Cruise Line Mergers (2002)

Małgorzata Bartkowska Ewelina Dawidczyk

Bartłomiej Wiśnicki

Agenda• Introduction • Background information about the case

i. Review Process and Competitive Issues• Basic Developments- The Merger Guidelines

Frameworki. Product market definitionii. Geographic market definitioniii. Competitive effects analysisiv. Coordinated effects- Pricingv. Coordinated effects- Capacityvi. Entry and Expansion

• Outcome and Subsequent Developments• Conclusion

Introduction•Three companies were involved into the

mergers: Royal Caribbean Cruises, P&O Princess Cruises and Carnival Corporation

•The transactions were under review at the same time because of the hostile tender offer between Carnival and Princess

•The transactions were reviewed by USA, UK and EU

Introduction

• Why were the transactions of interest of the antitrust agencies?i. complexity of the mergers and importance of the

specific industry,ii. application of many aspects of the Merger

Guidelines,iii. empirical analyses which involved assessments of

booking patterns and price dispersion analyses,iv. the specifics of the review and the key elements of

decision making were detailed to an extent greater than is typical for cases that were not subject to challenge

Background information

•Factors which induced the investigation:i. Competing bids for Princess in late 2001,ii. Carnival made a hostile tender offer for the

shares of Princess,iii. Dual- listing structure- two firms function

as a single operating business but they have separate identities and stock exchange listings,

iv. These companies represented the three of the four largest cruise lines in industry,

Review Process and Competitive Issues

•The U.S review focused mainly on the possible competitive effects of the transaction in North America and on North American customers,

•The EU review of the Carnival- Princess transaction focused principally on the effects on European- based customers for cruises within Europe,

•The UK review of the RCC- Princess transaction focused on the possible effects of the transaction on UK customers

Review Process and Competitive Issues• Issues that were central to final decisions:

i. Whether cruises were a relevant market or this market was much more broader and could included land- based vacations,

ii. Whether the high concentration of the antitrust market was determined as relevant was sufficient to suppose a competitive problem,

iii. Whether the transactions will promote coordination amid cruise lines or maybe allow for unilateral control that might be anticompetitive

iv. Whether the merger will strengthen the ability of cruise lines to price discriminate amid cruisers

Basic Developments- The Merger Guidelines

• The Merger Guidelines was the first methodology for analysis and exposition of the decision used by the FTC (Federal Trade Commission),

• The Merger Guidelines comprises: product and geographic market, coordinated effects, critical loss, diversion analysis as well as entry and expansion,

• The main first- stage question related to the analytics:

i. Were cruises a relevant market, or were they part of a larger vacation market?

Product market definition

•Crucial question: to what extent are land-based vacations substitutes for cruises?

•Method of analysis:▫Small but significant and non-transitory

increase in price test (SSNIP test)▫Price discrimination analysis: price

increase response

Features of the product

•Frequency of cruising•Trends in the types of cruises •Types of customers•On board amenities/activities•Duration of the cruise•Purchase and reservation method

SSNIP method

• Customers reaction to 5-10% price increase of the investigated company for at least one year

• Analysis of profit change of:▫The investigated company▫The hypothetical relevant market

• Relevant market is considered when the sum of profits is larger after the increase

• Estimating the elasticity of demand or „critical loss”

SSNIP method

•Issues with the methodology:▫Examining the merger of A and B, the

results of SSNIP test will differ among firms

▫Reasons for decrease in demand may not be connected to shifts to competition

▫Mixing the idea of market power and relevant market

▫Only price based competition

SSNIP test results

•FTC and EU:▫Estimates of -2.0 price elasticity as a response

to 5% price increase of cruise industry▫Experiment of substantial capacity – no price

decrease▫Marketing and yield management disturb the

results▫Price discrimination analysis: variation

explained by yield management ▫Significant notion: multi-continental routes –

geographical competition▫Relative market analysis: limited to

cruises.

Market share and concentration

• FTC: Analysis of market share changes based on HH index (only lower berth capacity)

• The mergers will result in change of HH index from 2700 to▫ In case of Royal Caribbean – Princess merger:

3700▫ In case of Carnival – Princess merger: 3800

• Either merged entity would control nearly half of North American market

• EU & UK: including „premium market”: no significant concentration issues.

Competitive effects analysis

•The analysis the theory of

▫Unilateral effects: decrease in competition allows the merged entity to exercise the market power

▫Coordinated effects: ability to coordinate the behavior of the whole industry, including not merged companies

Unilateral effects

• Homogeneous market: important role of market shares and capacity

• In differentiated markets the problem arises when goods are close substitutes

• No need for large market shares in differentiated market

• FTC: analysis of profitability of shifting capacity from North America

• Results: no sufficient predictability about the amount needed in order to make the shift profitable

Coordinated effects – pricing • No anti-competetive results in across-the-board

case – moving to selective coordination analysis• Essential factors:

▫ transparency of prices ▫ complexity of price mechanism

• The FTC analysis was conducted in regard to following matters:▫ Complexity of prices▫ Complexity of price discrimination▫ Connection between variation of prices and time-schedule of

cruises▫ Variation of prices due to booking system

Coordinated effects – pricing • The FTC analysis revealed that:

