Firms and Markets
Horizontal mergers
Christine Zulehner
Department of Economics
Johannes Kepler University Linz
Winter term 2011/12
Zulehner, Firms and Markets
1 / 45
Motivation
450
402
400
356
347
335
350
330
Number of notified cases
313
300
277
276
274
259
247
250
224
200
211
168
150
131
95
110
100
69
64
59
59
91
92
93
50
11
0
90
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
March
time [year]
notified cases
Zulehner, Firms and Markets
2 / 45
Outline
Introduction
Unilateral effects
Coordinated effects
Merger control in the EU
Merger simulations
Zulehner, Firms and Markets
3 / 45
Terminology
Merger
firm A and firm B transfer their shares to a new firm C
A and B cease to exist
horizontal, vertical or conglomerate
Acquisition or takeover
firm A (“acquirer”) buys out all the shares of firm B (“target”)
Joint venture
firm A and firm B set up and operate new firm C
A and B remain independent firms
Zulehner, Firms and Markets
4 / 45
Categorization of mergers
Categorization:
horizontal merger: mergers between actual or potential competitors in
the same market, A and B operate in the same industry
vertical merger: mergers between undertakings on different levels of
distribution or production, A is supplier of B
conglomerate merger: neither horizontal nor vertical, A and B operate
in completely different industries (merge for financial or tax reasons)
Business language:
hostile takeover: target’s other owners and/or management oppose the
takeover
defensive merger: firms merge to respond to deregulation of their
industry, to threat of competition from abroad, etc
white knight, etc
Zulehner, Firms and Markets
5 / 45
Why do firms merge?
Demand-side synergies (i.e. increase in efficiency)
Sony acquired film studio Columbia
quality movies to complement the “hardware” produced by Sony
Cost-side synergies
Nestlé and General Mills
joint venture for breakfast cereals
Bargaining power
Philip Morris and Kraft
merged large number of food products which they sell through
supermarket chains
Market entry
Nestlé acquired Rowntree (Smarties, After Eight, KitKat, etc) to enter
British market
Zulehner, Firms and Markets
6 / 45
Effects of mergers
Increase of market power
merged firms can set higher prices, outside firms can also charge higher
prices
EU: “single-firm dominance”(US: “unilateral effects”)
same mode of competition before and after the merger?
Increased scope for collusion
i.e. merger facilitates explicit or tacit agreements between competitors
to raise price above competitive level
EU: “joint” or “collective dominance” (US: “coordinated effects”)
Cost reductions:
efficiency gains (or “synergies”) might lead to a reduction in prices
Zulehner, Firms and Markets
7 / 45
Impact of mergers on consumers
Horizontal mergers increase concentration (i.e. reduce the number of
competitors in the industry) → prices likely to increase
Vertical mergers are intended to internalize double marginalization → prices
may decrease
Firms claim that prices will not increase because merger implies cost
efficiencies and the decrease in cost will be passed on to the consumers
fixed cost vs. marginal cost
scientific evidence on this is mixed
Zulehner, Firms and Markets
8 / 45
Impact of mergers on other firms
Concentration increases also for outside firms, not just for the merging firms
Outside firms benefit: can increase prices, too!
Example: in August 1998 BP announced takeover of Amoco → stock
prices of most major oil companies (e.g. Mobil) soared
Exception: merging firms become so efficient that merger is in fact “bad
news” for the outside firms.
Example: BA proposed merger with AA → Virgin Atlantic painted its
aircraft with the clear message “BA/AA No Way”
Zulehner, Firms and Markets
9 / 45
Merger failures
Strikingly high failure rate - by any standard you might apply
50% of US mergers (and 43% of mergers worldwide) report lower
profits than comparable non-merged firms (see Gugler et al 2003)
more than half of all merged firms end up being divested (Porter 1987)
Examples
Daimler Benz/Chrysler: in 1998, Daimler Benz bought US auto maker
Chrysler for $37 billion; in 2007, sold Chrysler to Cerberus for a mere
$7 billion.
