Public Policy in Private Markets

1. Public Policy in Private Markets Merger Policy

2. Announcements • Check iclicker grades. If you are using iclicker and do not see grades, let me know ASAP • Midterm exam: being graded, expect to get it back on 3/27 • Homework 4 coming up (right after break)

3. Merger Law • Very important part of antitrust • Mergers are very common – hundreds of mergers every year • Knowing this material will be useful for you at some point • 3 types of mergers: • Vertical • Horizontal • Conglomerate

4. Merger Typology 1. Horizontal: 2 or more direct competitors • Examples: Coke and Pepsi; McDonald’s-Burger King; Staples-Office Depot • Why may this be anticompetitive? • More concentration means less competition, therefore higher market power (↑P) 2. Vertical: firms that operate at different stages of production/distribution • Cement and concrete; microchip processors-computer manufacturers • Anticompetitive? • Foreclosure or increased costs for non-integrated firms • Barrier to entry for future potential entrants

5. Vertical Mergers: foreclosure/increased cost Manufacturer 1 Manufacturer 2 Manufacturer 3 Distributor A Distributor B • A vertically separated industry • All Manufacturers could use eitherof the two distributors • Distributor A is larger and more efficient • Manufacturer 1 is larger.

6. Vertical Mergers: foreclosure/increased cost Manufacturer 1 Manufacturer 2 Manufacturer 3 ? Distributor A Distributor B • 1 vertical merger (vertical integration) between large manufacturer and large distributor • Manufacturer 2 and 3 are left with “more costly” distributor potential distributor • Manufacturer 3 can be foreclosed (i.e. leaves the market as it is no longer profitable to operate) • Barriers to entry: to successfully enter the market you need to enter 2 stages

7. Merger Typology 3. Conglomerate: neither vertical nor horizontal • Product extension: merger between firms producing different but related products • Example: Coke buys Gatorade • Market extension: similar product, different region • Safeway-Stop and Shop • Pure Conglomerate: Unrelated products • Example: GE - Samsonite

8. Conglomerate Mergers • Anticompetitive effects: • Elimination of potential competitors: acquired firm is more likely to be a potential competitor than an inexperienced firm • Entrenchment: if acquired firm is a large company, de-concentration may be harder (when/if needed)

9. Merger Law • Clayton Act (1914): “To arrest the creation of trusts in their incipiency and before consummation…” • INCIPIENCY is important: get at CR in early stages of development (don’t wait until monopoly) • BEFORE CONSUMMATION: mergers can be challenged before they take place; injunction keeps businesses separate pending court review • Section 7, Clayton Act, is the merger law: • Can be enforced by either DOJ, FTC or private cases

10. Ex-Post v. Ex-Ante Regulation • Ex-Post: • After activity takes place. Examples: Collusion, Monopolization, Vertical Restrictions • Ex-Ante: • Before activity takes place. Example: Mergers! • Ex-ante regulation is generally considered to be tougher than ex-post (it deems activity potentially harmful even before it takes place)

11. Merger Law • Section 7: • Illegal to acquire stock or assets of another corporation: “Where in any line of business, in any section of the country, the effect of such acquisition may be substantially to lessen competition or tend to create a monopoly” • Emphasis on “may”: looking at what is possible (i.e. rule of reason)

12. Merger Law • 1976 Hart-Scott-Rodino Act • Pre-Merger Notification: FTC & DOJ must be notified 30 days in advance of any merger where: • Acquiring party has sales > $100 million • Acquired party has sales > $10 million • Agencies have 30 days to review and may issue temporary injunction before merger • Agencies can request more information • Agencies can negotiate with parties (e.g. sell off unit)

13. Merger Law • Enforcement impacts: • Since 1950’s, Section 7 has had impact on number and types of mergers • Biggest impact: Horizontal mergers • Rule of reason approach employed

14. Merger Law • 1950’s-1960’s: Strict enforcement • Mergers among firms with low mkt shares are challenged • Mergers treated almost on a per se rule • 1970’s-today: More lenient enforcement • More demanding evidence to block a merger • Rule of reason approach.

