Sonaecom/ PT: Merger in the mobile telephony market

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1 Sonaecom/ PT: Merger in the mobile telephony market Fernando Jiménez Latorre Associate Director NERA Economic Consulting 2008 Annual Conference in Budapest Association of Competition Economics November, 2008

2 Index I. Economic rationale II. III. Competition concerns i. Traditional approach to the analysis of market competition ii. Modern approach Objections to the AdC 1

3 I. Economic rationale of the merger Competitive disadvantages Optimus was the smallest player in a market in terms of: High unit costs Minimum Efficient Scale not achieved Packages (Mobile telephone, fixed telephone, Internet, Pay-per-view TV) Falling behind in terms of new technologies Experience only in local market - Small client base - Relatively low ARPU - Relatively high churn Low prospects Commercial entry efforts were exhausted 2

4 II. Competition concerns Concerns Does the merger create or reinforce a position of market dominance (individual or collective)? Are prices likely to increase after the merger? Merger control is not intended to: Remove competition concerns previous to the merger Unnecessarily restrict private initiative Capital markets also discipline product market Improve business prospects acquiring rivals is inherent to market dynamics 3

5 II. Traditional approach: Structural approach Structure of supply High market share + barriers to entry = Competition concerns Market concentration and prices are assumed to be correlated Relevant markets Wholesale (MNO) Between operators (MNO and MVNO) Network leasing for voice and data services (access and origination of calls) Retail Commercialization of mobile services for end consumers 4

6 II. Traditional approach Structure of supply Traditional HHI Results Calls Revenues Client base TMN % % % Optimus % % % Optimus/TMN % % % Vodafone % % % Total 100 % 100 % 100 % HHI post-operation Delta Source: AdC decision Market shares include pay-as-you-go and contract clients as well as discount services Concentration is based on average shares 5

7 II. Traditional approach Barriers to entry Administrative Authorization (does not appear to be a real burden) Technical Spectrum of technologies necessary Economic Sunk investments (network, brand) Network investment avoidable for MVNO Network effects Cost of clients who switch networks Clients who switch networks (below 0,5% of average market client base) Customer retention 6

8 III. Modern Approach Market tests Market test 1: Whether Optimus entry (1998) placed a competitive constraint on TMN and Vodafone (Pereira & Gagnepain, 2005) investigation Impact of new entry - Production costs decreased by around 27% Market test 2: Price trends at the time of Optimus entry Prices continually dropped after Optimus entry These tests significantly influenced the discussion Was this situation expected to reverse with the merger? 7

9 III. Modern Approach Market tests Evolution of Market Shares by Revenue Source: Gagnepain & Pereira 8

10 III. Modern Approach Market tests Evolution of Average Prices of TMN and Vodafone Source: Gagnepain & Pereira 9

11 III. Modern Approach Market tests However, these tests were not conclusive Optimus initial commercial efforts were exhausted Economic explanation: company reached a critical mass of clients Entered at a time when the penetration rate had increased substantially It was no longer the cheapest supplier Drop in prices seemed to be a market trend rather than a shock Started before the entry Coherent with cost reduction - Reduction of unit costs due to increased market size (penetration) - Technological innovation Similar to those of other EU countries The pre-merger situation depicts a different context than that of 1998 Inconclusive analysis: Unable to apply this scenario in the present pre-merger analysis Measure of Optimus ability to place a competitive constraint on its rivals 10

12 III. Modern Approach Cost analysis Size disadvantage Econometric analysis illustrate that Optimus was in the downward slope of its production cost curve Other evidence that there was an issue of economies of scale: the fourth 3G licence was not used Low yield after entry Optimus figures Prospects negatively influenced by the disadvantage of the network effect Economies of Vodafone Innovation, R&D and experience Brand name, advertising and marketing efforts 11

13 III. Modern Approach Merger Simulation Objective: Predict price changes due to a structural change Methodology: Standard static model of supply and demand (discrete choice) that combines: A model of consumer demand Summarizing substitution patterns among alternative products A model of competitive interactions Main result: Prices are likely to increase by 6% Fundamental Criticisms: Some assumptions in which model was based (IIA assumption) At entry, Optimus gained market share mainly from Vodafone Previous Portuguese mobile market investigation showed higher substitutability with Vodafone The analysis did not incorporate the expected remedies and efficiencies 12

14 III. Modern approach Efficiencies EU Directive: Should be merger specific: Optimus unable to attain the minimum efficiency scale Pass through to consumers: Part of the expected savings are on variable costs Competition not restricted Cost savings passed through to consumers should off-set any anticompetitive effects Results of the Optimus analysis: Company not operating at the optimum scale; in the downward slope of its production cost curve Costs savings both of fixed and variable nature; marginal costs would drop Econometric estimations showed that unit costs would decrease as a result of the merger Estimations showed that Optimus OPEX expenses were higher than those of TMN The most defendable version of the simulation does not reveal significant anti-competitive effects 13

15 IV. Decision Individual dominant position The merger will create an individual dominant position based on : Network effects: on-net / off-net calls Consumer retention initiatives Switching Costs Little concern about coordinated effects Indicators of asymmetries between both operators (fixed and mobile-mobile) Technological progress: Vodafone s leading role Vodafone strongly opposed the operation 14

16 V. Conclusion Decision based on a in depth economic analysis Applied both the modern and traditional approaches Carried out an analysis of market dynamics, based on numerous evidence Followed a rigorous analysis An attempt to balance laissez-faire with consumer welfare Transaction approved after accepting competitive remedies Were these remedies too demanding? 15