Jorde, Thomas M.

Teece, David J.

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Competing through Innovation: Implications for Market Definition

Chicago-Kent College of Law

Chicago-Kent Law Review Volume 64 Issue 3 Symposium on Antitrust Law and the Internationalization of Markets Article 4 October 1988 Competing through Innovation: Implications for Market Definition Thomas M. Jorde David J. Teece Follow this and additional works at: https://scholarship.kentlaw.iit.edu/cklawreview  Part of the Law Commons Recommended Citation Thomas M. Jorde & David J. Teece, Competing through Innovation: Implications for Market Definition, 64 Chi.-Kent L. Rev. 741 (1988). Available at: https://scholarship.kentlaw.iit.edu/cklawreview/vol64/iss3/4 This Article is brought to you for free and open access by Scholarly Commons @ IIT Chicago-Kent College of Law. It has been accepted for inclusion in Chicago-Kent Law Review by an authorized editor of Scholarly Commons @ IIT Chicago-Kent College of Law. For more information, please contact jwenger@kentlaw.iit.edu, ebarney@kentlaw.iit.edu. COMPETING THROUGH INNOVATION: IMPLICATIONSFOR MARKET DEFINITIONTHOMAS M. JORDE*DAVID J. TEECE**Hay, Hilke, and Nelson (hereinafter Hay et al.)' provide a usefulsurvey, as well as some extensions, on current thinking with respect togeographic market definition in an international context. Clearly, as theauthors recognize, foreign competition is extremely important in mostU.S. industries, and the manner in which it is taken into account in per-forming antitrust analysis can have a dramatic impact on the legal orpolicy considerations that are reached in a particular instance. Sincemarket power plays such a key role, the authors remind us that it isimportant "to have both a proper conceptual understanding and a work-able empirical means of identifying market power. ' ' 2 The authors believethat the first of these is relatively straightforward, the second more diffi-cult. We contend that neither are straightforward and that the authorshave erred with respect to how they have conceptualized market power,at least for an important class of industries.First, let us consider first the conceptual issues, and then the empiri-cal. Conceptually, Hay et al. argue, following the mainstream literature,that market power can be defined as "the ability of a firm or group offirms' profitability to raise prices significantly above competitive levelsfor a sustained period."'3 This definition, they claim, is fully consistentwith a consumer welfare orientation for antitrust.Yet, for an important class of situations, namely, where technologi-cal change is important, some period of market power may be required inorder to encourage and enable firms to invest in research, development,and commercialization activities. In many circumstances, particularlywhere the spillover benefits of innovation are high and imitation is easy,the exercise of market power by producers may be consistent with en-* Professor of Law, University of California, Berkeley. B.A. 1969, Yale College; J.D. 1972,Yale Law School.** Professor of Business Administration, University of California, Berkeley. B.A., M. Comm.1971, University of Canterbury; M.A. 1973, Ph.D. 1975, University of Pennsylvania.1. Hay, Hilke, & Nelson, Geographic Market Definition in an International Context, 64 Ci.-KENT L. REV. 711 (1989) (Messrs. Hay, Hilke & Nelson's article appears in this symposium issue).2. Id. at 714.3. Id..CHICAGO-KENT LAW REVIEWhanced consumer welfare. Moreover, in markets characterized by rapidtechnological progress, competition often takes place on the basis of per-formance features and not price. Given the importance of technologicalchange to economic progress, and the importance of trade in high tech-nology goods in the total international trading picture, the conceptualapproach offered by Hay et al. to the measurement of market power oftenneeds to be modified if consumer welfare is to be improved rather thanharmed by antitrust interventions.4The second step is to arrive at a workable empirical means to mea-sure market power. The authors correctly observe that the tradition inantitrust analysis, despite the lack of an unambiguous supportive evi-dence, has been to associate market power with market concentration. 5Of course, it is in deciding the relevant market and in computing sharesthat the most antitrust torment lies. Whether the courts believe that themarket is domestic or in some fashion global is likely to have huge impli-cations for market share determination and for conclusions about marketpower. Hence, the need to define correctly the geographic scope of themarket becomes crucial.Hay et al. recognize that while foreign producers can affect the mar-ket power of domestic firms even when foreign producers make no salesin the U.S., the most obvious way thai foreign firms can limit the marketpower of domestic firms is when foreign firms actually sell some or all oftheir output in the U.S., or are capable of doing so if U.S. prices riseabove competitive levels. 