Georgetown UniversityGeorgetown University

Potato CartelPotato Cartel

Why did Merrill Hanny bury $100,000 Why did Merrill Hanny bury $100,000 worth of Potatoes?worth of Potatoes?

Potato Farmers Mash SupplyPotato Farmers Mash Supply

Source: United Potato Growers of America, August 2009

“The offense of monopoly under Section 2 of the Sherman Act has two elements: (1) the possession of monopoly power in the relevant market and (2) the willful acquisition or maintenance of that power as distinct from growth or development as a consequence of a superior product, business acumen or historical accident”

United States v. Grinell Corp. 384 U.S. 563, 570-571 (1966)

Definition of monopoly power

1. The ability to control prices and exclude competitors 2. The ability to raise prices above marginal cost (competitive levels) without losing so many sales so rapidly that the price increase must be rescinded

Monopoly power is “analog” not digital Significant and insignificant monopoly power

Lerner Index L = (p-mc)/p

L= 1/η , where η is the (absolute value of the) firm-level price elasticity of demand.

0 ≤ L < 1

Measuring Market Power

The Dominant Firm Model:

a. Assumes a single “dominant” firm facing a competitive “fringe” b. The dominant firm calls out a price c. The competitive fringe responds as a price taker setting its output

The Dominant Firm-Competitive Fringe ModelThe Dominant Firm-Competitive Fringe Model

P

Q

S=Σmc

D

d

mr

P1

Qd

mc

d = D - S

Market Power Determinants

L = S/[ηm + (1-S)ef]

1.Market share (S)

2. Elasticity of Market demand (ηm)

3. Elasticity of Supply of the fringe firms (ef)

Suppose S=.4, ηm = 2, and ef = 1, What is the value of the Lerner Index?

Market definition

Market -A geographic area and a set of products within which price is determined

IF a relevant market then set of firms and geographic area that DOES determine price

Firms/areas that do affect price are included

Importance of market definition

a. Microsoft (operating systems, software) b. Coca-Cola – Dr. Pepper, Pepsi -7-up mergers

Market Definition Exercise – Begin with a small geographic and product market and ask:

Could a hypothetical monopolist within the proposed relevant market raise price by a small but significant and nontransitory amount?

If “yes” then found relevant market. If “no” then broaden proposed market and re-run exercise

a. demand side product substitutability

b. demand-side geographic substitutability

c. supply-side product substitutability

d. supply-side geographic substitutability

Willful maintenance or acquisitionWillful maintenance or acquisition

US v. AT&T (1978)US v. AT&T (1978) Aspen Skiing (1985)Aspen Skiing (1985)

Bell

Long Lines MCI

1. Refusal to deal2. Price discrimination3. Sabotage

customer

Aspen Skiing Co. v. Aspen HighlandsAspen Skiing Co. v. Aspen Highlands

Colorado

1962 – ASC and Highlands begin joint lift tickets

1978 – ASC announces it would not Participate unless revenues split wasAdjusted to 87.5 for ASC (hadPreviously divided based on usage. ASC had 85 % of traffic)

No joint ticket in 78-79 but Highlands offers Adventure Pack (3 days at Highlands and coupòns for 3 days at ASC facilities

ASC refused coupons

Issues:1. Duty to Deal2. Market definition

Predatory pricing

Simple story: Large firm cuts prices drives smaller firms from market then raises prices to monopoly levels

McGee (Journal of Law and Economics) -re-examines Standard Oil case. Predatory pricing is not rational. Why engage in predation when merger is cheaper.

More recent literature suggests that: 1. predatory pricing may reduce sales price if ultimately merge 2. Predation may be for demonstration effect 3. McGee assumes merger to monopoly is legal

Predation requires (necessary conditions): 1. Initial Market power 2. Low Barriers to Exit 3. High barriers to entry

Predatory pricing:

1. Areeda-Turner (Harvard Law Review, 1975) a. p<mc b. p<mc up to minAC then p<ATC c. p<avc

ATCMC

D

AVC

Price

Quantity

Baumol analysis of predationBaumol analysis of predation

A sound predation concept is built on 3 A sound predation concept is built on 3 principles: principles: The price-practice must have no legitimate business The price-practice must have no legitimate business

purposepurpose It must threaten the existence of equally efficient firmsIt must threaten the existence of equally efficient firms Recoupment of foregone profits is feasibleRecoupment of foregone profits is feasible

Threats to equally efficient rivals turn on AVC, so Threats to equally efficient rivals turn on AVC, so P P < AVC test is appropriate

Predation – the demonstration effect or “I’ll Predation – the demonstration effect or “I’ll Teach that SOB a lesson”Teach that SOB a lesson”

FOB

Price

Pricing of Concrete construction Blocks

Distance from plant

The importance of corporate and The importance of corporate and management statementsmanagement statements

MicrosoftMicrosoft Choke of air supplyChoke of air supply

Whole Foods Wild Oats mergerWhole Foods Wild Oats merger John MacKay (CEO of Whole Foods) John MacKay (CEO of Whole Foods) merger will “eliminate forever” the possibility that anyone else merger will “eliminate forever” the possibility that anyone else

could create a nationwide competitor in the natural and organic could create a nationwide competitor in the natural and organic grocery business grocery business

buying Wild Oats Markets Inc. would let Whole Foods “avoid buying Wild Oats Markets Inc. would let Whole Foods “avoid nasty price wars” in several cities where the two compete nasty price wars” in several cities where the two compete

KCI v. Hill-ROMKCI v. Hill-ROM Hill-Rom makes standard and specialty bedsHill-Rom makes standard and specialty beds

P-288P-288 1919

Cut ‘em off at the knees and watch them bleed … Competitively, idle words or a real threat? I promise you I consider these words a threat to all who propose to compete against Hill-Rom. Do you?

How sharp is your machete?

Nelson Baughman, HR Vice President:

Hill-Rom Intends To Destroy Competition

P-001P-001 2020

We have to work together to win in our markets and do away with KCI.

This is a job we are going to get done, and we’re going to get it done together. If anyone doesn’t want to do it that way, there’s a bus waiting outside, and you can get the hell out now.

Hill-Rom Intends To Destroy Competition

Hill-Rom executive speech

P-288P-288 2121

Hill-Rom’s Gus Hillenbrand

9/19/2002Hillenbrand Cross Examination

Q. Did you use the market power of Hill-Rom to attempt toobtain a hundred percent market share?A. Yes.Q. And you saw documents from your sales staff that talkedabout eliminating KCI, torturing KCI, killing KCI, doing awaywith KCI. You saw those things, didn't you?A. I saw those.Q. And you never sent out a directive saying, hey, we want totreat them fair, we want to play fair, did you?A. Never did.

Trial Transcript: Page 3950:12-21