Mergers and Acquisitions: Industries, Motives, and Economic Analysis, Study Guides, Projects, Research of Marketing

Download Mergers and Acquisitions: Industries, Motives, and Economic Analysis and more Study Guides, Projects, Research Marketing in PDF only on Docsity! Horizontal Mergers March 31, 2020: 6:18 PM Page 1 What is a “Merger”? Merger: The process in which two or more independently owned firms join under the same ownership. I Includes takeover, integration or acquisition I May affect internal governance of the firm We distinguish between horizontal and vertical mergers. March 31, 2020: 6:18 PM Page 2 Lecture Outline I. Data: Mergers are a common occurrence. II. Theory: Why do firms merge? • Homogenous goods markets. • Differentiated goods markets. III. Department of Justice (DOJ) Merger Guidelines. • Market definition. • Concentration measures. • Diversion ratios. • Challenge criteria. March 31, 2020: 6:18 PM Page 5 I. Data Facts March 31, 2020: 6:18 PM Page 6 I. Data Fact 1 Figure: Mergers & Acquisitions in the United States I Mergers are increasingly common (bars, left y-axis) and the overall value of M&A activity is also increasing (red line, right y-axis). I US M&A looks pro-cyclical: When times are bad (i.e., 90-91, 01, & 08-09 recessions), M&A activity (number, value) seems to decrease. Why? March 31, 2020: 6:18 PM Page 7 II. Theory: Why do competing firms choose to merge? 1. Reduce competition, raising prices and profits. 2. Coordination of prices or quantities. 3. Production efficiencies: lower fixed and/or marginal costs (greater economies of scale or scope), leads to higher profits. 4. Other efficiencies: Eliminate inefficient competitors. Takeovers, or the threat of takeovers, may discipline bad management. Let’s start by focusing on the effects of mergers on competition. March 31, 2020: 6:18 PM Page 10 Example 1 Number of Firms: N = 3 Demand: P(Y ) = 1− Y , Y = y1 + y2 + y3 Costs: c = 0 Firm 1 chooses output to maximize max y1 { (1− y1 − y2 − y3︸ ︷︷ ︸ p(Y ) )× y1 − 0 } Differentiating and solving for firm 1’s best reply y1 = 1− y2 − y3 2 Problem is symmetric so the best replies for Firms 2 and 3 are identical. Solving for the symmetric solution, the Nash equilibrium outcome is y?i = 1/4, p? = 1/4, π?i = 1/16,S? = 9/32,T ? = 15/32 March 31, 2020: 6:18 PM Page 11 A Merger Now suppose Firms 1 and 2 merge into firm 12. The merged firm chooses its output y12 to max y12 (1− y12 − y3)× y12 Differentiating and solving for firm 12’s best reply: y12 = 1 2 (1− y3) Firm 3’s best reply is identical. Solving for the symmetric duopoly outcome yields ỹ12 = y3 = 1/3, p̃ = 1/3, π̃12 = π3 = 1/9, S̃ = 2/9, T̃ = 4/9 March 31, 2020: 6:18 PM Page 12 A Merger Now suppose M < N of the firms merge so there are N −M + 1 firms in the market. Each firm earns πi = (A− c)2/[B(N −M + 2)2] Profits for outside firms are clearly higher since N + 1 > N −M + 2. Profits for the M merging firms are higher if and only if: (A− c)2/[MB(N −M + 2)2] > (A− c)2/B(N + 1)2 → (N + 1)2 > M(N −M + 2)2 This condition is not easily met. The number of merging firms typically needs to represent more than 80% of the firms. Main point: Effects of mergers are not so obvious. Not always profitable. I Strategic thinking is essential! Need to think through the consequences of the merger on behavior of rivals. March 31, 2020: 6:18 PM Page 15 Resolving the Merger Paradox with Fixed Costs Example 2: n = 3,P(Y ) = 150− Y ,C (y) = f + 30y Firm 1 chooses y1 to solve max y1 (150− y1 − y2 − y3 − 30)× y1 − f Differentiating and solving for Firm 1’s best reply y1 = 1 2 (120− y2 − y3) Note: fixed costs do not affect optimal output. In symmetric equilibrium, all three firms produce the same output. The equilibrium outcome is y? = 30,P? = 60, π? = 900− f March 31, 2020: 6:18 PM Page 16 A Merger Now suppose Firms 1 and 2 merge. The merged firm has to pay only one fixed cost to operate. I E.g.: when AT&T and Cingular merged, they need only one of the two sets of cell towers. Repeating the above steps yields the duopoly equilibrium outcome ỹ12 = ỹ3 = 40, P̃ = 70, π̃ = 1600− f Hence, the merger is profitable if 1600− f > 1800− 2f → f > 200 Main Point: Mergers can be profitable if they reduce fixed costs. I Price always rises, consumer surplus always falls. Another kind of cost efficiency arises when one of the firms in the merger has higher marginal costs. In this case, there is a trade-off that can benefit the consumer. March 31, 2020: 6:18 PM Page 17 Results I Best replies are y1 = 1 2 (120− y23) y23 = 1 2 (120− y1) I Solving the system of two equations and two unknowns yields the Nash equilibrium output: ỹ1 = 120− y23 2 ỹ23 = 120− y1 2 ⇒ ỹ1 = ỹ23 = 40; therefore P̃ = 70. March 31, 2020: 6:18 PM Page 20 Results, cont’d I Is the merger profitable? Will the firms agree to it? π̃1 = π̃23 = 1600 The merger is profitable since 1600 > 1406.25 + 56.25 = 1462.25 Main Points 1. Mergers can be profitable if they eliminate a higher marginal cost (i.e., less efficient) firm. 2. Here, CS↓ (since P ↑) but perhaps eliminating efficiency could be good for consumers (if equilibrium prices fall). March 31, 2020: 6:18 PM Page 21 Extension: Cost “Synergies” Consider a similar same set-up but firms have the same constant marginal cost. Firms 1 and 2 merge. By doing so, they decrease their marginal cost by s (i.e., cost synergies). The cost function for these firms is now ci (yi ) = (1− s)× 30yi . Questions I At what value of s is the merger profitable? I At what value of s does the third firm choose to shut-down? I Are there values of s where consumer prices actually fall and consumers benefit from the merger? March 31, 2020: 6:18 PM Page 22 Horizontal Mergers in Differentiated Good Markets Previous analysis assumed homogenous good markets. But most markets are differentiated good markets. What are the gains to merging in these kinds of markets? Example: Three firms, three goods, marginal costs are zero and demands are given by y1 = 1− p1 + s(p2 + p3) y2 = 1− p2 + s(p1 + p3) y3 = 1− p3 + s(p1 + p2) Assume substitutes so 1 > s > 0. Firms compete in prices. March 31, 2020: 6:18 PM Page 25 Benchmark Nash Equilibrium Firm 1 chooses price to solve max p1 p1 × ( 1− p1 + s(p2 + p3) ) Differentiating and solving for best reply, p1 = 1 2 [1 + s(p2 + p3)] Imposing symmetry, p? = 1 2(1− s) , y? = 1 2(1− s) , π? = 1 4(1− s)2 March 31, 2020: 6:18 PM Page 26 Merger Nash Equilibrium Suppose Firms 1 and 2 merge. The firms hire a marketing firm to conduct focus groups and choose “Firm 12” as the new name. Important In contrast to homogenous good case, the new firm continues to produce both types of goods. Firm 12 chooses p1 and p2 to maximize profits from both products: max p1,p2 { p1 ( 1− p1 + s(p2 + p3) ) ︸ ︷︷ ︸ π1(p1,p2,p3) + p2 ( 1− p2 + s(p1 + p3) ) ︸ ︷︷ ︸ π2(p1,p2,p3) } Differentiating, ∂π12 ∂p1 = 0⇒ 1− 2p1 + s(p2 + p3)︸ ︷︷ ︸ ∂π1 ∂p1 +sp2 = 0 ∂π12 ∂p2 = 0⇒ 1− 2p2 + s(p1 + p3)︸ ︷︷ ︸ ∂π2 ∂p2 +sp1 = 0 March 31, 2020: 6:18 PM Page 27 Motivating Case Coca-Cola Bottling Company of the Southwest vs Federal Commission The Market: Bottling, distribution, and sale of carbonated soft drinks (CSDs) in San Antonio. I Take-home market consists of all soft drinks sold for consumption at some place other than where they are purchased - i.e., stores. I Cold drink market is composed of those outlets where soft drinks are purchased for immediate consumption - vending machines, restaurants, etc. Main Suppliers: I Four branded CSD suppliers: Coca-Cola Bottling Co. (CCSW), San Antonio Dr. Pepper Bottling Co. (DP-SA), and Pepsi. I CCSW is a franchisee for Coca-Cola, Sunkist, and other concentrate companies. DP-SA was a wholly own subsidiary of Dr. Pepper and a franchisee for Canada Dry, Big Red, RC, Crush, Hires and other brands. Pepsi is company owned. March 31, 2020: 6:18 PM Page 29 I Private label CSD are sold in retail chains that own the trademark (e.g., HEB). I Warehouse suppliers (e.g., Shasta). Note: Franchisor grants franchisee an exclusive right in a specified geographic area to make and sell soft drinks in bottles and cans bearing the franchisor’s trademark. The Merger: CCSW acquired Dr. Pepper and Canada Dry franchises from DP-SA. I DP-SA sold its other franchisees to Grant- Lydick. March 31, 2020: 6:18 PM Page 30 The Charge The acquisition of Dr. Pepper and Canada Dry substantially lessened competition, violating Section 5 of FTC Act and Section 7 of the Clayton Act. I Administrative law judge had ruled in favor of the acquisition. I Complaint Counsel appealed and the case was reviewed by the Commission. Main Issue: Market Definition March 31, 2020: 6:18 PM Page 31 Market Definition I Economic definition typically based on price correlations and cross price elasticities. Products that are close substitutes are in the same market. I Antitrust definition is based on the Hypothetical Monopolist test: “A market is defined as a product or group of products and a geographic area in which it is sold that a hypothetical, profit-maximizing firm, not subject to price regulation, that was the only present and future seller of those products in that area would impose a small but significant and non-transitory increase in price (SSNIP) above prevailing or likely future levels.” Idea: A “market” should contain products which compete with each other and be small enough such that