Public Policy in Private Markets Merger Policy

Announcements Today: Dr. Matt Ouellett from the Center for Teaching will be conducting a Midterm Assessment

Announcements Debate # 2 next Tuesday, HW 5 due (posted)  Debaters: video due to me on March 30 th (Friday) Clicker issue still present for 2 students Midterm 2 on April 19  Length

Merger Law Important part of antitrust 3 types of mergers:  Horizontal (cost efficiencies)  Vertical  Conglomerate

Heinz – Beech Nut (K&W, Ch. 6) Market definition:  Geographic: National  Product: jar baby food Possible anti (and pro) competitive effects: Concentration (HHI): from 4775 to 5285 Increased prices  Unilateral  Collusive Loss of wholesale competition Cost efficiencies

Gerber (65%) Heinz (17%) Beech Nut (15%) Operates nationwide Gerber & Beech Nut = premium brands Heinz = discount brand (15% lower price)

The Cost Savings Argument Heinz to close Beech-Nut production facility  old, high cost, labor intensive  un-automated production process (requires intervention by workers)  320 workers produced 10 million cases/year Move production to Heinz facility  newly updated (1990), highly automated  150 workers produced 12 million cases/year Heinz: efficiencies would allow selling Beech- Nut brand at a 15% discount

Heinz – Beech Nut Two smaller firms in a 3-firm market Do not compete directly  But there is the threat of the other entering Main argument for merger:  Cost savings passed onto the consumer (econometric analysis)  Could more easily challenge Gerber  Consumer benefits from lower-priced higher quality product  Evidence of competition against Gerber rather than against each other (cross-elasticity study)

Heinz – Beech Nut FTC:  Loss of wholesale competition: Absent merger Beech Nut disciplines Heinz and vice versa  Increased prices: without competitor Collusion with Gerber more likely Unilateral increase in prices more likely  Cost savings estimates are unreliable Controversial case:  3-2 FTC vote  Merger first allowed, then overturned  Efficiencies are key defense for merged firms, but hard to prove

Merger Law Important part of antitrust 3 types of mergers:  Horizontal  Vertical  Conglomerate

Vertical and Conglomerate Mergers Recall concerns:  Vertical Mergers: Foreclosure and increased barriers to entry  Conglomerate Mergers: entrenchment and elimination of potential rivals Based on DOJ’s Non-Horizontal Merger Guidelines (last updated in 1987) The most critical burden of proof here is lessening of competition.

Vertical and Conglomerate Mergers Typical approach:  Is there market power at one level? Will market power translate/increase into the integrated market? Example:  Lockheed-Martin proposed merger with Northrop Grumman (1998, failed)  $11.6 Billion, both aerospace companies Lockheed: military aircraft Northrop: radars and electronics used in aircraft Department of Defense main customer for both firms  DOJ challenges: Substantial lessening of competition, in both upstream and downstream mkts

Lockheed Northrop Merger Northrop 4 th largest defense contractor In the world Lockheed Martin Largest defense contractor in the world 95% revenue from Department of Defense Northrop’s Competitors Lockheed’s Competitors Military Aircraft Radars, electronics

Lockheed Northrop Merger Northrop Lockheed Martin Northrop’s Competitors Lockheed’s Competitors Military Aircraft Radars, electronics Concerns: 1. New conglomerate will have a disproportionate % of contract $’s with government 2. Increased barriers to entry & possibility of foreclosure upstream and downstream

Non-Horizontal Merger Guidelines Set-up is fairly tolerant of vertical mergers DOJ unlikely to challenge, unless HHI in the acquired firm’s market is > 1,800 Less likely to challenge if:  Entry into acquiring firm’ market is easy  3 or more firms in the acquiring firm’s market would have equal advantage of entering the acquired firm’s market  Acquired firm has small mkt share (< 5%)  Efficiencies from merger

Non-Horizontal Mergers Procter & Gamble – Clorox merger (1967) Product extension merger, PG (54% of soaps and detergents mkt), Clorox (49% of bleach mkt) Anticompetitive effects in liquid bleach mkt:  Diminishing of potential competition (PG likely entrant) Even if did not enter it limited Clorox’s behavior  Entrenchment: Adding PG’s size and marketing to Clorox’s already powerful position may make any future challenge very difficult

Non-Horizontal Mergers FTC challenges merger (ex-post) District Court rules in favor of FTC Court of Appeals reverses ruling Supreme Court agrees with FTC’s opinion and orders divestiture of Clorox

Non-Horizontal Mergers 1980’s and 1990’s: large product extension and pure conglomerate mergers:  Nestle (large processed food manufacturer) - Carnation (“cooking milk”)  RJ Reynolds (tobacco) – Nabisco (snacks)  Philip Morris (cigarettes/food) - General Foods (cereals)  Philip Morris-Kraft (food and beverages)

Non-Horizontal Mergers Example: Philip Morris-Kraft (1988)  Total Sales after merger: $37.6 B; $11.5 B bid  Mostly product extension, with some overlap (frozen foods)  PM: unrivaled position in dry and frozen food lines  Arguments for challenge: PM’s dominated shelf space, advertising, rebates, promotional allowances; dominance into new market may reduce competition Lessening of competition: not as strong an argument as Kraft was one of many competitors  Counterargument: economies of scale/efficiencies  Outcome: no challenge

Non-Horizontal Mergers More recently: Philip Morris-Nabisco (1999)  Combined sales: $35 B  Mostly product extension merger (some horizontal)  Contentious issue. Horizontal segments in “individual” foods: crackers, pudding, etc.  Merger allowed with divestiture of Nabisco brands: Dry mix gelatin: PM (86%), Nab (6%) Dry mix pudding: PM (82%), Nab (9%) No-bake desserts: PM (90%), Nab (6%) Baking powder: PM (27%), Nab (17%)

Non-Horizontal Mergers 1980’s and 1990’s: large market extension mergers:  Kroger-Dillon, 1983  American Stores-Jewel, 1984  American Stores-Lucky, 1988 All retailing/supermarket mergers Agencies felt:  Big enough queue of potential competitors  Little or no BTE

Non-Horizontal Mergers Main Points:  Not all mergers are equal  Some mergers can have more than 1 of the 3 components (vertical, horizontal, conglomerate)  Main concern for antitrust authorities is lessening of competition  In general, non-horizontal mergers are frowned upon less frequently than horizontal mergers