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Merger control in dynamic
markets
OECD Global Competition Forum
6 December 2019
Giulio Federico
Head of Unit, Chief Economist Team, DG Competition
Disclaimer
• The views expressed in this presentation are the
personal views of the speaker only and cannot be
regarded as stating an official position of the
European Commission.
2
Competition is all about dynamics
• Competition is a dynamic process of rivalry where
firms seek to capture profitable sales from each
other, and to protect existing sales
• Rivalry induces firms to offer better deals to
consumers (e.g. lower prices; better products)
• A well-functioning competitive process delivers
allocative, productive and dynamic efficiency
• 3
Horizontal mergers may hinder the
competitive process
• Competition creates business stealing effects between rival
firms
• A horizontal merger allows two rivals firms to internalize
business stealing effects, by allowing for coordination of all
relevant competitive parameters, including dynamic ones (e.g.
future prices; innovation)
• A merger between two significant and close rivals may therefore
reduce the intensity of competition absent sufficient
countervailing effects (e.g. efficiencies)
• This mechanism applies to both static and dynamic competition
• 4
When are adverse dynamic effects
more likely?
• Merging parties are significant and close innovators (e.g. as
shown by overlaps in R&D activities and/or capabilities)
• Limited number of rival innovators to the merged entity
• High barriers to entry in R&D/innovation (e.g. closeness of
competition is durable)
• Disruptive innovation from "outside the market" unlikely
• Pro-competitive (countervailing) effects weak
5
Evidence: focus on overlaps and diversion
Firm A
Firm B
Development ProductCapabilities
Innovation competition
Actual and potential
competition
Capabilities Development Product
Line of research
Line of research
Line of research
Line of research
Line of research
Line of research
Line of research
Line of research
• Business stealing is generated by overlaps (within and across each stage of the
competitive process)
• Sources of evidence: internal documents; current pipelines; patent data
• Aim: understand underlying competitive process generating observables
overlaps, in order to infer likelihood and nature of future business stealing
effects
6
Is the economics really so
complicated?
• Academic literature sometimes relied upon to suggest that
relationship between “competition and innovation” is
ambiguous, offering limited guidance to merger policy
• This literature is mostly about (symmetric) variations in product
market competition, and not about mergers
• More recent formal work suggests that in standard models of
product differentiation, horizontal mergers increase prices and
reduce innovation absent efficiencies
• Even in those models where innovation may increase following a
merger, dynamic competition is typically still reduced due to
higher future prices
7
Pro-competitive effects
• Scope for pro-competitive effects (efficiencies) can be greater than in
traditional cases of static competition
• Need for consistency in standard of proof for harm and for efficiencies
(e.g. time horizon; qualitative nature of evidence) - but burden of
proof rests on merging parties
• Plausible efficiency mechanisms include internalization of knowledge
spillovers and exploitation of complementarities
• Merger-specificity needs to be assessed (e.g. R&D JVs; alternative
transactions)
• Beware of invalid efficiency claims
• Greater “appropriability” through higher market power (i.e. higher
prices) typically harms consumers
• Elimination of “duplicative” R&D may imply suppression of
beneficial innovation competition
• How to assess “investment-for-buyout” claims?
8
How to deal with uncertainty?
• Merger control is a forward looking exercise, characterised by
uncertainty
• The existence of uncertainty should not preclude effective merger
control
• Optimal decision theory should inform assessment, balancing expected
cost of Type 1 (over-enforcement) and Type 2 (under-enforcement)
errors, focusing on expected consumer welfare
• Expected cost of Type 2 errors depends on probability of future
overlaps and associated competitive benefits
• A dynamic counter-factual may need to be considered
• There is guidance from antitrust jurisprudence (e.g. US and EC Court
judgments in pay-for-delay; US Court in Microsoft) 9
In dynamic markets remedies need to be “future-proof” (to
address dynamic competition concerns, but also for viability)
Complexity of dynamic markets reinforces the case for structural
remedies, including all technologies needed to replicate the current
and future competitive constraint lost through the merger
A recurrent issue in remedy design is whether scope of the remedy
package should include just overlapping products/pipelines, or also
underlying R&D capabilities
Divestment of R&D assets necessary if the ultimate source of
concerns is the concentration of innovation capabilities (address
the “cause” of competition, and not just the “symptoms”)
10
How to address dynamic competition
concerns?
