By Smriti Parsheera, Ajay Shah and Avirup Bose.
The world of high technology companies is seen as a dynamic area with a rapid pace of creative destruction. There is, however, a class of industries where there are strong network effects, where the market tends to collapse into a narrow set of players. After one burst of innovation where a new online business is born, there is the possibility of entrenched market power with the extraction of consumer surplus.
Many firms, global and Indian, have resorted to the strategy of making large losses by subsidising users, as a way to obtain those network effects. This has created a new class of concerns about predatory pricing, with unprecedented negative profit margins on a sustained basis, being supported by equity capital infusions. In the short run, discounts are popular, but recoupment is inevitable and market power will adversely affect consumers in the future.
In a recent Paper, we argue that the existing competition law regime in India needs to be fine tuned, for technology-enabled markets with significant network effects, to address the possibility of new kinds of abusive conduct. We offer a series of tangible proposals through which the Competition Commission of India can better handle these emerging situations. We also look into the role and responsibilities of the investors who back these online businesses and the impact of their conduct on competition in the underlying markets.
Entry barriers in the new economy
Innovation is the foundation of economic progress. While we normally revere technology companies for their disruptive innovations and the efficiencies that they create, we must recognise that some technology-driven businesses are susceptible to the acquisition and abuse of market power. The Indian competition regime is an evolving one, and has only recently started facing some of these concerns. Our paper brings new evidence and arguments to the table, on these questions.
Internet-based businesses, along with several other high-technology sectors, form part of the ‘new economy’, characterised by high rates of innovation; low marginal cost; increasing returns of scale; and, in many cases, network effects. Direct `network effects’ arise where a user’s benefit from a product or service increases with the number of other users on that network. The benefit of being on Facebook or WhatsApp, for instance, corresponds with the number of friends and family who use that service. Contrast this with the benefit of having an email address, where the benefits are not limited to closed proprietary networks. This became possible due to the early adoption of interoperability standards in email protocols.
Network effects are particularly important in two-sided markets where users on each side of the market derive a positive effect from the expansion of users on the other side. Commuters who use taxi aggregation platforms like Ola and Uber will logically be attracted to a service that has a large number of drivers on its network, which yields a lower waiting time. The same is true for the drivers working with these platforms. Similarly, in case of payments wallets, in the absence of interoperability regulation, merchants and customers will both prefer a service that has the most addressable users.
With the use of modern technology, the cost of running the marketplace itself has dropped to near zero levels. As an example, the online classifieds site Craigslist reports that it has about 40 employees who manage a network that sees over 80 million classified ads per month. The marginal cost of a transaction has gone to near-zero levels. This gives a unique class of problems where technological innovation that yields cost reductions cannot be a mechanism to take on an incumbent.
Brain versus brawn
How can market power be established, in this new world? One mechanism through which one player can obtain a competitive advantage is to attract users through technological innovation, and thus get a network effect started. This is an attractive strategy for firms which have deep human capital. Another mechanism is by using financial capital to pay subsidies that entice users. This is an attractive strategy for firms which have superior access to financial capital. Many online businesses have resorted to practices like deep discounting, cash-back offers and other schemes designed to attract new users and establish the network effect. Sometimes, heavy losses have been sustained for years on end.
As an example, the global taxi company ‘Uber’ made worldwide losses in the first half of 2016 of US$1.27 billion (approximately Rs.86.5 billion). Uber’s behaviour impacts upon the Indian economy as it has applied the strategy of using financial capital as a competitive lever in India also. On a similar note, the Indian taxi company ‘Ola’ reported a net loss of Rs.7.96 billion in March, 2015. The company’s financial records for the periods after that are not yet available although it is reasonable to expect that the losses will be significantly higher due to the higher driver incentives. In the last two years, it is estimated that the two taxi companies, Uber and Ola, burned cash adding up to about Rs. 130 billion in India.
Such behaviour is found in other industries also. In the field of payments, where regulations have blocked interoperability and thus created the opportunity to kick off a network effect, the firm One97 Communications, which owns ‘PayTM’, reported a loss of Rs.15.49 billion in March, 2016.
The scale of these discounting practices, and the sustained periods for which they are continued, has created new barriers to competition. It is difficult to rationalise these sustained losses as being an introductory offer by a new player. Rather, these practices appear to be a systematic competitive strategy. Capital has become a competitive weapon. This gives rise to concerns that the market may eventually tip in favour of the player that may not necessarily have the most innovative product or service, but one that succeeds in obtaining more capital and enticing more users in the early days, using subsidies. While seeming beneficial for consumers in the short run, such practices raise concerns about competition on account of the creation of market power, and elevated prices for consumers in the following years when losses are recouped.
