Merger Enforcement Guidelines (Banks) - Market Definition

Merger Enforcement Guidelines (Banks) - Market Definition

22. The first stage in the Bureau's review of a merger involves defining the relevant market or markets in which the merging parties operate. Banks supply a large number of products to different types of customers, through various means of distribution and across a large number of geographic areas. As a result there are many relevant markets which will need to analysed in any review of a merger between two Schedule I banks.

23. The Bureau normally defines relevant markets by reference to actual and potential sources of competition that constrain the exercise of market power. However, the vast number of products and services offered by banks, and the similarity in the inputs that are required to offer many of these products, make it difficult to identify and measure the constraining effects of all potential suppliers in a timely manner. As a result, when analyzing a bank merger, relevant product markets are initially defined by actual sources of competition. The potential constraining influence of firms that can participate in the market through a supply response is considered subsequent to an initial market definition. The suppliers that will likely be added to the market within a year are included in market share calculations. This approach to merger assessment is consistent with the approach articulated in the MEGs, but considers supply substitution at a different stage in the analysis. It is also consistent with the merger review process undertaken by the Antitrust Division of the U.S. Department of Justice.⁽⁹⁾

24. The main advantage of using this approach in a bank merger assessment is that it allows the Bureau to quickly identify the markets in which there are likely to be concerns regarding market power arising from the merger. The market share and concentration thresholds discussed above will initially be applied to relevant markets defined with reference to demand substitution. ⁽¹⁰⁾ Unless there is information to suggest otherwise, product and geographic markets for which the thresholds are not surpassed will be given no further consideration. For product and geographic markets where the thresholds are surpassed, the supply of output that is likely to be added to the market by firms not currently producing output in the market, but likely to do so within a year and without incurring significant start-up costs, will be calculated. ⁽¹¹⁾ Market shares and concentration levels will then be re-calculated. The potential constraining influence of competition from sellers who would not likely respond to the postulated price increase in the relevant market within one year is considered subsequent to market share calculation, in connection with the assessment of future entry into the market.

25. In some circumstances, sellers with market power can identify and discriminate against certain buyers. When such discrimination is feasible, it may be appropriate to define relevant markets that associate products with certain classes of buyers. For example, a bank may be able to profitably set higher interest rates for loans to smaller businesses than for similar-sized loans to larger corporations, if the larger corporations have greater access to alternative sources of capital. Price discrimination in banking markets is facilitated by the exchange of information between buyers and sellers -- lenders normally require that borrowers disclose certain information, relating to income, type of business, assets, etc. in order to assess risk before loans are approved. Lenders may use this type of information to distinguish borrowers who are likely to have access to many substitutes from those with few substitutes by charging higher loan rates for borrowers with higher risk or inelastic demands. ⁽¹²⁾ In such cases, an assessment of the competitive effects of a merger would take into account the potential differential effects of the merger on various customers by defining relevant markets with reference to the characteristics of buyers.

26. Relevant markets are normally defined through use of the "hypothetical monopolist" test. Under this test, a relevant market is the smallest group of products (which includes those of the merging firms) and the smallest geographic area such that a sole supplier of these products could profitably maintain a small but significant, non-transitory price increase than would prevail absent the merger. ⁽¹³⁾ The hypothetical monopolist test is applied to define both the product and geographic boundaries of the relevant market.

27. In general, the base price that is employed in postulating a significant and non- transitory price increase is whatever is ordinarily considered to be the price of the product. As the base price for loans and deposits, the Bureau will use the interest rate, or alternatively, the total interest paid on a loan or received for a deposit. The base price for deposits and loans may also include any relevant service fees. For other types of transactions where the banks provide some service (such as wealth management, etc.) the base price will be the service fee.

The Product Dimension

28. The purpose of defining relevant markets is to identify the suppliers with which the merging parties compete. Each relevant market includes all substitute products and services to which consumers would likely turn in response to a significant and non-transitory price increase on the part of the merging banks. ⁽¹⁴⁾ Generally speaking, products are placed in separate product markets if consumers are unwilling and/or unable to switch from one to the other in response to a change in relative prices.

29.When defining relevant product markets, the Bureau will consider the following factors: views, strategies, behaviour and identity of buyers; trade views, strategy and behaviour; end use of products; physical and technical characteristics of products; the costs incurred by buyers in switching from one product to another; and, the relationship between the price movements of products and differences in relative prices. ⁽¹⁵⁾

30. Banks supply products that generally fall into one of the following categories: deposits; loans; mortgages; credit cards; brokerage services; and other services, such as wealth management. Within each of these categories, there may be separate products or groups of products, differentiated from other products, that constitute relevant markets. Whether or not such a subset of products constitutes a relevant market depends on whether customers are willing and/or able to substitute towards other products in response to a significant and non-transitory price increase.

