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Review of Industrial Organization

Erschienen in:

30.03.2022

Entry Deterrence, Concentration, and Merger Policy

verfasst von: Gopal Das Varma, Martino De Stefano

Erschienen in: Review of Industrial Organization | Ausgabe 2/2022

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^Abstract

In merger enforcement, entry is considered to be a factor that potentially can mitigate otherwise anti-competitive effects of a merger. The current framework for entry analysis evaluates whether potential entrants are likely to have the incentives and ability to enter the industry under the conditions of elevated profitability that are created by an anti-competitive merger. Missing from entry analysis is the notion that incumbent firms may proactively deter entry and how such incumbent incentives may change as a result of a merger. By modeling entry as the outcome of a game between incumbents and potential entrants, we show that a merger can reduce the likelihood of entry even at elevated profit levels by increasing incumbent incentives to invest in entry deterrence. The paper has two policy implications for merger enforcement: First, a merger that is benign by traditional measures may nonetheless have the effect of reducing future entry—entry that would have made the market more competitive relative to status quo. Second, evidence of recent historical entry—which is an important criterion that is used to assess the likelihood of post-merger entry—may be of less evidentiary value than is considered under the current merger enforcement policy.

Vorheriger Artikel Deregulation, Entry, and Competition in Local Banking Markets

Nächster Artikel A Note on Input Price Discrimination Under Bertrand Competition: Simultaneous vs. Sequential Contracting

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2010 U.S Horizontal Merger Guidelines issued by the Department of Justice and the Federal Trade Commission (“Guidelines”), §9 (https://www.justice.gov/sites/default/files/atr/legacy/2010/08/19/hmg-2010.pdf).

These include whether there has been successful prior entry into the relevant market, whether the necessary investments in production assets are not prohibitive, whether technology is freely available to potential entrants, whether a sufficient share of customers can freely choose to buy from a new entrant, etc.

In recent years, the U.S. antitrust agencies have approved a number of mergers—especially in the technology sector—based on evidence of historical entry. See, e.g., the FTC’s closing statements for Google’s acquisition of AdMob (https://www.ftc.gov/sites/default/files/documents/closing_letters/google-inc./admob-inc/100521google-admobstmt.pdf) or the DOJ’s closing statement for Expedia’s acquisition of Orbitz (https://www.justice.gov/opa/pr/justice-department-will-not-challenge-expedias-acquisition-orbitz).

The other factor that is considered to mitigate potentially anti-competitive incentives that are due to a merger is efficiencies. Efficiencies are credited when they are of the form that are likely to be passed through to consumers in the form of lower prices. To be credited, efficiencies must also be merger-specific: not achievable through means that are less anti-competitive relative to a merger. See §10 in Guidelines.

A non-exhaustive list of theoretical treatment of entry deterrence includes Gilbert and Newberry (1982), Gilbert and Vives (1986), Bernheim (1984), and Waldman (1987). In empirical work, among others, Berry and Waldfogel (2001), Ellison and Ellison (2011), Ciliberto and Zhang (2016), and Sweeting et al. (2019) find evidence of entry deterrence efforts by incumbent firms that use a variety of deterrence mechanisms in a variety of industries.

Specifically with regards to regulatory lobbying, Stigler (1971) argued that industry incumbents influence the political process and are able to acquire regulations that reduce entry and increase their profits: “regulation is acquired by the industry and is designed and operated primarily for its benefit … Every industry or occupation that has enough political power to utilize the state will seek to control entry.” Djankov et al. (2002) present data on the regulation of entry in 85 countries and find that “legal entry is extremely cumbersome, time-consuming, and expensive in most countries in the world.” Djankov et al. argue that the evidence supports the public choice theory over alternative theories of regulation. See also Gutiérrez and Philippon (2018; 2019).

In so far as entry deterrence by incumbents is sought to be achieved by “lobbying” an industry regulator or the legislature, such lobbying may be protected by the Noerr-Pennington doctrine. In two landmark cases in 1961 and 1965, the U.S. Supreme Court decided that under the First Amendment, businesses who petitioned the government for anticompetitive actions are immune from liability under the antitrust statutes. See, e.g., Paul Gowder (2009). This may potentially limit the ability of a U.S. antitrust agency to oppose a merger purely because it might increase the incentives of the industry incumbents to impede entry by lobbying for the creation of rules or laws that increase entry barriers. At the same time, lobbying is just one of many ways to create entry barriers.

Since the realization of entry is a binary event, and the amount of investment that is needed to prevent entry in our model is uncertain, this article is also related to the provision of discrete public goods with uncertain cost. See, e.g., Nitzan and Romano (1990).