Quaker/Snapple: in 1994, Quaker Oats purchased fruit drink producer
Snapple for $1.7 billion, only to sell it again for $300 million after 27
months.
Reasons: uncertainty, lack of experience, managers’ incentives not in line
with firm value maximization
Zulehner, Firms and Markets
10 / 45
Public policy toward mergers
in US and Europe, all mergers above a certain threshold are subject to
merger control
US: Federal Trade Commission (FTC) and Department of Justice (DoJ)
Europe: European Commission and national competition authorities
Goal: clear those mergers that are good for consumers, block the others
For merger to be good for consumers, efficiency gains must more than
outweigh market power effects
Zulehner, Firms and Markets
11 / 45
Problems in merger control
Looking into the future: authorities cannot perfectly quantify consequences
of mergers ex ante (and if merger is blocked, they will never know)
Regarding efficiency gains: merging firms know best what possible efficiency
gains are, but they have every incentive to overstate them
Regarding price increases: may not only arise from increased concentration
(“unilateral effect”) but also from facilitated collusion (“coordinated effect”)
Be more lenient towards mergers involving:
small firms
industries where entry is easy
target firms close to bankruptcy (“failing firm defense”)
Zulehner, Firms and Markets
12 / 45
Unilateral effects
absent efficiencies a merger increases market power
factors that affect unilateral market power
concentration
market shares and capacities
entry
demand variables
buyer power
failing firm defence
efficiency gains (efficiency defense)
Zulehner, Firms and Markets
13 / 45
Modeling unilateral effects of mergers
modeling mergers and their effects is difficult
basic feature: creation of a new firm which combines the assets of the
merging parties
two modeling strategies that capture the essence of a merger, i.e. asset
based models
models of product differentiation where assets at hand are the product
varieties sold by the firms
models where the firms produce a homogenous good but differ in their
production capacities
for that reason, the simple Cournot model does not capture the idea of a
merger, i.e. combination of assets, but treats the merger simply as a
reduction of one firm
Zulehner, Firms and Markets
14 / 45
Product differentiation and merger
assume three single product firms with equal and constant marginal cost c
consumers’ utility:
3
3
γ 3
3
2
2
U = ν
i =1 qi − 2(1+γ) (
i =1 qi + 3 (
i =1 qi ) ) + y
where γ ≥ 0 is the degree of substitution
which gives the direct demand function:
γ n
qi = 1 (ν − pi (1 + γ) +
j=1 pj )
3
3
product choice is exogenous
now a merger allows coordination of the outputs of the different products
but the merger does not lead to one of the products being eliminate
Zulehner, Firms and Markets
15 / 45
Before the merger
before the merger there are three identical single-product firms with a profit
function πi = (pi − c)qi , where qi is given by above demand function
FOCs are
∂πi
∂pi
= 0 → pi =
3ν+(3+2γ)c+γpj +γpk
,
2(3+2γ)
i, j, k = 1, 2, 3; i = j = k
assuming symmetry:
pb =
πb =
3ν+(3+2γ)c
and
2(3+γ)
(ν−c)2 (3+2γ)
4(3+γ)2
qb =
(ν−c)(3+2γ)
6(3+γ)
note: as the substitutability of products increases (higher γ), equilibrium
prices and profits decrease
consumer welfare CS = U(qb ) − 3pb qb
CSb =
(ν−c)(3+2γ)2
8(3+γ)2
Zulehner, Firms and Markets
and Wb =
(ν−c)2 (27+24γ+4γ 2 )
8(3+γ)2
16 / 45
A merger between two firms
suppose a merger takes place between firms 1 and 2
in the industry there is now firm I selling two products and firm O selling
one product with profits
2 pi −c
γ
πI =
i =1 3 (ν − pi (1 + γ) + 3 (p1 + p2 + p3 ))
