When Is Static Analysis A Sufficient Proxy For Dynamic Considerations? Reconsidering Antitrust and Innovation

When is Static Analysis a Sufficient Proxy for
Dynamic Considerations?
Reconsidering Antitrust and Innovation
Joshua Gans
Melbourne Business School
NBER Innovation Policy and the Economy

Washington DC
20th April 2010
Wednesday, 21 April 2010

Static Analysis

Static Analysis
Incumbent
Incumbent
Incumbent

Static Analysis
Incumbent
Incumbent
Incumbent

Static Analysis
Incumbent
Entrant
Incumbent
Entrant
Incumbent

Static Analysis
Incumbent
Entrant
Incumbent
Entrant
Incumbent

Static Analysis
Incumbent
Incumbent Entrant
Incumbent Entrant

Static Analysis
Incumbent
Incumbent Competition in Entrant

the Market
Incumbent Entrant

Static Analysis
Competition in
the Market

Static Analysis
• Lower prices
Competition in
the Market

Static Analysis
• Lower prices
Competition in
• Lower incumbent profits
the Market

Static Analysis
• Lower prices
Competition in
• Lower incumbent profits
the Market
• Higher entrant profits

Need to consider dynamic effects

• Permissive View

• Permissive View
• Restrictions risk damaging prize from innovation; namely, prospective

monopoly rents (Evans & Schmalensee, Gilbert, Manne & Wright)

• Permissive View

• Strict View

• Permissive View

• Strict View
• Allowing practices risks damaging competition for innovative prizes (DOJ,

Brennan)

• Permissive View

• Strict View
• Allowing practices risks damaging competition for innovative prizes (DOJ,

Brennan)
Both views argue that competition for the

market is important

This talk
• Based on formal model of Segal & Whinston (2007)
• How to evaluate dynamic impact of restricting practices
• What happens when entrants commercialize innovations

by cooperating with incumbents?

What Static Analysis misses

Higher Entrant
Profit

Higher Entrant
Profit

Higher Entrant Reduced Incumbent

Profit Rents


Profit Rents
Incentive to
Innovate


Profit Rents
Incentive to
=
Innovate


Profit Rents
Immediate Profits
Incentive to
= Under
Innovate
Competition


Profit Rents
Immediate Profits
Incentive to
= Under +
Innovate
Competition


Profit Rents
Immediate Profits Future

Incentive to
= Under + Incumbency
Innovate
Competition Rents


Profit Rents

Incentive to
Innovate
Competition Rents
Antitrust Policy


Profit Rents

Incentive to
Innovate
Competition Rents
Antitrust Policy


Profit Rents

Incentive to
Innovate
Competition Rents
Antitrust Policy

Dynamic Considerations

Future
Incumbency =
Rents

Future
Profits while
Incumbency =
Innovation Leader
Rents

Future
Profits while Profits when
Incumbency = +
Innovation Leader Displaced
Rents

Future
Incumbency = +
Rents
How long will leadership last?

Future
Incumbency = +
Rents
How long will leadership last?

What profits will the incumbent earn in
the face of innovative entry?

Impact on Rate of Innovation
Profits while
Innovation Leader
Profits when
Displaced

Immediate Profits
Under
Competition
Profits while
Innovation Leader
Profits when
Displaced

Antitrust Policy
Immediate Profits
Under
Competition
Profits while
Innovation Leader
Profits when
Displaced

Antitrust Policy
Immediate Profits
Under
Competition
Profits while
Innovation Leader
Profits when
Displaced

Antitrust Policy
Immediate Profits
Under
Competition
Profits while
Innovation Leader
Profits when
Displaced

Antitrust Policy
Immediate Profits
Under
Competition
Profits while Falling in Rate of

Innovation Leader Innovation
Profits when
Displaced

Antitrust Policy
Immediate Profits
Under Prize
Competition
Profits while
Innovation Leader
Profits when
Displaced
Innovation Rate
Antitrust Policy
Immediate Profits
Under Prize
Competition
Profits while
Innovation Leader
Profits when
Displaced
Innovation Rate
Antitrust Policy
Immediate Profits
Under Prize
Competition
Profits while
Innovation Leader
Profits when
Displaced
Innovation Rate
Antitrust Policy
Immediate Profits
Under Prize Supply
Competition
Profits while
Innovation Leader
Profits when
Displaced
Innovation Rate
Antitrust Policy
Immediate Profits
Under Prize Supply
Competition
Profits while
Innovation Leader
Profits when
Displaced
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition
Profits when
Displaced
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition High
Profits when
Displaced
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition High
Profits when
Displaced
Low
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition High
Expected
Incumbent
Profits Low
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition Low
Expected
Incumbent
Profits High
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition Low
Expected
Incumbent
Profits High
Innovation Rate
Antitrust Policy
Prize
Immediate Profits
Under
Competition
Expected
Incumbent
Profits
Innovation Rate
Evaluating practices
Immediate Profits Expected

Under Incumbent
Competition Profits


Under Incumbent
Competition Profits
Restrict
exclusive
contracts


Under Incumbent
Competition Profits
Restrict
exclusive Increase
contracts


Under Incumbent
Competition Profits
Restrict
exclusive Increase Neutral
contracts


Under Incumbent
Competition Profits
Prohibit
tying


Under Incumbent
Competition Profits
Prohibit
Increase
tying


Under Incumbent
Competition Profits
Prohibit
Increase Decrease
tying

Summary
• Baseline static considerations also determine impact of

antitrust policy on innovation.
• Intuition: the impact of reducing entry barriers is often

equivalent to the impact of encouraging entrant
innovation.
• Entrant innovation often encourages incumbent

innovation.

