GERMAN, EC AND U.S. MERGER CONTROL - CiteSeerX
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COORDINATED EFFECTS AND COLLECTIVE DOMINANCE - A COMPARISON OF GERMAN, EC AND U.S. MERGER CONTROL Working Paper Thorsten Kaeseberg, M.A. (Economics) Humboldt-University Berlin email: [email protected] First draft: August 2002 Final version: January 2003
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Transcript of GERMAN, EC AND U.S. MERGER CONTROL - CiteSeerX
COORDINATED EFFECTS AND COLLECTIVE DOMINANCE -
A COMPARISON OF
GERMAN, EC AND U.S. MERGER CONTROL
Working Paper
Thorsten Kaeseberg, M.A. (Economics)
Humboldt-University Berlin
email: [email protected]
First draft: August 2002
Final version: January 2003
2
CONTENTS
1 INTRODUCTION ....................................................................................... 81.1 Focus of the paper ............................................................................................. 9
1.2 Reasons for the paper ........................................................................................ 10
2 STATIC OLIGOPOLY THEORIES, UNILATERAL EFFECTS
AND SINGLE DOMINANCE ....................................................................... 112.1 Cournot oligopoly model with homogeneous products
- Merger implications ....................................................................................... 11
2.1.1 Cournot-Nash equilibrium ...................................................................... 11
2.1.2 Consumer surplus ................................................................................... 12
2.1.3 Rationale for efficiency defence ............................................................ 12
2.1.4 Producer surplus and overall welfare ..................................................... 13
2.1.5 Rationale for using the HHI and �HHI .................................................. 13
2.1.6 Rationale for using market shares .......................................................... 14
2.1.7 Distortions in EC merger control? ......................................................... 14
2.1.8 The relationship between unilateral and coordinated effects -
an extension of the Cournot model ........................................................ 15
2.2 Bertrand oligopoly model with differentiated products
- Merger implications ...................................................................................... 16
2.2.1 Pre-merger equilibrium .......................................................................... 16
2.2.2 Post-merger equilibrium ......................................................................... 17
2.3 A two-step approach for assessing unilateral and coordinated effects ............. 17
2.4 Repeated interaction as necessary condition for collusion ............................... 18
3 DYNAMIC OLIGOPOLY THEORIES, COORDINATED EFFECTS AND
COLLECTIVE DOMINANCE ...................................................................... 193.1 The theory of repeated games ........................................................................... 20
3.1.1 Finitely repeated oligopoly games ......................................................... 20
3.1.2 Infinitely repeated oligopoly games (supergames)
3
with perfect information ........................................................................ 21
3.1.2.1 The basic model ........................................................................... 21
3.1.2.2 Equilibria ..................................................................................... 22
3.1.2.3 The Folk theorem ......................................................................... 22
3.1.2.4 The coordination problem ............................................................ 23
3.1.2.4.1 Explicit vs. tacit collusion ................................................. 23
3.1.2.4.2 Focal points and cheap talk ............................................... 23
3.1.3 Punishment strategies and renegotiation-proofness ............................... 24
3.2 Merger implications .......................................................................................... 25
3.2.1 Collusive effects of a merger ................................................................. 25
3.2.1.1 Reduction of number of firms ...................................................... 25
3.2.1.1.1 Coordination and monitoring - the "dinner party story" ... 26
3.2.1.1.2 Enforcement ...................................................................... 26
3.2.1.2 More symmetric distribution of assets ......................................... 27
3.2.1.2.1 Coordination and monitoring ............................................ 27
3.2.1.2.2 Enforcement ...................................................................... 28
3.2.1.2.3 A Trade-off ........................................................................ 28
3.2.1.2.4 The case of capacity constraints - the model of
Compte, Jenny and Rey .................................................... 29
3.2.1.2.4.1 The results of the model ......................................... 29
3.2.1.2.4.2 Application to Nestlé / Perrier ................................ 31
3.2.1.2.5 Policy implications ............................................................ 31
3.2.1.3 Loss of a maverick or reducing its incentive to compete ............ 32
3.2.1.3.1 Identifying a maverick ...................................................... 32
3.2.1.3.2 Merger scenarios ............................................................... 33
3.2.2 Comparative institutional analysis ......................................................... 34
3.2.2.1 Merger control and the prohibition of collusion as
(imperfect) substitutes ................................................................ 34
3.2.2.2 Comparative cost-benefit-analysis ............................................... 34
3.3 Other approaches to collusion ........................................................................... 35
3.3.1 Truly dynamic models ............................................................................ 36
3.3.1.1 Tangible industry conditions ....................................................... 37
3.3.1.2 Intangible industry conditions (beliefs) ....................................... 37
4
3.3.2 Evolutionary game theory ...................................................................... 38
3.3.2.1 Tit for tat as evolutionary stable strategy .................................... 38
3.3.2.2 Implications for merger policy .................................................... 39
3.4 Necessary conditions for collusion ................................................................... 40
3.4.1 "Few" firms - is there a "magic" number? ............................................. 40
3.4.1.1 Selten's "four are few and six are many" ..................................... 40
3.4.1.2 Renegotiation-proofness as binding constraint ............................ 42
3.4.2 Barriers to entry/exit and expansion ...................................................... 42
3.4.2.1 Barriers to entry/exit: prevention of hit-and-run competition ..... 43
3.4.2.2 Barriers to expansion: prevention of
competitive pressure by fringe firms ........................................... 43
3.5 Market characteristics corresponding to the necessary conditions ................... 43
3.5.1 No large and lumpy orders ..................................................................... 45
3.5.2 Homogeneous products .......................................................................... 45
3.5.3 Market transparency ............................................................................... 46
3.5.3.1 Supergames with imperfect information ..................................... 46
3.5.3.2 Empiric evidence ......................................................................... 47
3.5.4 Stable demand conditions (low rate of change in market size
and low degree of innovation) ............................................................... 48
3.5.4.1 Market size ........................................................................... 48
3.5.4.2 Innovation ............................................................................ 48
3.5.5 Low buyer power ................................................................................... 49
3.5.6 Low price elasticity in the sub-market composed of
the leading firms' products ..................................................................... 49
3.5.7 Multi-market contact .............................................................................. 50
3.5.8 Excess capacity ...................................................................................... 50
3.6 Facilitating practices and structural links ......................................................... 51
3.6.1 Facilitating practices .............................................................................. 51
3.6.2 Structural links ....................................................................................... 52
3.7 Evidence of current coordination ...................................................................... 52
3.8 Relative importance of the market characteristics ............................................ 54
3.9 Policy implications ........................................................................................... 54
5
4 COLLECTIVE DOMINANCE IN GERMAN MERGER CONTROL ...................... 564.1 GWB (Act against Restraints of Competition) ................................................. 56
4.1.1 The definition of collective dominance .................................................. 57
4.1.2 Legal constructions and economic meanings ......................................... 57
4.2 Guidelines for Merger Control Procedures ("Auslegungsgrundsätze")
4.2.1 Underlying economics ............................................................................ 58
4.2.2 Three-step approach ............................................................................... 59
4.2.2.1 Internal competition
("Wettbewerbsbedingungen - Binnenwettbewerb") .................... 59
4.2.2.2 External competition
("Wettbewerbsbedingungen - Aussenwettbewerb") .................... 59
4.2.2.3 Conduct ("Wettbewerbsgeschehen") ............................................ 60
4.2.3 Checklist and case law ........................................................................... 61
4.2.3.1 Concentration and market shares ................................................. 61
4.2.3.2 Symmetry ..................................................................................... 62
4.2.3.3 Ressources and vertical up- and downstream integration ............ 63
4.2.3.4 Structural links ............................................................................. 63
4.2.3.5 Barriers to entry ........................................................................... 64
4.2.3.6 Buyer power on the opposite side of the market ......................... 64
4.2.3.7 Market transparency and homogeneity ........................................ 65
4.2.3.8 Market phase ................................................................................ 65
4.2.4 Comparison with economic framework ................................................. 65
4.3 Cases ................................................................................................................. 66
4.3.1 RWE / VEW ........................................................................................... 66
4.3.1.1 Findings ....................................................................................... 66
4.3.1.2 Remedies ...................................................................................... 67
4.3.2 Shell / DEA ............................................................................................ 68
5 COLLECTIVE DOMINANCE IN EC MERGER CONTROL ............................. 705.1 Development - from Nestlé / Perrier to Airtours / First Choice ....................... 71
5.1.1 Nestlé / Perrier (1991) ............................................................................ 72
5.1.2 Kali&Salz / MdK (1993, 1998) .............................................................. 73
5.1.3 Gencor / Lonrho (1996, 1999) ................................................................ 73
6
5.1.4 Airtours / First Choice (1999, 2002) ...................................................... 74
5.1.4.1 The Commission's decision (1999) – shifting the goalposts ....... 74
5.1.4.2 Critique and interpretation - "collective confusion" .................... 76
5.1.4.2.1 Unilateral effects in a collective dominance case ............. 76
5.1.4.2.2 Interpretation: distortions in EC merger control ............... 77
5.1.4.2.3 Solutions to eliminate the distortions ................................ 78
5.1.4.3 The CFI's ruling (2002) - shifting back and
cementing the goalposts ............................................................ 79
5.1.4.3.1 Necessary conditions for coordination .............................. 79
5.1.4.3.2 Market characteristics ....................................................... 80
5.1.4.3.2.1 Product homogeneity .............................................. 80
5.1.4.3.2.2 Market transparency ............................................... 80
5.1.4.3.3 Implications for future policy ............................................ 81
5.1.5 UPM-Kymmene/Haindl and Norske Skog/Parenco/Walsum
(2001): coordination on other parameters than price or output? -
the case of capacity coordination ............................................................ 81
5.2 Approach to collective dominance ................................................................... 82
5.2.1 Identification of oligopolists and initial screening test .......................... 83
5.2.2 Structural market characteristics ............................................................ 83
5.2.2.1 Homogeneous goods .................................................................... 84
5.2.2.2 Market transparency .................................................................... 84
5.2.2.3 Mature market .............................................................................. 84
5.2.2.4 Low rate of product and/or process innovation ........................... 85
5.2.2.5 Symmetry of costs and market shares ......................................... 85
5.2.2.6 Structural links ............................................................................. 86
5.2.2.7 Other factors ................................................................................ 86
5.2.3 Impact of the merger .............................................................................. 87
5.2.3.1 Past level of competition ............................................................. 87
5.2.3.2 Impact of merger on competition between the oligopolists ......... 88
5.2.4 External competitive constraints on the oligopoly ................................. 88
5.2.4.1 Competitors ................................................................................. 88
5.2.4.1.1 Fringe firms and mavericks ............................................... 88
5.2.4.1.2 Potential competitors ......................................................... 88
7
5.2.4.2 Buyer power ................................................................................. 89
5.3 The future after Airtours: Merger Guidelines ................................................... 90
6 COORDINATED EFFECTS IN U.S. MERGER CONTROL .............................. 916.1 Difference in substance: the SLC test ............................................................... 91
6.2 Difference in procedure: ex-ante review .......................................................... 92
6.3 The role of concentration .................................................................................. 93
6.4 Coordinated effects under the 1992 Horizontal Merger Guidelines ................. 94
6.4.1 Market factors ........................................................................................ 94
6.4.2 Relating the market factors to the
necessary conditions of coordination ..................................................... 95
6.4.3 Evidence of prior or current coordination .............................................. 95
6.4.4 Analysis of entry .................................................................................... 96
6.4.5 The relationship between coordinated and unilateral effects ................. 96
6.5 Cases ................................................................................................................. 97
6.5.1 Union Pacific / Southern Pacific ............................................................ 97
6.5.2 Heinz / Beech-Nut .................................................................................. 98
7 COMPARISON, POLICY SUGGESTIONS AND
LOOK INTO THE FUTURE ......................................................................... 1007.1 'Soft' convergence ............................................................................................. 100
7.2 Differences and resulting suggestions for reform ............................................. 102
7.3 The European Commission's proposals for a reform of EC merger control ..... 103
7.3.1 Single dominance: one undertaking having market power
without coordinating .............................................................................. 103
7.3.2 Collective dominance: more undertakings having market power
with coordinating (collusive oligopolies) .................................................... 103
7.3.3 More undertakings having market power without coordinating
(non-collusive oligopolies) ..................................................................... 104
7.3.4 'Hard' convergence ................................................................................. 105
8
1 INTRODUCTION
"The ultimate issue in reviewing a merger under the antitrust laws ... is whether the challenged acquisition is
likely to hurt consumers, as by making it easier for the firms in the market to collude, expressly or tacitly, and
thereby force prices above or farther above the competitive level."
Richard Posner (1986)1
Horizontal mergers2 can have two distinct types of effects: The first type, called unilateral
effects both in economics and in U.S. merger control, arises from reduced mutual
interdependence in an oligopolistic market after the merger: Absent cost synergies due to the
merger and absent barriers to entry, the merged entity will raise prices (or suppress output)
because part of the cost of the price increase (or output decrease), from lost sales, is
internalised by the acquisition of the competitor. Moreover, the remaining competitors might
find it profitable in certain circumstances to respond by raising their price in turn. Hence,
even if all firms increase their prices following the merger, this is still strictly a unilateral
effect because it arises from inherently self-enforcing behaviour without any form of
coordination. Methodically, this outcome of mergers can be associated with non-cooperative
Nash equilibria in one-shot games (see section 2 below). In German and EC merger control,
concerns about price increases by the merged entity are captured under the concept of single
dominance if the merged firm's market power would allow it to "determine its policy [to a
certain degree] free from competitive restraint".3
Second, a horizontal merger might enable the remaining firms to do better than simply adapt
independently to the new environment, as hinted at by Posner's statement above: In
particular by leading to a more concentrated market, by making oligopolists more symmetric
or by removing a maverick firm, the merger might increase the scope for the remaining firms
to exercise market power collectively by coordinating their actions. Hence, due to the
merger, prices can increase above the one-shot Nash equilibrium level since firms are more
1 Case Hospital Corporation of America v. FTC, 807 F.2d 1381, 1386 (7th Cir. 1986).2 The other two types of mergers, vertical and conglomerate, have different effects, e. g. foreclosure and
portfolio effects.3 See the ECJ's definition of a dominant position in the Article 82 case 27/76, United Brands Company v.
Commission (1978) ECR 207. The Commission also applies this definition for the purpose of the MergerRegulation. The question whether there is a relevant difference between the economics of unilateral effectsand the legal definition of "single firm dominance" will be addressed below (2.1.7).
9
likely to attain - expressly or tacitly - a collusive outcome. This consequence of a merger
falls under the category of coordinated effects (or cooperative or pro-collusive effects) in the
U.S. and joint or collective or oligopolistic dominance4 respectively in Germany and the EC.
For collusion to work, there must be some mechanism in place to defeat its natural instability
arising from the incentive for each firm to undercut rivals and thus benefit privately from
their price increases, i. e. a mechanism to overcome the static non-cooperative Nash
equilibria in a prisoner's dilemma situation. In the context of dynamic competition in the
sense of repeated interaction of firms, this mechanism is provided for by (the possibility of)
punishment in the case of defection from the explicit or implicit agreement, and is
formalized by the theory of repeated games (see section 3).
1.1 Focus of the paper
From the above (non-Schumpeterian) welfare perspective, a complete merger framework
would have to balance unilateral and coordinated effects against efficiencies arising from the
merger. This is beyond the scope of this thesis. The focus will be on coordinated effects, in
particular on, first, the necessary conditions for coordination derived from the theory of
repeated games and, second, on the market factors which feed into these conditions. Both
conditions and market factors make up a normative framework for the assessment of
coordinated effects (see section 3 below). Before, unilateral effects will be explained shortly
to allow for a clear distinction of unilateral and coordinated effects and to determine their
relationship (section 2).
Moreover, to cope with the phenomenon "coordinated effects", there are several regulatory
instruments provided for in nearly every competition regime. They can be grouped into ex
ante regulation (merger control) and ex post regulation (in particular the prohibition of
horizontal restrictions of competition). Hence, defining a coherent policy towards
coordinated effects would require a comparative institutional5 cost-benefit-analysis of the
different instruments which would have to take into account, inter alia, different error costs.
This analysis is only alluded very briefly. The focus will be on merger control.
4 These terms are used synonymously.5 "Institution" in the sense of a set of rules and the instruments to implement them (see Richter/Furubotn
(1999), p. 7).
10
1.2 Reasons for the paper
Due to increasingly concentrated oligopolistic markets, the assessment of coordinated effects
by competition authorities within a merger control procedure becomes increasingly
important: For example half of the phase 2 (i. e. in-depth) investigations of the EC
Commission's Merger Task Force involve questions of collective dominance. In the U.S.,
preventing from coordinated effects has long been the main target of merger policy. Hence,
from a public policy perspective, it seems worth to compare the existing (i. e. positive)
merger control regimes with the normative framework derived from game theory. This
comparison, which will be carried out separately for German, EC and U.S. merger control
(sections 4-6), allows to criticize (and potentially improve) actual policy.
