Staples Case - Create and answer a case study similar to the Staples Case (Chapters 3, 7, 9, 11) - Cases Available under Assignments tab on Blackboard that discusses how price elasticities and cross-price elasticities can help determine the relevant market, market concentration reactions, and the impact of mergers on markets.
Emre Tezcan
Final Paper
The Proposed MCI WorldCom – Sprint Merger
MCI WorldCom and Sprint Corporation announced a merger agreement on October 5th. MCI WorldCom offered $129 billion in stock and debt to top a rival $100 billion bid from BellSouth for Sprint (S) in October 1999. The plan was to combine MCI WorldCom's No. 2 long distance business with Sprint's third-place operation. It would have been the largest corporate merger in history, ultimately putting MCI WorldCom ahead of AT&T as the largest communications company in the United States if the agreement had been completed.
MCI WorldCom was one of the largest telecommunication providers with operations in more than 65 countries and more than 22 million residential and business customers worldwide. WorldCom’s 1999 annual revenues totaled approximately $37 billion. They were also the largest provider of Internet backbone services in the world when considered by traffic or revenues. The company was the second-largest domestic long distance telecommunications carrier and services in terms of revenues as well as the second-largest provider of various data network services and the second-largest of only three meaningful competitors in the market for custom network telecommunications services for large U.S. business customers. This company had made more than 60 acquisition of competitor and other companies such as MCI (second largest provider of long distance telecommunications and a leading internet backbone services provider), ANS Communications (which served as one of AOL’s primary Internet backbone networks), and Brooks Fiber Properties. WorldCom is bought by Verizon on January 6, 2006 as part of the corporation’s emergence from bankruptcy.
Sprint Corporation is now the third largest wireless telecommunications network in the United States, behind Verizon and AT&T. The company was renamed in 2005 after the purchase of Nextel Communications by Sprint Corporation. The company was one of the largest telecommunications providers in the United States, serving more than 17 million residential and business customers during the proposed merger date. Sprint built the first nationwide, all-digital, fiber optic network; operates the nation’s second-largest Internet backbone; and competes head-to-head against WorldCom in many markets in which the two companies operate.
After the proposed merger had been announced, both U.S. Department of Justice and European Union showed their concern; regulators in the U.S. and Europe balked, and the deal was canceled after nine months of discovery, filings, meetings by U.S. Department of Justice and the Commission of the European Communities. The merger had been terminated on July 13, 2000. Later, WorldCom was caught up in accounting fraud that led to the ouster of CEO Bernard Ebbers and other executives and left the company in bankruptcy. After that; WorldCom was ultimately acquired by Verizon for $7.6 billion in 2005. These two companies were the second and third largest long-distance companies in the United States, and the first and second largest Internet backbone service providers. This case was the only merger between major telecommunications carriers that was derailed by the government. The main reason of rejecting the merger was about the proposed merger is the increase in market power that the merged company will have from combining two well-known companies serving similar geographic markets and providing similar customer groups with similar services. If this merger had been allowed and then one merge would have been allowed as well, then all the telecommunications market was turned into complete dominance by a single firm that creates monopolistic market. In other words; a merged MCI WorldCom and Sprint would create a company that dominates the long-distance and Internet backbone service markets which lead to an illegal monopoly. The regulatory bodies in the U.S. were concerned both of the combined Internet market share of the companies and the combined data and long -distance voice market share.
The proposed merger affected concentration and competition in many telecommunication markets. There are several markets in which Sprint and MCI are considered; long-distance market, mass market, large business market, and internet backbone. Although all of are these part of the telecommunication industry; this proposed merger would have caused market to turn into duopoly at the same time. The industry was having highly concentrated, driven by strong demand, and where the intense competition determines pricing tools itself. I would like to consider the relevant market as Telecommunications. So the relevant markets broadly are Internet Backbone Services Market, Mass Market Domestic Long Distance Telecommunications Services, Mass Market International Long Distance Telecommunications Services, International Private Line Services, Private Line Services Market, Interlata Data Network Services Market and Custom Network Services Market as it is indicated by the plaintiff which is Department of The Justice. Internet Backbone Market does provide Internet network throughout the United States. Mass Market provides consumers to complete communications from their locations to locations throughout the world. This market is located throughout the United States as well. Private line services are dedicated circuits provided to a customer to use in any manner and with any hardware that the customer chooses. International private line services offered from the United States to a particular country are generally similar regardless of the U.S. location of the customer, although the prices for domestic connections to an international private line may differ depending on where the customer is located. Finally, Internet protocol virtual private networks (“IP/VPNs”) are data networks that use the same protocol -- known as “TCP/IP” -- that is commonly used over the public Internet. The relevant market is properly defined in terms of the provision of services to high-end customers in the United States. Generally, it is found that the relevant market is properly defined in terms of the provision of services to high-end customers in the United States.
The long distance market is a market in which the extent of product differentiation is limited and the key competitive features are the high investment costs involved, the risk of competitive entry by new technologies (e-mail, chat through the Internet, web phones, etc.), powerful companies (the “Baby Bell”, operating companies which could provide jointly long distance and local calling), and new competitive providers with brand new fiber. The long-distance market is divided into two separate and distinct segments. The “Mass Market” consists of residential and small business customers who purchase voice long-distance service, which is sold primarily through direct marketing channels (e.g., telemarketing). Mass market customers buy services “off the shelf” without individualized prices or other terms. The “Large Business Market” consists of large corporate customers. These companies purchase a wide range of voice and data services, with most business conducted by bidding for large multiyear contracts tailored to the individual needs of each customer. The Internet backbone consists of high-capacity long-haul data networks that connect smaller networks and customers. MCI and Sprint were second and third consecutively both in Long Distance – Mass Market and Long Distance – Large Business market. They were also first and second in Internet Backbone market. Prior to the merger, MCI would only raise prices if it does not lose too much business to its rivals. After the merger, MCI would not consider the loss of business to the Sprint brand a cost of raising the price of the MCI brand products. The market has three big players; AT&T, Sprint and MCI which provides differentiated product that are long-distance service. The long distance telecommunications services and many other services in the United States were monopolized by AT&T starting for most of the twentieth century. This monopoly was challenged by new entrants starting from 1970s. In the 1980s, this market started to change into oligopoly by emerged entrants MCI (merged with WorldCom in 1998) and Sprint. There were also many players in the market with smaller economies of scale.
Long-distance telecommunications services enable consumers to communicate from their home to the locations throughout the world. Although monopoly had been possessed by AT&T by the most of twentieth century, the market started to change because of AT&T was divided into a long-distance telecommunications carrier and several smaller companies provide local telephone service. The majority of mass market consumers were use wire line telephones to make long distance calls although now it has been doing with much more wireless phones. The Big Three was giving service throughout the United States and each generally charged same prices for the various calls the consumers were making. The mass market long distance services market was highly concentrated and was going to become significantly more concentrated after the proposed merger. HHI was approximately 3500 in terms of revenue; post-merger, the HHI will rise approximately 400 points to 3900, and the merged company would have a share of approximately 30%. Sprint was also in a vital position because of providing an important constraint for WorldCom on the prices the company charge. Those Big Three was about the control 80% of the market.
This Big Three (No.1 AT&T, No. 2 MCI WorldCom, and No. 3 Sprint) was controlling about 80% of the residential market. The next largest competitor was Qwest Communications which had only 2.5% market share. The suitable oligopoly model for this market is the Bertrand Model; the potential for harming consumers stems from the elimination of competition between two existing brands that are seen as close substitutes by many consumers. The applicants presented a unilateral effects model to the DOJ, which showed that the merger would lower the average long-distance price paid by residential consumers by an amount in the range of 0.2 percent to 0.8 percent. As the advertising was treated as marginal cost, the demand elasticity of MCI, Sprint and AT&T’s are -3.4, -6.5, and -3.2 respectively. Even without any cost savings from the merger, the simulation model would predict an average price increase of less than 1 percent resulting from the merger. The elasticity of supply for Internet transport services is high yet there are no barriers to expansion. In this case, the parties involved in different empirical elasticity estimates using structural oligopoly models. Whether MCI/WorldCom and Sprint were close substitutes or not, the question was a standard oligopoly model generates substantial price increases when simulating a merger, since the price increases depend directly on the value of the estimated cross-price elasticity.
Although the focus of discussion was the long distance market; the applicants argued that this was an industry in which margins were quickly collapsing, and which was in the midst of a structural change provoked by technological breakthroughs (the Internet) and regulatory changes (local networks etc.). According to the opponents, the MCI WorldCom-Sprint merger “failed” the Merger Guidelines’ HHI thresholds, thus creating a presumption of unlawfulness. WorldCom was very close to domination of Internet backbone market if the merger had been allowed. Another argument was made that MCI WorldCom and Sprint were each other’s closest competitors; they both compete against AT&T. Based on the analysis, the conclusion can be drawn that the long-distance is extremely concentrated market that will become even more after the proposed merger. This is also valid in internet backbone market. The sunk costs would also increase which precluding new firms entering the market and existing firms for expanding. Decreased market from AT&T, Sprint and MCI to AT&T and MCI-Sprint would also increase the brand name barrier and cause the network effect that allowing a few firms to dominate long-distance and data services markets. It is also said that the proposed merger would diminish consumers' choices, especially low-volume callers who make less than $4 per month in long-distance calls. The proposed merger would also cause a significant harm to competition in many of the nation’s telecommunications markets. This merger would extensively lessen the competition in the market by leading to higher prices, lower service quality, and less innovation than the merger absent situation. The competition was also going to lessen once Sprint had been purchased plus customers of this company would have derived relatively less benefit from being effectively connected to smaller networks than would have the customers of these smaller networks derive from being effectively connected to Sprint. Therefore United States wanted to enjoin this merger by making decisions about this merger; this was not going to prevent the anticompetitive effects of this merger for the country almost a whole.
As mentioned before; if transaction would have been completed, there were such effects were going to take place. These were; competition would be eliminated or lessened, sale of services in each of the relevant markets would be eliminated or lessened, prices would likely be increased to the levels above those that three companies would prevail absent the merger, innovation and quality services would likely decrease to levels below those that would prevail absent the merger, and the barriers to entering each of product markets will be increased. This merger is also blocked by European antitrust authorities due to it would create a dominant company capable of crushing internet competition in Europe. This would have allowed the merged company to behave independently of both its competitors and customers and, therefore, to dictate conditions and prices in the market to the detriment of consumers around the world and particularly in the 15 European Union states. The merger would have also created super Internet provider of both United States and global Internet connectivity. The merged company would have possibility of ability to control technical developments, raise prices, and discipline the market. With this merger, the two close competitors and innovators will immediately stop their long-standing competitive rivalry which leads to higher costs and prices. One economic study estimates the price increase at between 5% and 8% in various parts of the total long-distance markets which leads to lower service and quality and variety.
The proposed merger had been acted to terminate by board of directors of Sprint and WorldCom after Department of Justice reached had reached to the conclusions on the competitive impact of the merger. Although the Department said it would not be able to go to trial before 2001, approval of the merger by the Federal Communications Commission and the European Commission would still be needed after the successful conclusion of the trial so that the both companies concluded to end their deal.
The Questions:
1. What kind of competitive environment do AT&T, Sprint and MCI WorldCom compete in?
a. Monopoly
b. Oligopoly
c. Pure Competitive
d. Duopoly
1. How much market share do “Big Three” have?
a. 50%
b. 30%
c. 90%
d. 80%
2. Why this proposed merger had been opposed?
a. The merger would create huge losses to both of the companies.
b. One of the parties of the deal was having an accounting scandal.
c. The merger would decrease the prices the companies charge.
d. The merger would turn all the relevant markets into duopoly power.