The FDI guidelines issued by the government in March, 2016 turned the spotlight on pricing practices of e-commerce firms. It clarified that the automatic route of foreign investment would be available only to those e-commerce marketplaces that avoided such subsidies.
These issues have also come to the attention of the CCI in a few recent cases. In April 2015, the CCI passed a prima facie order recommending a detailed investigation into the allegation that, armed with substantial funding received from various investors, Ola had indulged in abusive market practices to garner greater market power in the city of Bengaluru. More recently, the COMPAT directed the Director General of the CCI to initiate a similar investigation to assess Uber’s dominance in the market for radio taxi services in the National Capital Region (NCR) of Delhi after the CCI had refused such an investigation. Uber has now challenged this decision before the Supreme Court, citing a ‘jurisdictional flaw’ in the Tribunal’s ability to order such an investigation. Alongside these developments, CCI is also reported to have set up an in-house panel to understand the cash-back incentives being offered by various online companies from the perspective of predatory pricing provisions under the Act.
Our paper explores the recent developments in India in this area, in the light of foundations of economics and competition law. It argues that there are grounds for concern about the harm to competitive dynamics from these new business strategies. At the same time, it is important to avoid intrusive interventions that bring the State into excessive involvement in the world of business.
New economy requires new thinking
There is a need to take into account the distinct economic features of certain high-technology businesses when looking into allegations of anti-competitive conduct by them. Practices like deep discounting and cash back offers may be aimed at building sufficient scale in today’s market to ensure that the business is able to fully capture tomorrow’s market, to the exclusion of other competitors. A robust economic analysis of the impact of increasing returns to scale, and network effects, is required for understanding the present and future impact of these practices on competition and consumer interests. A novel dimension, which is addressed in the paper, concerns collaboration between the investors in the multiple firms that they invest in.
Transient gains to consumers
We examine the question about gains to consumers from discounting. We suggest that the gains in the short term need to be seen in a larger context. The recoupment test examines the extent to which market power can be achieved in the future, after which prices can be raised. If the CCI were to adopt this test in investigations relating to predatory pricing by online firms it would see that in certain areas, there are network effects, and once a small cartel of firms has acquired market power, it would be difficult for entrants to compete with them in the future. In that future scenario, it would be possible for incumbents to raise prices, and recoup earlier losses.
Interoperability as a tool for competition policy
In some situations, the CCI could rely on the essential facilities doctrine to mandate interoperability between a dominant player that is found to be indulging in the abuse of its position and other operators in the market. For instance, imposing interoperability requirements on a dominant payments network can help extend the network effects of digital payments to the economy as a whole, rather than being limited
to a closed network. The imposition of any such requirements will, however, need to be balanced against factors such as the payment of fair and reasonable access fees, the complexity of institutional arrangements required to monitor such arrangements and assessment of the impact on future innovation. More generally, open standards are an important element of interoperability, and various arms of the regulatory State need to push in favour of competitive markets through interoperable open standards.
Acting within Internet time
Given the fast-changing nature of online businesses, there are concerns about the elapsed time between a full-fledged investigation and the determination of a violation. We suggest a two-pronged approach to address this issue. On one hand, the CCI needs to work towards adopting stricter time frames for the disposal of cases, particularly those relating to new economy firms. On the other, we propose a voluntary settlement process that will allow a business that is under investigation to voluntarily alter its market behaviour, with the concurrence of the authority but without the need for a conclusive finding of violation by the CCI.
In India, technology companies are generally revered as the source of technological progress. However, the problems of competition policy are universal and cut across all industries. The basic principles do not change. The purpose of competition policy is to stave off situations where a narrow set of firms have market power, and new players are not able to enter. Society gains when firms obtain profits and valuation through innovation, not through the crafty use of financial capital to kick off network effects.
These issues were not faced in thinking about Indian competition policy as recently as five years ago. They are, however, likely to become increasingly important in the future. We argue that this calls for fresh think about the legal framework also. There is a case for competition authorities to look into the unilateral abusive conduct of a firm, which, although not dominant at the given point of time, is engaging in anti-competitive practices that create a strong and imminent possibility of its dominance. We highlight some pros and cons of this approach and leave this question open for further research.
Smriti Parsheera and Ajay Shah are researchers at NIPFP, and Avirup Bose is a researcher at Jindal Global Law School.
Featured image source: davidfroud
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