1. RBB | Economics Economic Analysis and the new EC Merger Notice Derek Ridyard RBB Economics derek.ridyard@rbbecon.com 30 March 2004

2. RBB | Economics Overview Economic analysis under the Notice: 1.Non-coordinated effects 2.Coordinated effects 3.HHI thresholds 4.Impact of procedural/institutional changes on substantive analysis

3. RBB | Economics Classification of competition concerns  Notice creates a new category of concern to fill the perceived “gap” under the old regime. Historic practice Draft NoticeFinal Notice Single firm dominance Paramount market position Non-coordinated effects “the gap”Non-collusive oligopoly Collective dominance Coordinated effects

4. RBB | Economics 1.1 Non-coordinated effects Measures the impact that a merger has on incentives to keep prices low Encompasses dominance and other “close competitor” cases in differentiated product markets Some examples (old and new) –Scott/Kimberley Clark –Volvo/Scania –GE/Instrumentarium

5. RBB | Economics 1.2 Illustration of non-coordinated effects ModelSalesShareImplied Sales Gain Actual Sales Gain Ford80,00040%+5,000+1,000 VW40,00020%+2,500+1,500 BMW40,00020%+2,500+7,500 Mercedes40,00020%-10,000

6. RBB | Economics 1.3 Evidence of the gap? Lloyds TSB/Abbey National? FTC baby foods merger? John Vickers (2004): “numerous mergers that could seriously jeopardise competition without crossing the threshold of dominant market power.”

7. RBB | Economics 1.4 Non-coordinated effects – the role of economic theory Draft Notice relied explicitly on Bertrand and Cournot models See DG COMP study: –“A merger between competitors increases market power.. leading.. to higher prices and lower output” –“HHIs can be considered a good indicator [of the effect of a merger on price]” Same theory is embedded in merger simulation models  All merging firms are “guilty” – but are they guilty enough to justify prohibition?

8. RBB | Economics 1.5 Forgotten role of supply-side effects Unilateral effect theories rely on passive demand-side effects They ignore elements such as: –strategic buyer power –entry and investments by rivals –underlying market dynamics See OFT 1999 oligopoly study for an antidote

9. RBB | Economics 1.6 Non-coordinated effects - conclusions Notice remains heavily influenced by simple theoretical models Logic of the Notice suggests a move towards greater intervention But costs of extending powers to analyse non- coordinated effects have been ignored The real impact is: –Greater DG COMP discretion –Less predictability

10. RBB | Economics 2.1 Coordinated effects – stage 1 Identify focal point for co-ordination: Price Customer / territory sharing Output / Capacity

11. RBB | Economics 2.2 Coordinated effects - stage 2 Evaluate stability of coordination in terms of: Transparency Availability of credible enforcement mechanism Resilience to external shocks and fringe competition

12. RBB | Economics 2.3 Coordinated effects- stage 3 What changes as a result of merger? Creation or strengthening? Importance of eliminated factors Impact on asymmetries and incentives  Surprisingly, this critical stage is not properly addressed in the Notice

13. RBB | Economics 3.1 HHI “safe harbour” thresholds in the Notice HHI Delta < 1,000>1,000 <2,000 >2,000 <150? >150 >250 Safe harbour

14. RBB | Economics 3.2 “The safe harbour is mined!” HHI safe harbours have 6 caveats: Potential competition One merging firm is an innovator Cross-shareholdings Merger takes out a “maverick” player Past or ongoing coordination is evident One merging firm has >50% share

15. RBB | Economics 3.3 HHIs and the US Guidelines EC HHIs are modelled on US Guidelines, but in a study of US practice: –Median HHI for unchallenged cases is 2,500 –Median HHI for challenged cases >5,000 –Lowest challenged HHI >2,000 since 1985 (From Scheffman, Coate and Silva, FTC)

16. RBB | Economics Summary on Notice The Notice has: –confirmed the role of economic analysis –created a sophisticated debate on merger enforcement But: –it continues to shows undue dependence on theoretical models –creates very wide discretion –and can only be part of the story …

17. RBB | Economics 4.1 Process changes Chief Economist’s Office Tri-partite meetings CFI Judgments Hypothesis testing Internal Review

18. RBB | Economics 4.2 Hypothesis - testing CFI Judgment criticisms are fundamentally about empirical analysis Draft Notice does not help here – even adds to the problem Consequences: - much more work for parties - a better chance to prove case

19. RBB | Economics 4.3 Chief Economist’s office Professor Röller: leading academic with empirical orientation Assembling dedicated team of economists Consequences: –another audience for Oral Hearings –greater sophistication in analysis

20. RBB | Economics 4.4 Tri-partite meetings Provision for a crowded schedule during Phase I and II Consequences: –Greater scrutiny of 3 rd parties? –More work for parties –More transparency

21. RBB | Economics 4.5 Internal review panel Another independent check on case team Some notable influence already Consequences: –chance to stop the juggernaut in its tracks

22. RBB | Economics Conclusion – the new regime Changes signal a new era in ECMR enforcement The key areas to watch will be: –controlling DG COMP discretion and reliance on untested economic theory –maintaining the genuine scrutiny that has arisen from CFI Judgments