Contestable market and customer experience
December 7, 20201.2K views0 comments
By Ekelem Airhihen
When an organisation takes advantage of a monopoly position to charge whatever price it feels like, it has a new problem that it would have inadvertently created. It is the problem of a contestable market. Contestable markets are characterized by “hit and run” competition; if a firm/organisation/company in a contestable market raises its prices so as to begin to earn super normal profits, potential rivals will enter the market, hoping to exploit the high price for easy profit. When the original incumbent firm(s) responds by returning prices to levels consistent with normal profits, the new firms will exit. So, even a single-firm market can show highly competitive behaviour as a result of the contestability of the market.
The conditions for a contestable market are: no entry or exit barriers, so there is freedom of entry and exit. No or low sunk costs, which are costs that cannot be recovered when leaving the market for example advertising costs and access to the same level of technology by both the incumbent and the entrant. The existence of good information and a large pool of potential entrants also make the environment conducive to a contestable market. And as stated it is the fact that incumbent firms are subject to “hit and run” competition that calls up contestability of the market. In a contestable market, it is not the number of firms that is important, but the ease by which new firms can enter the market.
Low-cost airlines remain a commonly referenced example of a contestable market; entrants have the possibility of leasing aircraft and should be able to respond to high profits by quickly entering and exiting. Airlines with idle capacity can find profitable routes and then make some profit from it.
As a secondary school student in Port Harcourt, Nigeria in the 80s, sometimes, one had to take through the waters to school. Going through a canoe paddled by hand, one would cross from Mguosimini in Rumuolumeni to Agip (Mile 4) in Port Harcourt.
There could be many canoes tied down waiting to be put into service. These short service shuttle boats could provide competition on short routes. Young boys would make quick profits by paddling fast and then return to pick more passengers. Any monopolist on such a route would have to contend with these boys wanting to make quick profits from the surge in demand for boat service. However, this may not be the case on long distance trips like the Port Harcourt to Nembe journey that would require a machine powered boat rather than paddling with hand. The Badore to Ijede route in Lagos, also, may not lend itself to such service for the office worker or business traveller for whom speed and safety matter and for which there are other alternatives to a slow canoe ride unless it is for leisure.
The motor vehicle drivers are not immune to this also. Unions usually fix transport fares along various routes. The price changes and so does the commission received based on the number of persons awaiting bus service. Going some distance from the park, smart drivers pick up passengers at rates lower than that fixed by the transport union. Other road users also cash in on this large pool of passengers to also make quick money at fares lower than would have been paid in the motor park.
Incumbent firms are faced with various responses such as lowering profits to limit the threat of entry. So fares cannot just be fixed by incumbent firms or transport unions arbitrarily. Even when unions parade the roads to prevent “hit and run” entrants, their efforts have not been very successful in that regard. Lower prices and higher quality of service also help prepare the incumbent for competition.
These behaviours by incumbents to limit threat of entrants present benefits to the customers and improve the customer experience. So, with lower prices as would have been if there were a competitive market, higher quality of service to customers and greater choice for the customer, the customer experience is enhanced.
Looking at the bigger picture, there is need to ensure that lower profit margins and innovative ideas would bring progress to the transport industry and improve the customer experience. Wages, health and safety, vehicle safety and environmental standards should not be compromised. Existing firms should not be destroyed by new firms or regulation/agreements, such that there are job losses. Innovations in the industry if it displaces existing firms should be such that overall the market is greater and new firms are larger in size. So, while firms have been made to close down business and jobs lost, workers can move to the new firms in the industry.
Innovations in road transport such as Uber and taxify and the Bus Rapid Transport leverage on technology. Technology can improve on the ability to acquire consumer data and then engage in price discrimination. Trying to protect the existing firms by brute force attacks on competitors, as we see on the roads, price discrimination leveraging on technology and use of other non-ethical means is anti- contestability. This is where regulation will play a pivotal role in ensuring that customers and the industry gain from contestability of the market as well as protect health and safety standards, environmental standards and hold back anti-competitive forces.
Ekelem Airhihen is a Chartered Accountant and Airport Customer Experience Specialist. He can be reached on firstname.lastname@example.org