p −c
γ
πO = i
3 (ν − p3 (1 + γ) + 3 (p1 + p2 + p3 ))
∂πI
∂pi
= 0, i = 1, 2 and
∂πO
∂p3
= 0:
3ν + c(3 + γ) − 2(3 + 2γ)pi − 2γpj + γp3 = 0, i, j = 1, 2; i = j
3ν + c(3 + γ) − 2(3 + 2γ)p3 + γ(p1 + p2 ) = 0
post-merger equilibrium pI , pO as:
pI =
c(2+γ)(3+2γ)+ν(6+5γ)
2(γ 2 +6γ+6)
Zulehner, Firms and Markets
and pO =
c(3+γ)(1+γ)+ν(3+2γ)
(γ 2 +6γ+6)
17 / 45
A merger between two firms cont’d
post-merger quantities qI , qO and profits πI , πO :
qI =
πI =
2
(3+γ)(6+5γ)(ν−c)
(v−c)
and qO = (3+2γ)
18(γ 2 +6γ+6)
9(γ 2 +6γ+6)
2
2
3
(3+γ)(6+5γ) (ν−c)
(v−c)2
and πO = (3+2γ)
36(γ 2 +6γ+6)2
9(γ 2 +6γ+6)2
effect on prices and consumer surplus
the merger increase prices, i.e. pI > pb and decreases consumer
surplus, i.e. CSI < CSb
insiders’ profit: πI > πb
outsiders’ profit: πO > πb
effect on total welfare: Wb > Wm
Zulehner, Firms and Markets
18 / 45
Sources of efficiency gains
Market structure failures (e.g. entry barriers)
Economies of scale and of scope
Reallocation of production across plants (to favor more efficient but
underutilized plants, or to save on transportation cost)
Avoiding duplication of fixed costs of distribution, marketing and
administrative activities
Externalities in advertising or R&D
Replacement of inefficient management
“Market for corporate control”: threat of takeovers important in
disciplining managers (Marris, QJE 1963)
empirical evidence is mixed
Zulehner, Firms and Markets
19 / 45
Efficiency gains
If efficiency gains affect fixed costs:
no impact on equilibrium prices
however, higher welfare due to elimination of duplications.
If efficiency gains affect variable costs and are large enough:
outweigh the increase in market power → lower prices.
outsiders lose from the mergers (outsiders’ incentive to complain when
there are efficiency gains...)
consumers and total welfare benefit from the merger
Zulehner, Firms and Markets
20 / 45
Coordinated or pro-collusive effects
Does the merger increase the scope for collusion?
Factors that facilitate (overt or tacit) collusion:
concentration and number of firms
high entry barriers
observability of other firms’ behavior: exchange of information,
competition clauses, transparency of prices and public bids
symmetry
multimarket contacts
short information lags and frequent interactions
(...)
Zulehner, Firms and Markets
21 / 45
Merger Control in the EU
applies to all changes in market structure (as opposed to “market conduct”)
with the Merger Control Regulation 1989 European merger control was
established
Council Regulation (EC) No 139/2004 of 20 January 2004 on the control of
concentrations between undertakings (EC Merger Regulation) OJ [2004] L
24/1
under certain conditions Art. 101 and 102 TFEU apply (which regulate
market conduct, i.e. agreements between firms and abuse of dominance)
Zulehner, Firms and Markets
22 / 45
Definition and forms of concentration
Concentration = change of control on a lasting basis (Art. 3 ECMR)
Merger of two or more previously independent undertakings (Art. 3 para. 1
(a) ECMR)
Acquisition of direct or indirect control of another undertaking (Art. 3 para.
1 (b) ECMR)
decisive influence on an undertaking
rights or contracts which confer decisive influence (e.g. shares):
majority confers decisive influence
ownership or the right to use all or part of the assets
Joint venture:
concentration if the joint venture performs on a lasting basis all the
functions of an autonomous economic entity
no concentration if the joint venture is limited to specific functions for
the parent companies (e.g. R&D joint ventures)
Zulehner, Firms and Markets
23 / 45
Community dimension
ECMR applies to all concentrations with a Community dimension (Art. 1
ECMR).
