Competition controls prices and increases investments

Price-regulated industries have seen higher price rises than industries which are not, which seems counter-intuitive. This is so because regulation assures entities in such industries of a certain return on capital and of market share.


iStockPhoto
iStockPhoto

Patanjali and the shale oil phenomena have a lot in common. Both are disrupting their respective industries: as existing players raised prices more than necessary, opening the gates for competition to come charging in.

Price-regulated industries have seen higher price rises than industries which are not, which seems counter-intuitive. This is so because regulation assures entities in such industries of a certain return on capital and of market share. They do not need to worry about competition, which even if it comes, will have similar costs. In fact, a cost-plus-pricing in such industries creates a perverse incentive to bloat costs higher.

In the case of competitive industries, where there are no price regulations, every company is worried about losing market share. To retain or grow market share, prices have to be as low as possible. There are a few exceptions to this rule, such as luxury goods. Otherwise, the way to maximise revenue is to: keep prices low, increase the convenience of buying and keep competition at bay.

These organisations apply the micro-economic principle of ‘economies of scale’. It makes economic sense to defray the fixed costs of a business, over a larger volume and reduce the cost per unit. Newspapers are a classic example: pricing the newspaper below the cost of printing to improve the circulation, which in turn attracts advertisers who are the major source of revenue.

Technology is changing all that. Today one can consume media on the internet or use personalised navigation in the car, all for free. By making these services free, the companies provide a large audience for advertisers, who bring in the revenue.

When Amazon.com introduced 1-Click, it was a big hit and helped to attract customers because it made buying convenient. While other players are still playing catch-up, Domino’s Pizza Inc. has introduced Zero-Click ordering and Amazon introduced voice ordering (Echo). Relentless downward pricing combined with innovation ensures growth in volumes. This improves economies of scale and makes the company invest more to pursue such growth, so the virtuous cycle continues.

The power of micro-economics is quite under-rated. Most discussions are around macro-economics. Employing macro-economic tools to solve economic problems is like using an axe to clip a toenail.

In India, most industries have a regulator or a dedicated ministry. India also has the Competition Commission of India (CCI). While regulators are there to ensure that customer interests are protected, CCI ensures that no single company becomes too dominant. The regulator should ensure new players can enter easily so that customer needs are met at affordable prices. CCI should make the underlying rationale of its policies clear especially when deciding between ‘helping customer interest when a company is trying to achieve economies of scale’ and ‘protecting customer interest when a company is trying to become a monopoly’. If a company is unable to scale up, the customer would have to bear higher prices. This area of policymaking is quite tricky and just as macro-economic policies are discussed widely, so should these be.

Let’s look at two issues in this context.

One concerns regulators or ministries. Many times restrictions on corporate foreign ownership can keep competition low. Foreign investment is a source of cheap capital and has generated a lot of employment in India and provided enormous choice to customers. Yet one finds there is a lot of hesitation in opening sectors up to foreign direct investment (FDI). One cannot help but wonder why the opponents of FDI want to protect the existing owners of inefficient companies.

The second point concerns CCI. India runs a huge trade deficit with China. This is surprising because labour costs in China are higher than India and the Chinese currency has appreciated 73% against the rupee in the last 10 years. Are Indian companies not of a scale to be globally competitive? What should CCI’s objectives be when evaluating mergers and acquisitions?

Jack Ma uses a beautiful phrase in describing Alibaba. He says the company is building an ‘infrastructure of commerce’. This, in essence, is what India is also trying to do. Indian policymakers are at present focused on building physical infrastructure and improving the public-private interface by reducing the hurdles to do business. They should also look to remove micro-economic rigidities in rules and regulations that hinder competition.

Competition is a customer’s best friend. When oil prices were very high, shale oil producers found an opportunity to enter the market, which eventually caused oil prices to drop. When one looks at some of the top-listed consumer companies in India, a sharp rise in gross margins is visible in the past few years. This means they were raising prices faster than inflation and probably faster than what their price-sensitive consumers could afford, giving Patanjali a great opportunity to enter the market, much to the delight of customers.

Price control is not the answer to containing price rise. Competition is.

Huzaifa Husain, head equities, PineBridge Investments India

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