Network Effects and the Efficiency Defense in Mergers ... · Network Effects and the Efficiency...

Network Effects and the Efficiency

Defense in Mergers among Two-Sided

Platforms

Lapo Filistrucchi

University of Florence

and

TILEC, Tilburg University

CRESSE

Heraklion, 30-6-2017

What is a two-sided platform?

A firm that acts as a platform and sells two different products or services to two different groups of customers

taking into account that demand from at least one group of customers depends on demand from the other group of customers (so that these are not externalities for the firm)

while customers of the two groups do not take these indirect network effects into account (so that these are in fact externalities for buyers)

So that a two-sided platform

- is a particular two-product firm

- is different from a firm selling complement products

A two-sided platform - II

An additional condition is that customers on one side should not be able to pass through completely to customers on the other side an increase in the price they are asked by the platform for the service.

Network effects and the efficiency defense in two-sided markets-I

Is checking for the incentives to raise prices enough in assessing mergers among two-sided platforms?

In a two-sided market, even if prices increase as a result of the merger, consumer welfare might be higher because of the internalization of the (indirect) network effects

Network effects work differently than cost efficiencies: cost efficiencies work through prices, network effects increase willingness to pay

From an economic point of view one would wish to clear a merger which leads to higher concentration and higher prices but higher consumer welfare

So the decision should not be based on a lessening of competition (at least in a traditional interpretation of the word competition) but on a consumer surplus (or total welfare standard)

From a legal point of view this does not look at first sight easy as such a merger might indeed seem to lead to less competition.

Network effects and the efficiency defense in two-sided markets-II

Consider a merger among newspapers

Assume you expect the price of an advertising page to increase

A simple way is to solve the problem is not to stop at whether the price of an ad will rise or not

but

ask whether the price per reader would decline

As the price per reader takes into account the network effect, this type of efficiency is taken into account when looking at the price per reader

Merger between Dutch Yellow Pages in the NL cleared on this ground

However, this amounts to assuming a restriction of the demand function. Although the restriction seems justified by business practice in some media markets, it may not apply to other two-sided markets.

The issue is whether one could take into account the efficiency from the network effect more generally…

Network effects and the efficiency defense in two-sided markets-III

Recital 29 of the EU Merger Regulation acknowledges the

importance of taking efficiencies into account in the assessment of

mergers:

“In order to determine the impact of a concentration on competition

in the common market, it is appropriate to take account of any

substantiated and likely efficiencies put forward by the

undertakings concerned. It is possible that the efficiencies brought

about by the concentration counteract the effects on competition,

and in particular the potential harm to consumers, that it might

otherwise have and that, as a consequence, the concentration

would not significantly impede effective competition, in the

common market or in a substantial part of it, in particular as a

result of the creation or strengthening of a dominant position”.

Network effects and the efficiency defense in two-sided markets-IV

The EU 2010 horizontal merger guidelines at 76:

“It is possible that efficiencies brought about by a merger counteract the

effects on competition and in particular the potential harm to consumers

that it might otherwise have..”

while at 80:

“Mergers may bring about various types of efficiency gains that can lead to lower prices or other benefits to consumers”.

So the EU merger regulation (and horizontal merger guidelines), although

not written with two-sided markets in mind, would seem to leave room to

take efficiencies from network effects into account.

(note however that both in the EU merger regulation and in the EU

horizontal merger guidelines there is an assumption that a loss in

competition harms consumers)

Network effects and the efficiency defense in two-sided markets-V

• Similarly, in the 2010 US horizontal merger guidelines, at 10, provide

that:

• “To make the requisite determination, the Agency considers whether

cognizable efficiencies likely would be sufficient to reverse the merger’s

potential to harm consumers in the relevant market, e.g., by preventing

price increases in that market”

• It was the same in the 1997 US horizontal merger guidelines, at 4,

approved when the literature on two-sided markets was not around yet.

• So also the US merger guidelines would seem leave room to take

efficiencies from network effects into account.

• Both for the EU and for the US:

- Is it the same for direct or indirect network effects?

Welfare standard - I

Since there are two sides of the market and two groups of

customers, there are

• two producers’ welfare (e.g. newspaper publishers)

• two consumers’ welfares (e.g. readers and advertisers)

which are linked .

