Competition Economics

Competition policy and e-commerce

Competition law enforcement and its associated economic analysis faces constant challenge from the dynamism of the commercial world and the evolution of business strategies and practices. Over the past few years a leading form of challenge has been the ever-increasing prevalence of online forms of commerce, such as e-tail, sharing networks, platforms and electronic payment systems.

E-commerce promotes economic growth and development through its significant efficiencies and may reduce barriers to entry and expansion in markets. From a consumers’ perspective, e-commerce widens product choices, improves price transparency and simplifies transactions. However, the rise in online activity has also brought new opportunities and incentives for firms to conduct their businesses in ways that reduce rivalry. Advances in price transparency increase the risk of coordination among competitors, online platforms may facilitate collusion, and horizontal or vertical restraints can be used to raise entry barriers and reduce competition.

The online share of the economy will continue to escalate as high-speed internet services expand and the ‘internet of things’ takes shape. The implications of online commerce for the nature of the economic analysis that informs competition assessments must evolve with these economic changes. In this article, we canvass some of these implications for market definition and the assessment of market power.

Market definition

Establishing the bounds of the relevant market is a first step in merger or conduct assessment, since it provides a practical framework for evaluating the competitive landscape within which a particular firm operates. The relevant market includes all the goods and services that consumers regard as close substitutes for the product or service of interest, having regards to its characteristics, intended use and location. Although competition authorities may not always seek to define the bounds of a market precisely, no competitive assessment can avoid the need to consider the scope and strength of the constraints applying to a particular firm.

E-commerce changes the ways businesses interact with their customers and offers new opportunities for establishing linkages. For the purpose of market definition, this raises questions such as: whether online and offline sales channels compete with one another; the implications of e-commerce on geographic market boundaries; and the approach to identifying the markets in which platforms operate. There is no one-size-fits-all answer to these questions.

Economists often employ the hypothetical monopolist test (HMT) to assess whether products or suppliers are sufficiently substitutable for one another that they exist in the same market. Applying this test involves assessing whether a single firm with control over the supply of a given set of products would profit from instituting a small but significant non-transitory increase in price (SSNIP) – often taken to be a 5 per cent to 10 per cent increase sustained over a one-year period.¹ The market boundaries are defined to include the narrowest product set over which prices could be increased without the hypothetical firm losing significant sales to competing firms or products. This test remains relevant in the online economy, although some care must be taken to ensure it provides meaningful results.

Are online and brick-and-mortar businesses in the same market?

The circumstance in which online retailers compete with their brick-and-mortar counterparts depends essentially on consumers’ perceptions of the substitutability between these channels. The appropriate framing of the market definition question is whether a sufficient number of customers would be likely to switch channels in response to a generalised SSNIP across relevant prices in one of the channels.

Perceptions as to the convenience of online shopping, the risks associated with not physically viewing products, delivery costs and the like, will all contribute to determining whether different distribution models operate in the same market. The degree of substitutability between channels may be very strong for some retail products, such as clothing, books and groceries. For other products, the advantages of one distribution model over another may mean different channels are not close substitutes. For example, in its assessment of the Seek Asia/JobStreet merger, the Competition Commission of Singapore found that more traditional recruitment services channels were a poor substitute for online services and so were unlikely to exert a strong competitive constraint on online charges.² Similarly, in its assessment of the Expedia/Wotif.com merger, the Australian Competition and Consumer Commission (ACCC) found that bricks-and-mortar travel agents operated in a separate market from online travel agents.³

To what extent do online activities expand a market’s geographic boundaries?

The internet enables customers to view the product offerings of suppliers located virtually anywhere in the world. However, the extent to which this translates into a willingness to make purchases from businesses outside a buyer’s own locale will depend on the nature of the product and consumers’ perceptions of the associated risks. The ability of remotely located suppliers to act as a constraint on firms can play a significant role in determining the effect on competition of certain conduct, agreements or mergers. Properly identifying the extent of such distant constraints is therefore essential to avoid either unwarranted enforcement measures or allowing harmful conduct to proceed.

For some products, the cost of transportation, including the risk of needing to return unsuitable products, may preclude long-distance purchasing. Even for digital content, there is some evidence internet users prefer to purchase from local providers, perhaps on account of perceptions that contracts with local suppliers will be easier to enforce.⁴ However, for a wide range of products, consumers are becoming increasingly comfortable with purchasing products from other regions or across borders. As the prevalence of online activity increases, logistical support services and payments networks evolve, and businesses develop new means of reducing customer risks, geographic market boundaries can be expected to continue to expand.

