• Thresholds taken from US Guidelines
• Simpson & Hosken (1998) found adverse effects in mergers where HHI>2,500 but none for HHI <2000.
• CA Guidelines state thresholds do not constitute 'Safe Harbours'
• CA Hostility to Concentration Measures
• Common to use market concentration to identify potential anti-competitive mergers.
  Coate, M.B. and McChesney, F.S., (1992): Enforcement of the US Merger Guidelines. Empirical Evidence on FTC Enforcement of the Merger Guidelines, Economic Inquiry, 30: 277-93.

Potential Competition

Merger may harm competition if it involves removal of a potential competitor but will have no impact on market concentration.

Lyons Tea

• Tea market dominated by 2 firms Lyons (60%) and Barrys (30%)
• Unilever (Lipton) new entrant – secured 5% - made bid for Lyons. Lipton biggest tea brand in the world.
• Evidence of supernormal profits.
• PBT as % Turnover
• Lyons 34.1 Barrys 35.2
• Average of 7% for 27 food processing/distribution firms Only 4 others had PBT/Turnover ratio in double figures

Prices and Profitability in Tea

• Following referral to CA – Unilever announced it was withdrawing Lipton brand.
• CA majority concluded it was no longer a competitor and no longer a potential competitor.
• Unilever explanation – had used the wrong type of tea.

US – Must be a Viable Competitor

• US v General Dynamics
• Boeing McDonnell Douglas

Competitive Effects of Mergers

• Unilateral.
• Coordinated.
• See D. Scheffman and M. Coleman (2003): Quantitative Analysis of Potential Competitive Effects from a Merger, George Mason University Law Review available at http://www.ftc.gov/be/quantmergeranalysis.pdf

Unilateral Effects

• Refers to situation where, as a result of the merger, the merged firm would have power to unilaterally raise price.
• One way in which this can arise is where merger creates or strengthens a dominant position.
• Competitive fringe has little incentive to resist price increase.
• Kimberley-Clark/Scott
• EU Commission concluded that retailers would have little incentive to resist price increases for branded tissue products because it would enable them to increase the prices of their private label brands.
• See Levy (1996)

Unilateral Effects with Differentiated Products.

• Unilateral effects may also arise where merged firm would not satisfy traditional measures of dominance under EU law.
• In differentiated product markets, the closer are the merging firms' brands in the minds of consumers, the greater the likelihood that an increase in the price of one, will cause consumers to shift to the other. This increases the ability and incentive for the merged firm to unilaterally raise its prices.
• May be offset if rival brands are able to reposition themselves post merger.
• Merger should only be considered anti-competitive if a price increase would be profitable after accounting for supply side response by rivals.
• Factors such as the history of brand entry, exit, positioning and associated costs must be taken into account in assessing potential supply side responses.

Diversion Ratio

• An indicator of the relative closeness of merging products.
• Attempts to measure the proportion of buyers of each of the merging products who would switch to the other merging product in the event of a price increase.
• High Diversion Ratio indicates that products are perceived as close substitutes by consumers, while other products are regarded as less effective substitutes.
• Higher the Diversion Ratio the greater the proportion of the sales lost as a result of a price increase for one of the merging firm's products that will be captured by the other, thus offsetting any loss of profits due to a decline in sales caused by a price increase.

Estimating Post-Merger Price Increase in Differentiated Product Markets.

• (p*-p)/p = mD/(1-m-D)
• p* is the post-merger price, p is the pre-merger price, m is the percentage mark-up, defined as the difference between the pre-merger price and incremental cost, and D is the Diversion ratio, i.e. the proportion of sales lost by brand A due to a price increase that would be captured by brand B, the other merging brand.
• Formula assumes constant elasticity of demand. If actual elasticity of demand increases as price rises then formula will overestimate post-merger price increase.

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• The Competition Authority merger guidelines also refer to unilateral effects problems arising where merger results in a change in the non-cooperative market equilibrium.
• Authority Guidelines are somewhat unclear and in places, what they describe as a change in a non-competitive equilibrium appears rather similar to traditional coordinated effects.

