MiCRA

Presentation to Commissioners Malaysia Competition

Commissionby

Rughvir (Shyam) Khemani, PhD (LSE)Microeconomic Consulting and Research

Associates(www. micradc.com)

andFormer Advisor, Competition Policy

The World Bank Group, Washington D.C., USA

Kuala Lampur, Malaysia, 8-9 June 2013

MiCRA

The Purpose of Defining the “Relevant Market”The purpose of defining the “relevant market” in competition cases is:Assess the nature and degree of competition prevailing in the delineated “relevant market”Evaluate whether the firm(s) against which a complaint has been registered possess “market power”And gauge whether or not the firm(s) has/have/not exercised or are in a position to “exercise market power in the relevant market”Market power refers to the firm(s) ability to profitably charge prices above the ‘competitive’ level for a sustainable period of time and/or affect other competitive conditions to the detriment of consumers 2

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The Concept of the “Relevant Market”-1The concept of the relevant market applied in

competition/antitrust analysis is not the same conventionally used by business, and broadly in economics and marketing

Both ‘demand’ and ‘supply’ factors are considered. From demand side only the market (or sub-market) is delineated where the customers are able and willing to substitute away from one product in response to an actual or potential increase in price or a corresponding non-price change e.g., reduction in product quality or service. The delineated market will include the product/service being examined as well as the ‘substitutable’ products/service which customers may switch to.

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The Concept of the “Relevant Market”-2From a supply side, firms/suppliers are included in

the delineated market if they are already supplying the product/service that customers can switch to.

Competition Agencies give greater

weight/consideration to ‘demand side’ substitution than to the supply side substitution, which may none the less bear importantly on gauging “market power”.

In many court cases both demand and supply side responses to defining the relevant product market have been utilized.

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MiCRA

Case Example: Alleged Cartel in Steel RodsComplaint registered by Builders Association alleging Steel Rod & Wire Mesh producers have ‘cartelized’ the market and are charging identical/or very similar ‘excessively high prices’. The Association presents the following facts:1.There are three major steel rod manufacturers with ‘guess-estimated’ “market” shares:PSM35%,FJ25%,AF20% and 3 smaller firms combined 15% plus some imports2.In past 4-5 years prices of 3 largest firms tended to vary between 5-7% but in last year they have been virtually identical.3.Firms supply on a ‘contract’ basis but also in the open market, but recently only on a contract basis 6-12 months with required purchase of minimum quantities at negotiated prices. (continued…) 5

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Steel Rod Case Complaint--continued4. There is little variation in market shares or rank

of the leading 3 firms.5. Steel rods and wire mesh products of firms are almost

identical except for different strengths and cannot be substituted with other materials.

6. Steel rods and wire mesh are essential in construction of multi-story apartment and office buildings.

7. There is a construction boom and the builders cannot meet demand due to difficulties in obtaining steel rod-wire mesh supplies.

8. Some of the largest firms as well as medium-smaller firms are refusing supply to new customers.

9. It is alleged that the cartel is aimed at ‘price gouging’ of builders to their detriment and downstream customers

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MiCRA

Steel Rod Case Example: Investigation-1The Commission decided their was a prima facie case and directed the Investigation Branch to investigate. The Director of the Investigation Branch reported back that:1.The ‘relevant market’ was analyzed taking into demand and supply factors. It was determined that steel rods and wire mesh each constituted separate ‘product markets’ with no alternative substitutes. In terms of supply the relevant product market comprised of all producers in the greater metropolitan area. Two smaller producers were located at some geographic distance and were deemed not part of the relevant market due to transportation costs. Imports were mainly in the coastal towns. Market share of the three largest firms was therefore higher than the complainant indicated. 7

MiCRA

Steel Rod Case Example: Investigation-22. In delineating the relevant market the Director

had examined availability of other products that could be interchanged with steel rods and wire mesh and found none that could be considered significant. Small number/percentage of builders had used nylon/synthetic mesh and/or non-steel/iron/ferrous metal rods—but for low rise buildings.

3. Prices of the products had indeed varied in the past but recently were stable/almost identical. There was a high correlation between prices of different firms in the metropolitan and regional areas though prices in the latter were much higher. 8

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Steel Rod Case Example: Investigation-34. There did not seem to be a relationship between

prices and costs, and prices and price cost margins had increased significantly in recent years. Price changes were uncorrelated with cost changes.

