Horizontal Mergers and Horizontal Mergers and Coordinated EffectsCoordinated Effects

Eric Emch, OECDEric Emch, OECD

eric.emch@oecd.oreric.emch@oecd.orgg

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Why Have a Merger Policy?Why Have a Merger Policy?

• We care about price-fixing, for one We care about price-fixing, for one obvious and one not-so-obvious reason.obvious and one not-so-obvious reason.

• Prohibiting price-fixing without Prohibiting price-fixing without restrictions on horizontal mergers creates restrictions on horizontal mergers creates a loophole.a loophole.– In fact, this logic may have contributed to US In fact, this logic may have contributed to US

merger wave of 1887-1904; diff. between merger wave of 1887-1904; diff. between European (cartel) and US (merger) European (cartel) and US (merger) experience?experience?

– Merger wave stopped in part due to greater Merger wave stopped in part due to greater law enforcement attention to mergerslaw enforcement attention to mergers

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Why do we care?Why do we care?

• Obviously, we don’t only care about Obviously, we don’t only care about mergers to monopolymergers to monopoly

• More generally, reducing competition in a More generally, reducing competition in a market can lead to harmful effects on:market can lead to harmful effects on: – price dimensions (most straightforward)price dimensions (most straightforward)– quality dimensions (less straightforward)quality dimensions (less straightforward)– innovation dimensions (even less innovation dimensions (even less

straightforward)straightforward)

(we will focus on price, but discuss other dimensions too)(we will focus on price, but discuss other dimensions too)

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Consumer Surplus in a Consumer Surplus in a Competitive MarketCompetitive Market

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P

Q

Pc

Consumer Surplus

Qc

Demand Curve

A. Consumer Surplus

Effects of Price Rise After Effects of Price Rise After Acquisition of Market PowerAcquisition of Market Power

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P

Q

Pc

PmB. Profits

C. Deadweight Loss

QcQm

Demand Curve

Why are high prices bad?Why are high prices bad?

• Money transferred from consumers Money transferred from consumers to firmsto firms– EU explicitly, US implicitly consider this a bad EU explicitly, US implicitly consider this a bad

thingthing– Canada closer to ignoring thisCanada closer to ignoring this

• Creates deadweight lossCreates deadweight loss– Smaller in size, but more universal concernSmaller in size, but more universal concern

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Non-Price EffectsNon-Price Effects

• QualityQuality– Similar effects to pure price rise, but there are Similar effects to pure price rise, but there are

measurement issuesmeasurement issues

• InnovationInnovation– A complication: cooperation in R&D can often A complication: cooperation in R&D can often

be a good thing -- can bring critical economies be a good thing -- can bring critical economies of scale and reduce duplicative effortof scale and reduce duplicative effort

– Research joint ventures given much more Research joint ventures given much more leeway than pricing cartelsleeway than pricing cartels

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LEGAL HISTORY IN THE LEGAL HISTORY IN THE UNITED STATESUNITED STATES

Competitive Effects of Horizontal Mergers

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United States v. Brown ShoeUnited States v. Brown Shoe370 U.S. 294 (1962)370 U.S. 294 (1962)

• Prohibited merger between 3rd and 8th largest Prohibited merger between 3rd and 8th largest shoe sellers: In specific markets, combined shoe sellers: In specific markets, combined shares exceeded 5% (and in some cities ranged shares exceeded 5% (and in some cities ranged from 20% to 57%)from 20% to 57%)

• Court showed great concern with market shares, Court showed great concern with market shares, concentration, and number/type of competing concentration, and number/type of competing firms:firms:– ““If a merger achieving 5% control were now approved, If a merger achieving 5% control were now approved,

we might be required to approve future merger efforts we might be required to approve future merger efforts by Brown’s competitors seeking similar market shares.”by Brown’s competitors seeking similar market shares.”

– Stressed that a “large national chain” held this share in Stressed that a “large national chain” held this share in an industry that is characterized by fragmentation and an industry that is characterized by fragmentation and small competitorssmall competitors

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Brown Shoe, Brown Shoe, contcont.

• Was the Court protecting competitors at the Was the Court protecting competitors at the expense of efficiency?expense of efficiency?

• ““But we cannot fail to recognize Congress’ desire But we cannot fail to recognize Congress’ desire to promote competition through the protection of to promote competition through the protection of viable, small, locally owned business. Congress viable, small, locally owned business. Congress appreciated that occasional higher costs and appreciated that occasional higher costs and prices might result from the maintenance of prices might result from the maintenance of fragmented industries and markets. It resolved fragmented industries and markets. It resolved these competing considerations in favor of these competing considerations in favor of decentralization.” 370 U.S. at 344.decentralization.” 370 U.S. at 344.

