1. Vertical mergers - EWS/Marcroft
NEIL PRATT
ACE conference, November 2007

2. Agenda Framework for assessing input foreclosure
Comments on EWS/Marcroft

3. Vertical merger analysis – preliminaries
No direct loss of rivalry
Efficiency rationales
Elimination of double marginalisation
Improved investment incentives
Two main unilateral theories of harm
Input foreclosure: restrict/degrade input supply
Customer foreclosure: limit input purchases
Large body of theory relating to vertical mergers and vertical foreclosure.
Complex and subtle area – but for practitioners it is useful to bear in mind a few simple considerations
No real rocket science here – but a sensible (and hopefully uncontroversial) jumping-off point for analysis

4. The input foreclosure mechanism
Upstream
entity
Downstream
rivals
RRC?
Efficiencies?
CC used orthodox approach to input foreclosure – in line with approach set out in draft NHM guidelines
Slide shows the diagram in the draft NHM guidelines – neatly capture basic logic of input foreclosure.
Concern is that upstream division of vertically integrated firm will foreclose downstream rivals – via increased wholesale price, or reduced quality – reducing competition and harming customers
Need to assess a range of factors – market power upstream, nature of downstream competition, and scale and nature of merger-related efficiencies
No presumption of harm – factual analysis of specific case required to assess likely impact of merger
Softer competition?
Impact on customers?

5. Analytical framework Ability Incentive Effect
Significance of input to downstream firms
VI firm’s market power upstream
Barriers to entry and expansion upstream
Incentive
Margins in upstream and downstream markets
VI firm’s share of downstream market
Extent of share-shifting to VI firm
Impact on size of downstream market
Effect
Competitive significance of foreclosed rivals
Impact on barriers to entry
Competitive constraint from vertically integrated rivals
Merger-specific efficiencies

6. Empirical analysis of incentive
‘Vertical arithmetic’ approach can be used to assess profitability of input foreclosure – e.g.
Evraz/Highveld
Thales/Finmeccanica/Alcatel Alenia Space & Telespazio
Simple analysis can indicate likelihood of foreclosure
Estimate cost from foregone upstream margin based on loss of input sales
Estimate profit from additional downstream margin based on expected sales diversion
More sophisticated simulation approach can help assess competitive effects

7. EWS/Marcroft - background
Relatively low value deal in a difficult market
Some tricky economic issues to resolve
No economic advisers retained by parties
Apparently limited data available to CC in certain areas
Conflicting evidence from EWS and complainants

8. Vertical foreclosure: main lines of debate
Efficiencies did not play a significant role
EWS already vertically integrated
Parties did not make strong efficiency claims
Debate focused on two key issues:
Marcroft’s pre-merger position in the wagon maintenance market
EWS’s incentive to lower foreclose rivals in the haulage market

9. Marcroft’s pre-merger position
CC relied on structural analysis of wagon maintenance market
High share – 56% (volume)
Only one rival with national coverage
Self-supply not an effective constraint
Some conflicting evidence on performance and conduct
Poor financial performance of Marcroft
Examples of failed attempts to increase prices/lost tenders
CC concluded on balance that Marcroft had significant market power
Appears to have been area of major focus for CC post-PF - significantly more attention given in final report
Some 3rd party hauliers said that maintenance market was ‘fiercely competitive’

10. Two possible forms of input foreclosure
Reduction in service quality to haulage companies
Increased downtime, less reliable scheduling of works
Could be targeted at selected customers
Foreclosed customers would face higher costs, or lose contracts
Increase in price of maintenance services
Conflicting evidence on significance of maintenance relative to operating costs
Price increase expected to have some negative impact on rivals

11. Limited evidence on incentive and effect
Data limitations appear to have precluded application of vertical arithmetic
CC points to size of haulage market compared to maintenance market and EWS’s high share
Wabtec (and others) not seen as competitive alternative
High-level approach to haulage market
No concrete examples of potential foreclosure
Not much on harm to end users

12. Final remarks
EWS/Marcroft follows orthodox approach to vertical mergers
Debate focused on empirical questions
Market power of Marcroft
Profitability and effect of foreclosure
Threat of self-supply by e.g. Freightliner
Data appears to have been quite limited and contentious in this case

13. Frontier Economics Limited in Europe is a member of the Frontier Economics network, which consists of separate companies based in Europe (Brussels, Cologne and London) and Australia (Melbourne & Sydney). The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Limited.

14. FRONTIER ECONOMICS EUROPE BRUSSELS | COLOGNE | LONDON
Frontier Economics Ltd, 71 High Holborn, London, WC1V 6DA
Tel. +44 (0) Fax. +44 (0)