This presentation by Helen JENKINS, Managing Partner of OXERA was made during the discussion on “Market study methodologies for competition authorities” held at the 125th meeting of the OECD Working Party No. 3 on Co-operation and Enforcement on 20 June 2017. More papers and presentations on the topic can be found out at oe.cd/1ZX.

1. Analytical
techniques for
market studies
Dr Helen Jenkins
Managing Partner
Prepared for
OECD Competition Committee
20 June 2017

2. Analytical workstreams in
market studies and investigations
The role of economic analysis
20 June 2017 2
Analytical
workstreams in
market studies
Competition concerns: limited price competition,
degree of switching, market structure (e.g. limited competitors,
barriers to entry), pricing structures (bundling, cross-subsidies), etc.
Financial analysis:
profitabilty analysis,
customer acquisition
costs, cost orientation
principles, consumer
affordability, etc.
Consumer choice
framework: biases,
which may affect
switching, product
selection and product
use
Observable customer characteristics?
Trade-offs? For example,
price uniformity vs cost causality

3. Profitability assessments:
asking the right questions
Industry-level
Are there barriers to entry
or coordination concerns?
• non-coordinated oligopoly
(Cournot): what are the
barriers to entry?
• tacit coordination:
oligopolists behaving
strategically
• price-signalling evidence?
Energy versus cement
Company-level
Are there exclusionary
concerns?
• profits can spur
competition: efficiency,
rewards for innovation
Product-level
Are there fairness
concerns?
• measurement challenges
on allocating costs: gross
margins
• can be evidence that
certain products/
segments have much
higher profitability than
others
• dispersion as an indicator
of harm or a driver of
competition?
20 June 2017 3

4. Understanding profitability
A worthwhile exercise
Measuring profits is not the same as condemning them
• provides insight into incentives and behaviour
• how does it change over time? how persistent?
Need to extend practices to deal with service economy
• low capital intensity
• intangibles
• historical risks/survivor bias
• cost allocation
• variability/cyclicality
• these challenges in retailing, financial services and digital sector
• margins can be meaningful: how to match to risks?
• ROCE much less useful: cash-flow analysis (IRR) more robust
20 June 2017 4
Gives insight into
performance, but
levels can be hard
to benchmark

5. Pockets of market power?
Cross-subsidy or fairness issues
Different products in an industry/business can deliver very different levels
of profit contribution
• cross-subsidies—are some customers receiving service below direct
cost?
• varying cost allocation—is it fair for some customers to pay more?
Disciplining by consumers
• price dispersion is a driver for switching
• but, biases can result in customer inertia
Naive versus sophisticated consumers
• latter often protect former, but not always (price discrimination)
20 June 2017 5
Add-ons
Payday lending

6. Example: UK energy market investigation
Margins were higher on standard variable tariffs across the industry, and
had increased
• regulatory change had contributed to this, having removed energy firms’
ability to respond to competition in a geographically differentiated way
• no cross-subsidy, but vulnerable customers more likely to be on
expensive tariffs
Extensive consumer survey, but did not uncover why this pattern was
observed
• respondents did report high required gains from switching
• understanding behavioural biases essential to understanding market
outcomes
20 June 2017 6

7. SVT gross margins timeline
Source: Oxera.
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Percentage difference Average percentage difference (before and after SLC25A)
Introduction
of
SLC25a
‘While gains from switching
are likely to be present in
most markets, we attach
particular significance to the
fact that they are available at
such levels to customers for
domestic gas and electricity
(which are homogenous
goods and constitute a
significant proportion of
household expenditure).’
Competition and Markets Authority,
‘Energy Market Investigation: Final
report’, para. 134.
720 June 2017

8. Comparison of price dispersion and switching rates
(excluding bank accounts)
Source: Oxera.
Private life insurance
Mortgages
TV subscription Mobile Investment products
Fixed-line telephone
Gas services
Internet provision
Electricity services
Home insurance
Vehicle insurance
R² = 0.5226
0%
5%
10%
15%
20%
25%
30%
35%
0% 10% 20% 30% 40% 50% 60%
Annualswitchingrate
Median to low saving
820 June 2017

