Acquisition of Potential Competitors: Examining Concentration and Market Power

1. Acquisition of potential competitorsMassimo MottaICREA-UniversitatPompeuFabraBarcelona Graduate School of Economics Santiago de Chile 26 August, 2019

2. Outline • Framing the issue • research on concentration and market power, markups, common ownership...: competition (and merger control) under-enforcement? • Increasing worries about the power of large digital platforms  Calls for reforming merger control • Acquisition of potential competitors • The issue: examples, “killer acquisitions” • Difficulties in dealing with such cases in practice • A model: effects of acquisition of start-ups by incumbents, to shed light on both anti- and pro-competitive effects • Policy proposals

3. Increasing concentration and profitability Sectoral concentration has increased Mark-ups have been rising considerably in the last decades Firms’ profitability has increased and its distribution is more unequal (and big business is getting bigger?) Common ownership may reduce rivals’ incentives to compete Council of Economic Advisors (2016), McKinsey, The Economist, McKinsey Global Institute Competition Report (2015) De Loecker and Eeckhout (2017), Traina (2017), Hall (2018), Azar, Schmalz, & Tecu (J. Finance 2017)...  Weak merger (and antitrust) enforcement may be one of the factors contributing to this trend (which signals weaker competition) 3

4. Concerns about digital platforms’ power • Increasing dominance of some digital platforms (with concerns extending beyond pure competition issues) • Digital markets not working well, because of a combination of sunk costs, network effects, two-sided externalities, switching costs and behavioral biases, and lack of sufficient antitrust and merger enforcement (see “Furman”, “Crémer” and “Scott Morton” reports) • The role played by hundreds of acquisition of potential competitors, never challenged by AAs, particularly stressed.

5. Acquisitions by digital incumbents • Over 400 acquisitionsby Apple, Facebook, Google, Microsoft in thelastfewyears • Facebook/Instagram, Facebook/Whatsapp, Google/Wazeexamples of particularly controversial mergers • Synergies might be possible, but risk of systematic elimination of possible future rivals • Little or no overlap at the moment of the acquisition (often target firms active in complementary markets) makes it difficult to challenge these mergers • Competition is potential, and the AA has the burden of proving significant anticompetitive effects

6. An issue not only in digital markets... Some recent large mergers (beer, cement) likely aimed at eliminating reciprocal entry threats. But how to prove that entry would materialise within reasonable time? Need for internal documents (or evidence of a pattern of entry). Cunningham et al.(2018) carefully document “killer acquisitions” in the pharma sector: their empirical analysis of the development of thousands of drugs (their data cover about 25 years) show that: - acquired drug projects are significantly more likely to be discontinued than those which have not been acquired 6

7. Fumagalli, Motta & Tarantino, WP Model where a start-up, S, has a “prototype” which, if successfully developed, could become a competing product of the dominant incumbent, I Investment is costly, and S needs outside funding – moral hazard may create a credit constraint despite the positive NPV of the project if S has few assets The incumbent has sufficient funding to develop, but it would not necessarily have the incentive to do so if it owned the prototype (“Arrow replacement effect”: cannibalisation of current profits implies an incumbent has less incentive to innovate than an entrant) 7

8. The game I can acquireSbeforeit looks forfunding, orafteritinvests Relativeto a benchmarkwithoutmergers, theacquisition can haveanti-competitiveeffects: (i) suppression of development; (ii) elimination of futurecompetition And pro-competitiveeffects: (iii) if I developswhereasSwouldnot be funded; (iv) expectingthatImayacquireS (and itsobligationstorepaythe loan) maypushinvestorstofundit 8

9. Policy analysis Acquisition of start-ups by the incumbent might in some cases be pro-competitive But if there are “rich” outsiders which could also develop efficiently, a policy which prohibits I (but not the outsiders) from acquiring S would be best An outsider here has both the ability (assets) and incentive to develop the prototype Caveats: (1) Such outsiders may not always exist (analyse counterfactuals!). (2) If expected profits determine the effort of S to create the prototype in the first place, a policy which reduces bidding competition may also reduce probability of having the prototype. 9

10. Which policy implications? The model stresses that acquisitions of start-ups by dominant incumbents generate trade-offs that may not be trivial But continuing to let incumbents systematically acquire potential competitors is certainly not a good idea The policy rules in the model are stylised and coarse, but it would make sense to adopt changes that allow AAs to review such acquisitions, and – apart from those which are truly minor –to consider the realistic (rather than ‘more likely than not’) counterfactuals to the acquisition (independent development, acquisition by outsiders...) 10

11. Recent policy proposals Scott Morton et al.: obliging firms with bottleneck power to notify all mergers to a new Digital Authority, and shift the burden of proof Crémer et al.: dynamic approach considering that the integration of start-ups in the incumbent's ecosystem may make it more difficult to contest its position Furman et al.: revise UK merger guidelines and adopt a ``balance of harms´´ approach whereby both probability and magnitude of the impact of the merger should be considered 11