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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
   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
   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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