9. Understanding business models and biases
UK Financial Conduct Authority: ‘Strategic review of retail banking
business models’
• consumer behaviour and customer segmentation
• business line assessment and understanding of business models
• this informs the understanding of the market and competitive dynamics
• more use of experimental techniques to understand consumer choice
and how to effect change in undesirable market outcomes
20 June 2017 9

10. 20 June 2017 10

11. Contact:
Helen Jenkins
+44 (0) 1865 253016
helen.jenkins@oxera.com
www.oxera.com
Follow us on Twitter
@OxeraConsulting
Oxera Consulting LLP is a limited liability partnership registered in England
and Wales No. OC392464, registered office: Park Central, 40/41 Park End
Street, Oxford, OX1 1JD, UK. The Brussels office, trading as Oxera
Brussels, is registered in Belgium, SETR Oxera Consulting LLP 0651 990
151, registered office: Avenue Louise 81, Box 11, 1050 Brussels, Belgium.
Oxera Consulting GmbH is registered in Germany, no. HRB 148781 B
(Local Court of Charlottenburg), registered office: Rahel-Hirsch-Straße 10,
Berlin 10557, Germany.
Although every effort has been made to ensure the accuracy of the
material and the integrity of the analysis presented herein, Oxera accepts
no liability for any actions taken on the basis of its contents. No Oxera
entity is either authorised or regulated by the Financial Conduct Authority
or the Prudential Regulation Authority. Anyone considering a specific
investment should consult their own broker or other investment adviser.
Oxera accepts no liability for any specific investment decision, which must
be at the investor’s own risk.
© Oxera, 2017. All rights reserved. Except for the quotation of short
passages for the purposes of criticism or review, no part may be used or
reproduced without permission.

12. Source: Oxera | © Oxera 2016
Call to action
statement
Saying that eight out of
ten people lose out by
purchasing from their
pension provider led to a
32% shopping-around rate
2nd
Non-personalised
comparison
Showing an estimate of
how much consumers can
gain by shopping around
led to a shopping-
around rate of 22%
3rd
Control group
Not providing information
on the gains of shopping
around led to a shopping
around rate of 13%
4th
It is not too late
to shop around for
quotes from other
providers
In an online experiment, which
prompts were most effective?*
Many people could benefit by shopping
around for an annuity. Why don’t they?
I don’t think there is much to
gain by shopping around
I don’t understand the options available to me
This is an important decision – I would
hate to make the wrong decision
I’ll go with the
easiest option –
my pension
provider
Lack of clarity
Complexity
Regret
Inertia
Can prompts increase
shopping around for
annuities?
* These results are based on the responses of 1,996 participants aged 55-65.
Personalised
comparison
Showing the pension
provider quote against the
best available quote in the
market led to the highest
rates of shopping around
(40%)
1st
Based on your key
information, there are
quotes available from other
providers offering higher
rates. If you select our
product you would be losing
out on £46 a year.
Based on your key information, we
have estimated the highest annuity
income you might be offered by other
providers. Based on this estimate, if
you select our product, you might lose
out on around £50 a year.
This estimate does not use real-time
quotes from other annuity providers.
As a result, the estimate may be
higher or lower than the annuity
quotes you would actually be offered,
were you to shop around.
Estimated
highest quote
Our
Quote
£1,425
£46
£1,379
Estimated values
of people lose out by
purchasing from their own
pension provider according
to a 2014 survey.
80%
Participants in the experiment were presented with the information below:
Highest
Quote
Our
Quote
£1,425
£46
£1,379

