Price - based techniques for Market definition & Buying Power Index + Abstract

Transcription

1 Price - based techniques for arket definition & uying Power Index + Panagiotis N. Fotis * bstract This aer focuses on a recent merger in Greek diary sector and emirically investigates the delineation of the market of roduction and distribution of white milk in Greece, the role of roduct asymmetries in market delineation along with the unilateral effects of the merger and the uying Power Index of a large buyer in the relevant roduct market for the rocurement of raw milk. The emirical results indicate that the markets of roduction and distribution of fresh, High Pasteurization & Condensed milk in Greece are highly inelastic and constitute distinct relevant roduct markets. Large roduct asymmetries lead to broader relevant roduct markets, while unilateral effects are resent for secific airs of white milk roducts. Lastly, there are evidences that a large buyer may exercise its buying ower, even thought in the case where the market elasticity of suly and the own rice elasticity of demand of the cometitive fringe are highly inelastic. JEL classifications: C01; C13; C15; C21; K00; L16; Key words: Estimation, Conditional Elasticities, reak even SSNIP tests, Profit maximizing SSNIP test, Critical Loss nalysis, Diversion Ratio, Could roach, Unit Root tests, Cointegration nalysis, Uward Pricing Pressure, uying Power Index + The views exressed in this aer are solely those of the author and do not reflect by any means the General Directorate of Cometition, the Hellenic Cometition Commission or any individual Commissioner. Usual disclaimer alies. * Hellenic Cometition Commission, Director/ Directorate for Cometition and University of Central Greece, Deartment of Regional and Economic Develoment. Tel: Fax: address: fotis@eant.gr Postal ddress: P. Ioakim Peristeri ttikis Greece 1

2 1 Introduction In 2010 a horizontal merger 1 between two major manufacturers as well as distributers of various dairy roducts was notified in the General Directorate for Cometition («GDC») of Hellenic Cometition Commission («HCC»). Focusing on this concentration 2, the aim of this aer is on the one hand, to emirically investigate the delineation of the market of roduction and distribution of white milk in Greece and on the other hand, to calculate the uying Power Index («PI») of a large buyer in the relevant roduct market for the rocurement of raw milk. The remainder of the aer is organized in the following way. Section 2 theoretically and emirically reviews the literature of rice based techniques of Hyothetical onoolist Test («HT») and PI. Section 3 resents the market of white milk in Greece and section 4 elaborates the emirical results. Section 5 concludes. 2 Price based techniques of Hyothetical onoolist test 2.1 theoretical standoint The HT is a broader concet than the Small, but Significant Nontransitory Increase in Price («SSNIP») test, the Critical loss («CL») analysis and other rice based techniques used in arket definition. However, the scoe of the aer is to resent the role of rices and their use in arket definition analysis 3 which in turn imlies 1 Hereinafter the words merger and concentration are used interchangeable. 2 See also the analysis of hase II mergers in Greece from in Fotis & Polemis (2012), , Fotis & Polemis (2011), , Fotis & Polemis (2010a), , while in Fotis et al. (2011),.77 there is an elaboration of 13 requested derogations from susension of concentrations in Greece during the eriod from 1996 to 2008 and in Fotis (2012a),. 574, mergers are roosed as a solution in declining markets. 3 SSNIP test and Critical Loss analysis may be used for the definition of the geograhical market as well. See, inter alia, Federal Trade Commission v Occidental Petroleum Cor., 1996 I Trade vs. (CCH) 67,071 (D.D.C. 1986) and Strand (2006). 2

3 that I will assume that rices are the dominant form of strategic interaction among firms 4. In the next aragrah I elaborate the CL nalysis, Uward Pricing Pressure («UPP»), Gross Uward Price Pressure Index («GUPPI»), aka break even SSNIP tests and PI in one sided markets 5. lso, in endix I analyze the conditions of a rofit maximizing SSNIP test Critical Loss nalysis, Uward Pricing Pressure and uying Power Index I elaborate could aroach of CL analysis 6 by using the mathematical formulas resented by Harris & Simons (1989), Katz & Shairo (2003), O rien & Wickelgren (2003), Daljord et al. (2008) and Daljord & Sørgard (2011). 7 lso, I develo GUPPI by Salo & oresi (2009) and UPP by Farrell & Shairo (2008, 2010). The analysis of PI follows from lair & Harrison (2010). Esecially, following Harris & Simons (1989), the critical loss for a ercent rice increase is the ercentage reduction in quantity required for the rice increase to leave rofits unchanged 8. If the reduction in unit sales is greater than the critical loss, 4 In some markets, quality, advertising and other forms of non rice cometition are the dominant forms of strategic interaction among firms. The incororation of these strategic variables into the analysis here is out of the scoe of this aer. 5 For the use of SSNIP & CL methodologies in two sided markets see Filistrucchi (2008), In this aer I use the «could aroach» of CL analysis (or the EU aroach). The rationale for this is that the formula of the said aroach are identical either we assume linear or iso-elastic demand functions. In the literature the «could aroach» has been elaborated in relation to the rofit maximizing aroach, aka the «would aroach» (or the US aroach). For the latter aroach see Werden (1998, 2002) and the endix. 7 The reader who is interested in criticisms of CL analysis may see, inter alia, the aers of oresi et al. (2008), Farrell and Shairo (2008), Daljord et al. (2008), Katz and Shairo (2003),O rien and Wickelgren (2003), Werden (2002), Danger and Frech (2001), Lagenfeld and Li (2001), for more details. 8 lternatively, following Daljord & Sørgard (2011) The critical loss is calculated as the largest relative reduction in demand the hyothetical monoolist of all roducts in the candidate market can rofitably sustain following an increase in the rice of all firms in the candidate market by a given ercent. 3

