Winners take all

Indian regulators must deal with network externalities

As India’s economy modernises, the tasks facing the country’s regulators become ever more complex. More and more sectors are exhibiting a “winners take all” structure. In “normal” competitive markets, regulators have a straightforward set of objectives and tools. They intervene to make sure there is no cartelisation, that anti-competitive practices are not being used, and so on. Generally, the assumption in this case is that left to itself the market will take care of consumer welfare, and the regulator’s job is merely to ensure that no participant is seeking to distort the functioning of the market.

However, in the modern economy many sectors demonstrate marked network externalities. In other words, companies become more profitable or efficient when they become large. This leads to the creation of natural monopolies. In the past, sectors such as utility or infrastructure would be subject to the build-up of such natural monopolies and thus had to be regulated differently. However, now network externalities are a feature of several leading sectors of the economy, including those dominated by the private sector. Consider, for example, the online space — dominated as it is by Alphabet, the parent company of Google. It is hard to believe a search engine emerging that could compete with Google. Thus, Alphabet does not have to behave in an obviously anti-competitive manner for competition to vanish in the sector.

In India, there are several such sectors which require attention. Telecommunications is one such. The arrival of Reliance Jio, with the deep pockets of Reliance Industries behind it, means that many of the other participants in the sector are eyeing the door. If an incumbent indulges in predatory pricing, regulators understand what they can do. But if it is an entrant that is offering lower prices and a better deal? At what point can and should regulators intervene? Nor is the problem limited to telecom. Consider also the civil aviation sector. An airline that is filling its flights can afford to sell its final seats cheaper since their marginal cost is near-zero. This means that there is a built-in advantage for the airline already doing well. In India, this means that IndiGo, for example, manages to dominate the market.

 

Other sectors may soon see the emergence of network effects. E-retail, for example, can become more effective when the user base it has to draw on is larger. Also, a network of offline retailers, or a logistics network that is already in place, can help give one company an efficiency edge that others will struggle to make up. How can regulators manage a sector in which some companies will genuinely be more efficient because of network externalities? Setting prices and quantities, such as economic theory might recommend for natural monopolies, does not appeal as a solution especially in the Indian context. There needs to be a more robust discussion in India about when it is appropriate for a regulator to intervene to prevent the building up of a monopoly in a winners-take-all sector. Waiting till a monopoly is established may be too late. It may be necessary to intervene early to prevent the exit of other competitors. A longer-term view of consumer welfare is required.