Horizontal Mergers and Coordinated Effects

1. Horizontal Mergers and Coordinated Effects Eric Emch, OECD eric.emch@oecd.org

2. Why Have a Merger Policy? • We care about price-fixing, for one obvious and one not-so-obvious reason. • Prohibiting price-fixing without restrictions on horizontal mergers creates a loophole. • In fact, this logic may have contributed to US merger wave of 1887-1904; diff. between European (cartel) and US (merger) experience? • Merger wave stopped in part due to greater law enforcement attention to mergers

3. Why do we care? • Obviously, we don’t only care about mergers to monopoly • More generally, reducing competition in a market can lead to harmful effects on: • price dimensions (most straightforward) • quality dimensions (less straightforward) • innovation dimensions (even less straightforward) (we will focus on price, but discuss other dimensions too)

4. Consumer Surplus in a Competitive Market P Consumer Surplus Pc Demand Curve Q Qc 4

5. Effects of Price Rise After Acquisition of Market Power P A. Consumer Surplus C. Deadweight Loss Pm B. Profits Pc Demand Curve Q Qm Qc

6. Why are high prices bad? • Money transferred from consumers to firms • EU explicitly, US implicitly consider this a bad thing • Canada closer to ignoring this • Creates deadweight loss • Smaller in size, but more universal concern

7. Non-Price Effects • Quality • Similar effects to pure price rise, but there are measurement issues • Innovation • A complication: cooperation in R&D can often be a good thing -- can bring critical economies of scale and reduce duplicative effort • Research joint ventures given much more leeway than pricing cartels

8. Competitive Effects of Horizontal Mergers Legal history in the United states

9. United States v. Brown Shoe370 U.S. 294 (1962) • Prohibited merger between 3rd and 8th largest shoe sellers: In specific markets, combined shares exceeded 5% (and in some cities ranged from 20% to 57%) • Court showed great concern with market shares, concentration, and number/type of competing firms: • “If a merger achieving 5% control were now approved, we might be required to approve future merger efforts by Brown’s competitors seeking similar market shares.” • Stressed that a “large national chain” held this share in an industry that is characterized by fragmentation and small competitors

10. Brown Shoe, cont. • Was the Court protecting competitors at the expense of efficiency? • “But we cannot fail to recognize Congress’ desire to promote competition through the protection of viable, small, locally owned business. Congress appreciated that occasional higher costs and prices might result from the maintenance of fragmented industries and markets. It resolved these competing considerations in favor of decentralization.” 370 U.S. at 344. • No analysis of actual or likely effects; no consideration of efficiencies; collusion was basically impossible (at least 20 competing firms)

11. United States v. Von’s Grocery384 U.S. 270 (1966) • Blocked merger of 3rd largest grocery retail chain (4.7% share) and 6th largest (2.8%) • Combined market share (7.5%) less than the market leader (Safeway); Top 8 firms controlled 41% • Court focused on “trend” toward concentration and not the effects of this particular merger: Concern over smaller, independent competitors • Unilateral or coordinated effects? Very unlikely

12. Von’s, cont. • Justice Stewart’s famous dissent: • “[T]he Court pronounces its work consistent with the line of our decisions under Section 7 since the passage of the 1950 amendment. The sole consistency that I can find is that in litigation under Section 7, the Government always wins.”

13. Criticism of the 1960s Cases • Judge Posner said that these cases “seemed, taken as a group, to establish the illegality of any nontrivial acquisition of a competitor, whether or not the acquisition was likely either to bring about or shore up collusive or oligopoly pricing. The elimination of a significant rival was thought by itself to infringe the complex of social and economic values conceived by a majority of the Court to inform the statutory words ‘may . . . substantially . . . lessen competition.’” Hosp. Corp., 807 F.2d at 1385.

14. Current Analysis: Scrutiny of Effects • Lower courts undertake sophisticated, intensive analysis of market structure and firm behavior to determine when firms could successfully coordinate their behavior or unilaterally raise prices post-merger • Statistical evidence is credited, and qualitative factors are still given great weight

15. Competitive Effects from Horizontal Mergers Economic Theories of Harm

16. Coordinated Effects Theory (1) • Firms would generally like to have higher industry prices if they can manage it • Explicit price fixing is outlawed and can increasingly lead to criminal prosecution • There are many ways to effectively collude without a formal agreement on fixing prices • Tacit collusion: “A meeting of the minds without the meeting” • Can be more or less difficult depending on market circumstances

17. Coordinated Effects Theory (2) • Though firms generally have a collective incentive to collude, they also have an individual incentive to cheat on any agreement (classic Prisoner’s Dilemma: Nash equilibrium is suboptimal) • Repeated games allow for successful collusion, which requires: 1. Some way of reaching terms of coordination 2. Some way of monitoring compliance 3. Some way of punishing deviations

