Email Services – The perfect example of imperfect competition

This is a part of the work our group did for our Econ project. I hope I haven't made any blunders here.

The major email service providers in India – Gmail, Yahoo, Rediff, and Hotmail command over a 95% of the market share . The email market in India is thus an example of oligopoly- a market structure in which a small number of shares control a huge market share.

For an imperfect competition to exist there needs to be some amount of market power to be present with the firms. We will now examine the source of market power in case of our market of interest. Firstly, there are patents and copyrights which provide these firms with some amount of market power. Google has its page rank algorithm with the help of which it provides unique services to its customers. But patents are not a major part of the story here. Patents can be and have been circumvented in the past. The two most important reasons for market power vesting with individual firms are – Economies of Scale and Network Economies.

Economies of Scale are apparent in high tech email services industry. With the amount of storage space provided and the number of users of each service, each of these companies has to have big server farms. The average cost of each email account provided falls down with the number of email accounts given by the service provider. This is so because the air conditioning costs of the server farms and the charges for each server would tend to remain constant over a long range of email accounts because they are fixed costs. Hence, the marginal cost of providing one email account would be very small. Therefore, the companies which provide larger number of email accounts or in other words have a larger number of customers have to suffer a lower average cost per email account.

Network economies or externalities are another very important factor contributing to market power of the oligopolist. Network externalities are the effects on a user of a product or service of others using the same or compatible products or services. Positive network externalities exist if the benefits are an increasing function of the number of other users. Negative network externalities exist if the benefits are a decreasing function of the number of other users. A common example is computer software. Emails, through the use of add-ons, also fall in the same category. It was said that Google introduced gtalk only to drive more people to join its mail service gmail. People who wanted to use gtalk to chat with their friends on gtalk could only do so if they had an existing gmail account. Thus, network economies are also an important factor contributing to the market power of the email services.

Being oligopolists, these firms are able to practice price discrimination. They do so by offering the consumers ‘premium account’. These so called premium accounts do not have advertisements displayed with the emails and offer certain other services. The cost associated with offering these services is not much more than the cost of offering the normal vanilla email account. Thus, the firms are able to practice third-degree price discrimination. 

Consumers are divided into two groups, with separate demand curves for each group. The optimal prices and quantities are such that the marginal revenue from each group is the same and equal to marginal cost. Here group 1, with demand curve D1, is charged P1, and group 2, with the more elastic demand curve D2, is charged the lower price P2. Marginal costs depends on the quantity produced QT.