On January 7, 2009, the Anti-monopoly Bureau (AMB) of the PRC Ministry of Commerce (MOFCOM) published on its website draft Guidelines on the Definition of Relevant Market (Guidelines) for public comment. Comments must be submitted to the AMB before January 31, 2009. In light of the important impact the relevant market definition will have on many key issues in Chinese anti-monopoly enforcement, this edition of the Antitrust Update will brief you on the highlights of the draft Guidelines. A translation of the full text of the draft Guidelines is attached for your reference.  

Background  

The draft Guidelines were the subject of a number of internal discussions and deliberations, as well as external consultations, before publication. It is known that the AMB held several closed-door meetings with well-known experts in the antitrust field before offering draft Guidelines for public comment. Hogan & Hartson’s Beijing office participated in this external consultation process. Some of our comments on the initial version of the draft Guidelines are reflected in the publicly posted version. We will submit official written comments on this current version of the Guidelines to the AMB as well.  

Purpose of the relevant market definition  

As generally accepted in the U.S. and Europe, the relevant market definition is a tool used to identify and define the boundaries of competition between business operators. The draft Guidelines state that the relevant market definition is a precondition for conducting the analysis of competitive behavior and an important stage of anti-monopoly review. Once properly defined, the relevant market will affect all stages of antitrust review.  

Classification on the relevant market  

As an initial matter, the draft Guidelines classify the relevant market definition into two dimensions: the product market and the geographic market. The product market is comprised of the group of products which are substitutable in terms of the product’s characteristics, intended uses, and price. The geographic market defines the area in which the products compete. In certain cases the factor of timing will be a third dimension of market definition, such as when a product’s production cycle, lifetime, seasonal features, fashion style or intellectual property protection schedule constitute inevitable characteristics of the product.  

General method for defining a relevant market  

Under the draft Guidelines the general method for defining a relevant market is through substitution analysis. Specifically, when defining a relevant market the reviewing authority should first take into consideration demand substitution, which requires reviewing the product and its substitutes from a consumer perspective. However, where supply substitution has a constraining influence on the business operators’ behavior that is similar to that of demand substitution, supply substitution also needs to be taken into account.  

The draft Guidelines set forth a number of key elements that must be considered in the analysis of the product dimension of relevant market definition. These include the overall characteristics of the product, its intended use, differences in price, and distribution channels of the involved product and other important factors, such as the consumers’ preference over or reliance on the product . The business operators’ production process and crafts, difficulties in relation to the production switch, the timing required for the production switch, and other factors, need to be taken into account from the perspective of supply.  

The draft Guidelines similarly set forth factors that must be considered in defining the geographic dimension of the relevant market. From the demand perspective, they include the transportation cost and characteristics of the product involved, the actual regions where the majority of consumers choose their products, and the product distribution locations of the main business operators. Additionally, the reviewing authority should consider several factors—such as the promptness and feasibility of the supply or the distribution of a relevant product in other areas—in the definition of relevant market from the perspective of supply.  

Hypothetical Monopolist Test  

The draft Guidelines acknowledge that the method for defining a relevant market described above may fail to work in complex situations, such as when the involved market scope is unclear or when there are disputes regarding the market scope. The draft Guidelines introduce the Hypothetical Monopolist Test (SSNIP) to determine the relevant market under those types of special circumstances. Under this test, the relevant product market is determined by examining whether the hypothetical monopolist is able to maintain price increases at a small scale (5 – 10 percent) continuously (over one year) when conditions of sale remain the same. If the price increase leads to product substitution, the relevant market expands to include those products and the analysis of whether the hypothetical monopolist can maintain price increases continues. Eventually, the products become less substitutable and a product market emerges through which the hypothetical monopolist can profit through a price increase. This becomes the relevant product market. The geographic market is defined through a similar process, but using geographic area as opposed to products.

The draft Guidelines also address a few questions regarding the appropriate price to use in the SSNIP test.  

(Unofficial Translation by Hogan &Hartson LLP)  

Attachment  

Guidelines on the Definition of Relevant Market (Draft for Comments)  

Chapter I

General Provisions  

Article 1 - Purpose and Basis of the Guidelines  

In order to provide guidelines for defining a relevant market and enhancing transparency in enforcement work by anti-monopoly enforcement authorities of the State Council, these guidelines (hereinafter referred to as the Guidelines) are hereby promulgated in accordance with the Anti- Monopoly Law of the People’s Republic of China (the Anti-Monopoly Law).  

Article 2-Functions of the Relevant Market Definition  

Any competitive behavior, including any behavior that currently or potentially could eliminate or restrict competition, occurs within a particular market scope. Defining a relevant market is a process of determining the market scope within which business operators compete with each other. Therefore, defining the relevant market is a precondition for conducting an analysis of competitive behavior and an important stage in anti-monopoly enforcement work.

