A Quantitative Methodology for Determining Relevant Geographic Markets in Higher Transportation Cost Industries

AuthorJoanna Tsai,Martino De Stefano
Published date01 December 2018
Date01 December 2018
DOIhttp://doi.org/10.1177/0003603X18807807
ABX807807 431..443 Article
The Antitrust Bulletin
2018, Vol. 63(4) 431-443
A Quantitative Methodology
ª The Author(s) 2018
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DOI: 10.1177/0003603X18807807
Geographic Markets in Higher
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Transportation Cost Industries
Martino De Stefano* and Joanna Tsai*
Abstract
The U.S. Department of Justice/Federal Trade Commission Horizontal Merger Guidelines describes
the hypothetical monopolist test (HMT) and significant and nontransitory increase in price (SSNIP) as
tools to define antitrust markets. However, the discussion leaves some ambiguities with regards to the
implementation of such tools. In this article, we present a methodology for quantitatively delineating
geographic markets that is consistent with the Guidelines. In particular, for geographic markets that
are based on the locations of customers, the market boundaries encompass the region into which sales
are made from the merging parties’ plants, and competitors in the market are firms that sell to cus-
tomers in the specified region. We use two approaches to identify the competitive reach of a plant—
one based on actual shipping distances, which reflect the areas where the plant actually sells; and the
other based on distances at which the plant’s product can be shipped profitably, which reflect all areas
where the plant can potentially compete for customers. These distances are used to “draw circles”
around plants to identify areas where one merging party plant’s competitive reach overlaps with the
reach of another plant belonging to the merging partner, thus identifying the overlap customers. For
each identified overlap customer area, the HMT is implemented using the critical loss analysis following
a SSNIP by the hypothetical monopolist. We explain how to calculate the critical loss as well as the
likely actual loss from the SSNIP.
Keywords
antitrust, market definition, mergers, hypothetical monopolist test, critical loss
I. Introduction
Market definition helps to specify the line of commerce within which to evaluate whether a proposed
transaction raises competitive concerns. The geographic dimension of market definition, or geographic
market definition, delineates the geographic boundaries of competition affected by the merger in those
*Charles River Associates, Washington, D.C., USA
Corresponding Author:
Martino De Stefano, Charles River Associates, 1201 F Street, NW, Suite 800, Washington, D.C., 20004-122, USA.
Email: MDeStefano@crai.com

