Industrial Organization Introduction

Marc Bourreau

Telecom ParisTech

Marc Bourreau (TPT) Introduction 1 / 15 What is industrial organization?

Industrial organization is concerned with: the working of markets and industries, the way firms compete with each other in these markets.

It is also the object of microeconomics. But, Industrial organization focuses on the study of “imperfect competition”, in contrast with an utopian vision of perfect competition and the counterexample of monopoly. Industrial organization also analyzes in detail competition between firms by emphasizing the impact of non price variables (advertisement strategy, differentiation, investment in R&D...).

A dual approach, positive (explanation of facts) and normative (construction of theories, welfare analysis).

Marc Bourreau (TPT) Introduction 2 / 15 What use is industrial organization?

It provides conceptual analysis tools for the study of markets and firms’ strat- egy, in order to understand, evaluate, and anticipate. For industrial companies and strategy consulting firms (ex: BCG, McKin- sey), it helps analyzing and anticipating firms’ behavior on markets. It also helps the regulation (ex : ARCEP, CRE) and competition authorities (ex: Competition authority in France) that take actions in order to avoid the negative effects of excessive market powers.

Marc Bourreau (TPT) Introduction 3 / 15 The development of industrial organization

In the end of the 19th century, an antitrust law (competition policy) was voted in the United States (The Sherman Antitrust Act in 1890) In order to preserve competition and prevent cartels. Antitrust laws seek also to combat monopolization attempts (or abuse of dominant position). What was a cartel was clear, but what constituted an illegal conduct was less: in 1920, the U.S. Supreme Court ruled that U.S. Steel was not violating the Sherman Antitrust Act despite the company having 70% of the production capacity. First development of industrial organization: Harvard School The Harvard School (Chamberlin, Bain...) was developed from the 1930s to the 1960s for the purpose of providing guidance for competition policy. It seeks to determine whether one can infer an illegal behavior from certain characteristics such as a firm’s size. The SCP paradigm : Structure - Conduct - Performance. The structure → of a market (number of vendors, differentiation, costs...) determines market conduct (price, investment...), which then determines market performance (efficiency, product variety...).

Marc Bourreau (TPT) Introduction 4 / 15 The development of industrial organization

Second wave in the 1970s: the Chicago School During the 1970s, the SCP paradigm is called into question: no conclusive empirical support. The Chicago school (Posner, Bork, Peltzman, Stigler...) came about in reac- tion to the SCP approach. For them, the market regulation mechanism is free competition between companies. Little action is carried out on market structure... But the Chicago school lacks of tools to describe the strategic interactions between firms. Industrial organization from 1980 to 1990: "post-Chicago" or "new indus- trial organization" Analysis of strategic interactions between firms by using non cooperative game theory. Firms’ behavior, market structure and performance influence each other. Progress in two fundamental fields: the dynamic analysis of economic agents’ behavior and the study of information asymmetries.

Marc Bourreau (TPT) Introduction 5 / 15 The development of industrial organization

Industrial organization from the 2000s: Application of industrial organization models to specific markets: telecom- munication, digital market, etc. Development and adoption of new methodological tools: structural econo- metric modeling (empirical industrial organization), experimental economics, behavioral economics, etc.

Marc Bourreau (TPT) Introduction 6 / 15 How to do Industrial Organization?

Joseph Schumpeter, History of Economic Analysis, 1954. "What distinguishes the scientific economic analyst from other people who think, talk and write about economic topics, is a command of three main tech- niques: history, statistics and theory - theory being defined as "box of tools" or a set of models that per- mit one to deal analytically with broad classes of cases by focusing on certain properties or aspects they have in common".

In industrial economics, we develop quite general and simple models, so that→ they can apply to a large variety of cases.

Marc Bourreau (TPT) Introduction 7 / 15 An example: ad quotas on French public TV

The context On January 8, 2008, Nicolas Sarkozy announced the decision to gradually get rid of advertisement on French public TV channels. Since then, there is a debate about reintroducing advertisement on these channels.

