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IO and Competition Policy (Fach) / Horizontal Mergers (Lektion)

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• 3 avenues of Mergers Dominant firms Tacit collusion (subject to art. 101) and coordinated effects (merger regulation) based on the anticipation of a response to one’s own action requires entry barriers but no individual market power  Unilateral effects resulting from market power (merger regulation) Firms take competitors’ behaviour as given and not open to influence by the firm’s own actions 
• Focus on Horizontal Mergers Will the change in market structure caused by a merger have a significant impact on the market outcomes for consumers? Outcome of most direct concern will be price Variety and quality may also be important but...longer term and more difficult to assess 
• At the core of merger assessment • expected relationship between n and the size of firms operating in the market • the market structure, p and the qualities resulting from te competitive process 
• Two ways in which horizontal mergers may significantly impede effective competition 1. Non-coordinated (or unilateral) effects l einseitige Effekte A merger may diminish the degree of competition by eliminating important competitive constraints on one or more firms, which consequently would have ”increased market power”, even without co-ordination 2. Coordinated effects A merger may create or reinforce a situation where competition is reduced by co-ordination 
• Merger Paradox Cournot model in a homogeneous goods market  • efficiency gains (if these can decrease MC - not only AC) • change in the competition game (from symmetric to asymmetric) Consumer surplus might even increase when the efficiency gains are big enough to decrease MC and hence the P 
• Theory behind unilateral effects in differentiated goods markets 1. In the representative consumer model The merger creates an entity with a larger product portfolio or geographic coverage  1. In the representative consumer model  When firms are presumed to remain single-product and firms’ products are given exogenously The equilibrium remains symmetric with less variety and higher prices The merger does not provide any advantage to the merged entity versus the rivals The merger paradox remains  From a social welfare point of view, efficiency gains decreasing marginal costs need to be higher to compensate not only for ↗ P but also for ↘ variety 
• Theory behind unilateral effects in differentiated goods markets 1. In the preference for variety model - Closeness between products offered by merging parties matters - No price discrimitantion, unchanged product lines -> merger increases profits of merged entity - Adaption of product lines: merged entity has an incentive to relocate closer to competitors - Price discrimination: A merger will increase the profits of merged entity whilst outsiders are unaffected 
• How to measure the unilateral effects? Depends on the incentive for the merged entity to increase price : Two elements have to be taken into account in the measure proposed  1. The diversion ratio: Quantifying the cannibalization effect - How much lost sales due to the price increase by A are recouped by the other merging party B? 2. The profitability of the recouped sales
• Upward Pricing Pressure Index UPPI = upward pricing pressure index UPPI = DRAB ∗ ΠB DRAB =−∆QB/∆QA identical margins (Π) diversion ratios (DR) When this measure exceeds the expected cost efficiencies, the merged entity has an incentive to increase prices 
• Gross upward pricing pressure index GUPPI = DRAB ∗ ΠB /PA Once more, has to be compared with the size of the expected cost efficiencies 
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• The limits of the (G)UPPI approach 1.Prices and product offerings by rivals are taken as given → gives just an upper threshold • If small (in proportion to lost revenues), don’t worry and accept the merger • If not, check whether competitors’ reactions, customers’ reactions...might prevent the merged entity from increasing prices  2.Pre-merger margins are taken into account → before any merger-related efficiencies 3.Depending on the price rise considered by A or B, the outcome of the GUPPI might be different  GUPPI is just a screening device 
• IPR = indicative price rise A third indicator proposed for measuring the incentive for the merged entity to raise prices  IPR = indicative price rise is constructed by combining the incentives of the merging parties to set the prices of both products The standard formula assumes symmetric products and firms, ie identical margins (Π), prices and diversion ratios (DR) Requires an assumption about the shape of the demand curve faced by the firms  IPR = Π∗DR/ 2∗(1−DR) for linear demands  IPR = Π∗DR /(1−Π−DR)  for isoelastic demands 
• Limits of the IPR approach intensive restrictive assumptions Other empirical tools used to estimate post-merger effects 1. Estimation of a demand system 2. Estimation of the residual demand 3. Direct estimation of the price increase (model simulation)
• The EMCR : European Merger Control Regulation All mergers having a community dimension have to be notified Transfer of ownership and control of a company (or part of a company) Different types • Mergers • Acquisitions • Takeovers  • EMCR1989 A concentration which creates or strengthens a dominant position as a result of which effective competition would be impeded in the common market or a significant part of it shall be declared incompatible with the Common Market • EMCR2004 A concentration which would significantly impede effective competition in the common market or in a significant part of it, in particular as a result of the creation or strengthening of a dominant position shall be declared incompatible with the Common Market 
• The EC EMCR procedure Thresholds defining when a concentration has a community dimension • Phase 1 deadlines : 25 to 35 working days • Phase 1 decisions : • 6(1)b : compatible (with or without commitments) • 6(1)c : serious doubts and start of phase 2 • Phase 2 deadlines : 95 to 125 working days • Phase 2 decisions : 8(1) compatible without conditions 8(2) compatible with conditions and obligations 8(3) prohibition 8(4) restore competition (prohibition of a concentration that has already taken place) 
