REGULATION AND COMPETITION
Lesson 1.
Overview and economics background
Cabral 2, Froeb 3,4,6.
Instructor: Rafael Moner Colonques
1
Department of Economic Analysis
Slides
Industrial Organization: Markets and Strategies
Paul Belleflamme and Martin Peitz
University of Valencia
Degree in International Business
LESSON 1.
Firms, strategies and markets.
Allocative, productive and dynamic efficiency.
Market power.
Market structure and efficiency
Tools: game theory.
2
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Competition Policy
Based on microeconomic analysis and particularly
IO.
You should be familiar with monopoly and oligopoly
analysis.
Firms maximize profits so they need good
knowledge of
demand,
costs,
and strategies.
3
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Demand
A simple multiple question arises: how consumers see
your product, how many units they want to buy and
how much they want to pay for each specific amount.
This leads us to the “willingness to pay” concept.
Willingness to pay
Decreasing with the units bought.
It is used to derive the product demand curve.
Related with the “consumer surplus” concept.
4
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Consumer surplus
Definition.
How to spot it in a figure.
Relevance for firms
Demand elasticity
Gives interesting information about consumers’
behavior.
It is a mathematical notion related with the slope of a
particular function (in our case the demand curve).
It relates percent variations of units bought with
percent variations in price.
5
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Costs
Traditional view of a firm as a black box
transforming some commodities (inputs) into others
(outputs).
Some control on that process is required by the firm
managers.
Total cost function tells how efficient is the firm by
saying total cost paid for inputs required to produce q
units of output.
Different cost concepts
Fixed , variable and total cost.
Average and marginal cost.
6
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Managerial use of cost concepts
Average cost (AC) has to be looked at when deciding
whether to shut down the firm.
Marginal cost (MC) is the appropriate measure to
decide how much to produce.
Supply function
Definition: it is the MC function for values of price
greater than the minimum AC function.
7
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Opportunity cost
Useful for any decision process either by firms,
consumers and governments.
The opportunity cost of using time, money or any
other resource for a given use is defined as the
foregone benefit from not applying the resource in its
best alternative use.
Sunk cost
Definition and its relationship with the opportunity
cost concept.
8
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Economic cost
Important rule
Economic decisions must be based on
economic costs.
9
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Economies of scale
How costs grow as output increases.
A total cost function may exhibit economies of scale,
diseconomies of scale and/or constant returns to
scale.
Minimum efficient scale (MES)
Economies of scope
How cost increases as the number of products does.
10
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Strategy: Decision theory vs. Game theory
Decision theory → isolated choices → monopoly
Game theory → strategic interaction → oligopoly
Strategy
Firms develop strategies to gain a competitive
advantage.
A competitive advantage can take different shapes.
Competitors can’t easily imitate competitive
advantages.
Firms with a competitive advantage are able to earn
positive economic profits.
Broadly speaking, strategy is all about raising price
or reducing cost.
11
Monopoly
MONOPOLY AND MONOPOLY POWER
8-12
Monopoly
MONOPOLY AND MONOPOLY POWER
8-13
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Three basic strategies to keep one step ahead of
the forces of competition.
Cost reduction,
product differentiation, or
reduction in competition intensity.
It seems simple but it is not easy to find
successful strategies.
14
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Basic strategic decision: how to set output.
You need good knowledge of both the demand curve
of your product and the cost function.
Your goal is to maximize economic profits, defined as
the difference between revenues (R) and costs (C).
Π (q) = R(q ) − C (q )
Standard calculus tells us that the q that maximizes
profits is q* , the one that equates
MR(q*) = MC (q*)
15
LESSON 1 – FIRMS, STRATEGIES AND
MARKETS
Take the case where R(q) = p(q) q. Then,
MR(q ) = p (q ) +
∂p
q
∂q
And using the definition for demand elasticity,
1
MR(q ) = p1 −
ε
Since ε > 0 → MR < p
As ε increases, MR tends to p.
Our decision rule reads:
↑q
1 >
if p1 − MC →
ε <
↓q
16
LESSON 1 – ALLOCATIVE, PRODUCTIVE
AND DYNAMIC EFFICIENCY
In a simple economic activity as it is exchange,
all economic agents involved obtain gains from
trade.
Consumers obtain what is measured by the CS,
Firms what is measured by the PS.
Adding CS and PS we obtain the total surplus (TS).
Efficiency is a central concept in IO and we are
going to present three different notions of it.
17
LESSON 1 – ALLOCATIVE, PRODUCTIVE
AND DYNAMIC EFFICIENCY
Allocative efficiency
Measures whether resources are allocated to their
best (efficient) use (see figure).
Allocative efficiency is measured by TS. Thus
maximum allocative efficiency (or just allocative
efficiency) is equivalent to maximum TS.
Productive Efficiency
Relates how close is the actual production cost to the
lowest possible one.
18
LESSON 1 – ALLOCATIVE, PRODUCTIVE
AND DYNAMIC EFFICIENCY
Dynamic efficiency
Related with the reduction in cost along the time and
with the introduction of new products.
Trade-off between static and dynamic efficiency.
19
LESSON 1 - MARKET POWER
Market power
markets are usually classified into
Perfectly competitive markets
Both sides of the market are price-takers,
Correspond to industries with small entry barriers and
large number of small firms.
Individual demand curve with infinite elasticity.
Markets in which firms have market power
Applies to large firms, but also to small ones.
An incremental price increase does not lead to a loss of
all of the demand. Residual demands is downward
sloping.
20
LESSON 1 - MARKET POWER
Market power definitions
Narrow definition which focuses only on allocative
efficiency:
The ability of a firm to set its price p
(i) substantially above marginal costs c, or
(ii) above the competitive price level.
EC Commission definition focusing on dynamic
efficiency too.
“The ability to maintain prices
above competitive levels for a significant period of time or
to maintain output in terms of product quantities, product
quality and variety or innovation below competitive levels
for a significant period of time.”.
21
LESSON 1 - MARKET POWER
Market power is related to demand elasticity.
Retrieve the monopoly-pricing formula,
1
p1 − = MC
ε
and do some manipulation to reach the also known
inverse elasticity rule:
p − MC 1
=
p
ε
The relative mark-up (or Lerner index) is increasing as
demand become less price elastic.
To conclude that in general the larger the Lerner
index the stronger the market power.
22
LESSON 1 - MARKET POWER
Market power is also related to market concentration.
Consider now a n-firm symmetric oligopoly. Where firm i’s
profit function is
Π i = p (Q ) qi − C ( qi ), with Q =
n
∑q
i =1
at the symmetric equilibrium, qn= qi* for all i, the Lerner
index reads
p (Q) − MC
q n ∂p (Q)
=−
p (Q)
p (Q) ∂Q
or
p (Q) − MC si
= , with ε1 = − p (QQ ) ∂p∂(QQ ) and si = qQi
p (Q)
ε
Finally, we find that market power is decreasing with the
number of firms:
1
L=
nε
i
23
LESSON 1 - MARKET POWER
In case of an asymmetric oligopoly, we can define the
Lerner index as the weighted average of each firm’s
margin with the weights being the firm’s market
share.
p(Q) − MCi
L = ∑ si
p (Q)
i =1
n
We are interested in relating market power with
industry (or market) concentration.
Indices to measure industry concentration:
Concentration index (Ck)
Herfindahl-Hirschman index (HH)
24
LESSON 1 - MARKET POWER
Concentration index k (Ck) is defined as de sum of the
market shares of the k largest firms in the industry
4
with k < n. For instance, if k = 4
C4 = ∑ si
i =1
HH index is defined as the sum of the squared market
shares of all the firms in the industry.
n
Where 0 < HH < 1.
HH = ∑ si2
i =1
25
LESSON 1 - MARKET POWER
Finally using the definition of the Lerner index and
the equilibrium condition, we find that
p(Q) − MCi n si HH
= ∑ si =
L = ∑ si
p (Q)
ε
i =1
i =1 ε
n
Market power (approx. by L) decreases with the
demand elasticity and increases with the industry
concentration.
26
LESSON 1 – MARKET STRUCTURE AND
EFFICIENCY
27
LESSON 1 – MARKET STRUCTURE AND
EFFICIENCY
Goal of competition policy: avoid monopolization
However sometimes there are “natural
monopolies” (oligopolies)
Supply and demand conditions are such that only a
limited number of firms can enjoy positive profits.
For instance, in transport, telecommunications and
utilities.
Solution: regulated monopolies
28
LESSON 1 – TOOLS: GAME THEORY
29
LESSON 1 – TOOLS: GAME THEORY
30
LESSON 1 – TOOLS: GAME THEORY
31
LESSON 1 - TOOLS: GAME THEORY
Motivating example: Standards wars.
In February of 2002, nine of the world’s largest
electronics companies, led by Sony, announced plans
for a next-generation large-capacity optical disc video
recording format called Blu-ray.
In August of 2002, Toshiba and NEC announced
plans for a rival technology, which would become
known as HD-DVD.
They spent the next few years fighting what is known
as a “standards war” while consumers waited on the
sidelines to see who would win the war.
32
LESSON 1 - TOOLS: GAME THEORY
In 2004, Sony recruited HP, Dell, and Disney into the
Blu-ray camp, whereas Toshiba convinced
Paramount Pictures, Universal Pictures, Warner
Brothers, HBO, and New Line Cinema to support
HD-DVD.
In 2005, Microsoft and Intel also joined HD-DVD;
Lions Gate Home Entertainment and Universal
Music Group went with Blu-ray, and Paramount and
HP backed off their previous commitments in order to
back both standards.
In 2007, both camps resorted o big price cuts—Bluray players formerly priced at $499 could be had for a
price of $399, along with a $100 gift certificate and
five free movies.
33
LESSON 1 - TOOLS: GAME THEORY
In 2008, Blu-ray convinced Warner Brothers
Entertainment, owner of the hugely popular Lord of
the Rings and Harry Potter movies, to release movies
exclusively in Blu-ray.
The final victory for Blu-ray came in February of
2008 when Walmart announced it would drop HDDVD players in favor of Blu-ray.
34
LESSON 1 - TOOLS: GAME THEORY
In situations like this, the profit of one firm
depends critically on the actions of others. To
analyze this interdependence, we use what is
known as game theory.
Knowing game theory doesn’t just help you
figure out what’s likely to happen; it also gives
you insight on how you might be able to change
the game to your advantage.
The standards war was the result of Sony and
Toshiba efforts to convince other market
participants that their standard would emerge
victorious.
35
LESSON 1 - TOOLS: GAME THEORY
Some Definitions
A game consists of a set of players, a set of rules
(who can do and what) and a set of payoff functions.
Players’ planned decisions are called strategies.
Payoffs to players are the profits or losses resulting
from strategies.
Order of play is important:
Simultaneous-move game.
Sequential-move game.
Frequency of rival interaction
One-shot game.
Repeated game.
36
LESSON 1 - TOOLS: GAME THEORY
Simultaneous-move Games
We use the matrix or normal form of a game to study
these games.
A Normal Form Game consists of:
Set of players i ∈ {1, 2, … n} where n is a finite number.
Each players strategy set or feasible actions consist of a
finite number of strategies.
Take for example:
Player 1’s strategies are S1 = {a, b, c, …}.
Player 2’s strategies are S2 = {A, B, C, …}.
Payoffs:
• Player 1’s payoff: π1(a,B) = 11.
• Player 2’s payoff: π2(b,C) = 12.
…..
37
LESSON 1 - TOOLS: GAME THEORY
Player 1
…..
Strategy
a
b
c
A
(12,11)
(11,10)
(10,15)
Player 2
B
(11,12)
(10,11)
(10,13)
C
(14,13)
(12,12)
(13,14)
Best Response
Suppose P1 thinks P2 will choose “B”. Then P1 should
choose “a”. Thus Player 1’s best response to “B” is “a”.
Similarly, if P1 thinks P2 will choose C, Player 1’s best
response to “C” is “a”.
38
LESSON 1 - TOOLS: GAME THEORY
Player 1
…..
Strategy
a
b
c
A
(12,11)
(11,10)
(10,15)
Player 2
B
(11,12)
(10,11)
(10,13)
C
(14,13)
(12,12)
(13,14)
Secure Strategy
guarantees the highest payoff given the worst possible
scenario.
Strategy C guarantees 12 to P2 and a guarantees 11 to P1
39
LESSON 1 - TOOLS: GAME THEORY
Player 1
…..
Strategy
a
b
c
A
(12,11)
(11,10)
(10,15)
Player 2
B
(11,12)
(10,11)
(10,13)
C
(14,13)
(12,12)
(13,14)
Dominant Strategy
Regardless of whether P2 chooses A, B, or C, P1 is
better off choosing “a”!
Therefore “a” is Player 1’s Dominant Strategy!
π1(a,A) > π1(b,A) ≥ π1(c,A); π1(a,B) > π1(b,B) ≥ π1(c,B);
and π1(a,C) > π1(b,C) ≥ π1(c,C).
40
LESSON 1 - TOOLS: GAME THEORY
Player 1
…..
Strategy
a
b
c
A
(12,11)
(11,10)
(10,15)
Player 2
B
(11,12)
(10,11)
(10,13)
C
(14,13)
(12,12)
(13,14)
Putting Yourself in your Rival’s Shoes
What should player 2 do?
P2 has no dominant strategy! But P2 should reason that P1
will play “a”. Therefore P2 should choose “C”.
41
LESSON 1 - TOOLS: GAME THEORY
The Outcome
This outcome is called a Nash equilibrium, named for
John Nash, the mathematician and Nobel laureate in
economics.
“a” is player 1’s best response to “C”.
“C” is player 2’s best response to “a”.
A Nash equilibrium is a pair of strategies, one for
each player, in which each strategy is a best response
against the other.
42
LESSON 1 - TOOLS: GAME THEORY
The Outcome
In other words, a set of strategies such that no player
has an incentive to change given the other player’s
strategy because all players are doing the best that
they can.
Formally, (s1*,s2*) is a NE iff
π1 (s1*,s2*) ≥ π1 (s1,s2*) for all s1.
π2 (s1*,s2*) ≥ π2 (s1*,s2) for all s2.
43
LESSON 1 - TOOLS: GAME THEORY
Prisoners’ Dilemma
The prisoners’ dilemma is perhaps the oldest and
most studied game in the history of game theory.
Jesse
confess
Say nothing
FRANK
confess
say nothing
(-5,-5)
(-10,0)
(0,-10)
(-2,-2)
The only Nash equilibrium is in the upper-left corner
{Confess, Confess}.
Note the tension between conflict (self-interest) and
cooperation (group interest) inherent in the game.
44
LESSON 1 - TOOLS: GAME THEORY
Game of chicken
In the classic game of chicken, two teenage boys—
say, James and Dean—drive their cars straight
toward each other.
Dean
go straight
swerve
JAMES
go straight
swerve
(-10,-10)
(3,0)
(0,3)
(0,0)
Intuitively, you should realize that there are two
equilibria to this game.
Note that each party prefers one of the equilibria.
This implies an obvious strategy: Commit to a
position, and make sure your rival understands your
commitment.
45
LESSON 1 - TOOLS: GAME THEORY
Coordination here is important so that the players
don’t end up killing each.
Commitment changes what is essentially a
simultaneous-move game into a sequential-move game
with what is known as a “first-mover” advantage.
The difficult part is convincing the other player that
you have committed to a position (i.e., moved first).
One way to do this is to lock the steering wheel in place
and throw away the key.
Make sure that the other player sees you do this.
Otherwise, he may try to commit to going straight, and
you could both end up dead.
The standards war between Blu-ray and HD-DVD
can be thought of as a “coordination” game that has the
same logical structure as a game of chicken.
46
LESSON 1 - TOOLS: GAME THEORY
Sequential-move Games
Players take turns, and each player observes what
his or her rival did before having to move.
To compute the equilibrium of a sequential game, it’s
important to look ahead and reason back.
In the games that follow, we represent sequential
games using the extensive or tree form of a game,
familiar to anyone who’s ever used a decision tree.
47
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
48
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
49
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
In the game illustrated in the Figure, an entrant is
trying to decide whether to enter an industry in
competition with an incumbent firm.
50
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
The entrant has two strategies:
{In, Out}.
{if In play Fight, if In play Acc, If Out play Fight, If Out
play Fight}
The Monopolist has got four:
51
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
Sub-game perfect equilibrium is a set of
strategies that constitutes a Nash equilibrium and
allows no player to improve his own payoff at any
stage of the game by changing strategies.
Players are playing Nash in every possible sub-game.
It is a Nash equilibrium that involves only credible
threats.
52
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
Two NE, {Out, If In play Fight} and {In, If In play
Acc}
53
LESSON 1 - TOOLS: GAME THEORY
Entry deterrence game.
The sub-game perfect Nash equilibrium of the game
is {In, If In play Accommodate}.
54
LESSON 1 - TOOLS: GAME THEORY
The analysis doesn’t stop here, we also want some
guidance about how to change the game to our
advantage.
For example, if the incumbent could figure out how to
deter entry, he could end up on the right branch of
the tree and earn $10 instead of $5.
One way of deterring entry is to threaten to fight if
the entrant should enter.
If the entrant believes the threat, she’ll stay out
because entry, combined with an incumbent’s low
price, would yield a loss of $5 for the entrant.
We diagram the threat by eliminating one of the
branches of tree.
55
LESSON 1 - TOOLS: GAME THEORY
By eliminating one of his own options, the incumbent
has changed the equilibrium of the game.
The new equilibrium is {Out, Fight}.
56
LESSON 1 - TOOLS: GAME THEORY
The difficult part if you are the incumbent is figuring
out how to convince the entrant you’ll price low
following entry because pricing low is less profitable
than pricing high if entry does occur.
To make this threat credible, you have to act against
your own self-interest.
Remember that this is the whole point of studying
game theory. Analyzing the game helps you figure
out how you can restructure the game to your
advantage.
57
REGULATION AND COMPETITION
Lesson 2.
Introduction to regulation
Cabral 5, Baye (8th ed) 14
Instructor: Rafael Moner Colonques
1
Department of Economic Analysis
Slides
Industrial Organization: Markets and Strategies
Paul Belleflamme and Martin Peitz
University of Valencia
Degree in International Business
LESSON 2 - REGULATION AND
COMPETITION.
Regulation vs. competition policy.
Instruments of regulation.
The natural monopoly.
Regulation in natural monopolies.
2
LESSON 2 – REGULATION VS COMPETITION
POLICY
Regulation is broadly defined to be government
intervention to change market outcomes. The
intervention can directly affect market outcomes,
such as prices, quality, product variety, or the
number of service providers, by changing market
institutions.
3
LESSON 2 – REGULATION VS COMPETITION
POLICY
Why regulate? One prominent rationale is natural monopoly
Because the market outcome is not socially
desirable. The public interest explanation is
that regulation is a response to market failure.
There are also economic explanations,
based on the premise that there is a demand
for regulation from groups who could benefit
from the redistribution of income and wealth
resulting from regulation and that the political
process provides incentives for governments
and politicians to supply regulation.
