Lecture 4.

Market Definition Part II

The SSNIP Test

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• First set out in 1982 US Department of Justice Merger Guidelines.
• SSNIP test seeks to identify smallest market within which a hypothetical monopolist could impose a Small Significant Non-transitory Increase in Price
• Usually defined as a price increase of 5% for at least 12 months.

SSNIP Test Now Widely Accepted

• Nestle/Perrier EU Commission concluded that 'an appreciable non-transitory increase in the price of source waters' would not lead to a significant shift to soft drinks.
• Commission formally adopted SSNIP in 1997 Notice on Market Definition.
• Competition Authority has adopted SSNIP test.

But see EU Commission in Virgin/British Airways

SSNIP test only one of possible tests of market definition - somewhat troubling.

'Any statement to the effect that SSNIP is just one example of how to define a relevant market without clearly specifying what the alternative to SSNIP might be, clearly runs the risk of a return to a process of market definition by ad hoc reference to product characteristics.'

NERA, (2001): The Role of Market Definition in Monopoly and Dominance Inquiries, Office of Fair Trading, Economic Discussion Paper 2.

Applying SSNIP Test

• Start with smallest possible market and ask if 5% price increase profitable
• If not, then firm does not have sufficient market power to raise price.
• Next closest substitute is added to the relevant market and test repeated.
• Process continues until the point is reached where a hypothetical monopolist could profitably impose a 5% price increase.
• Market then defined.

Critical Elasticity of Demand

• To answer question could a hypothetical monopolist impose a 5% price increase, need to ask whether such a price increase would be profitable.
• Issue is whether selling a smaller quantity at a higher price would be more profitable than selling a larger quantity at a lower price.
• This will depend on how sensitive demand is to changes in price, i.e. on the elasticity of demand.
• Critical elasticity of demand (e) is the value of elasticity of demand necessary to leave profits unchanged following price increase.

• e = 1/(m+t)

• m is the pre merger price cost margin (defined as the gap between price and marginal cost) and t is the minimum price increase considered significant, i.e. usually 5%
• (See Massey and Daly Appendix 5.1 for mathmatical of formula)

Calculating Critical Elasticity of Demand - Example

• Price Cost Margin m = 40%
• Want to see if 5% price increase profitable
• e = 1/(m+t)
• e = 1/(.4+.05) = 2.22
• All that is required to calculate critical elasticity of demand is data on firms' price-cost margins.
• If firm's own elasticity of demand is less than critical elasticity, price increase would be profitable and market is defined.

Critical Loss

• • Alternative method for applying SSNIP test when demand elasticities cannot be estimated.
  • Critical loss (y) defined as the maximum loss in sales resulting from a price increase that would still make the price increase profitable.

  • y = t/(m+t)

  • m is the price cost margin and t is the minimum price increase considered significant.
  • If likely loss of sales is less than the critical loss, then a 5% price increase would be profitable and the market would be defined.

Calculating Critical Loss

• • Again take a price cost margin of 40% and ask if 5% price increase profitable.
  • y = t/(m+t)
  • y = .05/(.4+.05) = 11.1
  • States that firm could suffer drop in sales volumes of up to 11.1% as a result of 5% price increase and still increase its profits.
  • How does this compare with actual experience?

Values of Critical Elasticity of Demand (e) and Critical Loss (y)

Critical Loss Figures Must be Interpreted Carefully

• Critical loss values low when price marginal cost gap is high.
• But high price cost margins indicate that demand is relatively inelastic - actual loss in sales from a price increase will be relatively small.
• Claims that actual losses will exceed the critical loss threshold will need to be examined very closely.
• O'Brien, D.P. and Wickelgren, A.L., (2003): A Critical Analysis of Critical Loss Analysis, Federal Trade Commission.

Beware cellophane trap

• Problem in abuse cases. (EU Commission Notice on Market Definition).
• Need to use competitive rather than prevailing prices.
• But how can competitive prices be identified?
• Not a problem in merger cases – absent prior collusion.

Readings.

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