Market Definition

Market Definition Presentation to the Competition Commission of India US Chamber of Commerce October 26, 2010

Overview • Market power • Market definition • Relevant product market • Relevant geographic market • Case studies

Market Power • “Mergers should not be permitted to create, enhance, or entrench market power or to facilitate its exercise.” • (Source: Horizontal Merger Guidelines) • Market Power is the ability of a firm or a group of firms in a market to profitably raise prices, reduce quality, or slow down innovation for a significant period of time compared to these outcomes in a competitive market • Market power and monopoly power are often used interchangeably

Analysis of Market Power • Market structure approach / Indirect approach • Market definition • Market shares • Market concentration • Barriers to entry and expansion • Perception of market participants • Competitive effects analysis / Direct approach • Predict post-merger price effects • Elasticity of demand

Market Definition • In determining whether a transaction will create or enhance market power, the agencies and the courts look at the relevant markets within which the competitive effects are to be assessed

Relevant Markets: Two Components Product New York Geography Chicago Los Angeles Miami

Importance of Market Definition • Specifies the product and geographic scope in which the competitive concern may arise • May be different from how industry members uses the term “market” • Identifies market participants, shares, and concentration • Allows one to identify the competitive alternatives available to customers

Market Definition • Just because two products are used for similar purpose does not imply that they are in the same “antitrust” market Or even…

Relevant Product Market • Identifies a product or a set of products such that firms producing those products can defeat each others’ attempts to raise the price above the competitive level • Demand substitution • Customers’ ability and willingness to substitute away from one product to another in response to an increase in price or a reduction in quality

Demand Substitution: SSNIP Test • Hypothetical Monopolist/SSNIP Test: • “A hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future seller of those products likely would impose at least a small but significant non-transitory increase in price on at least one product in the market, including at least one product sold by one of the merging firms”

Demand Substitution: SSNIP Test • SSNIP is a methodological tool • Identifies a set of products that are reasonably interchangeable with a product sold by a merging party • Ensures that markets are not defined too narrowly • The most commonly used price increase threshold is 5%

Demand Substitution: Implementation of SSNIP • Extent to which customers will substitute away from the product in question • Examine how customers have shifted their purchase patterns in the past • Survey on how the buyers would respond to a price change • Interview customers and competitors to assess views on alternative products and competitors • Identify the existence of switching costs • Incremental profit margins on the product • Estimate incremental cost using merging parties’ data and/or documents • Incremental cost is measured over the change in output that would be caused by the hypothetical price increase

Demand Substitution: Critical Loss • Does imposing a SSNIP raise or lower the hypothetical monopolist’s profits? • Higher profits on sales made at higher prices • Lower quantity demand as consumers substitute away • “Critical Loss” is the number of lost unit sales that would leave profits unchanged • Price increase is profitable if: “Predicted Loss” < “Critical Loss”

Supply Substitution • Supply substitution • Suppliers’ ability and willingness to substitute away from their existing production facilities to make competing alternative products in response to an increase in price or reduction in quality of the product(s) at issue • Useful for identifying market participants, analyzing competitive effects, and potential entry

Supply Substitution: Implementation • Identify potential suppliers (“rapid entrants”) that are likely to provide rapid supply response without incurring significant sunk costs • Interview potential suppliers about feasibility of substitution, costs of switching between products, and the time it would take to switch • Analyze whether the potential suppliers have idle capacity or readily available “swing” capacity • Determine whether the customers would use the potential suppliers’ products

Relevant Geographic Market • Identifies a geographic area such that firms in that area can defeat each others’ attempts to raise the price above competitive level • Both supplier and customer locations can affect the scope • The principle behind defining a geographic market is similar to that used for defining a product market…SSNIP Test • The scope of a geographic market depends on transportation cost, language, regulation, tariff barriers, among others • The geographic market may be local, regional, national, continent-wide, or even world-wide

Market Definition: Recent Cases • FTC v. Staples • U.S. v. Oracle • FTC v. Whole Foods

FTC v. Staples: Background • Staples—the second largest office superstore in the U.S. with almost 500 stores in 28 states and DC • Office Depot—the largest office superstore chain in the U.S. with more than 500 stores in 38 states and DC • On September 4, 1996, Staples and Office Depot entered into a merger agreement

FTC v. Staples: FTC’s Claims • The proposed merger will result in competitive harm as a result of the loss of competition • Between the only office supply superstores (OSS) in many metropolitan areas (merger to monopoly) • Between two of only three office supply superstores in many other areas (3-to-2 merger)

FTC v. Staples: Market Definition • FTC defined the relevant product market to be the sale of consumable office supplies through office superstores

FTC v. Staples: Market Definition • Parties argued the relevant product market was simply the overall sale of office supplies through all venues • Staples and Office Depot account for only 5.5% of sales

FTC v. Staples: Market Definition • There was no dispute about the localized geographic market • Consumers are unwilling to travel very far to purchase office supplies