consumers can choose not to participate. But how to define what a market is? Big Question: Is there a simple, yet effective way (i.e., a “sufficient statistic”) of to identify a market as well as use the current equilibrium to forecast a future one? March 31, 2020: 6:18 PM Page 34 Concentration Measures I Order the firms by market share from largest to smallest. The m firm “concentration ratio” is given by CRm = m∑ i=1 si Most frequently used indices are CR4 and CR8. I Herfindahl-Hirschman Index (HHI) is given by HHI = N∑ i=1 (100si ) 2 Range of the index is from 10,000/N (equal- sharing) to 10,000. March 31, 2020: 6:18 PM Page 35 Properties of HHI a. HHI decreases with number of firms. b. HHI increases with the variance of the distribution of firm sizes. c. Recall from the Cournot model that in equilibrium, each firm i’s output satisfies the first order condition (P? − ci )/P ? = si/η(Y ?) Multiplying by 10000si and summing over all i yields N∑ i=1 10000si ((P? − ci )/P ? = (HHI )/η(Y ?) In other words, HHI is proportional to a weighted average of the firms’ percentage markups of price over cost. It is a summary statistic of market power. I A market with a higher HHI has a higher average markup. I Useful, since markups are not observable. March 31, 2020: 6:18 PM Page 36 An Example I Define the following matrix of diversion ratios where Dj0 is diversion to the outside good: D(p) = D10 D12 D13 D21 D20 D23 D31 D32 D30  I Consider consumers deciding between three fuel-efficient cars: Honda Civic, Toyota Prius, and a Tesla. The matrix of Diversion Ratios is: from / to: Civic Prius Tesla Civic 50 40 10 Prius 50 30 20 Tesla 0 80 20 I If Honda and Toyota propose a merger, should the DOJ be primarily interested 1. Diversion between the Civic and the Prius? 2. Diversion from the Prius to all possible alternatives (the entire row)? 3. All diversion ratios (e.g., diversion from Prius to Tesla, or aggregate diversion for the Prius)? March 31, 2020: 6:18 PM Page 39 Challenge Criteria The DOJ says it will not challenge a merger if post-merger HHI is I Less than 1000 I Between 1000 and 1800, and ∆HHI < 100; I > 1800 and ∆HHI < 50. Remark: Post-merger HHI is calculated on the basis of pre-merger shares. Theory suggests that this is not a reasonable assumption. What about Diversion Ratios? The 2010 U.S. merger guidelines: Diversion ratios between products sold by one merging firm and products sold by the other merging firm can be very informative for assessing unilateral price effects, with higher diversion ratios indicating a greater likelihood of such effects. Other Considerations I Efficiency gains cannot be achieved by other means. I Entry would be timely, likely and sufficient to deter or counteract any potential competitive effects. I In the absence of merger, either party would be likely to fail, causing its assets to exit the market. March 31, 2020: 6:18 PM Page 40 Back to the Coca-Cola Case What is the Market Definition? A. Product Market 1. CCSW argued that the relevant product market consists of all carbonated soft drinks (including national brand, private label, and warehouse brands) and certain non-carbonated soft drinks like iced tea, lemonade, and isotonic drinks. 2. Complaint Counsel argued that the relevant product market consists of all branded CSD. I Branded CSD are characterized by: wide availability in take-home and cold drink distribution channels, direct-store-door delivery, and heavy promotion. ⇒ Commission ruled in favor of the latter definition. March 31, 2020: 6:18 PM Page 41 B. Geographic Market 1. CCSW argued for a geographical market definition that included most of Texas, including the major cities of Austin, Houston, and Dallas. 2. Complaint Counsel argued for a narrower definition: the ten counties centered in San Antonio. ⇒ Commission rules in favor of the narrower market definition. March 31, 2020: 6:18 PM Page 43 Reasons: 1. Testimony from bottlers in San Antonio indicated that they could profitably raise prices by as much as 10% without fear of outside competition. 2. Bottlers outside San Antonio testified that they would not ship into the San Antonio market even if price of branded CSD increased by 10%. 3. Exclusive territory contracts covered San Antonio, not Texas. They also prevent competition from outside bottlers and are vigorously enforced. March 31, 2020: 6:18 PM Page 44 Market Concentration: Dr. Pepper acquisition: Pre-acquisition HHI 2807 Post-acquisition HHI 3421 → HHI increase 614 Canada Dry acquisition: Pre-acquisition HHI 2807 Post-acquisition HHI 2862 → HHI increase 55 Ruling: Dr. Pepper acquisition denied, Canada Dry approved. March 31, 2020: 6:18 PM Page 45