▫The ability of differentiating the cheating scheme from competitive response is extremely low

▫There is no common yield management practice

▫Due to price complexity of price mechanisms it is nearly impossible to coordinate in prices

•Conclusion: The probability of price coordination is very low

Coordinated Effects - Capacity• FTC examined likelihood that

it would be profitable to reduce capacity sufficiently so as to increase prices for cruises

• Empirical analysis: - diversion of sufficient ships to other regions - effects on overall margins from the shift• Conclusion: capacity reductions would have to be

sufficiently large that it would not be profitable

prices

capacity

Coordinated Effects - Capacity• Different opinions about treatment of the

capacity allocation and diversion theory in FTC

• EU and UK conclusion: it would be prohibitively costly for all the ships on order to be cancelled due to possible penalties

Dissenting commisioners

Companies monitored each other’s procisng and behavior

Postmerger concetration would be at a sufficient high levell to create the incentive to coordinate on pricing

Capacity additions could be delayed or reduced and it would cause greater opportunity foe coordinationn and some reductions in capacity

Entry and Expansion/Repositioning

• Focus on the number of new ships for which there were firm commitments with shipyards that could not be delayed without penalties

• Ability of the companies do divert or shift cruise ships

• The FTW concluded that there were substantial penalties associated with canceling contracts and it would take big capacity reduction in order to increase prices

Outcome and subsequent developments

•Common conclusion:

approval of the cruise line mergers under their jurisdiction and review

•EU and UK – focus on customer switching and customer choice of cruises as competitive constrains

•FTC – focus on empirical analyses

•Planned additions of capacity would provide a constraint on the merging parties

•Capacity and pricing trends followed the expectations set out in the decision

•CLIA’s (Cruise Line International Association) overview shows continuation of expansion after merger in terms of number of passengers served (presented on the next page)

• It is difficult to say whether the expansion would have been larger in the absence of the merger

Outcome and subsequent developments

Worldwide geographical Destinations for Cruises since 1987 (Source: 2006 CLIA Overview)

Outcome and subsequent developments

• The growth in passengers on cruises is reflected in growth in capacity (presented above)

Outcome and subsequent developments

2005 2004 2003 2005 2004 2003

Capacity

Number of ships 192 192 184 0.0% 4.3% 4.5%

Lower Berths 245,755 240,401

215,405

2.2% 11.6% 9.5%

Carryings (millions)

Global Passengers 11.5 10.85 9.83 6.0% 10.3% 6.6%

Passengers Residing in United States

9.06 8.31 7.48 9.0% 11.1% 7.0%

U.S. Embarkations 8.61 8.10 7.11 6.3% 13.9% 9.5%

Growth in Number of Barths/Total Capacity: Operating Statistics of the North American Cruise Industry (Source: the Cruise Industry 2005 Economic Summary, CLIA)

•Increase in price after 2003 caused by overall increases in costs associated with fuel

•In this case there is no anticompetitive changes in prices

Fuel prices increase

Overall costs increase

Prices for cruises

increase

Outcome and subsequent developments

Conclusion• Sharp focus on several elements of merger review like

importance of market definition for initial competitive analyses of the merger:

had the market been deemed to broader?

• Overriding importance of industry facts to assessment: nascent stage of the industry new ships were to be added costly reduction of capacity inability to articulate price discrimination markets extreme variability of pricesConclusion: customers would not be harmed by the transaction

Conclusion• Review conducted in various jurisdictions is

valuable because it highlights some similarities in merger review guidelines but differences in approach.

Different perspectives on: the scope of geographical markets the importance of brand and smaller markets based on quality of product market definition competitive effects

The SSNIP test:

a) measures competition based on pricesb) helps in defining the relevant marketc) can be applied by estimating the critical elasticity

of demandd) all of above

Question 1

Which of these sentences is false?

a) Unilateral effects arise where as a result of a merger, due to decrease in competition, the merged entity can profitably excerise the market power

b) The likelihood of coordination behavior in the whole market is connected with coordination effects

c) In differentiated markets, the ability to increase the price due to unilateral effects depends only on market share of the merged entity

d) All of above.

Question 2

Question 3What is the definition of the dual- listed company?

a) Two companies function as a single operating business through a legal equalization agreement, but retain separate legal identities and stock exchange listings

b) A firm lists its equity shares on one or more foreign stock exchange in addition to its domestic exchange

c) Strategic management, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities

d) A business agreement in which the parties agree to develop, for a finite time, a new entity and new assets by contributing equity

Question 4

What does the Merger Guidelines comprise?

a) Product and geographic marketb) Entry and expansionc) Coordinated effectsd) Critical loss and diversion analysise) All above

Is a review of the analyses conducted in various jurisdictions of value to antitrust practitioners?

a) no, because of differences in review guidelines

b) no, because of differences in perspectives on scope of geographic markets

c) Yes, because they agree on importance of brand and smaller markets based on quality product

d) Yes, because it highlights some similarities in merger review guidelines and some differences in approach

Question 5