MERGERS

1

Overview

• Context: market structure changes by means of entry, exit — andmergers and acquisitions

• Concepts: efficiency and market power; unilateral and coordinatedeffects; merger waves

• Economic principle: as always, there is the good, the bad and theugly

2

Why mergers?

• Synergies

− Sony and Columbia Pictures

• Entry into new market

− Nestle and Rowntree

• Supplier power

− Philip Morris and Kraft

• Distribution efficiencies

− Nestle and General Mills

3

Types of mergers

• Horizontal: between competitors

• Vertical and complementary: firms in different orcomplementary stages of the value chain

• Conglomerate: industry-unrelated firms

4

Largest M&A transactions as of 2014

Rank Year Acquiror Target $ b eb

1 1999 Vodafone AirTouch PLC Mannesmann AG 202.8 204.8

2 2000 America Online Inc Time Warner 164.7 160.7

3 2007 Shareholders Philip Morris Intl Inc 107.6 68.1

4 2007 RFS Holdings BV ABN-AMRO Holding NV 98.2 71.3

5 1999 Pfizer Inc Warner-Lambert Co 89.2 84.9

6 1998 Exxon Corp Mobil Corp 78.9 68.4

7 2000 Glaxo Wellcome PLC SmithKline Beecham PLC 76.0 74.9

8 2004 Royal Dutch Petroleum Co Shell Transport & Trading Co 74.6 58.5

9 2000 AT&T Inc BellSouth Corp 72.7 60.2

10 1998 Travelers Group Inc Citicorp 72.6 67.2

5

Effects of horizontal mergers

• Efficiencies

− Common cost savings

− Synergies, complementarities

• Market power

− Unilateral effects (closer to monopoly)

− Coordination effects (closer to collusion)

6

Merger effects: Hyundai and KIA

0

10

20

30

1996 1998 2000 2002 2004 2006 2008 2010

Year

# ratio

# models

# models/platform

# platforms

1

2

3

7

Merger effects: Hyundai and KIA

0

5

10

15

20

1996 1998 2000 2002 20004 2006 2008 2010

Year

Prices (1000 KW) Exports (million units)

domestic price

exports

0.4

0.8

1.2

1.6

2.0

8

Merger in Cournot triopoly

• Initially n = 3, all firms with C = F + c q

• Firms 2 and 3 merge, forming 2&3 with C = F ′ + c ′ q

• Merger efficiencies:∗ F < F ′ < 2F and c ′ < c

• Determine effect on

− merging parties

− non-merging parties

− consumers

∗ Merger efficiencies could also take place at the product level.

9

Merger effect on merging parties

• Equilibrium profits under Cournot

πi =

(a− n ci +

∑j 6=i cj

n + 1

)2

− Fi

• Firm profit before merger

π1 = π2 = π3 =

(a− c

4

)2

− F

• Firm 2&3 profit after merger

π′2&3 =

(a + c − 2 c ′

3

)2

− F ′

10

Merger effect on merging parties

• Taking differences

π′2 − (π2 + π3) =(2F − F ′

)+

(a + c − 2 c ′

3

)2

− 2

(a− c

4

)2

• Effects

− Fixed cost savings: F ′ < 2F (positive effect)

− Marginal cost savings: a + c − 2c ′ > a− c (positive effect)

− Market power: n′ < n (positive effect)

− Exit: from 2 to 1 π (negative effect)

11

Merger effect on outsiders

• Taking differences

π′1 − π1 =

(a + c ′ − 2 c

3

)2

−(a− c

4

)2

• Effects

− Rival’s marginal cost savings: a + c ′ − 2 c < a− c (negative effect)

− Market power: n′ < n (positive effect)

12

Merger effect on outsiders: examples

• BP acquires Amoco (oil industry). Mobil’s stock up $2.625

• Western Digital announced Hitachi acquisition (hard driveindustry). Seagate’s stock up by 9%

• BA and AA announce plans to merge (air travel industry). VirginAtlantic paints its aircraft with “BA/AA No Way”

• GKN plc and Alvis plc merge (European defense industry), puttingpressure on Vickers, the third competitor

13

Merger effect on consumers

• Consumer surplus under Cournot

CS = 12

(n a−

∑ni=1 ci

n+1

)2

= 12

(n

n+1

)2 (a− 1

n

∑ni=1 ci

)2

• Merger effect

CS ′ − CS = 12

(23

)2 (a− 1

2 (c + c ′))2 − 1

2

(34

)2(a− c)2

• Effects

− Cost savings passed through: a− 12

(c ′ + c) < a− c (positive effect)

− Market power: n′/(n′ + 1) < n/(n + 1) (negative effect)

14

Merger effects: Miller and Coors

0.00

0.01

0.02

-0.02

-0.01

2007 2008 2009 2010 2011 2012

Time

Change in price (%)

change in pdue to change in H

change in pdue to change in d

15

Merger dynamics

• Preemptive mergers

− Google and Waze

• Merger waves

− US supermarket chains

− Advertising agencies

• Mergers and entry

− US radio stations

16

Merger waves: US radio stations

0

100

200

300

400

500

600

700

800

1990 1995 2000 2005

Number of mergers and acquisitions

Year

17

Entry in US radio station markets

0.00

0.01

0.02

0.03

-0.03

-0.02

-0.01

−0.03 −0.02 −0.01 0.00 0.01 0.02 0.03

Pre-merger

Post-merger

Monthly net entry rates

18