13. Oxera Agenda March 2017
Agenda
Advancing economics in business
Cross-subsidies occur in a wide range of markets, when
a firm charges lower prices to one group of consumers,
who are then subsidised by the higher prices charged
to another group. Examples include student discounts,
teaser rates for new customers, loss-leader products in
supermarkets, and free-if-in-credit bank accounts. Cross-
subsidies can occur between different consumers buying
exactly the same product, but also between consumers
buying different combinations of products, so the concept
of cross-subsidy captures a broader range of situations
than pure ‘price discrimination’, where exactly the same
product is sold at different prices to different consumers.1
Careful analysis is required to ascertain whether
cross-subsidies are really occurring, as any firm will
face common costs (e.g. overheads) that it needs to
share across its customers, and some consumers
may be contributing more to those common costs
than others. There is a significant body of literature on
cost-allocation methodologies and the measurement
of economic profitability,2
which has been a key issue
in many competition and regulatory investigations.3
Strictly speaking, economists refer to cross-subsidies
in a narrower range of situations, where certain groups
of consumer products are priced below their ‘economic
cost’—i.e. they contribute less in revenues than the
incremental cost to the firm of serving those consumers.
In this narrower sense of cross-subsidy, the firm could
in principle increase its profits (in the short run) by not
serving those loss-making consumers who do not cover
their economic cost, but it is able to continue to do so
due to the profits it makes from serving other consumer
groups.
In this article, we consider this narrower concept of cross-
subsidies, why they may arise, and whether they should
Should we be cross about cross-subsidies?
Experience from the financial services sector
Cross-subsidies, where one group of consumers pays a higher amount so that the price paid
by another group can be reduced, are common in many markets. But the practice may raise
concerns about whether firms are exploiting those consumers who pay more, and can lead to
calls for competition authorities or regulators to intervene. How might we assess whether cross-
subsidies represent a problem? We look at examples from the consumer credit sector
1
be a cause for concern. We focus on examples from the
consumer credit market, where issues with consumer
behaviour have meant that cross-subsidies have been a
key issue for regulation. This provides some insights into
how firms can consider whether cross-subsidies between
their own customers could be a cause for concern.
Why might cross-subsidies arise?
Profit-maximising firms should not want to serve loss-
making consumers. In reality, however, a firm may not
know whether a new customer will be profitable when
they are first offered services. From the firm’s perspective,
there can be good reasons to offer the new customer
highly competitive (and, indeed, loss-making) services
to attract them, in the hope of providing more profitable
services in due course. A bank may offer the basic
facility of a personal current account for free, in hope of
attracting customers who then may use additional, more
profitable ‘services’, such as holding significant deposits
in the current account, or using overdraft facilities.4
From the point of view of society, there is no clear case
for these practices being either harmful or beneficial.
This was acknowledged in a 2016 FCA paper, which
noted that ‘such pricing practices may encourage
competing firms to charge lower prices to win customers
and may make all consumers better off than uniform
pricing.’5
But cross-subsidies can also be a signal of
weak price competition among certain consumers, and
the distributional consequences—some consumers
benefiting from lower prices, with others paying more—
may be deemed unfair. This could particularly be the
case if the consumers who pay more are deemed to
be ‘vulnerable’, or are exhibiting behavioural biases

