DEMAND ANALYSIS

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A PRACTITIONER'S GUIDE TO ANTITRUST:

Market Power

Merger Analysis

Demand Estimation

Patents

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The Proposed Merger of Coca-Cola And Dr Pepper (1986)

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The Legal and Procedural Background

Section 7 of the Clayton Act : "where in any line of commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly.”

The 1976 Hart-Scott-Rodino Amendments to the Clayton Act require that two agencies(DOJ and FTC) be given advance notice of any merger or acquisition that is above a specified size.

The Legal and Procedural Background

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PepsiCo announced its intentions to purchase the Seven-Up Company, which was a subsidiary of the Philip Morris Corporation.

Then the Coca-Cola Company announced its intention to purchase the Dr Pepper Company and merge the operations of the two companies.

These two mergers would have had the consolidation of the first and fourth and the second and third largest sellers of concentrate soft drinks in the US.

Judging Market Concentration

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Market Concentration is a function of # of firms & their respective market shares.

Two popular methods:1. N-Firm Concentration Ratios2. Herfindahl-Hirschman Index (HHI) (Used by FTC for Anti-trust Case)

Herfindahl-Hirschman Index (HHI)

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Calculation: Squaring the market share of each firm in

the market and then summing up. HHI= (S1)2+(S2)2+………..+(SM)2

Previously, Case 1:100*100=10,000 Case 2: (25)2+(25)2+(25)2+(25)2=2,500 Case 3: (40)2+(30)2+(20)2+(10)2=3,000

Spectrum of HHI

Below 1,000 Unconcentrated Market (Unlikely to have adverse effects-No further analysis)

Within 1,000 and 1,800 Moderately Concentrated

Above 1,800 Highly Concentrated (Violate Anti-trust regulation)

Any transaction that HHI by more than 100 points in concentrated markets presumably raise anti-trust concerns.

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Guideline Chart

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Unconcentrated: < 1000

Moderately Concentrated: 1000 to 1800

Highly Concentrated: > 1800

< 50 50 to 100 > 100

No challenge No challenge No challenge

No challenge No challenge High scrutiny

No challenge High scrutinyPresumed unlawful

Increase in Post-Merger Concentration

Post-Merger HHI

Using HHI: The Soda Business

Market Share

Cumulative Market Share

Individual HHI

Cumulative HHI

Coca Cola 37.4 37.4 1398.76 1398.76PepsiCo 28.9 66.3 835.21 2233.97Phillip Morris (7 Up) 5.7 72 32.49 2266.46Dr. Pepper 4.6 76.6 21.16 2287.62R.J. Reynolds (Sunkist) 3 79.6 9 2296.62Royal Crown 2.9 82.5 8.41 2305.03P&G (O. Crush/Hires) 1.3 83.8 1.69 2306.72Cadbury-Schweppes 0.5 84.3 0.25 2306.97

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1985 Market Share Figures for Carbonated Soft Drink (CSD) Market

Problems with HHI

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How to define a market?

CSD

or Portable bottle drink including juice, milk, etc

How about coffee and tea?

How to define a market

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Antitrust Market (1982 DOJ, merger guideline)

A market is defined as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit-maximizing firm, not subject to price regulation, …likely would impose at least a ‘small but significant and nontransitory’ increase in price…

SSNIP, 5% for one year

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Profit maximizing price must satisfy MR = MC

Total revenue is TR (Q) = P(Q) Q

P

P

Q

QP

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Q

P

P

QP 1

eP

11

Q

PQPMRTherefore

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Therefore, MR = MC becomes

denotes price elasticity of demand

The optimal price is set at a point where price elasticity is larger than 1.

MCe

P )1

1(

e

Measure of the degree of market power

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Lerner index: L =eP

MCP 1

e - price elasticity of demand

• A Firm’s gross margin is inversely proportional to the (absolute value) of price elasticity of demand.

Demand Elasticity

(p – mc)/p = 1/e, e is demand elasticity w.r.t price

Its own price elasticity includes all price elasticity with respect to other prices.

How to estimate demand elasticity, demand function?

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DEMAND ESTIMATION

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How Do You Know Your Demand?

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There are three major ways:

Interviews/surveys/co-investigation with your clients

Experiments

Statistical estimation

1. Interviews/Surveys

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The most direct way to obtain information about demand is through interviews in which consumers are asked how much of a product they would be willing to buy at different prices.

Problems

Consumers may lack information or interest, or be misled by the interviewers.

Their response might be significantly different from the response to hypothetical situation.

2. Experiments/Market Tests

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  Special Offers. Firm can offer different prices by

mail and check the responses.

For instance, firm can offer $20 to one hundred household and $25 to another hundred household. Then, check the response rate for each price.

 E.g. Britannica did for its CD offering by a direct mail campaign, with prices ranging from $70 to $125.

Are there any drawbacks with experiments as a way to find out price elasticity of demand?

3. Statistical Estimation: Regression Method

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This is a log-log regression equation which estimates the coefficients a, b, b2, b3, c, etc.

Q: demand; P: own price; P2 : price of a substitute; P3 : price of a complement; I: consumers’ income level

Other variables (weather, changes in law, promotional campaigns, public image, etc.)

)log()log()log()log()log( 3322 IcPbPbPbaQ

+ other variables

Problems with Statistical Estimation

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Data are not available.

Simultaneous problemhigh demand expected … high pricelow demand expected … low price

Curse of dimension

Simultaneous problem

Election Campaign spending vs. voting rates No relationship or negative one Not natural experiment

Premium for Tokyo University

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Instrument variables Price correlation, but no correlation with

demand side Fish Market Sugar Market

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Merger Simulation

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eP

MCP 1

1. Estimating demand elasticities2. From observed price, we estimate costs3. After merger, elasticities change.4. From the new elasticities and costs, we predict

new prices.

Why elasticities change?

Full service or self service gas station. Stations providing both services Stations providing only full service

In which stations gas prices are higher? Boston, empirical studies

Beer vs. Soju, Hyundai vs. Kia

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