In the past decade, upward pricing pressure (UPP) has become a widely used tool in merger analysis due to its intuitiveness, despite not accounting for the interdependence between the merging firms’ pricing incentives (‘feedback effects’). Recent merger cases involving this type of analysis include H3G/O2 and Tesco/Booker.
However, ignoring feedback effects can have an impact on the way competition authorities rank mergers. A recent publication by Oxera Technical Adviser, Bertram Neurohr, shows that UPP with feedback effects is equivalent to critical efficiencies, which are used in the alternative compensating marginal cost reduction (CMCR) test. Importantly, this link allows for the derivation of an expression that combines the intuition of UPP as the ‘value of diverted sales’ with the accuracy of critical efficiencies. Together with pass-through rates, it can be used to approximate merger-related price changes, hence going beyond the binary CMCR test.
For details see Neurohr, B. (forthcoming), ‘Critical Efficiencies as Upward Pricing Pressure with Feedback Effects’, The B.E. Journal of Theoretical Economics.