1. Entry analysis in merger investigations Economic Adviser, Mergers, CMA
Oliver Norden
Economic Adviser, Mergers, CMA
ICN Merger Workshop
Mexico City, Mexico
December 12-13, 2017
Note: The views expressed are those of the speakers and do not necessarily represent the views of the CMA

2. Entry in the context of merger analysis
Entry analysis is important because…
Prospect of entry into the relevant market will alleviate competitive concerns raised by a merger, but only if such entry will deter or counteract the competitive effects of concern so the merger will not substantially harm customers
Entry analysis can show…
Undermine unilateral effects
Disrupt coordination
Constraint from potential competition
Merger may increase barriers to entry

3. Entry in the context of merger analysis
Two key types of entry considered in different ways
Rapid entrants
Firms that are not current producers in the market, but would likely provide rapid supply responses in the event of a SSNIP without incurring significant sunk costs
Considered in the analysis of firms that participate in the relevant market – often called supply-side substitution
Slower entrants
Firms that would likely enter more slowly in response to adverse competitive effects, or that would require significant sunk costs to enter
Considered in the entry analysis
Barriers to entry are particularly important in cases which appear to raise competition concerns.
In the long term, competitive dynamics might change as new firms enter or existing ones compete more effectively.
Examples include:
Capacity expansion or conversion of existing capacity (e.g. converting food manufacturing facilities);
New technology or processes (e.g. online markets);
Investment in marketing and brand strength;
Sponsorship by customers (e.g supermarkets);
Investment into self-supply;
Greater use of importers.

4. Assessing entry
Consider the various steps needed to produce and sell in the market
Planning, design, and management
Permitting, licensing, or other approvals
Construction, debugging, and operation of production facilities
Promotion, marketing, distribution, testing, and qualification requirements
Consider history of entry (both successful and unsuccessful attempts)
Identify the elements of a practical entry (e.g., minimum viable scale, entry barriers, costs)
Determine how past attempts fared, and why the succeeded or failed
Past successful entry alone, however, does not necessarily end the inquiry
At Phase 1 the assessment of barriers to entry will typically focus on the views and experience of market participants with entry.
Other important evidence will include:
Examples of entry into the market. Particularly relevant is the costs of entry, how much market share did the entrant gain, how quickly and how the entry changed the dynamics of competition.
Evidence of planned entry or expansion
Estimates of the costs involved in operating at efficient levels of output (Minimum efficient scale)
Profitability
Costs of exit (think sunk costs)
Market factors such as where there are long contracts, the potential for effective entry is likely to be limited by the number of contracts that will be tendered in the short term
Customers supporting entry or more likely expansion (supermarkets offering guaranteed financial incentives to suppliers to ensure growth)
The incumbent might respond aggressively to entry, which might be particularly damaging where it has efficiency advantages, for example charging prices below new entrant’s costs.

5. Assessing Entry
Questions to consider when assessing the impact of potential entrants (a three-part test)
Timeliness: How soon could the entrant start selling the product?
Likelihood: What are the chances that the firm would be profitable enough to pursue?
Sufficiency: Would the competitive impact of the entrant be significant enough to offset the anticompetitive impact of the merger?
Note: There is no “right” order to carry out the three parts

6. Timely?
The timeliness test assesses whether entry will be rapid enough to deter or counteract the competitive concerns raised by the merger
Measurement of time period
Measured from initial planning to significant market impact
Not concerned with short-term, interim supra-competitive prices
Focus on whether entry will be rapid enough to make unprofitable overall the actions caused by the competitive effects of the merger, even though those actions may be profitable in the short term
Having identified the potential for an SLC, the CMA must be satisfied that entry and expansion will happen sufficiently quickly so as to deter the merged company from worsening their offer, for example raising prices.
MAGs describe entry within 2 years as timely, however:
The way the market operates matters. Even where barriers to entry are low, there might be reasons to think that entry would not happen quickly. For example sticky customers or long term contracts might make it more difficult for a new entrant to gain sufficient scale.
Even where entry is not likely within that time period, the threat of entry might be sufficient to discourage the merged group from raising prices.
However this is reserved for cases where we think entrants face few sunk costs and might be able to enter within one year