• No analysis of actual or likely effects; no No analysis of actual or likely effects; no consideration of efficiencies; collusion was consideration of efficiencies; collusion was basically impossible (at least 20 competing firms)basically impossible (at least 20 competing firms)

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United States v. Von’s GroceryUnited States v. Von’s Grocery384 U.S. 270 (1966)384 U.S. 270 (1966)

• Blocked merger of 3rd largest grocery retail Blocked merger of 3rd largest grocery retail chain (4.7% share) and 6th largest (2.8%)chain (4.7% share) and 6th largest (2.8%)

• Combined market share (7.5%) less than Combined market share (7.5%) less than the market leader (Safeway); Top 8 firms the market leader (Safeway); Top 8 firms controlled 41%controlled 41%

• Court focused on “trend” toward Court focused on “trend” toward concentration and not the effects of this concentration and not the effects of this particular merger: Concern over smaller, particular merger: Concern over smaller, independent competitorsindependent competitors

• Unilateral or coordinated effects? Very Unilateral or coordinated effects? Very unlikelyunlikely

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Von’sVon’s, cont., cont.

• Justice Stewart’s famous dissent:Justice Stewart’s famous dissent:– ““[T]he Court pronounces its work [T]he Court pronounces its work

consistent with the line of our decisions consistent with the line of our decisions under Section 7 since the passage of under Section 7 since the passage of the 1950 amendment. The sole the 1950 amendment. The sole consistency that I can find is that in consistency that I can find is that in litigation under Section 7, the litigation under Section 7, the Government always wins.”Government always wins.”

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Criticism of the 1960s CasesCriticism of the 1960s Cases

• Judge Posner said that these cases “seemed, Judge Posner said that these cases “seemed, taken as a group, to establish the illegality of any taken as a group, to establish the illegality of any nontrivial acquisition of a competitor, whether or nontrivial acquisition of a competitor, whether or not the acquisition was likely either to bring not the acquisition was likely either to bring about or shore up collusive or oligopoly pricing. about or shore up collusive or oligopoly pricing. The elimination of a significant rival was thought The elimination of a significant rival was thought by itself to infringe the complex of social and by itself to infringe the complex of social and economic values conceived by a majority of the economic values conceived by a majority of the Court to inform the statutory words ‘may . . . Court to inform the statutory words ‘may . . . substantially . . . lessen competition.’” substantially . . . lessen competition.’” Hosp. Hosp. Corp.Corp., 807 F.2d at 1385., 807 F.2d at 1385.

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Current Analysis: Current Analysis: Scrutiny of EffectsScrutiny of Effects

• Lower courts undertake sophisticated, Lower courts undertake sophisticated, intensive analysis of market structure and intensive analysis of market structure and firm behavior to determine when firms firm behavior to determine when firms could successfully coordinate their could successfully coordinate their behavior or unilaterally raise prices post-behavior or unilaterally raise prices post-mergermerger

• Statistical evidence is credited, and Statistical evidence is credited, and qualitative factors are still given great qualitative factors are still given great weightweight

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ECONOMIC THEORIES OF ECONOMIC THEORIES OF HARMHARM

Competitive Effects from Horizontal MergersCompetitive Effects from Horizontal Mergers

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Coordinated Effects Theory (1)Coordinated Effects Theory (1)

• Firms would generally like to have Firms would generally like to have higher industry prices if they can higher industry prices if they can manage itmanage it– Explicit price fixing is outlawed and can Explicit price fixing is outlawed and can

increasingly lead to criminal prosecutionincreasingly lead to criminal prosecution– There are many ways to effectively collude There are many ways to effectively collude

without a formal agreement on fixing without a formal agreement on fixing prices prices • Tacit collusion: “A meeting of the minds without Tacit collusion: “A meeting of the minds without

the meeting”the meeting”• Can be more or less difficult depending on Can be more or less difficult depending on

market circumstancesmarket circumstances16

Coordinated Effects Theory (2)Coordinated Effects Theory (2)

• Though firms generally have a collective Though firms generally have a collective incentive to collude, they also have an incentive to collude, they also have an individual incentive to cheat on any individual incentive to cheat on any agreement agreement (classic Prisoner’s Dilemma: Nash (classic Prisoner’s Dilemma: Nash equilibrium is suboptimal)equilibrium is suboptimal)

• Repeated games allow for successful Repeated games allow for successful collusion, which requires:collusion, which requires:1. Some way of reaching terms of coordination1. Some way of reaching terms of coordination2. Some way of monitoring compliance2. Some way of monitoring compliance3. Some way of punishing deviations3. Some way of punishing deviations

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(1,1)(1,1)(3,0)(3,0)

(0,3)(0,3)(2,2)(2,2)

DefectDefect

ColludeCollude

ColludeCollude DefectDefect

Firm 2Firm 2

Firm 1Firm 1

Coordinated Effects Theory (3)Coordinated Effects Theory (3)

