Cross-Border Mergers and Branding Strategies of the Multinational Firms Toshihiro Ichida Waseda University MWIEG 2009 Penn State

Motivation More than two-thirds of MNE's FDI flow is accounted for by the Cross-Border M&A. In buying the local firm, MNE faces choices in its branding strategy: to keep both brands or to integrate brand names into one Examples: Air France & KLM Royal Dutch Airlines, IHG (InterContinental Hotel Group) & ANA Hotels in Japan, and Nordea (European Bank)

Related Literature Long and Vousden (1995 RIE) Horn and Persson (2001 JIE) Qiu and Zhou (2006 JIE) Neary (2007 RES) Lommerud, Straume, and Sorgard (2006 Rand)

Basic Model 2 regions (N and S) 3 firms (0 in N, 1 and 2 in S) We consider the consumer market in S. Assumption: entry is restricted because of firm-specific ownership advantages by 0,1,2 N is advanced (cost advantage for firm 0) Cross-Border Trade is costly (firm 0 needs to pay t to ship to firms in S) Differentiated-Product Cournot Competition

Initial Setup Firm 0 Firm 1Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t

Model Consumers in Region S: linear demand for each brand i given outputs of other brands where b is an inverse measure of the degree of product differentiation.

Merger Formation 1.No merger: M 0 = {0,1,2} 2.One Cross-Border merger: M CB1 = {01,2} 3.One Cross-Border merger: M CB2 = {02,1} 4.One National merger: M N = {0,12} If N firm merges with a firm in S, then the merged firm can save on trade cost. If N firm merges with a firm in S, then the merged firm can reduce production cost.

No merger: M 0 = {0,1,2} Firm 0 Firm 1Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t

One Cross-Border merger: M CB1 = {01,2} Firm 0 Firm 1 Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t

One Cross-Border merger: M CB1 = {01,2} Firm 2 Region N Region S Consumers in Region S MC = c L < c MC = c Firm 01

One Cross-Border merger: M CB2 = {02,1} Firm 1 Region N Region S Consumers in Region S MC = c Firm 02 Symmetric! MC = c L < c

One National merger: M N = {0,12} Firm 0 Firm 1Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t

One National merger: M N = {0,12} Firm 0 Firm 1Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t

One National merger: M N = {0,12} Firm 0 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Firm {12}

The sequence of moves: stage 1.The firm owner decides whether to merge, who to merge with, etc. 2.If there is a merged firm, it decides whether to keep 2 brand names or to integrate into one brand name. 3.The firms simultaneously and independently set quantities.

Brand Strategy of the Merged Firm In the homogeneous product oligopoly model, the horizontal merger gives the merged firm a scale merit. (and there is no choice of brand) In the differentiated product oligopoly model, the merged firm faces a following choice in its branding strategy: 1.Brand Integration 2.Brand Separation

Brand Strategy of the Merged Firm 1.Brand Integration The merged firm will integrate (formerly separated) 2 brand names into one. 2.Brand Separation The merged firm decides to keep the original 2 brand names. The merged firm will maximize joint profit from the 2 brands.

One Cross-Border merger: M CB1 = {01,2} Firm 0 Firm 1 Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Brand 2 Brand 1 Brand 0 Firm 0 and Firm 1 will merge

One Cross-Border merger: M CB1 = {01,2} + Brand Integration Firm 2 Region N Region S Consumers in Region S MC = c L MC = c Firm {01} Brand {01} Brand 2

One Cross-Border merger: M CB1 = {01,2} + Brand Separation Firm 2 Region N Region S Consumers in Region S MC = c L MC = c Firm {01} Brand 1 Brand 2 Brand 0 Merged firm maintains 2 brand lines Output coordination

One National merger: M N = {0,12} Firm 0 Firm 1Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Brand 0 Brand 1 Brand 2 Firm 1 and Firm 2 will merge

One National merger: M N = {0,12} + Brand Integration Firm 0 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Firm {12} Brand {12} Brand 0

One National merger: M N = {0,12} + Brand Separation Firm 0 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Firm {12} Brand 2 Brand 0Brand 1 Output coordination Merged firm maintains 2 brand lines: 1 & 2

Export or Not For M 0 (No merger) case and M N (National merger) case, firm 0 (of region N) may or may not serve the consumer market in region S. Firm 0 must export its outputs by paying trade cost t. The govt. can control part of t. The government of region S may be able to foreclose its market from foreign firm 0 by setting the tariff level if it is beneficial.

No merger: M 0 = {0,1,2} Firm 0 Firm 1Firm 2 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Foreclosure condition

One National merger: M N = {0,12} + Brand Integration Firm 0 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Firm {12} Brand {12} Brand 0 Foreclosure condition

One National merger: M N = {0,12} + Brand Separation Firm 0 Region N Region S Consumers in Region S MC = 0 MC = c Trade Cost = t Firm {12} Brand 2 Brand 0Brand 1 Output coordination Foreclosure condition

Foreclosure or import from N Size of trade cost t An inverse measure of the degree of product differentiation b 01 a More differentiated Identical

Foreclosure or import from N Size of trade cost t An inverse measure of the degree of product differentiation b 01 a No merger case Foreclosure Allow import by 0

Foreclosure or import from N Size of trade cost t An inverse measure of the degree of product differentiation b 01 a Foreclosure Allow import by 0 One national merger with Brand Separation Output coordination effect → higher prices with the same number of brand lines

Foreclosure or import from N Size of trade cost t An inverse measure of the degree of product differentiation b 01 a One national merger with Brand Integration Foreclosure Allow import by 0 Reduction of brand lines

Cross-Border Merger case Firm 0 of region N will merge with one of the firms in region S (firm 1 or 2). WLOG, we look at the case of M CB1 = {01,2}. The merged firm {01} will compete with firm 2 in the consumer market in region S. The merged firm {01} locates now in S, so it need not pay trade cost t anymore. The merged firm {01} has lower production cost c L < c.

Cross-Border Merger case The merged firm {01} will compete with firm 2 in the consumer market in region S. The branding strategy of the firm {01}: 1.Brand Integration: brand {01} vs. brand 2 2.Brand Separation: brand 0 and 1 vs. brand 2 (where firm {01} will control output levels of two brand lines jointly.)

One Cross-Border merger: M CB1 = {01,2} + Brand Integration Firm 2 Region N Region S Consumers in Region S MC = c L MC = c Firm {01} Brand {01} Brand 2

One Cross-Border merger: M CB1 = {01,2} + Brand Separation Firm 2 Region N Region S Consumers in Region S MC = c L MC = c Firm {01} Brand 1 Brand 2 Brand 0 Merged firm maintains 2 brand lines Output coordination

Optimal Brand Strategy in M CB1 Proposition 3 (after cross-border merger) There exist a threshold value b* which does not depend on the parameters of the model (such as a, c, & c L ) such that for b ≥ b* ↔ π BI {01} ≥ π BS {01}. and for b < b* ↔ π BI {01} < π BS {01}. And b* ≈

Conclusion The paper looked at merger incentives and brand strategy after the merger. The analysis is still preliminary. I did not conduct global comparison of different merger types yet. Need to look at comparison of welfare (vary t) Trade cost is composed of t = t U + τ where t U is uncontrollable part of trade cost and τ is tariff level.