Mergers
Types of Mergers
Horizontal Merger - this is a merger between two competing
companies in the same industry
Vertical Merger – this is a merger between two firms at
different stages of the production process
Why Might Firms Merge?
Economies of Scale: both in production and in things like
R&D/administration/marketing…
Economies of Scope: synergies between two firms
Higher Prices: can result in horizontal mergers by reducing
competition through
-
creating or strengthening dominant position, resulting in
greater market power
-
diminishing competition in oligopolistic markets by
eliminating competitive constraints
-
changing the nature of behaviour in oligopolistic
markets to allow firms to co-ordinate their actions
Antitrust authorities are concerned with the possible anticompetitive effects of mergers. Consumer welfare or
“economic efficiency” ?
1
EU Merger Policy
Merger Regulation gives the European Commission
the exclusive power to investigate mergers with a
"Community dimension".
EU merger Control Regulation No 139/2004: a new
substantive test of whether a merger should be
challenged or not.
Article 2: any merger that will “significantly impede
effective competition, in the common market or in a
substantial part of it” is to be blocked.
EU criteria now closer to the US practice, where
mergers are prohibited if they would result in a
“substantial lessening of competition”.
Augments the previous legislation, which prohibited
mergers that create or strengthen a dominant market
position
Dominance remains an important concept, but now
includes oligopolistic markets where the merged
company may not be dominant.
2
Dominant Firm: can act on the market without having
to take account of the reaction of its competitors,
suppliers or customers e.g. can increase its prices
above those of its competitors without fearing any loss
of profit.
Likely effects: higher prices, a narrower choice of
goods or scarcity.
It is not illegal for a firm to hold a dominant position
on the market but the firm is disciplined under Article
82 of the Rome Treaty, which “prohibits the abuse of a
dominant position within the common market or a
significant part of it, in so far as it may affect trade
between Member States.”
However, acquiring a dominant position by buying out
competitors is in contravention of EU competition law.
Mergers assessed as to whether or not they enhance the
market power of companies and, subsequently, likely
have adverse effects for consumers in the form of
higher prices, poorer quality products, or reduced
choice.
3
EU merger guidelines (2004/C 31/03) outline two
ways that horizontal mergers may impede effective
competition (similar to the US horizontal merger
guidelines):
(i) by eliminating important competitive constraints
on one or more firms, which consequently would
have increased market power, without resorting
to coordinated behaviour (non-coordinated or
unilateral effects)1
(ii) by changing the nature of competition that raises
prospects for coordination (coordination effects)
i.e. merger results in collective dominance.2
How do Merger Studies Proceed?
1. Notification
2. Defining a market
3. Preliminary ‘screening’ using market shares and
concentration analysis within defined market
4. Competitive assessment of the merger
1
This may arise for example when merging firms have large market share; merging firms are close competitors;
customers have limited means of switching suppliers; etc (see EU merger guidelines No 26 – 38).
2
The EU merger guidelines outline three necessary conditions for sustainable coordination (i) ability to monitor
coordinating firms and whether they are keeping agreement (ii) credible ‘punishment’ deterrent mechanism if there
deviation is detected (iii) reactions of outsiders (current / future competitors) not in coordination can not jeopardise
expected gains from coordination.
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2. Defining a Market
This delineates market boundaries, within which the
analysis of competition may take place. Based on
product characteristics and on geographic area The
Relevant product and geographic market is primarily
examined with respect to demand side substitutability.
Measures of market concentration will depend on the
definition of the market.
Market definition is important, as too broad a
definition or too narrow a definition (in terms of what
products or geographical areas to include in the merger
analysis) can lead to wrong conclusions. e.g. too
narrowly defined may indicate dominance where there
is in fact none. Too broadly defined may incorrectly
infer competition and no dominance
A market is defined as a group of products and a
geographic area such that a hypothetical profit
maximising firm (a hypothetical monopolist) not
subject to price regulation, would impose a small but
significant and nontransitory increase in price
(SSNIP), 5-10 per cent, assuming that the terms of sale
of all other products is held constant.
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3. Calculating market shares within a market
Antitrust authorities have an initial screening process
to determine which mergers should be further
investigated.