15. Horizontal Merger Guidelines • Two-step process (as in monopolization cases): • Define relevant market: are the two firms in the same relevant market? If so, move to the second step • Define if market power (i.e. price) is likely to increase in the relevant market: main measure is concentration.

16. Horizontal Merger Guidelines 1. Market Definition • Product: physical characteristics, uses, cross-elasticity, absolute price levels, etc. • Geographic: transportation costs, legal restrictions, local product differentiation • Do 2 products belong to same market? • If so, then merged firm can more easily increase price of either of its products: customers will keep buying (other products) from this firm. • Example 1: Soda and Milk. What is the cross-price elasticity if the quantity of soda demanded increases by 0.1% when the price of milk increases by 5%? • Example 2: Diet Coke and Diet Pepsi.

17. Horizontal Merger Guidelines 2. Seller concentration • Impact of merger: change in HHI in the relevant market • Clicker question: Firm 1 has 60% of market, firm 2 has 20% of market and firm 3 has 20%, what is the HHI? (enter a number between zero and 10,000)

18. Horizontal Merger Guidelines 2. Seller concentration • Merger evaluated in terms of post- and pre-merger HHI: • Rarely challenged if post-merger HHI<1000 • Further analysis if 1000 < post-merger HHI < 1800 • Likely challenged if post-merger HHI>1800 and merger changes HHI by >100 • Clicker question: Suppose firms 2 and 3 in the prior example merge. Will this merger be challenged? • Yes • No

19. Horizontal Merger Guidelines

20. In-class Work (groups of 2-3 students) • There are four beer manufacturers in the market with corresponding market shares: • Pete’s: 40% • Sam’s: 30% • Berkshire: 20% • Paper City: 10% • What is the pre-merger HHI? • If Sam’s wants to merge with Berkshire, what would be the post-merger HHI? • Would this merger be challenged? • What about a Berkshire-Paper City merger?

21. In-class Work (groups of 2-3 students) • What is the pre-merger HHI? (enter a number between 0 and 10,000) • If Sam’s wants to merge with Berkshire, what would be the post-merger HHI? (enter a number between 0 and 10,000) • Would this merger be challenged? A. Yes, B. No • What about a Berkshire-Paper City merger? A. Yes, B. No

22. Horizontal Merger Guidelines 3. Other Factors that may affect decision to challenge: • Unilateral Effects: • Ability to raise prices after merger (without collusion). Why? • Ruled on a case by case basis • Entry: • If easy: post-merger HHI may be easily eroded (less concern) • If hard: smaller mergers may be more of a concern • Benchmark: are BTE’s small enough to erode prices to pre-merger levels within 2 years? Yes: less likely to challenge.

23. Horizontal Merger Guidelines 3. Other Factors that may affect decision to challenge: • Other market characteristics: • Is coordination between firms more or less likely? • Example: merger in homogeneous product market may be more of a concern than in a differentiated product market 4. Cost Savings and Efficiency Gains • Synergies (1 manager instead of 2) may reduce unit costs and also prices.

25. Next time • Second Microsoft case (1998)

26. Important points • FTC challenges if concentration increases significantly • What is relevant market? • Satellite radio? • Other audio: other radio, internet radio, HD radio, iPods, MP3 players • Sirius-XM claims: • Efficiency gains • Variety • New developments

28. What Happened? • July 25, 2008: merger approved in a 3 to 2 vote • Controversial: • 1997 FCC granted 2 licenses and stipulated that one of the holders would ‘not be permitted to acquire control of the other’ • February 10, 2009: Sirius-XM hires advisors to prepare for bankruptcy filing • February 17, 2009: Liberty Media (49% DirecTV owner) acquires 40% of Sirius-XM

29. Enforcement of Horizontal Merger Guidelines • Pre-merger notification • FTC/DOJ can negotiate with merging parties • Sell a unit, facilities, etc. • Agency announces whether it will challenge • If challenged: agency goes to a Federal District Court to seek for a preliminary injunction to block merger until full trial: • If injunction granted: companies frequently drop the merger • If injunction not granted: gov’t frequently drops the case • Either party can appeal decision to higher courts

30. Horizontal Enforcement: Bottom Line • Large horizontal mergers are strictly blocked • But smaller mergers may face challenge, too • Guidelines give us a good idea about how mergers will be treated