3. Which of the following is not one of the characteristics of a contestable market?
a. All firms have access to the same productive technology.
b. Consumers react quickly to a price change.
c. Existing firms cannot respond quickly to entry by lowering their price.
d. There are significant sunk costs.
4. Which of the following is not opponents’ opinion regarding the proposed merger?
a. The proposed merger is against competition law.
b. The competition in relevant markets would be eliminated or lessened.
c. The prices would likely be increased to the levels above those that three companies would prevail absent the merger.
d. The Internet backbone market MCI WorldCom and Sprint face was the only market for both of these companies.
The answers are B, D, D, D, and D. Those three competitors compete in oligopoly and they have 80% share of the market. This merger had been exposed due to the market would have been turned to duopoly. The answer of the fourth questions is that there are significant sunk costs. Plaintiff did not raise a question about MCI and Sprint were only two competitors in Internet Backbone market.
Summary 1: Google's Defense in Antitrust Hearing: An Evaluation of Market Power
This case is about Google's dominating the market. Competition Policy and Consumer Rights Subcommittee claims that Google was a monopoly and in way dominating the market. This probe examined the company's core search-advertising business. The probe comes from Google allowed online Canadian pharmacies to place advertisements through its AdWords program, resulting in the unlawful importation of controlled and non-controlled prescription drugs into the United States. Google had 70% market share which might be enough for courts to sue Google. But, it is not enough for courts determining anticompetitive behavior without determining other factors.
Summary 2: Market Failure- Antitrust, positive and negative externalities, public goods, rent seeking, tariffs Government failure
There are many reasons for a market unable to provide the socially efficient quantities of goods; anti-competitive market power, negative externalities, public goods, and rent seeking. A firm produces less than a socially effecient level of output in a monopoly market. Negative externalities like pollution are costs borne by parties who are not involved in the production or consumption of a good.A public good is a good that is non-rival and non-exclusionary in consumption.New technology has created new public goods, such as a lighthouses and street lights. Another example is rent seeking problem. Rent seeking is selfishly motivated efforts aimed at influencing another party’s decision.
Summary 3: Economies of scale, diseconomies of scale, constant returns to scale, Efficiency in production. Economies of scope and how to maximize profit when there’re two production plants, long-run equilibrium
Ability of larger companies to purchase more efficient manufacturing equipment, which is often either too expensive for smaller companies or not effective for small quantities. Larger companies are able to purchase input goods in higher quantity, often receiving discounts for their bulk orders. This results in lower average costs in the long run. The example of diseconomies of scale is Pharmaceutical industry. The firms must spend large amounts of capitals to first develop and then test a potential drug before they can offer it for scale.Production Function is defined as a function that defines the maximum amount of output that can be produced with a given set of inputs.
Summary 4: Create and answer a case study similar to Memo 10 from Time Warner - Optimal Auctioning Mechanisms
This paper is about methods and benefits of utilizing auctioning mechanisms which helps companies to sell off all or part of their firms in order to either liquidate or survive. During the auction process, buyers have to compete with another buyer in order to be the new owner of the firm being sold. There are some types of auctions; English Auction, First Price - Sealed Bid, Second Price - Sealed Bid, Dutch Auction, Independent Private Values, Affiliated Value Estimates, Common Value. Different strategies will be used by the bidders to win the auction while spending the least amount of money depending on the type of auction and the bidders valuation of the item. In order to avoid the winners curse, firms can determine what they think to be the value and bid below this amount.
Summary 5: Coca-Cola Company and Pepsi Corporation
This two firms have 70% of the coke market, forming a dupoly. The competitors are fierce competitors. They have been involved in many lawsuits in relation to its allegedly monopolistic and discriminatory practices. In 2005, European Unions investigation revealed that Cokes business methods stifled competition. It is alleged that Coke used its power to stifle competition through a series of sales agreements.Another example is, Mexico’s Federal Competition Commission fined the Coca-Cola system $13 million for monopolistic practices. Coca Cola has threatened by a company entered to the Mexican Coke market in 2002 called Big Cola and then captured the 5% of the market. Coca-Cola Company decided to kill its competitor by unleashing and aggressive and illegal marketing effort. After all, Federal Competition Commission conducted their field investigation they visited various shops and found that Big Cola was either not available or was placed at the back of the shop, away from Coca-Cola fridges at the front.Coke and Pepsi have personal relationships with their retail channels and would be able to defend their positions effectively through discounting and other tactics.
10/2/2011
On September 4, 1996, Staples and Office Depot announced plans to merge by saying that "Merger would generate economies of scale and further reductions in the price of office supplies."; but The Federal Trade Commission announced that this would unfairly increase office supply prices. Office Depot was the largest office superstore chain in the United States and Staples was the second one before plans to merge. Another office superstore OfficeMax did not have stores in many of the local markets that the merger would affect.
The FTC argued in court for a preliminary injunction on grounds that the Staples/Office Depot merger would violate federal antitrust laws by substantially reducing competition in the retail sale of office supplies by office supply superstores in various local markets throughout the country where each firm directly competes against each other. These markets include areas of California, Florida, Illinois, Kentucky, Maryland, Michigan, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Virginia, Washington, Indiana, Utah and Washington, D.C.
Next week I am going to review flaws about this decision.
As FTC filed suit to block the merger on the grounds that the merger would significantly reduce competition in many geographic market areas, and this reduction would lead to to anti-competitive pricing by the newly merged entity.
Merge is very powerful tool in business because it reduces competition and cost savings that will increase the market power of the company. Like In this case oligopolies are often accused of and found guilty of anti-competitive practices. Therefore, company mergers are often examined closely by government regulators to avoid reducing competition in an industry. Although anti-competitive practices often enrich those who practice them, they are generally believed to have a negative effect on the economy as a whole, and to disadvantage competing firms and consumers who are not able to avoid their effects, generating a significant social cost. For these reasons, most countries have competition laws to prevent anti-competitive practices, and government regulators to aid the enforcement of these laws. Thus the competition law, known in the United States as antitrust law, is law that promotes or maintains market competition by regulating anti-competitive conduct by companies. The law promotes healthy competition. It bans anti-competitive agreements to fix high prices, makes it illegal to agree not to compete with other businesses, and prevents companies from
abusing a dominant market position. The existence of monopolies or mergers which substantially change the balance of power can be of great concern to purchasers undertaking supply chain management. Thus mergers can generate anti-trust concerns and subject to government regulation. There are 3 types of mergers; horizontal merger, vertical integration, conglomerate merger. A merger occurring between companies producing similar goods or offering similar services is called horizontal merger. Mergers like Chevron & Texaco is an example of horizontal merger. The term vertical integration means that the company expands its business into areas that are at different points of the same production path. Merger of Time Warner & AOL is an example of vertical integration. This integration might harm competition significantly. Conglomerate merger is about totally unrelated companies such as US Steel & Marathon Oil.
The reason of FTC called the situation of Staples and Office Depot could lead to anti-competitive pricing may cause some practices if they had been merged. I will discuss these next week.
Anti-competitive prices may lead to several practices like price fixing, manipulation of supply, exclusive dealing arrangement, tying arrangements, retail price maintenance and price discrimination.
Price fixing is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand. The group of market makers involved in price fixing is sometimes referred to as a cartel. Deals can be made by competitors to collude to raise prices. We can see this in retail gasoline example around the world. Another example is the accusing of Visa and MasterCard lately. Visa Inc. and MasterCard Inc. (MA), the world’s biggest payment networks, were sued by a trade group representing operators of automated teller machines over claims the firms fix prices and suppress competition among ATM networks. The effects of price fixing are reduced competition based on price, higher prices and higher profits for the conspirators.
Manipulation of supply is a conspiracy by competitors to collude to reduce the supply of the product or service. It has effects such as higher prices and higher profits for the conspirators. Manipulation made by OPEC is an example for this situation. Opec's manipulation of oil production once held the world to ransom, prompting the 1973 oil shock that sent the whole global economy into turmoil. It was also blamed for the oil price spike that caused widespread fuel protests across much of Europe in 2000.
Exclusive dealing arrangements is about a seller agrees to sell to a buyer on the condition that the buyer agrees not to buy from other sellers. A gasoline refinery that sells to independent gas stations on the condition they agree to buy exclusively from the refinery and Microsoft pricing of Windows to computer manufacturers are this kind of examples. It is also connected to vertical integration but it is more like without an actual merger. It leads to reduced competition. If it substantially reduces the competition then it becomes illegal.
Seller may agree to sell one item to a buyer on the condition that the buyer also buys another item is called tying arrangements. Certain tying arrangements are illegal in United States law. This may be the action of several companies as well as the work of just one firm. There are four elements for tying arrangements; two separate products or services are involved, the purchase of the tying product is conditioned on the additional purchase of the tied product, the seller has sufficient market power in the market for the tying product, a not insubstantial amount of interstate commerce in the tied product market is affected. In recent years, changing business practices surrounding new technologies have put the legality of tying arrangements to the test. Windows & Internet Explorer is a good example for this situation that effects reduced competition.
Manufacturer agrees to sell to retailer on the condition that the retailer charges the retail price specified by the manufacturer is called retail price maintenance. A brand seller imposes RPM for one fundamental reason – it helps the seller win and retain retailers that will carry and promote the product. It does this by guaranteeing the retailer a high margin. The brand seller most likely to find RPM attractive is one who is selling a mid to high-priced brand whose inherent superiority is not readily evident to consumers. For such a manufacturer, RPM can give retailers a needed incentive not only to stock the brand but to actively promote it. Still, a competitive assessment of RPM is not complete without recognizing that even the brand seller with a relatively weak and relatively high priced brand has alternatives to RPM for widening distribution and sales. Here are some of the alternatives:
1) lowering the product’s price;
2) increasing advertising, or making ads more effective;
3) offering contractual promotion incentives (promotion allowances) to retailers;
4) sending manufacturer’s representatives to retail stores to offer on-site demonstrations;
5) agreeing to favorable terms for buying back a retailer’s unsold inventory; and
6) imposing distribution-limiting vertical restraints (such as exclusive territories or location clauses) that increase a retailer’s incentive to invest in and sell the branded product.
When tv manufacturer only sells to a retailer if the retailer charges the retail price specified by the TV manufacturer is an example for this situation, this reduces the price among retailers.
Seller charges different prices to different buyers for identical goods is called price discrimination. Essentially there are two main conditions required for discriminatory pricing:
1)Differences in price elasticity of demand between markets: There must be a different price elasticity of demand from each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase its total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.
2)Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “market seepage” or “consumer switching” – defined as a process whereby consumers who have purchased a good or service at a lower price are able to re-sell it to those consumers who would have normally paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut rather than with the exchange of tangible goods. Seepage might be prevented by selling a product to consumers at unique and different points in time – for example with the use of time specific airline tickets that cannot be resold under any circumstances.
Wal-Mart opens a store in a town and charges lower prices than it charges in other towns for the same merchandise could be called as price discrimination due to this may reduce the competition.
Due to this case has happened in oligopoly market; I am going to review some basic oligopoly models. An oligopoly is an intermediate market structure between the extremes of perfect competition and monopoly. Oligopoly firms might compete (noncooperative oligopoly) or cooperate (cooperative oligopoly) in the marketplace. Whereas firms in an oligopoly are price makers, their control over the price is determined by the level of coordination among them. The distinguishing characteristic of an oligopoly is that there are a few mutually interdependent firms that produce either identical products (homogeneous oligopoly) or heterogeneous products (differentiated oligopoly).
