3 What is a merger? Legal control: > 50% of voting shares Material influence: ability to influence policy25% shareholding (can block special resolutions)> 15% may attract scrutinyBSkyB/ITV: BSkyB acquired 17.9% stake in ITVNewscorp/BSkyB: held 39% already, wanted to increase to 100%other factors: distribution of remaining shares; voting restrictions; board representation; specific agreementsIncludes joint ventures (JVs)combine operations in one area onlyautonomous entity, e.g. jointly-owned subsidiary
4 Motives for merger Horizontal merger Market powertowards customerstowards suppliers (monopsony)Efficiencies and synergiescost savingsR&D spilloversVertical merger (lecture 6): complementary assetsConglomerate mergers: portfolio effectsStock market: under-pricing; corporate control
6 Measuring concentration Symmetric firmsMarket share of each firm, s = 1/n, may be usedE.g. 3 firms: s = 1/3Asymmetric 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
7 Example: UK supermarkets Market shares by retail by revenue(2002/03) sales area excl. petrolTesco 26% %Sainsbury’s 23% %Asda (Wal-Mart) 19% %Safeway 15% %Morrisons 7% %[Others 9% %]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
9 Merger in Cournot oligopoly Simple symmetric caseidentical marginal cost c; no fixed costslinear demand: P = a – bQCournot with n firmsset a = b = 1; c = 0
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 2.4Competitors benefit from positive externalitymerged firm qcompetitors q (RFs slope down)while P
11 Why merge? Cost asymmetries merger reallocates output to more efficient plantEfficiencies / synergies resulting from mergerfixed cost savingsmarginal cost reductionscomplementary assetsR&DPost-merger collusionassess change in critical discount factor
12 Cost asymmetries Pre-merger Post-merger: shut down unit 2 2 firms, unit costs c1 = 1, c2 = 4; demand p = 10 – QCournot eqm:q1 = 4, q2 = 1; p = 5welfare: W = + CS = = 29.5Post-merger: shut down unit 2monopoly with c = 1: p = 5.5, Q = 4.5welfare: W = + CS = =Despite concentration, welfare goes upwhat if W = + CS, with = 0.5? Critical ?
13 Concentration and average margin n-firm Cournot oligopolyasymmetric marginal costs, cilower ci higher equilibrium qi higher market share siRelationship between HHI (as fraction, i.e. 1) and weighted average PCM (“Lerner index”)where = price elasticity of demand (as absolute value)
14 Cost reductions What if merger reduces costs? Fixed cost saving lower F implies higher concentration implies P and CSMarginal cost reductioneffect on P (and CS) is ambiguoushigher concentrationoutput where MR = MC is alteredNB: Cost savings must be merger-specific
15 Fixed cost saving Merger to monopoly Pre-merger (Cournot) (inverse) demand P = 1–Q; marginal cost c = 0per-firm fixed cost F (0, 1/9)Pre-merger (Cournot)welfare W(n=2) = + CS = 2(1/9 – F) + 2/9 = 4/9 – 2FPost-merger: eliminate one Fwelfare W(n=1) = + CS = ¼ – F + 1/8 = 3/8 – FWelfare comparisonwelfare increases iff F > 5/72 0.07what if < 1?
16 Marginal cost reduction Merger to monopolyP = a – bQ; marginal cost falls from c0 to c1 < c0look at CS alone ( = 0)Pre-merger (Cournot):Post-merger:CS increases iff
18 Merger policy US: Clayton Act (1914) UK: Enterprise Act (2002) “substantial lessening of competition” (SLC) testUK: Enterprise Act (2002)replaced “public interest” criteria with SLC testEU merger regulation (1989/2003)1989: “create or enhance a dominant position”2003: “significant impediment to effective competition”, including creation or strengthening of a dominant positioncaptures reduction of competition in an oligopoly industry (without losing existing case law)
19 Assessing a merger (OFT guidance 2003) Competitive assessmentloss 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 counterfactualwhat would happen absent the merger?e.g. is the target a “failing firm”?
20 Competitive assessment Are merging firms (close) competitors?bidding datadiversion ratio: if A raises price, what proportion of lost demand goes to B? (ratio of cross- to own-price elasticity)Other competitorsdoes presence of third parties constrain prices?supply side as well as demand substitutionFramework: “market definition”set of products which compete closely with one anotheraspects: products, geographic market
21 Case: Staples-Office Depot (US 1997) Product: consumable office suppliesFTC’s market definition: “office superstores” (OSS)Office Depot (1), Staples (2), OfficeMax (3)merging parties had >70% sharenon-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 aloneCompetition effect: merger would raise prices
22 Staples-Office Depot: cost savings Would cost savings offset the (ve) competition effect?Parties’ claimslarge cost savings67% pass-through to customersnet effect: prices by –2.2%FTC’s claims43% of cost savings achievable without merger; some unreliable: actual savings = 1.4% of sales15% pass-throughnet 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&Dcomplementary skills/inputs of different firmsR&D involves large up-front costs; high riskmay be too much for one firm aloneAgainst cooperationwould 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 JVsresearch would not otherwise be undertakenmust not extend beyond activities necessary for R&De.g. joint R&D only; separate production & distributiontreated as a merger (rather than under Art. 101) if JV operates on an autonomous and permanent basissome concern over networks of JVs involving same party: may inhibit competition / entryE.g.: GM- Renault-Nissan JV to design a “light van”Also joint production: large economies of scaleseparate labels (Trafic, Vivaro), marketing and sales
25 Counterfactual to the merger Ideally, we want to comparefuture with merger (1)future without merger (2)(2) often proxied by actual pre-merger situationSometimes using pre-merger is not validtarget will exit the market (it is a “failing firm”)committed entry or expansionregulatory changes: market liberalisation; new environmental controls
26 Failing firm defence Key idea competition deteriorates even in the absence of mergerrelative to this benchmark, merger does not lessen comp.FFD: a merger which raises antitrust concerns may nonetheless be permitted ifthe failing firm would otherwise exitthe acquirer would gain the target’s market shareno 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 difficultiesextent of losses?; are losses unavoidable?e.g. Detroit newspapers: suspicion that firms were fighting “too hard” in order to gain merger clearanceare there other potential bidders?Predictive difficultieswill losses continue?; will exit occur?what would happen to market share, assets, etc?Comparing 2 counterfactual situations2 hypotheticals not one
28 Successful FFD casesPotash: Kali und Salz–Mitteldeutsche Kali (EC 1993)combined market share 98%MdK very likely to go bankrupt (supported by Treuhand); 30% fall in demandmarket share would go to K&S; no alternative purchaserSolvents: BASF–Pantochim–Eurodiol (EC 2001)targets already in receivershipno other buyer; merger would keep capacity in marketOther casesDetroit News–Free Press: local newspapers (US 1988)P&O–Stena: cross-Channel ferries (UK 1997)Newscorp–Telepiù: Italian pay-TV (EC 2003)