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Defining a Relevant Market Markus H. Meier Assistant Director African Competition Forum March 26, 2013 Introduction to 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). • A relevant market has both product and geographic dimensions. Key Questions in Defining Markets • What products do consumers view as reasonable substitutes? – Considering price, use, quality, and other significant characteristics • What alternative products can others supply, and under what circumstances will they do so? – Establishes others who are in the market • Where can consumers practicably turn for supply? – Can be local, regional, national, or international Product Market Definition • Start with each product at issue of the target of the investigation – this is the “tentative” relevant product market. – Use common product names • If there is more than one possible definition for a product, use the narrowest definition first. • Remember, a product can be a good, a service, or a combination of both. Demand-Side Analysis • What products do customers view as reasonable substitutes? • Would a significant number of customers substitute to other products? • Would so many substitute away so as to make the price increase unprofitable? • If yes, then expand the tentative product market by adding the closest substitutes. • What would customers do in response to a price increase in this new tentative product market? • Keep expanding the tentative product market until there is a relevant product that could be the subject of market power. Demand-Side Analysis Illustrated • • • • “A” is a tentative product market. Raising A’s price causes significant substitution to B. Raising A & B’s price does not cause substitution to C. A & B comprise a relevant product market. 1 2 C C A A B B Consumer substitution to B defeats price increase. No consumer substitution to C. A and B a market. The 5% Question • The hard question is: how close does a substitute have to be to be included in the market and at what price? • In the U.S., the antitrust agencies generally define product markets by asking this question: • “If there were a small but significant, non-transitory increase in the price of the product to what other products would customers turn (if any)?” – Most often, a 5% price increase is used. Note that this is a relative price increase, holding all else equal. – “Non-transitory” means the price increase is not just temporary. Supply-Side Analysis • Supply-side analysis involves the identification of which other firms are in the market. • It asks the question: if the price of the relevant product is increased by a small but significant amount, would other firms begin to produce the product? • Supply substitution is primarily a matter of evaluating whether other firms can begin to produce the product and whether they will do so if the price goes up. • Firms likely to enter and have a competitive impact within a year should be considered to be in the product market. Evidence for Defining Product Markets • Views and behavior of customers • Views and behavior of suppliers and potential suppliers • End use of product • Physical and technical characteristics of product • Customers’ switching costs • Price relationships (correlation) • Suppliers’ cost of adapting production processes, distribution, and marketing • Existence of second hand, reconditioned, or leased products Geographic Market Definition • 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. Geographic Market Definition Issues • Would a significant number of customers substitute to new sources of supply outside the area? • Would so many customers substitute away so as to make the price increase unprofitable? • If yes, then expand the tentative geographic market by adding the area of the closest substitutes. • What would customers do in response to a price increase in this new tentative geographic market? • Keep expanding the tentative geographic market until there is an area that could be the subject of market power. Geographic Market Definition Illustrated • • • • A is a tentative geographic market. Raising price in area A causes significant substitution to area B. Raising A & B’s price does not cause substitution to area C. Areas A & B comprise a relevant geographic market. 1 2 C C A A B B Consumer substitution to B defeats price increase. No consumer substitution to C. A and B a market. Evidence for Defining Geographic Markets • Views and behavior of customers • Views and behavior of suppliers • Transportation costs • Local set-up costs • Characteristics of the product (fragile, perishable) • Price relationships (correlation) • Shipment patterns • Foreign competition and trade barriers Combine the Information to Define the Market • Using the information learned during the investigation, combine it to define the market. • Normally this is stated as follows: “The relevant market in which to analyze the competitive effects of [the target’s conduct] is the sale of motorcycles in the Gambia.” • Double check the market definition against common sense: – Is it consistent with reality and common experience? – Could firms in this market impose a monopolistic price increase if they acted together? Others Ways to Define Markets • In economic terms, market definition is an attempt to indirectly evaluate the “cross-elasticity of demand” between a product and its closest substitutes. • It is used because the data to measure crosselasticities directly is rarely available. • There are economic methodologies to try to estimate cross-elasticities or market power more directly, when the right data is available. – Critical loss and diversion ratios – Market entry event studies