Presentation on theme: "TOPIC 11:MARKET DEFINITION Topic 11| Part 126 September 2013 Date ANTITRUST ECONOMICS 2013 David S. Evans University of Chicago, Global Economics Group."— Presentation transcript:
TOPIC 11:MARKET DEFINITION Topic 11| Part 126 September 2013 Date ANTITRUST ECONOMICS 2013 David S. Evans University of Chicago, Global Economics Group Elisa Mariscal CIDE, Global Economics Group
2 Overview Part 1 Role of Market Definition General Principles of Market Definition Hypothetical Monopolist Test Critical Loss Analysis Part 2 Overview of Issues in Multisided Platforms The Case of Additive Prices Newspaper Markets One-Sided Biases
3 Key Questions to Think About Why market definition isnt used by economists outside of their work on competition policy matters. Why market definition is used by courts and competition authorities Could the courts and competition authorities dispense with market definition? What is the role of false positives and negatives in market definition analysis, and does it matter whether it is merger or non-merger?
4 Things You Really Need to Know Relevant market and why it isnt the same as what laypeople or businesspeople might call a market Hypothetical monopolist test which is very popular among competition authorities The SSNIP test which is the name of the standard way of implementing this test.
Role of Market Definition 5
6 Market Definition and Market Power Market power is important for assessing whether a firm has the incentive and ability to engage in anti-competitive behavior and whether merger will result in an increase in market power Market power depends on the constraints that a firm faces in increasing the price of a product profitably; these constraints typically involve substitutes in demand and changes in supply by other firms. The market identifies the producers the impose significant constraints on the power or a firm or group of firms to raise price profitably. Market definition is primarily (perhaps solely) used for the purpose of helping the courts and competition authorities assess dominance/market power.
7 Market Definition and Context Identifies sets of firms, substitution patterns, and strategic relationships among firms. Market definition provides a context for examining firm strategies Market definition limits the discussion of rival products and firms to a manageable group. Firms in the market A, B, C, D, E Firms outside of the market: F, G, H, … F G H
8 Market Definition and Measures Share = Sales of firms product/total sales in the market Courts and competition authorities use market share as an indicator of possible market power or dominance for a firm (or group of firms in the case of collective dominance) Bigger market results in smaller share Smaller market results in bigger share Must make decision on what other products compete in the market to calculate the denominator of share. Other measures of concentration such as the HHI are based on market shares (HHI is sum of the shares, each squared, of all the firms in the marketsee below).
9 Market Definition, the Case Law, and Economics A relevant product market comprises all those products and/or services that are regarded as interchangeable or substitutable by the consumer, by reason of the products' characteristics, their prices and their intended use." (EC Notice of Definition of Market) Market share calculations put equal weight on all products in the market and zero weight on all products outside the market; no economic basis for this and it is obviously wrong. By putting products outside of the market we lose information which may be valuable and may make errors if the products outside do matter Economist claim they can analyze economic effects of business practices without defining the market first (is this true?). Economists see constraints on market power as a continuum rather than having some products in the market vs. outside the market.
10 Market Definition Sets Hard Boundaries Between Products that are In or Out of the Market. Think of the Hotelling Line with many ice cream stands on a beach of infinite length. Start with stand in the middle. Market definition would say that there is a definite point at which stands to left or right are not in the same market because they dont impose enough of a constraint. Out In Product in question Continuum of product substitutesfarther away are less substitutable
General Principles of Market Definition 11
12 Identifying Relevant Substitutes by Asking What Would Constrain an Increase in Price The goal of market definition is to identify the group of products which provide significant and timely competitive constraints to the firm/product as issue. Product market Geographic market Demand-sideSupply side How will marginal customers react? Will customers buy from other areas? Would firms in one area supply another? Will producers of other products divert capacity?
13 Demand-side substitution Substitution among products provides the main immediate competitive constraint and therefore plays the most important role in market definition in practice Average customers are not necessarily relevant. What matters most is the behavior of marginal customers – the ones who are most likely to move between products as a result of price changes and who therefore have biggest impact on revenue changes. Will the average buyers of product A switch to product B? is not the same question as Will the average buyers of product B switch to product A? since neither is necessarily the marginal consumers who matter Key question is whether many consumers are at the margin between using this product or an alternative and would switch following a price increase Asymmetric substitution
14 Demand-side substitution and the marginal consumer The average consumer may not switch to a substitute product in response to a small price increase; producer needs to worry about what consumers at the margin between buying and not buying the product will do. O G is not a consumer of beer at current prices A,B, C, D are at the margin of buying or not buying beer. F is an average consumer of beer (from O to C) F D C A B G
15 Supply-side substitution Would firms quickly switch capacity to producing demand-side substitutes for the product of the firm under investigation in reaction to a price increase of that product? For example, Can the same plants be used to produce different products? Can competitors utilize their existing marketing and distribution networks for new products? Relevant when firms can produce a range of different products using the same, or very similar, technologies and assets Will firms in distant economic areas increase supply? Geographic market is often important for assessing supply-side substitution
16 Standard Steps for Identifying a Relevant Market The candidate market The first step is to consider a reference product (or products) As discussed above, there are two potential sources of substitution Demand-side substitution Supply-side substitution But which substitutes do we consider? Identify the closest potential substitutes for products in the candidate market
17 Which products to consider as demand and supply substitutes for BMWs MINI Cooper Or maybe buyers of MINI Coopers would switch to scooters or bicycles…. Mini Cooper Other small cars Supply of new small cars Mid-size carsAll carsAll means of transportation
Hypothetical Monopolist (SSNIP) Test for Market Definition 18
19 Hypothetical Monopolist Test Is a market worth monopolizing? If yes, then the substitutes outside the market must be weak If no, then the substitutes outside the market must prevent the exercise of market power Thus the group worth monopolizing pulls in all of the relevant substitutes. Logic of the test Could this hypothetical monopolist profitably impose a small but significant not-transitory increase in price (SSNIP) or will too many customers switch to demand-side or supply-side substitutes? Yes Candidate Market = Relevant Market No Candidate Market < Relevant Market Include the closest substitutes and repeat the test Start with the narrowest candidate market and assume that there is a monopoly supplier
20 How to proceed? Demand-side then supply-side Potential substitute products Demand-side 1 2 A Candidate Market B C D 3 A+B+C Supply-side S1S1 S2S2 A+B+C A+B+C+S 1 X X
21 Issues Concerning Hypothetical Monopolist Test Focuses entirely on price and excludes non-price dimensions of competition. Firms may adjust quality and other attributes to compete instead of price and engage in other non-price strategies not considered. The standard Lerner equation doesnt always apply (e.g. two-sided markets). Estimates of demand and cost may not be reliable. The assumptions and measures may not be correct Cost of errors that lead to too narrow a market is that competitive constraints are completely excluded; cost of errors that led to too broad is that if all substitutes are weighted the same then overstates competitive constraints.
