Defining the market: a critical step in merger review

A “small but significant and non-transitory increase in price” will depend on the nature of the industry, but a common benchmark is a price increase of between 5% and 10%.

The Philippine Competition Act (PCA) prohibits merger or acquisition agreements that substantially prevent, restrict or lessen competition in the relevant market.

Thus, defining a relevant market is a critical step in merger analysis.

Defining the relevant market serves as a basis to identify the competitors in the market, the merging companies’ individual and combined market shares, and market concentration levels. Each of these factors helps to show the merger’s effect on competition. For example, higher market shares and market concentration levels typically mean the transaction is more likely to hurt competition in the market by, among other things, raising prices or decreasing output.

Basically, market definition involves identifying the specific line of commerce ( product market) and area of the country in which competition takes place ( geographic market). For this purpose, the “hypothetical monopolist” or SSNIP test may be used to determine the relevant market in which to analyze the competitive effects of a proposed merger. The SSNIP test generally identifies a product and a geographic space in which a hypothetical monopolist would profitably exercise market power.

Under this test, the Philippine Competition Commission (Commission) identifies the relevant market as a product or group of products and a geographic area in which it is produced or sold, for which a hypothetical, profit maximizing firm, not subject to price regulation, that was the only present and future producer or seller of the product in that area, would likely impose a “small but significant and non-transitory increase in price” (commonly referred to as a SSNIP), assuming the terms of sale for all products outside the candidate market are held constant.

According to the Commission’s Merger Review Guidelines ( Merger Guidelines), the Commission applies the SSNIP test to a candidate market of each product produced or sold by each of the merging firms, assessing what would happen if a hypothetical monopolist of that product imposed at least a SSNIP on that product, while the terms of sale of all other products remained constant. If the hypothetical monopolist would not profitably impose such a price increase because of substitution by customers to other products, the candidate market is not a relevant product market by itself. The Commission then adds to the product group the product that is the next-best substitute for the merging firm’s product and apply the SSNIP test to a candidate market of the expanded product group. The process continues until a group of products is identified such that a hypothetical monopolist supplying the products would be able to exercise market power and profitably impose a SSNIP in the candidate market. The relevant product market generally will be the smallest group of products that satisfies the test.

A “small but significant and nontransitory increase in price” will depend on the nature of the industry, but a common benchmark is a price increase of between 5% and 10% lasting for the foreseeable future (e.g., one to three years depending on market conditions and the type of market).

HYPOTHETICAL MONOPOLIST TEST FOR PRODUCT MARKET DEFINITION

As stated in the PCA, a relevant product market comprises all those goods and/or services that are regarded as interchangeable or substitutable by the consumer or the customer, by reason of the goods and/or services’ characteristics, their prices, and their intended use. Product definition considers the consumer’s perspective or the customers’ response to a price increase or a corresponding non-price change.

In determining the appropriate product market in which to assess the competitive effects of a merger, the Merger Guidelines provide that the Commission considers not only whether products are functional substitutes, but also whether they are good economic substitutes for sufficient numbers of customers so as to make a SSNIP unprofitable. In doing this, economic tools may be used.

Cross- price elasticity of demand measures the rate at which the quantity of a product sold changes when the price of another product goes up or down.

When the cross-price elasticity is positive, those products are substitutes; if they are negative, those products are complements. Where there is zero cross-elasticity, the products in question will be unrelated. Diversion ratios provide a direct measure of the closeness of competition between products. The diversion ratio between product A and B is defined as the percentage of lost sales of product A which are diverted to product B, should A increase its price. The higher the diversion ratio from A to B, the greater is the competitive constraint that B imposes on A.

HYPOTHETICAL MONOPOLIST TEST FOR GEOGRAPHIC MARKET DEFINITION

Relevant geographic market comprises the area in which the entity concerned is involved in the supply and demand of goods and services, in which the conditions of competition are sufficiently homogenous and which can be distinguished from neighboring areas because the conditions of competition are different in those areas. Geography may limit some customers’ willingness or ability to substitute some products, or some suppliers’ willingness or ability to serve some customers.

A single firm may operate in a number of geographic markets. The Merger Guidelines provide that the Commission applies the SSNIP test to a candidate market of each location in which each merging firm produces or sells the relevant product, assessing what would happen if a hypothetical monopolist in that location imposed at least a SSNIP on sales of the product in that location, while the terms of sale in all other locations remained constant. If the hypothetical monopolist would not profitably impose such a price increase because of substitution by customers to products from other geographic areas, the candidate market is not a relevant geographic market by itself.

( The views and opinions expressed in this article are those of the author. This article is for general informational and educational purposes only and not offered as and does not constitute legal advice or legal opinion.)