Horizontal mergers
Horizontal mergers
Industrial organization – lecture 4
Horizontal mergers
Horizontal mergers
What is the main motivation for horizontal mergers? What are the
welfare effects of horizontal mergers?
What are the unilateral and coordinated effects?
Should competition policy be concerned?
Horizontal mergers
Merger paradox
Pepall et al. (2010, pp. 287–290)
Cournot model prediction: Only a merger of two duopolists creating a
monopolist is profitable
• Merger reduces number of firms
• Non-merging firm increase their output
• Post-merger profit is less than the sum of pre-merger profits
The problem is that the merged firm is just like any one of the other
firms in the industry. What to add into the model?
• Economies of scale and scope
• Shared capacity makes merging firm a leader
• Product differentiation
Horizontal mergers
Model of product differentiation
Pepall et al. (2010, p. 301-304)
N firms each producing single product.
Demand for product i is qi = V − pi − γ pi − 1
N
N
j=1 pj .
Parameter γ measures the degree of product differentiation
Marginal costs c are normalized to zero.
Profit of each firm is Πi = pi V − pi − γ pi − 1
N
N
j=1 pj .
Horizontal mergers
Model of product differentiation
Pepall et al. (2010, p. 301-304)
First order condition
V − 2pi − 2γpi 1 −
1
N
+
γ
N
j∈{−i}
pj = 0
Symmetric Nash equilibrium
p =
NV
2N + γ(N − 1)
Horizontal mergers
Model of product differentiation
Pepall et al. (2010, p. 301-304)
Firms 1, . . . , M merge. There is no reason to remove any of the M
products.
The newly merged firm maximizes aggregate profit
M
j=1 Πj
The first order condition is
∂
M
j=1 Πj
∂pi
=
∂Πi
∂pi
+
M
j=1,j=i
∂Πj
∂pi
= 0
The second term captures the price effect on profits of other merging
firms. It can be seen from the profit function that
∂Πj
∂pi
=
γpj
N
Horizontal mergers
Model of product differentiation
Pepall et al. (2010, p. 301-304)
What does it mean for the equilibrium price?
• The reaction curves of the merged firms moves upward.
• The price of non-merged firms increases because reaction curves are
upward-slopping.
• These two effects cause that the prices of the merged firms increase.
The main conclusion of the model: Mergers are profitable and of potential
concern to antitrust authorities unless accompanied by cost reduction
Horizontal mergers
Merger policy
Anti-trust authority (AA) has to approve some mergers. How to make a
decision?
What effects should the AA take into account?
• Loss of consumer surplus due to higher prices
• Cost efficiency
• Failing firm defence
Can we compare these effects quantitatively? Sometimes yes.
Imagine you have all relevant data available and you know the structure
of the market game. How would you procced?
Horizontal mergers
Merger policy
What is the other option if AA cannot estimate the structural model?
AA should take into account all relevant factors in a less formal way.
Shapiro (1996) recommends the following steps.
1. Calculate the diversion ratio between merging firms.
2. Based on diversion ratio and current mark-ups calculate post-merger
price
3. Compare price increase against potential cost synergies.
Horizontal mergers
Merger policy: Remedies
An AA might approve a merger only if certain remedies were adopted by
merging firms.
• Structural remedies modify he allocation of property rights.
• Behavioral remedies set constraints on merged firms’ behavior.
Can you think of some pros and cons of structural and behavioral
remedies?
Structural remedies (particulary divesture) are applied much more likely
than beahvioral remedies.
Which assets should the merging firm sell?
Horizontal mergers
Merger policy: remedies
Consider our model with differentiated product and suppose that the
paramter γ might be different for different pairs of products.
Demand for product i is qi = V − pi − 1
N
N
j=1 γij (pi − pj ).
Firms 1, . . . , M merge. AA can order them to sell some of products
1, . . . , M to a new entrant. Which products should AA choose?
Horizontal mergers
Coordinated effects Pepall et al. (2010, p. 315-316)
Merger generates more favourable conditions for collusion (In EU this is
refered as joint dominance)
The analysis of coordinated effects is ambiguous. One may take into
account factors such entry barrires, information exchange and so on.
Do mergers have any impact on collusive behavior at all? Ganslandt and
Norback (2004) study retail gasoline market in Sweden.
The main idea follows form Cournot relationship LI = HHI
They estimate the equation ln( LI) = α + βHHI
They do not find any evidence that mergers have impact on collusion.