• Mergers
– if price competition (Mssr. Bertrand) then uninteresting as a strategic problem: if you’re in a 5-firm industry, going to 4 firms doesn’t eliminate the challenge of avoiding price wars.
» it also won’t change the price that the market leader posts in trying to hold together tacit collusion. after all, post-merger you will have excess capacity [price competition isn’t relevant unless you have excess capacity!] and lots of pressure to sell a lot to pay down merger-related debt. if the lead firm tries to raise price, you’ll face a huge temptation to hold your price and pick up market share and profits at their expense
» absent a price change, after a merger all you have is a bigger firm, not a more profitable one.
» yes, going from two firms warring with each other to one single firm does stop price wars and improve profits. however, even a weak-kneed antitrust authority will find it hard to approve the formation of an outright monopoly.
– so our quantity competition story is the relevant one
• n-opoly
– in our duopoly case, two firms reacted to each other’s output in a way that led to positive profits but at an output level higher [and price lower] than a monopolist would charge
› in particular an increase in price by your rival [synonymous with lower output] would lead you to increase output [muting the price increase]
– so if we have 10 identical firms, and 2 merge, then that merged firm will have too much output for a 9-firm market, and will raise price ← → lower ouput.
› as a result, the 8 firms outside the merger will each see a higher price, and because they’d initially been at a profit-maximizing strategic equilibrium, their response to a higher price is to increase output a bit, but not so much as to fully offset the higher price. they thus see their profits increase
= meanwhile the new firm has 2/10ths of the market, but in equilibrium should have only 1/9th of the market. it continues to shrink output.
= the question then is whether its profit with 1/9th of the market is bigger than the pre-merger profits of 2 firms each with 1/10th of the market
– the bottom line is that such mergers do not make sense
› here, manipulation of our duopoly model to make it an n-opoly model gives
p = a – b(qus + [n-1]qothers) leads to
c = MR = a – 2bqus – b[n-1]qothers.
with symmetry q* = qus = qothers so we eventually get q* = (1/[n+1])•([a-c]/b)
single firm profits are then (1/[n+1])2•([a-c]/b)2
› so the total profit of the two firms pre-merger is:
2 • (1/11)2 • ([a-c]/b)2
= once they reach the post-merger 9-firm equilibrium profits will be
(1/10)2 • ([a-c]/b)2
› but 2 • (1/11)2 > (1/10)2 !! so post-merger profits fall – merging does not make either cents or sense
› see the textbook for a table of multiple cases; this calculation is fairly general
• so why mergers?
– managerial firms where execs want a merger for reasons of power and empire, or because they earn bonuses from the merger, or … other non-economic reasons.
– stock markets that mis-price merged firms
= they may misperceive the benefits of a merger [“cost savings” “market power”]
» think of the many dot.com firms that never deliver promised profits … Amazon, Twitter, Tesla … but everyone knows are great things
= pre-merger firms may have different multiples [the P/E ratio of stock price to earnings] for very good reasons, such as different debt structures, and the market gives the new post-merger entity the higher of the two multiples
• merger waves then make some sense: such mis-pricing is pervasive
• legitimate reasons: cost savings
– such savings are always touted, seldom realized
› Daimler-Chrysler merger: common designs didn’t happen, purchasing teams buying for Europe versus the US could find few savings on steel, copper, glass etc. meanwhile setting up a common accounting system was very costly. so in the end no savings were realized.
= furthermore, the new owners weren’t superior managers, indeed they made mistakes that cost $600 million in profits just by mandating that Chrysler handle the launch of a new model year for their minivan in the same way that Mercedes did for a high-end luxury vehicle.
= in sum, CEO Jürgen Schrempp lost billions of euros for his shareholders on this and other acquisitions (including Mitsubishi Motors and various commercial vehicle and aerospace ventures). Chrysler alone resulted in a US$30 billion loss (purchase price less sales price), not counting financial losses and a lower Daimler stock value
– exception: buying poorly-run firms or firms in trouble and turning them around
› hard to do in practice: investment bank turnarounds zoom away … into brick walls, that is, failure rates are very high
= mergers of equals leave the “good” firm with too few resources to restructure
› some firms do however growth through small, targetted acquisitions
= Teleflex in cable-related businesses, buying engineer/founder ventures where the original managers want out due to age or lack of the right skill set
» can keep a team of experienced “integration” specialists who can install modern management information and accounting systems, leverage parent-company R&D skills and supplement marketing
= boat steering systems, car brakes & throttles, surgical devices. for them, they can deliver synergies while adding one more similar business line