GE-Honeywell (2001) Tom Giblin Hadley Heath Imran Ramji

Introduction  The Players General Electric   Diverse range of products  Revenues 2001 exceeded $125 billion Honeywell   Aerospace and technology  Revenues 2001 were approximately $23 billion  Nearly half of revenues from aerospace division

Introduction  The Players  Rivals International Aero Engines  Joint venture between Pratt & Whitney and Rolls Royce  U.S. DOJ  European Commission 20 members Goal: to demonstrate whether or not the proposed merger would lead to market dominance

Two Sides of the Case  Against the Merger GE and Honeywell have dominant market positions. Proposed merger would allow bundling of complementary products, lower prices, and an unbeatable advantage. Ultimate exit of rivals and market dominance of merged firm.

Two Sides of the Case  For the Merger GE does not have market dominance in aircraft engines. The proposed merger would not lead to bundling. Without bundling, there would be no exit of rivals and no ultimate market dominance by GE.

Market Dominance  The anti-merger case used the following market shares: GE = 52.5% P&W/IAE = 26.5% RR/IAE = 21%  This combines CFMI’s sales under GE, but splits IAE’s sales into P&W and RR.  Justification: “SNECMA would act jointly with GE as a profit-maximizing entity.”

Market Dominance  The pro-merger case:  Inaccurate evaluation of GE’s market share  If RR and P&W are not grouped as IAE, SNECMA and GE should not be grouped.  On exclusive contract sales with Boeing on 737s, GE has no ability to set prices.  Therefore, exclusive contract sales should not be part of GE’s market power evaluation.

Bundling  Pure Bundling Two products are sold together and are not available separately  Ex. Left and right shoes are not sold separately  Tying Product 1 is sold by itself, but product 2 is available only with product 1  Ex. NFL season pass is available only with satellite TV  Mixed Bundling Two items sold separately or together, but together they are sold at a discount price  Ex. A combo meal at a fast food restaurant

Bundling  Cournot Two monopolists act independently, but together can lower prices and earn more money. Ex. Zinc and copper make brass. Assumptions:  No other firms in the market  Firms set a single price to all consumers

Bundling  Expansion of Cournot’s Model Firms A1 and B1 produce good 1 Firms A2 and B2 produce good 2  This accounts for other firms in the market

Bundling  Case 1: All firms act independently  Results:  All firms charge a price of 1  All firms make a profit = 1/2

Bundling  Case 2: Bundle vs. Bundle  Results:  Prices fall by 50%  Profits fall by 50%

Bundling  Case 3: Bundle against Components  Results:  Firm A’s profits go from 1 to 0.91  Uncoordinated B firms’ profits go from 1 to 0.32

Mixed bundling  Firm A sells bundles at 19% discount  Best response of B firms is to lower component prices  This gives firm A an advantage Market share = 55.4% Rivals’ profits fall by 21%

The Anti-Merger Case  Rolls Royce presented this type of bundling as most appropriate to this case.  The EC used this model, along with an expected increase in market size, to conclude that GE would have an economic incentive to use mixed bundling.

Considerations  Existence of competitors Accounted for in expansion of Cournot model  Number of products More products  greater incentive to bundle  Total market demand Greater elasticity of demand  greater incentive to bundle  Asymmetry of products More symmetry  greater incentive to bundle Avionics ($100,000) and jet engines ($15 million)

Price Negotiation  Cournot Assumption: One price for all.  Consumers in this case are powerful.  Price discrimination (not a single price)

Timing  Engines are purchased before avionics Once engine competition is won, giving a discount on a bundle would be no different than giving an avionic discounts directly  Solution would be to promise discount on avionics before purchase of engine Wouldn’t work in avionics industry because negotiated prices

Exit by Rivals  The Commission’s belief that the merger would lead to rival exiting is questionable Rival stock increased when merger announced  Investors predict the merger will benefits rival companies Long term contracts  Typical plane is on the market 25 years  Competitors have 2/3 share of the engines on next generation planes

Exit by Rivals  Allied Signal and Honeywell merger 1999 merger between two large avionic component firms Despite widespread bundling little effect on the market  Hypocrisy of Commission’s decision Argued Allied Signal-Honeywell bundling effects were slow to arise Argued effects of GE-Honeywell merger would lead to quick exit of rivals

Policy Prescriptions  What possible regulations should be enacted if the Cournot effect is large? None? – prices fall, social welfare increases EC worried about long term market exit leading to market dominance and price increase  There are a few questions to be asked before deciding on any policies to stop possible bundling

Policy Prescriptions  Is there an incentive to bundle? Not really  What is the immediate gain to consumers from lower prices?  What will be the impact on competitors?  How long do we expect lower prices to persist?  If the rivals exit, what is the expected harm?

Policy Prescriptions  Nalebuff argues that the EC stopped after question 1  In addition, they focused on market competitiveness and did not examine the potential positive trade-offs of bundling Long-run harm vs. Short-run gain  This is not an area in which antitrust authorities should be involved

Remedies  The firms could agree to not bundle their products They would have to provide an itemized list of individual prices  However, the EC rejected this because they preferred structural solutions over behavioral ones Even though this solution would not be difficult to enforce

Conclusion  European Commission blocked the merger  According to the author Abandoned original model, but did not replace flawed model Used dynamic theory of predation Did not have enough support Backed away from bundling theory, but still concluded that bundling was a reason to block merger

Discussion  Two sides of the case…  European Commission Biased? Politics and “National Champions”  Author, Barry Nalebuff Biased? Economic expert for GE-Honeywell in their presentation to the European Union Merger Task Force.

Post Script 2005 Appeal to European Court of First Instance (CFI) CFI rejected bundling argument, and was not persuaded that GE would act anti- competitively. But, CFI denied the appeal because the merger would create market concentration in:  Small marine gas turbines  Engines for large regional jets  Corporate jet aircraft engines Even if appeal granted, it was too late.

The End