[think also of environmental protection, worker and
consumer protection].
4
LESSON 2 – REGULATION VS COMPETITION
POLICY
Regulation and competition policy differ:
Procedures and control rights
Regulation: more power (prices, investments, products…),
and may intervene market structure
Time horizon
Ex-post (competition policy) vs. ex-ante (regulation).
Continuity (regulation) vs. intermittency (competition pol)
Information
more industry specific in regulation
At any rate, distinction is unclear. Posner (1975)
said that the social cost of monopoly is larger
than the “deadweight loss”. (and include costs of
preventing market competition as well as wasted resources
in advertising, R&D, etc)
5
LESSON 2 – INSTRUMENTS OF
REGULATION
Price controls, price cap regulation (which provides
incentives for cost reduction).
Taxes and subsidies
Rate-of-return regulation, a mechanism whereby
prices are set to allow a fair rate of return on the
capital it invests.
Introduction of competition (RENFE faces entry of
OUIGO and IRYO).
Access pricing in essential facilities. ECPRule.
6
LESSON 2 – THE NATURAL MONOPOLY
Goal of competition policy: avoid monopolization
However sometimes there are “natural
monopolies” (oligopolies)
Supply and demand conditions are such that only a
limited number of firms can enjoy positive profits.
For instance, in transport, telecommunications and
utilities.
Solution: regulated monopolies
7
LESSON 2 – THE NATURAL MONOPOLY
8
LESSON 2 – THE NATURAL MONOPOLY
9
LESSON 2 – THE NATURAL MONOPOLY
Alcoa’s natural monopoly
1886: process of smelting aluminium is patented
A small number of firms use the patent and start
to dominate the industry.
Most successful: Alcoa (ALuminum COmpany of America)
How?
Large economies of scale Alcoa develops markets for
its growing output (intermediate and final aluminium
products)
Production intensive in energy in 1893, Alcoa signs in
advance for hydroelectric power produced at Niagara
Falls
Production intensive in bauxite Alcoa stakes out all
the best sources of North American bauxite for itself.
Efficiency gains Entry more difficult, even after
expiration of patents
Other factors Public policy, tariff protection, limited
antitrust check before 1914.
10
LESSON 2 – THE NATURAL MONOPOLY
Natural oligopolies. Industries usually
characterized by:
o
o
o
Economic dilemma in natural oligopolies.
o
very high sunk costs,
relatively low marginal costs,
increasing returns to scale.
Productive efficiency calls for few firms while
allocative efficiency says the contrary.
Public authorities should look for allocative
efficiency when regulating monopolies
11
LESSON 2 – REGULATION IN NATURAL
MONOPOLIES
Pareto efficiency conditions in general
equilibrium and the maximization of Total
Surplus in partial equilibrium lead to the same
rule: marginal cost pricing.
Then a first natural solution for a regulator is to
force the monopolist to marginal cost…firstbest outcome…see graph
12
LESSON 2 – REGULATION IN NATURAL
MONOPOLIES
Maximum allocative efficiency. However, it may
imply negative profits when average cost is not
constant. Subsidize F, then raise taxes, regulatory capture.
13
LESSON 2 - REGULATION IN NATURAL
MONOPOLIES
This pricing rule is first found in Dupuit’s (1844)
bridge: once build, it is inefficient to set a positive
toll since there is no variable cost involved, in the
absence of congestion.
Obviously, the bridge is there because an
investment was made. Then, how to finance that
investment?
If the natural monopoly cannot cover costs under
the marginal pricing rule, then the next option is
average cost pricing.
14
LESSON 2 - REGULATION IN NATURAL
MONOPOLIES
The firm is forced to
set the lowest price
consistent with
making nonnegative profits,
that is, price is
equal to average
cost (second best
outcome). A
mechanism also
known as rate-ofreturn regulation.
15
LESSON 2 - REGULATION IN NATURAL
MONOPOLIES
16
LESSON 2 - REGULATION IN NATURAL
MONOPOLIES
17
REGULATION AND COMPETITION
Lesson 3.
Competition law in the States and in
the EU
Instructor: Rafael Moner-Colonques
1
Department of Economic Analysis
Slides
Industrial Organization: Markets and Strategies
Paul Belleflamme and Martin Peitz
University of Valencia
Degree in International Business
OVERVIEW
Origins
Competition law in the States:
Competition law in the EU:
Sherman Act, Clayton Act and FTC Act.
from the Treaty of Rome to the Treaty of Lisbon.
The “per se” prohibition and the “rule of reason”.
2
MY WAY (FROM PEPALL, RICHARDS, NORMAN)
1890
Sherman Act
Railroads,
Steamships
“trusts”.
1914
Clayton Act
FTC Act
Sect 1. 1897 Trans-Missouri
Freight Association, Addyston
Pipe.
Sect 2. 1911 Standard Oil
Co, Tobacco trust.
1936
Robinson-Patman
Act
1920 US Steel Corp
(weakens Sect 2).
1933 Appalachian Coal (not
against Sect 1)
3
MY WAY (FROM PEPALL, RICHARDS, NORMAN)
1945 Alcoa (mkt definition
plus capacity expansion to
infer illegal monopolization
Sect 2); 1946 American
Tobacco (same for several
firms)
Use of concentration
measures against prices and
profits.
1956 DuPont definition of
relevant market (innocent of
Sect 2)
4
MY WAY (FROM PEPALL, RICHARDS, NORMAN)
1957
Treaty of Rome
Art. 81-82
1962 Brown Shoe, 1964
Grinnell Corp (against Sect 2)
1967 Utah pie vs
Continental (predation).
1964 First EU case Grosfillex
& Fillistorf,
5
LESSON 3 - ORIGINS
Why do we need to restrict market power?
Market power causes inefficiencies
Public policies are used to reduce the negative
consequences derived from firms’ market power:
Regulation
Competition policy (antitrust)
6
LESSON 3 - ORIGINS
Regulation and competition policy differ by:
Procedures and control rights
Timing of oversight
Information
Despite these differences, the distinction between
competition and regulation is not clear-cut.
7
LESSON 3 - ORIGINS
Definition of Competition(Antitrust) Law in US:
Legislation enacted by the federal and various state
governments to regulate trade and commerce by
preventing unlawful restraints, price-fixing, and
monopolies, to promote competition, and to encourage
the production of quality goods and services at the
lowest prices, with the primary goal of safeguarding
public welfare by ensuring that consumer demands
will be met by the manufacture and sale of goods at
reasonable prices.
8
LESSON 3 - ORIGINS
These fall into four main areas:
agreements between competitors,
contractual arrangements between sellers and
buyers,
the pursuit or maintenance of monopoly power, and
mergers.
9
LESSON 3 – ORIGINS
In the late XIXth century, the American industry
was dominated by large firms that flourish.
Firms devise a new ownership structure called
trust to monopolize their respective industries in
a way similar to that employed by German
cartels.
10
LESSON 3 – ORIGINS
Trusts consolidated control of industries.
Time for John D. Rockefeller and J. P. Morgan.
By the 1880s, abuses by the trusts brought a
public outcry over them.
11
LESSON 3 – ORIGINS
In 1890, Congress took aim at the trusts with
passage of the Sherman Anti-Trust Act.
The Sherman Act outlawed trusts altogether and
passed by nearly unanimous votes in both houses
of Congress.
However, for a public expecting overnight
change, the process worked all too slowly.
12
LESSON 3 – ORIGINS
Initial setbacks also came from the Supreme
Court's first consideration of the statute, in
United States v. E. C. Knight Co., (1895).
The Court rejected a challenge to a sugar trust
that controlled over 98 percent of the nation's
sugar refining capacity.
The situation changed with Presidents Theodore
Roosevelt and William Howard Taft.
13
LESSON 3 – ORIGINS
In 1911, the Supreme Court ordered the
dissolution of the Standard Oil Company and the
American Tobacco Company.
In Standard Oil Co. of New Jersey v. United
States the Court dissolved the trust into thirtythree companies.
14
LESSON 3 – COMPETITION LAW IN US
The Sherman Anti-Trust Act of 1890 is the
basis for antitrust law.
Congress added amendments to it at various times
through 1950.
The most important are the Clayton Act of 1914
and the Robinson-Patman Act of 1936.
A regulatory agency was created under the
Federal Trade Commission Act of 1914.
15
LESSON 3 – COMPETITION LAW IN US
The Sherman Act.
§1
Every contract, combination in the form of trust or
otherwise, or conspiracy, in restraint of trade or
commerce among the several States, or with foreign
nations, is declared to be illegal. Every person who shall
make any contract or engage in any combination or
conspiracy hereby declared to be illegal shall be deemed
guilty of a felony, and, on conviction thereof, shall be
punished by fine not exceeding $100,000,000 if a
corporation, or, if any other person, $1,000,000, or by
imprisonment not exceeding 10 years, or by both said
punishments, in the discretion of the court.
16
LESSON 3 – COMPETITION LAW IN US
The Sherman Act.
§2
Every person who shall monopolize, or attempt to
monopolize, or combine or conspire with any other
person or persons, to monopolize any part of the trade
or commerce among the several States, or with foreign
nations, shall be deemed guilty of a felony, and, on
conviction thereof, shall be punished by fine not
exceeding $100,000,000 if a corporation, or, if any other
person, $1,000,000, or by imprisonment not exceeding
10 years, or by both said punishments, in the discretion
of the court.
17
LESSON 3 – COMPETITION LAW IN US
These two sections of the Act contain the two
central key principles of modern antitrust policy
throughout the world,
conduct that restrains trade and
conduct that creates or maintains a monopoly
is deemed to be anticompetitive.
18
LESSON 3 – COMPETITION LAW IN US
The Sherman Act imposes criminal penalties of
up to $100 million for a corporation and $1 million for an
individual,
along with up to 10 years in prison.
Under federal law, the maximum fine may be increased
to twice the amount the conspirators gained from the
illegal acts or twice the money lost by the victims of the
crime, if either of those amounts is over $100 million.
19
LESSON 3 – COMPETITION LAW IN US
The Clayton Act
In 1914 Congress passed the Clayton Act, which
identified specific types of conduct that were believed to
threaten competition.
Section 7 of the Clayton Act prohibits mergers and
acquisitions where the effect “may be substantially to
lessen competition, or to tend to create a monopoly.”
Other sections of the Clayton Act address particular
types of conduct.
20
LESSON 3 – COMPETITION LAW IN US
The Clayton Act
Section 2, which was amended and replaced by Sect. 1 of
the Robinson-Patman Act in 1936, prohibits price
discrimination …. Also bans certain discriminatory
prices, services, and allowances in dealings between
merchants.
The Clayton Act was amended again in 1976 by the HartScott-Rodino Antitrust Improvements Act to require
companies planning large mergers or acquisitions to
notify the government of their plans in advance.
21
LESSON 3 – COMPETITION LAW IN US
The Clayton Act
Section 3 of the Clayton Act specifically prohibits certain
agreements in which a product is sold only under the
condition that the purchaser will not deal in the goods of
a competitor. (Exclusive dealing and tied sales)
The Clayton Act also authorizes private parties to sue for
triple damages when they have been harmed by conduct
that violates either the Sherman or Clayton Act and to
obtain a court order prohibiting the anticompetitive
practice in the future.
22
LESSON 3 – COMPETITION LAW IN US
Federal Trade Commission Act
The US is nearly unique among competition-law
countries in having two enforcement agencies (DOJ and
FTC).
Section 5 of the Federal Trade Commission Act, which
enables the FTC to challenge “unfair” competition, can be
applied to consumer protection as well as mergers.
In addition, the FTC has the power to enforce the Clayton
Act and the Robinson-Patman Act.
23
LESSON 3 – COMPETITION LAW IN US
The Enforcers
Federal Government
States
Private parties
Other Commissions
24
LESSON 3 – COMPETITION LAW IN US
The Enforcers: Federal Government
Both the FTC and the U.S. Department of Justice (DOJ)
Antitrust Division enforce the federal antitrust laws.
Over the years, the agencies have developed expertise in
particular industries or markets.
Before opening an investigation, the agencies consult
with one another to avoid duplicating efforts.
25
LESSON 3 – COMPETITION LAW IN US
The Enforcers: Federal Government (cont’d)
Premerger notification filings, correspondence from
consumers or businesses, Congressional inquiries, or
articles on consumer or economic subjects may trigger an
FTC investigation.
FTC investigations are non-public.
Final decisions issued by the Commission may be
appealed to a U.S. Court of Appeals and, ultimately, to
the U.S. Supreme Court.
26
LESSON 3 – COMPETITION LAW IN US
The Enforcers: Federal Government (cont’d)
The FTC also may refer evidence of criminal antitrust
violations to the DOJ. Only the DOJ can obtain criminal
sanctions.
The DOJ also has sole antitrust jurisdiction in certain
industries.
Some mergers also require approval of other regulatory
agencies using a “public interest” standard.
27
LESSON 3 – COMPETITION LAW IN US
The Enforcers: States
State attorneys general can play an important role in
antitrust enforcement on matters of particular concern to
local businesses or consumers.
The state attorney general also may bring an action to
enforce the state’s own antitrust laws.
In merger investigations, a state attorney general may
cooperate with federal authorities.
28
LESSON 3 – COMPETITION LAW IN US
The Enforcers: Private parties
Private parties can also bring suits to enforce the
antitrust laws.
In fact, most antitrust suits are brought by businesses
and individuals seeking damages for violations of the
Sherman or Clayton Act.
Individuals and businesses cannot sue under the FTC
Act.
29
LESSON 3 – COMPETITION LAW IN US
The Enforcers: Other commissions
The FCC (Federal Communication Commission) is the
enforcer of the Communications Act (1934).
The FERC (Federal Energy Regulatory Commission)
established in 1977 is in charge of regulating interstate
commerce of energy.
30
LESSON 3 – COMPETITION LAW IN US
The stages of a typical US antitrust litigation
With the exception of merger challenges, most civil
antitrust cases involve three stages where the court
assesses the sufficiency of evidence.
At the initial stage, the trial judge may dismiss a case if
the complaint itself fails to state “evidence” that can
support the claim. Motions to dismiss.
The next stage at which a court seriously assesses the
sufficiency of evidence in on a defendant’s motion for
summary judgment
31
LESSON 3 – COMPETITION LAW IN US
The stages of a typical US antitrust litigation (cont’d)
Under US procedural rules, a court may grant summary
judgment only if the pleadings
“show that there is no genuine issue as to any material fact and
that the moving part is entitled to judgment as a matter of law”.
Again the moving part bears the burden of proving that no
genuine issue of material fact exists.
If neither plaintiffs nor defendants are granted
summary judgment, then the case will usually
proceed to trial.
32
LESSON 3 – COMPETITION LAW IN US
The stages of a typical US antitrust litigation (cont’d)
Finally, even after a trial, a judge has the ability to set
aside the jury’s ruling on a motion for judgment
notwithstanding the verdict.
33
LESSON 3 – COMPETITION LAW IN EU
Some history
In 1945 after centuries of conflict, European leaders
finally understand that the path to a better future is to
form an economic and political league.
Jean Monnet proposed a pooling of resources in coal, iron
and steel sectors between the two countries (France and
West Germany) and others willing to join.
The Treaty of Paris establishes the ECSC (European Coal
and Steel Community).
34
LESSON 3 – COMPETITION LAW IN EU
Some history (cont’d)
In 1957, the Treaty of Rome is signed (European
Economic Community) to extend the previous treaty to all
sectors in the economy in order to form common market.
The foundation of European competition policy was laid
in the Treaty of Rome in 1957.
Article 3(1)(g) identifies as one of the general objectives of
the European Community the achievement of
“a system ensuring that competition in the internal market is not
distorted”.
35
LESSON 3 – COMPETITION LAW IN EU
Thus, treaties constitute the European Union’s
primary legislation.
Other legislation known as secondary legislation
includes
binding legal instruments (regulations, directives and
decisions) and
non-binding instruments (resolutions, opinions).
By means of a decision, the institutions can require a
Member State or a citizen of the Union to take or refrain
from taking a particular action, or confer rights or impose
obligations on a Member State or a citizen.
All the decisions handed down by bodies exercising
36
judicial powers constitute case-law.
LESSON 3 – COMPETITION LAW IN EU
Since 1957, the Treaty of Rome has been amended
several times,
the latest major amendments being made by the
Treaty of Lisbon in 2007, which entered into force on 1
December 2009. The institutional and normative
structure of the EU is now based on two core treaties:
the Treaty on European Union (EU Treaty) and
the Treaty on the Functioning of the European Union (FEU
Treaty).
In competition policy we are mainly concerned
with the Treaty on the Functioning of the
European Union (TFEU)
37
LESSON 3 – COMPETITION LAW IN EU
The objectives of the Competition policy in the EU
are:
“…to establish the competition rules necessary for the
functioning of the internal market” (Article 3 TFEU).
“…EU shall adopt measures with the aim of establishing
or ensuring the functioning of the internal market [...
that comprises] an area without internal frontiers in
which the free movement of goods, persons, services and
capital is ensured [...].” (Article 26 TFEU).
So, one main concern is that firms create market
divisions inside the EU.
38
LESSON 3 – COMPETITION LAW IN EU
The most important articles for competition policy
are 101,102,106 and 107 TFEU.
Article 101 TFEU (was previously called Article 85
EEC Treaty and later Article 81 EC Treaty) and deals
with the agreements between firms.
Article 102 TFEU (was Article 86 in the EEC Treaty
and later Article 82 EC Treaty) is concerned with the
abuse of a dominant position.
39
LESSON 3 – COMPETITION LAW IN EU
The most important articles for competition policy
are 101,102,106 and 107 TFEU. (cont’d)
Article 106 TFEU addresses monopolistic behaviors
which dominance is authorized, maintained, or
fostered by a Member State regulation. Article 106 has
been central in the liberalization of State monopolies.
Article 107 TFEU refers to states who may not provide
aid to firms which might distort competition and affect
trade between Member States.
40
LESSON 3 – COMPETITION LAW IN EU
Enforcement.
Enforcement powers related to the competition rules
were made effective in 1962 by the implementation of
Council Regulation 17.
In essence, Regulation 17 granted the Commission the
possibility to take action in the form of opening
investigations, taking decisions and imposing remedies
and sanctions.
41
LESSON 3 – COMPETITION LAW IN EU
Enforcement. (cont’d)
This Regulation constituted the basis for the
Commission to adopt decisions establishing:
(i) an infringement of Article 101(1) or 102 FEU Treaty;
(ii) an exemption from the applicability of Article 101(1)
FEU Treaty when the conditions laid down in Article
101(3) FEU Treaty were satisfied; or
(iii) declaring the non-applicability of competition rules
to a certain agreement (negative clearance).
The first European Commission decision on
competition, in Grosfillex & Fillistorf, is dated 11
March 1964.
42
LESSON 3 – COMPETITION LAW IN EU
Enforcement. (cont’d)
In May 2004, Regulation No. 1/2003 replaced
Regulation No. 17.
It confirmed and strengthened the powers granted to
the Commission by Regulation No. 17.
