297.This section describes the criteria on which the OFT and certain sectoral regulators may make a market investigation reference. In order to make a reference, the OFT must have reasonable grounds for suspecting that one or more ‘features’ of a market are preventing, restricting or distorting competition in the supply or acquisition of specified goods or services.
298.Subsection (2) provides that, for the purposes of Part 4, the following are to be considered features of a market: (a) its structure (or any aspect of its structure); (b) the conduct of persons supplying or acquiring goods or services who operate within it; and (c) the conduct of such persons’ customers.
299.The distinction between ‘structure’ and ‘conduct’ in a market is commonly made in economic analysis, and is intended to provide the framework for a wide-ranging inquiry into how firms compete in a market and the economic context in which they operate.
300.Some of the main elements that it is anticipated might be included in an analysis of market structure are outlined below:
Market definition: the starting point for an analysis of the structure of a market is market definition: the process of deciding what goods or services are included in the product market (e.g. ice creams bought from convenience outlets on the spur of the moment rather than from a supermarket) and what the geographic extent of this market is (e.g. is it local, regional, UK-wide, European, or global).
Measures of market shares and concentration can provide a rough indication of the competitive strength of those operating in a market, although they will seldom in themselves provide an unambiguous indication of market power and the state of competition in that market (e.g. the fact that three firms each have 30 per cent of a market now does not mean that the market is uncompetitive: it may be that their respective shares a year ago were quite different, or that, although their shares remain broadly stable over time, there is a great deal of customer ‘churn’ between them).
Barriers to entry and expansion in a market: these are factors that place actual or potential entrants into a market at a competitive disadvantage compared with established suppliers, or make it difficult for new entrants or existing smaller players to grow and thus act as an effective competitive constraint on larger incumbents. High barriers to entry and/or expansion are often a cause of competition problems in a market because they remove a competitive constraint, thus allowing the incumbents to raise prices above the competitive level, secure in the knowledge that new entrants cannot enter the market, undercut them, and win market share. Barriers to entry and expansion arise from a wide variety of causes; for example:
laws and regulations (e.g. where only a certain number of licences is issued to operate in a market);
sunk costs (investment costs of entering the market that cannot be recovered if the entrant subsequently exits the market) and economies of scale (which make it inefficient to operate in a particular market below a certain scale) will tend to increase the risks and difficulty of entry;
information constraints (e.g. where it is difficult or impossible for new entrants to gain the information that they need to compete, or where it is difficult and costly for consumers to gain sufficient knowledge to switch to a new product);
the strategic behaviour of incumbents (who may, for example, have positioned themselves so as to be able to take retaliatory action to eliminate any competitive threat posed by an entrant);
the likelihood or rate of market growth (a growing market is more likely to be attractive to new entrants than a declining one).
The degree of vertical integration and vertical links: the extent to which suppliers in a market are also active in upstream and downstream markets, or are linked with suppliers on upstream and downstream markets, may influence their competitive behaviour (as well as having an impact on the ease of entry into the market).
The cost or difficulty of switching from one supplier to another: such costs can act as a disincentive to vigorous competition either between incumbents or on the part of new entrants.
Buyer power: the strength of customers’ bargaining position relative to that of suppliers can have a significant impact on competition in a market and on the ease of entry into it.
Information asymmetries: the participants in a market will rarely all have the same information. The asymmetry of information between different participants buying or selling a product can have a significant impact on the nature and extent of competition in the market for that product. For example, in some markets consumers are poorly informed about the product in comparison with sellers (e.g. used cars); in others, sellers are poorly informed about consumers, and this may affect how they price their products (e.g. car insurance). Information asymmetries can feed in to other aspects of market structure (in particular, they may constitute a barrier to entry or a barrier to expansion, for example if information asymmetries make consumers unwilling to switch supplier). They can also play a part in the analysis of conduct where individual suppliers exploit or create informational asymmetries, for example through branding or through price discrimination (charging different prices to different customers).
301.The term ‘conduct’ includes any acts and omissions, whether intentional or unintentional, of the persons referred to in subsections (2)(b) and (c). By the decisions they take, the way in which they make decisions, and how they respond to their rivals and potential entrants, those operating within a market can prevent, restrict or distort not only competition within that market, but also competition in the markets in which their immediate suppliers (upstream) or customers (downstream) operate, and in complementary markets (e.g. the conduct of suppliers in a market for one of a pair of complementary markets, such as printers and printer cartridges, may prevent, restrict or distort competition in the market for the other product). The conduct of consumers and other customers, as well as that of the businesses that supply them, can also affect the conditions of competition in a market, and it is therefore included in the definition of features of a market in subsection (2)(c).
302.In some cases, it will be open to debate whether a given feature of a market is structural or an aspect of conduct (for example, information asymmetries and barriers to entry arising from the behaviour of incumbents could equally well belong in either category). However in indicating the range of features of a market which the competition authorities may take into account, the separate references to structure and conduct in section 131 do not require either the OFT under section 131 or the CC under section 134 to identify particular features of markets that are the subject of a reference as falling entirely within the terms of one of subsections (a), (b) or (c) to the exclusion of the others.
303.In considering whether it has reasonable grounds to suspect that features of a market are preventing, restricting or distorting competition, the OFT will have to evaluate the evidence available to it in each case. In some cases, it will be possible for a reference decision to be justified wholly or partly on the basis of indirect evidence, such as the prevailing levels of prices charged for goods or services in a market, or the prevailing levels of profitability or productivity of firms operating in that market (particularly when observed over time, or when compared to another market, in the UK or elsewhere, for similar or related products).
304.The OFT will be obliged to consult before making a reference decision, and to give reasons justifying its decision both before and after it is made (see further sections 169 and 172).
305.The power to make market investigation references is a discretionary one. The OFT is not obliged to make a reference where it has reasonable grounds for suspecting that the reference criteria are satisfied (unlike in the merger regime, where the provisions of Part 3 place it under a duty to refer in certain circumstances). Since potential market investigation cases will often raise many complex issues, the section sets no limits to the matters that may be taken into account in deciding whether or not to make a reference, once the OFT has reasonable grounds to suspect that the reference criteria are satisfied. For example, there could be circumstances in which the reference criteria were satisfied, but the competition problems in the market concerned were of a kind that it was more appropriate for the OFT to address using its powers under CA 1998. Or the OFT might take the view that the competition problems in a market that it had the power to refer were likely only to be temporary, or were too trivial for it to be likely that the costs and burdens of a CC investigation would be justified by any likely outcome of such an investigation.