Public Policy in Private Markets

Merger Policy

Announcements

Today: Dr. Matt Ouellett from the Center for Teaching will be conducting a Midterm Assessment

Announcements

Debate # 2 next Tuesday, HW 5 due (posted) Debaters: video due to me on March 30th

(Friday) Clicker issue still present for 2 students

Midterm 2 on April 19 Length

Merger Law

Important part of antitrust 3 types of mergers:

Horizontal (cost efficiencies) Vertical Conglomerate

Heinz – Beech Nut (K&W, Ch. 6)

Market definition: Geographic: National Product: jar baby food

Possible anti (and pro) competitive effects: Concentration (HHI): from 4775 to 5285 Increased prices

Unilateral Collusive

Loss of wholesale competition Cost efficiencies

Gerber (65%)Heinz (17%)

Beech Nut (15%)

Operates nationwide

Gerber & Beech Nut = premium brandsHeinz = discount brand (15% lower price)

The Cost Savings Argument

Heinz to close Beech-Nut production facility old, high cost, labor intensive un-automated production process (requires

intervention by workers) 320 workers produced 10 million cases/year

Move production to Heinz facility newly updated (1990), highly automated 150 workers produced 12 million cases/year

Heinz: efficiencies would allow selling Beech-Nut brand at a 15% discount

Heinz – Beech Nut

Two smaller firms in a 3-firm market Do not compete directly

But there is the threat of the other entering Main argument for merger:

Cost savings passed onto the consumer (econometric analysis)

Could more easily challenge Gerber Consumer benefits from lower-priced higher quality

product Evidence of competition against Gerber rather than

against each other (cross-elasticity study)

Heinz – Beech Nut FTC:

Loss of wholesale competition: Absent merger Beech Nut disciplines Heinz and vice versa

Increased prices: without competitor Collusion with Gerber more likely Unilateral increase in prices more likely

Cost savings estimates are unreliable Controversial case:

3-2 FTC vote Merger first allowed, then overturned Efficiencies are key defense for merged firms, but

hard to prove

Merger Law

Important part of antitrust 3 types of mergers:

Horizontal Vertical Conglomerate

Vertical and Conglomerate Mergers

Recall concerns: Vertical Mergers: Foreclosure and increased

barriers to entry Conglomerate Mergers: entrenchment and

elimination of potential rivals

Based on DOJ’s Non-Horizontal Merger Guidelines (last updated in 1987)

The most critical burden of proof here is lessening of competition.

Vertical and Conglomerate Mergers Typical approach:

Is there market power at one level? Will market power translate/increase into the integrated market?

Example: Lockheed-Martin proposed merger with Northrop

Grumman (1998, failed) $11.6 Billion, both aerospace companies

Lockheed: military aircraft Northrop: radars and electronics used in aircraft Department of Defense main customer for both firms

DOJ challenges: Substantial lessening of competition, in both upstream and downstream mkts

Lockheed Northrop Merger

Northrop4th largest defense contractor

In the world

Lockheed MartinLargest defense contractor in the world

95% revenue from Department of Defense

Northrop’s Competitors

Lockheed’sCompetitors

Military

Aircraft

Radars, electronics

Lockheed Northrop Merger

Northrop

Lockheed Martin

Northrop’s Competitors

Lockheed’sCompetitors

Military

Aircraft

Radars, electronics

Concerns:

1. New conglomerate will have a disproportionate % of contract $’s with government

2. Increased barriers to entry & possibility of foreclosure upstream and downstream

Non-Horizontal Merger Guidelines

Set-up is fairly tolerant of vertical mergers DOJ unlikely to challenge, unless HHI in the

acquired firm’s market is > 1,800 Less likely to challenge if:

Entry into acquiring firm’ market is easy 3 or more firms in the acquiring firm’s market would

have equal advantage of entering the acquired firm’s market

Acquired firm has small mkt share (< 5%) Efficiencies from merger

Non-Horizontal Mergers

Procter & Gamble – Clorox merger (1967) Product extension merger, PG (54% of soaps

and detergents mkt), Clorox (49% of bleach mkt)

Anticompetitive effects in liquid bleach mkt: Diminishing of potential competition (PG likely

entrant) Even if did not enter it limited Clorox’s behavior

Entrenchment: Adding PG’s size and marketing to Clorox’s already powerful position may make any future challenge very difficult

Non-Horizontal Mergers

FTC challenges merger (ex-post) District Court rules in favor of FTC Court of Appeals reverses ruling Supreme Court agrees with FTC’s opinion

and orders divestiture of Clorox

Non-Horizontal Mergers

1980’s and 1990’s: large product extension and pure conglomerate mergers:

Nestle (large processed food manufacturer) -Carnation (“cooking milk”)

RJ Reynolds (tobacco) – Nabisco (snacks)

Philip Morris (cigarettes/food) - General Foods (cereals)

Philip Morris-Kraft (food and beverages)

Non-Horizontal Mergers Example: Philip Morris-Kraft (1988)

Total Sales after merger: $37.6 B; $11.5 B bid Mostly product extension, with some overlap (frozen

foods) PM: unrivaled position in dry and frozen food lines Arguments for challenge:

PM’s dominated shelf space, advertising, rebates, promotional allowances; dominance into new market may reduce competition

Lessening of competition: not as strong an argument as Kraft was one of many competitors

Counterargument: economies of scale/efficiencies Outcome: no challenge

Non-Horizontal Mergers

More recently: Philip Morris-Nabisco (1999) Combined sales: $35 B Mostly product extension merger (some horizontal) Contentious issue.

Horizontal segments in “individual” foods: crackers, pudding, etc.

Merger allowed with divestiture of Nabisco brands: Dry mix gelatin: PM (86%), Nab (6%) Dry mix pudding: PM (82%), Nab (9%) No-bake desserts: PM (90%), Nab (6%) Baking powder: PM (27%), Nab (17%)

Non-Horizontal Mergers

1980’s and 1990’s: large market extension mergers:

Kroger-Dillon, 1983 American Stores-Jewel, 1984 American Stores-Lucky, 1988

All retailing/supermarket mergers Agencies felt:

Big enough queue of potential competitors Little or no BTE

Non-Horizontal Mergers

Main Points:

Not all mergers are equal Some mergers can have more than 1 of the 3

components (vertical, horizontal, conglomerate) Main concern for antitrust authorities is lessening

of competition In general, non-horizontal mergers are frowned

upon less frequently than horizontal mergers