1. Market Definition In Merger Investigations
Anne-Sophie Masson-Cote
Competition Law Officer
Canadian Competition Bureau
ICN Merger Workshop
Mexico City, Mexico
December 12-13, 2017

2. Elements of Merger Analysis
Market definition
Competitive effects
Entry
Efficiencies
Failing firms

3. Introduction Why Market Definition Matters Defining a Relevant Market
Product Market Definition
Geographic Market Definition
Hypothetical Monopolist Test – SSNIP
Evidence
Market definition is a widely applied analytical framework to examine and to evaluate competitive concerns. We will talk about how to identify the relevant markets that reflect the competitive constraints, including product and geographic markets. The relevant market is usually defined by applying the hypothetical monopolist test (also known as the SSNIP test), according to which a ‘market’ comprises all the products and regions for which a hypothetical profit maximizing monopolist would impose a Small but Significant Non-transitory Increase in Price. Finally, we will talk about what types and sources of evidence help us understand substitution, demand, pricing, and incentives in the market.

4. Goals Basic goal of antitrust enforcement:
protect the competitive process
Goal of merger review:
quickly identify and prevent or remedy mergers that harm competition
As you understand from your work on non-merger cases, the goal of antitrust enforcement is to protect the competitive process. Your law states, in Article One, “This Law shall apply with regards to the protection of competition.”
The rationale behind merger control is consistent with the overall goals antitrust law – we want to identify and prevent or remedy mergers that harm competition.
Market definition plays a key role in helping to reach this goal. Specifically, market definition provides an analytical framework for the ultimate inquiry of whether a particular conduct or transaction is likely to produce anticompetitive effects.

5. Why Define Markets?
Market definition helps us examine and evaluate how competition may be harmed
Helps identify quickly those mergers unlikely to be anticompetitive
Is a useful starting point for predicting competitive effects
Does not, by itself, tell us if a proposed merger harms competition
(1) Market definition helps us examine and evaluate how competition may be harmed. More basically, it helps us understand which firms participate in the market, how customers may react to changes in price, and the firms’ incentives to change price, quality, or output.
(2) We should only spend time investigating markets that could be subject to an increase of market power and that are likely to harm competition.
(3) In identifying relevant competitors, the market definition process/inquiry can help us evaluate the risk of potential unilateral or coordinated effects in mergers. In addition, identifying the area of competition
allows other relevant competition issues to be examined, such as potential barriers to entry.
(4) It is important to remember that this is just part of the merger analysis process, and market definition does not by itself determine whether a merger may harm competition.

6. Defining a Relevant Market
A “relevant” market is a group of products that significantly constrain each other’s pricing, when viewed from both the demand side (consumers) and supply side (producers).
An antitrust market should be the set of products and locations that exercise a significant competitive constraint on each other. Understanding how customers and competitors will react to changes in the market is essential. To understand this, SUBSTITUTION is key.
If a market definition is too big, meaning it includes too many products, it will understate market concentration,
while failure to include relevant products will overstate concentration. The same is true for geography. Understanding geographic markets is fundamental. Including too many firms will overstate the degree of competition, while omitting firms involved will understate the prevailing competitive environment.
Industry Usage of the Word "Market" Is Not Controlling
An important note. When reviewing mergers, parties often have internal documents or studies that identify the market or markets in which they compete. While this information is often helpful, the relevant market definition is, in the antitrust context, a technical exercise involving analysis of customer substitution in response to price increases; the "markets" resulting from this definition process are specifically designed to analyze market power issues. References to a "market" in business documents may provide important insights into the identity of firms, products, or regions that key industry participants consider to be sources of rivalry, which in turn may be highly probative evidence upon which to define the "relevant market" for antitrust purposes. The Agencies are careful, however, not to assume that a "market" identified for business purposes is the same as a relevant market defined in the context of a merger analysis. When businesses and their customers use the word "market," they generally are not referring to a product or geographic market in the precise sense used in a merger analysis, although what they term a "market" may be congruent with an antitrust market.

