Mergers

Types of Mergers zHorizontal: merger between two competitors. yGoods are substitutes. zVertical: merger between two firms at different stages of the production process. yGoods are complements. zConglomerate: no clear substitute or complementary relationship.

Why so many mergers? zEconomies of scale: both in production and in things like R&D. zEconomies of scope: synergies between the two companies. zDefensive mergers: to deal with contracting markets, excess capacity. zDecrease competition: these are the mergers that antitrust is worried about.

How successful are mergers? zStudies of past merger waves have shown that two of every three merger deals have not worked. zWhy? Real world -- not economic theory. yLinking distribution systems is often difficult. yInformation systems often very difficult to mesh together. yClash of corporate cultures.

The “Merger Paradox” zAssume firms are merging to decrease competition (no cost advantages). yFor horizontal mergers only 2 motives, economies of scale or decreasing competition. zStart with a basic Cournot model. zIf firms are symmetric, then profit of each firm is (a-c) 2 /b(n+1) 2.

“Merger Paradox” con’t zStart with n firms: y  i = (a-c) 2 /b(n+1) 2 zThen m of the firms merge together to make (n - m +1) firms in the market. zAfter merger, profits for each firm are: y  i = (a-c) 2 /b(n-m+2) 2 zLess competition, but have profits for the combined firm increased or decreased?

“Merger Paradox” con’t zIs (a-c) 2 /b(n-m+2) 2 greater than or less than m*(a-c) 2 /b(n+1) 2 ? yGet rid of the (a-c) 2 /b terms on both sides and rearrange to get this condition: zOnly profitable for the combined firm if (n+1) 2 >m(n-m+2) 2 yMergers cannot raise the profitability of the firms engaged in the merger even if 50% of the firms are involved in the merger.

“Merger Paradox” con’t zAccording to this model, almost no mergers are profitable. yThose that are probably wouldn't make it past the antitrust authorities. zIntuition behind the model: yFree-rider effect -- decreasing the number of firms raises industry profit and per firm profit, but combined firms get relatively smaller share of the industry.

“Merger Paradox” con’t zWhy is this not the best model to look at? yAssumes firms are identical and that the merged firm has no advantages other than it is facing fewer competitors.

Merged Firm as a Stackelberg Leader zIf the merged firm becomes a Stackelberg leader, it can improve its position. zAssume 2 firms merge and act as a industry leader a la Stackelberg. yLeader gets (a-c) 2 /4b(n-1). yEach follower gets (a-c) 2 /4b(n-1) 2. zCompare this to premerger: y  = 2 * (a-c)/b(n+1) 2

Merged Firm as a Stackelberg Leader, con’t zAlways more profitable to merge if you can act as a Stackelberg leader. yMerger decreases profits of non-merging firms are long as there are four or more firms in the industry originally. zIn this model, total output will increase. ySo now we have a new paradox: Why would antitrust officials want to stop this type of merger?

Horizontal Mergers with Product Differentiation zSpatial model of product differentiation zPossible benefits of merger. yCoordinate prices: price of one firm affects the demand for the other firm. yAlso can coordinate "location" (product design). zStart with a circle model this time, not a linear model.

Mergers with Product Differentiation, con’t zCircle model similar to linear model, except there is no "end" problem. yConsumers evenly spaced around the circle. yEach has a value of V and a cost of transport of t. zAll firms have the same costs. F is fixed cost and c is constant marginal cost. zEach firm sets price.

Mergers with Product Differentiation, con’t zConsumers pay p + t(distance traveled) zWith symmetric firms, they locate 1/n away from each other, all set the same price. zAs long as V is sufficiently high, every consumer on the circle will buy. zP* = t(length of circle)/n zAt this price, all consumers buy.

Mergers with Product Differentiation, con’t zMerger has no effect if the two firms aren't neighbors. yWhy? no competition between the firms that merge, so no way to decrease competition. zIf neighboring firms merge, can lessen competition. Have "captive consumers" over which they have more market power and can increase profits by raising price.

Mergers with Product Differentiation, con’t zMerger also benefits the other firms in the market -- allows them to raise price too. zAfter the merger, combined firms may also change their product lines -- get closer to their neighbors. zIn this case, if there are efficiencies, they will be due to economies of scope.

Evaluating Mergers zNone of the models presented assume any cost savings -- only reducing competition. zWe need a way to evaluate mergers that considers both the benefits of any cost savings as well as the affects of decreased competition.

1992 Merger Guidelines:  Define relevant product and geographic market.  Measure concentration pre- & post- merger with HHI. If merger raises HHI by 100 points and post-merger HHI is > 1000, investigate further.  Assess ease of entry into market.  Assess likely competitive effects of merger. zAssess any significant efficiencies that would result from the merger.