Introduced the possibility for the Commission to close
the investigations, accepting commitments proposed by
the parties.
It abolished the notification system provided by
Regulation No. 17.
The notification system has been replaced by the
“directly applicable exemption” system.
43
LESSON 3 – COMPETITION LAW IN EU
Enforcement. (cont’d)
Regulation No. 1/2003 operated an important
decentralization of the enforcement competences fully
involving NCAs and national Courts.
Accordingly, the Commission is statutorily no longer
the sole executor of European competition law.
In addition to decentralization, the Commission has
recently focused on the introduction of a legal system
facilitating private litigation with the 2008 White
Paper.
44
LESSON 3 – COMPETITION LAW IN EU
Enforcers.
Competition policy is in the area of responsibility of
the European Commission.
The European Commissioner for Competition
(Margrethe Vestager as of november 2014) enforces the
rules established in European competition law,
assisted by the Directorate-General for Competition
(DG Comp) (Olivier Guersent serves currently as
Director General) and in close cooperation with the
national competition authorities of the Member States.
45
LESSON 3 – COMPETITION LAW IN EU
Enforcers. (cont’d)
In 1989, the Court of First Instance (now “General
Court”) was established to deal as the first appellate
court for appeals of Articles 101 and 102 Commission
decisions.
Its creation allowed the European Court of Justice to
concentrate on appeals proceedings that involve
Member States, and second instance appeals
exclusively on points of law.
46
LESSON 3 – COMPETITION LAW IN EU
Enforcers. (cont’d)
In 2003, the Commission created the position of Chief
Competition Economist and its support team of
economists.
In addition, the Economic Advisory Group on
Competition Policy, a group of leading academic
economic advisors, was formed.
47
LESSON 3 – COMPETITION LAW IN EU
Article 101 TFEU
1.
(a)
(b)
(c)
(d)
(e)
The following shall be prohibited as incompatible with the internal
market: all agreements between undertakings, decisions by
associations of undertakings and concerted practices which may affect
trade between Member States and which have as their object or effect
the prevention, restriction or distortion of competition within the
internal market, and in particular those which:
directly or indirectly fix purchase or selling prices or any other trading
conditions;
limit or control production, markets, technical development, or
investment;
share markets or sources of supply;
apply dissimilar conditions to equivalent transactions with other
trading parties, thereby placing them at a competitive disadvantage;
make the conclusion of contracts subject to acceptance by the other
parties of supplementary obligations which, by their nature or
according to commercial usage, have no connection with the subject of
such contracts.
48
LESSON 3 – COMPETITION LAW IN EU
Article 101 TFEU
2. Any agreements or decisions prohibited pursuant to this Article shall be
automatically void.
3. The provisions of paragraph 1 may, however, be declared inapplicable in
the case of:
- - any agreement or category of agreements between undertakings,
- - any decision or category of decisions by associations of undertakings
- - any concerted practice or category of concerted practices, which
contributes to improving the production or distribution of goods or to
promoting technical or economic progress, while allowing consumers a
fair share of the resulting benefit, and which does not:
(a) impose on the undertakings concerned restrictions which are not
indispensable to the attainment of these objectives;
(b) afford such undertakings the possibility of eliminating competition
in respect of a substantial part of the products in question.
49
LESSON 3 – COMPETITION LAW IN EU
Article 101 TFEU establishes the prohibition of
agreements and concerted practices among firms
that affect trade between Member States as well
as restricting competition within the internal
market.
50
LESSON 3 – COMPETITION LAW IN EU
It is possible to identify four main types of
economic agreements or concerted practices to
which Article 101 TFEU applies:
horizontal conduct,
vertical restraints,
licensing, and
joint ventures.
51
LESSON 3 – COMPETITION LAW IN EU
Based on Regulation 17, Commission
investigations could translate into one of three
decisions:
negative clearance,
exemption, or
infringement.
52
LESSON 3 – COMPETITION LAW IN EU
A negative clearance follows when Article 101(1)
TFEU does not apply to the case under
consideration on the basis of the information
available at the time.
The agreement or practice is in accordance with
existing Community law.
53
LESSON 3 – COMPETITION LAW IN EU
Exemptions are granted when Article 101 (1) TFEU
applies to a notified case, but circumstances
specified in Article 101(3) TFEU also apply.
Exemptions are granted only temporarily.
Article 101(3) in particular facilitates the creation of
joint ventures or shared patent agreements with the
intent to foster innovation.
Industries were twice in a structural crisis and therefore
under Article 101(3) were temporarily allowed to form
cartels.
In addition, early regulations exempted certain sectors
from application of the EU competition laws (transport).
54
LESSON 3 – COMPETITION LAW IN EU
The Commission issues an infringement decision
whenever Article 101(1) applies but none of the
conditions mentioned in Article 101(3).
55
LESSON 3 – COMPETITION LAW IN EU
Article 102 TFEU
Any abuse by one or more undertakings of a dominant position
within the internal market or in a substantial part of it shall be
prohibited as incompatible with the internal market in so far as it
may affect trade between Member States. Such abuse may, in
particular, consist in:
(a) directly or indirectly imposing unfair purchase or selling prices or other
unfair trading conditions;
(b) limiting production, markets or technical development to the prejudice of
consumers;
(c) applying dissimilar conditions to equivalent transactions with other
trading parties, thereby placing them at a competitive disadvantage;
(d) making the conclusion of contracts subject to acceptance by the other
parties of supplementary obligations which, by their nature or according to
commercial usage, have no connection with the subject of such contracts.
56
LESSON 3 – COMPETITION LAW IN EU
Article 102 TFEU prohibits taking anticompetitive
advantage of a dominant position by unilateral
conduct, i.e. by a single firm.
Therefore, Article 102 TFEU must only be applied
after proving a firm's dominant position in the
relevant market.
Dominance is defined in the Commission's
guidelines on the application of Art. 82 EC Treaty.
“The Commission considers that an undertaking which is
capable of profitably increasing prices above the competitive
level for a significant period of time does not face sufficiently
effective competitive constraints and can thus generally be
regarded as dominant”
57
LESSON 3 – COMPETITION LAW IN EU
Unlike under Article 101 there is no possibility for
exemptions or negative clearances.
Article 102 abuses include,
discriminatory sales conditions and
monopolization strategies through tying and bundling
and predatory pricing.
Articles 101 and 102 TFEU apply to firms and the
relationship among firms.
58
LESSON 3 – COMPETITION LAW IN EU
The Commission uses block exemption regulations
in relation to certain forms of economic conduct, as
well as to small and medium size enterprises, partly
to alleviate its work load.
Two notices of December 1962 placed exclusive agency
contracts made with commercial agents and patent
licensing agreements outside the immediate scope of
European competition law.
In the first half of the 1980s, multiple block exemption
regulations were issued for example, for specialization
and R&D joint ventures and exclusive distribution and
purchasing, as well as for patent and know-how
licensing.
59
LESSON 3 – COMPETITION LAW IN EU
Block exemptions are used to allow agreements
conferring sufficient benefits to outweigh their
anticompetitive effects (e.g. car distribution, technology
transfers, horizontal cooperation in R&D, insurance,
transport and telecommunications).
In addition, the Commission adopted the ‘de minimis
doctrine’ for cases involving agreements of minor
importance, hardcore restrictions aside. (i.e. agreements
between competitors with less than 5% market share)
60
LESSON 3 – COMPETITION LAW IN EU
Additionally, the merger regulation covers horizontal
concentration that was not originally contemplated in
the Treaty of Rome.
The 1989 Merger Regulation (Council Regulation (EEC) No.
4064/89 etc. of 21 December 1989 on the control of concentrations
between undertakings [1989] OJ L 395/1 ) gave the
Commission the discretion to preemptively scrutinize
the effect on competition of envisaged mergers and
prohibit those potentially creating or strengthening a
dominant position on the relevant market.
The first Merger Regulation, as subsequently amended
by Council Regulation (EC) No. 1310/97 [1997] OJ L
40/17, has been substituted by Council Regulation
(EC) No. 139/2004 on the control of concentrations
between undertakings.
61
LESSON 3 – COMPETITION LAW IN EU
Under the new merger regulation, Article 2(3), no
merger – at least in case of non-coordinated effects –
that in any way significantly impedes effective
competition in the internal market is likely to be cleared
by the Commission.
Both in Phase I of a merger investigation and in Phase
II of the procedure, the merging firms can propose
remedies and commit to comply with them.
The Commission will consider whether the proposed
commitments are sufficient to overcome its competition
effect.
If so, the Commission can declare these proposed
remedies binding upon the undertakings and clear the
merger conditional on those divestments, as well as
other conditions and obligations.
62
LESSON 3 – COMPETITION LAW IN EU
The 2004 revision of the Merger Regulation also
introduced the possibility of an efficiency defense.
The system of merger control in Europe is based on a
jurisdictional division of competences between the
Commission and the NCAs.
The Merger Regulation applies only when certain
threshold requirements concerning the merging firms
are satisfied (i.e. the merger needs to have a Community
dimension) and only if the merger results in a lasting
change in the control of the undertakings concerned.
Otherwise, only national legislations may apply.
63
LESSON 3 – COMPETITION LAW IN EU
A necessary condition for the application of the EU
competition law is the existence of a direct or indirect,
actual or potential effect on trade between member
states of the EU. Otherwise national legislation is called
for.
Furthermore, the EC applies the effects doctrine stating
that domestic competition laws are applicable to firms
irrespective of their nationality, when their behavior or
transactions produce an effect within the domestic
territory.
64
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
An important distinction is between conduct that is
deemed to be a “per se” violation and conduct that is
judged under a “rule of reason.”
In the US the three substantive standards of review are
“per se”, “quick look” and rule of reason, ordered from
the least burdensome on an antitrust plaintiff (the per
se) to the most burdensome full rule of reason analysis.
65
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
The notion of per se offenses has been developed by the
courts over time to eliminate the need for extensive
proof of the anti-competitive effect of certain conduct.
The Supreme Court has limited per se analysis to the
following examples of Section 1 per se violations which
include
fixing prices,
dividing markets, and
a narrow range of group boycotts, bid-rigging,
and certain tie-in sales.
66
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
For the restraint to be condemned as naked price fixing,
bid-rigging or market allocations, a plaintiff need prove
only that an agreement among truly independent
horizontal competitors existed.
By contrast, group boycotts and tying arrangements may
have business justifications as well as pro-competitive
effects.
Group boycotts usually are condemned under the per se rule
when there is evidence of an agreement only among direct
competitors and the combined companies have a significant
degree of market power.
For tying arrangements, courts apply the per se rule only if the
supplier has substantial market power over the tying product
and there is substantial potential for impact on competition in
the tied market.
67
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
It is significant, however, that the distinction between
per se analysis and rule of reason was made during the
early period, and it remains important today.
By its nature, a per se rule creates a rebuttal
presumption of illegality once an appropriate set of facts
is found.
Per se rule is the exception to the rule-of-reason norm.
68
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
In virtually all other cases, courts take a case-bycase approach when examining the alleged unlawful
behavior,
requiring the plaintiff(s) to prove that the conduct, on
balance, does more harm than good to the competitive
process.
Recently, the Supreme Court decided that “vertical”
price fixing (resale price maintenance) should no
longer be considered per se illegal and is now
subject to the full rule of reason.
69
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
Under the rule of reason, the plaintiffs have the initial
burden to prove that an agreement has had or is likely to
have an anticompetitive effect.
After the plaintiffs have met this burden, the burden shifts
to the defendant to produce evidence of pro-competitive
effects of the agreement.
If the defendants offer evidence of pro-competitive
justifications or effects, plaintiffs then may attempt to
demonstrate that the challenged conduct is not reasonably
necessary to achieve the objective or that the anticompetitive
effects outweigh the precompetitive effects.
70
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
Ultimately the fact finder weighs all of the
circumstances of a case in deciding whether a
restrictive practice should be prohibited or as
imposing an unreasonable restriction on
competition.
Finally, in the absence of direct evidence of
anticompetitive effects most US courts apply a
“market power” threshold in assessing evidence
under the rule of reason.
The notion is that if the defendant lacks market power,
the restraint at use, even if found, is not likely to harm
competition.
71
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
An example of the application of rule of reason is
price discrimination.
Initially viewed as an exercise of monopoly power, the
practice was seen as suspect.
Indeed, the Robinson-Patman Act presumes that with
barriers to entry, price discrimination marks a deviation
from the competitive ideal that was presumed to have
monopoly purpose and effect.
Efficiency justifications for price discrimination and
other ‘restrictive practices’ -promoting investment,
better allocating scarce resources, and economizing on
transaction costs- were overlooked during the early
enforcement period.
72
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
An example of the application of rule of reason is
price discrimination. (cont’d)
Confusion also arose between the goal of protecting
competition and the practice of protecting competitors.
At the beginning of the twenty-first century, however,
efficiency arguments are clearly pertinent to the
evaluation of Robinson-Patman.
73
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
The quick look
When a challenge practice does not fall within the
traditional per se categories, but still appears facially
anticompetitive, a court may assess it under a quick look
analysis rather than going through the full rule of
reason framework.
Quick look analysis essentially is reserved for horizontal
agreements.
74
LESSON 3 – THE “PER SE” PROHIBITION
AND THE “RULE OF REASON”.
The quick look (cont’d)
Courts initially determine whether the challenge practice
in theory an in all practical likelihood has anticompetitive
effects, and, if so, the burden shifts to the defendant to
come forward with plausible justifications for its conduct.
If that burden of coming forward is met, the case flips into
a rule of reason analysis and the significant evidentiary
hurdles that go with it.
75
Analytical overview
Quantitative market definition methods
REGULATION AND COMPETITION
Market definition
Leeson 4
Instructor: Iván Vicente Carrión
Degree in International Business
Department of Economic Analysis
University of Valencia
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Analytical overview
Quantitative market definition methods
Table of contents
1
Analytical overview
Product market definition
2
Quantitative market definition methods
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Analytical overview
Quantitative market definition methods
Analytical overview
• As it was explained in the introductory chapter, market power
is what relates markets and strategies to one another.
• On a legal point of view, market power can also be defined with
the meaning of dominance.
• And because market power is exercised on a particular market,
it is important to define the boundaries of a market.
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Quantitative market definition methods
• Defining the market is necessary to
• identify the competitive constrains that a firm faces
• provide a framework for competition policy
• To define a market, one typically starts by identifying the closest
substitutes to the product (or service) that is the focus of the
analysis.
• The reason is that these substitutes exert the strongest
competitive constraints on the behaviour of the firms supplying
the product in question.
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• There are numerous sources of information on how to define
markets.
• Of particular importance in Europe is the European
Commission’s
• Notice on the Definition of the Relevant Market for the
Purposes of Community Competition Law → Comission Notice
• The Notice itself adopts the approach taken by the antitrust
authorities in the US in the analysis of horizontal mergers.
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In article 2 it is stated that the:
"main purpose of market definition is to identify in a systematic way
the competitive constraints that the undertakings involved face.
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 those undertakings’ behaviour
and of preventing them from behaving independently of effective competiti
pressure . It is from this perspective that the market definition makes
it possible inter alia to calculate market shares that would convey
meaningful information regarding market power for the purposes of
assessing dominance or for the purposes of applying Article 85."
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This paragraph contains a number of important points.
• First, market definition is not an end in itself. It provides a
framework within which to assess the critical question of
whether a firm or firms possess market power.
• Secondly, both the product and geographic dimensions of
markets must be analyzed.
• Thirdly, market definition enables the competitive constraints
only from actual competitors to be identified.
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According to the relevant market notice, using articles 7 to 9:
Article 7
“a relevant product market comprises all those products and/or
services which are regarded as interchangeable or substitutable by
the consumer, by reason of the products’ characteristics, their prices
and their intended use [...].
Article 8
The relevant geographic market comprises the area in which the
undertakings concerned are involved in the supply and demand of
products or services, in which the conditions of competition are sufficientl
homogeneous and which can be distinguished from neighbouring
areas because the conditions of competition are appreciably different
in those area. [...]
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Article 9
The relevant market within which to assess a given competition issue is
therefore established by the combination of the product and geographic
markets.”
The relevant market notice (article 13) specifies that firms :
“are subject to three main sources or competitive constraints: demand
substitutability, supply substitutability and potential competition.
From an economic point of view, for the definition of the relevant
market, demand substitution constitutes the most immediate and effective
disciplinary force on the suppliers of a given product, in particular in
relation to their pricing decisions. A firm or a group of firms cannot
have a significant impact on the prevailing conditions of sale, such as
prices, if its customers are in a position to switch easily to available
substitute products or to suppliers located elsewhere.”
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Analytical overview
Quantitative market definition methods
• The Notice points out, there are three main sources of
competitive constraint upon undertakings:
• demand substitutability
• supply substitutability and
• potential competition
• It continues that, for the purpose of market definition, it is
demand substitutability that is of the greatest significance
• supply substitutability may be relevant to market definition in
certain special circumstances, but normally this is a matter to be
examined when determining whether there is market power
• potential competition in the market is always a matter of
market power
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The legal test.
The judgments of the ECJ show that the definition is a matter of
interchangeability. If products can be interchangeable they are within
the same product market.
• For example in United Brands v Commission, where the
applicant was arguing that bananas were in the same market as
other fruit, the ECJ said that this issue depended on whether:
• “the banana could be singled out by such special features
distinguishing it from other fruits that it is only to a limited
extent interchangeable with them and is only exposed to their
competition in a way that is hardly perceptible”
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Analytical overview
Quantitative market definition methods
Product market definition
Product market definition
Measuring interchangeability
• The measurement of interchangeability can give rise to
considerable problems for a variety of reasons:
• there may be no data available on the issue, or
• the data that exist may be unreliable, incomplete or deficient in
some other way.
• The conceptual framework currently used by competition
authorities worldwide to establish which products are ‘close
enough’ substitutes to be in the relevant market is known as the
hypothetical monopolist test.’
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Analytical overview
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Product market definition
Hypothetical monopolist test (HMT)
• If a firm could raise its price by a significant amount and retain
its customers, this would mean that the market would be worth
monopolizing
• The test defines as the relevant market the smallest product
group (and geographical area) such that a hypothetical
monopolist (or cartel) controlling that product group (in that
area) could profitably sustain a Small and Significant
Non-transitory Increase in Prices, or a SSNIP for short.
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Product market definition
How it works?
1. Starting with a narrow market, it asks the following:
• If all the products (or geographies) in the proposed market were
controlled by a single hypothetical monopolist, would that
monopolist find it profitable to exert monopoly power by
imposing a price increase (SSNIP) in the proposed market?
• the test asks whether a hypothetical monopolist could sustain a
price increase (The EU guidelines refer to 5–10% whereas the US
guidelines refer to 5%.) above competitive levels for at least one
year (keeping constant the terms of sales of all other products).
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Product market definition
2. If the SSNIP is found to be profitable, then the proposed market is
found to be the relevant market for antitrust porpoises
3. If the SSNIP is not found to be profitable, then it must be that the
hypothetical monopolist’s price increase caused substantial substitution
to one or more products (or geographies) currently outside the proposed
market.