7. Key Questions when Defining a Relevant Market
What group of substitute products prevent a producer’s exercise of market power?
Where can consumers look for alternatives and at what cost to them?
What are the limits on seller’s pricing behavior?
Other sellers
Other products
Recall from previous slide: A relevant market is a group of products that significantly constrain each other’s prices.
When considering alternatives, look to
Firms that produce the same or similar products in the same area.
Firms that can easily produce the same or similar products in the same area, but don’t currently do so.

8. Analytical Framework for Market Definition
The Hypothetical Monopolist Test
Begin with the product sold by both merging firms (e.g., Pineapples)
Ask: “Would a monopoly seller of that product find it profitable to raise price significantly?”
If the answer is No, begin adding closest substitutes (Guavas? Mangos?) until the answer is Yes
When the answer is Yes, we have a market
Next steps:
Determine number and size of others in the market
Consider ease of entry into the market
Analyze pre-merger competition in the market and perform competitive effects analysis to gauge likely effect of the merger
The most common method to define a market, used by almost all competition authorities, is the hypothetical monopolist test (HMT). This test provides a means to understand whether the merged entity could impose a five percent or greater price increase for the foreseeable future without losing so many customers as to make the price increase unprofitable.
The U.S. antitrust authorities introduced the “SSNIP” test as a method for delineating markets and this approach has been adopted by competition authorities worldwide. The Small but Significant and Nontransitory Increase in Price (SSNIP) test begins by defining a narrow market and asking whether a hypothetical monopolist in the defined market could profitably implement a SSNIP (usually a 5 percent price increase for 1 year). If sufficient numbers of consumers are likely to switch to alternative products so as to make the price increase unprofitable, then the firm lacks the power to raise price. The relevant market therefore needs to be expanded. The next closest substitute is added and the process is repeated until the point is reached where a hypothetical cartel or monopolist could profitably impose a 5% (or higher) price increase. The set of products and locations so defined constitutes the relevant market.
To break that down, we’ll want to understand how prices are set, how consumers view the product, and which other products consumers would purchase if the price for the first product changed.

9. Importance of Substitution
Evidence of consumer substitution is the most important element in market definition
Past substitution
Statistical estimates of price sensitivity/elasticity
Evidence of company’s pricing strategy
Customer interviews
This a preview of our later discussion, though it is important to always be thinking about the sources of information and data when analyzing a merger.
Whether a hypothetical monopolist can profitably raise the price depends on how many consumers, representing how much demand, will switch to other products

10. Defining a Relevant Market
Product Market – identify practical and objective substitutes by considering:
How the product is used
How buyers will react to changes in price or quality
Availability of substitutes
How sellers will react
Ease of entry
Geographic Market
Buyer’s access to products and decision-making
Transportation costs and tariff and non-tariff barriers

11. Product Market Objective of analyzing the product market:
identify producers of close substitutes, whose actions would substantially affect the post-merger marketplace.
identify producers of distant substitutes, whose actions would only slightly affect the post-merger marketplace.
Are the merging parties, for example, producing close substitutes?

12. Product Market
Start by assessing the demand for each individual product.
What products do both merging parties sell?
How are these similar? Different?
Demand for a given product (e.g., a container of Nestlé brand ice cream) is related to:
The product’s own price.
The prices of other, substitutable, products (e.g., price of a container of Häagen-Dazs’ brand ice cream).
What we need to understand is what are reasonable substitutes from a consumer’s point of view?
Would they also eat ice cream sandwiches? Magnum bars? Ice cream from a shop? Other desserts?
In Canada, Häagen-Dazs is a premium Ice Cream. As small container ho Hägen-Dazs is likely to cost as much as a “tub” of Nestlé. So even if the two products fulfill the same function and maybe even come in the same flavors it is unlikely that consumer purchasing Nestlé ice cream, when faced with a SSNIP would turn to Häagen-Daz. They are more to turn to a similarly priced ice cream such as Breyer’s. while Häagen-Dazs customers are likely to turn to another premium brand such as Ben & Jerry’s.