432
The Antitrust Bulletin 63(4)
situations where geography limits customers’ willingness or ability to substitute to some (farther away)
products, or some suppliers’ willingness or ability to serve some (farther away) customers. In this
article, we propose a methodology to delineate geographic markets that is practical and simple to
implement.1 The methodology provides a preliminary screen in situations where plants are geogra-
phically dispersed and transportation costs are important determinants of the competitive landscape
within which merging parties (and their rivals) compete. We employed this methodology recently to
determine antitrust markets in the context of a merger reviewed by the Chinese antitrust authority.
Geographic markets can be defined around the location of firms or the location of customers. We
focus on the latter. Geographic markets are generally defined around the location of customers when
suppliers can discriminate between customers, which often occurs when suppliers deliver their prod-
ucts or services to customers’ locations. We begin by drawing areas around merging parties’ facilities
to identify “overlap” customers.2 The overlap customers are served or could be served by both merging
firms and thus could be affected by the merger. Geographic markets of this type cover the region into
which sales are made, and competitors in the market are firms that sell into the region, which may or
may not be themselves located inside the region. Customers that are potentially affected by the
transaction are customers that the merging parties either actually supply or could profitably supply.
For these customers, the number of independent supply options declines as a result of the merger.
We use two approaches to identify the competitive reach of plants, one based on actual shipping
patterns, and the other based on distances at which a plant’s product can be shipped profitably, which
we refer to as the profitable distance or the break-even distance. Once the shipping distance within
which most of a plant’s sales are made, or the profitable distance within which products can be
shipped, is determined, that distance is used to “draw circles” around plants to identify their compet-
itive reach and the resulting overlap customers. Areas where one merging party plant’s circle overlaps
with another merging party plant’s circle identify the overlap customers.
For each identified overlap customer area, the hypothetical monopolist test (HMT) is then used to
assess whether the overlap area itself or a broader region around the overlap area constitutes a relevant
antitrust market. If the hypothetical monopolist over a region into which sales are made is able to
profitably impose a small but significant and nontransitory increase in price (SSNIP), then this
candidate market is a relevant antitrust market. If not, the region is expanded to incorporate sources
of supply to which customers would be able to turn to in the event of the SSNIP. Given a candidate
market, we assess the profitability of a SSNIP based on a comparison of critical loss and likely actual
loss, as described below.
The SSNIP, as described in the U.S. Department of Justice (DOJ) / Federal Trade Commission
(FTC) Horizontal Merger Guidelines and adopted around the world, is mostly a theoretical construct
and application of the HMT to each of the (potentially numerous) local overlap areas is often imprac-
tical and rarely implemented. In practice, agencies or parties may assess the sensitivity of the com-
petitive effects results to using alternative radii to draw circles in lieu of carrying out the fully
implemented HMT to define the precise boundaries of the antitrust market. Agencies and parties may
also base their market definition investigation on qualitative evidence on the ability of customers to
switch to alternative sources of supply outside of a defined candidate market. The quantitatively
informed methodology we present in this article applies the SSNIP/HMT rigorously to identify the
1. To be clear, we do not claim to have developed a new methodology for market definition. The objective of the article is to
describe an empirical algorithm that “operationalizes” and implements the approach described in the U.S. DEPT. OF JUSTICE &
FED. TRADE COMM’N, HORIZONTAL MERGER GUIDELINES § 4 (2010), http://www.justice.gov/atr/public/guidelines/hmg-2010.pdf
(hereinafter GUIDELINES). We have ourselves used some elements of the algorithm in many cases that we have been involved
in. We believe that the contribution of this article is in bringing together, within a coherent quantitative framework, elements
of the market definition investigation that are, if not standard, commonly used.
2. This is a standard step in the analysis of mergers for which transportation costs play a significant role.

De Stefano and Tsai
433
precise boundaries of relevant antitrust geographic markets, and can be particularly useful when the
merger affects competition in many areas, at a local or regional level.
Additionally, we believe that useful applications of our proposed methodology extend beyond
assessing relevant markets in merger analysis. For example, the methodology can easily be adapted
to defining markets in monopolization or collusion cases.
II. Market Definition and Methodologies for Determining Relevant
Geographic Markets
Market definition plays two main roles: (1) it helps to specify the line of commerce within which
to evaluate whether a proposed transaction raises competitive concerns; and (2) it helps a com-
petition agency identify market participants and, in turn, measure market shares and market
concentration.3 Market definition focuses on demand substitution and assesses the customers’
ability and willingness to substitute away from one product (or geography) to another in response
to a price increase or reduction in product (or service) quality. It identifies the competitive
alternatives to the merging firms’ products that are available to customers, which can be a prelude
to competitive effects analysis. If a sufficient number of customers are able and willing to turn to
competitive alternatives, a reduction in the number of competing firms (e.g., from a merger of
two horizontal competitors) is unlikely to reduce competition and result in higher prices (or lower
quality). The reason is that an attempt by the merged entity to raise prices is likely to be defeated
as customers turn to the available alternatives.
The geographic dimension of market definition, or geographic market definition, delineates the
boundaries of competition affected by the merger in those situations where geography limits custom-
ers’ willingness or ability to substitute to some (farther away) products, or some suppliers’ willingness
or ability to serve some (farther away) customers.4 The scope of geographic markets often hinges on
the extent of transportation costs. For example, products that are expensive to ship often compete in
regional geographic markets, as products...

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