Hence

• What if the merger leads to lower readers’ prices and higher

advertisers’ prices?

• What if the resulting higher amount of readers is not enough to

compensate advertisers for the higher prices?

Welfare standard - II

• The EU 2004 Horizontal Merger guidelines provide that:

• “The relevant benchmark in assessing efficiency claims is thatconsumers will not be worse off as a result of the merger. For thatpurpose, efficiencies should be substantial and timely, and should,in principle, benefit consumers in those relevant markets where itis otherwise likely that competition concerns would occur.”

• So the benefit should be in the same market where the loss is.

• It is not possible to trade off (consumer) benefits in one marketwith a loss in another.

• Since in a two-sided non transaction market, theory and good practice (Filistrucchi et al. 2014) require that “two interrelated relevant markets” are defined, the guidelines would require that not the sum of consumer welfare (total welfare) on the two sides but consumer (total) welfare on each side increases

• This is rather strict. Is it desirable?

• Does it change matter whether a competition authority has a total welfare standard or a consumer welfare standard?

Welfare standard - III

• Both the 1997 and 2010 US horizontal merger guidelines, at 4 and 10 respectively, provide that:

• “To make the requisite determination, the Agency considers whether cognizable efficiencies likely would be sufficient to reverse the merger’s potential to harm consumers in the relevant market, e.g., by preventing price increases in that market”

• So there would seem to be the same problem.

• However, in both versions there is a note, 36 and 14 respectively:

• ”[…] In some cases, however, the Agencies in their prosecutorial discretion will consider efficiencies not strictly in the relevant market, but so inextricably linked with it that a partial divestiture or other remedy could not feasibly eliminate the anticompetitive effect in the relevant market without sacrificing the efficiencies in the other market(s).[..]”

• This seems to fit well two-sided markets …

• But what about case law?

Mastercard 2007: Cardholders versus merchants-1

• In the EU a stance on these issues has been taken explicitly, up to thehigher court level, in the 2007 Mastercard case

• COM: There is no reason to assume from the outset that an interchangefee paid by acquirers to issuers increases the utility of the payment cardsystem to both groups of consumers alike. The Commission does notdispute that merchants may benefit through enhanced network effectsfrom the issuing side, but this does not necessarily offset their losseswhich result from paying inflated merchant fees. In setting a MIF themember banks of a card scheme must guarantee a fair share of thebenefits to all customers, not only those that are on the side of thescheme which receives the MIF. In a scheme where the MIF is paid by theacquirer to the issuer, the efficiencies must in particular counterbalancethe restrictive effects to the detriment of merchants (and subsequentpurchasers). Mastercard has not submitted evidence in this respect.


• GC: It must be concluded therefore that, in the absence ofproof of a sufficiently close link between the MIF and theobjective advantages enjoyed by merchants, the fact that theMIF may contribute to the increase in MasterCard systemoutput is not, in itself, capable of establishing that the first

condition laid down under Article 81(3) EC is satisfied.• The applicants also criticise the Commission for failing to take

into account the advantages to cardholders that arise from the MIF and, moreover, for acting as a ‘price regulator’ in respect of the MIF.


• With regard to the first criticism, it is indeed settled case-lawthat the appreciable objective advantages to which the firstcondition of Article 81(3) EC relates may arise not only for therelevant market but also for every other market on which theagreement in question might have beneficial effects, andeven, in a more general sense, for any service the quality orefficiency of which might be improved by the existence of thatagreement ... However, as merchants constitute one of thetwo groups of users affected by payment cards, the veryexistence of the second condition of Article 81(3) ECnecessarily means that the existence of appreciable objectiveadvantages attributable to the MIF must also be establishedin regard to them.


• AG : It is the consumers that suffer the harm caused by therestrictive effects of the agreement at issue that must, inprinciple, be allowed, as compensation for that harm, the fairshare of the benefit resulting from the agreement referred to inArticle 81(3) EC.

• In fact, if it were possible to take into consideration theadvantages resulting from an agreement for one category ofconsumers of certain services in order to counterbalance thenegative effects on another category of consumers of otherservices on a different market, that would amount to allowingthe former category of consumers to be favoured to thedetriment of the latter category. However, distributive logic ofthat type seem to me, in principle, to have no connection withthe practical scope of competition law.


