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Countervailing buyer power and buyer market power

This entry was added to http://www.reckon.co.uk/headlines-franckblog on 3 June 2005.
Full blog table of contents available at Contents | viewpoint: Franck.

Update, February 2006: see Countervailing buyer power in telecoms | viewpoint: Franck for a commentary on the Competition Appeal Tribunal's treatment of countervailing buyer power in determinations of substantial market power for the purpose of the EC regulatory regime for electronic communications.

This article explores the possible meanings of the phrase "buyer power", initially prompted by reading some confused thinking about it in what were supposedly economic studies of competition.

I think that much of the confusion arises from the use of the phrase "buyer power" to refer to two different concepts:

It may seem odd that people should be unable to distinguish a power to generate competition (countervailing power) from a power that derives from a lack of competition (market power), but this confusion somehow appears to crop up again and again in theoretical and empirical studies alike.

I have now added what I think are useful characterisations of these terms to the Reckon Open Glossary. The discussion below provides a more detailed explanation and tries to illustrate some of the complex interactions and differences between the various relevant concepts.

Countervailing buyer power in merger cases

The main practical use of the words "buyer power" is in merger decisions, where a transaction that might otherwise lead to a risk of a substantial lessening of competition between suppliers in a market may sometimes be cleared on account of the countervailing buyer power held by the customers in that market.

Countervailing buyer power of this kind can take a variety of forms, and the analysis needs to establish in each case how the countervailing power creates constraints of a competitive nature and thereby avoids the lessening of competition that might otherwise arise. In most cases, the mechanism will involve either:

In the case of self-supply, the competitive constraint associated with countervailing power is merely someone's capability to enter and supply the market, in the case where the someone happens to be a buyer in the same market (although it may mean that the market disappears in the event that self-supply is implemented by all buyers).

Similarly, in the case of sponsorship of entry, the analysis of the effectiveness of the competitive constraint proceeds along the usual lines for an entry threat, albeit with a particular focus on the type of deal that powerful buyers can use to attract competition from new entrants — e.g. large or long-term contracts, financing arrangements, etc.

This concept of countervailing buyer power is well established and understood, to the point that it is now systematically mentioned in OFT decisions whether or not to refer a merger to the Competition Commission.

One limitation of the use of countervailing power to justify mergers, which is recognised in standard guidance documents and discussions, is the risk that only the buyers that are powerful may benefit from the countervailing buyer power, leaving other buyers to bear the brunt of any lessening of competition or supplier market power.

In more technical terms, this corresponds to the case where the merger would lead to a "split" of the pre-merger relevant market, with the post-merger situation having strong enough competition in a market for meeting the requirements of powerful buyers and weaker or no competition in a market for meeting other requirements.

Whether this is so can only be determined on the particular facts of the case. It will depend, amongst other things, on whether there is a link between the countervailing power of a buyer and the nature of its requirements from the market (for example if countervailing power derives from technical expertise rather than sheer size, and is held by large and small purchasers alike, then the competitive constraints arising from countervailing power may end up benefiting all buyers). Another question is whether the powerful buyers may end up competing with each other to act as intermediaries or wholesalers, in which case they could make the benefits of the competitive constraints supported by their countervailing power available to other buyers.

Countervailing power in dominance cases

Competition law guidance documents also make reference to countervailing power as part of the assessment of the market power of a supplier, and it does seem sensible that all potential forms of competitive constraints should be examined before concluding that anyone has a dominant position.

However, I suspect that countervailing power is of less practical importance in dominance assessments than in merger cases, for the simple reason that any countervailing power that actually exists is likely to have been exercised by the time there is a prima facie case of dominance, and exercised countervailing power is no different from any other form of actual competition. Thus, if there does not seem to be, in fact, effective competition in a market, then any countervailing power that might have appeared to exist is very likely to be illusory.

By contrast, in a merger case, countervailing buyer power can be valuable as a predictor of future (post-merger) competitive constraints.

Nonetheless, the concept of countervailing buyer power to refer to competitive constraints faced by suppliers which proceed more or less directly from the capabilities of buyers remains intact and applicable in principle to the assessment of dominance.

Buyer market power distinguished from countervailing buyer power

A different interpretation of the phrase "buyer power", if used without context, could be the idea of buyer market power, i.e. market power held by buyers.

Assessing competition between buyers is sometimes unfamiliar, but there is no particular magic in it. The underlying question is the same as for supplier market power: are there effective competitive constraints?

This is best illustrated by simple examples from a hypothetical bread supply chain.