FTC v. Staples: Evidence from Documents • Staples charges more than 5% higher where it has no office superstore competition than where it competes with the two other superstores • Price checking and tracking entry focuses largely on OSS and not other types of stores • Staples cut prices when an OSS entered, but did not do so when a non-OSS entered

FTC v. Staples: Empirical Evidence • Prices at Staples stores are 13% higher in one-firm geographic areas than those in three-firm areas • Prices at Office-Depot stores are more than 5% higher in one-firm areas than in three-firm areas

FTC v. Staples: Court’s Findings • Functional interchangeability does not mean that two products are in the same relevant market • All compete at some level but not enough to constrain price • Low cross-price elasticity of demand between office superstores and other retail sources of office supplies • Slight increase in price does not cause consumers to switch to Wal-Mart, Best Buy, Quill, Viking, etc. The appropriate product market definition is the sale of consumable office supplies through office supply superstores

U.S. v. Oracle: Background • Oracle—an integrated business software company with offices in 80 countries and sells products in over 120 countries • PeopleSoft—another business software company with offices in Europe, Japan, Asia-Pacific, Latin America and other parts of the world and sells products in most major markets • Oracle initiated its tender offer for the shares of PeopleSoft on June 6, 2003

U.S. v. Oracle: Background • Enterprise resource planning (ERP) software integrates most of an entity’s data across all or most of its activities • ERP software are licensed to end-users along with maintenance and upgrades • The range of activities handled by ERP software • Human resource management (HRM) • Financial management system (FMS) • Consumer relations management (CRM) • Supply chain management (SCM) • Product cycle management

U.S. v. Oracle: DOJ’s Claims • “High function HRM and FMS” sold by Oracle, PeopleSoft, and SAP are the only HRM and FMS products • The proposed merger would constrict this highly concentrated oligopoly to a duopoly of SAP America and a merged Oracle/PeopleSoft

U.S. v. Oracle: Market Definition • DOJ defined the relevant market to be “high functional software” in the U.S. • Based on this market definition, the merger would be a 3-to-2 merger • Oracle did not propose a product market definition, but claimed that DOJ’s definition was too narrow: • The relevant product market also includes “mid-market vendors,” “outsourcing,” and “best of breed solutions” • The relevant geographic market is worldwide, or at the very least, the U.S. and Europe • The basic approach used by both sides for defining markets was SSNIP

U.S. v. Oracle: Evidence • Customer testimony on purchasing decisions played a key role in supporting DOJ’s market definition • Ten customer witnesses • Five industry witnesses • three system integration witnesses • Other evidence • Oracle’s discount approval forms • Market research study

U.S. v. Oracle: Court’s Findings • Customer evidence offered in support of the claim was largely unhelpful and only stated preferences • The relevant issue is what customers could do in the event of an anticompetitive price increase post-transaction • Unsubstantiated customer apprehensions do not substitute for hard evidence • Without a properly defined relevant market, the Court could not pursue market share, market concentration analyses DOJ proposed a very restricted product market definition

FTC v. Whole Foods: Background • Whole Foods—the largest grocery chain specializing in premium natural and organic (PNO) foods with more than 190 stores in more than 30 states and DC • Wild Oats—the second largest PNO supermarket chain operating 74 stores in 24 states • On February 21, 2007, Whole Foods executed an agreement proposing to acquire Wild Oats

FTC v. Whole Foods: Background • Natural foods are minimally processed and largely free of artificial ingredients and preservatives • Organic foods are produced using agricultural practices that promote healthy ecosystem • No genetically engineered seeds or long-lasting pesticides • Healthy and humane livestock management practices • All products labeled “organic” must be meet USDA standards

FTC v. Whole Foods: FTC’s Claims • The proposed merger will increase prices and reduce quality and services in a number of geographic markets throughout the U.S. • Eliminated one of only two or three PNOs in a number of geographic markets • Eliminated significant price- and non-price competition • Resulted in the closing of numerous Wild Oats stores

Other PNO FTC v. Whole Foods: Market Definition • The FTC defined the relevant product market to be “premium natural and organic supermarkets” • The relevant geographic market ranged from five or six miles in radius from a PNO to a metropolitan area

FTC v. Whole Foods: Market Definition • Merging parties said they competed with other large grocers like Krogers and Safeway Other PNO

FTC v. Whole Foods: Evidence from Documents • PNO supermarkets “offer a distinct set of products and services to a distinct group of customers in a distinctive way” • The parties were each other’s “closest competitors” in a number of geographic areas • Internal documents reflected direct competition between the parties • Whole Foods targeted markets for entry where Wild Oats enjoyed a “monopoly”

FTC v. Whole Foods: Quantitative Evidence • Whole Foods took significant shares away from Wild Oats wherever they had opened new stores • Prices at Whole Foods stores did not vary depending on the presence of Wild Oats stores • Direct contrast to Staples’ pricing analysis

FTC v. Whole Foods:Outcome • The FTC and the parties announced a settlement on March 6, 2009 • Under the consent order, Whole Foods agreed to sell 32 PNOs and share intellectual property related to “Wild Oats” brand

Questions/Comments

Market Definition