unilateral effects in differentiated product markets commission, dg competition 1 unilateral effects...

European Commission, DG Competition

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Unilateral Effects in Differentiated Product Markets

Szabolcs Lőrincz* Chief Economist Team, DG Competition

European Commission

ICN Merger Working Group teleseminar

15 November 2011

*The views expressed are those of the speaker and do not necessarily reflect those of DG Competition or the

European Commission.


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Outline

• The economics of unilateral effects • How to assess unilateral effects


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Possible anti-competitive effects

• Two ways in which horizontal mergers may significantly impede effective competition:

– Non-coordinated (= unilateral) effects : a merger may diminish the degree of competition by eliminating important competitive constraints on one or more firms, which consequently would have “increased market power”, even without resorting to co-ordination

– Co-ordinated effects: a merger may create or reinforce a situation where competition is reduced by co-ordination


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Unilateral effects – Hypothetical example

• Suppose Coca Cola merges with Pepsi

• Pre-merger, if Coca increases prices, it will lose some of its sales to Pepsi

• Post-merger, the merged entity will recuperate the profit on the additional sales of Pepsi

• Incentive to increase prices will depend on:

– how close other competitors are

– competitors’ reaction (repositioning, entry, …)

– customers’ reaction (retailer buyer power, …)

– consumers’ reaction (price sensitivity, …)

– possible efficiencies


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Does it pay to increase prices?

Marginal cost

Demand

Price

Quantity

?

Leaving

customers


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What if customers left for another product that you also own?

Marginal cost

Demand

Price

Quantity

?

Leaving

customers


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An important distinction

• Bertrand competition: Firms set prices and customers then decide whether and how much to buy – Branded consumer goods

• Cournot competition: Firms set capacities and customers then decide the price level – Capacity-driven industries (ex. primary goods markets,

fresh dairy-products, paper production, printing)


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Tentative conclusions (1)

The merged entity may have an incentive to raise prices unilaterally after the merger if:

– The merged entity gets a significantly higher market share

• the change in HHI is a good indicator of how big this effect will be. In particular for homogeneous products

– The merger brings together close substitutes • The diversion ratio between two products captures how much of

the sales that is diverted from one is captured by the other.


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Tentative conclusions (2)

• Market wide effect depends also on competitors reactions: – Competitors will usually respond by increasing

both output and prices

– If competitors cannot increase capacity, then price increases are likely to be big

– Remaining competition/elastic demand may keep prices low


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The role of market shares

• Do unilateral effects have anything to do with whether or not the new entity will be the largest player in the market ?

• Not necessarily, but there is a correlation. – High market share gives incentive to compete less aggressive

– The larger the market share of the merged entity, the larger fraction of customers in the market will be directly affected.

– Small market shares of competitors may indicate that they exercise only a limited competitive constraint

• The legal guidance: – Merger Regulation Recital 32: Below 25% likely to be compatible with the

common market


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Methods of assessment

• How do we find out how likely a merger is to have a “significant” impact ?

• Much of the analysis is qualitative: see EC Horizontal Merger Guidelines (market share analysis, products offered by the parties, capacity constraints, entry barriers, buyer power, etc.).

• Information to be obtained from merging parties, customers, competitors, trade press, …

• Depending on the case, more detailed empirical analysis may also be possible


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Methods of assessment (cont’d)

• Often key question for assessment of merger impact: to what extent are market shares a reflection of market power? (do they overstate or understate market power?) – E.g. Differentiated products: Important element is how much “lost

sales” the merging parties pick up from each other in case of a price rise


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Best Practices for the submission of economic evidence and data collection • Scope and purpose • Assessing economic analysis

– The relevant question – Data – Methodology – Results and implications – Robustness

• Data request • Dos and don’t’s http://ec.europa.eu/competition/consultations/2010_best_practices/best_practice_submissions.pdf

http://ec.europa.eu/competition/consultations/2010_best_practices/best_practice_submissions.pdf


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Commonly employed empirical methods include:

I. Descriptive data analysis

II. Measures of substitutability

III. Direct estimation of competitive constraints

IV. Merger simulations


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I. Descriptive data analysis

• Descriptive analysis of industry data – Retail scanner data (e.g. Pernod/Ricard, Kraft/Cadbury, M. 5046

Friesland/Campina, M. 5658 Unilever/Sara Lee Body Care)

– Consumer panel data (e.g 5658 Unilever/Sara Lee Body Care)

– Import/export databases (e.g . M. 5907 Votorantim/Fischer) …

• Descriptive analysis of company data – Transaction-level data (e.g. M. 5046 Friesland/Campina, M. 4747

IBM/Telelogic)

– Bidding data (e.g. M. 5421 Panasonic/Sanyo)

– Descriptive event analysis (e.g. M. 5335 Lufthansa/SN Holding) …


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II. Measures of substitutability

• If good data on quantities and prices (and other relevant factors) are available, it may be possible to estimate elasticities (demand system estimation)

– Examples: M.3796 Omya/Huber, M.5046 Friesland/Campina , M.5114 Pernod Ricard/V&S

• Approximation: evidence on customer switching – Do we have information about some incident where the price of the products of one market participant went up

while the prices of other products were held constant. What happened? Can we get a good idea of where the customers went?

