Applying Econometrics to Assess Market Definition and Market Power

• Pages: 215-263

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CHAPTER 10

APPLYING ECONOMETRICS TO ASSESS MARKET

DEFINITION AND MARKET POWER

The analyses of market definition and market power are closely

related from both a legal and an econometric standpoint. From a legal

standpoint, evidence on market definition can be informative regarding

market power and vice versa. More directly, analyses of market power

depend on the market definition, with a narrower market definition being

more likely to lead to a finding of market power. From an econometric

standpoint, the same techniques are sometimes used to analyze both

market definition and market power.

This chapter will present the commonly used econometric techniques

for assessing market definition and market power in a legal setting.

A. Legal and Economic Framework

While economists have long discussed the concept of economic

markets and have made frequent reference to “the market,” market

definition from an economic perspective has not always coincided with

the market definition used in antitrust litigation.

1

When economists speak

of markets, what they typically mean is a set of interactions that

encompass all actual and potential customers and suppliers of a product.

In this construct, no bright-line boundaries separate suppliers and buyers

that are “inside” the market from those that are “outside” the market.

To define markets in the context of an antitrust litigation or a merger

review, economists have employed numerous empirical techniques,

2

1

. See, e.g., U.S. DEP’T OF JUSTICE & FED. TRADE COMM’N, HORIZONTAL

MERGER GUIDELINES (1992). Recent updates to these guidelines have

erased or downplayed these bright-line tests. See 2010 HORIZONTAL

MERGER GUIDELINES (“Relevant markets need not have precise metes

and bounds”).

2

. Historically, economists have not always paid attention to market

definition. See, e.g., George J. Stigler, The Economists and the Problem

of Monopoly, 72 AM. ECON. REV. 1, Papers and Proceedings of the

Ninety-Fourth Annual Meeting of the American Economic Association

216 Econometrics

including SSNIP, critical loss analysis, correlation, co-integration, price

responsiveness, and speed of adjustment. These techniques are generally

aimed at identifying the products and regions that should be included in

the relevant market by analyzing consumer substitution based on sales

and prices data.

Although the markets that have been defined by the courts and in

FTC and DOJ complaints are typically described as if they have sharp

product and geographic boundaries, the empirical tests that economists

employ typically focus on evaluating the degree of substitutability

among products.

3

The economic approach recognizes the difficulty in

delineating bright lines, especially in a market setting where the choices

available to consumers comprise a continuum of products.

4

The tension

between the need to define markets with clear boundaries and the

realities of the marketplace in which the boundaries are not well defined

is one that antitrust economists and attorneys have wrestled with for

years and is an issue that is unlikely to disappear.

5

For this reason,

empirical studies of market definition will continue to be an important

part of any antitrust analysis.

6

(1982) (the “battle on market definitions … has received virtually no

attention from us economists.”).

3

. Throughout this chapter, we will refer to goods, products, and services

interchangeably.

4

. Markets where products differ from each other along one or more

dimensions are referred to in th e econo mics literature as having

“differentiated products.”

5

. There is currently debate around the necessity of defining a relevant

market before analyzing market power, as economists have developed

methods for assessin g market power that do not req uire a precisely

defined market. See, e.g., PHILLIP E. AREEDA & HERBERT HOVENKAMP,

ANTITRUST LAW, ¶ 913a, at 66 (3d ed. 2007) and J oseph Farrell & Carl

Shapiro, Antitrust Evaluation of Horizontal Merger s: An Economic

Alternative to Market Definition, 10 B.E. J. THEORETICAL ECON. The

2010 HORIZONTAL MERGER GUIDELINES § 4 recognize this while also

indicating that the DOJ and FTC “will normally identify one or more

relevant markets.” See also United States v. H&R Block, Inc., 833 F.

Supp. 2d 36, 84 n.35 (D.D.C. 2011) (“[a]s a legal matter, however, a

market definition may be required by Section 7 of the Clayton Act”).

6

. For example, in 2004 the DOJ and FTC both lost bids to block or enjoin

mergers because they failed to adequately establish the validity of the

“bright line” markets they had defined. See United States v. Oracle Corp.,

Market Definition and Market Power 217

Once the relevant market has been defined, economists can begin to

assess whether any firm or group of firms has market power within that

market.

7

Market power is often measured using market structure (e.g.,

how many firms are in the market and what share of the market each

controls), profit margins, and prices, with the assumption that firms have

more market power (i.e., can increase their prices) if they control a

bigger share of the market and have fewer competitors.

The challenge of measuring the effect of a firm’s exercise of market

power is establishing a causal link between any observed increase in

price or profits and the alleged anticompetitive conduct. To do this

properly requires a reliable assessment of what the price or profits would

have been in the absence of the exercise of market power, and a method

for controlling for other factors that may affect prices or profits. The

central role of econometric analysis in assessing market power lies in its

ability to tackle precisely this challenge.

As discussed in more detail below, many econometric techniques can

be used to isolate the link between anticompetitive conduct and market

outcomes, and thereby help identify the exercise of market power.

B. Market Definition

Defining the relevant market involves delineating the boundaries of

the product and geographic market that will later be used to analyze

market power.

8

Within the boundaries of the relevant market lie the

products and regions among which the relevant demand and supply

forces interact (e.g., the products competing with the product(s) at issue

for consumer demand). Products and regions outside the relevant market

are effectively ignored or treated as a single “all other” category.

Defining the relevant market therefore focuses the analysis of market

power on a specific set of products within a specific set of regions.

From an economic standpoint, defining the product and geographic

market is equivalent to determining which products are substitutes. For

331 F. Supp. 2d 1098 (N.D. Cal. 2004); FTC v. Arch Coal Inc., 329 F.

Supp. 2d 109 (D.D.C. 2004). By contrast, in 2011 the DOJ successfully

blocked the merger of H&R Block and 2SS Holdings based, in part, on

the court’s acceptance o f a precisely d efined market. See United States v.

H&R Block, Inc., 833 F. Supp. 2d 36, 84 n.35 (D.D.C. 2011).

7

. As noted above, it may not always be necessary to define a relevant

market before analyzing market power.

8

. See, e.g., FTC v. CCC Holdings, 605 F. Supp. 2d 26, 37 (D.D.C. 2009).