Recent developments in Recent developments in (or random thoughts about) (or random thoughts about)
Merger AnalysisMerger Analysis
Luke M. FroebVanderbilt University
Office of Fair Trading, June 19, 2006
AcknowledgementsAcknowledgementsMalcolm Coate, FTCGregory Werden, US Department of JusticePaul Pautler, FTCDaniel Hosken, FTCChris Taylor, FTC
OutlineOutline
I. merger enforcement statisticsII. If merger is answer, what is question?III. Backlash against structural merger modelsIV. Lessons from consummated mergersV. FTC/DOJ Commentary on Horizontal Merger GuidelinesVI. Price-Concentration empirical merger models
1957 P&G1957 P&G--Clorox (Bleach)Clorox (Bleach)
Clorox dominant producer of bleachP&G makes household items, but not bleachFTC challenged merger because– P&G was most likely entrant into bleach– P&G was more efficient than other firms
…still waiting for P&G to enter
2000 Baby Food Merger2000 Baby Food Merger
2000: FTC Blocks $185 MM Merger Deal – Efficiency claims vs. 3 2 merger
2002: Heinz sells off baby food brands to Del Monte, including Natural Goodness
Ultimate fate of brand remains question.
Baby Food Shares Since MergerBaby Food Shares Since Merger
1013Beech-Nut
711Heinz (Del Monte after 12-02)
8073Gerber
Market Shares late 2003
Market Shares mid 2000
Firm
US Baby Food Market Shares
I. U.S. MERGER FILINGSI. U.S. MERGER FILINGS
0
500
1000
1500
2000
2500
3000
3500
4000
4500
500019
81
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Year
Num
ber o
f HSR
Tran
sact
ions
January 2001 System
MERGER INVESTIGATION RATEMERGER INVESTIGATION RATE
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Year
2nd
Req
uest
s as
a P
erce
ntag
e of
Tot
al F
ilin
FTC Merger Challenges, 96FTC Merger Challenges, 96--0303
0
10
20
30
40
50
60
70
80
90
2 to 1 3 to 2 4 to 3 5 to 4 6 to 5 7 to 6 8+ to 7+
Significant Competitors
Num
ber o
f Mar
kets
Enforced Closed
US. vs. EC US. vs. EC
US looks tougher than EC– US enforcement85% (2nd requests)
2 1 + 3 2 mergers
– EC enforcement60% (Phase II)Enforced + withdrawn (Mats Bergman)
But US investigates (2nd requests) at lower rate– Actual enforcement may be much closer
Merger Challenge PredictorMerger Challenge Predictor
Malcolm Coate & Shawn Ulrick (FTC), TRANSPARENCY AT THE FEDERAL TRADE COMMISSION: THE HORIZONTAL MERGER REVIEW PROCESS 1996–2003– Antitrust Law Journal, 2005
Demo
II. If merger is the answer, II. If merger is the answer, What is the question?What is the question?
Rule-of-thumb merger analysis– Are customers complaining?– Will merger lead to price increase? – Is there a benign reason for merger?
Most internal documents do a TERRIBLE job of articulating merger motive– Brain-damaged, middle-management?
Do Mergers Move Assets to Do Mergers Move Assets to HigherHigher--valued Uses?valued Uses?
Capitalism 101: Wealth is created when assets move to higher valued uses– Voluntary transactions create wealth
Stock-market event studies estimate 75% of mergers do NOT create value.– Target shareholders gain--but less than
acquiring firms lose– Experience reading internal merger documents
Why is it so hard to document value-creation?
Uplifting Merger Story:Uplifting Merger Story:DellDell--AlienwareAlienware
Companies were competitors, but…– Alienware makes liquid-cooled, high-end gaming
computers– Dell makes full line of computers.
BIG and obvious synergy– Alienware keeps design, design, sales, marketing, and
support of brand in separate Alienware Division– Dell manufactures Alienware machines
III. WhatIII. What’’s wrong with analysis s wrong with analysis based on market shares?based on market shares?
1. No bright line between “in” vs. “out” of market2. Market Shares in market may be poor proxies for competitive positions of firms3. Other mechanisms at work: entry, efficiencies, re-positioning1+2+3 Market shares and concentration are poor predictors of merger effectsAlso, no way to do benefit-cost analysis
Merger Analysis Requires Merger Analysis Requires Predictions about counterfactualPredictions about counterfactualTwo ways to do this.
Natural Experiments, e.g., in Staples-Office Depot case, mergers analogous to differences between one- and two-superstore cities.– Did you hold everything else constant?– How well does experiment mimic merger effect?
