Class 15 Antitrust, Winter, 2018 Horizontal Mergers 11/14/2018 Class 15 Antitrust, Winter, 2018 Horizontal Mergers Randal C. Picker James Parker Hall Distinguished Service Professor of Law The Law School The University of Chicago Copyright © 2000-18 Randal C. Picker. All Rights Reserved.

The Key Merger Tradeoff 11/14/2018 The Key Merger Tradeoff P Demand Curve P1 Q1 DWL P0 AC0 Savings AC1 Q0 Q November 14, 2018

11/14/2018 1976 as a Dividing Line Pre-1976 Many cases are litigated under Sec. 7 of the Clayton Act Over an extended period, the Supreme Court averages almost one case per year November 14, 2018

1976 as a Dividing Line After-1976 Cases vanish 11/14/2018 1976 as a Dividing Line After-1976 Cases vanish Passage of Hart-Scott-Rodino in 1976 changes antitrust practice from court-driven to agency driven November 14, 2018

Merger Policy as Regulatory Policy 11/14/2018 Merger Policy as Regulatory Policy Mergers are controlled through regulation. Mergers of any real size will trigger HSR notification duties. This results in a negotiation with the FTC or DOJ over how the transaction might be structured to eliminate competitive concerns. November 14, 2018

Merger Policy as Regulatory Policy 11/14/2018 Merger Policy as Regulatory Policy Absent a consent decree, most parties abandon proposed mergers. Litigation over the statute is rare. November 14, 2018

Clayton Act Section 7 Key Text 11/14/2018 Clayton Act Section 7 Key Text No person engaged in commerce or in any activity affecting commerce shall acquire, directly or indirectly, the whole or any part of the stock or other share capital and no person subject to the jurisdiction of the Federal Trade Commission shall acquire the whole or any part of the assets of November 14, 2018

11/14/2018 Clayton Act Section 7 another person engaged also in commerce or in any activity affecting commerce, where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly. November 14, 2018

November 14, 2018 HSR Annual Report 2016

November 14, 2018 HSR Annual Report 2016

November 14, 2018 HSR Annual Report 2016

November 14, 2018 HSR Annual Report 2016

Judging Concentration 11/14/2018 Judging Concentration Concentration Ratios Just add the market shares for a given number of firms So speak of four-firm concentration ratio or 8-firm concentration ratio November 14, 2018

Judging Concentration 11/14/2018 Judging Concentration Examples A: (25,25,25,25): 4-firm ratio is 100% B: (100,0,0,0): 4-firm ratio is 100% C: (40,20,10,10,5,5,5,2,2,1): 4 firm ratio is 80% November 14, 2018

The Herfindahl-Hirschman Index 11/14/2018 The Herfindahl-Hirschman Index Comparing A and B In the prior example, Industries A and B had the same four-firm ratio, but competition is almost certainly quite different. Try an alternative measure: square the market shares and add November 14, 2018

Calculating HHIs Examples A: 25*25 + 25*25 * 25*25 + 25*25 = 2,500 11/14/2018 Calculating HHIs Examples A: 25*25 + 25*25 * 25*25 + 25*25 = 2,500 B: 100 * 100 + 0*0 + 0*0 + 0*0 = 10,000 C: 40*40 + 20*20 + 10*10 + 10*10 + 5*5 + 5*5 + 5*5 + 2*2 + 2*2 + 1*1 = 2,284 November 14, 2018

11/14/2018 Mergers and HHIs A merger of two firms increases the HHI by 2 * S1 * S2 When the firms merge, their combined market share will be S1 + S2. (S1 + S2) * (S1 + S2) = S1*S1 + 2*S1*S2 + S2*S2 November 14, 2018

Mergers and HHIs Prior Examples 11/14/2018 Mergers and HHIs Prior Examples When the top two firms in Industry C merge, the HHI goes up by 2 * 40 * 20, or 1600, from 2284 to 3884. When the first firm merges with the fifth firm, the HHI rises by 2 * 40 * 5, or 400, from 2284 to 2684. This is a 1200 difference. November 14, 2018