In Cournot Oligopoly Model; firms in the market simultaneously choose the quantities they are going to produce. Cournot oligopoly is the simplest model of oligopoly in that firms are assumed to be naive when they think that their actions will not generate any reaction from the rivals. In other words, according to the Cournot model, rival firms choose not to alter their production levels when one firm chooses a different output level. Cournot thus focuses on quantity competition rather than price competition. While the naive behavior suggested by Cournot might seem plausible in a static setting, it is hard to image real-world firms not learning from their mistakes over time. The Bertrand model's significant difference from the Cournot model is that it assumes that firms choose (set) prices rather than quantities.
Bertrand Oligopoly Model; firms select prices. Each firm chooses its quantity as the best response to the quantity chosen by the others and its price as the best response to the price chosen by the others. The firms set quantities sequentially. The second firm’s quantity is the best response to the first firm’s quantity. The first firm sets a quantity. The second firm follows by setting a price and the firms jointly set the price that maximizes industry profits. Cournot and Bertrand oligopolies constitute the two most prevalent models of firm competition. The analysis of Nash equilibria in each model reveals a unique prediction about the stable state of the system. Quite alarmingly, despite the similarities of the two models, their projections expose a stark dichotomy. Under the Cournot model, where firms compete by strategically
managing their output quantity, firms enjoy positive profits as the resulting market prices exceed that of the marginal costs. On the contrary, the Bertrand model, in which firms compete on price, predicts that a duopoly is enough to push prices down to the marginal cost level. This suggestion that duopoly will result in perfect competition, is commonly referred to in the economics literature as the “Bertrand paradox”.
Stackelberg Oligopoly Model; firms sequantially select quantities. The Stackelberg model deals with the scenario in which there is a leader firm in the market whose actions are imitated by a number of follower firms. The leader is sophisticated in terms of taking into account rivals' reactions, while the followers are naïve, as in the Cournot model. The leader might emerge in a market because of a number of factors, such as historical precedence, size, reputation, innovation, information, and so forth. Examples of Stackelberg leadership include markets where one dominant firm dictates the terms, usually through price leadership. Under price leadership, the leader firm's pricing decisions are consistently followed by rival firms.
“Market Power” is the ability of a firm or group of firms within a market to profitably charge prices above the competitive level for a sustained period of time. This market power does not use for good all the time. Market power can be analyzed with 5 competencies; product market, geographic market, market concentration, entry conditions, any other structural characteristics of market and the market performance. The economic theory of monopolistic competitive markets, oligopoly and monopoly is used to suggest the nature of problems that may exist when firms or agents have market power and are able to distort prices away from the purely competitive optimum. A firm with market power has the ability to individually affect either the total quantity or the prevailing price in the market. Price makers face a downward-sloping demand curve, such that price increases lead to a lower quantity demanded. The decrease in supply as a result of the exercise of market power creates an economic deadweight loss which is often viewed as socially undesirable. As a result, many countries have anti-trust or other legislation intended to limit the ability of firms to accrue market power. Such legislation often regulates mergers and sometimes introduces a judicial power to compel divestiture.
Product Market:
As the FTC and DOJ Merger Guidelines indicate, economists attempt to identify those products that consumers will substitute for a given product in response to a “small but significant and nontransitory” price increase when identifying the products that compete in an antitrust market.They also will include in an antitrust market all producers that currently produce a relevant product and all producers that could easily and economically produce and sell the relevant product in a short period of time (e.g., one year) in response to a “small but significant and nontransitory” price increase.
Geographic Market:
Product market definition and geographic market definition are interrelated. In particular, the extent to which buyers of a particular product would shift to other products in the event of a "small but significant and nontransitory" increase in price must be evaluated in the context of the relevant geographic market. Antitrust economists will start with a fairly narrow area and then determine if firms located in that area are nsulated from competitive pressures from firms located in other areas. They will continue to include firms in the market (and hence expand the geographic scope of the market) until they identify an area in which a hypothetical monopolist could profitably impose a “small but significant and nontransitory” increase in price.
Relevant Market under Merger Guidelines:
In sum, an antitrust market is defined: “as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical, profit maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area likely would impose a ‘small but significant
and nontransitory’ increase in price, assuming the terms of sale of all other products are held constant. The Merger guidelines are a set of internal rules promulgated by the Antitrust Division of the United States Department of Justice (DOJ) in conjunction with the Federal Trade Commission (FTC).
Undertaking a market definition analysis at monopolistic prices can lead one to define too broad a market and fail to identify market power when it is present, which is known as the “Cellophane Fallacy.” A key lesson of the Cellophane Fallacy is that in some circumstances it may be sensible for economists to consider all of the elements of the monopolization case market power paradigm and to develop an internally consistent analysis that aligns with the available factual evidence before reaching a final conclusion about the scope of the relevant market. Cellophane was a DuPont Company plastic wrapping material that had its U.S. production restricted to du Pont by numerous patents in the early 1950s. Du Pont was sued under the Sherman Act for monopolization of the cellophane market by the U.S. Justice Department, and the case (U.S. v. E. I. du Pont[2]) was decided by the Supreme Court in 1956. The Court agreed with du Pont that when evaluated at the monopolistic price observed in the early 1950s, there were many substitutes for cellophane and, therefore, du Pont had only a small share of the market for wrapping materials (i.e., it possessed little or no market power). In particular, in monopolization cases it can be important to consider “performance” evidence to understand how a market is structured and/or directly determine if a firm has market power. In many cases, a firm or group of firms will not have significant shares even when the narrowest conceivable market is considered, which may mean that one does not have to reach a final conclusion about the scope of the relevant market. Many cases involve markets where there is substantial supply-side substitution, which may allow one to avoid fully analyzing the demand-side issues that underlie the Cellophane Fallacy.
In monopolization cases, relevant markets are defined to help determine if a firm has market power, although one need not define a relevant market if there is direct evidence of market power. When defining a relevant market, one must consider the pitfalls associated with the Cellophane Fallacy. The challenges posed by the Cellophane Fallacy do not mean that one should abandon the traditional monopolization case market power paradigm as a way of organizing market power presentations. To the contrary, recognition of the problems posed by the Cellophane Fallacy suggest that there can be risks associated with truncating the market power analysis (although there are circumstances when one
does not need to analyze every issue).
The Herfindahl Hirschman Index determines if a monopoly exists. The calculation gives higher weight to larger firms but also allows firms outside of the top four largest to factor into the equation. A similar index is the Four-Firm Concentration Ratio, which only factors in the four largest firms. The lower the Herfindahl Hirschman Index, the more spread out the market share with many large firms. The higher the Herfindahl Hirschman, the more concentrated the market share with only a couple of large firms.
This index is a commonly accepted measure of market concentration. It is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. For example, for a market consisting of four firms with shares of thirty, thirty, twenty and twenty percent, the HHI is 2600 (302 + 302 + 202 + 202 = 2600). The HHI takes into account the relative size and distribution of the firms in a market and approaches zero when a market consists of a large number of firms of relatively equal size. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases.
Markets in which the HHI is between 1000 and 1800 points are considered to be moderately concentrated, and those in which the HHI is in excess of 1800 points are considered to be concentrated. Transactions that increase the HHI by more than 100 points in concentrated markets presumptively raise antitrust concerns under the Horizontal Merger Guidelines issued by the U.S. Department of Justice and the Federal Trade Commission.
The usefulness of this statistic to detect and stop harmful monopolies however is directly dependent on a proper definition of a particular market (which hinges primarily on the notion of substitutability). For example, if the statistic were to look at a hypothetical financial services industry as a whole, and found that it contained 6 main firms with 15% market share apiece, then the industry would look non-monopolistic. However, one of those firms handles 90% of the checking and savings accounts and physical branches (and overcharges for them because of its monopoly), and the others primarily do commercial banking and investments. In this scenario, people would be suffering due to a market dominance by one firm; the market is not properly defined because checking accounts are not substitutable with commercial and investment banking. The problems of defining a market work the other way as well. To take another example, one cinema may have 90% of the movie market, but if movie theatres compete against video stores, pubs and nightclubs then people are less likely to be suffering due to market dominance. Another typical problem in defining the market is choosing a geographic scope. For example, firms may have 20% market share each, but may occupy five areas of the country in which they are monopoly providers and thus do not compete against each other. A service provider or manufacturer in one city is not necessarily substitutable with a service provider or manufacturer in another city, depending on the importance of being local for the business—for example, telemarketing services are rather global in scope, while shoe repair services are local.
