Concentration, Mergers and Entry Barriers...

Concentration, Mergers and Entry Barriers I


Chapter 8.

February 24, 2016


Concentration Measures

The very �rst device to carry the BlackBerry name was theBlackBerry 850, an email pager, released January 19, 1999.It was the �rst device to integrate email.

On January 9, 2007 Steve Jobs announced the iPhone atthe Macworld convention. On June 29, 2007 the �rstiPhone was released.

When Samsung Galaxy, was released in June 2009, it markedSamsung�s entry into the Android smartphone market.



Why do �rms in some industries make pure pro�ts?

When Oligopolies make pure pro�ts, how come entry of new�rms does not always occur, thereby eliminating all purepro�ts?

What can explain mergers among �rms in a given industry?

What is and what should be the regulators�attitudes towardsconcentrated industries?




Compare concentration among di¤erent industries in the sameor di¤erent countries

regulating authority would like to intervene or prevent

What is a concentrated industry?

The number of �rms in the industryThe distribution of output among the �rms

∑Ni=1 qi , Problems...

Market share of �rm i : si � 100� qiQ



The four-�rm concentration ratio

I4 � ∑4i=1 si and IHH � ∑N

i=1 (si )2 "The Her�ndahl-Hirshman

Index"



Merges (takeovers, acquisitions, integration)

Independently owned �rms join under the same ownership

We investigate the gains and incentives to merge andconsequences on productivity and performance

Three general categories (Federal Trade Commission)

Horizontal mergerVertical mergerConglomerate merger



Mergers (takeovers, acquisitions, integration)

Top 10 M&A deals worldwide by value (in mil. USD) from1990 to 1999

Rank Year Purchaser Purchased Transaction value (in mil.USD)

1 1999 Vodafone AirtouchPLC[16] Mannesmann 183,000

2 1999 Pfizer[17] WarnerLambert 90,0003 1998 Exxon[18][19] Mobil 77,2004 1998 Citicorp Travelers Group 73,0005 1999 SBC Communications Ameritech Corporation 63,000

6 1999 Vodafone Group AirTouchCommunications 60,000

7 1998 Bell Atlantic[20] GTE 53,3608 1998 BP[21] Amoco 53,0009 1999 Qwest Communications US WEST 48,000

10 1997 Worldcom MCI Communications 42,000




U.S. Airline Mergers and Acquisitions in the past �ve years.

Title Announced Closed Resulting EntityRepublic Airways / Midwest Airlines 6/23/2009 7/31/2009 Republic AirwaysRepublic Airways / Frontier Airlines 8/14/2009 10/1/2009 Republic AirwaysUnited Airlines / Continental Airlines 5/3/2010 10/1/2010 United AirlinesPinnacle Airlines / Mesaba Airlines 7/1/2010 7/1/2010 Pinnacle Airlines /

Mesaba AirlinesSkyWest / Atlantic Southeast Airlines/ ExpressJet Airlines

8/4/2010 11/15/2010 SkyWest / SureJet

Southwest Airlines / AirTran Airways 9/27/2010 5/2/2011 Southwest AirlinesUS Airways/AMR/American Airlines 2/14/2013 12/9/2013 American Airlines



Mergers 2015 (source Dealogic - M&A Analytics)

2015 has been a record year for M&A. It reached a volume of$4.9 trillion, beating the record of $4.6 trillion in 2007.

P�zer and Allergan: $191 billion. The US pharmaceuticalP�zer and Irish counterpart Allergan announced a plan tomerge late in November.Shell and BG Group: $81 billion. Royal Dutch Shell announcedplans to acquire British energy supplier BG in April. DiversifyShell�s operations.Charter and Time Warner Cable: $78 billion. announced latein May.Dow Chemical and DuPont: $68 billion, announced a "mergerof equals" in December.Dell and EMC: $66 billion. Dell signed an agreement toacquire data storage company EMC in October. The deal wasdescribed as the second-biggest technology merger.Heinz and Kraft Foods: $55 billion. Heinz and Kraftcompleted their merger early in July.




Why do mergers occur?

CompetitionCostsUncertainty about the future



Horizontal Merger

Should a regulator refuse to permit a merger to take place (onthe basis of increase in concentration)?