For an overview of issues raised by the merger, see Rogerson (2019).

See Net Neutrality, Public Knowledge, available at https://www.publicknowledge.org/issues/net-neutrality.

Comcast and Time Warner ultimately abandoned the proposed merger in the face of serious concerns expressed by the DOJ and the FCC. The DOJ’s Press Release stated that collectively, the two firms would have controlled broadband internet access of more than 30 million subscribers—something that would have made the merged entity “an unavoidable gatekeeper for Internet-based services that rely on a broadband connection to reach consumers”. (See https://www.justice.gov/opa/pr/comcast-corporation-abandons-proposed-acquisition-time-warner-cable-after-justice-department).

In February 2015, the FCC voted to approve the Open Internet Order, which enacted the strongest net neutrality rules in history. The decision faced multiple legal challenges from the wireless and cable industries. Subsequently in December 2017, after the change in administration, the Republican majority of the FCC voted to repeal the Open Internet Order. The repeal in turn faced legal challenges from several states in the U.S. Court of Appeals. The Court of Appeals allowed the repeal to stand but barred the FCC from prohibiting states or local authorities from enforcing net neutrality. See https://en.wikipedia.org/wiki/Net_neutrality_in_the_United_States.

One way in which incumbents can overcome the free-riding problem is by having industry associations coordinate their entry deterrence efforts. For example, the industry association can apportion the optimal entry deterrence investment across incumbent firms, say, in proportion to their private benefits from denying entry. The anti-competitive goal of such coordination is likely to invite prosecution by the antitrust authorities. Moreover, in certain situations, coordination by industry associations may not fully overcome the free-riding problem. As the Comcast-Time Warner example illustrates, preventing net neutrality rules from coming into effect would have benefitted both fixed broadband providers (such as Comcast, Time Warner, Charter, etc.) as well as mobile network service providers such as Verizon, AT&T, and T-Mobile. The two industries have separate trade associations. While the association of, say, fixed broadband providers can help to overcome free-riding among its members, it likely has little ability to dictate the amount of deterrence investments that are made by mobile network service providers.

The analysis can be easily extended to a situation with more than two incumbents, where each operates as a monopolist in a distinct market. Similarly, as a general matter, the analysis can also be extended to a setting in which the merging firms are not monopolists in their respective markets but face within-market competition from other firms. (Within-market competition is fully discussed in the more general model introduced in Section 3).

Bernheim (1984) and Gilbert and Vives (1986) consider environments with complete information and show that the free-rider problem does not cause incumbents to underinvest in entry deterrence. In contrast, Waldman (1987) shows that if the cost of entry deterrence is uncertain, then, for certain investment technologies, incumbents may underinvest.

A referee has pointed out that it is possible for a well-funded potential entrant to invest in breaking down entry barriers that are created by incumbents (say, by counter-lobbying the industry regulator to permit entry). An example may be the lobbying of city officials by a ride-hailing service to let it operate in the city over the objections of incumbent taxi-cab companies. We note that having to make additional upfront investments to neutralize entry barriers also amounts to reducing the likelihood of entry by requiring that the entrant’s profit upon entry cover those (sunk) barrier-breaking investments.

The concavity condition reflects the assumption of diminishing marginal returns from investing in entry deterrence.

If the value of the first-order condition when \(\sum_{k}{x}_{k}=0\) is negative, then the optimal investment is 0. Note that given the assumption that \(D^{\prime} > 0\) and \(D^{\prime\prime} \le 0\), the profit function is concave in \({x}_{i}\) such that the second-order profit maximization condition is satisfied.

An equilibrium exists if the derivative \(D^{\prime}\left( x \right)\) converges to zero or \(D\left(x\right)\) converges to infinity as \(x\) goes to infinity.

If firms are asymmetric, only the firm that has the most to lose from entry—the firm with the largest \({\Delta }_{i}\)—invests, while the other firms fully free-ride on that investment. See Waldman (1987).

We assume that the effectiveness of the investment to deter entry is not affected by the merger itself. However, it is possible that the merged firm’s investment is more effective: for example, because the merged firm can eliminate duplicative efforts between the two merging firms. In that case, the merger would reduce the likelihood of entry even more than what the model predicts.

The derivative of \(\frac{{D^{\prime}\left( X \right)}}{{\left( {D\left( X \right)} \right)^{2} }}\) with respect to \(X\) is \(\frac{{D^{\prime\prime}\left( X \right) \times \left( {D\left( X \right)} \right)^{2} - 2 \times \left( {D^{\prime}\left( X \right)} \right)^{2} \times D\left( X \right)}}{{\left( {D\left( X \right)} \right)^{4} }}\), which is negative because \(D^{\prime} > 0\) and \(D^{\prime\prime} \le 0\).