• Ways that firms can collude:Ways that firms can collude:– Price-based rules Price-based rules

• Explicit or implicit coordination or bid-Explicit or implicit coordination or bid-riggingrigging

– Quantity-based rules Quantity-based rules • Fixing sales volumes, market shares, or Fixing sales volumes, market shares, or

capacitiescapacities

– Assignment rules Assignment rules • Geographic/product market divisionGeographic/product market division

– Facilitating practices Facilitating practices • MFN, MCC clauses or common sales agentsMFN, MCC clauses or common sales agents

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Coordinated Effects Theory (4)Coordinated Effects Theory (4)

• Market conditions that facilitate Market conditions that facilitate collusion:collusion:– High concentration (few players) on seller High concentration (few players) on seller

side, low concentration on buyer sideside, low concentration on buyer side• But criminal record has shown cartels with But criminal record has shown cartels with

large # of firmslarge # of firms– Transparency (of prices, quality attributes)Transparency (of prices, quality attributes)– Homogeneity (of goods, firms, customers)Homogeneity (of goods, firms, customers)

• Absence of mavericksAbsence of mavericks

(many other factors have been mentioned that do not strictly (many other factors have been mentioned that do not strictly fall into these categories)fall into these categories)

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Coordinated Effects Theory (5)Coordinated Effects Theory (5)

• Merger may increase likelihood of Merger may increase likelihood of collusive activity, either explicit or implicitcollusive activity, either explicit or implicit– Increases concentrationIncreases concentration– May eliminate maverick firmMay eliminate maverick firm– May narrow asymmetries among firmsMay narrow asymmetries among firms

• Key questionKey question: Why weren’t they colluding : Why weren’t they colluding prior to merger? What difference does prior to merger? What difference does the merger make?the merger make?– One way to look at it: collusion may be a One way to look at it: collusion may be a

continuous, not a discrete variablecontinuous, not a discrete variable

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RECENT U.S. CASE STUDIESRECENT U.S. CASE STUDIESCompetitive Effects of Horizontal MergersCompetitive Effects of Horizontal Mergers

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Coordinated Effects:Coordinated Effects:FTC v. Arch Coal (2004)FTC v. Arch Coal (2004)

• Five major producers of coal in the Five major producers of coal in the relevant market: Peabody, Kennecott, relevant market: Peabody, Kennecott, Arch, RAG & Triton. Arch buying TritonArch, RAG & Triton. Arch buying Triton

• Post-merger, still five in that Arch would Post-merger, still five in that Arch would sell a mine to Kiewit (“fix-it-first”)sell a mine to Kiewit (“fix-it-first”)

• Although market was highly concentrated Although market was highly concentrated (HHI of around 2000-2200), merger (HHI of around 2000-2200), merger resulted in HHI change of only between resulted in HHI change of only between 49 and 224 points49 and 224 points

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Court’s AnalysisCourt’s Analysis

• Prima Facie burden met, but this Prima Facie burden met, but this was a weak “presumption” case (was a weak “presumption” case (cf.cf. HeinzHeinz where HHI increase of 510 on where HHI increase of 510 on a 4775 base), so D’s burden is not a 4775 base), so D’s burden is not as highas high

• Court also indirectly questions Court also indirectly questions “check-list” approach; prefers in-“check-list” approach; prefers in-depth analysis of exactly how depth analysis of exactly how coordinated activity is likely to occurcoordinated activity is likely to occur

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Focus on FactsFocus on Facts

• Court finds that although collusion Court finds that although collusion maymay occur, it is not occur, it is not likelylikely to occur: to occur:– Current market is competitiveCurrent market is competitive– No evidence of actual collusion (yet amazing No evidence of actual collusion (yet amazing

examples of interest)examples of interest)– Market structure inhibits coordination: Market structure inhibits coordination:

Powerful customers, incomplete information, Powerful customers, incomplete information, no effective punishment mechanismno effective punishment mechanism

– Fringe would step-inFringe would step-in

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DOJ v. Mactac/Raflatac (2003)DOJ v. Mactac/Raflatac (2003)

• Merger between producers of paper Merger between producers of paper labelstocklabelstock

• Pre-merger: Nine producers, but only three Pre-merger: Nine producers, but only three “first-tier” producers, Avery (49%), MACtac “first-tier” producers, Avery (49%), MACtac (12%), Raflatac (11%)(12%), Raflatac (11%)

• Merger between MACtac and Raflatac: Merger between MACtac and Raflatac: relatively small change in HHI, though market relatively small change in HHI, though market “highly concentrated” by guidelines“highly concentrated” by guidelines

