This presentation by Jorge Padilla, Senior Managing Director and Head, Compass Lexecon Europe, was made during the discussion “Non-Price Effects of Mergers” held at the 129th meeting of the OECD Competition Committee on 6 June 2018. More papers and presentations on the topic can be found out at oe.cd/npem.

1. Dr Jorge Padilla
6 June 2018
OECD Competition Committee - Non-price effects of mergers
The Effects of Horizontal Mergers on
Product and Process innovation
Taking Stock of the Recent Academic Debate

2. COMPASS LEXECON 1
 Focus on innovation effects is to be welcomed
 Horizontal mergers are bound to have an impact on the incentive and ability
to innovate of the merging firms
 Both product and process innovation will be impacted
 Economic analysis can help to assess the sign and magnitude of the effect on
innovation of horizontal mergers
HORIZONTAL MERGERS ARE LIKELY TO IMPACT INNOVATION OUTCOMES

3. COMPASS LEXECON 2
 Do horizontal mergers reduce the merging parties’ incentives to invest in
process and/or product innovation?
 Do they always reduce such incentives? Or, in other words, is there
justification for the adoption of a structural presumption?
 Could horizontal mergers affect the merging parties’ ability to engage in
process and/or product innovation?
 How should competition authorities and courts balance the potential
anticompetitive and procompetitive effects of horizontal mergers on
innovation?
KEY QUESTIONS

4. COMPASS LEXECON 3
 Horizontal mergers may reduce the merging parties’ incentives to invest in
process and/or product innovation
– E.g. Under certain assumptions about the structure of the market and R&D costs,
when the investment decision of a merging party impacts negatively the
profitability of the other merging party’s investment, a merger will reduce the
merging parties’ incentives to invest
– Federico et al. (2017): (a) the resulting innovations are bound to compete in the same
downstream market and (b) the merged entity prefers not to concentrate its
investment in one of the research facilities
– E.g. Motta & Tarantino (2017): horizontal merger may reduce process innovation
because it results in lower output, which reduces the incentives to cut costs
DO HORIZONTAL MERGERS REDUCE THE MERGING PARTIES’ INCENTIVES TO
INVEST IN PROCESS AND/OR PRODUCT INNOVATION?

5. COMPASS LEXECON 4
 No, horizontal mergers may increase the merging parties’ incentives to invest
in process and/or product innovation
– Under certain assumptions about the structure of the market and R&D costs,
when the investment decision of a merging party impacts positively the
profitability of the other merging party’s investment, a merger may increase the
merging parties’ incentives to invest
– Denicolò and Polo (2018): (a) merging parties’ invest in general purpose technologies
generating positive spillovers or (b) when their innovations compete but the merged
entity prefers to concentrate its investment in one of the research facilities only
– Jullien and Lefouili (2018): merging parties’ R&D programs are too similar from a social
viewpoint.
DO THEY ALWAYS REDUCE SUCH INCENTIVES? OR, IN OTHER WORDS, IS THERE
JUSTIFICATION FOR THE ADOPTION OF A STRUCTURAL PRESUMPTION?

6. COMPASS LEXECON 5
 Yes
 R&D synergies:
– Complementary skills, etc.
 Financial synergies:
– Firm with unfettered access to capital markets subsidizes the R& projects of
financially constrained start ups
– Mergers may facilitate investment by lifting credit constraints
– Relationship between cash flows and investment is well documented
– Accepted in state aid cases
COULD HORIZONTAL MERGERS AFFECT THE MERGING PARTIES’ ABILITY TO
ENGAGE IN PROCESS AND/OR PRODUCT INNOVATION?

7. COMPASS LEXECON 6
 Competition authorities should investigate the impact of mergers on
innovation with an open mind because mergers may reduce or promote
innovation depending on the circumstances
 The assessment of the impact of the horizontal merger on the innovation
incentives of the merging parties should correspond to the competition
authority in charge of the case. The competition authority must demonstrate
that the net incentive effect of the merger is negative to discharge its burden
of proof
 The assessment of the impact of the horizontal merger on the innovation
ability of the merging parties should correspond to the merging parties and
will be subject to the conditions of any other efficiency defense
HOW SHOULD COMPETITION AUTHORITIES AND COURTS BALANCE THE
EFFECTS OF HORIZONTAL MERGERS ON INNOVATION?

8. COMPASS LEXECON 7
 More or less the same:
 Horizontal mergers may reduce the merging parties’ incentives to invest quality;
e.g. when an increase in quality by one of them reduces the profitability of an
investment in quality by the other
 However, mergers may increase reduce the merging parties’ incentives to increase
product variety; e.g. when competition leads to too little product variety …
 And they may also increase the merging parties’ ability to invest in quality and
product variety
WHAT ABOUT QUALITY?

9. Dr Jorge Padilla
6 June 2018
OECD Competition Committee - Non-price effects of mergers
Mergers, Privacy and Prices
In Need of More Economic Analysis

10. COMPASS LEXECON 9
 Discussion has been focused on the impact of mergers on privacy provision
 I want to discuss a different issue: How mergers may allow firms to build
unique databases that can then be used to raise prices and/or price
discriminate more effectively
MERGERS AND PRIVACY

11. COMPASS LEXECON 10
INFORMATION IS VALUABLE (1)
 Consider a bilateral negotiation
between a buyer with a valuation for
the good equal to B and a seller with a
cost equal to C
 The negotiated price will be between
C and B. Suppose they agree to split
the difference
High
Low
B = Monopoly
price
C = Cost
Maximum price buyer is
willing to accept
Minimum price seller is
willing to accept

12. COMPASS LEXECON 11
INFORMATION IS VALUABLE (2)
 Consider a bilateral negotiation
between a buyer with a valuation for
the good equal to B and a seller with a
cost equal to C
 The negotiated price will be between
C and B. Suppose they agree to split
the difference
 The seller has the incentive to inflate C
and the buyer the incentive to pretend
that B is lower is than it is
High
Low
B = Monopoly
price
C = Cost
Maximum price buyer is
willing to accept
Minimum price seller is
willing to accept

13. COMPASS LEXECON 12
INFORMATION IS VALUABLE (3)
 Which party will strike a better deal?
 The party who manages to conceal its
private information better
 Suppose the buyer does not have a
clue about the cost C but the seller is
fully aware of the buyer’s valuation B,
then the price will be close to B (i.e.
close to the monopoly price)
High
Low
B = Monopoly
price
C = Cost
Maximum price buyer is
willing to accept
Minimum price seller is
willing to accept

14. COMPASS LEXECON 13
HOW CAN SELLERS LEARN ABOUT CONSUMERS’ VALUATIONS? (1)
 Search activity
 Browsing activity
 Responses to targeted ads
 Location
 Electronic communications
 Activity in social networks
 Past purchases

15. COMPASS LEXECON 14
HOW CAN SELLERS LEARN ABOUT CONSUMERS’ VALUATIONS? (2)
 Search activity
 Browsing activity
 Responses to targeted ads
 Location
 Electronic communications
 Activity in social networks
 Past purchases
Ability to combine data
from different sources
allows to extract
additional
informational rents

16. COMPASS LEXECON 15
 A transaction that allows one firm to build a unique database (combining
many different sources of data relevant to assess consumers’ willingness to
pay) will have significant price effects
MERGERS / PRIVACY / PRICES

17. COMPASS LEXECON 16
THANK YOU!
jpadilla@compasslexecon.com
View my research on my SSRN author
page: http://ssrn.com/author=47132