Introduction to Competition
Analysis
Regional Training Workshop on
Competition Law Enforcement
13-15 January 2010
Abuja, Nigeria
Overview
• Market Definition
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Hypothetical Monopolist (SSNIP Test)
Product Market Definition
Geographic Market Definition
Price Correlation Tests
• Market Power
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Market shares
Concentration indices
Constraints to market power
Welfare effects
Barriers to Entry
Theories of Harm
Assessing Competition in a Market
Efficiency Gains
What is a Market?
US DOJ and FTC Guidelines
• A market is defined as a product or a group of products and a geographic
area in which it is produced or sold, such that a hypothetical profit
maximizing firm, not subject to price regulation, that was the only present
or future producer or seller of those products in that area likely would
impose a “small but significant and nontransitory” increase in price,
assuming the terms of sale of all other products are held constant.
EU Guidelines
• Market definition is a tool to identify and define the boundaries of
competition between firms . . . The objective of defining a market in both
its product and geographic dimension is to identify those actual
competitors of the undertakings involved that are capable of constraining
their behavior and of preventing them from behaving independently of an
effective competitive pressure
What’s Important When Defining a
Market?
Demand substitution to other
•
Products
•
Geographic areas
Supply substitution from
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Quick entry
•
Product repositioning
Market definition
• It is all about market power – if market power exists then
there must be a market over which is can be exerted
• Often difficult, but nearly always crucial to any case
• Means to an end
• Requires: 1) theory of market workings and 2) data to be
sustained through expert evidence and testimony
• Hypothetical monopolist
– smallest product group and geographic area such that a
hypothetical monopolist could profitably and
permanently raise price by a small but significant amount
– SSNIP test: Small but Significant Non-Transitory Increase
in Price
• There may be several different markets all affected to
differing extents
Hypothetical monopolist
Example of ice cream sellers on a beach
A
Single ice cream
seller at A
Consumers
have no choice
but to buy
from A
Two Sellers: A and B
A
C
B
Consumers
in C can buy from
A or B
NB: No price
discrimination
Hypothetical Monopolist cont.
• Consumers within A all pay same price i.e. cannot charge
lower price to those within C
• If A raises price those within C can move to B – how big is
this overlap?
• If products are different not in space but in characteristics,
then can ask the same question: can and will a significant
group of consumers move to an alternative? (Example of
different qualities of products: premium beer?)
• If a significant number do so then price rise is unprofitable
• Similarly if B raises price
• A and B are together the “hypothetical” monopolist
 Market definition plus increase in concentration: will
prices increase as a result of the merger??
Chain of substitution
A
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•
•
•
•
•
B
C
D
E
F
G
If overlap significant then price of A
constrained by B and price of B by C etc
A and I in same market and hypothetical
monopolist is A+B+C+D+E+F+G
This how the new car market has been defined in Europe
Beach model applies to both geographic market and product market
definition
Market definition in practice
• All about substitution:
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demand and supply-side
Elasticities – responsiveness of output to change in price,
Own price and cross price elasticities
Very difficult empirically
• How big is overlap?
– can buyers switch supplier if price rise?
– what are the buyers costs of switching?
• How many will switch?
– is likely switching enough to constrain price rise?
• Sources of evidence
• Not a precise science
Demand side substitution
• What is a significant relative price rise? - 5% or
10%
• What is significant switching?
• If more than 10% of customers would switch in
response to a 10% price rise then the rise is
unprofitable (absent changes in costs)
• Often cannot calibrate effects to this precision switching of 10% or more - taken as evidence of
demand substitution
• Marketing documents – give firms’ own
understanding of competitive threats to their
products
Supply-side substitution
• Can existing firms profitably and quickly switch
production/supply using existing capital and
production facilities?
• Producers of red and blue T-shirts?
• If so, their potential output is included in the market
• Common plant but quite different markets, different
inputs etc?
• Substantial advertising and distribution costs?
• In US SSS not included in market definition
Sources of evidence
• Interviews with market participants
• Trends in volumes sold and prices charged
• Price correlations (and more powerful
econometric tests) between possible substitutes
– But: spurious correlations
• Common costs
• Common causal factors etc
• Consumer surveys
• Event studies
Evidence, documents, data
• Consistency of understanding of actual workings
of market with data
• Theory of harm solidly grounded in reality
• Triangulation: working at the same problem from
different stand points
• Dealing with anomalies – they may just be that
(and explainable without undermining the case)
• Obtain price and sales data, over time, to
different groups of customers
• Delivered prices and ex-factory prices
Approach
• Make initial product selection
• Talk to all market participants; producers, major
buyers and consumers, possible supply side
substituters
• Gather other evidence on price trends and
volumes
• Test product selection against all the evidence revise market definition if appropriate
• Look for pragmatic and workable solution using
facts not assertion
Product Market Definition
Merger of Brand C and D
Low Quality
High Quality
Expanded Market
Candidate Market
Brand C, D and E May Be a Relevant Market
Product Market Definition
• It matters where you start
• Start narrow
• This determines the questions you ask about
substitution
• Need to understand from consumers what
and why they are buying – how they view the
product (where, when consumed?)