22 Hypothetical Monopolist Test Depends on Where One Starts There is not a unique solution to market definition. The market can depend on where one (arbitrarily perhaps) starts. Starting with small cars competing with scooters could lead to a different answer than starting with small cars competing with large cars Large Cars Small cars Scooters
23 Relevant Market at End of Analysis A, B, C, D, E, F G, H I L K A…..F is the relevant market based on the SSNIP test. C is the firm whose actions we are assessing. G, H, L, and K are firms that the SSNIP test says are outside of the market.
Implementing the Hypothetical Monopolist (SSNIP) Test Critical Loss Analysis 24
25 Critical loss analysis is a method for implementing SSNIP test in practice Step (1)Profits, output, and sales before the price change for hypothetical monopolist (e.g. products A and B). MC$10 $ Price Quantity Profit = ($20 - $10) x 100 = $1,000
26 Critical loss analysis is a method for implementing the SSNIP test Step (2): How many units of sales would have to switch to substitutes to make a 10% price increase just unprofitable? Suppose the answer is slightly more than16.7 (with roughly break even). MC$10 $ Price Quantity $ If fewer than 16.7 units of sales switch than a 10% price increase is profitable
27 Critical Loss Analysis Depends on Customer Switchingan Example of a Calculation How many customers have to switch to substitutes to make a 10% price increase unprofitable? Initial price = $20; MC = $10; Profit Margin = $10; Quantity = 100; Profit = $10 x 100 = $1,000 New price = $22; MC = $10; Profit Margin = $12; Quantity = 83.33; Profit = $12 x = $1,000 Consider this example If sales fall by less than 16.7% the price increase is profitable Candidate market is the no wider than relevant market (i.e. a smaller market could have a profitable price increase too). If sales fall by more than 16.7% the price increase is unprofitable Candidate market is too narrow (one can also say that the true market is even broader than the candidate market). The critical loss is 16.7%--this is the dividing line. This implies that:
28 Step (3)--Whether actual loss of sales is higher or lower than the critical loss depends on the elasticity of demand which depends on the slope of the demand curve at the initial price (in previous example critical loss corresponds to a critical demand elasticity of 1.66; what if the true demand elasticity was 5.75?) MC$10 $ Price Quantity $ D implied by critical loss D more inelastic D more elastic Regression analyses, natural experiments, and internal market studies can help determine actual loss. Critical Loss Analysis is a Method for Implementing the SSNIP Test
29 Critical Loss Analysis is a Method for Implementing the SSNIP Test Marginal costs: data from at least one merging parties (and an assumption that these marginal costs are representative of other players in the market). Demand elasticities : natural experiments, regression studies, consumer surveys, diversion ratios are all ways to estimate the elasticity of demand. To conduct the demand-side portion of the test in practice we need Supply elasticities: change in output of substitute products by firms that arent currently producing those products In practice the supply-side response is usually ignored for critical loss. To conduct the supply-side portion of the test in practice we need
30 Comparison of Actual Versus Critical Loss Determines if Market is Large Enough to be Monopolized.
31 The Simple Math of Critical Loss Analysis For an X% price increase, the critical loss is Where M is the Lerner index (% difference between price and marginal cost) We can compare the critical loss to the actual loss based on data on elasticity of demand to assess whether a price increase would be profitable In the previous example the actual loss will be greater than the critical loss if a 10% increase in price leads to a more than 16.7% decline in sales which means in turn that the elasticity demand is greater than 1.66 (in absolute value). Formal calculation
32 The Simple Math of Critical Loss AnalysisExample For an 5% price increase with a 50% contribution margin, the critical loss is Which equals 1/11=roughly 9 percent We can compare the critical loss to the actual loss based on data on elasticity of demand to assess whether a price increase would be profitable Suppose the elasticity of demand is 3.0. Then a 5% increase in price would reduce sales by 15%. If correct, we could conclude that the true market is larger. Suppose the elasticity of demand is 1.5. Then a 5% price increase would reduce sales by 7.5 percent. If correct, we would conclude that the true market is at least this narrow.
33 End of Part 1, Next Class Part 2 Part 1 Overview of Market Definition General Principles of Market Definition Hypothetical Monopolist Test Critical Loss Analysis Part 2 Overview of Issues in multisided platforms The Case of Additive Prices Newspaper Markets One-Sided Biases