GE-Honeywell (2001)

GE-Honeywell (2001) Tom Giblin Hadley Heath Imran Ramji

Introduction • The Players • General Electric • http://www.youtube.com/watch?v=fViObqGvIjM&NR=1 • Diverse range of products • Revenues 2001 exceeded $125 billion • Honeywell • http://www.youtube.com/watch?v=rCCJVuUrP-Q • Aerospace and technology • Revenues 2001 were approximately $23 billion • Nearly half of revenues from aerospace division

Introduction • The Players • Rivals • International Aero Engines • Joint venture between Pratt & Whitney and Rolls Royce • U.S. DOJ • European Commission • 20 members • Goal: to demonstrate whether or not the proposed merger would lead to market dominance

Two Sides of the Case • Against the Merger • GE and Honeywell have dominant market positions. • Proposed merger would allow bundling of complementary products, lower prices, and an unbeatable advantage. • Ultimate exit of rivals and market dominance of merged firm.

Two Sides of the Case • For the Merger • GE does not have market dominance in aircraft engines. • The proposed merger would not lead to bundling. • Without bundling, there would be no exit of rivals and no ultimate market dominance by GE.

Market Dominance • The anti-merger case used the following market shares: • GE = 52.5% • P&W/IAE = 26.5% • RR/IAE = 21% • This combines CFMI’s sales under GE, but splits IAE’s sales into P&W and RR. • Justification: “SNECMA would act jointly with GE as a profit-maximizing entity.”

Market Dominance • The pro-merger case: • Inaccurate evaluation of GE’s market share • If RR and P&W are not grouped as IAE, SNECMA and GE should not be grouped. • On exclusive contract sales with Boeing on 737s, GE has no ability to set prices. • Therefore, exclusive contract sales should not be part of GE’s market power evaluation.

Bundling • Pure Bundling • Two products are sold together and are not available separately • Ex. Left and right shoes are not sold separately • Tying • Product 1 is sold by itself, but product 2 is available only with product 1 • Ex. NFL season pass is available only with satellite TV • Mixed Bundling • Two items sold separately or together, but together they are sold at a discount price • Ex. A combo meal at a fast food restaurant

Bundling • Cournot • Two monopolists act independently, but together can lower prices and earn more money. Ex. Zinc and copper make brass. • Assumptions: • No other firms in the market • Firms set a single price to all consumers

Bundling • Expansion of Cournot’s Model • Firms A1 and B1 produce good 1 • Firms A2 and B2 produce good 2 • This accounts for other firms in the market

Bundling • Case 1: All firms act independently • Results: • All firms charge a price of 1 • All firms make a profit = 1/2

Bundling • Case 2: Bundle vs. Bundle • Results: • Prices fall by 50% • Profits fall by 50%

Bundling • Case 3: Bundle against Components • Results: • Firm A’s profits go from 1 to 0.91 • Uncoordinated B firms’ profits go from 1 to 0.32

Mixed bundling • Firm A sells bundles at 19% discount • Best response of B firms is to lower component prices • This gives firm A an advantage • Market share = 55.4% • Rivals’ profits fall by 21%

The Anti-Merger Case • Rolls Royce presented this type of bundling as most appropriate to this case. • The EC used this model, along with an expected increase in market size, to conclude that GE would have an economic incentive to use mixed bundling.

Considerations • Existence of competitors • Accounted for in expansion of Cournot model • Number of products • More products greater incentive to bundle • Total market demand • Greater elasticity of demand  greater incentive to bundle • Asymmetry of products • More symmetry  greater incentive to bundle • Avionics ($100,000) and jet engines ($15 million)

Price Negotiation • Cournot Assumption: One price for all. • Consumers in this case are powerful. • Price discrimination (not a single price)

Timing • Engines are purchased before avionics • Once engine competition is won, giving a discount on a bundle would be no different than giving an avionic discounts directly • Solution would be to promise discount on avionics before purchase of engine • Wouldn’t work in avionics industry because negotiated prices

Exit by Rivals • The Commission’s belief that the merger would lead to rival exiting is questionable • Rival stock increased when merger announced • Investors predict the merger will benefits rival companies • Long term contracts • Typical plane is on the market 25 years • Competitors have 2/3 share of the engines on next generation planes

Exit by Rivals • Allied Signal and Honeywell merger • 1999 merger between two large avionic component firms • Despite widespread bundling little effect on the market • Hypocrisy of Commission’s decision • Argued Allied Signal-Honeywell bundling effects were slow to arise • Argued effects of GE-Honeywell merger would lead to quick exit of rivals

Policy Prescriptions What possible regulations should be enacted if the Cournot effect is large? None? – prices fall, social welfare increases EC worried about long term market exit leading to market dominance and price increase There are a few questions to be asked before deciding on any policies to stop possible bundling

Policy Prescriptions • Is there an incentive to bundle? • Not really • What is the immediate gain to consumers from lower prices? • What will be the impact on competitors? • How long do we expect lower prices to persist? • If the rivals exit, what is the expected harm?

Policy Prescriptions • Nalebuff argues that the EC stopped after question 1 • In addition, they focused on market competitiveness and did not examine the potential positive trade-offs of bundling • Long-run harm vs. Short-run gain • This is not an area in which antitrust authorities should be involved

Remedies • The firms could agree to not bundle their products • They would have to provide an itemized list of individual prices • However, the EC rejected this because they preferred structural solutions over behavioral ones • Even though this solution would not be difficult to enforce

Conclusion • European Commission blocked the merger • According to the author • Abandoned original model, but did not replace flawed model • Used dynamic theory of predation • Did not have enough support • Backed away from bundling theory, but still concluded that bundling was a reason to block merger

Discussion • Two sides of the case… • European Commission • Biased? • Politics and “National Champions” • Author, Barry Nalebuff • Biased? • Economic expert for GE-Honeywell in their presentation to the European Union Merger Task Force.

Post Script 2005 Appeal to European Court of First Instance (CFI) • CFI rejected bundling argument, and was not persuaded that GE would act anti-competitively. • But, CFI denied the appeal because the merger would create market concentration in: • Small marine gas turbines • Engines for large regional jets • Corporate jet aircraft engines • Even if appeal granted, it was too late.

The End

GE-Honeywell (2001)