Competitive commercialization

Innovative
Entry

Innovative
Entry

Innovative Compete with

Entry Incumbent

Cooperative commercialization
Innovative
Entry
Compete with
Incumbent

Innovative
Bargaining
Entry
Compete with
Incumbent

Innovative
Bargaining
Entry
Compete with
Incumbent

Innovative
Bargaining
Entry
Compete with
Incumbent

Licensing or
acquisition
Innovative
Bargaining
Entry
Compete with
Incumbent

Why cooperate?

Why cooperate?
• Savings from not duplicating complementary assets

(Teece 1987)

Why cooperate?

(Teece 1987)
• Prevent rent dissipation (Gans and Stern 2000)

Why cooperate?

(Teece 1987)
• Prevent rent dissipation (Gans and Stern 2000)
• However, the value of competitive outside options will

impact on returns

Gains from trade

Gains from trade
Cooperate

Gains from trade
Cooperate
Per period monopoly profit

Gains from trade
Cooperate
+ Market leader's future

profit

Gains from trade
Cooperate

profit
+ Entrant's future profit

Gains from trade
Cooperate

profit

Gains from trade
Cooperate Compete

profit

Gains from trade
Cooperate Compete
Per period monopoly profit Immediate competitive

profits
profit

Gains from trade
Cooperate Compete

profits
profit + Market leader's future
profits

Gains from trade
Cooperate Compete

profits
profit + Market leader's future
profits
+ Incumbent's future profit
as a follower

Gains from trade
Cooperate if ...
Immediate gain in monopoly rents
> Incumbent's future profit as a follower
- Entrant's future profit

Innovation prize
Half of the gains from trade
Incumbency Advantage

Antitrust Policy
Immediate Profits
Under Prize Supply
Competition
Ongoing Monopoly
Profits
Less Profits
if Displaced
Innovation Rate
Immediate Profits
Less Profits Ongoing Monopoly
Under
if Displaced Profits
Competition

Impact under cooperation
Immediate Profits
Under
Competition

Immediate Profits
Under
Competition
Impact under competition

Immediate Profits
Under
Competition
Immediate Profits
Under
Competition

Immediate Profits
Under
Competition
Immediate Profits
Profits when
Under
Displaced
Competition

Immediate Profits
Under
Competition
Immediate Profits
Profits when Profits while
Under
Displaced Innovation Leader
Competition

Restricting practices increases

innovation if ....


innovation if ....
Shift in rents from

incumbent to
entrant under
competition


innovation if ....
Shift in rents from

incumbent to
>
entrant under
competition


innovation if ....
Shift in rents from

Any reduction
incumbent to
> in monopoly
entrant under
profits
competition


innovation if ....
Shift in rents from

Any reduction
incumbent to
> in monopoly
entrant under
profits
competition
... but need to be careful not to deter

cooperative commercialization

Allowing cooperation
• Has potential to reduce competition in the market
• What about when competition is for the market?
• Parties have interest in slowing innovation rate
• Incumbent producers innovate more slowly
• Licensing may leave a vigorous innovative entrant so parties may prefer

not to cooperate
• Licensing may reinforce incumbent's ability to live a quiet life

Conclusions

Conclusions
• Competition for the market leads to antitrust policy designed

to improve entrant profitability upon entry

Conclusions

• Highlights ongoing but not novel concern regarding antitrust

policy errors

Conclusions


policy errors
• Under cooperation, policies that shift rents from the

incumbent to the entrant should they compete are desirable

Conclusions


policy errors
• Under cooperation, policies that shift rents from the

incumbent to the entrant should they compete are desirable
• Dynamic considerations reinforce static presumptions

towards preserving competition even if the analysis is a little
more nuanced

When Is Static Analysis A Sufficient Proxy For Dynamic Considerations? Reconsidering Antitrust and Innovation

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When is Static Analysis a Sufficient Proxy for

NBER Innovation Policy and the Economy

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Incumbent Competition in Entrant

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

• Restrictions risk damaging prize from innovation; namely, prospective

Wednesday, 21 April 2010

• Restrictions risk damaging prize from innovation; namely, prospective

Wednesday, 21 April 2010

• Restrictions risk damaging prize from innovation; namely, prospective

• Allowing practices risks damaging competition for innovative prizes (DOJ,

Wednesday, 21 April 2010

• Restrictions risk damaging prize from innovation; namely, prospective

• Allowing practices risks damaging competition for innovative prizes (DOJ,

Both views argue that competition for the

Wednesday, 21 April 2010

• Based on formal model of Segal & Whinston (2007)

• How to evaluate dynamic impact of restricting practices

• What happens when entrants commercialize innovations

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Immediate Profits Future

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Immediate Profits Future

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Immediate Profits Future

Wednesday, 21 April 2010

Higher Entrant Reduced Incumbent

Immediate Profits Future

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

Wednesday, 21 April 2010

How long will leadership last?

Wednesday, 21 April 2010