Aside from this reason for exploring merger policy towards coordinated effects for each of
the three merger regimes, there is an additional benefit from comparing different merger
control regimes with each other: Due to increasing communication between competition
authorities,6 there is a high probability of mutual learning and, consequently, convergence of
competition policies. Hence, the comparative approach allows to predict into which
directions the different merger control regimes will develop and where they will probably
converge to (section 7).
6 There are contacts between competition authorities, inter alia, on the level of global institutions (e. g. the
OECD or the International Competition Network) or in the context of global merger cases (these case-specific contacts are also to some extent institutionalised, see e. g. the respective EC-U.S. agreement).
11
2 STATIC OLIGOPOLY THEORIES, UNILATERAL EFFECTS AND
SINGLE DOMINANCE
"If I was Director-General of DG IV, I would be very happy if my policy induced the firms under investigation
to end up in a Cournot equilibrium."
L. Phlips, Applied Industrial Economics (1995)
In our context, static oligopoly theories (Cournot and Bertrand) serve four functions: First,
they give a rationale for merger control to target unilateral effects due to horizontal mergers.
Second, they explain why there might be a gap in those merger regimes which use
dominance tests (with a market share threshold). Third, as alluded by the introductory
quotation of Phlips (1995, p. 11), their equilibria serve as non-collusive benchmarks in the
sense of what would happen in a market without coordination. Fourth, they allow to
distinguish clearly and explain the relationship between unilateral and coordinated effects.
2.1 Cournot oligopoly model with homogeneous products - Merger implications
In static games, unilateral effects of a merger can be formalized by comparing the pre- and
the post-merger equilibrium.
2.1.1 Cournot-Nash equilibrium
The Nash equilibrium in a market with quantity-setting firms selling homogeneous goods
can be described by the Cournot oligopoly pricing formula. It shows the relationship
between the ratio between the profit margin and the price (Lerner index), the firm's market
share si�xi/X and the elasticity of demand �>0 at overall equilibrium demand X:
�
ii sXp
cXp�
�
)()(
. (1)
Apart from the basic Cournot oligopoly results (each firm recognizes that it possesses
(limited) market power and that the Cournot equilibrium is somewhere "in between" perfect
competition and the monopoly solution), the formula shows that the relative mark-up is
proportional to a firm's market share and inversely proportional to the elasticity of demand.
12
Moreover, the market share of the firms are directly related to their efficiencies (constant
marginal cost ci).
2.1.2 Consumer surplus
Incorporating the Herfindahl-Hirschman index of concentration (HHI)7
H � ��
n
iis
1
2
into the Cournot oligopoly pricing formula8 gives the following relationship:
p
scpn
iii )(
1��
�
= �
H . (2)
This suggests that with higher concentration due to a merger, mark-ups increase for a given
level of costs, and, hence, consumer surplus decreases. The explanation for this is that,
according to the Cournot model, the quantity produced by the merged firm following the
merger will be lower than the sum of the quantities produced by its parts before the merger
raising the market price. Stimulated by widened margins, the outsiders will - absent capacity
constraints - increase their outputs. However, this response by the non-merging firms will
always only partly offset the reduction in output by the merged entity, with the net effect that
all Cournot mergers in homogeneous goods markets - absent cost synergies - result in lower
total output, higher prices overall and, hence, lower consumer surplus.
2.1.3 Rationale for efficiency defence
If the merger allows for cost synergies, e. g. - statically - due the exploitation of economies
of scale and/or the amalgamation of overhead functions or - dynamically - due to learning
effects or increased potential for innovation, prices do not necessarily rise. This is the
rationale for an efficiency defence like the one explicitly provided for in the U.S. Merger
Guidelines which in particular recognize efficiencies which flow from the attainment of
scale economies, better integration of production facilities, plant specialisation and lower
transport costs. Under the Guidelines, efficiencies are cognizable if they are verified, merger
specific, and not a disguised anticompetitive effect.9
7 The HHI varies between 0, when the market is entirely fragmented (each firm has a market share close to
0), and 10.000, when there is only one firm in the industry with 100% of the market.8 By multiplying both sides of equation (1) by si and summing over all i.
13
2.1.4 Producer surplus and overall welfare
The effect on producer surplus and, hence, on overall welfare is more difficult to determine:
For symmetric firms (i.e. firms with equal cost functions), Bergstrom and Varian (1985)
show a positive relationship between the number of firms in the market and overall welfare.
However, this does not hold for firms with different cost functions.
Farrell and Shapiro (1990, p. 342), for instance, show that - with costs unchanged - the
overall welfare effect depends on the relative cost structures of the merging and non-merging
parts, and hence on the reallocation of output between these firms: in Cournot equilibrium,
larger firms have lower marginal costs, thus overall welfare is enhanced despite increased
concentration if a fixed total output X is shifted towards them away from smaller, less
efficient firms. Thus, although Cournot mergers, absent cost synergies, necessarily raise
prices and reduce consumer surplus, they may enhance total welfare nonetheless.
However, transferring production from a high-cost plant to a low-cost plant is not a
convincing efficiency since such a transfer can be achieved without a merger. Thus, such a
welfare gain is not merger specific in the sense of the U.S. Guidelines.
2.1.5 Rationale for using the HHI and �HHI
Equation (2) provides a direct link between concentration measured by the HHI and
unilateral effects: Mergers in already highly concentrated markets and/or which substantially
increase concentration should cause more concern with respect to a reduction in consumer
surplus than in the case of fragmented markets and/or a negligible changes in concentration.
Hence, the Cournot framework gives a rationale for using the HHI and a change in HHI as
screening devices for unilateral effects of mergers as they are used under the U.S. Merger
Guidelines.10
9 1992 Horizontal Merger Guidelines, Section 4 (revised 1997).10 However, in markets in which products are differentiated either by virtue of their characteristics or by
strong branding, market shares can provide an unreliable guide to the possible extent of any unilateraleffects. In such cases it is often more informative to directly assess the proportion of each of the mergingfirms' customers who would have switched to the other merging firm's products following a price rise('diversion ratios').
14
Table 1.1:
Safe harbours for mergers under the 1992 U.S. Horizontal Merger Guidelines11
safe unsafe unsafe
safe safe unsafePost- 1800merger
HHI 1000safe safe safe
0 50 100
Increase in HHI
However, in the case of coordinated effects, the HHI has to be used with caution: First, the
HHI "punishes" asymmetry. This has to be kept in mind when discussing the role of
symmetry of firms for coordinated effects. Second, the link between concentration and
coordinated effects is a more indirect one than between concentration and unilateral effects
(see below 3.2.1.1).
2.1.6 Rationale for using market shares
Similarly, equation (1) rationalises the use of market shares as indicator of the likely market
power created by the merger. In single dominance cases, the European Commission regards
40% as critical threshold for the market share of the merged firm.
2.1.7 Distortions in EC merger control?
Comparing the European single dominance test with the economic framework set out so far,
Motta (1999, 2000) concludes that the European approach has two distortions which have
repercussions on the application of the concept of a collective dominant position by the
Commission and, hence, have to be analysed in our context:
First, Motta criticizes that all mergers which allow firms to unilaterally raise prices but do
not create or reinforce dominant positions cannot be prohibited.12 This critique relies on the
11 See Section 1.51: a market with a post-merger HHI below 1000 is regarded as "unconcentrated", a market
with a post-merger HHI between 1000 and 1800 as "moderately concentrated" and a market with a post-merger HHI above 1800 as "highly concentrated". The table is taken from Viscusi et al. (1995), p. 214.
15
assumption that the legal definition of "single firm dominance" as the potential for the
merged firm to "behave independently of competitors" requires more than the prognosis of a
price increase by the merged entity (i. e. unilateral effects). Second, so far, EC merger
control does not provide an efficiency defence.
With regard to the first alleged distortion, Motta's critique has to be relativized: Significant
unilateral effects can arise only if actual competitors are not able to offset the merged
entity's suppress of output (i. e. in particular, if they face capacity constraints or barriers to
expansion respectively) and if there are barriers to entry such that there is no constraint by
potential competition.13 Qualitatively, this is (already in theory) not different from the
dominance test which requires that the merged firm is not significantly constrained by its
competitors and thus can behave independently.
However, Motta's critique can also be interpreted quantitatively: The 40%-threshold creates
a gap for those cases in which, due to barriers to expansion and entry, relevant unilateral
effects arise, but in which the threshold is not met. Whether such unilateral effects are
"significant enough" and, hence, should be captured by merger control, is a normative
question outside the scope of this thesis. However, the Commission might want to capture
those cases (positive analysis). Hence, Motta's critique might provide an explanation for the
Commission's attempt to stretch the concept of collective dominance in order to capture such
unilateral effects. This will be further explored when discussing the Commission's Airtours
decision in the context of EC merger control (see below 5.1.4.2.1 and 5.1.4.2.2).
2.1.8 The relationship between unilateral and coordinated effects - an extension of the
Cournot model
Willig (1991) extends the Cournot model by integrating coordinated effects (exogenous
paramter �) and assuming the following relationship between the Lerner index and the mode
of behaviour among firms in the market:
pcp � =
�
�H ,
12 This critique is shared by Caffarra and Neven (2000).13 This is recognised by all competition authorities. Aside from rivals' ability to expand output (i. e. their cost
functions) and the likelihood of entry, the size of unilateral effects depends particularly on the elasticity ofdemand and the degree of countervailing buyer power.
16
where �=0 represents price taking behaviour, �=1 represents Cournot behaviour and �=1/H
pure cartel behaviour. With � rising from 1 to 1/H, mark-ups are generated which are higher
than the Cournot value. Hence, although the mode of conduct is determined exogenously and
not much can be said about the actual effects of a merger, the model highlights that unilateral
and coordinated effects are conceptually different: Assuming that pre-merger firms are not
colluding, the post-merger equilibrium is either another Cournot equilibrium if the mode of
conduct parameter (�=1) does not change, or a collusive equilibrium, characterised by �>1.
2.2 Bertrand oligopoly model with differentiated products - Merger implications
In the case of symmetric price-setting firms which produce a homogeneous product and
which are able to supply the entire market, prices converge to marginal cost ("Bertrand
paradox").14 There are two main approaches to solve the paradox which both make the
Bertrand model more realistic: First, firms can have capacity constraints or sufficiently
increasing marginal cost so that they cannot serve the entire market demand. Second, firms
can produce products that are differentiated in product or geographical space.
Both assumptions are reflected in the U.S. Horizontal Merger Guidelines which distinguish
between the setting where firms are distinguished primarily by differentiated products
(Section 2.21 of the Guidelines) and firms distinguished primarily by their capacities
(Section 2.22). Here, the focus will be on product differentiation as suggested by the practice
of the U.S. competition authorities.
2.2.1 Pre-merger equilibrium
Whereas in the Cournot model with homogeneous goods the "reaction curves" are
downwards sloping, in the Bertrand model an increase in the price charged by one firm also
induces the other firms to increase their prices, such that the price of all products in the
market are likely to rise. In this case, the reaction curves are upwards sloping.
If one of two firms which produce each other's closest substitutes in a differentiated products
market tries to raise its price, it may gain extra revenue per product sold, but it will loose
more revenue in total from the sales that are diverted to the other firm if it was originally
selling at the profit maximising price. Hence, neither firm has an incentive to raise prices
and/or reduce output.
14 See Shapiro (1989), pp. 343-348.
17
2.2.2 Post-merger equilibrium
However, if these two firms merge, the two competing products will be under common
ownership. As a result, the lost sales caused by increasing the price of one of the products
are likely to be recaptured by the merged firm, even if only partially, in the sales of the other
product. Thus, there is an incentive for the merged firm to unilaterally raise the prices of
both products. Moreover, since the reaction curves are upwards sloping, non-merging firms
may also be able to raise their prices. For competition authorities, it is very difficult to
distinguish this unilateral effect arising from oligopolistic interdependence from parallelism
due to coordination, i. e. coordinated effects, although both are theoretically clear separable.
2.3 A two-step approach for assessing unilateral and coordinated effects
Comparing pre- and post-merger equilibrium without and with collusion, builds upon the
idea that firms at one point in time face the strategic choice of either competing (in a
Cournot or Bertrand style depending on the setting) or colluding. Hence, due to this
assumption, a merger which changes the market structure, either leads to unilateral or
coordinated effects (so far, the latter are exogenously given) suggesting that competition
authorities have to deal only with one effect when assessing a merger.
However, there might be a non-static real world sequence in which the firms initially adapt
to the new environment, i. e. the immediate post-merger equilibrium is non-collusive and
there are only unilateral effects, but, particularly with subsequent learning, this may be
displaced by collusion. This sequence is not unrealistic since the non-cooperative gains from
realising increased unilateral market power as such are "certain" (only the size of the
additional profit depends on the market structure). In contrast, gains from cooperation are
uncertain since they, by definition, depend on the other oligopolists or the stability of the
(implicit) agreement respectively. Hence, a merger might possibly lead to both unilateral and
coordinated effects.
This suggests a two-step-approach:
1. An analysis of unilateral effects will show the likelihood of a significant increase in prices
even without any collusion (or of the creation or strengthening of a single dominant
position respectively).
2. If unilateral effects are negligible or unlikely, but the structure and other characteristics of
the market suggest a likelihood of collusive conduct between the remaining firms (or the
18
creation or strengthening of a collective dominant position), then an analysis of
coordinated effects should also be carried out.
2.4 Repeated interaction as necessary condition for collusion
Static oligopoly theory allowed for three main conclusions: First, one shot games provide for
a non-collusive benchmark for oligopolistic markets. Or as the introductory quote of Phlips
makes clear: The competitive Nash equilibrium of a single shot game is the best result
antitrust policy against collusion can hope for in oligopolistic markets. Second, coordinated
effects or collective dominance respectively is "more" than just oligopolistic
interdependence. Third, the collusive outcome is not a Nash equilibrium of a single-period
game since an individual firm can increase its profit by producing more output or charging a
lower price given that all other firms adhere to the collusive strategies. Hence, without
repeated interaction, there cannot be collusion.
19
3 DYNAMIC OLIGOPOLY THEORIES, COORDINATED EFFECTS AND
COLLECTIVE DOMINANCE
"Successful coordinated interaction entails reaching terms of coordination that are profitable to the firms
involved and an ability to detect and punish deviations that would undermine the coordinated interaction.
Detection and punishment of deviations ensure that coordinating firms will find it more profitable to adhere to
the terms of coordination than to pursue short-term profits from deviating, given the costs of reprisal."
1992 U.S. Horizontal Merger Guidelines15
As demonstrated in section 2, static oligopoly theories cannot explain collusion due to the
lack of dynamics, i. e. repeated interaction of firms over time. However, in reality, inter alia
durable investments and barriers to entry promote long-run interactions among a relatively
stable set of firms.16 Assuming repeated interaction of a small number of identical firms
which produce a homogeneous product, Chamberlin (1933) introduced the concept of tacit
collusion:"If each seeks his maximum profit rationally and intelligently, he will realize that when there are
only two or a few sellers his own move has a considerable effect upon his competitors, and that
this makes it idle to suppose that they will accept without retaliation the losses he forces upon
them. Since the result of a cut by any one is inevitably to decrease his own profit, no one will cut,
and although the sellers are entirely independent, the equilibrium result is the same as though
there were a monopolistic agreement." (emphasis added)17
The main contribution of this statement is that it identifies the threat of retaliation as
mechanism which allows firms to gain profits above the static Nash outcome without legally
enforceable cartel agreements and even without communication. This idea has been
formalized by the theory of repeated games (see below 3.1).
However, Chamberlin's conjecture is far too optimistic about the success of collusion since it
assumes costless coordination on the monopoly outcome and perfect information, i. e.
costless monitoring of this outcome. In particular Stigler (1964) worked out factors that
hinder collusion such as unobservable price, demand shocks and buyer power as they relate
to the ability of firms to find, monitor and enforce a collusive equilibrium. Given these
15 Section 2.1 ("Lessening of Competition Through Coordinated Interaction").16 Tirole (1998), p. 239.17 Chamberlin (1933), p. 48.
20
necessary conditions of collusion, coordination is potentially more sinister than unilateral
exercise of market power (it results in welfare losses in terms of lower output, higher prices,
X-inefficiency, slower innovation, and reduced product variety), but also less frequent.
In order to design a merger policy which shall prevent coordination that would arise due to a
merger (coordinated effects), it is necessary to understand how a merger alters firms'
incentives to collude (3.2). These incentives depend, as the introductory quotation from the
U.S. Merger Guidelines suggests, on the relative gains of coordination which, in turn,
depend on market factors like those already identified by Stigler. Hence, a normative merger
framework has to derive the conditions for collusion from firms' incentives (3.4) and to
relate these conditions to those factors which render a market conducive to coordination
(3.5).
