Innovation matters in antitrust enforcement and the different ways in which it is defined, measured and, in general, understood, might bring different and sometimes opposing outcomes. The relationship between competition and innovation is complex, thus, understanding what innovation is, could be a fundamental first step to shape this relationship. This has been increasingly relevant as competition authorities have intensified their interest to account for the effects of transactions and conduct on variables that go beyond prices, such as innovation. This article discusses some aspects of the discussion on how to define innovation for competition enforcement purposes and the challenges that arise when measuring it. The article presents a brief overview of the way some competition authorities have incorporated it in their analysis. While focused on mergers, the discussion also generally applies to potentially anti-competitive conduct.
By Aura Garcia Pabon
Defining innovation is not as straightforward as one would think and depending on its definition, implications on different areas might differ. From defining businesses strategies to designing economic policy or enforcing competition law, different understandings of what innovation is and what it involves might generate diverse and even opposing outcomes. While this article does not aim at defining innovation for all purposes, it aims at approximating it in a way that captures different considerations and approaches to its relationship with competition in the framework of antitrust enforcement.
Why is innovation important in the context of competition enforcement? While not new, there is a recent intensified interest from competition authorities to account for the effects of transactions and market players’ behaviors on variables that go beyond prices and quantities, and innovation is one of those.
For example, guidelines on substantive assessment of mergers and acquisitions, which competition authorities constantly update to account for changes and developments in markets and analytical frameworks, are increasingly consider how innovation relates to competition and should be part of the assessment of a transaction.
As an illustration, both European Commission guidelines on the assessment of horizontal and non-horizontal mergers have considerations on innovation, stating that innovation is one of the criteria against which the Commission assesses the likely effects of a merger. Other jurisdictions such as France and the United Kingdom in Europe, Brazil and Chile in Latin America, Canada and the United States (in process of update but also holds for the draft published for public consultation) in North America, Kenya in Africa, Japan, the Philippines, Australia and New Zealand in Asia – Pacific are only some examples of competition authorities that have merger guidelines that explicitly include innovation as a variable to be taken into account in merger control.
Although the level of detail and scope for explicitly consider innovation in guidelines vary among jurisdictions, they all consider the potential impact of a merger or an acquisition on innovation. The difference in scope and detail could reflect differences in legal frameworks, but also on how competition authorities define innovation, the types of innovation they are interested in capturing in their analyses and how they perceive the relationship between competition and innovation.
There seems to be a consensus that innovation is more than just invention or generation of ideas. Innovation could be understood as “the development and realization, and frequently also the spread, of new creative ideas that challenge conventional wisdom and disrupt established practices.“ Furthermore, if we look closer as how definition has been considered for economic policy, we find that the OECD has defined innovation as “the successful development and application of new knowledge.” Both definitions mean that innovation involves other processes such as research and development of such inventions and bringing those new ideas into application, which involve their use, application and even commercialization. Besides, it implies that innovation takes place in different forms and contexts. This is, that there exist innovations in processes, organizational forms, tools, technologies, commodities, products and services, politics and even in social life.
Nonetheless innovating to improve a specific characteristic of a product that is already in the market cannot be seen as equal to launching a new product that disruptively changes the competitive dynamics of it, or even so, creates a new market. Changing size, color or other physical characteristics of a mobile phone have a completely different impact than when the first touchscreen mobiles entered the market.
Patented innovations that never reach a commercialization stage or others that end up significantly alter organizations and politics but not necessarily result in tangible products or services, for example, also have different implications than those who are marketed. This is relevant given that a significant share of patents granted are never commercialized. As an illustration, using advanced natural language processing and machine learning methods, a recent study estimated that the probability of commercialization of U.S. granted patents between 1981 and 2015 was, on average, 59 percent.
The public sector is one example of an area where innovation does not necessarily result in tangible products or services. Recent forms of accountability for government actions have been developed in the last years. They include algorithmic tools and modern technologies that lead to better outcomes such as higher transparency, engagement of citizens and empowerment of communities and, thus, can be considered as innovative in that context without necessarily translate it to innovation in product industries.
As the previous examples show, there are differences between innovations that, in turn, could impact differently competition dynamics in the markets. Understanding which innovations do relate to competition and which ones require analysis from a competition perspective is also relevant for competition law enforcers. The next section will deal with different types of innovation, as understanding the magnitude, intensity and impact of innovation is also a key step when introducing innovation considerations in competition assessment. The article will then highlight some of the challenges with measuring innovation and finally, the last section will present some considerations on the implications that defining and measuring innovation may have on competition enforcement, focused on merger review.
