Economic Analysis and the new EC Merger Notice

1. Economic Analysis and the new EC Merger Notice Derek Ridyard RBB Economics derek.ridyard@rbbecon.com 30 March 2004

2. Overview Economic analysis under the Notice: 1. Non-coordinated effects • Coordinated effects • HHI thresholds 4. Impact of procedural/institutional changes on substantive analysis

3. Classification of competition concerns • Notice creates a new category of concern to fill the perceived “gap” under the old regime.

4. 1.1 Non-coordinated effects • Measures the impact that a merger has on incentives to keep prices low • Encompasses dominance and other “close competitor” cases in differentiated product markets • Some examples (old and new) • Scott/Kimberley Clark • Volvo/Scania • GE/Instrumentarium

5. 1.2 Illustration of non-coordinated effects

6. 1.3 Evidence of the gap? • Lloyds TSB/Abbey National? • FTC baby foods merger? John Vickers (2004): “numerous mergers that could seriously jeopardise competition without crossing the threshold of dominant market power.”

7. 1.4 Non-coordinated effects – the role of economic theory • Draft Notice relied explicitly on Bertrand and Cournot models • See DG COMP study: • “A merger between competitors increases market power .. leading .. to higher prices and lower output” • “HHIs can be considered a good indicator [of the effect of a merger on price]” • Same theory is embedded in merger simulation models • All merging firms are “guilty” – but are they guilty enough to justify prohibition?

8. 1.5 Forgotten role of supply-side effects • Unilateral effect theories rely on passive demand-side effects • They ignore elements such as: • strategic buyer power • entry and investments by rivals • underlying market dynamics • See OFT 1999 oligopoly study for an antidote

9. 1.6 Non-coordinated effects - conclusions • Notice remains heavily influenced by simple theoretical models • Logic of the Notice suggests a move towards greater intervention • But costs of extending powers to analyse non-coordinated effects have been ignored • The real impact is: • Greater DG COMP discretion • Less predictability

10. 2.1 Coordinated effects – stage 1 Identify focal point for co-ordination: • Price • Customer / territory sharing • Output / Capacity

11. 2.2 Coordinated effects - stage 2 Evaluate stability of coordination in terms of: • Transparency • Availability of credible enforcement mechanism • Resilience to external shocks and fringe competition

12. 2.3 Coordinated effects- stage 3 What changes as a result of merger? • Creation or strengthening? • Importance of eliminated factors • Impact on asymmetries and incentives • Surprisingly, this critical stage is not properly addressed in the Notice

13. 3.1 HHI “safe harbour” thresholds in the Notice Safe harbour

14. 3.2 “The safe harbour is mined!” HHI safe harbours have 6 caveats: • Potential competition • One merging firm is an innovator • Cross-shareholdings • Merger takes out a “maverick” player • Past or ongoing coordination is evident • One merging firm has >50% share

15. 3.3 HHIs and the US Guidelines EC HHIs are modelled on US Guidelines, but in a study of US practice: • Median HHI for unchallenged cases is 2,500 • Median HHI for challenged cases >5,000 • Lowest challenged HHI >2,000 since 1985 (From Scheffman, Coate and Silva, FTC)

16. Summary on Notice • The Notice has: • confirmed the role of economic analysis • created a sophisticated debate on merger enforcement • But: • it continues to shows undue dependence on theoretical models • creates very wide discretion • and can only be part of the story …

17. 4.1 Process changes Chief Economist’s Office Tri-partite meetings CFI Judgments Internal Review Hypothesis testing

18. 4.2 Hypothesis - testing • CFI Judgment criticisms are fundamentally about empirical analysis • Draft Notice does not help here – even adds to the problem Consequences: - much more work for parties - a better chance to prove case

19. 4.3 Chief Economist’s office • Professor Röller: leading academic with empirical orientation • Assembling dedicated team of economists Consequences: • another audience for Oral Hearings • greater sophistication in analysis

20. 4.4 Tri-partite meetings • Provision for a crowded schedule during Phase I and II • Consequences: • Greater scrutiny of 3rd parties? • More work for parties • More transparency

21. 4.5 Internal review panel • Another independent check on case team • Some notable influence already Consequences: • chance to stop the juggernaut in its tracks

22. Conclusion – the new regime • Changes signal a new era in ECMR enforcement • The key areas to watch will be: • controlling DG COMP discretion and reliance on untested economic theory • maintaining the genuine scrutiny that has arisen from CFI Judgments