Downstream Mergers Research Articles

Horizontal Mergers and Supplier Power

Supplier market power—such as the ability of branded goods suppliers to dictate terms to retailers—is an important feature of many markets. We show that supplier power can counteract the effects of downstream mergers on consumer prices where there are two-part contracts. This is because greater market power allows suppliers to set contracts that internalise partially the impact of the merger on downstream prices. Post-merger, the supplier reduces the per-unit price at which it supplies the merged downstream firms, with the aim of maintaining total industry profitability—and then recoups the profits via a larger fixed fee. We modify the standard upward pricing pressure (UPP) formula to account for the supplier’s response to a horizontal merger in the downstream market, while preserving much of the simplicity of the standard approach.

Welfare Improving Horizontal Mergers in Successive Oligopoly*

We study welfare effects of horizontal mergers in a successive oligopoly model with general demand. We find that downstream mergers can increase welfare if they reduce input price. In an environment with asymmetric upstream firms, lower input price reallocates some input production from cost‐inefficient upstream firms to cost‐efficient ones. In the presence of fixed cost and free entry, lower input price rationalizes the upstream sector and decreases average cost of production for each upstream firm. Both reallocation and rationalization can improve welfare. We identify necessary and sufficient conditions for welfare‐improving horizontal mergers and explore how demand curvature, market structure and Herfindahl index (in case of asymmetric firms) affect these conditions. The possibility of consumer surplus improvement and upstream mergers is also explored.

Vertical Mergers in a Model of Upstream Monopoly and Incomplete Information

We examine the role of private information on the impact of vertical mergers. A vertical merger can improve the information that is available to an upstream monopolist because, after the merger, the monopolist can observe the cost of its downstream merger partner. In the pre-merger world, because the costs of the downstream firms are private information, the monopolist has incomplete information and cannot implement the monopoly outcome: The expected pre-merger equilibrium price of the downstream product is lower than the monopoly price. After a vertical merger, the equilibrium input price that is charged to the downstream rival can either increase or decrease -- depending on whether the downstream merger partner’s cost is low or high, respectively. However, in all cases the equilibrium price of the downstream product increases to the monopoly price. Therefore, the merger leads to consumer harm even when it leads to a reduction in the input price. The merged firm, however, cannot extract all of the monopoly profit: The merger causes production inefficiency (when the downstream rival has a relatively small cost advantage) and the downstream rival still earns an information rent (when it has a relatively large cost advantage). These results also have implications for vertical merger policy.

Horizontal mergers and supplier power

Supplier power, such as the ability of branded goods suppliers to dictate terms to retailers, is an important feature of many markets. We show that supplier power can counteract the effects of downstream mergers on consumer prices where there are two-part contracts. This is because greater market power allows suppliers to set contracts that internalise partially the impact of the merger on downstream prices. Post-merger, the supplier reduces the per-unit price at which it supplies the merged downstream firms, with the aim of maintaining total industry profitability. We modify the standard upward pricing pressure (UPP) formula to account for the supplier's response to a horizontal merger in the downstream market while preserving much of the simplicity of the standard approach.

Post-merger internal organization in multitier decentralized supply chains

This paper analyses the effects upon firms and consumers of horizontal mergers in a multitier decentralized supply chain with a finite number of players in each tier, when firms may opt for two different post-merger internal organization forms: multidivisional, in which separate divisions are kept, or traditional, with cost synergies. To this effect, we develop and solve a formal game theory-based Cournot model. The main results are: independently of the tier in which the merger takes place, higher synergies do not always lead to higher consumer welfare; despite the fact that the proposal of a traditional merger reveals significant cost savings consumer welfare may still decrease with the merger; traditional downstream mergers tend to be more profitable than traditional upstream ones; multidivisional mergers are always profitable.

Contract Unobservability and Downstream Competition

Problem definition: In this paper, we consider a supply chain with a manufacturer and two retailers who are contracted through wholesale prices or two-part tariffs. We depart from the existing literature by assuming that contract terms between the manufacturer and a retailer are not observed by the rival retailer. Academic/practical relevance: Although the existing literature typically assumes that they are common knowledge in the market, contract terms may not be observed by rival retailers under certain circumstances. This paper contributes to the literature by studying the effect of contract unobservability on supply chain performance. Methodology: We use game-theoretical methods to find the equilibrium. When there are multiple equilibria, we adopt passive beliefs as an equilibrium-refinement criterion. Results: We find that certain established results regarding observable supply chain contracts do not always apply when those contracts become unobservable to competing retailers. In particular, compared with when using two-part tariff contracts, the manufacturer may benefit from using wholesale-price contracts when contract terms are unobservable. Moreover, the total industry profit may increase under wholesale-price contracts. Managerial implications: Our results offer an alternative explanation for the popularity of wholesale-price contracts and suggest that members of the supply chain must take unobservability into account when selecting the right contracts. We also offer new insights into buyback contracts and downstream mergers under unobservable contracts.