6 The authors embark on a review of howtraditional merger analysis accounts for such foreign competition. Theypoint out that analysts usually decide to expand the geographic market toinclude foreign production when (1) there are no significant import barri-ers into the U.S., (2) domestic and foreign prices for the relevant productmove together, and (3) shipments into the U.S. are an actuality or a pos-sibility. With respect to the latter, there is considerable debate as towhich foreign shipments should be included in the relevant geographicmarket. Landes and Posner have argued that all foreign productionshould be included. 7 Others, including Harris and Jorde, have arguedthat only actual sales into the U.S. plus some portion of excess capacityshould be included.8 Hay et al. point out that whether foreign producers4. Id. at 714.5. Id. at 714-15.6. Id. at 718.7. Landes & Posner, Market Power in Antitrust Cases, 94 HARV. L. REV. 937 (1981).8. Harris & Jorde, Antitrust Market Definition: An Integrated Approach, 72 CALIF. L. REV. 1,57-59, 62-64 (1984).[Vol. 64:741COMPETING THROUGH INNOVATIONhave a greater supply responsiveness than domestic firms is essentially anempirical question that cannot be settled theoretically.9 Nevertheless,they suggest two approaches for ascertaining whether imports limit themarket power of domestic firms. One relies upon estimating import de-mand elasticities;' 0 the other uses historical data to explore whether ex-change rate changes, which supposedly proxy for changes in importprices, impact market shares. 1 Their empirical work along these lines isquite helpful, and is the most original part of the papei. Because theestimates obtained are generally quite low, it leads the authors to be cau-tious with respect to incorporating foreign production or capacity inamounts substantially greater than the actual amount of imports thathave entered the U.S.Hay et al. have crafted a nice piece which implicitly employs thestandard microeconomic analysis of markets to address the role of for-eign competition. However, like a good deal of other work in this tradi-tion, it is insensitive to a number of the realities of internationalcompetition today. For instance, in many industries it is, in our view,important to ask what is the nature of the competition which comes fromabroad?' 2 Is competition primarily on the basis of price, or on the basisof product performance? If it is the latter, import price elasticities maynot be all that interesting. Foreign competition may surge forward with-out a price advantage if product innovation abroad is on a faster trajec-tory than it is in the U.S. Also, questions of long-term corporate strategycome into play. If foreign firms are committed to a strategy of enteringthe U.S. market, as evidenced by their expenditures on market entry ac-tivities and other factors, then one might weigh imports differently thanif they were simply taking advantage of short-term arbitrage opportuni-ties. Also, foreign industrial policies impact the nature of competition inthe U.S., and these factors sometimes ought loom larger in market defini-tion analysis than the best point estimates of import demand elasticitiesor exchange rate elasticities. In short, because the authors' analysis isbased on a very simple market model and a very simple model of thefirm, much that is important with respect to competition never comesinto focus.The business strategy literature, which provides many insights into9. Hay, Hilke & Nelson, supra note 1, at 729.10. Id. at 729-31.11. Id. at 731-34.12. Jorde & Teece, Product Market Definition in the Context of Innovation: An Exploration(February, 1988) (University of California Berkeley Business School, Business & Public PolicyWorking Paper No. BPP-29).1988)744 CHICAGO-KENT LAW REVIEW [Vol. 64:741the nature of competition and competitive responses, is not, unfortu-nately, utilized in this paper or in the antitrust literature more generally.When economists begin to utilize richer models of the firm and of mar-kets, they will begin informing the courts and Congress in a meaningfulway about the competitive process. Hay et al. have made a start in atleast highlighting relevant data which might help assist one in, assessingthe strengths of competition. But the literature has a long way to gobefore it can provide the foundation for an antitrust policy which effec-tively comes to grips with the new forms of competition coming fromabroad.

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Competing through Innovation: Implications for Market Definition

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