The definition of relevant market will be taken into account in anti-monopoly enforcement work, such as in prohibiting the formation of monopoly agreements by business operators, prohibiting the abuse of dominant market positions by business operators, and controlling the concentration of business operators that have or may have the effect of eliminating or restricting competition. A scientific and reasonable definition of relevant market has an important impact on key issues such as the identification of competitors and potential competitors, the assessment of a business operator’s market share and the degree of market concentration, the determination of a business operator’s market position, the analysis of the influence of a business operator’s behavior on market competition, and the assessment of the illegality and legal liabilities of a business operator’s behavior.  

Article 3-Concept and Types of Relevant Markets  

A relevant market “refers to the product scope and geographic scope within which business operators compete for particular products or services (hereinafter referred to collectively as the product) during a particular period.” In the practice of anti-monopoly enforcement, it is usually required to define relevant product market and relevant geographic market.

Relevant product market is a market composed of a group or a category of products which are substitutable in terms of the products’ characteristics, their intended use and their prices. It mainly comprises of all products which are considered by the consumers to be close substitutes. Because of the “close substitution” found in these products, there is relatively intense competition among such products, which may be considered as the product scope within which business operators compete with each other in the practice of anti-monopoly enforcement.  

Relevant geographic market is a geographic area within which close substitutes compete with each other. The conditions of competition are sufficiently homogeneous in a relevant geographic market and are evidently distinguishable from the competition conditions in other geographic markets, therefore it may be considered as the geographic scope within which business operators compete with each other in the practice of anti-monopoly enforcement.  

Where a product’s production cycle, lifetime, seasonal features, fashion style or intellectual property protection schedule have become inevitable characteristics of the product, the factor of timing shall be considered in the definition of relevant market.  

In the anti-monopoly review work of technology trade or license agreements involving intellectual property rights, issues such as intellectual property rights, innovation market and technology market may also need to be taken into account.  

Chapter II  

Theoretical Basis for the Definition of Relevant Market  

Article 4-Substitution Analysis  

The definition of a relevant market is in fact a process of assessing close substitutes as well as the geographic areas that such products compete for among each other. In the practice of antimonopoly enforcement, the scope of the relevant market usually is determined according to the assessment of the range of close substitutes.

The existence of what consumers consider to be a close substitute constitutes the most direct and effective constraint on the business operators’ behavior. Therefore, demand substitution shall be a main consideration in defining a relevant market. Where supply substitution has a constraining influence on the business operators’ behavior similar to that of demand substitution, supply substitution may also be considered in defining a relevant market.  

Article 5-Demand Substitution  

Demand substitution is reviewed from the consumers’ perspective to determine the possibility of substitution among different products in terms of the products’ functions and intended uses, quality recognition, price acceptance, as well as their availability for the consumers.

In principle, from the perspective of consumers, the greater the degree of substitution among products, the fiercer the competition is, and the more likely that the products fall into the same relevant market.  

Article 6-Supply Substitution  

Supply substitution is reviewed from the perspective of suppliers to determine the possibility of switching to supply competitive close substitutes in a relatively short period without making any relatively significant investments, renovations or adjustments to the production facilities or assuming relatively substantial risks.  

In principle, the less an investment is required for production facility renovations and/or adjustments, the smaller the extra risks to be assumed, the swifter the switch to supply close substitutes, the stronger the competitive power possessed by the product in the market, the greater the degree of supply substitution, and the more likely it is that the products fall into the same relevant market.  

Chapter III

General Method to Define a Relevant Market

Article 7-Method to Define a Relevant Market  

There is no exclusive method for defining a relevant market. In anti-monopoly enforcement, different methods may be used according to specific circumstances. Generally speaking, in the process of anti-monopoly enforcement, the relevant product market and the relevant geographic market can be defined through demand substitution analysis examined mainly based on the product’s facts, such as its characteristics, intended use and price, and supply substitution analysis when necessary. However, in complex circumstances, such as where the market scopes are unclear for competitive business operators or there are disputes regarding these scopes, the relevant market can be defined through economic analysis using the “hypothetical monopolist test” (detailed in Article 10 below).  

Whichever method is taken to define a relevant market, it must grasp the essential characteristics of the product at any time and it shall not deviate from the fundamental attributes of the product.  

Article 8-Factors To Consider in the Definition of the Relevant Product Market  

From the perspective of demand, the following factors are usually considered in the definition of relevant product market:  

  1. Product’s overall characteristics and uses. The characteristics of a product include its exterior shapes, peculiarity, quality and technical features. Though there may be certain differences in the characteristics, nevertheless, consumers may regard it as a close substitute in terms of the identical or similar use of the product.  
  1. Product’s price difference. Usually, close substitutes share a similar range of prices, and present the same trend in price change. While products that are not close substitutes usually differ greatly in their prices, and they do not present the same trend in price change.
  1. Product’s distribution channel. Products that require different distribution channels may face different consumers, and it is difficult for such products to constitute competition between each other. Therefore, the possibility that such products constitute relevant products is relatively slim.  
  1. Other important factors. For instance, the consumers’ preference over or reliance on the product; their loyalty towards the brand of the product; barriers, risks and costs associated with a change to demanding substitutes; and whether differential pricing policies exist.  