• Methodological approach followed by the Commission Likelihood that the merger would have anticompetitive effects in the relevant market, absent countervailing factors  Likelihood that buyer power would act as countervailing factor  Likelihood that entry by new firms would maintain effective competition  Likelihood that efficiencies will result from the merger  Conditions for a failing firm defence 
• How does the removal of an actual or potential competitor affect competition? • Identify the relevant market(s) • Make the competitive assessment of the merger • establish the counterfactual : what would be the situation without the merger? • to what extent will the merger modify that situation? (failing firm defence) 
• Sources of efficiency gains - it is about probabilitys and cannot be quantified (to compare) Nature: - Economies of scale and scope - Synergies in R&D, rationalisation of distribution and marketing activities - Cost savings in administration (will increase profits and will not affect wellfare - no lower prices if there is a very strong story that explains the lower prices - Price is basically based on MC and not on AC - Cost saving might not affect the price and maybe only affect shareholder wellfare instead of consumer wellfare) AC affect profit of the firm MC affect profit of the customer (price based on this) - Substitution of less able managers Impact: - on profits - on total welfare versus consumer welfare (depending on the nature of efficiency gains) - on distribution of profits between insiders and outsiders The higher the efficiency gains, the more likely prices will decrease and the merged entity will become stronger (potentially becoming a monopolist) 
• Do efficiency gains exist? Empirical evidence (BCG study) on profitability of mergers suggest that mergers are on average unprofitable Proposed explanations - Managers of bidding companies overestimate their ability to run other companies - Divergence between (profit maximisers) shareholders and (size, growth, prestige of running bigger companies, risk diversification maximisers) managers
• How are efficiency gains treated? 1. Efficiency gains: provided by the merging parties (explained) Depends on whether fixed or variable costs (cost savings in fixed costs are looked at less favourably) Synergies = efficiencies attained through intimate integration of the parties’ unique, hard-to-trade assets (particularly welcome but difficult to quantify and verify) Sometimes: Necessity to merge for achieving the efficiencies (Aer Lingus - Ryanair case) 
• Efficiency gains and collusive outcomes Negative: If there are efficiency gains for the merged firm AA knows that it will expand and exploit the competitive advantage that is has gained through the merger This can increase the cooperative outcomes Efficientcy gains make the new entrant a powerful competitor to the excisting firm  Positive: Efficiency gains decrease the risk of coordinated effects by creating asymetries -> increases incentive to deviate Might allow firms 2 and 3 to become more similar to firm 1 and hence challenge its dominance
• UPP-Tool Assumption of no reaction from the competitors (the non-merging parties) what happens inside the merged entity l externalities inside the merging party when price increase, part of the sales are recaptured by firm B part of the profits by recapturing  Incentive for a merged entity  you don’t look what firm B,C,D do
• Merger Simulations When compare Cournot-Situation and Dominant-Firm equilibrium  Comparison of how competitors react Impact of reaction on equilibrium condition  Equilibrium conditions before the merger compared with equilibrium situation after the merger
• Collusive Outcomes In a Doupoly the Nash equilibrium of Cournot's model is in general less than the monopoly profit. That is, if the firms could agree to produce, between them, the output of a monopolist, they could both be better off. Hard- but at least one of the firms can increase its profit by choosing a different output, given the output of the other firm. When a firm deviates in this way, its rival's profit decreases by more than its own profit increases (the total profit cannot increase, since it is equal to the monopoly profit when the firms collude)
• Coordinated effects merger may change nature of competition game or harm effective competition. Merger also makes coordination easier, more stable and more effective compared to the situation before the merger. In a case must prove: Must prove: 1. Collusion post-merger is possible and  sustainable 2. There is a co-ordinated effect (i.e. the merger makes collusion easier, more stable or more effective) 3. Firms will reach an understanding on the collusive mechanism (toughest)
• Factors for sustainability of collusion 1. Critical factors - Many competitors (higer incentive to deviate as pie is shared with many) - Low barriers to entry (lowers profitability of collusion) - Frequency of interaction (allows firms to act more quickly to deviation) - Market transparency (allows to spot deviation from demand shocks 2. Influential factors SUSTAIN Demand growth (no deviation: today’s profits are small compared with tomorrow’s ones) Capacity constrains (capacity-constrained firm has less to gain from undercutting its rivals. Multi-market contacts (increases frequency of interaction, allows collusion in idustry even is characterstics would not allow it) Structural links like Cross-ownership, Joint ventures reduces the gains derived from undercutting the other firm, punishment by less investments Horizontal differentiation (limits the short-term gains from undercutting rivals since it becomes more difficult to attract their customers) DEVIATE Innovation (reduces both the value of future collusion and the amount of harm that rivals will be able to inflict if the need arises) Cost (and capacity) asymmetry (and quality differentiation) (difficult to agree to a common pricing policy. Low cost firms want lower prices and higher market share)      
• Mergers that might increase the sustainability of collusion by Reducing the number of participants  High concentration of market increasing symmetry: it is easier to collude among equals firms that have similar cost structures, similar production capacities, or offer similar ranges and quality of products. Creating structural links Reducing incentives to innovate Increasing multi-market contacts Vertical mergers may increase transparency (e.g. regarding input demand) and increase entry barriers 

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