The SSNIP test continues to provide a useful framework for evaluating the relevant geographic boundaries. The framing of such a test calls for an assessment as to whether a SSNIP imposed by local providers would be sufficient to cause customers to purchase from more remotely located online providers and, if so, over what distance would such switching occur.

The delivery fees associated with the product in question is a critical dimension of this assessment. For products with low transportation costs relative to their value, an SSNIP in the price of local products is more likely to drive consumers to purchase products from further afield. However, additional factors – such as the perceived risks of transacting with suppliers further afield – will also play a role and so focusing solely on delivery costs is unlikely to provide a complete picture.

The data generated by online purchases, and the decision-making processes that give rise to such purchases, may also provide valuable information on market boundaries. Virtually every click made online is recorded. In consequence, data that go well beyond basic details such as the location, age and gender of customers are gathered, and may include, for example, competing products and suppliers, advertisements and platforms that were viewed prior to a purchase. Analytics tools, including econometrics and other statistical techniques, can be used to draw meaningful linkages from these data regarding the geographic source of the products that consumers evaluate and the trade-offs they are willing to make.

Market definition in the context of platforms

Further market definition questions arise in relation to online platforms operating in multi-sided markets. Such platforms enable direct interactions between two or more distinct groups, each of which has a relationship with the platform provider.⁵ A platform’s success depends on securing a critical mass within each customer group, because network effects increase the perceived value of one set of services as customer numbers grow on the other side of the platform.

For these business models, when identifying the relevant market, it is necessary to determine whether the platform operates in a single market or if each side constitutes a separate market. Although the HMT construct remains theoretically sound for identifying the bounds of platform-based markets, the application of the SSNIP test may need to be modified in order to provide meaningful results.⁶ As a general guide, the separation of markets and the appropriate application of SSNIP tests depends on whether the platform is best classified as ‘transactional’ or ‘non-transactional’.⁷

In a transaction market, end users directly interact with one another. Examples of this type of platform include marketplaces in which buyers are connected with sellers, and payment platforms that involve a transaction between credit card companies and users. Competition authorities have generally treated such platforms as operating in a single market, with the transaction services being the relevant product.^8, 9 In these cases, the SSNIP test can be applied to the total price of the transaction, irrespective of how it is split between the parties, to determine the extent of competition between platforms or other sales channels.¹⁰

In contrast, a non-transaction platform does not involve direct interaction between customer groups. Examples include social networks, such as Facebook, Twitter and Instagram, which offer social connectivity to one group of customers and advertising services to another. For these platforms, it is more appropriate to treat each side of the platform as a separate, but related, market.

Applying the SSNIP test in these markets can be complicated by the implications of the network effects on pricing strategies. Network effects may lead to pricing strategies that would not make sense in simpler markets, such as providing services free to certain groups in order to encourage participation. Even when there are charges involved, the distortions to the pricing structure could mean that the results of a standard SSNIP application are not meaningful. In these cases, the SSNIP test must be modified to take account of the network externalities between user groups.¹¹ In some circumstances, it may not be practicable to apply the SSNIP test in a strictly quantitative manner. The Supreme People’s Court of the People’s Republic of China managed this issue in the Qihoo 360 v Tencent matter by relying on product characteristics to assess demand-and-supply substitution rather than applying a SSNIP-based assessment.¹²

Identifying market power

The competition implications of unilateral conduct, agreements or potential mergers almost always depend on existing and prospective market power – the ability of a firm to profitably raise and maintain the price of a good or service above the competitive level – while harm to competition is often equated with the existence of or an increase in market power.¹³

The e-commerce medium has the potential to disrupt, enhance or generate new sources of market power. The availability of new channels to market and improvements in logistics enabled by online activities work to reduce barriers to entry and expose firms to increased competition. Conversely, market power might be amplified by the ability to collate customer data, the network effects of platforms, or the availability of pricing algorithms to coordinate conduct.

