Kodak Case - Create and answer a case study similar to Kodak Case (3, 7, 11) - Cases Available under Assignments tab and Wikispaces Case Study folder on Blackboard- that looks at ways to measure market power through elasticities and market shares. Also consider the effects of commodity bundling and market power
- Jennifer Schaefer
Google’s Defense in Antitrust Hearing: An Evaluation of Market Power
Google
On September 21, 2011, Google Executive Chairman, Eric Schmidt testified before the Senate Judiciary Committee’s Antitrust, Competition Policy and Consumer Rights Subcommittee that Google was not a monopoly, and was in no way dominating the search market. The civil probe is one of the largest legal threats to Google because it examines the company’s core search-advertising business.
Google has been scrutinized for years on anticompetitive practices, including “using other companies’ content without permission, deceptive display of search results, manipulation of search results to favor Google’s products, and buying up competitive threats to its dominance.” 1 The company currently faces seven antitrust inquiries, and holds a 65% US market share and 90% EU market share2, but still claims to not be abusing its market power. What will determine if they are correct?
Google’s History
Google was created in January 1996 by Stanford University students, Larry Page and Sergey Brin, as a research project that analyzed the relationship between internet websites. Other search engines would position results by the number of times search terms appeared on the page, but Page and Brin believed they could improve the system. They wanted to explore a website’s relevance based on the number of pages, and the importance of those pages that would link back to the original site, and create a system that would “organize the world's information and make it universally accessible and useful.” 3
Today, Google is mostly known for its search capability, cloud computing and advertising technology. It hosts and cultivates a number of Internet-based services and products, and generates profit primarily through its AdWords program. 4
Google also offers products in the form of commodity bundling by selling or packaging products together (bundling) at a price less than the sum of its components. With certain advantages, such as the ability to enhance quality, measure consumption (for price discrimination) and create strategic advantage, Google has developed somewhat of a monopoly over bundles because that good is supplied in a perfectly competitive industry – preventing goods from being purchased or obtained separately.
Examples of Google-bundled products include, the 2005 Google Pack, which was a package of Google and third-party applications, such as Skype, RealPlayer, Adobe, Google Earth, Google Apps, and Google Picasa. It has since been dissolved due to the lack of interest and availability of downloading software online, but it was an attempt at measuring consumption. Skype (now a Microsoft product) however, has recently de-bundled Google from their 5.5 and 5.6 versions by choosing not to include their products in the installer.
Google also released an update in 2006 that included programs such as Ad-Aware, GalleryPlayer, Google Desktop, Google Talk, Google Toolbar, Mozilla Firefox, Norton Antivirus, and Trillian. Eventually, other companies picked up their bundles (such as Dell and Verizon), but it wasn’t until Google acquired Android in 2007 that they really staked their claim. With all the types of cell phones that users could purchase, controlling which mobile operating system they would run off of was a great advantage for the company.
They also worked out an agreement with the Mozilla Foundation – making them the default engine for the Firefox browser, and Apple’s Safari browser.
Google’s Current Market Position
Google currently controls 65% or more of all general internet searches, 94% European market share and 97% processing on all smartphone searches.5 Google also “defines its business and estimates its market share, it declares itself to represent approximately 3% of all advertising sales in the US, or alternatively as about 30% of all online advertising sales.”6
In attempting to determine if a company is a monopoly, evaluating market power and the impact on competitors can be beneficial. Typically courts will consider the following (according to the Federal Trade Commission) 7:
1. The Lerner Index
2. Market Shares
3. HHI Analysis
These items are the basis for market power assessment or “the firm's ability to maintain prices above competitive levels at its profit-maximizing level of output. Some would argue that the greater the market power, the more likely the company is act anti-competitively.
For a perfectly competitive firm, the competitive price level is that firm's marginal cost.8 The Lerner Index attempts to measure this by subtracting marginal cost from price, and then dividing the result by the company’s price. The range is from 0 to 1 (with scores closer to 0 as having less market power). It can be derived from the following equation:
P-MCP
where P is price and MC is marginal cost. This quantity measures a firm's ability to price above marginal cost in percentage terms.9
We can also note that an inverse relationship exists between a profit maximizing firm's ability to price above marginal cost and the market elasticity when the firm faces a downward sloping demand curve:10
P-MC = 1 P e where e = the market elasticity of demand.
Although using the Lerner Index would help us in evaluating market power, it’s not the best. It’s not as practical when applying to transactions, and doesn’t offer a “competitive benchmark except in perfectly competitive markets.”11 It’s also only useful if the company’s marginal cost is determined, so without that, we can’t calculate the Lerner score. Therefore, courts will typically look at market shares and HHI analysis instead.
Market shares, or “the percentage of sales or capacity that a firm controls in a relevant market,”12 are indirectly related to the company’s ability to set price above marginal cost. The Lerner Index is the reciprocal of the company’s demand elasticity at its own profit-maximizing level of output, so these "own-demand" elasticities can be difficult to measure. Therefore, economists attempt to measure market share and the market elasticity of demand, and the outcome is based on economic assumptions about how companies will compete through fringe output, supply substitutability and elasticity of demand.13
This measure of market power for the dominant firm depends upon the dominant firm's market share, the market price elasticity of demand, and the competitive fringe supply elasticity. Specifically,
Ls = P-cd/P = 1/Ed = s/ED + (1-s)Es
where Ls denotes the Lerner index for the single-market measure of market power, P is price, cd is the dominant firm's marginal cost and ED is the price elasticity of demand facing the dominant firm.14
For a given level of market-demand elasticity, a company’s own-demand elasticity decreases as its market share increases. The lower the own-demand elasticity, the higher the ratio under the Lerner Index. So for any given demand elasticity, higher market shares reflect a greater capacity for setting price above marginal cost. And ultimately, we’re looking to see if a company (or group of) has the ability and motivation to raise/sustain prices above competitive levels.
Differences in supply and demand elasticities can allow two different companies with two very different market shares to set price well over marginal cost.
HHI Analysis can also beneficial in looking at a company’s market power. It’s been used in horizontal merger analysis, where companies combine to operate as one, and is a cornerstone for the 1992 Horizontal Merger Guidelines. It gives a statistical measure of concentration, and by having more weight in market shares, HHI could more accurately predict the “likelihood of oligopolistic coordination in the post-merger market.”15
It also lays out calculations in the Guidelines for transactions: “If the HHIs of the pre- and post-merger markets fall within certain ranges, the agencies are not likely to challenge the transaction. Low HHIs may therefore bring some transactions into the safe harbors of the Merger Guidelines. The presumption may be overcome by a showing that factors set forth in Sections 2-5 of the Guidelines make it unlikely that the merger will create or enhance market power or facilitate its exercise, in light of market concentration and market shares."16
Senate Judiciary Committee Hearing
In September 2011, Federal regulators decided they had enough evidence to launch an investigation on Google, and would evaluate the company’s market power in regards to an AdWords claim.
The Department of Justice announced that Google had been fined $500 million for allowing online Canadian pharmacies to place advertisements through its AdWords program, resulting in the unlawful importation of controlled and non-controlled prescription drugs into the United States. The Department’s press release noted that “Google was aware as early as 2003, that generally, it was ‘illegal’ to ship pharmaceuticals into the U.S. Google is also well aware that online copyright infringement online occurs on a massive scale and that it is a ‘problem that [Google] takes very seriously.’”17
Executive Chairman, Eric Schmidt testified on behalf of Google, and Senator Richard Blumenthal questioned him as to whether or not Google was obligated to ensure that it did not abuse its own market position. And if so, what would ensure that such abuse did not occur?
Schmidt replied that “Google’s current practices that prevented it from becoming “evil,” even as its power grows. When the suggestion came up that Google convene a panel of outsiders to review changes the company makes to rankings in its search engine, Google’s lawyer, Susan Creighton, said she didn’t think that was a good idea. When senators asked some of Google’s competitors to describe how the company was harming consumers, they replied that consumers were being misled into believing Google’s search results were unbiased when, in fact, Google was displaying links to its own sites above others. Still, “in antitrust, we don’t let competitors speak for consumers,” Hovenkamp said.18
Senator Blumenthal also questioned as to whether or not it was fair to label Google as a monopoly. Schmidt disagreed. “Google provides its service for free and competition is ‘one-click away.’”19 He also told the Senate antitrust committee that the company does not dominate the search market. “Google has many strong competitors…Google has none of the characteristics that I associate with market power.”20
These statements created some confusion because a few months prior to the hearing, Schmidt agreed with Senator Herb Kohl that the company was “in that area” (when asked if Google had a monopoly or dominant position). Schmidt went on to later say that his description was “clearly wrong” and that “Google has many strong competitors and we sometimes fail to anticipate the competitive threat posed by new methods of accessing information.”21
Google's Increasing Market Power Furthers Antitrust Anxiety
Despite the ongoing investigation, Google’s market power intensifies. According to According to Eric Clemons, Professor of Operations and Information Management at The Wharton School, “[Google] does acknowledge a share of paid search in the US (approximately 70%), but argues that this is not an interesting or significant statistic, since search is not a business segment and advertising and online advertising are businesses. A 70% market share is within the range that that the Department of Justice uses to assess a rebuttable presumption of possession of monopoly market power. It is well above the level of 27% at which Apollo (United Airline's Computerized Reservation System) demonstrably possessed monopoly market power in the 1980s. Importantly, at that time Apollo employed a business model similar to the business model Google uses today.”22
Google was also recently rumored to finance a buyout of Yahoo to sell ads across its websites or possibly raise the purchase price for rivals. Had they succeeded, Google would have easily undermined Yahoo’s ability to compete with them. Also, if Google supplied their advertising, this will also give Yahoo less incentive to compete, and could potentially break up the Yahoo-Microsoft search advertising agreement (approved by the Department of Justice in 2010) with Microsoft, of course, being one of their top competitors.