II. TYPES OF INNOVATION
The multiple ways to define innovation and their scope lead to the need of identifying different types of innovations, which depend on their magnitude, intensity or impact they have in the economy and the competitive dynamics of markets.
The classification of innovations is relevant in the sense that it allows competition authorities to better understand the relevance of innovation in certain markets or industries, as well as it could help shedding some light on market definition itself.
One first classification relies on the form of the innovation. Innovation could refer to a process, meaning that it involves a change or an improvement in the production or distribution technologies of a product or a service, which would in turn reduce costs for the innovator or the user of such innovation or somehow bring improvements in its productivity, or it could refer to a product, meaning the introduction of a new product or further development of existing products or services, changing, for instance, their physical characteristics.
The moving assembly line model introduced by Ford, for instance, changed the way automobiles were made, impacting the use of time and resources, but did not imply a change in their design. In turn, the introduction of automated driving vehicles does impact on the final product sold in the market.
This goes in line with a second classification of innovation that refers to the magnitude of the innovation. In product innovations, if the new ideas rely on the same core concept and correspond to constant improvements, upgrades or updates of its components that add value to the product, the innovation is considered incremental. If the ideas drastically alter the markets because they introduce a distinct set of attributes than those already valued by consumers, they are considered breakthrough. In the previous example, automated driving is considered breakthrough, as it minimizes the need for human drivers and has the potential to transform everyday transportation, but other changes in the design of such vehicles such as speed, are then considered incremental.
Similarly, a third classification, often overlapping the previous one, corresponds to the intensity of the innovation. The difference with the previous categorization is that this grouping classifies innovations according to the frequency they happen and the way they impact the value network around it. This is, there are sustaining innovations that happen constantly, meaning that they maintain a rate of improvement in the attributes of the products, adding value to them frequently. Sustaining innovations are often equivalent to incremental ones. On the other side, there are innovations that are not regular or predictable improvements to the products and, therefore, alter the value network around them. Those innovations are considered disruptive. Disruptive innovations generate radical changes to the markets, occur irregularly and have a bigger impact on a value chain and the surrounding processes.
Breakthrough innovations are not necessarily disruptive if they do not impact the value network around them, for instance because they do not occur irregularly but are part of sustaining innovations that happen constantly in the market. They happen in markets that rely significantly on innovation, where changes to products and introduction of new ones are expected frequently. They introduce distinct features and attributes that generate value to consumers, such as the example above on automated driving, but do not necessarily alter the market structure or the network around it.
Disruptive innovations normally reduce or significantly alter market shares of incumbent firms in existing markets or create new markets and business models. Understanding the capability of disruptive innovations to create new markets could also imply the need to use novel approaches to define relevant markets in enforcement proceedings.
The previous distinctions are not mutually exclusive and somehow overlap. An innovation can also be categorized differently depending on the point in time where it is evaluated and the effects that has generated in the markets at said moment. Regardless of such limitations, it is relevant to acknowledge the distinct types, magnitudes, and intensities of innovations to better measure them and account for them in a competitive assessment.
III. MEASURING INNOVATION
Once we somehow understand what we are talking about when defining and categorizing innovation, measuring it also brings its own challenges.
The OECD has recognized that appropriately measuring innovation can help policymakers better understand the impact of innovation and its contribution to economic goals. Competition policy is not the exception. An adequate measure to capture, for instance, substitutability between R&D activities, to assess capabilities of agents to innovate and compete for innovation, to find the innovators that could restrict the market power of another innovator, is key in the assessment of a potentially anti-competitive behavior or a merger review. Whenever competition authorities find the need to define markets based on innovation specifically, relying on pertinent measures to account for the relevant innovation efforts has proven to be key.
Two of the most used variables to measure innovation are R&D expenditure and patent activity. While R&D expenditures are a measure via inputs, patent activity is a measure of outputs. This means that considering R&D expenditures accounts for all the efforts the companies are doing to innovate but does not necessarily reflect their success in doing so. This could be particularly relevant in industries where generating innovation takes time and is costly and where it is common that research projects do not lead to the results expected. Think about developing vaccines or medicines. The percentage of successful R&D projects is lower than in other industries, although the R&D expenditures are one of the highest. This happens because pharmaceutical laboratories take multiple R&D projects with expectations that they will result in a product, but this very often is not the case. On the opposite side, there is the measurement of patent activity. Patenting is the reflection of a final innovation. While it measures success, it does not measure all the effort behind it. Following an example from the same industry, consider two companies patenting one vaccine each. If measured by patent activity, they could be seen as innovative as the other one. However, this will not capture the fact that one of them took decades to develop its vaccine while the other only took two years and much less resources to do so.
