1. BIICL: The Seventh Annual Trans-Atlantic Antitrust Dialogue Empirical Evaluation of Coordinated Effects Dr Peter Davis 1 May 2007

2. CC Coordinated Effect Cases  Since the Enterprise Act came into effect (June 2003) the CC has considered coordinated effects in three merger inquiries  DS Smith/LINPAC Containers  James Budgett Sugars/Napier Brown Food  Wienerberger Finance Service BV/Baggeridge Brick plc (live case – provisional findings just issued)  Another case, Wiseman/SMD, was referred by the OFT to the CC but was abandoned

3. Framework for Analysis

4. Empirical Tests of Collusion versus Competition  Can we use data to test whether market participants are competing or colluding?  Bresnahan (1982, Economics Letters) says YES  But requires a model of behaviour under competition which you test against one under coordination  Idea: Use information on exogenous ‘rotations’ of demand  Subsequently a large economic empirical literature tests whether data were generated from competitive environments or via coordination.  Eg., (1) Differentiated products and (2) Auction data

5. Framework for Evaluating Coordination 1.AGREEMENT  Tacit colluders must know what it means to coordinate  Eg hundreds of products and hence prices may be complex to coordinate and require a system for simplification, Eg., price books or per-mile pricing 2.MONITORING  Aware of behaviour of competitors  Able to spot deviations from prevailing behaviour 3.ENFORCEMENT  Internal stability – main focus of current work  External stability – barriers to supply expansion from non-coordinating firms (Eg., entry barriers)

6. Ability to Support Tacit Collusion  The theoretical explanation of (tacit) collusion is based on the theory of non-coordinated repeated games (dynamic oligopoly models)  Firms meet repeatedly  Firms individual maximise stream of profits  But firms reach a tacit understanding of a mutually beneficial conduct  Many models but generic one says a firm is willing to collude if NPV of payoffs to tacit collusion > payoffs to cheating + NPV of payoffs under ‘punishment’ + NPV of payoffs under competition  Collusion and Competition payoffs normally calculated in a unilateral effects simulation model

7. Internal Stability  To sustain tacit collusion, each firm must find it: 1.sufficiently rewarding to tacitly collude 2.insufficiently rewarding to cheat when others are coordinating 3.sufficiently costly to cheat and then get caught  We can model each element of the incentive to collude 1.Return to collusion 2.Return to cheating 3.Costs of cheating  And putting them all together will tell us about one element of the ability to collude:  A collection of firms will be able to sustain collusion only when they each find it worthwhile

8. The Return to, or incentive for, Tacit Collusion Equilibrium Outcome ( prices or profits) Monopoly (perfect cartel) outcome Competitive outcome A = pre-merger B = post-merger CD (2) Coordinated effect of merger Strengthening of coordination: C to D Newly coordinate: A to D AB (1) Unilateral effect of merger A to B. Is B>A?

9. Incentives For Coordination - If you can coordinate, what does it do for you?  Impact of merger  If strengthening coordination = D–C  If results in newly coordinating = D–A  Profit Incentive to Newly Coordinate  Pre-merger = C–A  Post-merger = D–B  Notice we currently sometimes get A and B from unilateral effects simulation models

10. Ability to Collude Results from simulation models Some mergers will reduce or even entirely remove firms ability to ‘fully’ collude These tend to be mergers that generate additional asymmetry If partial collusion is possible then less dramatic effect – continuum between competition and collusive outcomes using the maximal sustainable profit level

11. Two different 3 to 2 mergers with 6 products, eg (4,1,1) to (5,1) merger D (5,1) A (4,1,1) C An Example of Incentives to Collude. NB: discount factor is in each of the ‘NPV’ calculations B (5,1)

12. Conclusions  Mergers that introduce asymmetries in market structures can hinder coordination  Pre-merger Coordination can be explicitly tested for against Competition  We can attempt to measure the impact of a merger on: 1.The three elements that drive the internal incentives to coordinate 2.The ability of a market structure to support coordination  However, as with unilateral effects simulation, formal empirical analysis requires that we settle on a particular model of competition and also a particular model of collusion for analysis