SUMMARY: Industrial organization. Markets and strategies., Sintesi del corso di Economia Industriale

Scarica SUMMARY: Industrial organization. Markets and strategies. e più Sintesi del corso in PDF di Economia Industriale solo su Docsity! CHAPTER 11 HORIZONTAL MERGERS Overview Context: market structure changes by means of entry, exit — and mergers and acquisitions. Concepts: efficiency and market power; unilateral and coordinated effects; merger waves. For simplicity, in this chapter I will often simply use the word "merger" even though I mean "horizontal merger"​. Market structure is not only determined by the entry/exit of firms, but is also determined by consolidation of firms already existing in the market. Why do mergers and acquisitions take place? A brief look at a few examples will show that the causes are manifold. ➺ Synergies In the 1980s Sony purchased the film studio Columbia with the objective of creating "synergies" between two complementary producers. Columbia's collection of quality movies was seen as a guarantee of a minimum supply of "software" to complement the "hardware" offered by Sony (e.g., video players). ➺ Supplier power Philip Morris and Kraft possessed a large number of food products sold through supermarket chains. Creating a new firm of greater size allowed Philip Morris and Kraft to increase their bargaining power with respect to retailers. This is important, for example, when it comes to obtaining shelf space for the launch of a new product. ➺ Entry into new market When Nestle acquired Rowntree, its main goal was to enter the British market for chocolates. Rowntree owned a vast number of well-known brands (Smarties, After Eight, Kit Kat, etc.). Buying Rowntree allowed Nestle to save the high costs of launching new brands. ➺ Distribution efficiencies Another example also involving Nestle is the joint venture with General Mills for the production and distribution of breakfast cereals in Europe. The main goal of this joint venture was to exploit the synergies between two complementary firms: Nestle's distribution skills (especially in Europe) and General Mills production skills. In addition to these examples, where some strategic or efficiency seems to play a role, there are a number of cases where mergers and acquisitions are motivated for financial or tax reasons. For example, acquiring firms from different industries is equivalent to holding a diversified investment portfolio, thus reducing the parent company's overall risk. Types of mergers Horizontal mergers​ → mergers or acquisitions between two firms within the same industry (between competitors). From the examples given earlier, both the Phillip Morris-Kraft and Nestle-Rowntree examples would qualify as examples of horizontal mergers; not so the Sony-Columbia example (or the examples where mergers result from financial or tax reasons). Vertical mergers​ ​and complementary​→ mergers between firms at different or complementary stages of the value chain ​(e.g., a gasoline refinery and a gas station). ​(Chapter 13) Conglomerate:​ between firms operating in unrelated industries. ​Mostly for financial reasons or for risk reduction. → ​we will not look at this type of mergers​!! 11.1 ECONOMIC EFFECTS OF HORIZONTAL MERGERS Total output typically decreases (and price increases) as the result of a horizontal merger. In particular, there is a tendency for the combined output of the merged firms to decrease (thus leading to a price increase). Why? Before the merger, if firm ​i​ were to decrease output by one unit, it would a) lose ​p - MC​ ​, its selling margin; and b) gain ​q​i ​Δp​ , where ​q​i​ is its output and ​Δp​ the increase in price that results from the output decrease. Since we start (before the merger) from an equilibrium situation, it must be that no firm would have an incentive to decrease (or increase) output. In other words, the positive and the negative effects of an output reduction exactly cancel out. Consider now the situation after the merger between ​firms A ​and ​B​. Starting from the same output levels as before the merger, the newly formed ​firm A&B​ stands to gain from a reduction in output. In fact, the loss in terms of lower output is still ​p - MC​, the gain from an increased price is now ​(q​A​ ​+ ​ ​q​B​)​ ​Δp​. In other words, when firm ​A​ lowers output, it now takes into account not only the effect of a higher price on its profits but also the effect on firm ​B'​s profits. Therefore, unless the merger implies a significant reduction in the marginal cost of the combined firm ​A&B​, total output of the merging firms goes down. The above analysis assumes that the mode of competition remains the same after the merger (e.g., Cournot before and Cournot after, though with a more concentrated industry). However, one of the implications of the merger may be precisely to change the industry's