Just as in traditional industries, assessing market power in online markets requires careful review of the means by which competition takes place, customers’ ability and willingness to switch between providers, and the ease with which new suppliers might enter markets. The utility of market-share information as an indicator of market power is questionable in many circumstances, but even more so in the case of online activities. Market shares may be a particularly weak indicator of market power for platforms,¹⁴ since they fail to take account of indirect network effects and can be problematic to apply when one side of a platform does not generate revenue,¹⁵ when customers have a propensity to multihome or when a market is particularly dynamic. For example, the Supreme Court in Qihoo 360 v Tencent found market shares to be relatively unhelpful, noting that high market share does not necessarily translate into market power.¹⁶

Two aspects of the online arena with particular implications for assessments of market power are its more dynamic nature and the increasing role of data.

The dynamic nature of competition

Ongoing innovation in the manner in which businesses organise themselves and the opportunities that arise from the ease of online connectivity drive dynamism in e-commerce to a greater extent than traditional markets. Market power may be quickly eroded as technology and product offerings evolve and customer preferences change, and so market power assessments must take account of the dynamics of competition and the ease with which new products or new means of making connections can be introduced.

Dynamism may be especially relevant in the case of platforms, where providers are exposed to the constant risk that an innovator may enter with a disruptive business model and quickly gain a substantial share of the market. This prospect can be characterised as a risk of ‘tipping’, as innovators leapfrog one another to gain market dominance. The speed at which Facebook displaced MySpace as the leading social media platform is a pertinent example. In these types of markets, it may be more relevant to consider competition ‘for’ the market, even in situations where network effects are very strong.¹⁷

Of particular relevance for the dynamism of a market is the ease with which new products or platforms are able to enter and the extent to which consumers are likely to be willing to move between providers. In its consideration of the Wotif/Expedia merger, the ACCC found that there was potential for companies in adjacent industries to enter the market with new business models and disrupt online travel agents’ business models. The commission found that such threat would be sufficient to discipline Expedia’s conduct post-acquisition.¹⁸ The dynamic nature of the mobile payments market was also a contributing factor to the ACCC’s 2016 draft decision not to authorise collective negotiating and boycotting arrangements by four Australian banks, which they had argued was necessary in order to protect competition in light of the strength of Apple’s negotiating power.¹⁹

Data as a source of market power

One defining feature of e-commerce is the increased availability of price and other information. Such transparency has the potential to strengthen competition and dilute market power, but also carries the risk that market power may be strengthened. For example, the collection and aggregation of ‘essential’ information may be difficult to substitute or replicate and so establish a barrier to entry, or increased transparency may establish new means of forming and enforcing collusive agreements.²⁰

The information that can be drawn from databases generated online offers consumers, businesses and public entities unprecedented opportunities to identify prospects for value creation and could provide an incumbent firm with a significant and sustainable competitive advantage over potential new entrants. For example, the ability to target online advertisements using customers’ browsing history has significantly increased the effectiveness of advertising, while consumption pattern data can be used to generate new product offerings or develop innovative cross-selling arrangements.

The potential market power associated with proprietary data may be particularly relevant when undertaking merger assessments. Merging firms may be able to draw commercially valuable linkages from combining databases of customer information that would otherwise be unrelated. This could increase the risk that mergers between firms that operate in unrelated or vertically related markets could harm competition through economies that are achievable through combining data sets so that entry barriers are heightened.

The means by which businesses use data to generate sustainable competitive advantages is evolving rapidly. As the collection and manipulation of data expands, so too will the risks that businesses establish an ability to use it in a way that lessens competition.

Conclusions

E-commerce remains a relatively new and fast-evolving trading sphere, offering firms new business opportunities and generating innovative linkages along supply chains and between customer groups. The potential for improvements in efficiency – in terms of cost savings, product offerings and innovation – are enormous. The flipside of this coin is that e-commerce can be a vehicle for enhancing market power and enabling firms to use that power to the detriment of competition and consumers.

Analysing and assessing novel business arrangements and activities taking place in markets that have been fundamentally reshaped brings new challenges to economists and competition authorities. The importance of carefully considering on a case-by-case basis the drivers of competition, entry and expansion barriers, consumer preferences, the role of data, and the incentives on industry parties, cannot be over-emphasised.

At the same time, the growth in online transactions and activities has the potential to significantly improve the information that is available to economists and competition authorities when assessing firm conduct, agreements or proposed mergers. The data that are recorded as customers compare and purchase products online provide a rich source of information. Data analytics techniques, including econometrics and other statistical tools, offer much potential to provide a clearer picture of consumer preferences, as well as the scope and nature of competition facing a particular business.

