An Economic Approach for Collective Dominance

Ekrem KalkanŞ.Demet Kaya Korkut

(Turkish Competition Authority)

Aim and Plan

• Aim: Present how empirical economics can be a useful tool in evaluating collective dominance in merger cases.

• Plan• Law: Legal assessment on collective dominance

• Merger legislation (single dominance and collective dominance)• Case law (old Ladik Çimento decision)

• Economics: Economic approach to assess collective dominance• Factual analysis (Merger guidelines)• Applied economics (Game theory: grim-trigger strategies, merger simulation method)

Confidentiality

• No details of the analysis at firm level• Only methodological issues to be presented

Legal assessment of collective dominace• Turkish Merger Legislation (Art. 7 of Competition Law):• Merger by one or more undertakings, or acquisition by any undertaking or person from another

undertaking … with a view to creating a dominant position or strengthening its / their dominant position, which would result in significant lessening of competition in a market … is illegal and prohibited.

• Dominant position (Art. 3): The power of one or more undertakings in a particular market to determine economic parameters such as price, supply, the amount of production and distribution, by acting independently of their competitors and customers,

Horizontal Merger Analysis (EU and USA Guidelines)• Single Dominance / Unilateral effects :

• Whether merging parties unilaterally - independent of the reaction of the rivals- could gain a market power or strengthen their existing power to increase prices, decrease production, restrict innovation etc.

• Loss of competition between the merging firms• Non-merging firms in the same market can also benefit from the reduction of competitive pressure that results from

the merger, since the merging firms' price increase may switch some demand to the rival firms, which, in turn, may find it profitable to increase their prices.

• Collective Dominance / Coordinated effects :• The concept of dominance is also applied in an oligopolistic setting to cases of collective dominance.• A horizontal merger may change the nature of competition in such a way that firms that previously were not

coordinating their behaviour, are now significantly more likely to coordinate and raise prices or otherwise harm effective competition. A merger may also make coordination easier, more stable or more effective for firms which were coordinating prior to the merger

Case Law on Collective Dominance: Airtours vs. Commission (CFI, 2002)• EU Commission prohibited Airtours/First Choice merger• CFI annuled the decision (2002) and criticized the Commission: Considering

only market characteristics is not sufficient• Three conditions for collective dominance: • 1. Ability to monitor to a sufficient degree whether the terms of coordination

are being adhered to • 2. Is there some form of credible deterrent mechanism, that can be activated,

if deviation is detected• 3. The reactions from outsiders such as current and future competitors not

participating in the coordination, as well as customers, should not be able to jeopardise the results expected from coordination

EU Merger Guidelines on Collective Dominance• EU Commission considers the changes that the merger brings about.• Structural factors which facilitate coordination:

• Low number of firms • Homogenous product• Stable economic environment (demand and supply conditions), difficult entry, no innovation.• Symmetric firms (cost/supply fn., similar capacity levels and vertical integration levels )• Easy exchange of information, transparency in firms’ conducts• Simple characteristics of consumers (easy to identify a customer’s supplier)• Cross-shareholding• A maverick firm in the merger?• Evidence of past coordination or evidence of coordination in similar markets may be useful information.

EU Merger Guidelines on Collective Dominance• Monitoring: Are markets sufficiently transparent to allow the coordinating firms to monitor

whether other firms are deviating and to know when to retaliate?

• Enforcement: Deterrent mechanisms: Is there a credible threat of future retaliation that keeps the coordination sustainable?• Credibility: Punishing the deviator by temporarily engaging in a price war or increasing output significantly, may

entail a short-term economic loss for the firms carrying out the retaliation. • Are the short-term losses smaller than the long-term benefits of retaliating, which aims to return to coordination.

• Other factors: Potential competition, buyer power, efficiencies.

