Transcript Calibrated Economic Models

Quantitative Analysis
Of Competitive Effects
For Antitrust
Day 1
Luke Froeb
Owen Graduate School of Management
Vanderbilt University
April, 2003
Case Studies Showing How
Modeling is Used in Antitrust
WorldCom-Sprint
Consumer Branded Product
Carnival-Princess
WorldCom-Sprint Merger:
Background
 Merger
scrutinized by
– U.S. Department of Justice
– Federal Communications Commission
– Interested third parties like Bell Atlantic
 Overlap
in residential long distance service
 Regulatory restrictions keeping local phone
companies out of market were soon to fall
WorldCom-Sprint Merger:
Methodology
Estimate consumer
choice model
(demand)
 Estimate/Calibrate
Firm Model (supply)
 Simulate “ownership”
effect of merger

Share
Price
World 16.5
Com
Sprint 6.9
16.5
AT&T 56.4
17.6
Others 20.1
14.4
17.9
WorldCom-Sprint Merger:
Simulated Merger Effects

Demand estimation from bill “harvesting”
– Inelastic demand
– Predicted price increases for merging firms
WorldCom: 5.4%

Sprint: 8.9%
Calibration from WorldCom’s margin
– Small margins imply more elastic demand
– Predicted price increases for merging firms
WorldCom: 2.2%
Sprint: 5.1%
WorldCom-Sprint Merger:
Mergers in a Post-Entry World
 Does
entry occur in response to merger?
 Entry by incumbent local exchange
carriers (“Baby Bells”)
– State-level “experiments” show 25% share
of long distance
– What is merger effect in post-entry world?
 Baby
Bell entry cuts the industry average
price effect in half
Branded Consumer
Goods Merger
 This
is a real case that must be kept
confidential, so numbers are disguised
 Entrant
gained 25% share in two years
 Proposed
 Only
to purchase rival brand
3 brands in “high end” segment
 Aggregate
segment elasticity 1.5
Branded Consumer Goods Merger:
Brand Elasticity, Prices, Shares
A-Price B-Price C-Price
Price Share
A-Quant.
2.21
0.44
0.28
$20
35%
B-Quant.
0.39
2.16
0.28
$20
40%
C-Quant.
0.39
0.44
2.32
$20
25%
Branded Consumer Goods Merger:
Findings
 Estimated
demand implies brands are
fairly good substitutes for one another
 Predicted industry price increase of 4%
 Merging
and 8%
 12%
brand price increases of 5%
and 18% marginal cost reductions
required to offset price increases
Is Merger Prediction Consistent
with Entry Experience?
 Incumbent
brands did not reduce price
in response to entry with a 25% share
 Implies entrant is bad substitute
 Yet,
we get a significant price increase
following merger
 Implies entrant is good substitute
 Is
post-merger price increase consistent
with no incumbent entry response?
How to Answer Question
 Calibrate
model to observed data
 “Undo”
entry by raising price of recent
entrant until zero quantity
 Compare
price changes of remaining
(incumbent) brands
 Entry
effects are reverse of “undoing”
entry effects
Consumer Goods Merger:
Entry Model
Prices of incumbent
brands barely change
 Quantity drops
significantly
 Entrants steal
quantity, but do not
affect price
 In general, other firms
do not much affect
price

A
B
ΔP -0.85% -0.95%
ΔQ -10.3% -9.98%
Consumer Goods Merger:
How Can We Test this Prediction?
 Where
from?
did entrant’s quantity come
 65% from “outside” option

Includes lower priced brands
 35% from incumbent brands
 Is
this consistent with entry data?
 If not, may want to modify model
2002 Cruise Line Merger:
Introduction
Carnival (largest) and Royal Caribbean
(second-largest) each bid for Princess (thirdlargest)
 Capacity constraints and “perishable” service

– big fixed costs, small marginal costs

Key strategy is “revenue management”
– Price to match uncertain demand to available
capacity, i.e. to “fill the ships”
Merger of Parking Lot Operators
Central Parking acquired Allright
 Two largest parking lot operators in US
 Pricing: “Is lot full by 9am?”

 If “no,” then reduce price
 If “yes,” then raise price
This profit calculus unchanged by merger
 No merger effect if lots are full
 But Justice Department opposed merger

 Asked for 74 lot divestitures in 18 cities
Cruise Lines vs. Parking Lots

Similar strategies: filling ships vs. filling lots

There is no uncertainty about parking
demand, but does that make a difference?

Theories considered by FTC
 Fill-the-ship pricing is unaffected by merger
 No quantity effect, but low-elasticity consumers
pay more

Were theories correct? Magnitude of effects?
Conclusions Based on Formal Model
of Revenue Management

Two merger effects
– Ownership effect raises price
– Information-sharing effect raises or lowers price
But always increases quantity
Both effects small and disappear as
uncertainty decreases
 Confirms basic intuition from parking lot
merger, i.e. firms price to fill the ships, and
this profit calculus is unchanged by merger

Spatial Competition
Grocery Store Merger
Parking Lot Merger
Geographic Differentiation
Retail Sector is Consolidating

In US, Wal-Mart, K-Mart, Target, Costco, and
Sears account for 60 percent of generalmerchandise sales
– General-merchandise is 15 % of all retail sales