4 then the rice increase will reduce rofits. If the reduction in unit sales is less than the critical loss, the rice increase will increase rofits 9. Calculating the critical loss requires balancing two effects: a) a given rice increase raises the rofit margin earned on all units that are sold, but b) it also reduces the quantity demanded resulting in fewer units being sold. The critical loss is the ercentage reduction in quantity such that these two effects just balance. The benefit of a hyothetical monoolist from a rice increase is the amount of the rice increase times the quantity that will be sold at the new rice. The cost of the said monoolist from the rice increase is equal to the re-merger margin times the quantity reduction caused by the rice increase. If we denote q q the ercentage reduction of quantity sold by the ercentage rice increase c and mu the margin measured as a ercentage of re merger rices, where the re merger variable cost is c, then the critical loss is q CL q mu (1) Equation (1) imlies that for a given ercentage rice increase, the critical loss is smaller the larger is the margin. Intuitively, the larger is the margin, the greater the rofit lost from a given reduction in quantity, so the smaller the reduction in quantity required for a given rice increase to be unrofitable. 9 The authors assume a relative rice increase of all sales of one roduct. 4

5 ercentage rice increase of a hyothetical monoolist will be rofitable if equation (2) is satisfied, own (2) mu own where : is the actual own rice elasticity, that is, the corresonding estimated coefficient from the demand function under scrutiny own L : The ctual Loss of the hyothetical monoolist from the rice increase. Solving for own from equation (2) we derive equation (3), mu (3) own where CL is the critical own rice elasticity. C own Therefore, a distinct relevant roduct market satisfies the following rule: own own C (4) Katz & Shairo (2003) assumed a hyothetical monoolist with two roducts, &. ssuming an increase in roduct s rice and given the fraction of sales that is 5

6 diverted to roduct following the rice increase of roduct, that is, the Diversion Ratio («DR») of roducts &, 10 then the ctual loss of a hyothetical monoolist is L 1 DR mu (5) ercentage rice increase of roduct by a hyothetical monoolist will be rofitable if (5 ) is satisfied, L CL if and only if DR CL (5 ) Following O rien & Wickelgren (2003), we can assess the consistency of critical loss analysis if we calculate the actual loss in unit sales from a given rice increase 11. The mathematical formula for actual loss from a given rice increase is given in equation (6), 1 L mu cross (6) 10 The DR from roduct to roduct is the fraction of the reduction in sales of roduct that is diverted to roduct following a rice increase on roduct. That is, cross, DR, / own,. In case where own and gross rice elasticities of demand cannot S be estimated, the DR is calculated in the following way: DR, Si S, where S is the market share of the i roducts in the market. 11 The authors assume that a hyothetical monoolist controls two roducts and derive the formula of a rofitable uniform rice increase of the two roducts. The formula is called the reak Even SSNIP Test. 6

7 where cross is the cross elasticity of demand for roduct with resect to the rice of roduct 12. ercentage rice increase for roducts and will be rofitable if the actual loss does not exceed the critical loss, that is, if 1 mu cross mu (7) If mu mu CL mu cross (8), then the actual loss exceed the critical loss and roducts & do not constitute a single roduct market. Therefore, a ercentage rice increase for roducts and will be rofitable if actual loss is lower than critical loss or equation (9) is satisfied, CL cross (9) mu Equation (9) imlies that holding cross elasticities between the merging firms constant, a given rice increase is more likely to be rofitable the larger is the margin. This result imlies that mergers are more anticometitive in more concentrated relevant roduct markets. Resectively, equation (9) may also be written as DR CL. 12 Suose that & are the merging roducts. rice increase for roduct causes a reduction in the quantity demanded for roduct. ssuming that roducts and are substitutes, it also causes an increase in the demand for roduct. 7

8 Daljord et al. (2008) criticize the CL formula resented by Katz & Shairo. Following the authors, roduct 13 will constitute a distinct relevant roduct market whether equations (10) or (11) are satisfied, own mu 1 DR, (10) or own own C 1 DR, (11) mu c is the roduct s margin measured as a ercentage of re merger rices &variable cost and is the relative rofitability of roducts &. c c Given that, equation (10) becomes, mu own 1 mu L DR, (12) If 1as in Katz & Shairo, then equation (12) is satisfied if and only if aggregate Diversion Ratio is higher than ctual Loss. That is, DR L. Lastly, Daljord & Sørgard (2011) consider large roduct s asymmetries in terms of sales in the market. The authors consider a hyothetical monoolist who imoses a uniform rice increase of both roducts, the «small roduct» and Β the «large 13 The authors assume that a hyothetical monoolist increases only the rice of roduct, which is a «small roduct» in terms of sales. This is called the «single roduct» criterion. 8

