1. DEMAND ANALYSIS 1 Sogang MBA 2007

2. A PRACTITIONER'S GUIDE TO ANTITRUST: Market Power Merger Analysis Demand Estimation Patents 2 Sogang MBA 2007

3. The Proposed Merger of Coca-Cola And Dr Pepper (1986) Sogang MBA 2007 3  The Legal and Procedural Background  Section 7 of the Clayton Act : "where in any line of commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly.”  The 1976 Hart-Scott-Rodino Amendments to the Clayton Act require that two agencies(DOJ and FTC) be given advance notice of any merger or acquisition that is above a specified size.

4. The Legal and Procedural Background Sogang MBA 2007 4  PepsiCo announced its intentions to purchase the Seven-Up Company, which was a subsidiary of the Philip Morris Corporation.  Then the Coca-Cola Company announced its intention to purchase the Dr Pepper Company and merge the operations of the two companies.  These two mergers would have had the consolidation of the first and fourth and the second and third largest sellers of concentrate soft drinks in the US.

5. Judging Market Concentration Sogang MBA 2007 5  Market Concentration is a function of # of firms & their respective market shares.  Two popular methods: 1. N-Firm Concentration Ratios 2. Herfindahl-Hirschman Index (HHI) (Used by FTC for Anti-trust Case)

6. Herfindahl-Hirschman Index (HHI) Sogang MBA 2007 6 Calculation:  Squaring the market share of each firm in the market and then summing up.  HHI = ( S 1 ) 2 +( S 2 ) 2 +………..+( S M ) 2  Previously, Case 1:100*100=10,000  Case 2: (25) 2 +(25) 2 +(25) 2 +(25) 2 =2,500  Case 3: (40) 2 +(30) 2 +(20) 2 +(10) 2 =3,000

7. Spectrum of HHI  Below 1,000  Unconcentrated Market (Unlikely to have adverse effects-No further analysis)  Within 1,000 and 1,800  Moderately Concentrated  Above 1,800  Highly Concentrated (Violate Anti-trust regulation)  Any transaction that  HHI by more than 100 points in concentrated markets presumably raise anti-trust concerns. 7 Sogang MBA 2007

8. Guideline Chart Sogang MBA 2007 8 Unconcentrated: < 1000 Moderately Concentrated: 1000 to 1800 Highly Concentrated: > 1800 < 5050 to 100> 100No challenge High scrutiny No challengeHigh scrutiny Presumed unlawful Increase in Post-Merger Concentration Post- Merger HHI

9. Using HHI: The Soda Business Sogang MBA 2007 9 n 1985 Market Share Figures for Carbonated Soft Drink (CSD) Market

10. Problems with HHI Sogang MBA 2007 10  How to define a market? CSD or Portable bottle drink including juice, milk, etc How about coffee and tea?

11. How to define a market Sogang MBA 2007 11  Antitrust Market (1982 DOJ, merger guideline)  A market is defined as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit- maximizing firm, not subject to price regulation, …likely would impose at least a ‘small but significant and nontransitory’ increase in price…  SSNIP, 5% for one year

12. Sogang MBA 2007 12  Profit maximizing price must satisfy MR = MC  Total revenue is TR (Q) = P(Q) Q

13. Sogang MBA 2007 13 Therefore, MR = MC becomes denotes price elasticity of demand  The optimal price is set at a point where price elasticity is larger than 1.

14. Measure of the degree of market power Sogang MBA 2007 14  Lerner index: L = - price elasticity of demand A Firm’s gross margin is inversely proportional to the (absolute value) of price elasticity of demand.

15. Demand Elasticity  (p – mc)/p = 1/e, e is demand elasticity w.r.t price  Its own price elasticity includes all price elasticity with respect to other prices.  How to estimate demand elasticity, demand function? Sogang MBA 2007 15

16. DEMAND ESTIMATION 16 Sogang MBA 2007

17. How Do You Know Your Demand? Sogang MBA 2007 17 There are three major ways:  Interviews/surveys/co-investigation with your clients  Experiments  Statistical estimation

18. 1. Interviews/Surveys Sogang MBA 2007 18  The most direct way to obtain information about demand is through interviews in which consumers are asked how much of a product they would be willing to buy at different prices.  Problems  Consumers may lack information or interest, or be misled by the interviewers.  Their response might be significantly different from the response to hypothetical situation.

19. 2. Experiments/Market Tests Sogang MBA 2007 19  Special Offers. Firm can offer different prices by mail and check the responses. For instance, firm can offer $20 to one hundred household and $25 to another hundred household. Then, check the response rate for each price. E.g. Britannica did for its CD offering by a direct mail campaign, with prices ranging from $70 to $125.  Are there any drawbacks with experiments as a way to find out price elasticity of demand?

20. 3. Statistical Estimation: Regression Method Sogang MBA 2007 20  This is a log-log regression equation which estimates the coefficients a, b, b 2, b 3, c, etc.  Q: demand; P: own price; P 2 : price of a substitute; P 3 : price of a complement; I: consumers’ income level  Other variables (weather, changes in law, promotional campaigns, public image, etc.) + other variables

21. Problems with Statistical Estimation Sogang MBA 2007 21  Data are not available.  Simultaneous problem high demand expected … high price low demand expected … low price  Curse of dimension

22. Simultaneous problem  Election  Campaign spending vs. voting rates  No relationship or negative one  Not natural experiment  Premium for Tokyo University Sogang MBA 2007 22

23.  Instrument variables  Price correlation, but no correlation with demand side Fish Market Sugar Market Sogang MBA 2007 23

24. Merger Simulation Sogang MBA 2007 24 1.Estimating demand elasticities 2.From observed price, we estimate costs 3.After merger, elasticities change. 4.From the new elasticities and costs, we predict new prices.

25. Why elasticities change?  Full service or self service gas station.  Stations providing both services  Stations providing only full service  In which stations gas prices are higher?  Boston, empirical studies  Beer vs. Soju, Hyundai vs. Kia Sogang MBA 2007 25