Productivity advantage over smaller retailers
– Economies of scale
– Economies of purchasing
– Economies of distribution
Productivity Gains Associated with
Industry Consolidation
Retail Consolidation
Also in Europe
 In
EU, top 10 grocery stores forecast to
increase share to 50-60%
– In 2002, top 10 had 38%
 Wal-Mart entering
Europe
Policy Reaction to Retail
Consolidation
 FTC
challenged some retail mergers
– Blocked Kroger + Winn-Dixie
– Blocked Staples + Office Depot
 Competitive
analysis based on increase
in local (within-city) horizontal market
power
– “standard” horizontal analysis
Quantitative Horizontal Analysis:
Benefit-Cost Analysis of Merger
 Goal:
effect
quantitative estimate of merger
– Necessary to weigh efficiencies against loss
of competition
 Two
methodologies
– “Natural” experiments, e.g. Staples-Office
Depot
– Model-based simulations
Natural Experiments:
Staples-Office Depot

Prices in two-office-superstore cities found to
be 7% lower than in one-office-superstore city
– Is this a good metaphor for merger?
Pass-through rate (from cost to prices) was
estimated to be 15%
 This implies that a 85% reduction in costs
necessary to offset merger effect
 FTC successfully challenged merger

Model-Based Simulation
 Model
current competition
 Estimate model parameters
 Simulate loss of competition using
estimated parameters
 Unilateral competitive effect computed
as difference between pre- and postmerger Nash equilibria
Model-Based Simulation:
Kroger + Winn Dixie

Estimate “gravity”
choice model
– Survey density in
Charlotte, NC
– Dots represent
grocery stores

Choice depends on
price, distance, and
“noise”
Pre-Merger Equilibrium:
Share of Kroger + Winn-Dixie
Post-Merger Equilibrium:
Share of Kroger+Winn-Dixie
Parking Lot
Merger



“Gravity” choice
model
Lots derive
market power
from location,
capacity
Higher prices if
– Few nearby lots
– Many nearby
consumers
– Small lot capacity
Parking Lot Merger Model:
Conclusions
Constraints on merging lots attenuate merger
effects by more than constraints on nonmerging ones amplify them
 Merger effects poorly approximated by
shares in geographic market areas

– No bright lines between “in” and “out”
– Shares poor proxies for localized competition

Justice Department erred when it asked for
divestitures in 5-square block areas where the
merging firms account for more than 35%
Gravity Choice Models
And Merger Effects
 Merger effects “depend” on
– Location of consumers
– Location of merging stores
– Location of non-merging firms
– Cost of travel
– Other factors affecting demand
 Weak
generalization: small price effects
if location only source of market power
Differentiated Products
What if we can’t estimate demand?
Modelling choices and trade-offs
Accounting for efficiencies
Model-Based Methodology
 Specify
and estimate a model
– Consumer model (demand)
– Firm model (supply)
 Use
model to simulate counterfactual
scenario
– Mergers, collusion, damages
Example and Questions
To “Test” Approach

Logit demand curve
– What about other forms?

Price-setting competition
– What about product, promotion, placement?
– What about auctions, quantity-setting, vertical
arrangements?

Constant marginal cost
– What about scale economies or capacity constraints?

Static game
– What about dynamic strategies?

Unilateral merger counterfactual
– What about coordinated effects?
Critique of Market Share Screens
With Differentiated Products
Competition does not stop at market
boundary
Shares may be poor proxies for
competitive effects
No role for efficiencies
How do you trade off a 10% marginal cost
reduction against a 400 point change in HHI?
Common Problem: Cannot Get
Reliable Demand Estimate
 Relatively
flexible functional forms
often lead to nonsensical estimates
– Goods are complements (when we know
they are substitutes)
– Inelastic demand (inconsistent with
optimization)
 Data
not up to task of estimating so
many parameters
Solution: Ask Less of Data by
Making Intuitive Assumptions

If one firm increases price, its rivals gain
quantity in proportion to existing shares
– Implies all goods are substitutes
– Implies margins proportional to shares
– Implies cross elasticities proportional to shares

These restrictive forms require less data
– Aggregate elasticity
– One brand level elasticity or margin




Swedish beer
merger
Aggregate
elasticity ≈ 1
Pripps margin ≈
30%
Significant
industry average
price increase
1.4
Aggregate Elasticity
Replacing
Market Share
Screens
4%
1.2
1
5%
0.8
0.6
6%
7%
2
2.5
3
3.5
4
Pripps 2.8% Demand Elasticity
Logit Model
as a Screen
WorldComSprint Merger
 Aggregate
elasticity ≈ -1
 WorldCom
Margin ≈ 30%
 Relatively
small price
effects

Using Logit Model as Screen III
 Rebuttable
presumption starts dialogue
– Show products are further apart than modeled
– Show competition is more intense than modeled
 Requires
different safe harbors
– “Give” parties a 5% MC reduction on each of their
merging products
Would have allowed MCI-Sprint, but not beer
How Do you Incorporate
Merger-Specific Efficiencies?
 How
much do cost savings affect postmerger equilibrium?
 One product assumes the mc of the other; or
 Parties “prove” merger-specific cost reductions
 Compute
cost reductions sufficient to
offset predicted price increase
 In general, 2X to 3X times computed
product price rise is enough.
 Because pass-through related to postmerger price increase
Which Welfare Standard?
Total vs. Consumer Welfare
 Do fixed costs count?
 Superior Propane in Canada fixed cost
savings but prices went up.
 Gain in profits was higher than consumer
welfare loss
 Canada
is only country with a total
welfare standard.
 Short-run price increases vs. long-run
efficiencies