Greg Werden in Defense of Defining Markets

Josh Wright —  6 March 2012

One of the more significant papers in antitrust of late has been Professor Kaplow’s Why (Ever) Define Markets?  Kaplow provocatively argues that the entire “market definition/ market share” paradigm of antitrust is misguided and beyond repair.  Kaplow describes the exclusive role of market definition in that paradigm as generating inferences about market power, argues that market definition is incapable of generating reasonable inferences for that purpose as a matter of basic economic principles primarily because one must have a “best estimate” of market power previous to market definition, and concludes that antitrust ought to do away with market definition entirely.  As my description of the paper suggests, and Kaplow recognizes, it is certainly an “immodest” claim.  But it is a paper that has evoked much discussion in antitrust circles, especially in light of the recent shift in the 2010 HMGs toward analysis of competitive effects and away from market definition.

Many economists were inclined to agree with the basic conceptual shift toward direct analysis of competitive effects.  Much of that agreement was had on the basis that the market definition exercise aimed to do a number of things directed toward identifying the potential competitive effects of a merger (identifying market power is certainly one of those things), and that if we had tools allowing for direct inferences we ought to use those instead.  Kaplow’s attack on market definition, however, was by far the most aggressive critique.

Greg Werden has now posted an excellent paper in response, “Why (Ever) Define Markets?  An Answer to Professor Kaplow.”  Here is the abstract:

Professor Louis Kaplow has argued that market delineation in antitrust should be abandoned because it is not useful in assessing market power or evaluating competitive effects. This article takes issue with that view, explaining that market delineation serves purposes overlooked by Professor Kaplow. Most importantly, market delineation separates active forces of competition from those in the background. This separation is significant in the application of economic models and in the narrative of presenting an antitrust case. This article also explains why Professor Kaplow’s proposed analyses dispensing with market delineation would break down in important circumstances.

The entire paper is worth reading.  It provides an important perspective on the debate over the value of market definition not only from an economic perspective, but also with respect to the role of market definition in the law.  I summarize a few of the key points and basic arguments of the paper for readers.

Werden first begins by attacking the presumption in Kaplow’s argument that the exclusive purpose of market definition in the modern antitrust paradigm is to infer market power from market share.  For example, Kaplow claims that “the entire rationale for the market definition process is to enable an inference about market power.”  Werden claims, I think correctly, that Kaplow’s premise is incorrect.  While Werden makes the point that courts use market definition to infer market power even in the absence of market shares, the more important argument is that courts have long recognized the high shares themselves do not establish market power — indeed, the law requires the market power be “durable.”  The durability requirement, in turn, requires some analysis of entry conditions before a court can infer market power and, as Werden points out, market delineation is a useful tool for understanding which products — upon entry — would be sufficiently close substitutes as to preclude a firm from charging supra-competitive prices.  Similarly, of course, courts use market definition to cabin where the relevant antitrust injury might occur.

Keith Hylton makes a related, but distinct, argument about the value of market definition in his paper on the 2010 HMGs published in a symposium in the Review of Industrial Organization (note: Professor Kaplow has a shorter article in the Review of IO symposium previewing his arguments in the longer Harvard Law Review piece; I also have an article (with Judd Stone) on the new Guidelines’ treatment of efficiencies in the same issue).  Hylton objects to the change in focus in the new HMGs on the grounds that courts have used the market definition exercise for a number of valuable functions involving the trading off of error concerns in merger analysis:

In implementing the discretionary test of Brown Shoe, courts have traditionally required a definition of the relevant market. In order to determine whether competition appears to be structurally or operationally intense, or whether entry is easy, courts first have to define a relevant market. The definition of a relevant market has involved a fact intensive inquiry that trades off many concerns, in addition to the strict concern of finding a market which could be monopolized by the defendant (through an acquisition or through some anticompetitive conduct). When courts determine a relevant market, they are taking into account the consequences of that decision for the competitive process itself. If defining a market too narrowly will lead to the replacement of the market process of industrial rationalization with an administrative process, or discourage innovation incentives, courts are likely to take those costs into account. They are aware of the possibility that they could err in the decision, and will therefore tend toward a market definition that minimizes the costs of errors.36 The FTC’s standard would relegate the market definition component of a merger dispute to a lesser status. In so doing, it would constrain the ability of courts to make the tradeoffs that currently go into a market definition finding.37

Werden acknowledges that market definition can be avoided in some cases, such as consummated mergers with evidence of actual anticompetitive effects after the acquisition, or in some cases involving unilateral price effects.  Note that while Werden would likely dispense with market definition in some of these cases, the role Hylton ascribes to market definition as applied by the courts would still provide value in both of these types of cases.  Werden also makes the key point that Kaplow’s “direct” analysis of market power assumes that “all of the competitive action is confined to a single homogenous good, and his analysis goes awry when the sellers of the good have a significant strategic interaction with the sellers of close substitutes.”

A related point is that Kaplow’s analysis implicitly uses perfect competition as a competitive benchmark for inferring market power.  Indeed, the analysis presumes that all sellers other than the producer at issue “behave as price-takers.”   As Werden points out, the direct analysis of market power Kaplow prefers establishes market power as a matter of degree measured by the Lerner Index (i.e. the price – cost margin).  For a number of reasons, setting perfect competition as a competitive benchmark can be problematic; but for present purposes, note that to the extent that courts use the market definition inquiry to incorporate considerations wherein a firm might have high margins but yet face intense competition rendering it incapable of harming the competitive process, this would be yet another valuable function of that market definition inquiry.

Werden ends the paper by offering up some examples of the differences between the “conventional” approach and Kaplow’s analysis that are helpful.  You can go to the paper to read them — but Werden’s key point, as I read the paper, is that market definition is useful not only for allowing the assignment of market shares, but also for separating the important elements of the competitive story of a proposed merger (for example) from unimportant elements.   The distinction between those important and unimportant elements can inform modeling choices in unilateral effects cases, or the likelihood of post-merger coordination, and focuses courts on the competitive process to be investigated for potential harm.  His conclusion in response to Kaplow is direct:

Placing less emphasis on market delineation and market shares would be for the best in many antitrust cases, but market delineation serves analytical and narrative purposes not served by other tools.  Professor Kaplow’s proposal to abandon market definition would bring chaos to antitrust litigation.

Please go do read the whole thing.  There is some narrow sense in which I find the debate trivial.  Courts are highly unlikely to adopt Professor Kaplow’s proposal.  There are a number of barriers to eliminating market definition and there is no demand to do so from courts or agencies.  But that would be far too narrow a viewpoint on the issues raised by the paper.  The debate over market definition in the 2010 HMGs, and now spurred by Kaplow’s provocative and well argued paper, is very useful in helping us understand exactly what we aim to achieve through market definition.  The role of market definition in antitrust analysis is much more flexible under the new Guidelines — even if all agree that the agencies must define markets.  How flexible courts and agencies are and should be with respect to market definition does depend precisely upon the answer to the questions Werden tangles with in his paper, i.e. what does market definition accomplish, how well does it accomplish it, and when might we rely upon other tools to accomplish those ends?