13. Key Questions for Product Market
What products do consumers view as reasonable substitutes?
What alternative products can others supply, and under what circumstances will they do so?
How do consumers react to changes in price of the product?
If the price of a container of Nestlé ice cream increases by 5%, will consumers choose to buy a different ice cream product?
How many consumers will choose another ice cream?
Finding out which ice cream products consumers would buy instead of a single scoop cone is part of the relevant product market analysis. These questions are just ways of finding out which products are reasonable substitutes.
Consumers will typically consider price, use, quality, and other significant characteristics when identifying substitute products. Is ice cream an impulse purchase or do consumers plan for it?
After we understand how consumers determine what products are substitutes, we turn to consider who supplies these products, and under what circumstances they will. Alternative products and supply, another way to ask this question is: Who else is in the market?
Finally, we get back to the hypothetical monopolist’s key question: [last bullet]

14. Analytical Framework for Product Market
Start with the a product sold by both merging parties.
Think about what customers would do if the price of the relevant product in the area increased by a small but significant amount.
If the price increases, how many consumers, representing how much demand, will switch to other products?
Consumers will substitute away from the product by either buying less of the product, choosing a substitute, buying in a different area or buying something completely different or nothing at all.
What will suppliers do?
Other firms could increase their supply of the product (or of substitute products), reposition their products, expand their capacities or new suppliers may enter the market.

15. Analytical Framework for Product Market
The Hypothetical Monopolist Test
Begin with a product sold by each of the merging firms as a candidate (possible) product 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 prevailing level.
If yes, stop. This product is a market.
If no, go to the next step.
Expand candidate market by adding the next closest substitute and return to step 2.
Now to apply the test, [1].
To determine the effects of this "'small but significant and nontransitory'' increase in price" (commonly referred to as a "SSNIP"), agencies generally use a price increase of five percent, though it can be higher. This test identifies which product(s) significantly constrain the price of the merging firms' products.
In basic settings, one begins with a narrow, homogeneous goods market and asks whether a hypothetical monopolist thereof would find it profitable to raise price above the preexisting level by at least 5% (HMG, §4.1.2). If so, that is deemed to be the relevant market. If not, one expands the market by adding the nearest substitutes and repeats the test. If it is passed, the process is complete and that redefined market is selected. If not, the process is repeated until the test is satisfied.
Caution: Other tools that provide alternative to market definition include, pricing pressure indices (PPI’s), compensating marginal cost reductions, merger simulations and a direct effects approach. Generally, these concepts cannot be considered as a replacement of market definition, but should be viewed as optional substitutes or methods that complement market definition by providing additional information. Economists can provide more details on these other concepts and how they relate to market definition in other presentations.
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[exact notes from slide 8] The Small but Significant and Nontransitory Increase in Price (SSNIP) test begins by defining a narrow market and asking whether a hypothetical monopolist in the defined market could profitably implement a SSNIP (usually a 5 percent price increase for 1 year). If sufficient numbers of consumers are likely to switch to alternative products so as to make the price increase unprofitable, then the firm or cartel lacks the power to raise price. The relevant market therefore needs to be expanded. The next closest substitute is added and the process is repeated until the point is reached where a hypothetical cartel or monopolist could profitably impose a 5% price increase. The set of products/locations so defined constitutes the relevant market.

16. Geographic Market Similar to Product Market Exercise
Will consumers easily substitute a product at another location?
Generally, apply the same principles (e.g., identification of substitutes) to defining geographic markets that one would to product markets.
Taking single scoop ice cream cones as our example, how far would someone travel to get another ice cream product? Two kilometers? Are they on foot? Driving?

17. Key Questions for Geographic Market
Will consumers travel to stores in a different town to buy the product?
How far will consumers travel?
How far is competitive effect from one store felt?
How does this distance vary across locales?