This acquisition would not prove beneficial for anyone other than Google. It would be an attempt at “using market power to collude to manipulate an informal auction of a public company that is Google’s leading competitor, with the purpose of driving up acquisition costs to make it harder for rivals to successfully compete.”23 Or in other words, “classic Sherman Act illegal monopolistic behavior.”24
But even dominant companies have threats. When Google CEO, Larry Page, was asked what the greatest threat was to Google, he simply said: “Google.” According to Forbes, here are their top 10 threats to the company25:
“There is copious evidence that Google lords over the Internet like a 21st century robber baron which believes it can do as it pleases with little fear of, or regard for, the rule of law. No other Fortune 500 company has ever self-generated so many serious diverse and far-reaching liabilities/threats as Google has. Google CEO Larry Page was painfully right in recently admitting that the greatest threat to Google — was “Google” itself.”26
Conclusion
Google’s continued growth may make them the target for many antitrust suits, so courts are therefore urged to consider the FTC’s recommendations of looking at other factors (such as indexes and market shares) when determining anticompetitive behavior. Speculation alone would not be sufficient in terms of ruling, and the unbiased information provided in this case study could lead to a more reasonable judgment.
**JASCHAEFER**Oct 3, 2011 3:03 pm Found an interesting article on price policy, and how companies handle discounting concerns of higher quality products:
Both great, thank you. Interesting bit about Rolex maintaining demand through restricting supply, rather than prices directly- very similar to the Playmobil case.
Merger Called Off
**JASCHAEFER**Oct 3, 2011 3:31 pm In response to the first discussion post, it looks like the merger was actually called off a month later:
WorldCom stated that "Opposition to this merger just adds to the list of...policies that ultimately will reduce innovation and choice and raise the cost of communications services for residential customers."
Even the case study for this stated that, if the merger actually happened, that AT&T and WorldCom/Sprint would have controlled about 80% of the market. Their next largest competitor would only have a market share of no more than 3%, so that seems rather monopolistic.
No wonder there was concern.
October 10, 2011 Vertical Integration
**JASCHAEFER**Oct 10, 2011 7:18 pm Found an interesting review on vertical integration:
It stated that some companies experienced "significant declines in market shares following changes in control." Made me wonder what types of companies and how much market power they had to see such results.
Thought it might be helpful.
re: Impact of Mergers
**emretez86**Oct 18, 2011 1:58 pm great. thank you so much. It will be helpful.
October 18, 2011 Regression Analysis
**JASCHAEFER**Oct 18, 2011 5:04 pm Found the following "recipe" for doing an Excel regression:
**JASCHAEFER**Oct 18, 2011 5:15 pm Found a great article on the economic theory of prohibition or the "government decree against the exchange of a good or service."
Good viewpoint from the author and support from fellow economists.
October 27, 2011 Deadly Monopolies
**JASCHAEFER**Oct 27, 2011 12:07 pm NPR was doing coverage the other day on a new book called "Deadly Monopolies." It basically talks about the corporate takeover of the medical industry and the consequences of doing so.
**aeroederer**Nov 14, 2011 8:09 pm Thanks so much! I definitely noticed as the economy began to decrease all over the world-- those countries all had risk-related stories about them.
Predatory Pricing
**JASCHAEFER**Oct 31, 2011 7:45 pm Current case of predatory pricing:
Talks a little bit about products with large demand and supply, high fluctuation in price, and how products free from government control are actually disturbing future trading.
Complementarities
**JASCHAEFER**Nov 14, 2011 3:16 pm Recent mention of how complementarities could benefit South Africa and Turkey's free trade agreement:
One way of measuring market power is to look at how a firm prices in relation to its marginal cost. For a perfectly competitive firm, the competitive price level is that of the firm's marginal cost. For a monopoly, price would be set above this cost. By using the Lerner Index, we can attempt to measure this by subtracting marginal cost from price, and then dividing the result by the company’s price. The range is from 0 to 1 (with scores closer to 0 as having less market power). It can be derived from the following equation: P-MCP where P is price and MC is marginal cost. This quantity measures a firm's ability to price above marginal cost in percentage terms.
We can also note that an inverse relationship exists between a profit maximizing firm's ability to price above marginal cost and the market elasticity when the firm faces a downward sloping demand curve: P-MC = 1 P e where e = the market elasticity of demand.
It can also be expressed as P/MC = PED/(1 + PED), where PED will be negative (the ratio should always be greater than one). Basically, the higher the P/MC ratio, the more market power the company is likely to possess (according to Wikipedia).
Also, as PED increases, the P/MC ratio approaches one and market power approaches zero. The equation is derived from the monopolist pricing rule: (P - MC)/P = -1/PED
Week of November 28, 2011
When Google CEO, Larry Page, was asked what the greatest threat was to Google, he simply said: “Google.” He believes the company is weakening due to all the company’s antitrust investigations, so could their market power lessen?
According to Forbes, it can. Here are top 10 threats to Google:
“There is copious evidence that Google lords over the Internet like a 21st century robber baronwhich believes it can do as it pleases with little fear of, or regard for,the rule of law. No other Fortune 500 company has ever self-generated so many serious diverse and far-reaching liabilities/threats as Google has. Google CEO Larry Page was painfully right in recently admittingthat the greatest threat to Google — was “Google” itself.”
Last week, another company stepped forward with an antitrust complaint. ShopCity, a website that helps local businesses sell products, complains that Google is stifling competition. Check it out:
More news develops, as Google’s rumored to finance a buyout of Yahoo to sell ads across its websites or possibly raise the purchase price for rivals. This is obviously anti-competitive, and with pending action in the EU, this definitely seems risky.
This also means that Google will easily undermine Yahoo’s ability to compete with them. Also, if Google supplies their advertising, this will also give Yahoo less incentive to compete. It’s a rumored action that could potentially break up the Yahoo-Microsoft search advertising agreement (approved by the Department of Justice in 2010) with Microsoft, of course, being one of their top competitors.
And in terms of buying out a portion of Yahoo, it wouldn’t be because the company is interested in merging. It would clearly be an attempt at “using market power to collude to manipulate an informal auction of a public company that is Google’s leading competitor, with the purpose of driving up acquisition costs to make it harder for rivals to successfully compete” (Google’s Playing with Antitrust…,2011). In other words, it would be “classic Sherman Act illegal monopolistic behavior” (Google’s Playing with Antitrust…, 2011).
So you can be sure that if Google acts on any of these rumors, that it will also definitely be snubbing the Department of Justice, which warned them three years ago to be careful. In 2008 they were threatened with a Sherman Act Section 1 and 2 monopolization case – with Sherman 2 being the most severe antitrust action the government can take.
This week Google chairman, Eric Schmidt, told a Senate antitrust committee that the company does not dominate the search market. With a reported market share of 65% (that continues to increase), it’s surprising that he would state “Google has many strong competitors…Google has none of the characteristics that I associate with market power.”
Especially, when just a few months ago Schmidt agreed with Senator Herb Kohl that the company was “in that area” (when asked if Google had a monopoly or dominant position). Schmidt went on to later say that his description was “clearly wrong” and that “Google has many strong competitors and we sometimes fail to anticipate the competitive threat posed by new methods of accessing information.”
Unfortunately, I don’t think the backpedaling will help in their investigations. Google is currently under seven by the FTC, DOJ, New York, Texas, California, European Union and Korea. The EU is expected to act, as Google’s market share in Europe is 90% or more. Plus, they have currently nine antitrust complaints, and monopoly law is much “tougher” (Google’s Playing with Antitrust…, 2011) there.
According to Eric Clemons, Professor of Operations and Information Management at The Wharton School, one of the first things we should look at in an anti-trust case is how to assess the relevant market. In other words, we need to know what market a company is in before we know if it dominates it or not (or if it enjoys monopoly power).
