For Welfare's Sake? Balancing Rivalry and Efficiencies in Horizontal Mergers

• Published date: 01 December 2010
• DOI: 10.1177/0003603X1005500411
• Date: 01 December 2010
• Author: Alison Oldale,Jorge Padilla
• Subject Matter: Article

For welfare’s sake?

Balancing rivalry and efficiencies

in horizontal mergers

BYALISON OLDALE*AND JORGE PADILLA**

There has been an extensive debate about whether the proper

objective of merger control should be long run consumer welfare or

long run total welfare. We review the various arguments that have

been put forward to justify the use of a consumer welfare standard

and find none of them convincing. However this debate risks missing

the point. Maximizing long run total welfare may be a suitable

objective for governments enacting merger control legislation. But

the long run effects of a merger are often too complex for this to serve

as a practical guide to decision making. Instead, competition

authorities are usually given a target related to competition, allowing

for some consideration of efficiencies. In practice this target is often

interpreted as a focus on the short term effects on consumers, so that

efficiencies count only to the extent that benefits are passed on. The

real debate is not about the objective of merger control, but about

whether this is the right target.

THE ANTITRUST BULLETIN:Vol. 55, No. 4/Winter 2010 :953

* Chief Economist, UK Competition Commission (CC).

** Economist, LECG Europe; Associate Professor, Barcelona Graduate

School of Economics; and Research Fellow, CEMFI (Madrid) and CEPR

(London).

AUTHORS’ NOTE: The views in this article are personal and do not necessarily

represent the views of the CC.

© 2010 by Federal Legal Publications, Inc.

I. INTRODUCTION

A merger between competitors (a horizontal merger) may affect total

welfare (the sum of consumer welfare and total industry profits) in the

short and long run in a variety of ways. First, it may result in an

increase in prices in the short run and, consequently, in a reduction in

consumer welfare and an increase in total industry profits. Second, the

merged entity may find it optimal to phase out some of the products

that the merging parties sold premerger. This reduction in product

variety is likely to harm consumers, but may save significant fixed

costs and may in some cases result in an increase in overall welfare.

Third, besides those static effects, the reduction in rivalry caused

by the merger may reduce the incentives to invest in process

innovation and facilitate managerial slack. In fact, the biggest loss to

aggregate welfare arising from a substantial increase in market power

may not be consumer harm, but the high costs that result from these

so-called X-inefficiencies.1

Fourth, a merger may also give rise to a number of cost

efficiencies. These can be the result of economies of scale and scope in

production and distribution or of synergies resulting from the

combination of the assets, know-how, and management skills of the

merging parties. These efficiencies generally increase total welfare, at

least in the short term, but will result in an increase in consumer

welfare only if they are passed on to consumers in the form of lower

prices. The extent to which consumers will benefit from cost

reductions thus depends on the strength of competition post-merger.

It is possible in principle (though exceptional in practice) for these

efficiencies to have harmful long run effects if they benefit the

merging firm to such an extent that rivals can no longer remain in the

market.

Fifth, a merger can change the incentives of firms to invest in

improving existing products or creating new ones, in marketing, and

other areas. It is difficult to know whether these incentives are higher

or lower after a merger. On the one hand, the merged company may

954 :THE ANTITRUST BULLETIN:Vol. 55, No. 4/Winter 2010

1Harvey Leibenstein, Allocative Efficiency v. X-Efficiency, 56 AM. ECON.

REV. 392 (1966).

have fewer incentives to invest because a successful new product

launch might cannibalize the existing products of the newly bought

firm. On the other hand, the merged company may have greater

incentives to invest because the fruits of the research can be shared

across a wider product range, because efficiencies mean the firm has

more cash, which relaxes a financing constraint and allows it to

pursue more projects, or because weaker rivalry means that

innovations are more profitable.

Sixth, a merger may also give rise to demand-side efficiencies,

which accrue directly to consumers and are particularly important in

industries characterized by network effects. They result in an increase

in consumer welfare and most often lead to an increase in total

welfare. As with cost efficiencies, there may be some exceptional

circumstances under which a merger that gives rise to significant

demand or cost efficiencies benefits consumers in the short term and

yet causes a reduction in total welfare. This can occur if the merger

places competitors at a competitive disadvantage, even forcing them

to leave the market. As a result, total industry profits may go down in

the short term, and prices may go up in the longer term.

This multiplicity of effects makes assessing the welfare effects of

a horizontal merger on both consumers and producers extremely

complex. Consumers may be worse off if the merger results in a

reduction in product variety, an increase in prices, or lower

investment. But they may end up better off if the merger results in

cost savings that are passed on in the form of lower prices, leads to

the introduction of new or better products, or allows consumers to

access wider networks. Competitors may benefit from the merger if

it gives rise to an industry-wide price increase, but may be worse off

if the merger gives rise to efficiencies that they cannot replicate

easily.

Despite the difficulty of analyzing the overall effect of a merger on

both consumer and total welfare in the long run, there has been

extensive debate about which of the two welfare criteria to use. This

debate has focused on an apparent paradox. On the one hand, many

economists agree that the decision as to the desirability of a horizontal

merger should be based on its impact on total welfare, as this is the

RIVALRY AND EFFICIENCIES :955