3.1 The theory of repeated games
Since the 1980s, the theory of repeated games has become the main tool for modelling the
mechanism of collusion. The various models differ in several dimensions:
- the number of periods in the game (finitely/infinitely; see 3.1.1 and 3.3.1.2),
- the punishment strategies (3.1.3),
- the information available to players (perfect/imperfect; infra 3.5.3.1), and
- the way in which players form beliefs about each other and each other's strategies
(3.3.1.2).
Generally, collusion is the more difficult to sustain the more realistic assumptions the model
makes (e. g. imperfect information).
3.1.1 Finitely repeated oligopoly games
Selten (1978) shows that, given the logic of game theory, no cooperation is possible as soon
as the game is finite. If the game has a final period, firms will cheat, as there cannot be
retaliation in the future. Knowing this, firms will also cheat in the period before the last and
so on until the first period. With this backward induction argument, the game unravels from
the back, and firms will never cooperate. Hence, the unique subgame perfect equilibrium18 of
a finitely repeated game with a unique Nash equilibrium in the stage game is a simple
repetition of the stage-game equilibrium. Thus, the dynamic element contributes nothing to
18 In general, the equilibrium concept of subgame perfection requires that future strategies out of the
equilibrium must themselves constitute an equilibrium in the future (sub)game (see e. g. Shapiro (1989), pp.357-360).
21
the model.19 This so-called "chain-store paradox" can be overcome by permitting the length
of the game, T, to be infinite or at least possibly infinite (see below 3.1.2) or by giving up the
assumption of perfect rationality (see below 3.3).
3.1.2 Infinitely repeated oligopoly games (supergames) with perfect information
The above inability of the firms to collude in a credible fashion rests on the exogenously
given terminal date of the game. However, in reality, competition continues indefinitely, or
at least firms cannot be sure when it will end. Indefinitely repeated games are fundamentally
different from finitely repeated ones in that there is always the possibility of retaliation and
punishment in the future.
3.1.2.1 The basic model
Assume that player i's overall payoff in the game is given by
�i = ��
�0tit
t�� (5)
where � is the discount factor.20
The game beginning at date t is assumed to look the same for all t in the sense that the
feasible strategies and the prospective payoffs that they induce are always the same.21 Each
firm produces its share of the collusive output in each period, as long as the others continue
to do so. If, however, any firm produces more than its "quota" under this arrangement, this
defection signals a collapse of the tacitly collusive arrangement, and each firm plays its static
noncooperative strategy thereafter ("Nash forever"). In the case of a quantity-setting
supergame, each firm plays its static Cournot output following any deviation ("trigger
strategy" or "grim strategy").
19 Considering the example of a two-fold repetition of Cournot oligopoly with i firms, each firm's strategy
consists of its first- and its second-period output conditional on its rivals' first-period outputs. Anyequilibrium must involve static Cournot behaviour in the second period because otherwise some firm wouldhave an incentive to change its second-period behaviour. Hence, e. g. to flood the market in the secondperiod if one deviates during the initial period is not credible. Since no credible punishment for defectors ispossible here, it is not possible to support any first-period outcome other than the standard Cournotequilibrium, i. e. there are no linkages in behaviour between the two periods.
20� = e-r�, where r is the instantaneous rate of interest and � is the real time between "periods". � close to 1represents high patience or rapid changes of price or quantity.
21 Investments by the firms or changes in the competitive environment will be addressed below (3.3.1.1).
22
3.1.2.2 Equilibria
To show that these strategies form a subgame perfect equilibrium two conditions have to be
verified: First, no firm wants to defect from the collusive scheme. Second, the punishment
strategies are themselves credible.
Starting with the second condition, credibility requires that the punishment itself forms a
perfect equilibrium. A punishment involving repetition of an equilibrium in the stage game
is credible, since it is always a perfect equilibrium to simply repeat any equilibrium in the
stage game indefinitely.
By cooperating, firm i earns �i*/(1-�). Hence, there is an equilibrium as long as the no-
defection condition
�i*/(1-�) � �i
d + ��ip/(1-�) (6)
<=> �i* � �i
d - ��id + ��i
p
<=> � � pi
di
idi
��
��
�
�
*
(7)
holds (where �id is firm i's profit from deviating from the collusive scheme and �i
p the profits
during the infinitely long punishment phase). That means that only mild punishments (�ip <
�i*) and bounded profits from defection (�i
d < �) are sufficient for collusion to succeed if � is
close enough to 1. Moreover, stronger, swifter, or more certain punishments allow the firms
to support a more collusive equilibrium outcome.22
3.1.2.3 The Folk theorem
Using such a framework, Friedman (1971) first showed formally that any Pareto optimal
outcome - in particular, many outcomes involving joint monopoly pricing - can arise as the
subgame-perfect equilibrium path of a repeated game, provided only that there is sufficiently
little discounting (i. e. � close to 1), as there will be if the market participants can respond
rapidly to each other (so-called folk theorem). Because of this multiplicity of equilibria,
supergame theory is "too successful" in explaining tacit collusion.23 On the other hand, any
attempts to theoretically limit the number of equilibria, are, so far, based on ad hoc
assumptions. Kreps (1990, p. 529) calls this the "twin problems of too many equilibria and
the selection of one of them".
22 Hence, anything (e. g. unlimited capacities) that makes more competitive behaviour as threat feasible or
credible actually promotes collusion. Shapiro calls this the "topsy-turvy principle of tacit collusion" (1989,p. 357).
23 Tirole (1998), p. 529.
23
Hence, game theory cannot predict whether firms will indeed coordinate on a particular
collusive equilibrium. It is possible, however, to derive necessary conditions for collusion
from game theory (see below 3.2 and 3.4).
3.1.2.4 The coordination problem
As a consequence of the folk theorem, firms that want to collude face the problem that -
given a mutually acceptable collusive equilibrium exists - they have to coordinate on it.
3.1.2.4.1 Explicit vs. tacit collusion
Cartels are forbidden and, therefore, void and unenforceable under most of the competition
laws. Hence, if in the case of explicit collusion, firms establish an equilibrium as described
above, it, nevertheless, has to be sustainable. There is, thus, no difference between explicit
and tacit collusion with regard to the stages of monitoring and enforcement.
However, in the initial stage of coordination, communication (i. e. explicit collusion) would
reduce the costs of finding equilibrium. Hence, with regard to their "behavioural"
instruments (in contrast to the "structural" approach of merger control; e. g., in the EC,
especially Article 81 EC), the task of competition authorities is (at least) to force firms into a
trade-off: Communication reduces the costs of finding equilibrium, but increases the
likelihood that collusion is detected and that the firms are fined.
3.1.2.4.2 Focal points and cheap talk
With direct communication being impossible or too costly due to expected fines, firms have
to solve the coordination problem tacitly, i. e. by a trial-and-error method.
Given this highly imperfect process of selecting a particular outcome only through market
interactions, "focal points"24 can be helpful: These are outcomes, or at least behavioural
rules, which are self evident. Firms may want to try to affect the perception of particular
outcomes, or particular rules, as self-evident. Hence, focal points may be created, inter alia,
by price leadership or by cheap talk25, i. e. costless, non-binding and non-verifiable messages
which are likely to affect the listener's beliefs (e. g. a public speech in which a well-defined
price increase is announced). In the case of tacit collusion, such practices are the only
"evidence" that competition authorities might find.
24 The theory of focal points was proposed by Schelling (1960).25 See Farrell and Rabin (1996). Cheap talk is one example of so-called "facilitating practices" which will be
addressed below (3.6.1).
24
3.1.3 Punishment strategies and renegotiation-proofness
Punishment strategies that have been used as threat in collusion models include, among
others,
- reversion to the noncooperative Cournot or Bertrand outcome ("trigger" or "grim
strategy" or "Nash forever" respectively),
- a phase of expanded outputs which optimally punishes the defector and a progressive
reversion to the low output level ("stick-and-carrot") (Abreu et al. (1986)),
- an output level which minimizes the profit of the firm that has deviated, given the
anticipated best reply of this deviator to the strategy of the punishing firm (minimax
strategy).
However, the minimax strategy lacks credibility because it is not in the best interest of the
punishing firm to use it and, therefore, no mutual best reply. Thus, this strategy infringes the
concept of subgame-perfection which demands that equilibrium strategies should be mutual
best replies not only for the whole game, but also in particular contingencies, which
correspond to particular truncations of the game.
Moreover, if the pre-specified punishment hurts the "innocent" firms as well as the defector,
firms would have an incentive not to implement it, but to renegotiate in order to achieve an
equilibrium in which all firms are better off. The expectation of renegotiation undermines the
strength of the punishment. This suggests that standard subgame-perfection is not generally
the binding constraint on collusion, but instead the more restricting concept of renegotiation
proofness (see Farrell and Maskin (1987) and below 3.4.1.2). The effect of renegotiation on
the credibility of punishment strategies depends on the cost of renegotiation: The higher the
cost, the less the credibility problem.26
3.2 Merger implications
So far, the theory of repeated games suggests that there are four necessary criteria for
collusion:
1. repeated interaction,
26 With respect to renegotiation, the same statement holds as for "negotiation" (i. e. the initial coordination on
an equilibrium): It does not necessarily imply that the firms actually get together and communicate, but thepossibility to communicate might make it easier. This also implies that the standard policy suggestion thatcompetition authorities should raise the cost of communication between firms is only partially correct withrespect to negotiation. Raising the cost of renegotiation, in contrast, makes collusion easier to sustain (see
25
2. the capacity to reach a mutually acceptable equilibrium (coordination),
3. the possibility of detection of cheating (monitoring),
4. enforceability of compliance (enforcement), i. e. firms find it rational to comply with the
collusive scheme since the profit from collusion is higher than the sum of the profit from
deviating and the profit during the punishment phase (see equation (6)).
3.2.1 Collusive effects of a merger
There are three main mechanisms by which mergers can directly change each of the above
conditions 2-4 such that the the likelihood of coordinated effects is increased:
1. By definition and most obviously, a merger reduces the number of firms in the market
(see below 3.2.1.1).
2. A merger can lead to a more symmetric distribution of assets (3.2.1.2).
3. A merger might decrease the incentives of a maverick firm to compete, or, more
obviously, might lead to the loss of a maverick firm (3.2.1.3).
Furthermore, a "concentration"27 notified by oligopolists which falls short of a full merger,
but is still captured by merger control (i. e. in particular a joint venture) creates a structural
link and, thus, an element of joint welfare maximization. Existing structural links are
analysed below (3.6.2) as factor which facilitates collusion. The statements made there also
hold with regard to the creation of such a link.
3.2.1.1 Reduction of number of firms
The reduction of the number of firms in the market facilitates coordination on a collusive
equilibrium as well as monitoring and enforcement of this equilibrium:
3.2.1.1.1 Coordination and monitoring - the "dinner party story"28
In the case of explicit collusion, costs due to communication increase with the number of
firms. In the case of tacit collusion, coordination on a specific equilibrium becomes more
McCutcheon (1997)). Hence, the first-best solution for competition authorities would be to distinguishbetween negotiation and renegotiation.
27 See § 37 GWB and Article 1 Merger Regulation.28 Baker (2002, p. 139) calls this reasoning the "dinner party story" since fewer firms make coordination more
likely or more effective for the same reason that "friends arranging a restaurant get-together likely will findit easier to coordinate the calendars of four people than five and more likely will notice if one personaccepts but does not show up".
26
difficult as the number of firms increases due to higher learning costs.29 In both cases, with
more firms, the probability of differing costs and other characteristics, i. e. asymmetry, and,
hence, of more divergent preferences increases.
With respect to monitoring, the argument is similar: The more firms there are in the market,
the harder it will be to determine the identity of the deviator once it becomes clear that
cheating has occured. Punishment strategies that specifically target the deviator (e. g. the
carrot-and-stick method of Abreu) become harder to apply. Moreover, an increase in the
number of firms decreases the impact of an individual firm's action on the aggregate market
parameters. Thus, if a firm believes that its actions cannot be monitored, it will more likely
deviate from the collusive equilibrium.
3.2.1.1.2 Enforcement30
Moreover, the gains from collusion are higher the less firms there are in the market because
the individual firm receives a higher share of the collusive profit (with symmetric firms and
constant marginal costs in the case of perfect collusion: �m/n per period). The gains from
cheating are lower since the firm can capture a smaller share of the market by undercutting
the other firms relative to the situation with more smaller firms in the market (in a repeated
Bertrand oligopoly framework the additional profit from cheating is: �m(1-1/n)-�).
Together, this implies that a higher concentration of the market increases the incentive to
collude. Formally (with "Bertrand forever" as punishment and, hence, zero profit), this can
be expressed by the condition under which the fully collusive outcome is sustainable:
n
m�
��11 > �m (8)
<=> � > 1-n1 . (9)
The required discount factor is larger for larger n. In that sense, collusion is more likely with
less firms.
29 In general, the number of bilateral relations is given by
)!2(2!�N
N .
27
3.2.1.2 More symmetric distribution of assets
In general, symmetry of firms refers to similarity of their cost structures. However,
symmetry can also concern other dimensions such as market shares, number of varieties in
the product portfolio, technological knowledge, capacities and degree of vertical integration.
The most general result of most of the models addressing this issue is that asymmetries make
collusion more difficult, in particular without any facilitating practices like cheap talk.31 Like
market concentration, asymmetry feeds into the three necessary criteria of coordination,
monitoring and enforcement:
3.2.1.2.1 Coordination and monitoring
Coordination on a particular equilibrium becomes difficult when firms' costs differ
significantly since low cost firms prefer a lower price and a higher output than high cost
firms.32 Moreover, if firms' cost structures differ significantly, their incentives to cheat differ
accordingly. Hence, if any company within an oligopoly shows persistent cost advantages,
this particularly disrupts a harmony of interests and creates an incentive for aggressive
competitive behaviour.33
A similar argument can be made for monitoring: Kreps (1990) points out that firms need to
have an implicit "rule" to follow. In a situation with symmetric firms, they can check that all
firms behave similarly. This "relative" comparison is easier than an "absolute" monitoring.
3.2.1.2.2 Enforcement
Finally, firm homogeneity facilitates the enforcement of compliance. For instance
Vasconcelos (2001), using a quantity setting supergame-framework with stick and carrot
punishment schemes in the style of Abreu and firms with linearly increasing marginal costs,
shows the following:
The smallest firm in an implicit agreement, being the one which is allotted the lowest share
in the collusive aggregate output34, represents the main obstacle for collusion to be enforced
30 See Tirole (1998), pp. 247-248.31 E. g. Rothschild (1999). It should be noted, however, that the presence of one highly efficient firm (or a
small group of similar and efficient firms) along with several less efficient firms could contribute to thestability of an agreement. In that case, the low cost firm(s) could take on the role of the leader(s) with theremaining firms as followers (Ross and Baziliauskas, 2000).
32 In theory, the low cost firm could pay the high cost firm to shut down its production. However, these sidepayments are not practical (there is, inter alia, an asymmetric information problem).
33 Kantzenbach et al. (1995), p. 61.34 Since, as output increases, marginal cost rises more rapidly for a small firm than for a large firm, joint profit
maximization implies that the smaller (and, hence, the more inefficient) a member firm is, the lower its
28
because its share may be too low with regard to its optimal deviation output. If it is not too
low, then its incentive constraint is binding on the collusive path. On the other hand, if the
punishment is started, then the largest firm (i. e. the one with the highest market share) is the
one which is proportionally more penalized by the price cut. Therefore, this firm faces the
greatest incentives to deviate from the first period of the punishment strategy, making its
incentive constraint binding on the punishment path. In that sense, asymmetry makes the
enforcement of collusion more difficult.
3.2.1.2.3 A trade-off
Extending the above result by comparative statics, Vasconcelos (2001) shows that a merger
can induce two distinct effects:
1. If collusion is not feasible before the merger, then a merger might make collusion
possible afterwards. This will happen when the merger involves very small and inefficient
firms that are not able to credibly participate in a collusive scheme before the merger
takes place, because their share in the aggregate output is too low in the above sense.
2. If firms in the market are already colluding before the merger, then a merger either has no
effect on the possibility of collusion or it hurts that possibility. The latter case will happen
when the merger increases the size of the largest firm in the market, because this will
induce an increase in the minimal threshold on the discount factor above which an
industry-wide collusive agreement is sustainable.35 The intuition which underlies this
result is the same as above: The larger the largest firm, the higher will be its share on the
one period losses due to the first phase of the punishment strategy. Therefore, increasing
weight has to be attached to the future stream of payoffs in order for this firm to comply
with the punishment strategy.
Hence, there is an important trade-off: Although collusion is facilitated due to an increase in
the number of competitors, this effect can be countervailed by a more asymmetric post-
merger industry configuration. In Vasconcelos' model, the effect of market concentration is
share in the aggregate output is. Banning side payments, this implies a correspondingly smaller share in thejoint profit.