competition mode: a more concentrated industry (the result of the merger) may allow for a greater degree of collusion among competitors. We thus have a second reason why mergers may result in higher prices. Mergers also have an impact on costs, normally referred to as ​cost efficiencies​. These cost savings may be divided into two parts: fixed costs and variable costs. Savings in fixed costs typically result from eliminating duplicated functions in the new merged firm. For example, each firm only needs one back office. Although the merged firm is likely to require a bigger back office than either of the previous companies, it is also likely that the total size of the new back office will be smaller than the sum of the two previous ones. Variable cost savings can result from different factors. For example, suppose firm A has good production expertise and poor distribution skills, whereas firm B's advantages are the exact opposite: poor production expertise and good distribution skills. By merging, the firms combine the best of each firm's competitive advantages (some refer to effects of this sort as ​merger synergies​). As an example, the joint venture between Nestle and General Mills combined complementary skills that lead to a lower marginal cost of producing and distributing breakfast cereals. In sum, we have two main effects from a merger: Mergers normally imply an increase in prices and a reduction in costs. Not every firm decreases its output as a result of a merger → for the non-merging firms, the opposite is true. Before the merger, if ​firm C​ were to decrease output by one unit, it would a) lose ​p - MC ​, its selling margin; and b) gain ​q​C ​Δp​. After the merger, (b) remains the same but (a) is now greater. Merger in ​Cournot​ triopoly ● Initially ​n = 3​, all firms are identical before the merger, with cost function: ​C = F + c q ● Firms ​2 ​and ​3​ merge, forming ​2&3 ​ ​ ​with ​C = F’ + c’ q ● Merger efficiencies for 2&3: the two efficiencies are both on variable and fixed costs. In particular, the new firm has a fixed cost equal to​ F’​ and a constant marginal cost equal to ​c’​ → we assume that the fixed cost of the new entity is smaller than the fixed costs that the two firms would have had ​(2F). The other way in which the merge creates efficiency is by reducing the marginal cost that the new firm is having. → ​F < F’ < 2F ​ and ​c’ < c ● Determine effect on 1. merging parties 2. non-merging parties (outsiders) 3. consumers 1. Merger effect on merging parties → general formula ↓ solving the example When is the merger profitable for firm 2 and 3? We want to check whether the profits of the merged firm are larger than when the firms operated independently. → ​π’ ​2&3​ > π​2​ + π ​2 ↓ (2F - F’)​ → is the difference in the fixed costs. It is the fixed cost saving due to the merger. The smaller F’, the larger is the reduction in fixed costs that occur because of the merger. The larger is this difference, the larger is the gain that the merging firm obtains from merging. → the first term is the variable profits that we had in the ( 3a + c − 2c′) 2 − 2 ( 4a − c) 2 case of a merger. The second term is the variable profits ​(net of the fixed costs)​ that the firms obtained before the merger. Assume ​F’=F​ (no fixed cost efficiencies) and ​c’=c​ (no marginal cost efficiencies) → a merger is not profitable for the firms. 2. Merger effect on outsiders How can we verify the effects of a merger on outsiders? In the usual way → we take the difference between the profits that the outsider makes when the merger has occurred and the profits that the outsider would have obtained without the merger. (This expression is much easier than the one we observed before). Notice again, that to understand whether or not the outsider has been made better off by the merger, what we simply need to do is to compare these two expressions​ (notice that there will also be minus​ -F ​and ​+F​ but these two terms cancel out). We know that the numerator in the first term is smaller than the numerator in the second term, when ​c’​ is smaller than ​c​. → ​c’ < c So, there is a ​negative effect​ on the outsider profits when the merged entity becomes more efficient. If my two rivals merge → ​c’ < c ​: if this occurs, the difference between ​π’​1​ - π​1​ ​ goes down. → I may be disadvantaged from the merger. On the other hand, there is a positive effect, which is due to the fact that the first expression is divided by a lower denominator ​(3) ​ which basically illustrates the fact that I have now one less competitor. So again, there are two contrasting forces: - one force is due to the fact that my rival is becoming more efficient by merging, and - the other effect is that I am having one less competitor in the market. Notice again that in the extreme case in which ​c’ = c​ , that is, my rival does not obtain any