Cross-Border Mergers and Branding Strategies of the Multinational Firms

1. Cross-Border Mergers and Branding Strategies of the Multinational Firms Toshihiro Ichida Waseda University MWIEG 2009 Penn State

2. Motivation • More than two-thirds of MNE's FDI flow is accounted for by the Cross-Border M&A. • In buying the local firm, MNE faces choices in its branding strategy: to keep both brands or to integrate brand names into one • Examples: Air France & KLM Royal Dutch Airlines, IHG (InterContinental Hotel Group) & ANA Hotels in Japan, and Nordea (European Bank)

3. Related Literature • Long and Vousden (1995 RIE) • Horn and Persson (2001 JIE) • Qiu and Zhou (2006 JIE) • Neary (2007 RES) • Lommerud, Straume, and Sorgard (2006 Rand)

4. Basic Model • 2 regions (N and S) • 3 firms (0 in N, 1 and 2 in S) • We consider the consumer market in S. • Assumption: entry is restricted because of firm-specific ownership advantages by 0,1,2 • N is advanced (cost advantage for firm 0) • Cross-Border Trade is costly (firm 0 needs to pay t to ship to firms in S) • Differentiated-Product Cournot Competition

5. Initial Setup Firm 0 Region N MC = 0 Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Consumers in Region S

6. Model • Consumers in Region S: linear demand for each brand i given outputs of other brands where b is an inverse measure of the degree of product differentiation.

7. Merger Formation • No merger: M0 = {0,1,2} • One Cross-Border merger: MCB1 = {01,2} • One Cross-Border merger: MCB2 = {02,1} • One National merger: MN = {0,12} • If N firm merges with a firm in S, then the merged firm can save on trade cost. • If N firm merges with a firm in S, then the merged firm can reduce production cost.

8. No merger: M0 = {0,1,2} Firm 0 Region N MC = 0 Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Consumers in Region S

9. One Cross-Border merger: MCB1 = {01,2} Region N Firm 0 MC = 0 Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Consumers in Region S

10. One Cross-Border merger: MCB1 = {01,2} Region N Region S Firm 01 Firm 2 MC = cL < c MC = c Consumers in Region S

11. One Cross-Border merger: MCB2 = {02,1} Region N Symmetric! Region S Firm 02 Firm 1 MC = cL < c MC = c Consumers in Region S

12. One National merger: MN = {0,12} Firm 0 Region N MC = 0 Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Consumers in Region S

13. One National merger: MN = {0,12} Firm 0 Region N MC = 0 Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Consumers in Region S

14. One National merger: MN = {0,12} Firm 0 Region N MC = 0 Trade Cost = t Region S Firm {12} MC = c Consumers in Region S

15. The sequence of moves: stage • The firm owner decides whether to merge, who to merge with, etc. • If there is a merged firm, it decides whether to keep 2 brand names or to integrate into one brand name. • The firms simultaneously and independently set quantities.

16. Brand Strategy of the Merged Firm • In the homogeneous product oligopoly model, the horizontal merger gives the merged firm a scale merit. (and there is no choice of brand) • In the differentiated product oligopoly model, the merged firm faces a following choice in its branding strategy: • Brand Integration • Brand Separation

17. Brand Strategy of the Merged Firm • Brand Integration • The merged firm will integrate (formerly separated) 2 brand names into one. • Brand Separation • The merged firm decides to keep the original 2 brand names. • The merged firm will maximize joint profit from the 2 brands.

18. One Cross-Border merger: MCB1 = {01,2} Region N Firm 0 MC = 0 Firm 0 and Firm 1 will merge Trade Cost = t Brand 0 Region S Firm 1 Firm 2 MC = c MC = c Brand 2 Brand 1 Consumers in Region S

19. One Cross-Border merger: MCB1 = {01,2} + Brand Integration Region N Region S Firm {01} Firm 2 MC = cL MC = c Brand {01} Brand 2 Consumers in Region S

20. One Cross-Border merger: MCB1 = {01,2} + Brand Separation Region N Merged firm maintains 2 brand lines Region S Firm {01} MC = cL Firm 2 MC = c Output coordination Brand 2 Brand 1 Brand 0 Consumers in Region S

