The GUPPI in Theory and Practice Paul T. Denis * The Gross Upward Pricing Pressure Index ( GUPPI ) has a storied lineage, drawing on theoretical work of highly regarded economists from within and outside the two federal enforcement agencies in the United States. But, in practice, the GUPPI has a checkered history, to put it charitably. The agencies have been unable to come up with consistent statements about how the GUPPI is to be used in practice. Given data availability, computation of the GUPPI often is at variance with the requirements of the economic model underlying the concept of upward pricing pressure, reducing the GUPPI to nothing more than a convoluted restatement of the simplistic structural presumption it was designed to replace. The GUPPI has fallen short of the potential it appeared to have for creating a framework for merger analysis that would integrate unilateral incentives to raise prices, efficiencies, and the dynamic response of rivals. Indeed the computational issues surrounding the GUPPI are so severe that the GUPPI may be inappropriate for even safe harbor duty, much less for the heavy lifting of forming the basis for inferences or presumptions of adverse competitive effects. Suffice it to say that the harbor in which the GUPPI swims is more perilous than safe these days. The GUPPI in Theory The concept of upward pricing pressure is most closely identified with Farrell and Shapiro (2010) which built, in part, on earlier insights of Willig (1991), Werden (1996), and O Brien and Salop (2000). Salop and Moresi (2009) extended an earlier working paper version of Farrell and Shapiro (2010) and coined the term GUPPI. Farrell and Shapiro looked to net upward pricing pressure ( UPP ) as an indicator or simple approach to gauging concerns about unilateral price effects in markets for differentiated products. Farrell and Shapiro (2010) at 2. UPP was the net of two potentially offsetting effects, the upward pressure on price resulting from a loss of competition between the products of the merging firms and the downward pressure on price resulting from marginal cost reductions enabled by merger efficiencies. The upward portion of this net effect was shown to be the function of two variables the diversion ratio between the products of the merging firms and the economic margin on the * Partner and Deputy Chair, Global Litigation Practice, Dechert LLP. This paper was prepared in connection with a panel discussion of GUPPI-Based Harbor: Safe or Perilous to occur at the 64 th Annual American Bar Association, Section of Antitrust Law, Spring Meeting (April 6, 2016). I have benefited from discussions with the other panelists and research help from Anna Aryankalayil, an associate at Dechert LLP, but readers should hold them blameless for what resulted from their contributions.
product to which sales were diverted. The merging firms were each assumed to produce a single product (Products 1 and 2, respectively) (multi-product firms, whether producing substitutes or complements, raise additional complications beyond the scope of this paper). The diversion ratio for Product 1 was the percentage of sales units lost in the event of a price increase for Product 1 due to substitution from Product 1 to Product 2. The economic margin in question was the difference between price and marginal cost for Product 2. Dynamic response of rivals, whether repositioning of existing products or entry with new products, was held constant. The appeal of Farrell and Shapiro s approach was that it seemed to eliminate the need to define markets or rely on outmoded notions of structural presumptions which were particularly illsuited to differentiated products markets. Mergers with a positive net effect on price under this UPP test were to be flagged for further scrutiny where dynamic response of rivals could be incorporated into the analysis. Id. Those with no or negative effect on price presumably were to be cleared into a safe harbor. Id. Perhaps more tantalizing, UPP offered the prospect for integrating unilateral competitive effects analysis, efficiencies and dynamic response by rivals. See Willig (2011) at 37. The GUPPI in Practice Whatever the theoretical promise offered by UPP as developed by Farrell and Shapiro, the practical application fell well short. The upward pricing pressure component of Farrell and Shapiro s UPP was given prominent placement in the unilateral competitive effects section of the 2010 Horizontal Merger Guidelines. But the upward pricing pressure component of UPP was disconnected from its fraternal twin, downward pricing pressure, which was given only passing reference in a later section of the Guidelines that was largely devoted to undercutting potential efficiency arguments. Compare Horizontal Merger Guidelines Sections 6.1 (two full paragraphs) and 10 ( In a unilateral effects context, incremental cost reductions may reduce or reverse any increases in the merged firm s incentive to elevate price. ). Not surprisingly, agency attention focused more on upward pricing pressure (GUPPIs) than downward pricing pressure (efficiencies) or net effects (UPP). But the focus on the GUPPI alone, as distinguished from Farrell and Shapiro s UPP which considered the net effect of upward and downward pricing pressure, created a practical problem. By construction, the GUPPI was always positive when there was ANY substitution between the products of the merging firms and the product to which sales were diverted was priced at some increment above marginal cost. The GUPPI could not be a useful indicator of anything if it gave the answer that every horizontal merger was likely to lead to a price increase. The DOJ was quick to announce a 5% safe harbor for the GUPPI, noting that measuring upward pricing pressure, or even performing a full merger simulation, typically is not the end of the story, especially in rapidly changing industries. Repositioning, entry, innovation, and efficiencies must also be considered. Shapiro (2010) at 25. The 5% safe harbor was a step back from the 10% efficiencies credit utilized in Farrell and Shapiro (2010) but at least offered some certainty as to how the GUPPI would be used in practice. 2
