Vertical mergers - EWS/Marcroft NEIL PRATT ACE conference, November 2007
Agenda • Framework for assessing input foreclosure • Comments on EWS/Marcroft
Vertical merger analysis – preliminaries • No direct loss of rivalry • Efficiency rationales • Elimination of double marginalisation • Improved investment incentives • Two main unilateral theories of harm • Input foreclosure: restrict/degrade input supply • Customer foreclosure: limit input purchases
Upstream entity Downstream entity Downstream rivals The input foreclosure mechanism RRC? Efficiencies? Softer competition? Impact on customers?
Analytical framework Ability • Significance of input to downstream firms • VI firm’s market power upstream • Barriers to entry and expansion upstream Incentive • Margins in upstream and downstream markets • VI firm’s share of downstream market • Extent of share-shifting to VI firm • Impact on size of downstream market Effect • Competitive significance of foreclosed rivals • Impact on barriers to entry • Competitive constraint from vertically integrated rivals • Merger-specific efficiencies
Empirical analysis of incentive • ‘Vertical arithmetic’ approach can be used to assess profitability of input foreclosure – e.g. • Evraz/Highveld • Thales/Finmeccanica/Alcatel Alenia Space & Telespazio • Simple analysis can indicate likelihood of foreclosure • Estimate cost from foregone upstream margin based on loss of input sales • Estimate profit from additional downstream margin based on expected sales diversion • More sophisticated simulation approach can help assess competitive effects
EWS/Marcroft - background • Relatively low value deal in a difficult market • Some tricky economic issues to resolve • No economic advisers retained by parties • Apparently limited data available to CC in certain areas • Conflicting evidence from EWS and complainants
Vertical foreclosure: main lines of debate • Efficiencies did not play a significant role • EWS already vertically integrated • Parties did not make strong efficiency claims • Debate focused on two key issues: • Marcroft’s pre-merger position in the wagon maintenance market • EWS’s incentive to lower foreclose rivals in the haulage market
Marcroft’s pre-merger position • CC relied on structural analysis of wagon maintenance market • High share – 56% (volume) • Only one rival with national coverage • Self-supply not an effective constraint • Some conflicting evidence on performance and conduct • Poor financial performance of Marcroft • Examples of failed attempts to increase prices/lost tenders • CC concluded on balance that Marcroft had significant market power
Two possible forms of input foreclosure • Reduction in service quality to haulage companies • Increased downtime, less reliable scheduling of works • Could be targeted at selected customers • Foreclosed customers would face higher costs, or lose contracts • Increase in price of maintenance services • Conflicting evidence on significance of maintenance relative to operating costs • Price increase expected to have some negative impact on rivals
Limited evidence on incentive and effect • Data limitations appear to have precluded application of vertical arithmetic • CC points to size of haulage market compared to maintenance market and EWS’s high share • Wabtec (and others) not seen as competitive alternative • High-level approach to haulage market • No concrete examples of potential foreclosure • Not much on harm to end users
Final remarks • EWS/Marcroft follows orthodox approach to vertical mergers • Debate focused on empirical questions • Market power of Marcroft • Profitability and effect of foreclosure • Threat of self-supply by e.g. Freightliner • Data appears to have been quite limited and contentious in this case
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