EC365 Theory of Monopoly and Regulation

Topic 4: Merger

2013-14, Spring Term

Dr Helen Weeds

2

Routes to monopoly power

Monopoly power

Merge

Collude Exclude

3

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

4

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

5

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”

6

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

7

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)

8

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

9

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

10

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

11

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

12

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

13

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

21

1

14

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

15

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?

16

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

17

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

18

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)

19

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”?

20

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

21

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

22

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

23

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

24

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

25

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

26

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.]

27

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

28

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)