Public Policy in Private Markets Merger Policy. Announcements Homework 4 due today Debate # 2 next Tuesday, HW 5 due Debaters: video due to my on March.

Public Policy in Private Markets

Merger Policy

Announcements

Homework 4 due today Debate # 2 next Tuesday, HW 5 due

Debaters: video due to my on March 30th (Friday)

Midterm grades have been posted, as well as answer key (will discuss at the end of class today)

Clicker issue still present for 4 students

Merger Law

Important part of antitrust 3 types of mergers:

Horizontal Vertical Conglomerate

Oracle acquires PeopleSoft

Market definition: DOJ

Geographic: US Product: “high function enterprise” software

(customer testimony) 3 to 2 merger: post merger HHI > 1800 and

increased by more than 1000 points Oracle

Worldwide, based on LIFO and LOFI rules (i.e. there was a lot of sales going abroad and a lot of domestic sales coming from abroad).

Clicker questions

1. What was the unilateral effects argument used by the DOJ?

A. That advertising by the merging firms would increase

B. That the merging firms would collude with the non-merging firms after the merger

C. That customers of both merging and non-merging firms would face higher prices as a result of the merger

D. That customers of non-merging firms would face higher prices after the merger

Oracle acquires PeopleSoft

DOJ – showing unilateral effects: Statistical analysis of transactions data: Oracle

and PeopleSoft less likely to win auction when the other is present

Price regressions: when PeopleSoft competes with Oracle, Oracle offers a 9.7% greater price discount.

Merger simulation: 5%-28% price increase Oracle:

Model is flawed, bargaining model is more appropriate (instead of auction model)

Clicker questions

1. How was merger simulation used by the DOJ?A. DOJ interviewed customers and asked what they

thought the post-merger prices would be

B. DOJ forecasted the post-merger price based on a time-series model

C. DOJ forecasted the post-merger prices based on an economic model calibrated to reflect the industry in the pre-merger period

D. DOJ forecasted the post-merger prices based on the behavior of a control group (i.e. other firms in a similar market) that resembled the post-merger scenario

The role of merger simulation

1. Come up with an economic model that depicts market (e.g. Cournot; in this case an auction model)

2. Use data from market to “calibrate” model: i.e. choose demand intercept, constant and supply functions that are consistent with observed p and q

3. Use the calibrated model to remove one of the firms from the market and recalculate p and q (the simulated merger equilibrium)

4. Compare p in 3. v p in 2

Oracle acquires PeopleSoft

The judge’s decision: Concentration (HHI) calculations were unreliable:

Testimony for high-functioning products as the relevant product market was unconvincing

LIFO and LOFI tests were more reliable (i.e. geographic market was not only US).

DOJ failed to provide reliable evidence of unilateral effects Failed to show that Oracle and Psoft were “closest”

competitors and that other competitors were poor substitutes

Failed to show that product repositioning by other competitors was not feasible

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 in 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 components of each of

the 3 types Main concern for antitrust authorities is lessening

of competition In general, non-horizontal mergers are frowned

upon less frequently than horizontal mergers

Grades

Mean: 70 Median: 69 Max: 97.5 Min: 41.5

Answer key: posted. Please take a close look at it. Assess whether grading was fair; only then make a decision of whether re-grading is a reasonable request.

Questions 1 and 3: partial credit for seemingly “ambiguous” answers

Distribution

Clicker participation and HW pay off

40

75