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EC365 Theory of Monopoly and Regulation Topic 4: Merger

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Presentation on theme: "EC365 Theory of Monopoly and Regulation Topic 4: Merger"— Presentation transcript:

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

2 Routes to monopoly power
Collude Exclude Merge

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

7 Example: UK supermarkets
Market shares by retail by revenue (2002/03) sales area excl. petrol Tesco 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 case identical marginal cost c; no fixed costs linear demand: P = a – bQ Cournot with n firms set a = b = 1; c = 0

10 General case n symmetric firms; 2 merge
Gain to merged firm:  = i(n–1) – 2i(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

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 Post-merger: shut down unit 2
2 firms, unit costs c1 = 1, c2 = 4; demand p = 10 – Q Cournot eqm: q1 = 4, q2 = 1; p = 5 welfare: W =  + CS = = 29.5 Post-merger: shut down unit 2 monopoly with c = 1: p = 5.5, Q = 4.5 welfare: W =  + CS = = Despite concentration, welfare goes up what if W =  + CS, with  = 0.5? Critical ?

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)

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 Pre-merger (Cournot)
(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

17 Figure 1: Marginal cost reduction

18 Merger policy US: Clayton Act (1914) UK: Enterprise Act (2002)
“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 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)

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