Transcript Slides - Competition Policy International

ANTITRUST ECONOMICS 2013
David S. Evans
University of Chicago, Global Economics Group
TOPIC 11:
Date
Elisa Mariscal
CIDE, Global Economics Group
MARKET DEFINITION
Topic 11| Part 1
26 September 2013
Overview
2
Part 1
Part 2
Role of Market
Definition
Overview of
Issues in
Multisided
Platforms
General
Principles of
Market
Definition
The Case of
Additive
Prices
Hypothetical
Monopolist Test
Newspaper
Markets
Critical Loss
Analysis
One-Sided
Biases
Key Questions to Think About
3
Why “market definition” isn’t used by economists outside of their work
on competition policy matters.
Why “market definition” is used by courts and competition authorities
Could the courts and competition authorities dispense with market
definition?
What is the role of false positives and negatives in market definition
analysis, and does it matter whether it is merger or non-merger?
Things You Really Need to Know
4
Relevant market and why it isn’t the same as what laypeople or
businesspeople might call a market
Hypothetical monopolist test which is very popular among
competition authorities
The SSNIP test which is the name of the standard way of
implementing this test.
5
Role of Market Definition
Market Definition and Market Power
6
Market power is important for assessing whether a firm has the
incentive and ability to engage in anti-competitive behavior and
whether merger will result in an increase in market power
Market power depends on the constraints that a firm faces in
increasing the price of a product profitably; these constraints typically
involve substitutes in demand and changes in supply by other firms.
The “market” identifies the producers the impose significant
constraints on the power or a firm or group of firms to raise price
profitably.
Market definition is primarily (perhaps solely) used for the purpose of
helping the courts and competition authorities assess
dominance/market power.
Market Definition and Context
7
Market definition provides a context for examining firm strategies
• Identifies sets of firms, substitution patterns, and strategic relationships
among firms.
Market definition limits the discussion of rival products and firms to a
manageable group.
F
G
Firms in the market
A, B, C, D, E
H
Firms outside of the market: F, G, H, …
Market Definition and Measures
8
Courts and competition authorities use “market share” as an
indicator of possible “market power” or “dominance” for a firm (or
group of firms in the case of collective dominance)
• Share = Sales of firm’s product/total sales in the “market”
Must make decision on what other products compete in the
“market” to calculate the denominator of share.
• Bigger market results in smaller share
• Smaller market results in bigger share
Other measures of concentration such as the HHI are based on
market shares (HHI is sum of the shares, each squared, of all the firms
in the market—see below).
Market Definition, the Case Law, and Economics
9
“A relevant product market comprises all those products and/or
services that are regarded as interchangeable or substitutable by the
consumer, by reason of the products' characteristics, their prices and
their intended use." (EC Notice of Definition of Market)
Economists see constraints on market power as a continuum rather
than having some products “in” the market vs. “outside” the market.
• Market share calculations put equal weight on all products in the market
and zero weight on all products outside the market; no economic basis
for this and it is obviously wrong.
• By putting products outside of the market we lose information which
may be valuable and may make errors if the products outside do matter
• Economist claim they can analyze economic effects of business
practices without defining the market first (is this true?).
Market Definition Sets Hard Boundaries Between
Products that are “In” or “Out” of the Market.
10
Think of the “Hotelling Line” with many ice cream stands on a beach
of infinite length. Start with stand in the middle. Market definition
would say that there is a definite point at which stands to left or right
are not “in the same market” because they don’t impose enough of
a constraint.
Out
In
Out
Product in
question
Continuum of product substitutes—farther away are less substitutable
11
General Principles of Market
Definition
Identifying Relevant Substitutes by Asking What
Would Constrain an Increase in Price
12
The goal of market definition is to identify the group of products
which provide significant and timely competitive constraints to the
firm/product as issue.
Demand-side
Product market
Geographic market
Supply side
How will
marginal
customers
react?
Will producers
of other
products divert
capacity?
Will customers
buy from
other areas?
Would firms in
one area
supply
another?
Demand-side substitution
13
Substitution among products provides the main immediate competitive
constraint and therefore plays the most important role in market
definition in practice
“Average” customers are not necessarily relevant. What matters most is
the behavior of “marginal” customers – the ones who are most likely to
move between products as a result of price changes and who
therefore have biggest impact on revenue changes.
Asymmetric substitution
• “Will the average buyers of product A switch to product B?” is not the
same question as “Will the average buyers of product B switch to product
A?” since neither is necessarily the marginal consumers who matter
• Key question is whether many consumers are at the “margin” between
using this product or an alternative and would switch following a price
increase
Demand-side substitution and the marginal
consumer
14
Pub Beer
$7
O
Price per Pint
$6
A,B, C, D are at “the
margin” of buying or
not buying beer.
F is an “average consumer” of beer
(from O to C)
$5
F
A
$4
D
$3
C
B
G
$2
$1
$0
0
1
2
3
4
5
6
7
8
Pints of Beer Demanded (Millions per Year)
9
10
G is not a consumer
of beer at current
prices
Supply-side substitution
15
Would firms quickly switch capacity to producing demand-side
substitutes for the product of the firm under investigation in reaction
to a price increase of that product?
Relevant when firms can produce a range of different products using
the same, or very similar, technologies and assets
• For example,
• Can the same plants be used to produce different products?
• Can competitors utilize their existing marketing and distribution networks
for new products?
Geographic market is often important for assessing supply-side
substitution
• Will firms in distant economic areas increase supply?
Standard Steps for Identifying a Relevant Market
16
The first step is to consider a reference “product” (or “products”)
• The “candidate market”
Identify the closest potential substitutes for products in the candidate
market
• As discussed above, there are two potential sources of substitution
• Demand-side substitution
• Supply-side substitution
• But which substitutes do we consider?
Which products to consider as demand and
supply substitutes for BMW’s MINI Cooper
17
Mini
Cooper
Other small
cars
Supply of
new small
cars
Mid-size cars
All cars
All means of
transportation
Or maybe buyers of MINI Coopers would switch to scooters or
bicycles….
18
Hypothetical Monopolist (SSNIP)
Test for Market Definition
Hypothetical Monopolist Test
19
Logic of the test
• Is a “market” worth monopolizing?
• If yes, then the substitutes outside the “market” must be weak
• If no, then the substitutes outside the “market” must prevent the exercise
of market power
• Thus the group worth monopolizing pulls in all of the relevant substitutes.
Start with the narrowest candidate market and assume that there is a
monopoly supplier
• Could this hypothetical monopolist profitably impose a “small but
significant not-transitory increase in price” (SSNIP) or will too many
customers switch to demand-side or supply-side substitutes?
• Yes  Candidate Market = Relevant Market
• No  Candidate Market < Relevant Market Include the closest
substitutes and repeat the test
How to proceed?
Demand-side then supply-side
20
Potential substitute products
Candidate Market
1
A
2
3
Demand-side
B

