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Mergers

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

Jimmy Stepanian

3 Types of Mergers
Economists distinguish between three
types of mergers:
1. Horizontal
2. Vertical
3. Conglomerate

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; LTVRepublic Steel; Konishiroku Photo-Minolta.

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 ShoeKinney, Ford-Bendix.

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.

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 SupermarketsSafeway;SBC Communications-Pacific Telesis
A pure conglomerate merger unites firms that have no
obvious relationship of any kind.
Examples:BankCorp of America-Hughes Electronics ;R.J.
Reynolds-Burmah Oil & Gas; AT&T-Hartford Insurance

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 P&G as a
prime potential entrant in the market for household bleach.

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: P MC
1

p
n
Where n is the number of sellers. A merge reduces n,
hence increases the price-cost margin and reduces TS,
other things being equal.

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.
Oliver Williamson. Economies as an Antitrust Defense: The
Welfare Tradeoffs, American Economic Review, March 1968.
1

Welfare trade-offs of a horizontal merger


Oliver Williamson contends that
a horizontal merger can be
welfare-enhancing, even if
the post-merger market
structure is monopolistic. Why? Because
the merger may result in greater
technical/cost efficiency.

The efficiency
gain from the merger
is indicated
by the shift
from AC to
AC

Price

PM
PC

A1
A2

QM

If area A2
exceeds
Audio explanation (wav)
area A1, the
AC merger
increases
the total
AC
surplus (TS)
D
QC

Quantity

Measuring the Welfare Tradeoffs


Let A1 be computed by
If A1 = A2,
the merger is
welfare-neutral

1
A1 (P )(Q)
2
Let A2 be computed by:

A2 AC QM

Percentage Cost Reduction Sufficient to Offset


Percentage Price Increases for Selected Values of .
Hear audio explanation (wav)

P
P

1/2

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

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.

Jimmy Stepanian

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