Margin squeeze regulation and infrastructure competition☆
Introduction
Margin squeezes can occur in markets where non-integrated downstream firms, which supply only retail goods, rely on wholesale access to an upstream good provided by a vertically integrated competitor. In this case, the integrated firm may be able to set the wholesale price such that it exceeds the margin between the retail price and the downstream costs of the non-integrated firm. In particular, by setting the wholesale price close to or even above its own retail price, the integrated firm may squeeze the margin of the downstream firm, and thus may ultimately induce its exit from the retail market, i.e., foreclose the non-integrated rival. Whether regulators or antitrust authorities should intervene in cases of margin squeeze conduct is controversial. European agencies and courts have qualified margin squeeze conduct as a stand-alone antitrust abuse (see the cases Deutsche Telekom, Telefónica, and TeliaSonera),1 whereas US courts have dismissed allegations based on the margin squeeze rationale (see the cases linkLine and Trinko).2
Bouckaert and Verboven (2004) identify three types of margin squeezes according to the prevailing regulatory regime: regulatory price squeezes (i.e., if wholesale and retail prices are regulated), predatory price squeezes (i.e., if only wholesale prices are regulated), and foreclosure (i.e., if no prices are regulated). In this study, we consider the latter type, because in industries of competing vertically integrated firms margin squeeze regulation is considered as a potential substitute to access price regulation, and not as a complement to it. This is exemplified by the ex ante economic replicability test in the European Commission’s (2013) Recommendation on consistent non-discrimination. The economic replicability test has been introduced as a regulatory instrument to fulfill non-discrimination obligations in the context of next-generation access networks and aims at a balance between protecting competition and fostering investment incentives. Thus, the ex ante economic replicability test is more specific with respect to its application context and its implementation parameters (e.g., the relevant cost standard) than the margin squeeze test in ex-post competition law. However, as noted by Jaunaux and Lebourges (2015), “[f]rom an economic point of view [both tests] are based on the same principles” (p. 488). Whereas we focus on these more fundamental principles and abstract from several specific issues (especially we do not consider integrated firms’ common costs), we specifically analyze the recommendation’s conjecture that margin squeeze regulation is an effective regulatory instrument if applied in the context of infrastructure competition.
To this end, we scrutinize margin squeeze regulation in markets with more than one integrated firm producing the upstream good and consider a retail triopoly with two vertically integrated firms and one non-integrated downstream competitor. This setting captures any industry in which, on the one hand, some downstream firms rely on the input of a vertically integrated competitor, but, on the other hand, there exists more than one vertically integrated firm. In particular, the scenario of infrastructure competition and retail competition resembles the current state of many European telecommunications markets, where vertically integrated network operators compete with retailers that rely on network access as an input.
In this setting, we consider two different upstream market structures. First, as is common in European fixed line telecommunications markets, we consider a wholesale monopoly, where, despite the presence of two vertically integrated firms (e.g., DSL-based vs. cable-based network operators), only one (e.g., the DSL-based operator) will ever offer the input to the non-integrated retailer.3 Second, we consider an alternative market structure with wholesale competition. This resembles more closely many mobile telecommunications markets, where at least two vertically integrated network operators make competing wholesale offers to mobile virtual network operators that do not operate their own network. In both market structures we consider the impact of margin squeeze regulation, which prohibits a vertically integrated firm to set the access price above its own retail price (neglecting marginal and common costs). According to this definition, an integrated firm, irrespective of its cost-efficiency, could not profitably participate in the retail market if it was required to pay its own wholesale price. We find that such regulation would diminish consumers’ surplus and, in many cases, total welfare. Indeed, under both, wholesale monopoly and wholesale competition, margin squeeze regulation is never beneficial from a consumer welfare perspective, not even if margin squeeze regulation prevents the foreclosure of the non-integrated retailer. If margin squeeze regulation prevents foreclosure, i.e., for relatively homogeneous retail goods, it may be beneficial from a total welfare perspective. However, this positive effect on total welfare is due to higher industry profits, and at the expense of consumer welfare. Moreover, we show that for a wide range of parameter values, margin squeeze regulation increases the vertically integrated firms’ incentives to tacitly collude on wholesale and retail prices in the presence of wholesale competition. Overall, our results strongly question the current initiative by the European Commission (2013) to augment the role of ex ante margin squeeze tests in the context of sector-specific regulation of telecommunications markets and infrastructure competition.