→ The test would then reject the narrow proposed market and proceeds
to expand it to include one or more of these substitutes.
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Analytical overview
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Product market definition
Example of SSNIP
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Product market definition
• Some limits of the SSNIP test
• The ‘Cellophane Fallacy’
(United States v EI du Pont de Nemour )
• This demonstrates that the SSNIP test may be appropriate in
merger cases, but not in a dominance case, where a crucial
issue is whether the defendant is a monopolist in the first place.
• It only focuses on demand-side substitutability.
The Merger case: Torras/Sarrio (1994))
• Supply substitution “means that suppliers are able to switch
production to the relevant products and market them in the
short term without incurring significant additional costs or risks
in response to small and permanent changes in relative prices”.
• Two products are supply-side substitutes if the supplier of one
of the products already owns all of the important assets needed
to produce the other product and has the commercial incentives
and capabilities to commence such production in a short period
of time.
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Analytical overview
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Product market definition
Examples of evidence that may be used in defining the relevant product
market :
• Evidence of substitution in recent past
• Failure of the brazilian coffee crop due to a late frost followed
by a large increase in tea drinking
• Quantitative tests
• E.g. Estimate own-price and cross-price elasticities.
• Views of customers and competitors
• The Commission will contact customers and competitors and
ask them to answer the SSNIP question
• Marketing studies and customer surveys
• The Commission will look at marketing studies as a useful
provider of information about the market item
• Physical characteristics
• For example: United Brands v. Commission
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Analytical overview
Quantitative market definition methods
Product market definition
• Intended Use
• For example: United Brands v. Commission
• Spare parts and the aftermarket
• For example: Hugin v. Commission
• The Commission’s finding that Hugin was dominant in the
market for spare parts for its own cash machines.
• For example: investigation Kyocera/Pelican (1984)
• EC concluded that Kyocera was not dominant in the market for
toner cartridges
• Structure of supply and demand
• Nederlandsche Banden-Industrie Michelin v Commission (1983)
• The ECJ upheld the Commission’s identification of the market
as replacement tires for heavy vehicles.
• Internal documents: In some cases, the Commission has relied
on the internal documents of an undertaking when identifying
the relevant market.
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Analytical overview
Quantitative market definition methods
Product market definition
The relevant geographic market
• It is also necessary, when determining whether a firm or firms
have market power, that the relevant geographic market should
be defined.
• The definition of the geographic market may have a decisive
impact on the outcome of a case.
• E.g.Volvo/Scania decision under the ECMR.
• The delineation of the geographic market helps to indicate which
other firms impose a competitive constraint on the one(s) under
investigation.
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Analytical overview
Quantitative market definition methods
Product market definition
• The cost of transporting products is an important factor:
some goods are so expensive to transport in relation to their
value that it would not be economic to attempt to sell them on
distant markets.
• Another factor might be legal controls which make it
impossible for an undertaking in one Member State to export
goods or services to another.
• Notice that this problem may be dealt with by the Commission
bringing proceedings against the Member State to prevent
restrictions on the free movement of goods or of services (under
Article 50 TFEU).
• With the completion of the internal market, there should be
fewer claims that fiscal, technical and legal barriers to inter-state
trade exist.
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Analytical overview
Quantitative market definition methods
Product market definition
• The Commission provides helpful guidance on the definition of
the geographic market in its Notice on Market Definition:
• “it will take a preliminary view of the scope of the geographic
market on the basis of broad indications as to the distribution of
market shares between the parties and their competitors, as well
as a preliminary analysis of pricing and price differences at
national and Community or EEA level.”
• In order to properly define the market, the Commission will
consider the importance of national or local preferences, current
patterns of purchases of customers and product differentiation.
• This survey is to be conducted within the context of the SSNIP
test outlined above, the difference being that, in the case of
geographic market definition, the question is whether, faced with
an increase in price, consumers located in a particular area would
switch their purchases to suppliers further away.
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Analytical overview
Quantitative market definition methods
Product market definition
Examples of evidence that may be used in defining the relevant geographic
market.
• Past evidence of diversion of orders to other areas
• Basic demand characteristics
• The scope of the geographic market may be determined by
matters such as national preferences or preferences for national
brands, language, culture and life style, and the need for a local
presence.
• Current geographic patterns
• Trade flows / Patterns of shipments
• Barriers and switched costs associated with the diversion of
orders to companies located in other areas
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Analytical overview
Quantitative market definition methods
Quantitative market definition methods
Three classes of methods will be discussed:
1. The first set of methods involves price comparisons over time:
either price correlations or tests of relative price stationary.
2. The second set of methods relies on finding econometric evidence
of demand substitution and price competition.
3. The third set of methods are empirical implementations of the
U.S. Guidelines’ Hypothetical Monopolist Test.
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Analytical overview
Quantitative market definition methods
1) Price comparisons along time
Imagine two competing products in the same market. If the cost
of an input used to produce one of the products were to fall, in a
competitive market the sellers of this product would then reduce prices
in an attempt to attract more customers. This competition would lead
sellers of the competing product to reduce their prices as well in order
to avoid losing large numbers of customers. This example is related
to the simple intuition behind the law of one price, and illustrates
how the prices of products in the same market can move together
over time. The law of one price provides the logic behind a number
of relatively simple techniques that examine market definition through
price comparisons. In particular, as discussed below
(a) Price correlations
(b) Relative price stationarity tests.
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Analytical overview
Quantitative market definition methods
1.a) Price correlation tests
• The Nestlé-Perrier merger investigation provides a helpful
example. The question of interest is whether mineral water sold
within France was a market in and of itself, or whether other
“refreshing drinks” such as soft drinks should be included in the
market definition.
• Qualitative analysis had been informative but inconclusive. It
indicated that still and sparkling bottled water were likely to
experience considerable demand and supply side substitution,
while it was less clear whether soft drinks should also be
considered within the relevant product market.
• The analysis found that the prices of bottled water brands were
highly correlated with each other, but that they were negatively
or very weakly correlated with the price of soft drinks, even for
brands of bottled water and soft drinks sold by the same
company.
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Analytical overview
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1.a) Price correlation tests (cont’d)
• These results, in conjunction with course-of-business documents
produced during the merger review, strongly suggested that soft
drinks should not be included in the relevant antitrust market.
Thus, in this case, price correlation was used to disprove the
hypothesis that soft drinks and bottled water competed in the
same market.
• Limitations of correlation analysis.
• The results can be sensitive to the frequency of the data.
• The finding of positive correlation between two products does
not necessarily imply that the products are close substitutes.
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1.b) Relative Price Stationarity Tests
• The intuition is that the relative price (e.g., the price ratio) of
two products that are substitutes should be relatively constant
over time, as they will face a common set of supply and demand
factors.
• Alternatively, the prices of two products that are generally
unrelated, but share only one factor in common, may diverge
substantially over time.
Stationarity.
• In general, a time series variable is said to be stationary if the
variable eventually returns to a particular long term value, even
if it deviated from that value for short periods of time.
• Testing for stationarity of a series is straightforward in most
statistical packages, for example through application of the
Dickey-Fuller test
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Analytical overview
Quantitative market definition methods
2) Econometric evidence of demand substitution and price competition
• Econometric methods can be used to more directly quantify
the substitution that occurs between two products. We consider
two methods:
• First, the estimation of the own- and cross- price demand
elasticities of products can provide direct evidence for whether
two products are close substitutes or not.
• Second, the application of careful econometric analysis of
prices in different localized marketplaces under different
competitive conditions has been an approach used in at least a
couple of high profile merger review cases with differentiated
products and numerous local marketplaces.
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Analytical overview
Quantitative market definition methods
2.a) Econometric estimation of demand elasticity.
• The proper empirical estimation of demand elasticity can be
challenging, and sometimes empirically impossible.
• A key challenge is that demand and supply conditions can both
be changing at any point in time.
• For this reason, it is frequently necessary to use econometric
techniques to help disentangle the part of the relationship
between quantity and prices that is due to underlying demand
conditions from the part that is due to changes in supply
conditions.
• Estimating demand econometrically involves a number of
assumptions. It is important to undertake sensitivity analyses to
understand when the results of the model may be driven by
particular assumptions or whether they are robust to relaxing
these assumptions.
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Analytical overview
Quantitative market definition methods
2.a) Econometric estimation of demand elasticity.
• Example: PanFish-Marine Harvest
• The merging parties both had substantial salmon farming
activities in Norway and Scotland.
• A central question in the merger review was whether
Norwegian and Scottish salmon were part of the same
antitrust market.
• The antitrust authority objective was to estimate the
relationship between the demand for Scottish salmon (as
opposed to the quantity transacted in the market, which is a
combination of supply and demand) and the prices of both
Scottish and Norwegian salmon.
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Analytical overview
Quantitative market definition methods
2.a) Econometric estimation of demand elasticity.
→ Example: PanFish-Marine Harvest :
The actual equation that was estimated by the antitrust authority was:
LSQ = α + βLSP + λLNP + δLEX + ϵ
• LSQ and LSP refer to the log of market quantity and price
respectively of Scottish salmon.
• LNP refers to the log of Norwegian salmon price, LEX refers to
the log of an index of household expenditures in food stores, and
ϵ is the error term capturing everything not measured by the
other included variables
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Analytical overview
Quantitative market definition methods
• α is a constant term
• β is an estimate of own-price elasticity of demand for Scottish
salmon,
• λ is an estimate of the cross-price elasticity between Scottish
and Norwegian salmon,
• δ is the income elasticity of demand for Scottish salmon.
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2.a) Econometric estimation of demand elasticity.
→ Example: PanFish-Marine Harvest
LSQ = α + βLSP + λLNP + δLEX + ϵ
Results:
• An own-price elasticity of (–3.5), statically significant,
implies that if the price of Scottish salmon increased by 1%, the
quantity demanded would drop by approximately 3’5%.
• A cross-price elasticity of 3, statically significant, implies that
if the price of Norwegian salmon increased by 1%, the quantity
of Scottish salmon demanded would increase by approx. 3%.
• These particular estimates helped the antitrust authority
to more confidently conclude that Norwegian and
Scottish salmon were in the same antitrust market.
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2.b) Econometric analysis of prices in different localized marketplaces
• When detailed pricing information is available, it may be possible
to draw useful conclusions about market definition even without
detailed quantity and marginal cost information. We illustrate
the potential for such analyses by discussing the review process
of a proposed merger, which involved differentiated products and
detailed information on multiple local marketplaces:
• Staples-Office Depot merger
• Whole Foods-Wild Oats merger.
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2.b) Econometric analysis of prices in different localized marketplaces
→ Staples-Office Depot merger
• Pricing evidence showed that the prices charged by Staples stores
were lower in cities where one of the other two office-supply
superstores (Office Depot and OfficeMax) were located than in
cities with no other office-supply superstore competitors.
• Question: Controlling for other factors that might affect prices,
how does the average price that Staples charges in a particular
store depend on:
(a) the number of nearby competing office-supply superstores,
and
(b) the number of other nearby competitors who are not
office-supply superstores.
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Quantitative market definition methods
2.b) Econometric analysis of prices in different localized marketplaces
→ Staples-Office Depot merger
• A finding that an increase in the former decreases prices but an
increase in the latter does not would suggest that office-supply
superstores compete more closely with each other than they do
with other stores and that therefore office-supply superstores and
other stores could be considered a separate relevant market.
• After the econometric work, the government argued that
office-supply stores were their own antitrust market, while the
parties argued that the market should be broader.
• How is the court to decide whether the statistical model
presented by the government or that presented by the parties is
more valid.
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2.b) Econometric analysis of prices in different localized marketplaces
→ Staples-Office Depot merger
• A general observation is that a statistical model is more
persuasive when its conclusions are corroborated by the
qualitative evidence.
• Language from internal documents in this matter were used to
argue that the parties recognized other office supply superstores
as their core competition.
• The documentary evidence on pricing was consistent with the
results of the antitrust agency’s econometric analysis.
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Quantitative market definition methods
2.b) Econometric analysis of prices in different localized marketplaces
→ Whole Foods-Wild Oats merger.
• In the Whole Foods-Wild Oats proposed Merger, the FTC made
a similar market definition argument to that in Staples-Office
Depot.
• However, both the qualitative and quantitative facts of the case
did not appear to be as favorable to the agency’s case.
• As a result, the court rejected the agency’s proposed market
definition and allowed the merger transaction to go forward.
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Quantitative market definition methods
2.b) Econometric analysis of prices in different localized marketplaces
→ Whole Foods-Wild Oats merger.
• In terms of quantitative pricing evidence, in the Staples-Office
Depot case the agency showed that office-supply superstores
lowered their prices after entry by other office-supply superstores,
but did not lower their prices after entry by other competitors.
• In contrast, in the Whole Foods-Wild Oats case the court was
not convinced that PNOS (Premium Natural Organic
Supermarket) entry reduced the prices of incumbent stores.
• In terms of qualitative evidence, internal documents in the
Staples-Office Depot case were consistent with office-supply
superstores not competing with other stores. In the Whole
Foods-Wild Oats case, the qualitative evidence was mixed
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Analytical overview
Quantitative market definition methods
3) Hypothetical Monopolist Test.
• The hypothetical monopolist test is designed to determine the
set of products (or geographies) that impose competitive
restraints on each other’s ability to exercise monopoly power. It
aims to find the narrowest market definition in which it would be
possible to exert monopoly power.
• The hypothetical monopolist test is going to be more credible if
its results are consistent with economic theory, industry
knowledge, and qualitative evidence.
• The advantage of the SSNIP test is that it provides a coherent
framework within which to assess market definition.
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3) Hypothetical Monopolist Test.
• The other methodologies discussed above provide direct or
indirect evidence of substitution and price competition, but do
not offer a definitive threshold that can be used to declare that a
particular product is or is not a “close enough” substitute.
• The SSNIP test provides such a threshold: if a SSNIP is
profitable, the products not included in the market definition are
by definition not close enough substitutes.
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3) Hypothetical Monopolist Test.
→ On the other hand, there are a number of shortcomings associated
with applying the SSNIP test.
• First, the test will not necessarily result in a definitive,
unique market definition. Rather, the resulting market
definition may depend on both the initial market chosen; the
way in which that market is expanded; and the size of SSNIP
used in the analysis.
• Finally, how long should the price increase be sustained to
be considered non-transitory?
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• The idea is to provide customers of the hypothetical monopolist
with adequate time to substitute to alternative products, yet not
so much time to jeopardize the integrity of the assumptions
and restrictions of the test
• For example, when implementing the SSNIP the prices for
products outside the candidate market are fixed. In addition, a
typical SSNIP test will not allow for the entry or exit of firms.
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REGULATION AND COMPETITION
Lesson 5.
Horizontal competition issues: merger
analysis
Cabral 15
Instructor: Rafael Moner Colonques
1
Department of Economic Analysis
Slides
Industrial Organization: Markets and Strategies
Paul Belleflamme and Martin Peitz
University of Valencia
Degree in International Business
LESSON 5. MERGER ANALYSIS
Motivation and definitions
Unilateral effects and coordinated effects.
Gains and losses of mergers: a formalization
(unilateral effects)
Procedural issues in the EU and in the US.
Coordinated effects.
Efficiency defense arguments.
Merger remedies.
2
LESSON 5 – MOTIVATION AND DEFINITIONS.
3
LESSON 5 – MOTIVATION AND DEFINITIONS.
Number of notified cases
Mergers 1990-2023
450
400
350
300
250
200
150
100
50
0
1990 1997 2004 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
compatible
with remedies
prohibited
4
LESSON 5 – MOTIVATION AND DEFINITIONS.
Mergers and acquisitions (M&As) can have
important effects on competitive conditions.
At the same time, they can generate significant
efficiencies, and so are often a natural part of
industry evolution.
An important distinction is made between
horizontal, vertical, and conglomerate mergers.
5
LESSON 5 – MOTIVATION AND DEFINITIONS.
Types of integration
Vertical integration
Horizontal integration
Conglomerate mergers
Various stages in the production
of a single product are carried out
in a single firm.
Merging two or more similar final
products into a single firm.
Integration of two or more
different product lines into a
single firm.
6
LESSON 5 – MOTIVATION AND DEFINITIONS.
Horizontal mergers involve companies that
operate at the same level of the supply chain,
producing substitute goods.
In horizontal mergers, there is a distinction
between two types of possible anticompetitive
effects:
unilateral effects and
coordinated effects.
7
LESSON 5 – MOTIVATION AND DEFINITIONS.
Vertical mergers, in contrast, involve
companies that operate at different levels of the
supply chain.
A common example is a merger between a
wholesaler and its retailer, or a manufacturer
and its input supplier.
In vertical mergers, there are concerns about
upstream or downstream foreclosure of rivals as
part of the strategic considerations to merge.
8
LESSON 5 – MOTIVATION AND DEFINITIONS.
Conglomerate concentrations involve
companies that operate in different markets.
Examples of conglomerate mergers are
Procter & Gamble/Gillette, which involved different
non-overlapping oral products sold to the same
retailers, and
GE/Amersham which involved medical scanning
hardware equipment and diagnostic pharmaceuticals
which either enhance or enable images to be
produced by such scanning hardware.
9
LESSON 5 – MOTIVATION AND DEFINITIONS.
Why do firms merge?
-demand-side synergies (i.e. increase in efficiency)
Sony acquired film studio Columbia, quality movies to
complement the “hardware” produced by Sony.
-cost-side synergies
Nestlé and General Mills joint venture for breakfast
cereals.
-bargaining power
Philip Morris and Kraft merged large number of food
products which they sell through supermarket chains
-market entry
Nestlé acquired Rowntree (Smarties, After Eight, KitKat,
etc) to enter British market
10
LESSON 5 – MOTIVATION AND DEFINITIONS.
Competition concerns raised by mergers can be
categorized as unilateral effects or coordinated
effects.
Unilateral effects (single-firm dominance in
EU) are said to arise when the merged entity has
the ability to increase prices or reduce quality to the
detriment of consumers despite the responses of the
remaining competitors. The expression "increased
prices" is therefore used as shorthand for these
various ways in which a merger may result in
competitive harm.
11
LESSON 5 – MOTIVATION AND DEFINITIONS.
The adverse effects associated with coordinated
effects (joint or coordinated dominance)
depend on one or more competitors to the merged
entity choosing to compete less vigorously postmerger, i.e. they collude tacitly.
In principle, all categories of mergers can give rise
to both concerns, but in practice coordinated effect
concerns arise only rarely in non-horizontal
mergers.
In this lesson we’ll concentrate on the analysis of
unilateral effects and coordinated effects in
horizontal mergers.
12
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
UNILATERAL EFFECTS.
Consider a homogeneous products industry with n symmetric
firms. Inverse demand is given by 𝑝𝑝 = 𝑎𝑎 − 𝑏𝑏𝑏𝑏 where 𝑄𝑄 = ∑𝑛𝑛𝑖𝑖=1 𝑞𝑞𝑖𝑖 .