On September 4, 1996, Staples and Office Depot announced plans to merge.[5[[http://en.wikipedia.org/wiki/Staples_Inc.#cite_note-4|]]] The Federal Trade Commission decided that the superpower would unfairly increase office supply prices despite competition from OfficeMax, because OfficeMax did not have stores in many of the local markets that the merger would affect.[6[[http://en.wikipedia.org/wiki/Staples_Inc.#cite_note-5|]]] Staples ultimately argued that chains such as Wal-Mart and Circuit City Stores represented significant competition, but this argument did little to sway the FTC. Following the denial of the merger by the FTC, a rivalry has formed between the two companies. ¨Manufacturer agrees to sell to retailer on the condition that the retailer charges the retail price specified by the manufacturer
The Proposed MCI WorldCom – Sprint Merger MCI WorldCom and Sprint Corporation announced a merger agreement on October 5th. MCI WorldCom offered $129 billion in stock and debt to top a rival $100 billion bid from BellSouth for Sprint (S) in October 1999. The plan was to combine MCI WorldCom's No. 2 long distance business with Sprint's third-place operation. It would have been the largest corporate merger in history, ultimately putting MCI WorldCom ahead of AT&T as the largest communications company in the United States if the agreement had been completed. MCI WorldCom was one of the largest telecommunication providers with operations in more than 65 countries and more than 22 million residential and business customers worldwide. WorldCom’s 1999 annual revenues totaled approximately $37 billion. They were also the largest provider of Internet backbone services in the world when considered by traffic or revenues. The company was the second-largest domestic long distance telecommunications carrier and services in terms of revenues as well as the second-largest provider of various data network services and the second-largest of only three meaningful competitors in the market for custom network telecommunications services for large U.S. business customers. This company had made more than 60 acquisition of competitor and other companies such as MCI (second largest provider of long distance telecommunications and a leading internet backbone services provider), ANS Communications (which served as one of AOL’s primary Internet backbone networks), and Brooks Fiber Properties. WorldCom is bought by Verizon on January 6, 2006 as part of the corporation’s emergence from bankruptcy. Sprint Corporation is now the third largest wireless telecommunications network in the United States, behind Verizon and AT&T. The company was renamed in 2005 after the purchase of Nextel Communications by Sprint Corporation. The company was one of the largest telecommunications providers in the United States, serving more than 17 million residential and business customers during the proposed merger date. Sprint built the first nationwide, all-digital, fiber optic network; operates the nation’s second-largest Internet backbone; and competes head-to-head against WorldCom in many markets in which the two companies operate. After the proposed merger had been announced, both U.S. Department of Justice and European Union showed their concern; regulators in the U.S. and Europe balked, and the deal was canceled after nine months of discovery, filings, meetings by U.S. Department of Justice and the Commission of the European Communities. The merger had been terminated on July 13, 2000. Later, WorldCom was caught up in accounting fraud that led to the ouster of CEO Bernard Ebbers and other executives and left the company in bankruptcy. After that; WorldCom was ultimately acquired by Verizon for $7.6 billion in 2005. These two companies were the second and third largest long-distance companies in the United States, and the first and second largest Internet backbone service providers. This case was the only merger between major telecommunications carriers that was derailed by the government. The main reason of rejecting the merger was about the proposed merger is the increase in market power that the merged company will have from combining two well-known companies serving similar geographic markets and providing similar customer groups with similar services. If this merger had been allowed and then one merge would have been allowed as well, then all the telecommunications market was turned into complete dominance by a single firm that creates monopolistic market. In other words; a merged MCI WorldCom and Sprint would create a company that dominates the long-distance and Internet backbone service markets which lead to an illegal monopoly. The regulatory bodies in the U.S. were concerned both of the combined Internet market share of the companies and the combined data and long -distance voice market share. The proposed merger affected concentration and competition in many telecommunication markets. There are several markets in which Sprint and MCI are considered; long-distance market, mass market, large business market, and internet backbone. Although all of are these part of the telecommunication industry; this proposed merger would have caused market to turn into duopoly at the same time. The industry was having highly concentrated, driven by strong demand, and where the intense competition determines pricing tools itself. I would like to consider the relevant market as Telecommunications. So the relevant markets broadly are Internet Backbone Services Market, Mass Market Domestic Long Distance Telecommunications Services, Mass Market International Long Distance Telecommunications Services, International Private Line Services, Private Line Services Market, Interlata Data Network Services Market and Custom Network Services Market as it is indicated by the plaintiff which is Department of The Justice. Internet Backbone Market does provide Internet network throughout the United States. Mass Market provides consumers to complete communications from their locations to locations throughout the world. This market is located throughout the United States as well. Private line services are dedicated circuits provided to a customer to use in any manner and with any hardware that the customer chooses. International private line services offered from the United States to a particular country are generally similar regardless of the U.S. location of the customer, although the prices for domestic connections to an international private line may differ depending on where the customer is located. Finally, Internet protocol virtual private networks (“IP/VPNs”) are data networks that use the same protocol -- known as “TCP/IP” -- that is commonly used over the public Internet. The relevant market is properly defined in terms of the provision of services to high-end customers in the United States. Generally, it is found that the relevant market is properly defined in terms of the provision of services to high-end customers in the United States. The long distance market is a market in which the extent of product differentiation is limited and the key competitive features are the high investment costs involved, the risk of competitive entry by new technologies (e-mail, chat through the Internet, web phones, etc.), powerful companies (the “Baby Bell”, operating companies which could provide jointly long distance and local calling), and new competitive providers with brand new fiber. The long-distance market is divided into two separate and distinct segments. The “Mass Market” consists of residential and small business customers who purchase voice long-distance service, which is sold primarily through direct marketing channels (e.g., telemarketing). Mass market customers buy services “off the shelf” without individualized prices or other terms. The “Large Business Market” consists of large corporate customers. These companies purchase a wide range of voice and data services, with most business conducted by bidding for large multiyear contracts tailored to the individual needs of each customer. The Internet backbone consists of high-capacity long-haul data networks that connect smaller networks and customers. MCI and Sprint were second and third consecutively both in Long Distance – Mass Market and Long Distance – Large Business market. They were also first and second in Internet Backbone market. Prior to the merger, MCI would only raise prices if it does not lose too much business to its rivals. After the merger, MCI would not consider the loss of business to the Sprint brand a cost of raising the price of the MCI brand products. The market has three big players; AT&T, Sprint and MCI which provides differentiated product that are long-distance service. The long distance telecommunications services and many other services in the United States were monopolized by AT&T starting for most of the twentieth century. This monopoly was challenged by new entrants starting from 1970s. In the 1980s, this market started to change into oligopoly by emerged entrants MCI (merged with WorldCom in 1998) and Sprint. There were also many players in the market with smaller economies of scale. Long-distance telecommunications services enable consumers to communicate from their home to the locations throughout the world. Although monopoly had been possessed by AT&T by the most of twentieth century, the market started to change because of AT&T was divided into a long-distance telecommunications carrier and several smaller companies provide local telephone service. The majority of mass market consumers were use wire line telephones to make long distance calls although now it has been doing with much more wireless phones. The Big Three was giving service throughout the United States and each generally charged same prices for the various calls the consumers were making. The mass market long distance services market was highly concentrated and was going to become significantly more concentrated after the proposed merger. HHI was approximately 3500 in terms of revenue; post-merger, the HHI will rise approximately 400 points to 3900, and the merged company would have a share of approximately 30%. Sprint was also in a vital position because of providing an important constraint for WorldCom on the prices the company charge. Those Big Three was about the control 80% of the market. This Big Three (No.1 AT&T, No. 2 MCI WorldCom, and No. 3 Sprint) was controlling about 80% of the residential market. The next largest competitor was Qwest Communications which had only 2.5% market share. The suitable oligopoly model for this market is the Bertrand Model; the potential for harming consumers stems from the elimination of competition between two existing brands that are seen as close substitutes by many consumers. The applicants presented a unilateral effects model to the DOJ, which showed that the merger would lower the average long-distance price paid by residential consumers by an amount in the range of 0.2 percent to 0.8 percent. As the advertising was treated as marginal cost, the demand elasticity of MCI, Sprint and AT&T’s are -3.4, -6.5, and -3.2 respectively. Even without any cost savings from the merger, the simulation model would predict an average price increase of less than 1 percent resulting from the merger. The elasticity of supply for Internet transport services is high yet there are no barriers to expansion. In this case, the parties involved in different empirical elasticity estimates using structural oligopoly models. Whether MCI/WorldCom and Sprint were close substitutes or not, the question was a standard oligopoly model generates substantial price increases when simulating a merger, since the price increases depend directly on the value of the estimated cross-price elasticity. Although the focus of discussion was the long distance market; the applicants argued that this was an industry in which margins were quickly collapsing, and which was in the midst of a structural change provoked by technological breakthroughs (the Internet) and regulatory changes (local networks etc.). According to the opponents, the MCI WorldCom-Sprint merger “failed” the Merger Guidelines’ HHI thresholds, thus creating a presumption of unlawfulness. WorldCom was very close to domination of Internet backbone market if the merger had been allowed. Another argument was made that MCI WorldCom and Sprint were each other’s closest competitors; they both compete against AT&T. Based on the analysis, the conclusion can be drawn that the long-distance is extremely concentrated market that will become even more after the proposed merger. This is also valid in internet backbone market. The sunk costs would also increase which precluding new firms entering the market and existing firms for expanding. Decreased market from AT&T, Sprint and MCI to AT&T and MCI-Sprint would also increase the brand name barrier and cause the network effect that allowing a few firms to dominate long-distance and data services markets. It is also said that the proposed merger would diminish consumers' choices, especially low-volume callers who make less than $4 per month in long-distance calls. The proposed merger would also cause a significant harm to competition in many of the nation’s telecommunications markets. This merger would extensively lessen the competition in the market by leading to higher prices, lower service quality, and less innovation than the merger absent situation. The competition was also going to lessen once Sprint had been purchased plus customers of this company would have derived relatively less benefit from being effectively connected to smaller networks than would have the customers of these smaller networks derive from being effectively connected to Sprint. Therefore United States wanted to enjoin this merger by making decisions about this merger; this was not going to prevent the anticompetitive effects of this merger for the country almost a whole. As mentioned before; if transaction would have been completed, there were such effects were going to take place. These were; competition would be eliminated or lessened, sale of services in each of the relevant markets would be eliminated or lessened, prices would likely be increased to the levels above those that three companies would prevail absent the merger, innovation and quality services would likely decrease to levels below those that would prevail absent the merger, and the barriers to entering each of product markets will be increased. This merger is also blocked by European antitrust authorities due to it would create a dominant company capable of crushing internet competition in Europe. This would have allowed the merged company to behave independently of both its competitors and customers and, therefore, to dictate conditions and prices in the market to the detriment of consumers around the world and particularly in the 15 European Union states. The merger would have also created super Internet provider of both United States and global Internet connectivity. The merged company would have possibility of ability to control technical developments, raise prices, and discipline the market. With this merger, the two close competitors and innovators will immediately stop their long-standing competitive rivalry which leads to higher costs and prices. One economic study estimates the price increase at between 5% and 8% in various parts of the total long-distance markets which leads to lower service and quality and variety. The proposed merger had been acted to terminate by board of directors of Sprint and WorldCom after Department of Justice reached had reached to the conclusions on the competitive impact of the merger. Although the Department said it would not be able to go to trial before 2001, approval of the merger by the Federal Communications Commission and the European Commission would still be needed after the successful conclusion of the trial so that the both companies concluded to end their deal. The Questions: 1. What kind of competitive environment do AT&T, Sprint and MCI WorldCom compete in? a. Monopoly b. Oligopoly c. Pure Competitive d. Duopoly 2. How much market share do “Big Three” have? a. 50% b. 30% c. 90% d. 80% 3. Why this proposed merger had been opposed? a. The merger would create huge losses to both of the companies. b. One of the parties of the deal was having an accounting scandal. c. The merger would decrease the prices the companies charge. d. The merger would turn all the relevant markets into duopoly power. 4. Which of the following is not one of the characteristics of a contestable market? a. All firms have access to the same productive technology. b. Consumers react quickly to a price change. c. Existing firms cannot respond quickly to entry by lowering their price. d. There are significant sunk costs. 5. Which of the following is not opponents’ opinion regarding the proposed merger? a. The proposed merger is against competition law. b. The competition in relevant markets would be eliminated or lessened. c. The prices would likely be increased to the levels above those that three companies would prevail absent the merger. d. The Internet backbone market MCI WorldCom and Sprint face was the only market for both of these companies. The answers are B, D, D, D, and D. Those three competitors compete in oligopoly and they have 80% share of the market. This merger had been exposed due to the market would have been turned to duopoly. The answer of the fourth questions is that there are significant sunk costs. Plaintiff did not raise a question about MCI and Sprint were only two competitors in Internet Backbone market.
Staples Case - Create and answer a case study similar to the Staples Case (Chapters 3, 7, 9, 11) - Cases Available under Assignments tab on Blackboard that discusses how price elasticities and cross-price elasticities can help determine the relevant market, market concentration reactions, and the impact of mergers on markets.
Emre TezcanFinal Paper
The Proposed MCI WorldCom – Sprint Merger
MCI WorldCom and Sprint Corporation announced a merger agreement on October 5th. MCI WorldCom offered $129 billion in stock and debt to top a rival $100 billion bid from BellSouth for Sprint (S) in October 1999. The plan was to combine MCI WorldCom's No. 2 long distance business with Sprint's third-place operation. It would have been the largest corporate merger in history, ultimately putting MCI WorldCom ahead of AT&T as the largest communications company in the United States if the agreement had been completed.
MCI WorldCom was one of the largest telecommunication providers with operations in more than 65 countries and more than 22 million residential and business customers worldwide. WorldCom’s 1999 annual revenues totaled approximately $37 billion. They were also the largest provider of Internet backbone services in the world when considered by traffic or revenues. The company was the second-largest domestic long distance telecommunications carrier and services in terms of revenues as well as the second-largest provider of various data network services and the second-largest of only three meaningful competitors in the market for custom network telecommunications services for large U.S. business customers. This company had made more than 60 acquisition of competitor and other companies such as MCI (second largest provider of long distance telecommunications and a leading internet backbone services provider), ANS Communications (which served as one of AOL’s primary Internet backbone networks), and Brooks Fiber Properties. WorldCom is bought by Verizon on January 6, 2006 as part of the corporation’s emergence from bankruptcy.