7. Likely? The likelihood test assesses whether entry would be profitable
Issue is not merely whether entry could occur, but whether it would occur (i.e., is there sufficient profit incentive to induce entry?)
Profitability measured taking into account
Output level the entrant is likely to obtain
Price the entrant would likely obtain in the post-merger market (new entry may push price down to premerger level or lower)
Cost per unit, which may depend on entrant’s scale of operation
We also think about the extent of certainty around entry or expansion. Having identified the potential for a lessening of competition, we must weigh that risk against the extent to which entry or expansion is likely.
The CMA will consider the extent to which entry is likely.
Evidence of well advanced investment?
The anticipation of profitability conditions matter for the entrant and by implication for the CMA
For example a firm might be deterred from entry in markets with low barriers to entry, where it does not think it would be profitable. This could for example be because the market is small and would not support a new entrant or for fear of retaliation from the incumbent.
Remember: What we are hoping for the entrant to do is to constraint the merged entity such that their offer remains the same. So we have to ask whether entrants do so on the expectation of pre-merger prices. If so they can/do enter and supply at those levels. If the incumbents try to raise prices than the entrant can gain share!

8. Sufficient? The weight on both sides of the scales matters
Big SLC  stronger evidence on entry required
Small scale entry may not offset the scale of SLC (think market shares!)
Geographic scope?
However even small scale entry may be sufficient
For example with homogenous products
Merged entity would lose market share quickly if it raised prices
Product differentiation matters
Move away from market shares
Think about closeness of competition
Diversion?

9. The threat of potential entry
Incumbents may be constrained by threat of potential competition
Potential competitor may be:
Actual potential competitor which is likely to enter the market and has advanced plans for entry
Perceived potential competitor which is perceived by incumbents as likely to enter and may constrain incumbent behaviour
Merger may remove potential competitor or make it more difficult for a third party potential competitor to enter
Entry barriers form an important part of the analysis
Difficult to measure barriers to entry
Bain and Stigler developed thinking on barriers to entry. According to Bain:
‘Advantages that incumbents have and entrants don’t which allow that former to raise prices above pre-merger levels without attracting entry’ (DG Comp)
Stigler thought that what mattered was the difference in costs of acquiring the advantages mattered. So for example economies of scale should not be seen as a barrier to entry.
Barriers to exit matter
We are talking about the extent of costs that are sunk, that is not recoverable. They important since they change the incentives to enter for firms:
‘entry will occur if, and only if, the present value of future profits from successful entry exceeds sunk costs associate d with entry’

10. Barriers to Entry
Structural barriers to entry: conditions outside the control of the firms in the market
Government regulations and policies
Reputation or consumer goodwill
Dominant firm controls key intellectual property
Sunk costs – consider barriers to exit
Behavioral barriers to entry: conditions within the control of firms in the market
Vertical restraints
History of predatory pricing
Excess capacity
Difficult to measure barriers to entry
Bain and Stigler developed thinking on barriers to entry. According to Bain:
‘Advantages that incumbents have and entrants don’t which allow that former to raise prices above pre-merger levels without attracting entry’ (DG Comp)
Stigler thought that what mattered was the difference in costs of acquiring the advantages mattered. So for example economies of scale should not be seen as a barrier to entry.
Government regulations and policies
Explicit barriers: permits, licenses, tariffs and quotas
Implicit barriers: regulations intended to promote health, safety and the environment
Reputation or consumer goodwill
Critical input in production and reliability is important
Existing firms viewed as low risk; entrants viewed as high risk
Dominant firm controls key intellectual property
Sunk costs
Investments specific to entering the market
Cannot be avoided by exiting the market
Size of sunk costs affect the financial risks associated with entering the market
Greater sunk costs less likely entry will occur
Barriers to exit matter
We are talking about the extent of costs that are sunk, that is not recoverable. They important since they change the incentives to enter for firms:
‘entry will occur if, and only if, the present value of future profits from successful entry exceeds sunk costs associate d with entry’
Behavioral barriers to entry: conditions within the control of firms in the market
Vertical restraints
Vertical integration
Exclusive contracts
Tying contracts
History of predatory pricing
Excess capacity
Can be used to support threat of predatory pricing or to reduce profit expectations
Existence of excess capacity may be a deliberate strategy or an accident of history

