Conglomerate Mergers: An Economic Reconsideration
Hamed Meshki
Conglomerate Merger – Defined
q A merger between firms that are neither competitors nor potential or actual customers or suppliers of each other.
Conglomerate Merger – Types and Attributes
q May be pure or mixed in form
o Pure – There are no economic relationships between the acquiring firm and the acquired firm
o Mixed – Aspects of both pure conglomerate merger, and of horizontal merger - 2 Varieties:
§ (1) Market-extension merger
§ (2) Mergers through which the manufacturer of one product acquires a different, but complementary product, which allows him to offer a full line
q No immediate impact on market concentration
Clayton Act § 7
q No person engaged in commerce … shall acquire … stock or other share capital … or any part of the assets … of another person also engaged in commerce … where in any line of commerce … the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.
Firm charges below-cost today and makes it up with monopoly
pricing later
q Difficulty
– recoupment of losses is too speculative, particularly if low costs of entry
Conglomerate – Idea that diversification of conglomerate merger
eliminates speculative aspect – makes predatory pricing more likely
q (1)
Firm must already possess monopoly in the market in which it seeks to offset
its losses
q (2)
Firm must already possess monopoly in the market in which it will price below
cost
q If
firm already possesses monopoly in both markets, this monopoly existed prior to
the merger
Idea is that firms will restrain their competitive efforts for fear of the retaliatory or financial power of the merged firm à price leadership
Goliath of the market – one very large and powerful firm, and a number of small, inconsequential competitors
q Wilson Sporting Goods
q But see Clorox
o “There is every reason to assume that the smaller firms would become more cautious in competing due to their fear of retaliation by Proctor.”
Argument may be more compelling if there is a Goliath in the market, but it is in financial distress
Note: If there is a Goliath in the market and the acquired firm is not that Goliath, not a concern
Competitively structured market
q Costs of retaliation are high
q Also, relative output of the merged firm is sufficiently low that its output decisions are unlikely to have any significant impact on market price
q If merger creates substantial efficiencies that the merged firm fully exploits them – uncertain competitive effects
1. Perceived Potential Competition (PPC)
q The
firms in the market, correctly or incorrectly, believed the acquirer to be on
the edge of the market, poised to enter
q As
a result, they maintained competitive prices in order to reduce attractiveness
of entry for the acquirer
q Merger
removes the acquirer from the edge of the market
q Firms
in the market are free to reduce output and charge supracompetitive prices
2. Actual Potential Competition (APC)
q The acquirer, whether recognized or not by the firms in the market, was on the edge of the market, poised to enter.
q The merger then effectively reduced the number of competitors by one.
Two assumptions – If either is missing, not a concern
q (1) Pre-merger market is oligopolistic or monopolistic, but is behaving competitively
q (2) Firm perceived to be poised to enter must also be perceived to be the most likely entrant, or at least one of few likely entrants
q Pennsalt and Olin Mathieson – joint venture to enter sodium chlorate market in the southeastern United States
q Neither operated in the market prior to the merger
o Merger necessarily adds one competitor to the market
o In such a case, potential competition is a concern only if either:
§ (1) Absent the merger, both firms would enter independently, or
§ (2) Absent the merger, one firm would enter, and the other would be perceived to be a likely entrant
Entry costs - Clorox
q Posner - Determining entry costs – existence of:
o Patents
o Scarce raw materials
o Heavy capital requirements
o Large economies of scale
o None exist in market of household liquid bleach)
§ 200 fringe firms, most w/assets >$75k
§ Suggests Proctor (even if a potential competitor), was one of many
· Was it the most likely? Unclear, but no evidence of that – only speculation
Bauer: Because a firm that actually would have entered the market would in most cases have been perceived by existing firms as a potential entrant, many of these cases will fit into the perceived potential competition category
Merger here will not result in rising prices
q Because firms did not recognize this potential entrant, their pricing decisions were not affected by its existence on the edge of the market
q Merger may result in failure to reduce prices
o If market is oligopolistic, acquiring firm may have caused price reduction if it entered independently
§ Assumes:
· (1) Market is not competitive pre-merger, and
· (2) Acquirer, if entered independently, would account for enough of market output to affect market price
General Foods
q Court found that entry of such a large, well-financed, aggressive competitor would necessarily hamper whatever effect potential competition had in the pre-merger market
q This is a different approach to potential competition
o Court seems worried, not that GF was lost as a potential competitor
o Rather, it seemed to worry that the merger made entry by other potential competitors less likely to enter
o Two problems in this case:
§ (1) Court’s concern of GF’s strength – size and economic strength, not post-merger market power
§ (2) Ignored the market evidence
Idea that a large diversified firm that acquires a company in a related business may be able to use its purchasing power in one market to cause the companies selling to it to look to its newly acquired subsidiary for their purchasing needs in another market
q (Like best customer saying: I’ll buy from you only if you buy from me)
Note: For this to be a concern, it is not necessary for the merged firm to actively engage in a strategy of reciprocity
q Courts have found that the mere existence of the merged firm’s purchasing power may make its conscious employment unnecessary, as sophisticated businessmen are quick to see the advantage of securing the good will of the possessor. See e.g. Ingersoll-Rand
What it is and what it is not – Wilson – “apt analogy”
q Reciprocity or purchasing efficiencies?
