MICROSOFT AND YAHOO! WHY SUCH MERGERS MAY BE BAD NEWS FOR CONSUMERS

Allowing the second-biggest firm in an industry to get stronger by acquisition or by the dominant firm selling off capacity can have the opposite effect to the regulators intent, weakening competition and hurting consumers through higher prices. That is the finding of new experimental research by Professor Hans-Theo Normann and Dr Miguel Fonseca published in the March 2008 issue of The Economic Journal.

Their findings have implications for many merger cases, including the pending takeover of Yahoo! by Microsoft. They also have implications for the announcement by European electricity giant Eon in February 2009 that it will be selling off 20% of its power plant capacity, a move seen as designed to appease regulators.

Regulators typically step in to prevent the largest firm in the industry taking over another firm. But they tend to be more relaxed about the second-biggest firm growing in this way – the idea being that a larger ‘challenger’ will be better able to compete against the market leader.

So regulators might allow the takeover of Yahoo! by Microsoft (the new firm would be second to Google in internet searches). But the experimental evidence from this study suggests that two equally large firms are prone to collude – and this harms consumers.

The report finds that:

• Mergers raise prices (by about 14%) and so are bad for consumers.
• But redistributing capacity away from the largest firm to the second largest does not result in lower prices. If some capacity is transferred from the largest to the second largest firm, then prices rise even more (by about 27%).

The reason that strengthening the second largest firm can harm consumers is that two firms of equal size are much more likely to collude than if one is much larger than the other. Although explicit price-fixing agreements are illegal, firms still watch the price charged by others. And while a firm will be unlikely to slash prices if they know that their equally large rival will ‘punish’ them by following suit, a firm with no large rival is more able, and willing, to cut prices.

This runs counter to conventional thinking, which suggests that weakening the dominant firm should improve competition. Competition authorities have therefore imposed merger remedies and requested that a newly merged firm sell off part of its capacity to a competitor to create a more symmetric and thus less concentrated market structure.

ENDS

Notes for editors: ‘Mergers, Asymmetries and Collusion: Experimental Evidence’ by by Hans-Theo Normann and Miguel Fonseca is published in the March 2008 issue of The Economic Journal.

Hans-Theo Normann is at Royal Holloway, University of London. Miguel Fonseca is at University of Exeter.

For further information: contact Hans-Theo Normann on 01784 414003 (email: hans.normann@rhul.ac.uk); Miguel Fonseca on 01392 262584 (email: M.A.Fonseca@exeter.ac.uk); or Romesh Vaitilingam on 07768 661095 (email: romesh@compuserve.com).