Public Policy in Private Markets

Merger Policy

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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

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

Vertical Mergers: foreclosure/increased cost

Manufacturer 1

Distributor A

Manufacturer 2

Distributor B

Manufacturer 3

• A vertically separated industry• All Manufacturers could use either of the two distributors• Distributor A is larger and more efficient• Manufacturer 1 is larger.

Manufacturer 1

Distributor A

Manufacturer 2

Distributor B

Manufacturer 3

• 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

?

Vertical Mergers: foreclosure/increased cost

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

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)

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

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)

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)

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)

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

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.

Horizontal Merger Guidelines

• Two-step process (as in monopolization cases):

1. Define relevant market: are the two firms in the same relevant market? If so, move to the second step

2. Define if market power (i.e. price) is likely to increase in the relevant market: main measure is concentration.

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.

Horizontal Merger Guidelines2. 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)

21( )

number of firms

nii

HHI Market Share

n

Horizontal Merger Guidelines2. 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?

A. YesB. No

Horizontal Merger Guidelines

Post Merger HHI

Change in HHI

DOJ/FTC Challenge?

FTC Classification

<1000 Not Considered

Typically not Unconcentrated

1000-1800 Not specified Further analysis needed

Moderately concentrated

>1800 >100 Likely to challenge

Highly Concentrated

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?

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

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.

Horizontal Merger Guidelines3. 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.

Next time

Second Microsoft case (1998)

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

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

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

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