Portfolio Effects in Conglomerate Mergers: The Empirical Evidence of Leverage Effects in the Korean Liquor Market

Jinhwa Chung (Keimyung University, Korea)and

Seonghoon Jeon (Sogang University, Korea)

2nd ATE Symposium: Antitrust Economics and Competition Policy

UNSW, Sydney

December 2014

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Contents

1. Introduction2. Beer and Soju Markets in Korea3. Data and Empirical Framework4. Results5. Concluding Remarks

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Introduction

Motivation

Portfolio effects have usually been referred to as anti-competitive concerns that arise from conglomerate mergers between firms producing weakly substitutable products.

There has been a fierce debate between the European and U.S. competition authorities on the competitive implications of portfolio effects: Leverage v. Efficiency-enhancing.

Despite abundant theoretical discussions, we cannot find many empirical works testing the portfolio effects of conglomerate mergers.

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IntroductionRelated Merger Case

In Korea, portfolio effects were an important issue in evaluating the competitive effects of a conglomerate merger between two liquor companies, Hite/Jinro, in 2005.

between weakly substitutable products.using common distribution channels

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Introduction

Goal of This Paper

Provide empirical evidence of the leverage effects, which are distinguished from efficiency-enhancing portfolio effects.

Implement empirical tests in order to differentiate the leverage effects between resulting in foreclosure and providing with a toehold

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Soju

• the most popular alcoholic beverage in Korea. • accounts for 1/2 of total alcohol consumed by Koreans.• about 20% alcohol content, • Korean consumers tend to drink soju socially.• Sometimes mix with beer in a proportion of about 1(soju)

to 5(beer), so-called ‘bomb liquor’.

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Soju Industry in Korea

10 regional markets*

Seoul and 9 regions.

9 firms*

one national company, Jinro,and 8 locally dominant companies.

Region1(Seoul)

Region10(Busan))

Region2(Gyeonggi)

Region3(Gangwon)

Region9(Gyeongnam)

Region8(Gyeongbuk)

Region5(Chungnam)Region4(Chungbuk)

Region7(Jeonnam)

Region6(Jeonbuk)

*We do not include Jeju Island and the local company which our data source of beer sales does not cover.

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Market Dominance

Soju Companies’ Regional Market Shares (Average for 1994~2008)

Such a market configuration mostly stems from the past government regulation of the mandatory local soju purchase policy introduced in 1976

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Beer Industry in Korea

Duopoly where Hite and OB are in a strong rivalry, sharing the national market almost evenly.

Different strengths across regionsRoughly saying, OB is strong in the upper regions, R1 to R5, while Hite is dominant in the lower regions, R6 to R10.

Beer Companies’ Regional Market Shares (Average for 1994~2008)

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Conglomerate Mergers

Conglomerate Mergers between Beer and Soju Companies (1990-2008)

5 conglomerate mergers between beer and soju companies during the

period 1990~2008.

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Conglomerate Mergers

beer company A’s M/S soju company B’s M/S

Conglomerate Merger

Region 1 Region 2Region 3 Region 4

Region 1 Region 2Region 3 Region 4

In order to differentiate portfolio effects between leverage and efficiency, we have to make a close look at the market dominance conditions of combined products. Suppose market shares of beer company A and soju company B across regions are as follows:

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Conglomerate Mergers

Conglomerate firm’s M/S

Region 1 Region 2Region 3 Region 4

Then we can classify the integration of two firms into 4 kinds of mergers according to the different market dominance combination in each region

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Two Aspects of Portfolio Effects

Efficiency v. Leverage

• efficiency-enhancing effects stem from economies of scale and scope or other sources such as bundling (Stigler 1968, Adams-Yellen 1976).

• leverage effects are through tying or full-line forcing.

How to distinguish leverage effects and efficiency-enhancing effects in the paper?

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Two Aspects of Portfolio Effects

How to distinguish...? Our presumptions are:

• Efficiency-enhancing effects

exist regardless of the market power of the combined company in beer market.

• Leverage effects

are present only where the combined company possesses dominance in beer market.