Section III of the EU merger guidelines outline
specific market share and concentration levels where
the Commission is likely to have, or not, competitive
concerns – ‘screening’
Market Shares
- very large market shares (50% or more) may in
themselves be evidence of the existence of a
dominant market position.
- Mergers where post-merger market share are not
likely to significantly impede effective competition
(as indicated where the market share of the
undertakings concerned does not exceed 25%).
This does not apply where the proposed merger is
likely to give rise to co-ordinated effects.
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Concentration
Screening process is primarily dictated by the degree
of concentration in the market and the change in
concentration post-merger.
A concentrated market is one with a small number of
firms with large market share
Implicit in the use of concentration is a mapping
from market structure into market power……..
i.e. Greater concentration is used as an indication
of the market power of firms
Measuring Market Concentration:
Firmi market share = sizei / total market size
(where size can be measured in terms of revenue
sales, output, assets…..)
1. Concentration Ratio
CRn is the n’th firm concentration ratio – this
measures the combined market shares of the top n
firms in the industry
e.g. CR4 measures the sum of the market shares of the
top 4 firms in the industry
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2. Herfindal-Hirschmann Index (HHI) –
this is the measure that is preferred in the screening
stage of mergers
HHI
s
= ∑
2
i
1
i.e. the sum of the squares of firm market share, which
gives proportionately greater weight to larger players
in the market (Thus, if data are unavailable for very small firms
in the market the HHI of market concentration will still provide a
good representation of overall concentration.
HHI ranges from close to zero to 10000 (in the case of
monopoly).
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Company
Warner Bros.
Buena Vista (Disney)
Twentieth Century Fox
Columbia
Universal
Paramount
TriStar (Merged w/ Columbia 1988)
New Line
MGM/UA
Miramax
Orion
All Others
1992
20
19
14
20
12
10
1990
13
16
13
14
13
15
2
1
1
0.5
0.5
4
3
1
6
2
CR4
CR8
HHI
73
98
1607
58
94
1246
1988
11
20
12
10
10
15
1986
12
10
8
9
9
22
7
1984
19
4
10
16
8
21
5
1982
10
4
14
10
30
14
10
4
7
11
7
5
7
12
5
5
3
4
58
95
1239
53
84
1068
66
91
1337
68
96
1638
Source: Adams&Brock, The Structure of American Industry, page 202.
1992
CR4 =20+20+19+14 = 73
CR8 = 20+20+19+14+12+10+2+1 = 98
HHI = (20)2+(20) 2+(19) 2+(14) 2+(12) 2+(10) 2+
(2) 2+(1) 2 + (1) 2 + (0.5) 2 + (0.5) 2 =1607
9
The HHI in Merger Screening
‘non-interventionist’ thresholds based on the level and
change in the HHI post-merger provide a screening
rule as to whether mergers are unlikely to be anticompetitive and so do not justify investigation. The
post-merger HHI normally assumes the current
market shares of the merging parties remains the
same….. (this may be naïve….)
Table 1: EC and US Screening Thresholds
HHI
∆ HHI
EC Screening Thresholds
Competitive Concern
1000 - 2000
> 250
Competitive Concern
> 2000
> 150
Competitive Concern
1000 - 1800
> 100
Competitive Concern
> 1800
US Screening Thresholds
>50
No Competitive Concerns for HHI < 1000 for any ∆ HHI
10
Are other criteria other than the level and change in
the HHI post-merge e.g. the presence of a regulatory
entry barrier or very high customer switching costs; a
merger involving a new/potential entrant with
miniscule market share or a maverick firm; or a
history of collusion or other competitive concerns in
the market but….