14. Oxera Agenda March 2017 2
Should we be cross about cross-subsidies?
that suggest they are unable to participate fully in the
competitive market, to their detriment.
So how can we judge when cross-subsidies are an
acceptable feature of a competitive market, and when
they reflect a concerning issue for market functioning?
As the FCA stated, ‘assessing whether pricing practices
are harmful to consumers and competition requires a
case-by-case assessment.’6
The consumer credit market
provides some interesting examples, due to its potential
for both procompetitive and less beneficial outcomes from
cross-subsidies.
Cross-subsidies in consumer credit
Cross-subsidies are inherent in consumer credit.
Borrowers who default are cross-subsidised by borrowers
who repay, just as insurance policyholders who make
a claim are cross-subsidised by those who do not. The
lender (as with the insurer) is fully incentivised to manage
this situation, by identifying the higher-risk individuals
and charging them more (or excluding them altogether).
The interests of the lender are therefore aligned with
those of the consumers (the borrowers) who repay, as
in a competitive market the lender that is better able
to manage default risk can offer its customers lower
prices. Figure 1 summarises this alignment of lender and
borrower interests in a well-functioning consumer credit
market.
This basis for effective market functioning can come
unstuck if the lender is able to profit much more from
consumers who use a lot of credit. A borrower who is
over-indebted and has a lot of debt, held for a long time,
can be very profitable for the lender, particularly if there
are additional fees associated with late payments or
extensions to the loan duration. This situation can be
exacerbated by significant customer acquisition costs in
financial services markets, which mean that profits are
naturally higher for consumers who stick with the same
provider, as the one-off acquisition costs are spread over
a longer time.
This creates the risk of an additional dimension to
cross-subsidy, with those struggling with debt (i.e.
delaying repayment) cross-subsidising those who are
not. Struggling with debt is associated with forms of
behaviour—which economists refer to as behavioural
biases—that can reduce the ability of the borrower to
make good decisions and find the cheapest option. These
include:7
• optimism bias—consumers may be over-confident
in their ability to repay, or may not judge future
outcomes appropriately when using credit;
• present bias—a decision may be unduly influenced
by consideration of present needs at the expense of
future needs, leading to regretful purchases;
• framing effects—consumers may perceive costs
expressed in percentage terms as being smaller than
the same costs expressed in monetary terms (£/€).
This creates the risk of a conflict in the alignment of
lender and borrower interests, as summarised in
Figure 2 overleaf. The lender can make the highest profits
from the new middle group—borrowers who have a high
risk of default, but from whom sufficient profits can be
made in the meantime (for example, from late payment
fees and high interest payments).
This dynamic is likely to occur to some extent in any
consumer credit market. Some people always use more
of a service than others, and these people will typically
be more profitable for the lender. So at what point does
this dynamic become a concern, and how can regulators
and firms spot when market functioning is being
corrupted? The relevant indicators can be illustrated
through the example of the high-cost short-term
credit market in the UK, and by looking at how market
functioning can evolve through regulatory intervention
to address these issues.
A need for effective regulation:
high-cost short-term credit
High-cost short-term credit (HCSTC) is the FCA’s term for
typically small loans of less than 12 months with interest
above 100% APR, aimed at ‘subprime’ consumers who
Figure 1 Firm and consumer outcomes
in a well-functioning credit market
Note: Loan default is assumed to be ‘unsuccessful’ for the consumer
from a regulatory viewpoint, although arguably some consumers
may consider the benefit of not repaying debt to outweigh the costs
associated with default, such as damage to credit ratings.
Source: Oxera.