Sprint Corporation is now the third largest wireless telecommunications network in the United States, behind Verizon and AT&T. The company was renamed in 2005 after the purchase of Nextel Communications by Sprint Corporation. The company was one of the largest telecommunications providers in the United States, serving more than 17 million residential and business customers during the proposed merger date. Sprint built the first nationwide, all-digital, fiber optic network; operates the nation’s second-largest Internet backbone; and competes head-to-head against WorldCom in many markets in which the two companies operate.
After the proposed merger had been announced, both U.S. Department of Justice and European Union showed their concern; regulators in the U.S. and Europe balked, and the deal was canceled after nine months of discovery, filings, meetings by U.S. Department of Justice and the Commission of the European Communities. The merger had been terminated on July 13, 2000. Later, WorldCom was caught up in accounting fraud that led to the ouster of CEO Bernard Ebbers and other executives and left the company in bankruptcy. After that; WorldCom was ultimately acquired by Verizon for $7.6 billion in 2005. These two companies were the second and third largest long-distance companies in the United States, and the first and second largest Internet backbone service providers. This case was the only merger between major telecommunications carriers that was derailed by the government. The main reason of rejecting the merger was about the proposed merger is the increase in market power that the merged company will have from combining two well-known companies serving similar geographic markets and providing similar customer groups with similar services. If this merger had been allowed and then one merge would have been allowed as well, then all the telecommunications market was turned into complete dominance by a single firm that creates monopolistic market. In other words; a merged MCI WorldCom and Sprint would create a company that dominates the long-distance and Internet backbone service markets which lead to an illegal monopoly. The regulatory bodies in the U.S. were concerned both of the combined Internet market share of the companies and the combined data and long -distance voice market share.
The proposed merger affected concentration and competition in many telecommunication markets. There are several markets in which Sprint and MCI are considered; long-distance market, mass market, large business market, and internet backbone. Although all of are these part of the telecommunication industry; this proposed merger would have caused market to turn into duopoly at the same time. The industry was having highly concentrated, driven by strong demand, and where the intense competition determines pricing tools itself. I would like to consider the relevant market as Telecommunications. So the relevant markets broadly are Internet Backbone Services Market, Mass Market Domestic Long Distance Telecommunications Services, Mass Market International Long Distance Telecommunications Services, International Private Line Services, Private Line Services Market, Interlata Data Network Services Market and Custom Network Services Market as it is indicated by the plaintiff which is Department of The Justice. Internet Backbone Market does provide Internet network throughout the United States. Mass Market provides consumers to complete communications from their locations to locations throughout the world. This market is located throughout the United States as well. Private line services are dedicated circuits provided to a customer to use in any manner and with any hardware that the customer chooses. International private line services offered from the United States to a particular country are generally similar regardless of the U.S. location of the customer, although the prices for domestic connections to an international private line may differ depending on where the customer is located. Finally, Internet protocol virtual private networks (“IP/VPNs”) are data networks that use the same protocol -- known as “TCP/IP” -- that is commonly used over the public Internet. The relevant market is properly defined in terms of the provision of services to high-end customers in the United States. Generally, it is found that the relevant market is properly defined in terms of the provision of services to high-end customers in the United States.
The long distance market is a market in which the extent of product differentiation is limited and the key competitive features are the high investment costs involved, the risk of competitive entry by new technologies (e-mail, chat through the Internet, web phones, etc.), powerful companies (the “Baby Bell”, operating companies which could provide jointly long distance and local calling), and new competitive providers with brand new fiber. The long-distance market is divided into two separate and distinct segments. The “Mass Market” consists of residential and small business customers who purchase voice long-distance service, which is sold primarily through direct marketing channels (e.g., telemarketing). Mass market customers buy services “off the shelf” without individualized prices or other terms. The “Large Business Market” consists of large corporate customers. These companies purchase a wide range of voice and data services, with most business conducted by bidding for large multiyear contracts tailored to the individual needs of each customer. The Internet backbone consists of high-capacity long-haul data networks that connect smaller networks and customers. MCI and Sprint were second and third consecutively both in Long Distance – Mass Market and Long Distance – Large Business market. They were also first and second in Internet Backbone market. Prior to the merger, MCI would only raise prices if it does not lose too much business to its rivals. After the merger, MCI would not consider the loss of business to the Sprint brand a cost of raising the price of the MCI brand products. The market has three big players; AT&T, Sprint and MCI which provides differentiated product that are long-distance service. The long distance telecommunications services and many other services in the United States were monopolized by AT&T starting for most of the twentieth century. This monopoly was challenged by new entrants starting from 1970s. In the 1980s, this market started to change into oligopoly by emerged entrants MCI (merged with WorldCom in 1998) and Sprint. There were also many players in the market with smaller economies of scale.
Long-distance telecommunications services enable consumers to communicate from their home to the locations throughout the world. Although monopoly had been possessed by AT&T by the most of twentieth century, the market started to change because of AT&T was divided into a long-distance telecommunications carrier and several smaller companies provide local telephone service. The majority of mass market consumers were use wire line telephones to make long distance calls although now it has been doing with much more wireless phones. The Big Three was giving service throughout the United States and each generally charged same prices for the various calls the consumers were making. The mass market long distance services market was highly concentrated and was going to become significantly more concentrated after the proposed merger. HHI was approximately 3500 in terms of revenue; post-merger, the HHI will rise approximately 400 points to 3900, and the merged company would have a share of approximately 30%. Sprint was also in a vital position because of providing an important constraint for WorldCom on the prices the company charge. Those Big Three was about the control 80% of the market.
This Big Three (No.1 AT&T, No. 2 MCI WorldCom, and No. 3 Sprint) was controlling about 80% of the residential market. The next largest competitor was Qwest Communications which had only 2.5% market share. The suitable oligopoly model for this market is the Bertrand Model; the potential for harming consumers stems from the elimination of competition between two existing brands that are seen as close substitutes by many consumers. The applicants presented a unilateral effects model to the DOJ, which showed that the merger would lower the average long-distance price paid by residential consumers by an amount in the range of 0.2 percent to 0.8 percent. As the advertising was treated as marginal cost, the demand elasticity of MCI, Sprint and AT&T’s are -3.4, -6.5, and -3.2 respectively. Even without any cost savings from the merger, the simulation model would predict an average price increase of less than 1 percent resulting from the merger. The elasticity of supply for Internet transport services is high yet there are no barriers to expansion. In this case, the parties involved in different empirical elasticity estimates using structural oligopoly models. Whether MCI/WorldCom and Sprint were close substitutes or not, the question was a standard oligopoly model generates substantial price increases when simulating a merger, since the price increases depend directly on the value of the estimated cross-price elasticity.
Although the focus of discussion was the long distance market; the applicants argued that this was an industry in which margins were quickly collapsing, and which was in the midst of a structural change provoked by technological breakthroughs (the Internet) and regulatory changes (local networks etc.). According to the opponents, the MCI WorldCom-Sprint merger “failed” the Merger Guidelines’ HHI thresholds, thus creating a presumption of unlawfulness. WorldCom was very close to domination of Internet backbone market if the merger had been allowed. Another argument was made that MCI WorldCom and Sprint were each other’s closest competitors; they both compete against AT&T. Based on the analysis, the conclusion can be drawn that the long-distance is extremely concentrated market that will become even more after the proposed merger. This is also valid in internet backbone market. The sunk costs would also increase which precluding new firms entering the market and existing firms for expanding. Decreased market from AT&T, Sprint and MCI to AT&T and MCI-Sprint would also increase the brand name barrier and cause the network effect that allowing a few firms to dominate long-distance and data services markets. It is also said that the proposed merger would diminish consumers' choices, especially low-volume callers who make less than $4 per month in long-distance calls. The proposed merger would also cause a significant harm to competition in many of the nation’s telecommunications markets. This merger would extensively lessen the competition in the market by leading to higher prices, lower service quality, and less innovation than the merger absent situation. The competition was also going to lessen once Sprint had been purchased plus customers of this company would have derived relatively less benefit from being effectively connected to smaller networks than would have the customers of these smaller networks derive from being effectively connected to Sprint. Therefore United States wanted to enjoin this merger by making decisions about this merger; this was not going to prevent the anticompetitive effects of this merger for the country almost a whole.
As mentioned before; if transaction would have been completed, there were such effects were going to take place. These were; competition would be eliminated or lessened, sale of services in each of the relevant markets would be eliminated or lessened, prices would likely be increased to the levels above those that three companies would prevail absent the merger, innovation and quality services would likely decrease to levels below those that would prevail absent the merger, and the barriers to entering each of product markets will be increased. This merger is also blocked by European antitrust authorities due to it would create a dominant company capable of crushing internet competition in Europe. This would have allowed the merged company to behave independently of both its competitors and customers and, therefore, to dictate conditions and prices in the market to the detriment of consumers around the world and particularly in the 15 European Union states. The merger would have also created super Internet provider of both United States and global Internet connectivity. The merged company would have possibility of ability to control technical developments, raise prices, and discipline the market. With this merger, the two close competitors and innovators will immediately stop their long-standing competitive rivalry which leads to higher costs and prices. One economic study estimates the price increase at between 5% and 8% in various parts of the total long-distance markets which leads to lower service and quality and variety.
The proposed merger had been acted to terminate by board of directors of Sprint and WorldCom after Department of Justice reached had reached to the conclusions on the competitive impact of the merger. Although the Department said it would not be able to go to trial before 2001, approval of the merger by the Federal Communications Commission and the European Commission would still be needed after the successful conclusion of the trial so that the both companies concluded to end their deal.
The Questions:
1. What kind of competitive environment do AT&T, Sprint and MCI WorldCom compete in?
a. Monopoly
b. Oligopoly
c. Pure Competitive
d. Duopoly
1. How much market share do “Big Three” have?
a. 50%
b. 30%
c. 90%
d. 80%
2. Why this proposed merger had been opposed?
a. The merger would create huge losses to both of the companies.
b. One of the parties of the deal was having an accounting scandal.
c. The merger would decrease the prices the companies charge.
d. The merger would turn all the relevant markets into duopoly power.
3. Which of the following is not one of the characteristics of a contestable market?
a. All firms have access to the same productive technology.
b. Consumers react quickly to a price change.
c. Existing firms cannot respond quickly to entry by lowering their price.
d. There are significant sunk costs.
4. Which of the following is not opponents’ opinion regarding the proposed merger?
a. The proposed merger is against competition law.
b. The competition in relevant markets would be eliminated or lessened.
c. The prices would likely be increased to the levels above those that three companies would prevail absent the merger.
d. The Internet backbone market MCI WorldCom and Sprint face was the only market for both of these companies.
The answers are B, D, D, D, and D. Those three competitors compete in oligopoly and they have 80% share of the market. This merger had been exposed due to the market would have been turned to duopoly. The answer of the fourth questions is that there are significant sunk costs. Plaintiff did not raise a question about MCI and Sprint were only two competitors in Internet Backbone market.