Industry definition and the correct market share figure is important, as Clemons states: “When Google defines its business and estimates its market share, it declares itself to represent approximately 3% of all advertising sales in the US, or alternatively as about 30% of all online advertising sales. It does acknowledge a share of paid search in the US of approximately 70%, but argues that this is not an interesting or significant statistic, since search is not a business segment and advertising and online advertising are businesses. A 70% market share is within the range that that the Department of Justice uses to assess a rebuttable presumption of possession of monopoly market power. It is well above the level of 27% at which Apollo (United Airline's Computerized Reservation System) demonstrably possessed monopoly market power in the 1980s. Importantly, at that time Apollo employed a business model similar to the business model Google uses today.”
So in the example above, would 3% in advertising or 70% in search be more significant? Definitely the 70%. Companies with that large of a market share can abuse power, and can face harsh penalties.
In it he talks about the relevant market for assessing market power, Google’s #1 product: advertising and the importance of determining and using market share figures. He also lays out possible consequences for Google, if they are ever found abusing their potential monopoly power.
Week of October 24th
Analysis: With Google’s Hunger Comes Anti-Trust Anxiety
Firstpost had a great article today on Google. It talks about how the company is under greater pressure from anti-trust regulators, and how they continue to end up in patent wars and lawsuits over their products. It also touches on vertical integration, their overall acquisition strategy, and the anti-trust scrutiny they’ve been faced with.
This week we’re going to look at commodity bundling. Typically this involves selling or packaging products together (bundling) at a price less than the sum of its components. Bundling has certain advantages, such as the ability to enhance quality, measure consumption (for price discrimination) and create strategic advantage.
A bundling firm usually has a monopoly over goods or bundles because that good is supplied in a perfectly competitive industry. If a monopolist can monitor purchases, then he can also prevent goods from being purchased or obtained separately.
Looking at a company like Google, for example, their bundles are usually free. By downloading their free package, users install handpicked software by Google. If it becomes popular, more people will use these programs, and Google will become the default search engine. More searches = more money.
Examples of Google bundling include the 2005 Google Pack, which was a package of Google and third-party applications, such as Skype, RealPlayer, Adobe, Google Earth, Google Apps, and Google Picasa. It has since been dissolved due to the lack of interest and availability of downloading software online, but it was an attempt at measuring consumption. Skype (now a Microsoft product) however, has recently de-bundled Google from their 5.5 and 5.6 versions by choosing not to include their products in the installer.
Google also released an update in 2006 that included programs such as Ad-Aware, GalleryPlayer, Google Desktop, Google Talk, Google Toolbar, Mozilla Firefox, Norton Antivirus, and Trillian. Eventually, other companies picked up their bundles (such as Dell and Verizon), but it wasn’t until Google acquired Android in 2007 that they really staked their claim. With all the types of cell phones that users could purchase, controlling which mobile operating system they would run off of was a great advantage for Google.
They also worked out an agreement with the Mozilla Foundation – making them the default engine for the Firefox browser, and Apple’s Safari browser.
Today, despite the declining interest in online packages, Google still offers a way to download its browser and other programs at the same time. For example, if you look at http://www.google.com/mac/, you’ll see that not only has Google provided you with the program that you’re looking for, but other applications as well. Google products are cleverly marketed alongside Mac applications for quick download. You know…in case you need them.
It’s also easy for PC users. Just go to the Chrome Market and handpick your programs. Either download them separately, at different times or all together, but they’re still all found in the same place. This strategy basically allows users to bundle products themselves, and allows Google to maintain a competitive edge.
Week of October 10th
Last week we looked at Google, and wondered if their market power could hurt them in a lawsuit. As we already know, they’re currently in a FTC antitrust investigation and courts are anxious to find out if they’re abusing their search power.
Let’s say they are. And the FTC decides they’re in violation of antitrust law. Would the courts actually evaluate their market power by means of limiting their control? Well, as we saw in the Kodak case…yes. It’s a definite possibility.
So what would the courts look at?
Well, I found some great information on the FTC’s website, and basically, they look at the following:
1) The Lerner Index 2) Market Shares 3) HHI Analysis
According to the website, the definition of market power is “the firm's ability to maintain prices above competitive levels at its profit-maximizing level of output. For a perfectly competitive firm, the competitive price level is that firm's marginal cost.” The Lerner Index attempts to measure this by subtracting marginal cost from price, and then dividing the result by the company’s price. The range is from 0 to 1 (with scores closer to 0 as having less market power).
But there are downsides to using this. It’s not as practical when applying to transactions, and doesn’t offer a “competitive benchmark except in perfectly competitive markets.” It’s also only useful if the company’s marginal cost is determined, so without that, we can’t calculate the Lerner score. Therefore, courts will typically look at market shares and HHI analysis instead.
Market shares, or “the percentage of sales or capacity that a firm controls in a relevant market,” are indirectly related to the company’s ability to set price above marginal cost. The Lerner Index is the reciprocal of the company’s demand elasticity at its own profit-maximizing level of output, so these "own-demand" elasticities can be difficult to measure. Therefore economists attempt to measure market share and the market elasticity of demand, and the outcome is based on economic assumptions about how companies will compete.
For a given level of market-demand elasticity, a company’s own-demand elasticity decreases as its market share increases. The lower the own-demand elasticity, the higher the ratio under the Lerner Index. So for any given demand elasticity, higher market shares reflect a greater capacity for setting price above marginal cost. And ultimately, we’re looking to see if a company (or group of) has the ability and motivation to raise/sustain prices above competitive levels.
Three things are also considered when looking at market shares:
1) Fringe Output 2) Supply Substitutability 3) Elasticity of Demand
Differences in supply and demand elasticities can allow two different companies with two very different market shares to set price well over marginal cost.
HHI Analysis can also beneficial in looking at a company’s market power. It’s been used in horizontal merger analysis, where companies combine to operate as one, and is a cornerstone for the 1992 Horizontal Merger Guidelines. It gives a statistical measure of concentration, and by having more weight in market shares, HHI could more accurately predict the “likelihood of oligopolistic coordination in the post-merger market.”
It also lays out calculations in the Guidelines for transactions: “If the HHIs of the pre- and post-merger markets fall within certain ranges, the agencies are not likely to challenge the transaction. Low HHIs may therefore bring some transactions into the safe harbors of the Merger Guidelines. The presumption may be overcome by a showing that factors set forth in Sections 2-5 of the Guidelines make it unlikely that the merger will create or enhance market power or facilitate its exercise, in light of market concentration and market shares."
Next week we’ll look at commodity bundling and the effect it has on consumerism.
Week of October 3rd
Is Google Next?
In the previous entry, we saw that Kodak once held 80-90% of the market. But by 1954, antitrust suits gave room to competition, and Kodak was forced out of monopoly. In 1921, Kodak was slapped with its first suit, and was stated as being in violation of Section 2 of the Sherman Act by “buying competitors and imposing various forms of exclusive dealing contracts on retailers” (United States v. Eastman Kodak Co., 226 Fed. 62, W.D.N.Y. 1915). The suit was later settled through a consent decree, and banned Kodak from preventing competitors to sell.
In 1954, it faced its second antitrust suit, and Kodak was prohibited from bundling products – particularly their Kodachrome and Kodacolor products.
But in 1994, Kodak decided to file a motion to amend or remove these decrees. The court agreed that in order to uphold the rulings, they would need to reexamine Kodak’s market power. The court concluded that Kodak (in fact) did not have any, and both decrees were terminated.
Today, Google is experiencing a similar situation. Following a hearing last week on Google’s market power and practices before the Antitrust, Competition Policy and Consumer Rights Subcommittee of the Senate Judiciary Committee, Senator Richard Blumenthal questioned CEO Eric Schmidt as to whether or not Google was obligated to ensure that it did not abuse its own market position. And if so, what would ensure that such abuse did not occur?
Schmidt stated that “As discussed during the September 21, 2011 hearing, on August 24, 2011, the Department of Justice announced that Google had been fined $500 million for allowing online Canadian pharmacies to place advertisements through its AdWords program, resulting in the unlawful importation of controlled and non-controlled prescription drugs into the United States. The Department’s press release noted that ‘Google was aware as early as 2003, that generally, it was illegal’ to ship pharmaceuticals into the U.S. Google is also well aware that online copyright infringement online occurs on a massive scale and that it is a “problem that [Google] takes very seriously (Blumenthal Continues to Press Google…, 2011).”
Since most of Google’s revenue is generated through advertising, it’s easy to see how this has raised concern.
Blumenthal also questioned as to whether or not it was fair to label Google as a monopoly. Schmidt disagreed. “Google provides its service for free and competition is ‘one-click away’ (Blumenthal Continues to Press Google…, 2011).” But with 65% or more of all general internet searches, 94% European market share and 97% processing on all smartphone searches, it’s hard to agree with him. In fact, today Google really only has Microsoft to contend with. Companies like Lycos, Ask.com and AOL have all dropped out of the competition.
