Mergers

1. Mergers

2. Types of Mergers • Horizontal: merger between two competitors. • Goods are substitutes. • Vertical: merger between two firms at different stages of the production process. • Goods are complements. • Conglomerate: no clear substitute or complementary relationship.

3. Why so many mergers? • Economies of scale: both in production and in things like R&D. • Economies of scope: synergies between the two companies. • Defensive mergers: to deal with contracting markets, excess capacity. • Decrease competition: these are the mergers that antitrust is worried about.

4. How successful are mergers? • Studies of past merger waves have shown that two of every three merger deals have not worked. • Why? Real world -- not economic theory. • Linking distribution systems is often difficult. • Information systems often very difficult to mesh together. • Clash of corporate cultures.

5. The “Merger Paradox” • Assume firms are merging to decrease competition (no cost advantages). • For horizontal mergers only 2 motives, economies of scale or decreasing competition. • Start with a basic Cournot model. • If firms are symmetric, then profit of each firm is (a-c)2/b(n+1)2.

6. “Merger Paradox” con’t • Start with n firms: • i = (a-c)2/b(n+1)2 • Then m of the firms merge together to make (n - m +1) firms in the market. • After merger, profits for each firm are: • i = (a-c)2/b(n-m+2)2 • Less competition, but have profits for the combined firm increased or decreased?

7. “Merger Paradox” con’t • Is (a-c)2/b(n-m+2)2 greater than or less than m*(a-c)2/b(n+1)2 ? • Get rid of the (a-c)2/b terms on both sides and rearrange to get this condition: • Only profitable for the combined firm if (n+1)2>m(n-m+2)2 • Mergers cannot raise the profitability of the firms engaged in the merger even if 50% of the firms are involved in the merger.

8. “Merger Paradox” con’t • According to this model, almost no mergers are profitable. • Those that are probably wouldn't make it past the antitrust authorities. • Intuition behind the model: • Free-rider effect -- decreasing the number of firms raises industry profit and per firm profit, but combined firms get relatively smaller share of the industry.

9. “Merger Paradox” con’t • Why is this not the best model to look at? • Assumes firms are identical and that the merged firm has no advantages other than it is facing fewer competitors.

10. Merged Firm as a Stackelberg Leader • If the merged firm becomes a Stackelberg leader, it can improve its position. • Assume 2 firms merge and act as a industry leader a la Stackelberg. • Leader gets (a-c)2/4b(n-1). • Each follower gets (a-c)2/4b(n-1)2. • Compare this to premerger: •  = 2 * (a-c)/b(n+1)2

11. Merged Firm as a Stackelberg Leader, con’t • Always more profitable to merge if you can act as a Stackelberg leader. • Merger decreases profits of non-merging firms are long as there are four or more firms in the industry originally. • In this model, total output will increase. • So now we have a new paradox: Why would antitrust officials want to stop this type of merger?

12. Horizontal Mergers with Product Differentiation • Spatial model of product differentiation • Possible benefits of merger. • Coordinate prices: price of one firm affects the demand for the other firm. • Also can coordinate "location" (product design). • Start with a circle model this time, not a linear model.

13. Mergers with Product Differentiation, con’t • Circle model similar to linear model, except there is no "end" problem. • Consumers evenly spaced around the circle. • Each has a value of V and a cost of transport of t. • All firms have the same costs. F is fixed cost and c is constant marginal cost. • Each firm sets price.

14. Mergers with Product Differentiation, con’t • Consumers pay p + t(distance traveled) • With symmetric firms, they locate 1/n away from each other, all set the same price. • As long as V is sufficiently high, every consumer on the circle will buy. • P* = t(length of circle)/n • At this price, all consumers buy.

15. Mergers with Product Differentiation, con’t • Merger has no effect if the two firms aren't neighbors. • Why? no competition between the firms that merge, so no way to decrease competition. • If neighboring firms merge, can lessen competition. Have "captive consumers" over which they have more market power and can increase profits by raising price.

16. Mergers with Product Differentiation, con’t • Merger also benefits the other firms in the market -- allows them to raise price too. • After the merger, combined firms may also change their product lines -- get closer to their neighbors. • In this case, if there are efficiencies, they will be due to economies of scope.

17. Evaluating Mergers • None of the models presented assume any cost savings -- only reducing competition. • We need a way to evaluate mergers that considers both the benefits of any cost savings as well as the affects of decreased competition.

18. 1992 Merger Guidelines: • Define relevant product and geographic market. • Measure concentration pre- & post- merger with HHI. If merger raises HHI by 100 points and post-merger HHI is > 1000, investigate further. • Assess ease of entry into market. • Assess likely competitive effects of merger. • Assess any significant efficiencies that would result from the merger.