35 See equation (31) in Vasconcelos (2001, p. 24): 1k�
�� > 0, where k1 is the fraction of the - fixed (!) -
industry capital stock owned by the the largest firm. ki is a parameter of the cost function which is Ci(qi, ki)
= cqi+i
i
kq2
2
, i. e. asymmetry is dealt with by assuming that firms have a different share of industry capital
which affects marginal costs.
29
more than compensated by post-merger asymmetry if firms have already been colluding
before the merger.
3.2.1.2.4 The case of capacity constraints - the model of Compte, Jenny and Rey
Using a similar method as Vasconcelos, but a Bertrand supergame, Compte, Jenny and Rey
(2002), instead of asymmetric capital share affecting marginal cost, assume asymmetric
capacity constraints. ki denotes firm i's limited capacity with k1...kn. M is the market size.
K-i � ��ij jk is the total capacity of firm i's rivals.
3.2.1.2.4.1 The results of the model
The first important result relates to mergers involving the largest firm such that capacity is
transferred from a small firm to the largest. The following table shows the effect of a
decrease in the "small"36 firm's capacity ki, of an increase in the large firm's capacity kn and -
as their sum - the overall impact of the transfer ki kn on collusion, i. e. either an increase
(+) in the lowest discount factor �(k) for which collusion is sustainable, no change of the
factor (=) or a decrease (-):
Table 3.1 - Impact of changes in capacity
case 1
K-n < M
kn < M
case 2
K-n < M
kn > M
case 3
K-n > M
kn < M
case 4
K-n > M
kn > M
ki � + + - - / =
kn � + = + =
ki kn + + = - / =
Source: Compte / Jenny / Rey (2002), p. 14
In the cases 1 and 2, when small firms cannot serve the entire market, transferring capacity
from a small firm to the largest one decreases the scope for collusion (� increases) because
the transfer reduces small firms' punishment ability. If additionally kn<M (case 1), such a
transfer increases the large firm's incentive to deviate. In contrast, if small firms can cover
the whole market (cases 3 and 4), such a transfer is either neutral or it facilitates collusion.
30
The result of cases 1 and 2 is very similar to that of Vasconcelos: Although the merger leads
to higher concentration, increased asymmetry decreases the scope for collusion.
Based on this result, Compte et. al. (2002, pp. 14-16) derive their second important result,
the distribution of capacity that most facilitates collusion: To facilitate collusion, first, the
retaliation possibilities of the smallest firms should be increased (up to M if possible).
Second, among the distributions which maximize punishment possibilites, the gains from
deviating should be minimized. If total capacity K<1�n
n M, i. e. the smallest (n-1) firms
cannot cover the market, the main problem is the deviation concern, i. e. the largest firm's
incentive to deviate. Starting from any asymmetric situation, transferring capacity from the
largest firm to a small one both enhances the small firm's retaliation power and limits the
large firm's incentive to deviate. Hence, the distribution of capacities that most facilitates
collusion in this case is the symmetric.37
3.2.1.2.4.2 Application to Nestlé / Perrier
In the light of these results, Compte et al. evaluate the Commission's decision in
Nestlé/Perrier, a merger on the French bottled water market which the Commission used to
introduce the concept of oligopolistic dominance into EC competition law (see below 5.1.1).
Before the merger, Nestlé had a market share of 17.1 % in terms of sold water, Perrier 35.9
% and BSN 23 %. The merger was cleared only after Nestlé accepted to sell Volvic, a major
still mineral source of Perrier, to BSN. Moreover, Nestlé commited itself to sell various
brands and some capacity to a third party so that this third party could become an active
player in the market.38
Estimating the ratios of capacity over market size for the four different scenarios (1.) pre-
merger, (2.) after the merger with the resale of Volvic to BSN, (3.) without the resale of
Volvic and (4.) with the resale and the divestiture to create a new third player, Compte et al.
(pp. 20-21) compute the minimum discount factor � that allows a collusive equilibrium in
each of the scenarios with the following result: �2<�1<�4<�3. That means, contradicting the
Commission's opinion, the scenario that minimises the scope for collusion is the solution in
36 "Small" in this context just means "not the largest".37 Compte et. al. first derive this result for "collusive �-equilibria", i. e. equilibria, where firms follow the
same strategy and maintain constant market shares �i with 0��i�ki (2002, p. 5). However, the above resultstill holds for general collusive equilibria (2002, p. 15).
31
which Nestlé and Perrier merge, but do not transfer Volvic to BSN. Hence, according to the
model, it would have been best to clear the merger without conditions or, as second best
solution, to block it completely.
3.2.1.2.5 Policy implications
Both the results of Vasconcelos and Compte et al. have several policy implications: First, the
instruments used to assess unilateral effects and single dominance respectively do not reflect
the possible adverse effects of increased asymmetry on collusion. As both Vasconcelos and
Compte et. al. hint at, the HHI even punishes asymmetry (see above 2.1.5). Second, in
addition to the common wisdom that asymmetry hurts collusion, competition authorities
have to take into account which firms (in particular the largest and the smallest) are involved
in a merger. Third, if asymmetry decreases the likelihood of collusion in the above sense, in
theory, this effect might outweigh unilateral effects due to a merger with the consequence
that a single dominant position should be tolerated. Fourth, the models at least cast doubt on
the standard remedy of divesting capacity of the merged firm and transferring it to
competitors.39
However, it has to be kept in mind that models which concentrate on the effects of symmetry
necessarily abstract from other factors which might be prevailing.
3.2.1.3 Loss of a maverick or reducing its incentive to compete
The concept of a maverick appears in the U.S. Merger Guidelines, where a maverick firm is
described as one with "a greater economic incentive to deviate from the terms of
coordination than do most of [its] rivals" (Section 2.12). As an example, the Guidelines
describe a firm that has an "unusually disruptive and competitive" influence in the market.
Mavericks can be seen as an extreme case of dissimilarity of firms in which one firm is so
different from the other firms that it is unwilling to accept the terms of coordination. Hence,
aside from increasing concentration and making firms more symmetric, the loss of a
maverick or relaxing its constraint on collusion can be a third consequence of a merger that
increases the likelihood of coordinated effects.
38 After the decision, the Commission was criticized for having "constructed" a market structure. Especially
from a Hayekian perspective, this seems questionable since a market structure 'designed on the drawingboard' is based on less information than a structure which evolves evolutionary in a selection process.
39 See Motta, Polo and Vasconcelos (2002), pp. 8-10; aside from increasing symmetry, the divestiture of assetsto strenghten an existing competitor might also allow for multimarket contacts which also increase the riskof collusion (see below 3.5.7).
32
3.2.1.3.1 Identifying a maverick
According to Baker (2002, pp. 173-177), mavericks can be identified in three ways:
1. The first way is to observe that the firm actually constrains industry pricing, i. e. by
revealed preference.
2. Some factors likely affecting the market price preferred by the maverick are firm specific.
For example, a firm's marginal costs may rise or fall for reasons related to the nature or
location of its production processes, and in consequence may not be paralleled by cost
changes affecting its rivals. If that firm is a maverick, the market price will change due to
the "natural experiment" because the maverick constrains collusion. If another firm is the
maverick, the market price will remain unchanged.
3. The third approach relies on a priori factors, i. e. the reasons for a firm's preference for a
high or low price in the particular market under investigation. The U.S. Merger
Guidelines provide for two examples of a priori factors tending to identify a likely
maverick. First,"in a market where capacity constraints are significant for many competitors, a firm is more
likely to be a maverick the greater is its excess or divertible capacity in relation to its sales or its
total capacity, and the lower are its direct and opportunity costs of expanding sales in the relevant
market. This is so because a firm's incentive to deviate from price-elevating and output-limiting
terms of coordination is greater the more the firm is able profitably to expand its output as a
proportion of the sales it would obtain if it adhered to the terms of coordination and the smaller
is the base of sales on which it enjoys elevated profits prior to the price cutting deviation."
(Section 2.12)
Second,"[a] firm also may be a maverick if it has an unusual ability secretly to expand its sales in relation
to the sales it would obtain if it adhered to the terms of coordination,"
as might arise"from opportunities to expand captive production for a downstream affiliate." (Section 2.12)
3.2.1.3.2 Merger scenarios
The first scenario,40 the acquisition of a maverick, is likely to remove the maverick's
constraint on collusion since, absent cognizable efficiencies from the transaction, the
merged firm most likely would prefer higher prices than the maverick on his own.41 Second,
vice versa, a merger might create a maverick if the merger confers such large efficiencies on
40 For a complete overview on and discussion of several scenarios see Baker (2002), pp. 177-188.41 See Baker (2002), pp. 177-179.
33
the merging parties as to lead them to prefer a much lower price than either did before the
transaction. This scenario was assumed by a U.S. court in the case Heinz/Beech-Nut (see
below 6.5.2) and is recognized in general by the U.S. Merger Guidelines which state"In a coordinated interaction context ..., marginal cost reductions may make coordination less
likely or effective by enhancing the incentive of a maverick to lower price or by creating a new
maverick firm." (Section 4)
A third scenario might be a merger which does not involve the maverick, but instead affects
the maverick's incentives to compete. An example is provided for by the OECD (1999):
Consider a market where the smallest of four leading firms is a maverick. If any of the other
three leading firms merge, the increased size of its rivals might convert the maverick into a
cooperative partner. However, at the same time, such a merger might plausibly increase
asymmetry in the leading firms' market shares. Hence, there might be a trade-off between
increasing asymmetry making collusion more difficult and reducing the maverick's incentive
to compete, thus facilitating collusion.
As this example highlights, making an oligopolistic group of firms more symmetric is not in
itself a sufficient indication of a net increase of the likelihood of coordinated effects.
3.2.2 Comparative institutional analysis42
So far, it has been shown that a merger in an oligopolistic market can increase the likelihood
of collusion by increasing concentration, by making oligopolists more symmetric, and by
reducing competition by a maverick. Hence, merger control can indeed be used to prevent
collusion or at least to reduce the risk of collusion. However, what yet is to be shown is that
merger control is the optimal instrument to fight collusion.
3.2.2.1 Merger control and the prohibition of collusion as (imperfect) substitutes
When trying to define the optimal policy against coordinated effects, the alternative ex post
instruments provided for by competition law have to be taken into account: The closest
substitute for merger control is the prohibition of horizontal restrictions of competition (i. e.
both explicit and tacit collusion) provided for in § 1 GWB, Article 81 EC and Section 1 of
the Sherman Act.43 However, as, inter alia, merger control can only prevent external growth
42 See OECD (1999), pp. 31-34 for an overview on the different instruments to fight collusion; see Stroux
(2001) for an overview on the EC instruments.43 § 1 GWB and Article 81 EC prohibit (legally binding and non-binding) "agreements" as well as "concerted
practices", Section 1 Sherman Act equivalently prohibits "contract[s], combination[s] ... or conspirac[ies]".Another substitute, the prohibition of the abuse of a collective dominant position, i. e. inter alia anti-
34
of firms, markets might become more concentrated and, hence, more conducive to
coordination due to internal growth. Thus, merger control and ex post instruments against
collusion are only imperfect substitutes.
3.2.2.2 Comparative cost-benefit-analysis
Given the substitutability of merger policy and the prohibition of collusion, an optimal
policy against coordinated effects would require a comparative cost-benefit-analysis of these
instruments. Generally, from a welfare perspective, a policy instrument should be applied,
first, if the expected utility of its use is higher than the expected costs (i. e. a positive net
utility) and, second, if there is no alternative with a higher positive net utility.
Applying the first condition to merger control, a merger should be blocked on grounds of
coordinated effects if the expected net utility of blocking the merger (i. e. expected utility
minus expected loss) is higher than the expected net utility of allowing it. The first is
associated with the cost of type I errors (false positives), the second with the cost of type II
errors (false negatives).
Comparing merger control with ex post instruments (second condition), the distinction
between ex ante and ex post regulation may not be essential here: Both the evaluation of
whether collusion has taken place and the evaluation of whether it might take place as a
consequence of a merger will be uncertain because there will be a margin of error in any
evaluation.44 Hence, the risk of type I and type II errors has to be taken into account not only
for merger control, but also for the prohibition of collusion.
With respect to the cost of errors, two statements are possible: First, from the point of view
of Schumpeterian competition, in merger control, type I errors might be more costly than
type II errors because of the indirect negative effect that type I errors will have on
investment and profit incentives: Firms do not invest in gaining a high market share if they
expect to be "punished" for that by "wrong" merger control decisions.
Second, generally, reducing the margin of error for ex post regulation may be easier than for
ex ante regulation since the marginal cost of reducing uncertainty will be typically lower ex
post because (more) evidence is available. However, this holds only for express collusion
since competition authorities face great problems proofing tacit collusion:45 In contrast to
competitive or exploitative abuse of a group of firms (§§ 19, 20 GWB, Article 82 EC) has a narrower scopesince it requires the use of market power against other firms (not consumers).
44 Neven (2000), p. 8.45 See e. g. the U.S. contribution to the OECD (1999), pp. 201-202.
35
"perceptible" mergers, there is a significant probability that tacit collusion is not detected at
all. Moreover, if it is detected, the legal standard of evidence might not be met since the only
evidence might be facilitating practices like cheap talk.
This justifies why many jurisdictions (see OECD 1999) use merger control as preventive
instrument. Hence, a preliminary cost analysis suggests at least that, merger control is an
appropriate instrument to fight tacit collusion.
3.3 Other approaches to collusion
So far, basic theory of repeated games was used to explain the mechanism leading to
collusion and the effects of a merger on the likelihood of collusion. However, some
objections are put forward against traditional game theory as an explanation for collusion,
among others:
1. the absence of change of the competitive environment,
2. the counterintuitive outcome of finitely repeated games (chain-store-paradox, see above
3.1.1) and
3. the vast multiplicity of equilibria (Folk theorem) and the difficulty of selecting among
them (above 3.1.2.3).
Especially the second point has been a major criticism since, in an experimental study,
Axelrod (1980, 1981) showed that in long, but finitely repeated prisoner's dilemma
situations, cooperation does emerge, even among very sophisticated players.
Hence, before a normative framework for assessing coordinated effects can be developed on
the basis of game theory (see 3.4), it has to be checked whether refinements of repeated
games, in particular truly dynamic models (3.3.1), can cope with the above shortcomings.46
Alternatively, if another approach outside traditional game theory - especially evolutionary
game theory (3.3.2) - does not feature such shortcomings, traditional game theory might
have to be replaced as theory which explains collusion.
3.3.1 Truly dynamic models47
Repeated games which have been presented above (3.1) are limited in that history has no
effect on prospective competition since the subgame beginning at any date is identical to the
original game. However, in reality, strategic (in the sense of sunk) investments alter the
46 See Shapiro (1989), p. 360.47 See Shapiro (1989), pp. 397-408; Fudenberg and Tirole (1986).
36
subsequent competitive environment. This was first formalized in two-stage models in which
a Nash equilibrium emerges in the second period, given a strategic first-period action.48
Truly dynamic models of oligopoly combine the repeated rivalry aspects of supergames with
the investment and commitment aspects of two-period models.49 There are two types of
industry conditions that may be strategically controlled: tangible (3.3.1.1) and intangible
(3.3.1.2).
3.3.1.1 Tangible industry conditions50
Tangible state variables51 which are strategically chosen can be, e. g., firms' capital stocks,
technological capabilities or capacities. Examining such capacity decisions in a duopoly,
Benoit and Krishna (1987) stress their result that firms build excess capacity in order to
better discipline their subsequent pricing behaviour (firm 1 must build some excess capacity
if it is to be in a position to punish firm 2 for expanding its capacity). In this sense, it is
possible, but costly for firms to sustain outcomes which are more collusive than the one-
stage Nash equilibrium.
3.3.1.2 Intangible industry conditions (beliefs)
In reality, history matters not only through its direct effect on tangible variables, but also
indirectly through the information which it brings to competitors who use it to estimate
variables that they do not know, e. g. its rivals' cost structures, demand expectations or
degree of rationality. Hence, history also matters through intangible variables (beliefs). In
particular, in a repeated game with asymmetric information, a firm can sacrifice short-run
profit by raising its price in order to signal that it prefers high prices, i. e. cooperative
behaviour, if it values future returns relatively high.52 This signal may be credible because it
is costly. Using such a reputation game and assuming a small probability of "craziness" (i. e.
a preference for cooperation), Kreps et al. (1982) show that even in a finite repetition of a
48 The Stackelberg model (1934) can be regarded as "ancestor" of two-stage models.49 Aside from endogenous changes in the conditions of competition due to strategic maneuvering by the
oligopolists, the source of industry dynamics can also be quite independently of firm behaviour, e. g. in thecase of exogenous technological progress.
50 See Shapiro (1989), pp. 398-405.51 In order to focus on the strategic aspects of competition, i. e. on the changing economic environment, the
tactical short-run decisions are folded into the background. Reduced-form profit functions indicate thefirms' profits as functions of the "state variables" which affect the ensuing subgame and measure theeconomic conditions at any point in time (e. g. the firms' capital stocks).
