Staples-Office Depot: Natural “Experiments” vs. Theoretical Models

1. 3 October, 2011 2pm Vanderbilt Law Staples-Office Depot:Natural “Experiments” vs. Theoretical Models  Luke M. Froeb Vanderbilt University

2. FTC Merger Enforcement Data1996-2003, “Other Industries”

3. What’s Wrong w/Structural Presumptions? • Market delineation draws bright lines even when there may be none • No bright line between “in” vs. “out” • Market Shares may be poor proxies for competitive positions of firms • Market shares and concentration may be poor predictors of merger effects

4. How do we know that market structure (concentration) matters? • Concentration is obviously correlated with merger enforcement • Oil & supermarkets have lower thresholds • Horizontal Merger Guidelines and judges demand more • Evidence of competitive effects • How do we draw inference about the “but-for” world?

5. One answer:price-concentration regression • Policy uses of price-concentration regression • Delineate antitrust markets in merger cases • Identify market power in monopolization cases • Estimate effects of mergers • Staples-Office Depot merger was successfully challenged by FTC using price comparisons • Prices 7.5% higher in one-office superstore cities than in two-office superstore cities • With a 15% estimated pass-through rate, would imply a 50% mc reduction to offset merger effect. • Would you block merger based on these data?

6. What could go wrong? • Experiment is “polluted,” i.e., something else accounts for results • Unobserved demand could increase price and increase number of firms (spurious negative correlation) • Unobserved costs could increase price and decrease number of firms (spurious positive correlation) • Example: movie tickets (Davis, 2005) • Measure of concentration: competitor >.5 mile away • Finding: Price is $0.90 higher with nearby competitor • How does this manifest in Staples case?

7. What could go wrong? (cont.) • Experiment might be bad metaphor for merger • Merger changes ownership concentration • Are changes in entry/exit across cities are good metaphor for changes in ownership concentration? • However: “some number beats no number” • “possibilities” are not enough to defeat analysis • Need alternative “positive” story

8. Natural Experiments are “Empirical” Models • Compare control vs. treatment group • Try to hold everything else constant • Backcast is the “control” group

9. Merger Retrospective:Marathon/Ashland Joint Venture • Combination of marketing and refining assets of two major refiners in Midwest • First of recent wave of petroleum mergers • January 1998 • Not Challenged by Antitrust Agencies • Change in concentration from combination of assets less than subsequent mergers that were modified by FTC

10. Merger Retrospective (cont.):Marathon/Ashland Joint Venture • Examine pricing in a region with a large change in concentration • Change in HHI of about 800, to 2260 • Isolated region • uses Reformulated Gas • Difficulty of arbitrage makes price effect possible • Prices did NOTincrease relative to other regions using similar type of gasoline

12. What else can we do? • Use a theoretical model • how do firms compete and how does merger change competition? • Price, quantity, capacity, bidding, bargaining competition • Models as “blueprints” for enforcement: • blueprint governs the assembly of the facts • facts govern the selection of the blueprint.  • Model tells you: • What matters • Why it matters • How much it matters

13. Example: Altivity-Graphic (2008): • What matters: Nicholas Hill (DOJ) “Mergers w/capacity closure,” • Elasticity of demand for CRB; elasticity of foreign supply; closing costs • Why it matters: Mergers increase profitability of shutdown • Altivity (35%) + Graphic (17%) of North American capacity • How Much it matters: • Divest 2 plants representing 11% of capacity

14. Model of Parking Merger • 1999 Central Parking $585 million acquisition of Allright. • Remedy: divestitures if merged share >35% in 4X4 block area is • Divestitures in 17 cities • Results • Capacity constraints on merging lots attenuate merger effects • By more than consraints on non merging lots amplify them

15. Super-premium ice cream in North America Nestlé 36.5% + Dreyer 19.5% revenue share Remedy: divest 3 brands to new entrant FTC v. Nestlé and Dreyer (2002)

16. Question: Is super-premium a relevant product market? Answer: Simulate merger-to-monopoly of four super-premium ice cream producers If price goes up by 5% then it is a relevant product market Models help delineate markets

17. Inputs to unilateral effects analysis: Own- and Cross-Elasticity Estimates Tenn et al., “Mergers when firms compete using price and promotion,” Int’l. J. Ind. Org.

18. Question: did new entrant Dreyer obtain a 20% share without affecting incumbent price? Does this mean that super-premium is not a relevant antitrust market? Answer: Build a model of post-merger world, simulate exit (by raising Dreyer’s MC), and see what happens to price Does incumbent pricing change? Models help interpret data

19. Question: How does promotional activity affect merger analysis and tools that economists use? What happens if we ignore promotional activity? Answer: Build a model of promotion + price. If promotion affects elasticity, then it matters; if not then it doesn’t Models help interpret data (continued)

20. Demand, prices, and promotion level1.None, 2.display, 3.feature, 4.both

21. Table 4: Elasticity Varies with Promotion • Own-price

22. Answer: promotion matters in this case • Price-only merger models under-predict (5% instead of 12%) the price effects of mergers in industries where firms compete using price and promotion • Estimation bias: demand is too elastic • Extrapolation bias: promotion decreases 31% in post-merger equilibrium

23. B,C merge Merger to monopoly Estimation Bias vs. Extrapolation Bias

24. Conclusion • Natural experiments change focus of investigation/litigation • Did we hold everything else constant? • Is the experiment a good metaphor for merger? • Models change focus of investigation/litigation • How well does the model explain the pre-merger observed world? • Do the model assumptions bias its predictions for the unobserved post-merger world?