Table 2: US Data for Fiscal Years 1999—2003 on Individual Relevant Markets in Cases in
which the Agencies Challenged Mergers
Ex-Ante
Merger
HHI
0-99
0-1,799
0
17
18
19
1,799-1,999
0
7
5
2,000-2,399
1
1
2,400-2,999
1
3,000-3,999
Change in the HHI
800 1,199
1,200 2,499
2,500+
3
0
0
0
14
14
0
0
0
7
32
35
2
0
0
5
6
18
132
34
1
0
0
3
4
16
37
63
53
0
4,000-4,999
0
1
3
16
34
30
79
0
5,000-6,999
0
2
4
16
9
14
173
52
7,000+
0
0
0
2
3
10
44
223
Total Cases
2
36
47
133
267
153
350
275
100-199 200-299 300-499 500-799
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Advantages of HHI in screening:
Good measure of market concentration (gives
proportionately greater weight to larger players)
Data unavailability of small firms is not a big problem
Allows antitrust authorities to assess pre-merger and
expected post-merger concentration levels and define
various zones as to likelihood of anticompetitive
effects
Main advantage: Use of HHI as an indicator of
market power is theoretically motivated at least in the
case of homogenous goods
12
Aside: HHI as an indicator of market power in
Homogenous Goods
Market structure ranges from the extreme of monopoly
to that of perfect competition with no market power
and marginal cost pricing. Intuitively, one might
expect that as the number of firms increase in the
market, price will decline toward marginal cost.
Non-cooperative Cournot oligopoly
N firms in the industry
each setting output qj as simultaneous players.
Each firm j profit function and first order condition for
profit maximization is written in equations (1) and (2)
respectively,
π (q ) = P(Q)q − C (q ) where Q = ∑ q
(1)
N
j
∂π j
∂q j
j
j
=
j
j
dP
q j + P − MC j (q j ) = 0
dQ
j =1
j
(2)
Each firm’s mark-up can thus be written as the
following Lerner index,
P − MC
P
j
= −
sj
dP Q q j
.
=
dQ P Q
η
(3)
where sj is the firm j market share, and η denotes the
industry demand elasticity.
13
If N identical firms, each has an identical market share
of 1/N and the price-cost mark up is inversely related
to the number of firms in the market. The price-cost
mark up under Cournot oligopoly with homogenous
goods can be shown to be directly and positively
linearly related to the HHI: higher concentration as
measured by the HHI yields higher price-cost mark
ups.
From equation (3) we can write the average price-cost
margin in the market as,
∑ s HHI
⎛ P − MC ⎞
∑ s ⎜⎜ P ⎟⎟ = η = η
(4)
2
j
j
j
j
⎝
j
⎠
Thus, use of market concentration as measured by the
HHI in merger analysis has a well founded theoretical
motivation for homogenous good industries with each
firm producing only one good.
One can expect greater market power to result from the
proposed merger of two or more firms in such a
market. Whether this raises real competitive concerns
depends upon the level of the post-merger
concentration and the change in the HHI as a result of
the merger. Hence, the general zones outlined in the
previous section when deciding whether or not to
investigate a merger.
14
Disadvantages of HHI in screening:
F. Mariuzzo, P.P.Walsh and C. Whelan, "EU Merger
Control in Differentiated Product Industries”, in Recent
Developments in Antitrust Theory and Evidence, Edited by
Jay Pil Choi, MIT Press December 2006
The post-merger HHI assumes the current market
shares of the merging parties remains the same…..
(this may be naïve….)
Key disadvantage - in the case of differentiated
products, market power may bear no relation to
concentration or the HHI.
So screening on this basis may result in the
investigation of mergers that will have little
anticompetitive effects (Type II error) – or the failure
to investigate mergers that can have big
anticompetitive effects (we consider this issue now)
(Type I error).
Differentiated Products Industries:
Firm size is no longer a good approximation of the
ability to mark-up price over cost.
Market is now made up of a number of products that
are differentiated, either by location or some product
attributes. Some products are more similar than others.
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The competitive constraint on a firm’s pricing is now
determined by the degree of substitutability between
the various goods in the market. Market may consist
of a number of different ‘segments’ (differentiated by
geographic location, or by product characteristics)
‘Segments’ encompass a group of products/brands
that are very substitutable with lots of strategic
interaction, but are independent of, or tend not to,
compete with products/brands in other segments
Things become even more complex in the case that
firms produce multiple products in the market.
The problem here has little to do with market
definition, but rather the complex way in which firms
operate within a market:
firms may specialise in producing goods with very
similar attributes, …… or have a portfolio of goods
with very different attributes, …….and may or may
not operate alongside other multi-product firms
producing similar or different goods. They may be
present or dominant in certain segments of the market,
and absent in others.
