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) 2 nd ATE Symposium: Antitrust Economics and Competition Policy UNSW, Sydney December 2014

Slide 2 Contents 1. Introduction 2. Beer and Soju Markets in Korea 3. Data and Empirical Framework 4. Results 5. Concluding Remarks

Slide 3 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.

Slide 4 Introduction Related 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 between weakly substitutable products. using common distribution channels

Slide 5 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

Slide 6 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’.

Slide 7 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.

Slide 8 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

Slide 9 Beer Industry in Korea Duopoly where Hite and OB are in a strong rivalry, sharing the national market almost evenly. Different strengths across regions Roughly 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)

Slide 10 Conglomerate Mergers Conglomerate Mergers between Beer and Soju Companies ( ) 5 conglomerate mergers between beer and soju companies during the period 1990~2008.

Slide 11 Conglomerate Mergers beer company A’s M/Ssoju company B’s M/S Conglomerate Merger Region 1Region 2 Region 3Region 4 Region 1Region 2 Region 3Region 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:

Slide 12 Conglomerate Mergers Conglomerate firm’s M/S Region 1Region 2 Region 3Region 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

Slide 13 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?

Slide 14 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.

Slide 15 The efficiency-enhancing effects ProducersRegion A Common Distributors A1 Region B Common Distributors 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

Slide 16 The efficiency-enhancing effects ProducersRegion A Common Distributors Region B Common Distributors 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. efficiency enhancing effects would spread out across the country Not being concentrated exclusively on some local regions

Slide 17 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 18

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. 19 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 20 Fixed-effect Panel Model

Slide 21 β 1 : represents efficiency effects β 2 : 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

Slide 22 Data Soju: the Korean Alcohol and Liquor Industry Association : from KALIA-Net, : 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 23

Slide 24 Baseline Estimates The estimates of β1 on congloit are not statistically significant. But we obtained positive and statistically significant estimates for coefficient β 2 on conglo it × dominance irt. 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.

Slide 25 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. 26

Subsample Estimates 27

Slide 28 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 β 2 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. 29