Commission has sole jurisdiction on mergers with a Community dimension
(Art. 21 ECMR)
member states are not allowed to apply their national competition laws
(“one-stop-shop”)
referral from Commission to the competent authorities of a Member
State and vice versa possible
no one-stop-shop principle outside the EU: e.g. GE-Honeywell was
subject to merger control both in the EU and the US!
Zulehner, Firms and Markets
24 / 45
Community dimension: measured by quantitative
thresholds
because of the size of the undertakings concerned (Art. 1(2) ECMR):
worldwide turnover of all undertakings combined > 5bn euro
community-wide turnover of at least two undertakings each > 250m
euro.
because of effects in several member states (Art. 1(3) ECMR):
worldwide turnover of all undertakings combined (a) > 2.5bn euro.
community-wide turnover of at least two undertakings each (d) >
100m euro.
affecting at least three member states (b and c): combined aggregate
turnover in at least three member states > 100 m euro, turnover of at
least two of the undertakings in three member states > 25m euro)
Zulehner, Firms and Markets
25 / 45
Community dimension
Overall, about 2% of all European mergers have Community dimension,
hence go through EC merger control.
A concentration has no community dimension if each of the undertakings
achieves more than two-thirds of its aggregate community-wide turnover in
one member state (Art. 1 (2 and 3))
Concentrations with relevance for only one member state shall remain in the
jurisdiction of that member state.
Zulehner, Firms and Markets
26 / 45
Substantive analysis
Market Definition: Product market and geographic market
Quantitative criteria: cross-price elasticities, price correlation tests, etc.
Qualitative information: interviews, questionnaires
Assessment of market power
concentration and distribution of market shares
elasticity of market demand
elasticity of supply of rivals and degree of excess capacity
potential entrants
buyer power
Zulehner, Firms and Markets
27 / 45
Substantive analysis
Effect of the concentration on competition
Anti-competitive effects arise if the concentration creates or strengthens a
dominant position.
Dominant position is defined as:
“...a position of economic strength enjoyed by an undertaking which
enables it to prevent effective competition [from] being maintained on
the relevant market by giving it the power to behave to an appreciable
extent independently of its competitors, customers and ultimately of its
consumers.” (see e.g. ECJ United Brands ibid. para. 65; ECJ
Hoffmann-La Roche ibid. para. 38 and others).
Zulehner, Firms and Markets
28 / 45
How to assess a dominant position
Market structure esp. market shares
very high market shares usually show dominance (> 70-75%)
low market shares usually preclude dominance (< 25 %)
between 25%-70% additional criteria have to be examined: actual and
potential competition, market share and strength of competitors, buyer
power.
Properties of the undertaking
technological advantage, economic and financial strength
market behavior
behavior that shows the ability to act independently
Zulehner, Firms and Markets
29 / 45
Substantive analysis cont’d
Horizontal mergers (> 80% of all merger cases)
Creation or strengthening of a dominant position (the same analysis as
under Art. 102 TFEU, also in regard to market definition)
Unilateral and coordinated effects are considered
Vertical mergers (about 10% of all cases)
are examined mainly whether they result in foreclosure (entry barriers)
Conglomerate mergers (about 5% of all cases)
are less likely to significantly impede effective competition than
horizontal mergers
Zulehner, Firms and Markets
30 / 45
The EU merger control procedure
Informal talks between firms and EC
merger announcement (to the press)
merger “notification” (to the EC)
Phase I decision (25 working days)
cleared (80% - 90%)
cleared with remedies
raise serious doubts → Phase II (1% - 5%)
Phase II decision (90 working days)
cleared
cleared with remedies
blocked
Zulehner, Firms and Markets
31 / 45
Merger remedies
Merger remedies increasingly important in the EU and US
Two types of remedies
Structural remedies
firms are obliged to divest part of their assets to create more symmetric
industry structure post-merger, include divestiture of an entire ongoing
business or partial divestiture (possibly a ‘mix and match’ of assets of
the different firms involved)
preferred by the EC (if feasible)
Non-structural or behavioral remedies
firms’ engagements not to abuse of certain assets available to them,
including compulsory licensing or access to property rights.