Bibliography
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Sprint Nextel. (n.d.). Retrieved November 27, 2011, from Wikipedia: http://en.wikipedia.org/wiki/Sprint_Corporation
Summaries
Summary 1: Google's Defense in Antitrust Hearing: An Evaluation of Market Power
This case is about Google's dominating the market. Competition Policy and Consumer Rights Subcommittee claims that Google was a monopoly and in way dominating the market. This probe examined the company's core search-advertising business. The probe comes from Google allowed online Canadian pharmacies to place advertisements through its AdWords program, resulting in the unlawful importation of controlled and non-controlled prescription drugs into the United States. Google had 70% market share which might be enough for courts to sue Google. But, it is not enough for courts determining anticompetitive behavior without determining other factors.
Summary 2: Market Failure- Antitrust, positive and negative externalities, public goods, rent seeking, tariffs Government failure
There are many reasons for a market unable to provide the socially efficient quantities of goods; anti-competitive market power, negative externalities, public goods, and rent seeking. A firm produces less than a socially effecient level of output in a monopoly market. Negative externalities like pollution are costs borne by parties who are not involved in the production or consumption of a good.A public good is a good that is non-rival and non-exclusionary in consumption.New technology has created new public goods, such as a lighthouses and street lights. Another example is rent seeking problem. Rent seeking is selfishly motivated efforts aimed at influencing another party’s decision.
Summary 3: Economies of scale, diseconomies of scale, constant returns to scale, Efficiency in production. Economies of scope and how to maximize profit when there’re two production plants, long-run equilibrium
Ability of larger companies to purchase more efficient manufacturing equipment, which is often either too expensive for smaller companies or not effective for small quantities. Larger companies are able to purchase input goods in higher quantity, often receiving discounts for their bulk orders. This results in lower average costs in the long run. The example of diseconomies of scale is Pharmaceutical industry. The firms must spend large amounts of capitals to first develop and then test a potential drug before they can offer it for scale.Production Function is defined as a function that defines the maximum amount of output that can be produced with a given set of inputs.
Summary 4: Create and answer a case study similar to Memo 10 from Time Warner - Optimal Auctioning Mechanisms
This paper is about methods and benefits of utilizing auctioning mechanisms which helps companies to sell off all or part of their firms in order to either liquidate or survive. During the auction process, buyers have to compete with another buyer in order to be the new owner of the firm being sold. There are some types of auctions; English Auction, First Price - Sealed Bid, Second Price - Sealed Bid, Dutch Auction, Independent Private Values, Affiliated Value Estimates, Common Value. Different strategies will be used by the bidders to win the auction while spending the least amount of money depending on the type of auction and the bidders valuation of the item. In order to avoid the winners curse, firms can determine what they think to be the value and bid below this amount.
Summary 5: Coca-Cola Company and Pepsi Corporation
This two firms have 70% of the coke market, forming a dupoly. The competitors are fierce competitors. They have been involved in many lawsuits in relation to its allegedly monopolistic and discriminatory practices. In 2005, European Unions investigation revealed that Cokes business methods stifled competition. It is alleged that Coke used its power to stifle competition through a series of sales agreements.Another example is, Mexico’s Federal Competition Commission fined the Coca-Cola system $13 million for monopolistic practices. Coca Cola has threatened by a company entered to the Mexican Coke market in 2002 called Big Cola and then captured the 5% of the market. Coca-Cola Company decided to kill its competitor by unleashing and aggressive and illegal marketing effort. After all, Federal Competition Commission conducted their field investigation they visited various shops and found that Big Cola was either not available or was placed at the back of the shop, away from Coca-Cola fridges at the front.Coke and Pepsi have personal relationships with their retail channels and would be able to defend their positions effectively through discounting and other tactics.
10/2/2011
On September 4, 1996, Staples and Office Depot announced plans to merge by saying that "Merger would generate economies of scale and further reductions in the price of office supplies."; but The Federal Trade Commission announced that this would unfairly increase office supply prices. Office Depot was the largest office superstore chain in the United States and Staples was the second one before plans to merge. Another office superstore OfficeMax did not have stores in many of the local markets that the merger would affect.
The FTC argued in court for a preliminary injunction on grounds that the Staples/Office Depot merger would violate federal antitrust laws by substantially reducing competition in the retail sale of office supplies by office supply superstores in various local markets throughout the country where each firm directly competes against each other. These markets include areas of California, Florida, Illinois, Kentucky, Maryland, Michigan, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Virginia, Washington, Indiana, Utah and Washington, D.C.
Next week I am going to review flaws about this decision.
Sources:
http://www.cato.org/pub_display.php?pub_id=6131
http://www.ftc.gov/opa/1997/03/staples.shtm
10/9/2011
As FTC filed suit to block the merger on the grounds that the merger would significantly reduce competition in many geographic market areas, and this reduction would lead to to anti-competitive pricing by the newly merged entity.
Merge is very powerful tool in business because it reduces competition and cost savings that will increase the market power of the company. Like In this case oligopolies are often accused of and found guilty of anti-competitive practices. Therefore, company mergers are often examined closely by government regulators to avoid reducing competition in an industry. Although anti-competitive practices often enrich those who practice them, they are generally believed to have a negative effect on the economy as a whole, and to disadvantage competing firms and consumers who are not able to avoid their effects, generating a significant social cost. For these reasons, most countries have competition laws to prevent anti-competitive practices, and government regulators to aid the enforcement of these laws. Thus the competition law, known in the United States as antitrust law, is law that promotes or maintains market competition by regulating anti-competitive conduct by companies. The law promotes healthy competition. It bans anti-competitive agreements to fix high prices, makes it illegal to agree not to compete with other businesses, and prevents companies from
abusing a dominant market position. The existence of monopolies or mergers which substantially change the balance of power can be of great concern to purchasers undertaking supply chain management. Thus mergers can generate anti-trust concerns and subject to government regulation. There are 3 types of mergers; horizontal merger, vertical integration, conglomerate merger. A merger occurring between companies producing similar goods or offering similar services is called horizontal merger. Mergers like Chevron & Texaco is an example of horizontal merger. The term vertical integration means that the company expands its business into areas that are at different points of the same production path. Merger of Time Warner & AOL is an example of vertical integration. This integration might harm competition significantly. Conglomerate merger is about totally unrelated companies such as US Steel & Marathon Oil.
The reason of FTC called the situation of Staples and Office Depot could lead to anti-competitive pricing may cause some practices if they had been merged. I will discuss these next week.
Sources:
http://www.uio.no/studier/emner/sv/oekonomi/ECON4820/v06/undervisningsmateriale/Lecture%2012.pdf
http://en.wikipedia.org/wiki/Anti-competitive_practices
http://en.wikipedia.org/wiki/Competition_law
10/18/2011
Anti-competitive prices may lead to several practices like price fixing, manipulation of supply, exclusive dealing arrangement, tying arrangements, retail price maintenance and price discrimination.
Price fixing is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand. The group of market makers involved in price fixing is sometimes referred to as a cartel. Deals can be made by competitors to collude to raise prices. We can see this in retail gasoline example around the world. Another example is the accusing of Visa and MasterCard lately. Visa Inc. and MasterCard Inc. (MA), the world’s biggest payment networks, were sued by a trade group representing operators of automated teller machines over claims the firms fix prices and suppress competition among ATM networks. The effects of price fixing are reduced competition based on price, higher prices and higher profits for the conspirators.
Manipulation of supply is a conspiracy by competitors to collude to reduce the supply of the product or service. It has effects such as higher prices and higher profits for the conspirators. Manipulation made by OPEC is an example for this situation. Opec's manipulation of oil production once held the world to ransom, prompting the 1973 oil shock that sent the whole global economy into turmoil. It was also blamed for the oil price spike that caused widespread fuel protests across much of Europe in 2000.
Exclusive dealing arrangements is about a seller agrees to sell to a buyer on the condition that the buyer agrees not to buy from other sellers. A gasoline refinery that sells to independent gas stations on the condition they agree to buy exclusively from the refinery and Microsoft pricing of Windows to computer manufacturers are this kind of examples. It is also connected to vertical integration but it is more like without an actual merger. It leads to reduced competition. If it substantially reduces the competition then it becomes illegal.
Sources:
http://en.wikipedia.org/wiki/Price_fixing
http://www.bloomberg.com/news/2011-10-12/visa-mastercard-accused-of-price-fixing-by-atm-operators.html
http://news.bbc.co.uk/2/hi/business/1860361.stm
10/24/2011
Seller may agree to sell one item to a buyer on the condition that the buyer also buys another item is called tying arrangements. Certain tying arrangements are illegal in United States law. This may be the action of several companies as well as the work of just one firm. There are four elements for tying arrangements; two separate products or services are involved, the purchase of the tying product is conditioned on the additional purchase of the tied product, the seller has sufficient market power in the market for the tying product, a not insubstantial amount of interstate commerce in the tied product market is affected. In recent years, changing business practices surrounding new technologies have put the legality of tying arrangements to the test. Windows & Internet Explorer is a good example for this situation that effects reduced competition.
Manufacturer agrees to sell to retailer on the condition that the retailer charges the retail price specified by the manufacturer is called retail price maintenance. A brand seller imposes RPM for one fundamental reason – it helps the seller win and retain retailers that will carry and promote the product. It does this by guaranteeing the retailer a high margin. The brand seller most likely to find RPM attractive is one who is selling a mid to high-priced brand whose inherent superiority is not readily evident to consumers. For such a manufacturer, RPM can give retailers a needed incentive not only to stock the brand but to actively promote it. Still, a competitive assessment of RPM is not complete without recognizing that even the brand seller with a relatively weak and relatively high priced brand has alternatives to RPM for widening distribution and sales. Here are some of the alternatives:
1) lowering the product’s price;
2) increasing advertising, or making ads more effective;
3) offering contractual promotion incentives (promotion allowances) to retailers;
4) sending manufacturer’s representatives to retail stores to offer on-site demonstrations;
5) agreeing to favorable terms for buying back a retailer’s unsold inventory; and
6) imposing distribution-limiting vertical restraints (such as exclusive territories or location clauses) that increase a retailer’s incentive to invest in and sell the branded product.
When tv manufacturer only sells to a retailer if the retailer charges the retail price specified by the TV manufacturer is an example for this situation, this reduces the price among retailers.
Seller charges different prices to different buyers for identical goods is called price discrimination. Essentially there are two main conditions required for discriminatory pricing:
1)Differences in price elasticity of demand between markets: There must be a different price elasticity of demand from each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase its total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.
2)Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “market seepage” or “consumer switching” – defined as a process whereby consumers who have purchased a good or service at a lower price are able to re-sell it to those consumers who would have normally paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut rather than with the exchange of tangible goods. Seepage might be prevented by selling a product to consumers at unique and different points in time – for example with the use of time specific airline tickets that cannot be resold under any circumstances.
Wal-Mart opens a store in a town and charges lower prices than it charges in other towns for the same merchandise could be called as price discrimination due to this may reduce the competition.
Sources:
http://en.wikipedia.org/wiki/Tying_(commerce)
http://www.ftc.gov/opp/workshops/rpm/docs/wgrimes0219.pdf
http://tutor2u.net/economics/revision-notes/a2-micro-price-discrimination.html
http://else.econ.ucl.ac.uk/papers/uploaded/222.pdf
11/07/2011
Due to this case has happened in oligopoly market; I am going to review some basic oligopoly models. An oligopoly is an intermediate market structure between the extremes of perfect competition and monopoly. Oligopoly firms might compete (noncooperative oligopoly) or cooperate (cooperative oligopoly) in the marketplace. Whereas firms in an oligopoly are price makers, their control over the price is determined by the level of coordination among them. The distinguishing characteristic of an oligopoly is that there are a few mutually interdependent firms that produce either identical products (homogeneous oligopoly) or heterogeneous products (differentiated oligopoly).
