Mergers

A merger is a transaction that results in the transfer of ownership and control of a corporation.

3 Types of Mergers
Economists distinguish between three types of mergers: 1. Horizontal 2. Vertical 3. Conglomerate

Horizontal mergers
A horizontal merger results in the consolidation of firms that are direct rivalsthat is, sell substitutable products within overlapping geographic markets. Examples: Boeing-McDonnell Douglas; Staples-Office Depot(unconsummated); Chase Manhattan-Chemical Bank; Southern Pacific RR-Sante Fe RR; Pabst-Blatz; LTVRepublic Steel; Konishiroku Photo-Minolta.

Vertical Mergers
The merger of firms that have actual or potential buyer-seller relationships Examples: Time Warner-TBS; Disney-ABC Capitol Cities; Cleveland Cliffs Iron-Detroit Steel; Brown Shoe-Kinney, Ford-Bendix.

Conglomerate mergers
Consolidated firms may sell related products, share marketing and distribution channels and perhaps production processes; or they may be wholly unrelated. Product extension conglomerate mergers involve firms that sell non-competing products use related marketing channels of production processes. Examples: Cardinal Healthcare-Allegiance; AOL-Time Warner; Phillip Morris-Kraft; Citicorp-Travelers Insurance; Pepsico-Pizza Hut; Proctor & Gamble-Clorox.

Market extension conglomerate mergers join together firms that sell competing products in separate geographic markets. Examples: Scripps Howard PublishingKnoxville News Sentinel; Time Warner-TCI; Morrison SupermarketsSafeway;SBC Communications-Pacific Telesis A pure conglomerate merger unites firms that have no obvious relationship of any kind. Examples:BankCorp of America-Hughes Electronics ;R.J. Reynolds-Burmah Oil & Gas; AT&T-Hartford Insurance

Anticompetitive Effects of Mergers

Issue: When and how are mergers welfare-reducing (that is, result in a post-merger decrease in TS ? Horizontal mergers eliminate sellers and hence reshape market structure. Recall that the structuralists believe that market structure is the primary determinant of market performance. Mergers may result in market foreclosure. For example, the Justice Department feared that Microsoft's proposed acquisition of Intuit would result in a foreclosure of the market for personal finance software. Mergers may diminish potential competition. For example, the acquisition of Clorox by Proctor & Gamble eliminated P&G as a prime potential entrant in the market for household bleach.

Horizontal mergers have a direct impact on seller concentration (as measured by the concentration ratio or the Herfindahl index). Hence the potential to diminished competition is clear to see. Remember the formula from the Cournot Model: P MC 1 = p n Where n is the number of sellers. A merge reduces n, hence increases the price-cost margin and reduces TS, other things being equal.

The Williamson contribution

It would seem at first blush that horizontal mergers would invariably be welfare-reducing. However, if the consolidation of direct rivals leads to greater cost efficiency, then a horizontal merger could (in theory at least) be welfare-enhancing.

Oliver Williamson. Economies as an Antitrust Defense: The Welfare Tradeoffs, American Economic Review, March 1968.
1

Welfare trade-offs of a horizontal merger

Oliver Williamson contends that a horizontal merger can be welfare-enhancing, even if the post-merger market structure is monopolistic. Why? Because the merger may result in greater technical/cost efficiency.

Price

The efficiency gain from the merger is indicated by the shift from AC to AC

PM PC

A1 A2

If area A2 exceeds Audio explanation (wav) area A1, the AC merger increases the total AC surplus (TS) D Quantity

QM

QC

Measuring the Welfare Tradeoffs

Let A1 be computed by If A1 = A2, the merger is welfare-neutral

1 A1 = (P )( Q) 2
Let A2 be computed by:

A2 = AC QM

Percentage Cost Reduction Sufficient to Offset Percentage Price Increases for Selected Values of . Hear audio explanation (wav)

P P 5

3 0.43 2.00 10.37

2 0.28 1.21 5.76

1 0.13 0.55 2.40

1/2 0.06 0.26 1.10

10 15

Source: Viscusi, Vernon, and Harrington, Table 7.1, p. 200

Vertical and conglomerate mergers do not affect market structure (e.g., seller concentration) directly. As you will discover subsequently, these types of mergers mergers can nevertheless have anticompetitive consequences.

Back to Lesson 6