The press reaction: "The windfall effect for the two private channels of this possible reform did not escape anyone. They would have taken a significant part of the advertising revenue brought by France Televisions - about 760 million euros in 2007" (Le Monde, January 9th 2008). After Nicolas Sarkozy’s announcement, stock exchange prices of TF1 and M6 have sky-rocketed to 10% and 4,5% respectively. In June 25th 2008, the Cope Commission estimated the loss of earnings of France Television (FTV) at 450 million euros (FTV’s advertisement revenue in 2007, that is 800 million euros, minus the advertisement revenue of before 20 p.m. (e 200M) and on RFO and France3 Regions (e 150M)).

Marc Bourreau (TPT) Introduction 8 / 15 An example: ad quotas on French public TV

In your opinion... Is it a good analysis of the TV market economics?

What could be the effects of removing advertisement on public TV chan- nels? Other TV channels could grab advertisers’ demand? TNT Channels... Other media carriers/platforms (Printing press, Internet, ...) ? Effect on the price of advertising space? Taking into account "capacity constraints" (advertisement space is limited)? Effect on the public channels’ audience?

Industrial organization provides tools to analyze such questions: com- petition→ models, strategic reactions, etc.

Marc Bourreau (TPT) Introduction 9 / 15 An example: ad quotas on French public TV

A "windfall effect"?

112 days after the reform 301 days after the reform TF1 -15% -2% M6 -7% +2% Non specialized Radios +9% +11% FM Radios +4% +5% Daily papers +9% +6%

Evolution of different media channels advertisement revenues 112 and 301 days after the reform

Source : Bourreau and Grece (2011)

Marc Bourreau (TPT) Introduction 10 / 15 Another example: the 4th mobile license

The context A fourth mobile phone license was allocated to Free in December 2009. Free Mobile has launched its non binding offer in January 2012.

The entrance of a fourth operator was seen as a good thing to stimulate competition in the mobile telephony market, which was often considered as "sluggish".

But the 4th entrant has started being active on the market much later than the three other operators Considerable investments were necessary.. and controversy on wholesale contract with Orange What is the reaction of the three other operators to the entrance of a new competitor? Investments in 4G, launch of low-cost branches (fighting brands)... In industrial organization, we consider other dimensions of competition than the price dimension: investment→ in production capacity, in R&D, ... In order to "stimulate competition", the creation of a fourth network was authorized: is this duplication of equipment desirable? Efficiency criterion: social welfare →

Marc Bourreau (TPT) Introduction 11 / 15 Course structure

Part 1 : From monopoly to oligopoly Monopoly, regulation of monopoly, price discrimination Oligopoly Collusion Part 2 : Strategic behavior Differentiation and advertising Market structure and market power Strategic behavior, entry and exit Vertical relations and vertical integration Competition and technology (R&D, networks and standards, etc.)

Marc Bourreau (TPT) Introduction 12 / 15 Sessions

Six course sessions: Today: Monopoly and price discrimination Oligopoly; Collusion Product differentiation and advertising Market structure and market power; Strategic behavior, entry and exit (1) Strategic behavior, entry and exit (2); Verticalrelations and vertical integration (1) Vertical relations and vertical integration (2); Competition and technology (R&D, networks and standards, etc.)

Marc Bourreau (TPT) Introduction 13 / 15 Evaluation and follow-up

Evaluation The course will be graded on the basis of a final exam. Ability to make use of industrial organization concepts to analyze a prob- lem. Ability to resolve a simple modelling problem.

Suivi Syllabus Slides: available on the web site http://ses-perso.telecom- paristech.fr/bourreau/ ("Teaching" section). To send an email: [email protected]

Marc Bourreau (TPT) Introduction 14 / 15 Indicative bibliography

A good introduction: Cabral, 2000, Introduction to Industrial Organization, MIT Press. More advanced: Belleflamme and Peitz, 2010, Industrial Organization: Mar- kets and Strategies, Cambridge Univ. Press. Main reference: Tirole, 1988, Theory of industrial organization, Economica (2 volumes). Reference for competition policy: Motta, 2004, Competition Policy: Theory and Practice, Cambridge Univ. Press. On the same subject, Reperes "La politique de la concurrence", Emmanuel Combe, 2008.

Marc Bourreau (TPT) Introduction 15 / 15