Mergers

A merger is a
transaction that results
in the transfer of
ownership and control
of a corporation.
 3 Types of Mergers
Economists distinguish between three
types of mergers:
1. Horizontal
2. Vertical
3. Conglomerate
Horizontal mergers

A horizontal merger results in the consolidation of

firms that are direct rivals—that is, sell substitutable
products within overlapping geographic markets.

Examples: Boeing-McDonnell Douglas; Staples-Office

Depot(unconsummated); Chase Manhattan-Chemical Bank;
Southern Pacific RR-Sante Fe RR; Pabst-Blatz; LTV-
Republic Steel; Konishiroku Photo-Minolta.
Vertical Mergers
The merger of firms that have actual or
potential buyer-seller relationships

Examples: Time Warner-TBS; Disney-ABC Capitol

Cities; Cleveland Cliffs Iron-Detroit Steel; Brown Shoe-
Kinney, Ford-Bendix.
Conglomerate mergers
Consolidated firms may sell related products,
share marketing and distribution channels and
perhaps production processes; or they may be
wholly unrelated.

•Product extension conglomerate mergers involve firms that

sell non-competing products use related marketing channels
of production processes.
Examples: Cardinal Healthcare-Allegiance; AOL-Time
Warner; Phillip Morris-Kraft; Citicorp-Travelers Insurance;
Pepsico-Pizza Hut; Proctor & Gamble-Clorox.
•Market extension conglomerate mergers join together firms
that sell competing products in separate geographic markets.

Examples: Scripps Howard Publishing—Knoxville News

Sentinel; Time Warner-TCI; Morrison Supermarkets-
Safeway;SBC Communications-Pacific Telesis
•A pure conglomerate merger unites firms that have no
obvious relationship of any kind.
Examples:BankCorp of America-Hughes Electronics ;R.J.
Reynolds-Burmah Oil & Gas; AT&T-Hartford Insurance
Anticompetitive Effects of Mergers
Issue: When and how are mergers welfare-reducing (that is, result
in a post-merger decrease in TS ?
•Horizontal mergers eliminate sellers and hence reshape market
structure. Recall that the structuralists believe that
market structure is the primary determinant of market performance.
•Mergers may result in market foreclosure. For example, the
Justice Department feared that Microsoft's proposed acquisition of
Intuit would result in a foreclosure of the market for personal
finance software.
• Mergers may diminish potential competition. For example, the
acquisition of Clorox by Proctor & Gamble eliminated P&G as a
prime potential entrant in the market for household bleach.
 Horizontal mergers have a direct
impact on seller concentration (as
measured by the concentration
ratio or the Herfindahl index).
Hence the potential to diminished
competition is clear to see.

Remember the formula from the

Cournot Model: P  MC 1

p n
Where n is the number of sellers. A merge reduces n,
hence increases the price-cost margin and reduces TS,
other things being equal.
 The Williamson contribution 1

It would seem at first blush that horizontal mergers

would invariably be welfare-reducing. However, if the
consolidation of direct rivals leads to greater cost
efficiency, then a horizontal merger could (in theory at
least) be welfare-enhancing.

Oliver Williamson. “Economies as an Antitrust Defense: The

1

Welfare Tradeoffs,” American Economic Review, March 1968.

Welfare trade-offs of a horizontal merger

Oliver Williamson contends that

a horizontal merger can be
welfare-enhancing, even if
the post-merger market
structure is monopolistic. Why? Because
the merger may result in greater
technical/cost efficiency.
 The efficiency
gain from the merger
Price
is indicated
by the shift
from AC to
AC’ If area A2
PM exceeds
Audio explanation (wav)
area A1, the
A1
PC AC merger
A2 increases the
total
AC’
surplus (TS)
D

0 QM QC Quantity
Measuring the Welfare Tradeoffs
Let A1 be computed by
If A1 = A2, 1
the merger is A1  (P )(Q)
2
welfare-neutral
Let A2 be computed by:

A2  AC  QM
Percentage Cost Reduction Sufficient to Offset
Percentage Price Increases for Selected Values of .
Hear audio explanation (wav)


P 3 2 1 1/2
P
5 0.43 0.28 0.13 0.06

10 2.00 1.21 0.55 0.26

15 10.37 5.76 2.40 1.10

Source: Viscusi, Vernon, and Harrington, Table 7.1, p.

200
 Vertical and conglomerate mergers do
not affect market structure (e.g.,
seller concentration) directly. As you
will discover subsequently, these
types of mergers mergers can
nevertheless have anticompetitive
consequences.

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