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Amicus Curiae

Defining the market: a critical step in merger review

Felice Suzanne D. Soria

September 26, 2017

The Philippine Competition Act (PCA) prohibits merger or acquisition agreements that
substantially prevent, restrict or lessen competition in the relevant market.
 
Thus, defining a relevant market is a critical step in merger analysis.
 
Defining the relevant market serves as a basis to identify the competitors in the market,
the merging companies’ individual and combined market shares, and market
concentration levels. Each of these factors helps to show the merger’s effect on
competition. For example, higher market shares and market concentration levels
typically mean the transaction is more likely to hurt competition in the market by, among
other things, raising prices or decreasing output.
 
Basically, market definition involves identifying the specific line of commerce (product
market) and area of the country in which competition takes place (geographic market).
For this purpose, the “hypothetical monopolist” or SSNIP test may be used to determine
the relevant market in which to analyze the competitive effects of a proposed merger.
The SSNIP test generally identifies a product and a geographic space in which a
hypothetical monopolist would profitably exercise market power.
 
Under this test, the Philippine Competition Commission (Commission) identifies the
relevant market as a product or group of products and a geographic area in which it is
produced or sold, for which a hypothetical, profit maximizing firm, not subject to price
regulation, that was the only present and future producer or seller of the product in that
area, would likely impose a “small but significant and non-transitory increase in price”
(commonly referred to as a SSNIP), assuming the terms of sale for all products outside
the candidate market are held constant.
 
According to the Commission’s Merger Review Guidelines (Merger Guidelines), the
Commission applies the SSNIP test to a candidate market of each product produced or
sold by each of the merging firms, assessing what would happen if a hypothetical
monopolist of that product imposed at least a SSNIP on that product, while the terms of
sale of all other products remained constant. If the hypothetical monopolist would not
profitably impose such a price increase because of substitution by customers to other
products, the candidate market is not a relevant product market by itself. The
Commission then adds to the product group the product that is the next-best substitute
for the merging firm’s product and apply the SSNIP test to a candidate market of the
expanded product group. The process continues until a group of products is identified
such that a hypothetical monopolist supplying the products would be able to exercise
market power and profitably impose a SSNIP in the candidate market. The relevant
product market generally will be the smallest group of products that satisfies the test.
 
A “small but significant and non-transitory increase in price” will depend on the nature of
the industry, but a common benchmark is a price increase of between 5% and 10%
lasting for the foreseeable future (e.g., one to three years depending on market
conditions and the type of market).
 
HYPOTHETICAL MONOPOLIST TEST FOR PRODUCT MARKET DEFINITION
As stated in the PCA, a relevant product market comprises all those goods and/or
services that are regarded as interchangeable or substitutable by the consumer or the
customer, by reason of the goods and/or services’ characteristics, their prices, and their
intended use. Product definition considers the consumer’s perspective or the customers’
response to a price increase or a corresponding non-price change.
 
In determining the appropriate product market in which to assess the competitive effects
of a merger, the Merger Guidelines provide that the Commission considers not only
whether products are functional substitutes, but also whether they are good economic
substitutes for sufficient numbers of customers so as to make a SSNIP unprofitable. In
doing this, economic tools may be used.
 
Cross-price elasticity of demand measures the rate at which the quantity of a product
sold changes when the price of another product goes up or down.
 
When the cross-price elasticity is positive, those products are substitutes; if they are
negative, those products are complements. Where there is zero cross-elasticity, the
products in question will be unrelated. Diversion ratios provide a direct measure of the
closeness of competition between products. The diversion ratio between product A and
B is defined as the percentage of lost sales of product A which are diverted to product
B, should A increase its price. The higher the diversion ratio from A to B, the greater is
the competitive constraint that B imposes on A.
 
HYPOTHETICAL MONOPOLIST TEST FOR GEOGRAPHIC MARKET DEFINITION
Relevant geographic market comprises the area in which the entity concerned is
involved in the supply and demand of goods and services, in which the conditions of
competition are sufficiently homogenous and which can be distinguished from
neighboring areas because the conditions of competition are different in those areas.
Geography may limit some customers’ willingness or ability to substitute some products,
or some suppliers’ willingness or ability to serve some customers.
 
A single firm may operate in a number of geographic markets. The Merger Guidelines
provide that the Commission applies the SSNIP test to a candidate market of each
location in which each merging firm produces or sells the relevant product, assessing
what would happen if a hypothetical monopolist in that location imposed at least a
SSNIP on sales of the product in that location, while the terms of sale in all other
locations remained constant. If the hypothetical monopolist would not profitably impose
such a price increase because of substitution by customers to products from other
geographic areas, the candidate market is not a relevant geographic market by itself.