GE - Honeywell

Vertical Mergers, Bundling and Protectionism

Introduction
‡ On July 3, 2001, the European Commission blocked a $42 billion merger between General Electric and Honeywell. ‡ The reason for blocking this merger centered around the economic theory of bundling. ‡ On October 22, 2000, this merger was announced. The US Department of Justice gave it the green light. However, the European Commission also had to approve it because of the size of the two firms¶ Euro sales. The EC denied the merger on July 3 of 2001.

auxiliary power supplies. a French company ‡ GE competes with Pratt & Whitney and Rolls Royce as well as IAE. however ‡ Achieved market prominence through a series of mergers and acquisitions ‡ Over half of $23 billion 2001 revenue came from aerospace division . starter motors. etc. GE produces aircraft engines both independently and through a 50-50 joint venture called CFMI with SNECMA. engine accessories. a joint venture between the two Honeywell ‡ Produces a basket of aeronautical products including avionics. brakes. grossing over $125 billion in 2001 ‡ Among many other interests. ‡ Does not produce engines. wheels.The Players General Electric ‡ One of the largest corporations in the world.

and ultimately of consumers. ‡ Instead the Commission focused on potential problems arising from horizontal integration .The Case Against ‡ The EC must prove that the merger would lead to market dominance: A position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market by giving it the power to behave to an appreciable extent independently of its competitors. ‡ Market dominance exists if a firm can price in an anticompetitive manner. ‡ A strange case because firms were neither competitors. customers. nor did they have a vertical relationship.

The Case Against (cont.) ‡ The Commission¶s rejection hinged on their assertion that because GE and Honeywell were market leaders in their respective aeronautical fields. because the cause would be pricing efficiencies rather than production efficiencies. which it viewed as anticompetitive ‡ Potential increases in consumer surplus were shunned for fear of the possibility of anticompetitive behavior down the road . they could price other firms out of business and then assume a monopoly status ‡ The Commission denied a proposal that would lower costs to consumers? ‡ Yes. the merger would allow them to bundle complementary products at unbeatable prices ‡ Thus.

You can pay more for leather seats when you buy a car. They are unavailable separately. a. a. 2. a. Your burger. µMeals¶ at restaurants. . New car options. You need both a left and a right shoe. Shoes. fries. but you can¶t go to the dealership and get them a la carte 3. Tying: One item is available by itself and also in a bundle with another item that is unavailable alone. Mixed Bundling: Items are available separately but also as a bundle at a reduced price. and Coke cost less together when you order them as a meal. Pure Bundling: Two products are only sold together. but normally you cannot buy them individually.Bundling: The Economics Three Types of Bundling 1.

‡ Two independent monopolists selling complementary goods could make more money if they merged or coordinated and lowered their prices. ‡ You buy more jet engines because they are cheaper.) ‡ Cournot first considered the concept of bundling. ‡ Cournot¶s example is the horizontal version of double marginalization. ‡ This is a Pareto improvement: everyone is better off. More consumers served and more company revenues. Instead of each firm extracting welfare from the one below it. firms harm demand for complementary goods through their own high prices. so now you have more incentive (and money) to purchase the avionics with which to operate them. .Bundling: The Economics (cont. The price drop of each good would stimulate sales of the other.

It is unlikely that cost savings here would prompt manufacturers to construct very many more planes.Problems with Cournot¶s model ‡ The firms are alone in the market. ‡ Firms in this market stand to gain from a merger primarily through conquering rivals¶ market share ‡ Firms set the same price to all customers. ‡ Aircraft engines and avionics are only a small percentage of the cost of the airplane. Their merger does not undercut someone else. so they have considerable power to negotiate . ‡ Instead of simply selling more products. ‡ Bundling advantages vanish in the presence of price discrimination and negotiation ‡ Airplane manufacturers are few and valuable to vendors like GE and Honeywell. mergers can be used as a weapon against the competition when more than two firms populate the market.

consumers in the model must purchase both goods ‡ Thus.Bundling Theory Note: The following information is useful to us as students. A2). B2). there are four choices í (A1. A2) ‡ Consumers will choose the package that best suits their preferences. B2). (B1. (A1. but as we will see it will not be relevant to the case ‡ Four firms in the market í Two firms A1 and B1 sell different versions of good 1 í Two firms A2 and B2 sell different versions of good 2 ‡ Like an airplane manufacturer who needs avionics and engines. ‡ There are three possible market structures: í All goods sold separately í A1 and A2 bundle versus B1 and B2 bundle í A1 and A2 bundle versus B1 and B2 separate . (B1.

bundling firm sacrifices profits (~3%) for market share . so bundle price must equal independent price in equilibrium Case 3: Bundle Versus Components ‡ Bundling reduces profits slightly (~10%) ‡ Though it gives the bundler an advantage in market share.Bundling Theory (cont. it comes at the price of lower profits and it will not do it Mixed Bundling ‡ Again. Case 2: Bundle Versus Bundle ‡ Profits fall by 50% ‡ Intuition: Cutting price brings the same number of incremental customers as when selling individually. Assume profit is 1.) Case 1: All Firms Act Independently ‡ This is the baseline.

