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  1. Public Policy in Private Markets Merger Policy

  2. Announcements • Homework 4 due today • Debate # 2 next Tuesday, HW 5 due • Debaters: video due to my on March 30th (Friday) • Midterm grades have been posted, as well as answer key (will discuss at the end of class today) • Clicker issue still present for 4 students

  3. Merger Law • Important part of antitrust • 3 types of mergers: • Horizontal • Vertical • Conglomerate

  4. Oracle acquires PeopleSoft • Market definition: • DOJ • Geographic: US • Product: “high function enterprise” software (customer testimony) • 3 to 2 merger: post merger HHI > 1800 and increased by more than 1000 points • Oracle • Worldwide, based on LIFO and LOFI rules (i.e. there was a lot of sales going abroad and a lot of domestic sales coming from abroad).

  5. Clicker questions • What was the unilateral effects argument used by the DOJ? • That advertising by the merging firms would increase • That the merging firms would collude with the non-merging firms after the merger • That customers of both merging and non-merging firms would face higher prices as a result of the merger • That customers of non-merging firms would face higher prices after the merger

  6. Oracle acquires PeopleSoft • DOJ – showing unilateral effects: • Statistical analysis of transactions data: Oracle and PeopleSoft less likely to win auction when the other is present • Price regressions: when PeopleSoft competes with Oracle, Oracle offers a 9.7% greater price discount. • Merger simulation: 5%-28% price increase • Oracle: • Model is flawed, bargaining model is more appropriate (instead of auction model)

  7. Clicker questions • How was merger simulation used by the DOJ? • DOJ interviewed customers and asked what they thought the post-merger prices would be • DOJ forecasted the post-merger price based on a time-series model • DOJ forecasted the post-merger prices based on an economic model calibrated to reflect the industry in the pre-merger period • DOJ forecasted the post-merger prices based on the behavior of a control group (i.e. other firms in a similar market) that resembled the post-merger scenario

  8. The role of merger simulation • Come up with an economic model that depicts market (e.g. Cournot; in this case an auction model) • Use data from market to “calibrate” model: i.e. choose demand intercept, constant and supply functions that are consistent with observed p and q • Use the calibrated model to remove one of the firms from the market and recalculate p and q (the simulated merger equilibrium) • Compare p in 3. v p in 2

  9. Oracle acquires PeopleSoft • The judge’s decision: • Concentration (HHI) calculations were unreliable: • Testimony for high-functioning products as the relevant product market was unconvincing • LIFO and LOFI tests were more reliable (i.e. geographic market was not only US). • DOJ failed to provide reliable evidence of unilateral effects • Failed to show that Oracle and Psoft were “closest” competitors and that other competitors were poor substitutes • Failed to show that product repositioning by other competitors was not feasible

  10. Merger Law • Important part of antitrust • 3 types of mergers: • Horizontal • Vertical • Conglomerate

  11. Vertical and Conglomerate Mergers • Recall concerns: • Vertical Mergers: Foreclosure and increased barriers to entry • Conglomerate Mergers: entrenchment and elimination of potential rivals • Based on DOJ’s Non-Horizontal Merger Guidelines (last updated in 1987) • The most critical burden of proof here is lessening of competition.

  12. Vertical and Conglomerate Mergers • Typical approach: • Is there market power at one level? Will market power translate/increase in the integrated market? Example: • Lockheed-Martin proposed merger with Northrop Grumman (1998, failed) • $11.6 Billion, both aerospace companies • Lockheed: military aircraft • Northrop: radars and electronics used in aircraft • Department of Defense main customer for both firms • DOJ challenges: Substantial lessening of competition, in both upstream and downstream mkts

  13. Lockheed Northrop Merger Northrop 4th largest defense contractor In the world Radars, electronics Northrop’s Competitors Lockheed Martin Largest defense contractor in the world 95% revenue from Department of Defense Lockheed’s Competitors Military Aircraft

  14. Lockheed Northrop Merger Northrop Radars, electronics Northrop’s Competitors Lockheed Martin Lockheed’s Competitors Military Aircraft Concerns: 1. New conglomerate will have a disproportionate % of contract $’s with government 2. Increased barriers to entry & possibility of foreclosure upstream and downstream

  15. Non-Horizontal Merger Guidelines • Set-up is fairly tolerant of vertical mergers • DOJ unlikely to challenge, unless HHI in the acquired firm’s market is > 1,800 • Less likely to challenge if: • Entry into acquiring firm’ market is easy • 3 or more firms in the acquiring firm’s market would have equal advantage of entering the acquired firm’s market • Acquired firm has small mktshare (< 5%) • Efficiencies from merger

  16. Non-Horizontal Mergers • Procter & Gamble – Clorox merger (1967) • Product extension merger, PG (54% of soaps and detergents mkt), Clorox (49% of bleach mkt) • Anticompetitive effects in liquid bleach mkt: • Diminishing of potential competition (PG likely entrant) • Even if did not enter it limited Clorox’s behavior • Entrenchment: Adding PG’s size and marketing to Clorox’s already powerful position may make any future challenge very difficult

  17. Non-Horizontal Mergers • FTC challenges merger (ex-post) • District Court rules in favor of FTC • Court of Appeals reverses ruling • Supreme Court agrees with FTC’s opinion and orders divestiture of Clorox

  18. Non-Horizontal Mergers • 1980’s and 1990’s: large product extension and pure conglomerate mergers: • Nestle (large processed food manufacturer) -Carnation (“cooking milk”) • RJ Reynolds (tobacco) – Nabisco (snacks) • Philip Morris (cigarettes/food) - General Foods (cereals) • Philip Morris-Kraft (food and beverages)

  19. Non-Horizontal Mergers • Example: Philip Morris-Kraft (1988) • Total Sales after merger: $37.6 B; $11.5 B bid • Mostly product extension, with some overlap (frozen foods) • PM: unrivaled position in dry and frozen food lines • Arguments for challenge: • PM’s dominated shelf space, advertising, rebates, promotional allowances; dominance into new market may reduce competition • Lessening of competition: not as strong an argument as Kraft was one of many competitors • Counterargument: economies of scale/efficiencies • Outcome: no challenge

  20. Non-Horizontal Mergers • More recently: Philip Morris-Nabisco (1999) • Combined sales: $35 B • Mostly product extension merger (some horizontal) • Contentious issue. • Horizontal segments in “individual” foods: crackers, pudding, etc. • Merger allowed with divestiture of Nabisco brands: • Dry mix gelatin: PM (86%), Nab (6%) • Dry mix pudding: PM (82%), Nab (9%) • No-bake desserts: PM (90%), Nab (6%) • Baking powder: PM (27%), Nab (17%)

  21. Non-Horizontal Mergers • 1980’s and 1990’s: large market extension mergers: • Kroger-Dillon, 1983 • American Stores-Jewel, 1984 • American Stores-Lucky, 1988 • All retailing/supermarket mergers • Agencies felt: • Big enough queue of potential competitors • Little or no BTE

  22. Non-Horizontal Mergers • Main Points: • Not all mergers are equal • Some mergers can have components of each of the 3 types • Main concern for antitrust authorities is lessening of competition • In general, non-horizontal mergers are frowned upon less frequently than horizontal mergers

  23. Grades • Mean: 70 • Median: 69 • Max: 97.5 • Min: 41.5 • Answer key: posted. Please take a close look at it. Assess whether grading was fair; only then make a decision of whether re-grading is a reasonable request. • Questions 1 and 3: partial credit for seemingly “ambiguous” answers

  24. Distribution

  25. Clicker participation and HW pay off 75 40