15. Oxera Agenda March 2017 3
Should we be cross about cross-subsidies?
often have chequered credit histories and consequently
a high perceived risk of default. When this sector first
came under the regulatory spotlight, in 2013, it was
dominated by ‘payday loans’, which were small loans
(typically around £100–£500) due to be repaid at the
borrower’s next payday, to cover short-term cash-flow
needs. The market provides an interesting case study into
how market functioning was affected by cross-subsidies,
but also how that dynamic has now changed with the
introduction of a new regulatory framework.
Since 2013, payday lending has been the subject of
intensive regulatory review. Investigations into the sector
were conducted first by the Office of Fair Trading (OFT),
then by the Competition and Markets Authority (CMA),
and then by the FCA. One of the key concerns of these
regulators was lenders’ reliance on revenues earned as a
result of consumers incurring late fees, extending loans,
or relending. The initial investigation by the OFT8
found
that half of lenders’ revenues were coming from the 28%
of loans that were rolled over or refinanced at least once.
This indicated that lenders were, to a significant extent,
relying on borrowers who were over-using a service
meant for short-term credit needs.
In terms of behavioural economics, some consumers
(but certainly not all) exhibited optimism bias, by
overestimating their ability to repay. They took out a
single-period loan, expecting to be able to repay it on
their next payday, and when this was not possible they
incurred late payments and loan extensions (roll-overs).
This dynamic altered the nature of competition in the
market. The profits from these borrowers who extended
loans encouraged some lenders to increase spending
on customer acquisition to such an extent that it meant
that lending only once to a borrower who repaid on time
became unprofitable—the original OFT investigation
found that customers would be profitable only as a result
of relending, extensions and late payment fees.9
This meant that, on average, borrowers who struggled to
repay debt cross-subsidised those who repaid on time (in
addition to those who defaulted). This in turn meant that
the incentives of the lender were no longer aligned with
those of the consumers who repaid, which in turn led to
lender conduct issues. The incentive to conduct thorough
credit-risk assessments could be reduced if the highest
profits came from relatively high-risk borrowers struggling
with debt.
In addition, borrowers struggling to repay debt were
less able to benefit from competition in the market to
obtain a better deal. In its market investigation, the CMA
found that, while it is relatively easy to shop around for a
better consumer credit deal (compared to searching for
other financial products), payday consumers could be
reluctant to switch due to concerns about the availability
of loans and the application process.10
The behaviour
of consumers therefore also affected the competitive
dynamics of the market.
Fundamental change to market
functioning
FCA regulation of the sector from April 2014 has changed
this dynamic. Lenders are no longer able to profit from
excessive lending, as regulation restricts roll-overs, late
fees and the ability of lenders to collect payments from
those struggling with debt.11
Measures from the CMA
have also bolstered price competition.12
This means that
lenders can no longer benefit from behavioural biases
to the same extent. Instead, lenders now rely to a much
greater extent on the contractual interest payments
agreed with consumers upfront, rather than revenues
from late fees and roll-overs that the consumer might not
have expected when agreeing the loan.
Market functioning has therefore fundamentally
changed.13
Business models are better aligned with
consumer interests, without the reliance on behavioural
biases. In terms of the framework set out above, this
means that the HCSTC market now looks more like
Figure 1 than Figure 2.
However, it is important to consider both the costs and
the benefits of such rapid regulatory change. The impact
of regulation, including the price cap, on access to
HCSTC was much greater than the FCA expected when
it set the cap in 2014. The FCA expected a decline of
approximately 250,000 consumers per year, whereas the
actual decline has been around 600,000 consumers per
year.14
Some of these consumers will have been able to
turn to other credit sources, but as HCSTC serves the
subprime market, many will not have been able to do this.
Figure 2 Firm and consumer outcomes
where there is a misalignment
of incentives
Source: Oxera.

16. Oxera Agenda March 2017 4
Should we be cross about cross-subsidies?
Applying these lessons to other areas
These dynamics, due to a misalignment of consumer
and firm interests, could arise in a wide range of areas,
given that cross-subsidies between different consumer
groups are fairly common. The important aspect here is
the link between consumer behaviour, firms’ business
models, and competitive dynamics. Potential reliance
on behavioural biases is the key question in assessing
cross-subsidies. Is the business making profits from
normal behaviour consistent with the competitive market,
or is the model relying on biases, and consequently a
lack of effective competition in some areas?
For example, when the FCA looked at another part of
the consumer credit market—credit cards—it segmented
the customer base according to consumer behaviour,
then examined whether there were cross-subsidies.15
It looked at ‘revolvers’ (customers who carry balances,
paying off those balances over time and thus ‘revolving’
them) and ‘transactors’ (customers who use credit cards
to make transactions and then pay off the balance in full
each month). The FCA found that both groups could be
expected to be profitable, and that cross-subsidies were
not related to behaviour. There are cross-subsidies in
credit cards—for example, many companies offer teaser
rates for new customers—but as these were not found
to be linked to behaviours, they did not raise the same
concerns as with payday lending.
Businesses can assess these issues in their sector by
looking at their customers’ behaviour. For example,
consumers can be segmented into groups according
to aspects of their behaviour that are relevant to
the product, such as their use of debt in the case of
consumer credit. The nature of the business model
can then be considered in terms of the profitability of
those groups, using the concept of cross-subsidies as
described in this article. This will help to identify whether
the business model is overly reliant on behaviours that
might go against the consumer interest. The competitive
environment can also be considered, to understand
whether there are reasons why certain consumer groups
(defined by behaviour) are less able than others to take
advantage of competition in the market to obtain a better
deal.
This concept is summarised in Figure 3. The framework
requires a combination of consumer segmentation
based on behaviour, business model analysis, and
assessment of competitive dynamics. The approach
provides a basis for assessing whether cross-subsidies
between consumers are simply a reasonable outcome of
a competitive market which, as the FCA acknowledges,
can be in the interests of consumers, or if they represent
a more concerning indicator of business models acting
against the interests of consumers, or an issue with
market functioning.
Figure 3 Framework for assessing the
relevance of cross-subsidies
Source: Oxera.
1
There is a body of literature that looks at the economics of price discrimination. For a summary of the key issues, see Oxera (2015), ‘The Cloud, or a
silver lining? Differentiated pricing in online markets’, Agenda, May, http://www.oxera.com/Latest-Thinking/Agenda/2015/The-Cloud,-or-a-silver-lining-
Differentiated-prici.aspx.
2
Oxera has long been involved in this debate. For example, see Oxera (2003), ‘Assessing profitability in competition policy analysis’, July, http://www.oxera.
com/Latest-Thinking/Publications/Reports/2003/Assessing-profitability-in-competition-policy-anal.aspx, prepared for the Office of Fair Trading.
3
For example, the allocation of costs came up as an important issue in the UK Financial Conduct Authority’s (FCA) market study into insurance add-on
products. See Oxera (2014), ‘Adding up the add-ons: the FCA’s first market investigation’, Agenda, May, http://www.oxera.com/Latest-Thinking/Agenda/2014/
Adding-up-the-add-ons-the-FCA-s-first-market-inves.aspx.
4
Deposits held in current accounts will be profitable for the bank if it can earn higher interest on the sums held than it pays to the account holder, which is
usually the case. Banks also typically charge for overdraft facilities.

