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Market Power

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Title: Market Power


1
Market Power Pricing Behaviour
Banking Enquiry
  • Banking Enquiry - Technical Team Presentation
  • 18 June 2007

2
Introduction
  • Structure of retail banking in South Africa
  • Market Shares and level of concentration
  • Barriers to entry
  • Sources of Market Power
  • Product differentiation
  • Information Asymmetries
  • Search and Switching Costs
  • Rational Oligopoly behaviour
  • Competition Bertrand and Cournot
  • Horizontal restraints agreements and concerted
    practices
  • Price shadowing
  • Strategic avoidance of price competition
  • Effectiveness of competition in South African
    Banking
  • Penalty Fees
  • Discussion of possible remedies
  • Basic banking product
  • International experience

3
Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
  • National Treasury and the South African Reserve
    Bank on Competition in South African Banking
    (April 2004)
  • the concentration levels of the South African
    banking industry are high, but not out of line
    with other emerging markets. However, it is in
    the market segments rather than at firm level
    that concentration is even more marked. For
    example, while the Big Four (ABSA, First Rand,
    Nedcor and Standard) accounted for 83 of the
    total deposits of the public in June 2003, they
    accounted for 92 of mortgage loans and 89 of
    bank financed installment sales. Each of the Big
    Four has a scale monopoly (25 or more market
    share) in one or more of the retail market
    segments (credit cards, current accounts,
    mortgages or leasing and instalment sales).
  • Technical Team analysis shows that this situation
    has not changed materially since 2004.

4
Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
Table 1. Market shares for cluster of personal
banking products in low income and middle income
segments (average based on various sources)
5
Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
Table 2. Market shares for personal transaction
product segment (average based on various
sources) and DI900 monetary value of month end
balances.
6
Structure of Retail Banking in South
AfricaMarket Shares and Level of Concentration
  • Figures not based on market definition, so
    individual banks market share of relevant
    anti-trust market not conclusive (cluster vs
    segment approach).
  • Retail banking sector is very concentrated
    regardless of how market is defined.
  • The four banks share more than 80 of the market
    at the broad retail banking level and in the
    market segments.
  • Personal transactional account segment very
    concentrated top four share approximately 90.

7
Structure of Retail Banking in South
AfricaBarriers to Entry
  • High entry barriers explicit and implicit
  • Explicit R250 Million required capital to become
    a registered bank and other costs of entry (e.g.,
    high fixed costs, time taken to build reputation)
  • Newly registered banks must obtain a SAMOS
    account with the SARB and membership of PASA and
    the Banking Association. Membership and usage
    fees to be paid to PASA and SAMOS and ultimately
    Bankserv or any other operator or association
    (like Mastercard and VISA). All of these are
    explicit costs that mount-up as a would-be
    entrant expands its participation in more payment
    streams.
  • Implicit Discretion of Registrar in granting
    license and approval of existing clearing banks
    of new-entrants and innovations in payment
    streams (danger of turf protection).

8
Structure of Retail Banking in South
AfricaConclusions
  • South African banking sector characterised as an
    oligopoly.
  • Individual banks likely to have some degree of
    market power.
  • Considerable scope for strategic interaction.
  • However, these factors alone are not sufficient
    to conclude whether or not competition is working
    effectively.
  • Competition analysis must probe whether market
    power of individual banks is appreciable and, if
    yes, implications for conduct and strategic
    interaction and
  • Scope for and extent of coordinated conduct
    (horizontal restraints/concerted practices).
  • Taking all these factors into account is
    competition likely to be effective given the
    likely rational behaviour of the banks?

9
Market Power
  • Own-price elasticity of demand measures the
    extent to which a firm exercises market power.
  • The more inelastic the price elasticity of demand
    the more likely the exercise of market power.
  • Distinction between market demand curve and
    residual demand curve.
  • As the number of firms increases, for a given
    market elasticity, the more elastic the demand of
    the single firm.
  • So, in a market that becomes more concentrated,
    individual firms demand (residual demand) will
    be more inelastic.
  • BUT although this implies some market power it
    does not indicate whether it is appreciable.

