Blog Paul de Bijl: Competition and resilience

Industrial policy and competition policy regularly make the headlines. The covid-19 pandemic, the energy crisis, and geopolitical tensions have put the economic-policy debate on edge, too. One of the key topics in that context is resilience. For example, the European Commission recently organized a consultation on a review of the European Merger Guidelines, in order to have these better contribute to the competitiveness and resilience of Europe (see ACM’s response to consultation of European guidelines for mergers and acquisitions | ACM).

Resilient means being healthy, strong, and able to recover, so that one can absorb shocks and adversity. This may apply to individuals and businesses, but also to economic sectors and geographical areas. In their pursuit of their private objectives, businesses do not necessarily aim at the level of resilience that is desired by society. Can competitive pressure steer them in the right direction? Or more generally speaking: what connection is there between competition and resilience? That is what I will discuss in this blog. I will limit myself to the resilience of a business or sector, meaning its ability to absorb shocks, and to adapt to unexpected events, such as trade wars, cyber attacks, energy disruptions, or lockdowns.

Comparisons to innovation

There is still little economic literature about competition and resilience, but quite a lot has been written on competition and innovation. That relationship is not linear, but follows an inverted U-shape. At first, more competition stimulates businesses to innovate more (the line goes up). Yet, from a certain point, that is reversed (the line starts to descend). From that point on, even fiercer competition puts too much pressure on the profit margins, at the expense of the opportunity to invest in risky R&D.

Resilience is connected to innovation: when firms experience pressure through competition to keep on innovating and adapting to new situations, they will be able to inventively deal with unforeseen disruptions as well. In that sense, effective competition contributes to an innovative economy as well as a resilient economy.

However, that does not mean that the relationship between competition and resilience, too, can be described by an inverted U-shape, if only because resilience is multifaceted. In addition, the number and position of weak links in value chains play a role. Therefore, specific characteristics and the geographical ties of sectors and value chains are rather determining factors for resilience.

Various mechanisms

Depending on the sector and value chain, one can identify various mechanisms that affect the connection between competition and resilience.

1. Competition can strengthen resilience: With more competitors in a market, the market will be less vulnerable if one of them were to drop out – an example of ‘just in case’. Take telecom, for example. Over the past few decades, incumbents and newcomers have invested in infrastructure, such as 4G, 5G, and fiber-optic networks, and have introduced improved value propositions for buyers. In that way, they do not solely compete on price and market share, but also on quality and innovation. Competition between firms with their own overlapping networks makes the sector as a whole stronger. In that situation, ‘redundancy’ (multiplicity) enables other networks to replace a firm that drops out. In that way, competition between multiple networks not only stimulates innovation and investments, but also supports the resilience of communication infrastructures.
2. Competition can undermine resilience: In a market with homogenous products, pure price competition forces providers to keep their costs as low as possible. That can lead to tight inventories and ‘just-in-time’ delivery. Think of run-off-the-mill semiconductors with applications in cars and electronic devices. The last few years, import in Europe was stalled several times due to disruptions at Asian manufacturers or geopolitical tensions. Or think of generic prescription drugs. Due to low costs, manufacturers and importers leave the production of active ingredients mostly to China and India. During the covid-19 pandemic, import in the Netherlands virtually came to a halt because of closures and lockdowns at production plants in those countries. Combined with a lack of buffers and strategic reserves, shortages in everyday drugs occurred (since 2023, wholesalers must hold at least two weeks of inventory). In that way, pure and fierce price competition with a one-sided focus on low costs can undermine resilience.

Collaborations

When competition stimulates resilience, co-operation can be a useful, additional ingredient. A real-world example shows that this is not contradictory. In 2012, there was a fire in a building next to a Vodafone telephone exchange in the city of Rotterdam. Many Vodafone customers in the greater Rotterdam/The Hague area experienced problems for almost an entire week. In response to that incident, the three major telecom companies in the Netherlands (KPN, Vodafone, and T-Mobile) created a joint emergency system. With that system, they were able to share each other’s 2G and 3G networks in cases of major disruptions, allowing customers to ‘roam’ at no additional cost. Such a collaboration does undermine competition, and serves as a useful supplement to redundancy by overlapping networks. (ACM is available to offer guidance to businesses that wish to collaborate for reasons like these, just like with sustainability agreements: Arrangements with other businesses regarding resilience | ACM (in Dutch)).

Conclusion

There is no clear-cut relationship between competition and resilience. Depending on technology, sector, and value chain, the underlying mechanism can vary greatly. Resilience therefore does not necessarily call for greater scale, less competition, or ‘European champions’ (as incumbents suggest from time to time). On the contrary, more market power also produces more dependence, and, thus, vulnerability. Resilience often calls for more instead of fewer providers: it lessens the impact of a firm dropping out. It also helps if businesses do not compete on price alone, but also have room to invest in resilience, and to keep on innovating. That supports inventiveness when unexpected shocks occur. At the same time, decisions of individual businesses do not yet result in a resilient economy. That’s why the government also has to play a role, varying from investing in resilience to maintaining strategic reserves.