Downstream mergers in vertically related markets with capacity constraints

Motivated by a recent merger proposal in the French outdoor advertising market, we develop a model in which firms are initially endowed with some advertising capacities and compete on two fronts. First, firms compete to acquire additional advertising capacities on an upstream market; a first stage modeled as a second-price auction with externalities. Second, those firms, privately informed on their own costs, use their capacities on the downstream market to supply advertisers whose demand is random; a second stage modeled by means of mechanism design techniques. We study the linkages between the equilibrium outcomes on both markets. When a firm is endowed with more initial capacity, through the acquisition of a competitor for instance, whether it becomes more or less eager to acquire extra capacity on the upstream market depends a priori on fine details of the downstream market. Under reasonable choices of functional forms, we demonstrate that a downstream merger does not create any bias in the upstream market towards the already dominant firm.

Contract Unobservability and Downstream Competition

In this paper, we consider a supply chain with a manufacturer and two retailers who are contracted through wholesale prices or two-part tariffs. We depart from the existing literature by assuming that contract terms between the manufacturer and a retailer are not observed by the rival retailer. While the existing literature typically assumes that they are common knowledge in the market, contract terms may not be observed by rival retailers under certain circumstances. This paper contributes to the literature by studying the effect of contract unobservability on supply chain performance. We use game theoretical methods to find the equilibrium. When there are multiple equilibria, we adopt passive beliefs as an equilibrium refinement criterion. We find that certain established results regarding observable supply chain contracts do not always apply when those contracts become unobservable to competing retailers. In particular, compared to when using two-part tariff contracts, the manufacturer may benefit from using wholesale price contracts when contract terms are unobservable. Moreover, the total industry profit may increase under wholesale price contracts. Our results offer an alternative explanation for the popularity of the wholesale price contracts and suggest that members of the supply chain must take unobservability into account when selecting the right contracts. We also offer new insights into buyback contracts and downstream mergers under unobservable contracts.

WELFARE EFFECTS OF DOWNSTREAM MERGERS AND UPSTREAM MARKET CONCENTRATION

We consider a dominant upstream firm selling an input to several downstream firms through observable, non-discriminatory two-part tariff contracts. Downstream firms can alternatively buy the input from a less efficient source of supply. In this setting, we analyze the relationship between the competitive effects of downstream mergers and the level of concentration at the upstream level. We show that a downstream merger leads to lower wholesale prices. This translates into lower final prices only when the upstream market is sufficiently concentrated. In this case, a downstream merger tends to be both procompetitive and profitable.

Effects of upstream and downstream mergers on supply chain profitability

This paper studies the implications of upstream and/or downstream horizontal mergers on suppliers, retailers and consumers, in a bilateral oligopolistic system. We especially focus on market power and operational synergy benefits that such mergers engender. Starting with a benchmark pre-merger scenario in which firms compete on prices at each level, we find that the above two consequences individually almost have opposite effects on the merging and non-merging firms’ optimal decisions/profits after a merger. Furthermore, even though the effects of upstream and downstream mergers are different, the vertical supply chain partners will always try to reduce their losses if the market power effect dominates, but will take actions that improve their profits if the synergy effect is stronger. The above results are robust enough to hold even when taking into account intra-brand competition among retailers.

Horizontal Mergers in the Presence of Vertical Relationships

We study welfare effects of horizontal mergers under a successive oligopoly model and find that downstream mergers can increase welfare if they reduce input prices. The lower input price shifts some input production from cost-inefficient upstream firms to cost-efficient ones. Also, the lower input price makes upstream entry less attractive, reduces the number of upstream entrants, and decreases their average costs in the presence of fixed entry costs. We identity necessary and sufficient conditions for a reduction in input prices and welfare-improving horizontal mergers under a general demand function. Qualitative nature of our findings remains unchanged for upstream mergers.

Losses from Horizontal Merger: an Extension to a Successive Oligopoly Model with Product Differentiation

This paper generalizes the model of Salant et al. (1983; Quarterly Journal of Economics, Vol. 98, pp. 185–199) to a successive oligopoly model with product differentiation. Upstream firms produce differentiated goods, retailers compete in quantities, and supply contracts are linear. We show that if retailers buy from all producers, downstream mergers do not affect wholesale prices. Our result replicates that of Salant's, where mergers are not profitable unless the size of the merged firm exceeds 80 per cent of the industry. This result is robust to the type of competition.

UPSTREAM HORIZONTAL MERGERS AND (THE ABSENCE OF) RETAIL PRICE EFFECTS

The article explores the retail price effects of upstream and midstream horizontal mergers. It questions the prevailing assumption in merger review according to which such transactions will have similar effects on retail price as that of downstream horizontal mergers. The analysis illustrates how a sophisticated profit-maximizing merged entity may find it more profitable to enter into efficient contracts that seek to maximize the profit of the distribution channel, and so ensure that retail prices are not raised. The merged entity uses its market power and improved bargaining position to extract as much of that profit as possible from the retailer. We therefore argue that one cannot simply assume a direct link between the creation of market power upstream following a merger transaction, and the subsequent increase in retail prices. An analysis of the effects of upstream mergers on retail prices should call for a more nuanced appraisal that distinguishes the transfer of wealth within the operators in the distribution chain from the possible price impacts on final consumers.