10
Market Power 2
  • Market power implies the ability of the firm to
    maintain prices above the competitive level.
  • Depends on the elasticity of the firms residual
    demand curve.
  • In addition to market shares and concentration,
    this is influenced by
  • Barriers to entry
  • Availability of substitute products and degree of
    product differentiation
  • Asymmetry of information
  • Costs of searching and switching
  • Strategic interaction between firms

11
Market Power 3
  • The South African Competition Act defines market
    power as the power of a firm to control prices,
    or to exclude competition or to behave to an
    appreciable extent independently of its
    competitors, customers or suppliers.
  • Section 7 of the Act
  • A firm is dominant in a market if
  • It has at least 45 of that market
  • It has at least 35, but less than 45, of that
    market, unless it can show that it does not have
    market power, or
  • It has less than 35 of that market, but has
    market power.

12
Market Power 4
  • OFT Guideline on Market Reference Inquiries
  • A firm may have market power, and the capacity
    to act in ways that may restrict or distort
    competition, with a market share below that
    usually regarded as necessary to suggest
    dominance for the purposes of CA98. Much will
    depend on the constraints exerted by its
    competitors or its customers.
  • Important factors constraining or facilitating
    market power that will be discussed here product
    differentiation, information asymmetries, search
    and switch costs.

13
Market Power 5Product Differentiation
  • Horizontal product differentiation relates to
    different preferences of consumers.
  • Vertical product differentiation relates to
    differences in the quality of products (real or
    perceived).
  • Product differentiation dampens the degree of
    price competition between firms by making the
    residual demand curve of each firm less elastic.
  • Therefore, does confer some degree of market
    power on the differentiating firm.
  • Pro-competitive to the extent of meeting a
    variety of customer preferences and needs, and
  • Innovation and quality improvements rewarded

14
Sources of Market PowerProduct Differentiation
  • Elements of horizontal and vertical product
    differentiation in banking.
  • E.g., expenditure on top-of mind advertising a
    form of vertical differentiation. Suggests that
    banks can influence consumers willingness to pay
    (also dependent on income levels of consumers).
  • Horizontal differentiation reflected in different
    packages and product bundles targeted at
    different customer segments

15
Sources of Market Power 2Product Differentiation
  • However, intrinsic horizontal differentiation may
    in fact be limited.
  • Bank is multi-product firm E.g. Transactional
    banking consists of a bundle of features for
    which customers are charged.
  • Farrell and Klemperer note, selling an extra
    variety can attract demand away from rival
    suppliers for this firms existing varieties
  • So, all the multi-product oligopolists will tend
    to offer similar products and product lines. Each
    bank may offer many features on the transactional
    product but, intrinsically, there will not
    necessarily be much variety produced by the
    industry as a whole.
  • Farrel J and Klemperer P (2006) Coordination and
    Lock-In Competition with Switching Costs and
    Network Effects, from www.paulklemperer.org

16
Sources of Market Power 3Information Asymmetries
  • When customers have sufficient information they
    are able to use this information to make
    efficient and rational choices.
  • However, when firms have more information than
    their customers about the attributes of their
    products, this information asymmetry confers on
    these suppliers a degree of market power over
    their customers.
  • In SA banking sector there are significant
    information asymmetries that prejudice consumers.
    This is particularly true in the case of personal
    transaction accounts. There are a bewildering
    array of different packages and bundled offerings
    with complicated fee structures

17
Sources of Market Power 4Information Asymmetries
  • Technical team experienced considerable
    difficulties in trying to compare the different
    offerings, both within and across banks.
  • Submissions by consumers and other anecdotal
    information tells a similar story.
  • The wide array of packages and bundled offerings
    complicate choices for customers but do not seem
    to reflect intrinsic horizontal product
    differentiation between the banks.
  • This may have a significant dampening effect on
    the extent of price competition.
  • Consumers may also not be sufficiently informed
    to be able to choose between differentiated
    offerings on the basis of positive criteria other
    than price

