[BETA] Fortnightly

Flexible prices make markets hum,

but discounts discriminate when monopolies rule.

Many expect that the electricity industry is moving inexorably toward a much-publicized "new competitive era." Companies, regulatory officials and experts all regard the momentum as powerful.

So far, the changes are just beginning, and there is a long way to go to reach fully effective competition. %n1%n Yet even at this early stage, the merger and pricing strategies adopted by the established electric firms may be threatening the prospects for competition.

Among these strategies, possibly the strongest weapon is strategic price discrimination for favored customers, which has already spread widely in the industry. The discounts are widespread, and often deep. Many also are secret and long-term. These conditions mean the discounts may well arrest or block the movement toward competition before it really gets going.

As a result, the shift toward effective competition may soon become stalled, even while the old monopolies still hold a high degree of market dominance (with a market share more than 50 percent). This dominance could prevent effective competition in many or most local power markets, and it could entrench many or most of the private utilities as near-monopolies. The hoped-for new competitive era may not, in fact, arrive. However, there is a solution (em regulatory action limiting use of such anti-competitive tactics.

Discounts are not always damaging

The incentives to discount are nearly universal. In many market settings, the discounting strongly promotes competition. Unfortunately, in other settings where there is market dominance, discounting by the dominant firm tends to suppress competition.

The issue is discriminatory pricing, particularly as it is done by dominant firms in a dynamic and strategic process. It is a complicated, and often subtle, phenomenon, which can pack a large anti-competitive punch. Price discrimination always has been a widespread and well-known business practice, in all kinds of industries and markets for more than a century in industrial experience, economic writings, and regulatory policies. %n2%n It has long been attacked for being unfair; "charging what the traffic will bear" does make one group pay more than another group.

However, a price discount is not automatically discriminatory. If the costs differ in just the same proportion as the prices, then the discounts to the "favored" buyers actually are "cost justified," (em not discriminatory.

Discrimination arises because demand elasticities differ among customers. The discrimination generally follows an "inverse-elasticity" pattern: Customers with good alternative sources get charged lower prices than do the captive customers.

In the extreme case, discrimination may be so complete and refined as to extract all consumer surplus from individual customers.

Price discrimination is found in nearly all market situations, and often, it is pervasive. The prices reflect the varying price-sensitivity (or demand elasticity) of the differing customers.

Large market share can mean anti-competitive pricing

In general, the extent of price discrimination varies directly with the firm's market share. The higher the market share, the more extensive and deep the discrimination will be. The competitive or anti-competitive impacts usually vary in line with the market share of the firm doing the discriminating.

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