Joseph J. Simons

Upward Pressure on Price (UPP) Analysis: Issues and Implications For Merger Policy

Farrell and Shapiro’s Upward Pressure on Price (UPP) framework is an innovative and elegant technique designed to evaluate mergers in differentiated product markets. The authors advance their approach primarily as a screen for unilateral effects cases, although others suggest that UPP might be implemented to create a presumption of anticompetitive effect. Whether used as a screen or to establish a presumption, the fundamental workings are the same and the same two issues are present. First, there is no empirical evidence confirming that the method can reliably predict whether a merger is likely to increase price and second, UPP analysis screens or presumes as anticompetitive a very large universe of mergers. We develop simple simulations illustrating that a UPP- based approach would identify mergers as potentially problematic at levels that have not attracted serious scrutiny from any major antitrust authority in decades. Farrell and Shapiro’s UPP methodology also has potential as an alternative to merger simulation. Here, we are cautiously optimistic that UPP analysis can replace the complex simulation models introduced by economists over the last 20 years. While the UPP analysis does sacrifice some detail, it offers greater transparency, and thus everyone (economists, lawyers, judges, and even business executives) can easily understand the effects of the parameters on the predictions of the model. However, we advocate caution because UPP simulation analysis, although holding numerous advantages over traditional simulation, has not been shown to reliably predict the price effects of mergers and should not be used in any particular case without such evidence.

In Defense of Market Definition

Market definition, a concept that has long served to structure competitive analysis, is under assault from theoreticians who object to the inability of the standard analysis to define a market compatible with their models of unilateral effects. Although these unilateral models have not been shown to reliably predict competitive behavior in the real world, our paper raises other concerns associated with substituting unilateral effects models for market definition. We suggest that the criticisms of market definition are misplaced, because the theoretical analyses lack the benchmarks necessary to establish findings of monopoly power. Moreover, market analysis serves to build the foundation for a case-specific competitive analysis that reaches well beyond the confines of any one particular economic model. Market definition, structured by the hypothetical monopolist test, and implemented with critical loss analysis, remains a valuable tool for antitrust analysis. As usually applied, the test accepts a proposed market definition as relevant for antitrust analysis whenever the predicted loss in volume (Actual Loss) from a small, but significant and non-transitory increase in price is less than the computed break-even loss in volume (Critical Loss). We discuss how markets can be defined in homogeneous goods, static differentiated goods, and dynamic differentiated goods structures, drawing examples from the case law. Within a relevant market, a case-specific analysis, structured by the concepts in the Merger Guidelines, is able to determine if the merger at issue is likely to substantially lessen competition. Comparable economic analyses can be defined to evaluate a range of other potentially anti-competitive behavior associated using the Rule-of-Reason as a guide.

Should DOJ’s Controversial Approach to Market Definition Control Merger Litigation, the Case of US v. H&R Block

Sometimes what appears to be a little, almost imperceptible change can have a huge impact on a policy regime. The recently revised DOJ/FTC Horizontal Merger Guidelines contain such a change, as the document recognizes the importance of Critical Loss Analysis in defining a market, but introduces a theoretical construct to control the analysis. This approach imposes a structure based on the economist’s Lerner index, and then applies a specific style of diversion analysis to compute the actual loss to a hypothetical price increase. We show that this methodology almost guarantees narrow markets, a change that could support a very significant increase in the level of merger enforcement. However, we also show how this aggressive policy result depends on specific assumptions that are often not justified. Change these assumptions and the traditional implications of a critical loss analysis are restored. The recent Department of Justice (DOJ) challenge of H&R Block’s proposed acquisition of the TaxACT software is used to illustrate the problem. Unjustified theoretical assumptions allowed the DOJ’s expert economist to testify to a narrow market that virtually guaranteed that the merger would be found anticompetitive. In effect, theory, if allowed to control market definition analysis, would significantly reduce the plaintiff’s burden of proof and expand the potential for merger enforcement.