52 Tirole (1998), p. 257.
37
prisoner's dilemma, collusion is sustainable.53 However, still a Folk theorem holds, i. e. any
outcome can be sustained as an equilibrium of a sufficiently long and little discounted game
with incomplete information.54
Hence, refinements of traditional game theory can cope with criticism 1 and 2, but not with
point 3 (see above 3.3).
3.3.2 Evolutionary game theory
Whereas the approach of Kreps et al. (1982) of assuming a small probability of craziness
remains within the boundaries of traditional game theory,55 evolutionary game theory which
is derived from biology56 assumes, first, bounded rationality of the players.57 It understands
an equilibrium as the outcome of adaption (or learning) and selection rather than as the result
of calculating best replies by rational agents. Hence, "players need to know only what was
successful, not why it was successful" (Mailath, 1998, p. 1355).
Aside from the difference in assumed rationality, second, the evolutionary approach does not
focus on individuals, but on the population distribution of behaviours (decision rules,
strategies). Strategies that provide good replies to the current population will be imitated and
played by a larger fraction in the next round. A particular type of player is evolutionary
stable if its population cannot be invaded successfully by any mutant (i. e. a competing
society). A strategy played by an evolutionary stable type is called an evolutionary-stable-
strategy (ESS).
In contrast to traditional game theory, third, evolutionary game theory specifies single
outcomes and, fourth, allows to model the coordination process between the oligopolists
which traditional theory of repeated games takes as given.58
53 According to Tirole (1998, p. 259), the intuition for this result is the following: By cooperating, each player
exposes himself to the risk that the other player does not cooperate, and that he obtains a low profit duringone period. However, by non cooperating, he reveals that he is not of a cooperative type and, therefore,loses future gains from cooperation if the other player is of a cooperative type. If the horizon is longenough, the loss of future cooperation exceeds the loss from being cheated on.
54 Fudenberg and Maskin (1986).55 In reputation games, generally, perfect rationality is assumed, but under incomplete information there might
be a small but positive probability that a player makes a mistake, e. g. fails to identify the optimal strategy.56 In nature, the basic selection mechanism is biological survival and reproduction, and the mutation process
is basically genetic. In the market place, the basic selection mechanism is economic survival, and themutation process is experimentation, innovation and mistakes (Weibull, 1998, p. 3).
57 Tirole (1998), p. 261. For a formal description of evolutionary game theory see Weibull (1995).58 More precisely, evolutionary game theory uses two sets of solution concepts: the above ESS and a set of
dynamic concepts which examine the stability of the evolutionary process. Whereas the evolutionarystability criterion does not explain how a population arrives at a strategy, but instead asks whether, oncereached, a strategy is robust, the second set allows to explicitly model a selection process (so-calledreplicator dynamics).
38
However, so far, there is no general oligopoly theory based on evolutionary game theory
which allows to derive a detailed explanation of tacit collusion.59
3.3.2.1 Tit for tat as evolutionary-stable-strategy
Based on experiments, Axelrod (1984) suggests that in the repeated prisoner's dilemma, the
tit-for-tat strategy of beginning with cooperation and then matching one's rival's previous
move tends to be evolutionary-stable.
Tit for tat combines the following properties: "It is nice, forgiving, and retaliatory. It is never
the first to defect; it forgives an isolated defection after a single response; but it is always
incited by a defection no matter how good the interaction has been so far".60 Hence, tit for tat
allows for a mix of cooperation and punishment. In contrast, the "always cheat" rule forbids
gains from cooperation with cooperative types, while the "always cheat after a deviation"
rule (grim strategy) is not forgiving enough in case of a mistake. Another advantage of the
tit-for-tat stragey is that, in an evolutionary context, it allows the survival of other
cooperative strategies such as "always cooperate" (i. e. the cartel outcome).61
3.3.2.2 Implications for merger policy
Because of its shortcomings, Amstutz (1999)62 suggests that merger policy against
coordinated effects cannot be based on new industrial economics which rests upon
traditional game theory. Instead, the concept of collective dominance should not be applied
by the EC Commission until evolutionary game theory has developed a general oligopoly
theory which allows to draw robust policy conclusions.
However, experimental studies confirm the insights of the theory of repeated games that,
first, a higher number of suppliers leads to more competition and less cooperation and that,
second, cooperation increases the more periods the game has (Alger (1986), Holt (1995)).63
The first insight is also confirmed by empirical studies on cartels (see e. g. Marquez (1992),
Dick (1997)). Hence, game theory has not been falsified. Moreover, imperfect information
and unstable market conditions (the starting point of evolutionary economics) can be
integrated into the framework of repeated games (see below 3.5.4).
59 Amstutz (1999), Kollektive Marktbeherrschung im europäischen Wettbewerbsrecht – Eine evolutorische
Perspektive, p. 47.60 Axelrod (1984), p. 46.61 Tirole (1998), p. 261.62 Amstutz (1999), pp. 49-51.63 This argument against Amstutz' conclusion stems from Haucap (2000), p. 4.
39
What remains as criticism against the theory of repeated games, is that it cannot predict that
firms will collude (point 3 above). Hence, it has to be regarded as exemplifying theory. An
exemplifying theory does not tell what must happen, but what can happen.64 Most
importantly for merger policy, it does not only allow to derive necessary conditions for
collusion, but it can also explain with theoretical rigour how certain market characteristics
might support these conditions as will be pointed out in the upcoming sections. Hence, it
allows a relative prognosis of the probability of collusion.
3.4 Necessary conditions for collusion
So far, four necessary criteria for collusion have been worked out on the basis of the theory
of repeated games (see above 3.2):
1. repeated interaction,
2. the capacity to reach a mutually acceptable equilibrium (coordination),
3. the detection of cheating (monitoring) and
4. enforciability of compliance (enforcement).
Two additional criteria should be added:
5. few firms and
6. barriers to entry/exit and expansion.
It has already been outlined that a low number of firms feeds into the conditions 2-4 (see
above 3.2.1). Consequently, there is an intersection of condition 5 with these conditions. The
same holds for condition 6 (see below 3.4.2). Despite these intersections, conditions 5 and 6
should be included in the list of necessary criteria to highlight their importance.65 Both
conditions are going to be addressed in more detail now.
3.4.1 "Few" firms - is there a "magic" number?
Basic supergame models suggest that even with many firms monopoly pricing is possible.
For example, in repeated n-firm Bertrand oligopoly with constant marginal costs, shared
monopoly is sustainable in subgame-perfect equilibrium provided that the per-period
discount factor � is at least 1-n1 (see equation (9)). With �=0.99, representing a plausible
interest rate if the detection and response lag is a month, 100 firms can sustain the monopoly
64 See Fisher (1989), p. 117.65 The importance of the conditions of few firms and barriers to entry and expansion is also emphasized in the
OECD roundtable report (1999, pp. 21-23).
40
price. As Shapiro (1989, pp. 365-366) calculates, a symmetric Cournot industry can sustain a
shared monopoly with up to 400 firms if punishment consists of Cournot reversion.
In practice, however, there is a consensus that coordinated effects are likely only in much
more concentrated markets. Two answers from theory shall be presented.
3.4.1.1 Selten's "four are few and six are many"
In Selten's model (1973), firms can either be cartel members or fringe competitors. The
competitive fringe competes in a Cournot fashion, while those in the cartel collude. In this
situation, there must be both internal and external stability for the cartel to work. Internal
stability requires that, given the number of firms in the cartel and the number of firms in the
fringe, the cartel members are better off in the cartel than in the fringe. External stability
symmetrically requires that members of the fringe must be better off outside the cartel than
in it.
Using linear demand and cost functions and assuming perfect and complete information,
Selten shows that with four firms or less a complete cartel will always be formed.66
However, as the number of firms rises, joining the fringe becomes relatively more attractive.
This is because the members of the cartel behave as one player and the output of the cartel
does not depend on the number of firms in it. Thus, the higher the number of firms in the
cartel the lower the profit of each participant and the greater the attraction of competing on
the fringe. As Phlips (1995) points out, this is a very different point from the one which
states that more competitors make it harder to enforce the agreement. In the Selten model,
there is no cheating since the cartels are Nash equilibria. Hence, it would be misleading to
regard the model as noncooperative theory of cartels.67
In Selten's equilibrium a partial cartel will exist with some firms in the cartel and others
outside. Specifically, within the framework used by Selten, there will be four cartel members
with five or six symmetric firms in the industry, five members with seven or eight symmetric
firms and six members with nine or ten symmetric firms. Finally, Selten calculates the
probability that a firm takes part in a partial or complete cartel. Due to symmetry this
probability is the same for all firms. Using the derived probabilities, Selten is able to derive
the probability of a complete or partial cartel actually being formed. For four firms or fewer
66 Selten's result that a complete cartel arises in equilibria only if there are four firms or less has also been
obtained by Martin (1993) who extends the analysis to repeated games and by Shaffer (1995) who derivesconditions under which the behaviour of the fringe and the cartel emerges endogeneously.
67 Wolfstetter (1999), p. 101.
41
the probability is 100 per cent, for five firms it is 22 per cent, but for six firms it is only 1 per
cent. This suggests that with six firms or more, even if a partial cartel is an equilibrium, the
chances of a cartel actually forming are extremely low.
This suggests that coordinated effects or collective dominance respectively with more than 5
firms in the market are highly unlikely. Hence, 6-5 mergers could be regarded as "absolute
boundary" for merger control.
3.4.1.2 Renegotiation-proofness as binding constraint
Elaborating the the theory of "weak renegotiation-proofness" in repeated games of Farrell
and Maskin (1989), Farrell (2001) defines "quasi-symmetrically weakly renegotiation-
proofness" in the following way: A subgame-perfect equilibrium is quasi-symmetrically
weakly renegotiation-proof (QSWRP) if, evaluated at the beginning of the period after
player i alone deviates from prescribed play, every other player's continuation payoff
(weakly) exceeds what it would have been had player i not just deviated. Thus no innocent
player would want to forget and forgive.
Using this definition, Farrell (2001, pp. 11-12) shows that in repeated Bertrand competition,
full collusion is impossible in QSWRP equilibrium if n>3, even for discount factors very
close to 1. In repeated Cournot oligopoly, full collusion is not QSWRP with more than nine
firms, even for � very close to 1 (p. 17).
In particular the result for Bertrand competition seems to be very plausible. It coincides with
the practice of competition authorities which focus on 4-3 and 3-2 mergers.
3.4.2 Barriers to entry/exit and expansion
There are two related mechanisms by which barriers to entry and expansion can facilitate
collusion by preventing from hit-and-run competition (3.4.2.1) and from competitive
pressure by fringe firms (3.4.2.2).
3.4.2.1 Barriers to entry/exit: prevention of hit-and-run competition
In repeated games, the number of player is assumed to be constant. In reputation games,
some models specifically address entry with the decisions of the incumbent and the potential
entrant modelled explicitly. In both scenarios, costless entry changes the game such that
collusion becomes unprofitable since without (significant) barriers to entry and exit, there is
always the threat of "hit-and-run competition": With expected positive profits, firms will
42
enter, reap the profit and possibly retreat from the market. If they can exit the market as
easily as they entered, no threat of future losses can keep them from entering and
undercutting the incumbent firms.68 Hence, the likelihood of collusion depends on the extent
of barriers to entry (e. g. sunk costs, economies of scale and regulation) and exit.
3.4.2.2 Barriers to expansion: prevention of competitive pressure by fringe firms
Fringe players are small firms that have overcome barriers to entry and already operate in the
market. They act as price takers and follow the price of the leading oligopolistic group.69
But, as prices rise, they increase output. Hence, if cooperation in the market leads to
permanently supra-competitive prices (competitive prices in the sense of one-shot game
prices), the fringe firms have the incentive to expand their output in order to capture more of
the market. Thus, if fringe firms can expand relatively easily, they can exert a strong
competitive pressure on the coordinating firms. Or as von Weizsäcker (2001) phrases it:
Collusion is only stable if it is at the expense of the non-colluding fringe. Vice versa, if
expansion of output is easy for the fringe firms, they will gain a higher market share at the
expense of the cartel.
However, first, the same features that act as barriers to entry may also act as barriers to
expansion, thus impeding destabilisation of the coordinated behaviour. Second, even if a
fringe firm is able to expand, barriers to entry could allow the colluding firms to retaliate
successfully against the expanding firm (e. g. in the case of sunk costs) or to include the firm
into the colluding group. The latter case might arise if market conditions are such that only
one or two fringe firms reach the scale needed to effectively compete with the leading firms
making it profitable for the former fringe to join the colluding group as in Selten's "four are
few and six are many".
3.5 Market characteristics corresponding to the necessary conditions
In contrast to the necessary conditions of "few firms" and "barriers to entry and expansion"
which constitute market factors themselves, the other four conditions derived from game
theory are abstract concepts that cannot directly be established by observation. However,
there are structural market characteristics that feed into these necessary criteria. Most of
them are already part of the "checklists" that competition authorities use when assessing
68 This is the idea of the "contestable market hypothesis" formalised by Baumol, Panzar and Willig (1982).69 This price-taking behaviour can be formalised by leader-follower models along the lines of Stackelberg
(1934).
43
mergers to find out whether a market is conducive to coordination. The following table
provides for an overview of these market factors which correspond to the conditions
necessary for coordinated conduct.
Table 3.1 - Conditions for coordinated conduct in oligopolistic markets70
Necessary condition Factors contributing to the condition
Few firms
Barriers to entry/exit
Repeated interaction No large and infrequent orders
(see below 3.5.1)
Capacity to reach a mutually acceptable
equilibrium (coordination)
- Symmetry (see above 3.2.1.2)
- No maverick firm (3.2.1.3)
- Homogeneous products (3.5.2)
- Market transparency (3.5.3)
- Stable demand conditions (3.5.4)
- Low buyer power (3.5.5)
Detection of cheating (monitoring) - Symmetry (3.2.1.2)
- Homogeneous products (3.5.2)
- Market transparency (3.5.3)
- Stable demand conditions (3.5.4)
- Low buyer power (3.5.5)
Enforceability of compliance
(enforcement)
- Symmetry (3.2.1.2)
- No maverick firm (3.2.1.3)
- Stable demand conditions (low rate of
change in market size and low degree of
innovation) (3.5.4)
- Low price elasticity in the sub-market
composed of the leading firms' products
(3.5.6)
- Multi-market contact (3.5.7)
- Excess capacity (3.5.8)
70 See Europe Economics (2001), p. 29.
44
The relationships between the necessary conditions and the demand and supply factors
contributing to them will be outlined now.71
3.5.1 No large and lumpy orders
Repeated interaction is necessary both for coordination, which - in the absence of readily
identifiable focal points - can be thought of as a trial-and-error approximation or iterative
process, and for punishment (see above difference between finite and infinite games). In
practice, it seems unlikely that this criterion is not met. A market characteristic which
corresponds to it are many and frequent orders. Vice versa, large and lumpy orders would
hinder collusion.72
3.5.2 Homogeneous products
Product homogeneity mainly feeds into the necessary criteria of coordination and
monitoring:
Coordination on a particular collusive equilibrium is facilitated by product homogeneity
since it becomes easier to find, e. g., a common collusive price. Vice versa, if products are
differentiated and firms produce a large number of products, they will have difficulties
determining a complete schedule of collusive prices for these products. Moreover, product
homogeneity makes markets more transparent by reducing the parameters that need to be
observed. Hence, detection of any deviation tends to be easier.73
With respect to enforcement, the effect is ambiguous: On the one hand, product homogeneity
increases the gain from cheating by allowing the deviating firm to capture a larger share of
the market by undercutting its rivals. On the other hand, homogeneous products allow for
harsher punishment, thus reducing the incentive to cheat.74 Häckner (1996) shows for a
horizontally differentiated duopoly that the best collusive price is lower, the more
substitutable the products are, i. e. product differentiation can lead to higher prices in the
case of tacit collusion.
The degree of product homogeneity is closely linked to how broadly the market is defined:
Ceteribus paribus, the narrower the definition of a market, the greater the likelihood that
71 Except symmetry and the absence of a maverick firm which have been discussed already in detail above
(see 3.2.1.2 and 3.2.1.3).72 Formally, a more infrequent interaction corresponds to a decrease in � (see Tirole (1998), p. 248, and
Shapiro (1989), p. 378).73 See Kantzenbach et al. (1995), p. 17.74 See Ross (1992).
45
products will be regarded as homogeneous. Hence, because of the importance of product
homogeneity as a facilitating factor, the market definition must be particularly robust in
coordinated effects or collective dominance cases respectively.
3.5.3 Market transparency
Market transpareny can, inter alia, refer to the transparency of price, production, capacity,
R&D and advertisement levels. Very similarly to product homogeneity, transparency is one
of the "classic" market characteristics which makes it easier for firms to coordinate on and to
monitor a particular collusive equilibrium by making market parameters and firms' actions
more observable.
