"Should Antitrust Enforcers Rely on
Potential Competition Analysis or
the Concept of Innovation Markets"

Outline of Comments by Richard Gilbert

I. Innovation markets can be useful to identify economic effects that would escape a potential competition analysis. In some circumstances, innovation market analysis is a superior analytical method.

Example 1: (based on the stylized facts in United States v. General Motors, 1993)

Firms A and B manufacture and sell a durable good: (automatic transmissions for large trucks and buses).

Consumers have only limited substitutes for the durable good. It is a relevant product market.

Transportation costs are significant and producers engage in geographical price discrimination. The United States and Europe are separate relevant geographic markets.

Firms A and B compete in Europe. Only firm A sells the relevant product in the U.S. Firm B is not an actual or potential competitor in the U.S.

In this example, a merger of firms A and B will affect product market competition in Europe. If the merger also affects innovation, these effects will be felt in the U.S. where consumers are denied the benefits of those innovations.

Notes:

(i) No potential competition in the U.S.

(ii) Product market effects in Europe may be sufficient to block the merger.

(iii) The merger does not directly affect competition in the U.S., but it may affect the economic welfare of U.S. consumers.

(iv) Have to show with reasonable certainty that the merger of A and B will reduce total investment in research and development.

(v) Have to show with reasonable certainty that a reduction in research and development will adversely affect the introduction of improved products or processes.

Example 2: (based on Example 4 in the DOJ/FTC Antitrust Guidelines for the Licensing of Intellectual Property)

Firms A, B, and C produce plastic used in disposable containers.

Only firms A, B, and C have the research and development capability to produce a new type of biodegradable plastic for disposable containers.

Firms A, B, and C form a joint venture to engage in research and development to produce the new type of plastic.

None of the firms presently produces the new type of plastic.

If developed, the new type of plastic will be economically superior to other containers, such as the old plastic and glass bottles.

If the new plastic is commercially available, environmental legislation will require elimination of the old type of plastic container. This will be costly to the firms that produce the old type of plastic.

In this example, the joint venture may reduce R&D to produce the new type of plastic. Innovation is costly to firms A, B, and C, because they will be required to replace their existing production. Acting independently, it could be profitable for a single firm to introduce the new biodegradable plastic to gain a competitive advantage.

Notes:

(i) The "product market" in which competition is affected (the new type of biodegradable plastic) does not yet exist.

(ii) A challenge to the joint venture based on a potential competition theory may not succeed. The firms are not actual competitors. At best, they are potential competitors in a non-existent product market.

(iii) The joint venture may only slow the development of the new type of plastic. It may not affect competition after the new plastic is developed. This would make a challenge based on a potential competition theory even more difficult.

(iv) Have to show with reasonable certainty that the joint venture will reduce total investment in research and development.

(v) Have to show with reasonable certainty that a reduction in research and development will adversely affect the introduction of the new plastic.

II. In some circumstances, potential competition analysis is a superior analytical method to identify competitive effects in R&D-intensive markets.

Potential competition analysis is superior where the most likely anticompetitive effect of a combination is the elimination of competition in an existing product market.

Example 2: (based on Example 11 in the DOJ/FTC Antitrust Guidelines for the Licensing of Intellectual Property)

Firm A has a patent on product alpha, which is a relevant product market. Firm B is the only other firm with the R&D capability to produce a substitute for alpha. Firm A licenses firm B to produce alpha under the condition that B terminate all R&D on new products that would substitute for alpha.

Notes:

(i) The competitive effects in this example could be addressed in the framework of an innovation market or potential competition.

(ii) The possible anticompetitive effect of the agreement is the elimination of likely competition in product alpha.

(iii) Firm B is a likely potential competitor in product alpha. A potential competition analysis would appear to be appropriate.

III. Is it possible to predict the effects of market concentration on innovation?

The link between market concentration and innovation is complex. However, economic theory supports conditions under which an increase in concentration may reduce innovation. In any case, the investigation and analysis must be fact intensive.

The effects of market concentration on innovation are easier to predict when innovation is incremental.

IV. Is innovation a line of commerce? I don't know. Whether it is or not, innovation market analysis can be useful in some circumstances to identify economic effects that would escape other analytical methods.