Oller’s Brief on Market Definition The Product Market Brown Shoe established the general rule for defining a product market. The outer-boundaries of the product market are determined by reasonable interchangeability of use or the cross-elasticity of demand between the product itself and the substitutes for it. This test suggests trying to identify the cross-elasticity between the product (of the defendant) and potential substitutes, or the change in Q of a related good resulting from a change in price (This relationship should be positive and significant if the goods are truly substitutes). In defining this market, you will find the smallest market possible such that the product in question has a low cross-elasticity with the potential substitutes for it. For example, if colas had a low cross-elasticity with other sugared carbonated beverages (such as Sprite or Mountain Dew) then colas would be a distinct product market. In this case, all sugared carbonated beverages would also likely have a low cross-elasticity with diet drinks, but the cola market is smaller and more appropriate for a product market analysis. Cross-elasticity is often difficult or impossible to perform, due to problems with obtaining the necessary data. In addition, cross-elasticity must isolate the effect of a price change of a good on the sales of potential substitutes which can be tricky because many factors can influence the demand of a product and one must ensure that the change in quantity of the substitute is truly due to the price change in the competing product rather than some other demand factor changing. For example, suppose that a study indicated that drinking wine was released and that the price of soda was increased near that time period. A regression might reveal that the price of sodas increased with the quantity of wine, but it was not the price increase in soda that explains the increase in wine consumption. Historical data may be useful in the absence of a cross-elasticity analysis. Such data may include evidence of: 1. 2. 3. 4. Sellers bidding against each other Purchasers bidding for supply Shipping patterns Parallel movements in P or Q Be careful in using this data, because it tends to show what is happening in the market, not what will happen if there is an increase in P (see the discussion regarding the merger guideline). A product market has both a demand side and supply side analysis. Brown Shoe also stated that within the broader product market, sub-markets might exist, which may constitute a separate market for antitrust purposes. The factors pertinent to determining whether a sub-market exists include: 1. 2. 3. 4. 5. 6. 7. Industry or public recognition of the sub-market as a separate economic entity Products peculiar characteristics and uses Distinct customers Distinct prices Sensitivity to price changes Unique production facilities Specialized vendors There are two important notes one should recognize when using the factors of a sub-market: 1. Not all 7 factors are necessary to constitute a “sub-market” 2. These factors can be viewed as proxies for cross-elasticity. The Merger Guidelines Approach: The merger guidelines stipulate that a product market is the smallest market for where the hypothetical firm having all production could and would maximize profits by imposing a small but significant and non-transitory increase in price. In this case small but significant means 5%. You should note that this means that a price increase of at least 5% would be profit maximizing, not simply profitable. For example, suppose the hypothetical monopolist could increase profits by imposing a 5% price increase, but its profit maximizing increase would be 3%. In this case, the hypothetical firm would not impose a 5% price increase and the market would need to be expanded until that condition was met. The merger guidelines incorporate a demand and supply side analysis. The demand side analysis examines what will happen to sales of competing products if the price of the good changes. A supply analysis would examine what competitors would shift production to making the product if the price significantly increased. For example, consider what would happen if two different companies owned Almond Joy and Mounds and the price of Almond Joy significantly increased because consumers had a distinct value for feeling like a nut. Even if consumers didn’t consider them substitutes (demand side), the producer of Mounds may easily begin adding nuts to the candy in response to the increase. Typical problems with product market delineation: 1. Product Differentiation- when products are differentiated it may become more difficult to separate the market. Many brands have very loyal customers that would not switch in light of a price change. This may make it more difficult to truly assess whether the market would respond to an increase in price. Most courts have concluded that a firm’s brand will not constitute a separate market. 2. Cellophane Fallacy- We discussed in class that a firm may already be a monopoly that is profit maximizing. In that case, they couldn’t increase profits by imposing a price increase. This makes it appear that the market should be expanded when in fact it should not. 3. Cluster Theory- Sometimes numerous products should be grouped together to form a market when it reflects commercial realities. For example, a convenient store sells numerous items. In defining the market the numerous products should be grouped under a “convenient store” rather than defining numerous markets for the numerous products. The Geographic Market A geographic market is the area in which the seller is located and where buyers in that area could turn to for alternative sources of supply. Cross-elasticity is often utilized for this market analysis as well. You would examine whether a change in price in one geographic location causes a change in quantity in another geographic location. If it does, the geographic market must be expanded to include the more remote sellers. One thing to be careful about with a geographic market definition is the concept of a trade area. A trade area is generally the geographic area from which a firm receives 80% of its sales. For example, Edmond Memorial Hospital likely gets more than 80% of its patients from Edmond. However, customers in Edmond would likely travel to Oklahoma City if prices increased significantly. This means that parts of Oklahoma City must be included in the relevant geographic market. ***The most significant factor affecting the geographic market are transportation costs. If transportation costs for the customer or seller are high relative to the price of the good, then buyers will likely not travel outside the relevant area and sellers cannot offer competitive prices in the geographic area. Other factors that tend to restrict or expand markets are import capacities, buyer convenience and government restrictions. The Elzinga-Hogarty TestThis test attempts to delineate markets based on product shipments. It defines a market based on two principles named LIFO “Little In From Outside” and LOFI “Little Out From Inside”. According to this test, a proper geographic market is one in which both of these conditions holds. The article articulating this standard defined little as 10%. Thus, if 10% of the market sales come from outside the geographic area, or 10% of shipments leave the geographic area then the market must be expanded. Limitations of the LIFO and LOFI testThese proxies have major limitations in some cases. Specifically, they mis-represent the market when there are capacity constraints in a market. In class, we discussed an example using electricity. Recall that there were instances where there could be shipments occurring in two areas, but additional product could not enter in response to an increase in price. In this instance, the narrower market was appropriate even though the LIFO and LOFI methods would indicate that the market should be expanded. If this occurs, the best market analysis would consider the sales of the remote firm in the market share calculation, but not their entire capacity. In addition, we also showed that price in two areas could be equal with no shipments occurring. In this case, we discussed how the LOFI and LIFO methods would illustrate two distinct markets even though prices in one geographic area could constrain prices in the other market.