What is Meant by Geographic Market?
• Geographic market refers to the location of
production (when price discrimination is not a
concern).
• Geographic market refers to the location of
consumption (when price discrimination is a
concern).
Geographic market
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Equivalent to product definition
Geographic markets within country?
With regard to international trade flows?
To what suppliers can consumers switch?
Transport costs
Trade flows: imports, exports, transport flows
within country
• Other barriers
• May be asymmetric
Geographic Market Definition
Note that the market is location of
Merger Between Company B and D
production - not consumption when price discrimination
Company A
is not possible.
Expanded Market
Company B
Company C
Candidate Market
Company D
Company E
Econo-land
Company F
Companies A, B, and D
May Be the Relevant
Market
Note: Cellophane fallacy
• What is the appropriate counter-factual?
– The ‘competitive price’?
• A profit maximising monopolist would operate
such that any rise in price was not profitable
• Have to form a view about the current price
Price Correlation “Theory”
• If two products or geographies are in the same market then the
price of each will have a constraining impact on the other. Price
correlation theory suggests that when the prices of two
products (that are substitutes) are highly correlated, each
product places some constraint the on the price of the other
product.
• The idea is that switching by marginal customers should keep
relative prices unchanged.
• Price correlations have been extensively used for purpose of
market definition, especially in Europe, where agencies have
used them, but also in U.S. (e.g., high fructose corn syrup,
where, though agencies have shied away from using them,
courts have accepted them).
• Using price correlations analysis to define the market is suspect
and should generally be avoided.
Market Definition Through Price
Correlation: What Kind of Data Do You
Need?
• Price correlation analysis has been used to define the geographic
market and the product market.
• Geographic market definition
– Price data over time for the same product in two geographic
areas
• Product market definition
– Price data over time for two different products in the same
geographic area
– Price data across different geographic areas for two different
products
What Does High Price Correlation Look Like?
PB
PA
x
x
x
x
o
o
o
x
x
o
o
x
x
x
x
o
x
o
x
x
o
o
o
o
o
Time
o
Correlation Does Not Mean Causality
• Sales of rum and number of lawyers are positively correlated. What does
this mean?
• Both the sales of rum and the number of lawyers are correlated with the
number of people in the U.S. As the number of people increases, it causes
an increase in demand for both lawyers and for rum.
• If you adjusted for the number of people, for example by computing the
sales of rum and the number of lawyers per capita, then the association
would disappear.
• There are many examples where a high correlation between two variables
can be explained by a third factor. Always look for an alternate explanation
of the correlation.
Using Price Correlation Analysis Can lead to a Overly
Broad Market Definition
• Common Influences
– Common inputs, correlated demands over time (e.g., GDP
effect, inflation)
• Cost advantages
– Incumbent may price just below the price level of another
product to keep it out of the geographic area. This
strategy leads to high price correlations.
• Cellophane problem
– Colluding firms will raise price and “use up their monopoly
power” to the point where other products become good
substitutes.
Using Correlation Analysis May lead to a too Narrow
Market Definition
• Multiple poor substitutes
– Often referred to as death by a thousand cuts.
• Products can be negatively correlated and still be good
substitutes.
– R&D reduces the cost of one good over time and making it
a better substitute over time.
– Good news over time increases the price of one product
while reducing that of another (e.g., Ford and Hyundai)
Further issues
• Two sided markets
• Primary and secondary products (and aftermarkets)
• Measuring capacities or actual production and
sales volumes
• Temporal/seasonal markets
Market Power
• Market definition is only an intermediary objective, what is
more important is to assess market power in the defined
market
• Market power measures the extent to which a firm can act
independently of consumers and competitors?
• Competition is a means, not an end; it constrains market power
• Why worry?
• The power of consumers versus the power of producers - we
are all consumers, but producers maximise profits?
• Efficient organisation of production across the economy
requires matching the value placed on goods with the costs of
producing them
• In the absence of market power (and lots of other assumptions
holding) the free market system achieves this
Assessment of Market Power
The traditional approach
• Central role of market shares
• Which thresholds for market shares?
• Measurement and relative strengths (reserves,
capacities, persistence of shares)
• Ease and likelihood of entry
• Buyers’ power
• Import competition
Econometric techniques
• Estimation of residual demand elasticity
• Logit models
Challenges in assigning market share
•
Common denominator
– Output measures
• Bread (weight vs. slices vs. loaves)
• Toilet paper (rolls vs. sheets, vs. length)
• Coal (ton from one mine may produce same heat BTUs as two tons from
another, low sulfur vs. high sulfur coal)
• Sweeteners (some sweeteners are 200 times more powerful, by weight,
than sugar)
• Durable vs. non-durable products (in surgery, durable product may be
used hundreds of times, non-durable just once, though purpose is same)
– Revenue measures
• Shares assigned on basis of revenues may account for efficiency and
durability differences, at least in part
• Challenges:
– price differences may be based entirely on brands (e.g. store brands
may be cheaper than name brands, but not objectively inferior)
– Integrated and non-integrated products (e.g. chips may be sold with
a dip included, while at other times with dip excluded
Concentration indices
• Concentration indices are statistics of the degree of concentration in a
given market
- Could look at market shares: below 35%, above 45%
- Another popular index is the Herfindahl-Hirschman Index (HHI), given by
the sum of the squares of the market shares (in percentage terms) of all
the firms participating to the market
• A market with a result of 1,000-1,800 is considered to be a moderately
concentrated ;1,800 or greater to be a highly concentrated
• HHI is only one measure of concentration and can provide some initial
guidance as an exclusionary measure (
– low HHI and low HHI change in correctly defined market generally
suggests little competitive effect from merger
– high HHI and high HHI change does not establish competitive effect.
