3What 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
4Motives 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
6Measuring 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
7Example: 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)
8Use of HHI in merger control US DoJ “safe harbours”; OFT guidelines
9Merger in Cournot oligopoly Simple symmetric caseidentical marginal cost c; no fixed costslinear demand: P = a – bQCournot with n firmsset a = b = 1; c = 0
10General 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
11Why 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
12Cost 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 ?
13Concentration 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)
14Cost 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
15Fixed 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?
16Marginal 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
18Merger 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)
19Assessing 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”?
20Competitive 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
21Case: 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
22Staples-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
23R&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
24Policy 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
25Counterfactual 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
26Failing 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.]
27Difficulties 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
28Successful 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)