Antitrust & Competition Policy Blog

Editor: D. Daniel Sokol
University of Florida
Levin College of Law

Friday, May 15, 2009

Illustrative Price Rises from Mergers in Differentiated Products Markets

Posted by D. Daniel Sokol

David Parker (Frontier Economics) offers some thoughts on Illustrative Price Rises from Mergers in Differentiated Products Markets.

ABSTRACT: The approach taken by U.K. competition authorities to analyzing the extent of merger concerns in differentiated products markets has evolved over time. An approach which has been applied in an increasing number of cases, especially by the Office of Fair Trading (“OFT”), involves calculating illustrative price rises from a combination of the “diversion ratio”—the proportion of sales lost by one firm following a price increase that are recaptured by another firm—and the variable profit margin. This technique can identify mergers of concern more accurately in some circumstances than through the use of market share and concentration measures alone. It also allows the focus of the inquiry to be more on the competitive effects analysis than on market definition, although market definition will likely continue to play an important filtering role. The validity of the technique is based on several assumptions, as this is a form of simplified merger simulation. However, in practice these assumptions are rarely scrutinized in detail to see whether they hold in specific cases, and, taken in combination, the assumptions usually employed by the authorities may lead to some mergers being blocked which would ordinarily appear not to be of genuine concern.

This article concentrates on unilateral effects concerns arising from mergers, typically measured as a post-merger increase in prices or an equivalent reduction in quality, range, innovation, or other aspects of the offer. A starting point for merger investigations is the market shares of the firms involved. However, where firms sell products that are differentiated, market shares can be a poor proxy for merger concerns, as customers may not view the firms as being close substitutes even if they are in the same market.

To make more accurate assessments of the prospects for merger concerns, one needs to understand better how customers view the substitutability of the products in question. One technique for doing this is the calculation of “illustrative price rises” using two key items of information—the pre-merger margin and the diversion ratio between the merging firms. This technique, a form of simplified merger simulation, is starting to become more common in U.K. merger inquiries, particularly at the Phase I OFT stage (although the approach was first used in the United Kingdom at the Phase II Competition Commission (“CC”) stage).

This article describes the illustrative price rises technique, identifies the data required to employ it, and briefly explains how these data might be captured in practice. For the illustrative prices generated by the technique to be valid, a number of assumptions must be satisfied. The article outlines these assumptions and shows that these are often taken as given, without serious consideration of whether they apply in a particular situation. Moreover, we argue that the assumptions typically employed, when taken in combination, appear to raise the bar extremely high, leading to a concern that unproblematic mergers may be blocked.

At present, the evolution of the use of this technique in the United Kingdom has taken place in a somewhat ad hoc manner on the basis of individual cases. The main aim of this article is to stimulate a debate about the use in theory and in practice of the illustrative price rises technique, in order that the issues above may be explored in a transparent manner outside the pressures of specific cases.

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