Coordinated Effects

• Merger may facilitate the operation of a formal cartel, because a reduction in the number of competitors may make it easier to detect cheating, and thereby ensure that the remaining firms adhere to any cartel arrangement.
• Merger may reduce the number of firms to the stage where each of the remaining firms is far more likely to recognise that they can gain if they compete less vigorously, i.e. merger may facilitate tacit collusion.
• For detailed description of actual case see Coleman et.al.(2003) on FTC cruise ships merger.
• Economic analysis 200+ pages, 100GB of transactions price data.
• Contrast with EU in Airtours/First Choice

Statoil Acquisition of Conoco

• Motor fuels market highly concentrated
• Merger reduced the number of significant suppliers from six to five.
• 'the strong price competition which in the past was offered by Conoco would simply disappear, lessening the competitive pressure on the remaining suppliers'. (p.50 emphasis added).
• Conoco had a reputation as a low price supplier.
• Takeover of a 'maverick firm', i.e. one with a reputation of being a price cutter increases the likelihood of coordinated effects.

Fig.13.1: Average Price of Unleaded Petrol (ppl Jun-Dec 1995)

• Airtours plc had attempted to acquire First Choice plc, a rival UK tour operator.
• EU Commission prohibited the acquisition, as the short-haul tour operating market was already highly concentrated, consisting of four vertically integrated companies.
• Commission decision overturned by CFI on appeal.

• CFI concluded that Commission had 'prohibited the transaction without having proved to the requisite legal standard that the concentration would give rise to a collective dominant position of the three major tour operators, of such a kind as significantly to impede effective competition in the relevant market.'
• Three necessary conditions to establish collective dominance:

1. Market must be sufficiently transparent for each member of the oligopoly to monitor behaviour of others;
2. Must be a clear incentive for firms not to cheat by departing from any common policy on the market. Therefore, there should be adequate deterrents to ensure long-term compliance; and
3. It must be established that the reactions of any actual or future competitors, customers or consumers will not be able to jeopardise the results expected from the common policy.

• CFI found firms would have insufficient information to detect 'cheating', i.e. firms deviating from the collusive outcome.
• There would be no credible deterrent that would discourage 'cheating' and provide firms with an incentive not to compete.
• 'the Commission made errors of assessment when it concluded that if the transaction were to proceed, the three major tour operators remaining after the merger would have an incentive to cease competing with one another.'
• '…the Decision, far from basing its prospective analysis on cogent evidence, is vitiated by a series of errors of assessment as to factors fundamental to any assessment of whether a collective dominant position might be created.'

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Barriers to Entry

• An otherwise anti-competitive merger might be permitted if barriers to entry are low.

• Competition Authority Decision in Grafton/Heiton

• Lack of Clarity on Entry Barriers

• Market share thresholds in merger analysis are often clearly identified, the evaluation of entry, which is arguably more important, is much less systematic

• Willig, R.D., (1991): Merger Analysis, Industrial Organisation Theory and Merger Guidelines, Brookings Papers: Microeconomics, Washington: Brookings Institute.

• Salop, S., (1991), Comment on R. Willig (1991), Merger Analysis, Industrial Organisation Theory and Merger Guidelines, Brookings Papers: Microeconomics, Washington: Brookings Institute.

• Cabral, L.M., (2003): Horizontal Mergers with Free-Entry: Why Cost Efficiencies May be a Weak Defense and Asset Sales a Poor Remedy, International Journal of Industrial Organization, 21(5): 607-23.

• Werden, G.J. and Froeb, L.M., (1998): The Entry Inducing Effects of Horizontal Mergers: An Exploratory Analysis, Journal of Industrial Economics, (December): 525-43 question tendency of US Courts to assume that, absent significant entry barriers, a merger is unlikely to have anti-competitive consequences.

• 'in the absence of strong evidence that an otherwise anti-competitive merger generates efficiency gains, there is a sound basis for presuming that entry obstacles will prevent entry in response. Thus, the best way for courts to treat entry in many merger cases may be not to consider it at all.'

• Massey (2001): Competition Authority may need to re-consider its treatment of entry barriers.

Treatment of Efficiencies

• Standard practice among competition agencies to consider whether any anti-competitive effects of a proposed merger are likely to be outweighed by efficiency gains arising as a result of the merger. Williamson, O.E., (1968): Economies as an Anti-trust Defence: the Welfare Trade-offs, American Economic Review, 58: 18-36.
• Price could fall post-merger if price reducing effect of a decline in marginal cost (MC) due to efficiency gains exceeds the price increasing effect of a reduction in rivalry as a result of the merger.
• In conventional one period oligopoly models, not difficult to calculate how much of a decline in MC is required to keep price unchanged.

