Estimating Incremental Margins for Diversion Analysis

Over the past twenty years, antitrust agencies increasingly have used diversion and pricing pressure analyses to help identify which mergers to investigate and then to help identify which mergers to challenge. A key input in these analyses is an estimate of the profits that firms earn on incremental sales. In this paper, we consider how best to estimate incremental margins for diversion and pricing pressure analyses given that for a number of reasons measures drawn from aggregate accounting data sometimes poorly measure the relevant incremental margin. We conclude such estimates often can be improved by making greater use of general knowledge about how the relevant market works, using detailed data to create incremental profit measures tied to a particular change in output, and presenting sensitivity analyses based on a range of plausible incremental margin estimates.