Competition Policy Market definition and the Assesment of Market Power

Step 1: Market Definition  Market definition is done with the aim of assessing market power  The RELEVANT market is the set of products (& geographical areas ) that exercise some competitive constraints on each other  The test that guides the analysis of market definition is the SSNIP Test (or “Hypotethical monopolist test)  SSNIP: Small but Significant Non-transitory Increase in Prices (originally introduced by the US Dept. of Justice)

SSNIP  Ex.:merger between two sellers of bananas  focus on the definition of the product market  Suppose an hypothetical monopolist: Would he find it profitable to raise the price of bananas above the current level by 5-10%?  Answer: YES, then no significant competitive constraints from other (substitute) products  bananas are a separate market  Answer: NO, because part of the demand will be redirected to kiwi, and to other exotic fruits  then bananas could not be considered a separate market  The test continue by considering a wider market: banana and kiwi  Would the H. Monopolist find it profitable to raise the price of babanans and kiwi by 5-10%  ANSWER Yes  bananas and kiwi are a separate market  Answer: No the test continue until we have identified a separate market (exotic fruits?)

Demand & Supply substituability  Do not consider just substitutes from the point of view of demand  There could be supply substitution if producers can switch to a new product if its price increases  Switching must be easy-rapid and feasible  No considerable sunk costs and entry barriers (it should be easy and cheap to overcome entry-barriers)  Example of civil aviation: no supply substituability because of airport congestion.

Problem in non merger cases: abuse of dominant positions  Using SSNIP test in non merger investigations may raise problems  Ex.: abuse of dominant position: the question is: did the firm increase prices above the competitive level?  Applying SSNIP to current prices may distort results: the firm, if dominant, has already increased prices  it won’t find it profitable to further raise prices  according to the SSNIP test we must reply the test for a wider market  A too wide market could be identified and the calculation of small market shares follows  No dominance is found  Caution in applying SSNIP in non merger cases

Implementing the SSNIP test  Own price elasticity: not sufficient  Cross price elasticity  useful to rank substitutes (some closer some not): % change in the demand for B with a 1% increase of product A  When own price elasticity of A is high ( a monopolist is not likely to charge higher prices)  look at cross elasticities  If estimates of cross elasticities are low, products are not close substitutes and suggest a separate market

Geographic market definition  The same considerations hold  EX: merger between mineral water producers in Italy  SSNIP test: would a h. monopolist increase the price by 5-10%? YES  the geographic market is Italy  No  Imports from France are expected and rising prices is unprofitable  test to be repeated on a H. Monopolist in Italy & France

Step 2: assessment of market power  Perfect competition is an “ideal” model  in reality we expect each firm to enjoy some market power (some fixed cost and some substitutes in most cases do exist)  1.Which measure of market power?  2.Which treshold to call the attention of competition agencies?

Which measure  A theoretical measure: the Lerner Index: L = (P – MC)/ P  it increases with the mark up charged by the firm  The direct application can create problems: 1) Estimating MC is not easy 2) High cost can be due to the productive inefficiency caused by market power  paradox: one obtains high costs and lower margins  lower market power  Alternative approach: L = 1 /ε P  ε P easier to assess with modern econometrics  Traditional approach  look at market shares  Other variables: potential entrants/ countervailing power of buyers

Traditional approach: market shares  To assess market power  let us measure market shares  A firm with a tiny market share would be unable to excercise much market power  restraints on the ability to increase prices come from competitors  BUT a firm with high market share is not necessarily dominant  If entry was easy the firm would not be able to increase price OR if the buyer has countervailing power

Market shares as screening devices  Market shares could be used as a screening device: a market share below a treshold (40%..) leads to presume low market power (it cannot be considered dominant..) – above the treshold dominance is presumed and the burden of proof may fall on the defendant  In practice the EC and the European Court of justice follow this approach (useful to increase legal certainty and reduce the cost of investigations)

Market shares and beyond  Market shares both in units and in values might be available  In certain industries reserves might be more informative  If one firm is supposed to be not a crucial player in the future (cause it uses an old inefficient technology)  current market shares may overestimate competitive constraints  Excess capacity by rival firms may be important: if it is just enough to satisfy current demand their supply elasticity is low – If they have huge excess capacity the market power of the investigated firm is low  It is also the persistence of market shares over time that informs on market power  if the distribution varies over a short time we presume no dominance and greater competition