STAND ON REBATES? An economic view on rebates and competition Dr. - PowerPoint PPT Presentation

WHERE DO WE STAND ON REBATES? An economic view on rebates and competition Dr. Henrik Ballebye Okholm and Torben Thorø Pedersen 17 January 2018

1 2 COMPETITION ECONOMICS CALLS COMPETITION LAW AND ECONOMICS FOR AN EFFECTS-BASED APPROACH ARE BECOMING MORE ALIGNED 3 4 SCREENING FOR POSSIBLE ILLEGAL QUESTIONS AND DISCUSSION REBATES 2

1 COMPETITION ECONOMICS CALLS FOR AN EFFECTS-BASED APPROACH

A helicopter economic view on rebates and competition …. I will take on my thermal head camera….. …. a scan for effects on competition. Where do we stand on rebates? 4

Rebates are used in all competitive industries and all types of firms Common examples • Large firms with market power • Small firms with no market power • Most firms (99,9%?) giving rebates have no or limited market power • Rebates are in the DNA of a business man • Why? Where do we stand on rebates? 5

Rebates are a powerful tool to attract marginal customers – especially secret rebates Total otal Profit fr Pr ofit from om Total otal sold sold already s alr eady sold old pr profit ofit units units units units Br Breakeven sales sales Rebate increase inc se ? 25% 33% General price 40% 67% reduction 50% 100% Breakeven sales Br sales Rebate inc increase se 25% >0% Rebate 40% >0% 50% >0% Where do we stand on rebates? 6

Rebates are effective to implement price discrimination… Type ype Pr Prod oduc ucer er Prod Pr oduc uct Custome ustomer Whic hich h reba bates? tes? Price 1 Individual rebate based 1. DEGREE on willingness to pay Price 2 Price 3 Price 1 Self-selection schemes, 2. DEGREE e.g. airport parking Price 2 Price 3 Student Rebates offered to Price 1 certain customers 3. DEGREE groups, e.g. students Price 2 Enterprise and elderly people Price 3 Home user Where do we stand on rebates? 7

Price discrimination can increase sales when secret rebates are not possible Task • Sell airport parking to three customers Willingness to pay • No variable costs 300 • Goal: Maximise profit 200 100 Bo Ole Ib Where do we stand on rebates? 8

Price discrimination can increase sales when secret rebates are not possible Task Sell airport parking to three • customers Willingness to pay 300 Solution 1: One price Higher price is possible Optimal price = 200 DKK • Revenue = 400 DKK • 200 Price Problems? 100 Bo could be charged a higher price • More Ib would buy at a lower price • sales is possible Bo Ole Ib Where do we stand on rebates? 9

Price discrimination can increase sales when secret rebates are not possible Task Sell airport parking to three • customers Willingness to pay Solution 2: Individual prices 300 Price 1 Optimal prices = 300, 200 and 100 • DKK 200 Price 2 Profit = 600 DKK • Problems? 100 Price 3 The customers may not accept this • pricing How do we find out what much the • customers will pay? Bo Ole Ib Where do we stand on rebates? 10

Price discrimination can increase sales when secret rebates are not possible Task Sell airport parking to three • customer Willingness to pay Solution 3: 1 price, 2 rebates and 300 Price let the costumer chose Rebate 1 Optimal price = 300 DKK in airport Rebate 2 • 200 Rebate 1: Away from airport • Rebate 2: Budget parking far away • 100 Profit = 600 DKK • Advantages? Higher price (Bo pays 300 DKK, not • 200 DKK) Bo Ole Ib Higher sales (Ib buys now) • Where do we stand on rebates? 11

Copenhagen Airport’s parking products Ib Ole Bo Where do we stand on rebates? 12

Firms can use rebates to realise efficiencies Where do we stand on rebates? 13

Rebates create incentives to concentrate purchases on one supplier only Example: 20% retroactive volume rebate above threshold of 9 units Total price @16 units, EUR Marginal unit price, EUR 1.600 1.600 100 +25% 1.400 1.280 80 60 1.200 40 1.000 20 800 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 -20 600 -40 400 -60 -80 200 -100 0 One supplier Split on two suppliers Where do we stand on rebates? 14

If strong enough, this incentive may foreclose rival firms Sup Supplier plier 1 Supplier 2 No rebates Offer rebates Downstream 1 Downstream 2 Predatory Loyalty effects Bundling pricing Where do we stand on rebates? 15 17 Janua ry 2018

