Seminar Paper, 2006
18 Pages, Grade: 1
II.) Efficiency gains and market power effects of horizontal mergers:
1.) Anti-competitive Effects:
a) Market Power:
b) Market Power and allocative efficiency:
2.) Efficiency Gains:
a) Productive Efficiencies:
b) Dynamic Efficiencies:
d) Economies of Scale and Scope:
e) Technical Progress:
f) Other efficiencies:
III. )Welfare Analysis:
1.) The total welfare standard:
a) From perfect competition to monopoly:
b) From ‘partial monopoly’ to monopoly:
2. ) The Consumer Welfare standard:
IV.) Merger Control in Europe and Efficiency Defence:
1.) Enforcement Regime in Europe:
2.) The E.U. approach to efficiencies:
3.) The reform of 2004:
VI.) Concluding Remarks:
Efficiencies as a Defence in Merger Analysis: a comparison of European and American Competition Policy
Changes in the global political and economic environment went along with a unprecedented wave of mergers between firms nationally and more important internationally within the last decade. The liberalisation of markets, declining trade barriers and progress in transport and information technology as well as the implementation of uniform norms in the European Single Market has led to major corporate reorganisations in the European Union as well as, due to the ongoing globalisation, in the United States, particularly in the form of cross-border horizontal mergers. A horizontal merger is defined as one in which rivals in the same market from one company.1
These mergers are motivated by the desire to enter new markets and the opportunity to realize economies of scale and scope through the expansion of production. Most economists therefore agree that mergers can be pro-competitive as they allow the economy to reorganize the production process and create companies that are more efficient. In addition, consumers may benefit from lower prices and higher quality. However, mergers can also be a means to increase market power. Merger control focuses on these activities because growth by acquisition of a competitor rather than by market expansion is an easy way to achieve market power. Therefore, mergers are subject to approval either by government agencies or by courts.
The two most notable enforcement regimes operate in the European Union (EU) and the United States (US). Both enforcement regimes set thresholds that require firms to give the authorities prior notice to large transactions.2
Thereby, two major questions arise that the enforcement agencies have to deal with.
First, will the merger in question significantly impede effective competition (EU) or substantially lessen competition (US)? Second, the question remains what happens, when there is an increase in market power leading to a decrease in competition on the one hand and efficiencies resulting from the merger on the other hand. Is it then the task of merger control to compare the advantages of higher concentration with the disadvantages of greater market power? Oliver Williamson in the 1960s was the first, who addressed this tricky question in his trade-off model.3
The purpose of this paper is to show the conflict of an increase in market power and efficiency gains resulting from horizontal simultaneously. To achieve this goal the paper is divided into three parts. At the beginning, it deals with possible efficiency gains occurring when firms merge and the anti-competitive consequences. The major part of the paper will focus on the economic welfare analysis and its policy implications. Finally, the merger regimes in the U.S. and the E.U. will be discussed briefly, emphasizing the way competition policy in both regimes deals with the efficiency defence.
Mergers may have anti-competitive effects but they can also generate efficiency gains.4 The following section focuses on these costs and benefits generated by a merger.
In general, competition is regarded as a way to achieve efficient market results and an optimal allocation of resources. In some cases, mergers are said to weaken competition by increasing market power.
Market power may be increased by the elimination of side-by-side competition between the two firms. Market power or market dominance is given when a firm or a group of firms is able to raise prices above the competitive level (marginal cost) for a sustained period of time. The extent to which firms can exercise market power depends inversely on the firms’ elasticity of demand, i.e. the less elastic its demand curve, the more market power a firm has.5 That is, it exists at the whim of consumer preferences for the firm’s product, relative to those of its competitors.6 A downward sloping firm demand curve reflects the fact that, as the price increases, consumers will opt to switch to the closest available substitutes or reallocate their expenditures towards other goods.7
Different factors influence a firm’s demand elasticity: the demand elasticity corresponds with the demand elasticity of the market. The number of firms in the market also plays a key role. The greater the number of competitors (for homogenous goods) or the larger the cross-elasticity of demand with the products of other producers (for differentiated products) the greater the elasticity of a firm’s demand curve and the less the market power.8 If the firm’s elasticity of demand goes down, it is able to reduce output below the pre-merger level in order to set higher prices and increase profits. However, sometimes it is very difficult to obtain elasticity estimates that are readily available for the specific industry or firm and therefore other measurements for demand elasticity are necessary. In practice, market shares and concentration ratios are often the only tools available to the enforcement agencies. However, market share alone can be an inaccurate measure of market power. Therefore, market share is usually a starting point in determining market power. The extent to which established suppliers are constrained by the prospect of new market entry is a key factor in whether the established suppliers have market power.
Pricing and profitability are other factors relevant to a determination of market power.
b) Market Power and allocative efficiency:
The reason why market power is of importance in a merger assessment analysis is that it may lead to allocative inefficiency.9 A market will be allocatively efficient if it is producing the right goods for the right people at the right price. At an allocatively efficient outcome, market prices are equal to the real resource costs of producing and supplying the products (Price = Marginal Costs), also referred to as Pareto Efficiency. To see how allocative inefficiency can derive from increased market power, let us assume a profit-maximizing monopolist. In order to maximize his profit the monopolist reduces output and thereby increases prices above the competitive level. Hence, there will be a shift from consumer surplus to producer surplus. An increase in the price of a product above its marginal cost creates (or strengthens) an allocative inefficiency, also called the dead-weight loss.10 That is, there remain profitable opportunities for trade within the market.
