Quantitative Methods for Evaluating Unilateral Competitive Effects in Differentiated Products Mergers

Size: px

Start display at page:

Download "Quantitative Methods for Evaluating Unilateral Competitive Effects in Differentiated Products Mergers"

Marcia Emerald Walters
6 years ago
Views:

Quantitative Methods for Evaluating Unilateral Competitive Effects in Differentiated Products Mergers David W. Meyer Bureau of Economics U.S.

1 Quantitative Methods for Evaluating Unilateral Competitive Effects in Differentiated Products Mergers David W. Meyer Bureau of Economics U.S. Federal Trade Commission November 15, 2011 The views expressed in this presentation do not necessarily represent the views of the Federal Trade Commission or of any individual Commissioner

2 Outline Differentiated Products Overview Diversion Ratios & Upward Price Pressure Econometric Studies Natural Experiments Event Studies Demand Estimation & Merger Simulation 2

3 Differentiated Products Differentiated products are similar products but not perfect substitutes. The source of the differentiation could be product attributes or location. For example, an iphone versus an Android phone If product A and B are differentiated products, the price of product B affects the demand of product A. As the price of product B increases, the demand for product A increases as some consumers switch from product B to product A. 3

4 Differentiated Product Mergers When analyzing a merger involving differentiated products, the main issue is how close of substitutes are the competing products. To determine how close of substitutes the products are, we analyze the behavior of consumers who would stop buying a product following a price increase. These consumers are often referred to as the marginal consumers. If enough marginal consumers switch to products of the acquired firm, there may be an incentive to increase prices significantly. 4

5 Marginal and Infra-marginal Consumers After a price increase from P 1 to P 2 the marginal consumers stop purchasing the product while the inframarginal consumers continue to purchase the product. P Infra-Marginal Consumers P 2 P 1 Marginal Consumers Market Demand Q 2 Q 1 Q 5

6 Marginal Consumers Infra-marginal consumers are said to be protected from a price increase by marginal consumers if there are enough marginal consumers. In other words, if demand is more inelastic, the merger will have a larger impact on prices. Keep in mind that in most situations most consumers are infra-marginal consumers. 6

7 Merger Analysis There are several types of economic analyses that can be done to assess how close of substitutes the products are. Diversion Ratios/Upward Price Pressure Demand Estimation Merger Simulation There are many sources of information for conducting these types of analyses, including: Customer interviews/surveys Documents Data 7

8 What is the Diversion Ratio? The diversion ratio measures the fraction of all marginal consumers currently purchasing product A that switch to product B in response to a price increase. DR AB Q Q Example: If in response to a price increase for product A, sales fall by 150 units and rise by 30 for product B, then the diversion ratio is 30/150 = 0.2 or 20%. B A 8

9 Why is Diversion Important? Why does diversion matter? After a merger of product A and B, the merged firm will take into account the diverted sales when setting prices. A merger that would combine two products that have very low diversion ratios would provide little incentive to raise price. A merger that would combine two products that have very high diversion ratios would provide significant incentives to raise price. Note, diversion ratios are related to cross-price elasticities 9

10 Useful Information for Estimating Diversion Ratios Switching studies: Nielsen and IRI collect data on all purchases made by a large number of families over time Can use this data to see which products compete Might think that products are close substitutes if buying more of one tends to go with buying less of the other Must be careful though This can hold for products that clearly are not substitutes Better to look for variation in price If Product A goes on sale, and people buy a lot more of Product A and a lot less of Product B, that suggests that they are close substitutes Further complicated by inventory behavior combined with the fact that households have more than one person 10

11 Useful Information for Estimating Diversion Ratios Win/Loss reports May say what product customers switched to/from Consumer surveys Ask What would you do in response to an X% price increase in the product of concern? Need to be careful about identifying marginal consumers Since most consumers are not marginal a large sample may be required Market share shifting patterns over time E.g., what was the effect of past entry on the products of concern Did both shares go down similarly or not? 11

12 Using Shares to Approximate Diversion Ratios With limited information on diversion ratios, it is possible to approximate them just using market shares. However, this methodology relies on strong assumptions about the demand for these products. S S DR or DR 1 DR B B AB AB Outside Market 1 - SA 1 - SA Common criticisms Need to define a market or at least a boundary What s the denominator for share? (doesn t have to be narrowest SSNIP market but do need some idea of diversion outside that market) Competitive significance of competing products on the product of concern is proportional to the competing products market share. Fails to incorporate marginal consumer into analysis. Products may be distant substitutes but each may have a large share. 12

13 Upward Price Pressure To determine how much the diverted sales affect the firm s incentives, we also need to know something about margins. The Upward Price Pressure Index (UPPI) multiplies the diversion ratio by the margin of the other product. UPPI = D AB (P B C B ) After the merger, UPPI provides an estimate of the changed incentives to raise prices. It can be thought of as similar to an increase in marginal cost. 13

