Potential Anti-Competitive Effects of Mergers

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Potential Anti-Competitive Effects of Mergers

• Ping Lin
• Department of Economics
• Lingnan University of Hong Kong
• Asian Competition Forum
• 12 June, 2008

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CPRC Report (2006)

• Review of the Effectiveness of Hong Kongs
  competition policy
• Recommendations
• Introduction of a cross-sector competition law,
• Enforced by independent Competition Commission.
• MAs not to be covered.

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The Governments Proposal (2008)

• Three options
• to introduce merger provisions that would be
  suitable in the Hong Kong context
• to introduce merger provisions, but to delay
  their enforcement until after a review of the
  effect of the law or
• not to include merger provisions initially, but
  to reconsider later.

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Various views about the need for merger control

• In a relatively compact geographical area, such
  as Hong Kong, there may be limited scope for
  multiple providers of certain products or
  services to co-exist.
• Mergers may be the most efficient way to
  consolidate the industry and achieve economies of
  scale.
• Mergers do not pose any practical competition
  concern in Hong Kong, given that
• large-scale mergers are not common here and
• the open economy allows competition from firms
  outside Hong Kong.

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Various views about the need for merger control
(contd)

• Regulating firm conduct alone does not provide a
  complete safeguard against the adverse effects
  that a merged entity can have on competition and
  consumers.
• It may be more difficult to regulate
  anti-competitive conduct after a merger has
  occurred than to prevent the creation of
  substantial market power through a merger in the
  first place.
• Even if there is a limited level of merger
  activity amongst local undertakings, as a small,
  open economy, global mergers may have an impact
  on Hong Kong.

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The S-C-P Paradigm (of Harvard School, 1950s-)

• How to analyze an industry?
• First look at market structure
• Number of competitors/Industry concentration
• Barrier to entry (market contestability)
• Product differentiation/substitutability
• Degree of vertical integration, etc.
• Then look at firm conduct
• Pricing, merger and acquisitions, advertising,
  RD, product quality, etc.
• Then you understand firm/industry performance
• Profitability/Price-cost margin
• Technological progress
• Efficiency (static and dynamic), etc.
• Structure ? Conduct ? Performance

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Structure-Conduct-Performance Paradigm

• Structure ? Conduct ? Performance
• Mergers affect market structure (no. of
  competitors, industry concentration, the degree
  of vertical integration) and hence firm conduct
  post merger.
• Competition laws/policy regulate both Structure
  and Conduct, so as to achieve economic
  efficiency.
• The rule of reason approach
• Merger policy does not prevent all mergers.

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Anti-competitive effects of mergers

• Horizontal mergers
• may raise prices and thus hurt consumers and
  causing inefficiency, despite the benefits from
  the resulting economies of scale
• Vertical mergers (e.g., between a real estate
  developer and a retailing store)
• May raise the costs of rival firms, thus
  lessening competition
• Conglomerate mergers
• May reduce potential competition

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Social Costs of Horizontal Mergers

• The Williamson Trade-off
• Efficiency gains (econ. of scale, econ. of scope)
• Only merger specific efficiencies are relevant.
• Social costs (reduction in competition, DWL)
• Coordination effect
• Unilateral effect
• Entry
• Merger review Balancing efficiency enhancing
  effects against potential competition reducing
  effects

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The Williamson Trade-Off
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Anti-Competitive Effects of Horizontal Mergers

• The unilateral effect
• The merged entity AB has stronger incentive to
  raise price than stand-alone companies (A or B),
  in markets of differentiated products.
• The coordination effect
• Mergers may make collusion more likely (in more
  homogeneous product markets)

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Anti-competitive effects of vertical mergers

• Raising rivals costs
• E.g., a merger between a manufacturer and a
  retailer may make it more costly for a competing
  manufacturer to distribute its products.

