Price Discrimination under Customer Recognition and Mergers

• Published date: 01 September 2015
• Date: 01 September 2015
• DOI: http://doi.org/10.1111/jems.12107

Price Discrimination under Customer Recognition

and Mergers

ROSA-BRANCA ESTEVES

Department of Economics

Universidade do Minho

Campus de Gualtar, 4710-057 Gualtar, Braga, Portugal

rbranca@eeg.uminho.pt

HELDER VASCONCELOS

Faculdade de Economia

Universidade do Porto

CEF.UPand CEPR

Rua Dr. Roberto Frias, 4200-464 Porto, Portugal

hvasconcelos@fep.up.pt

This paper studies the interaction between horizontal mergers and price discrimination by endog-

enizing the merger formation process in the context of a repeated purchasemodel with two periods

and three firms wherein firms may engage in behavior-based price discrimination (BBPD). From

a merger policy perspective, this paper’s main contribution is twofold. First, it shows that when

firms are allowed to price discriminate, the (unique) equilibrium merger gives rise to significant

increases in profits for the merging firms (the ones with information to price discriminate), but

has no ex-post effect on the outsider firm’s profitability, thereby eliminating the so-called (static)

“free-riding problem.” Second, this equilibrium merger is shown to increase industry profits

at the expense of consumers’ surplus, leaving total welfare unaffected. This then suggests that

competition authorities should scrutinize with greater zeal mergers in industries where firms are

expected to engage in BBPD.

1. Introduction

The large body of previous literature on the effects of horizontal mergers on firms’ pric-

ing policies has mainly focused on the balance between anticompetitive price (market

power) effects and procompetitive merger-related efficiency improvements.1It should

be noted, however, that market power and efficiencies are not the only important chan-

nels through which horizontal mergers can affect the pricing policies of a merged firm.

Particularly important is the use of the merging partners’ customer information

databases for price discrimination policies after the merger. An interesting variant of

Weare grateful to the Editor,Daniel Spulber, to an anonymous coeditor and to four anonymous referees for their

thorough and thoughtful reports. We have also benefited from useful comments and suggestions on earlier

versions of the paper from Tore Nilssen, Lars Persson, Joel Sandonis, and seminar participants at the 2009

EARIE Conference (Ljubljana) and at the XXIV Jornadas de Econom´

ıa Industrial (Vigo).This work is funded by

FEDER funds through the Operational Program for Competitiveness Factors—COMPETE and National Funds

through FCT—Foundation for Science and Technologywithin the project PTDC/EGE-ECO/108784/2008. The

usual disclaimer applies.

1. See, for instance, Motta (2004, chapter 5) and Whinston (2006, chapter 3), for general discussions of the

effects of horizontal mergers.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume24, Number 3, Fall 2015, 523–549

524 Journal of Economics & Management Strategy

price discrimination is the so-called behavior-based price discrimination (BBPD),2which

occurs when firms have information about consumers’ past behavior and use this infor-

mation to offer different prices to consumers with different purchasing histories.3

The main objective of this paper is to study the interaction between horizontal

mergers and price discrimination in a context where information about consumers is

a key asset of the firms in the industry. In doing so, this paper proposes and explores

anew motive for horizontal mergers. In our setting, the pooling of the merging firms’

purchase history databases, through a merger, will improve the profitability of price

discrimination and the value of each merger partner’s databases. This will, in turn,

promote the profitability of mergers.

The fact that the new Horizontal Merger Guidelines (HMGs), issued by the U.S.

Antitrust Agencies on August 19, 2010,4include an enlarged and more detailed discus-

sion of price discrimination constitutes an important signal that the agencies are willing

to devote more attention to the alleged effects of price discrimination in their merger

investigations.5In particular, the new HMGs identify price discrimination as an inde-

pendent competitive arm, thereby suggesting that the potential for price discrimination

should be a key factor in any competitive analysis of mergers.6As McDavid and Stock

(2010, p. 5) highlight, the expanded discussion of price discrimination issues in this new

version of the HMGs (when compared to the previous version) illustrates “a greater

willingness on the part of the agencies to pursue theories of competitive harm based

on alleged effects on narrow categories of customers that can be specially targeted for

a price increase.” Indeed, the new HMGs provide that “[w]hen price discrimination is

feasible, adverse competitive effects on targeted consumers can arise, even if such effects

will not arise for other consumers” (p. 6). Along these lines, Shapiro (2010, p. 746) high-

lights that “DOJ investigations often begin by asking whether there are particular types

of customers who are most likely to be harmed by the merger. We often find that some

types of customers are more vulnerable than others to adverse competitive effects. We

look for preexisting price discrimination and we consider the possibility of postmerger

price discrimination. . . . The Guidelines are focused on whether the merger is likely

to enhance market power. Price discrimination is highly relevant to this question if the

merger may enhance market power over some customers but not others.”

The recognition that each firm’s customer information databases can become more

valuable through the process of mergers when price discrimination is likely to occur

2. For a comprehensive survey on BBPD, see Chen (2005), Fudenberg and Villas-Boas (2007), and Esteves

(2009b).

3. As pointed out by Fudenbergand Villas-Boas (2007), “[t]his sort of ‘behavior-based price discrimination’

(BBPD) and use of ‘customer recognition’occurs in several markets, such as long-distance telecommunications,

mobile telephone service, magazine or newspaper subscriptions, banking services, credit cards,labor markets;

it may become increasingly prevalent with improvements in information technologies and the spread of e-

commerce and digital rights management.” (p. 2) Along these lines, Gehrig and Stenbacka (2005) highlight

that, “[a] typical example of behaviour-based price discrimination is a pricing scheme, which is contingent on

the history of internet clicks.” (p. 132)

4. U.S. Department of Justice and the Federal TradeCommission, Horizontal Merger Guidelines, available

at http://www.justice.gov/atr/guidelines/hmg-2010.pdf.

5. As pointed out by Langenfeld (2010), “[c]learly the Agencies must believe there needs to be a much

better understanding of the way they view the impact of price discrimination on merger analysis. Moreover,

since [in the newHMGs] the Agencies devote so much space to the topic, the Agencies presumably believe

that there will be many mergers involving price discrimination that should be challenged.”

6. In particular, in the new section 3 of the HMGs on “Targeted Customers and Price Discrimination,” it

is stated that “[w]hen examining possible adverse competitive effects from a merger, the Agencies consider

whether those effects vary significantly for different customers purchasing the same or similar products.

Such differential impacts are possible when sellers can discriminate, e.g., by profitably raising price to certain

targeted customers but not to others.”