Capacity Constraints and Horizontal Merger Effects

• Author: Jay Ezrielev
• DOI: 10.1177/0003603X18807805
• Published date: 01 December 2018
• Date: 01 December 2018

Article
The Antitrust Bulletin
2018, Vol. 63(4) 444-454
Capacity Constraints and
ª The Author(s) 2018
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Horizontal Merger Effects
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DOI: 10.1177/0003603X18807805
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Jay Ezrielev*
Abstract
This article examines how capacity constraints affect horizontal mergers. Binding capacity constraints
for merging firms may mitigate merger price effects, but capacity constraints for nonmerging firms may
either amplify or mitigate such effects. The presence of capacity constraints for both the merging and
nonmerging firms in a market further complicates the analysis of merger price effects. Capacity
constraints may also confound the relationship between market concentration and merger price
effects. In addition, capacity constraints affect market definition analysis and analytical tools such as
merger simulation and upward pricing pressure indexes. Analyzing the effects of capacity constraints
on mergers continues to be a challenge for merger reviews.
Keywords
antitrust, mergers, competitive effects, capacity constraints
I. Introduction
In many industries, firms face capacity constraints that affect their output and pricing decisions. For
example, gasoline refiners and mining firms have finite production capacities that may limit their
output levels. Capacity constraints also have significant antitrust implications in terms of their effects
on mergers and merger analysis. Yet capacity constraints have received relatively little attention from
the courts or antitrust enforcement agencies. Two recent merger cases delved into the issue of capacity
constraints. The UK’s Competition and Markets Authority (CMA) considered the effects of capacity
constraints in its Pure Gym – The Gym decision.1 The issue of capacity constraints also came up in the
1. See Anticipated Combination of Pure Gym Limited and The Gym Limited, COMPETITION AND MARKETS AUTHORITY at { 9, 141–
45 (June 26, 2014), https://assets.publishing.service.gov.uk/media/5411599fed915d12db00000b/Pure_Gym-The_Gym-full_
text_decision.pdf. The Pure Gym – The Gym case involved a proposed merger of two gym chains in the UK. The CMA found
that the merger may be expected to result in a substantial lessening of competition in a number of local area where the
merging parties competed against each other. The parties claimed that, because their gyms are at or near capacity in a number
of local areas, their gyms did not significantly compete against each other in these areas. The CMA acknowledged that in
some cases capacity constraints may limit the extent of pre-merger competition between merging parties, which may also
*Federal Trade Commission, Washington, D.C., USA
Corresponding Author:
Jay Ezrielev, Federal Trade Commission, 600 Pennsylvania Avenue, NW, Washington, D.C. 20580, USA.
Email: jezrielev@ftc.gov