• For differentiated products where firms engage in Bertrand competition the reduction in each firm's MC required to keep prices unchanged is given by:

• (m/(1-m)).(D/(1-D))

• where m is the premerger price-cost margin and D is the premerger diversion ratio.
• In the case of homogenous products with Cournot competition the required reduction in MC is given by:

• s/(e - s)

• where s is the premerger market share and e is premerger elasticity of demand.

• Merger may produce efficiencies, but prices may still rise due to reduced competition, producers may gain while consumers lose out.
• Effect on total welfare will depend on the relative size of these gains and losses.
• Competition Authority will only take account of efficiency gains where they offset a potential price increase.
• Consistent with its decision to interpret a substantial lessening of competition in terms of consumer welfare rather than total welfare, i.e. consumers plus producers' welfare.
• Similar approach taken by most competition agencies.
• Gotts and Goldman (2002): The Role of Efficiencies in M&A Global Antitrust Review: Still in Flux?, in B. Hawk ed. International Antitrust Law & Policy. Expressed strong criticism of consumer oriented treatment of efficiencies and advocated a total welfare test.
• 'The view that firms should be encouraged to seek out more efficient methods of operation – including by merger – has now generally been accepted as one of the benefits of competition rather than a threat to it.' NERA, (1999), Merger Appraisal in Oligopolistic Markets, OFT Discussion paper no.19, London: Office of Fair Trading, p.48)
• Efficiency arguments rejected in FTC v. Proctor & Gamble Co., 386 US 568 (1967)
• Expectations that efficiencies would be permitted under EU Merger Regulation, contributed to development of efficiencies defence by the US authorities.
• Each version of US Merger Guidelines since 1982 has expanded the efficiencies defence.
• Where there is little direct impact on competition, Guidelines presume transaction is motivated by efficiencies 'a real sympathy to efficiencies is built into the Guidelines from the start.'
• Original EU Merger Regulation contained no efficiency defence.
• Neven et. al. (1998) claim that the Commission has blocked mergers on the grounds of efficiency gains, an approach that is completely inconsistent with economic analysis.
• Kovacic, W.E., (2001): Transatlantic Turbulence: The Boeing-McDonnell Douglas Merger and International Competition Policy, Antitrust Law Journal, 68(3): 805-73. EU's perspective resembles 'U.S. merger policy in the 1960s and early 1970s, where courts and enforcement agencies distrusted efficiency arguments and believed that greater concentration invariably begat the exercise of market power.'
• Only gains that cannot be achieved by the firms acting unilaterally should be taken into account, e.g. efficiencies due to economies of scale could frequently be achieved through internal growth. Onus on merging parties to show that the efficiencies cannot be achieved by less anti-competitive means.

Onus on Parties to Prove Efficiency Claims.

• 'The burden of proof as to cost savings or other offsetting efficiencies, however, should rest squarely on the proponents of a merger, and here I would require a very high standard (of proof). Such claims are easily made and, I think, often too easily believed.'
• Fisher, F.M., (1987), Horizontal Mergers: Triage and Treatment, Journal of Economic Perspectives, 1: 23-40.
• Staples, parties claimed efficiency gains that were five times higher than forecasts provided to their respective boards.
• Statoil, not 'provided with sufficient information to enable it to take a view as to the accuracy or otherwise' of claimed efficiency gains. Even if all claimed benefits were passed on to consumers, the effect on fuel prices would be relatively limited.
• Lyons Tea, efficiency gains relatively small and insufficient to offset potential anti-competitive effects.
• 'If companies used the argument that it would be too difficult to identify specific benefits, that would tell us everything we need to know about the real merits of their proposals.' J. Kay: Poor Odds on the Takeover Lottery, Financial Times, 26.1.1996.

‘Failing Firm Defence'.

Merger or take-over may prevent company collapse - may be permitted even though it might significantly reduce competition.

Accepted under US law since the 1930s.

US Merger Guidelines:

The allegedly failing firm probably would be unable to meet its obligations in the near future;

It would probably not be able to reorganize successfully under Chapter 11 of the Bankruptcy Act;

It had made unsuccessful good faith efforts to elicit reasonable alternative offers of acquisition that would keep it in the market and pose a less severe danger to competition.

Fact that alternative offer is less than the proposed transaction does not make it unreasonable. Any offer to purchase assets of failing firm for a price above their liquidation value reasonable.