31. Using the hypothetical monopolist test, a given set of products constitutes a relevant product market if a sole supplier of these products could profitably raise prices by a small but significant amount. This is possible only if consumers would not switch a sufficient amount of demand to products outside the set to render the price increase unprofitable. The boundaries of the relevant product market therefore separate the products that are close substitutes for a given product of the merging banks from products that are not close substitutes. Products in the relevant market need not be supplied by banks or other deposit-taking institutions; what matters for the purposes of market definition is not the identity of the supplier, but the characteristics of the products and consumers' willingness to switch their consumption from one product to another in response to changes in relative prices.

32. As an example, loans that differ in their size, amortization, collateral, etc., may not be close enough substitutes to merit inclusion in the same relevant market. Two loans with different characteristics are considered to be demand substitutes only if borrowers would switch from one to the other in sufficient numbers to render an increase in the interest rate of the first loan unprofitable. Thus even loans for different amounts may be in separate markets: a borrower will not necessarily substitute a $100,000 loan for a $10,000 loan in response to an increase in the interest rate on the latter. ⁽¹⁶⁾

33. Similarly, deposits that differ in their characteristics, such as size, maturity, and risk, may be in separate product markets. Deposits with different characteristics will be considered to be in the same relevant market if a sufficient number of depositors is likely to switch to other types of deposits in response to a significant decrease in the interest rate offered.

34. A "grouping" of diverse banking products may also constitute a relevant product market even though the individual products within the grouping are not regarded as close substitutes for each other. A grouping would include a set of products and services that buyers tend to purchase from the same institution (e.g. RRSP investments plus loans to purchase RRSPs; or mortgages with mortgage insurance). A grouping is not necessarily sold as a bundle, but the price or availability of some components of the grouping may be more favourable for the buyer when purchased in conjunction with other products from the same institution.

35. A grouping of banking products constitutes a relevant market when the individual components purchased separately are not a close substitute for the grouping for a significant number of customers. ⁽¹⁷⁾ This will be the case when consumers will not, in response to an increase in the price of a grouping, purchase the various components separately from different institutions. This may be because of the "transactions" costs associated with using a number of suppliers (physical transportation costs, the time taken to make several applications) and economies of scope. If the cost to a supplier of providing the grouping is less than the sum of the costs of providing the components individually, the price a consumer pays for the elements purchased separately is likely to be higher than the price of the grouping. ⁽¹⁸⁾

36. The Bureau will conduct the necessary factual enquiry to determine whether consumers purchase their banking products in groupings and if so what products are included. The Bureau will not be assuming a priori that banking product markets should be delineated on the basis of particular “clusters” of products. Thus, the analytical framework adopted for product market definition is consistent with the approach of the Antitrust Division of the U.S. Department of Justice and does not follow the approach of the U.S. Federal Reserve Board. ⁽¹⁹⁾

37. With respect to whether a grouping of products constitutes a relevant market, the Bureau will consider the following information:

i) survey or industry data on consumers' propensity to purchase a number of products from a single institution;

ii) data on the number of products purchased per person and the number of products purchased from a given institution per person;

iii) survey data on consumer preferences; and,

iv) data on the extent to which consumers have broken up their purchases of a grouping of products in response to relative price changes.

The Geographic Dimension

38. Geographic markets for various types of banking services may be local, regional, national, or international. The size of the geographic market for a particular banking product depends on the extent to which the buyer values being in close proximity to the supplier. This, in turn depends upon the characteristics of the product, the characteristics of the customer, the means of delivering the product, and the nature of the transaction. In particular, one needs to establish what is the need for personal contact between supplier and customer and what are the costs, in terms of time and transportation, of accessing more distant suppliers for the given product. It is the relative cost of personal contact that is important. A customer needing a small loan may not be willing to travel regularly to make personal contact just to obtain a loan with slightly lower lending rate. However for a larger size loan, the cost of this travelling may be worthwhile.

39. Consumers of certain types of banking products may be unable and/or unwilling to switch to suppliers outside of their local areas in response to an increase in the prices of these products in their own areas. Where there are sufficient number of consumers in such circumstances, geographic markets will be local.

