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When is Static Analysis a Sufficient Proxy for Dynamic Considerations?

Reconsidering Antitrust and Innovation
Joshua Gans Melbourne Business School NBER Innovation Policy and the Economy Washington DC 20th April 2010

Wednesday, 21 April 2010

Static Analysis

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Static Analysis

Incumbent

Incumbent

Incumbent

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Static Analysis

Incumbent

Incumbent

Incumbent

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Static Analysis

Incumbent Entrant Incumbent Entrant Incumbent

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Static Analysis

Incumbent Entrant Incumbent Entrant Incumbent

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Static Analysis
Incumbent

Incumbent

Entrant

Incumbent

Entrant

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Static Analysis
Incumbent

Incumbent

Competition in the Market

Entrant

Incumbent

Entrant

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Static Analysis

Competition in the Market

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Static Analysis

• Lower prices Competition in the Market

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Static Analysis

• Lower prices Competition in the Market • Lower incumbent profits

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Static Analysis

• Lower prices Competition in the Market • Lower incumbent profits • Higher entrant profits

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Need to consider dynamic effects

Wednesday, 21 April 2010

Need to consider dynamic effects
• Permissive View

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Need to consider dynamic effects
• Permissive View
• Restrictions risk damaging prize from innovation; namely, prospective monopoly rents (Evans & Schmalensee, Gilbert, Manne & Wright)

Wednesday, 21 April 2010

Need to consider dynamic effects
• Permissive View
• Restrictions risk damaging prize from innovation; namely, prospective monopoly rents (Evans & Schmalensee, Gilbert, Manne & Wright)

• Strict View

Wednesday, 21 April 2010

Need to consider dynamic effects
• Permissive View
• Restrictions risk damaging prize from innovation; namely, prospective monopoly rents (Evans & Schmalensee, Gilbert, Manne & Wright)

• Strict View
• Allowing practices risks damaging competition for innovative prizes (DOJ, Brennan)

Wednesday, 21 April 2010

Need to consider dynamic effects
• Permissive View
• Restrictions risk damaging prize from innovation; namely, prospective monopoly rents (Evans & Schmalensee, Gilbert, Manne & Wright)

• Strict View
• Allowing practices risks damaging competition for innovative prizes (DOJ, Brennan)

Both views argue that competition for the market is important

Wednesday, 21 April 2010

This talk
• Based on formal model of Segal & Whinston (2007) • How to evaluate dynamic impact of restricting practices • What happens when entrants commercialize innovations by cooperating with incumbents?

Wednesday, 21 April 2010

What Static Analysis misses

Wednesday, 21 April 2010

What Static Analysis misses

Higher Entrant Profit

Wednesday, 21 April 2010

What Static Analysis misses

Higher Entrant Profit

Wednesday, 21 April 2010

What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents

Wednesday, 21 April 2010

What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents

Incentive to Innovate

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What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents

Incentive to = Innovate

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What Static Analysis misses

Higher Entrant Profit Immediate Profits Under Competition

Reduced Incumbent Rents

Incentive to = Innovate

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What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents Immediate Profits Under + Competition

Incentive to = Innovate

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What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents Immediate Profits Under + Competition Future Incumbency Rents

Incentive to = Innovate

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What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents Immediate Profits Under + Competition Future Incumbency Rents

Incentive to = Innovate Antitrust Policy

Wednesday, 21 April 2010

What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents Immediate Profits Under + Competition Future Incumbency Rents

Incentive to = Innovate Antitrust Policy

Wednesday, 21 April 2010

What Static Analysis misses

Higher Entrant Profit

Reduced Incumbent Rents Immediate Profits Under + Competition Future Incumbency Rents

Incentive to = Innovate Antitrust Policy

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Dynamic Considerations

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Dynamic Considerations

Future Incumbency = Rents

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Dynamic Considerations

Future Profits while Incumbency = Innovation Leader Rents

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Dynamic Considerations

Future Profits while Profits when + Incumbency = Innovation Leader Displaced Rents

Wednesday, 21 April 2010

Dynamic Considerations

Future Profits while Profits when + Incumbency = Innovation Leader Displaced Rents

How long will leadership last?