So is Google next? As they grow closer to becoming a monopoly, are they also closer to violating antitrust and competition laws? Will their highly concentrated market power hurt them in a lawsuit?
Every morning I wake up to the sound of people having a conversation over some relevant, but randomly chosen topic. NPR has been my alarm of choice for many years now, and it always surprises me how I manage to tune in just at the right moment. This week was no exception.
Having newly been assigned to this topic (and not intending on writing about Kodak specifically) it was a bit of a coincidence to wake up to a Morning Edition story on them. This week they had a giant drop in share price, and they were reporting a new low of $1.74 versus a low of only $4.16 in the 3rd quarter of last year (closing the year at $5.36). That’s a 71% decline.
Basically, what happened was that Kodak decided to tap into its credit line for reinvention purposes, but investors were already doubtful of their ability to maintain or grow within the market. Since Kodak had less cash than the $160 million they wanted (and cash was tied up overseas), it was expected that they would sell assets instead of borrow. When that didn’t happen, sustainability concerns were reinforced, and the price share fell. The full story can be found here: http://www.nytimes.com/2011/09/27/business/kodak-stock-dives-after-credit-line-is-tapped.html
A few days later, the price is still falling. Clearly this has affected investor confidence, but it made me wonder…if reinvention (if it includes product development) is unsuccessful, how will this affect their pricing, and therefore, their market power? Kodak will need to price above its marginal cost of production, or it’ll lose money. And for as many competitors as they have, it could be difficult for them to diversify and generate the necessary funds to cover this extension of credit. Seasonal sales are expected to be high, but by already entering the year with a 71% drop, it’s difficult to see how they will perform.
This wasn’t always the case. The once popular film giant held 80-90% of the market and 50% of its price in margin above manufacturing costs (Baye, Kodak Appeals to Court…, 2). But by 1954, an antitrust suit and consent gave room to competition, and Kodak was forced out of monopoly. Companies could produce similar or superior products, and over time, Kodak adjusted to its competition. It accepted price sensitivity and the availability of substitutes, and realized that it no longer had the market power it once did.
In the past, they could have easily increased prices, and it would not have changed their demand or market power. If the average cost of a camera then was $30.00, increasing it to $40.00 would just increase profitability. So in determining markup, all Kodak had to do was look at the elasticity of demand, the # of existing firms in the industry (presence or absence of barriers to entry), the degree of product differentiation, and the nature of its competition. At that time, they would have found demand to be less elastic (for the lack of substitutes) and they could charge well above the marginal cost of production…which they did. It was an easy and profitable move.
Today, Kodak has less market power and less room to “screw up.” Their descent appears to be perpetual, so it’ll be interesting to see if this reinvention improves their bottom line. I’m sure future share prices will be an indicator.
Quiz:
1. Market power is described as: a) The ability of a firm to set its price above marginal cost b) The ability of a firm to set its price below marginal cost c) The ability of a firm to set its price at marginal cost d) None of the above
2. How does antitrust policy keep firms from monopolizing markets? a) By ignoring deadweight loss b) By eliminating price discrimination c) By eliminating deadweight loss d) By legalizing firms to collude with other domestic or foreign firms
3. What is an example of commodity bundling? a) A travel company package, including airfare, hotel and meals b) A new computer, including CPU, monitor and software c) Car tune-up service, including engine inspection, filter replacement and fuel system cleaning d) All of the above
4. What is the most common way to measure market power? a) Through concentration ratios b) Through consensus c) By measuring a single firm’s output d) Through pricing
5. What are the sources of monopoly power? a) Economies of scale and scope b) Cost complementarities c) Patents d) All of the above
Answers:
1. a – a firm is said to have market power if it produces less than the socially efficient level of output because it charges a price that exceeds its marginal cost of production 2. c – antitrust policy attempts to eliminate the deadweight loss of monopoly by making it illegal for managers to engage in activities that foster monopoly power, such as price-fixing agreements and other collusive practices 3. d – all of these are examples of commodity bundling because it refers to bundling several different products together and then selling them at a single “bundle price" 4. a – concentration ratios are the most common measures of market power because they measure the percentage of total industry output or market shares of all participants in the market 5. d – all of these are sources of monopoly power because one or more of these create a barrier to entry that prevents other firms from entering the market to compete against the monopolist
- Jennifer Schaefer
Google’s Defense in Antitrust Hearing: An Evaluation of Market Power
Google
On September 21, 2011, Google Executive Chairman, Eric Schmidt testified before the Senate Judiciary Committee’s Antitrust, Competition Policy and Consumer Rights Subcommittee that Google was not a monopoly, and was in no way dominating the search market. The civil probe is one of the largest legal threats to Google because it examines the company’s core search-advertising business.
Google has been scrutinized for years on anticompetitive practices, including “using other companies’ content without permission, deceptive display of search results, manipulation of search results to favor Google’s products, and buying up competitive threats to its dominance.” 1 The company currently faces seven antitrust inquiries, and holds a 65% US market share and 90% EU market share2, but still claims to not be abusing its market power. What will determine if they are correct?
Google’s History
Google was created in January 1996 by Stanford University students, Larry Page and Sergey Brin, as a research project that analyzed the relationship between internet websites. Other search engines would position results by the number of times search terms appeared on the page, but Page and Brin believed they could improve the system. They wanted to explore a website’s relevance based on the number of pages, and the importance of those pages that would link back to the original site, and create a system that would “organize the world's information and make it universally accessible and useful.” 3
Today, Google is mostly known for its search capability, cloud computing and advertising technology. It hosts and cultivates a number of Internet-based services and products, and generates profit primarily through its AdWords program. 4
Google also offers products in the form of commodity bundling by selling or packaging products together (bundling) at a price less than the sum of its components. With certain advantages, such as the ability to enhance quality, measure consumption (for price discrimination) and create strategic advantage, Google has developed somewhat of a monopoly over bundles because that good is supplied in a perfectly competitive industry – preventing goods from being purchased or obtained separately.
Examples of Google-bundled products include, the 2005 Google Pack, which was a package of Google and third-party applications, such as Skype, RealPlayer, Adobe, Google Earth, Google Apps, and Google Picasa. It has since been dissolved due to the lack of interest and availability of downloading software online, but it was an attempt at measuring consumption. Skype (now a Microsoft product) however, has recently de-bundled Google from their 5.5 and 5.6 versions by choosing not to include their products in the installer.
Google also released an update in 2006 that included programs such as Ad-Aware, GalleryPlayer, Google Desktop, Google Talk, Google Toolbar, Mozilla Firefox, Norton Antivirus, and Trillian. Eventually, other companies picked up their bundles (such as Dell and Verizon), but it wasn’t until Google acquired Android in 2007 that they really staked their claim. With all the types of cell phones that users could purchase, controlling which mobile operating system they would run off of was a great advantage for the company.
They also worked out an agreement with the Mozilla Foundation – making them the default engine for the Firefox browser, and Apple’s Safari browser.
Google’s Current Market Position
Google currently controls 65% or more of all general internet searches, 94% European market share and 97% processing on all smartphone searches.5 Google also “defines its business and estimates its market share, it declares itself to represent approximately 3% of all advertising sales in the US, or alternatively as about 30% of all online advertising sales.”6
In attempting to determine if a company is a monopoly, evaluating market power and the impact on competitors can be beneficial. Typically courts will consider the following (according to the Federal Trade Commission) 7:
1. The Lerner Index
2. Market Shares
3. HHI Analysis
These items are the basis for market power assessment or “the firm's ability to maintain prices above competitive levels at its profit-maximizing level of output. Some would argue that the greater the market power, the more likely the company is act anti-competitively.
For a perfectly competitive firm, the competitive price level is that firm's marginal cost.8 The Lerner Index attempts to measure this by subtracting marginal cost from price, and then dividing the result by the company’s price. The range is from 0 to 1 (with scores closer to 0 as having less market power). It can be derived from the following equation:
P-MCP
where P is price and MC is marginal cost. This quantity measures a firm's ability to price above marginal cost in percentage terms.9
We can also note that an inverse relationship exists between a profit maximizing firm's ability to price above marginal cost and the market elasticity when the firm faces a downward sloping demand curve:10
P-MC = 1 P e
where e = the market elasticity of demand.
Although using the Lerner Index would help us in evaluating market power, it’s not the best. It’s not as practical when applying to transactions, and doesn’t offer a “competitive benchmark except in perfectly competitive markets.”11 It’s also only useful if the company’s marginal cost is determined, so without that, we can’t calculate the Lerner score. Therefore, courts will typically look at market shares and HHI analysis instead.
