The Consideration of Economies in Merger Cases

Abstract

In recent merger cases under section 7 of the Clayton Act, the courts have taken the position that improvements in efficiency produced by the merger cannot be given consideration as a defense if the merger also produced anticompetitive effects. In fact, the existence of economies has usually been given added weight in the reasoning for disallowing merger. For example, the presence of economies in advertising was used in the reasoning which prohibited the merger of Procter and Gamble with Clorox.' While the courts have used the possibilities of economies as reasons for disallowing mergers, the Justice Department has accepted the notion that some mergers can be justified by cost savings even though there may be anticompetitive effects as well. According to Justice Department guidelines on horizontal mergers, different standards are used for highly concentrated markets where the four largest firms have 75 percent or more of industry output than for less highly concentrated markets where the four largest firms have less than 75 percent.2 The difference suggests implicit welfare tradeoffs in effect in these guidelines between anticompetitive effects and the possible benefits of economies for different market structures, but no clue is provided as to the criteria used in developing these tradeoffs. The view that economies can be used to offset anticompetitive effects also was expressed by Justice Harlan in his concurring opinion in the Clorox case. He writes, Where the case against the merger rests on the probability of increased market power the merging companies may attempt to prove that there are countervailing economies reasonably probable which should be weighed against the adverse effects.3 But again, while economies have been suggested for consideration in merger cases, there are no criteria given for judging at what point the anticompetitive effects are outweighed by the cost savings. In the following sections, a model will be developed which will attempt to determine the relevant tradeoff conditions. An appraisal of firm strategy in the tradeoff situation is also made. This model develops further an initial formulation constructed by 0. E. Williamson who concluded, Since a relatively large percentage increase in price is usually required to offset the benefits from a 5 to 10 percent reduction in average costs, the existence of economies of this magnitude is sufficiently important to give the antitrust authorities pause before disallowing such a merger.4 However, Williamson's conclusion is unwarranted * This paper was written at the Center for Research in Government Policy and Business at the University of Rochester. The author received helpful comments from Walter Oi and James Ferguson.