18
Sources of Market Power 5Search and Switch Costs
  • Wilson, Charles, M. 2006., Markets with Search
    and Switching Costs, MPRA Paper No. 131.
    http//mpra.ub.uni-muenchen.de/131
  • Search costs are the total costs spent by a
    consumer in identifying and interpreting a firms
    product and price offering, regardless of whether
    the consumer buys the product from that firm or
    not.
  • Switching costs are the total costs incurred by a
    fully informed consumer through deciding to
    change suppliers that would not have been
    incurred by remaining with the current supplier

19
Sources of Market Power 6Search and Switching
Costs
  • Wilson notes further
  • Due to the assumption that search costs, unlike
    switching costs, are incurred unconditionally on
    the decision to switch suppliers it is shown that
    the anticompetitive effects of search costs are
    consistently larger than those from an equivalent
    level of switching costs. The finding suggests
    that obfuscation practices that aim to deter
    customers from switching, such as competing on
    deliberately complex tariffs, may be particularly
    powerful relative to practices that increase the
    costs of substitution between firms.

20
Sources of Market Power 7Search and Switching
Costs
  • Complicated packages and bundled offerings
    suggest significant search costs re
    transactional product offerings.
  • Switching costs
  • Competition tends to be more robust when
    consumers are able to easily switch from one
    supplier to another in response to a competitive
    price or some other factor that offers the
    customer better value for money.
  • However, when customers are restricted from
    switching due to inconvenience, administrative
    hurdles, monetary costs, and/or other factors,
    competition may be inhibited.

21
Sources of Market Power 8Search and Switching
Costs
  • Banks have argued that switching costs are not a
    significant barrier.
  • Refer to churn figures which are higher in South
    Africa relative to other countries.
  • Higher churn does not really tell us anything
    about the effectiveness of competition in
    bringing about switching.
  • Search costs may dampen price competition,
    despite higher churn figures.
  • Churn figures greater in the lower income
    segments i.e., current and savings accounts
  • Reasons Account abandonment? Lower switching
    costs associated simplified product offerings?
    Opportunity cost of time lower for low income
    customers?

22
Churn figures calculated by Standard Bank for
market segments
Source Standard Bank Presentation, 13 November
2006.
23
Sources of Market Power 9Search and Switching
Costs
  • The pattern in these churn figures more or less
    consistent with other banks data on churn
  • Sophisticated customers in the middle and higher
    income categories tend to purchase more complex
    packaged and bundled offerings which may have
    higher switching costs associated them.
  • Less financially sophisticated customers in the
    low income segment may be able to switch more
    easily possibly due to the simplified nature of
    the product, but other factors may be at play.
  • Churn figures higher for more atomised products
    like term deposits and home loans where
    switching costs are likely to be lower.

24
Rational Oligopoly Behaviour Cournot Bertrand
Competition
  • Although firms in an oligopoly may recognize
    their interdependence this alone does not mean
    they will not compete.
  • Cournot firm competes by setting output, given
    the output of its rivals.
  • With Cournot type competition price will be
    greater than marginal cost but difference
    between price and MC reduce as the number of
    firms increase.
  • Bertrand firms compete by setting price, given
    prices of rivals

25
Rational Oligopoly Behaviour Cournot Bertrand
Competition
  • In simple Bertrand model (even with only two
    firms) outcome is similar to perfect competition
    (PMC).
  • But simple Bertrand model is not realistic.
    Assumes homogenous products. If one introduces
    product differentiation, then price will exceed
    marginal cost.
  • However, the fact that price is greater than
    marginal cost does not mean that there will not
    be effective competition.
  • Must consider other factors contributing to
    market power of firms and nature of oligopoly
    interaction

26
Rational Oligopoly BehaviourHorizontal
Restraints
  • Where firms recognize their interdependence they
    may have an incentive to not act independently
    but coordinate their conduct (either by direct
    agreement or indirectly through some other
    arrangement) in order to restrict or prevent
    competition.
  • There is no evidence of collusion in the setting
    of fees and charges on transactional products.
  • However, there is concern that arrangements among
    the banks in certain payment streams may restrict
    competition.
  • In the case of ATMs and payment cards there
    appear to be arrangements among the banks which
    may serve as a basis to introduce restrictions
    which may inhibit competition.
  • E.g., Absence of direct charging for ATM
    withdrawals and restrictions on entry of non-bank
    providers restricts the extent to which ATM fees
    can be competed down.

