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PR
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Hidden inconsistenciesDavid Stallibrass
Shanghai | March 2013
Personal views of author. Does not represent opinion or position of any institutions to which he is affiliated.
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Contents
Economics, assumptions, and the law
Market shares and equilibrium
Collusion and profit maximisation
Dominance and One Monopoly Profit
Conclusion
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Economics, assumptions, and the lawJoke
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Engineer: how shall we get
water?
Lawyer: when we find water, who
will own it?
Economist: Lets just assume we
have some water.
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Economics, assumptions, and the lawBackground
All economic models require simplifying assumptions
In economic law – such as antitrust – the results of economic models inform the substantive application of the law
“Even the most practical man of affairs is usually in the thrall of the ideas of some
long-dead economist” JM Keynes
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Economics, assumptions, and the lawExample – market shares and mergers
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Law
Market share safe harbors Market share as major tool of merger control
Model
Market shares are a good proxy for market power
Assumption
Markets are in equilibrium Firms profit maximize Transition costs are
low
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Economics, assumptions, and the lawQuestion in China
Has China imported assumptions from other jurisdictions that are not suitable for the Chinese economy?
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Chinese Law
Assumptions about the European
economy
Inform
European LawBased on
Assumptions about the Chinese economy
Imply
Assess?
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Economics, assumptions, and the lawCaveat
Relative concision of Chinese antitrust decisions and guidance
Exercise is necessarily one of speculative explanation
But…throw some light on what might be different about antitrust in China
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Contents
Economics, assumptions, and the law
Market shares and equilibrium
Collusion and profit maximisation
Dominance and One Monopoly Profit
Conclusion
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Market shares and equilibriumUse of market shares in merger control
MOFCOM relies heavily on market shares AML Article 27 HHI and market share
Notification form 2 years of market share
Proposal for fast-track (10% combined for horizontal, 20% for vertical)
Cases All cases mention market share analysis
All but three include market shares
Google – just 1 quarter!
Delphi – “growing market shares” suggests dynamic analysis 9
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Market shares and equilibriumUse of market shares dominance
Less clear how important AML article 19 presumptions of dominance
QQ / 360 very high market shares consistent across time, no decision yet
Baidu, J&J market shares not sufficient (though perhaps market not well defined)
Ad-hoc nature means perhaps a little less important
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Market shares and equilibriumAssumptions behind market share use
Models of mergers utilize “comparative statics”
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Model of market before the merger
(market shares imply cost, product
differentiation, etc)
market shares ≈ market power
Change in market structure
Model of market after the merger
(changes in price, production, output)
∆market shares ≈ ∆market power
Requires equilibrium Assumes quickly move to new equilibrium
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Market shares and equilibriumAssumptions behind market share use
No authority relies totally on these models PCAIDS / ALM experimentation by EU / OFT
But central to determining safe harbours HHI and safe harbor discussions in the US (1970s and
1980s) still a major driver of thresholds in many jurisdictions
Substantial modern criticism Market share a “lagging variable”
Requires definition of a market (which doesn’t really exist in reality)
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Market shares and equilibriumAssumptions behind market share use
The assumption of equilibrium requires: The speed of economic change is slower than the speed
of firms ability to react to it
In practice: Change is slow: consumer tastes, regulatory landscape,
business opportunities
Reactions are quick: access to capital, low regulation, easy entry
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Market shares and equilibriumDo the assumptions hold in China?
Are tastes and business opportunities moving very quickly? High growth
Very large regional and sectoral variation
Can firms react quickly? Extensive regulation
Limited and un-even access to capital markets
Conclusion: assumption less likely to hold than in Europe
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Market shares and equilibriumSuggestions for Chinese enforcement
Market shares a good proxy for young authorities Limited resources
Learning
Provides legal clarity
Short-term changes Ask for three years’ market share
Consider Adopting GUPPI doesn’t need market shares
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Market shares and equilibriumGUPPI introduction
“First round incentives” of horizontal mergers always to raise price
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Profit
Cost of production
Profit
Cost of production
Profit
Cost of production
Firm A
Firm C
Firm B
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Market shares and equilibriumGUPPI introduction
“First round incentives” of horizontal mergers always to raise price
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Profit
Cost of production
Profit
Cost of production
Firm A
Firm C
Firm B If firm A raises price, loses sales, but makes extra profit on what it does sell.
