Market Definition
Presentation to the
Competition Commission of India
US Chamber of Commerce
October 26, 2010
Overview
• Market power
• Market definition
– Relevant product market
– Relevant geographic market
• Case studies
Market Power
• “Mergers should not be permitted to create, enhance, or
entrench market power or to facilitate its exercise.”
– (Source: Horizontal Merger Guidelines)
• Market Power is the ability of a firm or a group of firms in a
market to profitably raise prices, reduce quality, or slow
down innovation for a significant period of time compared to
these outcomes in a competitive market
• Market power and monopoly power are often used
interchangeably
Analysis of Market Power
• Market structure approach / Indirect approach
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Market definition
Market shares
Market concentration
Barriers to entry and expansion
Perception of market participants
• Competitive effects analysis / Direct approach
– Predict post-merger price effects
– Elasticity of demand
Market Definition
• In determining whether a transaction will create or enhance
market power, the agencies and the courts look at the
relevant markets within which the competitive effects are to
be assessed
Relevant Markets:
Two Components
Product
New York
Geography
Chicago
Los Angeles
Miami
Importance of Market
Definition
• Specifies the product and geographic scope in which the
competitive concern may arise
– May be different from how industry members uses the term
“market”
• Identifies market participants, shares, and concentration
– Allows one to identify the competitive alternatives available to
customers
Market Definition
• Just because two products are used for similar purpose
does not imply that they are in the same “antitrust” market
Or even…
Relevant Product Market
• Identifies a product or a set of products such that firms
producing those products can defeat each others’ attempts
to raise the price above the competitive level
• Demand substitution
– Customers’ ability and willingness to substitute away from
one product to another in response to an increase in price or
a reduction in quality
Demand Substitution:
SSNIP Test
• Hypothetical Monopolist/SSNIP Test:
– “A hypothetical profit-maximizing firm, not subject to price
regulation, that was the only present and future seller of those
products likely would impose at least a small but significant
non-transitory increase in price on at least one product in the
market, including at least one product sold by one of the
merging firms”
Demand Substitution:
SSNIP Test
• SSNIP is a methodological tool
• Identifies a set of products that are reasonably
interchangeable with a product sold by a merging party
• Ensures that markets are not defined too narrowly
• The most commonly used price increase threshold is 5%
Demand Substitution:
Implementation of SSNIP
• Extent to which customers will substitute away from the
product in question
– Examine how customers have shifted their purchase patterns
in the past
– Survey on how the buyers would respond to a price change
– Interview customers and competitors to assess views on
alternative products and competitors
– Identify the existence of switching costs
• Incremental profit margins on the product
– Estimate incremental cost using merging parties’ data and/or
documents
– Incremental cost is measured over the change in output that
would be caused by the hypothetical price increase
Demand Substitution:
Critical Loss
• Does imposing a SSNIP raise or lower the hypothetical
monopolist’s profits?
– Higher profits on sales made at higher prices
– Lower quantity demand as consumers substitute away
• “Critical Loss” is the number of lost unit sales that would
leave profits unchanged
• Price increase is profitable if:
“Predicted Loss” < “Critical Loss”
Supply Substitution
• Supply substitution
– Suppliers’ ability and willingness to substitute away from their
existing production facilities to make competing alternative
products in response to an increase in price or reduction in
quality of the product(s) at issue
• Useful for identifying market participants, analyzing
competitive effects, and potential entry
Supply Substitution:
Implementation
• Identify potential suppliers (“rapid entrants”) that are likely
to provide rapid supply response without incurring
significant sunk costs
• Interview potential suppliers about feasibility of substitution,
costs of switching between products, and the time it would
take to switch
• Analyze whether the potential suppliers have idle capacity
or readily available “swing” capacity
• Determine whether the customers would use the potential
suppliers’ products
Relevant Geographic Market
• Identifies a geographic area such that firms in that area can
defeat each others’ attempts to raise the price above
competitive level
– Both supplier and customer locations can affect the scope
• The principle behind defining a geographic market is similar
to that used for defining a product market…SSNIP Test
• The scope of a geographic market depends on
transportation cost, language, regulation, tariff barriers,
among others
• The geographic market may be local, regional, national,
continent-wide, or even world-wide
Market Definition: Recent
Cases
• FTC v. Staples
• U.S. v. Oracle
• FTC v. Whole Foods
FTC v. Staples: Background
• Staples—the second largest office superstore in the U.S.
with almost 500 stores in 28 states and DC
• Office Depot—the largest office superstore chain in the U.S.
