What do consumers do for

competition?
To mark World Consumer Rights Day the Australian consumer movement and
Consumer Affairs Victoria hosted the National Consumer Congress. The congress
brought together consumer advocates, regulators, policy makers, government
officials, industry and academics.

Do they stand for free enterprise (that is,

businesses should be free to do as they please)
or free markets (businesses should not be free
to act in ways that restrain competition)?1
The empirical evidence from eminent scholars such as
Michael Porter and others is that vibrantly competitive
economies are not those that eschew regulation but those
that ensure vigorous domestic rivalry through strict antitrust
law towards mergers and collusive behaviour coupled with
energetic enforcement of those competition laws. While that
empirical evidence has been crucial in framing our thinking
about competition, like most economic work in the area,
the focus has tended to be on the supply side.2
Industrial economiststhe people who really provide the
evidence for competition lawhave almost exclusively
concerned themselves with the behaviour of firms. They
commonly assume in their modeling that consumers will
change their behaviour or allegiances in response to
a price (or equivalent) change. And in many markets,
that is the case. But in other markets, it simply doesnt
happen. In fact, consumer behaviour can often create
significant barriers to entry or other frictions in the way
a market operates.

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ACCC update 15 July 2004

In fact, in almost all discussions of competition policy,

the commentary is about what competition does for
consumers. However we also need to ask what do
consumers do for competition? That question achieves
the proper focus on the effective operation of both
sides of the market.
The complementarity of competition enhancing
consumer protection policy and competition policy is
increasingly recognised. John Vickers FBA, an eminent
economist and the current chairman of the Office of
Fair Trading UK, considered these issues in his British
Academy Keynes Lecture in October last year, 'Economics
for consumer policy':
...market imperfections do not necessarily call for
public policy solutions it cannot be taken for
granted, however, that product market competition
between firms is necessarily competition to
serve customers well. That depends, and one
of the things it depends on is the stance and
effectiveness of consumer policy.4
Despite the lack of systematic work on the demand side
of the competition equation, some very exciting examples
of empirical work on the question of consumers and
competition are beginning to be published.

3 George Akerlof, The Market for Lemons: Quality Uncertainty and the Market Mechanism, Quarterly Journal of Economics, Vol 84, May 1970.

A well accepted principle in market economiessome

describe it as a paradoxis that regulation is often
required to make markets work. Competition law involves
active intervention by a government to achieve free
competitive markets. Ross Gittins at The Sydney Morning
Herald put the concept quite clearly, in a column in
which he challenged the so-called economic rationalists:

Newer on the agenda are the behavioural economics

issues that are crucial in understanding how consumers
behave in markets. These include how consumers frame
risk, how they behave when faced with decision-conflict
(overwhelming choice), endowment issues (we value
much more what we have than what we might acquire),
snap decision-making, seeking legitimacy in markets
(consumers will often drive to a store quite far away
actually spending more on the petrol than the amount
they saveif they think their local supplier is ripping
them off), and many more. While none of this is news,
there has nevertheless been limited focus on the
systemic behaviour of consumers in markets, how
frictions and barriers to entry occur as a result of
consumer behaviour, and what to do about it.

4 John Vickers FBA, British Academy Keynes Lecture 'Economic for consumer policy' October 2003.

First, competition between firms needs to be working

thats the supply side set of issues. And second, consumers
need to be able to exercise their market powerthats the
demand side set of issues. When circumstances exist that
interfere with efficient market functioning on either side,
then that market is less competitive than it should be,
with consequential detriment.

2 See, for example, most textbooks on industrial organisation where solutions to the Bertrand Paradox almost invariably put only firms in the spotlight.

It may seem to be a statement of the totally obvious, but

markets have two sides. For markets to work effectively,
both are important.

There is nothing new about this concept of market

failure. On the demand side, the main failures are
information deficiencies of various sorts (e.g. under
supply, free riders, loyalty and branding, complex
products, one-off products), the lemons problem where
consumers cannot judge the quality of goods or services
on offer,3 and other market problems, many of which
have been well researched.

1 Ross Gittins, Allan Fels: Economic rationalist hero of the decade, Sydney Morning Herald, 15 July, 2003

ACCC Deputy Chair, Louise Sylvan, spoke to the congress

on the complementary relationship between consumer
protection and competition policy and suggested some
key competition questionsquestions that focus on the
essential role of consumers in making markets work.

Paul Klemperer at Oxford and Michael Waterson at the

University of Warwick are two of the most advanced
researchers in this area. Klemperers seminal examination
of consumer switchingwith a competition lens
onidentified no less than six types of switching costs
affecting the market:
the need for compatibility with existing equipment
transaction costs of switching suppliers
(both in terms of actual cost and the hassle factor)
costs of learning to use new brands
uncertainty about the quality of untested brands
discount coupons and similar devices
(e.g. frequent flyer programs)
psychological costs of switching, or brand loyalty.
We can add to this the difficulties that bundled products
and lock-in contracts can cause. And complexity
fatigue should also feature here. The crucial point is
that this research is focusedin terms of an analysis
of competitionfirmly on market issues for consumers.
Klemperer makes the point that switching costs have
significant impact on competition not only in terms of the
market power over existing customers, but that where
products are artificially differentiated by switching costs,
the incentives for firms to differentiate their products in
any real, functional way, are reduced.5
This suggests a catch-22 situation where a lack of
differentiation contributes to further consumer inertia
which further reduces competition. Klemperer also notes
that some switching costs are the result of deliberate
actions by firms and advocates dealing with this through
activities such as standardisation that enhances
comparability and reduces learning costs or switching
costs, and quality regulation and information sources that
reduce consumer uncertainty about untested brands ...6
Watersons work focuses on the importance in practice
of the role of consumers in competition and the
implications for research and for policy. He does this
by making demand side market inquiries, much as
others have been doing for years on the supply side.