Case Law in Turkey

• (2005) Acquisition of Ladik Çimento by Akçansa (Cement market)• TCA blocked the merger depending on the argument of creation of

collective dominance• Council of State: interim judgement

• Collective dominance is not defined in the Turkish Competition Act

• TCA objected• Market conditions changed (a JV is terminated by their owner)• Akçansa re-applied and got the permission• Case is closed, we did not have any final judgement on the problem of

lack of «the defitinion of collective dominance in the Act»

Case Law in Turkey

• (2009) Acquisition of LaFarge plants by OYAK (Cement)• TCA assessed the collective dominance, but decided that the merger

does not create a collective dominace due to the existence of powerful rival in the market (Nuh Çimento)• No economic analysis is done for collective dominance in these cases• Only factual analysis done

Literature on sustainability of coordination• In the recent studies the enforcement mechanism has become a central concern to gauge

coordinated effects. • Sabbatini (2006), Kovacic et al. (2009), Davis and Huse (2010), Harrington (2013) study

sustainability of collusion in differing market conditions. • They present empirical methods to be employed in the assessing the risk of collusion after the

merger as focusing on a collusive equilibrium and relevant discount factors which are used to calculate the future profits and make this equilibrium feasible and profitable for all the parties.

• They differentiate in employing several market features such as differentiated products, existence of competitive fringe, multi-market contact, the existence of antitrust authority etc.

• Besides, all of them adopt an approach for the type of competition, whether Bertrand or Cournot, but the same punishment mechanism in the market.

• Punishment mechanism: Trigger strategies (Friedman 1971), and results in a competitive equilibrium forever, once cheating occurs from the collusive behavior.

• We follow Davis and Huse (2010).

Incentive of a firm (f) to coordinate

• , and are the profits of the one-period stage game in cases of coordination, defection and Nash equilibrium, respectively. • These profits are calculated by assuming a particular strategic

interaction among firms (coordination, defection or Nash equilibrium) and then by solving the first-order conditions of firms according to this behavioral assumption. • Behavioral assumption: firms compete in prices with differentiated

products (Bertrand game)

Incentive of a firm to coordinate

• (1)

• (2) • (3)

• Is the incentives to coordinate increase after merger?

Problem and solution we suggest:

• : discount factor at firm level (Between 0-1)• This is a measure of the «importance that a firm assigns to future

revenues»• difficult to know for every firm, for every period.

• : cost of capital (weighted average of equity and cost of borrowing)• Solution: Find and use «critical» discount factor for every firm f.

Interpretation of critical discount factor• Coordination is profitable if the true discount factor is larger than

• If decreases after merger, then the incentive to coordinate for a firm f increases.

0 1𝛿 𝑓∗

Coordination possible

0 𝛿 𝑓∗

1

Larger possibility of coordination after merger

Why would change after merger (and how)?Remember:• : same before and after merger, for all firms• : same before and after merger for non-merging firms,

but decreases after merger for merging firms, because they deviate from coordination together instead of deviating individually.• : increases after merger for all firms, because merging firms increase their prices and non-merging firms respond also by increasing their prices (Bertrand game).

How much change in ?

• It depends on the changes in and after merger.

Merger simulation: estimate demand elasticities• First, estimate a demand function for firms• Examples: Logit, nested logit, random coefficients, AIDS …• logit demand. • Restrictions on cross-price elasticities:

• Use firm level monthly data:• Prices,• Market shares• Demand shifters• Cost instrumental variables to address endogeneity of prices.

., mjmjkj

Merger Simulation

• Choose an initial period and equilibrium (price) with a particular conduct (i.e. Bertrand Nash equilibrium)• FOC:

• s: revenue market share (vector)• E: elasticity matrix• m: gross-profit margins (vector)

• Solve for m vector, obtain MC.• Iterative process: p, s, e, m … new p, s, e, m … until convergence • p(t)=p(t-1)

0).('. mSdiagEs

Simulation: Merger, Coordination, Defection• Calculate first, Bertrand-Nash profits before merger.• Then, use same MC to find equilibrium prices and profits under• Full-coordination scenario• Merger scenario• Different defection equilibrim prices and profits before and after merger

• given

• Repeat both before and after merger: get critical discount factors

0ˆ).ˆ('.ˆˆ mSdiagEs

Conclusion

• Compare critical discount factors of every firm before and after merger• If it decreases, this firm’s incentive to coordinate increases• If it increases, this firm’s incentive to coordinate decreases

• Evaluate whether the increase/decrease in incentives is large/small.• If delta decreases only for some of firms :

• Find joint probability : (1-)x…x(1-)

• Other game theoretic punishment mechanisms may be modelled and applied for similar purpose.