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How, and Whether, to Define a Market (in Mergers) Joseph Farrell Based on work with Carl Shapiro.

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Presentation on theme: "How, and Whether, to Define a Market (in Mergers) Joseph Farrell Based on work with Carl Shapiro."— Presentation transcript:

1 How, and Whether, to Define a Market (in Mergers) Joseph Farrell Based on work with Carl Shapiro

2 Merger Review Flood of cases Need for transparent, manageable screens Green light Yellow/red lights –Identify targets for further analysis –Stop some mergers when things are complex or hard to prove?

3 Full Merger Review How will an oligopoly change with a merger? Oligopolies are hard to predict How to avoid analysis paralysis?

4 For green light For this, use pessimistic theory: –Merger might cause full collusion in any set of products where it substantially raises concentration Greed, incompetence, and market power? Is there any set of products for which –Merger substantially raises concentration, AND –wed be badly harmed by full collusion? Roughly hypothetical monopoly approach –No narrowest market principle

5 Concerns about Market Definition Can be hard to prove even when competitive effect seems fairly clear –Staples, Evanston Northern, Oracle Despite technical flavor of hypothetical monopolist test, very lawyer-driven Also complex and disputablenot a screen Verbal confusion of same market phrase Etc.

6 For orange light Merger could trigger collusion theory seems alarmist for this purpose –Arch Coal case (AirTours?) What class of oligopoly theories would imply concern?

7 Least-Alarmist Oligopoly Theory of Merger Oligopoly game among firms –Merging parties –Other industry participants Merging parties reaction functions surely shift Others may also –Probably in less-competitive direction?

8 Two Concepts of Unilateral Effects General concept: outsiders reaction functions dont shift with merger –Approximation or quasi-bound? Special model: e.g. static differentiated- product Bertrand, or Cournot –Often not accurate description of oligopoly Reactions as sign that firms compete? Intangibles, complements…

9 Model (price) level before & after? Typically use static differentiated-product Bertrand, or Cournot –Often not accurate description of oligopoly Reactions as sign that firms compete? Intangibles, complements… –Problem both with modeling levels and with market definition paradigm Focus on change due to merger!

10 Unilateral-Effect Analysis: Focus on Change Reduced elasticity of demand –Sales diverted to (equal-margin) partner not effectively lost –Raise partners price also: less consumer response –Hypothetical monopoly test often conceived this way What elasticity remains for HM? How does elasticity change if introduce HM? Cannibalization cost internalized –New private marginal cost of competitive moves –Our focus here

11 Internalizing competitive effects Change from merger Newly internalize effect of price cut, etc Opportunity cost or cannibalization cost Thought-experiment: how would you manage firm on the day after merger? –Should we focus on such short-run effects? –Efficiencies –Manageability

12 Quantify internalization term As per-unit tax on own product In static Bertrand competition, diversion ratio times absolute gross margin More generally, how much own-sales boost from competitive move that hurts rival/partner? –After (pre-merger) industry dynamics play out –Price-matching dynamics reduce own-sales effect –Non-price competition

13 What if quantify cannibalization? Compare to MC efficiency? Critical efficiency –Werden, Goppelsroeder et al., … We seek –Simpler, transparent versions –Bounds rather than precision –Targeted replacement of market definition, not just part of efficiencies question

14 A Robust Theory of Oligopoly When some marginal costs rise, consumers will be worse off –[Comment on use of consumer surplus standard…] What if some rise and some fall?

15 Treatment of Efficiencies Incorporate them into the screen early on But then dont tolerate potentially small adverse effect How to estimate efficiencies? Standard deduction?

16 Characterize Unilateral Effect Net effect of merger on price is the oligopoly pass-through of asymmetric cost shock from adding internalization terms and MC efficiencies –Implicit in HM market definition question –Implicit in merger simulation Not a closed-form solution because internalization terms endogenous Bound them?

17 Bounding Internalization Term Horizontal merger without (yet) efficiencies has predicted price increase Hence underestimate equilibrium margins if use pre-merger prices Adding MC efficiencies raises margins further For negative net impact, efficiencies must outweigh internalized margins using pre-merger prices

18 Pass-Through in Hypothetical Monopoly Can also use these ideas in hypothetical monopolist calculations Hypothetical monopolist will raise price by sp if and only if pass-through of equilibrium cannibalization terms is at least sp. Pass-through is small if highly elastic segment of demand from unaffected competition But if highly elastic everywhere, strong pass-through! If pass-through is source of trouble, why go there?

19 Avoid Pass-through Calculations? Illinois Brick/Hanover Shoe rule –often misinterpreted Theoretically and econometrically difficult –Non-transparent: battle of the experts Already see this in discussion of efficiencies Substantive disagreement and ignorant rhetoric –Assumed functional form matters a lot Froeb Tschantz Werden IJIO 2005 Hard to use for screening/presumption Unnecessary to sign net effect!

20 A proposal When antitrust agency shows that internalization tax is likely to outweigh MC efficiencies for any (substantial?) product, Agency should be entitled to court presumption that merger is anticompetitive –How strong a presumption? –What kinds of rebuttal evidence? Entry? –How sensitively used?

21 Should market definition remain route to adverse presumption? Could the theories (in practice) fail to nest as they ought? –What if coordinated effects actually predicted? False negatives from strong competition between merging products if use pre-merger margins as proposed –Catch this with market definition? –Or refine bound as neededbut keep simple?

22 How can one not define market? Market definition is a locus to analyze alternatives/substitutes Thats a helpful thing to do…BUT: Doesnt have to be done that way Margins capture revealed-preference information on substitutes

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