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10 Antitrust 23 (1995-1996)
Mergers with Differentiated Products

handle is hein.journals/antitruma10 and id is 81 raw text is: A R T I C L E S * A N D * F E A T U R E S Mergers with Differentiated Products by Carl Shapiro T he antitrust treatment of hori- zontal mergers by the Justice Department and the Federal Trade Commission is one of the most well developed and closely scru- tinized areas of antitrust law. The enforcement agencies have extraordinary experience reviewing mergers and the merger bar is no less sophisticated. From my perspective as an antitrust economist, this sophistication permits merger enforcement to be at the cutting edge when it comes to incorporating econom- ic learning into competition policy. The 1992 DOJ and FTC Merger Guidelines have placed important atten- tion on the unilateral effects of a merg- er, i.e., the tendency of a horizontal merg- er to lead to higher prices simply by virtue of the fact that the merger will eliminate the direct competition between the two merging firms, even if all other firms in the market continue to compete independently. Unilateral effects are con- trasted to coordinated effects, i.e., the danger that the merger will lead to collu- sion between the merged entity and its remaining rivals. This article discusses some of the methods used by the Antitrust Division to analyze unilateral effects in mergers involving differentiated products. While the methods outlined here do not replace the standard steps of defining markets and measuring market shares and con- Carl Shapiro is the Deputy Assistant Attorney General in charge of economics at the Antitrust Division, U.S. Department of Justice. He is currently on leave from his position as the Transamerica Professor of Business Strategy at the Haas School of Business and Professor of Economics in the Economics Department at the University of California at Berkeley. Dr Shapiro thanks Joseph Kattan, George Rozanski, Steve Salop, Greg Werden, and Robert Willig for valuable comments on this paper centration, they can significantly supple- ment those steps. To place the topic in context, it is instructive to compare mergers with homogeneous products to those involving differentiated products. For homoge- neous products, the traditional structural approach of defining markets and mea- suring market shares and market concen- tration has deep roots, along with a rich empirical tradition linking market struc- ture to performance. In these markets, it is both natural and appropriate to count up each firm's unit or dollar sales, or capacity, to measure market shares, and to make inferences about a merger's effects based on market structure, includ- ing the HHI of market concentration. The danger of collusion is surely related to market concentration (although quanti- fying this relationship is difficult), and economists' primary model of non-coop- erative oligopolistic competition among manufacturers of homogeneous goods relates market structure to performance.' Although economists continue to debate the empirical relationship between mar- ket structure and performance, there exists a solid foundation for using market structure prominently in evaluating hori- zontal mergers involving homogeneous goods.2 This traditional structural approach towards merger policy, which dates back to the 1960s but has been refined as just described, is less attractive for differenti- ated products. When products are highly differentiated, concerns about coordinat- ed effects may be secondary to concerns about unilateral effects. And, to assess unilateral effects most accurately, it is highly desirable to go beyond industry concentration measures to look directly at the extent of competition between the merging brands. This is especially true if competition is localized, i.e., if some brands are especially close substitutes for other brands due to their product charac- teristics or image. To put this differently, at the Antitrust Division we must con- cern ourselves with the prospect that the prices for one or more brands sold by the merging parties will rise after the merger, even if prices do not uniformly rise throughout the relevant market. Such concerns are not present, or are far less pronounced, in markets for homogeneous products. The danger that a merger of Brands A and B will cause anticompetitive price increases for one or both of these brands is greatest if the merging brands are close, in the sense that many customers using one brand consider the other brand their second choice. Ultimately, unilateral anticompetitive effects are based on the following logic: As the price of Brand A rises, some customers will shift from Brand A to Brand B. Prior to the merger, these customers would be lost to the firm owning Brand A. After the merger, this same firm owns Brand B and thus does not lose these customers. As a result, the price increase is more profitable to the merged entity. To explicate this logic, consider a merger between Brands A and B. The likely post-merger price increase for Brand A is driven by two variables, each of which we have a good chance of observing with a proper investigation. The first I call the Diversion Ratio from Brand A to B. This Diversion Ratio is the answer to the following question: If the price of Brand A were to rise, what frac- tion of the customers leaving Brand A would switch to Brand B? The second variable is the Gross Margin - the per- centage gap between price and incre- mental cost - for Brand B.3 Roughly speaking, a valuable index of the poten- tial anticompetitive unilateral effects is obtained by multiplying the Diversion Ratio by the Gross Margin. Any danger of a unilateral price increase may be alle- viated by product repositioning, entry, or efficiencies. Nonetheless, the Diversjgn Ratio and the Gross Margin are the key variables in the demand-side portion of the analysis. S PRING 1996 23

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