Relevant market

Relevant Market

A relevant market is a core concept in the field of antitrust law and competition policy, defining the specific area of economic activity within which businesses compete. It encompasses both the product or service in question (product market) and the geographic area where it is offered (geographic market). Regulators and courts use the definition of a relevant market to assess the competitive effects of mergers, acquisitions, and business practices that might restrict trade or create a monopoly. Establishing the boundaries of the relevant market is crucial for determining whether a firm possesses market power or has engaged in anticompetitive conduct.

History and Origin

The concept of the relevant market evolved alongside the development of antitrust enforcement, particularly in the United States. Early U.S. antitrust legislation, such as the Sherman Antitrust Act of 1890, broadly prohibited anticompetitive agreements and monopolization without explicitly defining how markets should be delineated. The Sherman Act, passed by Congress and named for Senator John Sherman, declared illegal "every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations."⁷

Over time, legal precedents and economic analysis led to more sophisticated methods for defining the competitive arena. Key developments included the recognition that competition authorities needed a structured approach to identify the boundaries within which a firm's market power could be meaningfully assessed. This analytical framework became vital in evaluating potential violations of antitrust laws. Modern approaches to defining a relevant market involve rigorous economic tests to determine substitutability from both demand and supply perspectives.

Key Takeaways

• A relevant market defines the specific product or service and geographic area within which companies compete.
• It is a foundational concept in antitrust and competition policy, used to assess market power and the impact of business activities.
• The definition relies on determining the substitutability of products or services from the perspective of both consumers (demand) and producers (supply).
• Regulatory bodies, such as the U.S. Department of Justice (DOJ) and Federal Trade Commission (FTC), as well as the European Commission, utilize established guidelines for relevant market definition.
• Accurate relevant market definition is crucial for effective antitrust enforcement and ensuring fair competition.

Formula and Calculation

While there isn't a single, universally applied mathematical formula for the overarching definition of a relevant market, a primary conceptual tool used by competition authorities is the "Small but Significant Non-transitory Increase in Price" (SSNIP) test. This test helps determine the boundaries of a product market.

The SSNIP test asks: If a hypothetical monopolist imposed a small (e.g., 5-10%), but significant and non-transitory increase in the price of a product, would enough customers switch to alternative products or suppliers to make the price increase unprofitable?

If enough customers switch, then the market definition is too narrow, and the alternative products (or their suppliers) should be included in the relevant market. If the price increase would be profitable, then the proposed market is considered to be a relevant market.

The application of the SSNIP test is often qualitative and empirical, relying on data analysis of consumer behavior, price correlation, and industry characteristics rather than a precise formula with numerical inputs. It aims to identify the closest substitute goods that constrain a firm's pricing strategy.

Once a relevant market is defined, market concentration within that market is often calculated using measures like the Herfindahl-Hirschman Index (HHI). The HHI involves summing the squares of the individual market share of all firms in the market.

Interpreting the Relevant Market

Interpreting the relevant market involves understanding the competitive landscape a firm operates within. Regulators define the relevant market to evaluate a company's ability to influence supply and demand or exert market power. For instance, if a company has a high market share within a narrowly defined relevant market, it might be deemed to have significant market power, potentially raising antitrust concerns. Conversely, a seemingly large company might have a small market share if the relevant market is broadly defined, indicating less power.

The determination of a relevant market involves both a product market and a geographic market component. The product market considers which goods or services are interchangeable from the consumer's perspective, while the geographic market determines where those products or services are realistically available to consumers. The interpretation helps authorities understand if consumers have viable alternatives should a dominant firm attempt to raise prices or reduce quality.

Hypothetical Example

Consider two major soft drink manufacturers, Company A and Company B, proposing to merge. To assess the competitive impact of this proposed merger and acquisition (M&A), antitrust authorities would first define the relevant market.

Step 1: Product Market Definition
Authorities would consider whether consumers view Company A's popular cola drink as substitutable with Company B's popular cola. They might apply the SSNIP test. If Company A were to significantly raise the price of its cola, would consumers switch to Company B's cola, other carbonated soft drinks, juices, bottled water, or even tap water? If consumers primarily switch to other colas, the initial product market might be "cola beverages." If they switch to all carbonated soft drinks, the market expands to "carbonated soft drinks." The objective is to find the smallest set of products for which a hypothetical monopolist could profitably raise prices.

Step 2: Geographic Market Definition
Next, authorities would determine the geographic scope. Is the market local, national, or international? If soft drinks are distributed and priced nationally, the geographic market might be the entire country. If local distribution networks and pricing variations are significant, it could be regional or even city-specific.

Step 3: Market Power Assessment
Once the relevant market (e.g., "national market for carbonated soft drinks") is defined, the authorities would calculate the combined market share of Company A and Company B within this market. If their combined market share is very high, and there are significant barriers to entry for new competitors, the merger might be challenged on antitrust grounds.

