Market Definition

1
Market Definition DOJs Approach to Mergers

• What Constitutes a Market?
• When Does A Merger Concern DOJ?

2
Markets Mergers

• If Coke Starbucks are unrelated goods, then
  merger for market power is a non-issue.
• If Coke Dr Pepper compete "in the same market"
  then MFM is an issue and antirust authorities may
  act.
• Definition of what constitutes a market is
  critical

3
Proposed Methods of Defining Markets

• Cross-elasticities
• If increase Pcoke causes increase DDpepper they
  are in same market
• But how strong must this be?
• Price Correlations
• If we observe that prices of Coke and Dr. Pepper
  move together, they are affected by the same
  forces, and hence might be considered in same
  market.

4
DOJs Approach to Market Definition

• Two or more goods define a market if a
  significant, collusive, price increase of these
  goods would be profitable.
• Example let the lemonade market be competitive
  w/ 1000s of identical sellers.

5

• If two lemonade firms were to collude on their
  own (or merge), their attempt to raise price
  would be futile.
• If Coke (which has market power) purchases a
  lemonade firm and substitution is weak, a price
  increase would not be profitable.
• But if Coke bought Pepsi?
• Raising prices would raise profits, so they are
  in the same market.

6
Geographic Considerations

• Many markets are local
• A merger of 100 gas stations spatially dispersed
  across S. Carolina would not cause concern
• A merger of 100 gas stations in the Clemson
  Seneca Anderson would create significant market
  power
• How does DOJ consider local conditions?

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• Demand substitution
• Can consumers substitute purchases elsewhere?
• Yes for mail order items
• No for gasoline
• Can consumers buy something else?
• Yes for Earl Grey Tea
• No for gasoline
• Supply substitution
• Will other suppliers elsewhere pick up the slack?
• Yes for
• No for gas
• Will quick entry be likely if none of the above
  margins of substitution are operative?
• Are there market or legal barriers to entry
  (permits, environmental restrictions)?

8
DOJ/FTC MERGER GUIDELINES

• Est. in 1968, revised periodically since
• Provide a screen "mergers should not be
  permitted to create or enhance market power or to
  facilitate its exercise."
• Also useful to firms contemplating efficient
  mergers "Agency seeks to avoid unnecessary
  interference with the larger universe of mergers
  that are competitively beneficial or neutral

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5 Step Method of Application

• Step 1. Market Definition Concentration
• A market is defined by the following procedure
• Could a small (say 5 per cent) price increase, if
  maintained, be profitable? If not, add the next
  closest substitute. Continue until the answer is
  affirmative.
• Example
• Natural Light beer in cans (switch to NL bottles
  and other cans of light beer)
• Natural Light beer (people switch to other cheap
  light beers)
• Cheap Light beer (people switch to other cheap
  beers and other light beers
• Light beer (people switch to other beers)

10
Measuring Market Concentration

• Herfindahl Index
• H S Si 2
• H with identical firms
• Monopoly Si2 1002 10000
• Duopoly 2(Si2) 2502 5000
• 4 firms 4(Si2) 4252 2500
• General H N(100/N)2 10000/N
• Example for N 10, H 1000

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Herfindahl Index Scrutiny of Mergers

• Three Classes of Markets for Merger Challenges
• Un-concentrated Markets H lt 1000
• no merger challenges
• Moderately Concentrated 1000 ? H ? 1800
• only mergers that raise H by 100 points get
  scrutiny
• Concentrated H gt 1800
• ?H lt 50 no scrutiny
• ? H gt 50 scrutiny
• ? H gt 100 challenge likely "such mergers are
  likely to create or enhance market power or
  facilitate its exercise," thus subject to
  scrutiny and must meet additional requirements to
  avoid a challenge

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Herf Concentration Example

• Example Merger of two firms in a market with 8
  firms of equal size
• H 10000/8 1250
• Market is moderately concentrated
• H 612.52 252 1462.5
• ?H 212.5 so merger gets scrutiny

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Step 2 Adverse Competitive Effects

• Does merger raise concerns in light of failing
  the test in Step 1?
• -- i.e. will price be likely to increase?
• i) "coordinated interactions" -- does merger
  increase likelihood of collusion?
• ii) "unilateral effects" -- does merged firm
  have sufficient market power to profitably raise
  price ?
• If not, merger ok. If so, then Step 3

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Step 3 Entry

• Is timely entry likely in the event of a price
  increase?
• Timeliness lt 2 years
• Likelihood Do incumbents control essential
  assets? Other barriers?
• Sufficiency Assess sales opportunities at min
  efficient scale pre-merger prices
• If merger fails to pass this hurdle, it is in
  trouble, but there are still a few "outs" left

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Step 4 Efficiencies

• The merging companies can make a case that the
  merger creates substantial cost-savings and
  should be permitted on those grounds
• This is a high hurdle as many claims are viewed
  with skepticism by DOJ

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Step 5 Failing Firm Exception

• Two prong test
• i) acquired firm must be failing
• ii) no less anticompetitive partner is available
• DOJ must be convinced that assets of failing firm
  would otherwise exit the market and be unused
• follows the S. Court decision in Citizen
  Publishing (1969) where two Tucson newspapers
  were denied the right to merge

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Recent Applications

• Coca-Cola-Dr. Pepper (1986)
• Staples-Office Depot (1997)
• Exxon-Mobil (1999)
• Chevron-Texaco (2001)

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Summary Commentary on Merger Guidelines

• Guidelines are warning flag to MFM practitioners
• Systematic process implies approval for clearly
  benign mergers
• Most injunctions stop mergers
• Market definition remains contentious in
  contested cases
• Still, Big Improvement over earlier practice