ABA Brownbag Series
Market Definition
Patrick DeGraba
U.S. Federal Trade Commission*
December 14, 2015
*The views expressed in this presentation are my own and
do not necessarily represent those of the Federal Trade
Commission or any individual Commissioner.
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Outline
• What is Market Definition?
• Why Do Market Definition?
• Product Market Definition:
– Hypothetical Monopolist Test
– Targeted Customers
• Geographic Market Definition
• Market Definition in Some Cases
2
What is Market Definition?
• Ultimate goal of merger analysis is
competitive effects. Will market power be
created and exercised?
• Useful to identify products that are “close
substitutes” for the product under analysis.
• What are the products that are likely to constrain
the pricing of the product under consideration?
• Market Definition is an over inclusive first
approximation of close substitutes.
3
What is Market Definition?
• Terrible Use of the English Language
• There is no “actual market.”
• How can you define something that does not exist?
• We would be better served with a term
such as “substitutes triage” or “likely
competing products delineation.”
• Back of the envelope competitive effects.
4
Why Do Market Definition?
• To calculate HHI or other concentration measures one
needs an aggregate market number.
• Best with commodities and high concentration or low concentration
• Concentration only a first cut of likely harm in close cases
• Might be useful to determine what are important
competing products.
• Might help organize an investigation
• May need a structural case if competitive effects measures
are not available
• Judges seem to insist on it.
– Slight exception in Evanston
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Pitfalls of Market Definition
• Merger guidelines- “[competitive effects] analysis need
not start with market definition.”
– Competitive effects can be calculated without reference to
market definition
• Evanston
• Whole Foods-Wild Oats
• Once a competitor is in the market, temptation to treat all
competitors equally
• Arch Coal
• “…Perplexing…” “threshold market definition” can block
useful competitive analysis.
• Lundbeck
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How to do Market Definition
• Intuitively - Find all the products to which “lots of
customers” might switch if the prices of the products
under investigation increase
• There are two dimensions
– Product Market – based entirely on customer willingness to
substitute among products with different attributes
– Geographic Market – Based either on customer location or
supplier location
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The Hypothetical Monopolist Test
Product Market
• The Hypothetical Monopolist Test uses an iterative
process to “define” a market
– Begin with a product sold by each of the merging firms as a
candidate market.
– Ask if a hypothetical monopolist that controlled this product could
profitably impose a “small but significant and nontransitory”
increase in price” (SSNIP) above the benchmark (often
prevailing) level.
• If yes, stop. This product is a market
• If no, go to the next step
– Expand candidate market by adding the product to which the
most sales divert, and return to the SSNIP question
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The Hypothetical Monopolist Test
Product Market Illustrated
•
•
Product “A” is a tentative product market
Raising product A’s price by a SSNIP is unprofitable because of substitution
to products B and some substitution to C
Now consider A and B as the tentative market
Raise A and B’s price by a SSNIP
Substitution to C (and others) does not make the price increase unprofitable
Then, A & B comprise a relevant product market
•
•
•
•
2
1
C
A
B
Consumer substitution to B defeats price increase.
C
A
B
Insifficient consumer substitution to C to defeat
price increase. A and B comprise a market.
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SSNIP test is over inclusive
• When the price of product A increases the price of
substitutes will typically increase as well.
• This increase in price makes the substitutes less of a
competitive constraint than it would be if its price
remained unchanged.
• The SSNIP test keeps the price of substitutes
unchanged.
• Thus SSNIP overstates the competitive constraint a
substitute will impose if its price is allowed to adjust.
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Critical Loss and Market Definition
• A price increase implies
– sales of some units will be lost
– remaining units will be sold at a higher price
• The SSNIP test just asks, “Are the increased profits
on the remaining sales more than the lost profits
from the lost units?”
• The number of lost units that allows a hypothetical
monopolist to just break even from a SSNIP is called
the “Critical Loss.”
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Critical Loss and Market Definition
• Critical Loss (CL) is the number of lost units such that the lost profit
from those lost sales just equals the increase in profits from the
remaining sales
%CL =
•
•
•
•
%Δp
M + %Δp
Where M =
p - mc
p
Derivation
Increase in profits = Δp(q – Δq) Lost profits = (p – mc)Δq
CL = Δq such that the Added Profit just equals the Lost Profit
Δp(q – Δq) = (p – mc)Δq
qΔp
CL = Δq* =
p + Δp - mc
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Critical Loss and Market Definition
• The “Predicted Loss” (also called the “Actual Loss”) is defined as
the number of lost unit sales that the hypothetical monopolist is
predicted to lose due to the price increase.