If multiple firms have the same amount to lose from entry, there are multiple equilibria with the same level of total investment, and any allocation of the total investment across these firms is an equilibrium.

For the merged firm, \({\Omega }_{post}^{merged}=\left({\pi }_{post}^{1}\left(NE\right)+{\pi }_{post}^{2}\left(NE\right)-{\pi }_{post}^{1}\left(E\right)-{\pi }_{post}^{2}(E)\right)\)

We can obtain some intuition for why the sufficient condition holds by re-writing (13) as \(\left({\pi }_{post}^{j}\left(NE\right)-{\pi }_{pre}^{j}\left(NE\right)\right)>\left({\pi }_{post}^{j}\left(E\right)-{\pi }_{pre}^{j}\left(E\right)\right)\); in words, the effect of a merger on any firm’s profit must be larger when there are fewer firms to begin with.

“The Agencies consider the actual history of entry into the relevant market and give substantial weight to this evidence.” Guidelines §9.

Guidelines §1.

We experimented with alternative bounds for the distributions that we used to generate the model parameters, which did not change the conclusion.

The STATA codes that implement the Monte Carlo simulations in the appendices are available upon request.

We experimented with alternative bounds for the distributions that we used to generate the model parameters, which did not change the conclusion.

We experimented with alternative bounds for the distributions used to generate the model parameters, which did not change the conclusion.

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Berry, S., & Waldfogel, J. (2001). Do mergers increase product variety: Evidence from radio broadcasting. The Quarterly Journal of Economics, 116(3), 1009–1025.CrossRef

Ciliberto, F., & Zhang, Z. (2016). Multiple equilibria and deterrence in airlines markets. Economic Inquiry, 55(1), 319–338.CrossRef

Cowgill, B., Pratt A., & Valletti, T. (2021). Political power and market power. arXiv working paper arXiv:2106.13612, Available at Retrieved from July 5, 2021, https://arxiv.org/abs/2106.13612

Djankov, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2002). The regulation of entry. The Quarterly Journal of Economics, 117(1), 1–37.CrossRef

Ellison, G., & Fisher Ellison, S. (2011). Strategic entry deterrence and the behavior of pharmaceutical incumbents prior to patent expiration. American Economic Journal: Microeconomics, 3(1), 1–36.

Gilbert, R., & Newberry, D. (1982). Preemptive patenting and the persistence of monopoly. American Economic Review, 72(3), 514–526.

Gilbert, R., & Vives, X. (1986). Entry deterrence and the free rider problem. Review of Economic Studies, 53(1), 71–83.CrossRef

Gowder, P. (2009). The first amendment encyclopedia. The Free Speech Center, Available at https://www.mtsu.edu/first-amendment/article/1122/noerr-pennington-doctrine

Gutiérrez, G. & Philippon, T. (2018). How EU markets became more competitive than US markets: A study of institutional drift. NBER Working Paper no. 24700.

Gutiérrez, G. & Philippon, T. (2019). The failure of free entry. NBER Working Paper no. 26001.

Nitzan, S., & Romano, R. (1990). Private provision of a discrete public good with uncertain cost. Journal of Public Economics, 42(3), 357–370.CrossRef

Rogerson, W. P. (2019). Economic theories of harm raised by the proposed comcast/TWC transaction. In J. E. Kwoka Jr. & L. J. White (Eds.), The antitrust revolution (7th ed.). Oxford University Press.

Scherer, F. M. (1979). Product variety: An application to the ready-to- eat cereals industry. Journal of Industrial Economics, 28(2), 113–134.CrossRef

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Sweeting, A., Roberts, J., & Gedge, C. (2020). A model of dynamic limit pricing with an application to the airline industry. Journal of Political Economy, 128(3), 1148–1193.CrossRef

Waldman, M. (1987). Noncooperative entry deterrence, uncertainty, and the free rider problem. Review of Economic Studies, 54(2), 301–310.CrossRef

Titel: Entry Deterrence, Concentration, and Merger Policy
verfasst von: Gopal Das Varma
Martino De Stefano
Publikationsdatum: 30.03.2022
Verlag: Springer US
Erschienen in: Review of Industrial Organization / Ausgabe 2/2022
Print ISSN: 0889-938X
Elektronische ISSN: 1573-7160
DOI: https://doi.org/10.1007/s11151-022-09865-y

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