• Elements of both coordinated effects and Elements of both coordinated effects and unilateral effects in harm storyunilateral effects in harm story– UPM (Raflatac) now sells paper to all first-tier firms UPM (Raflatac) now sells paper to all first-tier firms – Only two first-tier firms remainOnly two first-tier firms remain– Fringe can’t discipline potential price increaseFringe can’t discipline potential price increase– MACtac, Raflatac each other’s closest competitorsMACtac, Raflatac each other’s closest competitors

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Coordinated Effects FactorsCoordinated Effects Factors

• Coordinated effects checklist:Coordinated effects checklist:– High concentration on seller side, low on High concentration on seller side, low on

buyer side?buyer side?• Yes: 3 “first tier” sellers, buyers unconcentrated Yes: 3 “first tier” sellers, buyers unconcentrated

– Transparency?Transparency?• Producers know lots about competitorsProducers know lots about competitors

– Firms in many cases know competitors’ sales Firms in many cases know competitors’ sales to each customer. In individual competitions, to each customer. In individual competitions, often know both competitor & priceoften know both competitor & price

• Raflatac sells label paper to Avery (cost side info)Raflatac sells label paper to Avery (cost side info)

– Homogeneity?Homogeneity?• Little product differentiation between big three; Little product differentiation between big three;

MFN clause means cost similarity for big twoMFN clause means cost similarity for big two

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• Terms of coordination:Terms of coordination:– Possible coordination on prices– Raflatac upstream parent UPM sells label paper to

Avery; avenue for transfers and information exchange

– Evidence of attempts to collude pre-merger (signaling, retaliatory price cuts, noncompete agreements), though market seen as reasonably competitive

• What difference does merger make?What difference does merger make?– Elimination of maverick (Raflatac changes behavior)– One fewer top-tier competitor– Greater homogeneity

Coordinated Effects FactorsCoordinated Effects Factors

Final ThoughtsFinal Thoughts

• Market definition and market shares are Market definition and market shares are necessary, but only a first step.necessary, but only a first step.

• Current guidelines by most competition Current guidelines by most competition authorities provide a way to structure authorities provide a way to structure your thinking, not a simple formulayour thinking, not a simple formula

• Logic must be clear and backed up by Logic must be clear and backed up by quantitative and qualitative evidence to quantitative and qualitative evidence to be convincing to outside arbiters, like be convincing to outside arbiters, like courtscourts

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Some ReferencesSome References• European Commission, European Commission, Guidelines on the assessment of horizontal mergers under Guidelines on the assessment of horizontal mergers under

the Council Regulation on the control of concentrations between undertakings the Council Regulation on the control of concentrations between undertakings (2004/C 31/03) (2004/C 31/03) , available at , available at http://ec.europa.eu/comm/competition/mergers/legislation/notices_on_substance.hthttp://ec.europa.eu/comm/competition/mergers/legislation/notices_on_substance.html#hor_guidlinesml#hor_guidlines

• Japanese Fair Trade CommissionJapanese Fair Trade Commission, Guidelines to Application of the Antimonopoly Act , Guidelines to Application of the Antimonopoly Act Concerning Review of Business CombinationConcerning Review of Business Combination, May 31, 2004, (amended on May 1, , May 31, 2004, (amended on May 1, 2006, March 28, 2007). (English translation available at: http://www.jftc.go.jp/e-2006, March 28, 2007). (English translation available at: http://www.jftc.go.jp/e-page/legislation/ama/RevisedMergerGuidelines.pdf)page/legislation/ama/RevisedMergerGuidelines.pdf)

• Korean Fair Trade CommissionKorean Fair Trade Commission, Notification on M&A Review Guidelines, Notification on M&A Review Guidelines, Notification , Notification 1999-2 (English Translation available at http://www.ftc.go.kr/eng/)1999-2 (English Translation available at http://www.ftc.go.kr/eng/)

• U.S. Department of Justice and Federal Trade Commission, U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Horizontal Merger GuidelinesGuidelines, March 2006 (available at: , March 2006 (available at: http://www.usdoj.gov/atr/public/guidelines/215247.htm)http://www.usdoj.gov/atr/public/guidelines/215247.htm)

• U.S. Department of Justice and Federal Trade Commission, U.S. Department of Justice and Federal Trade Commission, Commentary on the Commentary on the Horizontal Merger GuidelinesHorizontal Merger Guidelines, March 2006 (available at: , March 2006 (available at: http://www.usdoj.gov/atr/public/guidelines/215247.htm)http://www.usdoj.gov/atr/public/guidelines/215247.htm)

• Motta, Massimo, Motta, Massimo, Competition Policy: Theory and PracticeCompetition Policy: Theory and Practice, Cambridge University , Cambridge University Press, 2004, Chapter 5: “Horizontal Mergers.”Press, 2004, Chapter 5: “Horizontal Mergers.”

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