Transcript Market Definition - Canadian Bar Association

Geographic Market Definition
Presentation to the CBA Competition Section’s
Young Lawyers Committee
Neil Campbell, McMillan LLP
Lilla Csorgo, Competition Bureau
Margaret Sanderson, Charles River Associates
November 19, 2009
4584497.2
Disclaimer
• Discussions of particular policies and cases are for
teaching purposes only.
• These slides are part of a presentation and cannot be fully
understood separately from that presentation. Ideas
presented here are preliminary and their intent is to
promote further discussion and analysis.
• These slides do not necessarily reflect the views of the
authors’ organizations.
1
Topics for Discussion
• Identifying geographic market definition issues
• Merger analytical framework
• Practical indicators
• Hypothetical monopolist test
• Testing for regional price discrimination
• Critical loss analysis
• Conduct cases and the “cellophane trap”
• Canada Pipe
• Making use of market definition evidence
2
Identifying Geographic Market Definition Issues
• Where do the merging parties have overlaps?
◦ Sales offices / production facilities
◦ Customers
• Does geographic market matter?
◦ Market share similarities / differences
◦ Differences in competitors’ presence / position
◦ Price differences
• Note: need to consider product market definition in parallel
◦ Similar questions
3
Merger Analytical Framework
Product & Geographic
Market Definition
• “Market definition is
based on
substitutability and
focuses on demand
responses to changes
in relative prices”
(MEGs, 3.3)
• May not correspond
to standard company
or industry
segmentations
• May not follow
political boundaries
4
Market Shares /
Concentration
• 35% unilateral
effects safe
harbour
• 65% CR4
coordinated effects
safe harbour
Competitive Effects
(s. 93) Factors
• Effectiveness of
remaining competition
• Removal of vigorous
competitor
• Entry
• Change / innovation
• Countervailing power
• Failing firm
• Efficiencies (possible
defence)
• Other
Practical Indicators for Defining Geographic Markets
• Closeness of substitution possibilities
◦ Demand side: extent to which buyers would switch suppliers
◦ Supply side: scope for expansion or repositioning
• Potentially relevant factors (MEGs, 3.21-3.26)
◦ Buyers’ and trade views
◦ End use and product attributes
◦ Price relationships and levels
◦ Switching costs
◦ Transportation costs
◦ Shipment patterns
◦ Foreign competition
5
Hypothetical Monopolist Test
• Product dimension:
◦ Smallest group of products over which it would be profitable for a single
firm acting as a monopolist to implement and sustain a small yet
significant non-transitory increase in price (“SSNIP”)
• Geographic dimension:
◦ Smallest geographic area over which it would be profitable for a single
firm acting as a monopolist to implement and sustain a SSNIP
• Conceptual, iterative process
6
7
8
9
Hypothetical Monopolist Test (cont’)
• What is a SSNIP?
◦ Usual test is 5% price increases over 1 year (MEGs, 3.4)
◦ May vary depending upon the product
• What base is used?
◦ Prevailing prices for mergers (even if not competitive)
◦ Demand responses depend upon price faced by customer
(e.g., transportation plus tipping fees in waste disposal)
◦ Supply responses depend upon margin faced by entrant
(e.g., FOB mill price in case of delivered pricing where supplier pays for
freight cost)
• Is price discrimination relevant?
◦ If different buyers pay different prices for the same relevant product,
subsets of buyers may comprise separate markets over which
hypothetical monopolist profitably can impose a SSNIP
10
Testing for Regional Price Discrimination
• Merger involving two firms based in Western Canada
• Merging parties consider the relevant geographic market to be
North America given their extensive exports to U.S. customers
• There are no imports into Canada
• Regression analysis employed to test whether geographic
price discrimination exists
◦ Test whether the “netback” (per unit sales revenues less freight costs)
from the merging firms’ sales to customers in the U.S. is similar to the
netback earned from customers in Western Canada
◦ If netbacks (as a measure of margin) are materially higher for sales to
customers in Western Canada than to U.S. customers, the threat of entry
from the U.S. does not appear to discipline prices in Western Canada
◦ Common netbacks are a necessary but not a sufficient condition for
finding that Western Canada is part of a wider geographic market
11
Merger Case – Practical Example (cont’)
• Transaction level data is obtained from merging firms
◦ Prices, quantities, discounts, freight costs, customer location, product type
for all shipments to U.S. and Canadian customers
• Regression specification used:
Log(netback per tonne) = α + β*log(volume) + γ*(region dummy) +
δ*(month dummy) + ζ*(product type dummy) + error
• Log-linear regression means the coefficient “γ” measures the %
difference in netback per tonne for sales to customers in other regions
relative to netbacks earned from customers located in B.C.
