1. Week 2: Market Power, Market Definition & (Horizontal) Mergers Francis O'Toole (fotoole@tcd.ie) Department of Economics Trinity College Dublin 11 th October 2013

2. Introduction: Market Power n Why Market Definition? Market Power! n Abuse of Market Power/Abuse of Dominance/SLC (+ Anti-Competitive Agreements + State Aid) n Main Example = Horizontal Mergers n Economics + Law + Politics (merger control) + Business (why merger?) n (Perfect Competition – Monopoly) Spectrum n Theoretical Approach

3. Market Power & Merger Policy n Protect/Enhance Competition as a Process n Substantial Market Power Mitigates Against Competition as a Process n Market Power (US) and Dominance (EU) n Market Power and Own-Price Elasticity (Market Power and Cross-Price Elasticity) - Cellophane Fallacy n Indicators of Market Power

4. Market Power Indicators: Process n 1. Market Definition n 2. Market Concentration n 3. Barriers to Entry n 4. Competitive Environment (unilateral effects, co-ordinated effects, potential competition) n 5. Efficiencies (merger context)

5. 1. Market Definition n Definition of Market Definition n Increased Prices and Reduced Demand: A. Demand Substitution (by consumers) B. Supply Substitution (by existing competitors) [not included in US or elsewhere] C. Supply Substitution (by new competitors, i.e. new entry) [kind of included in EU] n Example: Winter Shoes, Winter Boots, Winter Footwear

6. 1. Market Definition n Benchmark Prices? n Abuse of Market Power/Abuse of Dominance - Competitive Prices Current Prices (Cellophane Fallacy) n Merger - Current Prices (in general) Counterfactual Analysis! n Broad Markets: 10 percent, 24 months n Narrow Markets: 5 percent, 12 months

7. 1. Market Definition (EU) n Past: Product Characteristics Approach n Present: Formal Notice (December 1997) n Dominance & Mergers (& State Aids?): Market Definition Notice n Supply Substitution (included)

8. 1. Market Definition (Ireland) n Notice in Respect of Guidelines for Merger Analysis, Decision No. N/02/004, 16 December 2002. n Merger Guidelines being revised.

9. 2. Market Concentration n Concentration Increases as: (i) Number of Firms Decrease; and, (ii) Inequality in Market Shares Increase n Proposed Concentration Measures: Lorenz Curve/Gini Co-efficient Concentration Ratio Hirschman-Herfindahl Index (HHI) n SCP Paradigm

10. 2. Market Concentration n Concentration Ratio C r = S 1 + S 2 +... + S r (r = 4, 5,.. 8?) n Hirschman-Herfindahl Index (HHI) HHI = S 1 2 +... + S n 2 0 < HHI 10,000

11. 2. Market Concentration n HHI as a Filter n Moderately Concentrated 1,000 < HHI < 1,800 n Highly Concentrated 1,800 < HHI n HHI as applied?

12. 3. Barriers to Entry n Approaches A: Definitions B: Determinants of Market Structure C: Entry Deterrence in Practice n 1968 US Merger Guidelines (Entry ignored) n 1982 US Merger Guidelines (Entry central)

13. 3. Barriers to Entry: Definitions n Bain (1956)... factors that enable established firms to earn supra-competitive profits without threat of entry. n Stigler (1967)... costs that must be incurred by an entrant that were not incurred by established firms. n Natural, Strategic, Exogenous, Endogenous, … n Importance of First-Mover Advantage

14. 3. Barriers to Entry: Determinants of Market Structure n Economies of Scale n Diseconomies of Scale n Minimum Viable Scale (MVS) Minimum Efficient Scale (MES)

15. 3. Barriers to Entry: Examples? n Learning Curve/Learning-By-Doing n Better Technology n Product Differentiation/Brand Loyalty n Scale Economies/Fixed Costs n Distributional Agreements/Restrictions n Imperfect Capital Markets n First-Mover Advantage

16. 3: Barriers to Entry: Entry Deterrence in Practice n Limit Pricing (Output) & Excess Capacity: Credibility and Commitment n Raising Rivals Costs (e.g. vertical restraints?) n Predation (reputation) n Brand Proliferation n Switching Costs (e.g. quantity discounts)

17. 4. Competitive Environment? n Unilateral Price Effects ( single firm dominance) n Co-ordinated Price Effects ( collective dominance) Market Shares: Symmetry, Stability Homogeneity: Firm Structure, Firm Product Transparency Inelastic Market Demand Non-Presence of Maverick Firms Non-Presence of Strong Buyers Non-Presence of Excess Capacity

18. 5. Efficiencies (merger context) n Corporate Control Market n Efficiency offence originally (entry ignored) n Efficiency defence? 1968 Slight Possibility 1984 Clear and Convincing Evidence 1992 Limited Efficiencies Defence n Total Surplus (Efficiency) Standard n Consumer Surplus (Price) Standard

19. 5. Efficiencies n Requirements: Burden of Proof on Merging Parties Clear and Convincing Evidence Efficiencies Specific to Merger Consumers Must Benefit (Consumer Surplus or Price Standard)

20. 5. Efficiencies: Examples n Corporate Control Market n Economies of Scale/Plant Specialisation n Better Integration of Production Facilities n Lower Transportation (Distribution) Costs n Variable Costs (recurring) v. Fixed Costs (once off) n Efficiency arguments are easy to make, but hard to evaluate.