Conglomerate Mergers - Essay Example

A merger is said to take place when two companies become one by combining all the assets and liabilities and take a new The reason for mergers is usually to create value, because the value of combined companies is always higher than that of the individual companies that are combining1. Conglomerate mergers take place when the firms involved in the merger operate in different product markets. These mergers may be product extension mergers - merger involving firms that produce different but related products - or pure conglomerate mergers - mergers between firms operating in entirely different markets. It is rare indeed for such mergers to lead any substantial reduction in competition, solely due to the conglomerate effect. In a few cases, especially if the products acquired, complement the acquirer's own products, "potentially adverse effects can be identified related to so-called 'portfolio power'"2. These are mergers between complementary products, neighbouring products, and unrelated products. A "pure" conglomerate merger involves the acquisition of products that are not related on the demand or supply side. It is a merger in which there is neither horizontal, vertical, complementary nor neighbourhood relationship between the products. Conglomerate mergers involve portfolio power. When the combined market power of a portfolio of brands exceeds the market power of the sum of its parts, a firm is said to have portfolio power. This enables the firm to significantly reduce the competition, as its exercise of market power in the individual markets is much more effective. Portfolio effects could possibly have anti-competitive effects, especially where they affect the structure of the market directly. This increases the possibility of entry preventing strategies and eliminates the competitive restrictions brought to bear upon it by neighbouring markets3. Frequently, customers get an incentive in the form of reduced transaction costs by purchasing from the portfolio of one supplier, where the supplier's firm has many brands under its control due to a conglomerate merger; this is the effect on market structure of conglomerate mergers. If the non - portfolio competitors or competitors who control a few brands do not impose an effective competitive restriction on a firm which has portfolio power, then competition may be reduced to a large extent4. Large conglomerates will usually encourage customers to purchase a range of their products and the result of a conglomerate merger may be that tying or bundling occurs if complementary goods are sold by such firm. This may have adverse effects on competition. Sometimes the predatory behaviour of a conglomerate merger may be feasible when the competition is confined to a small area, thereby enabling firms to face a competitive threat in respect of a few brands or in a few geographic markets at point of time.5 Finally, conglomerate mergers usually facilitate coordination if the merged firm's opponents in one market are also contenders in some of its other markets6. In the case Tetra Laval v. Commission, The European Commission gave a ruling whereby it prohibited the merger of Sidel SA and Tetra Laval BV. Sidel was a manufacturer of stretch blow moulding machines used for packaging liquid foods in plastic. Tetra was a dominant company in the carton-packaging market operating through a related company. Although conglomerate mergers, similar to this one are usually neutral in respect of the competitive aspect, the European Commission was of the opinion that this merger would only serve to enhance Tetra's leverage as in respect of its dominant position in the carton-packaging market. It further, held that this would serve to influence customers using plastic packaging to buy Sidel's machines, thereby foreclosing smaller competitors from the market for those machines. The parties to this merger offered to address the Commission's concerns by entering into certain binding commitments that would preclude the merged entity from engaging in anticompetitive conduct. The Commission refused to consider these commitments, conveying its preference for structural remedies and ordered Tetra to divest itself of its Sidel shares. Tetra appealed seeking annulment of the Commission's decisions. The Court of First Instance granted Tetra's application on October 25, 2002. It opined that the Commission had failed to produce convincing evidence that the proposed conglomerate merger would create or strengthen a dominant position within a foreseeable period. Finally, it held that the Commission had wrongly refused to take into account the commitments that the parties had offered to make in order to dispel the Commission's concerns7. The Commission asked the European Court of Justice to review the Court of First Instance's decision, even though the Commission subsequently re-evaluated the proposed transaction and permitted the parties to conclude a merger agreement. In its decision of February 15, 2005, the ECJ dismissed the European Commission's appeal. The ECJ held that the Court of First Instance's reference to convincing evidence was not, an attempt by the Court of First Instance to impose a higher standard of proof on the Commission, but that it was simply a statement designed to draw 'attention to the essential function of evidence, which is to establish convincingly the merits of an argument or, as in the present case, of a decision on a merger.' The ECJ further contended that the proper analysis of a conglomerate merger required the Commission to take into consideration, whether any anti-competitive effects might not occur for 'a lengthy period of time in future' and that 'the leveraging necessary to give rise to a significant impediment to effective competition means that the chains of cause and effect are dimly discernible, uncertain and difficult to establish.' Consequently to disallow a conglomerate merger, the Commission had to produce evidence of sufficient 'quality' to 'support the Commission's conclusion.' The ECJ further held that the Community Courts had to ensure that the evidence relied upon by the Commission was 'factually accurate, reliable and consistent,' that it sufficiently took into account the complexity of the situation, and that it was 'capable of substantiating the conclusions drawn from it. Such a review is all the more necessary in the case of a prospective analysis required when examining a planned merger with conglomerate effect.' Though the ECJ's decision could cause the Commission to shift its enforcement efforts away from conglomerate mergers, the ECJ refused to consider conglomerate mergers as unlawful and in a manner similar to that of the Court of First Instance, was unconvinced of the Commission's leveraging theory because, it held that conglomerate mergers in general do not pose any significant risk of anti-competitive harm8. The Court of First Instance held that a conglomerate merger is a merger of undertakings which, essentially, do not have a pre-existing competitive relationship, either as direct competitors or as suppliers or customers. Thus it cannot be presumed as a general rule that