At the consumer end of the supply chain, consumers face a wide variety of sources of bread. Market definition is likely to be quite complicated as between different kinds and qualities of bread and locations of shops, but however it pans out it seems highly likely that there will be effective competition between a supermarkets, corner shops and local bakers over the bulk of the bread retail supply markets.

One could ask whether end consumers have buyer market power. But this would be a bit of a silly question since it is unlikely that buying bread for family consumption meets the Fenin definition of the activities of an undertaking, and who cares whether someone who is not acting as an undertaking has market power?

(The answer in case someone does care: leaving aside any trade buyers using supermarkets as a cash-and-carry, and assuming no systematic shortages of bread, each individual end consumer has market power in its own individual market for the purchase of bread, since there is no conceivable competitive constraint on that consumer's bread buying behaviour arising from any ability of shops to switch to other potential buyers. This is true, even though it looks a bit silly; but I did say you should not care.)

At the top of the supply chain, and focusing on high-volume manufacturing, the supply sector is probably quite concentrated. But the big supermarket chains are likely to have countervailing power through their ability to finance the entry of a new production facility (provided that supermarket brands are now strong enough for a wide-ranging entry strategy). Thus we might reasonably find effective competition in bulk supply, in product markets defined by reference to substitutability in the eyes of end consumers as above (for reasons that I do not need to go into for the purpose of this article).

The relevant buyer market power question is whether the supermarkets may have buyer market power over bread manufacturers. In fact, there are two questions:

(Note that in the discussion of countervailing buyer power we did not necessary care very much whether competitive constraints arose from individual power or by a collective exercise of power, except insofar as collective action may be constrained by law.)

So which competitive constraints might a supermarket face in buying bread in bulk? Obviously competition in the retail markets will be utmost in managers' mind — it is the end purpose of all the buying — but it does not amount to a competitive constraint in any wholesale bread purchasing market. In theory there could be constraints in cases where a manufacturer offers its future production in an auction, selling it to the highest bidding buyer. But this finding would conflict with the assumption made above that the prices offered by manufacturers were constrained by supply competition, not least by the threat of competition from potential entrants sponsored by supermarkets with countervailing buyer power. If this assumption is true then it does not look like there will be competitive constraints between supermarkets in their buying activities, and therefore the likely outcome is individual market power in buying. If this assumption is false and a manufacturer in fact has market power then the auction scenario becomes credible, in which case buyers would be competing in a manufacturer-specific auction market.

In a nutshell:

The superficial link between countervailing buyer power and buyer market power that this appears to establish is highly imperfect — it is only one way, and even then the meaning of "sufficient" countervailing power is highly dependent of the circumstances of the case.

The truth is that buyer market power is a consequence of effective competition in supply, and countervailing buyer power is merely one contributory factor to such competition.

Does buyer market power matter?

Given that there is little doubt that supermarkets act as undertakings in buying bread, we might want to take a closer look at this finding that it has market power whenever there is effective competition between manufacturers. Would a merger strengthen that market power/dominant position and thereby lessen or impede effective competition? Can this buyer market power be abused?

The merger question is easy: the buying markets are buyer-specific and buyers already do not compete, thus there is no lessening of competition in these markets from a merger between buyers.

As regards abuse, it is difficult to imagine a scenario within the context of the above example in which the conduct of a buyer who has buyer market power as a result of effective competition between suppliers could be abusive. All the obvious candidates — exploitative abuse, imposing de facto exclusivity or loyalty-inducing contract or payment terms, tying etc. — do not seem to "work" for the simple reason that suppliers would exit the relevant market (it does not matter whether they exit the industry altogether or displace their efforts to another buyer-specific market) in response to any terms of trade that are worse than those set by competition on the supply side, thus rendering the abuse attempt ineffective. Thus one might speculate that buyer market power, in the sense of an absence of competition between buyers, that merely results from effective competition between suppliers, is in fact an illusory power.

If adverse effects on competition result from some arrangements between buyer and supplier by which the buyer pays the supplier the full "competitive" price of implementing a restriction on competition, then this would be an agreement or concerted practice captured by Article 81 rather than unilateral abusive conduct governed by Article 82.

This particular example should not be taken to mean that buyer market power can never be abused. First, there may be conduct that I have not thought of which would constitute an abuse of buyer market power. Second, the above logic rests heavily on the specific fact that supply competition was the source of buyer market power. It would not apply if buyer market power came from other causes (e.g. regulation, incumbency, talent and/or luck), and it is not difficult to imagine both exclusionary and exploitative abuses in such cases.

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Entry added by Franck Latrémolière on 3 June 2005

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Last changed by Franck at 6:09 AM on Thursday 19 October 2006.

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Reckon Open "Countervailing buyer power and buyer market power | viewpoint: Franck" 2006-10-19T06:09:29