9 roduct». ssuming that DR of both roducts are roortional to sales 14, roduct will constitute a distinct relevant roduct market if equation (13) is satisfied 15, 16. 2( mu) S L DR (13) The authors state that equation (12) leads to narrower relevant roduct market rather than equation (13) if mu S 2 mu (14) UPP and GUPPI methodology The UPP methodology assumes static rice setting cometition with differentiated roducts (i.e. firms in the market exhibit excess caacity) 17. Consider two firms 1 & 2 that roduce & resectively. Suose a merger of firms 1 & 2. Farrell & Shairo (2010) 18 state that an UPP on roduct sold by firm 1 will be created after the merger, if DR * S 14 That is, DR. 1 S 15 For symmetric firms (identical rice and marginal costs, i.e., margins) the equivalent formula of equation (13) is Si DRi, j ( 1 Si ) DR j, i. mu 16 If we assume no asymmetries in Daljord et al. (2008) then equation (12) leads to a broader market rather than equation (13). 17 In addition the UPP methodology does not take into account the effects of otential side resonses (i.e., inert alia, entry). See for an equivalent methodology O rien & Salo (2000). The UPP methodology can also be used in quantity setting cometition and bidding (auctions) cometition. See oresi (2009) and oresi (2010), See equation (4),

10 UPP : DR * U VCE (15) where DR : the DR from roduct to roduct U P mu P P C P P C : rice cost margin (currency er unit) of roduct at re-merger values mu : rice cost margin of roduct VCE : variable cost efficiencies ost merger for roduct at re-merger values. Therefore, firm 1 has an incentive to increase the rice of roduct after the merger if the net rofit effect of such an increase is higher than the efficiencies emerged by the merger in the roduction of the roduct in question. 19 Farrell & Shairo roose UPP be used as an indicator of the merger s likely unilateral effects. They roose that mergers generating ositive net UPP, warrant, at least, further scrutiny 20. They also assume that roduct s rice does not change after the merger and there are no roductive efficiencies 21. The GUPPI methodology in euro terms exresses the incentive of firm 1 to increase the rice of its roduct () «as a result of substitution between that roduct and the 19 The same test must be erformed for roduct. That is, UPP : DR * U VCE. 20 See Farrell & Shairo (2010), Schmalensee (2009) has roosed the following formula for UPP: UPP * DR * U VCE DR VCE. See also Werden (1996). 10

11 roduct sold by its merger artner firm 2». 22 The GUPPI formula is given in equation (16) 23 GUPPI DR * U (16) The higher the diversion ration of firm1 or the rice cost margin of the merger artner or both of them, the higher the GUPPI of roduct after the merger. Equation (17) exresses the GUPPI using the ercentage margin rather than the euro margin, 24 GUPPI DR * mu (17). Following oresi (2010), 7, «the roducts of the two merging firms would comrise a relevant antitrust market if», GUPPI, 2SSNIP (18) where SSNIP : the rofit maximizing small but significant non-transitory increase in rice uying Power Index onosony may be resent on the selling side of the market (i.e., see the dominant firm model). In this aer I am interested in the existence of market ower on the 22 See Salo & oresi (2009), The equivalent formula for firm 2 s roduct () is GUPPI DR * U. 24 The equivalent formula for firm 2 s roduct () is GUPPI DR * mu. 25 See endix 1 for rofit maximizing SSNIP formulas. Following Werden (2002) the said formula may be DR. 2 mu 11

12 buying side of the market where a large buyer may be resent in several geograhical areas. In articular, the uying Power «is the ower to reduce rice below the cometitive levels by restricting urchases». 26 The existence of a large buyer on the buying side, assuming no rice discrimination, may affect the total suly in the downstream market by reducing the quantities sold from the firms in the ustream market and inut rices as well as may harm downstream consumers by increasing final rices. The measurement of the uying Power of the merged entity deends on the structure of the downstream market. In a cometitive downstream market each buyer urchases the quantity sulied from the ustream firms until the value of the marginal roduct equals the rice of the roduct under scrutiny. In a ure monosony downstream market, the buyer will restrict its urchases at the oint where the value of the marginal roduct equals its marginal cost. In the latter case, the PI is written as 1 PI (19) where is the market elasticity of suly 27. The higher the, the lower the buyer s buying ower. That is, the higher the ability of the firms in the ustream market to monitor the suly in resonse to rice changes, the lower the ability of the buyer to ossess monosony ower. When the downstream market consists of a large buyer and a fringe of cometitive firms the PI is given in equation (20), 26 See lair Harrison (2010),. 53. See, also, OECD (2008), See lair Harrison (2010), and the footnotes therein. 12

13 PI S CF ( 1 S) (20) where S is the market share of the large buyer and elasticity of the cometitive fringe. CF is the own demand rice PI Sensitivity analysis of equation (20) indicates that a) 0 S and b) PI PI CF 0. That is, the higher the market share of the large buyer the higher the deviation from the cometitive outcome. However, the higher the market elasticity of suly and the own rice elasticity of demand of the cometitive fringe, the lower the buying ower of the large buyer. dditionally, as the quantity sulied becomes more resonsive to changes in rices, the ability of the large buyer to exercise its buying ower declines and firms in the ustream market redirect its emloyment to other roducts where rices may be higher. On the other hand, as the demand elasticity of the cometitive fringe becomes more elastic, the deviation from the cometitive level declines since any decline of the large buyer s urchases are catured by the enhanced urchases of the cometitive fringe. 2.2 n emirical standoint Price based techniques for merger control have been used in many merger cases much like in the Euroean Union and the U.S.. Table 1 resents selected merger cases where the said techniques were used by the cometition authorities. [Please insert Table 1 about here] 13