• The price increase is predicted to raise the hypothetical monopolist’s
profits if the Predicted Loss is less than the Critical Loss.
• In that case, the product in question comprises a product market.
• A key issue, then, is how to reliably estimate the Predicted Loss.
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Critical Loss and Market Definition
• Predicted Loss estimates are based on data that
allow us to estimate diversion among products
or price effects.
– Nestle/Dreyer’s (2003) – super premium ice cream
• Looked at retail data and observe entry by Dreyer’s resulted in
lower prices of other super premium ice cream.
• Could calculate diversion between super-premium and premium ice
cream base on retail data.
– Sysco (2015) – broadline food services
• looked at bidding data and inferred the next best alternative to one
of the merging parties would be if that party raised it prices by a
SSNIP (FTC v Sysco; M&O at 36 https://www.ftc.gov/enforcement/cases-proceedings/ftc-v-sysco-usfholding-corp-us-foods-inc
)
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Critical Loss and Market Definition
• SSNIP analysis by itself is rarely dispositive. Courts will
also check such results are consistent with other
evidence of market definition.
• Data may not always be available to perform a SSNIP
test.
1.
Interviews with market participants
1.
2.
2.
3.
Buyers
Sellers
Depositions (investigational hearings)
Documents
–
Business and Marketing Plans
–
Sales reports
–
Internal and third-party industry studies
–
E-mail discussions of pricing and competition
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How Should We Interpret High
Margins?
• High margins mean the Critical Loss will be small:
• Remember: CL =
%Δp
M + %Δp
• But high margins also suggest that price elasticity is low,
which means predicted loss is low.
• Remember: M = 1/Eown
• While not dispositive this creates an inherent tension
from a claim of low critical loss but high predicted
loss.
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Market Definition if Mergers
Prevents Price Reduction
• Nascent or potential competition theories limit
competitively important products to those whose prices
could fall in the future
• Appropriate benchmark price is price that would have
prevailed but for the merger, not current price
• Example Verisk EagleView merger
–
–
–
–
EagleView dominant provider aerial rooftop photos
Their likely price constrained by measurement by hand
Verisk nascent entry would have lowered photo price
Measurement by hand would have no competitive impact, so it should
not be in the market
– (see, Economics at the FTC, RIO, Oct 2015, section 4.3, https://www.researchgate.net/journal/0889938X_Review_of_Industrial_Organization )
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Targeted Customers
Product Market Definition
• Products sold to an identifiable group of customers can be a
separate market if:
– Seller can charge that group of customer a different price than other customers
– No arbitrage between this group and other groups
• Analysis of targeted customers very close to competitive effects
analysis.
• Recent examples:
– Sysco – Broadline food service to national customers
– Whole Foods – Core customers
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Geographic Market
• Could be of competitive importance if customers purchase
products in a limited geographic area.
– Pinnacle/Ameristar
• Local markets St Louis and Lake Charles
• Exclude Las Vegas.
– Evanston Northwestern Health
• Determine which hospitals near merging hospitals are good substitutes
• SSNIP test can be applied to geography just like products.
– Start with merging location and raise the price.
– If SSNIP not profitable adding closet competitor (all else equal) and try
again.
• SSNIP approach replacing Elzinga-Hogarty
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Geographic Market
• Targeted customers.
– If national firms can discriminate by location, each location could
potentially by a separate market.
– Things to consider
• If price is national but promotions are local, each locality could be a market
• If non-price attributes like service quality are chosen on a local basis
• If two national competitors have different local competition in different cities
– FCC uses local geographic markets for mobile service (AT&T-T-Mobile staff
report para 32-34 https://transition.fcc.gov/transaction/att-tmobile.html )
• Local casinos might offer promotions by zip code.
• In many cases geographic component adds nothing
– Airline Markets – product defined as city pairs
• What more geography does one need?
– Arch Coal – ~10 mines and all of the electricity producer that used that
coal were identified. What help is geography?
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FTC v Sysco (2015)
• Merger between two largest and only national broadline food service
providers in the U.S.
• FTC asserted a market for targeted broadline foodservice
distribution to national customers.
– Customers with large geographic presence would not switch their purchases to a
patchwork of smaller service in Response to a SSNIP
• Economic expert performed a SSNIP test
– Based on margin calculations determined critical loss to be 50%
– Calculated predicted loss to be much lower than 50% (FTC v Sysco M&O 35-37)
• Looked at bidding and RFP data to determine how customers would divert to another
bradliner if the price of one broadliner were to increase by 5%.
