Geographic Market Definition: Horizontal Merger Guidelines vs. Tampa Electric

A court recently excluded an economist’s expert witness testimony because it found that the expert’s hypothetical monopolist test to define the geographic market did not conform to the standard that the Supreme Court articulated in 1961 in Tampa Electric Co. v. Nashville Coal Co. (Tampa Electric). The decision of the U.S. District Court for the Eastern District of Tennessee surprised many observers, since the expert contended that he used the hypothetical monopolist test as it is outlined in the U.S. Department of Justice and Federal Trade Commission’s Horizontal Merger Guidelines (Guidelines). Circuit courts have recognized this test as a valid diagnostic tool, and both sides in this case agreed that, properly applied, the test mirrors the Tampa Electric standard. The district court judge, however, questioned the expert’s application of the test and specifically the equivalence between the expert’s methodology and the Supreme Court’s standard.

The case pertains to an antitrust suit involving the sale of fresh milk in the southeastern United States. Defendants had filed a Daubert motion to exclude the testimony of plaintiffs’ expert witness on the grounds that the methodology that he used to qualify the relevant geographic market was flawed. In his deposition testimony, plaintiffs’ expert explained that he had formed his opinion of the relevant geographic market by applying the Guidelines’ hypothetical monopolist test. The Guidelines outline the antitrust agencies’ general approach towards the enforcement of merger policy and describe the geographic market as a region in which a hypothetical monopolist that was the only supplier of the relevant product could profitably impose a small but significant and non-transitory increase in price (SSNIP). The basic tenet of the test is as follows: If consumers were to respond to a price increase by shifting to an alternate source of supply, and the extent of the shift were sufficient to make the price increase unprofitable, then the geographic market would be too narrow, and additional locations would have to be added.

In Tampa Electric, the Supreme Court defined the relevant geographic market as “the area in which the seller operates, and to which the purchaser can practicably turn for supplies.” Further, the Supreme Court explained both in Tampa Electric and in Brown Shoe Co. v. United States that the relevant geographic market must “correspond to the economic realities of the industry and be economically significant.”

The judge acknowledged that antitrust law has recognized that a hypothetical monopolist test is a valid diagnostic tool for market definition, but he indicated that there was no legal precedent that specifically equated the hypothetical monopolist test to the Tampa Electric standard. The judge was clear that unless and until the Tampa Electric standard was repudiated or modified by the Supreme Court, that standard, and not the definition in the Guidelines, remains the ultimate benchmark against which to evaluate a geographic market test. Since both sides agreed that the hypothetical monopolist test, as it is described in the Guidelines, was an acceptable method of delineating the geographic market for milk sales, the judge was willing to allow such a test, but he sided with the defendants in concluding that the application of the hypothetical monopolist test by plaintiffs’ expert was improper and deviated from the Tampa Electric standard.

To reach this conclusion, the judge indicated that he was relying on what the expert said in the course of his sworn deposition testimony. In particular, when asked about whether he would agree that “a relevant geographic market is the area in which the seller operates, and to which the purchaser can practicably turn for supplies,” plaintiffs’ expert responded that he had taken a “different approach” for the purposes of his analysis. The judge based his decision on that statement and refused to consider the expert’s subsequently filed clarifying declaration, in which the expert sought to explain that the approach he had taken did embody a hypothetical monopolist test and that he had indeed considered the area where plaintiffs had bought milk from defendants.

The judge also sided with defendants in ruling that the expert’s methodology did not conform to the standard in Tampa Electric and in Brown Shoe because it did not duly consider the commercial realities of the market for milk sales. The judge noted a number of facts about the market, such as the location of certain retailers, that the expert ignored. The judge also seemed to take issue with a fundamental underpinning of the expert’s methodology, i.e., the hypothetical nature of his geographic market test. Specifically, the judge pointed out that the expert had used a theoretical model based on “‘estimates’ and ‘assumptions,’” that economic literature describing the expert’s methodology refer to the model’s inputs as hypothetical facts that are not necessarily observable in the real world, and that plaintiffs’ expert had attested in the course of his sworn deposition testimony that he had attempted to identify an area in which there is potential for the exercise of market power, regardless of how agents actually behaved in the market.

The judge also found that the expert’s testimony implied that he in fact had not properly applied the Guidelines hypothetical monopolist test in this case. Interestingly, whether the expert had properly applied the Guidelines test or not, by definition, applying the test would have required some degree of abstraction from the commercial realities of the market, because the test assumes a sole supplier and the market may actually include several suppliers. Thus, the decision implies that the judge might find even a proper application of the Guidelines’ hypothetical monopolist test as being misaligned with Tampa Electric. That implication is disturbing because the test, which has been accepted by many courts, is now a standard procedure among antitrust economists. Economic experts in future proceedings may have to explain the purpose of the test, including why it is necessary to abstract from “commercial realities” and consider a hypothetical monopolist, how they take those realities into account to establish the actual competitive structure of the market, and how their methods are consistent with the Supreme Court’s standard.

Lona Fowdur is a Senior Economist with EI. She has analyzed geographic markets in the context of mergers and acquisitions as well as in antitrust litigation related to the energy and health care industries.