L8 - Horizontal Mergers

Question 1

What are Mergers?

Answer 1

• Structural types of mergers: horizontal (rivals and same stage of production process), vertical (different stages of the production process) or conglomerate (complementary products e.g. Sainburys and Argos)
• Motives for merger → increase profits
  
  • ● exploit economies of scale and scope, greater market power
• Mergers activity proceeds in waves and tends to follow the business cycle –> mergers occur in the good times when they have the money

Why is it important?

• How do mergers affect market structure and market outcomes?
• What tools are available to policymakers to prevent problems?
  
  • Policymakers need to promote pro-competitive mergers and stop anti-competitive merger (usually the ones they would expect prices to rise from afterwards)
• Are these tools effective?

Question 2

How do we model the effect of a merger on the quantity of output they produce?

Answer 2

• c2 represents the marginal cost of the firm pre-merger
• In this duopoly case, once the two firms have merged they would output at the monopoly level
  
  • Given the merger should create new efficiencies, this lowers the MC to c1
  • Given the intercept of c1=MC and the new demand curve –> the price now increases to the monopoly level
    
    • In line with Cournot’s theories
• What is the effect on the market?
  
  • Pre-merge
    
    • Top triangle is consumer welfare, including the rectange of profit below to create total welfare
  • Post-merger
    
    • CS triangle is now smaller and the profit rectangle is bigger
    • Two competing affects:
      
      • Red is the total reduction in welfare as less is being produced in the market
      • Green is the increase it total welfare brought about from the increased efficiencies brought about by the merger that has also increased the firm’s profit
• Williamson was the first to observe this and advocated a merger to monopoly might actual bring a net positive to total welfare
  
  • Now-a-days –> Competition agencies only focus on CS –> lot simpler to consider whether the price goes up or down rather than the total trade-off of welfare and they consider firms to be large enough to look after themselves in comparison to the small individual consumers

Question 3

Potential Anti-competitive effects of a merger?

Answer 3

• Anticompetitive mergers: substantial lessening of effective competitive (SLEC)
  
  • unilateral effects: a merger is likely to increase price noncooperatively
  • coordinated effects: a merger may increase the likelihood of tacit collusion
    
    • Could merge firms in a market closer to a symmetric duopoly –> to make collusion easier to sustain
  • conglomerate effects: a merger brings together a portfolio of complementary products which, when bundled together, may foreclose rivals without full range
  • (vertical effects: a merger may foreclose rivals in a downstream market)
• Common defences:
  
  • Usual line: low entry barriers and/or the market is defined too narrowly (widely?)
  • Efficiency defence: expected marginal cost savings would incentivise lower prices
  • Failing firm defence: one of the parties claims it would exit without a merger

Question 4

Potential solutions to anti-competitive mergers?

Answer 4

• Solutions:
  
  • Prohibition: prevent the merger from taking place
    
    • Problem is that you also negate the efficiency that could come with it
  • Remedies: allow merger but require conditions to remove anti-competitive effects
    
    • ● structural (sell off some of their assets to prevent the anticompetitive effects) versus behavioural (prevents the firms from behaving a certain way - less common )
• Errors: Remedies and interventions may not be socially optimal
  
  • ● type 1 (too harsh – eliminates efficiencies)
  • ● type 2 (too lenient – anticompetitive effects remain)
  • ● investigations may delay mergers and require substantial resources –> this is why competition agencies have 1 short and 1 medium-term phase to look over the merger before giving it the go-ahead.

Question 5

What used to be the test for merger in the EU?

Answer 5

• Note:prior to 1 May 2004, the competitive test in EU was for “dominance”, not SLEC
  
  • Single dominance: where largest firm can unilaterally increase prices
  • Collective dominance: where firms can collectively raise prices through collusion
• “The Gap” → The European Commission could not intervene in mergers where
  
  • :i) merged entity did not have largest market share
  • ii) but feared the merger would raise prices unilaterally

Question 6

What are the methods for screening for unilateral effects?

Answer 6

Question 7

What does the US horizontal merger guideline as about screening for unilateral effects?

Answer 7

• Post HHI –> the US assumes that the post-merger market share will be the sum of the two market shares squared and then added back into the equation

Question 8

How can we analyse what the equilibrium amount of merger are in a market?

Answer 8

• A = choke price

When two firms merge, that sell homogenous products, it is the same as saying that the firm has dropped out of the market?

Question 9

How do we solve for the equilibrium quantities after a merger?

Answer 9

• When two firms merge, that sell homogenous products, it is the same as saying that the firm has dropped out of the market?
• Analysing total welfare:
  
  • After mergers Outsiders ( those not involved in the merger) see their profits go up
  • But insiders see their profits go down
    
    • Not privately optimal –> merger paradox

Question 10

What is the Merger Paradox?

Answer 10

Question 11

How can we derive the merger paradox on a graph?

Answer 11

• Comparing insiders output (q) against outsider output (Q)
• Graph shows for Q₀
  
  • the best response function for both the outsider and the insiders (summed together) pre-merger
• Following the merger –> in our case, we end up with an asymmetric duopoly
  
  • Here we see that under the new equilibrium the insider combine and produce less after the merger,
    
    • Because the two firms gain market power, therefore they restrict output in a bid to increase market prices
  • whereas the outsiders end up increasing their output quantity
    
    • Response to the newly merged firms’ tactic of reducing output by increasing their own
    • this response actual lower the price of the insiders
• However this paradox is only found if you are looking at the Cournot model

Question 12

Why do we get the Merger Paradox under Cournot’s framework?

Answer 12

• In the Cournot model: firms’ choice variables are strategic substitutes
  
  • ● two firms merge they reduce their joint output to exploit new market power
  • ● rivals increase their output (which undermines the effect of the merger)
• Cournot model is weird for mergers: merger = one less firm/store
• So what about Bertrand?
  
  • Bertrand with homogeneous products: merger paradox remains
    
    • ● firms receive zero profit before the merger
    • ● firms receive zero profit after the merger (provided not monopoly)
  • Bertrand with differentiated products: merger paradox resolved
    
    • In Bertrand model: the firms’ choice variables are strategic complements
      
      • ● two firms merge they increase price to exploit new market power
      • ● rivals increase their price (which strengthens the effect of merger)