VGUPPI: Scoring Unilateral Pricing Incentives in Vertical Mergers

One key concern in vertical merger cases is input foreclosure. Input foreclosure involves raising the costs of competitors in the downstream market, which could in turn increase the sales and profits of the downstream merger partner. In this article, we explain how the upward pricing pressure resulting from unilateral incentives following a vertical merger can be scored with vertical Gross Upward Pricing Pressure Indices (“vGUPPIs”). These vGUPPIs are derived from an economic model where upstream firms sell differentiated inputs to downstream firms which in turn sell differentiated products. There are separate vGUPPIs for the upstream and downstream merging firms and, in addition, vGUPPIs for the rivals of the downstream firm whose costs are raised. Our model also explains how the vGUPPIs can account for potential input substitution and merger-specific elimination of double marginalization. These vGUPPIs are analogous to the horizontal GUPPIs commonly used for the evaluation of unilateral effects in horizontal mergers. Like the horizontal GUPPIs, the vGUPPIs provide more direct evidence on unilateral pricing incentives than other metrics commonly carried out in vertical merger cases, such as concentration indices and vertical arithmetic. They also are simpler to implement and require less data than merger simulation models.The Appendix:The Appendix supplements the technical analysis in the Moresi and Salop Vertical GUPPI article published in the Antitrust Law Journal.The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2368872

DOWNSTREAM MERGERS AND UPSTREAM INVESTMENT*

In this paper, we show that downstream mergers increase the incentives of an up-stream firm to invest in cost-reducing R&D. The upstream firm revenues increase with industry profits, which in turn increase with concentration downstream and this explains the positive link between concentration and investment. This effect is so important that it outweights the negative effect on prices due to lower competition. Therefore, in our context, horizontal mergers are pro-competitive.

Downstream merger and welfare in a bilateral oligopoly

I analyse the effects of a downstream merger in a differentiated oligopoly when there is bargaining between downstream firms and upstream agents (firms or unions). Bargaining outcomes can be observable or unobservable by rivals. When competition is in quantities, upstream agents are independent and bargaining is over a uniform input price, a merger between downstream firms may raise consumer surplus and overall welfare. However, when competition is in prices or the upstream agents are not independent or bargaining is over a two-part tariff or bargaining covers both the input price and the level of output, the standard welfare results are restored: a downstream merger always reduces consumer surplus and overall welfare.

Horizontal Acquisitions and Buying Power: A Product Market Analysis

This paper examines whether horizontal acquisitions create buying power by studying the effect of a broad, inter-industry sample of horizontal acquisitions on the selling price of supplier industries. We find that supplier industries that are more dependent on the merging industry for buying its output suffer bigger declines in selling prices after the downstream acquisition. Moreover, dependent suppliers and suppliers that suffer more adverse price changes after downstream consolidation undertake significantly more horizontal acquisitions of their own in the following two (three) years. This suggests that consolidation in supplier industries is partly motivated by the need to countervail buying power created by the downstream merger. Additional tests indicate that more dependent supplier industries have lower profit margins in the two (three) following downstream consolidation but this poor performance is mitigated if supplier industries subsequently undertake horizontal acquisitions of their own. To our knowledge, this is the first paper to provide formal evidence that horizontal acquisitions hurt selling prices and profit-margins in supplier industries causing supplier industries to engage in countervailing acquisitions.

Upstream Mergers, Downstream Mergers, and Unionized Oligopoly

In a duopolistic industry characterized by unobserved vertical contracts, and where there are two vertical chains with two upstream manufacturers selling to two downstream retailers, we show that the wage is jointly determined by the union and the firm through bargaining and that the wage bargaining power of the union under different regimes, regardless of whether an upstream merger or a downstream merger takes place, will determine the degree of the welfare damage effect. It is also found that an upstream or a downstream monopolist, regardless of whether it possesses the right to franchise, will exert no impact on the equilibrium outputs and total profit, and will only affect the distribution of profits within the vertical chain.

Downstream merger with upstream market power

We examine how a downstream merger affects input prices and, in turn, the profitability of a such a merger under Cournot competition with differentiated products. Input suppliers can be interpreted as ordinary upstream firms, or trade unions organising workers. If the input suppliers are plant-specific, we find that a merger is more profitable than in a corresponding model with exogenous input prices. In contrast to the received literature, we find that it can be more profitable to take part in a merger than being an outsider. For firm-specific input suppliers, on the other hand, results are reversed. We apply our model to endogenous merger formation in an international oligopoly, and show that the equilibrium market structure is likely to be characterised by cross-border merger.

Downstream Merger with Oligopolistic Input Suppliers

We examine how a downstream merger affects input prices and, in turn, the profitability of a such a merger under Cournot competition with differentiated products. Input suppliers can be interpreted as ordinary upstream firms, or trade unions organising workers. If the input suppliers are plant-specific, we find that a merger is more profitable than in a corresponding model with exogenous input prices. In contrast to the received literature, we find that it can be more profitable to take part in a merger than being an outsider. For firm-specific input suppliers, on the other hand, results are reversed. We apply our model to endogenous merger formation in an international oligopoly, and show that the equilibrium market structure is likely to be characterised by cross-border merger.