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Raising rivals cost effect of vertical mergers

• An acquisition of an key input (land or telecom
  network, e.g.) by a downstream firm can enable it
  to use the so-called price squeeze strategy
  against its competitors.
• Entry deterrence effect
• Vertical integration may lower the likelihood of
  new entry.

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Conglomerate mergers

• May reduce potential competition
• Mergers between two firms that are not (actual)
  head-to-head competitors may harm competition if
  they would enter each others market absence a
  merger.
• The Bell Atlantic-NYNEX Merger (1997)

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Rule of reason analysis toward mergers

• Merger control aims at preventing socially
  harmful mergers.
• Market definition
• Efficiencies vs. increased market power
• Generally speaking, conglomerate and vertical
  mergers are less likely to harm competition,
  relative to horizontal mergers.

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The Need for Merger Control in Hong Kong

• Small-economy arguments
• Scale economies are more important for small
  economies.
• But it does not follow that every industry in a
  small economy is a natural monopoly.
• Merger control does not prevent socially
  beneficial mergers (i.e., those mergers for which
  the resulting scale economies more than offset
  the competition reducing effect).

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How harmful can a merger be?An illustration The
Staples-Office Depot Merger in the US (1997)

• Relevant market Office Supplies Superstores
• Direct estimates of the mergers effects on
  prices
• Price comparison between cities where Office
  Depot and Staples currently competed and those
  where they did not.

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Average price differentials in Staples-Office
Depot (Kwoka White, Antitrust Revolution, 2004)
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The Staples-Office Depot Merger (1997)

• FTCs econometric analysis using store-level
  data
• An average of 7.3 increase in overall prices
• Efficiency gains 1.4
• Passing through rate 15
• Net increase in price 7.1 7.3 - 0.15x1.4
• The merger is blocked by the court.

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Staples-Office Depot Merger Contd

• Stock-market Event study (additional evidence)
• The proposed merger would raise the value of
  competitor OfficeMaxs shares by 12
  (Warren-Boulton and Dalkir, 2001)
• Thus, the Staples-Office Depot merger would
  likely be anticompetitive.

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Implications for Hong Kong?

• Mergers can be anti-competitive, even when they
  result in economies of scale.
• A no-control policy may prove too costly for Hong
  Kong (7.1 price increase for consumers in one
  merger case).

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Type I error vs. Type II error in policy design

• Type I error (falsely regulating non-harmful
  mergers)
• Type I errors are more likely in small
  economies.? more permissive merger policy.
• Type II error (falsely not regulating harmful
  mergers)
• Smallness does not rule out Type II errors.
• A policy not covering MAs gives all weight to
  the harm of Type I errors and none to Type II
  errors.
• It is hard to believe that a duopoly-to-monopoly
  merger is not harmful, even in small economies.

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Misconception 2 Conduct regulation is substitute
for merger control

• Some hold the view that as long as there are
  effective safeguards against anti-competitive
  conduct, it might well be superfluous to control
  merger
• since a corporation enjoying market dominance and
  engaging in anti-competitive conduct would in any
  event be caught under the law.

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Is conduct regulation is substitute for merger
control?

• However, lost competition as a result of a merger
  cannot be restored by regulating the behavior of
  the combined firm ex post (Lin and Chen,2008).
• E.g., post a duopoly to monopoly merger,
  competition is absent no matter how the
  government regulates the new firms conduct.
• No longer competing in prices
• No longer competing in advertising
• No longer competing in services
• No longer competing in RD,

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Misconception 3 New entry will remove the
anti-competitive effects of a merger

• It may be argued that new entry would keep the
  price level down after a merger between incumbent
  firms.
• However, entry barriers may exist.
• Brand name
• Minimum efficient size
• Enter deterrence conduct by the merged firm

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Proper Merger Control Regime for Hong Kong

• Should take into account small economy features.
• Safe harbours should be broader than those in
  other/large economies.