Zulehner, Firms and Markets
32 / 45
Notifications vs. cleared mergers
450
402
395
400
356
346
Number of notified cases
s/
ompatible merg
gers
Number of co
350
335
330
325
320
347
340
313
296
300
259
256
249
250
274
270
277
276
224
219
247
238
241
222
211
200
168
150
100
89
59 64
60 59
56 59
91
92
93
95
131 132
110 119
107
64 69
50
7 11
0
90
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
March
Zulehner, Firms and Markets
33 / 45
Phase I vs. Phase II
phases over time (bar diagram)
450
450
386
400
336
350
350
326
305
311
NumberofphaseIIevaluations
NumberoffphaseIevaluatiions
400
291
300
300
267
249
242
250
238
232
250
214
212
200
200
150
150
100
124
115
102
100
85
56
55
64
53
50
50
7
0
6
4
4
6
7
6
11
11
90
91
92
93
94
95
96
97
98
20
18
21
7
9
8
10
13
15
10
5
4
2
02
03
04
05
06
07
08
09
10
11
0
0
99
00
01
March
Page 1
Zulehner, Firms and Markets
34 / 45
Number of cases with remedies vs. prohibited mergers
45
2
40
Num
mber of cases w
with remedies/
Nu
umber of prohiibited cases
35
30
1
5
25
20
40
2
0
0
15
15
02
03
15
27
23
10
1
0
16
2
1
5
1
6
7
91
92
0
3
6
4
0
3
2
0
90
Zulehner, Firms and Markets
93
9
94
95
96
97
98
99
00
01
35 / 45
Techniques in merger control
Estimate impact of the merger on concentration, then relate concentration
to price
Problems:
market definition
concentration-price relation
Direct estimation of impact of merger on consumer prices
e.g. Staples/Office Depot: compare price level in cities with two or
more suppliers to cities with only one supplier
Merger simulations
e.g. Volvo/Scania: calculate post-merger prices
Zulehner, Firms and Markets
36 / 45
Merger analysis - examples/cases
Beer market
“Nearly ideal demand system”
effects of a hypothetical merger
Office superstores → presentation
Staples/Office Depot
Price - market structure estimations
Insurance market → presentation
Zulehner, Firms and Markets
37 / 45
Merger simulation: Cournot model
pre-merger
let’s assume there are n firms with constant marginal cost ci ,
i = 1, . . . , n and who face a linear demand function p(q) = a − bq
firms maximize πi = (p − ci )qi = (a − bq − ci )qi
FOC: p(q) − ci + ∂p(q)
∂qi qi = 0
price-cost margins without using cost data
use of price and output data only
we need an estimate for μ
finally, we can regress ĉ on cost shifters to obtain estimates for the marginal
cost function
linear marginal cost: ĉ = c0 + c1 w1 + . . . + ck wk + ω
new equilibrium after the merger of two firms
calculate new prices and quantities
Zulehner, Firms and Markets
38 / 45
“Nearly ideal demand system”
compatible with utility maximization
multi-stage budgeting → restrictions on the cross-price elasticities
market level: product (all cars) - yes/no
segments k, m (small cars, estate cars, people carriers, etc)
choice of a specific good - brands i, j
corresponding to these three decision levels, there are three levels at which
demand equations are estimated
elasticity for the market as a whole
middle level equations estimate elasticities for segments within the
market
lower level equations estimate elasticities within each segment
Zulehner, Firms and Markets
39 / 45
“Nearly ideal demand system”
Stage 1: sit = αi + βi log (yGt /Pt ) +
J
j=1
γij log (pjt ) + it ,
sit share at expenditures in segment of brand i at time t;
yGt expenditures in the segment
Pt price index for expenditures in the segment
pjt price of brand j at time t.