In Cournot Oligopoly Model; firms in the market simultaneously choose the quantities they are going to produce. Cournot oligopoly is the simplest model of oligopoly in that firms are assumed to be naive when they think that their actions will not generate any reaction from the rivals. In other words, according to the Cournot model, rival firms choose not to alter their production levels when one firm chooses a different output level. Cournot thus focuses on quantity competition rather than price competition. While the naive behavior suggested by Cournot might seem plausible in a static setting, it is hard to image real-world firms not learning from their mistakes over time. The Bertrand model's significant difference from the Cournot model is that it assumes that firms choose (set) prices rather than quantities.
Bertrand Oligopoly Model; firms select prices. Each firm chooses its quantity as the best response to the quantity chosen by the others and its price as the best response to the price chosen by the others. The firms set quantities sequentially. The second firm’s quantity is the best response to the first firm’s quantity. The first firm sets a quantity. The second firm follows by setting a price and the firms jointly set the price that maximizes industry profits. Cournot and Bertrand oligopolies constitute the two most prevalent models of firm competition. The analysis of Nash equilibria in each model reveals a unique prediction about the stable state of the system. Quite alarmingly, despite the similarities of the two models, their projections expose a stark dichotomy. Under the Cournot model, where firms compete by strategically
managing their output quantity, firms enjoy positive profits as the resulting market prices exceed that of the marginal costs. On the contrary, the Bertrand model, in which firms compete on price, predicts that a duopoly is enough to push prices down to the marginal cost level. This suggestion that duopoly will result in perfect competition, is commonly referred to in the economics literature as the “Bertrand paradox”.
Stackelberg Oligopoly Model; firms sequantially select quantities. The Stackelberg model deals with the scenario in which there is a leader firm in the market whose actions are imitated by a number of follower firms. The leader is sophisticated in terms of taking into account rivals' reactions, while the followers are naïve, as in the Cournot model. The leader might emerge in a market because of a number of factors, such as historical precedence, size, reputation, innovation, information, and so forth. Examples of Stackelberg leadership include markets where one dominant firm dictates the terms, usually through price leadership. Under price leadership, the leader firm's pricing decisions are consistently followed by rival firms.
Sources:
http://www2.wiwi.hu-berlin.de/institute/hns/material/L-HSE-3-Oligopoly.pdf
http://www.enotes.com/business-finance-encyclopedia/oligopoly
http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=5&ved=0CEoQFjAE&url=http%3A%2F%2Fwww.econ.ucsb.edu%2F~tedb%2FCourses%2FGameTheory%2FGame%2520Theory%2520Lecture%2520Jan%252018.pptx&ei=QJ23TrmDNOTe2AX7runMDQ&usg=AFQjCNH0nB-rTQyfiYWlkZBehnMBiv6n_A&sig2=o6fmKhA2Hi3ztNalE1XaBQ
11/13/2011
“Market Power” is the ability of a firm or group of firms within a market to profitably charge prices above the competitive level for a sustained period of time. This market power does not use for good all the time. Market power can be analyzed with 5 competencies; product market, geographic market, market concentration, entry conditions, any other structural characteristics of market and the market performance. The economic theory of monopolistic competitive markets, oligopoly and monopoly is used to suggest the nature of problems that may exist when firms or agents have market power and are able to distort prices away from the purely competitive optimum. A firm with market power has the ability to individually affect either the total quantity or the prevailing price in the market. Price makers face a downward-sloping demand curve, such that price increases lead to a lower quantity demanded. The decrease in supply as a result of the exercise of market power creates an economic deadweight loss which is often viewed as socially undesirable. As a result, many countries have anti-trust or other legislation intended to limit the ability of firms to accrue market power. Such legislation often regulates mergers and sometimes introduces a judicial power to compel divestiture.
Product Market:
As the FTC and DOJ Merger Guidelines indicate, economists attempt to identify those products that consumers will substitute for a given product in response to a “small but significant and nontransitory” price increase when identifying the products that compete in an antitrust market.They also will include in an antitrust market all producers that currently produce a relevant product and all producers that could easily and economically produce and sell the relevant product in a short period of time (e.g., one year) in response to a “small but significant and nontransitory” price increase.
Geographic Market:
Product market definition and geographic market definition are interrelated. In particular, the extent to which buyers of a particular product would shift to other products in the event of a "small but significant and nontransitory" increase in price must be evaluated in the context of the relevant geographic market. Antitrust economists will start with a fairly narrow area and then determine if firms located in that area are nsulated from competitive pressures from firms located in other areas. They will continue to include firms in the market (and hence expand the geographic scope of the market) until they identify an area in which a hypothetical monopolist could profitably impose a “small but significant and nontransitory” increase in price.
Sources:
http://www.boisestate.edu/econ/lreynol/web/PDF/short_13_Market_power.pdf
http://en.wikipedia.org/wiki/Market_power
http://www.justice.gov/atr/public/guidelines/horiz_book/11.html
11/20/2011
Relevant Market under Merger Guidelines:
In sum, an antitrust market is defined: “as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical, profit maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area likely would impose a ‘small but significant
and nontransitory’ increase in price, assuming the terms of sale of all other products are held constant. The Merger guidelines are a set of internal rules promulgated by the Antitrust Division of the United States Department of Justice (DOJ) in conjunction with the Federal Trade Commission (FTC).
Undertaking a market definition analysis at monopolistic prices can lead one to define too broad a market and fail to identify market power when it is present, which is known as the “Cellophane Fallacy.” A key lesson of the Cellophane Fallacy is that in some circumstances it may be sensible for economists to consider all of the elements of the monopolization case market power paradigm and to develop an internally consistent analysis that aligns with the available factual evidence before reaching a final conclusion about the scope of the relevant market. Cellophane was a DuPont Company plastic wrapping material that had its U.S. production restricted to du Pont by numerous patents in the early 1950s. Du Pont was sued under the Sherman Act for monopolization of the cellophane market by the U.S. Justice Department, and the case (U.S. v. E. I. du Pont[2]) was decided by the Supreme Court in 1956. The Court agreed with du Pont that when evaluated at the monopolistic price observed in the early 1950s, there were many substitutes for cellophane and, therefore, du Pont had only a small share of the market for wrapping materials (i.e., it possessed little or no market power). In particular, in monopolization cases it can be important to consider “performance” evidence to understand how a market is structured and/or directly determine if a firm has market power. In many cases, a firm or group of firms will not have significant shares even when the narrowest conceivable market is considered, which may mean that one does not have to reach a final conclusion about the scope of the relevant market. Many cases involve markets where there is substantial supply-side substitution, which may allow one to avoid fully analyzing the demand-side issues that underlie the Cellophane Fallacy.
In monopolization cases, relevant markets are defined to help determine if a firm has market power, although one need not define a relevant market if there is direct evidence of market power. When defining a relevant market, one must consider the pitfalls associated with the Cellophane Fallacy. The challenges posed by the Cellophane Fallacy do not mean that one should abandon the traditional monopolization case market power paradigm as a way of organizing market power presentations. To the contrary, recognition of the problems posed by the Cellophane Fallacy suggest that there can be risks associated with truncating the market power analysis (although there are circumstances when one
does not need to analyze every issue).
Sources:
http://www.jstor.org/stable/796239?seq=4
http://en.wikipedia.org/wiki/Cellophane_Paradox
http://en.wikipedia.org/wiki/Merger_guidelines
11/27/2011
Herfindahl-Hirschman Index:
The Herfindahl Hirschman Index determines if a monopoly exists. The calculation gives higher weight to larger firms but also allows firms outside of the top four largest to factor into the equation. A similar index is the Four-Firm Concentration Ratio, which only factors in the four largest firms. The lower the Herfindahl Hirschman Index, the more spread out the market share with many large firms. The higher the Herfindahl Hirschman, the more concentrated the market share with only a couple of large firms.
This index is a commonly accepted measure of market concentration. It is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. For example, for a market consisting of four firms with shares of thirty, thirty, twenty and twenty percent, the HHI is 2600 (302 + 302 + 202 + 202 = 2600). The HHI takes into account the relative size and distribution of the firms in a market and approaches zero when a market consists of a large number of firms of relatively equal size. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases.
Markets in which the HHI is between 1000 and 1800 points are considered to be moderately concentrated, and those in which the HHI is in excess of 1800 points are considered to be concentrated. Transactions that increase the HHI by more than 100 points in concentrated markets presumptively raise antitrust concerns under the Horizontal Merger Guidelines issued by the U.S. Department of Justice and the Federal Trade Commission.
The usefulness of this statistic to detect and stop harmful monopolies however is directly dependent on a proper definition of a particular market (which hinges primarily on the notion of substitutability). For example, if the statistic were to look at a hypothetical financial services industry as a whole, and found that it contained 6 main firms with 15% market share apiece, then the industry would look non-monopolistic. However, one of those firms handles 90% of the checking and savings accounts and physical branches (and overcharges for them because of its monopoly), and the others primarily do commercial banking and investments. In this scenario, people would be suffering due to a market dominance by one firm; the market is not properly defined because checking accounts are not substitutable with commercial and investment banking. The problems of defining a market work the other way as well. To take another example, one cinema may have 90% of the movie market, but if movie theatres compete against video stores, pubs and nightclubs then people are less likely to be suffering due to market dominance. Another typical problem in defining the market is choosing a geographic scope. For example, firms may have 20% market share each, but may occupy five areas of the country in which they are monopoly providers and thus do not compete against each other. A service provider or manufacturer in one city is not necessarily substitutable with a service provider or manufacturer in another city, depending on the importance of being local for the business—for example, telemarketing services are rather global in scope, while shoe repair services are local.
Sources:
http://en.wikipedia.org/wiki/Herfindahl_index
http://www.justice.gov/atr/public/testimony/hhi.htm
http://www.ehow.com/how_6107751_calculate-herfindahl-hirschman-index.html
On September 4, 1996, Staples and Office Depot announced plans to merge.[5[[http://en.wikipedia.org/wiki/Staples_Inc.#cite_note-4|]]] The Federal Trade Commission decided that the superpower would unfairly increase office supply prices despite competition from OfficeMax, because OfficeMax did not have stores in many of the local markets that the merger would affect.[6[[http://en.wikipedia.org/wiki/Staples_Inc.#cite_note-5|]]] Staples ultimately argued that chains such as Wal-Mart and Circuit City Stores represented significant competition, but this argument did little to sway the FTC. Following the denial of the merger by the FTC, a rivalry has formed between the two companies.
¨Manufacturer agrees to sell to retailer on the condition that the retailer charges the retail price specified by the manufacturer
The Proposed MCI WorldCom – Sprint Merger
MCI WorldCom and Sprint Corporation announced a merger agreement on October 5th. MCI WorldCom offered $129 billion in stock and debt to top a rival $100 billion bid from BellSouth for Sprint (S) in October 1999. The plan was to combine MCI WorldCom's No. 2 long distance business with Sprint's third-place operation. It would have been the largest corporate merger in history, ultimately putting MCI WorldCom ahead of AT&T as the largest communications company in the United States if the agreement had been completed.
