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EC365 Theory of Monopoly and Regulation Topic 4: Merger 2013-14, Spring Term Dr Helen Weeds.

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Presentation on theme: "EC365 Theory of Monopoly and Regulation Topic 4: Merger 2013-14, Spring Term Dr Helen Weeds."— Presentation transcript:

1 EC365 Theory of Monopoly and Regulation Topic 4: Merger 2013-14, Spring Term Dr Helen Weeds

2 2 Routes to monopoly power Monopoly power Merge ColludeExclude

3 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 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 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 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: CR r =  Herfindahl-Hirschman index: HHI or H = Monopoly: CR = HHI = 1 (as %: HHI = 10,000) Perfect competition: both approx. 0

7 7 Example: UK supermarkets Market shares by retailby revenue (2002/03) sales areaexcl. petrol  Tesco26% 31%  Sainsbury’s23% 21%  Asda (Wal-Mart)19% 21%  Safeway15% 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 8 Use of HHI in merger control US DoJ “safe harbours”; OFT guidelines

9 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 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 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 12 Cost asymmetries Pre-merger  2 firms, unit costs c 1 = 1, c 2 = 4; demand p = 10 – Q  Cournot eqm:  q 1 = 4, q 2 = 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 ?

13 13 Concentration and average margin n-firm Cournot oligopoly  asymmetric marginal costs, c i  lower c i  higher equilibrium q i  higher market share s i Relationship between HHI (as fraction, i.e.  1) and weighted average PCM (“Lerner index”) where  = price elasticity of demand (as absolute value)

14 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 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 16 Marginal cost reduction Merger to monopoly  P = a – bQ; marginal cost falls from c 0 to c 1 < c 0  look at CS alone ( = 0) Pre-merger (Cournot): Post-merger: CS increases iff 

17 17 Figure 1: Marginal cost reduction

18 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 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 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 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 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 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 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 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 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 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 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)


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