Assets must remain employed in the industry as otherwise output and welfare would fall.

Competition Authority will consider 'failing firm' arguments in merger cases.

ECJ in Kali and Salz failing firm defence may be invoked, if no other means of saving failing competitor, and no less anti-competitive options.

Commission subsequently applied concept in BASF/Pantochim/Eurodiol.

Merger of Air Canada and Canadian Airlines giving it 80% of internal flights and 40% of international air traffic to and from Canada. Merger was ‘profitable beyond even the most optimistic expectations of airline analysts'. Consumers experienced 'higher ticket prices, lost luggage and disrupted travel plans.' Government forced to hint that it might allow foreign airlines to begin flying domestic routes if service did not begin to improve. Financial Times, 17 May 2000.

Illustrates importance of applying strict criteria to 'failing firm' mergers.

May be prompted by desire to block rivals' access to essential raw materials or to block access to retail outlets.

Vertical integration may reflect fact that a vertically integrated firm can secure significant economies of scope and thereby reduce transactions costs.

May facilitate co-ordination effects. Collusion by manufacturers may be undermined by competition between downstream retailers. Might be overcome by acquiring retailers.

May foreclose entry at one or more levels, e.g. a commodity processor that vertically integrates with upstream suppliers of the commodity may be able to foreclose processing market.

May increase entry barriers by requiring entrants to enter simultaneously at two levels.

May raise access concerns. A vertically integrated firm that owns an essential facility has the ability to discriminate in favour of its own affiliated activities in the downstream market. Affiliated activities could also benefit from information gained about rivals through those rivals requiring access at the upstream level.

Conglomerate Mergers.

Parties are not actual or potential competitors and do not have an actual or potential customer-supplier relationship.

Appear less likely to pose a threat to competition than horizontal or vertical mergers.

General Electric/Honeywell International Inc., would have created or strengthened GE's dominant position on several markets. Commission concluded that there was a risk that the merged entity would be able to leverage the respective market power of the two companies into the products of one another, which would have the effect of foreclosing competitors, severely reducing competition in the aerospace industry, and adversely affecting product quality, service and prices for customers. The remedies proposed by GE were deemed insufficient by the Commission. The decision proved controversial, as the US Department of Justice had approved the merger, subject to commitments, and attracted significant political criticism.

• 'a somewhat vague term for which we could find no generally accepted definition. From a reading of a number of cases using the term, we deduce that portfolio effects in the context of conglomerate mergers usually refer to the pro- and anti-competitive that may arise in mergers combining branded products:
• in which the parties enjoy market power, but not necessarily dominance; and
• which are sold in neighbouring or related markets.'
• OECD, (2002): Portfolio Effects in Conglomerate Mergers, Paris: OECD.
• Argument that conglomerate mergers involving complements could facilitate tying, bundling or similar conduct.

Doubts on the validity of portfolio effects.

• 'Many of the anti-competitive effects allegedly arising from certain conglomerate mergers involving portfolio effects are more hypothetical and off in the future than the effects commonly cited as grounds for blocking or conditioning horizontal and vertical mergers.' OECD, (2002)
• Competition Authority 'anticompetitive harm from portfolio effects is extremely unlikely.'
• US Department of Justice:
• 'We are concerned that the ‘range effects' theory of competitive injury that is gaining currency in certain jurisdictions places the interests of competitors ahead of those of consumers and will lead to blocking or deterring pro-competitive, efficiency-enhancing mergers.'

• May be possible to address competition concerns without blocking proposed merger.

• Two possible remedies.

• Behavioural remedies are less satisfactory than structural ones. Does not mean they should never be used.
• Kimberley-Clark, EU Commission approved the merger subject to combination of structural and behavioural undertakings.
• Structural remedies involving some divestiture of assets better
• FTC rejected proposal by merging parties to divest 63 stores in Staples because it failed to deal with potential competition issues. Most likely buyer was third firm in the market. Within three years of merger being blocked, both firms had expanded and were equal in size to what the merged entity would have been 'driving prices down to levels not seen before the merger was proposed.'
• Cabral (2003) - voluntary offers of divestiture may constitute an attempt to 'buy-off' rivals and cites reports of Staples' willingness to cut the price of the stores it offered to divest in support of this.
• Note criticism of Commission decision in Nestle/Perrier in Compte et. al. (2002).

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