11. A relevant UK example Barr / Britvic (2013)
Large soft drinks manufacturers behind brands such as J2O, Tango, Robinson and IRN-Bru
CMA looked at the cost of entry for a completely new product / brand, as well as for a new pack format for an existing product or a similar product to one produced by a competitor
CMA concluded it unlikely that the threat of a new entry of a product that would compete with IRN-Bru would act as a significant constrain on the merger entity
However, CMA concluded that the merger would not be likely to give rise to an SLC in any market in the UK
Note: the merger did not go ahead in the end with Britvic rejecting AG Barr’s offer
This cost is likely to be higher for a mainstream CSD such as cola or IRN-Bru ie Virgin Cola failed entry
Over the medium term, new soft drinks brands are likely to be launched but probability of success is low.
The most significant barrier to entry in CSDs is the development of a successful brand identity and associated marketing strategy together with achieving distribution.

12. ICN Recommended Practices for Merger Analysis
Section VII. Entry & Expansion
The assessment of firm entry and/or expansion by existing competitors should be an integral part of the analysis of whether a merger is likely to harm competition significantly (e.g., the merged firm could raise prices or reduce output, quality, or innovation).
In assessing whether entry and/or expansion would effectively constrain the merged entity, competition agencies should consider whether entry and/or expansion would be: (a) likely; (b) timely; and, (c) sufficient in nature, scale and scope. -

13. Practical techniques for evaluating entry
Historical evidence
Third party views
Modelling entry strategies
Sunk costs
Profitability

14. Practical techniques for evaluating entry
Historical evidence
Useful to have real examples of entry, but:
Might there have been developments which changed entry barriers since previous entry occurred?
Could low entry/exit simply reflect existing firms actively competing?

15. Practical techniques for evaluating entry
Third party views
May provide important evidence
Useful in corroborating entry cost figures with those of the parties
May suggest that entry is unlikely, even if entry barriers appear low
Issue of third parties attempting to frustrate the process

16. Practical techniques for evaluating entry
Modelling entry strategies
Both main and third parties may provide useful accounts of the strategies that could be used by a potential entrant
In some cases the parties present formal economic models to assess the likelihood of entry

17. Practical techniques for evaluating entry
Sunk costs
Costs that a firm cannot recover even if it leaves the market
Incumbents have sunk costs but entrants have not
A reliable measure of sunk costs could show the risk of entry
How to measure?
How to place sunk costs in context?

18. Practical techniques for evaluating entry
Profitability
Evidence of persistently high profits amongst incumbents may indicate that barriers to entry are high
May therefore examine profitability as part of the assessment of entry barriers
Be careful
Relationship between long-run profitability and entry barriers may not hold.
Low profits may also conceal barriers to entry because of rent extraction. If an input is scarce, the price may be so high as to reduce the profitability of downstream users
Problems with the valuation of assets for profitability analysis

19. Final slide – a way forward
Identify recent entry efforts (successful and unsuccessful)
Identify potential barriers to entry (structural and behavioral)
Apply the three-part test:
Timeliness: Can entry occur relatively quickly?
Likelihood: Is new entry likely to be profitable?
Sufficiency: Will new entry be sufficient in character and magnitude
to deter or counteract the competitive effects of concern?
Entry will be considered easy if, and only if, it passes all three tests