Model-based prediction– Model current competition– Predict loss of competition following merger
Bertrand (priceBertrand (price--only) Merger Modelonly) Merger Model
Assumptions: Differentiated products, constant MC, Nash equilibrium in prices.
Model current competition– Estimate demand elasticity– Recover costs from FOC’s (P-MC)/P =1/|elasticity|
Prediction: Post-merger, MR for the merging firms falls as substitute products steal share from each other– Merged firm responds by raising prices – Non-merging firms raise price sympathetically
Structural Model BacklashStructural Model Backlash
How reliable are model predictions?Test merger predictions against real mergers– Yes (Nevo, US breakfast cereal)– No (Peters, 3/5 US airlines; Weinberg, US motor
oil and breakfast syrup)Test model restrictions, i.e., does (p-mc)/p=1/|elas| ?– Yes (Werden, US bread; Slade, UK beer)
Backlash (cont.)Backlash (cont.)
Does model leave out features that bias its predictions?– Static, Price-only competition, MC constant
Research finds that ignoring…– demand curvature can under- or overstate merger effect– retail sector can under- or overstate merger effect– capacity constraints likely overstates merger effect– promotional competition likely understates merger
effect– repositioning likely overstates merger effect
Demand Curvature MattersDemand Curvature Matters
Following slide plots four demand curves between competition and monopoly– Observationally equivalent (same
Q,P,elasticity) at competition– But very different post-merger prices (monop.)
Take-away: big merger effects imply big pass-through rates
Demand Curvature (cont.)Demand Curvature (cont.)
Recommendation– sensitivity analysis or a conservative form– Compute “Compensating MC Reductions”
(CMCR’s); they depend only on elasticity
Demand Curvature (cont.) Demand Curvature (cont.)
Contract with third party that penalizes merged firm for reductions in output (and rewards for increases)– Payment=CMCR*(Q0-Q)– Contract reduces effective MC to exactly offset
incentive to raise price– Allows realization of fixed cost merger savings
In a static world, Expected[payment]=0
Retail sector mattersRetail sector mattersfor upstream mergersfor upstream mergers
When is retail sector transparent?– Constant or constant percentage markup– two-part tariffs, and retail sector must carry
profitable productsRetail sector earns no profit
When does it affect upstream merger price?– Double marginalization price effect– Two-part tariffs, and option of exclusivity
no price effect
Capacity Constraints MatterCapacity Constraints Matter
Capacity constraints on non-merging firms amplify merger effect– Recognized by Horizontal Merger Guidelines
Capacity constraints on merging firms attenuate merger effect– Much bigger effect– Intuition: if I price to fill the parking lot, how
does profit calculus change post-merger?
Promotional Competition Promotional Competition MattersMatters
Ignoring promotion results in prediction BIAS.– “estimation bias” (estimated demand is too price-
elastic); and – “extrapolation bias” caused by assuming that post-
merger promotional activity does not change (it declines).
Predicted merger effect is too small (5% instead of 12%)– Bias depends on whether promotion makes demand
more or less elastic
ReRe--positioning matterspositioning matters
Berry and Waldfogel, “Do Mergers Increase Product Variety?”
– Radio stations change format post-merger to eliminate overlap– Clear Channel
Country music aims at middle-aged womenClassic rock aims at middle-aged menPop aims at young women
Sweeting “Too much rock n roll,” post-merger:– play lists of merged stations become more differentiated.– merged stations steal share from non-merging stations.– no increase in price of listening (commercials)
ReRe--positioning (cont.)positioning (cont.)Re-positioning by merged firms is more significant than re-positioning by non-merging firms– Similar to effects of capacity constraints.
Merged firms move apart– Pre-merger substitution pattern likely overstate loss of competition.– Non merging firms can do worse following merger– Consumers can be better or worse off
IV. Consummated Merger IV. Consummated Merger
Control Group: Pre-merger periodExperimental Group: Post-merger period
Did price increase?
BIG question: “Compared to what?”– Compared to “control” cities hit by the same
demand and cost shocks– Jargon: “Differences in Differences Estimation”
First difference: pre- vs. post-mergerSecond difference: target vs. control
MAPMAP--UDS (Oil merger)UDS (Oil merger)
Experimental CitiesLansing, MI: 17% + 13% DHHI=442Flint, MI: 23% + 7% DHHI=322
Control CitySouth Bend, IN DHHI=0
Consummated Merger Consummated Merger EnforcementEnforcement
Once you have a post-merger price increase…– Can you pin it on the merger?– Crucial role for theory
AND supporting evidence
POLICY QUESTION: what are incentives created by consummated merger enforcement?
V. TheoryV. Theory--based Inferencebased Inference
Posit pro- and anti-competitive merger theoriesWhich one better explains the evidence?