Notes

1. See, for example, Tilburg Law and Economics Centre and Howrey LLP (2010) ‘Mergers in Two-Sided Markets – A Report to the NMa’, page 58.
2. Competition Commission of Singapore (November 2014) Grounds of Decision issued by the Competition Commission of Singapore – In relation to the notification for Decision of the proposed acquisition by Seek Asia Investment Pte Ltd of the JobStreet Business in Singapore pursuant to section 57 of the Competition Act, pages 24–25.
3.  ACCC (2015) Public Competition Assessment – Expedia, Inc – proposed acquisition of Wotif.com Holdings Limited, page 9.
4. Paolo Buccirossi (2013) Background note to OECD Policy Roundtable on Vertical Restraints for On-line Sales, page 19.
5. See, for example, Andrei Hagiu and Julian Wright (2015) ‘Multi-Sided Platforms’, Harvard Business School Working Paper, page 5.
6. See, for example, Tilburg Law and Economics Centre and Howrey LLP (2010) ‘Mergers in Two-Sided Markets – A Report to the NMa’, pp 119-121; DotEcon (2015) E-commerce and its impact on competition policy and law in Singapore – A DotEcon study for the Competition Commission of Singapore, pages 89–91.
7. See, for example, Tilburg Law and Economics Centre and Howrey LLP (2010) ‘Mergers in Two-Sided Markets – A Report to the NMa’, page 116; Lapo Filistrucchi, Damien Geradin, Eric van Damme and Pauline Affeldt (2013) ‘Market Definition in Two-Sided Markets: Theory and Practice’, Working Paper N. 05/2013, Disei, Università degli Studi di Firenze.
8. See, for example, Tilburg Law and Economics Centre and Howrey LLP (2010) ‘Mergers in Two-Sided Markets – A Report to the NMa’, page 56; ACCC (2015) Public Competition Assessment – Expedia, Inc – proposed acquisition of Wotif.com Holdings Limited.
9. We note that competition authorities have not always followed this approach. For example, see Commerce Commission New Zealand (2014) Determination – Expedia, Inc and Wotif.com Holdings Limited, page 10.
10. Lapo Filistrucchi, Damien Geradin, Eric van Damme and Pauline Affeldt (2013) ‘Market Definition in Two-Sided Markets: Theory and Practice’, Working Paper N. 05/2013, Disei, Università degli Studi di Firenze, page 37.
11. See Lapo Filistrucchi, Damien Geradin, Eric van Damme and Pauline Affeldt (2013) ‘Market Definition in Two-Sided Markets: Theory and Practice’, Working Paper N. 05/2013, Disei, Università degli Studi di Firenze, page 36.
12. David Evans and Vanessa Yanhua Zhang (2014) Qihoo 360 v Tencent: First Antitrust Decision by The Supreme Court.
13. See, for example, Commerce Commission New Zealand (2014) Determination – Expedia, Inc and Wotif.com Holdings Limited, page 4.
14. See, for example, David Evans (2016) ‘Multisided Platforms, Dynamic Competition and the Assessment of Market Power for Internet-based Firms’, the Law School, the University of Chicago.
15. Pier Luigi Parcu, Maria Luisa Stasi and Marco Botta (2016) ‘Antitrust Enforcement in Traditional v Online Platforms’, European University Institute, Issue 2016/02, page 2.
16. David Evans and Vanessa Yanhua Zhang (2014) Qihoo 360 v Tencent: First Antitrust Decision by The Supreme Court.
17. Pier Luigi Parcu, Maria Luisa Stasi and Marco Botta (2016) ‘Antitrust Enforcement in Traditional v Online Platforms’, European University Institute, Issue 2016/02, page 3.
18. ACCC (2014) Statement of Issues – Expedia, Inc – proposed acquisition of Wotif.com Holdings Limited, para 74 and ACCC (2015) Public Competition Assessment – Expedia, Inc – proposed acquisition of Wotif.com Holdings Limited, pages 11–13.
19. ACCC (2016) ACCC proposes to deny authorisation for banks to collectively bargain with and boycott Apple on Apple Pay; and ACCC (2016) Draft Determination: Applications for authorisation A91546 & A91547 lodged by Bendigo and Adelaide Bank, Commonwealth Bank, National Bank & Westpac Banking Corporation, page 20.
20. See ‘Autorité de la concurrence and Bundeskartellamt’ (2016) Competition Law and Data, page 11.