Market shares, or “the percentage of sales or capacity that a firm controls in a relevant market,”12 are indirectly related to the company’s ability to set price above marginal cost. The Lerner Index is the reciprocal of the company’s demand elasticity at its own profit-maximizing level of output, so these "own-demand" elasticities can be difficult to measure. Therefore, economists attempt to measure market share and the market elasticity of demand, and the outcome is based on economic assumptions about how companies will compete through fringe output, supply substitutability and elasticity of demand.13
This measure of market power for the dominant firm depends upon the dominant firm's market share, the market price elasticity of demand, and the competitive fringe supply elasticity. Specifically,
Ls = P-cd/P = 1/Ed = s/ED + (1-s)Es
where Ls denotes the Lerner index for the single-market measure of market power, P is price, cd is the dominant firm's marginal cost and ED is the price elasticity of demand facing the dominant firm.14
For a given level of market-demand elasticity, a company’s own-demand elasticity decreases as its market share increases. The lower the own-demand elasticity, the higher the ratio under the Lerner Index. So for any given demand elasticity, higher market shares reflect a greater capacity for setting price above marginal cost. And ultimately, we’re looking to see if a company (or group of) has the ability and motivation to raise/sustain prices above competitive levels.
Differences in supply and demand elasticities can allow two different companies with two very different market shares to set price well over marginal cost.
HHI Analysis can also beneficial in looking at a company’s market power. It’s been used in horizontal merger analysis, where companies combine to operate as one, and is a cornerstone for the 1992 Horizontal Merger Guidelines. It gives a statistical measure of concentration, and by having more weight in market shares, HHI could more accurately predict the “likelihood of oligopolistic coordination in the post-merger market.”15
It also lays out calculations in the Guidelines for transactions: “If the HHIs of the pre- and post-merger markets fall within certain ranges, the agencies are not likely to challenge the transaction. Low HHIs may therefore bring some transactions into the safe harbors of the Merger Guidelines. The presumption may be overcome by a showing that factors set forth in Sections 2-5 of the Guidelines make it unlikely that the merger will create or enhance market power or facilitate its exercise, in light of market concentration and market shares."16
Senate Judiciary Committee Hearing
In September 2011, Federal regulators decided they had enough evidence to launch an investigation on Google, and would evaluate the company’s market power in regards to an AdWords claim.
The Department of Justice announced that Google had been fined $500 million for allowing online Canadian pharmacies to place advertisements through its AdWords program, resulting in the unlawful importation of controlled and non-controlled prescription drugs into the United States. The Department’s press release noted that “Google was aware as early as 2003, that generally, it was ‘illegal’ to ship pharmaceuticals into the U.S. Google is also well aware that online copyright infringement online occurs on a massive scale and that it is a ‘problem that [Google] takes very seriously.’”17
Executive Chairman, Eric Schmidt testified on behalf of Google, and Senator Richard Blumenthal questioned him as to whether or not Google was obligated to ensure that it did not abuse its own market position. And if so, what would ensure that such abuse did not occur?
Schmidt replied that “Google’s current practices that prevented it from becoming “evil,” even as its power grows. When the suggestion came up that Google convene a panel of outsiders to review changes the company makes to rankings in its search engine, Google’s lawyer, Susan Creighton, said she didn’t think that was a good idea. When senators asked some of Google’s competitors to describe how the company was harming consumers, they replied that consumers were being misled into believing Google’s search results were unbiased when, in fact, Google was displaying links to its own sites above others. Still, “in antitrust, we don’t let competitors speak for consumers,” Hovenkamp said.18
Senator Blumenthal also questioned as to whether or not it was fair to label Google as a monopoly. Schmidt disagreed. “Google provides its service for free and competition is ‘one-click away.’”19 He also told the Senate antitrust committee that the company does not dominate the search market. “Google has many strong competitors…Google has none of the characteristics that I associate with market power.”20
These statements created some confusion because a few months prior to the hearing, Schmidt agreed with Senator Herb Kohl that the company was “in that area” (when asked if Google had a monopoly or dominant position). Schmidt went on to later say that his description was “clearly wrong” and that “Google has many strong competitors and we sometimes fail to anticipate the competitive threat posed by new methods of accessing information.”21
Google's Increasing Market Power Furthers Antitrust Anxiety
Despite the ongoing investigation, Google’s market power intensifies. According to According to Eric Clemons, Professor of Operations and Information Management at The Wharton School, “[Google] does acknowledge a share of paid search in the US (approximately 70%), but argues that this is not an interesting or significant statistic, since search is not a business segment and advertising and online advertising are businesses. A 70% market share is within the range that that the Department of Justice uses to assess a rebuttable presumption of possession of monopoly market power. It is well above the level of 27% at which Apollo (United Airline's Computerized Reservation System) demonstrably possessed monopoly market power in the 1980s. Importantly, at that time Apollo employed a business model similar to the business model Google uses today.”22
Google was also recently rumored to finance a buyout of Yahoo to sell ads across its websites or possibly raise the purchase price for rivals. Had they succeeded, Google would have easily undermined Yahoo’s ability to compete with them. Also, if Google supplied their advertising, this will also give Yahoo less incentive to compete, and could potentially break up the Yahoo-Microsoft search advertising agreement (approved by the Department of Justice in 2010) with Microsoft, of course, being one of their top competitors.
This acquisition would not prove beneficial for anyone other than Google. It would be an attempt at “using market power to collude to manipulate an informal auction of a public company that is Google’s leading competitor, with the purpose of driving up acquisition costs to make it harder for rivals to successfully compete.”23 Or in other words, “classic Sherman Act illegal monopolistic behavior.”24
But even dominant companies have threats. When Google CEO, Larry Page, was asked what the greatest threat was to Google, he simply said: “Google.” According to Forbes, here are their top 10 threats to the company25:
1. Criminal Liability
2. Antitrust Franchise Risk
3. Privacy Legislation Franchise Risk
4. Android Franchise Risk from Patent/Copyright Liabilities
5. Anti-Piracy Legislation Franchise Risk
6. Sovereignty Backlash from Foreign Governments Risk
7. Security Breach Liabilities
8. Copyright Lawsuit Liability: Google Books & Viacom vs. Google-YouTube
9. IRS Tax Audit and Sarbanes Oxley Financial Reporting Compliance Risk
10. Motorola Acquisition Risk
“There is copious evidence that Google lords over the Internet like a 21st century robber baron which believes it can do as it pleases with little fear of, or regard for, the rule of law. No other Fortune 500 company has ever self-generated so many serious diverse and far-reaching liabilities/threats as Google has. Google CEO Larry Page was painfully right in recently admitting that the greatest threat to Google — was “Google” itself.”26
Conclusion
Google’s continued growth may make them the target for many antitrust suits, so courts are therefore urged to consider the FTC’s recommendations of looking at other factors (such as indexes and market shares) when determining anticompetitive behavior. Speculation alone would not be sufficient in terms of ruling, and the unbiased information provided in this case study could lead to a more reasonable judgment.
References
1 Catan, Thomas, Efrati, Amir. (2011). Feds to Launch Probe of Google. Wall Street Journal, 1. Retried November 28, 2011 from the World Wide Web: http://online.wsj.com/article/SB10001424052702303339904576403603764717680.html
2 Cleland, Scott. (2011). Google’s Playing With Antitrust Fire If it’s Courting Yahoo. Forbes, 1. Retrieved November 7, 2011 from the World Wide Web: http://www.forbes.com/sites/scottcleland/2011/10/24/googles-playing-with-antitrust-fire-courting-yahoo/
3 "Google Corporate Information". Google, Inc.. Retrieved November 28, 2011.
4 Vise, David A. (2005). "Online Ads Give Google Huge Gain in Profit".The Washington Post.
Nguyen, D.H.M, Wong, K.P. (2002). Analysis of Competitive Power Market with Constant Elasticity Function. IEE Proc.-Gener. Transm. Distrib., 150 (5), 595-603.
5 Blumenthal, Richard. (2011). Blumenthal Continues to Press Google on Market Power and Competition Policy. Press Release Retrieved October 3, 2011 from the World Wide Web: http://blumenthal.senate.gov/newsroom/press/release/blumenthal-continues-to-press-google-on-market-power-and-competition-policy-
6 Clemons, Eric K. (2011). Is Google Just Another Adversiting Company? Maybe and Maybe Not. Huffington Post, 1. Retrieved October 31, 2011 from the World Wide Web: http://www.huffingtonpost.com/eric-k-clemons/is-google-just-another-ad_b_958556.html
7, 8, 12 How Do Courts and Agencies Evaluate Market Power? Retrieved October 10, 2011 from the World Wide Web: http://www.ftc.gov/opp/jointvent/classic3.shtm.
9, 10 Glick, Mark A., Campbell, Donald. (2007). Market Definition and Concentration: One Size Does Not Fit All. The Antitrust Bulletin, 52 (2), 231.
11, 12, 13, 15, 16, 17 How Do Courts and Agencies Evaluate Market Power? Retrieved October 10, 2011 from the World Wide Web: http://www.ftc.gov/opp/jointvent/classic3.shtm.