Pre-2010 DOJ-FTC Grid Increase in Post-Merger Concentration < 50 11/14/2018 Pre-2010 DOJ-FTC Grid Increase in Post-Merger Concentration < 50 50 to 100 > 100 Unconcentrated: < 1000 Moderately Conc: 1000 to 1800 Highly Conc.: > 1800 No challenge Post-Merger HHI No challenge High scrutiny No challenge High scrutiny Presumed unlawful November 14, 2018

Revised DOJ-FTC Grid Increase in Post-Merger Concentration < 100 11/14/2018 Revised DOJ-FTC Grid Increase in Post-Merger Concentration < 100 100 to 200 > 200 Unconcentrated: < 1500 Moderately Conc: 1500 to 2500 Highly Conc.: > 2500 No challenge Post-Merger HHI No challenge Scrutiny Scrutiny No challenge Scrutiny Presumed unlawful November 14, 2018

Implementing the Grid Increase in Post-Merger Concentration 11/14/2018 Implementing the Grid Increase in Post-Merger Concentration Remember that the increase in the HHI is 2*S1*S2. 50 points is two 5% market share firms or a 10% firm and a 2.5% firm 100 points is roughly two 7% firms or a 10% firm and a 5% firm. November 14, 2018

Mergers and Markets Don’t necessarily need to define the market “The Agencies’ analysis need not start with market definition. Some of the analytical tools used by the Agencies to assess competitive effects do not rely on market definition, although evaluation of competitive alternatives available to customers is always necessary at some point in the analysis.” November 14, 2018

Mergers and Markets Substitutes and Market Definition “Market definition focuses solely on demand substitution factors, i.e., on customers’ ability and willingness to substitute away from one product to another in response to a price increase or a corresponding non-price change such as a reduction in product quality or service.” November 14, 2018

Market Definition The Hypothetical Monopolist Test 11/14/2018 Market Definition The Hypothetical Monopolist Test “The Agencies employ the hypothetical monopolist test to evaluate whether groups of products in candidate markets are sufficiently broad to constitute relevant antitrust markets. The Agencies use the hypothetical monopolist test to identify a set of products that are reasonably interchangeable with a product sold by one of the merging firms.” November 14, 2018

Market Definition The Hypothetical Monopolist Test 11/14/2018 Market Definition The Hypothetical Monopolist Test “The hypothetical monopolist test requires that a product market contain enough substitute products so that it could be subject to post-merger exercise of market power significantly exceeding that existing absent the merger.” November 14, 2018

Market Definition and SSNIP 11/14/2018 Market Definition and SSNIP Defining SSNIP “Specifically, the test requires that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future seller of those products (“hypothetical monopolist”) likely would impose at least a small but significant and non-transitory increase in price (“SSNIP”) November 14, 2018

Market Definition and SSNIP 11/14/2018 Market Definition and SSNIP Defining SSNIP “on at least one product in the market, including at least one product sold by one of the merging firms.” November 14, 2018

Market Definition Example 11/14/2018 Market Definition Example Example 5 “Products A and B are being tested as a candidate market. Each sells for $100, has an incremental cost of $60, and sells 1200 units. For every dollar increase in the price of Product A, for any given price of Product B, Product A loses November 14, 2018

Market Definition Example 11/14/2018 Market Definition Example Example 5 “twenty units of sales to products outside the candidate market and ten units of sales to Product B, and likewise for Product B.” November 14, 2018

Guidelines Example Example 5 11/14/2018 Guidelines Example Example 5 “Under these conditions, economic analysis shows that a hypothetical profit-maximizing monopolist controlling Products A and B would raise both of their prices by ten percent, to $110. Therefore, Products A and B satisfy the hypothetical monopolist test using a five percent November 14, 2018

Guidelines Example Example 5 11/14/2018 Guidelines Example Example 5 “SSNIP, and indeed for any SSNIP size up to ten percent. This is true even though two-thirds of the sales lost by one product when it raises its price are diverted to products outside the relevant market.” November 14, 2018