14 The horizontal acquisition between the Ineos Grou Limited and the Norwegian comany Kerling S in the market of Standard PVC (hereinafter «S PVC») rovides a standard examle of alication of rice based techniques in merger control. The said acquisition was declared to be comatible with the common market and the functioning of the EE greement on One of the issues of controversy in this case was that if UK S PVC market was art of a Euroean market or could be delineated in National grounds. The Chief Economist Team («CET») of DG Com used CL analysis in order to estimate market elasticity of suly with resect to domestic rices. Imorts were claimed by the arties in the merger to be the cometitive constraint of the domestic roducers. The critical loss estimates «ranged from 61 to 108 Kt and from 107 to 170 Kt, resectively for 5% and 10% rice increases». 29 The actual loss was estimated by surveys or other qualitative data (lanned uncommitted caacity exansions, demand forecasts or the costs of switching). 30 Daljord & Sørgard (2011) elaborate CL methodology in a grocery market in Norway. 31 The authors evaluate single roduct criterion (eq. 12) and uniform rice SSNIP test (eq. 13) and conclude that the delineation of the roduct market deends on «whether we imose a rice increase on only one or all the roducts». In articular, for a 5% SSNIP, the estimate of the critical diversion ratio, the left hand side of eq. (13), is 16,7%, while the corresonding estimate of eq. (12) is 20%. The alication of the said estimates in the above mentioned grocery market indicates 28 See Commission Decision of 30/1/ See melio et al. (2008), The CET estimated a artial residual demand elasticity of the merging arties using instrumental variable regression. However, the emirical results weren t statistical significant. 31 See Daljord & Sørgard (2011),

15 that single roduct criterion leads to narrower roduct markets than uniform rice SSNIP test in 2 out of 28 outlets under scrutiny. lication of the UPP methodology is limited in the literature. Cheung (2011) analyses the merger between US irways and merica West that was cleared in 2005 by the Deartment Of Justice («DOJ»). The author mostly addresses the theoretical issues between UPP analysis and merger simulation. lso, she investigates if UPP may roduce false estimates deending on the tye of roducts under scrutiny (comlements or substitutes) and she comares the structural estimates of rice changes with UPP results. She states that on average 10% of the elaborated observations of airlines markets, the UPP formula roduces wrong estimates. Lastly, she examines the UPP with the traditional HHI test and she concludes that the HHI is a more severe test in both cases. Varma (2009) simulates different industries with a hyothetical merger in each industry in order to elaborate usefulness of UPP methodology. The author comares the traditional structural aroach of market definition with UPP methodology and concludes «that some mergers that would not create a structural resumtion under the aroaches to market definition tyically used in ractice would likely create a resumtion under the UPP test with a 10 ercent resumtive efficiency credit». 32 Cometition authorities also use diversion ratios to simulate the anticometitive effects of a merger. Walters (2007) elaborated diversion ratios in order to calculate anticometitive effects of retail chain mergers in UK. 33 The author stated that the 32 See Varma (2009), «The 2006 Vue/3 Cinema cinema merger and the 2006 HV/Ottakar s book store merger». See Walters (2007),

16 emirical results of diversion ratios were romised in the majority of the merger local markets were estimated and these results, combined with local characteristics of the local markets, may be used in order to elaborate the unilateral effects of mergers. athiesen et al. (2009) also analysed diversion ratios in order to elaborate the unilateral effects of Somerfield s acquisition of orrison s 115 grocery stores in UK. 34 The authors concluded that market shares may be oor redictors of the actual cometition among asymmetrically differentiated roducts. They found that the rice increase following the above mentioned acquisitions was 40% lower using the observed diversion ratios than the ones based uon market shares. The Euroean Commission («EC») has assessed the existence of buyer ower in many cases. In the case of buying co-oeratives 35 the EC declared that the resence of a large sulier in the ustream market may countervail the increase of the rices in the downstream market. esides, «an examle of a dominant osition existing in both the downstream and ustream market was highlighted in the case ritish irways, which has been a dominant buyer on the ritish market for air travel agency services» 36. In the merger between REWE and deg 37 the EC stated that the ability of the merged entity to exercise its buying ower may be outweighed by the ability of the consumers to buy from the alternative suermarkets and therefore to increase the sales of the rivals. oreover, in ritish irways case 38 the EC deicted that ritish irways had infringed article 82 by making arrangements with travel agents intending to exclude its rivals from the downstream 34 See athiesen (2009),. 1 & footnotes therein. 35 See the judgment of the Euroean Court Gøttru-Klim e.a. Grovvareforeninger v. Dansk Landbrugs Grovvareselskab mb [ECR 5641 (1994)]. 36 See OECD, (2008), See Case COP/ See IV/D-2/ Virgin/ritish irways. 16

