The Use of Proportional Market Shares as Estimates of Diversion Ratios in Merger Analysis

Abstract

In this article, I employ a linear differentiated demand model to demonstrate the risks associated with using market shares as a proxy for diversion ratios when calculating the unilateral effects of a merger. In particular, when pro-rata market shares are not adjusted for recapture rates, the estimated diversion ratios are significantly higher than the true diversion ratios. As a result, the estimated unilateral effects price increase is much higher than the actual unilateral effects price increase. Even when recapture rates are introduced, problems arise with nested demand structures and inaccurate market definition. In each case, the use of market share based estimates of diversion ratios can both underestimate and overestimate the actual diversion ratio. This result calls into question the usefulness of proportional market shares as a proxy for actual diversion ratios.

JEL Classification: D43, K21, L13, L41