Known Unknowns: Uncertainty and its Implication for Antitrust Policy and Enforcement in the Standard-Setting Context

This article analyzes unilateral misconduct in standard-setting organizations, including in particular various forms of patent hold-up. The authors identify uncertainties facing agencies and courts reviewing such conduct and describe certain analytical frameworks that agencies can use to determine whether enforcement action is appropriate in a particular case. The article examines three key “unknowns”: whether a standard-setting process was abused or misused in some way; whether such misconduct, if any, had a significant adverse effect on competition; and what remedy, if any, would cure such competitive harm. The authors argue that agencies and courts should protect the reasonable expectations of other participants in the standard-setting process, should adopt a practical approach (a “substantial contribution” test) to problems of causation raised by misconduct in the standard-setting arena, and should favor compulsory licensing as a presumptive remedy in standard-setting cases, reserving others (such as disgorgement) for unusual cases in which compulsory licensing fails adequately to deter or remedy anticompetitive misconduct.

A Comment on Choosing Among Tools for Assessing Unilateral Effects Analysis

In a recent paper, Gregory Werden and Luke Froeb present a general discussion of unilateral effects analysis with a particular focus on factors that limit the applicability of the Upward Pressure on Price (UPP) model. In one of our earlier papers, we had provided simple simulations showing that the application of UPP in the broad manner suggested by Farrell and Shapiro could be used to dramatically expand the universe of mergers subject to challenge. Werden and Froeb, in contrast to Farrell and Shapiro, see application of UPP screening as constrained by Bertrand competition, an assumption that implies our simulations over-estimate the potential for the UPP model to increase enforcement. Moreover, they posit that merger simulation is well suited for use in either screening or competitive effects’ analysis, a result, which if true, would marginalize the UPP model. We disagree with their observations, noting that the UPP methodology, as described by Farrell and Shapiro, is designed to be agnostic to the underlying competitive process, and potentially applicable in a range of situations in which simulation would be infeasible. As a result, our simulations do not over-estimate the extent to which a broad application of UPP could possibly expand merger enforcement. We also stress the importance of verifying the predictions of any theoretical model (including an UPP analysis generalized to predict actual price effects) with empirical evidence as an important tool to realistically limit the analysis. Successful substantiation would be necessary to allow the analysis to survive a Daubert challenge. Under Daubert, experts must move beyond theory that is generally accepted in their fields and present evidence to the court to show that the theory fits the facts at issue and is reliably predictive.

Critical Loss: Modeling and Application Issues

Critical Loss analysis is an empirical implementation of the hypothetical monopolist test for market definition contained in the Department of Justice and Federal Trade Commission Horizontal Merger Guidelines. As usually applied, the test accepts the proposed market definition as relevant for antitrust analysis whenever the predicted loss in volume (Actual Loss) from a small, but significant and non-transitory price increase is less than the computed break-even loss in volume (Critical Loss). Critics complain that the predicted Actual Loss must be linked to the Critical Loss, claiming both calculations depend heavily upon the firm/industry margin. We note that the critics derive their result from a particular modeling structure useful only in markets where product differentiation leads to a simple form of price-based competition. Moreover, no clear link between Critical Loss and Actual Loss is likely when the markets are best defined with either homogeneous goods or dynamic differentiation assumptions. Thus, the critics have only introduced a special case generalization of the standard Critical Loss methodology.

Models, Mathematics and Critical Loss

Critical Loss Analysis is an empirical implementation of the hypothetical monopolist test for market definition contained in the Department of Justice and Federal Trade Commission Horizontal Merger Guidelines. As usually applied, the test accepts the proposed market definition as relevant for antitrust analysis whenever the predicted Actual Loss from a small, but significant and non-transitory price increase is less than the computed break-even Critical Loss. While the traditional analysis does not posit an analytical link between the predicted Actual Loss and the break-even Critical Loss, some economists claim the two concepts are mathematically related. They believe that the Critical Loss test will almost never generate broad market definitions in high margin markets. We suggest that the critics overstate their case, because they have only identified a special case modeling structure which may have limited applicability. Revised analyses, drawing on the concepts introduced in this paper, are available elsewhere on SSRN. Text based on Sections II and IV form the core of Coate, Malcolm B. and Joseph J. Simons, “Critical Loss: Modeling and Application Issues,” 2009. Available at SSRN: http://ssrn.com/abstract=1520069. Text building on Section III, along with Appendix A was published as Coate, Malcolm B. and Joseph J. Simons, “Critical Loss vs. Diversion: Clearing up the Confusion,” GCP Antitrust Chronicle, Dec. 2009. Through the courtesy of the editors, this paper is also available at http://ssrn.com/abstract=1562006.