17. Oxera Agenda March 2017 5
Should we be cross about cross-subsidies?
5
Financial Conduct Authority (2016), ‘Price discrimination and cross-subsidy in financial services’, Occasional Paper No.22, September, p. 3.
6
Financial Conduct Authority (2016), ‘Price discrimination and cross-subsidy in financial services’, Occasional Paper No.22, September, p. 3.
7
For an in-depth look at consumer behaviour with regard to credit cards, see Agarwal, S. and Zhang, J. (2015), ‘A review of credit card literature: perspectives
from consumers’, FCA, 19 October, https://www.fca.org.uk/publication/market-studies/review-credit-card-literature.pdf.
8
Office of Fair Trading (2013), ‘Payday Lending: Compliance Review Final Report’, p. 2.
9
Office of Fair Trading (2013), ‘Payday Lending: Compliance Review Final Report’.
10
See Competition and Markets Authority (2015), ‘Payday lending market investigation: final report’, February, paras 6.46–6.68.
11
For example, lenders are now allowed only two attempts to collect payment with the widely used continuous payment authority (CPA). See Financial
Conduct Authority, ‘CONC 7.6 Exercise of continuous payment authority’, FCA Handbook, https://www.handbook.fca.org.uk/handbook/CONC/7/6.html.
12
The CMA measures have included increasing transparency of pricing information, and mandating that all lenders are listed on at least one price comparison
website. See Competition and Markets Authority (2015), ‘Payday lending market investigation: Order 2015’, https://assets.publishing.service.gov.uk/
media/55cc691e40f0b6137400001f/Payday_Lending_Market_Investigation_Order_2015.pdf.
13
For a summary of the changes in this sector since the introduction of FCA regulation, see Financial Conduct Authority (2016), ‘Call for Input: High-cost credit
including review of the high-cost short-term credit price cap’, November.
14
See Consumer Finance Association (2017), ‘Impact of regulation on High Cost Short Term Credit’, March, http://cfa-uk.co.uk/wp-content/
uploads/2017/03/030317-HCSTC-and-market-functioning-Oxera.pdf.
15
See Financial Conduct Authority (2016), ‘Credit card market study: Final findings report’, MS14/6.3, section 6, https://www.fca.org.uk/publication/market-
studies/ms14-6-3-credit-card-market-study-final-findings-report.pdf.