Conjectural variations: unilateral effects
Incorporating rival responses into simplified unilateral effects measures
Adrian Majumdar & Chris Doyle
adrian.majumdar@rbbecon.com chris.doyle@rbbecon.com
Overview
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Authorities’ use of price pressure tests
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Theoretical approach to integrating rival responses into UPP: GePP
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Applying GePP in practice
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–
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Formal implementation
Informal implementation
Intuitive implications of GePP
Policy implications
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Authorities’ Use of Price Pressure Tests

Recognition that market share based screens can be poor indicators of harm in
differentiated goods markets (Werden 1996, Shapiro 1996)
CC
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Somerfield Morrisons, 2005 (symmetric IPR)
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Zipcar /Streecar, 2011 (GUPPI)
OFT
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Lovefilm/Amazon (rebuttable presumption of SLC arising from high D and high
M)
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[NB. Rebuttable presumption no longer applies]
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Asda/Netto, 2010 (IPR, isoelastic, asymmetric diversion ratio, efficiencies)
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Unilever/ Alberto Culver, 2011 (GUPPI with multi products, upstream market)
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These days GUPPI is more likely to be considered than IPR?
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Upwards pricing pressure (UPP)

A first order approach to calculating the impact of a merger on price

UPP on product 1
=
D12 (P2 – C2) – EC1
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Standard approach – internalisation of demand spill-over to firm 2
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Opportunity cost (cannibalisation) intuition of Farrell & Shapiro
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Weighed up against efficiency gain (reduction in marginal cost)
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Can then think about pass through of higher cannibalisation cost
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GUPPI = Gross Upward Pricing Pressure Index
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GUPPI for product 1
D12 * (P2 – C2)
P1
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Perceived increase in marginal cost of selling another unit, as a percentage of
price

Intuition: post merger, the owner of product 1 faces a perceived increase in
cost, if the cost increase is a high share of the price of product 1, then pass
through (higher prices) are more likely.

Can multiply GUPPI by pass through rate to obtain “first order” estimate of price
increase caused by a merger.
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“Illustrative” price rises with symmetric demand and cost
What is a price pressure test?

Merger simulation?

A way to put information on percentage margins and diversion ratios in
context?
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Screen: IPR > 5% or GUPPI > 10% => worth looking further? (Retail mergers
with many local overlaps.)
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Evidence weighed up with other factors.
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Judging a price pressure test
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Lucid (understood by policy makers)
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Implementable at Phase I (data, time)
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Predictive power (good or bad?!)
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Example:
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Do “equilibrium properties” of IPRs trump First Order Approach to Mergers
(FOAM)?
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Not if FOAM offers a better LIP service…
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Both are approximations anyway (e.g. ignore supply side responses)

The research question: given an environment where the OFT uses price
pressure tests, should such tests be updated to include pricing conjectures?
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Jaffe and Weyl – Generalised Pricing Pressure (GePP)
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Extend UPP to incorporate rival responses using conjectural variations
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A complex theoretical model which covers a range of issues
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We aim to simplify and present the main intuitive implications for policy
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Adding greater realism should act towards better predictive power…
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But is GePP implementable and clear to policy makers?
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GePP: incorporating CVs requires a conjectured diversion ratio
𝐷𝑖𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜 1 𝑡𝑜 2 =

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
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𝐶𝑢𝑠𝑡𝑜𝑚𝑒𝑟𝑠 𝑔𝑎𝑖𝑛𝑒𝑑 𝑏𝑦 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 2
𝐶𝑢𝑠𝑡𝑜𝑚𝑒𝑟𝑠 𝑙𝑜𝑠𝑡 𝑏𝑦 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 1
Conventional UPP uses the standard diversion ratio which holds rivals’
prices constant following a price increase by firm 1
Jaffe and Weyl consider the implications of rival responses for diversion
patterns, and how this affects incentives to change price in the first place
In particular they consider firms as having “accommodating” pricing reactions
Post merger, firm 1 also considers how rivals will respond but treats firm 2’s
price as fixed
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GePP: incorporating CVs requires a modified diversion ratio

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This “conjectured” diversion ratio is different from the standard one in 2
ways:
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Fewer customers will be lost by firm 1 as a result of a price increase, as
accommodating rivals will be more expensive
–
More customers will be recaptured at firm 2 as a result of the price increase by
firm 1, as firm 2 will now be relatively cheaper than accommodating rivals
Therefore with accommodating reactions the conjectured diversion ratio is
greater than the standard one – indicating the potential for greater price
increases than with standard UPP
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GePP: end of accommodating reactions


Jaffe and Weyl highlight that a consideration of rival responses introduces a new
effect - the merger will lead to the “end of accommodating reactions” (EAR)
Pre-merger the fact that an increase in firm 1’s price would lead to an increase in
the price of firm 2 would have encouraged higher pricing by firm 1

Post merger the price of product 2 is directly controlled by firm 1, so this indirect
incentive to increase price is removed
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Indicates the potential for smaller prices increases than with UPP
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Broad intuition: if 1 and 2 were accommodating each other pre-merger, there is
less competition to be “lost” as a result of the merger
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Overall 2 opposing effects: conjectured diversion vs. EAR
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Implementing GePP formally
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By assuming consistent conjectures GePP can potentially be formally
estimated using data obtained from cost shocks
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However this is potentially (very) complex:
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Clean cost shocks to the merging parties
Sufficient data to allow us to accurately observe their impact
Econometric approaches required to estimate GePP using this data

Given the time and data constraints faced during the screening phase for
mergers, unlikely that this formal approach will be practically implementable

Simplified versions of GePP outlined by Jaffe & Weyl may be more
implementable – but they appear to be based on strong assumptions (as are
IPRs)
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Implementing GePP informally

Sometimes measures used to imply diversion ratios may in some senses
already incorporate the reactions of rivals (e.g. internal business documents)
–
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Rather than being a problem, Jaffe & Weyl claim this may be an advantage
as GePP emphasises that we actually want a measure that incorporates rival
responses
–
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Notable exception is surveys which potentially measure the standard diversion
ratio
Though note this information will only be a rough approximation as it typically will
not hold the price of product 2 constant as desired
BUT don’t just plug this diversion ratio into a standard UPP formula, as this
will ignore the EAR term and could therefore bias the outcome
–
–
Don’t mix and match models: implement GePP fully or stick to UPP
But it may be difficult to estimate EAR here
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Intuitive implications of GePP
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Even if GePP can’t be properly implemented, it may provide an indication of
when standard UPP over- or understates true upwards pricing pressure
Example: NBTY/Julian Graves
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Evidence indicated supermarkets did not monitor the parties’ pricing
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2 major specialist retailers of nuts seeds and dried fruit
Key question is the role of supermarkets in providing a competitive constraint
Implies zero conjectures, meaning conjectured DR equals the conventional DR
But EAR is likely to be present (parties monitored each other)
This indicates that UPP here likely overstates upwards pricing pressure
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Policy Implications

GePP may potentially provide a way to take into account rivals’ reactions in an
upwards pricing pressure measure

However, this approach will usually not be (properly) implementable at Phase I

Nevertheless, GePP indicates that if we ignore conjectures and undertake
standard UPP, no obvious bias is introduced into merger control
(benchmarked against a standard UPP screen)
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Parties may not volunteer to the OFT that they accommodate each other!
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But why wouldn’t the merger change conjectures?
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Perhaps we shouldn’t try to pack too much into a single model
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