The use of profitability analysis in market investigations

Use of profitability analysis in market investigations

The appropriate approach for measuring and interpreting economic profitability.

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Profitability analysis

Caitlin Wilkinson, Director, Competition Economics and Stella Deakin, Associate Director, Regulatory Finance, both from KPMG in the UK's Economics team, explain the significant considerations required when measuring profitability. They discuss the importance of following correct principles when interpreting profitability levels, in order to avoid deterring firms from making efficient operational decisions and future investments.

Profitability analysis has figured prominently in some recent high profile market investigations by competition authorities, for example in the private healthcare (September 2016) and energy (June 2016) market investigations. This brings into focus the appropriate approach for measuring profitability of firms in different industries and how much weight should be placed upon this analysis. 

Where profitability analysis has been conducted, the Competition & Markets Authority (CMA) has been very willing to put significant weight on the results - both to support adverse effect on competition (AEC) findings and to quantify the benefits of potential remedies. In doing so, the CMA appears in some cases not to have fully recognised the issues with profitability analysis - and therefore may have failed to hold itself to the highest standards, in the weight it has placed on its results.

Failure by competition authorities to address the issues with profitability analysis in future could stifle investment and the proper functioning of competitive markets, not just in private healthcare and energy, across the economy more broadly. This, ultimately, risks creating significant harm to consumers.

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