Louise Sylvan, ACCC Deputy Chair

Looking at the UK electricity market, Waterson found:

high consumer awareness of the ability
to change supplier
significant savings possible from switching
complex tariff structuresto make a decision
consumers must know their usage pattern and
need to be able either to create a spreadsheet
or carry out similar complex analyses
only 18 per cent of consumers are supplied
by a company other than their former monopoly
supplier.
Waterson discovered that after five years of supplier
competition consumers had not activated competition
in part because of complexities in the evaluation of
the product and the hurdles in the switching process.
No amount of supply side remedy is likely to fix this
situation.
In his study of financial services Waterson compared
the considerable differences UK consumers experience
in trying to shop for a bank account as opposed
to shopping for car insurance. The differences are
striking (Australian figures are not too dissimilar in
a relative sense).
Car insurance
ease of changingsimply telephone and answer
a few questions

6 ibid. p. 536.

5 Paul Klemperer, Competition when Consumers have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade, Review of Economic Studies (1995) 62, p. 516.

consumers do not just benefit from competition,

they activate it.

time cost for consumers 1015 minutes

53 per cent of consumers have switched
ACCC staff at the congress.

ACCC update 15 July 2004

13

the deliberate disempowering of consumers to activate

competition is a misuse of market power.

opening new account can be cumbersome

costs and effort of re-establishing a credit standing
6 per cent of consumers have switched
Once again, it appears that consumers cannot make
the market work in terms of bank accounts, but they
can and do in terms of car insurance in the UK.
Waterson concludes that the difficulties of a new player
trying to capture a significant fraction of the banking
market will not be easily overcome, even if they are
providing different and better performance, without
first implementing a policy designed to render banking
(for domestic and small business customers) more
competitive by addressing both the ease of switching
and the opacity of their charging structures.7
Waterson also compares the profits of companies in
industries where consumers can activate competition
and where they cannot. The personal banking business
in the UK has high/excessive profitability while motor
insurance has low/negative profitability. He argues
that a proximate explanation of this markedly different
performance is the very different consumer behaviour
across the markets .8 It would need a major study
across many markets to know whether the relationship
between profitability and consumer switching held in
general. If it does, then we may have one pointer for
where to focus attention on improving demand side
consumer activity.

Where to from here?

The exciting thing about viewing competition through this
lens of what do consumers do for competition is that it
can be effective in determining whether a competition
problem, or part of a problem, is occurring on the
demand side of a market, whether an intervention might
remedy the problem, and if so, what form that should
take. It enables the common realities of information
asymmetry, transaction costs and other market failures
to properly influence the nature of any regulatory
response and provides an evaluative tool for measuring
whether the response has been effective. No stakeholder
is keen on ineffective regulatory responses.

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ACCC update 15 July 2004

In situations of lock-in the consumer is in effect

individually vulnerable to the exploitation of
market power ex post. The consumer might
be compensated in part for this by getting a
correspondingly good deal as a result of ex ante
competition. But the outcome is still inefficient
and worse if there are undue surprises ... So
one way to see the consumer policies that
address such issues is as policy to combat
micro-competition problems in large numbers.
On this view, much consumer policy is
competition policy.9
As governments have become more sophisticated in
applying supply side competition laws to firms in the
marketlimiting the opportunities for anti-competitive
mergers or increasing the risks of engaging in collusive
and other prohibited conductit may be that firms are
pursuing other strategies for reducing the intensity of the
competitive environment. An aspect of both Klemperer
and Watersons work is their understanding that firms
can and do deliberately inhibit rivalry in various ways,
for example, using artificial differentiation to avoid
real functional differentiation, various stickiness
strategies making switching behaviour difficult or costly
for consumers in time and/or money, and a variety of
tactics creating complications in product or service
comparability. These are matters for active consideration
by policy makers, researchers, regulators and others
concerned with a nations economic outcomes and
with overall consumer welfare.
Many thanks to Catriona Lowe for her research
and extensive contributions to this paper and to
Ian McAuley for his insightful comments.
A complete copy of this speech can be found at
www.accc.gov.au.

9 John Vickers FBA, British Academy Keynes Lecture 'Economic for consumer policy' October 2003.

cancelling direct debits are made difficult with

the onus on the customer to make it work and
follow up

The deliberate disempowering of the ability of consumers

to activate competition between firms is in some ways
analogous to a misuse of market poweronly it is
a firms use of market power directed at individual
consumers. Vickers in his Keynes Lecture also elaborated
on this point which he calls micro-competition policy:

7 Michael Waterson, 'The Role of Consumers in Competition and Competition Policy', Warwick Economic Research Papers, July 2001.

complexity of analysis of costsconsumers need to

know usage pattern, may need complex calculation,
opacity of fees and charges

Reality check

8 ibid.

Bank accounts