14 Upward Pricing Pressure Index Simple, theory-based approach to assessing the potential for significant unilateral effects Not dependent on market definition Data requirements relatively easy to satisfy Focuses on the first order effects on the incentives of the merging firms Ignores equilibrium responses by competing and merging firms Not a merger simulation Does not directly produce predicted price effects Key ingredients Pre-Merger margins Diversion ratios 14

15 Econometric Studies When data and time are available, more sophisticated economic analysis may be possible. Event Studies, including entry/exit Natural Experiments Demand Estimation Merger Simulation 15

16 Entry/Exit Event Analysis Entry and exit events can provide powerful evidence regarding competitive effects. This evidence may directly demonstrate competitive effects, eliminating need to define a market. e.g., Schering, Whole Foods/Wild Oats, or Staples/Office Depot. 16

17 Natural Experiments Entry and exit events may also provide natural experiments. What is a Natural Experiment? What is the effect of the variable of interest? Look for settings where: The variable of interest takes on different values. There is no variation in the values of other variables (or the variation can be controlled for). 17

18 Demand Estimation and Merger Simulation The general idea behind the empirical models is to measure price sensitivity for a product and between products (own and cross-price elasticities). Elasticity estimates and economic intuition or modeling can be used to measure unilateral competitive effects. With further modeling assumptions, the estimated own and cross-price elasticities can be used to simulate post-merger prices. Note: These elasticity estimates can also be used to define product markets. 18

19 Three Commonly Used Methodologies for Estimating Demand Elasticities Constant Elasticity of Demand simplest and easiest to interpret Nearly Ideal Demand System (or Almost Ideal Demand System) addresses some of the shortcomings of the CE demand estimates Discrete Choice Modeling A structural approach tied directly to an economic model. Can be directly applied to simulating an answer to the question. 19

20 Example 1: Advertising Campaign Advertising campaigns at times can provide useful information about what products new users would otherwise use For example, when a shampoo is advertised, its sales increase even after the advertising campaign Sales of certain other shampoos decline But not all shampoos suffer an equivalent decline 20

21 Example 1: Hypothetical Advertising Campaign Shampoo brand Share before (%) Share after (%) Diversion ratio Flowers and fruit Fancy Luxuriation Smooth Silk Quick Ordinary Bottom shelf Kidz Shampoo Miser shampoo STOP Dandruff

22 Example 2: FTC v. Swedish Match In 2000, the FTC sued to block a merger between Swedish Match and National Tobacco Company. Swedish Match Producer of loose-leaf chewing tobacco (e.g., Red Man) 36% share of sales in loose-leaf category Also produced moist snuff tobacco National Tobacco Producer of loose-leaf chewing tobacco (e.g., Beech Nut) 13% share of sales in loose-leaf category 22

23 Example 2: FTC v. Swedish Match Margins: Evidence suggested price-cost margins were in the range of 55% to 65%. Diversion Ratios From Swedish Tobacco to National: 0.25 From National to Swedish Tobacco:

24 Example 2: FTC v. Swedish Match What does the Shapiro model predict? Effect on Swedish Match Prices P/P = 0.25(0.6)/2(1 0.25) = 0.1 Effect on National Prices P/P = 0.4(0.6)/2(1 0.4) = 0.2 Note: These sorts of exercises should not be interpreted as precise predictions of effects, but they can be illustrative. 24

25 1200 Example 3: The Effect of Generic Entry on Schering's K-Dur 20 Total Prescriptions (000s) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Month K-Dur 20 Generic K-Dur Source: Public Trial Exhibit CX 1480

26 Example 3: Only Generic K-Dur 20 Constrains Sales of K-Dur 20 (Generic 8 and 10 meq Had No Effect on K-Dur 20 Sales) $0.45 $0.47 $0.35 $0.37 $0.39 $0.34 $0.41 $0.36 $0.42 $0.38 $0.43 $0.39 $0.41 $0.42 Total Prescriptions (000s) $0.33 $0.29 $0.31 $ : Additional generic 8 and 10 meq products enter September 2001: Upsher's Klor-Con M20 enters the market Price Per Tablet Month Nov-01 K-Dur 20 Total Prescriptions I Range of Schering's K-Dur 20 Price Per Tablet Sources: Total Prescriptions CXs ( ), ( ), 1480 (2001); Pricing CX 49 * See USX 626 at USL15228; IDF

5 Star London Hotels - Example Report

5 Star London Hotels - Example Report January 2018 CONTENTS Your Benchmark Report Website Traffic Conversion Rates Ecommerce Performance AdWords Spend Your Traffic Index Your Conversion Rate Index Your