Intervention in pricing decisions can reduce competition

Viðskiptaráð has responded to Samkeppniseftirlitið's discussion paper on the fuel market, the development of mark-ups and monitoring of the VAT reduction. This is the second discussion paper issued by the Authority within a short space of time, the first having concerned pricing in the grocery market.

The paper was prompted by a temporary reduction in VAT on petrol from 24% to 11%. Alongside this change, a temporary provision was enacted in the Competition Act requiring sellers to pass the full VAT reduction on to consumers, with Samkeppniseftirlitið tasked with monitoring its implementation.

Viðskiptaráð believes it is important that discussion of price formation in the fuel market is based on robust evidence, and that a clear distinction is drawn between, on the one hand, characteristics of the market, such as concentration, and, on the other, indications that competition is insufficient. The Chamber also believes there is cause for caution regarding proposals to intervene in companies' pricing decisions, which could reduce effective price competition.

An oligopoly does not equate to a lack of competition

In its response to the previous discussion paper, Viðskiptaráð pointed out that the number of companies in a market says little on its own about how effective competition is. What matters most to consumers is how vigorously the companies operating in the market compete with one another.

In such circumstances, economies of scale can be considerable. Spreading the same fixed costs over more units sold can lower the cost per unit and thereby benefit consumers. Increasing the number of companies is therefore not an independent goal of competition policy, and a high degree of market concentration is not, on its own, proof that competition is insufficient. The goal should instead be effective competition that delivers lower prices, better service, greater choice and innovation for consumers.

Speculation about tacit collusion requires a more robust basis

Samkeppniseftirlitið has repeatedly stated that an oligopoly prevails in the fuel market and that so-called "tacit collusion" may thrive under its cover. Tacit collusion is a concept in economics that broadly refers to companies being able, without any agreement or direct contact, to set their prices in a way that results in less competition than would otherwise exist.[1]

It is important to draw a clear distinction between such behaviour and companies' prices moving in similar ways due to shared market conditions. In the fuel market, a large share of companies' costs is determined by the same external factors, such as global fuel prices, the exchange rate of the króna, transport costs, and public taxes and charges. When the same cost changes affect all companies at around the same time, it is natural for their prices to move in a similar way without this reflecting coordinated behaviour.

In Viðskiptaráð's view, sufficiently strong evidence has not been presented to conclude that tacit collusion is taking place in the Icelandic fuel market. Parallel price movements or market concentration cannot, on their own, support such a conclusion.

Given the extensive powers vested in Samkeppniseftirlitið, it is important that the Authority observes the principle of proportionality and does not draw conclusions beyond what the evidence supports. Statements by a public regulator alleging tacit collusion among companies can significantly affect public debate and trust in the market concerned, and must therefore be based on robust and transparent analysis in which other possible explanations have been assessed.

Intervention in pricing decisions can reduce competition

Viðskiptaráð urges caution regarding the measures raised by Samkeppniseftirlitið in the discussion paper to strengthen competition in the fuel market, including rules on the frequency of pricing decisions and maximum mark-ups.

Effective competition among companies in a free market relies, among other things, on companies being able to respond quickly to changing market conditions and to competitors' pricing decisions. A company that offers less favourable terms than its competitors risks losing business to them. This competitive pressure creates an incentive to cut costs, improve service and offer better prices.

Rules limiting how often companies may change their prices can reduce this pressure. If a company cannot respond to a competitor's price cut until a certain period has elapsed, the competitor's incentive to lower prices in order to attract business is diminished. Such an arrangement can therefore, contrary to its stated aim, reduce the speed and effectiveness of price competition.

Similar concerns arise regarding proposals for a maximum mark-up. Companies' mark-ups need, among other things, to cover operating costs and investment, and can vary depending on business model, location, level of service and other factors.

A mark-up ceiling set by the authorities could also become a reference point for companies in the market. Companies that would otherwise have competed with lower mark-ups may thus align their pricing with the official ceiling. A measure intended to lower prices could therefore create a common price benchmark and reduce companies' incentive to compete with one another on price.

It would be more appropriate to reduce barriers to entry

Instead of direct intervention in companies' pricing decisions, Viðskiptaráð believes it would be more sensible for the authorities and Samkeppniseftirlitið to focus on whether barriers to entry and expansion for companies in the market could be reduced.

Fuel retailing depends on access to suitable sites and facilities. The location of filling stations is largely determined by local authorities' planning decisions and government permits. There are examples of applications for new fuel pumps having received special treatment from planning authorities, and Reykjavíkurborg has made policy decisions on the location and reduction in the number of filling stations. Such decisions may be based on legitimate planning, environmental or safety considerations, but they can nonetheless directly affect the ability of new companies to enter the market, or of existing ones to expand their operations.

Fuel retailing is also, by its nature, subject to various requirements concerning facilities, fuel storage, pollution control, safety and operating licences. Such requirements may be fully justified on environmental or public-interest grounds, but this does not change the fact that they increase the fixed and irrecoverable costs a new entrant must bear before sales can begin.

When access to a market requires substantial investment and is also subject to planning, land availability and government permits, it is especially important that the authorities take care not to create unnecessary barriers to the entry of new competitors.

In Viðskiptaráð's view, consideration should therefore be given to whether market access can be simplified, whether neutral and predictable conditions can be ensured for the allocation and planning of land, and whether unnecessary administrative barriers can be removed. Such measures are aimed at strengthening the competitive process itself, rather than steering its outcome through rules on price or mark-ups.

In conclusion

Viðskiptaráð believes it is important that Samkeppniseftirlitið maintains objectivity and impartiality in presenting data and findings on the fuel market. A clear distinction must be drawn between facts, indications and hypotheses, not least when discussing possible coordination among companies.

Market concentration may warrant scrutiny, but it is not, on its own, proof that competition is insufficient. In markets characterised by high fixed costs and economies of scale, concentration can be a natural consequence of the cost structure, and a precondition for economies of scale to be passed on to consumers in the form of lower prices.

Viðskiptaráð also believes that before measures involving direct intervention in price formation are undertaken, there should be a clear analysis of the problem they are intended to solve, robust evidence of its scale, and an assessment of whether the measures themselves could reduce competition. Consideration should also first be given to whether the authorities could strengthen competition by reducing barriers to entry and making it easier for new and existing companies to compete in the market.

This article was automatically translated from the Icelandic original.