27
Rational Oligopoly BehaviourPrice Shadowing
  • Firms will either shadow one anothers pricing
    upwards or will follow a price leader who tends
    to set a price umbrella under which firms can
    safely keep their prices up at an
    above-competitive level. Firms who are aware of
    their strategic interdependence can achieve this
    outcome without the need for any kind of
    coordination they are able to act unilaterally
    to implement their best strategy in order to
    maximize profits.
  • Our analysis of transaction fees is not
    conclusive. In some cases fees diverge
    considerably across banks whereas in other cases
    there are parallel movements.
  • However, price following not unprecedented in SA
    banking
  • Standard Bank ATM carriage fee adjustment in
    1997, and
  • Banks responses to repo rate adjustments

28
Rational Oligopoly BehaviourStrategic avoidance
of price competition
  • Recent developments in the economics of search
    and switching costs tell an interesting story
    about the incentives of firms in oligopoly
    markets where such costs are present. In such
    cases firms may have an incentive to gain and
    extend market power by making it difficult for
    customers to shop around and switch to more
    competitive offerings or by disrupting or
    preventing any standardization or compatibility
    of offerings that would otherwise facilitate
    switching and price competition.
  • We have noted in previous slides the prevalence
    of information asymmetries, search and switching
    costs in the South African banking sector all
    factors which facilitate strategic avoidance of
    price competition by oligopoly firms.

29
Penalty Fees
  • The level and incidence of penalty fees
    particularly concerning because they add to the
    overall costs faced by customers of transactional
    banking products.
  • Customers often not aware of the full extent of
    the penalty fees they will incur and only become
    aware, after incurring substantial costs, after
    experiencing the full effect of the penalty fee.
  • In the case of rejected debit orders due to
    insufficient funds the debit order request may be
    resubmitted a number of times against the
    customers account. For as long as there are
    insufficient funds in the account the debit order
    request will be rejected and the customer will
    incur a penalty fee.
  • Poor customers are hit particularly hard as a
    result of these fees as they are most likely to
    experience shortfalls in income and to
    temporarily have insufficient funds in their
    accounts (e.g., at the end of the month when most
    payments become due).

30
Penalty Fees
  • Data analysed by the technical team suggest that
    a substantial portion of bank fee income is
    derived from penalty and penalty type fees.
    Further, it is suggested that these fees have
    become an important revenue stream for the banks.
  • There is no relationship between the level of the
    penalty fee and the cost associated with the
    transaction that generated the penalty fee (e.g.,
    debit order rejection)
  • Rejected debit order penalty fees are set at a
    level considerably higher than the estimated cost
    of those transactions.
  • Cost estimate based on confidential submissions
    of certain banks.

31
Effectiveness of Competition in South African
Banking
  • There are a number of factors that may inhibit
    effective competition in retail banking in South
    Africa. Primary among these are
  • The information asymmetries that arise out of
    inadequate disclosure of product and price
    information to customers
  • Significant costs of searching that arise out of
    the complicated packages and fee structures
    making it difficult for customers to shop around
    and make efficient and rational choices and
  • Switching costs, which act as a barrier to
    customers moving from their current provider to a
    more competitive alternative.

32
Effectiveness of Competition in South African
Banking
  • To the extent that these factors indicate some
    degree of market power the enquiry must assess
    whether this power is appreciable and, if it is,
    what impact this would have on the likely
    rational and strategic behaviour of the banks. In
    this regard, are the banks likely to avoid direct
    price competition (through obfuscating price or
    product differentiation and/or cautiously
    following each other) or are they likely to
    compete in order to gain a foothold in a growing
    but untapped low income consumer market?
  • It appears that in South Africa, banks may face
    the prospect of competing for a share of an ever
    growing yet untapped market. In such an
    environment competition may be more intense and
    banks forced to compete on price as they grow
    their share of the market. However, this does
    depend on the scope for growth. If it is limited,
    competition may only be temporary.