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Ezrielev
445
Federal Trade Commission’s recent challenge of the merger between Penn State Hershey Medical
Center and Pinnacle Health System.2
The U.S. Department of Justice/Federal Trade Commission Horizontal Merger Guidelines (2010)
(hereafter Horizontal Merger Guidelines) and the UK’s Merger Assessment Guidelines (CC2/
OFT1254) discuss how capacity constraints by nonmerging firms may amplify merger price effects.3
The Horizontal Merger Guidelines also explain how a merger where one of the merging firms has
excess capacity may likewise lead to competitive harm.4 However, capacity constraints have other
significant effects on mergers that are not described in the Horizontal Merger Guidelines. In fact,
capacity constraints can, in some cases, mitigate merger price effects.
In this article, I examine how capacity constraints affect horizontal mergers and merger analysis. I
show that in some circumstances, binding capacity constraints of merging firms may mitigate or
eliminate any anticompetitive harm from horizontal mergers.5 I also explain that binding capacity
constraints of nonmerging firms may exacerbate the anticompetitive effects of horizontal mergers, but
in some cases also mitigate such effects. In markets where capacity constraints are binding for both
merging and nonmerging firms, the capacity constraints have ambiguous effects on postmerger prices.
Thus, assessing merger price effects of capacity constraints may necessitate an analysis of the specific
circumstances of the markets.
My discussion of the effects of capacity constraints in this article applies to both homogenous and
differentiated goods markets. The production of differentiated goods can likewise be constrained by
capacity. For example, hospitals offer differentiated goods and services but also face potential capacity
constraints. My review of the effects of capacity constraints is limited to static and single market
competition models. Although capacity constraints have other effects under dynamic and multimarket
competition models,6 I do not discuss such effects here.
mitigate mergers’ competitive effects. However, the CMA found that in the case of the Pure Gym – The Gym merger, the
parties still competed for new customers premerger (even in the presence of capacity constraints) to replace the customers
who leave the gyms as a result of customer churn.
2. See David J. Balan, Patrick DeGraba, & Jason O’Connor, Horizontal Mergers with One Capacity Constrained Firm Increase
Prices (April 2018), https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name¼IIOC2018&paper_id¼346.
3. U.S. DEPT. OF JUSTICE & FED. TRADE COMM’N, HORIZONTAL MERGER GUIDELINES at § 6.3 (2010), https://www.ftc.gov/sites/
default/files/attachments/merger-review/100819hmg.pdf (hereinafter HORIZONTAL MERGER GUIDELINES); and Competition
Commission & Office of Fair Trading (CC2/OFT1254), Merger Assessment Guidelines at §§ 5.2.26, 5.4.11 (Sep.
2010),https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/284449/
OFT1254.pdf.
4. HORIZONTAL MERGER GUIDELINES, supra note 3, § 6.3.
5. A binding constraint is a constraint that reduces economic output. In contrast, a nonbinding constraint does not reduce
economic output. For example, suppose that a firm wants to produce 10 units of output and has capacity to produce 12 units.
In this case, the capacity constraint is nonbinding because it does not prevent the firm from producing its desired output
quantity. But if the capacity were 8 instead, it would be binding because it would reduce the firm’s output from 10 to 8. In
practice, capacity constraints may not be hard (such as limiting the output not to exceed 8), but soft. Under a soft capacity
constraint, a firm would be able to produce more than 8 units of output, but doing so may be very expensive. In this case, the
marginal cost of output above 8 units may be so high that the firm would find it uneconomic to produce at that level. A soft
capacity constraint may thus be binding because it can cause output to be smaller than in the absence of the constraint.
6. See Sandro Shelegia, Is the Competitor of My Competitor also My Competitor? 21 J. ECON. & MANAGE. STRAT. 927 (2012);
Gautam Gowrisankaran, A Dynamic Model of Endogenous Horizontal Mergers, 30 RAND J. ECON. 56 (1999); Carl Davidson
& Raymond Deneckere, Excess Capacity and Collusion, 31 INT. ECON. REV. 521 (1990); Olivier Compte, Frederic Jenny, &
Patrick Rey, Capacity Constraints, Mergers and Collusion, 46 EUR. ECON. REV. 1 (2002); Jiawei Chen, The Effects of Mergers
with Dynamic Capacity Accumulation, 27 INT. J. INDUS. ORGAN. 92 (2009); Jeremy I. Bulow, John D. Geanakoplos, & Paul D.
Klemperer, Multimarket Oligopoly: Strategic Substitutes and Complements, 93 J. POL. ECON. 488 (1985); Guy Arie, Sarit
Markovich, & Mauricio Varela, On the Competitive Effects of Multimarket Contact, 100 EUR. ECON. REV. 116 (2017); and JAY
EZRIELEV, MERGERS UNDER CAPACITY CONSTRAINTS AND MULTIMARKET COMPETITION (February 2018).

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The Antitrust Bulletin 63(4)
The article proceeds as follows. In Section II, I discuss how capacity constraints affect merger
outcomes. In Section III, I discuss how capacity constraints affect merger analysis tools. Section IV
concludes.
II. Merger Effects of Capacity Constraints
How capacity constraints affect mergers depends on whether the capacity constraints affect merging or
nonmerging firms. Several economic studies show that capacity constraints facing merging firms can
mitigate merger price effects.7 In fact, if both merging firms face binding capacity...