3.5.3.1 Supergames with imperfect information
Market transparency can be identified with perfect or - better - costless information. Hence,
transpareny can be seen as a combination of various other factors contributing to making the
finding of information cheaper, e. g. product homogeneity. If the market is intransparent or
information expensive respectively, then secret price cuts and detection lags can occur.
Secret price cuts have been formalized as supergames with imperfect information by Porter
(1983) and by Green and Porter (1984). The basic idea is that when one of the oligopolists
observes a low profit during period t, it is incapable of determing whether the low price is a
consequence of low demand or a price cut by its rival.75 If the observed price falls below a
certain level, a price war is triggered. After T periods, the firms return to their original
strategies, again cooperating at the optimal quantity x* (or price) until the price falls below
the trigger again.76 Porter (1983) shows that it is optimal for the firms to produce in excess of
the monopoly output in order to ease the problem of cartel enforcement (x*<xc if �<1).77
The intuition is the following: The fully collusive outcome could be sustained only if the
firms continued to collude fully even when making small profits with the argument that even
under collusion small profits can occur as a result of low demand. However, a firm that is
confident that its competitor will continue to cooperate even if its profit is low has the
75 E. g. in a quantity-setting supergame, demand uncertainty can be modelled by assuming that demand has
the form pt=�tp(X), where �t~N(1,��
2) is the realization of a random demand shock at period t and �t's areuncorrelated.
76 According to Shapiro (1989), the key contribution of repeated oligopoly games with imperfect monitoringis that they actually predict the occurence of price wars in equilibrium (with higher probability duringrecessions than in booms). In contrast, in supergames with perfect monitoring, while the credibility and sizeof punishments is critical, price wars never actually occur.
46
incentive to (secretly) undercut. Hence, full collusion is not consistent with the deterrence of
price cuts.78
The main conclusion from this class of models (Abreu, Pearce and Stacchetti (1986),
Fudenberg and Maskin (1986), Matsushima (2000)) is that imperfect information or market
intransparency generally tends to limit the extent to which firms can tacitly collude.
However, there is some ambiguity concerning this finding: Transparency also decreases
consumers' costs to search for the best deal (transaction costs). This may make consumers
switch suppliers more easily, increasing cross-price elasticity and, thus, the incentives to
cheat as well as the severity of punishment.79
3.5.3.2 Empiric evidence80
Empiric evidence for this result is provided, inter alia, by Albaek et al. (1997) who study the
impact of the 1993 decision by the Danish competition authority to publish statistics on
transaction prices for ready-mixed cement following the guidelines set out in the Danish
Competition Act which calls for transparency in competitive conditions. The authors suggest
that the impact of this move backfired since the publication of such data allowed firms to
reduce the intensity of the competition between themselves and increase their prices.
Similarly, Christie and Schultz (1994a, b) present strong evidence for tacit collusion of
brokerage firms trading in Nasdaq stocks which was facilitated by the very high
transparency in the market
3.5.4 Stable demand conditions (low rate of change in market size and low degree of
innovation)
As already Stigler (1964) noted, fluctuations in demand in a realistic imperfect information
environment are one of the major problems for firms wishing to collude. As was pointed out
previously with respect to market transparency, if the output or price of each firm is not
77 Formally, a small reduction in output below the monopoly level has no first-order effect on �*, but does
reduce the gains from deviation.78 Tirole (1998), p. 252. Contrary to Green's and Porter's finding, Rotemberg and Saloner (1986) in an
alternative model show that the gain from defection increases with demand (random variable �), i. e., tacitcollusion becomes more difficult in high-demand states. However, as Rotemberg and Saloner point outthemselves, capacity constraints are likely to be binding during periods of high demand making defectionimpossible.
79 See Møllgaard and Overgaard (2001).80 For an extensive overview on the empiric evidence on market factors which may increase the scope for
collusion see the contribution of the Antitrust Division of the U.S. Department of Justice to the OECDroundtable report (1999, p. 237).
47
observable, random demand fluctuations make it difficult for the non-cheating firms to
determine whether cheating has occured or not.81
Considering the risk of coordinated effects, market demand can be unstable especially in two
dimensions:
3.5.4.1 Market size
In markets with stagnant demand, there is no incentive among incumbent firms to compete
for an increase in demand since any gain in market share can only be achieved at the expense
of competitors, possibly ending in a damaging price war with no winners. Moreover, low
growth does not attract outsiders to enter the market. Hence, in particular mature markets
with no or only low growth are prone to collusion.
3.5.4.2 Innovation
Apart from the variability of demand due to a change in market size, the likelihood and
degree of innovation plays a significant role: Technical change means that at any one time
firms in the industry may have very different technologies and, therefore, very different cost
bases and may consequently face very different incentives to expand output at the margin,
making tacit collusion more difficult. Moreover, if the nature of the game is set to change
radically following major innovation or product development, the incentive to collude
decreases since there may be no stream of long term collusive profit to set against the higher
short term profits available from cheating.
Both arguments (market growth and innovation) come together in the case of Schumpeterian
competition: competition may not be primarily on price, but may take the form of
competition to be the first to produce the next generation of the product. If a firm expects to
reap a temporary monopoly profit, there is no necessity for collusion. Similar arguments can
be made with respect to market phase (product and/or technology life cycle): In earlier stages
of an industry's development, there are a larger number of factors on which firms could
compete, plus overall growth is quicker, making coordination more difficult.82
81 This similarity or intersection of arguments shows that market intransparency identfied with imperfect
information can be thought of as a sort of supra-characteristic that becomes relevant in situations whereinformation become relevant.
82 OECD (1999), p. 29.
48
The above arguments on the role of innovation are similar to those concerning barriers to
entry and expansion. This highlights that the absence of innovation is very important for
coordination to be sustainable.
In this context of business cycles and collusive behaviour, the model of Fershtman and Pakes
(2000) should be mentionned who find that only collusive industries generate price wars.
Hence, price wars that occured in the past can be used as additional indication that there has
been collusion in the industry.
3.5.5 Low buyer power
Buyer power is generally recognised as a countervailing force to destabilise collusion among
a small group of sellers. Powerful and concentrated buyers might be able to induce
competition among their suppliers by providing a sufficient incentive for a member of the
oligopoly to deviate from coordinated behaviour. For example, if an order from a single
buyer is important enough, each member of the oligopoly will be under strong pressure to
make a competitive offer before any other oligopolist does.83
There are two other possibilities of powerful buyers to constrain the oligopolists:84 first, (the
threat of) vertical integration upstream to counteract collusive behaviour of suppliers and,
second, (the threat of) inducing entry into the upstream market by sponsoring a new entrant
or by committing to a certain volume of purchases from the new firm.
3.5.6 Low price elasticity in the sub-market composed of the leading firms' products
Ceteribus paribus, a lower price elasticity of demand for the leading firms products'
translates into greater incentives to engage in coordination and lower incentives to cheat.85
3.5.7 Multi-market contact
It appears that the incentive to cheat is larger with multiple markets, as more can be gained if
cheating occurs simultaneously in all markets. On the other hand, punishment is also more
severe since the gains from cheating in one market can more easily be wiped out by
punishments in all markets. Hence, when deciding whether to deviate or not, firms might
fear the possibility of a general warfare.
83 See OECD (1999), p. 30.84 Ross and Baziliauskas (2000).85 Kantzenbach et al. (1995), pp. 15-16. Contrary to a low price elasticity of demand for the leading firms'
products, a low individual elasticity of demand of each of those firms means a higher degree of productdifferentiation facilitating collusion (see above 3.5.2).
49
Due to Bernheim and Whinston (1990), firms can pool the sustainability criteria over several
markets, i. e. they can transfer slack in the sustainability condition from one market to
another. It is feasible that in one market the discount factor is well above the minimum value
required for stable collusion, whereas in another market the discount factor is too low to
sustain collusion. If firms operate in both markets, collusion might be extended to both
markets.86 Additionally, multi-market contacts allow firms to obtain additional information
about their competitors which make it easier to engage in coordination.87
Evans and Kessides (1994) examined the impact of multi-market contact on domestic pricing
in the U.S. airline industry. They show that airline fares are higher in those city-pair markets
served by airlines with extensive contacts across different routes. This result is consistent
with the view that airlines are less likely to price aggressively on a route for fear of reprisals
on other routes and fits in with the above theoretical analysis.
3.5.8 Excess capacity
As already illustrated in the model of Compte et al., excess capacity has an ambiguous effect
on the sustainability of collusion depending on its distribution: If firms have excess capacity,
they can gain more from cheating. But, if their rivals have excess capacity, they can easily
punish the deviator.
In the model of Davidson and Deneckere (1990), investment in capacity is followed by tacit
collusion and an infinitely repeated pricing game. Their result indicates a positive correlation
between the effectiveness of collusion and the level of industry and excess capacity.
However, if only one firm invests into capacity, committing itself to this capacity and hence
making capacities more asymmetric, this might make collusion less likely.88
3.6 Facilitating practices and structural links
In addition to - more or less exogenous - structural market factors that facilitate collusion,
there are practices and business strategies (i. e. conduct) which firms can adopt and which
are likely to contribute to meeting the six conditions outlined previously. They can be
grouped under two headings: facilitating practices (3.6.1) and structural links (3.6.2).
86 For an example see Tirole (1998), p. 251.87 Kantzenbach et al. (1995), pp. 73-74.88 See e. g. the reasoning of the EC Commission in Pilkington-Techint/SIV, case IV/M.358, (1994) OJ
L158/24.
50
3.6.1 Facilitating practices
Facilitating practices are schemes adopted by firms, either individually or industry-wide,
which increase the probability of an implicit agreement by stimulating the contact between
them and/or by creating focal points (reaching a "meeting of the minds"), aiding the
detection of cheating, increasing the severity of punishment or decreasing the response time
for punishment. Some examples of facilitating practices can be grouped as follows:89
Main mechanism to facilitate
collusion
Facilitating practice
Helping to reach an understanding - Exchange of information90
- Cheap talk (e. g. public speeches)91
- Standardisation
Helping to detect deviations - Exchange of information
- Meeting competition clauses92
Helping to punish deviations - Resale price maintenance
- Most-favoured-customer clauses
In collusion cases, mainly the exchange of information is used as evidence. Whereas it
serves as direct evidence when using ex-post-instruments targetted at coordinated conduct,
structure-oriented merger control can use such communication - like any other evidence of
prior or current coordination - only as indication that market conditions are currently
favourable to collusion (see below 3.7).
3.6.2 Structural links
In contrast to facilitating practices, structural links can be identified more easily and used as
indication for coordination in merger control. In particular, in EC competition law, there has
89 See Europe Economics (2001), p. 41; for a more extensive overview on facilitating practices and detailed
explanations of their effects see OECD (1999), pp. 237-242.90 The degree of exchange of information and the evidence on this exchange determines whether the
coordinated conduct is legally qualified as explicit or tacit collusion.91 See above 3.2.92 In a contract between a buyer and a seller, a meeting competition clause (MCC) ensure the buyer that he
will not be paying a price above that asked by other competing sellers. This converts buyers into monitorsof coordinated interaction (OECD (1999), p. 28). Moreover, MCCs lower the incentive of firms to undercuttheir prices as they know that their prices as they know that their rivals are contractually obliged to lowertheir own prices (see Salop (1986)).
51
been a discussion whether structural links between oligopolists are a necessary condition for
joint dominance from the legal point of view (see below 5.1.3 and 5.2.2.6).
On a scale reflecting cooperation, structural links are located between facilitating practices
and a merger: Contrary to facilitating practices, they are formal agreements which lead firms
to cooperate in some field of their activity such that the objective function of each partnering
firm will partly reflect the welfare of its partners, while at the same time falling short of a
merger (see above 3.2). Examples are partial cross shareholding, inter-locking directorships,
cooperative R&D agreements, joint ventures and shared ownership of suppliers or
distribution channels.
By reducing the number of independent decision makers and introducing an element of joint
profit maximisation, structural links create a greater similarity of interest. In addition to the
shift of behaviour towards joint-profit-maximisation, structural links make firms more
transparent to rivals and allow them to come into closer contact to each other.
However, with respect to incentives, particularly cross ownership provides for a trade-off:
On the one hand, it reduces the gain from cheating since some of the gains accrue to rivals.
On the other hand, it softens the punishment since some of the penalty is borne by rivals.
Overall, in particular when emphasising the importance of mutual learning and common
industry "culture", structural links facilitate collusion. However, they are not a necessary
condition for collusion. Hence, in turn, the condition that structural links between
oligopolists have to be cut, which is a typical remedy in coordinated effects cases, is not
sufficient to eliminate the risk of collusion.
3.7 Evidence of current coordination
Evidence of prior or current coordinated conduct is used by all competition authorities in
merger control (particularly by the U.S. authorities, see below 6.4.3). However, as alluded
above (3.6.1), this has to be done with caution: Competition authorities have to assess how
the merger changes the game, i. e. to estimate the risk of future coordinated conduct on the
basis of the future market structure. Evidence of prior or current collusion only allows for the
conclusion of future coordination if the merger leaves the likelihood of coordinated effects
unchanged or even increases it. However, it has to be kept in mind that a merger (though
increasing concentration) might decrease the likelihood of coordination (for example if it
creates a maverick), i. e. it might change the game such that current coordination will be
brought to an end.
52
In most cases, where evidence on collusion is available, such evidence will consist of
communication between the colluding firms. Even without taking into account that a merger
changes the game, it might be wrong to conclude from such past explicit collusion that there
is a risk of future tacit collusion:
When deciding whether to collude, firms take into account the gains from collusion (see
equation (6)). These gains are determined to some extent by the costs of reaching a (tacit)
agreement. These costs, in turn, depend on the trade-off that a firm faces when deciding
whether to use express communication (explicit collusion) or not (tacit collusion): By using
communication, the costs of finding a common equilibrium are reduced, but at the same time
the risk of being detected and fined should be increased (see above 3.1.2.4.1). Depending on
the solution of the trade-off, four outcomes are possible: First, there is no collusion at all
because both explicit and tacit collusion are prohibitively costly. Second, only explicit
collusion fulfills the condition for collusion (equation (6)). Third, only tacit collusion is
sustainable (for instance because of a high detection probability concerning explicit
collusion due to very efficient monitoring by the antitrust authority in combination with high
fines). Fourth, either explicit or tacit collusion constitutes the optimal solution of the trade-
off, but in both cases, collusion is sustainable.
Hence, in the second case, where finding an equilibrium by "meeting of the minds" is
prohibitively costly, it would be wrong to draw a conclusion from explicit collusion to the
risk of tacit coordination.
Despite these restrictions, prior collusion can be seen as a natural experiment which helps to
find out how the industry works and in particular whether entry is easy:93 If there has been
collusion and no firm entered despite prise increases, one can conclude that there are (still)
considerable barriers to entry in the industry (if technology has not changed).
3.8 Relative importance of the market characteristics
Economic models draw conclusions about a subset of factors by keeping all others constant.
Therefore, no conclusion about the relative importance of several factors can be drawn from
one model. Also, in practice, it seems to be generally accepted that it is very difficult, if not
impossible, to give a clear ranking of the above market characteristics.94
93 See an interview with Michael Katz, the DoJ's chief antitrust economist, American Bar Association Section
of Antitrust Law "Brown Bag Program", 5 December 2001 (available at<http://www.antitrustsource.com>), pp. 16-17.
94 E. g. Shapiro (1995) and OECD (1999) round-table report on oligopoly, Section 3: "none of the factorsconsidered individually can conclusively establish a high probability of coordinated interaction".
53
Nevertheless, the two market characteristics which at the same time constitute necessary
conditions for collusion in the above framework - few firms (and, consequently, high
concentration) and barriers to entry and expansion - could be used to construct safe
harbours.95 Both the German Checklist and the U.S. Merger Guidelines point into this
direction by attributing a central role to concentration and entry barriers (see below 4.2.4.5
and 6.4.4).
From economic theory, one cannot conclude that a stable demand is a necessary condition
like concentration and entry barriers. However, if the market is characterised by high growth,
high volatility and uncertainty, firms' ability to coordinate on, monitor and enforce a
collusive equilibrium is severely impeded. Hence, at least, stable demand should be singled
out as very important factor.
Furthermore, as important should be regarded a certain degree of product homogeneity
(although already "included" in the market definition) and of market transparency. The same
holds for the absence of mavericks, a strong fringe and sophisticated large buyers.
3.9 Policy implications
Given the relative importance of the above factors, some rules for the assessment of
coordinated effects or collective dominance cases respectively can be established:
1. If there are more than five leading firms in the market or if there are no (significant)
barriers to entry, competition authorities should not start to investigate a merger on
grounds of coordinated effects.
2. Otherwise, an investigation should be carried out. It should include demand conditions,
product homogeneity, market transparency, mavericks, the fringe and the buyers. If
demand conditions turn out to be unstable, the merger should be cleared, unless the other
market factors do not point into the other direction.
