Question

does either economic theory or the UK experience suggest that vertical seperation of an incumbent firm eases competition into a network industry?

Answer 1

Many econometric studies evidence the claim that vertical separation is beneficial as it helps in efficiency sourcing through competition. While divestiture leads to distributional inefficiencies, the gain from opportunities to compete and enter markets through quality and process improvement over powers the loss from separation. Reorganization and management costs should be covered by the gains from efficiency and competition under an ideal vertical separation scenario.

The UK experience of the vertical separation of the Central Electricity Generating Board (CEGB) shows the success of gradual and progressive reductions in operating costs of transmission and electricity generation that provide efficiency to the business even after initial hindrances from the government. Economies of scale and scope have a high level of subjectivity with respect to the industry that the firm operates in. For example, empirical research has shown that water industry would not reap the same benefits from vertical separation as would be expected from electricity as the scale of operation is huge and possibility of stimulating competition is low.

Thus, economic theory suggests that benefits of vertical separation depend on the returns through efficiency and the degree of competition and regulation facilitated through this divestiture.