Monopoly Merger and Cartel Three Key Issues in

Monopoly, Merger and Cartel -Three Key Issues in Competition Hu, Tzu-Shun Senior Specialist, Taiwan FTC Vientiane, Lao PDR 7 -8 March 2006 1

Market Structure Highly Competitive Perfect Competition Farming Stocks Currencies High Degree of Market Power Monopolistic Competition Restaurants Small Builders Solicitors Oligopoly Supermarkets Banks Electrical Goods Monopoly Gas Water Electricity Telecommunications 2

Give me answers , please. o Which market structure(s) do you prefer? why? o Well, different people have different answers: o o if your are consumers, you prefer… if you are … 3

Money! Monopoly! 4

Monopoly and Competition: Which One is better? Diverging views: Question 1 o The libertarian view o The innovator view 5

The libertarian view: Adam Smith (1723 -1790) 6

o the anonymous free market is a guarantee for political freedom o government interference brings us on the road to serfdom Milton Friedman 7

The innovator view: Joseph A. Schumpeter (1883 -1950) 8

Why should there be anything wrong with monopoly? The performance of large firms with respect to R&D is much better than those of small firms 9

Competition Price Short run profits Long run equilibrium L(S)MC L(S)ATC L(S)AVC CE Shut down min LAC q 3 q 2 q 1 Output 10

Given a set of alternative allocations and a set of individuals, a movement from one alternative allocation to another that can make at least one individual better off, without making any other individual worse off Long-run equilibrium 1. Pareto efficiency (P = MC) 2. Productive efficiency 3. Allocative efficiency Min LAC Minimum efficiency scale 11

Monopoly P Income transfer Lost Consumer Surplus Pm Deadweight Loss A B C PC Social welfare = Consumers’ surplus + producers’ surplus Social welfare = public interest MC Because of the higher price, consumers lose A+B and producer gains A-C. AR MR Qm QC Quantity 12

Disadvantages 1. Higher price, lower production 2. Deadweight loss ( P > MC) 3. Rent seeking 13

o The social costs of P monopoly are unfortunately often much higher than the P* DWL. o Every producer has an incentive to establish a monopoly. o He is willing to spend the monopoly profits (at least some of it) to bring him in that position. Rent seeking MC AR MR Q* Quantity 14

Advantages 1. Economies of scale (or scope) 2. Ability of innovation 15

A firm may be monopolist (dominant) for several reasons: 1. The firm may have an exclusive licence. 2. The firm is natural monopoly. 3. The firm has operated more efficiency than its competitors. Note: 1. monopoly (dominance) is not per se illegal. 2. competition authority will be concerned only if the firm misuses its market power to deter entry of potential competitors or to substantially lessen competition 16

Types of Misuse of Market Power (Abuse of A Dominant Position) 1. Excessive pricing 2. Predatory pricing selling at below cost for the purpose of driving out competitors 3. Refusals to deal 4. Price discrimination a practice where by a firm charges different customers or classes of customers different prices for the same good for reasons unrelated to costs 5. Exclusive dealing requiring a retailer or distributor not to sell products competing with the supplier's products 6. Tie-ins 7. Third line forcing requiring purchasers of one product to purchase other products from named suppliers 8. Territorial restrictions the retailer or distributor may not resell outside of a defined territory 9. Customer restrictions the retailer or distributor may only deal with specified customers 10. Resale price maintenance minimum price at which the product may be resold to customers 17

Question 2 o Do you want to your enterprise is as large as Microsoft? o Yes, but how can I let my enterprise grow up? o Internal Growth o External Growth 18

Types of Merger Internal Growth Horizontal Merger Growth of Firms Vertical Merger External Growth (Merger) Conglomerate 19

Horizontal Merger：two competitors combine Primary Secondary Mobile Manufacturers New Mobile Manufacturer Tertiary 20

Vertical Merger：one company acquires a supplier/customer Vertical Merger Backwards – acquisition takes place towards the source Primary Secondary Manufacturer Tertiary Retail Stores 21

