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Jorge Padilla (joint work with Georges Siotis)
28 November 2016
A presentation to the OECD
Supply Side Substitution in Geographic Market Definition
An economic perspective
COMPASS LEXECON 1
TWO QUESTIONS
When should we use supply-side substitution (SSS) to widen the geographic scope of markets?
Should we bother dealing with SSS arguments given that we can consider the competitive constraints imposed by entrants?
COMPASS LEXECON 2
ONE PRELIMINARY COMMENT
Some consider SSS a variant of entry. SSS is taken to mean faster, costless entry.
That is wrong.
The assessment of entry is made at a company level. The conclusions of that assessment may lead to change market structure within a given relevant product market.
Instead, the assessment of SSS takes place at the market level and involves all the companies that are part of the market which may be aggregated to the initial candidate or putative market. This assessment may lead to change the boundaries of the relevant product market.
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Scenario I
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SCENARIO I
All yellow firms serve the red customer located in the middle of the Union territory; the orange firms serve both the red and the purple customer. The orange firms price discriminate between the red and purple customers
The Union is a relevant geographic market
Market shares are calculated taking into account the production and capacity of all yellow and orange firms
UNION
Red customer
Firms serving
red customer
Firms serving
red and purple
customer
Purple customer
COMPASS LEXECON 5 |
Scenario II
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SCENARIO II
All yellow firms served the red customer located in the middle of the Union territory; the orange firm serves both the red and purple customers and price discriminates between them; the green firm does not compete for the red customer’s business
The Union is a relevant geographic market
Market shares are calculated taking into account the production and capacity of all yellow firms and the orange firm
But we may also have to take into account the green firm – SSS
Firm not serving any
customer
UNION
COMPASS LEXECON 7 |
Scenario III
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SCENARIO III
All yellow firms serve the red customer located in the middle of the Union territory.
The orange firm also serves the red customer but is no longer part of the Union.
The orange firm engages in price discrimination
All yellow firms compete with the orange firm on a level playing field – there are no barriers to trade (soft union exit)
The green firm does not serve the red customer but competes with the orange firm for the purple customer
UNION
COMPASS LEXECON 9
SCENARIO III
What are the boundaries of the relevant geographic market?
How should we compute market shares?
What do we do with the green firm?
UNION
COMPASS LEXECON 10 |
Option 1
Narrow geographic market
+
Imports
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OPTION 1 – NARROW MARKET
What are the boundaries of the relevant geographic market?
– UNION
How should we compute market shares?
– INCLUDING SALES/CAPACITY OF YELLOW FIRMS AND SALES TO/CAPACITY AVAILABLE FOR SALE IN THE UNION OF ORANGE FIRM
What do we do with the green firm?
– CONSIDER WHETHER IT COULD ENTER THE MARKET IF THE RED CUSTOMER’S PRICES INCREASED SSNIP
UNION
COMPASS LEXECON 12 |
Option2
Wide geographic market
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OPTION 2 – WIDE MARKET
What are the boundaries of the relevant geographic market?
– UNION + LIGHT BLUE COUNTRY
How should we compute market shares?
– INCLUDING SALES/CAPACITY OF YELLOW, ORANGE AND GREEN FIRMS
What do we do with the green firm?
– IT IS PART OF THE RELEVANT PRODUCT MARKET
UNION
COMPASS LEXECON 14 |
Comparing options 1 and 2
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COMPARING OPTIONS 1 AND 2
Option 1
– Competitive constraint exerted by orange firm likely to be underestimated in practice, since it may be very difficult to estimate the capacity available for the Union market
– This means that only actual imports would be taken into account, even when the orange firm could export more if the yellow firms raised their prices
– So, a cross-border merger may be incorrectly cleared, while a domestic merger may be wrongly prohibited if the assessment is largely driven by structural factors
UNION
COMPASS LEXECON 16
COMPARING OPTIONS 1 AND 2
Option 2
– The strength of the competitive constraint exerted by the orange firm on the yellow firms competing for the demand of the red customer may be over- or under-estimated
– On the one hand, the inclusion of the green firm into the market will dilute the competitive significance of the orange firm
– On the other, adding sales of the orange firm to the purple customer will inflate its market share and cause authorities to over-estimate the constraint it imposes on the yellow firms
UNION
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COMPARING OPTIONS 1 AND 2
Option 2 (cont.)
– The strength of the competitive constraint exerted by each yellow firm on the other yellow firms competing for the demand of the red customer will be under-estimated
– First, the inclusion of the green firm into the market will dilute the competitive significance of each yellow firm
– Second, adding the sales made to the purple customer will reduce its market share and cause the authorities to under-estimate the constraint it imposes on the other yellow firms
UNION
COMPASS LEXECON 18
COMPARING OPTIONS 1 AND 2
Option 2 (cont.)
– So, a cross-border merger may be incorrectly prohibited or approved, while a domestic merger may be wrongly approved if the assessment is largely driven by structural factors
– Option 2 creates a bias in favour of domestic mergers, and option 1 a bias in favour of cross-border mergers
UNION
COMPASS LEXECON 19 |
Aggregating geographic markets
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WHEN SHOULD MARKETS BE AGGREGATED?
Simple answer is when aggregation would produce market share figures that provide a more reliable view of the competitive position of the merging parties and their competitors or of the companies whose behaviour is being investigated
Necessary condition: there are no green firms in the candidate market for aggregation to the putative Union market – near universal substitutability
But while the condition above may be sufficient for assessing the impact on the Union of cross-border mergers, it is clearly not sufficient for the assessment of domestic mergers in the Union
UNION
COMPASS LEXECON 21
WHEN SHOULD MARKETS BE AGGREGATED?