Practical Applications

The concept of a relevant market is fundamental to the enforcement of antitrust laws and plays a critical role in several real-world scenarios:

• Merger Review: Government agencies, such as the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), meticulously define relevant markets when reviewing proposed mergers and acquisitions. Their 2023 Merger Guidelines, for example, detail how they assess whether a merger would significantly increase concentration and potentially harm competition within a properly defined relevant market.⁵, ⁶ The European Commission also recently revised its Notice on the definition of the relevant market for similar purposes in Union competition law.⁴
• Monopolization Cases: In cases alleging monopolization, courts must first determine if the accused firm possesses monopoly power within a relevant market. A landmark example is United States v. Microsoft Corp., where the relevant market was defined as Intel-compatible personal computer operating systems worldwide. The court found that Microsoft held a monopoly in this market, protected by an "applications barrier to entry."³
• Abuse of Dominant Position: In jurisdictions like the European Union, competition authorities investigate companies for abusing a dominant market position. Defining the relevant market is the first step in establishing such dominance.
• Cartel Investigations: While defining the relevant market is less central to proving a cartel (which involves explicit agreements to fix prices or divide markets), understanding the competitive landscape helps illustrate the impact of such agreements.
• Regulatory Policy: Beyond enforcement, regulatory bodies consider relevant market definitions when crafting policies related to telecommunications, energy, and other regulated industries to ensure a level playing field and promote consumer welfare.

Limitations and Criticisms

Defining a relevant market is often a complex and sometimes contentious process, facing several limitations and criticisms:

• Dynamic Markets: In rapidly evolving industries, especially those driven by technological innovation, the boundaries of a relevant market can shift quickly. New products or services can emerge as substitutes, making static market definitions challenging. This is particularly true in digital markets where products may be offered at a zero monetary price, complicating traditional SSNIP tests.¹, ²
• Blurred Lines: Many modern products and services are multi-functional or operate on multi-sided platforms, making it difficult to define discrete product markets. For example, is a smartphone part of the "mobile phone market," "portable computing market," or "digital camera market"?
• Data Challenges: Obtaining the precise data required for rigorous economic analysis, such as consumer switching patterns or cross-price elasticity of demand, can be difficult and expensive.
• Subjectivity: Despite economic tools like the SSNIP test, there can be a degree of subjective judgment involved in determining what constitutes a "small but significant" price increase or a "non-transitory" period.
• Litigation Burden: Disputes over relevant market definition can significantly prolong antitrust litigation, consuming substantial resources for both companies and regulatory bodies. Critics argue that overly narrow or broad definitions can lead to erroneous antitrust outcomes.

Relevant Market vs. Market Share

While often discussed together, the relevant market and market share are distinct but interdependent concepts in competition analysis.

Relevant Market refers to the theoretical boundary that defines the arena of competition. It answers the question, "In which specific product or service space, and geographic area, do these firms actually compete?" It's a qualitative and quantitative exercise to identify all reasonably interchangeable products or services available to consumers within a given region.

Market Share, on the other hand, is a quantitative measure that expresses a company's sales or volume as a percentage of the total sales or volume within that defined relevant market. It answers the question, "How large is this firm's portion of the competitive pie?" A firm's market share is only meaningful once the relevant market has been accurately identified. A company might have a large share in a narrowly defined market, but a small share if the market is defined more broadly.

In essence, the relevant market provides the context, and market share provides the measurement within that context. Competition authorities first define the relevant market to then meaningfully calculate and interpret market shares for individual firms and assess market concentration.

FAQs

What is the primary purpose of defining a relevant market?
The primary purpose is to identify the competitive boundaries within which a firm operates, enabling antitrust authorities to assess its market power and determine if its actions might harm competition or consumers.

How do regulators determine the product market?
Regulators determine the product market by identifying all products or services that consumers consider to be close substitutes. The conceptual SSNIP test is often used, asking if a small price increase by a hypothetical monopolist for one product would cause enough customers to switch to alternatives to make the price hike unprofitable.

What factors are considered when defining the geographic market?
Factors for defining the geographic market include transportation costs, consumer travel patterns, distribution networks, regulatory barriers, and regional pricing differences. The goal is to identify the area where competitive conditions are sufficiently homogeneous.

Why is the relevant market important in merger cases?
In merger cases, defining the relevant market helps authorities determine if the combined entity resulting from a merger would gain excessive market power, potentially leading to higher prices, reduced choices, or less innovation for consumers.

Can a relevant market change over time?
Yes, a relevant market can change over time, especially in industries experiencing rapid technological advancement or shifts in consumer preferences. New technologies or business models can introduce new substitutes or alter existing competitive dynamics.