Georgetown University

The Law and Economics of Horizontal Mergers

Incentives to Merge  Merger to attain monopoly  Merger for Improved efficiency  Takeovers

The Williamson Tradeoff D AC 1 AC 2 Q2Q2 Q1Q1 P2P2 P1P1 A B $/Q Q

The Economic effects of Mergers  Theoretical Considerations Dominant Firm-Competitive Fringe Dominant Firm-Competitive Fringe Cournot Cournot Bertrand Bertrand  Empirical Analyses Event analyses (Eckbo; Prager) Event analyses (Eckbo; Prager) Merger Specific Analyses (Northwest- Republic) Merger Specific Analyses (Northwest- Republic)

Implications of DF-CF Model for Mergers  If a dominant firm mergers with a competitive fringe firm, market power and price will rise (ceteris paribus)  The magnitude of market power increases depend on standard DF-CF Market power factors (concentration; fringe SS elasticity, market DD elasticity)  Without barriers to entry, no MP increase  Efficiency gains may offset market power effects

Cournot Each firm produces an output to maximize profit, given the output of all other firms. Nash Equilibrium, when, given the output of others, no firm wishes to change outputEach firm produces an output to maximize profit, given the output of all other firms. Nash Equilibrium, when, given the output of others, no firm wishes to change output Bertrand Each firm sets a price to maximiye ist profit, given the price of other firms. Nash Equilibrium when, given the price of all other firms, no firm has an incentive to change price.

Northwest/Republic Merger Markup Relative to industry average prices (%) NW +Rep + Other NW or Republic + Other NW + REP NW or Rep

Merger Policy in Practice  Legal foundation of merger Policy Clayton Act, Section 7 Clayton Act, Section 7 Hart Scott Rodino Hart Scott Rodino  Antitrust enforcement  Judicial Treatment of mergers

The Clayton Act, Section 7 That no corporation engaged in commerce shall acquire, directly or indirectly, the whole or any part…of another corporation also engaged in commerce, where in any line of commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly. * in any line of commerce in any section of the country *the effect…may be to lessen competition or tend to create Language matters….

Hart Scott Rodino  Requires pre-notification of intent to merger be filed with both the Federal Trade Commission and the Department of Justice, Antitrust Division  The relevant antitrust agency has 30 days to green light or issue a “second request”  Second requests typical involve large detailed filing  Once complete DOJ/FTC has 20 days

1997 Merger Guidelines  The unifying theme of the Guidelines is that mergers should not be permitted to create or enhance market power or to facilitate its exercise.

The DOJ/FTC Merger Guidelines  Market Definition  Market concentration  Entry Conditions  Other Competitive Indicators  Merger-induced efficiencies

Market Definition  Begin with a small geographic and product definition.  Could a hypothetical monopolist raise prices by a small but significant and non- transitory amount? Yes Yes No No (dd-side product, dd-side geographic, ss-side product, ss-side geographic substitutability)(dd-side product, dd-side geographic, ss-side product, ss-side geographic substitutability)

Market Concentration  Herfindahl-Hirschmann Index HHI = Σ S 2 i HHI = Σ S 2 i 0<HHI<10,000 0<HHI<10,000 (Post merger) HHI < unconcentrated (Post merger) HHI < unconcentrated 1000 <HHI< moderately concentrated 1000 <HHI< moderately concentrated if ΔHHI <100if ΔHHI <100 if ΔHHI >100if ΔHHI > <HHI -- highly concentrated 1800 <HHI -- highly concentrated if ΔHHI <50if ΔHHI <50 if ΔHHI >50if ΔHHI >50

Entry conditions  Uncommitted Entry Within one year and not involving significant sunk costs Within one year and not involving significant sunk costs  Committed entry Entry requiring significant sunk costs Entry requiring significant sunk costs Timely (w/i two years)Timely (w/i two years) Likely (profitable at pre-merger prices), andLikely (profitable at pre-merger prices), and Sufficient (enough to discipline prices)Sufficient (enough to discipline prices)

Other Competitive Indicators  Would merger facilitate collusion? Facilitate monitoring of cheating Facilitate monitoring of cheating Promote ability to punish cheaters Promote ability to punish cheaters Factors: e.g., product homogeneity; are transactions prices “visible”; are demand and cost changing rapidly; maverick firm Factors: e.g., product homogeneity; are transactions prices “visible”; are demand and cost changing rapidly; maverick firm

Merger-Induced Efficiencies  Consistent with Williamson Trade-off  Only considered if merger is only means of achieving efficiencies Consider the case of efficiencies to gain economies of scale... Consider the case of efficiencies to gain economies of scale...

FTC v. Coca-Cola  Coca-Cola - Dr. Pepper, Pepsi - 7-Up announce merger plans  FTC issues preliminary injunction  Coca-Cola-Dr. Pepper challenge in court  Critical issue: Market definition FTC - carbonated soft drinks (pricing decisions of executives) FTC - carbonated soft drinks (pricing decisions of executives) Coca-Cola - all potable liquids sold in North America (Lake Erie defense) Coca-Cola - all potable liquids sold in North America (Lake Erie defense)

FTC v. Coca-Cola (cont.)  Barriers to entry sunk costs of entry (brand name awareness) sunk costs of entry (brand name awareness) requirements for distribution network requirements for distribution network limited buttons on “Coke Machines” limited buttons on “Coke Machines”  Anticipated anticompetitive effects Third party bottler problem Third party bottler problem  Court’s finding “the acquisition totally lacks any apparent redeeming feature.”