title: New Insights for Regulation in Competition Policy
Creators: name: Brunner, Philipp
Publisher: name: Universität Bern
Year: 2024
Subjects: subject: 330 Economics

description: This thesis comprises three chapters providing new theoretical frameworks and insights for regulators, policy-makers, and competition authorities. Each chapter studies a particular problem in the field of industrial organization, aiming to inform decisions for competition policy. The first analyzes the effects of horizontal cooperation on innovation when financial resources are scarce. The second and third chapter study markets in which firms sell add-ons and complementary products, respectively, when consumers are subject to context effects.
In the first chapter, together with Igor Letina and Armin Schmutzler, we investigate collaboration on research and development (R&D) between competitors that face financial constraints. Innovation often involves immense R&D investments such that even large companies struggle to finance it internally. While external financing is possible, it is more costly. Cooperation in the form of a research joint venture (RJV) can be cheaper because the members combine their (financial) resources. Particularly in the automobile industry, we observe an increasing number of RJVs for the development of electric vehicles. When forming an RJV, firms share the costs and benefits of innovation and coordinate their research effort, but stay competitors in the product market. This cooperation alleviates the financing problem, especially because coordination eliminates wasteful duplication of effort.
Typically, collusion among competitors is prohibited as it harms consumers. With innovation, the matter is different. Resources can be used more efficiently, promoting innovation and eventually benefiting consumers. However, research incentives could also be lower with an RJV. If a firm innovates alone, it gets a technological, and thus competitive, advantage. In this case, it would escape competition and increase profits. In an RJV, this is not possible anymore.
We provide a novel reason when RJVs are beneficial and increase innovation probability, and thus, competition authorities should allow it. This depends on how intense the competition in the product market is and how costly external financing is. When competition is soft, the benefit of escaping competition it is relatively small. In that case, an RJV always increases innovation probability. If competition is intense, the benefit of inventing alone is large. Hence, the cost-saving aspects of an RJV must be sufficiently strong that it increases innovation probability, which is the case when external financing is expensive. Further, RJVs can be a better alternative to mergers. While efficiency gains, and thus the effect on innovation, are similar, the negative impact on competition is smaller because an RJV does not reduce the number of firms in a market.
In the second chapter, together with Christian Zihlmann, we study markets with add-on selling and consumers with context-dependent preferences, coming from relative thinking or salience effects. Firms initially sell a base good and then offer an additional product. Behavioral consumers relate the extra offer to the price of the base good, which affects their price sensitivity and temporarily increases demand for the add-on. For instance,a seat upgrade for $50 feels less expensive when the flight costs $1000 than if the same flight costs only $300.
We observe the decoupling of products into a base good and an add-on in many markets. This practice leads to a sequential presentation of prices called drip pricing. Experimental and empirical evidence document that consumers purchase more add-ons when shown sequentially than when base goods and add-ons are bundled products. Firms may exploit behavioral consumers by increasing the price of the add-on. Importantly, the behavioral effect is stronger the larger the reference point is, which, in our case, is the base good price. Thus, firms also have an incentive to increase the price of the main goods. However, this lowers the demand for this primary good, and, in turn, the demand for the add-on. It is well known in the add-on literature that firms attract consumers with a low price for the first good and then generate profits with expensive add-ons. In our model, firms face a trade-off between exploiting more behavioral consumers or selling the add-on at a higher price. We investigate how this affects classical consumers in the market, who are not subject to behavioral effects.
We find that the presence of behavioral consumers has mixed, non-monotonic effects on these classical buyers. Depending on how large the behavioral population is, classical consumers can be better or worse off. When firms exploit the relative thinking of customers, products can become cheaper or more expensive. This novel result raises new questions for regulators about whether we need to protect classical consumers from the behavior of others. We show that an effective policy that prevents firms from exploiting can help all consumers and increase consumer surplus. However, an inefficient regulation can also increase prices and worsen the situation for consumers. Thus, policy-makers must be careful when implementing new policies and regulations, as it could cause more harm than good.
In the third chapter, I consider consumers with context-dependent preferences who purchase complementary products. In contrast to the second chapter, the two products are offered by different firms. For instance, consumers must buy a flight and book a hotel room. A surprisingly good deal on one product may catch the attention of consumers, who then are less price-sensitive for the other complement. Or, when complements are purchased sequentially, the price of the first may impact how the price of the second complement is perceived.
In the model, two firms compete and offer one complement, while a monopolist produces the other complement. Because each firm maximizes its profits, we have the inefficiency problem of double marginalization. This can be solved by vertical integration, which usually lowers prices for the total product. In our case, one of the competitive firms merges with the monopolist. In the benchmark case without behavioral effects on consumers, vertical integration increases profits and, thus, occurs when formation costs are not too high.
I analyze how behavioral consumers in the market affect the incentives for vertical integration. More specifically, consumers underweight the price of the competitive good. This makes competition less intense, which decreases the efficiency gains of vertical integration for the merged firms. This results in lower merger incentives, and vertical integration is less likely to happen in markets with this type of consumer.