◦ If no regional price discrimination exists, the netbacks for sales to
customers in B.C. should not be significantly (either economically or
statistically) different from the netbacks for sales to customers in other
regions
12
Merger Case – Practical Example (cont’)
• Netbacks are 10-11% lower for sales to customers in the U.S.
compared to netbacks on sales to customers in B.C. and Prairies
• Suggest B.C. + Prairies are in one geographic market, but U.S. Pacific
Northwest and U.S. Southwest are in a separate geographic market
Variable
Parameter Estimate
T-statistic
Intercept
5.970*
10.83
Volume
-0.005
-1.47
Prairies
-0.030
-1.13
U.S. Pacific Northwest
-0.104**
-2.07
U.S. Southwest
-0.113**
-2.11
Observations
1,194
R2
0.481
* Statistically significant at 1% level
13
** Statistically significant at 5% level
Critical Loss Analysis in Market Definition
• No regional price discrimination is a necessary but not a sufficient
condition for finding a single, common geographic market
• Sufficient test is the hypothetical monopolist test (critical loss analysis)
◦ If hypothetical monopolist imposes a SSNIP, are the gains in revenue from
customers who still purchase (area A) greater than the losses from
customers who are no longer buying (area B)?
P
P1
Demand Curve
A
P0
B
Q1
14
Marginal Cost
Q0
Q
Market Definition Tool: Critical Loss Analysis
First Step:
Second Step:
Third Step:
Contribution Margin
Critical Loss in Sales
Lost Customers
Estimate the hypothetical
monopolist’s initial per unit
margin
Percentage of customers the
hypothetical monopolist could
lose before the price increase
becomes unprofitable
Estimate whether the
hypothetical monopolist
would lose customers
beyond the critical level if
it increased price
Contribution margin =
(initial price – marginal cost)
÷ initial price
Critical loss in sales = SSNIP 
(SSNIP + contribution margin)
15
Involves quantifying how many
customers would be lost either to
rival firms or by not purchasing
when faced with the SSNIP
Critical Loss Analysis - Implications
• As the critical loss formula indicates:
◦ The greater the contribution margin, the smaller the critical loss for a given
postulated price increase
◦ The greater the postulated price increase, the larger the critical loss for a
given contribution margin
Percentage
Percentage Price Increase
Contribution
Margin
16
5
10
15
0
100.0
100.0
100.0
10
33.3
50.0
60.0
20
20.0
33.3
42.9
30
14.3
25.0
33.3
40
11.1
20.0
27.3
50
9.1
16.7
23.1
Critical Loss Analysis - Adjustments and Caveats
• Important adjustments and considerations
◦ Alternative production facility use may attenuate the effects of lost sales
◦ Joint product production
◦ Margins may be high for a reason (e.g., inelastic demand); therefore do not
assume high margins always mean broad geographic markets because the
critical loss is small
• Assumptions
◦ No price discrimination
◦ Marginal cost is constant over the range of output relevant to the postulated
price increase
◦ Average variable cost is often used as a proxy for marginal cost
◦ Accounting data is typically used to calculate the average variable cost, but
this introduces measurement problems
17
Critical Loss Analysis – Practical Example
• Geographic market analysis for a possible ChemCo / TargetCo
merger – separate East and West markets vs. all Canada?
◦ Available data only for ChemCo plants throughout North America
• Assume hypothetical monopolist of all Western Canada plants
• Hypothesize 5% price increase in Western Canada only
◦ Price increase is realized by shutting down enough Western Canada capacity
to increase price by 5% given elasticity of demand
◦ Calculate the contribution margin associated with the shut down capacity by
assuming production is shut down at the highest cost plants – find 2 plants
need to be shut down to remove enough volume in Western Canada to raise
price by 5%
◦ Contribution margin associated with the 2 shut-down plants is roughly 20%
• Forgone margin = 20%, price increase = 5% → critical loss = 20%
18
Critical Loss – Practical Example (cont’)
• Will actual loss > 20% if hypothetical monopolist in West raises
price by 5%?
◦ Assume prices in East remain the same and assume netbacks earned by
rival firms are similar to ChemCo netbacks in East
◦ Calculate existing ChemCo netbacks (Transaction Price - Freight Cost) for
each eastern plant for sales to current customers
◦ Assume prices in Western Canada rise by 5% and calculate potential
netbacks from each eastern plant to ship to customers in the West
◦ Compare post-price-increase netbacks in West with netbacks for current
customers in East; if netback to shift an Eastern sale to a Western
customer is improved assume East volume is diverted to West
◦ Calculate total volumes that would be diverted to West, assuming diversion
begins with the highest netback opportunity
◦ Is the total volume diverted from East to West > 20% of total Western
volume?