40. To make this determination, the Bureau will examine the following factors ⁽²⁰⁾: views, strategies, behaviour and identity of buyers; trade views, strategies, and behaviour; switching costs, transportation costs; local set-up costs; particular characteristics of the product; price relationships and relative price levels; distribution channels; and, foreign competition.

41. In the U.S. experience of reviewing bank mergers, one of the most useful data sources for the purpose of defining the boundaries of local markets where these are relevant geographic markets is data on commuting patterns. Markets have been found to be local when frequent interaction between the customer and the bank (or other service provider) is required, and the value of the transaction is relatively small. This interaction need not take place close to the customer's place of residence, and may rather occur near the customer's place of work. Thus, the competitive conditions facing a “bedroom” community may not accurately reflect the choices available to customers living in these communities where a large percentage of these customers commute to work in adjacent urban centres. Banks operating in the bedroom community may not find it profitable to exercise market power if a sufficient number of their customers would turn to competitors in the urban centre. In such circumstances the geographic market should be expanded beyond the bedroom community to also include the adjacent urban centre. Data that indicates the proportion of a population that commutes to some other area (typically an urban centre) to work, and may therefore be able to do their banking in this other area, has been useful in defining markets.

42. American experience also indicates that for rural areas, from which there may be less commuting to urban centres for the purpose of work, information about the location of nearby shopping areas or any other location that is visited frequently for non-banking purposes is useful, as is information about how often such trips are made. However, areas in which the destinations of interest are visited relatively infrequently, such as appliance stores and hospitals, may not be included in the relevant market since interaction with a bank may be more frequent than visits to such locations. Again, the competitive conditions facing a particular rural area may not accurately reflect the choices available to its residents where a large percentage frequently commute to adjacent areas. In such circumstances, the relevant geographic market would need to be expanded to include the adjacent areas along lines similar to those described in paragraph 41.

43. The Bureau will gather information to determine whether similar patterns exist in Canada. If this is found to be true, commuting data available from Statistics Canada will be one of the data sources used when delineating the geographic boundaries of relevant product markets, particularly for retail and small business customers.

44. Other important information to be used will include banks' current drawing areas for customers, although these areas are more likely to define the inner bound of a market (that is, banks outside this drawing area may be close substitutes for some consumers within its bounds). This data can often be acquired through survey data.

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⁽⁹⁾ Antitrust Division of the U.S. Department of Justice and U.S. Federal Trade Commission Horizontal Merger Guidelines (April 2, 1992)

⁽¹⁰⁾ As noted earlier, with concurrent merger examinations underway, the concentration ratios will be calculated assuming that both transactions were to proceed.

⁽¹¹⁾ The calculation of likely supply responses is discussed in paragraphs 51 to 53.

⁽¹²⁾ In certain limited circumstances, price discrimination may contravene section 50(1)(a) of the Competition Act. The Bureau's enforcement policy with respect to price discrimination is articulated in the Director's Price Discrimination Enforcement Guidelines.

⁽¹³⁾ Significant in this context usually means five per cent, and non-transitory means a price increase lasting at least one year.

⁽¹⁴⁾ Or a decrease in interest rates in the case of deposits.

⁽¹⁵⁾ These are discussed more fully in section 3.2.2 of the MEGs.

⁽¹⁶⁾ This is not to say that an institution that supplies $100,000 loans cannot respond to a profit opportunity created by an increase in the interest rate on $10,000 loans. The supply responses of firms not currently supplying the market are considered in paragraphs 51 to 53.

⁽¹⁷⁾ This is akin to purchases of groceries from a supermarket as opposed to purchases of the same products individually from a butcher, green grocer, warehouse club etc.

⁽¹⁸⁾ The purchase of various banking products as a group is not necessarily caused by tied selling on the part of banks. Tied selling is prohibited, in certain circumstances, under the tied selling (section 77 (2)) and abuse of dominance (section 79) provisions of the Competition Act.

⁽¹⁹⁾ The U.S. Federal Reserve Board traditionally defines relevant banking product markets to be clusters of products and services denoted by such terms as “commercial banking” with total deposits used as a proxy for the ability of commercial banks to provide this cluster to businesses and households. By rejecting the notion that each banking product or service line may constitute a relevant market, the cluster approach reduces the number of competitors considered to those who currently or potentially offer deposit services. In contrast, the Antitrust Division of the U.S. Department of Justice focuses on specific products or services that customers would regard as close substitutes, assessing any particular bank merger as a merger of multi-product firms with current and potential competition available from other multi-product or single-product firms depending upon the product under consideration.

⁽²⁰⁾ Merger Enforcement Guidelines, section 3.3.2.