Economic Fundamentals:

Transcription

1 Economic Fundamentals: Vertical and Coordinated Effects in Mergers Debra J. Aron, Ph.D. Navigant Economics Northwestern University May 27, 2016

2 Disclaimer This presentation covers only a sampling of the important ideas, models, and methodologies related to vertical and coordinated effects in mergers, and does not purport to acknowledge or discuss all of the economic principles or result that one would address in a vertical or coordinated effects merger, nor to address all of the caveats or limitations of those that are discussed. 1

3 Merger Analyses Horizontal Mergers Vertical Mergers Unilateral Effects Coordinated Effects Vertical Effects 2

4 Unilateral effects refers to the incentives of the merging parties to increase their prices post-merger due to the elimination of competition between them. 3

5 What are coordinated effects of a horizontal merger? A merger may diminish competition by enabling or encouraging post-merger coordinated interaction among firms in the relevant market that harms customers. Coordinated interaction involves conduct by multiple firms that is profitable for each of them only as a result of accommodating reaction of the others Merger Guidelines, Section 7 4

6 Coordinated effects include: Explicit coordination, such as price fixing. Does the merger increase the likelihood of explicit coordination? Accommodating conduct without agreement or coordination Does the merger alter the competitive environment so that individual firms, acting in their own interest, will collectively increase price (or reduce quality)? 5

7 Example 2013 investigation of American Airlines and US Airways posited a theory of coordinated effects*: Alleged that structure of the industry is conducive to coordinated behavior ( few large players dominate the industry; each transaction is small; and most pricing is readily transparent ) *Complaint, Commonwealth of Virginia v. US Airways Group, Inc. and AMR Corporation, Before the United States District Court for the District of Columbia, Case 1:13-cv-01236, August 13,

8 The Fundamental Insights and Paradox of Perfect Competition Can Be Illustrated with a Simple 2-Firm Game FIRM B PRICE HIGH PRICE LOW PRICE HIGH A s profit= $1000 B s profit= $1000 A s profit= $0 B s profit=$1200 FIRM A PRICE LOW A s profit= $1200 B s profit= $0 A s profit= $600 B s profit= $600 7

9 The Fundamental Insights and Paradox of Perfect Competition Can Be Illustrated with a Simple 2-Firm Game FIRM B PRICE HIGH PRICE LOW PRICE HIGH A s profit= $1000 B s profit= $1000 FIRM A PRICE LOW A s profit= $1200 B s profit= $0 8

10 The Fundamental Insights and Paradox of Perfect Competition Can Be Illustrated with a Simple 2-Firm Game FIRM B PRICE HIGH PRICE LOW PRICE HIGH A s profit= $0 B s profit=$1200 FIRM A PRICE LOW A s profit= $600 B s profit= $600 9

11 Basic Principles Competition drives prices toward costs and causes profits to erode because firms try to attract customers away from each other by reducing price. Firms can collectively earn more profits if they can agree to all charge the monopoly price and split the monopoly profits. But each has a private incentive to cheat on the agreement whether or not the others uphold it, by undercutting the monopoly price. 10

12 George Stigler established an influential framework for analysis*: effective (explicit) coordinated behavior requires that coordinating firms can reach an agreement monitor and detect deviations from it punish deviations *George J. Stigler, A Theory of Oligopoly, The Journal of Political Economy 72, no. 1 (Feb., 1964). 11

13 What makes a market more vulnerable to explicit coordination or collusion? Stigler proposed market characteristics that increase vulnerability to explicit coordination. Game theory has formalized, expanded on, and modified Stigler s insights, and analyzed accommodating conduct, via analysis of repeated games and development of the folk theorems. 12

14 Some factors that may facilitate collusion Simplicity and visibility of pricing chances of deviations being detected are high and rapid ability of conspirators to punish defector high conspirators are patient (low discount rate of future earnings) customers respond slowly or weakly to price reductions Entry barriers Market concentration 13

15 Vertical Effects of Merger A concern in vertical mergers is whether the merger facilitates vertical foreclosure. Vertical foreclosure can be defined as the use of vertical integration (e.g., vertical merger) or other vertical restraints by an input ( upstream ) supplier to achieve market power in the output ( downstream ) market (or vice versa). 14

16 Vertical Chain of Production chemicals plastics, etc. steel polyurethane foam fabrics automotive seats auto assembly retailing end user 15

17 Cable Television Services Entertainment Content Network Services End User 16

18 Example 2011 Joint Venture of Comcast Corporation and NBC Universal*: Largely analyzed by the FCC as a vertical transaction combining the creation of content of NBC Universal with the distribution of content.* Considered input foreclosure and output foreclosure. *Memorandum Opinion and Order, In the Matter of Applications of Comcast Corporation, General Electric Company and NBC Universal, Inc.; For Consent to Assign Licenses and Transfer Control of Licensees, Before the Federal Communications Commission, FCC 11-44, MB Docket No (Released: January 20, 2011). 17

19 The traditional concern was that vertical merger was an attempt to leverage upstream monopoly power into the downstream market. The Chicago School challenged this view: opportunity cost critique single monopoly profit critique 18

20 Opportunity cost critique: A vertically integrated supplier has no incentive to discriminate in favor of its own downstream subsidiary by selling to itself at marginal cost while selling to rivals at monopoly price because it thereby forgoes the monopoly profits (its opportunity cost) of selling to downstream rivals. 19

21 Single monopoly profit critique: If the merging firm is an upstream monopolist, and the downstream market is competitive, the monopolist has no incentive to leverage its monopoly downstream because there are no additional profits to be thereby obtained. Caveat: efficiency gains from reducing distortions in the downstream subsidiary s input mix by vertical integration can increase profits. 20

22 Efficiency Gains from Vertical Integration Elimination of Double Marginalization Improved coordination / incomplete contracts / supply assurances 21

23 Theories of Anticompetitive Vertical Merger More strategically complex markets Oligopoly settings Game theoretic methods 22

24 In some models (for example) before vertical integration after vertical integration In some models, price of input to integrated downstream firms falls but price of input to unintegrated downstream firms rise. Net effect may be an increase in price to consumers. 23

25 Effects are highly fact-dependent: Elasticity of downstream demand Nature of upstream competition Nature of downstream competition Rationality of foreclosure behavior 24

26 Thank you! 25