G406, Regulation,

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• G406, Regulation,
• Eric Rasmusen, erasmuse_at_indiana.edu
• 13 Feb. 2007
• 7-mergers

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4-Firm Concentration Ratios

• Cigarettes
• Concrete
• Flat glass
• Womens and girls cut-and-sew dresses
• Audio and video equipment
• Iron and steel mills
• Petroleum refineries
• Breweries
• Turbines
• Cereal
• Pharmaceuticals
• Farm machinery
• Gasoline engines

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1992 HORIZONTAL MERGER GUIDELINES a)
Post-Merger HHI Below 1000. OK. b)
Post-Merger HHI Between 1000 and 1800. An
increase in the HHI of less than 100 points is
OK. A bigger increase needs analysis. c)
Post-Merger HHI Above 1800. An increase in the
HHI of less than 50 points is OK. An increase
of more than 100 is presumed to be likely to
create or enhance market power or facilitate its
exercise, but the presumption may be
overcome by showingthat competition would be
vigorous anyway.
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1992 HORIZONTAL MERGER GUIDELINES Two firms
have market shares of 10 and 15, and all other
firms are tiny. Can the two firms merge?

• a) Post-Merger HHI Below 1000. OK.

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MERGER GUIDELINES EXAMPLE II Two of the
firms in this industry have market shares of 5
each. Can they merge? b) Post-Merger HHI
Between 1000 and 1800. An increase in the HHI
of less than 100 points is OK. A bigger increase
needs analysis.
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MERGER GUIDELINES EXAMPLE III c)
Post-Merger HHI Above 1800. An increase in the
HHI of less than 50 points is OK. An increase
of more than 100 is presumed to be likely to
create or enhance market power or facilitate its
exercise, but the presumption may be
overcome by showingthat competition would be
vigorous anyway. Two firms in the industry
have market shares of 10 each. Can they merge?
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Mittal-Arcelor (2007 merger)

A global steel giant that will be almost 3 times
bigger than the nearest rival, Nippon Steel
Parameters Unit Mittal Arcelor Capacity m
MT 63.0 46.7 Revenues US bn 28.1 39.1
US 32 bn takeover bid . 10 share of the global
steel capacity of 1,132 m tonnes (MT) per year.
(1997 world capacity 800, 2005 1132 MT The
Mittal family will hold a 43.4, Arcelor
shareholders will own 50.5 stake.
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(1) As part of Mittal's bid an agreement
to sell Dofasco , to ThyssenKrupp. Arcelor
put Dofasco, its recently acquired Canadian
subsidiary, into a Netherlands trust to keep
Dofasco out of Mittal's grasp and make the whole
acquisition of Arcelor more difficult. The
United States government ordered Arcelor Mittal
to sell Dofasco. If it cannot do that because of
the trust structure, the company must divest
either Mittals Sparrows Point mill near
Baltimore or its mill in Weirton, W.Va. Also,
Dofasco must operate like a stand-alone company.
It cannot disclose any substantive information
about operations to Arcelor Mittal the six
directors the European company appointed to
Dofasco no longer attend board meetings, which
are now conducted by the Dofascos six
independent directors and Arcelor Mittal only
receives very limited information about the
Canadian companys financial performance. (2) -
Steel giant Arcelor Mittal said Friday thatit was
selling its Polish steel mill Huta Bankowa to
Alchemia SA as part of its compliance with EU
antitrust . It had 81 million euros (104.7
million) in turnover in 2005 and employs about
700 workers.

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Case 1 Merger Raises Price and Cost

• Each of the two firms in the industry has TC
  2 QQ/10, so MC
• Q/5 and FC 2. Each produces 10 units, so TC
  2 1010/10 12
• for each. Average cost is 1.2 and marginal cost
  is 2. The price is
• 3.
• Industry profit is 320 - 22 1010/10
  60 - 2 (12) 36.
• After the merger, there is just one firm, with
  TC 2 QQ/10.
• Suppose it produces 15 units, which makes so
  the price goes up to 5.
• TC 2 1515/10 2 225/10 24.5. Average
  cost is 24.5/15 1.6
• and marginal cost is 15/53.
• So total cost has risen, but output has fallen.
• Industry profit is 515 - 24.5 75-24.5
  50.5. So the merger did
• raise profits, even though it reduced welfare.

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Case 2 Merger Reduces Cost and Price

• Each of the two firms in the industry has TC
  2 3Q, so MC3
• and FC 2. Each produces 10 units, so TC 2
  310 32 for each
• firm. Average cost is 3.2 and marginal cost is
  3. The price is 4.
• Industry profit is 420 - 2(2 310) 80 -
  232 16.
• The merger allows the firms to share
  complementary technologies and reduce marginal
  cost. Therefore, after the merger, there is just
  one firm, with TC 2 .5Q.
• The firm could reduce output from 20 to 15 and
  the price would rise
• to 5. Its profit would be 155 - 2 .5(15)
  75- 9.5 65.5.
• But the firm prefers to increase output from
  20 to 30, which
• drives down the price to 3. Its profit is 303
  - 2 .5(30) 90 -
• 17 73.

