Worked example 4 — Defining the relevant market with cross elasticity

The Competition Act 2002 does not prohibit being large. It prohibits agreements that damage competition, under section 3, and the abuse of a dominant position, under section 4. Both provisions can only be applied once the market has been defined and the firm's position within it established. Defining the market narrowly makes a firm look dominant; defining it widely makes it look small. That is why the definition of the market is the most heavily contested issue in most competition litigation — and why an examiner who sets a dominance problem is really setting a market-definition problem.

The Act supplies them, and they are pure economics.

• Relevant market means the market which may be determined by the Commission with reference to the relevant product market or the relevant geographic market or with reference to both.
• Relevant product market means a market comprising all those products or services which are regarded as interchangeable or substitutable by the consumer, by reason of characteristics of the products or services, their prices and intended use.
• Relevant geographic market means a market comprising the area in which the conditions of competition are distinctly homogenous and can be distinguished from the conditions prevailing in the neighbouring areas.

Three words in the product-market definition carry the whole test: interchangeable, substitutable, and — decisively — by the consumer. It is not the regulator's view of similarity that matters, nor the producer's. It is whether buyers switch.

Cross elasticity supplies the number. It is the responsiveness of demand for commodity X to a change in the price of commodity Y: the proportionate change in the quantity demanded of X, divided by the proportionate change in the price of Y.

| Cross elasticity | Meaning | Market-definition consequence | |---|---|---| | Approaches infinity | X is nearly a perfect substitute for Y | X and Y are certainly in the same relevant product market | | Is zero | The two commodities are not related at all | Separate markets | | Is negative | Y is complementary to X | Separate markets — and a tying question may arise instead |

The two goods may be substitutes, as with tea and coffee, or complementary, as with ball pens and refills.

The rule, stated in one line. If a rise in the price of X sends buyers to Y — a high positive cross elasticity — then X and Y are in the same relevant product market, and a firm that looks dominant in X alone may not be dominant at all once Y is counted.

The facts that follow are invented for this exercise. They describe no real enterprise, product or proceeding.

Suppose an enterprise supplies a packaged beverage, product X. It has 70 per cent of the sales of X in a State. A complaint alleges abuse of a dominant position under section 4.

The enterprise contends that the relevant product market is not X alone but all packaged beverages, X together with Y and Z, in which its share would be 22 per cent.

Apply the test.

(a) Compute the cross elasticities. Suppose that when the price of X rose by 10 per cent, the quantity of Y demanded rose by 12 per cent, and the quantity of Z demanded did not move at all.

• Cross elasticity of Y with respect to the price of X = 12 ÷ 10 = +1.2. Strongly positive: buyers leaving X go to Y. Y belongs in the market.
• Cross elasticity of Z with respect to the price of X = 0 ÷ 10 = 0. The two are not related at all. Z is out.

(b) Test the answer against the statutory words. The definition asks about interchangeability by reason of the characteristics of the products, their prices, and their intended use. A coefficient of +1.2 is evidence of all three at once: buyers who could switch, did. A coefficient of 0 says the opposite about Z, whatever the two products look like on a shelf.

(c) Recompute the share. With Y in the market and Z out, the enterprise's share of the combined X-plus-Y sales might be, say, 44 per cent — neither the 70 per cent the complaint asserted nor the 22 per cent the enterprise asserted. Market definition has moved the case, and it has moved it on evidence rather than on assertion.

(d) Then, and only then, ask about dominance. Section 4 defines a dominant position as a position of strength, enjoyed by an enterprise, in the relevant market, in India, which enables it to operate independently of competitive forces prevailing in the relevant market, or to affect its competitors or consumers or the relevant market in its favour. That is the economist's price maker, put into statutory language — and notice that it is a test of strength, not a share threshold. A 44 per cent share is a fact from which strength may be inferred; it is not itself the statutory test.

(e) And remember that dominance is lawful. Section 4(1) says only that no enterprise shall abuse its dominant position. Being dominant is not an offence; abuse is, and section 4(2) lists what counts — unfair or discriminatory conditions or prices including predatory pricing, limiting production or technical development to the prejudice of consumers, denial of market access, tying supplementary obligations unconnected with the subject of the contract, and using a dominant position in one relevant market to enter or protect another. There is a defence built into the first item: a discriminatory condition or price adopted to meet the competition is not caught.

The geographic definition asks where the conditions of competition are distinctly homogenous and can be distinguished from the conditions prevailing in the neighbouring areas. The economic test is the same in substance: if buyers in district A will buy from a supplier in district B when the price in A rises, the two districts are one market.

What makes conditions non-homogeneous is usually cost or law: transport cost that makes distant supply uneconomic, perishability, or a regulatory barrier that stops goods moving. Note that the last of these is a legal fact producing an economic one — which is why market definition in a regulated sector so often turns on the terms of the regulation rather than on the product.

Cross elasticity is not confined to section 4. It reappears in three places on this syllabus, and naming them shows range.

1. Section 3(3) horizontal agreements. Enterprises are caught by the presumption when they are engaged in identical or similar trade of goods or provision of services. Whether two firms are competitors at all is the same substitutability question.
2. Price discrimination. The second of the five conditions for workable price discrimination is that different segments must have different price elasticities — and the fourth, that there must be no seepage between the two markets, meaning a consumer cannot buy at the low price in the elastic sub-market and re-sell to consumers in the inelastic sub-market at a higher price. Seepage is substitutability inside the firm's own customer base.
3. Monopolistic competition. Product differentiation is what creates the structure: products are made different to attract separate groups of consumers, and each firm becomes a monopolist in its own variety. Differentiation is, in this vocabulary, a deliberate reduction in cross elasticity — which is precisely what a trade mark protects and what a competitor is not allowed to appropriate.

It reports no decision, cites no authority for any outcome, and uses no real market. What is sourced, and may be quoted, is the statutory language of sections 3 and 4 and of the definitions, and the economic definitions of cross elasticity and of the market structures.

1. Define the market first: relevant market = relevant product market and/or relevant geographic market.
2. Product market = products regarded as interchangeable or substitutable by the consumer, by characteristics, prices and intended use. Geographic market = area where conditions of competition are distinctly homogenous and distinguishable from neighbouring areas.
3. The measure is cross elasticity: high positive → same market; zero → unrelated; negative → complements.
4. A narrow market makes a firm look dominant; a wide one makes it look small. Hence it is the most contested issue in the litigation.
5. Only then does section 4 apply — and dominance is lawful; abuse is the offence, with a meet-the-competition defence to discriminatory pricing.