Primary Dairy Farming Cooperative Secondary Cheese Processing Plant Vertical Merger Forwards – acquisition takes place towards the market Tertiary 22

Conglomerate ：two firms from different industries combine 23

Why should mergers occur? Motives Cost Savings External growth may be cheaper than internal growth – acquiring an underperforming or young firm may represent a cost effective method of growth Managerial Rewards External growth may satisfy managerial objectives – power, influence, status Shareholder Value Improve the value of the overall business for shareholders Asset Stripping Selling off valuable parts of the business Economies of Scale(Scope) The advantages of large scale production that lead to lower unit costs 24

Efficiency Improve technical, productive or allocative efficiency Synergy The whole is more efficient than the sum of the parts (2 + 2 = 5!) Risk Bearing – Diversification to spread risks Control of Markets -- Gain some form of monopoly power – Control supply – Secure outlets 25

and may make conspiracy) Vertical -- possibility of cut-off supply to the competitors Conglomerate -- deep pockets, internal cross-subsidization, may facilitate predatory pricing 26

P Cost-saving Deadweight Loss P 2 P 1 AC 1 B A AC 2 AR Q 2 Q 1 Quantity 27

Merger control Criterion Economic Benefit > Competition Restraint (cost-saving) ( deadweight loss) 28

“What shall I do about it? They say this is no concerted practice but their way to greet each other!“ 29

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. ” Adam Smith, The Wealth of Nations (1776) 30

Why Investigate Concerted Action: The Monopoly Problem A monopolist creates artificial scarcity of its product by producing less and selling it at a higher price than if it faced competition. Firms, by entering into horizontal or vertical agreements, may be able to collectively exercise monopoly power, thereby doing the same harm to competition and consumers as a monopolist. 31

Types of Concerted Action Horizontal Agreement (Cartel, Collusion) Price Fixing Bid Rigging Market Division Concerted Action Hard Core Cartel Vertical Agreement Tying Exclusive dealing Resale Price Maintenance (RPM) 32

How Horizontal Agreements May Benefit/Harm Competition Benefit 1. Economies of Scale 2. Economies of Scope 3. Sharing or spreading of risk. Harm 1. International Cartels -- DRAM Cartel -- Graphite Electrodes Cartel -- Lysine Cartel -- Vitamins Cartel 33

How Vertical Agreements May Benefit/Harm Competition Benefit Harm 1. Lowering transaction costs. 1. Eliminating competition 2. Assuring a steady supply through “foreclosure”. of key input. 2. Raising barriers to entry 3. Eliminating negative or “raising rivals’ cost. ’ externalities. 3. Creating distributors’ or 4. Getting around another manufacturers’ cartels. company’s exercise of market power. 5. Preventing “free riding”. 34

Exemption 1. 2. 3. 4. unifying the specifications or models of goods for the purpose of reducing costs, improving quality, or increasing efficiency; joint research and development on goods or markets for the purpose of upgrading technology, improving quality, reducing costs, or increasing efficiency; each developing a separate and specialized area for the purpose of rationalizing operations; entering into agreements concerning solely the competition in foreign markets for the purpose of securing or promoting exports; 35

5. 6. 7. joint acts in regards to the importation of foreign goods for the purpose of strengthening trade; joint acts limiting the quantity of production and sales, equipment, or prices for the purpose of meeting the demand orderly, while in economic downturn, the market price of products is lower than the average production costs so that the enterprises in a particular industry have difficulty to maintain their business or encounter a situation of overproduction; or joint acts for the purpose of improving operational efficiency or strengthening the competitiveness of smallmedium enterprises. 36

1. New Policies for Cartels The Need for International Cooperation Bilateral Agreements • Arrange Comparable economies • Imbalance of interest if large with small economy Regional Integration FTA negotiations in many regions; some involve common competition rules as a longerterm objective. 37

Leniency Program : To encourage a member of a cartel to confess and implicate its co-conspirators with first-hand, direct“insider” evidence about their clandestine meetings and communications, an enforcement agency may promise a smaller fine, shorter sentence, less restrictive order, or complete amnesty (immunity). 38