© Frontier Economics Ltd, London.

Vertical mergers - EWS/Marcroft NEIL PRATT

ACE conference, November 2007

Agenda

1. Framework for assessing input foreclosure

2. 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

The input foreclosure mechanism

Upstreamentity

Downstream entity

Downstreamrivals

RRC?

Softer competition?

Impact on customers?

Efficiencies?

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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