Economists Dennis Beling, Andrew Swan, Guillaume Duquesne and Zita Vasas participated in a Q&A with Financier Worldwide discussing dynamic competition in merger control. The full article was originally published for Financier Worldwide here and in PDF format here. The views expressed are those of the authors only and do not necessarily represent the views of Compass Lexecon, its management, its subsidiaries, its affiliates, its employees, or clients.
You can find a summary of the article below:
FW: Why is dynamic competition important?
Vasas: In dynamic competition, rivals primarily focus their efforts on research and development (R&D) activities so that they can create demand for new products and services. That is, they innovate, competing to create something new.
Swan: Innovation is what really matters for advancing consumer welfare. That can take different forms – inventing new products and services, new methods of production and distribution, or new ways of doing and organising business.
These benefits are larger than the benefits that come from improvements in static competition and so, the impact that mergers might have on the dynamic competition to innovate should rightly be a central concern of merger enforcement policy.
“Innovation is what really matters for advancing consumer welfare.”
— Andrew Swan
FW: Why has concern about protecting dynamic competition grown recently?
Beling: A merger could harm dynamic competition if it reduces incentives to innovate. For instance, firms that mainly compete by investing to develop the next disruptive product may invest less in innovation after a merger. This is because the threat of losing sales to a rival’s innovative new product in the future is less than it would be if the merging parties still competed on a standalone basis. Similarly, the benefits of developing one’s own new product may decrease.
Duquesne: The growing importance of technology companies, and the increase in their M&A activity, has triggered interest in dynamic theories of harm. In part, that is because digital markets often feature characteristics which favour concentration or a tendency to tip to one single platform, which makes them harder to contest through static competition.
The main mechanism left to discipline large digital platforms is dynamic competition ‘for’ the market – potential and actual entry of an alternative platform may mitigate the ability of the incumbent to exert market power. In fast-evolving markets, that threat can be powerful, as even small firms could rapidly become major competitors.
Vasas: Disruptive innovation can happen relatively rapidly and more frequently in the technology sector than in other sectors, which is another reason why dynamic theories of harm are appearing in mergers involving technology companies. As digitalisation spreads and creates possibilities for transformational innovation beyond high-tech products, concern about dynamic competition may spread to more and more sectors.
Swan: The concern stems from a perceived lack of scrutiny of mergers by competition authorities, particularly on this issue. Lack of intervention is not evidence that there has been underenforcement, or that acquisitions have harmed innovation. Clear-cut examples of mergers that have been permitted and reduced innovation are lacking. Nonetheless, given the importance of maintaining and fostering innovation, this issue does merit attention.
“Dynamic competition ‘for’ the market… may mitigate the ability of the incumbent to exert market power.”
— Guillaume Duquesne
FW: Why is analysing dynamic competition challenging?
Duquesne: Analysing dynamic competition is inherently uncertain. Not only do authorities need to predict what impact the merger might have, they also need to predict what will happen to the market absent the merger. In mature markets, that counterfactual is typically the status quo – the past can be a reliable guide to the imminent future. This is not likely in dynamic and innovative digital markets. The number of credible counterfactuals can quickly multiply and attaching a credible probability to each of these scenarios becomes extremely difficult. This is an inherently speculative and difficult task, especially in fast-evolving markets and for nascent companies.
Beling: The standard tools used in static competition assessments – shares of supply in the relevant market and concentration indices – are typically still the starting point of an analysis. However, they are much less informative for assessing dynamic competition, because in that case, what matters most are the incentives to invest and innovate.
Duquesne: There is a perceived asymmetry in the standard of proof when analysing the potential impact of a digital merger. Competition authorities have been willing to express concerns in one among several possible scenarios, while parties must demonstrate efficiencies in many possible scenarios. In practice, this means efficiencies get dismissed, which can be sizeable in these markets.
“Parties must demonstrate efficiencies in many possible scenarios. In practice, this means efficiencies get dismissed, which can be sizeable in these markets.”
— Guillaume Duquesne
FW: What evidence can be used to analyse dynamic competition?
Beling: It is crucial in an assessment of dynamic competition to identify clearly what the merging parties compete on – a step the UK’s Competition Appeals Tribunal (CAT) referred to as ‘identification of the dynamic element’. This may be R&D efforts to develop a new medicine, developing a new mechanism to attract social media users, or a programme of entering local markets.
To understand the extent to which the merging parties innovate in the same area, or can be expected to in future, it is also crucial to analyse the parties’ respective innovation capabilities. In some cases, it is possible to use quantitative indicators for this purpose. However, in many cases that will not be possible, and the assessment will focus on records of past innovation and the firms’ own plans.
For companies contemplating transactions, it is advisable to carry out a thorough review of potential future overlaps – in terms of overlapping products and innovation pipelines, and also in terms of overlapping capabilities – that pays close attention to areas in which complaints from customers or competitors might be expected.
Vasas: The European Commission has also set out in its new draft market definition guidelines that it would apply a forward-looking assessment with respect to expected technological or regulatory developments that could drive structural changes, and that for technological developments this would likely involve evidence on firms’ R&D and innovation activities.
“For companies contemplating transactions, it is advisable to carry out a thorough review of potential future overlaps”
— Dennis Beling
FW: In your opinion, is the future of assessing dynamic competition looking clearer?
Duquesne: While developments in the UK and Europe have helped in setting the direction of travel, there is still a long way to go. There is still no clear agreement on how to assess dynamic competitive effects, particularly in fast-evolving digital markets. Developing robust and widely accepted tools for analysing these impacts, that can be applied in practice, is a key challenge for economic practitioners.
“As digitalisation spreads and creates possibilities for transformational innovation beyond high-tech products, concern about dynamic competition may spread to other sectors.”
— Zita Vasas