3. If these important market factors - as will typically be the case - do not point into one
direction, the competition authority should further examine the other less important
factors mentioned above. Particularly, in these complex cases, the assessment should
contain an analysis of the interaction of the market factors which should be based on a
sound understanding of the respective industry.
Despite these substantive guidelines, there remains much discretion for competition
authorities. This suggests two additional procedural safeguards:
95 OECD (1999), p. 21.
54
4. There should be clear guidelines on the assessment of coordinated effects in merger
control. These will - although issued by competition authorities themselves and although
possibly not legally binding - increase transparency and, hence, constitute a (self-)binding
of the competition authority.
5. Especially in merger cases, judicial review by courts should be as swift as possible in
order to constrain the bargaining position of the competition authority.
Whether and to what extent the German, EC and U.S. merger control regimes correspond to
the above normative framework, will be explored in the following sections 4, 5 and 6. Each
of these sections contains an analysis of the law and the (alleged) policy towards coordinated
effects or collective dominance respectively. Reference will be made to case law in order to
check whether and how the abstract approach is applied in reality. In addition, for each
merger regime, two recent cases will be presented in more detail.
55
4 COLLECTIVE DOMINANCE IN GERMAN MERGER CONTROL
"Oligopoly does not feature prominently in the decision-making practice of the Bundeskartellamt. This is true,
in particular, of prohibitions in the field of merger control."
Bundeskartellamt (1999)96
There are two reasons why the BKartA - in comparison to the European Commission and the
FTC and the DoJ - might block relatively few mergers on grounds of collective dominance:
First, the underlying concept of collective dominance might be more narrow than in the EC
and the U.S.. This is going to be explored below. Second, as pointed out in the introduction,
oligopolies, in particular due to economies of scale, involve few large firms which often
have a high turnover. Since merger cases are allocated between the EC and its Member
States on the basis of turnover thresholds (see Article 1 Merger Regulation),97 the
distribution of mergers investigated by national competition authorities might be biased
towards "smaller" mergers involving relatively few oligopolistic dominance cases.
4.1 GWB (Act against Restraints of Competition)
Starting point for the assessment of a merger is § 36(1) GWB which states:"A concentration which is expected to create or strengthen a dominant position shall be
prohibited by the Federal Cartel Office unless the participating undertakings prove that the
concentration will also lead to improvements of the conditions of competition, and that these
improvements will outweigh the disadvantages of dominance."98 (emphasis added)
Usually, in practice, the Bundeskartellamt - like the European Commission - first assesses
whether a single dominant position is created or strenghtened. If this is not the case,
collective dominance is assessed.
4.1.1 The definition of collective dominance
§ 19(2)2 GWB gives the following definition of collective dominance:
96 OECD (1999), p. 139; see also Emmerich (1999), p. 315 ("... Bedeutung der Oligopolklausel im Rahmen
der Fusionskontrolle bisher gering geblieben").97 The turnover thresholds and the allocation of cases are currently under review (see the Commission's Green
Paper (2001), pp. 10-19).98 Quotation according to the official English translation by the Bundeskartellamt.
56
"Two or more undertakings are dominant insofar as no substantial competition exists between
them with respect to certain kinds of goods or commercial services and they jointly satisfy the
conditions of sentence 1." (emphasis added)
§ 19(2)1 GWB defines a single dominant position:"An undertaking is dominant where, as a supplier or purchaser of certain kinds of goods or
commercial services, it
1. has no competitors or is not exposed to any substantial competition, or
2. has a paramount market position in relation to its competitors; ..."
4.1.2 Legal constructions and economic meanings
The dominance test builds upon the idea of independence of one market participant: One
firm cannot be effectively constrained by its actual or potential competitors and, hence,
dominates the market. As was pointed out above (2.1.7), this approach can be (at least)
reconciled with the economics of unilateral effects.
In order to capture coordinated effects, the dominance test needs the legal construction of
"joint dominance": The notion of "dominance" or "independence" respectively is maintained
by regarding the colluding firms as group which dominates the market. Both the reference to
sentence 1 in § 19(2)2 GWB ("jointly satisfy the conditions of sentence 1") and the notion of
"external competition" take this construction of joint dominance 'too serious' insofar as they
imply the notion of an "oligopolistic entity". Economically, the "dominance" or
"independence" of the collusive firms corresponds to the absence of significant fringe firms
and potential competitors. Hence, it would be sufficient to talk of barriers to expansion
(capacity constraints) and to entry.
Additionally, to capture coordination, § 19(2)2 GWB requires that there is no competition
between the oligopolists (so-called internal competition). Hence, trying to rationalise
economically the legal distinction between "internal" and "external competition" would
mean to identify "internal competition" with the five other necessary conditions of collusion
(i. e. except barriers to entry; see above 3.4) and the market characteristics (see above 3.5)
which contribute to them (first approach).
A second approach to align § 19(2)2 GWB with the economic framework in section 3 would
be to assume that the absence of internal competition captures all necessary conditions of
collusion. Consequently, there would be no additional problem in showing the lack of
57
external competition since an oligopolistic group which fulfills all these conditions will
typically have a dominant position towards the fringe.99
Analysing its revised 2000 Guidelines for Merger Control Procedures (in the following
referred to as Guidelines),100 it is particularly interisting to see whether the BKartA adopts
one of the two above approaches and succeeds in breaking down the notions of "internal"
and "external competition" into a practical framework for the assessment of collective
dominance which comes close to the economic framework set out in section 3.
4.2 Guidelines for Merger Control Procedures ("Auslegungsgrundsätze")
In Section II of its Guidelines, the BKartA outlines how it assesses collective dominance in
merger control:
4.2.1 Underlying economics101
Citing the research by Kantzenbach, Kottmann and Krüger (1996), the Guidelines explicitly
recognise that modern oligopoly theorie is based on industrial economics which rests on
game theory. With respect to collusive effects, the Guidelines state that both game theory
and case law have worked out a number of factors which might facilitate a collusive
outcome. Referring to section 2.1 of the U.S. Horizontal Merger Guidelines, the German
Guidelines highlight the potential for punishment ("Vergeltungspotenzial") as decisive for
maintaining collusive "discipline". According to the Guidelines, the scope for punishment in
turn depends on several market factors which are set out in a checklist.
In line with the preliminary comparative analysis above (3.2.2) and with the EC and U.S.
approaches, the Guidelines emphasize that the structure-oriented merger control is the
primary instrument to prevent from collusive oligopolies. According to the Guidelines, the
conduct-oriented instruments - the prohibition of concerted practices (set out in § 1 GWB)
and the prohibition of the abuse of a joint dominant position (set out in §§ 19, 20 GWB) -
can often only be applied too late, i. e. after welfare losses have occured over a longer period
due to collusion.
99 Mestmäcker/Veelken in Immenga/mestmäcker (2001), GWB § 36 GWB, 172; Rittner (1999), pp. 281-282;
Möschel in Immenga/Mestmäcker, GWB, § 19, 82. For an overview on the different interpretations of"internal" and "external competition" and their distinction see also Möschel in Immenga/Mestmäcker(2001), GWB, § 19, 80.
100 The new version was issued in October 2000 by the Bundeskartellamt. Like notices of the Commission, theGuidelines are not legally binding.
58
4.2.2 Three-step approach
On the basis of § 19(2)2 GWB, the Guidelines set out a three-step approach assessing the
following conditions respectively:
4.2.2.1 Internal competition ("Wettbewerbsbedingungen - Binnenwettbewerb")
First, the BKartA assesses whether there are market characteristics which facilitate
coordinated behaviour. If yes, there is no internal competition between the oligopolists in the
sense of § 19(2)2. In this context, many of the 'usual' market factors are checked (see below
4.2.3).
4.2.2.2 External competition ("Wettbewerbsbedingungen - Aussenwettbewerb")
Second, the BKartA asks whether there is substantial competition from the fringe. Given the
reference to § 19(2)1 GWB, there is no external competition if there is no substantial
competition between the oligopoly and the competitive fringe (case 1) or if the oligopoly has
a paramount market position to the competitive fringe (case 2).
The Guidelines (p. 52) explicity confirm that this corresponds to the assessment of a single
dominant position of the oligopolistic group as entity in relation to the competitive fringe.
According to the Guidelines (p. 52), here the same criteria have to be checked as with regard
to internal competition.
This appears to be superfluous with respect to those factors which characterise the market as
such (for instance, the market is transparent for both the oligopolists (internal) and the fringe
(external)) and which, hence, have already been checked under the heading of "internal
competition". Accordingly, with regard to external competition, the Guidelines (p. 52)
suggest to focus on those factors for which the change of perspective from the oligopolists
(internal) to the fringe (external) makes sense: For example, structural links between the
oligopolists would be checked under the heading of "internal competition", links between the
oligopolists and the fringe would belong to "external competition".
Moreover, according to the Guidelines, the assessment of "external competition" focuses on
the potential of the fringe to compete with the oligopolists (p. 52), i. e. economically in
particular barriers to expansion and entry. This interpretation of "external competition"
points into the direction of the first approach towards § 19(2)2 outlined above (4.1.2).
101 See the Guidelines (2000), pp. 41-43.
59
However, the Guidelines (p. 50) also put barriers to entry under the heading of "internal
competition". This suggests, instead, that the BKartA interpretes the distinction
'internal/external' in the second way which was outlined above.
In practice, the BKartA does not stick to the Guidelines: For example in RWE/VEW the
assessment of external competition completely focused on the fringe players and barriers to
entry (suggesting that the BKartA applies the first approach suggested above). In Shell/DEA,
the distinction 'internal/external' is even not mentioned at all; this also holds for the BKartA's
contribution to the OECD (1999, pp. 135-137).102
Hence, overall, the interpretation of the distinction 'internal/external' by the BKartA remains
unclear and cannot be not completely aligned to the structure of the economic framework set
out in section 3. Although this appears to be unsatisfactory from the point of view of
consistency and transparency, the checklist itself - and this is decisive - is very much in line
with our framework as will be pointed out immediately (4.2.3).
4.2.2.3 Conduct ("Wettbewerbsgeschehen")
Whereas internal and external competition (due to the Guidelines) refer to the market
structure, finally the oligopolists' conduct is assessed, i. e. whether and how the oligopolists
actually use competitive parameters. According to the Guidelines, the oligopolists' conduct
shall serve as an indicator for the first two points. However, it has already been emphasized
(see above 3.6.1) that evidence on past or current coordinated conduct has to be applied with
caution due to the prospective nature of merger control. This is acknowledged by the
BKartA and the courts.103
According to the Guidelines (pp. 55-56), in particular the interaction of market transparency
and conduct and between homogeneity and conduct shall be analysed.
4.2.3 Checklist and case law104
The Guidelines provide a list of market factors which are examined in cases of collective
dominance and which are grouped under the headings of the above three conditions.
Although all factors are assessed in their totality ("Gesamtbetrachtung")105 like in the EC
102 See Mestmäcker/Veelken in Immenga/Mestmäcker (2001), § 36 GWB, 172: "... Unterscheidung [von
Binnen- und Aussenwettbewerb] kommt in der Praxis nur geringe Bedeutung zu."103 See KG WuW/E OLG 3051, 3072, case Morris/Rothmans.104 For an overview on the case law on collective dominance in merger control see Möschel in
Immenga/Mestmäcker (2001), § 19, footnote 576, and Emmerich (1999), pp. 315-316.105 See WuW/E BGH 1824, case Tonolli-Blei- und Silberhütte Braubach (1981).
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and the U.S., the BKartA regards market shares and barriers to entry as necessary conditions
for coordinated effects and, hence, central criteria of the assessment.106 Additionally, in its
the contribution to the OECD (1999, pp. 137, 139), the BKartA specifies structural links,
market phase and symmetry as very important.
4.2.3.1 Concentration and market shares
In contrast to the European Merger Regulation, the GWB in § 19(3)2 provides for rules of
presumption concerning a joint dominant position:"A number of undertakings is presumed to be dominant if it
1. consists of three or fewer undertakings reaching a combined market share of 50 percent, or
2. consists of five or fewer undertakings reaching a combined market share of two thirds, unless
the undertakings demonstrate that the conditions of competition may be expected to maintain
substantial competition between them, or that the number of undertakings has no paramount
market position in relation to the remaining competitors."
According to its Guidelines (p. 44), the BKartA, referring to the policy of the European
Commission, usually considers only two or three firms to be able to maintain a joint
dominant position.107 Hence, in practice, only § 19(3)2 No. 1 GWB (C3�50%)108 is relevant.
The presumption in § 19(3)2 GWB can be rebutted by showing that there is internal or
external competition. However, since the BKartA has the duty arising from public law to
investigate all relevant facts (Amtsermittlungsgrundsatz), the presumption of § 19(3)2 GWB
becomes relevant only in the (theoretic) cases of non liquet, i. e. where the facts are not
completely convincing evidence of a joint dominant position. The BKartA itself states (p.
46) that the presumption rules are not reliable without additional factors and have been
rebutted in the vast majority of cases. However, due to the presumption, the concentration
screening is the starting point for the assessment like in the U.S. and the EC.109
In addition to the actual figures and the differences between the firms (with regard to
symmetry between the oligopolists), the BKartA assesses fluctuations of market shares over
the last years. If market shares have remained stable this may point to an uncompetitive
oligopoly, in particular, if there have been significant changes in external circumstances
during this time period, such as a substantial drop in demand.
106 Guidelines (2000), p. 53.107 Insofar, the case of Philip Morris/Rothmans (BKartA, WuW/E 2247) in which five leading producers of
cigarettes were held to be collectively dominant constitutes an exception.108 "C" means concentration ratio; C2 is the combined market share of the two largest firms, C3 of the three
largest, etc.109 See Mestmäcker/Veelken in Immenga/Mestmäcker (2001), § 36 GWB, 172.
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For example in Philips/Lindner, Philips intended to acquire a share in Lindner, a medium-
sized manufacturer of lamps. The BKartA blocked the merger because it would have
strengthened the dominant oligopoly consisting of Philips and Osram arguing, inter alia, that
their market shares had been stable for years.110
4.2.3.2 Symmetry
With regard to symmetry, there has been a change in the policy of the BKartA: Initially, the
BKartA did not block mergers if they made the oligopoly more symmetric111 (in this context,
the term "Aufholfusion" was developed to justify a merger between a small oligopolist and
another small (fringe) firm112). However, in Morris/Rothmans, the Kammergericht
emphasized that a market with symmetric oligopolists might be particulary conducive to
coordination.113 After this judgment of the KG, the BKartA changed its practice.114
Now, with regard to similarity of market shares, capacities, cost structures, financial
resources and access to supply and sale markets, the Guidelines (pp. 47-48) and the
BKartA's contribution to the OECD reflect the economic reasoning as outlined above (see
above 3.2.1.2): Symmetric oligopolies have a stronger tendency towards collusion than
asymmetric ones since "any competitive moves would be equally perceptible to all firms,
easily detectable due to the transparency of competitive
conduct and hardly promising because all the firms have a similary retaliatory potential".115
However, a merger which makes firms more similar does not always increase the likelihood
of collusion: In innovative, expanding markets (with Schumpeterian competition), firms'
incentives are mainly set by expected monopoly profits due to innovation or system
competition and, hence, the relative gains from coordination are low. A merger in such a
market which helps a smaller firm to catch up with the leading firm and, thus, makes it more
symmetric, might even increase competition.
This was acknowledged by the BKartA in Checkpoint/Meto:116 It held that the acquisition of
Meto (market share: 10-15%) by Checkpoint (13-17%) would not create a joint dominant
position by Sensormatic (35-40%) on the expanding market for electronic security systems
for larger stores where three non-compatible systems competed with each other.
110 WuW/E BKartA 2669, 2674, case Lindner Licht GmbH (1994).111 See Tätigkeitsbericht 1979/80, pp. 88-89 (case Tchibo/Reemtsma).112 See Mestmäcker/Veelken in Immenga/Mestmäcker (2001), § 36 GWB, 174.113 See KG WuW/E OLG 3051, 3079 and 3080.114 See Tätigkeitsbericht 1985/86, p. 85 (case NUR/ITS).115 OECD (1999), p. 136.
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4.2.3.3 Ressources and vertical up- and downstream integration
With respect to this factors, the Guidelines (p. 48) refer to Section I where the assessment of
single dominance is set out. However, this reference does not take into account the different
functions of these factors for single and collective dominance: The stronger the market
leader in comparison with its competitors e. g. with regard to financial ressources, the more
dominant his position. Thus asymmetry with respect to these factors increases the likelihood
of a single dominant position. This also holds for "external competition" under the concept
of collective dominance: If the oligopolistic group is much 'stronger' than the fringe with
respect to ressources and integration, it presumably has a collective dominant position
towards the fringe.
In contrast, the more similar the oligopolists to each other with regard to ressources and
integration, the better coordination and punishment work, i. e. the weaker "internal
competition".