Necessary condition: there are no green firms in the candidate market for aggregation to the putative Union market – near universal substitutability
But while the condition above may be sufficient for assessing the impact on the Union of cross-border mergers, it is clearly not sufficient for the assessment of domestic mergers in the Union
For that purpose we should require symmetric conditions of competition – i.e. all suppliers should be orange
UNION
COMPASS LEXECON 22 |
Supply-side substitution
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SUPPLY-SIDE SUBSTITUTION
Consider the scenario depicted in the figure below, should we aggregate the Light Blue market to the Union market when assessing the competitive implications of a domestic merger?
Three conditions:
UNION
COMPASS LEXECON 24
SUPPLY-SIDE SUBSTITUTION
Consider the scenario depicted in the figure below, should we aggregate the Light Blue market to the Union market when assessing the competitive implications of a domestic merger?
Three conditions:
– Timely and costless entry: A green firm can transform itself into an orange firm quickly and a minimal cost
UNION
COMPASS LEXECON 25
SUPPLY-SIDE SUBSTITUTION
Consider the scenario depicted in the figure below, should we aggregate the Light Blue market to the Union market when assessing the competitive implications of a domestic merger?
Three conditions:
– Timely and costless entry: A green firm can transform itself into an orange firm quickly and a minimal cost
– Near universal substitutability: all green firms will become orange in the event of a SSNIP by the yellow firms
UNION
COMPASS LEXECON 26
SUPPLY-SIDE SUBSTITUTION
Consider the scenario depicted in the figure below, should we aggregate the Light Blue market to the Union market when assessing the competitive implications of a domestic merger?
Three conditions:
– Timely and costless entry: A green firm can transform itself into an orange firm quickly and a minimal cost
– Near universal substitutability: all green firms will become orange in the event of a SSNIP by the yellow firms
– Symmetry: the yellow firms also compete for the purple business
UNION
COMPASS LEXECON 27
SUPPLY-SIDE SUBSTITUTION
Consider the scenario depicted in the figure below, should we aggregate the Light Blue market to the Union market when assessing the competitive implications of a domestic merger?
Three conditions:
– Timely and costless entry: A green firm can transform itself into an orange firm quickly and a minimal cost
– Near universal substitutability: all green firms will become orange in the event of a SSNIP by the yellow firms
– Symmetry: the yellow firms also compete for the purple business
UNION
The last two requirements make the assessment of SSS very different from the assessment of DSS, where symmetry is not necessary
COMPASS LEXECON 28 |
What else?
COMPASS LEXECON 29
WHAT ELSE?
Refine Option 1
– Focus on capacity shares as opposed to volume shares or revenue shares, and
– Try to estimate accurately the capacity of orange firm that is available for the Union market
UNION
COMPASS LEXECON 30
WHAT ELSE?
Forget about market definition
– Focus on diversion ratios and assess predicted price increases directly
Problem market share analysis is attractive to both competition authorities and companies
Once market shares have been calculated, everyone forgets how the sausage was made, so structural presumptions are very hard to overcome
UNION
COMPASS LEXECON 31
WHAT ELSE?
Price correlation evidence and/or price cointegration evidence is not conclusive regarding SSS
In the scenario below, there is no symmetry and no near-universal substitutability and there is price discrimination and, hence, markets should not be aggregated
Yet, we may observe prices in both markets to be correlated / cointegrated. This is a price reduction in the union may lead to a diversion of orange capacity to the Light Blue Country and therefore to a price reduction there
UNION
COMPASS LEXECON 32 |
Geo markets in Cyber space
COMPASS LEXECON 33
GEO MARKETS IN CYBER SPACE
Suppose the orange and yellow firms below are considering to merge
Markets are regarded as separate because the orange firm price discriminates between the Union and the Light Blue Country
The merger is treated as a two to one in the Union and remedies are imposed; it is cleared in the Light Blue Country as there is no overlap
But suppose the merged entity’s business plan implied that it would not price discriminate any longer (no geo blocking), should the merger be conditioned in the Light Blue Country as well?
UNION
COMPASS LEXECON 34
GEO MARKETS IN CYBER SPACE
Suppose the orange and yellow firms below are considering to merge
Markets are regarded as separate because the orange firm price discriminates between the Union and the Light Blue Country
The merger is treated as a two to one in the Union and remedies are imposed; it is cleared in the Light Blue Country as there is no overlap
But suppose the merged entity’s business plan implied that it would not price discriminate any longer (no geo blocking), should the merger be conditioned in the Light Blue Country as well?
UNION
Market definition pre and post merger may be different – market definition may be endogenous; this possibility may be more relevant in digital industries
COMPASS LEXECON 35
GEO MARKETS IN CYBER SPACE
Suppose the orange firm in the light does not price discriminates between the Union and the Light Blue Country and, due to that, a single market is defined comprising both countries
The orange firm is not dominant in the wide market
The orange firm engages in exclusionary behaviour against the green firm
After the green market exits, the orange firm starts to price discriminate and becomes dominant in the Light Blue Country
Is this an abuse of a dominant position?
Market definition may be determined endogenously by the conduct of the dominant company; this possibility may be more relevant in digital industries
UNION
COMPASS LEXECON 36
THANK YOU!
View my research on my SSRN author page: http://ssrn.com/author=47132