14 Weisman, Dennis L. (2007). The Antitrust Bulletin, 52 (2), 170.
17 Blumenthal, Richard. (2011). Blumenthal Continues to Press Google on Market Power and Competition Policy. Press Release Retrieved October 3, 2011 from the World Wide Web: http://blumenthal.senate.gov/newsroom/press/release/blumenthal-continues-to-press-google-on-market-power-and-competition-policy-
18 Efrati, Amir. (2011). Live Blog: Google Antitrust Hearing on Capitol Hill. The Wall Street Journal, 1. Retrieved November 28, 2011 from the World Wide Web: http://blogs.wsj.com/digits/2011/09/21/live-blog-google-antitrust-hearing-on-capitol-hill/
19 Blumenthal, Richard. (2011). Blumenthal Continues to Press Google on Market Power and Competition Policy. Press Release Retrieved October 3, 2011 from the World Wide Web: http://blumenthal.senate.gov/newsroom/press/release/blumenthal-continues-to-press-google-on-market-power-and-competition-policy-
20 Woollacott, Emma. (2011). Google Lacks Market Power, Says Schmidt. TG Daily, 1. Retrieved November 7, 2011 from the World Wide Web: http://www.tgdaily.com/business-and-law-features/59487-google-lacks-market-power-says-schmidt
21 Woollacott, Emma. (2011). Google Lacks Market Power, Says Schmidt. TG Daily, 1. Retrieved November 7, 2011 from the World Wide Web: http://www.tgdaily.com/business-and-law-features/59487-google-lacks-market-power-says-schmidt
22 Clemons, Eric K. (2011). Is Google Just Another Adversiting Company? Maybe and Maybe Not. Huffington Post, 1. Retrieved October 31, 2011 from the World Wide Web: http://www.huffingtonpost.com/eric-k-clemons/is-google-just-another-ad_b_958556.html
23, 24 Cleland, Scott. (2011). Google’s Playing With Antitrust Fire Courting Yahoo. Forbes, 1. Retrieved November 14, 2011 from the World Wide Web: http://www.forbes.com/sites/scottcleland/2011/10/24/googles-playing-with-antitrust-fire-courting-yahoo/
25, 26 Cleland, Scott. (2011). The Top Ten Threats to Google. Forbes, 1. Retrieved November 28, 2011 from the World Wide Web: http://www.forbes.com/sites/scottcleland/2011/11/15/the-top-ten-threats-to-google/
Summaries:
October 3, 2011
Minimum Resale Price Policy
Found an interesting article on price policy, and how companies handle discounting concerns of higher quality products:
http://www.freebornpeters.com/docs/publications/20030801_Article.pdf
Also found an article on Rolex and its development into a luxury item:
http://w4.stern.nyu.edu/sternbusiness/fall_winter_2004/rolex.html
**Steve_Speece** Oct 10, 2011 12:09 am
Both great, thank you. Interesting bit about Rolex maintaining demand through restricting supply, rather than prices directly- very similar to the Playmobil case.
In response to the first discussion post, it looks like the merger was actually called off a month later:
http://news.cnet.com/2100-1033-243110.html
WorldCom stated that "Opposition to this merger just adds to the list of...policies that ultimately will reduce innovation and choice and raise the cost of communications services for residential customers."
Even the case study for this stated that, if the merger actually happened, that AT&T and WorldCom/Sprint would have controlled about 80% of the market. Their next largest competitor would only have a market share of no more than 3%, so that seems rather monopolistic.
No wonder there was concern.
Vertical Integration
Found an interesting review on vertical integration:
http://blogs.hbr.org/hbr/mcgrath/2009/12/vertical-integration-can-work.html
I liked its emphasis on management control and innovation.
Recently read an abstract on the impact of mergers and the effect on the economy:
http://www.bos.frb.org/economic/conf/conf31/conf31f.pdf
It stated that some companies experienced "significant declines in market shares following changes in control." Made me wonder what types of companies and how much market power they had to see such results.
Thought it might be helpful.
**emretez86** Oct 18, 2011 1:58 pm
great. thank you so much. It will be helpful.
October 18, 2011
Regression Analysis
Found the following "recipe" for doing an Excel regression:
http://www.chem.missouri.edu/Greenlief/courses/234W04/Excel%20Handout.pdf
Thought it might be helpful.
Found a great article on the economic theory of prohibition or the "government decree against the exchange of a good or service."
http://mises.org/books/prohibition.pdf
Good viewpoint from the author and support from fellow economists.
Deadly Monopolies
NPR was doing coverage the other day on a new book called "Deadly Monopolies." It basically talks about the corporate takeover of the medical industry and the consequences of doing so.
Sounded interesting: http://www.npr.org/2011/10/24/141429392/deadly-monopolies-patenting-the-human-body
**ajkitzman** Nov 6, 2011 12:27 pm
This is very interesting! Thanks for forwarding it along.
Read an interesting article on input procurement in the ethanol industry:
http://www.e10-kraftstoff.de/dateien/interessen-agrarwirtschaft-e10.pdf
It talks about rising costs, increased demand and change in food pricing.
Risk Aversion
Current case of risk aversion:
http://www.businessday.co.za/articles/Content.aspx?id=157426
**aeroederer** Nov 14, 2011 8:09 pm
Thanks so much! I definitely noticed as the economy began to decrease all over the world-- those countries all had risk-related stories about them.
Current case of predatory pricing:
http://www.bbc.co.uk/news/uk-scotland-scotland-business-15531332
Comparative Advantage
Found an interesting article on comparative advantage in the apparel industry of global markets:
http://tribune.com.pk/story/280478/comparative-advantage-american-buyers-still-prefer-pakistani-apparel/
Interesting article on the AT&T and T-Mobile merger:
http://www.washingtonpost.com/blogs/post-tech/post/critics-of-atandt-t-mobile-merger-see-hope-in-court-blocking-of-tax-merger/2011/11/01/gIQAi3flcM_blog.html
Talks about how the market concentration created by the combination of identical businesses wouldn’t uphold competition laws.
Cournot Model
Recent mention of the Cournot model. Talks about how the integrated dominant producer faces more
elastic demand, and will ultimately choose a lower price than the sum of the prices of two
disintegrated producers:
http://blogs.economictimes.indiatimes.com/figuringitout/entry/china_as_super_power_in_two_decades_seems_a_tall_order
**emretez86** Nov 29, 2011 12:09 am
thanks!
Talks about explicit and implicit costs, and economic profit:
http://www.unc.edu/depts/econ/byrns_web/Economicae/Essays/Actg_V_Econ.htm
November 14, 2011
Futures Market
Interesting article on the suitability of commodity for future trading:
http://www.firstpost.com/investing/has-the-bse-finally-cracked-the-futures-market-129967.html
Talks a little bit about products with large demand and supply, high fluctuation in price, and how products free from government control are actually disturbing future trading.
Recent mention of how complementarities could benefit South Africa and Turkey's free trade agreement:
http://www.timeslive.co.za/politics/2011/11/10/no-sa-turkey-trade-agreement
Blog:
Week of December 5, 2011
One way of measuring market power is to look at how a firm prices in relation to its marginal cost. For a perfectly competitive firm, the competitive price level is that of the firm's marginal cost. For a monopoly, price would be set above this cost. By using the Lerner Index, we can attempt to measure this by subtracting marginal cost from price, and then dividing the result by the company’s price. The range is from 0 to 1 (with scores closer to 0 as having less market power). It can be derived from the following equation:
P-MCP
where P is price and MC is marginal cost. This quantity measures a firm's ability to price above marginal cost in percentage terms.
We can also note that an inverse relationship exists between a profit maximizing firm's ability to price above marginal cost and the market elasticity when the firm faces a downward sloping demand curve:
P-MC = 1 P e
where e = the market elasticity of demand.
It can also be expressed as P/MC = PED/(1 + PED), where PED will be negative (the ratio should always be greater than one). Basically, the higher the P/MC ratio, the more market power the company is likely to possess (according to Wikipedia).
Also, as PED increases, the P/MC ratio approaches one and market power approaches zero. The equation is derived from the monopolist pricing rule:
(P - MC)/P = -1/PED
Week of November 28, 2011
When Google CEO, Larry Page, was asked what the greatest threat was to Google, he simply said: “Google.” He believes the company is weakening due to all the company’s antitrust investigations, so could their market power lessen?