17 market. However, the said exclusionary effect on ritish irways rivals was uheld by the Euroean Court of Justice The market of roduction and distribution of white milk in Greece The market of roduction and distribution of white milk in Greece can be groued into three segments: a) the segment of total market of white milk (S 1 ), b) the roduct s segment (S 2 ) and c) the brand s segment (S 3 ). Figure 1 deicts the market of roduction and distribution of white milk 40. The roduct s segment of white milk market in Greece consists of three major roducts, fresh, high asteurization and condensed milk. The said roducts constitute the majority of sales of white milk. The brand s segment of white milk market consists of, inter alia, four major brands. The brands in question constitute between 65% - 70% of the total sales of fresh milk in Greece. 41 [Please insert figure 1 about here] In the following aragrahs I resent the main results of HCC s decision (No 515/VI/2011) concerning the delineation of the market of roduction and distribution of white milk in Greece. I also evaluate Katz & Shairo (2003), Daljord & Sørgard (2011), GUPPI and UPP methodologies in the above mentioned market and I resent the emirical results from the calculation of PI. 39 Dynamic effects of buying ower have also been analysed. See OECD (2008), For an alication of buying ower in merger and antitrust cases see OECD (2008), See Fotis & Polemis (2011), The remaining brands of fresh milk consist of the 30%-35% of total sales of fresh milk. See HCC s Decision No 515/VI/2011,

18 4 Emirical ssessment 4.1 Emirical results of HCC s decision in relation with the delineation of market of roduction and distribution of white milk The emirical results of HCC s decision regarding the delineation of the market of roduction and distribution of white milk in Greece may be summarized into three categories: a) the estimation of the own and cross rice elasticities by elaborating a log linear demand system in first (S1) and second (S2) segments of white milk market 42, b) the analysis of CL methodology by Harris & Simons (1989), O rien & Wickelgren (2003) and Daljord et al. (2008) 43 and c) the analysis of rice correlation and cointegration methodology. The monthly time series data of rices used in the econometric estimations is from Nielsen. The eriod under scrutiny sans from 2000 until Setember In terms of the econometric results in the second (S2) segment, the conditional own - rice elasticities of fresh, high asteurization and condensed milk are of considerable significance rather than the cross rice elasticities. The results indicate that the rice elasticity of conditional demand for the said roducts are highly significant inelastic 44 ( - value < 0,01) and may constitute distinct roduct markets. 42 The demand functions in question (aggregate demand in first segment and roduct s demand in the second segment) estimated with an autoregressive scheme of order 1 and Cochrane-Orcutt estimation rocedure. The urose of the aer is not to focus on the brand s segment. However, the GDC has estimated the brand s demand functions. For more details about the estimated demand models see HCC s Decision No 515/VI/2011, endix 1, Econometric estimations, See also Case Com Camina/Friesland, endix 1, See HCC s Decision No 515/VI/2011, endix 1, Econometric estimations, See also Fotis & Polemis (2011), This result coincides with the majority of studies in the last 2 decades. See the review of emirical results resented in the endix of Case Com Camina/Friesland, Table 2,

19 The aggregate demand for dairy roducts is considered to be rice inelastic. In articular, the estimated coefficient of aggregate rice index 45 in first segment is almost zero. 46 The last conclusion indicates that rice elasticities could be used as evidence toward a delineation of the above mentioned roducts of white milk. However, since here the elasticities in question are conditional rice elasticities, they are conditional on the level of exenditure of white milk in the total market of white milk (S1), a researcher must handle with roer care their interretation and esecially the indirect effect of rices on the total amount of exenditure of white milk 47. Therefore, the estimates of rice elasticities for market definition must be accomanied with formal tests that used for the delineation of roduct markets, such as rofit maximizing SSNIP tests and the CL methodology and cointegration analysis, whose emirical results are resented below. The emirical results of CL analysis by Harris & Simons (1989), O rien & Wickelgren (2003) and Daljord et al. (2008) for several ercentage rice increases of fresh, high asteurization & condensed milk indicate that the roduction and distribution of the roducts in question constitute distinct roduct markets. Therefore, 45 t t log Pt : F, HP, C T s deflated (white) milk rice index, where s : market shares of fresh, high T asteurization and condensed milk in first segment (S1) and log P log P : the natural log t t F, HP, C of the rice index of fresh, high asteurization and condensed milk. See also HCC s Decision No 515/VI/2011, endix 1, Econometric estimations, n analytic review of log-linear demand models can be found in Davis & Garces (2010), See also Deaton & uellbauer (1980b), Hausman et al. (1994). 47 For examle, suose that the rice of fresh milk goes u. Then art of the consumtion of fresh milk will reallocate to other tyes of white milk, but total consumtion of white milk might also fall either because consumers switch to other dairy roducts or reduce consumtion altogether. In order to overcome the indirect effect of rices on total exenditure of white milk we may regress income (GDP) instead of exenditure on total demanded quantity of white milk along with the aroriate use of instrumental variables, such as cost shifters of white milk roducts or rice of roducts that share the same cost shocks with white milk roducts but are not substitutes or comlements with them. t 19