18. Analytical Framework for Geographic Market
Start with the area in which the target of the investigation sells the relevant product.
If there is more than one factory or similar location, start by treating each separately.
Think about what customers would do if the price of the relevant product in the area increased by a small but significant amount.
An equivalent procedure is used to define the relevant geographic market. Starting with the locations of the merging firms, additional locations are added to the candidate markets until the test is satisfied.
NOTES:
For geographic market definition, the HMT “requires that a hypothetical profit-maximising firm that was the only present or future producer of the relevant product(s) located in the region would impose at least a SSNIP from at least one location, including at least one location of one of the merging firms. In this exercise the terms of
sale for all products produced elsewhere are held constant.” US Horizontal Merger Guidelines, sect

19. Analytical Framework for Geographic Market
The Hypothetical Monopolist Test
Begin with an initial geographic location such as the area around a manufacturing plant or retail location as a candidate geographic market.
Ask if a hypothetical monopolist of the relevant product located within this geographic area could profitably impose a “small but significant and nontransitory increase in price” (SSNIP) above the prevailing level.
If yes, stop. The candidate geographic market is the relevant geographic market.
If no, go to next step.
Expand the candidate geographic market to encompass this larger geographic area and return to step 2.
Exactly as we did with the product market, Start with initial product(s), in a particular area as a candidate market. Ask whether a monopolist could profitably raise price in this candidate market. If yes, then stop here. This is the relevant geographic market. Otherwise, expand the market by adding products sold in a wider geographic area and repeat until you have arrived at the group of products for which the answer is yes.

20. Geographic Markets and Price Discrimination
If a hypothetical monopolist can discriminate based on customer location, relevant geographic markets may be based on the locations of targeted customers.
Examples:
Customers require local service to support and repair a highly technical relevant product.
Suppliers have service and support operations in many geographic areas and can discriminate based on customer location.
● Relevant geographic markets, therefore, can be defined around the locations of customers.
Price discrimination happens when sales of identical goods or services are sold at different prices from the same provider. For example, at a Superama Supermarket in a town center, the price of one container of Nestlé ice cream may be higher than in a Superama Supermarket located on the outskirts of town.

21. Elasticity and Substitution
● If two products are close substitutes, then the demand for each product is very sensitive to the price of the other. The cross-price elasticity between these two products is large.
● If containers of Nestlé and Häagen-Dazs ice cream are close substitutes, a small change in the price of Nestlé should result in a big change in the sales of Häagen-Dazs ice cream, and vice-versa.
Elasticities show how many consumers would switch to other products given a price increase.

22. Market Definition and Critical Loss
A price increase implies that some sales will probably be lost, while the remaining sales will be made at a higher price.
Ask: are the increased profits on the remaining sales sufficient to make up for the forgone profits from the lost sales?
Following a SSNIP, the number of lost unit sales that allows a hypothetical monopolist to just break even is referred to as the “Critical Loss.”
─ Critical Loss is the maximum percentage of its sales that a hypothetical monopolist could lose before a given percent price increase would be unprofitable.
Another way to analyze markets is by considering how customer’s demand changes in relation to a price increase together with the profit margins of the firms.
A price increase by the monopolist has 2 effects: the margin of the quantity he continues to sell
after the price increase has become larger but the quantity he sells has decreased. A price increase therefore is
profitable only if the additional revenue due to sales at a higher margin is larger than the reduced revenue due
to the drop in the quantity sold.
The Critical Loss test proceeds in three steps. For a given set of firms, the first step is to determine, for a given price increase, the percentage reduction in demand that would render such a price increase unprofitable. This percentage reduction is a function of the proposed price increase (typically fixed at 5%) and the gross margin of the firm.
It is not an alternative to the HMT but a way to implement this test.