According to Forbes, it can. Here are top 10 threats to Google:
1. Criminal Liability
2. Antitrust Franchise Risk
3. Privacy Legislation Franchise Risk
4 .Android Franchise Risk from Patent/Copyright Liabilities
5. Anti-Piracy Legislation Franchise Risk
6. Sovereignty Backlash from Foreign Governments Risk
7. Security Breach Liabilities
8. Copyright Lawsuit Liability: Google Books & Viacom vs. Google-YouTube
9. IRS Tax Audit and Sarbanes Oxley Financial Reporting Compliance Risk
10. Motorola Acquisition Risk
“There is copious evidence that Google lords over the Internet like a 21st century robber baron which believes it can do as it pleases with little fear of, or regard for, the rule of law. No other Fortune 500 company has ever self-generated so many serious diverse and far-reaching liabilities/threats as Google has. Google CEO Larry Page was painfully right in recently admitting that the greatest threat to Google — was “Google” itself.”
http://www.forbes.com/sites/scottcleland/2011/11/15/the-top-ten-threats-to-google/
Week of November 21, 2011
Last week, another company stepped forward with an antitrust complaint. ShopCity, a website that helps local businesses sell products, complains that Google is stifling competition. Check it out:
http://news.businessweek.com/article.asp?documentKey=1376-LUM1AK0D9L3501-0F2DUD08DIROUI4FAMIRL7VIB8
Week of November 14, 2011
Playing with Fire
More news develops, as Google’s rumored to finance a buyout of Yahoo to sell ads across its websites or possibly raise the purchase price for rivals. This is obviously anti-competitive, and with pending action in the EU, this definitely seems risky.
This also means that Google will easily undermine Yahoo’s ability to compete with them. Also, if Google supplies their advertising, this will also give Yahoo less incentive to compete. It’s a rumored action that could potentially break up the Yahoo-Microsoft search advertising agreement (approved by the Department of Justice in 2010) with Microsoft, of course, being one of their top competitors.
And in terms of buying out a portion of Yahoo, it wouldn’t be because the company is interested in merging. It would clearly be an attempt at “using market power to collude to manipulate an informal auction of a public company that is Google’s leading competitor, with the purpose of driving up acquisition costs to make it harder for rivals to successfully compete” (Google’s Playing with Antitrust…,2011). In other words, it would be “classic Sherman Act illegal monopolistic behavior” (Google’s Playing with Antitrust…, 2011).
So you can be sure that if Google acts on any of these rumors, that it will also definitely be snubbing the Department of Justice, which warned them three years ago to be careful. In 2008 they were threatened with a Sherman Act Section 1 and 2 monopolization case – with Sherman 2 being the most severe antitrust action the government can take.
And I don’t see that ending well for them.
http://www.forbes.com/sites/scottcleland/2011/10/24/googles-playing-with-antitrust-fire-courting-yahoo/
Week of November 7, 2011
This week Google chairman, Eric Schmidt, told a Senate antitrust committee that the company does not dominate the search market. With a reported market share of 65% (that continues to increase), it’s surprising that he would state “Google has many strong competitors…Google has none of the characteristics that I associate with market power.”
Especially, when just a few months ago Schmidt agreed with Senator Herb Kohl that the company was “in that area” (when asked if Google had a monopoly or dominant position). Schmidt went on to later say that his description was “clearly wrong” and that “Google has many strong competitors and we sometimes fail to anticipate the competitive threat posed by new methods of accessing information.”
Unfortunately, I don’t think the backpedaling will help in their investigations. Google is currently under seven by the FTC, DOJ, New York, Texas, California, European Union and Korea. The EU is expected to act, as Google’s market share in Europe is 90% or more. Plus, they have currently nine antitrust complaints, and monopoly law is much “tougher” (Google’s Playing with Antitrust…, 2011) there.
To read more on this, check out:
http://www.tgdaily.com/business-and-law-features/59487-google-lacks-market-power-says-schmidt
http://www.forbes.com/sites/scottcleland/2011/10/24/googles-playing-with-antitrust-fire-courting-yahoo/
Week of October 31st
According to Eric Clemons, Professor of Operations and Information Management at The Wharton School, one of the first things we should look at in an anti-trust case is how to assess the relevant market. In other words, we need to know what market a company is in before we know if it dominates it or not (or if it enjoys monopoly power).
Industry definition and the correct market share figure is important, as Clemons states: “When Google defines its business and estimates its market share, it declares itself to represent approximately 3% of all advertising sales in the US, or alternatively as about 30% of all online advertising sales. It does acknowledge a share of paid search in the US of approximately 70%, but argues that this is not an interesting or significant statistic, since search is not a business segment and advertising and online advertising are businesses. A 70% market share is within the range that that the Department of Justice uses to assess a rebuttable presumption of possession of monopoly market power. It is well above the level of 27% at which Apollo (United Airline's Computerized Reservation System) demonstrably possessed monopoly market power in the 1980s. Importantly, at that time Apollo employed a business model similar to the business model Google uses today.”
So in the example above, would 3% in advertising or 70% in search be more significant? Definitely the 70%. Companies with that large of a market share can abuse power, and can face harsh penalties.
For more information, check out Clemon’s article “Is Google Just Another Advertising Company? Maybe and Maybe Not.”
http://www.huffingtonpost.com/eric-k-clemons/is-google-just-another-ad_b_958556.html
In it he talks about the relevant market for assessing market power, Google’s #1 product: advertising and the importance of determining and using market share figures. He also lays out possible consequences for Google, if they are ever found abusing their potential monopoly power.
Week of October 24th
Analysis: With Google’s Hunger Comes Anti-Trust Anxiety
Firstpost had a great article today on Google. It talks about how the company is under greater pressure from anti-trust regulators, and how they continue to end up in patent wars and lawsuits over their products. It also touches on vertical integration, their overall acquisition strategy, and the anti-trust scrutiny they’ve been faced with.
Check it out:
http://www.firstpost.com/tech/analysis-with-googles-hunger-comes-anti-trust-anxiety-117742.html
Week of October 17th
This week we’re going to look at commodity bundling. Typically this involves selling or packaging products together (bundling) at a price less than the sum of its components. Bundling has certain advantages, such as the ability to enhance quality, measure consumption (for price discrimination) and create strategic advantage.
A bundling firm usually has a monopoly over goods or bundles because that good is supplied in a perfectly competitive industry. If a monopolist can monitor purchases, then he can also prevent goods from being purchased or obtained separately.
Looking at a company like Google, for example, their bundles are usually free. By downloading their free package, users install handpicked software by Google. If it becomes popular, more people will use these programs, and Google will become the default search engine. More searches = more money.
Examples of Google bundling include the 2005 Google Pack, which was a package of Google and third-party applications, such as Skype, RealPlayer, Adobe, Google Earth, Google Apps, and Google Picasa. It has since been dissolved due to the lack of interest and availability of downloading software online, but it was an attempt at measuring consumption. Skype (now a Microsoft product) however, has recently de-bundled Google from their 5.5 and 5.6 versions by choosing not to include their products in the installer.
Google also released an update in 2006 that included programs such as Ad-Aware, GalleryPlayer, Google Desktop, Google Talk, Google Toolbar, Mozilla Firefox, Norton Antivirus, and Trillian. Eventually, other companies picked up their bundles (such as Dell and Verizon), but it wasn’t until Google acquired Android in 2007 that they really staked their claim. With all the types of cell phones that users could purchase, controlling which mobile operating system they would run off of was a great advantage for Google.
They also worked out an agreement with the Mozilla Foundation – making them the default engine for the Firefox browser, and Apple’s Safari browser.
Today, despite the declining interest in online packages, Google still offers a way to download its browser and other programs at the same time. For example, if you look at http://www.google.com/mac/, you’ll see that not only has Google provided you with the program that you’re looking for, but other applications as well. Google products are cleverly marketed alongside Mac applications for quick download. You know…in case you need them.
It’s also easy for PC users. Just go to the Chrome Market and handpick your programs. Either download them separately, at different times or all together, but they’re still all found in the same place. This strategy basically allows users to bundle products themselves, and allows Google to maintain a competitive edge.
Week of October 10th
Last week we looked at Google, and wondered if their market power could hurt them in a lawsuit. As we already know, they’re currently in a FTC antitrust investigation and courts are anxious to find out if they’re abusing their search power.
Let’s say they are. And the FTC decides they’re in violation of antitrust law. Would the courts actually evaluate their market power by means of limiting their control? Well, as we saw in the Kodak case…yes. It’s a definite possibility.
So what would the courts look at?
Well, I found some great information on the FTC’s website, and basically, they look at the following:
1) The Lerner Index
2) Market Shares
3) HHI Analysis
According to the website, the definition of market power is “the firm's ability to maintain prices above competitive levels at its profit-maximizing level of output. For a perfectly competitive firm, the competitive price level is that firm's marginal cost.” The Lerner Index attempts to measure this by subtracting marginal cost from price, and then dividing the result by the company’s price. The range is from 0 to 1 (with scores closer to 0 as having less market power).
But there are downsides to using this. It’s not as practical when applying to transactions, and doesn’t offer a “competitive benchmark except in perfectly competitive markets.” It’s also only useful if the company’s marginal cost is determined, so without that, we can’t calculate the Lerner score. Therefore, courts will typically look at market shares and HHI analysis instead.