C

D
X
S

A+B+C
A+B+C
Supply-side
1
S
2
A+B+C+S
1
X
Issues Concerning Hypothetical Monopolist Test
21
Focuses entirely on price and excludes non-price dimensions of
competition. Firms may adjust quality and other attributes to
compete instead of price and engage in other non-price strategies
not considered.
The assumptions and measures may not be correct
• The standard Lerner equation doesn’t always apply (e.g. two-sided
markets).
• Estimates of demand and cost may not be reliable.
Cost of errors that lead to “too narrow” a market is that competitive
constraints are completely excluded; cost of errors that led to “too
broad” is that if all substitutes are weighted the same then overstates
competitive constraints.
Hypothetical Monopolist Test Depends on Where
One Starts
22
There is not a unique solution to market definition. The market can
depend on where one (arbitrarily perhaps) starts.
Starting with small cars competing with scooters could lead to a
different answer than starting with small cars competing with large
cars
Large
Cars
Scooters
Small
cars
Relevant Market at End of Analysis
23
G, H
A, B, C, D, E, F
L
K
I
A…..F is the “relevant market” based on the SSNIP test. C is the
firm whose actions we are assessing. G, H, L, and K are firms that
the SSNIP test says are outside of the market.
24
Critical Loss Analysis
Implementing the Hypothetical Monopolist
(SSNIP) Test
Critical loss analysis is a method for implementing
SSNIP test in practice
25
Step (1)—Profits, output, and sales before the price change for
hypothetical monopolist (e.g. products A and B).
Price
Profit = ($20 - $10) x 100 = $1,000
$20
$10
MC
100
Quantity
Critical loss analysis is a method for implementing
the SSNIP test
26
Step (2): How many units of sales would have to switch to substitutes to
make a 10% price increase just unprofitable? Suppose the answer is
slightly more than16.7 (with 16.67 roughly break even).
Price
$22
$20
$10
MC
83.33
100
Quantity
If fewer than 16.7 units of sales switch than a 10% price increase is profitable
Critical Loss Analysis Depends on Customer
Switching—an Example of a Calculation
27
How many customers have to switch to substitutes to make a 10% price
increase unprofitable?
Consider this example
• Initial price = $20; MC = $10; Profit Margin = $10; Quantity = 100; Profit =
$10 x 100 = $1,000
• New price = $22; MC = $10; Profit Margin = $12; Quantity = 83.33; Profit =
$12 x 83.33 = $1,000
This implies that:
• If sales fall by less than 16.7% the price increase is profitable
• Candidate market is the no wider than relevant market (i.e. a smaller
market could have a profitable price increase too).
• If sales fall by more than 16.7% the price increase is unprofitable
• Candidate market is too narrow (one can also say that the true market
is even broader than the candidate market).
• The “critical loss” is 16.7%--this is the dividing line.
Critical Loss Analysis is a Method for Implementing
the SSNIP Test
28
Step (3)--Whether actual loss of sales is higher or lower than the critical loss depends on
the elasticity of demand which depends on the slope of the demand curve at the initial
price (in previous example critical loss corresponds to a “critical” demand elasticity of
1.66; what if the true demand elasticity was 5.75?)
Price
$22
$20
$10
Dmore elastic
MC
Dmore inelastic
83.33
100
Dimplied by critical loss
Quantity
Regression analyses, natural experiments, and internal market studies can help determine
actual loss.
Critical Loss Analysis is a Method for Implementing
the SSNIP Test
29
To conduct the demand-side portion of the test in practice we need
• Marginal costs: data from at least one merging parties (and an
assumption that these marginal costs are representative of other players
in the market).
• Demand elasticities: natural experiments, regression studies, consumer
surveys, diversion ratios are all ways to estimate the elasticity of demand.
To conduct the supply-side portion of the test in practice we need
• Supply elasticities: change in output of substitute products by firms that
aren’t currently producing those products
• In practice the supply-side response is usually ignored for critical loss.
Comparison of Actual Versus Critical Loss Determines if
Market is Large Enough to be Monopolized.
30
The Simple Math of Critical Loss Analysis
31
X
CL 
X M
P  MC
M 
P
The Simple Math of Critical Loss Analysis—Example
32
CL 
.05
.05  .50
End of Part 1, Next Class Part 2
33
Part 1
Part 2
Overview of
Market
Definition
Overview of
Issues in
multisided
platforms
General
Principles of
Market
Definition
The Case of
Additive
Prices
Hypothetical
Monopolist Test
Newspaper
Markets
Critical Loss
Analysis
One-Sided
Biases