The HHI for the market tells us little about the
underlying structure of such markets or the market
power of firms. Why?
16
Sutton (1998): Differences in firm size emerge due to
firms operating over different segments in the market –
big firms operate over many different product
attributes/locations, while small firms specialise in just
a few/one.
Implications for market power? Firms ability to
mark-up prices is determined by localised within
segment competition
It is possible that small firms can extract as high a
mark-up as larger firms in a market - if the small firm
is specialising in a segment where it commands a high
share of that segment – thus, although small in the
overall market, the specialist firm may be big within a
segment and thus have market power
Thus, firm size in a market is not a good indication of
market power in differentiated products industries
Using HHI to screen may result in the investigation of
mergers that will have little anticompetitive effects –
or the failure to investigate mergers that can have big
anticompetitive effects
e.g merger between 2 firms with small output market
share….. will have little impact on the HHI and will
not be investigated under screening thresholds
17
BUT… if these 2 firms are very specialised into
different geographic / product segments…… then,
although small in size in the overall market, they may
be large within specific segments and have large
market power….. so the merger may have big
implications for market power….
Rather than using market shares in screening notified
mergers, it is more desirable to use a simple
structural model to estimate the market power of
firms, that incorporates all the complexities of multiproduct firm behaviour and market segmentation in
differentiated industries.
Thereby, screening on the basis of predicted levels
and changes in market power (rather than market
size or concentration) as a result of a merger, rather
than on the basis of size.
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19
20
3. Competitive assessment of the merger
Once it has been decided to investigate a merger,
examine the likely impact of merger on effective
competition in the market, i.e.
I.
Does the merger lead to a “unilateral”
exercise of market power?
i.e. does the merger eliminate important competitive
constraints on one or more firms, which consequently
would have increased market power, without resorting
to co-ordinated effects…..
II. Does the merger lead to “coordinated
interaction”
i.e. does the merger change the nature of competition
such that it increases the prospects for co-ordination
III. Other Competitive Effects
And then policy needs to weigh up all the
possible effects of the merger, to decide
whether or not the merger is desirable
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I. Does the merger lead to a “unilateral”
exercise of market power?
i.e. does merged firm find it profitable to raise price,
irrespective of actions of other participants in the
market?
4 main steps in this analysis…
1. Examine market structure in detail
- concentration (merged firm share compared to
other firms in the market)
- stability concentration over time
- level of vertical integration
- cost and technology factors
- product differentiation
- level and intensity of R&D
22
2. Examine effect of merger on behaviour of
merging party
(note degree of substitutability between products and
ability of merged firm to unilaterally increase price)
3. Examine reactions of existing competitors
4. Examine reactions of customers
Any switching costs that prevent consumers from
switching away from merged party in event of price
increase by them…..
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II. Does the merger lead to “coordinated
interaction”
Refers to either tacit or explicit collusion that results
from the merger – requires that firms can reach
agreement on terms of coordination (e.g. common
price, stable market shares, territorial restrictions)
profitable to all, and have ability to detect and punish
deviations from these terms
1. Identify whether market is characterised by
factors conducive to collusion
2. and whether post-merger conditions are
conducive to detection and punishment of
deviations?
(see lecture on Factors conducive to collusion)
- Number of competitors
- transparency of market conditions
- homogeneity of product
- homogeneity of firms
- multi-market contact (presence of same firms in
other markets)
- entry barriers
- trend in demand (cyclical models of collusion)
- unpredictability in demand (imperfect monitoring
models of collusion)
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III. Other Competitive Effects
1. Entry –
Would merger have significant impact in timely
period?
Is entry profitable at existing (or lower) prices and
thus likely to occur? (Barriers to entry important
here….)
Would entry return prices to pre-merger levels, thus
deterring merged parties from increasing price in the
first place?
2. Efficiencies
Would these compensate for price increase?
What is the nature of potential efficiencies?
3. Failing Firms
If part or all of merging assets are certain to exit
market if the merger did not take place, then merger
is unlikely to be anticompetitive.
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