A margin squeeze involves situations in which a vertically integrated dominant firm hampers downstream rivals’ competitiveness in (i) raising the wholesale price of its essential input and/or (ii) reducing the retail price of the product/service.
A margin squeeze test entails assessing whether the vertically integrated dominant firm's own downstream operations could operate profitably on the basis of the upstream price charged to its competitors by its upstream operating arm. EE&MC applies two methods to assess this: the "period-by-period" approach and the "discounted cash flow" approach.
The period-by-period approach consists of comparing for every year (or for shorter periods) the observed revenues and costs extracted from the dominant firm's accounts in which investment expenditure have been amortised over appropriate periods.
The discounted cash flow (DCF) approach consists of assessing the overall profitability over an adequate period (in general several years) in order to take account not only of current revenues but also of future revenues flowing from current investments. The firm's future growth is taken into account in the profitability analysis by aggregating the expected future cash flows over time. The aggregation results in the net present value. What constitutes an "adequate period" and the cost of capital to the company are two important parameters in this analysis.