The total cost function of a firm is 𝐶𝐶 𝑞𝑞𝑖𝑖 = 𝑐𝑐𝑞𝑞𝑖𝑖 . The profits
expression is:
𝑛𝑛
𝜋𝜋𝑖𝑖 = (𝑎𝑎 − 𝑏𝑏 ∑𝑖𝑖=1 𝑞𝑞𝑖𝑖 − 𝑐𝑐)𝑞𝑞𝑖𝑖
𝜕𝜕𝜋𝜋𝑖𝑖
𝜕𝜕𝑞𝑞𝑖𝑖
= 𝑎𝑎 − 2𝑏𝑏𝑞𝑞𝑖𝑖 − 𝑏𝑏 ∑𝑛𝑛𝑗𝑗≠𝑖𝑖 𝑞𝑞𝑗𝑗 − 𝑐𝑐 = 0
Apply symmetry 𝑞𝑞1 = ⋯ 𝑞𝑞𝑖𝑖 = ⋯ 𝑞𝑞𝑛𝑛 = 𝑞𝑞 to write
𝑎𝑎 − 2𝑏𝑏𝑏𝑏 − 𝑏𝑏 𝑛𝑛 − 1 𝑞𝑞 − 𝑐𝑐 = 0 so that equilibrium Cournot quantity is
𝑎𝑎−𝑐𝑐
𝑞𝑞 𝐶𝐶 =
𝑏𝑏(𝑛𝑛+1)
13
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
Plug this quantity in the profits expression
𝑎𝑎−𝑐𝑐
𝑏𝑏 𝑛𝑛+1
(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛+1)2
𝜋𝜋 𝐶𝐶 = 𝑎𝑎 − 𝑏𝑏𝑏𝑏𝑞𝑞𝐶𝐶 − 𝑐𝑐 𝑞𝑞𝐶𝐶 = 𝑎𝑎 − 𝑏𝑏𝑏𝑏
𝑛𝑛+1 𝑎𝑎−𝑛𝑛 𝑎𝑎−𝑐𝑐 − 𝑛𝑛+1 𝑐𝑐
𝑎𝑎−𝑐𝑐
𝑛𝑛+1
𝑏𝑏 𝑛𝑛+1
=
− 𝑐𝑐
𝑎𝑎−𝑐𝑐
𝑏𝑏 𝑛𝑛+1
=
And this is equilibrium profits for all firms BEFORE merger…
…whether they are insiders (those that will merge) or outsiders
(those that will remain independent).
14
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
Now assume that a number of firms 𝑚𝑚 ≥ 2 is willing to merge. The
merger results in an industry with 𝑛𝑛 − 𝑚𝑚 + 1 firms. We need not
rework the calculations…just apply the formula above:
𝑀𝑀
𝜋𝜋
=
(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛−𝑚𝑚+2)2
And are the same for all firms, insiders and outsiders.
15
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
We are now in a position to offer some results. Clearly, outsiders
are happier! Each produces more and therefore makes more profit
(fewer competitors). Regarding output of insiders:
𝑎𝑎−𝑐𝑐
𝑏𝑏(𝑛𝑛+1)
𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏
𝑚𝑚
>
𝑎𝑎−𝑐𝑐
𝑏𝑏(𝑛𝑛−𝑚𝑚+2)
𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
𝑎𝑎𝑎𝑎𝑎𝑎𝑒𝑒𝑟𝑟
Which is true as long as 𝑚𝑚 𝑛𝑛 − 𝑚𝑚 + 2 > (𝑛𝑛 + 1) , and it holds since
𝑚𝑚 ≥ 2. Therefore, we conclude that output by insiders falls!
16
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
What happens to total output???
𝑎𝑎−𝑐𝑐
𝑛𝑛
𝑏𝑏(𝑛𝑛+1)
𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏
> (𝑛𝑛
𝑎𝑎−𝑐𝑐
− 𝑚𝑚 + 1)
𝑏𝑏(𝑛𝑛−𝑚𝑚+2)
𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
𝑎𝑎𝑎𝑎𝑎𝑎𝑒𝑒𝑟𝑟
It falls! Consequently, price increases and so consumer surplus
decreases!
17
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
We have already noted that outsiders’ profits increase (output and
price go up).
What happens to insiders’ profits? They have to be higher than
before, otherwise there will be no incentive to merge. For this to
happen,
𝐶𝐶
𝑚𝑚𝜋𝜋 < 𝜋𝜋
𝑀𝑀
→
(𝑎𝑎−𝑐𝑐)2
𝑚𝑚
𝑏𝑏(𝑛𝑛+1)2
<
(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛−𝑚𝑚+2)2
→ 𝑚𝑚(𝑛𝑛 − 𝑚𝑚 + 2)2 < (𝑛𝑛 + 1)2
18
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
To check that whether it holds, let’s make the following change
𝑚𝑚 = 𝜃𝜃𝜃𝜃, 0 < 𝜃𝜃 < 1, so that 𝜃𝜃 represents the percentage of firms that
are willing to merge.
We may then calculate the percentage for which a merger is
privately profitable. Let us write:
𝜃𝜃𝑛𝑛(𝑛𝑛 − 𝜃𝜃𝜃𝜃 + 2)2 < (𝑛𝑛 + 1)2
19
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
Take e.g. 𝑛𝑛 = 5. Then we have that 5𝜃𝜃(7 − 5𝜃𝜃)2 < (5 + 1)2
The two functions on each side of the inequality cross at 𝜃𝜃 = 0.8
20
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
The foregoing argument has given rise to the well-known 80% rule.
Rather naturally, authorities will never approve such a merger.
The result is known as the merger paradox, according to which it is
hard to build a setting where firms are better off with merger
unless it leads to monopoly…
What are the welfare effects of a merger? We write welfare before
merger as the sum of consumer surplus and industry profits,
𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏
𝑊𝑊
=
𝑛𝑛2 (𝑎𝑎−𝑐𝑐)2
2𝑏𝑏(𝑛𝑛+1)2
+
𝑛𝑛(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛+1)2
=
𝑛𝑛(𝑛𝑛+2)(𝑎𝑎−𝑐𝑐)2
2𝑏𝑏(𝑛𝑛+1)2
21
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
Welfare with merger includes consumer surplus, insider (merging
firms) profits and outsider (non-merging firms) profits:
𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚
𝑊𝑊
=
(𝑛𝑛−𝑚𝑚+1)2 (𝑎𝑎−𝑐𝑐)2
2𝑏𝑏(𝑛𝑛−𝑚𝑚+2)2
𝐶𝐶𝐶𝐶
+
(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛−𝑚𝑚+2)2
𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖
+
(𝑛𝑛−𝑚𝑚)(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛−𝑚𝑚+2)2
𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
=
𝑎𝑎 − 𝑐𝑐 2 (3 + 𝑚𝑚2 + 4𝑛𝑛 + 𝑛𝑛2 − 2𝑚𝑚 2 + 𝑛𝑛 )
=
2𝑏𝑏(𝑛𝑛 − 𝑚𝑚 + 2)2
22
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
The difference 𝑊𝑊 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 − 𝑊𝑊𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 is positive when
(𝑛𝑛 − 𝑚𝑚 + 2)2 > (𝑛𝑛 + 1)2
Which does not hold…We conclude that a merger results in a
welfare decrease.
Critiques: symmetry, capacity, price competition.
The only hope to find a welfare improvement is that the merger
brings cost reductions → Williamson’s graph.
23
LESSON 5 – GAINS AND LOSSES OF MERGERS: A FORMALIZATION
Williamson (Nobel Prize 2009): “a merger normally imply an
increase in prices and a reduction in costs”.
24
LESSON 5 – PROCEDURAL ISSUES IN THE EU
EC Merger Control
The EC Merger Regulation first came into force
in 1990. The current version,EC council regulation
No 139/2004, was passed in 2004.
Article 2(1) of the Merger Regulation states that:
"Concentrations
within the scope of this Regulation shall be
appraised in accordance with the objectives of this
Regulation and the following provisions with a view to
establishing whether or not they are compatible with the
common market.
25
LESSON 5 – PROCEDURAL ISSUES IN THE EU
Article 2(1) (cont’d)
“In making this appraisal, the Commission shall take into account:
(a)
the need to preserve and develop effective competition within the
common market in view of, among other things, the structure of all
the markets concerned and the actual or potential competition from
undertakings located either within or without the Community;
(b)
the market position of the undertakings concerned and their
economic and financial power, the opportunities available to
suppliers and users, their access to supplies or markets, any legal or
other barriers to entry, supply and demand trends for the
intermediate and ultimate consumers, and the development of
technical and economic progress provided that it is to consumers'
advantage and does not form an obstacle to competition.”
26
LESSON 5 – PROCEDURAL ISSUES IN THE EU
Article 2(3) states:
“A concentration which would significantly impede effective
competition in the common market or in a substantial part of
it, in particular as a result of the creation or strengthening of a
dominant position, shall be declared incompatible with the
common market.”
Initially mergers were assessed with respect to whether they
created or strengthened a dominant position. In January 2004,
the substantive test of the Merger Regulation was changed to
whether a merger gives rise to a significant impediment to
effective competition (hereafter, SIEC). The SIEC test is
analogous to the "substantial lessening of competition"
test (SLC test) used in US, the UK, Ireland and Australia.
27
LESSON 5 – PROCEDURAL ISSUES IN THE EU
EC Merger Regulation only covers those mergers
which have a significant Community dimension:
A merger (or concentration in the parlance of the legislation) is
said to have a Community dimension where:
(a) the combined aggregate worldwide turnover of all the undertakings
concerned is more than EUR 5 000 million; and
(b) the aggregate Community-wide turnover of each of at least two of the
undertakings concerned is more than EUR 250 million, unless each of
the undertakings concerned achieves more than two-thirds of its
aggregate Community-wide turnover within one and the same Member
State.
28
LESSON 5 – PROCEDURAL ISSUES IN THE EU
A merger that does not meet the above thresholds is
also said to have a Community dimension where:
(a) the combined aggregate worldwide turnover of all the undertakings
concerned is more than EUR 2 500 million;
(b) in each of at least three Member States, the combined aggregate
turnover of all the undertakings concerned is more than EUR 100
million;
(c) in each of at least three Member States included for the purpose of
point (b), the aggregate turnover of each of at least two of the
undertakings concerned is more than EUR 25 million; and
(d) the aggregate Community-wide turnover of each of at least two of
the undertakings concerned is more than EUR 100 million, unless each
of the undertakings concerned achieves more than two-thirds of its
aggregate Communitywide turnover within one and the same Member
State.
29
LESSON 5 – PROCEDURAL ISSUES IN THE EU
Mergers that do not meet these criteria and, thus, do
not have a Community dimension are assessed by
the competition authorities of one or more Member
States.
30
LESSON 5 – PROCEDURAL ISSUES IN THE EU
The Merger Regulation also provides for a fixed
timetable in which decisions are made.
Formally, the Commission's assessment of mergers takes the
form of a short initial assessment, usually termed Phase I.
Phase I formally lasts one month from the date of notification.
Where the Commission considers that the proposed
concentration is likely to give rise to significant competition
concerns. Parties seeking to settle must submit their remedial
proposal.
If it raises serious doubts as to its compatibility with the
common market, a second more detailed Phase II
investigation is undertaken. Phase II formally lasts for up to
four months at the end of which a decision is made.
31
LESSON 5 – PROCEDURAL ISSUES IN THE EU
The EU merger control procedure (outline)
-informal talks between firms and EC
-merger announcement (to the press)
-merger “notification” (to the EC)
-phase I decision (25 working days).
cleared (80% - 90%)
cleared with remedies (behavioral, structural)
raise serious doubts → Phase II (1% - 5%)
-phase II decision (90 working days)
cleared
cleared with remedies (behavioral, structural)
blocked (very rare).
32
LESSON 5 – PROCEDURAL ISSUES IN THE EU
Since the introduction of the Merger Regulation in
1990, 8,990 mergers have been notified to DG
COMP. (up to September 2023)
The majority of these (about 97%) were cleared in
Phase I or withdrawn.
Only 251 mergers (approximately 3 per cent of all
notified mergers) progressing to a Phase II inquiry.
33
LESSON 5 – PROCEDURAL ISSUES IN THE EU
For a merger subject to a Phase II investigation,
there are three possible outcomes.
First, the merger can be cleared in its entirety
(Article 8(1)).
Secondly, the merger can be cleared subject to the
parties giving undertakings to remedy the
competitive concerns raised by the investigation
(Article 8(2)).
Up to the end of September 2023, 65 Phase II
investigations have been cleared without conditions
and a further 148 with commitments.
34
LESSON 5 – PROCEDURAL ISSUES IN THE EU
Article 8(3) provides for a third outcome, namely
prohibition.
The first merger subject to prohibition was
Aerospatiale/de Havilland in 1991.
Between then and the end of September 2023, in
total 33 concentrations were prohibited, although a
number of other mergers which faced the prospect of
being prohibited following a Phase II investigation
have been withdrawn.
Of the 8,990 notified mergers 190 have been
withdrawn in Phase I and 53 in Phase II.
35
LESSON 5 – PROCEDURAL ISSUES IN THE EU
Several Commission's prohibition decisions have
been challenged before the European Court of
First Instance.
Prominent examples in which substantive elements
of the Commission's decision were challenged
include Airtours/First Choice, Tetra Laval/Sidel,
GE/Honeywell and Sony/BMG.
The Court of First Instance's decisions can be
further appealed to the European Court of
Justice (ECJ).
The decisions of the latter are final.
36
LESSON 5 – PROCEDURAL ISSUES IN THE US
US Merger Regulation.
The 1890 Sherman Act
Soon after enactment, the Sherman Act was used to
challenge anticompetitive mergers and acquisitions.
Famous cases are:
*E.C. Knight (1895)
First Supreme Court antitrust case that challenged the Sugar Trust’s
acquisition of its four remaining major competitors
*Northern Securities (1904)
Roosevelt challenged J.P. Morgan’s attempt to consolidate the only two railroad trunk
lines serving the Northern part of the United States
*Standard Oil (1911)
Perhaps the most famous of all antitrust cases. Challenged, among other things,
acquisitions by the Oil Trust.
37
LESSON 5 – PROCEDURAL ISSUES IN THE US
FTC Act § 5’s prohibition on “unfair methods of
competition” also reaches anticompetitive mergers
and acquisitions
The 1914 Clayton Act
Section 7 was directed specifically at prohibiting
mergers and acquisitions that were likely to be
anticompetitive
Limitations of the original Section 7
-Limited to corporations
-Limited to corporations “in commerce”
-Limited to stock acquisitions
-Widely viewed as limited to horizontal acquisitions.
38
LESSON 5 – PROCEDURAL ISSUES IN THE US
Celler-Kefauver Act of 1950
-Amended Section 7 to
Expand coverage to asset acquisitions.
-Two significant restrictions remained
Applied only to corporations.
Reached only combinations of firms “in commerce”.
39
LESSON 5 – PROCEDURAL ISSUES IN THE US
Hart-Scott-Rodino (HSR) Act,
Parties to certain large mergers must file premerger
notification and wait for government review.
The parties may not close their deal until the waiting
period outlined in the HSR Act has passed, or the
government has granted early termination of the
waiting period.
Any person filing an HSR form may request that the
waiting period be terminated before the statutory
period expires. (Which corresponds to the "early
termination“).
40
LESSON 5 – PROCEDURAL ISSUES IN THE US
Steps in the Merger Review Process
Step One: Filing Notice of a Proposed Deal
-Not all mergers or acquisitions require a premerger filing.
-Generally, the deal must first have a minimum value and the
parties must be a minimum size.
-These filing thresholds are updated annually.
-In addition, some stock or asset purchases are exempt, as are
purchases of some types of real property.
-There is a filing fee for premerger filings.
-For most transactions requiring a filing, both buyer and seller
must file forms and provide data about the industry and their
own businesses.
-Once the filing is complete, the parties must wait 30 days (15
days in the case of a cash tender offer or a bankruptcy) or until
the agencies grant early termination of the waiting period
before they can consummate the deal.
41
LESSON 5 – PROCEDURAL ISSUES IN THE US
Step Two: Clearance to One Antitrust Agency
Parties proposing a deal file with both the FTC and DOJ, but
only one antitrust agency will review the proposed merger.
Staff from the FTC and DOJ consult, and the matter is
"cleared" to one agency or the other for review (this is known
as the "clearance process").
Once clearance is granted, the investigating agency can
obtain non-public information from various sources,
including the parties to the deal or other industry
participants.
42
LESSON 5 – PROCEDURAL ISSUES IN THE US
Step Three: Waiting Period Expires or Agency Issues
Second Request
After a preliminary review of the premerger filing, the agency
can:
-terminate the waiting period prior to the end of the waiting period
(grant Early Termination );
-allow the initial waiting period to expire; or
-issue a Request for Additional Information ("Second Request") to
each party, asking for more information.
If the waiting period expires or is terminated, the parties are
free to close their deal.
A second request extends the waiting period and prevents the
companies from completing their deal until they have
"substantially complied" with the Second Request and
observed a second waiting period.
43
LESSON 5 – PROCEDURAL ISSUES IN THE US
Step Three: Waiting Period Expires or Agency Issues
Second Request (cont’d)
A Second Request typically asks for business documents and
data that will inform the agency about the company's
products or services, market conditions where the company
does business, and the likely competitive effects of the
merger.
The agency may conduct interviews (either informally or by
sworn testimony) of company personnel or others with
knowledge about the industry.
44
LESSON 5 – PROCEDURAL ISSUES IN THE US
Step Four: Parties Substantially Comply with the
Second Requests
Typically, once both companies have substantially complied
with the Second Request, the agency has an additional 30
days to review the materials and take action, if necessary.
The length of time for this phase of review may be extended by
agreement between the parties and the government in an
effort to resolve any remaining issues without litigation.
45
LESSON 5 – PROCEDURAL ISSUES IN THE US
Step Five: The Waiting Period Expires or the Agency
Challenges the Deal
The potential outcomes at this stage are:
1. close the investigation and let the deal go forward
unchallenged;
2. enter into a negotiated consent agreement with the
companies that includes provisions that will restore
competition; or
3. seek to stop the entire transaction by filing for a preliminary
injunction in federal court pending an administrative trial on
the merits.
Many merger challenges are resolved with a consent
agreement between the agency and the merging parties.
46
LESSON 5 – PROCEDURAL ISSUES IN THE US
US MERGER GUIDELINES
Along the time, the US have issued several Merger Guidelines.
The currently applied one is the one issued in 2010.
The 1968 Guidelines were based on one big idea: horizontal
mergers that increase market concentration inherently are
likely to lessen competition.
This is rather shocking, since in an industry in which the
combined share of the four largest firms is at least 75%, the
state will challenge a merger if the acquiring firm’s share is
at least 15% and the acquired firm’s share is at least 1%.
.
The 1982 Guidelines were a revolution. Five innovations
formed the foundation on which all subsequent Merger
Guidelines have been built.
47
LESSON 5 – PROCEDURAL ISSUES IN THE US
The 1982 Guidelines five innovations and how
2010 Guidelines articulate them:
1. The 1982 Guidelines articulated a “unifying theme” for merger
enforcement: “that mergers should not be permitted to create or
enhance ‘market power’ or to facilitate its exercise.”