Profit
Cost of production
Profit
Cost of production
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Market shares and equilibriumGUPPI introduction
“First round incentives” of horizontal mergers always to raise price
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Profit
Cost of production
Profit
Cost of production
Firm A
Firm C
Firm B In this instance, it will not raise it’s price.
Increased profit < value
of lost sales
Profit
Cost of production
Profit
Cost of production
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Market shares and equilibriumGUPPI introduction
“First round incentives” of horizontal mergers always to raise price
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Profit
Cost of production
Profit
Cost of production
Profit
Cost of production
Firm A
Firm C
Firm B Some of those sales go to competitors, who make extra profit
Profit
Cost of production
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Market shares and equilibriumGUPPI introduction
“First round incentives” of horizontal mergers always to raise price
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Profit
Cost of production
Profit
Cost of production
Profit
Cost of production
Firm A
Firm C
Firm B If Firm A owned firm C then it would count firm C’s profit when it thought about raising it’s price
Profit
Cost of production
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Market shares and equilibriumGUPPI introduction
“First round incentives” of horizontal mergers always to raise price
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Profit
Cost of production
Profit
Cost of production
Profit
Cost of production
Firm A
Firm C
Firm B In this case, it would raise it’s price
Profit
Cost of production
Increased profit of firm A
and B > value of lost
sales to firm A
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Market shares and equilibriumGUPPI calculation
The real drivers of horizontal unilateral effects are not market share or market definition, but diversion ratio’s and profit margins.
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A has a stronger incentive to raise prices if it either A loses a lot of customers to C when it raises it’s price, or C has very high profits
Profit
Cost of productionProfit
Cost of production
Firm A
Firm CProfit
Cost of production
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Market shares and equilibriumGUPPI calculation
Two things we need to know for UPP UPPA = Diversion RatioAC x Unit profitC
Maybe a lot easier than market definition!
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Profit
Cost of productionProfit
Cost of production
Firm A
Firm CProfit
Cost of production
Diversion ratio (units diverted to Firm C as
proportion of units lost by Firm A) Profit of Firm C
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Market shares and equilibriumGUPPI calculation
GUPPI puts that in context GUPPIA = UPPIA / PriceA
In US, if < 5% then safe harbor. > 10% raises concerns
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Profit
Cost of productionProfit
Cost of production
Firm A
Firm CProfit
Cost of production
Price of Firm A
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Market shares and equilibriumSummary
PRC enforcement (especially in mergers) very market share focused
May not be appropriate given nature of PRC economy
Could consider more direct ways of establishing competitive harm from mergers
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Contents
Economics, assumptions, and the law
Market shares and equilibrium
Collusion and profit maximisation
Dominance and One Monopoly Profit
Conclusion
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Collusion and profit maximisationPRC approach to collusion
Merger control Co-ordinated effects commonly mentioned: the belief
that the merger will increase the likelihood of collusion
Novartis / Alcon, HDD, Potash
All foreign firms. Nexus of competition often outside of China
Administrative enforcement Unilever pricing intention case
Foreign and domestic firms, competing in China
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Collusion and profit maximisationAssumptions behind collusion analysis
Primary assumption: firms only collude if it is in their unilateral incentive to do so Expected gains from collusion > expected cost
Collusion likely sustainable where Firms are symmetric
Market is stable
Goods are homogenous
Collusion almost always harmful Raises price and lowers quantity compared to non-
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Collusion and profit maximisationDo the assumptions hold in China?
No strong evidence. But: Large number of family owned firms
Theory that Chinese business sometimes more focussed on win-win than win-lose
Theory that Chinese businessmen sometimes care more about winning than maximising profit
Substantial state intervention
Trade associations may sustain collusion where otherwise it would fail
Etc.
