Legal Definitions - hypothetical monopolist test

The hypothetical monopolist test is a fundamental tool used in antitrust law, particularly by government agencies like the Federal Trade Commission (FTC) and the Department of Justice (DOJ), when evaluating proposed mergers between companies. Its primary purpose is to accurately define the "relevant market" for a specific product or service before assessing whether a merger would create excessive market power or violate antitrust laws.

The test works by posing a hypothetical question: If a single, imaginary company (a "hypothetical monopolist") were to control all sales of a particular product or service within a proposed market, could it profitably raise prices by a small but significant amount (typically 5-10%) for a sustained period?

• If the answer is yes, meaning consumers would not switch to other products or services in sufficient numbers to make the price increase unprofitable, then the proposed market definition is considered accurate. This indicates that consumers have limited alternatives within that defined market.
• If the answer is no, meaning consumers would readily switch to other products or services, making the price increase unprofitable for the hypothetical monopolist, then the proposed market definition is too narrow. In this case, the market must be expanded to include those alternative products or services that consumers would switch to.

Once the relevant market is correctly defined using this test, antitrust authorities can then proceed with their analysis to determine whether a merger would lead to excessive market power, reduce competition, and potentially harm consumers through higher prices or reduced innovation.

Examples:

• Example 1: Specialty Coffee Roasters

  Imagine two prominent companies that roast and distribute high-quality, single-origin coffee beans propose to merge. Antitrust regulators need to define the relevant market. They might initially propose the market as "premium, ethically sourced coffee beans."

  The hypothetical monopolist test would then ask: If a single company controlled all sales of premium, ethically sourced coffee beans, could it profitably raise prices by 7%? If consumers who buy these beans are highly loyal and would not switch to cheaper, mass-produced coffee, or even other hot beverages like tea, if prices went up, then the answer is "yes." This would mean "premium, ethically sourced coffee beans" is a well-defined market. However, if a significant number of these consumers would readily switch to slightly less premium coffee brands, or even high-end tea, then the answer is "no," indicating the market definition is too narrow and needs to include those alternatives.

  This example illustrates how the test helps determine if a specific niche product truly constitutes its own market where a merged entity could exert power, or if it's part of a broader market with more substitutes.

• Example 2: Enterprise Cloud Storage

  Consider a scenario where two major providers of highly specialized cloud storage solutions, designed specifically for large corporations in regulated industries (like finance or healthcare), plan to merge. Regulators might propose the market as "enterprise-grade cloud storage for regulated industries."

  The hypothetical monopolist test would then ask: If a single company controlled all enterprise-grade cloud storage for regulated industries, could it profitably increase its subscription fees by 10%? If large corporations in these sectors have very specific security, compliance, and scalability needs that only these specialized providers can meet, and they cannot easily switch to general-purpose cloud storage or manage their data on their own servers (on-premise) without significant cost or risk, then the answer is "yes." The market would be correctly defined. Conversely, if many of these corporations could relatively easily switch to slightly less specialized cloud providers or revert to on-premise solutions if prices rose significantly, then the answer is "no," and the market definition would be too narrow, needing to include those other options.

  This example demonstrates how the test accounts for the unique needs and switching costs of specific customer segments, helping to define whether a specialized service truly operates in its own distinct market.