The Telefónica – E-Plus merger

Benno Buehler, European Commission

ACE Conference - Mannheim 05/12/2014

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Disclaimer: The views expressed are solely those of the presenter and cannot be regarded as stating an official position of the European Commission.

Agenda

1. Context: Past mobile telecom cases of the Commission

2. Overview of transaction 3. Theory and quantification of harm 4. Efficiencies

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Past mobile telecom cases

Past mobile telecom cases of the Commission

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Case Description, Outcome

T-Mobile/tele.ring (2006) • 5 to 4 in Austria • Phase II, cleared with remedies

T-Mobile/Orange NL (2007) • 4 to 3 in the Netherlands • Phase I, cleared unconditionally

T-Mobile/Orange UK (2010) • 5 to 4 in the UK • Phase I, cleared with remedies

H3G Austria/Orange AT(2012) • 4 to 3 in Austria • Phase II, cleared with remedies

H3G/Telefónica IE (2014) • 4 to 3 in Ireland • Phase II, cleared with remedies

Telefónica DE/E-Plus (2014) • 4 to 3 in Germany • Phase II, cleared with remedies

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1.The Telefónica DE/E-Plus merger (Germany)

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1.Overview

• T-Mobile (DTAG) [20-30]% • Vodafone [20-30]%

• E-Plus [15-25]% • O2 Deutschland [15-25]%

• Freenet [5-15]% • Drillisch [0-10]% • 1&1 [0-10]% • Other SPs/MVNOs [0-10]%

Characteristics of German mobile telecommunications market

• Both O2 and E-Plus strong in pre-paid segment

• Freenet hosted by all MNOs, in particular by T-Mobile and VF

• Industry generally profitable • Entry of MNOs post-merger

depending on entry conditions • MVNO entry and competitive

impact depends on wholesale terms

• Especially residential customers atomistic with virtually no bargaining power

Retail market shares (subscribers) Further market characteristics

Merging Parties

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Key claims of Notifying Party

• Merged entity intends to offer improved quality network and become stronger in the segment of high value customers ("merger to compete")

• Large claimed synergies with NPV of roughly EUR 5 bln, mostly stemming from network consolidation

• In low value segment, competitive pressure maintained to a large extent due to non-MNOs

Efficiency claims submitted already in pre-notification

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1.Theory and quantification of harm

• Focus on non-coordinated effects • Both E-Plus and O2 are currently

important competitive forces (especially E-Plus growing)

• E-Plus and O2 are close competitors with a focus on pre-paid customers

• Loss of competition between E-Plus and O2

• Competitors would likely follow price increases

Main Theory of Harm

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• Diversion ratios and market shares (also at the segment level)

• Market investigation • Internal documents • Accounting data (profitability) • Quantitative analysis

• Upward Pricing Pressure (UPP) analysis (based on diversion ratios and margins)

• Demand estimation & Merger simulation

Main observations Used evidence

UPP intuition • Core intuition is at the heart of all theories of

unilateral effects with differentiated products • Pre-merger: firm A does not take into account impact of

its pricing decision on the profits of firm B • Post-merger: owner of firm A now faces incentives to set

higher prices since the resulting diversion of (some) volumes to firm B increases B’s profits

• “GUPPI” measures the “tax” that the joint owner of firms A and B would effectively charge to its subsidiaries in order to induce them to adopt optimal pricing decisions post-merger

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GUPPI

• GUPPIi = Diversion Ratioij * Marginj / Pricei • Where

• Diversion Ratioij is the fraction of the total sales lost by Firm i following a price increase that is recaptured by Firm j

• Marginj: Margin of Firm j; Which margin to use? • Contribution margin (short run) • Incremental margin (long run)

• ∆𝑃𝑖 > 0 if 𝑃𝑗 − 𝑐𝑗 𝐷𝑖𝑗 > 𝑒𝑒𝑒𝑒𝑐𝑒𝑒𝑒𝑐𝑒𝑒𝑒

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From UPP to price effects (IPR)

• Translating UPP measures into price effects requires additional assumptions

• Pass-through: how do merging firms pass on a given “cost increase” into higher prices (pass-through also relevant for efficiencies)

• Feedback effects: • Feedback effects between merging parties (straight

forward but leads to complicated expressions) • Feedback effects of competitors (more complicated

expressions but straight forward to implement)

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Applied in Telefónica-E-Plus case

Calibrated merger Sim.

Calibrated Merger Simulation/IPR vs. Demand estimation - overview

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Margins

• Input: based on accounting information

• Output: inferred from optimality conditions (but depends on size of outside good)

Substitution Patterns

• Input: diversion ratios based on number portability / surveys

• Input: tariff level price and quantity data

• Input: Potential market size • Output: substitution patterns

Demand estimation

Remarks

• Relatively simple • Aggregated data required • Reliability depends on quality of

margin / diversion data

• Complex and resource intense • Very detailed data required • Estimating potential market

size difficult • Further technical challenges

Demand estimation: telecom data

• Tariff level data • 2010-2013 monthly, 4 operators + 1 Service Provider • Tariff characteristics

• Fixed fees, allowances, out-of-bundle prices • By on-, off-, fixed network • Subscriber numbers (new, retained)

• Usage at segment level (minutes, SMSs, GBs)

• Data request as a process • Several rounds with draft templates with each carrier • Follow-up data corrections

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Demand estimation: variable construction

• Single price for each tariff • Fixed basket of consumption (mins, SMSs, GBs) • Calculate out-of-bundle charge • Add fixed fees • Use tariff options • Apply special rules • Observed/estimated handset subsidies Highly complex exercise!

• Subscriber shares • In terms of "contestable" (new+retained) subscribers

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Demand estimation: models used • Discrete choice models

• Static choice problem of contestable subscribers • Characteristics: price and other tariff properties, brand

fixed effects • Model forms

• Nested Logit (nests: prepaid/postpaid) • Random coefficient Logit

• Estimation • Linear/non-linear IV estimation • Characteristics based instruments

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1.Efficiencies

• Combined spectrum allows to use equipment more efficiently

Intuition of mobile network synergies

• A large part of network savings can be achieved by network sharing

• Effect of reduction in network costs on customers unclear (better network quality and/or more aggressive competition?)

Although network savings are generally plausible…

… there are some important issues

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Network Sharing

• Efficiencies can only be accepted to the extent that they cannot be achieved by plausible other less-competitive means

• Currently no network sharing in Germany: network sharing negotiations unsuccessful

• EC: Possibly network sharing negotiations fail because merger is more profitable. Therefore important criterion is to assess profitability of network sharing compared to stand-alone competition

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Conclusions

• Commission used well known competition framework • Framework would have allowed to balance anti-

competitive effects and efficiencies • (Incremental) cost savings • Higher value to customers from improved quality

• Efficiencies could be to a large extent achieved by network-sharing

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Conclusion & Discussion

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