Doing the Numbers in Ex 5 Pre-Merger Position 11/14/2018 Doing the Numbers in Ex 5 Pre-Merger Position A selling 1200 units at a price of 100 with a marginal cost of 60 Profits = 1200*(100-60) = 48000 Same for B Total profits of 96000 November 14, 2018

11/14/2018 Doing the Numbers in Ex 5 Would A be willing to raise its price to $110 in the pre-merger world? For every $1 increase in price, A loses 10 units to B and 20 units to other sellers A $10 price increase would lose 300 units total A profits would be 900*(110-60) = 45000 Profits drop, so A wouldn’t raise its price November 14, 2018

11/14/2018 Doing the Numbers in Ex 5 Would the merged firm be willing to raise its prices to $110 in the post-merger world? For every $1 increase in price, A loses 10 units to B and 20 units to other sellers But with the merger diversion outside the merged firm drops November 14, 2018

11/14/2018 Doing the Numbers in Ex 5 Would the merged firm be willing to raise its prices to $110 in the post-merger world? (1200 - 200)*(110 - 60) =1000*50 = 50,000 (for each product (A&B)) With A and B raising price together as part of the merged firm, the price increase to $110 would be profitable November 14, 2018

11/14/2018 Doing the Numbers in Ex 5 Meaning: Treat A and B as being in the same market November 14, 2018

Market Analysis v. Direct Harms Analysis But … What work is the idea of market doing here? Do we need it? Shouldn’t we just evaluate harm to consumers? Critical loss analysis (4.1.3) gets at this idea November 14, 2018

Critical Loss Analysis Approach to Example 5 Set Up Hypothetical monopolist raises price on A & B by $10 What is the drop in sales such that the hypo monop will just be indifferent between leaving prices as is and raising prices by $10? That number is the critical loss November 14, 2018

Critical Loss Analysis Approach to Example 5 On the numbers Pre-merger profits for A, $48K and B, $48K for total of $96K on 1200 units sold of each At a new price of $110, profits would be $50 per unit At what X, does X*50 = 96,000? 1920 Critical loss = 2400 – 1920 = 480 units November 14, 2018

Critical Loss Analysis Approach to Example 5 On the numbers Critical loss = 2400 – 1920 = 480 units Predicted loss was 400 units (200 units outside the new firm on each of A & B) Critical loss > Predicted loss Meaning, again, price increase is profitable November 14, 2018

Unilateral Effects and Differentiated Products 11/14/2018 Unilateral Effects and Differentiated Products Upward Pricing Pressure “In some cases, where sufficient information is available, the Agencies assess the value of diverted sales, which can serve as an indicator of the upward pricing pressure on the first product resulting from the merger. November 14, 2018

Unilateral Effects and Differentiated Products 11/14/2018 Unilateral Effects and Differentiated Products Upward Pricing Pressure “Diagnosing unilateral price effects based on the value of diverted sales need not rely on market definition or the calculation of market shares and concentration.” November 14, 2018

Unilateral Effects and Differentiated Products 11/14/2018 Unilateral Effects and Differentiated Products Upward Pricing Pressure “The Agencies rely much more on the value of diverted sales than on the level of the HHI for diagnosing unilateral price effects in markets with differentiated products. If the value of diverted sales is proportionately small, significant unilateral price effects are unlikely.” November 14, 2018

11/14/2018 Coordinated Effects Assess potential competitive problems from the merger Will the merger enhance coordination in a concentrated industry? How many sellers must we have for cartelization or tacit collusion to be difficult? November 14, 2018

Entry Contestable Market Theory 11/14/2018 Entry Contestable Market Theory Cannot judge market power by number of actual sellers Potential entry make exert substantial control over prices November 14, 2018

Efficiency Benefits Merger-specific efficiencies Market by Market 11/14/2018 Efficiency Benefits Merger-specific efficiencies Efficiencies that would not be achieved but for the merger Market by Market Assess each market, and challenge if anti-competitive in any market November 14, 2018

11/14/2018 Efficiency Benefits Not: assess net gains, net costs and go forward if gains exceed costs But: restructure in harmed markets to solve problem November 14, 2018