• Competition law is intended to protect the structure of themarket, and thus competition, in the interest of competitors and,ultimately, consumers in general. Conversely, it is not intended tofavour one category of consumers to the detriment of adifferent category.

• In that regard, I must further observe that those considerationsare not necessarily inconsistent with the settled case-law of theGeneral Court, … according to which it is not excluded that itmay be possible to take into consideration the advantagesresulting from the agreement that occur on a different marketfrom that on which the agreement produces the restrictiveeffects. Such advantages may be taken into consideration where,for example, the category of consumers affected by theagreement on the two separate markets is the same.


• ECJ: […] it must be held that, in the light of what has been stated inparagraphs 234 to 236 of the present judgment, the General Court was,in principle, required, when examining the first condition laid down inArticle 81(3) EC, to take into account all the objective advantagesflowing from the MIF, not only on the relevant market, namely theacquiring market, but also on the separate but connected issuingmarket.

• It follows from this that, should the General Court have found thatthere were appreciable objective advantages flowing from the MIFfor merchants, even if those advantages did not in themselves provesufficient to compensate for the restrictive effects identified pursuantto Article 81(1) EC, all the advantages on both consumer markets inthe MasterCard scheme, including therefore on the cardholders’market, could, if necessary, have justified the MIF if, taken together,those advantages were of such a character as to compensate for therestrictive effects of those fees.


• ECJ: However, as is recalled in paragraph 234 of the present judgment,examination of the first condition laid down in Article 81(3) EC raisesthe question whether the advantages derived from the measure atissue are of such a character as to compensate for the disadvantagesresulting therefrom. Thus, where, as in the present case, restrictiveeffects have been found on only one market of a two-sided system,the advantages flowing from the restrictive measure on a separatebut connected market also associated with that system cannot, inthemselves, be of such a character as to compensate for thedisadvantages resulting from that measure in the absence of anyproof of the existence of appreciable objective advantagesattributable to that measure in the relevant market, in particular, as isapparent from paragraphs 21 and 168 to 180 of the judgment underappeal, where the consumers on those markets are not substantiallythe same.


• ECJ: In the present case, and without any distortion having beenclaimed in that regard, the General Court concluded in paragraph226 of the judgment under appeal that there was no proof of theexistence of objective advantages flowing from the MIF andenjoyed by merchants. In those circumstances, it was notnecessary to examine the advantages flowing from the MIF forcardholders, since they cannot, by themselves, be of such acharacter as to compensate for the disadvantages resultingfrom those fees.

Welfare standard - IV• According to the ECJ ruling on Mastercard, some benefits should

be in the same market where the damage is “when the category ofconsumers is not the same” or “when the consumers are notsubstantially the same”

• In some cases defining customers on the two-sides as “ofdifferent categories” may be more problematic (e.g. night clubs orvirtual market places)

• In fact, think of the aggregation implicit in the definition ofconsumers surplus… (e.g. Bill Gates and me)

• It seems however that, according to the ECJ, while benefits shouldbe present on both sides of the market, they need not compensatethe harm on each side of the market (quite ambiguous)

• In the payment card case it may not be so relevant if marketdefinition is correctly carried out (i.e. a single market is defined asmentioned above)

• Hence the ECJ decision, despite referring to the payment cardcase, should be seen as mainly relevant for media markets andother two-sided non-transaction markets

Conclusions

The EU seems to have adopted a strict approach for taking intoaccount efficiencies from indirect network effects (though maybenot as strict as often claimed)

The US instead seems to have adopted a less strict one

However, also in the EU, despite the ECJ decision on Mastercard,efficiencies from indirect network effects may be taken intoaccount more often than it seems at first sight if market definitionis correctly carried out

Also because there is a strong economic incentive to movetowards transaction platforms also in the media markets and thefuther development of digital technologies (consumers trackingand algorithms) may help to move in this direction

Network Effects and the Efficiency Defense in Mergers ... · Network Effects and the Efficiency...

Documents

Transcript of Network Effects and the Efficiency Defense in Mergers ... · Network Effects and the Efficiency...