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Dynamic Considerations

Future Profits while Profits when + Incumbency = Innovation Leader Displaced Rents

How long will leadership last? What profits will the incumbent earn in the face of innovative entry?

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Impact on Rate of Innovation

Profits while Innovation Leader Profits when Displaced
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Impact on Rate of Innovation

Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced
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Impact on Rate of Innovation
Antitrust Policy Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced
Wednesday, 21 April 2010

Impact on Rate of Innovation
Antitrust Policy Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced
Wednesday, 21 April 2010

Impact on Rate of Innovation
Antitrust Policy Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced
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Impact on Rate of Innovation
Antitrust Policy Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced
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Falling in Rate of Innovation

Impact on Rate of Innovation
Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced Innovation Rate
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Antitrust Policy Prize

Impact on Rate of Innovation
Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced Innovation Rate
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Antitrust Policy Prize

Impact on Rate of Innovation
Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced Innovation Rate
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Antitrust Policy Prize

Impact on Rate of Innovation
Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced Innovation Rate
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Antitrust Policy Prize Supply

Impact on Rate of Innovation
Immediate Profits Under Competition Profits while Innovation Leader Profits when Displaced Innovation Rate
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Antitrust Policy Prize Supply

Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition

Profits when Displaced Innovation Rate
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Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition High

Profits when Displaced Innovation Rate
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Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition High

Profits when Displaced

Low

Innovation Rate

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Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition High

Expected Incumbent Profits

Low

Innovation Rate

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Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition Low

Expected Incumbent Profits

High

Innovation Rate

Wednesday, 21 April 2010

Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition Low

Expected Incumbent Profits

High

Innovation Rate

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Impact on Rate of Innovation
Antitrust Policy Prize Immediate Profits Under Competition

Expected Incumbent Profits Innovation Rate
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Evaluating practices
Immediate Profits Under Competition Expected Incumbent Profits

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Evaluating practices
Immediate Profits Under Competition Restrict exclusive contracts Expected Incumbent Profits

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Evaluating practices
Immediate Profits Under Competition Restrict exclusive contracts Expected Incumbent Profits

Increase

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Evaluating practices
Immediate Profits Under Competition Restrict exclusive contracts Expected Incumbent Profits

Increase

Neutral

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Evaluating practices
Immediate Profits Under Competition Expected Incumbent Profits

Prohibit tying

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Evaluating practices
Immediate Profits Under Competition Expected Incumbent Profits

Prohibit tying

Increase

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Evaluating practices
Immediate Profits Under Competition Expected Incumbent Profits

Prohibit tying

Increase

Decrease

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Summary
• Baseline static considerations also determine impact of antitrust policy on innovation. • Intuition: the impact of reducing entry barriers is often equivalent to the impact of encouraging entrant innovation. • Entrant innovation often encourages incumbent innovation.

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Competitive commercialization

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Competitive commercialization

Innovative Entry

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Competitive commercialization

Innovative Entry

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Competitive commercialization

Innovative Entry

Compete with Incumbent

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Cooperative commercialization

Innovative Entry

Compete with Incumbent
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Cooperative commercialization

Innovative Entry

Bargaining

Compete with Incumbent
Wednesday, 21 April 2010

Cooperative commercialization

Innovative Entry

Bargaining

Compete with Incumbent
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Cooperative commercialization

Innovative Entry

Bargaining

Compete with Incumbent
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Cooperative commercialization
Licensing or acquisition Innovative Entry

Bargaining

Compete with Incumbent
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Why cooperate?