• As a general rule, mergers that increase the HHI by more than 100 points
in concentrated markets raise concerns.
Constraints on market power
• Price elasticity of demand: the responsiveness of
quantity to price
• Very responsive (highly elastic):
– an increase in price means a very large reduction in quantity
purchased;
– a lower price means a very large increase in quantity
purchased
• Inelastic: means there will only be a very small
reduction in quantity for an increase in price
• Lerner index: the markup of price over marginal cost,
expressed as a proportion of price
Constraints (over time)?
• The availability of substitutes:
– Good substitutes means a change in the price of one
product leads to switching and big changes in the
quantities purchased of each: cross price elasticities of
demand (response to changes in relative prices)
• The ability of competing firms to respond
(capacity constraints)
• Likelihood of entry: sunk costs; access to inputs;
marketing/advertising expenses; reputation of
incumbent
• Countervailing power
Welfare effects
• Allocative efficiency: pricing with market power
means under-consumption of these goods (a misallocation of goods produced to consumption)
• Productive efficiency: using the resources
efficiently to minimise the costs of production
• Dynamic efficiency: the incentives and allocation
of resources for changing what is possible: R&D,
innovation etc.
• High profits could be good: enables funding for
product development (although also encourages
rent seeking)
Barriers to Entry
• Entry barriers are factors that make entry unprofitable
while permitting established firms to set prices above
marginal cost and persistently earn monopoly returns
• Barriers to entry exist only if after entry, the entrant’s
long-run costs are greater than those of the incumbent
• Three factors generally contribute to entry barriers:
– Economies of scale
– Product differentiation
– Absolute cost advantages
• These are entry barriers because they are potential
sources of disadvantage for entrants vis-à-vis
incumbents.
Economies of Scale
• Economies of scale imply that the entrant has to have
minimum market share to be profitable
• The ability to sink costs allows incumbent to commit to
greater level of output, thereby restricting the
equilibrium market share of the entrant
• Incumbents can strategically deter entry of an equally
efficient rival if there are economies of scale and some
mechanism whereby the incumbent can commit to
producing greater output
• The greater the economies of scale the smaller the
required degree of commitment
Product Differentiation
• Product differentiation is a barrier to entry if it leads to
significant buyer preferences between established products
and the products of new entrants.
• We assume that entra
• nts cannot enter and produce a product identical to the
incumbents from the customer’s perspective
• Product differentiation can raise entry barriers when it
reduces the size of the market and thereby enhances the
effect of economies of scale
• Incumbent products that have characteristics that appeal to
most consumers or that have greater cross-elasticities of
demand with an entrant’s product will reduce the
profitability of entry
Absolute Cost Advantages
• Absolute cost advantages make entry
deterrence on part of incumbent more likely
• Absolute cost advantages occur when the
incumbent firm has lower average costs than
an entrant at any potential scale of operation
Barriers to Entry (cont.)
• Product differentiation, economies of scale and
capital cost differentials create entry barriers
because of the costs of information
• To the extent that product differentiation,
economies of scale and cost differentials create
entry barriers and preserve monopoly profits,
they supplement the incentives provided for
research and development
• Barriers to entry into production reduce barriers
to entry into innovation and vice versa.
Theories of Harm
• Unilateral effects (horizontal mergers)
– Market power
– Elimination of an effective competitor
• Co-ordinated effects (horizontal and vertical
mergers)
– Ability to collude, market structure, number of players
– Flow of information, detecting cheating, retaliation
• Foreclosure (vertical mergers)
– Input or customer
• Portfolio effects (conglomerate mergers)
Key Factors in Assessing Strength of
Competition
Factors considered when assessing the strength of competition
in the relevant market
• Actual and potential levels of import competition
• Ease of entry, tariff, regulatory barriers, contestability of the
market
• Trends in concentration, history of collusion
• Degree of countervailing power
• Dynamic characteristics of the market, growth, innovation,
product differentiation
• Nature and extent of vertical integration: foreclosure,
collusion
• Failing firm arguments
• Removal of an effective competitor
Weighing of Efficiency Gains
• Evaluation of technological, efficiency or other
procompetitive gains
• Defence to an anti-competitive merger or
restrictive vertical or horizontal practice
• Efficiencies must be quantifiable, sustainable, and
attainable by no means other than the merger or
restrictive conduct
• Total welfare concept vs consumer welfare
concept. Consumer welfare more important
consideration.