• Survey evidence – Examples: M. 4439 Ryanair/Aer Lingus, M.4919 Statoil/ConocoPhillips, M.5335 Lufthansa/SN Holding (Brussels

Airlines)

=> Combined with margin data, this can give an indication of the pricing pressure (“UPP”, etc.) created by the

merger (data reliability is key for the weight to attribute to such measures).

• Empirical market definition methods are also relevant: – Examples: M.4513 Arjowiggins/M-Real Zanders Reflex, M.5153 Arsenal/DSP , M.5190 Nordic Capital/Convatech


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III. Direct estimation of competitive constraints: Econometric analysis

• Cross-section analysis:

• Price-concentration analysis: are there differences in prices in geographic areas where both 1 and 2 are present when compared to areas where only one is present?

• Example: M.4919 Statoil/ConocoPhillips

• Time-series analysis: • Entry event: are there examples of entry of, say, company 1 into geographic areas

where company 2 was already present? Did the price of 2 change (significantly) ? • Example: M.4439 Ryanair/AerLingus

• “Natural experiments” are of particular interest: • Unexpected plant closure: what impact does it have on prices? How are imports

affected? • Examples: M.3625 Blackstone/Acetex, M.4734 Ineos/Kerling


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Direct estimation of competitive constraints: Bidding analysis

• In bidding markets useful information can be found from tender offers (bidding

analysis):

– Do the merging parties systematically participate in the same tenders (and refrain from participating in the same tenders)?

– When one of the merging parties wins a contract, does the other often come high (perhaps even second) in the ranking?

– Cross section analysis (see above): are there differences in the prices offered in those tenders where both 1 and 2 are present when compared to tenders where only one is present?

• Examples: M.3083 GE/Instrumentarium, M.3216 Oracle/PeopleSoft, M.4647 AEE/Lentjes, M.4662 Syniverse/BSG, M.5232 WPP/TNS, M. 5421 Panasonic/Sanyo, M. 5669 Cisco/Tandberg


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IV. Merger simulation

• On the basis of “reasonable” assumptions on the nature of competition in the market (a suitable model describing the nature of competition in the market), try to ‘predict’ the likely impact on prices following a merger.

• Examples: M.1672 Volvo/Scania, M.3191 Philip Morris/Papastratos, M.4985 BHP Billiton/Rio Tinto, M. 5644 Kraft Foods/Cadbury, M. 5658 Unilever/Sara Lee Body Care

• Sensitivity analysis!


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Merger simulation: the general scheme

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1. Demand Consumer heterogeneity

2. Supply Product differentiation

3. Equilibrium Oligopoly – Bertrand

• Substitution? Demand estimation

• Price effects? Merger simulation


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Merger simulation Examples from recent consumer goods cases

• Chocolates: M. 5644 Kraft Foods/Cadbury • Nested logit demand (one-level)

– By economic advisor of the Parties

• Predicted price effects moderate/low

• Deodorants: M. 5658 Unilever/Sara Lee Body Care • Nested logit demand (one- and two-level)

– By the Commission

• Predicted price effects significant in several countries


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Some remarks on econometrics

• Econometric analysis should be seen as complementary evidence to the qualitative analysis

• In many cases, qualitative information is the most readily available information, and is deemed sufficient to resolve the concerns being addressed.

• Econometric exercises are always based on a theory according to which a cause-effect relation is established and on certain economic and statistical assumptions

• Practical requirements for econometric analysis: 1. Availability of a good quantity of reliable data 2. A certain amount of time - Early involvement of economists 3. Consult “Best practices for the submission of economic evidence and data

collection”


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Example: Friesland Foods/Campina

• Campina and Friesland Foods are the two largest dairy cooperatives in the Netherlands (2007: Campina 6,885 farmers, Friesland Foods 9,417 farmers).

• Both collect raw milk and process it into consumer

and industrial dairy products. • Full legal merger leading to the establishment of a

single cooperative.


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http://www.frieslandfoods.com/en/frieslandfoods/brandsproducts/chocomel

http://www.frieslandfoods.com/en/frieslandfoods/brandsproducts/fristi

http://www.frieslandfoods.com/en/frieslandfoods/brandsproducts/frieschevlag

http://www.campina.com/english/Products/Brands/Mona.aspx

http://www.campina.com/english/Products/Brands/Campina.aspx


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• Focus now on two products: – Fresh Milk – Organic Fresh Dairy Products

• Starting point: high market shares – 69.1% fresh milk – 70% organic fresh

• Conclusion: different – SIEC for fresh milk – No concerns for organic fresh

Why?


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Example: Friesland Foods/Campina Fresh Milk Organic Dairy

Close competitors YES --

Limited possibilities to switch suppliers

YES NO

Unlikely to increase supply if prices

increases

YES NO

Countervailing buyer power

NO --

Entry NO YES

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