Network industries differ from regular, competitive markets in that inequality exists naturally in the market. Economides (2004), states that in the case of a network industry with network externalities, the introduction of competition does not significantly alter the structure of the market. The equilibrium of the market is not a competitive one, and prevents perfect competition from developing.
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The conditions of free entry imposed on network industries do not alter what Economides calls the “incompatibility equilibrium” or the extreme inequality in market share. This equilibrium occurs naturally in network industries, and is not sustained through anti-competitive behaviour, so competition laws will not amend this flaw in the market. This market structure results in a natural equilibrium called “winner takes most”, in which there will always be a dominant firm, preventing a perfectly competitive equilibrium. Economides (2004) warns against the imposition of a competitive market structure, suggesting that the effects of doing so would be detrimental rather than beneficial to the market, and recommends that competition law should be applied, not using a perfectly competitive market structure as its basis, but judging the industry on its individual features.
Whilst moving towards a policy of full deregulation within a state owned monopoly, it is common to have a transitional stage when the industry is partially deregulated (Viscusi et al. 2005), as has been seen in the UK public utilities. It is preferable to have a gradual, staged move towards a fully liberalised market to allow firms time to adapt. In the UK, this course of action was taken by industry regulators within the traditional, state-owned network industries, with the allowance of free entry to the markets, yet price controls were maintained. It is common for the regulator to control the prices of the established firm whilst allowing new entrants to set their own prices. This is to prevent predatory pricing from the incumbent operator driving competitors to insolvency. However, this type of regulation is asymmetric, and has been criticised for allowing unfair competition. Asymmetric regulation can result in ‘cream skimming’ by competitors who are able to gain much of the profitable custom from the incumbent due to the freedom they have to set their own prices.
Network effects or externalities describe the value added to a unit of the good when the number of goods sold increases (Economides 1996). For instance, there is very little value in being the sole user of a telecommunications network, and so the value to the buyer of a telephone would be very low were this the case. The value of having a telephone and connectivity is heightened by the number of your peers who are also connected to the network. Therefore, contrary to normal goods, the willingness to pay for the last unit rises with the number of units sold (Economides 2004).
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