Perhaps they hold less29
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Collusion and profit maximisationImplications for enforcement
Enforcement – perhaps correct to be more concerned If features of market suggest collusion more likely
No evidence that increased Chinese concern is linked to characteristics of Chinese business In mergers, all firms were foreign, and nexus of business
largely outside China
In administrative enforcement, then increased concern may be acceptable
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Collusion and profit maximisationImplications for enforcement
There may be situations where cartel enforcement would be welfare reducing Current “Chinese equilibrium” sustains cartel with large
number of firms (quantity high, price medium, output high, employment high)
Busting the cartel leads to standard competition
If market is highly competitive, then inefficient firms will leave the market until remaining firms re-enter tacit collusion
This new collusion may involve lower production than previous
Welfare effects may be ambiguous
Further research required31
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Contents
Economics, assumptions, and the law
Market shares and equilibrium
Collusion and profit maximisation
Dominance and One Monopoly Profit
Conclusion
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Dominance and One Monopoly ProfitPRC approach to Leveraging
Merger control appears open to the idea of a dominant firm “leveraging” market power from one market into another CocaCola
WalMart
Shenhua
Decisions are short and not much detail is given
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Dominance and One Monopoly ProfitLeveraging theory
Before merger, Firm 1 is dominant in Market A
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Market A Market B
Producers
Consumers
Firm 1
Firm 2
Firm 3
Firm 4Firm 5
Firm 6Firm 7
Consumer
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Dominance and One Monopoly ProfitLeveraging theory
Firm 1 buys firm 3 in market B
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Market A Market B
Producers
Consumers
Firm 1
Firm 2
Firm 3
Firm 4Firm 5
Firm 6Firm 7
Consumer
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Dominance and One Monopoly ProfitLeveraging theory
Firm 1 bundles the two goods together…
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Market A Market B
Producers
Consumers
Firm 1
Firm 2
Firm 3
Firm 4Firm 5
Firm 6Firm 7
Consumer
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Dominance and One Monopoly ProfitLeveraging theory
Forcing other firms out of the market
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Market A Market B
Producers
Consumers
Firm 1
Firm 2
Firm 3
Firm 7
Consumer
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Dominance and One Monopoly ProfitLeveraging theory
But the Chicago school (1970s, 1980s) says this is wrong: Before the merger, Firm 1 already charging “monopoly
price”
Forcing customers to buy the good of Firm 3 when previously they didn’t want to is the same as lowering the price of the good of Firm 1
This would be unprofitable, since they are already charging the profit maximising price for the good of Firm 1
Firm 1 has only “one monopoly profit” which it has already extracted – it can not extract it again!
Post-chicago modifies this, but Chicago school still starting point for most analysis
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Dominance and One Monopoly ProfitApplication in other jurisdictions
EU comparison DGCOMP, ‘EU non-horizontal guidelines’, 2008: "it is
acknowledged that conglomerate mergers in the majority of circumstances will not lead to any competition problems.“
CFI (Tetra Lavell): “Since the effects of a conglomerate-type merger are generally considered to be neutral, or even beneficial, for competition on the markets concerned, ... the proof of anti-competitive conglomerate effects of such a merger calls for a precise examination, supported by convincing evidence, of the circumstances which allegedly produce those effects.”
Pure leveraging theory of harm is not credible Other arguments necessary: Raising rivals costs,
Increased ability and incentive to foreclose, Increased ability and incentive to predate, etc.
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Dominance and One Monopoly ProfitKey assumption behind Chicago School
All firms are profit maximising
Even dominant firms
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Dominance and One Monopoly ProfitDoes the assumption hold in China?
Substantial intervention of state into management of firms Large firms SOE’s
Medium and small firms Local development plans
Different firm objective Sustain status quo?
Sense of civic responsibility?
OMP may not hold
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Dominance and One Monopoly ProfitImplications for enforcement
Leveraging theories of harm may be more plausible in China Monopoly profit not yet extracted in Market A, so may
try and extract some in Market B through bundling / tying
Power of government intervention may force firms to accept the bundle, despite not wanting to do so
But unclear whether merger cases are compatible with this Do not appear to be firms with substantial state
involvement
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Contents
Economics, assumptions, and the law
Market shares and equilibrium
Collusion and profit maximisation
Dominance and One Monopoly Profit
Conclusion
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ConclusionProblem of identification
PRC decisions are short Hard to know why they were made
Hard to know what assumptions underpinned analysis
Makes it hard for external observers to understand Lawyers less able to advise firms
Firms less able to self-police
Government less able to benefit from advice and support of academia
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ConclusionMixed sensitivity to different assumptions
PRC enforcement appears to have a strong focus on market shares Not consistent with analysis of economic differences
PRC enforcement appears to be more concerned about collusion Generally consistent with analysis of economic
differences, but unclear in particular cases
PRC enforcement appears to be more concerned about leveraging market power Generally consistent with analysis of economic
differences, but unclear in particular cases 45
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ConclusionFurther work
RPM in China – a two headed dragon
Practical analysis of GUPPI vs. Market Shares in PRC merger control
Modelling of “Chinese collusion equilibrium”
“Chicago in Shanghai”: how the Chicago school applies to Chinese antitrust
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Contact details
PRC Tel: (+86) 186 1307 4004
www.davidstallibrass.com
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