Friday, January 8, 2016

Richard Langlois on Dynamic Competition

This is probably the clearest explanation of the differences between the concepts of dynamic and static competition I've ever read. In his written testimony to the British Parliament in December 2015, Richard Langlois explains the differences between these two ways of understanding competition in the context of technological innovation and competition in electronics. While he focuses on electronics, many of the concepts can be applied to agricultural innovation. One especially interesting application to agriculture is the increases in the features seed companies provide to their customers (e.g. crop scouting for a relatively small fee). This testimony would be a very good addition to the reading list of any IO course.

The document is pretty short and is certainly worth reading. Here are a few of my favorite paragraphs:

No doubt almost everyone who has submitted testimony has noted that platforms partake of network effects. The desirability of a platform depends not only on the characteristics of the product considered in isolation (what some authors call the autarky value of the product) but also on the number of other customers who use, or are expected to use, the product (its synchronization value). As a result, we seldom see competition in the static sense of multiple platforms providing essentially the same service; consumers will gravitate to whichever platform has the highest synchronization value (assuming similar autarky values), and it is in fact efficient for a single platform to serve the entire (narrowly defined) market. From a static point of view there is “monopoly.” From a dynamic point of view, however, the locus of competition has simply shifted. In platform markets with network effects, competition within the market (again, narrowly defined) has given way to competition for the market. Existing successful platforms are disciplined by the threat from potential new platforms. Sometimes this threat comes in the form of competitors who improve the autarky value of their product, often starting out as niche players catering to first users who appreciate the autarky characteristics of the competitor and then expanding as new users provide synchronization value. Most significantly, platforms face the challenge of competitors that provide a similar or improved service in a wholly different and often unexpected way.
On monopoly and barriers to entry:
There are only two ways that a platform can maintain prices above marginal costs. One is to be more efficient that one’s competitors – to have lower costs, for example. Such a situation would not be “policy relevant,” in the sense that taking regulatory or antitrust action against the more-efficient competitor would make society worse off. The other way to maintain price durably above marginal cost is to have a barrier to entry. 
The static and dynamic views are in agreement that competition requires free entry. Taking a static view often leads to intellectual confusions about the nature of barriers to entry (that they can arise from the shape of cost curves, for example); but in the dynamic view it is clear that barriers to entry are always property rights – legal rights to exclude others.(1) For example, one can have a monopoly on newly-mined diamonds if one owns all the known underground reserves of diamonds. More typically, especially in the case of platforms, the property rights involved are government-created rights of exclusion, either in the form of intellectual property or regulatory barriers.
On the abuse of market power:
What if it is customers who complain about the “abuse” of market power? To an economist, the problem with market power is the (static) inefficiency it creates. There is no such thing as the “abuse” of market power. Economists have understood for some time that a firm possessing market power cannot by its own actions increase that market power. The only way a firm can get market power (apart from being more efficient) is to possess a barrier to entry. What many see as “abuses” are usually what modern-day economists have come to call non-standard contracts: contractual practices beyond the simple calling out of prices in a market, practices that seem “restrictive.” These practices are often solutions to a much more complicated problem of production and sales than is contemplated in the simplified models of market power. They are very frequently an effort to overcome problems created by high transaction costs.(2)
Langlois blogs at Organizations and Markets. Here are some related Farmer Hayek posts.

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