The unifying theme from the 1982 Guidelines is repeated in the
introductory section of the 2010 Guidelines.
2. The 1982 Guidelines introduced the hypothetical monopolist
test (HMT) for defining the relevant market. The HMT has been
widely accepted by the courts and other jurisdictions. Section 4
of the 2010 Guidelines, “Market Definition,” retains the HMT
and explains its correct implementation in greater detail.
.
48
LESSON 5 – PROCEDURAL ISSUES IN THE US
.
49
LESSON 5 – PROCEDURAL ISSUES IN THE US
.
50
LESSON 5 – PROCEDURAL ISSUES IN THE US
The 1982 Guidelines five innovations and how
2010 Guidelines articulate them:
3. The 1982 Guidelines introduced the Herfindahl-Hirschman
Index (HHI) into merger analysis and established
enforcement thresholds based on the post-merger HHI and
the change in the HHI resulting from the merger. Section 5 of
the 2010 Guidelines, “Market Participants, Market Shares,
and Market Concentration,” retains the usage of HHI
thresholds, adjusting them upwards.
The Agencies generally classify markets into three types:
Un-concentrated Markets: HHI below 1500.
Moderately Concentrated Markets: HHI between 1500 and 2500.
Highly Concentrated Markets: HHI above 2500.
51
LESSON 5 – PROCEDURAL ISSUES IN THE US
% share
𝐻𝐻𝐻𝐻𝐻𝐻 =
s1
𝑆𝑆𝑖𝑖 2
𝑁𝑁
10,000 ∑𝑖𝑖=1
𝑆𝑆𝑇𝑇
s2
s3
s 4, s 5
s6,s7, s8
s9,s10
C4
HHI
Ind.1
60
10
5
5
5
0
80
3850
Ind. 2
20
20
20
20
0
0
80
2000
Ind. 3
100/3
100/3
100/3
0
0
0
100
3333
Ind. 4
49
49
0.25
0.25
0.25
0.25
98.5
4802
The change in HH index:
Suppose two firms, A and B, have market shares a and b, respectively.
HH before merger is a2 + b2
If merger occurs, the combined market share is a+b. Then HH=(a+b)2
Then Δ𝐻𝐻𝐻𝐻 = 𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻 – 𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻𝐻 = (𝑎𝑎 + 𝑏𝑏)2 − 𝑎𝑎2 +𝑏𝑏 2 = 2𝑎𝑎𝑎𝑎
52
LESSON 5 – PROCEDURAL ISSUES IN THE US
The 1982 Guidelines five innovations and how
2010 Guidelines articulate them:
4. The 1982 Guidelines expanded the discussion of competitive
effects, somewhat downplaying the role of market concentration
in comparison with the 1968 Guidelines. The 2010 Guidelines
continue this trend.
5. The 1982 Guidelines provided a list of factors that affect the
ease and profitability of collusion. Many of these same factors
can be found in Section 7 of the 2010 Guidelines, “Coordinated
Effects.”
The 1982 Guidelines were written with relatively homogeneous,
industrial products in mind.
The Guidelines were slightly revised in 1984, but the next major
change arrived with the 1992 Guidelines, the first that were jointly
issued by the DOJ and the FTC.
53
LESSON 5 – PROCEDURAL ISSUES IN THE US
The 1992 Guidelines:
The 1992 Guidelines increased the sophistication of the
economic analysis and explained more fully how the
Agencies evaluate various types of competitive effects.
Two innovations in the 1992 Guidelines stand out.
First, the most significant advance was their introduction of
“unilateral effects.” In recent years, more DOJ investigations
have involved unilateral effects than coordinated effects. The
2010 Guidelines build upon the treatment of unilateral effects
in the 1992 Guidelines.
Second, it introduced a more detailed and sophisticated analysis
of entry. Entry analysis is built upon the principle that entry
must be “timely, likely, and sufficient” to deter or counteract the
competitive effects of concern.
The 2010 Guidelines retain this basic approach to the analysis
of entry.
54
LESSON 5 – PROCEDURAL ISSUES IN THE US
The 1997 Guidelines:
The next change to the Guidelines was the substantial
revision and expansion in 1997 of the treatment of
merger efficiencies.
The 1997 changes reflect an appreciation that mergers can
promote competition by enabling efficiencies, and that
such efficiencies can be great enough to reduce or reverse
adverse competitive effects that might arise in their
absence.
The 2010 Guidelines make very few changes to the
treatment of efficiencies articulated in 1997.
55
LESSON 5 – PROCEDURAL ISSUES IN THE US
The 2010 Guidelines:
The biggest shift in merger enforcement between 1992 and
2010 has been the ascendency of unilateral effects as the
theory of adverse competitive effects most often pursued
by the Agencies.
Section 6 in the 2010 Guidelines, “Unilateral Effects,” is
broken into four parts.
Sections 6.1 and 6.2 address pricing and bidding competition
among suppliers of differentiated products;
Section 6.3 addresses capacity and output for homogeneous
products;
Section 6.4 addresses innovation and product variety and is
entirely new.
Regarding differentiated products pricing, the central role of
diversion between the products sold by the merging firms
is then stressed.
56
LESSON 5 – COORDINATED EFFECTS
Coordinated effects of mergers relate to an increase in
concentration in the market, which may increase the
likelihood of tacit and overt collusion in the entire
industry.
The reduction of the number of independent actors in the
market due to the merger may create market conditions
in which it is easier for the remaining firms to engage in
collusion.
The main concern is that either the reduction of the
number of actors alone, or the more symmetric
distribution of their assets, or a combination of these two
factors, allows the post-merger market participants to
coordinate their actions with considerably more ease.
57
LESSON 5 – COORDINATED EFFECTS
Relevant factors in relation to this are structural
factors recognized to facilitate collusion such as
a small number of firms,
barriers to entry,
cross ownerships and other links among competitors,
symmetry in the cost structure,
dimension of the firm,
product homogeneity, and
absent or weak buying power.
The availability of information and the transparency
of rivals’ strategies are relevant to the success of
collusive agreements. Mergers can greatly influence
these conditions.
58
LESSON 5 – COORDINATED EFFECTS
Thus, we are interested in knowing how much the
scope for collusion is changed as a result of a
merger.
A definition of collusion should be put in place:
“Collusion refers to the ability of firms to raise prices
above the best response prices through a system of
rewards and punishments in the future triggered
by current behavior.”
For policy purposes we are interested in answering
one question:
Does collusion get easier or more difficult after the
merger?
59
LESSON 5 – COORDINATED EFFECTS
From the different models of explicit collusion,
we can derive two general conclusions:
a) reducing the number of firms makes collusion
easier,
b) increasing asymmetry makes collusion
harder.
However, in a merger, although several firms
become one single entity, the assets do not leave
the market.
Therefore, the second effect tends to dominate
the former and mergers can make collusion
more difficult. Although no general result is
reached.
60
LESSON 5 – COORDINATED EFFECTS
When are the coordinated effects of a merger
small?
The number of competitors.
Collusion gets harder when there are more firms, if assets
increase with firms.
However, distributing the same number of assets into more
firms does not reduce the short run incentives to raise prices.
The scope for collusion is increased by distributing equally
capacity.
61
LESSON 5 – EFFICIENCY DEFENSE ARGUMENTS
Recent Merger Guidelines open the possibility
for merging parties to invoke an efficiency
argument for mergers that raise antitrust
concerns.
To invoke this argument requires in principle
that the potential anticompetitive effects of the
merger are weighed against possible mergerspecific efficiencies.
The most commonly argued efficiencies result
from economies of scale and scope, the creation
of synergies in R&D, distribution and
marketing, and administrative cost savings.
62
LESSON 5 – EFFICIENCY DEFENSE ARGUMENTS
In order to be admissible in the overall
assessment of the effects of the merger on
competition, an efficiency defense has to show
convincingly that the claimed efficiencies can be
achieved only by way of the merger and not in a
less restrictive way, (merger specific efficiencies).
In addition, credible efficiencies will have to
affect marginal and/or variable costs rather than
fixed costs because the latter are not likely to be
passed on to consumers.
Thus, if competition authorities follow the CS
standard when deciding on merger clearance,
fixed cost savings would not be considered.
63
LESSON 5 – EFFICIENCY DEFENSE ARGUMENTS
In recent years, it has long been possible for a
company acquiring another to merge into a
highly concentrated market to mount a failing
firm defense.
To determine whether indeed without the
takeover the acquired company would have
disappeared from the market as an independent
competitor requires rather deep economic
analysis.
64
LESSON 5 – MERGER REMEDIES
As the DOJ Guide notes, DOJ consents to remedies
that have a “logical nexus” to the alleged violation
and that “preserve[s] the efficiencies created by [the]
merger...without compromising the benefits that
result from maintaining competitive markets”.
As a general rule, remedies can be divided between
structural and conduct remedies.
In both the U.S. and in Europe, implementing
structural remedies generally takes the form of
forcing a sale of physical assets, and/or intellectual
property rights, to an approved, third-party buyer.
65
LESSON 5 – MERGER REMEDIES
The FTC, DOJ and the EC agree that the most
effective structural remedy involves the sale of assets
that, pre-divestiture, operated as a viable,
competitive and stand-alone business; such a
package is generally thought to contain all the
components necessary to operate autonomously
under new ownership, and best facilitate the recreation of the premerger competitive environment.
66
LESSON 5 – MERGER REMEDIES
The FTC, DOJ and EC have identified a number of
conduct remedies that can be used to alleviate the
prospective anticompetitive effects of a merger.
The conduct remedies in the EC tend to focus on
access remedies, which include the granting of access
to key infrastructure, networks, and technology,
including patents, know how or other IP rights.
The DOJ has also identified several types of conduct
remedies, including supply agreements, firewalls,
fair dealing provisions, and transparency provisions.
67
LESSON 5 – MERGER REMEDIES
Remedies policy in the EU
The Commission issued a notice in 2001 which the
following general principles:
The Commission prefers structural remedies (such as the
sale of a subsidiary) over conduct remedies that may not
be suitable to ensure the competitiveness of the market
structure.
The remedy must be able to restore effective competition
in the common market on a permanent basis.
The remedy must be capable of being implemented
effectively within a short period of time and without
additional monitoring or oversight by the Commission.
68
LESSON 5 – MERGER REMEDIES
Although the Notice recognizes that circumstances
may warrant terminating exclusive agreements or
requiring access to infrastructure or key technology,
the remedy of preference is divestiture.
The primary concern with divestiture is making
sure that the divested assets, when in the hands of
a suitable purchaser, can compete with the merged
entity on a lasting basis.
The Commission may also require a divestiture of
activities in related markets in which there are no
competitive concerns, if this is the only possible way
of creating or enhancing an effective competitor in
the affected markets.
69
LESSON 5 – MERGER REMEDIES
This occurred in TotalFina/Elf Acquitaine (Case No.
COMP/M.1628, Commission Decision, 9 February
2000), in which the parties’ initial proposal to sell
portions of their assets in the liquid petroleum gas
industry was deemed neither adequate nor precise
enough to allay all serious doubts about the
transaction.
The Commission subsequently required the
divestiture of a full subsidiary, in its approval of the
merger in February 2000.
70
LESSON 5 – MERGER REMEDIES
In certain circumstances, the Commission’s recent
practice has been to require crown jewel divestiture
provisions. Like the US, these provisions require
that, if the sale of the preferred divestiture asset
does not occur by a specific deadline, the
Commission will require the divestiture of a more
valuable asset or group of assets.
As a condition for approval, the Commission will
require the parties to transfer the viable business to
a suitable purchaser within a specific deadline.
71
LESSON 5 – MERGER REMEDIES
The Commission’s criteria for determining the
suitability of a purchaser require the purchaser to
be
“a viable existing or potential competitor, independent of and
unconnected to the parties, possessing the financial
resources, proven expertise and having the incentive to
maintain and develop the divested business as an active
competitive force in competition with the parties.”
If the viability of the divestiture package depends
largely on the identity of the purchaser, the
Commission will require the parties to enter into a
binding agreement with an up-front buyer approved
by the Commission, before completing the notified
transaction.
72
LESSON 5 – MERGER REMEDIES
In Bosch/Rexroth (Case No. COMP/M.2060,
Commission Decision, 4 December 2000), the
Commission found that, if Bosch had divested the
business to a weak buyer (such as one with limited
resources or expertise), over time it could have won
back lost market share.
The Commission decided that the deal could not
proceed until a suitable up-front buyer had been
found.
73
LESSON 5 – MERGER REMEDIES
The Commission may place several additional
requirements on parties to ensure the viability of
the divested business.
Those obligations may include appointing a hold
separate trustee, who can ensure that the merging
entity fulfils its duty to maintain the economic
viability and competitiveness of the divested assets
until they are sold.
The Commission may also appoint a divestiture
trustee, who is responsible for overseeing the search
for a purchaser for the divested assets, and to dispose
of the divested assets at any price, within a specific
deadline and subject to the Commission’s approval.
74
LESSON 5 – MERGER REMEDIES
Remedies policy in the US.
In April 2003, the FTC’s Bureau of Competition
issued a policy statement on negotiating merger
remedies.
Both the FTC and the DOJ prefer to resolve
concerns about anticompetitive effects by having the
parties divest business lines or assets to restore the
competition reduced by the merger.
75
LESSON 5 – MERGER REMEDIES
In general, such remedies are negotiated by the
parties with the agency staff and then incorporated
into:
A binding consent order issued by the FTC; or
A binding consent decree issued by a federal court at
the request of the DOJ.
76
LESSON 5 – MERGER REMEDIES
The content of consent decrees varies according to
the facts of the case, but most share several features,
including the following:
The divestiture must be absolute, meaning that the
merging parties must cut all ties to the divested
businesses or assets and have no ongoing financial
interest in the buyer’s success. Firms should divest an
autonomous, ongoing business unit. The proposed buyer
of the assets must have the competitive incentive to
maintain or restore competition in the market.
Provisions for naming a trustee to oversee the sale of the
assets, if the assets are not divested within a certain
time, may be included in the consent decree.
77
LESSON 5 – MERGER REMEDIES
Until completing divestiture, the parties are typically
required to operate the assets to be divested
independently of the remainder of the business. The
objectives of such “hold separate” requirements are to:
❑ preserve the assets' viability pending divestiture; and
❑ prevent competitive harm in the interim.
The agencies are also using crown jewel provisions.
The agencies have also recently shortened the time
available for parties to divest the assets, now
requiring divestitures to occur within three to six
months of the granting of the consent order.
78
LESSON 5 – MERGER REMEDIES
In roughly half of the FTC mergers resulting in
consents since the beginning of 2007, the FTC has
insisted that the merging parties divest to a specific
buyer, a trend that is likely to continue in the future.
Examples are:
In AGroup/Abrika Pharmaceuticals, the merged entity
was required to divest to Cobalt Laboratories all rights
and assets necessary to produce generic israpidine.
In Hospira Inc./Mayne Pharmaceuticals, the merged
party was required to divest to Barr Pharmaceuticals all
rights and assets necessary to produce hydromorphone,
nalbuphine, morphine and deferoximine.
79
LESSON 5 – MERGER REMEDIES
In Johnson & Johnson/Pfizer, the parties were required
to divest all rights and assets relating to Pfizer’s Zantac
H-2 blocker business to Boehringer Ingelheim, and
Pfizer’s Cortizone anti-itch business, Pfizer’s Unisom
night-time sleep aid business and Johnson & Johnson’s
Balmex diaper rash business to Chattem, Inc..
In Schering-Plough/Organon Biosciences N.V., the
parties were required to divest all assets required to
develop, manufacture and market various poultry
vaccines to Wyeth.
80
LESSON 5 – MERGER REMEDIES
Examples where conduct remedies were used.
In Newscorp/Telepiu, Case COMP/M.2876, the EC
used a conduct remedy, in part, to ensure competitive
access to all essential elements of a pay-TV network.
Newscorp proposed to acquire both Telepiu, a pay T.V.
platform operating predominantly in Italy, and Stream, a
pay T.V. platform also operating in Europe.
The EC claimed that, among other things, the
merger would result in a near monopoly in the pay
T.V. market in Italy. It also noted that very few
competitors existed, and that the costs of entering
the business, including programming and subscriber
acquisition costs, were extreme.
81
LESSON 5– MERGER REMEDIES
The EC required the parties to make available to
other providers access to
(1) necessary content,
(2) the relevant technical platforms, and
(3) all necessary technical services, before it would
allow the merger to proceed.
Additionally, the EC limited the duration to which
the parties could enter into exclusive contracts with
programming providers.
82
LESSON 5 – MERGER REMEDIES
The FTC has also utilized conduct remedies to
alleviate the anticompetitive concerns of prospective
transactions.
The Boeing Company and Lockheed Martin Corp were the
only two competitors in the satellite launch services market,
and comprised two of the three competitors in the space
vehicle market.
Accordingly, the FTC charged that the transaction would
significantly reduce competition in both markets.
The parties, however, agreed to take certain steps to address
competitive concerns, including agreeing to
nondiscrimination requirements in choosing and working
with Launch Service and Space Vehicle contractors and
agreeing to various firewalls.
83
REGULATION AND COMPETITION
Lesson 6.
Horizontal competition issues:
collusion and cartels
Cabral, 8
Instructor: Rafael Moner Colonques
1
Department of Economic Analysis
Slides
Industrial Organization: Markets and Strategies
Paul Belleflamme and Martin Peitz
University of Valencia
Degree in International Business
LESSON 6. COLLUSION AND CARTELS
Motivation and definitions. Legislation.
Collusion vs competition: a simple static model.
A dynamic model of collusion.
Facilitating practices.
2
LESSON 6. MOTIVATION AND DEFINITIONS
3
LESSON 6. MOTIVATION AND DEFINITIONS
4
LESSON 6. MOTIVATION AND DEFINITIONS
What is a cartel: a secret agreement between two or
more firms with the objective of fixing prices,
production or sales quotas, market sharing
(including bid rigging), or restricting imports and/or
exports.
Collusion can be explicit or tacit.
Economic theory places an emphasis on the outcome
but according to competition laws, only explicit
collusion is deemed illegal (as it leaves traces and
can be detected).
5
LESSON 6. MOTIVATION AND DEFINITIONS
6
LESSON 6. MOTIVATION AND DEFINITIONS
7
LESSON 6. MOTIVATION…LEGISLATION
Sherman Act, sect 1.
Every contract, combination in the form of trust
or otherwise, or conspiracy, in restraint of trade
or commerce among the several States, or with
foreign nations, is declared to be illegal. […]
8
LESSON 6. MOTIVATION…LEGISLATION
Article 101 TFEU
The following shall be prohibited as incompatible with the
common market: all agreements between undertakings,
decisions by associations of undertakings and concerted
practices which may affect trade between Member States, and
which have as their object or effect the prevention, restriction
or distortion of competition within the common market, and in
particular those which:
(a) directly or indirectly fix purchase or selling prices or any
other trading conditions;
(b) limit or control production, markets, technical
development, or investment;
(c) share markets or sources of supply;…
9
LESSON 6. COLLUSION VS COMPETITION.