MCI WorldCom was one of the largest telecommunication providers with operations in more than 65 countries and more than 22 million residential and business customers worldwide. WorldCom’s 1999 annual revenues totaled approximately $37 billion. They were also the largest provider of Internet backbone services in the world when considered by traffic or revenues. The company was the second-largest domestic long distance telecommunications carrier and services in terms of revenues as well as the second-largest provider of various data network services and the second-largest of only three meaningful competitors in the market for custom network telecommunications services for large U.S. business customers. This company had made more than 60 acquisition of competitor and other companies such as MCI (second largest provider of long distance telecommunications and a leading internet backbone services provider), ANS Communications (which served as one of AOL’s primary Internet backbone networks), and Brooks Fiber Properties. WorldCom is bought by Verizon on January 6, 2006 as part of the corporation’s emergence from bankruptcy.
Sprint Corporation is now the third largest wireless telecommunications network in the United States, behind Verizon and AT&T. The company was renamed in 2005 after the purchase of Nextel Communications by Sprint Corporation. The company was one of the largest telecommunications providers in the United States, serving more than 17 million residential and business customers during the proposed merger date. Sprint built the first nationwide, all-digital, fiber optic network; operates the nation’s second-largest Internet backbone; and competes head-to-head against WorldCom in many markets in which the two companies operate.
After the proposed merger had been announced, both U.S. Department of Justice and European Union showed their concern; regulators in the U.S. and Europe balked, and the deal was canceled after nine months of discovery, filings, meetings by U.S. Department of Justice and the Commission of the European Communities. The merger had been terminated on July 13, 2000. Later, WorldCom was caught up in accounting fraud that led to the ouster of CEO Bernard Ebbers and other executives and left the company in bankruptcy. After that; WorldCom was ultimately acquired by Verizon for $7.6 billion in 2005. These two companies were the second and third largest long-distance companies in the United States, and the first and second largest Internet backbone service providers. This case was the only merger between major telecommunications carriers that was derailed by the government. The main reason of rejecting the merger was about the proposed merger is the increase in market power that the merged company will have from combining two well-known companies serving similar geographic markets and providing similar customer groups with similar services. If this merger had been allowed and then one merge would have been allowed as well, then all the telecommunications market was turned into complete dominance by a single firm that creates monopolistic market. In other words; a merged MCI WorldCom and Sprint would create a company that dominates the long-distance and Internet backbone service markets which lead to an illegal monopoly. The regulatory bodies in the U.S. were concerned both of the combined Internet market share of the companies and the combined data and long -distance voice market share.
The proposed merger affected concentration and competition in many telecommunication markets. There are several markets in which Sprint and MCI are considered; long-distance market, mass market, large business market, and internet backbone. Although all of are these part of the telecommunication industry; this proposed merger would have caused market to turn into duopoly at the same time. The industry was having highly concentrated, driven by strong demand, and where the intense competition determines pricing tools itself. I would like to consider the relevant market as Telecommunications. So the relevant markets broadly are Internet Backbone Services Market, Mass Market Domestic Long Distance Telecommunications Services, Mass Market International Long Distance Telecommunications Services, International Private Line Services, Private Line Services Market, Interlata Data Network Services Market and Custom Network Services Market as it is indicated by the plaintiff which is Department of The Justice. Internet Backbone Market does provide Internet network throughout the United States. Mass Market provides consumers to complete communications from their locations to locations throughout the world. This market is located throughout the United States as well. Private line services are dedicated circuits provided to a customer to use in any manner and with any hardware that the customer chooses. International private line services offered from the United States to a particular country are generally similar regardless of the U.S. location of the customer, although the prices for domestic connections to an international private line may differ depending on where the customer is located. Finally, Internet protocol virtual private networks (“IP/VPNs”) are data networks that use the same protocol -- known as “TCP/IP” -- that is commonly used over the public Internet. The relevant market is properly defined in terms of the provision of services to high-end customers in the United States. Generally, it is found that the relevant market is properly defined in terms of the provision of services to high-end customers in the United States.
The long distance market is a market in which the extent of product differentiation is limited and the key competitive features are the high investment costs involved, the risk of competitive entry by new technologies (e-mail, chat through the Internet, web phones, etc.), powerful companies (the “Baby Bell”, operating companies which could provide jointly long distance and local calling), and new competitive providers with brand new fiber. The long-distance market is divided into two separate and distinct segments. The “Mass Market” consists of residential and small business customers who purchase voice long-distance service, which is sold primarily through direct marketing channels (e.g., telemarketing). Mass market customers buy services “off the shelf” without individualized prices or other terms. The “Large Business Market” consists of large corporate customers. These companies purchase a wide range of voice and data services, with most business conducted by bidding for large multiyear contracts tailored to the individual needs of each customer. The Internet backbone consists of high-capacity long-haul data networks that connect smaller networks and customers. MCI and Sprint were second and third consecutively both in Long Distance – Mass Market and Long Distance – Large Business market. They were also first and second in Internet Backbone market. Prior to the merger, MCI would only raise prices if it does not lose too much business to its rivals. After the merger, MCI would not consider the loss of business to the Sprint brand a cost of raising the price of the MCI brand products. The market has three big players; AT&T, Sprint and MCI which provides differentiated product that are long-distance service. The long distance telecommunications services and many other services in the United States were monopolized by AT&T starting for most of the twentieth century. This monopoly was challenged by new entrants starting from 1970s. In the 1980s, this market started to change into oligopoly by emerged entrants MCI (merged with WorldCom in 1998) and Sprint. There were also many players in the market with smaller economies of scale.
Long-distance telecommunications services enable consumers to communicate from their home to the locations throughout the world. Although monopoly had been possessed by AT&T by the most of twentieth century, the market started to change because of AT&T was divided into a long-distance telecommunications carrier and several smaller companies provide local telephone service. The majority of mass market consumers were use wire line telephones to make long distance calls although now it has been doing with much more wireless phones. The Big Three was giving service throughout the United States and each generally charged same prices for the various calls the consumers were making. The mass market long distance services market was highly concentrated and was going to become significantly more concentrated after the proposed merger. HHI was approximately 3500 in terms of revenue; post-merger, the HHI will rise approximately 400 points to 3900, and the merged company would have a share of approximately 30%. Sprint was also in a vital position because of providing an important constraint for WorldCom on the prices the company charge. Those Big Three was about the control 80% of the market.
This Big Three (No.1 AT&T, No. 2 MCI WorldCom, and No. 3 Sprint) was controlling about 80% of the residential market. The next largest competitor was Qwest Communications which had only 2.5% market share. The suitable oligopoly model for this market is the Bertrand Model; the potential for harming consumers stems from the elimination of competition between two existing brands that are seen as close substitutes by many consumers. The applicants presented a unilateral effects model to the DOJ, which showed that the merger would lower the average long-distance price paid by residential consumers by an amount in the range of 0.2 percent to 0.8 percent. As the advertising was treated as marginal cost, the demand elasticity of MCI, Sprint and AT&T’s are -3.4, -6.5, and -3.2 respectively. Even without any cost savings from the merger, the simulation model would predict an average price increase of less than 1 percent resulting from the merger. The elasticity of supply for Internet transport services is high yet there are no barriers to expansion. In this case, the parties involved in different empirical elasticity estimates using structural oligopoly models. Whether MCI/WorldCom and Sprint were close substitutes or not, the question was a standard oligopoly model generates substantial price increases when simulating a merger, since the price increases depend directly on the value of the estimated cross-price elasticity.
Although the focus of discussion was the long distance market; the applicants argued that this was an industry in which margins were quickly collapsing, and which was in the midst of a structural change provoked by technological breakthroughs (the Internet) and regulatory changes (local networks etc.). According to the opponents, the MCI WorldCom-Sprint merger “failed” the Merger Guidelines’ HHI thresholds, thus creating a presumption of unlawfulness. WorldCom was very close to domination of Internet backbone market if the merger had been allowed. Another argument was made that MCI WorldCom and Sprint were each other’s closest competitors; they both compete against AT&T. Based on the analysis, the conclusion can be drawn that the long-distance is extremely concentrated market that will become even more after the proposed merger. This is also valid in internet backbone market. The sunk costs would also increase which precluding new firms entering the market and existing firms for expanding. Decreased market from AT&T, Sprint and MCI to AT&T and MCI-Sprint would also increase the brand name barrier and cause the network effect that allowing a few firms to dominate long-distance and data services markets. It is also said that the proposed merger would diminish consumers' choices, especially low-volume callers who make less than $4 per month in long-distance calls. The proposed merger would also cause a significant harm to competition in many of the nation’s telecommunications markets. This merger would extensively lessen the competition in the market by leading to higher prices, lower service quality, and less innovation than the merger absent situation. The competition was also going to lessen once Sprint had been purchased plus customers of this company would have derived relatively less benefit from being effectively connected to smaller networks than would have the customers of these smaller networks derive from being effectively connected to Sprint. Therefore United States wanted to enjoin this merger by making decisions about this merger; this was not going to prevent the anticompetitive effects of this merger for the country almost a whole.
As mentioned before; if transaction would have been completed, there were such effects were going to take place. These were; competition would be eliminated or lessened, sale of services in each of the relevant markets would be eliminated or lessened, prices would likely be increased to the levels above those that three companies would prevail absent the merger, innovation and quality services would likely decrease to levels below those that would prevail absent the merger, and the barriers to entering each of product markets will be increased. This merger is also blocked by European antitrust authorities due to it would create a dominant company capable of crushing internet competition in Europe. This would have allowed the merged company to behave independently of both its competitors and customers and, therefore, to dictate conditions and prices in the market to the detriment of consumers around the world and particularly in the 15 European Union states. The merger would have also created super Internet provider of both United States and global Internet connectivity. The merged company would have possibility of ability to control technical developments, raise prices, and discipline the market. With this merger, the two close competitors and innovators will immediately stop their long-standing competitive rivalry which leads to higher costs and prices. One economic study estimates the price increase at between 5% and 8% in various parts of the total long-distance markets which leads to lower service and quality and variety.
The proposed merger had been acted to terminate by board of directors of Sprint and WorldCom after Department of Justice reached had reached to the conclusions on the competitive impact of the merger. Although the Department said it would not be able to go to trial before 2001, approval of the merger by the Federal Communications Commission and the European Commission would still be needed after the successful conclusion of the trial so that the both companies concluded to end their deal.
The Questions:
1. What kind of competitive environment do AT&T, Sprint and MCI WorldCom compete in?
a. Monopoly
b. Oligopoly
c. Pure Competitive
d. Duopoly
2. How much market share do “Big Three” have?
a. 50%
b. 30%
c. 90%
d. 80%
3. Why this proposed merger had been opposed?
a. The merger would create huge losses to both of the companies.
b. One of the parties of the deal was having an accounting scandal.
c. The merger would decrease the prices the companies charge.
d. The merger would turn all the relevant markets into duopoly power.
4. Which of the following is not one of the characteristics of a contestable market?
a. All firms have access to the same productive technology.
b. Consumers react quickly to a price change.
c. Existing firms cannot respond quickly to entry by lowering their price.
d. There are significant sunk costs.
5. Which of the following is not opponents’ opinion regarding the proposed merger?
a. The proposed merger is against competition law.
b. The competition in relevant markets would be eliminated or lessened.
c. The prices would likely be increased to the levels above those that three companies would prevail absent the merger.
d. The Internet backbone market MCI WorldCom and Sprint face was the only market for both of these companies.
The answers are B, D, D, D, and D. Those three competitors compete in oligopoly and they have 80% share of the market. This merger had been exposed due to the market would have been turned to duopoly. The answer of the fourth questions is that there are significant sunk costs. Plaintiff did not raise a question about MCI and Sprint were only two competitors in Internet Backbone market.
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