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The efficiency-enhancing effects

Producers Region A

CommonDistributors A1

Region B

CommonDistributors B1

Producers are prohibited from •operating in distribution channel.•making exclusionary contracts.

Soju and beer are produced in separate facilities and share a small portion of inputs, and thus economies of scope are unlikely to arise.

Producers only have the manufacturing sector.

Distributors are•operating in regional market •dealing with all kinds of liquors

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The efficiency-enhancing effects

Producers Region A

CommonDistributors

Region B

CommonDistributors

Producers •have to supply each of their products to all distributors at the same wholesale price.•are prohibited from running a TV commercial and offering bundled discounts.

efficiencyenhancing

effectswould spread out across the country

Not being concentrated exclusively on some local regions

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The Leverage Effects

On the other hand, leverage effects are confined only where the combined company has dominance in beer market.

Implications of Portfolio Effects on Local Soju Markets

Some Evidence from Hite+Jinro Merger

After the merger Jinro’s soju market shares have increased in Region 8, 9 and 10 where Hite was dominant in market shares, and decreased Region 1 and 2 where the rival company OB was strong.

Sources: Korean Alcohol and Liquor Industry Association and AC Nielsen Korea

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Fixed-effect Panel Model

an indicator of whether firm i produced both soju and beer in

region r at year t.

an indicator of whether firm i has bear market dominance in

region r at year t.

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We have 90 individuals and 19 annual periods in our panel dataset.

The dependent variable is the regional market share of a soju company.

Wholesale Price Index

Advertisement expenditure

The Number of total products

Distance, Designated (brand loyalty in the region)

Income (regional macro shocks)

Control Variables

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Fixed-effect Panel Model

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• β1 : represents efficiency effects

• β2 : represents leverage effects.

If it is positive, it implies that increases in market shares are realized nationwide due to efficiency-enhancing effects.

if it is positive, it means that additional increases in market shares exist due to leverage effects, and they exist only where the combined company has beer 21market dominance.

Fixed-effect Panel Model

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Data

Soju: the Korean Alcohol and Liquor Industry Association

• 1994-2008: from KALIA-Net, • 1985-1993: from trade magazines and

The history of Korean Alcohol and Liquor Industry Association (1983~1997)

Beer: AC Nielsen Retail Index

• Regional sales volumes of all beer firms were obtained from POS transaction information.

Baseline Estimates

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Baseline Estimates

The estimates of β1 on congloit are not statistically significant.But we obtained positive and statistically significant estimates for coefficient β2 on congloit × dominanceirt.

We interpret these results as suggesting that we do not have the nationwide efficiency effect, but there are leverage effects, i.e.,

• The combined company can increase its regional soju market shares by 2.5~3.1% points where it has beer market dominance.

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Two Implications

Foreclosure

If the combined company has dominance in both markets it may deter potential entrants or exclude current competitors from the market by tying or full-line forcing. (Whinston 1990, Choi-Stefanadis 2001,Carlton-Waldmand 2002)

Toehold

If a party of the combined company is in a weak market position, it can erode dominance of the incumbent firm with a toehold of leverage. (Campbell-Shephard 1968, Kaplan 1970, Ponsoldt-David 2007)

Campbell-Shepherd(1968), Easterbrook(1972), Kaplan(1980), Lord(1982)], US DOJ(1997)

The leverage effects may have different implications for competition policy. They may be either anti-competitive or competitive.

Subsample approach

In order to distinguish the leverage effects between foreclosure and toehold, we implemented separate empirical tests for two subsamples.

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Subsample Estimates

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Subsample Estimates

The empirical results showed that the evidence is more consistent with “toehold effects” rather than “foreclosure effects”

• Non-dominant soju companies can increase their regional market share by about 3.5% points in the region where their beer partner is dominant.

• We cannot find comparable results for dominant soju companies. The estimates of β2 for low soju subsample are not statistically meaningful.

Concluding Remarks

In this paper, we provided an empirical analysis on the effects of conglomerate mergers in the Korean liquor market.

First, we found some empirical evidence which seems to support the leverage effects of conglomerate mergers, rather than efficiency effects.

Second, the leverage effects were competitive rather than anti-competitive in that they are not resulting in foreclosure, but providing with a toehold.

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