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Policies to increase contestability in markets

A-Level, IB
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 11 Feb 2019

There are a number of different policies that might be used to stimulate an increase in market contestability for different goods and services. The crucial factor affecting contestability is the level of sunk cost.

Policies include the following:

Market liberalisation and network access

Liberalisation involves lowering some of the legal barriers to entry into an industry. For example, broadband services and parcel deliveries have both been liberalised over the years and this has led to a substantial increase in the intensity of price and non-price competition. Liberalisation can also involve requiring a monopoly network supplier to allow rival firms access to the network.

Good examples include some of the smaller energy suppliers in the UK such as First Utility and Ovo Energy. Another example is in the railway industry where there is a handful of open access operators such as Grand Central who bid to run services on parts of their network where there is spare capacity.

Tougher competition policy

In recent years, both the UK Competition and Markets Authority (CMA) and the EU Competition Commission have been proactive in investigating allegations of anti-competitive practices that block real competition between suppliers. In some (relatively rare) cases, the CMA has opted to block a proposed merger / takeover on competition grounds. Alternatively they can insist on the divestment of parts of a business before a merger is given the go-ahead.

The CMA is currently investigating the proposed merger between Sainsbury's and Asda which might lead to a substantial lessening of competition in the retail grocery sector. The CMA is also carrying out a market study into competition in the funerals market, to review how well the market works and if consumers are getting a good deal.

That said, only 12 mergers and takeovers have actually been prohibited / blocked in the UK between the years 2004 and 2018.

Trade policy

Trade policy can be an important way of increasing competition. For example, free trade agreements that lower import tariffs and lower import quotas can have the effect of increasing the scale of import competition facing domestic businesses. Countries favouring open capital markets can also promote contestability, for example by allowing inflows of foreign direct investment. Consider for example the entry of retailers from other countries who invest in opening stores as well as providing direct competition online.

How to be a disruptor

The impact of new technology

Access to the available industry technologies is an import determinant of market contestability.

Many new digital technologies lower barriers to entry and make it easier and less costly for business start-ups to join a market and challenge incumbent firms. In the last decade we have seen the rapid rise to prominence and scale of businesses such as Uber (taking on well-established taxi monopolies) and Netflix (a major challenger to mainstream cinemas). Businesses such as the peer to peer lender Funding Circle and the online bank Monzo are a potential threat to the mainstream commerce cal banks.

Often contestability can be increased when a business loses some of their most highly-skilled staff who decide to set out on their own in business and use their experience, contacts and ideas to develop start-ups with a different business model. The availability of open source software (freely available for developers to use) has also lowered the costs of setting up new businesses.

It is often easier for businesses that are already scaled and competitive to break into a new sector. They might have established strong consumer loyalty which can be transferred into selling goods and services in a fresh industry. A good example might be Virgin Money’s rise to prominence as a high street and online bank. Or Amazon using their acquisition of Whole Foods to effectively enter the bricks and mortar world of retail grocery on the high street.

Disruption to markets from new technologies have been around for a long time - consider the impact of the IT revolution (PC, online, mobile, social). Now we see the expansion of investment in and application of the internet of things (IoT), virtual reality, artificial intelligence, robotics, blockchain and much else besides.

Lean start-ups and entrepreneurial zeal

Market contestability can be increased when new businesses are able to get the skilled employees, raw materials and components they need at a competitive price. These days, the ability to hire/lease machinery helps to lower entry costs and building a lean start-up with limited fixed costs helps to reduce the exit costs associated with an unsuccessful foray into a market.

Do not underestimate the latent power of entrepreneurial zeal to build new businesses and challenge the status quo.

Entrepreneurs taking on the tech giants

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