20 CL analysis verifies the highly inelastic estimated own rice elasticities from log - linear demand functions 48. In articular, the alication of the single roduct criterion (Daljord et al., 2008) in two airs of the said roducts (between fresh high asteurization and fresh condensed milk) indicates that for various increases in the rice of fresh milk (5% - 30%), eq. (12) is satisfied since DR L. Figure 2 resents the evolution of log rices and its differences of fresh, high asteurization & condensed milk in Greece from 2000 to It is evident that the series are moving in the same direction. Esecially, the correlation coefficient between the said roducts is estimated 0,94 and the corresonding coefficient between fresh & condensed milk is estimated However, the grah with the differences of the log rices of the abovementioned tyes of white milk highlights a temoral trend. Esecially, even though the grah with the log rices deicts a drifting uward together at roughly the same rate of all tyes of white milk in Greece, the grah with their differences indicates that this drifting must be due to a stochastic trend and not a structural relationshi among the log rices 50. [Please insert figure 2 about here] 48 See HCC s Decision No 515/VI/2011, endix 1, Econometric estimations, Euroean Commission has used the said test for market definition in many cases. See, inter alia, Case IV/ 619 Gencor/Lonhro, Case COP/.2187 CVC/Lenzzing and Case COP/ rjowiggins/-real Zanders Reflex. In Case COP/.2187 the Euroean Commission stated that for correlation coefficients between 0,65 and 0,80 the delineation of roduct market must be further enhanced by other tests such as SSNIP tests and cointegration analysis. 50 Time series with the abovementioned characteristics are called random walk or first order integrated I(1) time series. 20

21 Two roducts belong in the same roduct market if their time series of log rices are cointegrated, that is, there exists a stable and structural relationshi between each other. rerequisite for this is that each time series to be a random walk, since if the time series are I(1), the difference among them may be stable around a fixed mean 51. GDC erformed unit root tests 52 and Johansen Cointegration Unrestricted Cointegration Rank (max eigenvalue) tests 53, between fresh & high asteurization milk, fresh & condensed milk and in the total market of white milk in Greece 54. The unit root tests indicate that each tye of white milk is a first order integrated I(1) time series. The ugmented Dickey-Fuller (DF) t-statistic 55 and the Phillis- Perron (PP) unit root test 56 cannot reject the null hyothesis of the existence of a unit root since the associated values of ackinnon one-sided -values are above 0,05 test critical value. The unit root tests between the differences of the log rices of the roducts in question show that the series are I(1) time series.. The DF t- statistic (in level) of the differences is above 1 and almost 1 for the deflated (white) milk rice index, while the associated ackinnon one-sided -values are statistically insignificant (for two of the three series the -value is close to 1). Regarding the cointegration analysis, the null hyothesis of the trace statistic elaborates whether there are at most r cointegrating relations against the alternative hyothesis of m cointegrating relations (i.e., the series are stationary, r = 0, 1,..., m 1). The maximum eigenvalue test statistic tests the null hyothesis that there are r 51 See Green (1993),. 567; Forni (2004); O Donoghue & Padilla (2006), section See, inter alia, reitung, & Pesaran (2007). 53 See Johansen (1991). 54 For an alication of unit root & cointegration tests in gasoline market see Fotis & Polemis (2012), See Dickey & Fuller (1979) & Rothenberg & Stock (1996). 56 See Phillis & Perron (1988) 21

22 cointegrating relations against the alternative hyothesis that there are r +1 cointegrating relations. 57 The emirical results clearly indicate that the 3 tyes of white milk in Greece constitute distinct relevant roduct markets. Esecially, the ackinnon Haug ichelis -values of both cointegration tests indicate that the series are not cointegrated. The associated -values are higher than the critical value of 0,05 and therefore the null hyothesis cannot be rejected. 4.2 Further results from the Could roach. The role of roduct asymmetries in market definition The CL methodology by Katz & Shairo (2003) also indicates that fresh, high asteurization and condensed milk constitute distinct relevant roduct markets 58. Given eq. (5) the ctual Loss is lower than Critical Loss for almost all the estimated airs of roducts in question since the corresonding Diversion Ratio is higher than the Critical Loss (Table 2). [Please insert Table 2 about here] The henomenon of «Cellohane Fallacy», states that in monooly rices the level of substitution is high and the researcher will estimate larger roduct markets than the researcher would if cometitive rices were used instead. 59 However, in the aer, 57 The models and the number of the lags of the Johansen & max eigenvalue Cointegration tests have been automatically chosen by Schwartz criterion. 58 The estimated variable costs of white milk roducts are 46%, 51% and 57% of the average rice of fresh, high asteurization and condensed milk resectively during the eriod The estimates are based on market reorts, exert s oinions and internet sources (see, inter alia, htt://dsace.aua.gr/xmlui/bitstream/handle/10329/49/%ce%3%cf%85%ce%c%ce%5%cf% 89%CE%D%CE%F%CE%4%CE%F%CF%85-secure.df?sequence=3, htt:// oikonomia/article/?aid=70406, htt://estia.hua.gr:8080/dsace/bitstream/ /1029/-1/galatoulas.df, htt://nefeli.lib.teicrete.gr/browse/sdo/ba/2011/drouganinastasia,-tzatzarakinastasia/- attached-document /drougani_tzatzaraki2011.df). 59 See United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377 (1956). 22