efficiency gain because of the merger, the outsiders are always better off. So, again, two contrasting effects: - the first effect is lower profits. ​π ↓ Profits for the outsiders go down because of efficiency gain of rival efficiency gain - the second effect is profits go up ​π ↑ ​because of one less competitor. Does this effect sound strange c’ = c? Well, not much we have observed that in some situations like the next examples, the realization of a merger has actually benefited the profits. Merger effect on outsiders: examples ー BP acquires Amoco (oil industry). Mobil’s stock up $2.625. → valuation of the firm increased because market operators anticipated an increase in the profits of this rival firm. ー Western Digital announced Hitachi acquisition (hard drive industry). Seagate’s stock up by 9%. → the stock price went up again in anticipation of an increase in profits. Clearly this is not always the case. There are cases in which a merger actually damaged the profits of the outsider, of the existing competitors. ー BA and AA announce plans to merge (air travel industry). Virgin Atlantic paints its aircraft with “BA/AA No Way”. ー GKN plc and Alvis plc merge (European defense industry), putting pressure on Vickers, the third competitor. But recall the formula and remember, - when two competitors merge, my market power goes up because I'm operating in an industry with one less competitor, but - on the other hand if the merger allows my competitors to obtain efficiency gains, this of course puts me at a disadvantage relative to the new firm. 3. Merger effect on consumers Remember we anticipated two possible effects that a merger could have on consumers: - one negative effect due to more market power by the firm's operating in this industry (they are bigger and in a lower number); - the other possibility is that the merger has a public positive effect on consumer surplus because of efficiency gains, translating into lower prices. Does our model confirm this prediction? ​Yes. We have this pretty complicated expression for consumer surplus ​(which is again in your textbook in exercise 815 - I'm not going to derive this expression). We see that the consumer surplus increases with the number of firms, increases with the size of the market and consumer surplus decreases with the cost of the firms. Consumer surplus goes down as the cost of the firm goes up. Prices are really positively related to costs and as costs increase, prices increase and then the consumer surplus goes down. Rearranging this expression in this way, we can look at the difference between consumer surplus before and after the merger. 11.3 HORIZONTAL MERGER POLICY There are essentially three interested parties in a horizontal merger: the merging firms, the non-merging firms, and consumers. Broadly speaking, Section 11.1 suggests that ○ consumers in general lose from the merger; ○ non-merging firms may gain or may lose; and ○ merging firms are expected to gain from the merger, at least in expected terms (or else they wouldn't merge). The task for public policy is to evaluate the relative importance of each gain and loss; and then to assess the overall merger effect, taking into account the relative weight given to firm profits and to consumer welfare. One of the few general policy rules is that ​the greater the price increase, the less desirable a merger is​. The idea is simple: a higher price implies a consumer loss that is less than compensated by a gain for firms (the difference being the allocative inefficiency caused by the gap between price and marginal cost). Moreover, policy makers normally give more weight to consumer welfare than to firm profits. So, even if there were no allocative efficiency loss, a higher price would imply a transfer from consumers to firms, a negative effect (from a policy maker's perspective). How can a policy maker estimate the likely increase in price following a merger? In Section 10.3​ I showed that, for a given mode of competition, equilibrium price is increasing in market concentration. So a merger between two large firms is likely to imply a greater increase in price than a merger between two small firms. Moreover, collusion is more likely in concentrated industries; so a switch to collusive behavior is more likely to take place as a result of a merger. It is important to distinguish these two channels of price increase. The first one, known as the ​unilateral effect​ of the merger, is essentially a function of the increase in concentration. The idea is that the merger implies a reduction in the number of purchasing choices available to consumers. This is particularly relevant if products are differentiated ​(a possibility I consider in Chapter 14)​, but also in the homogenous-goods case. The second channel of price increases motivated by a merger, the ​collusion effect​, also depends on the distribution