Assume a High and Low cost �rm: c1 = 1 and c2 = 4

Demand p = 10�QUnder the Cournot Duopoly market qC1 = 4 q

C2 = 1, p

C = 5and πC1 = 16,π

C2 = 1

Hence CS(Q) = 252 ,W

C = CS(Q) + πC1 + πC2 = 29.5



Horizontal Merger

Allow merger between two �rms (Multiplant Monopoly)

Plant 2 is shut downQm = 4.5 and pm = 10� 4.5 = 5.5, hence πm = 81

4 = 20.25,CS(Qm) = 81

8 = 10.125,Wm = CS(Qm) + πm = 30.375

Comparing the premerger concentration with that of thepostmerger:

ICHH = (80%)2+(20%)2 = 6, 800 < 10, 000 = (100%)2 = ImHH



Horizontal Merger

Proposition 8.1: Under Cournot market structure, a mergeramong �rms leading to an increase in concentration does notnecessarily imply an overall welfare reduction.

There exist a trade o¤ between product e¢ ciency and thedegree of monopolization

What would happen if �rms play Bertrand?



Examples Vertical Mergers

One of the most well-known examples of a vertical mergertook place in 2000 when internet provider America Onlinecombined with media conglomerate Time Warner.

Time Warner supplied content to consumers throughproperties like CNN and Time Magazine, while AOLdistributed such information via its internet service.

Disney teaming up with Pixar in a $7.4 billion deal. SteveJobs to become board member at Disney.



Vertical Merger

Merger between Supplier of an intermediate good andproducer of the �nal good.Intermediate-good suppliers is called upstream �rmsFinal-good producers is called downstream �rmsLet�s think about the case where upstream and downstreammarkets are characterized by a Bertrand price competition.Assume Bertrand price competition for the upstream marketand Cournot quantity competition for the downstream market.



Downstream Competition

Demand: p = α� q1 � q2, where α > 0 and q1 and q2 arethe output levels sold by downstream �rms 1 and 2.

Assume c1 and c2Hence

qi =α� 2ci + cj

3and Q =

2α� c1 � c23

πi =(α� 2ci + cj )2

9and p = α�Q = α+ c1 + c2

3



Upstream Competition Before the Merger

The upstream �rms A and B sell their product to thedownstream �rms 1 and 2

Assume cA and cB equal to zero

Since we assume Bertrand competition, prices fall to their unitproduction cost.

Hence q1 = q2 = α3 ,π1 = π2 =

α2

9 and πA = πB = 0



Upstream and downstream merge

Suppose that Upstream A merges with Downstream �rm 1:A1

The input cost of the merged �rm A1 is zero

The Upstream �rm B is now a monopoly in the factor

maxc2

πB = c2q2 =c2 (α� 2c2 + c1)

3

c2 = α4 , c1 = 0, q1 =

5α12 , q2 =

α6 ,Q =

7α12 , and p =

5α12

πA1 = pqA1 = 25α2

144 and π2 = (p � c2)q2 = α2

36



Upstream and downstream merge

Proposition 8.2: A merger between an upstream anddownstream �rm increases the output level of the merged �rmand reduces the output level of the downstream �rm that doesnot merge.

Proposition 8.3:

1 The combined pro�t of the merging upstream anddownstream �rms increase after they merge.

2 A merger between the upstream and the downstream �rmswill not foreclose the market of the disjoint downstream �rmbut will only reduce its pro�t.



Horizontal merger among �rms producingcomplementary goods

Consider a market for computer systems (Computers (X) andMonitors (Y))

pX is the price of one computer and pY the price of a monitorThe price of a System is : pS = pX + pYThe aggregate consumers demand is :Q = α� pS = α� (pX + pY )



Horizontal merger among �rms producingcomplementary goods

Independently owned producing �rms:

maxpX

πX = pXX (pX ) = pX [α� pX � pY ]

∂πX∂pX

= α� 2pX � pY = 0

Hence, pX = pY = α3 ,Q = α� (pX + pY ) = α

3 and

[πX + πY ] = Q � pX = α2

9



Monopoly producing all components

Assume that Firm Y and X merge under a single ownership.

Monopoly

maxpS

πXY = pS [α� pS ]

∂πXY∂pS

= α� 2pS = 0

Hence pMS =α2 ,Q

M = α2 and πMXY =

α2

4

Proposition 8.4: A merger into a single monopoly �rmbetween �rms producing complementary products would:

reduce the price of the systems (pMS < pX ); increase thenumber of systems sold (QM > Q); and increase the sum ofpro�ts (πMXY > πX + πY )

Concentration, Mergers and Entry Barriers...

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