23 the estimated CL formulas indicate narrowly delineated roduct markets for each tye of white milk 60. Table 2 also resents the estimates by Daljord & Sørgard (2011) CL methodology. One interesting result from the Table in question is that for a 10% rice increase of fresh milk in relation to high asteurization milk, the former tye of milk does not constitute a single roduct market. This result contradicts with the estimated result from the alication of Daljord et al. (2008) CL methodology. It is evident that for a 10% increase of fresh milk the CL methodology by Daljord & Sørgard (2011) leads to a broader market definition than the CL methodology by Daljord et al. (2008). This in turn imlies that the asymmetry between the two roducts is large or eq. (14) for a 10% rice increase of fresh milk in relation to high asteurization milk must be satisfied. The calculation of the said equation clearly indicates that the inequality holds, that is, S 36.5% where S : the market share of the «small roduct». 4.3 Unilateral effects In this section I resent the estimated coefficients of GUPPI and UPP (Table 3). The calculation of GUPPI 61 intends to measure the uward ricing ressure solely from the closeness of substitution between the roducts under scrutiny. 60 Froeb & Werden (1992) have ointed out that roduct markets are narrowly delineated even if the observed market rices are below cometitive rices («Reverse Cellohane Fallacy»). Reasons for this may be redatory ricing or infrequently large increases of nominal rices instead of frequently small increases of rices (see Sortech/Vernons merger inquiry, UK Cometition Commission, htt:// _ub/reorts/2007/fulltext/533). 23

24 [Please insert Table 3 about here] It is evident from the Table in question that a hyothetical monoolist would have an incentive to increase the rice of high asteurization milk in relation to fresh and condensed milk (Unilateral effects). This result is due to the highly estimated coefficient of Diversion Ratio (the fraction of the reduction in sales of high asteurization milk that is diverted to fresh or condensed milk following a rice increase on high asteurization milk) and a high estimated rice cost margin or both. That is, «The higher the diversion ratio or the higher the margin of the merging artner, the greater the rofits that are recatured by the merging artner and thus the greater the incentive to raise rice». 62 Regarding the other airs of tyes of white milk the magnitude of estimated GUPPI is lower. The said index of condensed milk in relation to fresh milk is 15%, while the corresonding index of the same tye of milk in relation to high asteurization milk is 6%. The emirical results from the calculation of Uward Pricing Pressure imly that the downward ricing ressure due to the emerged efficiencies must be high enough in order to outweigh the incentive of a hyothetical monoolist to raise the rice of the roduct under scrutiny. Efficiencies (variable cost savings) tend to reduce rice due to cost savings (Figure 3). [Please insert figure 3 about here] ssume the air of fresh and high asteurization milk. hyothetical monoolist would have an incentive to raise the rice of fresh milk for any rice increase lower 61 See eq. 17 & oresi (2010),

25 than 11,18%. However, for any rice increase above the said ercentage (or equal to 11,18%), the rice effect due to diversion effect is lower than the variable cost saving effect. s it concerns the UPP of high asteurization milk in relation to fresh and condensed milk the emirical results verify the corresonding results from the calculation of GUPPI. oth fresh and condensed milk create strong UPP on high asteurization milk and a hyothetical monoolist would find difficult not to increase the rice of the latter. Nevertheless, condensed milk does not imose strong UPP on fresh milk since all the rice increases of the latter above or equal to 1.3% are less rofitable than the efficiencies generated from a decrease of fresh milk s rice by 1.6%. 4.4 easuring the uying Power of the merged entity in the relevant roduct market for the rocurement of raw milk Sensitivity nalysis & uyer Power Index Figure 4 illustrates the results of sensitivity analysis of eq. (20). Recall that the PI roerties of the said equation are 0 S PI PI and 0. That is, the CF higher the market share of the large buyer the higher the deviation from the cometitive outcome and the higher the market elasticity of suly and the own rice elasticity of demand of the cometitive fringe, the lower the buying ower of the CF large buyer. In articular, for = 4 and s 35%, the deviation from the 25

26 CF cometitive level is 5,3%, but for = 1 and s 65%, the PI of a large buyer is 48,1%. 63 [Please insert figure 4 about here] In Table 4 we resent the range of estimated PI of a large buyer in one of the biggest refectures in Greece for the year [Please insert Table 4 about here] It is evident from the Table in question that the PI of a large buyer is lower in markets with high elasticity of suly and rice demand elasticity of the cometitive fringe than in inelastic markets. Hereto, if the market elasticity of suly is 0 and the own rice elasticity of demand of the cometitive fringe is 0.5 then the estimated PI is between 230% and 240%. 5 Concluding remarks Focusing on a recent horizontal merger in the Greek diary sector, the aim of this aer is on the one hand to emirically investigate the delineation of the market of roduction and distribution of white milk in Greece and on the other hand, to calculate the uying Power Index of a large buyer in the relevant roduct market for the rocurement of raw milk. The econometric results in combination with rice based techniques of Hyothetical onoolist Test and cointegration analysis indicate that the markets of roduction and distribution of fresh, high asteurization & condensed milk in Greece are highly inelastic and constitute distinct relevant roduct markets. 63 The DOJ uses a 35% as a threshold for s (lair & Harrison, 2010,. 59). 26