THE INCENTIVE TO COOPERATE
Remember formula for equilibrium profits in a
Cournot model:
𝜋𝜋 𝐶𝐶
=
(𝑎𝑎−𝑐𝑐)2
𝑏𝑏(𝑛𝑛+1)2
Consider a duopoly, n=2, and that firms have to
choose between competition and cooperation.
If they play (compete, compete) then, making use of
formula, profits will be:
𝜋𝜋𝑖𝑖 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶, 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 =
(𝑎𝑎−𝑐𝑐)2
9𝑏𝑏
𝑓𝑓𝑓𝑓𝑓𝑓 𝑖𝑖 = 1,2.
10
LESSON 6. COLLUSION VS COMPETITION.
THE INCENTIVE TO COOPERATE
If the two firms cooperate then they will share the
monopoly profits…
𝜋𝜋𝑖𝑖 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶, 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 =
𝜋𝜋 𝑚𝑚𝑚𝑚𝑚𝑚
(𝑎𝑎−𝑐𝑐)2
8𝑏𝑏
=
(𝑎𝑎−𝑐𝑐)2
,
4𝑏𝑏
that is,
𝑓𝑓𝑓𝑓𝑓𝑓 𝑖𝑖 = 1,2.
What if one cooperates and the other does not??
Write reaction function of firm that does not cooperate 𝑞𝑞1 =
𝑎𝑎−𝑏𝑏𝑞𝑞2 −𝑐𝑐
and plug output of firm two, which is half the monopoly
2𝑏𝑏
output since she is willing to cooperate: 𝑞𝑞1 =
𝑎𝑎−𝑐𝑐
𝑎𝑎− 4 −𝑐𝑐
2𝑏𝑏
=
3(𝑎𝑎−𝑐𝑐)
4
2𝑏𝑏
=
3(𝑎𝑎−𝑐𝑐)
8𝑏𝑏
…>
(𝑎𝑎−𝑐𝑐)
4𝑏𝑏
𝑎𝑎−𝑐𝑐
𝑎𝑎−𝑏𝑏 4𝑏𝑏 −𝑐𝑐
2𝑏𝑏
=
11
LESSON 6. COLLUSION VS COMPETITION.
THE INCENTIVE TO COOPERATE
Making use of these quantities, we obtain:
𝜋𝜋1 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶, 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 =
𝜋𝜋2 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶, 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 =
9(𝑎𝑎−𝑐𝑐)2
64𝑏𝑏
3(𝑎𝑎−𝑐𝑐)2
.
32𝑏𝑏
𝑎𝑎𝑎𝑎𝑎𝑎
Note that all equilibrium profits are multiplied by
(a-c)2 and divided by b…so their values are
irrelevant for the competition vs cooperation
decision!
12
LESSON 6. COLLUSION VS COMPETITION.
THE INCENTIVE TO COOPERATE
Firm 1/// Firm 2
cooperate
compete
cooperate
compete
1 1
,
8 8
3 9
,
32 64
9 3
,
64 32
1 1
,
9 9
×
(𝑎𝑎−𝑐𝑐)2
𝑏𝑏
(Nash) Equilibrium is (Compete, Compete): there
are no incentives to cooperate in a static setting,
hence cartel instability.
13
LESSON 6. COLLUSION VS COMPETITION.
THE INCENTIVE TO COOPERATE
-
-
There is this passage in Lazarillo,
Agora quiero yo usar contigo de una
libertad, y es que ambos comamos este
racimo de uvas y que hayas de él tanta
parte como yo. Partirlo hemos de esta
manera ; tú picarás una vez y yo otra, con
tal que me prometas no tomar cada vez
más de una uva. Yo haré lo mismo hasta
que lo acabemos, y de esta suerte no habrá
engaño.
After a while, the blind discovers that
Lazarillo cheated! Why? He cannot see…
How do I know that you took grapes in
threes??? Because I was taking them in
twos and you were silent…
14
LESSON 6. A DYNAMIC MODEL OF COLLUSION
The thing is that cartels are observed!
Then the question is: can a cartel be stable if the
game is repeated many times, instead of being
played only once? …Then there is an opportunity to
punish a cheater.
15
LESSON 6. A DYNAMIC MODEL OF COLLUSION
Consider a homogeneous product duopoly where
firms simultaneously set prices and marginal
costs are constant and equal.
If firms were to set prices in a static framework,
we already know that they would end up in the
Bertrand equilibrium:
Both firms setting prices equal to marginal costs and
earning zero profits.
Consider now that firms can select different
prices over time (infinite).
Time is divided into series of periods denoted by
t = 1,2,… and in each period firms
simultaneously set prices.
16
LESSON 6. A DYNAMIC MODEL OF COLLUSION
What is the equilibrium is such a dynamic
game?
One possible solution consists of firms playing
the static equilibrium (Bertrand in this case) in
each period, ignoring at each stage the previous
play.
“In fact, if firm 2 knows that firm 1 will be
playing price equal to marginal cost each period
regardless of what firm 2 does, her best response
is to set price equal to marginal cost as well.”
17
LESSON 6. A DYNAMIC MODEL OF COLLUSION
However, there are other equilibria.
Suppose firms play what is called “grim strategies”.
Which read as follows:
a) In the first period both firms set price equal to the
monopoly level, pm , and share monopoly profits
equally,
𝜋𝜋𝑀𝑀
.
2
b) In each subsequent period each firm observe price
history before setting their own prices.
b.1) If historical prices have all been at pm , that is if firms
have “respected” the collusive agreement, then each
firm sets pm in the current period.
b.2) Otherwise, they set price at marginal cost.
18
LESSON 6. A DYNAMIC MODEL OF COLLUSION
If both respect the agreement, it is respected next
period, if one of them does not, then the other
firm “punishes” the deviation be reverting
(forever) to the marginal cost level.
Why do grim strategies form an equilibrium?
To answer the question, we must check whether
the firms’ “non-deviation constraints” are
satisfied.
If both play pm over time, then a firm earns:
𝜋𝜋𝑀𝑀
2
𝜋𝜋𝑀𝑀
+ 𝛿𝛿
2
𝑀𝑀
𝜋𝜋
+ 𝛿𝛿 2
2
+⋯=
𝜋𝜋𝑀𝑀 1
2 1−𝛿𝛿
Which is the expected discounted payoff .
19
LESSON 6. A DYNAMIC MODEL OF COLLUSION
The discount factor 𝛿𝛿 is the value of €1 one period
into the future compared to €1 now.
𝑀𝑀
If firm 1 deviates by setting 𝑝𝑝1 ≠ 𝑝𝑝 in some
period t, then its future payoff is zero, by
assumption.
Since future profits are not function of what the
deviation was, but only on whether there was a
deviation, it follows that the best deviation for
firm 1 is the one that maximizes its short-run
profits.
𝑀𝑀
That is, a price 𝑝𝑝 − 𝜀𝜀 to get all demand and
make aprox. monopoly profits 𝜋𝜋 𝑀𝑀 .
20
LESSON 6. A DYNAMIC MODEL OF COLLUSION
Firms are better off respecting the agreement
than deviating as long as:
𝜋𝜋 𝑀𝑀 1
≥ 𝜋𝜋 𝑀𝑀
2 1 − 𝛿𝛿
1
2
which simplifies to 𝛿𝛿 ≥ .
If n firms operate in the market the condition
becomes:
𝛿𝛿 ≥ 1 −
1
𝑛𝑛
21
LESSON 6. A DYNAMIC MODEL OF COLLUSION
Normally, 0 < 𝛿𝛿 < 1. One reason is the
opportunity cost of time: an investor might use €1
to gain €(1+r) next period, where r is the interest
1
rate per period. That is, 𝛿𝛿 =
.
1+𝑟𝑟
Therefore, collusive behavior is more likely to be
an equilibrium the lower the interest rate… firms
are sufficiently patient.
22
LESSON 6. A DYNAMIC MODEL OF COLLUSION
Collusion is normally easier to maintain among
few firms and similar firms.
It is also easier when firms compete in more than
one market.
23
LESSON 6 - FACILITATING PRACTICES
The economic and legal antitrust literature
qualifies facilitating practices as actions that
foster collusion.
In the legal literature, collusion mainly refers to
a situation where firms coordinate their
strategies through some form of concerted
activity with the aim to restrict competition.
Although a formal agreement is not strictly
necessary, collusion requires some ‘‘meeting of
the minds,’’ ‘‘mutual assent,’’ or ‘‘concerted
practice.’’
24
LESSON 6 - FACILITATING PRACTICES
The economic notion of collusion contrasts with
the legal notion, as it refers directly to the
market outcome.
Collusion occurs if prices are above those that
would result with competitive conditions.
This definition poses the problem of identifying
the competitive benchmark.
It is now prevalent in the economic literature to
identify the competitive benchmark with the
outcome of a static game.
25
LESSON 6 - FACILITATING PRACTICES
Collusion, then, arises only if firms are able to
sustain higher prices by threatening to punish in
the future rivals that deviate from their collusive
strategy profile (as seen earlier in this chapter).
Therefore, a practice facilitates collusion if it
helps firms to coordinate on a price above
the static equilibrium in their repeated
interaction.
26
LESSON 6 - FACILITATING PRACTICES
Facilitating practices arise because collusion
entails two fundamental problems.
The first one is a coordination problem regarding which
collusive profile is chosen.
The second arises even if the first problem is overcome:
how to enforce the coordinated profile of strategies.
A practice facilitates coordination if it helps firms
to form prior beliefs on how rivals will play that
improve the likelihood of coordinated and more
privately efficient strategies.
27
LESSON 6 - FACILITATING PRACTICES
Facilitating practices arise because collusion
entails two fundamental problems.
The first one is a coordination problem regarding which
collusive profile is chosen.
The second arises even if the first problem is overcome:
how to enforce the coordinated profile of strategies.
A practice facilitates coordination if it helps firms
to form prior beliefs on how rivals will play that
improve the likelihood of coordinated and more
privately efficient strategies.
28
LESSON 6 - FACILITATING PRACTICES
Let’s describe some of them.
Information Exchanges That Facilitate Collusion
The exchange of information among competitors is
likely to have dangerous pro-collusive effects when it
allows to communicate disaggregated and recent data
concerning firms business variables such as prices,
output, volume sales, customers, costs, and
investments.
Recent and frequent data allow firms to react timely
to deviations, reducing the scope for profitable
cheating.
Information on costs can help colluding firms in
spotting deviation episodes, when firms are able to
observe their rivals’ prices but not their costs.
29
LESSON 6 - FACILITATING PRACTICES
Best price policies:
1.
A best-price policy is a commitment made by a firm
either to match or beat the lower price charged by
other firms (price matching guarantee and price
beating guarantee) or by itself to other current or
future customers (most-favored customer clause).
Price-Matching and Price-Beating Guarantees
Price-matching (PMG) and price-beating guarantees
(PBG) (collectively referred to as low price
guarantees) are facilitating practices as they can lead
to supra-competitive prices by preventing firms to be
undercut by rivals, or by reducing the rivals’
incentives to undercut.
30
LESSON 6 - FACILITATING PRACTICES
Best price policies:
2.
Most-Favored Customer
A most-favored-customer clause (MFCC) obliges a firm to
charge a buyer the same price charged by the same firm to
other customers. It can be either retroactive or
contemporaneous.
A retroactive MFCC entitles the buyer to receive a discount
(or a refund) if the seller charges anyone a lower price within
a given period of time in the future. A contemporaneous
MFCC corresponds to a commitment not to price discriminate
as it forces the firm to charge the same price to all buyers.
MFCCs have similar effects as LPGs. The main difference is
that while the latter reduce the rivals’ incentive to lower the
price, the former reduce the incentive of the firm that adopts
the clause to lower its own price in the future or to some
selected customers.
31
LESSON 6 – FINAL FIREWORKS
Antitrust: Commission fines maritime car carriers and car parts
suppliers a total of €546 million in three separate cartel settlements
Brussels, 21 February 2018
Commissioner Margrethe Vestager, in charge of competition policy said:“ The Commission has sanctioned
several companies for colluding in the maritime transport of cars and the supply of car parts. The three separate
decisions taken today show that we will not tolerate anticompetitive behavior affecting European consumers and
industries. By raising component prices or transport costs for cars, the cartels ultimately hurt European consumers
and adversely impacted the competitiveness of the European automotive sector, which employs around 12 million
people in the EU.”
The Commission's investigation revealed that, to coordinate anticompetitive
behaviour, the carriers‘ sales managers met at each other's offices, in bars,
restaurants or other social gatherings and were in contact over the phone on
a regular basis. In particular, they coordinated prices, allocated customers
and exchanged commercially sensitive information about elements of the
price, such as charges and surcharges added to prices to offset currency or oil
prices fluctuations.
MOL received full immunity for revealing the existence of the cartel, thereby
avoiding a fine of €203 million.
32
LESSON 6 – CARTELS NEED AGREEMENT
1981-82, American Airlines (AA) and Braniff
Airlines (BA) have fare war
Feb 21, 1982: Robert Crandall (RC), president
and CEO of AA calls Howard Putnam (HP),
president and chief executive of BA
HP taped the call (RC didn’t know)
33
LESSON 6 – CARTELS NEED AGREEMENT
RC: I think it’s dumb as hell for Christ’s sake,
all right, to sit here and pound the @#%#@!$
out of each other and neither one of us
making a #@$#!@ dime.
HP: Well…
RC: I mean, you know, @$#@, what the hell is
the point of it?
HP: But if you’re going to overlay every route
of American’s on top of every route that
Braniff has—I just can’t sit here and allow
you to bury us without giving our best effort.
RC: Oh sure, but Eastern and Delta do the
same thing in Atlanta and have for years.
34
LESSON 6 – CARTELS NEED AGREEMENT
HP: Do you have a suggestion for me?
RC: Yes, I have a suggestion for you. Raise
your @$@~!$ fares 20 percent. I’ll raise mine
the next morning.
HP: Robert, we…
RC: You’ll make more money and I will too.
HP: We can’t talk about pricing!
RC: Oh !#!@*!, Howard. We can talk about
any @#!$! thing we want to talk about.
35
LESSON 6 – THE WOODPULP CASE
In 1981, 40 firms (6 Canadian, 10 American, 11
Finnish, 10 Swedish, 1 Norwegian, 1 Portuguese
and 1 Spanish) were informed by the European
Commission that evidence of collusive behaviour
had been found relative to their export prices to
the European Communities, i.e. to over 800
European paper producers.
Main evidence was the parallel movement in
quarterly prices during 1975 and 1981. Every time
a firm announced a price change, the rest matched
it.
36
LESSON 6 – THE WOODPULP CASE
On December 19th 1984 the European Commission
imposed fines ranging from 50,000 and 500,000 ECUs,
except on an American firm, the Norwegian, the
Portuguese and the Spanish one.
In April 1985 firms appealed to the European Court of
Justice.
On July 7th 1992 the General Attorney concluded that
the Commission had not proved collusion and that
comovements in prices do not imply tacit collusion.
On March 31st 1993 the fines were annulled.
37
REGULATION AND COMPETITION
Lesson 7.
Horizontal competition issues: abuse of
dominance
Cabral 15
Instructor: Rafael Moner Colonques
1
Department of Economic Analysis
Slides
Industrial Organization: Markets and Strategies
Paul Belleflamme and Martin Peitz
University of Valencia
Degree in International Business
LESSON 7. ABUSE OF DOMINANCE
Motivation
What a dominant position is.
Building the case for abuse of a dominant
position
Commitment and credibility in dynamic games
Preemptive strategies: deterrence.
Brand proliferation
Elements of predatory pricing.
Areeda Turner rule.
Refusal to deal and essential facilities.
2
LESSON 7. MOTIVATION. PRICE CONDUCT
Following, to a great extent, the example of
Southwest Airlines, easyJet started operating
low-cost, no frills air services between different
European cities. Soon after entering the LondonAmsterdam segment, KLM, which held 40% of
the market, responded by matching easyJet’s low
fares.
For KLM, this amounted most certainly to
pricing below cost, and it implied serious losses
for easyJet on that route. It seems plausible that
KLM’s tactics were directed at inducing easyJet
to exit the market.
3
LESSON 7. MOTIVATION. NON-PRICE CONDUCT
In 2004, the European Commission found that
Microsoft had leveraged its market power from its
primary market for PC operating systems (OS) into the
secondary, complementary market for work group
server OS (work group servers are low-end servers that
link PC clients). In the primary market, Microsoft
controlled over 90% of the market with Windows. In
the secondary market, Microsoft’s market share rose
from 20% in the late 90s to over 60% in 2001…
The Commission argued that it was due to
anticompetitive actions and, in particular, to
Microsoft’s deliberate restriction of the interoperability
between Windows PC and non-Microsoft work group
servers.
4
LESSON 7. MOTIVATION. NON-PRICE CONDUCT
Microsoft was concerned about rival work group server
OS. Limiting interoperability made competitors less
attractive and application developers shifted away to
Microsoft and customers followed suit.
There was real bundling in the case of Windows Media
Player (a decoding software for media content) to
Windows OS.
Microsoft was fined with €497 million and imposed
behavioural remedies including compulsory licensing of
intellectual property and forced unbundling. In 2007,
Microsoft was fined a further €280 million for delaying
compliance with the remedy requiring the provision of
technical information to facilitate interoperability.
5
LESSON 7. WHAT A DOMINANT POSITION IS
Definition
In United Brands and in Hoffmann-La Roche,
the European Court of Justice gave the definition
of market dominance, which is still used
nowadays:
“[the dominant position] relates to a position of economic strength
enjoyed by an undertaking, which enables it to prevent effective
competition being maintained on the relevant market by affording
it the power to behave to an appreciable extent independently of its
competitors, its customers and ultimately of the consumers. Such a
position does not preclude some competition, which it does where
there is a monopoly or quasi-monopoly, but enables the
undertaking, which profits by it, if not to determine, at least to
have an appreciable influence on the conditions under which that
competition will develop, and in any case to act largely in disregard
of it so long as such conduct does not operate to its detriment”.
6
LESSON 7. WHAT A DOMINANT POSITION IS
Definition
The Hoffmann-La Roche EC case delineated the
concept of abuse of a dominant position, as
a behavior “which, through recourse to methods
different from those which condition normal
competition in products or services on the basis of the
transactions of commercial operators, has the effect
of hindering the maintenance of the degree of
competition still existing in the market or the growth
of that competition”.
7
LESSON 7. WHAT A DOMINANT POSITION IS
The cornerstone of European law on abuse of
market power is Article 102 of the TFEU.
The prohibition on abuse of dominance covers a
wide and diverse range of corporate behavior.
The practical meaning of the prohibition has
evolved over time through the case law,
especially since judgments by the European
Court of Justice (ECJ) from the late 1970s, before
which there were very few cases.
It applies only to firms that have dominant
positions.
