Transcript Mergers - Sarah L. Stafford | Old Page

Mergers
Types of Mergers
Horizontal: merger between two
competitors.
Goods are substitutes.
Vertical: merger between two firms at
different stages of the production process.
Goods are complements.
Conglomerate: no clear substitute or
complementary relationship.
Why so many mergers?
Economies of scale: both in production
and in things like R&D.
Economies of scope: synergies between
the two companies.
Defensive mergers: to deal with
contracting markets, excess capacity.
Decrease competition: these are the
mergers that antitrust is worried about.
How successful are
mergers?
Studies of past merger waves have shown
that two of every three merger deals have
not worked.
Why? Real world -- not economic theory.
Linking distribution systems is often difficult.
Information systems often very difficult to
mesh together.
Clash of corporate cultures.
The “Merger Paradox”
Assume firms are merging to decrease
competition (no cost advantages).
For horizontal mergers only 2 motives,
economies of scale or decreasing competition.
Start with a basic Cournot model.
If firms are symmetric, then profit of each
firm is (a-c)2/b(n+1)2.
“Merger Paradox” con’t
Start with n firms:
i = (a-c)2/b(n+1)2
Then m of the firms merge together to
make (n - m +1) firms in the market.
After merger, profits for each firm are:
i = (a-c)2/b(n-m+2)2
Less competition, but have profits for the
combined firm increased or decreased?
“Merger Paradox” con’t
Is (a-c)2/b(n-m+2)2 greater than or less
than m*(a-c)2/b(n+1)2 ?
Get rid of the (a-c)2/b terms on both sides
and rearrange to get this condition:
Only profitable for the combined firm if
(n+1)2>m(n-m+2)2
Mergers cannot raise the profitability of the
firms engaged in the merger even if 50% of
the firms are involved in the merger.
“Merger Paradox” con’t
According to this model, almost no
mergers are profitable.
Those that are probably wouldn't make it
past the antitrust authorities.
Intuition behind the model:
Free-rider effect -- decreasing the number of
firms raises industry profit and per firm profit,
but combined firms get relatively smaller
share of the industry.
“Merger Paradox” con’t
Why is this not the best model to look at?
Assumes firms are identical and that the
merged firm has no advantages other than it
is facing fewer competitors.
Merged Firm as a Stackelberg
Leader
If the merged firm becomes a Stackelberg
leader, it can improve its position.
Assume 2 firms merge and act as a
industry leader a la Stackelberg.
Leader gets (a-c)2/4b(n-1).
Each follower gets (a-c)2/4b(n-1)2.
Compare this to premerger:
 = 2 * (a-c)/b(n+1)2
Merged Firm as a Stackelberg
Leader, con’t
Always more profitable to merge if you
can act as a Stackelberg leader.
Merger decreases profits of non-merging
firms are long as there are four or more firms
in the industry originally.
In this model, total output will increase.
So now we have a new paradox: Why would
antitrust officials want to stop this type of
merger?
Horizontal Mergers with
Product Differentiation
Spatial model of product differentiation
Possible benefits of merger.
Coordinate prices: price of one firm affects
the demand for the other firm.
Also can coordinate "location" (product
design).
Start with a circle model this time, not a
linear model.
Mergers with Product
Differentiation, con’t
Circle model similar to linear model,
except there is no "end" problem.
Consumers evenly spaced around the circle.
Each has a value of V and a cost of transport
of t.
All firms have the same costs. F is fixed
cost and c is constant marginal cost.
Each firm sets price.
Mergers with Product
Differentiation, con’t
Consumers pay p + t(distance traveled)
With symmetric firms, they locate 1/n
away from each other, all set the same
price.
As long as V is sufficiently high, every
consumer on the circle will buy.
P* = t(length of circle)/n
At this price, all consumers buy.
Mergers with Product
Differentiation, con’t
Merger has no effect if the two firms
aren't neighbors.
Why? no competition between the firms that
merge, so no way to decrease competition.
If neighboring firms merge, can lessen
competition. Have "captive consumers"
over which they have more market power
and can increase profits by raising price.
Mergers with Product
Differentiation, con’t
Merger also benefits the other firms in the
market -- allows them to raise price too.
After the merger, combined firms may
also change their product lines -- get
closer to their neighbors.
In this case, if there are efficiencies, they
will be due to economies of scope.
Evaluating Mergers
None of the models presented assume
any cost savings -- only reducing
competition.
We need a way to evaluate mergers that
considers both the benefits of any cost
savings as well as the affects of decreased
competition.
1992 Merger Guidelines:
 Define relevant product and geographic market.
 Measure concentration pre- & post- merger with
HHI. If merger raises HHI by 100 points and
post-merger HHI is > 1000, investigate further.
 Assess ease of entry into market.
 Assess likely competitive effects of merger.
Assess any significant efficiencies that would
result from the merger.