Until last year, the FTC was silent on whether the GUPPI potentially offered a safe harbor or was to be used as a basis for presuming adverse competitive effects. The Dollar Tree/Family Dollar merger finally forced the issue. Commissioner Wright s dissent from the Commission s decision to insist on divestitures as a condition to clearing the transaction suggested that the Commission s reliance on GUPPIs was indistinguishable from the application of a presumption of competitive harm. Dollar Tree (2015), Wright Dissent at 7. The majority saw things differently and, in what might have been their only point of agreement with the dissent, held that a GUPPI-based presumption of competitive harm is inappropriate at this stage of economic learning. Dollar Tree (2015), Statement of the Federal Trade Commission at 3. But while rejecting GUPPI-based presumptions, the majority would not adopt any form of GUPPI-based safe harbor finding it equally inappropriate and suggesting instead that the GUPPI be used flexibly and as merely one tool of analysis in the Commission s assessment of unilateral anticompetitive effects. Dollar Tree (2015), Statement of the Federal Trade Commission at 4. The level at which the GUPPI might influence the Commission s actions remains a mystery. The recent Electrolux/GE Appliance merger trial suggests that the DOJ may have other ideas about the use of the GUPPIs, at least in litigation. Professor Michael Whinston, testifying for the DOJ opined that one can measure the incentive to raise price by calculating upward pricing pressure (UPP) and proceeded to predict price increases on the basis of GUPPIs computed from an assumption that diversion was proportional to retail shares, and without incorporating efficiencies into that prediction. Whinston (2015), Slides 48 and 59. The GUPPI had swum far from the safe harbor. Whatever the role of the GUPPI, be it the source of safe harbors, the source of presumptions, or evidence of competitive effects, its computation in practice is often disconnected from the underlying economic model that led to their consideration. Margins are drawn from accounting data, a notoriously poor source for information about economic variables. While typically there is some effort to distinguish between fixed and variable costs, rarely is there the ability to reliably estimate marginal costs and, therefore, rarely is there the opportunity to compute economic margins. Cost allocation issues further confound the measurement of economic margins. Diversion ratios have proven to be even more problematic. Few companies compute diversion ratios or even maintain the records from which they could be computed. Event studies around entry and exit events or analysis of bidding data and consumer surveys sometimes are used to estimate diversion ratios. But frequently the agencies dispense with estimating diversion ratios and instead apply an assumption that diversions are proportional to market share. The assumption of diversion proportional to market shares is particularly ill-suited to differentiated product markets in which consumers have heterogeneous preferences. While the proportionality assumption has nice mathematical properties and is imbedded in many of the discrete choice models commonly used by economists in differentiated markets analyses, it assumes away the very issue that is at the core of differentiated products merger analysis whether the products of the merging firms are particularly close or more distant substitutes. In addition, the probability that this assumption is correct in a differentiated products market is virtually nil while it is always true in homogeneous product markets. Finally, by incorporating market share data, the proportionality assumption forces the analysis to rely on market definition 3
(the dimension over which shares are measured), something that concept of upward pricing pressure was originally designed to avoid. The GUPPI in the Future Without data on economic margins or meaningful estimates of diversion ratios, there is no sound theoretical foundation for relying on GUPPI calculations. Complicating the issue, there is no empirical support for the belief that the GUPPI, however computed, can reliably play a role in merger analysis. See Carlton (2010) at 7. If there is a future role in merger analysis for the GUPPI, that role likely will require the GUPPI to stop swimming alone and, instead, to reunite with its fraternal twin of downward pricing pressure, considering both efficiencies and the dynamic response of rivals in an integrated analysis more reflective of actual market behavior. 4
References Carlton (2010), Revising the Horizontal Merger Guidelines, 10 Journal of Competition Law & Economics 1. Dollar Tree (2015), In the Matter of Dollar Tree, Inc., FTC File No. 141-0207, available at https://www.ftc.gov/enforcement/cases-proceedings/141-0207/dollar-tree-incfamily-dollarstores-inc. Farrell and Shapiro (2010), Antitrust Evaluation of Horizontal Mergers: An Economic Alternative to Market Definition, The B.E. Journal of Theoretical Economics, Vol. 10, Issue 1, Article 9. O Brien and Salop (2000), Competitive Effects of Partial Ownership: Financial Interest and Corporate Control, 67 Antitrust Law Journal 559. Salop & Moresi (2009), Updating the Merger Guidelines: Comments, available at http://www.ftc.gov/os/comments/hoizontal mergerguidelines/545095-00032.pdf. Shapiro (2010), Update from the Antitrust Division, Remarks as Prepared for the American Bar Association Section of Antitrust Law Fall Forum November 8, 2010, available at https://www.justice.gov/atr/speech/update-antitrust-division. U.S. Department of Justice and Federal Trade Commission (2010), Horizontal Merger Guidelines, available at https://www.justice.gov/atr/merger-enforcement. Werden (1996), A Robust Test for Consumer Welfare Enhancing Mergers Among Sellers of Differentiated Products, 44 Journal of Industrial Economics 409. Whinston (2015), GE-Electrolux merger analysis, Exhibits in Support of Testimony (November 23, 2015), available at https://www.justice.gov/atr/us-v-ab-electrolux-et-al-trialexhibits. Willig (1991), Merger Analysis, Industrial Organization Theory and Merger Guidelines, Brookings Papers on Economic Activity, 281-332. Willig (2011), Unilateral Competitive Effects and Mergers: Upward Pricing Pressure, Product Quality, and Other Extensions, Rev. Ind. Org. 39:19-38. 5