone markets. To do so, it develops a structural econometric model that allows managers to be heterogeneous in their ability to correctly conjecture competitor behavior. The model adapts Camerer, Ho, and Chong’s (2004) Cognitive Hierarchy model to a real-world setting. We observe the industry in 1998, shortly after the Telecommunications Act of 1996 opened up the market. We find that older firms with older, more experienced managers have higher estimated levels of strategic ability. Managers with degrees in economics or business, and managers with graduate degrees, also have higher estimated levels of strategic ability. We find no evidence that university quality is related to ability. We repeat this exercise using data from 2000, 2002, and 2004. While the core results do not change, the overall level of measured strategic ability increases substantially by 2004. The estimates of strategic ability are also correlated with survival: those firms with lower estimated levels of ability are more likely to exit the industry early.
    Keywords: entry games, behavioral industrial organization, cognitive hierarchy, CLECs, local telephone competition
    JEL: L96 L20 C72
    Date: 2008–10
  18. By: Robert Seamans (Haas School of Business, UC Berkeley); ;
    Abstract: This paper links empirical literature on the use of price as an entry deterring mechanism with literature on the effect of multi-market contact on competition. The analysis uses a dataset of cable TV system prices to provide evidence that incumbent cable TV firms use price to deter entry by telecom overbuilders as well as cities with municipal utilities. There is also some evidence that multi-market contact with telecom overbuilders results in lower prices. However, there is no evidence that incumbents use price to deter cable overbuilders. In addition to linking entry deterrence with multi-market contact, this study has two other unique features. First, it establishes entry deterrence using two techniques, one of which relies on theory by Ellison and Ellison (2008) on non-monotonic price decreases in response to entry probability. Second, it uses detailed price and channel data at the service tier level.
    Keywords: price, entry, public enterprises, multi-market contact
    JEL: L11 L13 L32 L82
    Date: 2008–10
  19. By: Gustavsson Tingvall, Patrik (China Economic Research Center (CERC)); Karpaty, Patrik (Department of Economics)
    Abstract: The central prediction of the Aghion et al. (2005) model is an inverted U-shaped relation between innovation and competition. The model is built on the assumption of a product market and has not yet been empirically tested on service-sector firms. Using detailed firm-level data, we find the inverse U-shaped relation to hold for both small and large service-sector firms. However, non-exporting service firms deviate from the overall pattern. A more detailed breakdown of innovation expenditures shows that the inverse U-shaped pattern holds for both intramural R&D and training, but not for extramural R&D. Finally, as competition increases, small firms tend to seek more strategic alliances with competitors while large firms tend to decrease their collaboration with competitors. To some extent, the behavior of large firms can be due to their greater capacity to handle innovation projects internally and as competition increases, so does the payoff of an edge to competitors.
    Keywords: R&D; innovation; competition; service sector
    JEL: D40 L10 L60 O30
    Date: 2008–10–10
  20. By: Jin-Hyuk Kim (Pembroke College, University of Cambridge); ;
    Abstract: This paper analyzes DRM-based technological tying, where the content and hardware form a system. A closed DRM system makes the legal content incompatible with a rival’s hardware, whose users must then obtain illegal copies. The main finding is that the tying firm gains market power in a competitive hardware market and invests in product upgrades at a later stage. Welfare implications of the policy that requires an open DRM system are also discussed.
    Keywords: digital rights management, copying, tying
    JEL: L12 L41 M21 O32
    Date: 2008–09
  21. By: Antonio Estache; Atsuhi Iimi
    Abstract: To utilize public resources efficiently, it is required to take full advantage of competition in public procurement auctions. Joint bidding practices are one of the possible ways of facilitating auction competition. In theory, there are pros and cons. It may enable firms to pool their financial and experiential resources and remove the barrier to entry. On the other hand, it may reduce the degree of competition and can be used as a cover of collusive behavior. The paper empirically addresses whether joint bidding is pro- or anti-competitive in ODA procurement auctions for infrastructure projects. It is found that there is no strong evidence that joint bidding practices are compatible with competition policy, except for a few cases. In road procurements, coalitional bidding involving both local and foreign firms has been found pro-competitive. In the water and sewage sector, local joint bidding may be useful to draw out better offers from potential contractors. Joint bidding composed of only foreign companies is mostly considered anticompetitive.
    Keywords: Public procurement; auction theory; infrastructure development; joint bidding
    Date: 2008
  22. By: Antonio Estache; Atsuhi Iimi
    Abstract: Asymmetric auctions are among the most rapidly growing areas in the auction literature. The potential benefits from improved auction efficiency are expected to be enormous in public procurement auctions related to official development projects. Entrant bidders are considered a key to enhance competition in an auction and break potential collusive arrangements among incumbent bidders. Asymmetric auction theory predicts that weak (fringe) bidders would bid more aggressively when they are faced with a strong (incumbent) opponent. With ODA procurement data, it has been found that in the major infrastructure sectors, entrants submitted systematically aggressive bids in the presence of an incumbent bidder. It is also shown that high concentration of incumbents in an auction would harm auction efficiency, raising procurement costs. The results suggest that auctioneers should encourage fringe bidders to actively participate in the bidding process while maintaining the quality of the projects. It is conducive to enhancing competitive circumstances in public procurements and improving allocative efficiency.
    Keywords: Public procurement; auction theory; infrastructure development; bidder asymmetry; fringe bidders; market entry
    Date: 2008

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