RBB | Economics

Economic Analysis and the new EC Merger Notice

Derek RidyardRBB Economics

derek.ridyard@rbbecon.com

30 March 2004

RBB | Economics

Overview

Economic analysis under the Notice:

1. Non-coordinated effects2. Coordinated effects3. HHI thresholds

4. Impact of procedural/institutional changes on substantive analysis

RBB | Economics

Classification of competition concerns

Notice creates a new category of concern to fill the perceived “gap” under the old regime.

Historic practice

Draft Notice Final Notice

Single firm dominance

Paramount market position Non-coordinated

effects“the gap” Non-collusive oligopoly

Collective dominance

Coordinated effects

Coordinated effects

RBB | Economics

1.1 Non-coordinated effects

• Measures the impact that a merger has on incentives to keep prices low

• Encompasses dominance and other “close competitor” cases in differentiated product markets

• Some examples (old and new)– Scott/Kimberley Clark– Volvo/Scania– GE/Instrumentarium

RBB | Economics

1.2 Illustration of non-coordinated effects

Model Sales Share Implied Sales Gain

Actual Sales Gain

Ford 80,000 40% +5,000 +1,000

VW 40,000 20% +2,500 +1,500

BMW 40,000 20% +2,500 +7,500

Mercedes 40,000 20% -10,000 -10,000

RBB | Economics

1.3 Evidence of the gap?

• Lloyds TSB/Abbey National?• FTC baby foods merger?

John Vickers (2004):

“numerous mergers that could seriously jeopardise competition without crossing the threshold of dominant market power.”

RBB | Economics

1.4 Non-coordinated effects – the role of economic theory

• Draft Notice relied explicitly on Bertrand and Cournot models

• See DG COMP study:– “A merger between competitors increases market

power .. leading .. to higher prices and lower output”– “HHIs can be considered a good indicator [of the

effect of a merger on price]”• Same theory is embedded in merger simulation models

All merging firms are “guilty” – but are they guilty enough to justify prohibition?

RBB | Economics

1.5 Forgotten role of supply-side effects

• Unilateral effect theories rely on passive demand-side effects

• They ignore elements such as:

– strategic buyer power

– entry and investments by rivals

– underlying market dynamics

• See OFT 1999 oligopoly study for an antidote

RBB | Economics

1.6 Non-coordinated effects - conclusions

• Notice remains heavily influenced by simple theoretical models

• Logic of the Notice suggests a move towards greater intervention

• But costs of extending powers to analyse non-coordinated effects have been ignored

• The real impact is:– Greater DG COMP discretion– Less predictability

RBB | Economics

2.1 Coordinated effects – stage 1

Identify focal point for co-ordination:

• Price

• Customer / territory sharing

• Output / Capacity

RBB | Economics

2.2 Coordinated effects - stage 2

Evaluate stability of coordination in terms of:

• Transparency

• Availability of credible enforcement mechanism

• Resilience to external shocks and fringe competition

RBB | Economics

2.3 Coordinated effects- stage 3

What changes as a result of merger?

• Creation or strengthening?• Importance of eliminated factors• Impact on asymmetries and incentives

Surprisingly, this critical stage is not properly addressed in the Notice

RBB | Economics

3.1 HHI “safe harbour” thresholds in the Notice

HHI

Delta

< 1,000 >1,000

<2,000

>2,000

<150 ?

>150

>250

Safe

harbour

RBB | Economics

3.2 “The safe harbour is mined!”

HHI safe harbours have 6 caveats:

• Potential competition

• One merging firm is an innovator

• Cross-shareholdings

• Merger takes out a “maverick” player

• Past or ongoing coordination is evident

• One merging firm has >50% share

RBB | Economics

3.3 HHIs and the US Guidelines

EC HHIs are modelled on US Guidelines, but in a study of US practice:– Median HHI for unchallenged cases is 2,500– Median HHI for challenged cases >5,000– Lowest challenged HHI >2,000 since 1985

(From Scheffman, Coate and Silva, FTC)

RBB | Economics

Summary on Notice

• The Notice has:– confirmed the role of economic analysis– created a sophisticated debate on merger

enforcement

• But:– it continues to shows undue dependence on

theoretical models– creates very wide discretion – and can only be part of the story …

RBB | Economics

4.1 Process changes

Chief Economist’s Office

Tri-partite meetings

CFI Judgments

Hypothesis testing

Internal Review

RBB | Economics

4.2 Hypothesis - testing

• CFI Judgment criticisms are fundamentally about empirical analysis

• Draft Notice does not help here – even adds to the problem

Consequences:

- much more work for parties

- a better chance to prove case

RBB | Economics

4.3 Chief Economist’s office

• Professor Röller: leading academic with empirical orientation

• Assembling dedicated team of economists

Consequences:

– another audience for Oral Hearings

– greater sophistication in analysis

RBB | Economics

4.4 Tri-partite meetings

• Provision for a crowded schedule during Phase I and II

• Consequences:

– Greater scrutiny of 3rd parties?

– More work for parties

– More transparency

RBB | Economics

4.5 Internal review panel

• Another independent check on case team

• Some notable influence already

Consequences:

– chance to stop the juggernaut in its tracks

RBB | Economics

Conclusion – the new regime

• Changes signal a new era in ECMR enforcement

• The key areas to watch will be:

– controlling DG COMP discretion and reliance on untested economic theory

– maintaining the genuine scrutiny that has arisen from CFI Judgments