Mergers

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Mergers
A merger is a transaction that results in the
transfer of ownership and control of a
corporation.
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3 Types of Mergers

• Economists distinguish between three types of
  mergers
• Horizontal
• Vertical
• Conglomerate

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Horizontal mergers
A horizontal merger results in the
consolidation of firms that are direct
rivalsthat is, sell substitutable products
within overlapping geographic markets.
Examples Boeing-McDonnell Douglas
Staples-Office Depot(unconsummated) Chase
Manhattan-Chemical Bank Southern Pacific
RR-Sante Fe RR Pabst-Blatz LTV-Republic Steel
Konishiroku Photo-Minolta.
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Vertical Mergers
The merger of firms that have actual or
potential buyer-seller relationships
Examples Time Warner-TBS Disney-ABC Capitol
Cities Cleveland Cliffs Iron-Detroit Steel
Brown Shoe-Kinney, Ford-Bendix.
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Conglomerate mergers
Consolidated firms may sell related products,
share marketing and distribution channels and
perhaps production processes or they may be
wholly unrelated.

• Product extension conglomerate mergers involve
  firms that sell non-competing products use
  related marketing channels of production
  processes.
• Examples Cardinal Healthcare-Allegiance
  AOL-Time Warner Phillip Morris-Kraft
  Citicorp-Travelers Insurance Pepsico-Pizza Hut
  Proctor Gamble-Clorox.

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• Market extension conglomerate mergers join
  together firms that sell competing products in
  separate geographic markets.Examples Scripps
  Howard PublishingKnoxville News Sentinel Time
  Warner-TCI Morrison Supermarkets-SafewaySBC
  Communications-Pacific Telesis
• A pure conglomerate merger unites firms that have
  no obvious relationship of any kind.
• ExamplesBankCorp of America-Hughes Electronics
  R.J. Reynolds-Burmah Oil Gas ATT-Hartford
  Insurance

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Anticompetitive Effects of Mergers

• Issue When and how are mergers
  welfare-reducing (that is, result in a
  post-merger decrease in TS ?
• Horizontal mergers eliminate sellers and hence
  reshape market structure. Recall that the
  structuralists believe that market structure is
  the primary determinant of market performance.
• Mergers may result in market foreclosure. For
  example, the Justice Department feared that
  Microsoft's proposed acquisition of Intuit would
  result in a foreclosure of the market for
  personal finance software.
• Mergers may diminish potential competition. For
  example, the acquisition of Clorox by Proctor
  Gamble eliminated PG as a prime potential
  entrant in the market for household bleach.

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Horizontal mergers have a direct impact on seller
concentration (as measured by the concentration
ratio or the Herfindahl index). Hence the
potential to diminished competition is clear to
see.
Remember the formula from the Cournot Model
Where n is the number of sellers. A merge reduces
n, hence increases the price-cost margin and
reduces TS, other things being equal.
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The Williamson contribution 1
It would seem at first blush that horizontal
mergers would invariably be welfare-reducing.
However, if the consolidation of direct rivals
leads to greater cost efficiency, then a
horizontal merger could (in theory at least) be
welfare-enhancing.
1Oliver Williamson. Economies as an Antitrust
Defense The Welfare Tradeoffs, American
Economic Review, March 1968.
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Welfare trade-offs of a horizontal merger
Oliver Williamson contends thata horizontal
merger can bewelfare-enhancing, even if the
post-merger marketstructure is monopolistic.
Why? Becausethe merger may result in
greatertechnical/cost efficiency.
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The efficiencygain from the mergeris
indicatedby the shift from AC toAC
Price
If area A2 exceedsarea A1, the mergerincreases
the total surplus (TS)
PM
Audio explanation (wav)
A1
AC
PC
A2
AC
D
0
QC
Quantity
QM
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Measuring the Welfare Tradeoffs
Let A1 be computed by
If A1 A2, the merger is welfare-neutral
Let A2 be computed by
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Percentage Cost Reduction Sufficient to Offset
Percentage Price Increases for Selected Values of
?. Hear audio explanation (wav)

3 2 1 1/2
5 0.43 0.28 0.13 0.06
10 2.00 1.21 0.55 0.26
15 10.37 5.76 2.40 1.10
Source Viscusi, Vernon, and Harrington, Table
7.1, p. 200
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Vertical and conglomerate mergers do not affect
market structure (e.g., seller concentration)
directly. As you will discover subsequently,
these types of mergers mergers can nevertheless
have anticompetitive consequences.
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