EC313 Industrial Economics – Class 2

Monopolization case: ALCOA

Issues
1. Market power and the definition of the relevant market:
a. Product dimension
b. Geographic dimension

2. Exclusionary practices:
a. Price squeeze
b. Strategic investment to pre-empt entry

1. Is Alcoa a monopoly?

The offence of monopoly under section 2 of the Sherman Act has two elements:
1. the possession of monopoly power in the relevant market, and

2. the willful acquisition or maintenance of that power as distinguished from

growth or development as a consequence of a superior product, business
acumen, or historic accident.”

 We are mainly going to discuss how to evaluate the possession of monopoly

power. Two steps:

Step 1 = define the relevant market

Step 2 = analyse market power in the relevant market

A. Market Definition

Market definition is KEY in most anti-trust cases. Market definition is important to

determine whether there are actual competitors which are capable of
constraining the behaviour of the firm(s) in question and to assess the degree of
real competition on the market.

 Two dimensions of market definition

the product market (recycling model)
the geographic market

 Market definition is based on the consideration of

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 potential demand substitutability
potential supply subsitutability

B. Market definition in the ALCOA case

We want to understand what competitors are capable of constraining the pricing

behaviour of ALCOA.

 Product market:
o Is copper a substitute for aluminum?

Supply
Substitutability
Low High
Demand Low No ???
Substitutability High ??? Yes

o Is secondary aluminum a substitute for primary aluminum?

 Geographic market:
o Is imported aluminum a substitute for domestic aluminum?

Think in terms of demand and supply substitutability to answer these questions.

Peculiarity of this case: secondary aluminum is not an independent source of

supply!

C. Assessment of ALCOA’s market power

 Market shares

MARKET’s DENOMINATOR
Primary Primary Primary + Primary +
+secondary imports secondary +
imports
Total virgin
90% 64%
ALCOA’s production
NUMERATOR Virgin prod - 33%
own use

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 “Right definition”:

Totalprimary
S
Totalprimary Secondary Im ports

D. Profitability

 Profits about 10 per cent: reasonable!

 BUT:
- problems with estimation and the use of accounting rates of return (part
of profits due to primary production is hard to assess);
- are costs really being minimized?

The absence on high profitability is not a good proxy to measure monopoly

power!

Is ALCOA guilty of monopolization?

 Recall that

“The offence of monopoly under section 2 of the Sherman Act has two elements:
1. the possession of monopoly power in the relevant market, and

2. the willful acquisition or maintenance of that power as distinguished from

growth or development as a consequence of a superior product,
business acumen, or historic accident.”

We have insofar discussed point 1. What about point 2?

A. Vertical price squeeze?

 Aim of Perry’s article: prove that Alcoa’s forward integration was motivated
by price discrimination.

 An intuitive illustration of the price squeeze models:

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 - Monopoly
Intermediate good - Weak elasticity of demand

P1 P2
- Competition
- Greater elasticity of
demand
Final good 1 Final good 2 - P1 < P2

 Methodology: compare the elasticity of demand in the 5 main final

industries which use primary aluminum with Alcoa’s vertical integration on
these respective industries.

 How to measure elasticity? For a perfectly competitive market, the

Marshallian demand elasticity can be expressed:

( e) ke( )
( e) k ( )

where the components are as follows:

= elasticity of demand for primary aluminum

= elasticity of final demand
k = proportion of revenue from primary aluminum
elasticity of substitution between primary aluminum and other inputs
e elasticity of supply of other inputs

Simplifying assumptions:

e → : infinite supply elasticity (fixed prices) of alternative inputs

= 0 : no substitution between inputs

Hence: k

 Alcoa displays greater vertical integration in industries with greater

elasticity of demand:

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 Industry Elasticity of demand Degree of integration
Metallurgy Low None
(aluminum is not a great (too costly to diversify in metallurgy)
substitute)
Cooking Strong Subsidiary in heavy utensils
accessories (Substitutes: copper,
steel, iron…)
Cables High Subsidiary in aluminum electric cables
(Great substitute :
copper)
Automobile High Subsidiary in aluminum automobile
parts (substitutes : steel, iron, parts
secondary aluminium)
Aircrafts No substitutes and None
inelastic demand
(driven by military)

 Conclusion: Alcoa did not integrate into downward industries to

demonstrate the feasibility of aluminum in new applications but more likely
in order to price discriminate.

Indeed:
- No integration into aircraft despite its newness;
- Integration into cables although aluminum had been used for a
long time in that industry.

B. Preemption

 Are the extensive production capacities of Alcoa designed to meet

anticipated demand or should they be considered as an entry deterrent?

 Intuition: despite potential profit opportunities, entry is discouraged

because extensive capacities allow Alcoa to increase production and thus
drive prices down very quickly.

 Next term: we will see models to answer this question…