23. Sources of Evidence Interviews with Market Participants
─ Customers, competitors, and others
Documents
─ Business and Marketing Plans, Sales Reports
─ Internal and third-party industry studies
─ discussions of pricing and competition
Data/Empirical Analyses
─ Effects of differential cost changes
─ Price changes over time
─ Effects of different market structures across different geographic markets
Natural Experiments
─ Effects of past price increases
Continue to revisit market definition through out the investigation, and combine all information gathered to define the market.
As mentioned earlier, it’s helpful to think of the sources of information you have as you are identifying candidate markets and theories of harm.
The goal of a customer interview is to understand which products or locations consumers would turn to in order to substitute for the product under consideration, if the price were to be increased by a SSNIP.
Interview questions can be quite specific: “What would you do if prices went up 10%?” “Why do you think X is a substitute?” To understand the reasoning behind customer’s and competitors responses, ask: “Why is that product a substitute?” “How do you use this product?” “What are the characteristics of the product that you most like?” Interviews with competitors further helps to understand who is in the market and who may be entering the market. Others to interview include industry experts, consultants, former executives, and suppliers of complements or distributors.
Many of these issues will be discussed in the company’s documents. When looking at documents, those that were created in the ordinary course of business, before the merger was contemplated, tend to be very helpful. Documents often contain sales figures, price, and volumes, and also identify who the parties consider as competitors. Many times a firm’s marketing division may have collected data on buyer substitution behaviour to identify the closest rivals. Documents might also analyze the customers’ preferences for certain products or qualities of certain products. This type of information should inform your analysis.
When considering the party’s own data and empirical analysis, be sure to understand what their assumptions were and the basis for any conclusions. Regarding effects of cost changes, you may be able to find a period where there is a substantial cost change. What happened next in the market? Did the firms raise prices? By how much? Did competitors follow? How did sales change after changes?
When looking at past information, consider whether the market conditions are the same. Be especially careful when considering older data and analyses. On different market structures: In one town there may only be a single seller, while in other towns there may be many sellers. Do prices vary? [Staples anecdote?]
[read natural experiments] For example, if there has been a recent entry by a new supplier, how did the market react? Differences in sales across geographic markets in which prices vary is another example of a natural experiment.
All of these can help you define the relevant product market, but they can also be helpful in understanding the competitive effects of the merger.
Make sure the market definition makes common sense.

24. Exercise 1: Product & Geographic Market
Each table is assigned to represent one of the three different interests:
Tables 1 – 3 : Merging parties
Tables 4 – 6 : Complainant to the merger
Tables 7 – 9 : Competition authority
Product Market Discussion: minutes
Geographic Market Discussion: 5-10 minutes

25. Market Shares and Market Concentration
Why is it important?
Market shares can directly influence firms’ competitive incentives
Market shares also can reflect firms’ capabilities
Should be based on:
Properly defined product and geographic markets
Reliable data, sources, and assumptions
Measure that is the best indicator of competitive conditions of the market (unit sales, dollar sales, capacity, etc.)
Typically annual data are used
But may be unrepresentative where transactions are large and infrequent
May want to measure market shares over a several year period
The Agencies normally consider measures of market shares and market concentration as part of their evaluation of competitive effects. The Agencies evaluate market shares and concentration in conjunction with other reasonably available and reliable evidence for the ultimate purpose of determining whether a merger may substantially lessen competition.
Market shares can directly influence firms’ competitive incentives. For example, if a price reduction to gain new customers would also apply to a firm’s existing customers, a firm with a large market share may be more reluctant to implement a price reduction than one with a small share. Likewise, a firm with a large market share may not feel pressure to reduce price even if a smaller rival does.
Market shares also can reflect firms’ capabilities. For example, a firm with a large market share may be able to expand output rapidly by a larger absolute amount than can a small firm. Similarly, a large market share tends to indicate low costs, an attractive product, or both.

26. Market Shares and Market Concentration
Useful indicator of likely competitive effects of a merger
Consider both the post-merger level of concentration and the change in concentration
4 firm concentration ratio (CR4)
Summation of the of the 4 largest firms market shares
CR4 = 20% + 20% + 20% + 20% = 80%
CR4 = 40% + 35% + 4% + 1% = 80%
Herfindahl-Hirschman Index (HHI)
Summation of the squares of the individual firms’ market shares
Gives proportionally greater weight to the larger market shares
Lack of information about smaller firms is not critical because they do not affect the HHI significantly
4 firm concentration ratio (CR4)
It is the sum of the market share of the 4 largest firms in the industry
It is simple to calculate but not very informative.
Per example you could have a CR4 of 80%, where the 4 largest firms each have a 20% market share and the fifth company that also has a 20% market share.
Or you could have a CR4 of 80% where the 4 largest firms in the market respectively have market shares of : 40%, 35%, 4% and 1%.
In Canada, the Merger Enforcement Guidelines states that the Commissioner generally will not challenge a merger on the basis of a concern related to a coordinated exercise of market power when:
the post‑merger market share accounted for by the four largest firms in the market would be less than 65 percent.