o Not – I’ll buy from you if you buy from me
o But – You’re buying this from me; I also sell that
Consolidated Foods
q Consolidated – failed attempts at reciprocity because of quality concerns
o Suggested that Consolidated could not use its buying power to exert sufficient pressure on its purchasers such that they would forego their preferences in their own purchasing decisions
o Supported by 10 years of post-merger market evidence – Consolidated was unable to engage successfully in a strategy of reciprocity
q Court of Appeals – no evidence of probability of substantial anticompetitive effect
q Supreme Court – Reversed – market evidence, while probative, could not override probability of anticompetitive effect
o - ? – Probability of anticompetitive effect is based on a market influence that post-merger evidence has shown Consolidated does not possess
§ Unclear to what probability Court was referring
o On another level, Court’s unwillingness to rely exclusively on the market evidence is sensible
q Consolidated’s purchasing power (necessary for successful reciprocity strategy)
o Consolidated was a distributor rather than ultimate consumer
o Difficult even if Consolidated was ultimate purchaser
Idea that the merger will allow two firms, currently operating in separate markets, to be positioned for monopoly at some point in the future when the two markets merge to create a new market.
q Next generation IYV would use broadband connection
o Worry that when this market (broadband ITV) developed, the merged firm would be well positioned for monopoly
§ Pitofsky: Merger would deny competitors access to the new technology
o Moreover, Time Warner could deny other ISPs the same points of connection that it would give to AOL
q Note: this market did not yet exist (but still within the scope of § 7 if its emergence is likely)
Two tasks:
q (1) Determining whether there is a substantial likelihood that the two markets will merge
o If the product or service offered in one market constitutes a medium that can or may in the reasonably foreseeable future, effectively transfer, convey, or distribute the product or service of the other market without an excessive increase in operating costs whose disutility would outweigh the utility of the new medium
q (2) Deciding how to treat mergers in which there is a substantial likelihood of merging markets
o Bright-line rules
§ Allowing – enables early monopolization of emerging markets, particularly where, like in the AOL-Time Warner case, network externalities may create high entry costs
§ Prohibiting – may stifle innovation – DWL of monopoly in a new market may be preferable to nonexistence of that market altogether, particularly where but for the merger, the market is not likely to develop, at least for a while
How AOL-Time Warner merger came out
q Consent decree required that Time Warner provide nonaffiliated ISPs with same points of connection as it provided affiliated ISPs (i.e., AOL)
An Efficiency Defense?
q FTC Non-Horizontal Merger Guidelines: Merger that would otherwise be prohibited may be justified by efficiencies
o Must be merger-specific
o More than just speculative
q Hard to justify a merger based on efficiency
o Difficult to show in negotiations with FTC pre-merger
o Even after merger is consummated, litigation may ensue before any efficiencies can be realized
o Posner: “Speculation flavored by hope”
Efficiencies as a grounds for Invalidating a Merger?
q Brown Shoe
q Foremost Dairies
q Protecting competition and not competitors? – unclear
o Turner – not only bad economics, but bad law
How to treat Efficiency-Creating Mergers
q Turner – perhaps require clear and convincing evidence
q Blair – conglomerate mergers have least claim to creating efficiencies
q But where they can be shown – these mergers should be promoted rather than prohibited
o Spreading a brand name
o Marketing advantages of carrying a full brand
o Ability to diversify risk over different sources of income – prevents social costs of failure
o Even pure conglomerate mergers – efficiencies in administrative costs (accounting, engineering, legal)
o Market extension mergers – a lot of same efficiencies that are available in horizontal mergers
§ Pooling of skills and know-how gained from production of same product in different facilities
q Reduce competitive concerns
q Courts have shown unwilling or unable to recognize – See Clorox