EC365 Theory of Monopoly and Regulation Topic 4: Merger 2013-14, Spring Term Dr Helen Weeds

EC365 Theory of Monopoly and Regulation

Topic 4: Merger

2013-14, Spring Term

Dr Helen Weeds

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Routes to monopoly power

Monopoly power

Merge

Collude Exclude

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What is a merger?

Legal control: > 50% of voting shares

Material influence: ability to influence policy 25% shareholding (can block special resolutions) > 15% may attract scrutiny

• BSkyB/ITV: BSkyB acquired 17.9% stake in ITV• Newscorp/BSkyB: held 39% already, wanted to increase to 100%

other factors: distribution of remaining shares; voting restrictions; board representation; specific agreements

Includes joint ventures (JVs) combine operations in one area only autonomous entity, e.g. jointly-owned subsidiary

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Motives for merger

Horizontal merger Market power

• towards customers• towards suppliers (monopsony)

Efficiencies and synergies• cost savings• R&D spillovers

Vertical merger (lecture 6): complementary assets

Conglomerate mergers: portfolio effects

Stock market: under-pricing; corporate control

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Lecture outline

Measuring concentration

Merger in Cournot oligopoly symmetric firms asymmetric firms cost efficiencies merger policy and case: Staples-Office Depot

R&D joint ventures

Relevant counterfactual “failing firm defence”

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Measuring concentration

Symmetric firms Market share of each firm, s = 1/n, may be used E.g. 3 firms: s = 1/3

Asymmetric firms: no unique measure (r firm) Concentration Ratio: CRr =

Herfindahl-Hirschman index: HHI or H =

Monopoly: CR = HHI = 1 (as %: HHI = 10,000)

Perfect competition: both approx. 0

r

iis

1

i

is2

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Example: UK supermarkets

Market shares by retail by revenue(2002/03) sales area excl. petrol

Tesco 26% 31% Sainsbury’s 23% 21% Asda (Wal-Mart) 19% 21% Safeway 15% 13% Morrisons 7% 7% [Others 9% 6%]

C4 ratio? HHI?

Market: one-stop grocery shopping (stores over 1,400 sq m); local (these are national shares)

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Use of HHI in merger control

US DoJ “safe harbours”; OFT guidelines

Increase in HHI

0-150 150-250 250+

Post-merger HHI

2000+ Safe Unsafe Unsafe

1000-2000 Safe Safe Unsafe

0-1000 Safe Safe Safe

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Merger in Cournot oligopoly

Simple symmetric case identical marginal cost c; no fixed costs linear demand: P = a – bQ

Cournot with n firms set a = b = 1; c = 0

bn

canπi 2

2

1

Merger from 2 1 3 2 4 3

Pre-merger profit (combined) 2/9 1/8 2/25

Profit of merged firm 1/4 1/9 1/16

Change 1/36 -1/72 -7/400

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General case

n symmetric firms; 2 merge

Gain to merged firm: = i(n–1) – 2i(n)

sgn = sgn[2–(n–1)2]: negative when n > 1+2 2.4

Competitors benefit from positive externality merged firm q competitors q (RFs slope down) while P

b

ca

nn

n

b

ca

nnπ

2

22

22

22 1

12

1

21

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Why merge?

Cost asymmetries merger reallocates output to more efficient plant

Efficiencies / synergies resulting from merger fixed cost savings marginal cost reductions complementary assets R&D

Post-merger collusion assess change in critical discount factor

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Cost asymmetries

Pre-merger 2 firms, unit costs c1 = 1, c2 = 4; demand p = 10 – Q

Cournot eqm:

q1 = 4, q2 = 1; p = 5 welfare: W = + CS = 16 + 1 + 12.5 = 29.5

Post-merger: shut down unit 2 monopoly with c = 1: p = 5.5, Q = 4.5 welfare: W = + CS = 20.25 + 10.125 = 30.375

Despite concentration, welfare goes up what if W = + CS, with = 0.5? Critical ?

jii ccq 2103

1

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Concentration and average margin

n-firm Cournot oligopoly asymmetric marginal costs, ci

lower ci higher equilibrium qi higher market share si

Relationship between HHI (as fraction, i.e. 1) and weighted average PCM (“Lerner index”)

where = price elasticity of demand (as absolute value)

ε

H

p

cps

p

cps

p

cpsL n

n

...2

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1

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Cost reductions

What if merger reduces costs?

Fixed cost saving lower F implies higher concentration implies P and CS

Marginal cost reduction effect on P (and CS) is ambiguous

• higher concentration• output where MR = MC is altered

NB: Cost savings must be merger-specific

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Fixed cost saving

Merger to monopoly (inverse) demand P = 1–Q; marginal cost c = 0 per-firm fixed cost F (0, 1/9)

Pre-merger (Cournot) welfare W(n=2) = + CS = 2(1/9 – F) + 2/9 = 4/9 – 2F

Post-merger: eliminate one F welfare W(n=1) = + CS = ¼ – F + 1/8 = 3/8 – F

Welfare comparison welfare increases iff F > 5/72 0.07 what if < 1?