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Need for merger control in HK

• Not to control mergers may prove too costly for
  Hong Kongs consumers.
• At least to regulate duopoly to monopoly
  mergers.
• Even small economies are big enough to allow (at
  least) two firms to compete against one another
  in a given industry.
• Insight from the S-C-P framework

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Merger Guidelines (2004)in the Telecom Industry
of Hong Kong

• Market definition (SSNIP test)
• Safe harbours
• CR4 test
• Combined mkt share less than 15 or
• Combined mkt share between 15 and 40 AND
  industry CR4 lt 75.
• HHI test (the US threshold points)
• Unconcentrated industry, 0,1000,
• Moderately concentrated industry, 1000, 1800,
  Dlt100
• Highly concentrated industry, 1800,10000, Dlt 50

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Recent Dealings of MAs by the Office of
Telecommunications (TA)

• Factors to look at
• unilateral and co-ordination effects
• removal of maverick
• barriers to entry
• Potential competition
• countervailing buying power
• import competition
• technological change
• efficiency defence
• etc.

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Recent Dealing by the TA

• Seven merger transactions were considered
• Acquisition of PCCW by China Netcom (2005)
• Acquisition of Sunday by PCCW (2005)
• Acquisition of Peoples by China Mobile (2005)
• Joint Ownership pf CSL and NWPCS (2006)
• Change of Ownership of Asia Netcom and C2C (2006)
• Acquisition of PacNet by Asia Netcom (2007)
• Acquisition of AsiaSat Holdings by GE Capital
  Corp. (2007)
• All were approved.
• TAs dealing has been permissive (see Lin and
  Fung, 2007)

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Comments on the Safe Harbors in the
Telecommunications Industry of HK

• The HHI test is exactly the same as that in the
  US.
• As an alternative test, the HHI safe harbor is
  narrower than the CR4 safe harbor
• I.e., The HHI test is stricter than the CR4 test
• (see figure 1)

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A Proposal

• Adopt a modified version of the telecom merger
  control to cover the entire economy
• Stick to the same CR4 test (among the most
  lenient in the world, and for consistency)
• Relax the HHI test (so that it is more comparable
  with the CR4 test)
• One possibility is to use the following new
  decision points (Chen and Lin, 2008 and Lin and
  Fung, 2007)
• Unconcentrated industry, 0,1500,
• Moderately concentrated industry, 1500, 2500,
  Dlt200
• Highly concentrated industry, 2500,10000, Dlt
  100

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Concerns of SMEs

• SMEs skeptical of new legislation, used to
  laissez-faire
• Concerned about high compliance costs, and
• Prohibitive litigation costs, if unwittingly
  fallen foul of the law
• Reluctant to confront big players in court for
  fear of retaliation.

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Partial Exemption of SMEs (Chen and Lin, 2007)

• SMEs are exempt from provisions governing
• Abuse of dominant position
• Merger and acquisition
• Are liable for price-fixing violations, however.

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SMEs to be better off with a law (Chen and Lin,
2008)

• SMEs better off in a fair play
• Compliance costs can be kept down
• SMEs can be exempted from certain prohibitions
  (mostly within safety zones), hence minimal need
  for legal advice
• Door open to sue under the law, if victimized
  nowhere to seek justice without a law (infinitely
  high legal costs).

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Concluding Remarks

• Small economy does not rule out anti-competitive
  mergers. The harm of type II errors should not be
  underestimated.
• Conduct regulation is no substitute for merger
  control.
• A lenient merge control regime is recommended to
  take into account features of a small economy.
• A modified version of the merger control regime
  in the telecom industry seems suitable.
• Partial exemptions for SMEs can be justified on
  economics ground.

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• - Thank you -
• Ping Lin
• Department of Economics
• Lingnan University
• plin_at_ln.edu.hk

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Concluding Remarks

• Small economies demand a greater need for
  competition policy
• Merger control with large safe harbors seems
  appropriate for Hong Kong
• A leniency program is highly recommended to
  combat cartels.

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Thank you!

• Ping Lin
• plin_at_ln.edu.hk