19
Critical Loss – Practical Example (cont’)
• Findings
◦ Price increases up to 5.2% in Western Canada induce cumulative potential
divertible volume from ChemCo plants of 41,414 tonnes
◦ Scaling ChemCo divertible volumes by ratio of total plant capacity to
ChemCo plant capacity in Eastern Canada (5.64) yields potential industry
divertible volume from Eastern Canada to Western Canada of 233,706
tonnes
◦ This represents 37% of total Western Canada sales, which exceeds the
critical loss of 20%
• Assumes competitors have freight costs, netbacks and diversion opportunities
similar to those of ChemCo’s Eastern plants
• Assumes no contract constraints would restrict diversion of sales from Eastern
customers to West
20
Conduct Cases and the “Cellophane Trap”
• The wrong base price can lead to overly large markets
(cellophane trap) or overly small ones (reverse cellophane trap)
• Cellophane trap: If the prevailing price is one that already
exhibits substantial market power as result of anticompetitive
conduct, a further (hypothetical) price increase in relation to that
price may cause buyers to switch to products they would not
normally consider as substitutes
◦ U.S. v. Dupont: the alleged monopolist Dupont had priced its cellophane
wrap product so high that substitution of less desirable wrapping materials
finally occurred
• Reverse Cellophane Trap: Some suggest that the competitive
price be used as the base price instead to avoid the trap, but
using the competitive price when market power has already
been exercised can lead to overly narrow markets
21
Reverse Cellophane Trap Example: Canada Pipe
• In Canada Pipe, prevailing prices were used
◦ No switching to imports in face of a price increase was found, but the
absence of switching was possibly due to the anti-competitive act (the
stocking distribution program) and the related penalties associated with
switching
• It is expensive to transport cast iron product
◦ As a consequence, if price is at the competitive level (i.e., at marginal cost
or even average cost), applying the hypothetical monopolist test would
likely find that imports are not in the relevant geographic markets
• The price that would prevail absent the anti-competitive act (the
“but-for” price) did not appear to be the competitive price
◦ At the “but-for” price, imports would be in the market
22
Abuse Case Example – Canada Pipe
• Six regions of Canada were defined as separate markets
◦ B.C., Alberta, the Prairies, Quebec, Ontario and the Maritimes
◦ Commissioner submitted that Canada Pipe had at least 82% market share
in each geographic market
• Canada Pipe has production facilities in only one of the
geographic markets, Quebec
◦ Finding on geographic market would imply that buyers located in B.C.
would not find sellers located in Quebec to be adequate substitutes
◦ How can the location of Canada Pipe be reconciled with its participation in
all six geographic markets?
• In considering the potential effects of the alleged anticompetitive acts, the Tribunal considered the effects on imports
from the U.S.
◦ How can this be reconciled with a geographic market that consists of
regions of Canada?
23
Conundrum 1: Correlations and Price Discrimination
• Tribunal decided in favour of six markets based on evidence that
prices across those six regions were not correlated (para. 112).
• MEGs: “When price discrimination is feasible, it may be
appropriate to define relevant markets with reference to the
characteristics of the classes of buyers or to the particular
locations of the targeted buyers.” (para. 3.9)
• Telecom Abuse Bulletin: “The Bureau generally aggregates
locations that have the same competitive alternatives (within the
product market) for the relevant telecommunications services
into a single geographic market.” (section 2.6)
24
Canada Pipe - Location of Manufacturers and Importers
**
*
**
*
*
*
4584497.2
Sellers of Relevant Product in North America
26
Seller
Location
Area of Distribution
Canada Pipe
Ste Croix, QC
Canada
Vandem
Hamilton, ON
Ontario
Fernco
Sarnia, ON
Canada
New Centurion
Nanaimo, BC
British Columbia (?)
Sierra
Abbotsford, BC
British Columbia and Alberta (?)
Mission Rubber
California
?
Ideal
Indiana and Arkansas
?
Conundrum 2: Hypothetical Monopolist Test in
Abuse Cases
• Base Price
◦ The Tribunal noted that markets are based on sufficiently close substitutes.
Substitutes are considered close if buyers are willing to switch from one
product to another in response to a relative price change (para. 68)
◦ Nowhere does it consider the relevant base price
◦ Based its conclusions on the Commissioner’s submissions on price
correlations
• Those correlations were based on prices that prevailed during the stocking
distribution program (the alleged anticompetitive conduct)
◦ The prevailing price is not typically the right base price when defining
markets in abuse cases
27
Market Definition in Conduct Cases
• Test: hypothetical monopolist
• Base price: an “appropriate benchmark”
◦ Likely the price level that would prevail absent the alleged anti-competitive
act(s)
◦ Allows for a determination of the products and geographic areas that an
allegedly abusive firm would have to control, or otherwise adversely affect,
in order to be able to raise price above the price that would prevail absent
the anticompetitive act
28
Abuse Case Example
• Sections of relevant geographic markets can overlap
• The alternative supply locations buyers have available to them
need not be uniform
• For example, a product is imported into both Eastern and
Western Canada from Central America
• Within Canada, the product imported into or produced in the
East is not shipped past Manitoba, and product imported into or
produced in the West is not shipped past Saskatchewan
• Buyers throughout Canada have the option of buying product
from Central America
• The relevant geographic markets are Eastern Canada plus
Central America, and Western Canada plus Central America
29
Making Use of Market Definition Evidence
• Who is proving (or disproving) what?
• Use visuals (maps, graphs, tables)
• Disclose methodology
◦ Assumptions
◦ Data sets
• Reality check
◦ Is the economic analysis compatible with key business documents and the
client’s market behaviour?
30