33
Discussion of Possible RemediesBasic Banking
Product
  • The remedies here refer to those that would
    enable the consumer to play a more proactive role
    in ensuring effective competition
  • Focus on two areas basic banking product and
    switching
  • Propose for discussion the introduction of a
    simplified basic banking product that has easily
    identifiable features that are generic across all
    the banks and over which the banks can compete on
    price.
  • The product would have to be designed so that it
    meets certain minimum customer requirements but
    is sufficiently simple so that it can be
    identified as the core basic banking product.
  • Similar to Mzansi but more widely available

34
Discussion of Possible RemediesBasic Banking
Product
  • There are number of points to consider with
    regards to the design of this product
  • Should there be a fixed fee per month for the
    bundle of transactions, or unbundled pricing of
    the transaction items?
  • The fixed fee is probably preferable because
    consumers can compare more easily on the basis of
    a single fee rather than a set of unbundled
    transaction fees. Unbundled transaction fees are
    also likely to be price higher relative to the
    options in the various bundled packages.
  • The product must not become a dinosaur that does
    not improve with new innovations and advances in
    technology.
  • A regular review process, with input from civil
    society, may be needed to ascertain whether any
    adjustments are needed in order to meet customer
    needs.

35
Discussion of Possible RemediesBasic Banking
Product
  • The product must fit some general profile that
    cuts across a significant section of the customer
    base.
  • If the basic product cannot be used effectively
    by a significant number of customers then it will
    not succeed in stimulating price competition as
    customers will move to other packages that better
    meet their needs.
  • It must be possible for customers to add on
    additional features if they so wish.
  • It is important that individual tastes be catered
    for that otherwise may not be catered for in the
    generic product This is the apple but you
    can add candy if you like!
  • Banks should be free to offer other
    differentiated bundles and packages in addition
    to the basic product.

36
Discussion of Possible RemediesInternational
Experience
  • United Kingdom Competition Commission market
    investigation of Personal current account banking
    services in Northern Ireland.
  • Introduced a package of remedies to address
    factors preventing effective competition in
    Northern Ireland
  • Easy-to-understand terminology and descriptions
    of personal current account services.
  • Explanations of the levels of charges and
    interest rates and how and when they are applied.
  • Information on statements.
  • Summary and breakdown of charges and interest.
  • Advance notice of charges and debit interest
    incurred.
  • Regular rights reminder.
  • Changes to the switching process

37
Discussion of Possible RemediesInternational
Experience
  • Switching packs have been introduced in a number
    of countries.
  • E.g., Republic of Ireland
  • Two switching pack systems have been
    implemented in Ireland a Personal Account
    Switching Code (January 2005) and a Business
    Account Switching Code (June 2006). These codes
    were developed by the Irish Banking Federation
    the representative organization for the retail
    banks.
  • The Competition Authoritys final report on
    competition in the (non-investment) banking
    sector in Ireland, published in September 2005
    recommended that the Irish Banking Federation
    should develop codes for switching personal and
    business current accounts
  • The financial regulator published its consumer
    protection code- which is mandatory for banks- in
    August 2007

38
Discussion of Possible RemediesInternational
Experience Switching Packs
  • Republic of Ireland example continued..
  • The switching codes are a set of rules that the
    banks must adhere to, and standards that they
    must endeavour to achieve, in order to facilitate
    an efficient, predictable and reliable system for
    individual consumers and business who wish to
    switch their account.
  • For personal account customers, the balance on
    the account, standing orders and direct debits,
    plus any charges will be transferred from the old
    bank directly to the new bank within 7 working
    days and the old account closed. Business account
    customers follow a similar process, with the same
    time scale of 7 working days, but have to also
    consider their payroll system, informing their
    own customers, and the most suitable date to
    switch. Switching is free.
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