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Why cooperate?
• Savings from not duplicating complementary assets (Teece 1987)

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Why cooperate?
• Savings from not duplicating complementary assets (Teece 1987) • Prevent rent dissipation (Gans and Stern 2000)

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Why cooperate?
• Savings from not duplicating complementary assets (Teece 1987) • Prevent rent dissipation (Gans and Stern 2000) • However, the value of competitive outside options will impact on returns

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Gains from trade

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Gains from trade
Cooperate

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Gains from trade
Cooperate Per period monopoly profit

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Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit

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Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit + Entrant's future profit

Wednesday, 21 April 2010

Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit + Entrant's future profit

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Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit + Entrant's future profit Compete

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Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit + Entrant's future profit Compete Immediate competitive profits

Wednesday, 21 April 2010

Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit + Entrant's future profit Compete Immediate competitive profits + Market leader's future profits

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Gains from trade
Cooperate Per period monopoly profit + Market leader's future profit + Entrant's future profit + Incumbent's future profit as a follower Compete Immediate competitive profits + Market leader's future profits

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Gains from trade
Cooperate if ... Immediate gain in monopoly rents > Incumbent's future profit as a follower - Entrant's future profit

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Innovation prize

Half of the gains from trade + Incumbency Advantage

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Impact on Rate of Innovation
Immediate Profits Under Competition Ongoing Monopoly Profits Less Profits if Displaced Innovation Rate
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Antitrust Policy Prize Supply

Impact on Rate of Innovation

Immediate Profits Under Competition

Less Profits if Displaced

Ongoing Monopoly Profits

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Impact on Rate of Innovation
Impact under cooperation Immediate Profits Under Competition Less Profits if Displaced Ongoing Monopoly Profits

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Impact on Rate of Innovation
Impact under cooperation Immediate Profits Under Competition Less Profits if Displaced Ongoing Monopoly Profits

Impact under competition

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Impact on Rate of Innovation
Impact under cooperation Immediate Profits Under Competition Less Profits if Displaced Ongoing Monopoly Profits

Impact under competition Immediate Profits Under Competition

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Impact on Rate of Innovation
Impact under cooperation Immediate Profits Under Competition Less Profits if Displaced Ongoing Monopoly Profits

Impact under competition Immediate Profits Under Competition Profits when Displaced

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Impact on Rate of Innovation
Impact under cooperation Immediate Profits Under Competition Less Profits if Displaced Ongoing Monopoly Profits

Impact under competition Immediate Profits Under Competition Profits when Displaced Profits while Innovation Leader

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Impact on Rate of Innovation
Restricting practices increases innovation if ....

Wednesday, 21 April 2010

Impact on Rate of Innovation
Restricting practices increases innovation if .... Shift in rents from incumbent to entrant under competition

Wednesday, 21 April 2010

Impact on Rate of Innovation
Restricting practices increases innovation if .... Shift in rents from incumbent to entrant under competition

>

Wednesday, 21 April 2010

Impact on Rate of Innovation
Restricting practices increases innovation if .... Shift in rents from incumbent to entrant under competition Any reduction in monopoly profits

>

Wednesday, 21 April 2010

Impact on Rate of Innovation
Restricting practices increases innovation if .... Shift in rents from incumbent to entrant under competition Any reduction in monopoly profits

>

... but need to be careful not to deter cooperative commercialization

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Allowing cooperation
• Has potential to reduce competition in the market • What about when competition is for the market?
• Parties have interest in slowing innovation rate • Incumbent producers innovate more slowly • Licensing may leave a vigorous innovative entrant so parties may prefer not to cooperate • Licensing may reinforce incumbent's ability to live a quiet life

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Conclusions

Wednesday, 21 April 2010

Conclusions
• Competition for the market leads to antitrust policy designed to improve entrant profitability upon entry

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Conclusions
• Competition for the market leads to antitrust policy designed to improve entrant profitability upon entry • Highlights ongoing but not novel concern regarding antitrust policy errors

Wednesday, 21 April 2010

Conclusions
• Competition for the market leads to antitrust policy designed to improve entrant profitability upon entry • Highlights ongoing but not novel concern regarding antitrust policy errors • Under cooperation, policies that shift rents from the incumbent to the entrant should they compete are desirable

Wednesday, 21 April 2010

Conclusions
• Competition for the market leads to antitrust policy designed to improve entrant profitability upon entry • Highlights ongoing but not novel concern regarding antitrust policy errors • Under cooperation, policies that shift rents from the incumbent to the entrant should they compete are desirable • Dynamic considerations reinforce static presumptions towards preserving competition even if the analysis is a little more nuanced
Wednesday, 21 April 2010