Market shares, or “the percentage of sales or capacity that a firm controls in a relevant market,” are indirectly related to the company’s ability to set price above marginal cost. The Lerner Index is the reciprocal of the company’s demand elasticity at its own profit-maximizing level of output, so these "own-demand" elasticities can be difficult to measure. Therefore economists attempt to measure market share and the market elasticity of demand, and the outcome is based on economic assumptions about how companies will compete.
For a given level of market-demand elasticity, a company’s own-demand elasticity decreases as its market share increases. The lower the own-demand elasticity, the higher the ratio under the Lerner Index. So for any given demand elasticity, higher market shares reflect a greater capacity for setting price above marginal cost. And ultimately, we’re looking to see if a company (or group of) has the ability and motivation to raise/sustain prices above competitive levels.
Three things are also considered when looking at market shares:
1) Fringe Output
2) Supply Substitutability
3) Elasticity of Demand
Differences in supply and demand elasticities can allow two different companies with two very different market shares to set price well over marginal cost.
HHI Analysis can also beneficial in looking at a company’s market power. It’s been used in horizontal merger analysis, where companies combine to operate as one, and is a cornerstone for the 1992 Horizontal Merger Guidelines. It gives a statistical measure of concentration, and by having more weight in market shares, HHI could more accurately predict the “likelihood of oligopolistic coordination in the post-merger market.”
It also lays out calculations in the Guidelines for transactions: “If the HHIs of the pre- and post-merger markets fall within certain ranges, the agencies are not likely to challenge the transaction. Low HHIs may therefore bring some transactions into the safe harbors of the Merger Guidelines. The presumption may be overcome by a showing that factors set forth in Sections 2-5 of the Guidelines make it unlikely that the merger will create or enhance market power or facilitate its exercise, in light of market concentration and market shares."
For more information, check out http://www.ftc.gov/opp/jointvent/classic3.shtm.
Next week we’ll look at commodity bundling and the effect it has on consumerism.
Week of October 3rd
Is Google Next?
In the previous entry, we saw that Kodak once held 80-90% of the market. But by 1954, antitrust suits gave room to competition, and Kodak was forced out of monopoly. In 1921, Kodak was slapped with its first suit, and was stated as being in violation of Section 2 of the Sherman Act by “buying competitors and imposing various forms of exclusive dealing contracts on retailers” (United States v. Eastman Kodak Co., 226 Fed. 62, W.D.N.Y. 1915). The suit was later settled through a consent decree, and banned Kodak from preventing competitors to sell.
In 1954, it faced its second antitrust suit, and Kodak was prohibited from bundling products – particularly their Kodachrome and Kodacolor products.
But in 1994, Kodak decided to file a motion to amend or remove these decrees. The court agreed that in order to uphold the rulings, they would need to reexamine Kodak’s market power. The court concluded that Kodak (in fact) did not have any, and both decrees were terminated.
Today, Google is experiencing a similar situation. Following a hearing last week on Google’s market power and practices before the Antitrust, Competition Policy and Consumer Rights Subcommittee of the Senate Judiciary Committee, Senator Richard Blumenthal questioned CEO Eric Schmidt as to whether or not Google was obligated to ensure that it did not abuse its own market position. And if so, what would ensure that such abuse did not occur?
Schmidt stated that “As discussed during the September 21, 2011 hearing, on August 24, 2011, the Department of Justice announced that Google had been fined $500 million for allowing online Canadian pharmacies to place advertisements through its AdWords program, resulting in the unlawful importation of controlled and non-controlled prescription drugs into the United States. The Department’s press release noted that ‘Google was aware as early as 2003, that generally, it was illegal’ to ship pharmaceuticals into the U.S. Google is also well aware that online copyright infringement online occurs on a massive scale and that it is a “problem that [Google] takes very seriously (Blumenthal Continues to Press Google…, 2011).”
Since most of Google’s revenue is generated through advertising, it’s easy to see how this has raised concern.
Blumenthal also questioned as to whether or not it was fair to label Google as a monopoly. Schmidt disagreed. “Google provides its service for free and competition is ‘one-click away’ (Blumenthal Continues to Press Google…, 2011).” But with 65% or more of all general internet searches, 94% European market share and 97% processing on all smartphone searches, it’s hard to agree with him. In fact, today Google really only has Microsoft to contend with. Companies like Lycos, Ask.com and AOL have all dropped out of the competition.
So is Google next? As they grow closer to becoming a monopoly, are they also closer to violating antitrust and competition laws? Will their highly concentrated market power hurt them in a lawsuit?
For more information, check out:
http://blumenthal.senate.gov/newsroom/press/release/blumenthal-continues-to-press-google-on-market-power-and-competition-policy-
Week of September 26th:
Every morning I wake up to the sound of people having a conversation over some relevant, but randomly chosen topic. NPR has been my alarm of choice for many years now, and it always surprises me how I manage to tune in just at the right moment. This week was no exception.
Having newly been assigned to this topic (and not intending on writing about Kodak specifically) it was a bit of a coincidence to wake up to a Morning Edition story on them. This week they had a giant drop in share price, and they were reporting a new low of $1.74 versus a low of only $4.16 in the 3rd quarter of last year (closing the year at $5.36). That’s a 71% decline.
Here’s the story:
http://www.npr.org/2011/09/27/140834495/kodak-shares-plunge
Eastman KodakYearly Stock Prices
http://www.stocknod.com/EK-Eastman-Kodak-stock-prices.aspx
Basically, what happened was that Kodak decided to tap into its credit line for reinvention purposes, but investors were already doubtful of their ability to maintain or grow within the market. Since Kodak had less cash than the $160 million they wanted (and cash was tied up overseas), it was expected that they would sell assets instead of borrow. When that didn’t happen, sustainability concerns were reinforced, and the price share fell. The full story can be found here: http://www.nytimes.com/2011/09/27/business/kodak-stock-dives-after-credit-line-is-tapped.html
A few days later, the price is still falling. Clearly this has affected investor confidence, but it made me wonder…if reinvention (if it includes product development) is unsuccessful, how will this affect their pricing, and therefore, their market power? Kodak will need to price above its marginal cost of production, or it’ll lose money. And for as many competitors as they have, it could be difficult for them to diversify and generate the necessary funds to cover this extension of credit. Seasonal sales are expected to be high, but by already entering the year with a 71% drop, it’s difficult to see how they will perform.
This wasn’t always the case. The once popular film giant held 80-90% of the market and 50% of its price in margin above manufacturing costs (Baye, Kodak Appeals to Court…, 2). But by 1954, an antitrust suit and consent gave room to competition, and Kodak was forced out of monopoly. Companies could produce similar or superior products, and over time, Kodak adjusted to its competition. It accepted price sensitivity and the availability of substitutes, and realized that it no longer had the market power it once did.
In the past, they could have easily increased prices, and it would not have changed their demand or market power. If the average cost of a camera then was $30.00, increasing it to $40.00 would just increase profitability. So in determining markup, all Kodak had to do was look at the elasticity of demand, the # of existing firms in the industry (presence or absence of barriers to entry), the degree of product differentiation, and the nature of its competition. At that time, they would have found demand to be less elastic (for the lack of substitutes) and they could charge well above the marginal cost of production…which they did. It was an easy and profitable move.
Today, Kodak has less market power and less room to “screw up.” Their descent appears to be perpetual, so it’ll be interesting to see if this reinvention improves their bottom line. I’m sure future share prices will be an indicator.
Quiz:
1. Market power is described as:
a) The ability of a firm to set its price above marginal cost
b) The ability of a firm to set its price below marginal cost
c) The ability of a firm to set its price at marginal cost
d) None of the above
2. How does antitrust policy keep firms from monopolizing markets?
a) By ignoring deadweight loss
b) By eliminating price discrimination
c) By eliminating deadweight loss
d) By legalizing firms to collude with other domestic or foreign firms
3. What is an example of commodity bundling?
a) A travel company package, including airfare, hotel and meals
b) A new computer, including CPU, monitor and software
c) Car tune-up service, including engine inspection, filter replacement and fuel system cleaning
d) All of the above
4. What is the most common way to measure market power?
a) Through concentration ratios
b) Through consensus
c) By measuring a single firm’s output
d) Through pricing
5. What are the sources of monopoly power?
a) Economies of scale and scope
b) Cost complementarities
c) Patents
d) All of the above
Answers:
1. a – a firm is said to have market power if it produces less than the socially efficient level of output because it charges a price that exceeds its marginal cost of production
2. c – antitrust policy attempts to eliminate the deadweight loss of monopoly by making it illegal for managers to engage in activities that foster monopoly power, such as price-fixing agreements and other collusive practices
3. d – all of these are examples of commodity bundling because it refers to bundling several different products together and then selling them at a single “bundle price"
4. a – concentration ratios are the most common measures of market power because they measure the percentage of total industry output or
market shares of all participants in the market
5. d – all of these are sources of monopoly power because one or more of these create a barrier to entry that prevents other firms from entering
the market to compete against the monopolist