Rebate schemes may be complex and difficult to understand Some are simple… …other are more complex Where do we stand on rebates? 16

Complex rebates can harm competition through lack of transparency = + ? Final price Should rebates be public? Where do we stand on rebates? 17

Conclusion: The pros and cons of rebates should be balanced. Rebates should be assumed pro-competitive unless the opposite is shown….. Ant Anti-competit competitiv ive e ef effects ects Pr Pro-competit competitiv ive ef e effects ects Where do we stand on rebates? 18

…and harm to competition should be tested Stage 2 Stage 3 Stage 1 • Test theory of • Draw • Formulate harm conclusion theory of harm about effect on competitor Where do we stand on rebates? 19

2 COMPETITION LAW AND ECONOMICS ARE BECOMING MORE ALIGNED

The two approaches to rebates Case ase law law: : Whe here e do do we e stand stand in in 2009 2009 Form-ba based sed app pproa oach 2018? 2018? Enforcement paper and Intel: Effects-based approach Where do we stand on rebates? 21

The As-Efficient-Competitor (AEC) test Question: Can the dominant firm take its own medicine? Would the dominant firm survive, if it had to fight a competitor with the prices and rebates used by the dominant firm? Why? • Inefficient competitors generally need not be protected by competition law • A dominant firm is unlikely to exclude competitors, if the effective price charged is not below the costs for an as efficient competitor • The actual costs of dominant company is known How? Where do we stand on rebates? 22

The AEC test: Contestable volume Inc Increme ementa ntal l reba bates = T tes = The he incr increme ementa ntal l pu purcha hases ses • The purchases above threshold which allows for a given rebate Retr etroa oactiv ctive e reba bates = T tes = The he pa part o t of dema demand nd rivals rivals can can compe co mpete te for or • Customers ’ willingness to switch (e.g. strong brand loyalty) • Rivals ’ capacity to expand sales • Realistic scale of entry • Historical growth patterns of new entrants Where do we stand on rebates? 23

The AEC test: The effective price The effective price is the price that a rival would have to offer in order to compensate the customer for the loss of the conditional rebate by switching the contestable volume to the rival. Where do we stand on rebates? 24

Retroactive rebates can be very hard to compete against Retroactive rebates imply that competitors have to offer much higher rebates in order to compete Where do we stand on rebates? 25

The AEC test: The effective price List List price price = 100 EUR per unit Illustrative example Retr etroactiv oactive e reba bate te = 5% applies to List price = 100 Price Rebate price = 95 purchases of at least 100 units Effective price = 90 The contes he contesta table v ble volume olume = 50 units 100 EUR 500 Custome Cust omer r dem demand and = 100 units Effective EUR 500 95 rebate = 10 Option 1 Opti on 1 90 Buy all 100 units from dominant firm • Total price of EUR 9,500. ((100-5)*100=9,500) • Option 2 Option 2 50-50 split between dominant firm and rival • 50 unit from the dominant firm cost EUR 5,000 • (50*100=5,000) Must buy Contestable Effective price = EUR 90 EUR 90 for the volume volume contestable volume of 50 units 50 100 Units Where do we stand on rebates? 26

The AEC test: Cost benchmarks Aver erage T ge Total otal LRAIC plus share of common costs • Cos Costs ts (A (ATC) C) Common costs Long Run A Long R un Aver erage ge Average variable and fixed costs that a • Inc Incremental C emental Cost ost company incurs when producing a particular product (increment), including development (LRAIC (LRAIC) costs Aver erage A ge Avoida oidable ble The costs that would fall away if it had not • costs cost s (AA (AAC) C) produced the relevant output May costs include both variable costs and some • fixed costs LRAIC and ATC are equal for single product firms Where do we stand on rebates? 27

The AEC test: Compare the effective price and the cost Price Test est result esult In Inter terpr preta etation tion Comp ompetitiv etitive e Imp Impac act Rebate does foreclose equally P>ATC Positive efficient competitors Rebate may foreclose equally Grey zone AAC<P<ATC efficient competitors. Other factors must be examined Rebate foreclose equally Negative P<AAC efficient competitors Where do we stand on rebates? 28

3 SCREENING FOR POSSIBLE ILLEGAL REBATES