how, and whether, to define a market (in mergers) joseph farrell based on work with carl shapiro
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How, and Whether, to Define a Market (in Mergers)
Joseph Farrell
Based on work with Carl Shapiro
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?
Full Merger Review
• How will an oligopoly change with a merger?
• Oligopolies are hard to predict
• How to avoid analysis paralysis?
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
– we’d be badly harmed by full collusion?
• Roughly hypothetical monopoly approach– No narrowest market “principle”
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 disputable—not a screen• Verbal confusion of “same market” phrase• Etc. Etc.
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?
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?
Two Concepts of Unilateral Effects
• General concept: outsiders’ reaction functions don’t 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…
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!
Unilateral-Effect Analysis: Focus on Change
• Reduced elasticity of demand– Sales diverted to (equal-margin) partner not effectively
lost– Raise partner’s 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
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
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
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
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?
Treatment of Efficiencies
• Incorporate them into the screen early on
• But then don’t tolerate potentially small adverse effect
• How to estimate efficiencies?
• “Standard deduction”?
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?
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
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?
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!
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?
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 needed—but keep simple?
How can one not define market?
• Market definition is a locus to analyze alternatives/substitutes
• That’s a helpful thing to do…BUT:
• Doesn’t have to be done that way
• Margins capture revealed-preference information on substitutes
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