Selected non-technical references
• Jonathan Baker, The Antitrust Paradigm, 2019 (chapter 8)
• Jonathan Baker, “Beyond Schumpeter vs. Arrow: How Antitrust
Fosters Innovation” Antitrust Law Journal, 2007
• Carles Esteva Mosso, “Innovation in EU Merger Control”, Speech at
the ABA Spring Meetings, April 2018
• Giulio Federico, “Horizontal Mergers, Innovation and the Competitive
Process”, Journal of European Competition Law & Practice, 2017
• Giulio Federico, Fiona Scott Morton and Carl Shapiro, “Antitrust and
Innovation: Welcoming and Protecting Disruption”, in Innovation
Policy and the Economy, NBER, Forthcoming (2020)
• Michael Porter, “The Competitive Advantage of Nations”, Harvard
Business Review, 1990
• Pierre Régibeau and Katharine Rockett, “Mergers and Innovation”,
The Antitrust Bulletin, 2019
• Carl Shapiro, “Competition and Innovation. Did Arrow Hit the Bull’s
Eye?” In The Rate and Direction of Inventive Activity Revisited, 2012
Back-up
12
Benefits of competition
13
"Competition is not only
reflected in lower prices. It
encourages businesses to
produce more efficiently and
to innovate. It promotes
diversity of approaches and
experiments…”
14
Competition is good for consumers for the simple
reason that it impels producers to offer deals – lower
prices, better quality, new products, and more choice;
[…] rivalry benefits consumers both directly in terms of
better deals, and further over time as producers strive
to increase their efficiency and to come up with new
and better ways of doing things
John Vickers, 2001, “Competition is for consumers”
Benefits of competition
Basic economic framework: key
externalities
15
• Focus on the externalities which
a merger internalises
1. Pricing externalities (-)
2. Innovation externalities (-)
3. Knowledge spillovers (+)
R&D
Product
Market
Competition
2
1
3
• Standard of assessment: how does
the merger affect current and
future consumer welfare?
R&D
Product
Market
Competition
Firm A Firm B
Guidelines
European Commission
- 2004 Horizontal Merger
Guidelines
- 2011 Horizontal Cooperation
Guidelines
- 1984 Block Exemption on R&D
agreements
US DOJ/FTC
- 2010 Horizontal Merger
Guidelines
- 1995 / 2017 IP Licensing
Guidelines
- 1984 National Cooperative
Research Act
Recent Cases
European Commission
- Western Digital/Hitachi
- Deutsche Boerse/Euronext
- GE/Alstom
- GSK/Novartis Oncology
- Dow/DuPont
- Bayer/Monsanto
US DOJ/FTC
- AT&T /T-Mobile
- Nielsen/Arbitron
- Applied materials/Tokyo
Electron
- Halliburton/Baker Hughes
- Bayer/Monsanto
- Mallinckrodt
- CDK/Auto-Mate
16

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Merger Control in Dynamic Markets – FEDERICO – December 2019 OECD discussion

  • 1. Merger control in dynamic markets OECD Global Competition Forum 6 December 2019 Giulio Federico Head of Unit, Chief Economist Team, DG Competition
  • 2. Disclaimer • The views expressed in this presentation are the personal views of the speaker only and cannot be regarded as stating an official position of the European Commission. 2
  • 3. Competition is all about dynamics • Competition is a dynamic process of rivalry where firms seek to capture profitable sales from each other, and to protect existing sales • Rivalry induces firms to offer better deals to consumers (e.g. lower prices; better products) • A well-functioning competitive process delivers allocative, productive and dynamic efficiency • 3
  • 4. Horizontal mergers may hinder the competitive process • Competition creates business stealing effects between rival firms • A horizontal merger allows two rivals firms to internalize business stealing effects, by allowing for coordination of all relevant competitive parameters, including dynamic ones (e.g. future prices; innovation) • A merger between two significant and close rivals may therefore reduce the intensity of competition absent sufficient countervailing effects (e.g. efficiencies) • This mechanism applies to both static and dynamic competition • 4
  • 5. When are adverse dynamic effects more likely? • Merging parties are significant and close innovators (e.g. as shown by overlaps in R&D activities and/or capabilities) • Limited number of rival innovators to the merged entity • High barriers to entry in R&D/innovation (e.g. closeness of competition is durable) • Disruptive innovation from "outside the market" unlikely • Pro-competitive (countervailing) effects weak 5
  • 6. Evidence: focus on overlaps and diversion Firm A Firm B Development ProductCapabilities Innovation competition Actual and potential competition Capabilities Development Product Line of research Line of research Line of research Line of research Line of research Line of research Line of research Line of research • Business stealing is generated by overlaps (within and across each stage of the competitive process) • Sources of evidence: internal documents; current pipelines; patent data • Aim: understand underlying competitive process generating observables overlaps, in order to infer likelihood and nature of future business stealing effects 6