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Marginal cost reduction

Merger to monopoly P = a – bQ; marginal cost falls from c0 to c1 < c0

look at CS alone ( = 0)

Pre-merger (Cournot):

Post-merger:

CS increases iff

b

cacCS

20

0 9

2 ;2

b

cacCS

21

1 8

1 ;1

b

ca

b

ca 20

21

9

2

8

1

001 3

1cacc

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Figure 1: Marginal cost reduction

p , c

q

D

c 0

c 1

p m (c 1 )

p C (c 0 )

Q C Q m

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Merger policy

US: Clayton Act (1914) “substantial lessening of competition” (SLC) test

UK: Enterprise Act (2002) replaced “public interest” criteria with SLC test

EU merger regulation (1989/2003) 1989: “create or enhance a dominant position” 2003: “significant impediment to effective competition”,

including creation or strengthening of a dominant position captures reduction of competition in an oligopoly industry

(without losing existing case law)

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Assessing a merger (OFT guidance 2003)

Competitive assessment loss of rivalry, not constrained by other competitors? entry: sufficient in scope, likely and timely? buyer power: will this constrain any price rise?

Are there offsetting efficiency gains, benefiting consumers?

Relevant counterfactual what would happen absent the merger? e.g. is the target a “failing firm”?

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Competitive assessment

Are merging firms (close) competitors? bidding data diversion ratio: if A raises price, what proportion of lost

demand goes to B? (ratio of cross- to own-price elasticity)

Other competitors does presence of third parties constrain prices? supply side as well as demand substitution

Framework: “market definition” set of products which compete closely with one another aspects: products, geographic market

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Case: Staples-Office Depot (US 1997)

Product: consumable office supplies FTC’s market definition: “office superstores” (OSS)

• Office Depot (1), Staples (2), OfficeMax (3)• merging parties had >70% share

non-OSS outlets: Wal-Mart, Kmart, Target, etc.

Issue: are non-OSS outlets in the same market? econometric analysis of prices in local markets (cities)

• prices lower where Staples competes with Office Depot than with non-OSS alone (FTC: 7.3%, parties: 2.4%)

• prices lower where all 3 OSS compete than where Staples and OfficeMax alone

Competition effect: merger would raise prices

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Staples-Office Depot: cost savings

Would cost savings offset the (ve) competition effect?

Parties’ claims large cost savings 67% pass-through to customers net effect: prices by –2.2%

FTC’s claims 43% of cost savings achievable without merger; some

unreliable: actual savings = 1.4% of sales 15% pass-through net price effect = 7.3% – 0.15 x 1.4% = +7.1%

District Court ruled in favour of FTC: merger blocked

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R&D joint ventures

Innovation generates dynamic efficiency gains

Benefits of cooperative R&D complementary skills/inputs of different firms R&D involves large up-front costs; high risk

• may be too much for one firm alone

Against cooperation would each firm innovate on its own? Likely to reduce R&D effort (Team issue) more competitive product market is desirable

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Policy towards cooperative R&D

Principles underlying R&D JVs research would not otherwise be undertaken must not extend beyond activities necessary for R&D

• e.g. joint R&D only; separate production & distribution treated as a merger (rather than under Art. 101) if JV

operates on an autonomous and permanent basis some concern over networks of JVs involving same party:

may inhibit competition / entry

E.g.: GM- Renault-Nissan JV to design a “light van” Also joint production: large economies of scale separate labels (Trafic, Vivaro), marketing and sales

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Counterfactual to the merger

Ideally, we want to compare future with merger (1) future without merger (2)

(2) often proxied by actual pre-merger situation

Sometimes using pre-merger is not valid target will exit the market (it is a “failing firm”) committed entry or expansion regulatory changes: market liberalisation;

new environmental controls

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Failing firm defence

Key idea competition deteriorates even in the absence of merger relative to this benchmark, merger does not lessen comp.

FFD: a merger which raises antitrust concerns may nonetheless be permitted if the failing firm would otherwise exit the acquirer would gain the target’s market share no alternative purchaser poses a lesser threat to competition

(regardless of price)

[US; similar principles in EU, UK, etc.]

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Difficulties in using the FFD

Evidential difficulties extent of losses?; are losses unavoidable?

• e.g. Detroit newspapers: suspicion that firms were fighting “too hard” in order to gain merger clearance

are there other potential bidders?

Predictive difficulties will losses continue?; will exit occur? what would happen to market share, assets, etc?

Comparing 2 counterfactual situations 2 hypotheticals not one

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Successful FFD cases

Potash: Kali und Salz–Mitteldeutsche Kali (EC 1993) combined market share 98% MdK very likely to go bankrupt (supported by Treuhand);

30% fall in demand 1988-93 market share would go to K&S; no alternative purchaser

Solvents: BASF–Pantochim–Eurodiol (EC 2001) targets already in receivership no other buyer; merger would keep capacity in market

Other cases Detroit News–Free Press: local newspapers (US 1988) P&O–Stena: cross-Channel ferries (UK 1997) Newscorp–Telepiù: Italian pay-TV (EC 2003)