21. One National merger: MN = {0,12} Firm 0 Region N MC = 0 Firm 1 and Firm 2 will merge Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Brand 0 Brand 1 Brand 2 Consumers in Region S

22. One National merger: MN = {0,12} + Brand Integration Firm 0 Region N MC = 0 Trade Cost = t Region S Firm {12} MC = c Brand 0 Brand {12} Consumers in Region S

23. One National merger: MN = {0,12} + Brand Separation Firm 0 Region N MC = 0 Merged firm maintains 2 brand lines: 1 & 2 Trade Cost = t Region S Firm {12} MC = c Output coordination Brand 0 Brand 1 Brand 2 Consumers in Region S

24. Export or Not • For M0 (No merger) case and MN (National merger) case, firm 0 (of region N) may or may not serve the consumer market in region S. • Firm 0 must export its outputs by paying trade cost t. The govt. can control part of t. • The government of region S may be able to foreclose its market from foreign firm 0 by setting the tariff level if it is beneficial.

25. No merger: M0 = {0,1,2} Firm 0 Region N Foreclosure condition MC = 0 Trade Cost = t Region S Firm 1 Firm 2 MC = c MC = c Consumers in Region S

26. One National merger: MN = {0,12} + Brand Integration Firm 0 Foreclosure condition Region N MC = 0 Trade Cost = t Region S Firm {12} MC = c Brand 0 Brand {12} Consumers in Region S

27. One National merger: MN = {0,12} + Brand Separation Firm 0 Foreclosure condition Region N MC = 0 Trade Cost = t Region S Firm {12} MC = c Output coordination Brand 0 Brand 1 Brand 2 Consumers in Region S

28. Foreclosure or import from N a Size of trade cost t More differentiated Identical 0 1 An inverse measure of the degree of product differentiation b

29. Foreclosure or import from N No merger case a Size of trade cost t Foreclosure Allow import by 0 0 1 An inverse measure of the degree of product differentiation b

30. Foreclosure or import from N One national merger with Brand Separation a Size of trade cost t Foreclosure Output coordination effect → higher prices with the same number of brand lines Allow import by 0 0 1 An inverse measure of the degree of product differentiation b

31. Foreclosure or import from N One national merger with Brand Integration a Size of trade cost t Foreclosure Reduction of brand lines Allow import by 0 0 1 An inverse measure of the degree of product differentiation b

32. Cross-Border Merger case • Firm 0 of region N will merge with one of the firms in region S (firm 1 or 2). • WLOG, we look at the case of MCB1 = {01,2}. • The merged firm {01} will compete with firm 2 in the consumer market in region S. • The merged firm {01} locates now in S, so it need not pay trade cost t anymore. • The merged firm {01} has lower production cost cL < c.

33. Cross-Border Merger case • The merged firm {01} will compete with firm 2 in the consumer market in region S. • The branding strategy of the firm {01}: • Brand Integration: brand {01} vs. brand 2 • Brand Separation: brand 0 and 1 vs. brand 2 (where firm {01} will control output levels of two brand lines jointly.)

34. One Cross-Border merger: MCB1 = {01,2} + Brand Integration Region N Region S Firm {01} Firm 2 MC = cL MC = c Brand {01} Brand 2 Consumers in Region S

35. One Cross-Border merger: MCB1 = {01,2} + Brand Separation Region N Merged firm maintains 2 brand lines Region S Firm {01} MC = cL Firm 2 MC = c Output coordination Brand 2 Brand 1 Brand 0 Consumers in Region S

36. Optimal Brand Strategy in MCB1 Proposition 3 (after cross-border merger) There exist a threshold value b* which does not depend on the parameters of the model (such as a, c, & cL) such that for b ≥ b* ↔ πBI{01} ≥ πBS{01}. and for b < b* ↔ πBI{01} < πBS{01}. And b* ≈ 0.72082.

37. Conclusion • The paper looked at merger incentives and brand strategy after the merger. • The analysis is still preliminary. I did not conduct global comparison of different merger types yet. • Need to look at comparison of welfare (vary t) • Trade cost is composed of t = tU + τwhere tU is uncontrollable part of trade cost and τ is tariff level.