May 31, 2008

ENVC exercise 5

Lesson 7 explores the concepts of Intellectual Property Rights and Competition Law. This blog will analyse the introduction of a new product from the anticompetitive practises perspective, describing what the business can and cannot do in this context and on the other hand assuming that the company have already taken all the necessary measures to assure that the R&D investment is protected by intellectual property rights.

The aim of bringing a new product to the market is to seek a competitive advantage against the competition. However, this competitive advantage cannot be excessive to a point where it is detrimental to welfare (in example creating a monopoly). In other words, the business have to work towards defeating their competitors but have to be careful that the “intensity” of this practice doesn’t conflict with the existing competition law regulation. This is a clear concept but the frontier for what is legal and not is somehow vague.

As breaching the competition law can be very costly including important fines, the company must be sure that the new product’s strategy doesn’t go against the law. Although in some cases the improved margins obtained by the anticompetitive practices can exceed the fines (10% of revenue) and someone might think that the risk is worth taking, there are other penalties that the company might incur, including deep scrutiny of all aspects of the firm’s strategies or even jail for the executives involved in the practice.

In order to avoid these harmful consequences, we must take into consideration that in our context, the law prohibits

  • Agreements or practices that restrict free trading and competition
  • Abusive behaviour by a firm dominating a market, or anti-competitive practices that tend to lead to such a dominant position.  

Therefore, we must assure that our strategy does not include any the following unlawful practices:

Price gouging:

The price must be defendable against the ex-ante profits (expected profits). Clearly we want to maximize our profits, accordingly we will want to charge as much as the consumers are willing to pay, specially if there are few alternatives in the market for our product, however we cannot do so if consumer welfare is going to be affected. On the other hand, if the demand is inelastic (a reduction in price is not going to stimulate additional consumption) we still can charge high prices.

Predatory Pricing:

The price cannot be as low as to be considered “predatory pricing” (selling the product at very low price) as this will motivate the authorities to intervene in order to avoid a monopolistic market as other firms that cannot sustain equal or lower prices without losing money, will go out of business, and the new entrants will found unfair entry barriers that will discourage them to enter the market.

However, it is usually difficult to prove that a drop in prices is due to predatory pricing rather than normal competition, and predatory pricing claims are difficult to prove due to high legal hurdles designed to protect legitimate price competition.

Tying:

We must be sure that the “add on” to the existing product is not considered a tying practice. Here, the company has to be sure that we are not forcing the consumers to buy an undesired good (the base product) in order to purchase a good they actually want (the add on). If this is the case, the company must study a change in the product strategy to sell the add-on and the base product separately.

Carteling:

The law prohibits the cartels (an agreement among firms for example to fix prices). Moreover, in my opinion cartel-administered prices are not an interesting business practice (apart from the fact that it is illegal) for two reasons. First, the above normal prices will attract new entrants to the industry moving the prices back to the competitive levels. Second, the members of the cartel have great incentives to cheat lowering the prices to increase market share, at the expense of other cartel members. So it looks like that cartels are inherently unstable and difficult to maintain.

Refusal to Deal:

We cannot decide to supply only to certain buyers and on the other hand we have to be sure that different prices among firms does not contravene the law.

Monopoly:

Finally, we must be sure that the market share for the product is not as high as can be considered as a monopolistic practice. We have to avoid having so much control over a this product that will determine significantly the terms on which other individuals shall have access to. We have to be sure that economic competition exists in this particular industry and there are substitutes for our product, otherwise it can be considered a monopoly under the existing law.

Sources:

Iandiorio, Joseph, S. (2006), “Intellectual Property” in Burke, Andrew; “Modern Perspectives on Entrepreneurship”, Senate Hall.

A, Burke, K. Mole (2008). The Warwick MBA for IBM: Entrepreneurship and New Venture Creation. Warwick.

http://www.internationalcompetitionnetwork.org/


- One comment Not publicly viewable

  1. Kevin Mole

    Sergio,
    Set out the dilemma between competitive advantage and competition law well. A good discussion of the consequences for the business of a breach of competition law followed. Finally, the list of practices to avoid was presented. This answer is fine as it stands.

    02 Jun 2008, 10:22


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