The Competition Council of Latvia Adopts New Economic Methods for Merger Assessment

Merger control is one of the most important instruments of competition policy, ensuring that markets do not become excessively concentrated in ways that could undermine the competitive process. At the same time, as the number[1] and complexity of merger transactions continue to grow, so does the need to quickly and accurately distinguish between transactions that pose no threat to competition and those that require further examination. To more effectively identify potentially problematic mergers, competition authorities are increasingly relying on modern analytical tools, such as the Upward Pricing Pressure test (UPP) and the Gross Upward Pricing Pressure Index (GUPPI). The Competition Council of Latvia (CC) has likewise strengthened the economic assessment of its merger cases by integrating these evaluation tools into its analytical framework.

The primary advantage of quantitative assessment tools is their ability to indicate at an early stage of the review whether prices in the affected market are likely to rise following the transaction. When these screening instruments signal potential concerns, more in-depth analytical methods are subsequently applied.[2]

Before a horizontal merger, firms compete directly, often by offering lower prices, and this competitive pressure helps keep the market functioning effectively. After the merger, however, this pressure is removed: when a customer who previously chose between the merging firms switches from one to the other, the revenue remains within the same undertaking. This reduces the incentive to compete on price and increases the likelihood of price increases, although mergers may also create efficiencies that can offset these upward pricing pressures.

For example, consider a situation in which four coffee shops - A, B, C and D operate within a particular geographic area. Shop A planned to raise the price of its coffee and, in order to understand how such a change might affect consumer behaviour, carried out a customer survey.

The results showed - if the price of coffee at Shop A increased by 15 %, approximately 29 % of its customers would switch to Shop B, while 16 % would choose Shops C or D; the remaining customers would not change their purchasing habits. Based on the survey results, Shops A and B can be regarded as close competitors, as the high diversion ratio between them indicates a strong degree of substitutability. If Shops A and B were to merge, the competition between them would disappear, since customers who previously chose between the two would make their purchases from a single undertaking. This means that the merged entity could have a stronger incentive to increase the price of coffee by 15 %, as the revenue would remain within the same undertaking. However, a merger may also reduce costs – for example, through joint procurement or optimised supply chains – enabling the merged entity to operate more efficiently and thereby lowering the risk of price increases. It is precisely this interplay between reduced competitive pressure and potential efficiency gains that the UPP and GUPPI tests are designed to assess in practice.

UPP and GUPPI assess the merging parties’ incentives to increase prices after the transaction, indicating the likely direction of post-merger price effects.[3] While these tests do not measure the exact magnitude of any potential price change, they offer a qualitative assessment of whether prices are likely to rise.

The UPP test balances two main price effects that arise from a merger: the upward pressure to increase prices due to the weakening of competition between the merging parties, and the downward pressure resulting from merger-related efficiency gains. GUPPI, by contrast, measures the merging parties’ incentive to raise prices.[4]

The European Commission (EC) has applied UPP and GUPPI tests in horizontal merger cases in sectors such as telecommunications, information technology, and others. In vertical merger cases, by contrast, EC has assessed firms’ incentives to raise prices using the vertical Gross Upward Pricing Pressure Index (vGUPPI).

The use of UPP and GUPPI has also been examined by the General Court, which has concluded that such economic analysis may be employed as an initial tool for identifying potentially problematic transactions.[5] Accordingly, quantitative analysis should be used as part of a broader body of evidence when assessing whether a merger would give rise to significant impediments to effective competition.

The CC applied UPP and GUPPI tests for the first time in the economic assessment of a merger to evaluate the incentives of fuel market participants to increase petrol and diesel prices following the transaction. The quantitative assessment tools were calculated using:

1. Sales volumes of the merging parties in euros and tonnes;
2. Publicly available information on the components of fuel price structures;
3. Studies available to the CC and information provided by market participants to estimate diversion ratios.[6]

The introduction of UPP and GUPPI analysis tools into merger review also entails changes to the information-request process. Although these tests require additional data - such as information on production costs, sales volumes, and consumer behaviour - such data are typically held by the merging parties rather than by third parties. As a result, the use of these tools reduces the need to conduct extensive surveys of competitors, suppliers, or customers, while increasing the quantity and accuracy of the data required from the parties to the transaction. Moreover, UPP and GUPPI tests can also be carried out by companies themselves prior to the implementation of a transaction, enabling them to assess potential competition risks at an early stage.

At the same time, it should be noted that the CC will continue to use its existing tools for merger assessment, such as market share calculations, the Herfindahl-Hirschman Index for measuring market concentration, and others.

It is expected that the CC will increasingly rely on quantitative assessment tools in the evaluation of future merger cases. UPP and GUPPI tests are particularly suitable for analysing transactions in markets where the merging parties are close competitors and their products exhibit a high degree of substitutability, such as in the telecommunications, information technology and pharmaceutical retail sectors.

It should also be noted that UPP and GUPPI tools are unlikely to be applied in every investigation. Their usefulness is more limited in markets with regulated prices, as well as in cases where the parties’ products are poor substitutes or where one of the merging firms is a small market player.

Author: Elija Ķerpe, Economist of the Economic Analysis and Mergers Department