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Analyzing Vertical Mergers: Impact, Mechanisms, and Effects

Explore the complexities of vertical mergers, including input and customer foreclosure mechanisms, competitive effects, efficiencies, and empirical analysis. This document delves into the EWS/Marcroft merger case study, highlighting market power dynamics and potential barriers to entry.

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Analyzing Vertical Mergers: Impact, Mechanisms, and Effects

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  1. Vertical mergers - EWS/Marcroft NEIL PRATT ACE conference, November 2007

  2. Agenda • Framework for assessing input foreclosure • Comments on EWS/Marcroft

  3. Vertical merger analysis – preliminaries • No direct loss of rivalry • Efficiency rationales • Elimination of double marginalisation • Improved investment incentives • Two main unilateral theories of harm • Input foreclosure: restrict/degrade input supply • Customer foreclosure: limit input purchases

  4. Upstream entity Downstream entity Downstream rivals The input foreclosure mechanism RRC? Efficiencies? Softer competition? Impact on customers?

  5. Analytical framework Ability • Significance of input to downstream firms • VI firm’s market power upstream • Barriers to entry and expansion upstream Incentive • Margins in upstream and downstream markets • VI firm’s share of downstream market • Extent of share-shifting to VI firm • Impact on size of downstream market Effect • Competitive significance of foreclosed rivals • Impact on barriers to entry • Competitive constraint from vertically integrated rivals • Merger-specific efficiencies

  6. Empirical analysis of incentive • ‘Vertical arithmetic’ approach can be used to assess profitability of input foreclosure – e.g. • Evraz/Highveld • Thales/Finmeccanica/Alcatel Alenia Space & Telespazio • Simple analysis can indicate likelihood of foreclosure • Estimate cost from foregone upstream margin based on loss of input sales • Estimate profit from additional downstream margin based on expected sales diversion • More sophisticated simulation approach can help assess competitive effects

  7. EWS/Marcroft - background • Relatively low value deal in a difficult market • Some tricky economic issues to resolve • No economic advisers retained by parties • Apparently limited data available to CC in certain areas • Conflicting evidence from EWS and complainants

  8. Vertical foreclosure: main lines of debate • Efficiencies did not play a significant role • EWS already vertically integrated • Parties did not make strong efficiency claims • Debate focused on two key issues: • Marcroft’s pre-merger position in the wagon maintenance market • EWS’s incentive to lower foreclose rivals in the haulage market

  9. Marcroft’s pre-merger position • CC relied on structural analysis of wagon maintenance market • High share – 56% (volume) • Only one rival with national coverage • Self-supply not an effective constraint • Some conflicting evidence on performance and conduct • Poor financial performance of Marcroft • Examples of failed attempts to increase prices/lost tenders • CC concluded on balance that Marcroft had significant market power

  10. Two possible forms of input foreclosure • Reduction in service quality to haulage companies • Increased downtime, less reliable scheduling of works • Could be targeted at selected customers • Foreclosed customers would face higher costs, or lose contracts • Increase in price of maintenance services • Conflicting evidence on significance of maintenance relative to operating costs • Price increase expected to have some negative impact on rivals

  11. Limited evidence on incentive and effect • Data limitations appear to have precluded application of vertical arithmetic • CC points to size of haulage market compared to maintenance market and EWS’s high share • Wabtec (and others) not seen as competitive alternative • High-level approach to haulage market • No concrete examples of potential foreclosure • Not much on harm to end users

  12. Final remarks • EWS/Marcroft follows orthodox approach to vertical mergers • Debate focused on empirical questions • Market power of Marcroft • Profitability and effect of foreclosure • Threat of self-supply by e.g. Freightliner • Data appears to have been quite limited and contentious in this case

  13. Frontier Economics Limited in Europe is a member of the Frontier Economics network, which consists of separate companies based in Europe (Brussels, Cologne and London) and Australia (Melbourne & Sydney). The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Limited.

  14. FRONTIER ECONOMICS EUROPE BRUSSELS | COLOGNE | LONDON Frontier Economics Ltd, 71 High Holborn, London, WC1V 6DA Tel. +44 (0)20 7031 7000 Fax. +44 (0)20 7031 7001 www.frontier-economics.com

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