‡ To make robust conclusions about the market. elasticity of total market demand.) ‡ The European Commission reached the conclusion that economic incentives would lead the firm to engage in mixed bundling ‡ It is a robust conclusion that a firm that bundles has an advantage over rivals ‡ More tenuous a conclusion. is whether a multiproduct firm has an economic incentive to bundle ‡ This would depend of the number of products in the bundle. relative importance of the products to the consumer. and other factors. however. but its effect on competition in the future ‡ The Commission believed that this merger would lead to rivals exiting the market and the merged firms exploiting their dominant position . ‡ In the end. the Commission¶s issue was not the impact of bundling on social welfare.Bundling Theory (cont. our models must likewise be robust.

but it would also level the playing field ‡ Firms may fear that the original bundler will use its higher profits to invest in capital or R&D that will give it advantages in a repeated game í Customers may drive competition to offer a bundle even against its will í Customers win in bundle-to-bundle competition ‡ Remember. customers in this market are powerful and could easily pressure competitors into offering a bundle ‡ Advantages to bundling disappear when competitors offer a bundle of their own í Thus.Market Dynamics ‡ Can we assume that competitors will not respond in any way to bundling? í This is unrealistic í Competitors could coordinate and offer a bundle of their own í This would reduce profits. a bundling firm must expect the competition to follow suit .

Negotiating Bundles ‡ Previous discussion assumes that market prices are uniform to consumers í In aerospace industry. this is not the case í Customers have power to negotiate prices with vendors í Vendors also spend resources to gain information on customers ‡ They know about their customers¶ previous purchases and what kind of products they are likely to require í This gives them negotiating power. bundling cannot lead to higher profits ‡ If customers want some products from both firms. they won¶t bundle ‡ Imposing a bundle on consumers will force firms to pay for one good¶s lost profits with the money they make on the other ‡ Firms profit only to the extent that their products are differentiated. which gives them power over the consumer ‡ Bundling has little effect when firms have good information because it mitigates their power over consumers . too í When customer type is know and prices are negotiable.

though it is a joint venture with SNECMA. which essentially eliminates the possibility of an engine firm being dominant. the EC claimed GE's dominant position in aircraft engines meant the company retained a commanding market share of 52. Even if CFMI control did contribute to market power. In reality.5% Resale of parts drops market share to 41%. and they have no incentive to aid Honeywell. engine sales are only 20% of total plane sales. CFMI only existed at the time to produce engines for Boeing 737s. so GE's control of it had no effect on market power. Ultimately. SNEMCA would have to agree to bundling. . consideration drops market share to 28% (excluding planes in production). which still assumes CFMI is completely attributed to GE. If half of CFMI is attributed to GE.Empirical Evidence Against GE Dominance and Bundling ‡ ‡ ‡ ‡ ‡ ‡ Initially.

In fact. the "bundling" discounts were small and probably a result of price negotiation. the cases that did involve bundling found it useless in signing purchasers. especially because price negotiation would take place anyway. ‡ . In addition to the fact that competitors could fight back by bundling themselves. The only way to "bundle" in GE's situation would be to offer future discounts on Honeywell parts. planes stay in service for 25 years.Impracticality of Bundling for GE ‡ ‡ ‡ In the cases cited as relevant by the EC. so they could stay in business for quite a while. but there would be no incentive to do so once the engine is sold.

How long do we expect these lower prices to persist? 5. Incentive to Bundle? 2. What is the immediate gain to consumers from lower prices? 3.Making a Decision A Check List of Weights and Balances 1. what is the expected harm? Developed by Carl Shapiro and the US Department of Justice . What will be the impact on competitors? 4. If the rivals exit.

ii. If we see bundling. is there evidence that bundling is a common practice in this industry? i. Under what circumstance does the combined firm earn higher profits through a bundled pricing strategy? b. then what is the marginal impact of increasing the potential scope of the bundle? If we do not see bundling.What the EC Considered 1. Incentive to Bundle? a. then how do the opportunities created by this combination create a different incentive to bundle? . Did either firm have an opportunity to bundle prior to the combination? If so.

Increased market dominance will decrease competition Decreased competition will result in increased long-term prices and decreased long-term consumer welfare . GE-Honeywell Will Engage in Bundling Activities ‡ ‡ ‡ ‡ Bundling enables significant price advantages Long-run lower prices will increase market dominance.Recap: The Issue with the Merger 1.

A Remedy: Block Bundling Behavior Enforce a "no-bundle discount" strategy: ‡ Individual price levels must be no greater than the price of a bundle of the same goods To aid enforcement. punishable by the EC Rejected on EC philosophy against Behavioral Remedies . each firm would supply ‡ ‡ a price list of each good a price list of all bundles of goods Any discord with the "no-bundle discount" rule would be a violation.

Conclusion ‡ GE-Honeywell Merger is Blocked ‡ Block was based on concerns that bundling would flourish. causing competition to decline ‡ Claims that bundling would occur were dismissed ‡ Still the EC ruled that bundling was the primary reason to stop the merger A shining example of international protectionism .

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