with more than 500 stores in 38 states and DC
• On September 4, 1996, Staples and Office Depot entered
into a merger agreement
FTC v. Staples: FTC’s Claims
• The proposed merger will result in competitive harm as a
result of the loss of competition
– Between the only office supply superstores (OSS) in many
metropolitan areas (merger to monopoly)
– Between two of only three office supply superstores in many
other areas (3-to-2 merger)
FTC v. Staples: Market Definition
• FTC defined the relevant
product market to be the
sale of consumable office
supplies through office
superstores
FTC v. Staples: Market Definition
• Parties argued the
relevant product market
was simply the overall sale
of office supplies through
all venues
– Staples and Office Depot
account for only 5.5% of
sales
FTC v. Staples: Market Definition
• There was no dispute about the localized geographic
market
– Consumers are unwilling to travel very far to purchase office
supplies
FTC v. Staples: Evidence from
Documents
• Staples charges more than 5% higher where it has no office
superstore competition than where it competes with the two
other superstores
• Price checking and tracking entry focuses largely on OSS
and not other types of stores
• Staples cut prices when an OSS entered, but did not do so
when a non-OSS entered
FTC v. Staples: Empirical
Evidence
• Prices at Staples stores are 13% higher in one-firm
geographic areas than those in three-firm areas
• Prices at Office-Depot stores are more than 5% higher in
one-firm areas than in three-firm areas
FTC v. Staples: Court’s
Findings
The appropriate product market definition is the sale
of consumable office supplies through office supply
superstores
• Functional interchangeability does not mean that two
products are in the same relevant market
– All compete at some level but not enough to constrain price
• Low cross-price elasticity of demand between office
superstores and other retail sources of office supplies
– Slight increase in price does not cause consumers to switch to
Wal-Mart, Best Buy, Quill, Viking, etc.
U.S. v. Oracle: Background
• Oracle—an integrated business software company with
offices in 80 countries and sells products in over 120
countries
• PeopleSoft—another business software company with
offices in Europe, Japan, Asia-Pacific, Latin America and
other parts of the world and sells products in most major
markets
• Oracle initiated its tender offer for the shares of PeopleSoft
on June 6, 2003
U.S. v. Oracle: Background
• Enterprise resource planning (ERP) software integrates
most of an entity’s data across all or most of its activities
• ERP software are licensed to end-users along with
maintenance and upgrades
• The range of activities handled by ERP software
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Human resource management (HRM)
Financial management system (FMS)
Consumer relations management (CRM)
Supply chain management (SCM)
Product cycle management
U.S. v. Oracle: DOJ’s Claims
• “High function HRM and FMS” sold by Oracle, PeopleSoft,
and SAP are the only HRM and FMS products
• The proposed merger would constrict this highly
concentrated oligopoly to a duopoly of SAP America and a
merged Oracle/PeopleSoft
U.S. v. Oracle: Market
Definition
• DOJ defined the relevant market to be “high functional
software” in the U.S.
– Based on this market definition, the merger would be a 3-to-2
merger
• Oracle did not propose a product market definition, but
claimed that DOJ’s definition was too narrow:
– The relevant product market also includes “mid-market
vendors,” “outsourcing,” and “best of breed solutions”
– The relevant geographic market is worldwide, or at the very
least, the U.S. and Europe
• The basic approach used by both sides for defining markets
was SSNIP
U.S. v. Oracle: Evidence
• Customer testimony on purchasing decisions played a key
role in supporting DOJ’s market definition
– Ten customer witnesses
– Five industry witnesses
– three system integration witnesses
• Other evidence
– Oracle’s discount approval forms
– Market research study
U.S. v. Oracle: Court’s
Findings
DOJ proposed a very restricted product market
definition
• Customer evidence offered in support of the claim was
largely unhelpful and only stated preferences
– The relevant issue is what customers could do in the event of
an anticompetitive price increase post-transaction
– Unsubstantiated customer apprehensions do not substitute
for hard evidence
• Without a properly defined relevant market, the Court could
not pursue market share, market concentration analyses
FTC v. Whole Foods:
Background
• Whole Foods—the largest grocery chain specializing in
premium natural and organic (PNO) foods with more than
190 stores in more than 30 states and DC
• Wild Oats—the second largest PNO supermarket chain
operating 74 stores in 24 states
• On February 21, 2007, Whole Foods executed an
agreement proposing to acquire Wild Oats
FTC v. Whole Foods:
Background
• Natural foods are minimally processed and largely free of
artificial ingredients and preservatives
• Organic foods are produced using agricultural practices that
promote healthy ecosystem
– No genetically engineered seeds or long-lasting pesticides
– Healthy and humane livestock management practices
• All products labeled “organic” must be meet USDA
standards
FTC v. Whole Foods: FTC’s Claims
• The proposed merger will increase prices and reduce
quality and services in a number of geographic markets
throughout the U.S.
– Eliminated one of only two or three PNOs in a number of
geographic markets
– Eliminated significant price- and non-price competition
– Resulted in the closing of numerous Wild Oats stores
FTC v. Whole Foods:
Market Definition
• The FTC defined the
relevant product market
to be “premium natural
and organic
supermarkets”
– The relevant
geographic market
ranged from five or six
miles in radius from a
PNO to a metropolitan
area
Other PNO
FTC v. Whole Foods:
Market Definition
• Merging parties said they
competed with other large
grocers like Krogers and
Safeway
Other PNO
FTC v. Whole Foods: Evidence
from Documents
• PNO supermarkets “offer a distinct set of products and
services to a distinct group of customers in a distinctive
way”
• The parties were each other’s “closest competitors” in a
number of geographic areas
• Internal documents reflected direct competition between the
parties
• Whole Foods targeted markets for entry where Wild Oats
enjoyed a “monopoly”
FTC v. Whole Foods: Quantitative
Evidence
• Whole Foods took significant shares away from Wild Oats
wherever they had opened new stores
• Prices at Whole Foods stores did not vary depending on the
presence of Wild Oats stores
– Direct contrast to Staples’ pricing analysis
FTC v. Whole Foods:
Outcome
• The FTC and the parties announced a settlement on March
6, 2009
• Under the consent order, Whole Foods agreed to sell 32
PNOs and share intellectual property related to “Wild Oats”
brand
Questions/Comments