Even though R&D expenditures and patent activity approach innovation differently, there is something both measurements have in common. None of them captures accurately the contestability of markets where innovations take place, measure the appropriability of returns from such innovations or capture their diffusion across industries. Besides, different allocations of expenditures in R&D projects might affect the first measure, while lack of differentiation between magnitude and intensity of innovations captured through patents might affect the second one. Other exogenous variables, non-observable considerations and business strategies of innovators can also impact both measurements.
IV. IMPLICATIONS FOR COMPETITION ENFORCEMENT
A recent hearing held at the OECD Competition Committee discussed the relationship between competition and innovation from a theoretical perspective. One of the findings, unsurprisingly, was that although the theory could give authorities some insights, there is no one-size-fits-all theoretical explanation of the relationship between the two variables as innovation processes work differently in different industries with different technologies, skills, capabilities, and resources. In turn, this implies that if competition authorities want to consider innovation in their enforcement proceedings or merger reviews, they must do so on a case-by-case basis. Where there seemed to be a consensus was on the need for competition authorities to understand the role that their enforcement activities can play to ensure that innovation processes can occur in well-functioning markets as well as the risk that a competition policy not properly enforced could end up discouraging innovation.
In practice, competition authorities have taken different approaches to introduce innovation in their competitive assessments. These approaches differ, for example, in how innovation is defined and measured. Some authorities have focused their analysis on the impact of competition in innovation, others have concentrated their efforts on understanding the effect that innovation has on competition and others have considered both, either independently or as part of the same assessment. Moreover, they have analyzed innovation on existing product markets, on future product markets, as well as on innovation markets.
In past cases, innovation has played a role in various stages of the proceedings. It has been a relevant factor by competition authorities when defining markets and analyzing their structure, when assessing the effects of a transaction or a conduct and determining its legality, as a countervailing factor to market power, a justification of a certain behavior or even as an efficiency gain. No less important, innovation has played a prominent role in the design of remedies and of commitments.
When introducing innovation in their analysis, competition authorities face different decisions related to deciding how and to what extend they should consider it. For instance, for defining markets where innovation is one of the most important competing factors, competition authorities need to measure somehow the different innovative activities companies are engaged in and what are the substitutability dynamics among them. In other words, bearing in mind the uncertainty that innovation processes bring, competition authorities must find ways to understand if possible outcomes could compete in the future.
For this, competition authorities must decide which types of innovations to review and define the best strategy to analyze the dynamics of competition between innovators, an exercise that becomes more difficult in cases where the result of the innovation is not clear or cannot be directly associated to an existing market or a specific product or service. On defining innovation, aspects such as how advanced an R&D project should be to be considered as feasible or as probable to enter a market, have been considered by competition authorities.
To overcome some of the drawbacks of measuring innovation that were described above, sometimes, competition authorities use different approximations to measure innovation. These approximations are usually presented together, for example, analyzing simultaneously the R&D expenditures of a company and its patent activity to completely understand the relevance of the market players as innovators (or as potential ones). These measures are often complemented with other information on historical behavior of the companies, business plans and strategies, and in general internal documentation or third parties’ opinion on existing and potential competitive pressure that relies on innovation.
In the complaint filed by the United States Federal Trade Commission (“FTC”) seeking to block Meta’s acquisition of Within in 2022, the FTC alleged that it was reasonably probable that Meta would have entered the VR Dedicated Fitness App market through alternative means absent the transaction. To justify its claim, the FTC used information on value of investments of Meta on R&D in the specific field, particularly in its Reality Labs division, and complemented it with the company’s business plans, information on its financial resources, historic innovations related to the relevant market and past behavior of the company. For the FTC, Meta’s Reality Labs had plans, as well as relevant R&D projects that could generate innovations allowing the company to enter the market by itself. The reasoning behind that is that the efforts made by the labs could be considered, even if in the future, as innovations that were close substitutes to the products sold by Within.