  • 7. Is the economics really so complicated? • Academic literature sometimes relied upon to suggest that relationship between “competition and innovation” is ambiguous, offering limited guidance to merger policy • This literature is mostly about (symmetric) variations in product market competition, and not about mergers • More recent formal work suggests that in standard models of product differentiation, horizontal mergers increase prices and reduce innovation absent efficiencies • Even in those models where innovation may increase following a merger, dynamic competition is typically still reduced due to higher future prices 7
  • 8. Pro-competitive effects • Scope for pro-competitive effects (efficiencies) can be greater than in traditional cases of static competition • Need for consistency in standard of proof for harm and for efficiencies (e.g. time horizon; qualitative nature of evidence) - but burden of proof rests on merging parties • Plausible efficiency mechanisms include internalization of knowledge spillovers and exploitation of complementarities • Merger-specificity needs to be assessed (e.g. R&D JVs; alternative transactions) • Beware of invalid efficiency claims • Greater “appropriability” through higher market power (i.e. higher prices) typically harms consumers • Elimination of “duplicative” R&D may imply suppression of beneficial innovation competition • How to assess “investment-for-buyout” claims? 8
  • 9. How to deal with uncertainty? • Merger control is a forward looking exercise, characterised by uncertainty • The existence of uncertainty should not preclude effective merger control • Optimal decision theory should inform assessment, balancing expected cost of Type 1 (over-enforcement) and Type 2 (under-enforcement) errors, focusing on expected consumer welfare • Expected cost of Type 2 errors depends on probability of future overlaps and associated competitive benefits • A dynamic counter-factual may need to be considered • There is guidance from antitrust jurisprudence (e.g. US and EC Court judgments in pay-for-delay; US Court in Microsoft) 9
  • 10. In dynamic markets remedies need to be “future-proof” (to address dynamic competition concerns, but also for viability) Complexity of dynamic markets reinforces the case for structural remedies, including all technologies needed to replicate the current and future competitive constraint lost through the merger A recurrent issue in remedy design is whether scope of the remedy package should include just overlapping products/pipelines, or also underlying R&D capabilities Divestment of R&D assets necessary if the ultimate source of concerns is the concentration of innovation capabilities (address the “cause” of competition, and not just the “symptoms”) 10 How to address dynamic competition concerns?
  • 11. Selected non-technical references • Jonathan Baker, The Antitrust Paradigm, 2019 (chapter 8) • Jonathan Baker, “Beyond Schumpeter vs. Arrow: How Antitrust Fosters Innovation” Antitrust Law Journal, 2007 • Carles Esteva Mosso, “Innovation in EU Merger Control”, Speech at the ABA Spring Meetings, April 2018 • Giulio Federico, “Horizontal Mergers, Innovation and the Competitive Process”, Journal of European Competition Law & Practice, 2017 • Giulio Federico, Fiona Scott Morton and Carl Shapiro, “Antitrust and Innovation: Welcoming and Protecting Disruption”, in Innovation Policy and the Economy, NBER, Forthcoming (2020) • Michael Porter, “The Competitive Advantage of Nations”, Harvard Business Review, 1990 • Pierre Régibeau and Katharine Rockett, “Mergers and Innovation”, The Antitrust Bulletin, 2019 • Carl Shapiro, “Competition and Innovation. Did Arrow Hit the Bull’s Eye?” In The Rate and Direction of Inventive Activity Revisited, 2012
  • 13. Benefits of competition 13 "Competition is not only reflected in lower prices. It encourages businesses to produce more efficiently and to innovate. It promotes diversity of approaches and experiments…”
  • 14. 14 Competition is good for consumers for the simple reason that it impels producers to offer deals – lower prices, better quality, new products, and more choice; […] rivalry benefits consumers both directly in terms of better deals, and further over time as producers strive to increase their efficiency and to come up with new and better ways of doing things John Vickers, 2001, “Competition is for consumers” Benefits of competition
  • 15. Basic economic framework: key externalities 15 • Focus on the externalities which a merger internalises 1. Pricing externalities (-) 2. Innovation externalities (-) 3. Knowledge spillovers (+) R&D Product Market Competition 2 1 3 • Standard of assessment: how does the merger affect current and future consumer welfare? R&D Product Market Competition Firm A Firm B
  • 16. Guidelines European Commission - 2004 Horizontal Merger Guidelines - 2011 Horizontal Cooperation Guidelines - 1984 Block Exemption on R&D agreements US DOJ/FTC - 2010 Horizontal Merger Guidelines - 1995 / 2017 IP Licensing Guidelines - 1984 National Cooperative Research Act Recent Cases European Commission - Western Digital/Hitachi - Deutsche Boerse/Euronext - GE/Alstom - GSK/Novartis Oncology - Dow/DuPont - Bayer/Monsanto US DOJ/FTC - AT&T /T-Mobile - Nielsen/Arbitron - Applied materials/Tokyo Electron - Halliburton/Baker Hughes - Bayer/Monsanto - Mallinckrodt - CDK/Auto-Mate 16