5. There was Steel Products Manufacturers & Suppliers Association that met quarterly.

6. Minutes of Association meetings discussed high costs of energy and raw materials, investment plans, expansion of capacity, lobbying government for favorable tax treatment on earnings and wages, concerns of ‘dumping’ by China in coastal markets areas, etc. No evidence, even anecdotal referred to prices, output, and/or sales.

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MiCRA

Steel Rod Case Example: Investigation-47. The Director indicated that to determine the

“relevant market” the SSNIP test and the Elzinga-Hogerty (E-H) test had been applied.

8. The SSNIP Test entailed assuming that if any two of the three largest firms decided to merge, would the merged firm be able to impose profitably a “Small but Significant Non-transitory Increase in Price” without losing customers to other existing or new competitors?

9. The E-H test was applied to delineate the geographic market. Product ‘inflows’ and ‘outflows’ were examined to determine that 90% of steel rods and wire mesh purchased in the metropolitan area came from manufacturers in that area.

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MiCRA Steel Rod Case Example: Investigation-5

The Director’s Conclusion

10. Based on the analysis outlined above, it was concluded that the steel rod and wire mesh producers had exercised market power to cartelized the metropolitan market to earn excess profits.

11. The Director estimated that compared with past years, on average the prices were 10% higher and the profit margins were 10-15% higher.

12. The Director recommended that a appropriate fine be levied by the Commission, taking into account the higher prices and profit margins, based on the past year’s sales revenue when the firms started to charge similar/identical prices.

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The Commission’s DeliberationsInternally two of the five members of the Commission had some reservations about the Director’s Investigation Report, analysis, findings and conclusions. Before deciding on the matter, hearings were held. The various firms were presented confidential versions of the report, and requested to respond in writing and appear ‘in camera’ hearings.

Each firm individually presented counter-arguments by senior executives, marketing-sales staff, production managers, economic experts and legal representatives

A brief synthesis of the main counter arguments were:

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MiCRA The Counter-Arguments-1

1. The “Relevant Market” has not been properly defined. Steel rods are substitutable with other ferrous metal rods and wire mesh is substitutable with nylon/plastic/resin based mesh. Q. How to validate this counter-claim?

2. The SSNIP test is only applicable in assessing the actual or potential effects on competition of a merger and not in alleged existing cartel cases.Q. If this is the case then why have SSNIP tests in

Market Definition Guidelines?3. High price correlations do not indicate firms are

necessarily colluding or even in the same market. All firms have common cost elements(energy, iron) the changes in which result in high correlations.Q. Are the correlations “spurious”?

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MiCRA

The Counter-Arguments-24. High prices, high profit margins are not illegal.

Nor do prices necessarily correlate with costs during “boom” periods where demand exceeds supply.Q. How should these and what other factors be weighed?

5. Prices previously varied due to low levels of demand, firm(s) excess capacity, weak bargaining power vis-à-vis builders…….Q. How should excess capacity and relative

bargaining power be considered in relevant market definition and gauging “market

power”?14

MiCRA The Counter-Arguments-3

6. Firm(s) are currently operating at full capacity. Contract sales has always been a usual feature of the market and given high demand very little production can be supplied in the outside market.Q. How are ‘captive’ and ‘contract’ outputs to be treated in defining the relevant market?

7. There is oligopolistic inter-dependence between the leading three producers, and prices tend to converge as price-output changes by one are countered/followed by the other large firms….other smaller firms follow in their pricing policies. The Director is using ‘conscious parallelism’/ ‘circumstantial evidence’ to infer cartelized behavior Q. Is this sufficient? What ‘plus’ factors could be considered?

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MiCRA

The Counter-Arguments-43. If the firm(s) has/have indeed cartelized the

market, the maximum price that the customers/market can bear are already being charged. Any ‘market power’ the firm(s) has/have is already being exercised.Q. Is the Director’s case falling into the “cellophane trap” in defining the relevant market and exercise of market power?

4. The Director’s Investigation relates only to one year—which is too short a period to conduct competition analysis.Q. What should be the period of competition analysis especially re: alleged cartel? 16

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The Case DecisionThe Commission was divided in its deliberations. No

direct evidence of written or oral/tacit or overt information on alleged cartel behavior was presented in the Investigation Report.

Many of the counter-arguments made sense but at the same time the builders complaint that there was little change in market shares, rank of firms, the fact that there had been no new entry and other such factors weighed heavily in the Commission’s discussion.

The Commission decided to take a recess before concluding.

What should be its conclusion re: the relevant product market, market power and alleged cartelized behavior?

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