In one of its most recent merger prohibitions, the European Commission blocked a transaction between two South Korean shipbuilders, based, among other arguments, on the fact that the transaction would contribute to the creation of a dominant position as the merging parties were relevant innovators in a market mainly driven by innovation. To reach such conclusion, the Commission analyzed all the recent patents by the merging parties, examined qualitatively their technologies, the type of innovations and how those innovations acted as barriers to enter the market.
Competition authorities can also take different paths when analyzing the effects of a conduct or a transaction. There are theories of harm built around changes in innovation because of reduced competition depending on how agencies understand the relationship between the two variables.
In merger review, authorities have analyzed how increased concentration can affect incentives and ability to innovate, both for the merging parties and for their competitors. When taking a more dynamic perspective, authorities have also been interested in reviewing how transactions that have the potential to reduce, restrict or delay R&D activities can impact future competition. While neither common nor often accepted by competition authorities, innovation has also been part of efficiency claims by merging parties, who have argued that merging complementary assets will lead them to process and product innovations, which in turn will have a positive effect on consumers, reflected in a decrease in prices and/or increases in quality and variety.
In the framework of the assessment done by the UK CMA of the acquisition of Giphy by Facebook in 2022, the parties claimed that the user experience would be enhanced with the transaction. They argued that the merger would allow Facebook to offer more innovative products following significant investments in additional Giphy services and further integrating it into Facebook’s ones. However, the CMA rejected the argument as there was no evidence that such efficiencies would raise as a direct result of the transaction.
Authorities have also reviewed potentially anti-competitive conduct in light of changes in innovation. Some co-operation agreements which are normally prohibited in competition law, could be seen as legal if the efficiencies they bring are higher than their potential distortion on competition. R&D agreements are part of this group.
Innovation can also play a prominent role in abuse of dominance investigations. When considering the impact on innovation of an abusive conduct, competition authorities are interested in determining whether the conduct that potentially had the effect of excluding a rival would end up benefiting consumers since it protected innovation of the dominant firm in the first place, or whether it would harm them as it retarded or deterred innovation from the excluded rival. This is, changes in innovation can be seen as part of the negative effect of the abusive conduct or as part of the positive effects, justifying it.
The most recent abuse of dominance investigations against Google are a great example of this. In the Android operating system case, the Commission’s concerns relied on Google stifling choice and innovation in a range of mobile apps and services, including mobile browsing, by requiring manufacturers to pre-install the Google Search app and browser app (Chrome) as a condition for licensing the Play Store. Similar arguments were used by the Commission to analyze the effects of Google’s conduct on innovation, mainly of reducing or eliminating incentives of competitors to innovate, in the Shopping Service case in 2017, and in the AdSense case in 2019.
Finally, the way competition authorities define and consider innovation also impacts the way they design, examine, and impose remedies or analyze and accept commitments. If competition authorities are looking to preserve incentives of companies to innovate, remedies will relate more to adjusting the behavior of the companies and preserving the levels of competition in the market. If competition authorities perceive more a need to maintain capabilities of companies to innovate, remedies should tend to be more structural and include transmission of know-how, as well as all the necessary specialized assets so that the buyer could become be an effective innovator.
To illustrate this, let us review the remedies in the Alstom/General Electric transaction, conditionally approved by the European Commission in 2015. The concerns the Commission had relied purely on existing technologies already active in the market. The Commission argued that post transaction, General Electric would reduce or discontinue the production of innovative products developed by Alstom in the market for heavy-duty gas turbines. For that reason, the remedies involved selling key assets of Alstom’s business to a competitor to guarantee the existence of a third player. This included all the necessary elements to act as a relevant innovator in the same market and keep the number of effective competitors unchanged.
In other scenarios, selling or licensing of actual intellectual property rights, or intangible assets, including the expertise can play a vital role, when innovation considerations have to do with future products and even future markets.
The concept of innovation is fundamental for competition enforcement. As innovation is increasingly considered to be interrelated with competition in many ways, understanding what innovation is, how to measure it and what could be its impact on competition, are part of the priorities of competition authorities to make sure their decisions are sound and relevant.
From defining relevant markets in a merger review context to justify or understand the effects of anti-competitive conduct, innovation takes part in the assessments that competition authorities do when deciding on a transaction or investigating a conduct. The way competition authorities understand innovation would have an impact on how they consider it in their activities and how important it is in their decisions. Depending on the approach competition authorities chose to incorporate innovation considerations in their enforcement, aspects such as how the markets are defined, which theory of harm to explore, and how to design remedies or commitments might differ.
 Competition expert at the OECD.
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