such mergers produce anti-competitive effects. However, they may have anti-competitive effects in certain cases9. The anticompetitive effects of conglomerate mergers as determined by the Commission include the creation of portfolio power or the acquisition of a full range of products that would eliminate other suppliers at the distribution level, bundling or tying and leveraging dominance existing in one market to another adjacent market. Subsequently, an extraordinary and changed merger control system was adopted and implemented. The new merger regime included the following key developments for assessing concentrations, namely, a new test for assessing concentrations and horizontal merger guidelines. This new test for assessing a transaction is whether the transaction would 'significantly impede effective competition, in the common market or in a substantial part of it, in particular as a result or strengthening of a dominant position'10. In general, the extant guidelines tend to recognise that the justification for intervention in order to prevent vertical and conglomerate mergers is weaker than for horizontal mergers because horizontal mergers 11 eliminate actual competition whereas vertical and conglomerate mergers do not12. The UK Competition Commission Guidelines state that in general conglomerate mergers do not raise competition issues, whilst recognizing several instances in which they could be problematic13. A wide range of conglomerate effects have been identified14, but the main focus has been on portfolio power, because the combination of activities in neighbouring markets may itself be a source of market power15. This theory in respect of portfolio power in conglomerate mergers is however disputed by many authorities on this subject. The European Commission's Substantive Assessment of the CFI's approach in these cases follows the judgment of the European Court of Justice in Kali and Salz v Commission where the Court emphasized the necessity for the Commission to evaluate and elucidate anti-competitive effects using cogent and accurate economics16. The CFI concluded that there were several obvious errors, omissions and contradictions in the Commission's compilation, interpretation and economic analysis of market data. As depicted in Tetra Laval/Sidel, the CFI disagreed with the Commission's conclusions on leveraging. Moreover, in respect of the Schneider Legrand case, the CFI criticised the Commission for defining geographic markets as being national, but basing its assessment on global considerations, extrapolated from a single market without demonstrating their relevance at the national level. It also concluded that the Commission's analysis must be based on detailed facts and not mere assumptions and deductions. Additionally, it held that there should be no over-estimation of the economic power of the merged entity, with a corresponding under-estimation of the competitor's power17. The CFI acknowledged that though the transaction would give rise to anti-competitive effects in France, all the same the prohibition was to be annulled as it would constitute a serious infringement of the parties' rights of defence. The most important feature is the CFI's persistent criticism of the Commission's economic analysis and approach to evidence. This will force the Commission to exercise greater caution while challenging conglomerate mergers. Conglomerate mergers are to be found in the financial services field also. The EC consults three regulatory committees, namely the Banking and Advisory Committee, the Insurance Committee and the High Level Securities Supervisors Committee in this regard. In order to effectively deal with the much increased competitive pressures, the financial institutions have resorted to mergers and acquisitions to increase their size. At present most financial conglomerates in Europe are composed of banking and securities groups. The number of major financial conglomerates spanning all the three sectors of banking, securities, and insurance still remains relatively small, although increasing at a very rapid pace. A conglomerate merger that involves the acquisition of complements or independent goods creates the opportunity for the conglomerate to bundle or tie post-acquisition. A conglomerate firm in many circumstances would have exclusionary incentives to bundle or tie its products if this resulted in the departure or barred the entry of a competitor. In the absence of this exclusionary effect not only would its rival be put at a disadvantage but it would also reduce the profits of the conglomerate. The Commission's approach to the anti-competitive effects of conglomerate mergers is brought out vividly in the fact that it had prohibited five mergers in 2001, since the EC Merger Regulation (ECMR) became effective18. The prohibition decision in Tetra Laval Sidel relied on the assertion that the combined entity could extend a pre-existing dominant position on one market to a neighbouring product market using leveraging techniques like mixed bundling, the offering of two products for a combined price that is lower than if the products were purchased individually, or pure bundling or tying i.e., selling two or more products only together. These mergers are the only ones that the Commission is not critical of. The foregoing provides a clear basis for the Commission to apply the test to non-collusive oligopolies that do not come under the purview of the traditional theories of single undertakings or collective dominance. There are now circumstances where the Commission has a clearer basis to prohibit a merger that is likely to have anti-competitive effects, even if the transaction is unlikely to create or strengthen a dominant undertaking. Some guidelines suggest that the combination of activities in neighbouring markets may itself be a source of market power. However, there is widespread disagreement about whether it is advisable to prohibit mergers on the grounds of portfolio power. Conglomerate mergers giving rise to a unilateral effect because they result in the exit of rivals or deter their entry based on a similar scale effect. The Commission's reluctance to accept such mergers has drawn a lot of criticism and adverse judgements from the CFI and the ECJ. Bibliography. Adams, W., and J. Yellen. 1976. "Commodity Bundling and the Burden of Monopoly." Quarterly Journal of Economics 90: 475-98. Ahlborn, C., D. Evans, and A. J. Padilla. 2003. The Antitrust Economics of Tying: A Farewell to Per Se Illegality. NERA Economic Consulting. Bonanno, G., and J. Vickers. 1988. "Vertical Separation." Journal of Industrial Economics 36: 257-266. Brander, J. A., and T. R. Lewis. 1986. "Oligopoly and Financial Structure: The Limited Liability Effect." American Economic Review 76: 956-70. Capps, O., Jr., J. Church, and H.A. Love. 2003. "Specification Issues and Confidence Intervals in Unilateral Price Effects Analysis." Journal of Econometrics 113: 3- 31. Carbajo, J., D. de-Meza, and D. J. Seidmann. 1990. "A Strategic Motivation for Commodity Bundling." Journal of Industrial Economics 38: 283-98. Diamond, D. 1984. 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