The remainder of this article is organized as follows. Next, we relate our study to the extant economic literature. In Section 3 we introduce the general market structure and model that is used to analyze the effect of margin squeeze regulation (MSR) in lieu of no regulation (NR). In Section 4 we study the case of a wholesale monopoly, whereas in Section 5 we investigate the case of wholesale competition. Finally, in Section 6 we conclude by discussing the policy implications and limitations of our model.
Section snippets
Related literature
The extant economic literature on margin squeeze regulation focuses on market structures with a single integrated monopolist under different settings. First, starting from a setting with homogeneous retail goods, Jullien et al. (2014) point to ambiguous effects of banning margin squeezes: although wholesale prices decrease, retail prices may increase. In other words, non-integrated retailers benefit from margin squeeze regulation, whereas consumers may be worse off due to increased double
The model
Consider the industry depicted in Fig. 1 with two vertically integrated firms i ∈ {A, B} and a non-integrated firm, D, which operates only in the downstream market. For each unit of its retail good, firm D is required to purchase a unit of the homogeneous upstream good, which firm i offers at price ai. Without loss of generality, we denote the access provider as firm A and the non-access provider as firm B. In case of a wholesale monopoly, only firm A will make a wholesale offer aA, whereas in
Wholesale monopoly
In this section, we consider the setting where only one of the vertically integrated firms may provide access to the retailer. This setting has previously been investigated in the context of MSR by Höffler and Schmidt (2008), but in our analysis we additionally consider possible foreclosure of the retailer. In practice, a wholesale monopoly may exist despite infrastructure competition, because only one infrastructure-based competitor is able to provide wholesale access due to technical
Wholesale competition
Under the assumption that both vertically integrated firms potentially make viable wholesale offers, the timing of the model is as follows:
- Stage 1
Firm A and firm B simultaneously set their wholesale prices aA and aB. Then firm D chooses its wholesale provider.
- Stage 2
Firms A, B and D simultaneously set their retail prices pA, pB and pD.
In order to follow the extant literature we distinguish between the case where the retailer firm D must always be supplied by at least one integrated firm (as assumed by
Discussion and conclusions
This study scrutinizes margin squeeze regulation in the presence of infrastructure competition under both monopolistic and duopolistic wholesale provision. More specifically, we consider two integrated firms and one non-integrated firm that depends on the wholesale good as an input to produce its retail good. In contrast to a market with a single integrated firm, it is shown that under infrastructure competition the access provider may engage in a margin squeeze also in the case of an equally
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Cited by (3)
Network modeling approaches for calculating wholesale NGA prices: A full comparison based on the Greek fixed broadband market
2021, Telecommunications PolicyCitation Excerpt :The efficiency of the modeled operator is a topic discussed in the context of margin squeeze regulation and tests conducted by NRAs who must define a “Reasonably Efficient Operator” (REO). Gaudin and Saavedra (2014) presented a benchmark of ex ante REO implementation choices of various European agencies and suggested that “NRAs should correspond to concrete trade-off analyses that balance the cost of short-run efficiency losses against long-run efficiency gains”, while Krämer and Schnurr (2018) investigate the effect of such regulation on wholesale markets and infrastructure competition by modeling a general market structure. Many NRAs use the resulting wholesale prices of their LRIC models as inputs for margin squeeze tests, thus the level of efficiency of the operator and level of scorching chosen in the technoeconomic model are closely related, a point usually overlooked.
Price-Cap Regulation of Firms That Supply Their Rivals
2024, Review of Network EconomicsAccess price structure and entrant build-or-buy incentives in mobile markets
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The authors are grateful for the valuable feedback of the editor, Marc Bourreau, two anonymous reviewers, as well as Martin Peitz and participants at the 43rd Annual Conference of the European Association for Research in Industrial Economics (EARIE) in Lisbon. Moreover, the authors are indebted to Niklas Horstmann for his contributions at an early stage of this project.