18. Firm 2 Collude Defect (2,2) (0,3) Collude Firm 1 (1,1) (3,0) Defect

19. Coordinated Effects Theory (3) • Ways that firms can collude: • Price-based rules • Explicit or implicit coordination or bid-rigging • Quantity-based rules • Fixing sales volumes, market shares, or capacities • Assignment rules • Geographic/product market division • Facilitating practices • MFN, MCC clauses or common sales agents

20. Coordinated Effects Theory (4) • Market conditions that facilitate collusion: • High concentration (few players) on seller side, low concentration on buyer side • But criminal record has shown cartels with large # of firms • Transparency (of prices, quality attributes) • Homogeneity (of goods, firms, customers) • Absence of mavericks (many other factors have been mentioned that do not strictly fall into these categories)

21. Coordinated Effects Theory (5) • Merger may increase likelihood of collusive activity, either explicit or implicit • Increases concentration • May eliminate maverick firm • May narrow asymmetries among firms • Key question: Why weren’t they colluding prior to merger? What difference does the merger make? • One way to look at it: collusion may be a continuous, not a discrete variable

22. Competitive Effects of Horizontal Mergers Recent U.S. Case Studies

23. Coordinated Effects:FTC v. Arch Coal (2004) • Five major producers of coal in the relevant market: Peabody, Kennecott, Arch, RAG & Triton. Arch buying Triton • Post-merger, still five in that Arch would sell a mine to Kiewit (“fix-it-first”) • Although market was highly concentrated (HHI of around 2000-2200), merger resulted in HHI change of only between 49 and 224 points

24. Court’s Analysis • Prima Facie burden met, but this was a weak “presumption” case (cf.Heinz where HHI increase of 510 on a 4775 base), so D’s burden is not as high • Court also indirectly questions “check-list” approach; prefers in-depth analysis of exactly how coordinated activity is likely to occur

25. Focus on Facts • Court finds that although collusion may occur, it is not likely to occur: • Current market is competitive • No evidence of actual collusion (yet amazing examples of interest) • Market structure inhibits coordination: Powerful customers, incomplete information, no effective punishment mechanism • Fringe would step-in

26. DOJ v. Mactac/Raflatac (2003) • Merger between producers of paper labelstock • Pre-merger: Nine producers, but only three “first-tier” producers, Avery (49%), MACtac (12%), Raflatac (11%) • Merger between MACtac and Raflatac: relatively small change in HHI, though market “highly concentrated” by guidelines • Elements of both coordinated effects and unilateral effects in harm story • UPM (Raflatac) now sells paper to all first-tier firms • Only two first-tier firms remain • Fringe can’t discipline potential price increase • MACtac, Raflatac each other’s closest competitors 26

27. Coordinated Effects Factors • Coordinated effects checklist: • High concentration on seller side, low on buyer side? • Yes: 3 “first tier” sellers, buyers unconcentrated • Transparency? • Producers know lots about competitors • Firms in many cases know competitors’ sales to each customer. In individual competitions, often know both competitor & price • Raflatac sells label paper to Avery (cost side info) • Homogeneity? • Little product differentiation between big three; MFN clause means cost similarity for big two 27

28. Coordinated Effects Factors • Terms of coordination: • Possible coordination on prices • Raflatac upstream parent UPM sells label paper to Avery; avenue for transfers and information exchange • Evidence of attempts to collude pre-merger (signaling, retaliatory price cuts, noncompete agreements), though market seen as reasonably competitive • What difference does merger make? • Elimination of maverick (Raflatac changes behavior) • One fewer top-tier competitor • Greater homogeneity 28

29. Final Thoughts • Market definition and market shares are necessary, but only a first step. • Current guidelines by most competition authorities provide a way to structure your thinking, not a simple formula • Logic must be clear and backed up by quantitative and qualitative evidence to be convincing to outside arbiters, like courts

30. Some References • European Commission, Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings (2004/C 31/03) , available at http://ec.europa.eu/comm/competition/mergers/legislation/notices_on_substance.html#hor_guidlines • Japanese Fair Trade Commission, Guidelines to Application of the Antimonopoly Act Concerning Review of Business Combination, May 31, 2004, (amended on May 1, 2006, March 28, 2007). (English translation available at: http://www.jftc.go.jp/e-page/legislation/ama/RevisedMergerGuidelines.pdf) • Korean Fair Trade Commission, Notification on M&A Review Guidelines, Notification 1999-2 (English Translation available at http://www.ftc.go.kr/eng/) • U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines, March 2006 (available at: http://www.usdoj.gov/atr/public/guidelines/215247.htm) • U.S. Department of Justice and Federal Trade Commission, Commentary on the Horizontal Merger Guidelines, March 2006 (available at: http://www.usdoj.gov/atr/public/guidelines/215247.htm) • Motta, Massimo, Competition Policy: Theory and Practice, Cambridge University Press, 2004, Chapter 5: “Horizontal Mergers.”