• Looked at Linc database maintained by U.S. Foods services and found much less than
50% of customers would switch to non-broadline services in response to a SSNIP.
• Two conditions for targeted customers
• Ability to price discriminate
• No arbitrage
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FTC v Sysco (2015)
• Two conditions for targeted customers
– Ability of sellers to price discriminate
– No arbitrage
• Judge found FTC expert analysis “persuasive”
– Had reservations because data was not from ordinary course documents but
rather assembled for the proceeding and were not necessarily complete
– Found it important that results of the data analysis were consistent with ordinary
course documents and business practices
•
“the determination of the relevant market in the end is 'a matter of business reality-[ ] of how the
market is perceived by those who strive for profit in it”
22
FTC v Whole Foods (2007)
• Merger between Whole Foods and Wild Oats
• Two largest organic grocery chains
• Market Definition
– FTC - Premium Natural Organic Stores (PNOS)
– Defendants - Premium Natural Organic Stores Trader Joe’s, Conventional
Supermarkets, Gourmet Stores, Club Stores.
• District Judge - Because there are marginal customers that would
switch to other stores there was not PNOS market. The larger
market unlikely to have antitrust harm
• Circuit Court – Viewed this case as a targeted customer case.
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FTC v Whole Foods (2007)
• Court found
– competition between PNOS stores and other supermarkets for
dry goods
– no such competition for perishable goods between PNOS
– Competition between Whole Foods and Wild Oats (and other
PNOS) did affect prices of perishable goods
– “Core” PNOS customers bought primarily perishable goods
– Thus they could be price discriminated against
– Thus the cluster of goods they purchased constituted a
submarket.
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FTC v Whole Foods (2007)
• “Diversions Ratios”: Based on analysis of Wild Oats Revenues
Other
PNOS
PNOS
Whole
Foods
PNOS
Trader Joe's
Vitamin Cottage
Conventional Sup.
Gourmet Sup.
Mass Merchants
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FTC v Whole Foods (2007)
• Wild Oat’s Response to Entry
Whole Foods
Other PNOS
Trader Joe's
Margins
Gourmet Sup.
Conventional
Sup.
Mass
Merchants
Implied Prices
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Evanston Northwestern
Healthcare (2005)
– FTC brought suit against a consummated merger of hospitals in
Evanston Illinois
– FTC alleged a small geographic market consisting of 3 hospitals
two of which had merged
– Defendants claimed a larger market including more hospitals
– FTC presented direct evidence of price increases as a result of
the merger.
– 3 Interesting findings by Judge McGuire
• Elzinga-Hogarty not appropriate for hospital geographic market because it
returned overly large geographic markets
• The geographic market contained 7 hospital even though the plaintiffs
proposed a three hospital market
• The direct evidence of anticompetitive effects were enough to overcome the
larger market.
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FTC v Lundbeck (2009)
• “…perplexing…” market definition precluded any
competitive effects analysis
https://www.ftc.gov/sites/default/files/documents/cases/2010/08/110919lundbeckfindings.pdf
– Lundbeck purchased Indocin IV with retail price of $78. Treats
PDA in preterm babies.
– Purchased the only other drug to treat PDA, NeoProfen, about to
receive FDA approval. Two days later raised the price of Indocin
IV to ~$1500.
– After FDA approval, Lundbeck priced NeoProfen similarly.
– Eight doctors testified, would not switch for small price difference.
– Defendant’s expert said a hospital that would prefer lower priced
drug could not “steer” doctors towards cheaper drug.
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FTC v Lundbeck (2009)
• District Court Judge concluded
– Doctors would not switch, implies low cross price elasticity
– Low cross price elasticity implies not in same market
– Not the same market implies no antitrust harm
• Low cross elasticity by itself DOES NOT imply not in
same market. Must be compared to own price elasticity.
– Competitive Effects (symmetric linear case)
%ΔP =
MD
2(1-D)
p - mc
Where M =
p
and D =
εji
εii
• Casual analysis of a 5% price change may not help
analyze a 1300% price change.
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Takeaways
• Market definition is best viewed as an over inclusive first
approximation of the important competing products.
• Based on customer substitution to other goods.
• SSNIP test results should be consistent with other evidence.
• Can be useful
– When structural analysis is appropriate.
– As a way to organize an investigation.
• Pitfalls of use
– Not a prerequisite for doing competitive effects and can divert attention
from the competitive analysis.
– Potential for all sellers in the market to be treated as equals when they
are not.
• “Targeted customers” useful in focusing on competitive effects.
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