Defining a Relevant Market Markus H. Meier Assistant Director African Competition Forum March 26, 2013

Introduction to Defining a Relevant Market A “relevant” market is a group of products that significantly constrain each other’s pricing, when viewed from both the demand side (consumers) and supply side (producers). A relevant market has both product and geographic dimensions.

Key Questions in Defining Markets What products do consumers view as reasonable substitutes? –Considering price, use, quality, and other significant characteristics What alternative products can others supply, and under what circumstances will they do so? –Establishes others who are in the market Where can consumers practicably turn for supply? –Can be local, regional, national, or international

Product Market Definition Start with each product at issue of the target of the investigation – this is the “tentative” relevant product market. –Use common product names If there is more than one possible definition for a product, use the narrowest definition first. Remember, a product can be a good, a service, or a combination of both.

Demand-Side Analysis What products do customers view as reasonable substitutes? Would a significant number of customers substitute to other products? Would so many substitute away so as to make the price increase unprofitable? If yes, then expand the tentative product market by adding the closest substitutes. What would customers do in response to a price increase in this new tentative product market? Keep expanding the tentative product market until there is a relevant product that could be the subject of market power.

Demand-Side Analysis Illustrated “A” is a tentative product market. Raising A’s price causes significant substitution to B. Raising A & B’s price does not cause substitution to C. A & B comprise a relevant product market.

The 5% Question The hard question is: how close does a substitute have to be to be included in the market and at what price? In the U.S., the antitrust agencies generally define product markets by asking this question: “If there were a small but significant, non-transitory increase in the price of the product to what other products would customers turn (if any)?” –Most often, a 5% price increase is used. Note that this is a relative price increase, holding all else equal. –“Non-transitory” means the price increase is not just temporary.

Supply-Side Analysis Supply-side analysis involves the identification of which other firms are in the market. It asks the question: if the price of the relevant product is increased by a small but significant amount, would other firms begin to produce the product? Supply substitution is primarily a matter of evaluating whether other firms can begin to produce the product and whether they will do so if the price goes up. Firms likely to enter and have a competitive impact within a year should be considered to be in the product market.

Evidence for Defining Product Markets Views and behavior of customers Views and behavior of suppliers and potential suppliers End use of product Physical and technical characteristics of product Customers’ switching costs Price relationships (correlation) Suppliers’ cost of adapting production processes, distribution, and marketing Existence of second hand, reconditioned, or leased products

Geographic Market Definition Start with the area in which the target of the investigation sells the relevant product. If there is more than one factory or similar location, start by treating each separately. Think about what customers would do if the price of the relevant product in the area increased by a small but significant amount.

Geographic Market Definition Issues Would a significant number of customers substitute to new sources of supply outside the area? Would so many customers substitute away so as to make the price increase unprofitable? If yes, then expand the tentative geographic market by adding the area of the closest substitutes. What would customers do in response to a price increase in this new tentative geographic market? Keep expanding the tentative geographic market until there is an area that could be the subject of market power.

Geographic Market Definition Illustrated A is a tentative geographic market. Raising price in area A causes significant substitution to area B. Raising A & B’s price does not cause substitution to area C. Areas A & B comprise a relevant geographic market.

Evidence for Defining Geographic Markets Views and behavior of customers Views and behavior of suppliers Transportation costs Local set-up costs Characteristics of the product (fragile, perishable) Price relationships (correlation) Shipment patterns Foreign competition and trade barriers

Combine the Information to Define the Market Using the information learned during the investigation, combine it to define the market. Normally this is stated as follows: “The relevant market in which to analyze the competitive effects of [the target’s conduct] is the sale of motorcycles in the Gambia.” Double check the market definition against common sense: –Is it consistent with reality and common experience? –Could firms in this market impose a monopolistic price increase if they acted together?

Others Ways to Define Markets In economic terms, market definition is an attempt to indirectly evaluate the “cross-elasticity of demand” between a product and its closest substitutes. It is used because the data to measure cross- elasticities directly is rarely available. There are economic methodologies to try to estimate cross-elasticities or market power more directly, when the right data is available. –Critical loss and diversion ratios –Market entry event studies