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24 Antitrust 27 (2009-2010)
Will Use of the Upward Pricing Pressure Test Lead to an Increase in the Level of Merger Enforcement

handle is hein.journals/antitruma24 and id is 29 raw text is: Will Use of the Upward Pricing Pressure Test
Lead to an Increase in the Level of
Merger Enforcement?

BY GOPAL DAS VARMA

OSEPH FARRELL AND CARL SHAPIRO,
Chief Economists of the Federal Trade Commission
and the Antitrust Division of the Department of
Justice, respectively, have recently proposed an alter-
native to market definition as a screen for the unilat-
eral effects of a merger between firms that produce differen-
tiated products.' This alternative is called the Upward Pricing
Pressure (UPP) test. It eschews the traditional structural
approach, in which a relevant antitrust market is defined
and shares and concentration are calculated to determine
whether the merger exceeds certain thresholds (structural
presumption).2 Instead, the UPP test appeals directly to the
economic theory of how a merger alters unilateral pricing
incentives.' Separately, in his recent writings, Shapiro has
argued forcefully that merger enforcement by the agencies
was too lax during the George W. Bush administration and
he recommended strengthening merger enforcement activi-
ty by, among other things, updating the structural presump-
tion.4 The agencies' recently announced plans to consider
revising the Horizontal Merger Guidelines has led to con-
siderable interest in the UPP test and the possibility that it
might supplant the traditional structural presumption.'
Two questions are raised by the potential replacement of
the structural presumption with the UPP test. First, what are
the characteristics of mergers that do not create a structural
presumption but are likely to create a UPP presumption,
and vice versa? Second, overall, will the UPP alternative to the
structural approach lead to fewer or more instances in which
the agencies will subject mergers to additional scrutiny on
unilateral effects grounds?
Background of the UPP Test
To answer these questions, it may be helpful to review how
the UPP test works in practice and how it differs from struc-
Gopal Das Varma is a Principal in the Washington, DC office of Charles
River Associates. The views expressed in this article are the author's per-
sonal opinions and do not necessarily represent the views of Charles
River Associates or its other consultants. The author would like to thank,
without implicating, Martino DeStefano, Andrew Dick, and Serge Moresi for
helpful comments on an earlier draft.

tural analysis.' A key determinant of the competitive con-
straint imposed by one differentiated product on another is
the extent to which the products are close substitutes of one
another in the chain of buyer substitution. Closeness of sub-
stitution may not be reflected accurately by market shares.
For example, a large proportion of the buyers of one product
might consider another specific product to be their second
choice even though the collective share of the two products
in a defined relevant market is small. A merger between two
such products, by eliminating the local competitive con-
straint between them, might nevertheless result in higher
prices. The UPP test avoids this potential problem with the
structural approach because it directly evaluates the potential
for a merger's unilateral price effects by appealing to the the-
ory of how a merger affects the merging firms' post-merger
pricing incentives.
A related practical problem with the structural approach
is the decision regarding where to draw the boundaries of the
relevant market, i.e., which products to include in the mar-
ket definition. In both Whole Foods-Wild Oats and Oracle-
PeopleSoft-two relatively recent mergers in which the agen-
cies sought enforcement action-the district courts held that
the relevant market definitions proposed by the agencies
were too narrow because they did not include other prod-
ucts that, in the courts' judgment, were reasonably inter-
changeable with the merging firms' products.7 The UPP
test can avoid such controversies regarding which products to
include in the relevant market and which ones to leave out.
UPP derives from the basic economic theory of unilater-
al effects. Under certain assumptions, the UPP test measures
the competitive constraints that are eliminated by a merger.
Following a merger, each merging firm has an incentive to
raise its price because it stands to recapture through its merg-
ing partner's product some of the sales that it loses due to the
price increase. The value of the recaptured sales is measured
by the appropriate diversion ratio between the merging firms'
products multipled by the dollar value of the variable margin
earned on the merging partner's product. The more closely
substitutable are the merging firms' products, the higher is
the diversion ratio between them. The higher is the variable
margin earned on the merging partner's product, the greater

FALL  2009  -  27

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