GE-Honeywell (2001)
Tom Giblin
Hadley Heath
Imran Ramji
Introduction

The Players

General Electric
 http://www.youtube.com/watch?v=fViObqGvIjM&NR=1
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Diverse range of products
Revenues 2001 exceeded $125 billion
Honeywell
 http://www.youtube.com/watch?v=rCCJVuUrP-Q
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Aerospace and technology
Revenues 2001 were approximately $23 billion
Nearly half of revenues from aerospace division
Introduction
The Players
 Rivals


International Aero Engines

Joint venture between Pratt & Whitney and Rolls
Royce
U.S. DOJ
 European Commission



20 members
Goal: to demonstrate whether or not the
proposed merger would lead to market
dominance
Two Sides of the Case

Against the Merger


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GE and Honeywell have dominant market
positions.
Proposed merger would allow bundling of
complementary products, lower prices, and an
unbeatable advantage.
Ultimate exit of rivals and market dominance
of merged firm.
Two Sides of the Case

For the Merger



GE does not have market dominance in aircraft
engines.
The proposed merger would not lead to
bundling.
Without bundling, there would be no exit of
rivals and no ultimate market dominance by
GE.
Market Dominance

The anti-merger case used the following
market shares:



GE = 52.5%
P&W/IAE = 26.5%
RR/IAE = 21%
This combines CFMI’s sales under GE, but
splits IAE’s sales into P&W and RR.
 Justification: “SNECMA would act jointly
with GE as a profit-maximizing entity.”

Market Dominance
The pro-merger case:
 Inaccurate evaluation of GE’s market share
 If RR and P&W are not grouped as IAE,
SNECMA and GE should not be grouped.
 On exclusive contract sales with Boeing on
737s, GE has no ability to set prices.
 Therefore, exclusive contract sales should
not be part of GE’s market power evaluation.

Bundling

Pure Bundling

Two products are sold together and are not available
separately

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Tying

Product 1 is sold by itself, but product 2 is available only
with product 1


Ex. Left and right shoes are not sold separately
Ex. NFL season pass is available only with satellite TV
Mixed Bundling

Two items sold separately or together, but together they
are sold at a discount price

Ex. A combo meal at a fast food restaurant
Bundling

Cournot


Two monopolists act independently, but
together can lower prices and earn more
money. Ex. Zinc and copper make brass.
Assumptions:


No other firms in the market
Firms set a single price to all consumers
Bundling

Expansion of Cournot’s Model
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
Firms A1 and B1 produce good 1
Firms A2 and B2 produce good 2
This accounts for other firms in the market
Bundling
Case 1: All firms act independently
 Results:
 All firms charge a price of 1
 All firms make a profit = 1/2

Bundling
Case 2: Bundle vs. Bundle
 Results:
 Prices fall by 50%
 Profits fall by 50%

Bundling
Case 3: Bundle against Components
 Results:
 Firm A’s profits go from 1 to 0.91
 Uncoordinated B firms’ profits go from 1
to 0.32

Mixed bundling
Firm A sells bundles at 19% discount
 Best response of B firms is to lower
component prices
 This gives firm A an advantage

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Market share = 55.4%
Rivals’ profits fall by 21%
The Anti-Merger Case
Rolls Royce presented this type of
bundling as most appropriate to this case.
 The EC used this model, along with an
expected increase in market size, to
conclude that GE would have an economic
incentive to use mixed bundling.

Considerations

Existence of competitors
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Number of products
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More products greater incentive to bundle
Total market demand


Accounted for in expansion of Cournot model
Greater elasticity of demand  greater incentive to
bundle
Asymmetry of products
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More symmetry  greater incentive to bundle
Avionics ($100,000) and jet engines ($15 million)
Price Negotiation
Cournot Assumption: One price for all.
 Consumers in this case are powerful.
 Price discrimination (not a single price)

Timing

Engines are purchased before avionics


Once engine competition is won, giving a
discount on a bundle would be no different
than giving an avionic discounts directly
Solution would be to promise discount on
avionics before purchase of engine

Wouldn’t work in avionics industry because
negotiated prices
Exit by Rivals

The Commission’s belief that the merger
would lead to rival exiting is questionable

Rival stock increased when merger announced


Investors predict the merger will benefits rival
companies
Long term contracts

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Typical plane is on the market 25 years
Competitors have 2/3 share of the engines on next
generation planes
Exit by Rivals

Allied Signal and Honeywell merger

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
1999 merger between two large avionic
component firms
Despite widespread bundling little effect on the
market
Hypocrisy of Commission’s decision

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Argued Allied Signal-Honeywell bundling
effects were slow to arise
Argued effects of GE-Honeywell merger would
lead to quick exit of rivals
Policy Prescriptions

What possible regulations should be
enacted if the Cournot effect is large?

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None? – prices fall, social welfare increases
EC worried about long term market exit
leading to market dominance and price
increase
There are a few questions to be asked
before deciding on any policies to stop
possible bundling
Policy Prescriptions

Is there an incentive to bundle?

Not really
What is the immediate gain to consumers
from lower prices?
 What will be the impact on competitors?
 How long do we expect lower prices to
persist?
 If the rivals exit, what is the expected
harm?

Policy Prescriptions
Nalebuff argues that the EC stopped after
question 1
 In addition, they focused on market
competitiveness and did not examine the
potential positive trade-offs of bundling

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Long-run harm vs. Short-run gain
This is not an area in which antitrust
authorities should be involved
Remedies

The firms could agree to not bundle their
products


They would have to provide an itemized list of
individual prices
However, the EC rejected this because
they preferred structural solutions over
behavioral ones

Even though this solution would not be difficult
to enforce
Conclusion
European Commission blocked the merger
 According to the author
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Abandoned original model, but did not replace
flawed model
Used dynamic theory of predation
Did not have enough support
Backed away from bundling theory, but still
concluded that bundling was a reason to block
merger
Discussion
Two sides of the case…
 European Commission



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Biased?
Politics and “National Champions”
Author, Barry Nalebuff


Biased?
Economic expert for GE-Honeywell in their
presentation to the European Union Merger
Task Force.
Post Script
2005 Appeal to European Court of First
Instance (CFI)


CFI rejected bundling argument, and was not
persuaded that GE would act anticompetitively.
But, CFI denied the appeal because the merger
would create market concentration in:


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Small marine gas turbines
Engines for large regional jets
Corporate jet aircraft engines
Even if appeal granted, it was too late.
The End