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Margin Squeeze: Defining a Reasonably Efficient Operator

What standard should a regulator or competition authority apply when determining if a dominant firm has been margin squeezing its competitors: the Equally Efficient Operator (EEO) or Reasonably Efficient Operator (REO)?

This article, originally published in Intermedia, proposes a definition on a REO and the circumstances in which this standard should be used.

What standard should a regulator or competition authority apply when determining if a dominant firm has been margin squeezing its competitors: the Equally Efficient Operator (EEO) or Reasonably Efficient Operator (REO)? Traditionally competition authorities, at least, have applied the EEO on the basis that economic efficiency is only served if competitors are at least as efficient as incumbent firms. However, the European Commission (EC) has on several occasions introduced the concept of a REO, most recently in its Recommendation of regulation of Next Generation Access where the EC writes: “In the specific context of ex ante price controls aiming to maintain effective competition between operators not benefiting from the same economies of scale and scope and having different unit network costs, a “reasonably efficient operator test” will normally be more appropriate.” The problem is that a REO has not been properly defined leaving it difficult for regulators to apply the test. In this article we seek to define a REO to meet two objectives. First, the REO standard should promote efficient entry in markets where there is a dominant firm. Secondly, the REO standard should be sufficiently transparent that it can be applied by the dominant firm when setting its own prices.