27 oreover, roduct asymmetries (in terms of sales) lay a crucial role in market definition. That is, for a 10% increase of fresh in relation to high asteurization milk, the Critical Loss methodology by Daljord & Sørgard (2011) estimates broader relevant roduct market than the Single Product Criterion by Daljord et al. (2008). This in turn imlies that the asymmetry between the two roducts is large. esides, the evidences from the calculation of Uward Pricing Pressure imly that unilateral effects are resent. The downward ricing ressure due to the efficiencies (variable cost savings) generated by the merger must be high enough in order to outweigh the incentive of a hyothetical monoolist to raise the rice of the roducts. The emirical results from the calculation of the uying Power Index of a large buyer in the relevant roduct market for the rocurement of raw milk indicate its ability to deviate from the cometitive equilibrium even in the cases where its resonsiveness to monitor the quantity sulied to changes in rices is low and the demand elasticity of the cometitive fringe is highly elastic. n interesting result indicates that if the demand elasticity of the cometitive fringe falls from 1 to 0.5, while the market elasticity remains stable, the PI of a large buyer almost doubles. Summarizing, rice based techniques of merger control are useful tools in order to define relevant roduct markets as well as market ower, so as long as they are handled with roer care in markets where other forms of non rice cometition are the dominant forms of strategic interaction among firms. 27

28 endix Conditions of a rofit - maximizing SSNIP test. The Would roach. The SSNIP test assumes a fixed rice increase of a grou of roducts or a single roduct. It evaluates whether a SSNIP of a roduct in a market will be rofitable for a hyothetical monoolist. It is based on the idea that a set of roducts do not face significant cometition from outside the market roducts. Let c be the constant marginal cost 64 C C for all levels of roduction, D... ; 2 i the inverse demand function, a hyothetical monoolist s rice and C C 2...i the rices of cometitors roducts. In a homogeneous single roduct market a hyothetical monoolist maximizes its rofits with resect to its rice: C C C C ;... max cd ;... max 2 i 2 1 (1.1) i The monoolist will increase its rice as long as it generates more rofits than the monoolist s rofits rior to the increase of the rice. That is, onoolist's mark u c 1 ; C 2... C i 65 (1.2) where is the own rice elasticity of demand of monoolist s roduct. In terms of hyothetical monoolist rofits rior and after the rice increase, equation (1.2) can be written as 64 Equivalently, if marginal cost data is absent the researcher may use average variable cost (hereafter and VC) as a roxy of marginal cost of roduction. 65 In terms of hyothetical monoolist rofits rior and after the rice increase, equation (1.2) can be C C C C written as ; 2... i i 0, where 0 is the rice of the roduct rior the increase. 28

29 C C C C ; 2 i 0 2 i (1.3) where 0 is the rice of the roduct rior the increase. In a differentiated roduct market, where all the roducts in the market are considered to be erfect substitutes, equation (1.2) becomes onoolist's mark u c 1 ;... C 2 C i 66 (1.4) where is the own rice elasticity of candidate market demand faced by a hyothetical monoolist 67. In a multiroduct market a hyothetical monoolist must recognize the cross roduct effects 68. That said, given hyothetical (multiroduct) monoolist roduct s & 69, their rice increase will be rofitable if onoolist's mark u c 1 ; C C 2... k c * DR, (1.5) onoolist's mark u c 1 ; C C 2... k c * DR, (1.6). 66 If the rice elasticity of demand is low, a hyothetical monoolist has an incentive to increase the rice. 67 C C C C ln D Recall that ;... i C D... C i, where ; 2 is the market demand. 2 ; 2... i 68 That is, given that roducts & belong to hyothetical monoolist, the effect of the increase of roduct s rice on the demand for roduct. 69 In a general multiroduct environment a hyothetical monoolist comares the rofits of k roducts rior to rice increase with the rofits that generated after a on rices,,..., k. 29

30 The 1984 US erger guideline test by Ivaldi & Lorincz While the rofit maximizing SSNIP test assumes a fixed rice increase of a grou of roducts or a single roduct (see equation (1.7)), the 1984 US merger guideline test by Ivaldi & Lorincz (2011) assumes equilibrium rice increase. It also redicts that other roducts in the market («the outside goods») react to the rice increase of candidate roducts by increasing their rices too (see equation (1.8)) 70. Following Ivaldi & Lorincz (2011, ), a subset of roducts is a single roduct market of roduct if equation (1.7) 71 below is satisfied, SSNIP i SSNIP i 0 0 *100 0 (1.7) where : a subset of firms in the single roduct market i : roducts, other than j, in the single roduct market 0 : the rice of roduct rior its increase. ccording to 1984 US merger guidelines test, [Ivaldi & Lorincz (2011, )], the equilibrium relevant market rice index of a subset of roducts is defined as 70 The use of a simle merger simulation model for arket definition uroses has also been ointed out by Schmalensee (2009). See also Fotis & Polemis (2011), See also equation (1.3). 30

31 1984 US q 1984 US P 1 *100 (1.8) q single roduct market exists whether US P 1984 > US 1984, where rice increases take values between 5% 15% and is the smallest subset of roducts among all the subsets of roducts in the market that satisfies the above mentioned inequality See, inter alia, C5885, Centrica Plc/Dynegy Storage Ltd and Dynegy Onshore Processing, ugust 2003, Case COP/. 3216, Oracle/PeoleSoft, [2005] L218/6, Case COP/.1672, Volvo/Scania, [2001] O.J. L143/74, Case COP/.3083, GE/Instrumentarium, [2004] O.J. L109/1 for an alication of merger simulation analysis in merger cases. 31

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