27. Market Shares and Market Concentration
Example of Herfindahl-Hirschman Index (HHI)
Firm A Proposes to Acquire Firm B
Pre-Merger HHI
Post-Merger HHI
Firm
Market Share
HHI A
35.0%
1225
A & B
57.0%
3249 B
22.0%
484
0.0% C
15.0%
225 D
12.0%
144 E
9.0% 81 F
7.0% 49
Total
100.0%
2208
3748
The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases.
Pre-merger HHI = 2,208
Post-merger HHI = 3,748
Delta = 1,540

28. Market Participants, Market Shares and Market Concentration
Market concentration statistics
HHIs range from 10,000 (a pure monopoly – i.e., 100% x 100% = 10,000) to a number approaching zero (an atomistic market)
Consider both the post-merger HHI and the increase in the HHI
Generally classify markets into three types based on HHI levels:
Unconcentrated Markets: HHI below 1500
Moderately Concentrated Markets: HHI between 1500 and 2500
Highly Concentrated Markets: HHI above 2500
But recall that you need to consider the post merger HHI and the increase in the HHI.

29. Market Shares and Market Concentration
Market concentration statistics (continued)
Small Change in Concentration: Mergers resulting in an increase in the HHI of less than 100 points are unlikely to have adverse competitive effects and ordinarily require no further analysis.
Unconcentrated Markets: Mergers resulting in unconcentrated markets (HHI below 1500) are unlikely to have adverse competitive effects and ordinarily require no further analysis.
Moderately Concentrated Markets: Mergers resulting in moderately concentrated markets (HHI between 1500 and 2500) that involve an increase in the HHI of more than 100 points potentially raise significant competitive concerns and often warrant scrutiny.
Highly Concentrated Markets: Mergers resulting in highly concentrated markets (HHI above 2500) involving
an increase in the HHI of between 100 points and 200 points potentially raise significant competitive concerns and often warrant scrutiny; and
an increase in the HHI of more than 200 points will be presumed to be likely to enhance market power.
Horizontal Merger Guidelines, U.S. Department of Justice and the Federal Trade Commissione – Issued: August 19, 2010.

30. Market Participants, Market Shares and Market Concentration
Example of Herfindahl-Hirschman Index (HHI)
Firm A Proposes to Acquire Firm B
Pre-Merger HHI
Post-Merger HHI
Firm
Market Share
HHI A
35.0%
1225
A & B
57.0%
3249 B
22.0%
484
0.0% C
15.0%
225 D
12.0%
144 E
9.0% 81 F
7.0% 49
Total
100.0%
2208
3748
Pre-merger HHI = 2,208
Post-merger HHI = 3,748
Delta = 1,540
The purpose of these thresholds is not to provide a rigid screen to separate competitively benign mergers from anticompetitive ones, although high levels of concentration do raise concerns. Rather, they provide one way to identify some mergers unlikely to raise competitive concerns and some others for which it is particularly important to examine whether other competitive factors confirm, reinforce, or counteract the potentially harmful effects of increased concentration. The higher the post-merger HHI and the increase in the HHI, the greater are the Agencies’ potential competitive concerns and the greater is the likelihood that the Agencies will request additional information to conduct their analysis.
What if the post-merger HHI were 10,000? Would that merger be conclusively anticompetitive? Why or why not?
This proposed merger would result in a highly concentrated market involving an increase in the HHI of more than 200 points and thus will be presumed to be likely to enhance market power. That presumption, however, may be rebutted by persuasive evidence showing that the merger is unlikely to enhance market power.
What might that persuasive evidence include?

31. Exercise 2: Market Shares and Concentration
Discussion: 15 minutes

32. Thank You!