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17 Antitrust 49 (2002-2003)
Critical Loss: Let's Tell the Whole Story

handle is hein.journals/antitruma17 and id is 143 raw text is: Critical Loss: Let's Tell the Whole Story BY MICHAEL L. KATZ AND CARL SHAPIRO I N LITIGATION CHALLENGING A proposed or consunmnatcd horizontal merger, the gov- ernment typically attempts to establish a presumption that the challenged merger would likely harm competi- tion based on a showing that the merger would signifi- cantly increase concentration in one or more defined relevant antitrust markets. Because the delineation of the relevant market determines the market shares of the merging firms and the impact of the merger on concentration, market def- inition can he critically important in merger litigatiun. Market definition alsn plays a role in governmental deci- sinns whether in challenge mergers. Although many econo- mists think that market definition and market shares tend to get too much attention in the analysis of horizonta mergers, in practice market definition is often a central topic in agency investigations of mergers. The Antitrust Division of the U.S. Department of Justice, the Federal Trade Commission, and at least one other federal agency that examines mergers, the Federal Communications Commission, all conduct market definition exercises. The now-standard procedure for defining relevant prod- uct markets in horizontal merger cases asks whether a hypo- thetical monopolist controlling a group of products would find it profitable to raise the price ofat least one product sig- nificantly above the prevailing level.' According to the DOJ and FTC 1 Iorizuttal Merger Guidelines, a relevant product market is: a product or group of products such that a hypothetical profit-maximizing firm that was the only present and future seller of rhose products (monopolist) likely would impose at east a ma l but significant and nontransitory increase in price .... Michael L. Kali Is Edward J. and Moille Arnold Professor of Business Administraiion. Hoes Schoo of Business, University of California at Berkeley. This article was written while Katz was the Deputy Assistant Altorney General for Economic Analysis ot the U.S. Department of Justice. The arlicle (toes not draw on any confidential materials or Information, and the views erpressed do nol necessarily represent the views of tIhe U.S. Detvattment of justlce. Carl Siapiro Is rransameriea Professor of Business Strategy, lions School of Business, Universliy of California at Berkeley, and Senior Consultant, Charles River Associates. The authors thank Joseph Ferell, Sloven Salop. Grog Vistnes. and Gregory Werden far helpful comments an earlier draffs of this paper. Specifically, the Agency will begin with each product (nar- rowly defined) protduced or sold by each merging firm and ask what would happen if a hypothetical motmplist of dita product imposed at least a snall but significant and nnn- transitory incra.C'S in price. but the terms tEfSaIe Ofall other products remained constant. If, in response to the price increase, the reduction in sales of the product would be large enough that a hypothetical monopolist would not find it profitable to impose such an increase in price, then the Agency will add to the product group the product that is the next-best substitute for the merging firm's product. (footnote omitted),.. The price increase question is then asked for a hlthlstical monopolist controlling tie expanded product group. It per- forming successive iterations of the price increase test, the hypothetical monopolist will be assumed to pursue maxi- mum profits in deciding whether to raise the prices of any o all of the additional products under its control. This process will continue until a group of products is identified such that a hypothetical monopolist over that group of products would profitably impose at least a small but significant and non- transitory increase, including the price ofa product of one of the merging firm%. The Agency generally will consider the relevant product market to he the smallest group nfproducts that satisfies this test.2 To illustrate, consider a proposed merger between two colipanies manufacturing prescription sleeping pills. If a single firm controlling all brands of prescription sleeping pills would find it profitable to impose a small but significant and nontransitory increase in price (5SNIP) for at least one of the brands sold by the merging parties, then prescription sleeping pills constitute a relevant product market. If not, then the next-best substitute, e.g., non-prescription sleeping pills, is added to the candidate relevant market and the test is repeated. As a matter of arithmetic, the effect of a SSNIP on the hypothetical monopolist's profits depends upon the prevail- ing profit margin earned on each unit sold and ill the per- centage of unit sales that would be lost as a result of the price increase. We call the latter the actual hoss. 'lhe maxi- trial percentage of unit sales that can be lost for the price increase to be profitable is known as the critical loss. ' If the actual loss from a price increase would be greater than the critical loss, the price increase Would be unprofitable. A critical loss calculation can thus usefully frame the empirical estimation of demand responsiveness for the put- SPRINO 200 4 9

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