8
LESSON 7. WHAT A DOMINANT POSITION IS
All but a few EC cases on abuse of dominance
have concerned exclusionary conduct by
dominant firms—namely conduct preventing or
restricting competitors rather than behavior
directly exploitative of consumers.
Many EC cases have dealt with pricing issues,
such as predatory pricing, selective price cuts,
margin squeezes, and discounts and rebates.
Non-price issues have included tying, bundling,
exclusive dealing, and refusal to supply.
9
LESSON 7. WHAT A DOMINANT POSITION IS
Case law has established some general
principles:
- That a dominant firm has a special responsibility not
to allow its conduct to impair genuine undistorted
competition.
- That a dominant firm may not eliminate a competitor
or strengthen its position by recourse to means other
than those based on competition on the merits.
- That abuse involves recourse to methods different
from those that condition normal competition.
- That the concept of abuse is objective, so does not
require anticompetitive intent (though evidence on
intent can be relevant to finding abuse).
10
LESSON 7. WHAT A DOMINANT POSITION IS
The United States has a much longer tradition of
competition law than Europe.
As you already know Section 2 of the Sherman
Act of 1890 makes it illegal to ‘‘monopolize, or
attempt to monopolize,…’’
Monopolization has two elements, which very
roughly correspond to dominance and abuse:
- Possession of monopoly power.
- ‘‘the willful acquisition or maintenance of that power
as distinguished from growth or development as a
consequence of a superior product, business acumen
or historic accident.’’
11
LESSON 7. WHAT A DOMINANT POSITION IS
Here is the fundamental issue:
How to distinguish between (unlawful)
exclusionary or competition-distorting
behavior and (lawful) ‘‘competition on the
merits’’ by firms with market power?
12
LESSON 7. ABUSE OF DOMINANCE.
COMMITMENT AND CREDIBILITY IN DYNAMIC GAMES
1, 1
Microhard
Newvel
1,1
0,3
13
LESSON 7. ABUSE OF DOMINANCE.
COMMITMENT AND CREDIBILITY IN DYNAMIC GAMES
Microhard is the incumbent firm. Newvel is the
potential entrant and moves first (sequentiality),
choosing either to enter or stay out.
If she stays out, her economic profits are zero;
Microhard continues to earn monopoly profits 3.
If she enters, then Microhard may accommodate
entry so that each earns a profit of 1; if
Microhard sells at a price below average total
cost (fights) then each firm earns – 1.
14
LESSON 7. ABUSE OF DOMINANCE.
COMMITMENT AND CREDIBILITY IN DYNAMIC GAMES
(Enter, Accommodate) is a Nash equilibrium:
given that Microhard accommodates, Newvel will
choose enter (otherwise she would earn zero).
Likewise, given that Newvel enters,
accommodate is the best response by Microhard.
(Stay Out, Fight) is a Nash equilibrium: given
that Microhard fights, Newvel is better off
staying out (getting zero) rather than entering
(getting – 1). Likewise, given that Newvel stays
out, Microhard’s profit is 3 regardless of what
choice she makes.
15
LESSON 7. ABUSE OF DOMINANCE.
COMMITMENT AND CREDIBILITY IN DYNAMIC GAMES
However, the latter does not make sense since it
relies on a non-credible threat. Once Newvel has
entered the market, Microhard does not have an
incentive to carry out her threat (she prefers
accommodation and earn 1 rather than fight and
earn – 1).
It is said that (Enter, Accommodate) is the
unique Subgame Perfect Nash Equilibrium
(Selten, Nobel 94).
Chain-Store Paradox
16
LESSON 7. ABUSE OF DOMINANCE.
STRATEGIC BEHAVIOUR
Consider this numerical example to illustrate
strategic behaviour. (implicitly assumes sequentiality).
Inverse demand is 𝑝
56 2 𝑞
𝑞 and cost is
𝑇𝐶
20𝑞 𝑎𝑛𝑑 𝑇𝐶
20𝑞
18 .
An entrant has to check whether it is profitable
to enter the market. As she maximizes profits,
𝜋
56 2 𝑞
𝑞
20 𝑞
18
Taking the derivative with respect to 𝑞 , setting
it equal to zero and solving leads to
18 𝑞
𝑞
2
17
LESSON 7. ABUSE OF DOMINANCE.
STRATEGIC BEHAVIOUR
The incumbent anticipates how the entrant will
respond…so he chooses 𝑞
9.
Then, 𝑞
4.5 and entrant’s profit is 𝜋
22.5…in the same manner, 𝜋
81.
Suppose that the fixed cost is no longer 18, by 32.
The quantities will obviously be the same, but
entrant’s profit fall… 𝜋
8.5
There is another way, which depends on the
incumbent’s choice, of driving entrant’s profits
down: increase 𝑞
10…then 𝑞
4, 𝜋
14 but
80.
incumbent’s profit would be 𝜋
18
LESSON 7. ABUSE OF DOMINANCE.
STRATEGIC BEHAVIOUR
Maybe the incumbent did not increase output
sufficiently…suppose he chooses 𝑞
12.
Then, 𝑞
3. Remember what happens with
Cournot: if I produce more, then the rival
responds by producing less. And we know that
profits are related to output, so that now we
have:
𝜋
56 2 12 3
20 3 18
56 30
6 3
18 0‼!
20 3 18
19
LESSON 7. ABUSE OF DOMINANCE.
STRATEGIC BEHAVIOUR
Would you enter? No. In which case, the
incumbent would earn:
𝜋
56 2 12 0
20 12
56 24 20 12
144 81‼
Given that, the incumbent will rather produce 12
and deter entry.
Your intuition tells you that if the fixed cost is
low, the incumbent will produce 9 and
accommodate entry.
If, in contrast, the fixed cost is high then the
incumbent need not worry and behaves as a
monopolist since entry is blockaded.
20
LESSON 7. ABUSE OF DOMINANCE.
STRATEGIC BEHAVIOUR
The message is that by committing in advance
and in a credible manner, for example, building
capacity, a firm can deter entry and remain alone
in the industry.
Titanium Dioxide is a white chemical pigment
employed in the manufacture of paint. The
primary raw material is either ilmenite ore or
rutile ore. By 1970 there was DuPont and six
other smaller firms. In 1970 there was a sharp
increase in the price of rutile, which gave DuPont
a cost advantage; it was also in a better financial
state.
21
LESSON 7. ABUSE OF DOMINANCE.
STRATEGIC BEHAVIOUR
DuPont expanded capacity, which discouraged
rivals from entering/expanding…DuPont’s
market share increased from 30% in 1970 to
more than 60% in 1985! Her growth strategy
materialized in a “first-mover” advantage.
Next, we move to another non-price strategy that
can deter entry…
22
LESSON 7. ABUSE OF DOMINANCE.
BRAND PROLIFERATION
Consider an incumbent that produces a base
product. She would like to produce also a
substitute product… her profits would be 𝜋 1
and 𝜋 2 with 𝜋 1
𝜋 2 . So that if
incumbent is alone then it is better to produce
just one product.
Take this game.
Incumbent chooses to produce either 1 or 2 products
Entrant decides to enter. If so, entrant incurs an
entry cost e, and competes with incumbent’s second
product.
Active firms simultaneously set price.
23
LESSON 7. ABUSE OF DOMINANCE.
BRAND PROLIFERATION
What is the equilibrium?
In case of entry, we find duopoly profits denoted
𝜋 𝑘 firm 1 and in brackets the number of
products offered by the incumbent.
Entrant’s profits are 𝜋 1
𝑒 with one product,
but entry is not profitable with two product – it
competes head on with incumbent’s second
𝑒 0 𝑒
𝑒.
product – that is, 𝜋 2
The incumbent can deter entry by offering 2
products! This is so when 𝜋 2
𝜋 1 .
We would have a SPNE with brand proliferation
as an entry deterrent.
24
LESSON 7. ABUSE OF DOMINANCE.
BRAND PROLIFERATION
1
1 product
2 products
2
entry
d (1)
1
d
2 (1) e
no entry entry
2
no entry
m (1) d (2)
1
0 e
m (2)
0
25
LESSON 7. ABUSE OF DOMINANCE.
BRAND PROLIFERATION
Case. The ready-to-eat (RTE) cereal industry
US, 1940s to 1970s: high concentration
4 major manufacturers (Kellogg, General Foods, General Mills
and Quaker Oats) 85% of sales
No entry in this period, although profitable industry
Barriers to entry
No real barrier coming from economies of scale, capital requirements,
product differentiation, patents...
Main cause: brand proliferation
No new firm entered but 80 new brands were introduced by 6 major
incumbent firms between 1950 and 1972!
Federal Trade Commission (1972): ‘these practices of proliferating
brands, differentiating similar products and promoting trademarks through
intensive advertising result in high barriers to entry into the RTE cereal
26
market’.
LESSON 7. ELEMENTS OF PREDATORY
PRICING
In all theories of predatory pricing there is a
common mechanism:
The predator sets low prices for a period, thereby
sacrificing short-run profits, in order to make a rival
(or its lenders) believe that it should not expect high
profitability.
When the rival revises its plans (or its lenders stop
financing it) and exits, or abandons the project of
entering, or reduces the scale of its operations, the
incumbent will increase its prices and reap high
profits, that in the long-run outweigh early losses.
27
LESSON 7. ELEMENTS OF PREDATORY
PRICING
Two elements should be stressed from this
mechanism:
(a) the sacrifice of short-run profits;
(b) the ability to increase profits in the long-run
by exercising market power once predation has
been successful.
28
LESSON 7. ELEMENTS OF PREDATORY
PRICING
It is on these two elements that the legal
treatment of predatory pricing should be built.
Accordingly, it makes sense to have a two-tier test
of predation, as follows:
1.
Analysis of the industry to determine the degree of
market power of the allegedly dominant firm. If the
firm is not dominant, dismiss the case; if the firm is
dominant, proceed with
2.
analysis of the relationship between price and costs.
29
LESSON 7. ELEMENTS OF PREDATORY
PRICING
-A price above average total costs should definitely
be considered lawful, without exceptions.
-A price below average total costs but above
average variable costs should be presumed
lawful, with the burden of proving the opposite
on the plaintiff.
-A price below average variable costs should be
presumed unlawful, with the burden of proving
the opposite on the defendant.
30
LESSON 7. ELEMENTS OF PREDATORY
PRICING
Coming back to how to deal with predatory
pricing allegations, remember that a first
necessary condition for predation is the
ability to increase prices. This has to do with
dominance.
In EU law, an oligopolistic firm that does not
have a dominant position would not be found
guilty of predatory behavior. In current practice,
this means that a firm with a market share
below 40% would probably not be accused of
predation.
31
LESSON 7. ELEMENTS OF PREDATORY
PRICING
In the US, the issue is much less clear, and
courts have found firms guilty of predation even
when they held relatively small market shares.
A case in point is Brooke Group, although the
final Supreme Court decision eventually
dismissed the predation allegations, after an
initial guilty verdict.
In that case, a small cigarettes producer, Liggett & Myers
(later to be part of the Brooke Group) had filed suit against
Brown and Williamson - which held 12% of the cigarettes
market -accusing the latter of having entered the generic
and private label segment of the market and of selling
below cost to drive Liggett -the main firm in that segment out of the market.
32
LESSON 7. ELEMENTS OF PREDATORY
PRICING
A high market power standard is needed to avoid
the risk of jeopardizing competition in
oligopolistic markets.
It would be paradoxical if antitrust authorities
put hurdles to practices used by non-dominant
firms to increase their market power.
33
LESSON 7. ELEMENTS OF PREDATORY
PRICING
A second necessary condition is the
sacrifice of short-run profits
This means that the incumbent-predator is not
choosing the price that it would optimally choose
were it taking as given the presence of the rivalprey, but rather a lower price at which it will
make lower current profits.
If the authority has no way to check whether a
sacrifice in profits has been produced, then the
sacrifice of short-run profits is established if the
alleged predation price is lower than (some
appropriate measure of) costs.
34
LESSON 7. ELEMENTS OF PREDATORY
PRICING
By doing so authorities establish a necessary
(although not sufficient) condition for proving a
predatory allegation of monopolization (or abuse
of dominance) is that the predator makes losses
during the predation period.
This rule makes a lot of sense. A firm that makes
profits should be excluded from predatory
charges because nobody could prove that it could
have made even more profits had it acted
differently.
35
LESSON 7. ELEMENTS OF PREDATORY
PRICING
A firm that makes negative profits, instead,
might be a predator, although there are other
reasons why a firm might want to charge below
costs, such as selling perishable products that
would otherwise be unsold - thus causing even
greater losses -, making promotional offers,
stimulate sales of complementary products and
so on.
To summarize, a price below cost test might not
allow to catch all the possible instances of
predation. Yet, the cost of making errors seems
small.
36
LESSON 7. ELEMENTS OF PREDATORY
PRICING
Compare it instead with the error that we would
make if we allowed to find predation at prices
above costs.
Since low prices improve consumer surplus
and welfare, and it should be an objective of any
competition policy to create circumstances
favorable to low prices, the risk of deterring
firms from setting low prices is simply too high.
37
LESSON 7. ELEMENTS OF PREDATORY
PRICING. AREEDA-TURNER RULE.
Which definition of cost in a "price below
cost" test?
Determining whether at a certain price a firm is
making positive profits or not (i.e., is selling
above or below cost) is a very hard task.
Areeda and Turner (1974) argue that the best
measure from a conceptual point of view would
be that of marginal cost, since a firm that sets
price below marginal cost would clearly not
maximize short-run profits.
38
LESSON 7. ELEMENTS OF PREDATORY
PRICING. AREEDA-TURNER RULE.
However, they suggest to use in practice average
variable cost - defined as the sum of all variable
costs divided by output - as a surrogate for
marginal cost, given "the difficulty of
ascertaining a firm's marginal cost.
As already noted, under current US law, a price
above average total cost (ATC) is conclusively
lawful, while a price below average variable cost
(AVC) is at least suspect.
39
LESSON 7. ELEMENTS OF PREDATORY
PRICING. AREEDA-TURNER RULE.
A price between AVC and ATC is sometimes held
unlawful, depending on other factors. But judicial
decisions are not consistent, and courts have
increasingly relied on the AVC benchmark as the
main criterion for illegality.
40
LESSON 7. ELEMENTS OF PREDATORY
PRICING. AREEDA-TURNER RULE.
The concept of average incremental costs
(AIC), defined by Bolton, Brodley and Riordan
(2000) as the per unit cost of producing the added
output to serve the predatory sales.
AIC differs from average variable cost in at least
two ways.
First, it is not measured over the firm's whole output,
but only over that increment of output used to supply
the additional predatory sales.
Second, incremental cost includes not only variable
cost, but any fixed costs incurred in expanding to
serve the new sales.
41
LESSON 7. ELEMENTS OF PREDATORY
PRICING. AREEDA-TURNER RULE.
Incremental cost is a better standard than either
average variable cost or full costs because it most
accurately reflects the costs of making the
predatory sales.
Accordingly, these authors would presume illegal
a price below AIC and lawful one above ATC,
with a grey area in between.
Perhaps AIC better matches the concept of
predation, but it might not be always easy in
practice to identify precisely the costs that are
sustained for a given output, and/or isolate the
predatory output from total output.
42
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Each firm is free to choose its business partners
and customers to supply. This lies at the very
foundation of the freedom of enterprise.
Compulsory dealing is usually not subject to
contract law.
Some competition concerns may nonetheless
arise in case of dominant firms refusing to supply
certain customers. Through a refusal to supply,
an undertaking may attempt to maintain or
acquire market power.
This strategy can be used to raise entry barriers,
to discriminate among customers, or to exclude
competitors from downstream markets.
43
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
This practice, in particular when essential
facilities are involved, may result in irreversible
exclusion from the market for firms being denied
access to an essential facility at the dominant
firm’s disposal.
Common examples of essential facilities are ports
and airport infrastructures, but they may also
include IP.
It is often difficult to determine conclusively that
a certain good or a service is indeed essential for
carrying out a certain business.
44
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
For a certain asset to be considered an “essential
facility,” it is typically required that it is
irreproducible or reproducible only under
uneconomical conditions.
Often a facility is considered essential when
viable alternatives to enter the market are
lacking or there exists excess capacity in the
facility so that granting access would not impose
an unreasonable financial burden on the
dominant firm.
45
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
There are many examples that might satisfy this
very loose definition of essential inputs.
In the airline industry, slots in an airport;
for maritime transportations, a port's installations;
in fixed telephony, the local loop which links each
home's telephone with the network;
for electrical power generation, the transmission and
distribution network of electricity;
for the production of pharmaceuticals, a certain
chemical component; and so on.
46
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Example from Motta (2004).
Imagine for instance that a shipping company X
integrates backwards and builds new port
installations in a certain town A, located in the
"home" country.
Given the location, using this port's infrastructure
gives firm X a great advantage in serving the
maritime route from the home country to a certain
other foreign country.
Company Y now requests use of the port and firm
X denies it (refusal to supply).
47
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Example from Motta (2004). (cont’d)
Then, firm Y complains with the competition
authorities that it should also have access (possibly
even at a price, provided it be fair) to town A's port
installations.
Is there something illegal in firm X’s behavior?
Competition authorities in different countries have
often been too ready to accept allegations like that
made by firm Y.
But there are a number of considerations which
should be properly analyzed before granting rivals
access to a facility owned by a firm.
48
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Example from Motta (2004). (cont’d)
In the port example, for instance, it should be seen
to which extent transport from ports other than
port A is really such a poor substitute for the
maritime route to the foreign country. Are really
all the other ports so far away? Are their facilities
so inferior?
Second, supposing that there are no other existing
ports which might provide a substitute route for
transport to the foreign country, is it feasible for
company Y to reproduce a similar investment and
build (or improve) port facilities in another nearby
town, say B?
49
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Example from Motta (2004). (cont’d)
Third, it should also be checked that by letting
rivals access the infrastructure the owner of the
facility would not find it more costly to produce. If,
for instance, there is no spare capacity, then it
would be more difficult to argue for access.
If all the previous tests were favorable to the firm
requesting use of the input, the possibility of using
access pricing to cope with this issue could be
considered.
50
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Example from Motta (2004). (cont’d)
However, there is another argument which
suggests caution before granting access to rivals
too generously. In this example, the new port
installation has been the result of a deliberate (and
presumably costly) investment by a firm.
Obliging it to share its facilities with rivals would
be an infringement of its property rights. More
importantly, it would have the effect of
discouraging similar investments elsewhere, as the
prospect of being expropriated of own investments
will make firms refrain from introducing new
inputs and facilities in the first place.
51
LESSON 7 - REFUSAL TO DEAL AND
ESSENTIAL FACILITIES .
Example from Motta (2004). (cont’d)
The last observation is crucial. There is an
important difference between firms which have
invested and firms which have obtained the right
of using a certain facility without having borne the
risk of its creation or having paid for it.
In the above example, one should not consider in
the same way the case where firm X has built itself
(bearing the risk and cost of the investment) the
port installations and the case where the
investment has been made by the state and the
firm has received the monopoly rights to use them.
52
