On the offensive

I recently posted on some concerns I had with the Booking/eTraveli merger decision, which in my opinion is an example of an efficiency offence. One could just reject the concept of the efficiency offence as a policy position. But in the spirit of trying to meet the European Commission halfway, is there any way in which one could argue an efficiency offence case that would lead to the “right” outcome (where “right” here means “from a consumer welfare perspective”)?

I think the answer is – just about - maybe. But it would require extensive analysis that the European Commission did not do in Booking/eTraveli.

What happens to consumer welfare after a hypothetical efficiency offence merger?

Initially consumers are better off, because they are benefiting from the efficiency generated by the merger (in the case of Booking/eTraveli, this is the additional convenience that is gained from being able to purchase flights and hotels together).

This is true for retained customers (who now have a better product) and new customers (by revealed preference, new customers must prefer the merged firms product to their previous supplier, and so are also better off).

Rivals will have lower sales, as some customers now prefer to purchase from the merged firm. But this, by itself, does not create any adverse merger effect. Indeed, it is likely that there is a reinforcing positive effect on consumer welfare in the short term, because if the merged firm increases the attractiveness of its offer, rivals will cut their prices to compete better[1]. This is a corollary of (and the reverse of) the standard merger effect, which is that the merger will raise prices of the merged firm, and the reduced level of competition will allow other competing firms to raise prices.

So far, therefore, consumers of the merged firm are better off; consumers that switch to the merged firm are better off; and consumers that remain with their existing firms are better off.

Where does the adverse effect on consumers arise, if at all? It has to arise from the long-term strategic behaviour of rivals. E.g.

o?? Might rivals will reduce or cease investing in quality/R&D because they face a more competitive merged firm? This contrary to the standard view, which is that if one firm increases its quality, rivals will also seek to increase their quality (as it is more critical to catch up when you are behind) – for instance, see the discussion about incentives for R&D competition in the Bayer/Monsanto case. If anything, therefore, one would expect rivals to compete harder on quality/R&D, facing a more attractive rival.

o?? Might rivals will reduce capacity, or expand capacity by less, because it is less attractive to add capacity when facing a more competitive merged firm? This could be an negative effect ?- but it is likely outweighed by the additional incentive for the merged firm to increase capacity.[2]

o?? Might rivals will exit the market entirely, because they cannot compete with the merged firm? This is unlikely to happen in the short term, as the rival’s capacity is likely sunk and so it would remain in the market as long as they are covering their variable costs. It could happen in the longer term if rivals found it unprofitable to replace depreciated capacity, but this is then the same argument as the previous point.

But any of these potential adverse effects would be at best highly uncertain and difficult to prove.

In addition, if there was a genuine advantage in the eyes of consumers from putting the two merging firms together, rivals would likely seek to counter-merge and so to generate similar efficiencies – again increasing consumer welfare. (Indeed, in Booking/eTraveli there were rivals such as Expedia that already operated flights and hotels, so this effect was already in place.)

The overriding point being:

-??????????? Benefits to consumers are certain and immediate

-??????????? Costs to consumers – if any – are uncertain and distant

The evidential burden on the authority to demonstrate that the costs outweigh the benefits ought to be extremely high. Yet in Booking/eTraveli, such an analysis was not carried out at all.

Could an authority get around these issues by arguing that there were no merger efficiencies? No. You cannot (or at least should not) run an efficiency offence without acknowledging that the first effect must be that consumers are better off. (The clue is in the name.) It is the fact that consumers find the offer of the merged firm more attractive, and so are more likely to purchase from them, that leads to the diversion of sales towards the merged firm and away from rivals. If it is denied that there is any such efficiency, then the entire premise of the merger concern is DOA.

[1] For the economists, I am assuming strategic complements here. ?

[2] Otherwise we would expect to see less and less capacity in markets where quality increases, which does not seem particularly plausible.