Vertical Mergers: Between two or more firms who are in a potential buyer/seller relationship.

Conglomerate Mergers:

Product Extension Mergers: Mergers between nonrival firms who have related marketing channels or production processes.

Market Extension Mergers: Mergers between two nonrival firms selling similar products in separate geographical territories.

"Pure" Conglomerate Mergers: Mergers between firms with no obvious relationship.

Antitrust Laws and Merger Trends:

Merger waves:

1890-1904: merger for monopoly (ex: US Steel, GE, DuPont, PPG, Am. Tobacco)

1916-1929: mergers for oligopoly (ex: Bethlehem Steel)-Clayton Act stymied mergers-for-monopoly.

1945-1968: Led to passage of Celler-Kefauver Act of 1950, amending Clayton Act of 1914 section 7, adding language outlawing the acquisition of assets via merger that substantially lessens competition; this law reduced horizontal and vertical mergers, but had less impact on conglomerate mergers.

1980s: Food company and tobacco company mergers; use of leveraged buyouts.

Reasons for Mergers:

Monopoly/Collusion: Transform rivals into a single monopoly, or to increase capability for collusion

Economies of Scale/Scope: Unit costs may decline with increased scale or scope of production under unified ownership. Examples: Bank mergers that allow for closure of some branch offices reduce unit costs and may be an economy of scale.

Reducing Managerial Inefficiencies: Hostile takeovers help resolve the agency problem of poorly aligned management/ownership incentives.

Horizontal Mergers: Clearest example of possible anticompetitive effects. Evaluating benefits and costs: Suppose that a horizontal merger (i) leads to some sort of cost-reducing economy, but (ii) also transforms a zero-profit equilibrium with a monopoly. What are the tradeoff issues? Draw diagram….

Horizontal Merger Cases:

Brown Shoe (1962): Proposed merger between Brown (4 percent of US shoe market) and Kinney (.5 percent of US shoe market); their combined shares of shoe retailing were similar. Court: What is the relevant market? All retail shoe sales, or should men's and women's shoe sales in specific geographical markets be evaluated?

The court argued that both product and geographical markets must be evaluated, and developed the concept of reasonable interchangeability of use based on cross-price elasticity of demand.

The court also observed that there may be distinct submarkets within a broad product market, the boundaries of which may be demonstrated by "industry or public recognition of the submarket as a separate economic entity, the product's peculiar characteristics and uses, unique production facilities, distinct customers, distinct prices, [differences in] sensitivity to price changes, and specialized vendors." Based on this test the court ruled that there were distinct men's, women's, and children's shoe markets.

In terms of geographical market, the court argued that the criteria are similar in assessing the relevant product market, namely that the market boundaries must "correspond to the commercial realities" of the industry, and may range from the entire US (or larger?) down to a specific metro area. Based on this test, the court argued that there were distinct geographical markets for every city with a population exceeding 10,000 and its immediate contiguous surrounding area in which both Kinney and Brown sold shoes at retail stores they either owned or controlled.

As a consequence, the court found some geographical markets such as Dodge City Kansas in which their combined market shares exceeded 50 percent, and 118 separate geographical markets in which their combined market shares exceeded 5 percent.

The court argued that the intent of congress was to stop mergers when the trend toward lessening competition was still in its incipiency, and not actually occurring.

The court also argued that any possible economies from horizontal merger were not as important as the goal of maintaining a decentralized industry.

Von's Grocery (1966): Third largest grocery chain in LA area. Acquired Shopping Bag Food Stores. Combined market share of 7.5 percent. The court found the merger illegal. Justice Black: The purpose of the Cellar-Kefauver Act was to prevent economic concentration in the American economy by keeping a large number of small competitors in business."

Shenefield and Stelzer (1993 book): As recently as 1960s mergers were stopped based on post-merger market shares of under 10 percent. Since that time the critical market share that triggers illegality has steadily risen to 25 percent or more.

Department of Justice (Horizontal) Merger Guidelines (1992):

1. Define Relevant Antitrust Market(s): Defined as a product or group of products and a geographical area in which it is sold such that a hypothetical profit-maximizing firm not subject to price regulation that was the only present or future seller of those products in that area would likely impose at least a "small but significant and nontransitory" increase in price…. A relevant market is a group of products and a geographical area that is NO BIGGER THAN NECESSARY TO SATISFY THIS TEST.

The test is a 5 percent price increase.

What does this market definition mean? Consider retail gasoline sales in our area. Is Arcata a distinct geographical market? Suppose that there was one owner of all gas stations in Arcata, and a 5 percent price premium is charged. Could this price increase be sustained (be nontransitory), or would people buy their gas in McKinleyville and/or Eureka? Suppose the answer was that it could not be sustained, and that people would go to McK. or Eureka. Then widen the geographical market to include them-Arcata, Eureka, and McKinleyville. If a single firm owned all the gas stations in this broader geographical market, could a 10 percent price premium be sustained for a nontransitory period of time? What if we included Fortuna and Trinidad? Ultimately we could construct the smallest market necessary to satisfy the test, and that would be the relevant antitrust market if a retail gas station merger in our area was to be evaluated by antitrust authorities based on the 1992 guidelines.

2. Compute Pre-and Post-Merger HHI in the Relevant Antitrust Market(s):

• If Post-Merger HHI is at or above 1800 the market is deemed to be "highly concentrated," and if the merger caused the HHI to rise by at least 50 or more, then the merger is not considered "safe" and should be analyzed for possible challenge.
• If Post-Merger HHI is between 1000 and 1800 the market is deemed to be "moderately concentrated," and if the merger caused the HHI to rise by at least 100, then the merger is not considered "safe" and should be analyzed for possible challenge.
• If Post-Merger HHI is below 1000 the market is deemed to be "unconcentrated" and mergers are usually considered "safe" and not challenged.

3. IF further analysis is called for based on analysis of market concentration, then:

• Evaluation of entry conditions
• Evaluation of efficiency considerations for merger, including economies of scale, better integration of production facilities, plant specialization, and lower transportation costs, excluding efficiencies that could be realized by means other than merger….

Conglomerate Mergers:

Any efficiency-based arguments for merger?

• Internal capital markets: If information on project quality is more easily transmitted within than across firms, then a conglomerate can self-capitalize otherwise unrelated projects.
• Managerial discipline-resolving the agency problem via competitive financial markets and hostile takeovers.

Anti-competitive effects of conglomerate merger?

• Reciprocal Dealing: I buy from you only if you agree to buy from me; may allow for a lessening of competition at intermediate-good stage, which can be passed along to consumers. Bell-Western Electric effect….
• Eliminating Potential Competition: Merger Guidelines arbitrarily define this as firms that "must construct significant new productive or distributive facilities in order to produce and sell the relevant product." Example: Procter and Gamble (1967). The Merger guidelines call for a challenge of a potential competition merger if post-merger HHI exceeds 1800, entry is difficult, the eliminated potential competitor is one of only three or fewer firms having comparable advantages in entering the market, and the acquired firm's market share was at least 5 percent.