GE-Honeywell (2001)

Tom GiblinHadley HeathImran Ramji

Introduction The Players

General Electric http://www.youtube.com/watch?v=fViObqGvIjM&NR=1

Diverse range of products Revenues 2001 exceeded $125 billion

Honeywell http://www.youtube.com/watch?v=rCCJVuUrP-Q

Aerospace and technology Revenues 2001 were approximately $23 billion Nearly half of revenues from aerospace division

Introduction The Players Rivals

International Aero Engines Joint venture between Pratt & Whitney and Rolls

Royce

U.S. DOJ European Commission

20 members Goal: to demonstrate whether or not the

proposed merger would lead to market dominance

Two Sides of the Case Against the Merger

GE and Honeywell have dominant market positions.

Proposed merger would allow bundling of complementary products, lower prices, and an unbeatable advantage.

Ultimate exit of rivals and market dominance of merged firm.

Two Sides of the Case For the Merger

GE does not have market dominance in aircraft engines.

The proposed merger would not lead to bundling.

Without bundling, there would be no exit of rivals and no ultimate market dominance by GE.

Market Dominance The anti-merger case used the following

market shares: GE = 52.5% P&W/IAE = 26.5% RR/IAE = 21%

This combines CFMI’s sales under GE, but splits IAE’s sales into P&W and RR.

Justification: “SNECMA would act jointly with GE as a profit-maximizing entity.”

Market Dominance The pro-merger case: Inaccurate evaluation of GE’s market share If RR and P&W are not grouped as IAE,

SNECMA and GE should not be grouped. On exclusive contract sales with Boeing on

737s, GE has no ability to set prices. Therefore, exclusive contract sales should

not be part of GE’s market power evaluation.

Bundling Pure Bundling

Two products are sold together and are not available separately

Ex. Left and right shoes are not sold separately

Tying Product 1 is sold by itself, but product 2 is available only

with product 1 Ex. NFL season pass is available only with satellite TV

Mixed Bundling Two items sold separately or together, but together they

are sold at a discount price Ex. A combo meal at a fast food restaurant

Bundling Cournot

Two monopolists act independently, but together can lower prices and earn more money. Ex. Zinc and copper make brass.

Assumptions: No other firms in the market Firms set a single price to all consumers

Bundling Expansion of Cournot’s Model

Firms A1 and B1 produce good 1 Firms A2 and B2 produce good 2

This accounts for other firms in the market

Bundling Case 1: All firms act independently Results: All firms charge a price of 1 All firms make a profit = 1/2

Bundling Case 2: Bundle vs. Bundle Results: Prices fall by 50% Profits fall by 50%

Bundling Case 3: Bundle against Components Results: Firm A’s profits go from 1 to 0.91 Uncoordinated B firms’ profits go from 1 to

0.32

Mixed bundling Firm A sells bundles at 19% discount Best response of B firms is to lower

component prices This gives firm A an advantage

Market share = 55.4% Rivals’ profits fall by 21%

The Anti-Merger Case Rolls Royce presented this type of

bundling as most appropriate to this case. The EC used this model, along with an

expected increase in market size, to conclude that GE would have an economic incentive to use mixed bundling.

Considerations Existence of competitors

Accounted for in expansion of Cournot model Number of products

More products greater incentive to bundle Total market demand

Greater elasticity of demand greater incentive to bundle

Asymmetry of products More symmetry greater incentive to bundle Avionics ($100,000) and jet engines ($15 million)

Price Negotiation Cournot Assumption: One price for all. Consumers in this case are powerful. Price discrimination (not a single price)

Timing

Engines are purchased before avionics Once engine competition is won, giving a

discount on a bundle would be no different than giving an avionic discounts directly

Solution would be to promise discount on avionics before purchase of engine Wouldn’t work in avionics industry because

negotiated prices

Exit by Rivals The Commission’s belief that the merger

would lead to rival exiting is questionable Rival stock increased when merger announced

Investors predict the merger will benefits rival companies

Long term contracts Typical plane is on the market 25 years Competitors have 2/3 share of the engines on next

generation planes

Exit by Rivals Allied Signal and Honeywell merger

1999 merger between two large avionic component firms

Despite widespread bundling little effect on the market

Hypocrisy of Commission’s decision Argued Allied Signal-Honeywell bundling

effects were slow to arise Argued effects of GE-Honeywell merger would

lead to quick exit of rivals

Policy Prescriptions What possible regulations should be

enacted if the Cournot effect is large? None? – prices fall, social welfare increases EC worried about long term market exit leading

to market dominance and price increase There are a few questions to be asked

before deciding on any policies to stop possible bundling

Policy Prescriptions Is there an incentive to bundle?

Not really What is the immediate gain to consumers

from lower prices? What will be the impact on competitors? How long do we expect lower prices to

persist? If the rivals exit, what is the expected

harm?

Policy Prescriptions Nalebuff argues that the EC stopped after

question 1 In addition, they focused on market

competitiveness and did not examine the potential positive trade-offs of bundling Long-run harm vs. Short-run gain

This is not an area in which antitrust authorities should be involved

Remedies The firms could agree to not bundle their

products They would have to provide an itemized list of

individual prices However, the EC rejected this because

they preferred structural solutions over behavioral ones Even though this solution would not be difficult

to enforce

Conclusion European Commission blocked the merger According to the author

Abandoned original model, but did not replace flawed model

Used dynamic theory of predation Did not have enough support Backed away from bundling theory, but still

concluded that bundling was a reason to block merger

Discussion Two sides of the case… European Commission

Biased? Politics and “National Champions”

Author, Barry Nalebuff Biased? Economic expert for GE-Honeywell in their

presentation to the European Union Merger Task Force.

Post Script2005 Appeal to European Court of First

Instance (CFI) CFI rejected bundling argument, and was not

persuaded that GE would act anti-competitively.

But, CFI denied the appeal because the merger would create market concentration in:

Small marine gas turbines Engines for large regional jets Corporate jet aircraft engines

Even if appeal granted, it was too late.

The End