Whether this could still be socially beneficial will be examined under the welfare analysis in section III).
Not all mergers are anti-competitive. Efficiency gains may derive from economies of scale, economies of scope and learning economies, from enhanced technological progress and from improved management efficiencies.11 Economists divide efficiencies usually in two broad classes, productive and dynamic efficiencies.
Productive efficiency focuses on a particular firm or industry. It addresses the question of whether any given level of output is being produced by that firm/industry at least cost or, alternatively, whether any given combination of inputs is producing the maximum possible output. Productive efficiency depends on the existing technology and resource prices.12 That is, production efficiencies include savings that are associated by integrating the two firms activities and the transfer of existing but superior technology from one party to the other. Mergers (as well as joint ventures and other cooperative practices) hold the potential to increase productive efficiency in a number of ways, including by fostering economies of scale, economies of scope, and synergies.
Dynamic efficiencies refer to gains achieved by the optimal introduction of new products, the development of more efficient processes and the innovative activity over time that may yield cheaper or better goods or new products that afford consumers more satisfaction than previous consumption choices. The dynamic efficiency principle is most closely associated with Austrian economist Joseph Schumpeter.13 Röller, Stennek and Verhoven have systematised merger efficiencies by distinguishing between:
This well-known term refers to an improvement of the merged firm’s cost structure by shifting output from plants with relatively high marginal costs of production to plants with relatively lower marginal costs.14 Rationalisation efficiencies usually are merger specific and likely to benefit consumers immediately because of the reduction in marginal costs.
They occur when average costs fall if output increases. Röller distinguishes between short-run and long-run economies of scale realised through a merger. The former may arise when physical capital is held fixed if as output is expanded average costs decline, whereas the latter may be the result of co-ordination of the (formerly separate) firms’ investments in physical capital. In addition, economies of scope and learning effects may also result from mergers. Economies of scope arise when the cost of producing two products together is lower than the sum of costs of producing them separately because they require a common input. Learning effects are the reduction in unit cost due to accumulated experience, as measured by cumulative past output.15
A merger may enhance the efficiency of R&D. First, the merger may eliminate truly unnecessary duplication of R&D and thereby reduces the costs of innovation. Second, the merger may help exploit scale economics in R&D.
But be cautious about that: mergers between sizeable companies that already have significant R&D capabilities may induce anti-competitive reductions in R&D intensity and foreclose market entry by further raising the minimum investment required for participating in the innovation race.16
A threat of take-over may also be an incentive for management to run the business in the best interest of the shareholders. Increased discipline may play a part in the solution of the principal-agent problem. Empirical evidence, however, does not give strong support for this “management-discipline” theory, also because managerial skills and performance may be difficult to measure sometimes.
Some mergers also lead to foreseeable savings due to an increased bargaining power of the merged companies. However, the conclusion of enhanced buying power is far to simple as it depends on the structure of the buyer and the supplier market. Verifiable economies of scale and scope corresponding with real cost savings are most likely to occur in a competitive input market with many suppliers and buyers. In addition, improved access to capital may be one positive result. The paper now turns to the question of welfare analysis.
Horizontal mergers can differ in their effect on social welfare. From the point of view of welfare economics mergers should only be allowed if they enhance competition and increase social welfare, and mergers that restrain competition should be prohibited. As shown in the section above, the exercise of market power by raising prices above the competitive level leads to allocative inefficiency, whereas production and dynamic efficiencies can lead to real cost savings. Thus, if antitrust authorities find both an anti-competitive effect and efficiency gains in a horizontal merger case, they face the difficult question whether, and if yes, how to balance the two effects. The resolution of this possible trade-off depends on the welfare standard chosen by the antitrust
1 Viscusi/Harrington/Vernon p. 203.
2 See Hart-Scott Rodino Act.
3 Williamson „Economies as an Antritrust Defense“, in American Economic Review 1968. pp. 18 - 24. 1
4 Ilkowitz/ Meiklejohn p. 8
5 W. M. Landes; R. A. Posner: Market Power in Antitrust Cases, in: Harvard Law Review, 1981, pp. 937-981.
6 De la Mano, p. 9.
7 De la Mano p. 10.
8 De la Mano p. 10.
9 De la Mano p. 9.
10 Roeller/ Stennek/Verboven p. 49.
11 Ilkowitz/ Meiklejohn p. 8.
12 De la Mano p. 8.
13 Joseph Schumpeter A. Schumpeter, Capitalism, Socialism, And Democracy (1950).
14 Roeller/ Stennek/Verboven p. 42.
15 Ilkowitz/ Meiklejohn p. 9.
16 Aghion, P., N. Bloom, R. Blundell, R. Griffith and P. Howitt (2002).
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