From the perspective of supply, the following factors are considered in the definition of relevant product market: the business operators’ production process and crafts, difficulties in relation to the production switch, the timing required for the production switch, extra investment and risks in relation to the production switch, the competitive power of the product as a substitute after the production switch, and the distribution channels.  

Article 9 Factors To Consider in the Definition of Relevant Geographic Market

From the perspective of demand, the following factors are usually considered in the definition of relevant geographic market:  

  1. Product’s transportation cost and transportation characteristics. In comparison with the product price, the higher the cost is for transportation, the smaller the scope is of the relevant geographic market, as in the case of cement; the product’s transportation characteristics will also determine the sales region, as in the case of industrial gases supplied through pipeline transportation.  
  1. The actual regions where the majority of consumers choose their products and the product distribution locations of main business operators.  
  1. Regional trade barriers, such as duties and local administrative regulations. When a customs duty is higher than the price of the product, it is well possible that the relevant geographic market is a regional market.  
  1. Other important factors. For instance, the consumers’ preference in a particular area, the amount of product transported into the geographic region versus that transported out of the region.  

From the perspective of supply, the following factors are considered in the definition of relevant geographic market: promptness and feasibility of supply or distribution of a relevant product in other areas, for example, the costs associated with switching the orders to operators in other geographic areas, etc.

Chapter IV

Defining a Relevant Market Using the Hypothetical Monopolist Test

Article 10-Hypothetical Monopolist Test  

The hypothetical monopolist test is an analytical method that is used to define a relevant market, and that is currently being widely adopted in anti-monopoly guidelines of various countries. According to this method, people may use economic analysis tools to analyze relevant data that has been obtained and to determine the relevant market, in order to assist in reducing the uncertainty that may arise form the definition of relevant market.  

The main purpose of the hypothetical monopolist test is to define the minimum product aggregation level and geographical area, i.e. the relevant market, in which the hypothetical monopolist is able to maintain a price higher than the competitive price level.  

The hypothetical monopolist test usually begins with the definition of relevant product market. Starting with the target product supplied by the business operator concerned in the anti-monopoly review, the hypothesis states that the business operator in the geographical area is a monopolist aiming at profit maximization, and the issue that will be examined is whether the hypothetical monopolist is able to maintain price increases at a small scale (e.g. 5 -10 percent) and continuously (over one year), provided that the sales conditions of other products remain the same. Price increase of the target product will result in consumers shifting to other closely substitutable products, which consequently leads to sales reduction for the hypothetical monopolist. If the sales reduction after the price increase is not significant enough to prevent the hypothetical monopolist from gaining profit, the hypothetical monopolist is the sole producer of the product, and the relevant market is the target product in the target geographic area.  

If the price increase leads to a massive substitution of the target product with other products and the price increase by the hypothetical monopolist becomes an unprofitable act, the close substitutes shall be added in the relevant market. Thereafter, based on the expanded product group, taking the analytical method similar to the one above, examine whether the hypothetical monopolist would still make a profit after the price increase of the expanded product group. If the result is affirmative, the new product group constitutes the relevant product market. Otherwise, the analytical process above continues.  

As the product group grows increasingly larger, the products inside and outside the group become increasingly less substitutable. Eventually, a particular product market emerges, in which the hypothetical monopolist can attain profit through price increase. Hence, the relevant product market is defined.  

In addition to the definition of relevant product market, the definition of relevant geographical market is also needed. Similar to the definition of relevant product market, the definition of relevant geographical market starts from the target geographical market concerned in the anti-monopoly review, and the issue that will be examined is whether it is profitable for the hypothetical monopolist to increase the price of a relevant product at a small scale in the target geographic market, provided that the sales conditions in other geographical areas remain the same. If the result is affirmative, then the relevant geographical market is identified. If the massive substitution in other geographical areas makes the price increase an unprofitable act, the geographical market needs to be expanded until it is large enough that the price increase finally becomes profitable, which is then defined as the relevant geographical market.  

Article 11-A Few Practical Questions Regarding the Hypothetical Monopolist Test  

In principle, the benchmark price selected to define the relevant market via the hypothetical monopolist test shall be the competitive price. In many circumstance, the benchmark price is the prevailing market price. However, in the event that the prevailing price notably departs from the competitive price due to such reasons as dominant position in the market, or the prevailing price is the result of tacit collusion, the prevailing price used as the benchmark price would lead to an inaccurate definition of the relevant market. In this case, an analysis of the prices is necessary for selecting a price that is more competitive.  

In addition, in the enforcement practice, the margin of small price increase may be determined through an analysis that is in line with the various circumstances in which different industries are involved.  

When a business operator sets a small price increase, not all consumers (or geographic areas) have the same reaction to substitution. Where substitution reactions are different, tests with different margins are given to different consumer groups (or geographic areas). In this case, the definition of the relevant market shall take into account the specific circumstances of consumer groups and geographic areas.