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Case 3 Merger Reduces Costs but Raises Price

• Each of the two firms in the industry has TC
  3Q, so MC3 and FC
• 0. Each produces 10 units, so TC 310 30
  for each firm.
• Average cost is 3 and marginal cost is 3. The
  price is 4.
• Industry profit is 420 - 320 80-60
  20.
• The merger allows the firms to share
  complementary technologies and
• reduce marginal cost. Therefore, after the
  merger, there is just one
• firm, with TC 2Q.
• The firm could increase output from 20 to
  30, which drives down
• the price to 3. Its profit would be 303 - 302
  90-60 30.
• But the firm prefers to reduce output from 20
  to 15 so the price
• will rise to 5. Its profit would be 155 - 152
  75 - 30 45.

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Table 7.1 Minimum cost reduction to make a
merger raise PSCS

• Price Elasticity of demand
• Increase 3 2 1 .5
• 5 .43 .28 .13 .06
• 10 2.00 1.21 .55 .26
• 20 10.37 5.76 2.40 1.10

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Staples-Office Depot Merger (1997)

• The FTC and Justice were notified
  (Hart-Scott-Rodino Act)
• What is the concentration ratio?
• Staples, Office Depot and Office Max clearly
  competed. Who else? What is the market?

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Price and Cost Effects

• Assume no cost change. The FTC said the merger
  would raise prices 7.3. Staples said 2.4.
• What are cost savings? The FTC said 1.4 of
  sales, passed along to consumers. Staples said
  more, and being passed along was irrelevant.
• What is the ultimate price effect? The FTC said
  a 7.3 increase. Staples said a 2.2 decrease.

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An Efficient Merger?

• Use the FTC numbers Costs fall by 1.4 of sales,
  prices rise by 7.3.
• Suppose the elasticity of demand is 1, which is
  average loosely speaking.
• Table 7.1 says a merger is OK if costs fall by
  .55 or more, prices rise by 10, and the
  elasticity is 1.
• Even if the elasticity is 2, if costs fall by
  1.21 or more, the merger is OK.
• But the FTC and the Court said the efficiency
  analysis wasnt going to decide the case.

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Evanston Northwestern Healthcare

• The FTC challenged the 2000 takeover of
  Highland Park Hospital by Evanston Northwestern
  Healthcare Corp., Northwestern U's nonprofit
  hospital.
• (1) FTC administrative law judge.
• (2) Any appeal of his ruling goes to the full
  five-member FTC
• (3) Further appeals by either side go to the
  federal appeals court.
• In 2000 the hospital system raised United
  Healthcare's HMO rates by 52 at its Evanston and
  Glenbrook hospitals and by 38 at Highland Park.
• "Evanston Northwestern says it rescued the
  once-struggling community hospital in Highland
  Park and improved the quality of care. The
  hospital system has said that a forced
  divestiture, as demanded by the FTC, would
  "disrupt the lives of patients, doctors,
  employees" and others.""
• In 2004, 130 hospitals were acquired or merged
  in the U.S. in transactions valued at a total of
  9.07 billion.

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Nonprofit Status

• In some previous mergers, courts have pointed to
  hospitals' nonprofit status as a reason to let
  mergers go through.
• In the mid-1990s the FTC fought unsuccessfully
  to block a Grand Rapids, Mich., merger. A federal
  court allowed it to proceed, based on economic
  analysis that nonprofit mergers tended to reduce
  costs and prices.
• The court also ruled that nonprofit hospital
  boards, as community leaders, had an incentive to
  restrain prices. A federal appeals court upheld
  that ruling in 1997.
• Nonprofit hospitals, the FTC argues, do have an
  incentive to maintain a "surplus" of revenue over
  expenses, and while they don't distribute these
  "profits" to shareholders, they can use them for
  salaries, equipment or expansion.
• Evanston Northwestern 850 beds in three
  hospitals, about 7,600 employees and annual
  revenue of 1.8 billion. 239-bed Highland Park
  has 239 beds.

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Two Charges

• The FTC alleges it imposed big price increases
  on insurers such as Aetna Inc., Humana Inc. Cigna
  Corp., United Healthcare ... Several of the
  insurance companies, unhappy with the price
  increases, are expected to be called as witnesses
  by the FTC at the trial.
• In 2000 the hospital system raised United
  Healthcare's HMO rates by 52 at its Evanston
  and Glenbrook hospitals and by 38 at Highland
  Park.
• The hospital raised its preferred-provider rates
  by 190 at Evanston and Glenbrook hospitals and
  by 20 at Highland Park.
• The FTC also has accused Evanston Northwestern of
  price-fixing of physician fees, after combining
  two large groups of physicians following the
  merger.
• The FTC is taking a highly unusual step in
  seeking to undo a merger.
• Dec. 2005 FTC wins with the administrative law
  judge.
• Feb. 2007 The case is currently on de novo
  review before the FTC on appeal from an
  Administrative Law Judge determination.