K
Stage 2: log (qmt ) = αm + βm log (yBt ) + k=1 δmk log (πkt ) + mt
qmt revenues in segment m at time t
yBt expenditures for the product (i.e. across all segments)
πmt price index for segment k at time t
Zulehner, Firms and Markets
40 / 45
“Nearly ideal demand system” cont’d
Stage 3: ut = β0 + β1 log (y1 ) + β2 log (Πt ) + δZt + it
ut overall revenues for the product at time t
y1 deflated income
Πt deflated price index for the product
Zt further exogenous variables at time t
Consistency checks: relative size of elasticities
individual elasticities should be (in absolute values) larger than the
segment elasticities
which in turn should be larger than the overall elasticity
Zulehner, Firms and Markets
41 / 45
Beer market
Hausman, Leonard, and Zona 1994; Bishop and Walker 2002
demand function: “Nearly ideal demand system”
market level: beer - yes/no
segment k, m: premium beer, light beer and popular beer
choice of brand i, j: Budweiser, Miller, etc.
estimated price elasticities
elasticity standard error
Budweiser
-4.2
0.13
Molson
-5.4
0.15
Labatts
-4.6
0.25
Miller
-4.4
0.15
Coors
-4.9
0.21
Molson Light
-5.8
0.15
Source: Hausman, Leonard and Zona, 1994
Zulehner, Firms and Markets
42 / 45
Beer market
light segment own and cross elasticities
Genesee
Genesee
-3.763
(0.072)
Coors
0.569
(0.085)
Old Milwaukee
1.233
(0.121)
Lite
0.509
(0.095)
Molson
0.683
(0.124)
Source: Hausman, Leonard
Zulehner, Firms and Markets
Old
Coors Milwaukee
0.464
0.397
(0.060)
(0.039)
-4.598
0.407
(0.115)
(0.058)
0.956
-6.097
(0.132)
(0.140)
0.737
0.587
(0.122)
(0.079)
1.213
0.611
(0.149)
(0.093)
and Zona, 1994
Lite
0.254
(0.043)
0.452
(0.075)
0.841
(0.112)
-5.039
(0.141)
0.893
(0.125)
Molson
0.201
(0.037)
0.482
(0.061)
0.565
(0.087)
0.577
(0.083)
-5.841
(0.148)
43 / 45
Merger simulation: Bertrand oligopoly with differentiated
products
before the merger
Max: Πi = (Pi − MCi )Qi (P1 , . . . , Pn )
Pi −MCi
i
FOC: Qi (P1 , . . . , Pn ) + (Pi − MCi ) ∂Q
= μ1ii
∂Pi = 0 ↔
Pi
using an estimate for the demand elasticity marginal cost can be
backed out
merger: brand i and j
Max: Πi = (Pi − MCi )Qi (P1 , . . . , Pn ) + (Pj − MCj )Qj (P1 , . . . , Pn )
m
l
FOC: sk + l=1 Pl −MC
sl μlk = 0
Pl
with m to be the number of products produced by the merged firm
and market share sk of product k
calculate new equilibrium
assuming marginal cost do not change
efficiency gains
Zulehner, Firms and Markets
44 / 45
Hypothetical merger: beer market
Hypothetical merger between Coors and Labatts
Simulation based on a non-cooperative model without entry and reposition
of product supply
Cross price elasticities show that
price of Coors is more restricted by the prices of Miller and Budweiser
than by the price of Lababtts
price of Labatts is more restricted by the price of Molson than by the
price of Coors
price changes after the merger
Reduction in marginal cost
0%
5%
Coors
4.4%
-0.8%
Labatts 3.3%
-1.9%
Source: Hausman, Leonard and Zona, 1994
Zulehner, Firms and Markets
10%
-6.1%
-7.0%
45 / 45