of market shares. How does one go about estimating the price effect of a merger? One possibility is to estimate the impact of the merger on concentration and then apply a formula like Equation 10.7​, which relates concentration to price. The practical problem of this approach is that, in order to compute the concentration index, one first needs to compute market shares; and, in order to compute market shares, one first needs to define the market; and the latter is far from trivial. A second general rule for merger policy is that ​the smaller the relative size of the merging firms, the more likely the overall impact of the merger is positive​. There are two reasons for this rule. 1. First, the smaller the merging firms are, the lower the price increase caused by the merger. For example, going from 20 to 19 firms implies a lower increase in price than going from three to two firms. 2. The second reason is that a merger between small firms indicates that efficiency gains are likely to be significant. G​eneral principles (slides + prof del discorso sopra del libro) ー If there are economies of scale, merger leads to lower cost; various synergies may create additional value. In principle, all mergers need to be reported to the relevant Competition Authority and the relevant Competition Authority has to authorize a merger. What are the elements for the evaluation of the Competition Authority? The analysis of the Competition Authority follows exactly the lines that we highlighted so far. So basically we have that a merger may lead to lower cost and lower cost both in terms of fixed cost and variable cost, and these lower costs may create additional value. So they may benefit the society because of higher efficiency and better utilization of resources. ー But: greater concentration leads to greater market power, and greater market power may have: - Unilateral effects → that is effects on prices (effects of each firm in isolation). - Collusion effects → so a market with ​n​ firms may not be conducive to collusion, while instead a market with ​n-1​ firms may drift toward a collusive outcome. ー When assessing a merger, the Competition Authority basically tries to balance the positive and negative effects of mergers on firms and on consumers. Merger policy is an attempt at measuring the pros and cons of each merger. - Benefits and costs for firms - Benefits and costs for consumers Economics analysis ● Relevant market definition → to understand the effect of a merger in a market, we should first define the market itself. The market definition is not an easy exercise. ● Lower fixed cost: efficiency gained by firms. ● Lower marginal cost: typically shared between firms, consumers. ● Fewer competitors (lessening of competition): - Unilateral effects - Collusion ● Equilibrium readjustment - Number of firms (entry or exit) - Number of locations / varieties - Prices - R&D ● Remedies - behavioural remedies - structural remedies Merger policy in practice In most countries in the world, merging firms are required to notify their plans with the appropriate government regulator or agency. This is especially true if the merging parties' sales revenue falls above a certain threshold. Typically, the agency has a period of time to declare whether it has any antitrust concerns with the operation. In most cases, the agency says nothing and the merger goes through. If there is a "case" ​(a merger which is deemed to have potentially serious anti-competitive implications)​ then the agency may try to negotiate possible remedies with the interested parties. These remedies may be: behavioral remedies​ (for example, prices cannot be increased more than ​x%​ during the next ​n ​years);​ or structural remedies​ (for example, sell assets​ y​ and ​z​ to a competitor). Sometimes the remedies are initially proposed by the merging parties​ (anticipating possible objections by the agency). In other occasions, the merging parties respond to the agency's proposal with a remedy package counteroffer. As a result of the case, various outcomes are possible. If the agency and the interested parties agree on a set of remedies, then the merger goes through. If they do not, then the merger is blocked. The precise meaning of a blocked merger depends on the particular jurisdiction. SUMMARY ● Mergers normally imply an increase in prices and a reduction in costs. ● The value of non-merging firms may decrease or increase as the result of a merger, depending on the cost efficiencies generated by the merger. ● Merger waves may result from ​exogenous events​ ​(e.g., industry deregulation)​ or from ​endogenous events​ ​(e.g., a merger between two large firms). ● If barriers to entry are not very high, then mergers tend to be followed by new firm entry. ● The smaller the size of the merging firms, the more likely the total effect of a merger is positive.