Example: Merger in bargaining markets
Bargaining TheoryBargaining Theory
From Oracle-Peoplesoft trial:
“the area [that] is the most indeterminate in all of antitrust economics where you have negotiations between two parties. There is no determinate theory that predicts the outcome.”
Question: can economics predict effects of mergers in bargaining markets?
John NashJohn Nash’’s s ““Split the DifferenceSplit the Difference””TheoryTheory
Same problem confounded John Nash – Proved any “reasonable” solution would “split
the difference”Theorem: the gains relative to the alternatives determine the terms of any bargainImplication: If I can improve your gain; or worsen your alternative, I get more from you– Example: What happens if a manager offers a
$50 sales incentive to salespeople?
Implications of NashImplications of Nash’’s Theory s Theory for Provider Mergers?for Provider Mergers?
If merger changes alternatives to agreement, it also changes the terms of agreement.Example: Drugs bargaining with PBM to get onto a formulary.– If two substitutes bargain jointly, and no other
substitutes, merged company gets better priceEvidence: – How good are alternatives to merged provider?– Are payors (customers) complaining?
Bargaining Natural ExperimentBargaining Natural Experiment
“Any-willing-provider” (AWP) laws compel managed care plans to include any health care provider willing to accept plan’s terms
Theory: Threat of exclusion induces competition between providers to be included in “network.”
Prediction: Getting rid of threat increases price
Evidence: For states that adopt AWP, health care expenditures increase by 2%
FTC/DOJ FTC/DOJ Commentary on Commentary on Horizontal Merger GuidelinesHorizontal Merger Guidelines
Unilateral Merger effects come in all flavors– Price competition– Quantity competition’– Auctions– Bargaining
How does entry mitigates merger effect?– Entry induced by merger– Entry not-induced by merger
When does an outside alternative become so attractive that the merger is not a problem?
Still ambiguous about which welfare standard we use– Total vs. consumer
One observation about priceOne observation about price--concentration relationshipconcentration relationship
Can changes across markets better predict merger effect than changes over time within a market (caused by entry and exit).– Which kind of variation mimics merger effect?
Cross sectional correlation looks weaker than time time series correlation– Omitted cost variables in the cross section?– Omitted demand variables over time?
ReferencesReferencesFroeb, Luke, If Merger is the Answer, What is the Question? M&A Journal. (March, 2006) (pdf)*Werden, Gregory, Luke Froeb, and Steven Tschantz, Incentive Contracts as Merger Remedies, working paper (pdf)*Werden, Gregory J., Luke M. Froeb and Steven Tschantz, The Effects of Merger Efficiencies on Consumers, European Competition Journal, 1:2 (October, 2005) 245-264. (link)*Werden, Gregory J., Luke M. Froeb, and David T. Scheffman, A Daubert Discipline for Merger Simulation, Antitrust Magazine, 18:3 (Summer, 2004) pp. 89-95.(pdf)Werden, Gregory J., and Luke M. Froeb, Unilateral Competitive Effects of Horizontal Mergers, in Advances in Economics of Competition Law, Paolo Buccirossi (ed.), (Boston: MIT Press), 2005. (pdf)Froeb, Luke, and Steven Tschantz, Mergers among Firms that Manage Revenue, working paper. (pdf)Gandhi, Amit, Luke Froeb, Steven Tschantz, and Gregory Werden, Post-merger Product Repositioning, revise & resubmit from J. Industrial Economics. (pdf)Froeb, Luke and Steven Tschantz, and Gregory Werden, Pass Through rates and the Price Effects of Mergers, International Journal of Industrial Organization, 23 (2005) 703-715. (link)Tenn, Steven, Luke Froeb, and Steven Tschantz, Merger Effects When Firms Compete by Choosing Both Price and Advertising, Owen Working paper (6/20/01). pdfEvans, William, Luke Froeb, and Gregory Werden, Endogeneity in the Concentration-Price Relationship: Causes, Consequences, and Cures, Journal of Industrial Economics, 41 (September, 1993) 1-8.Froeb, Luke, Steven Tschantz & Philip Crooke, Bertrand Competition with Capacity Constraints: Mergers Among Parking Lots, Journal of Econometrics 113(1) (March, 2003) 49-67. (link)Crooke, Philip, Luke Froeb, Steven Tschantz, and Gregory Werden The Effects of Assumed Demand Form on Simulated Post-Merger Equilibria, Review of Industrial Organization, 15(3), (November, 1999) pp. 205-217. pdfWerden, Gregory, and Luke Froeb, The Entry-Inducing Effects of Horizontal Mergers, Journal of Industrial Economics, 46 (4), (1998) pp. 525-543.
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