4.2.3.4 Structural links
Both Guidelines and case law show a clear emphasis on interlocks117, both on the merger's
relevant market and on other markets, especially up- and downstream markets. However, the
Guidelines (pp. 48-49) also recognize the insight from above (3.6.2) that structural links are
not a necessary condition for collusion. This is also in line with the EC approach after
Gencor/Lonrho (see below 5.1.3 and 5.2.2.6).
Due to the BKartA's broad definition of "link", apart from interlocking directorates and
capital arrangements, also e. g. a seller-buyer-relationship is captured. In Philips/Lindner, a
cross-licensing agreement between Philips and Osram was considered as sufficient link.
4.2.3.5 Barriers to entry
Barriers to entry are - in line with the economic approach and the U.S. Horizontal Merger
Guidelines - regarded as necessary conditions for collusion by the BKartA118 and,
accordingly, are assessed in each case of collective dominance. A sub-section of section I of
116 Case Checkpoint Systems/Meto B7-173/99, available at <http://www.bkarta.de/B7-173-99.pdf>.117 See OECD (1999), p. 137, and, e. g., case Philips/Lindner, decision of 11 August 1994, WuW/E BKartA
2669, and case RWE/VEW, B8 - 309/99, available at <http://www.bundeskartellamt.de /B8-309-99.pdf>,pp. 52, 59.
118 See the Guidelines (2000), p. 53, which explicitly refer to the U.S. Merger Guidelines.
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the Guidelines (pp. 25-31), which deals extensively with barriers to entry in the context of
single dominance, distinguishes between legal, structural and strategical barriers.
An example of a legal barrier to entry in the context of collective dominance is provided for
in the case "Bertelsmann/Kirch/Premiere" which concerned the proposed transformation of
the pay-TV channel Premiere into a 50:50 joint venture by CLT/UFA (Bertelsmann) and
KirchGruppe. According to the BKartA, the concentration would have led to a spillover
effect on the free-TV market creating or strengthening a joint dominant position of
CLT/UFA and KirchGruppe on this market. In the TV advertising market, public channels
were considered to constitute no effective constraint due to the regulation of advertising time
that allows them only partially to participate in this market.119
4.2.3.6 Buyer Power on the opposite side of the market
In both its Guidelines (pp. 50-51) and its contribution to the OECD, the BKartA
acknowledges that "relatively large buyers can disrupt the oligopolistic discipline by playing
the members of the oligopoly off against each other and causing them to engage in secret
competition".120 The BKartA also takes into account the potential of a buyer to produce the
good on its own which serves as threat to and, thus, as constraint on the oligopolists (hence,
"internal competition" would be increased).121
4.2.3.7 Market Transparency and homogeneity
In its Guidelines (pp. 55-56) and its practice (see the cases RWE/VEW and Shell/DEA
below), the BKartA acknowledges the above insights (3.5.2, 3.5.3) that market transparency
and product homogeneity facilitate collusion.
The fact that both market characteristics are put under the heading of “conduct”
(Wettbewerbsgeschehen) shows that the BKartA especially takes into account practices of
firms which increase transparency and – vice versa -, in the case of homogeneity, which lead
to product differentiation.
119 BKartA, WuW/E DE-V 53, 61 (1998).120 OECD (1999), p. 137.121 See BKartA's decision of 11 February 2000, Dürr/Alstom, p. 11 (available at <http://www.
bundeskartellamt.de>).
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4.2.3.8 Market phase
Also with respect to market phase, the Guideline's approach (pp. 52-53) is in line with
economic theory (3.5.4): The BKartA acknowledges that dynamic markets, which are
characterised by rapid change of technology, innovation competition and market growth, are
less conducive to coordination than mature and stagnant markets.
However, it is unclear how much weight the BKartA attaches precisely to this factor in
practice since there seems to be no clear-cut case in the past in which demand conditions
were unstable, but all other factors suggested that the market is conducive to coordination.
This also holds for the EC Commission and its case law.
The case Checkpoint/Meto (see above 4.2.3.2), in which system competition in an expanding
market played a decisive role, suggests that the factor is regarded as very important also in
practice.
4.2.4 Comparison with economic framework
Overall, the BKartA’s checklist is very much in line with the economic framework set out in
section 3. As will become clear in the following sections, this also holds for the analytical
frameworks of the EC Comission, the FTC and the DoJ.122
However, particularly in contrast to the U.S. Horizontal Merger Guidelines, the German
checklist does not relate the market characteristics to the necessary conditions of
coordination like the framework presented in section 3. Hence, the interdependence of the
different factors is not worked out clearly.
4.3 Cases
Given its two recent prominent cases of RWE/VEW (2000) and Shell/DEA (2001) which are
going to be presented in the following the BKartA would probably not repeat its 1999
statement quoted in the beginning. However, at least the case Shell/DEA does not contradict
the hypothesis that the distribution of mergers investigated by national competition
authorities might be biased towards "smaller" mergers involving relatively few oligopolistic
dominance cases: The concentration met the thresholds of Article 1 MR, but the
Commission partly referred the case to the BKartA.123
122 See the summarising table in Section 7.123 The Commission may refer a case to a national competition authority under Article 9 MR (the so-called
"German clause").
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4.3.1 RWE / VEW124
Since the European Commission parallely investigated the merger of VEBA and Viag and
harmonized its conditions and obligations with those which were imposed on RWE/VEW by
the BKartA, the cases confirm to some extent the conjecture from the introduction that the
approach to coordinated effects converges due to mutual learning of competition authorities.
4.3.1.1 Findings
After the merger, RWE/VEW together with E.ON (the former PreussenElektra AG, a
subsidiary of VEBA, and Bayernwerk AG (VIAG)) would have controlled over 70% of the
German market in electricity supply of major industrial customers and well over 55% of the
market in electricity delivered to private customers. Hence, the merger would have created a
symmetric duopoly fulfilling the presumption of § 19(3)2 No. 1 GWB.125
Expected small growth in demand, low price elasticity and the fact that electricity is a totally
homogeneous and mature product, which is sold on a highly transparent market (production
costs and prices are well-known), all favour coordination.126 Moreover, the duopolists were
symmetric in terms of market shares, cost structures and vertical integration.127 Hence, the
decision explicitly states that price cuts would be easy to monitor and, due to similar
potential to retaliate, unlikely to be successful.128 Finally, there were various structural links
between the duopolists, particularly their holdings in the east German interconnected
company Vereinigte Energiewerke AG (VEAG) and the lignite producer LAUBAG which
additionally created parallel interests and which would facilitate the exchange of
information.129
The counterargument that there were significant price drops before and at the time of the
investigation of the merger was refuted by the BKartA with two arguments: First, the market
was still in the initial phase of the liberalisation process, in which firms were positioning
themselves on the German market and trying to deter from entry into "their" regional or local
sub-market. Second, from the fact that reductions in price happened before the
concentrations took place one cannot draw the conclusion that there would be similar price
124 Decision of 3 July 2000, case RWE/VEW, B8 - 309/99; see <http://www.bundeskartellamt.de /B8-309-
99.pdf>.125 See paras 112-115 of the decision.126 See para 122.127 Para 123.128 Para 129.129 Para 124.
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competition post merger.130 Hence, the BKartA concluded that no substantial competition
between duopolists could be expected.131
With respect to external competition, the decision puts emphasis on the enormous difference
in market share between on the one side RWE/VEW and E.ON and on the other side EnBW
and HEW and regionally fragmented competitors which in addition partially depend on the
supply by the duopolists. Explicitly, the decision states that EdF/EnBW might have
ressources to compete with the duopolists. But as long as there are no other larger potential
mavericks in the market, it would be very likely that EdF/EnBW abstains from active
competition. Moreover, there are high barriers to entry due to high fixed costs. Additionally,
interconnection fees have to be paid to the duopolists as owner of the transmission networks.
Finally, imports are constrained by restricted interconnection facilities (paras 138, 139).
Hence, the BKartA concludes that there is no substantial external competition.
Overall, the market characteristics assessed by the BKartA in this decision fit in with the
checklist set out in section 3. However, the decision does not exactly relate the market
characteristics to the necessary conditions of coordination.
4.3.1.2 Remedies
The BKartA cleared the merger, but imposed conditions and obligations on RWE/VEW (the
same holds for the Commission in relation to VEBA/VIAG) which had three main goals:
first, the reduction of its market share by disposing of numerous holdings in other
companies; second, the severance of the main links between RWE/VEW and VEBA/VIAG;
third, the creation of a "third force" on the German market for electricity supply. The
condition on RWE/VEW (and VEBA/VIAG) to sell all holdings in VEAG and LAUBAG to
a third party (HEW, which today, together with VEAG and BEWAG, constitutes the "third
force") served all three goals.
However, by assuming that RWE and E.ON have a joint dominant position in the case of
E.ON/Ruhrgas (2002), the BKartA itself conceded that the conditions and obligations could
not prevent from collective dominance on the German power market.
130 Paras 131, 132.
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4.3.2 Shell / DEA132
Shell and DEA (DEA Mineralöl is a 100-percent subsidiary of RWE) intended to combine
their downstream oil and petrochemicals business in a joint venture. The agreement foresees
that Shell will take sole control of DEA from 1 July 2004 at the latest. Due to the acquisition
of DEA by Shell and the merger of BP and Aral (a subsidiary of VEBA Oil), which was
registered shortly afterwards, Shell/DEA, BP/Aral and Esso would have reached a combined
market share of 61% on the German market for supply of petrol at filling stations. Hence,
according to the presumption of § 19(3)2 No. 1 GWB, the concentration Shell/DEA would
have created an oligopolistic dominant position. As the BKartA states in its decision, even
without taking into account the merger of BP/Aral, the combined market share of
Shell/DEA, Aral and Esso would have been above 50%.133
The decision checks the usual factors (similar oligopolists, high market transparency, low
price elasticity, stagnant demand, homogeneous good) and concludes that competition
initiated by the oligopolists could not be expected due to easy monitoring and similar
potential of punishment.134 Moreover, structural links (in the form of share holding in the
same refineries and in a pipeline system) create common interests and provide for a
possibility to exchange information.135
Without explicitly paying reference to the distinction of internal and external competition,
the BKartA states that the next largest competitors Total-FinaElf and Conoco are too small
to constrain coordination. According to the decision, this also holds for the independent fuel
stations since they heavily depend on the supply of the oligopolists which, in contrast, are
integrated upstream.136
Since the presumption of oligopolistic market dominance was not rebutted by Shell and
DEA, conditions and obligations were imposed on the merging parties.
131 Paras 128, 129.132 Case B8 - 120/01, available at <http://www.bundeskartellamt.de/B8-120-01.pdf>.133 Case Shell/DEA, B8 - 120/01, available at <http://www.bundeskartellamt.de/B8-120-01.pdf>, pp. 15-16.134 P. 18.135 P. 20.136 Pp. 21-23.
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5 COLLECTIVE DOMINANCE IN EC MERGER CONTROL
"The Commission does not consider that it is necessary to show that the market participants as a result of the
proposed merger would behave as if there were a cartel, with a tacit rather than explicit cartel agreement. In
particular, it is not necessary to show that there would be a strict punishment mechanism."
EC Commission, Airtours decision, 22 September 1999137
"... the Court concludes that the [Commission's] Decision [in Airtours], far from basing its prospective
analysis on cogent evidence, is vitiated by a series of errors of assessment as to factors fundamental to any
assessment of whether a collective dominant position might be created."
Court of First Instance, Airtours judgment, 6 June 2002138
Article 2(3) of the Merger Regulation which came into force in 1990 provides that:"A concentration which creates or strengthens a dominant position as a result of which effective
competition would be significantly impeded in the common market or a substantial part of it shall
be declared incompatible with the common market." (emphasis added)
The term "dominant position" is not defined in the Merger Regulation. So far,139 the
Regulation lacks, in particular in comparison to Article 82 EC, an explicit reference to
dominance by "one or more undertakings". Because of this "oligopoly blind spot" in the
Merger Regulation, the law governing the assessment of oligopolistic dominance in merger
control had to be developed by the Commission and the European courts, i. e. the Court of
First Instance (CFI) and the European Court of Justice (ECJ).
Consequently, the best access to the concept of collective dominance - like to European
(competition) law in general - is via landmark cases which will be presented first (see below
5.1). Special attention is paid to the Airtours case (5.1.4) since the case can be interpreted as
focus of the general problems of the European approach. Moreover, the recent CFI judgment
sets important limits to the concept of joint dominance. Additionally, the recent parallel
cases of UPM-Kymmene/Haindl and Norske Skog/Parenco/Walsum will be discussed
137 Commission decision of 22 September 1999, Airtours/First Choice, Case IV/M.1524, available at
<http://www.europa.eu.int>, para 150.138 Judgment of 6 June 2002, Airtours v. Commission, Case T-342/99, available at <http:www.curia.eu.int>,
para 294.139 See below 7. .
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(5.1.5) because they raised the general question whether coordination on long-term variables
like capacities is sustainable.
Then, the European approach to oligopolistic dominance in merger controll will be analysed
in abstracto (5.2). So far, in contrast to Germany and the U.S., no EC Merger Guidelines
exist. Hence, one has to rely on extracts of the case law and unofficial statements, in
particular a Commission contribution to the OECD (1999), a Commission working
document on the telecommunications sector140 and a statement by Commission members.141
5.1 Development142 - from Nestlé / Perrier to Airtours / First Choice
During the first year after the entering into force of the Merger Regulation, the Commission
applied the Regulation exclusively to prevent mergers that led to a single firm dominance.
The Commission considered the presence of other large firms on the market as constraint on
a single dominant position rather than as risk with regard to a collective dominant
position.143
Emerging concern of the Commission that a merger can lead to coordinated effects can be
found in its Varta/Bosch decision where it noted that"the existence of an equally strong competitor could lead for several reasons to alignment of the
behaviour of both competitors. In particular the absence of other large competitors able to
counter any alignment of the behaviour of the main competitors on the ... market is noted."144
In 1992, the merger of Alcatel/AEG Kabel created an oligolistic market with three
significant firms on the German power cable market which is characterised by, inter alia,
industrial maturity, static demand and product homogeneity. In its decision, the Commission
rejected a request by the Bundeskartellamt to apply a 'German version' of the concept of
collective dominance by stating:"[Unlike German merger control law, the Merger Regulation] does not contain a legal
presumption of the existence of a collective dominant oligopoly as soon as certain companies
attain a certain combined market share. ... Under the Regulation, such a presumption which
amounts to a reversal of the burden of proof does not exist. On the contrary, the Commission
would have to demonstrate in all cases that effective competition could not be expected on
140 Commission Working Document On Proposed New Regulatory Framework for Electronic Communications
Networks and Services (2001), paras 77-93.141 Christensen and Rabassa (2001). Since this article is the attempt to justify the Airtours decision by its case
handler, it will be dealt with in the context of the decision (see 5.3.1).142 An in-depth overview on the early cases is given by Morgan (1996).143 See e. g. Renault/Volvo, Case IV/M.004, (1990) OJ C281/2, where the Commission cleared the merger
because the post-merger firm would not dominate its rivals such as Mercedes and Iveco, but did not discussthat the merger created an oligopoly.
144 Varta/Bosch, Case IV/M.012, (1991) OJ L320/26.
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structural grounds between the leading companies in a highly concentrated market." (emphasis
added)145
The last sentence of the quotation shows that the Commission was ready to introduce
collective dominance under the Merger Regulation, but was waiting for a clear-cut case.
5.1.1 Nestlé / Perrier (1991)146
Shortly after the Court had finally accepted the concept of collective dominance under
Article 82 EC,147 such a clear-cut case seemed to have arrived with the notification of the
merger Nestlé/Perrier. By widening the interpretation of the notion of "dominance" in
Article 2(3) MR, the Commission introduced joint dominance into EC merger control.
The most important facts of the case have already been outlined above (see 3.2.2) when
discussing the role of symmetry. Whereas the Commission did not consider properly
symmetry and the effects of its condition, the split-off of Volvic to BSN, it applied notions
and a checklist of criteria suggested by game theory as outlined in section 3: Inter alia, the
Commission found that the 3-2 merger would make anti-competitive parallel behaviour
much easier and explicitly referred to the possibility of "immediate detection of any
deviation ... of the expected performance". According to the decision, "tacit coordination" of
pricing policies was facilitated by transparent prices, a low price elasticity of demand,
mature technology, high barriers to entry and an insignificant competitive fringe.148 In
addition to these structural factors, the Commission found that the oligopolists had acted
together to deter the entry of a third party into the market.
The decision was appealed, but not on issues related to collective dominance with the
consequence that the Commission had to wait until the ECJ's judgment in Kali&Salz to get
confirmation for its use of the concept of collective dominance.
5.1.2 Kali & Salz / MdK (1993, 1998)149
The case concerned a proposed joint venture between Kali&Salz (K&S), a subsidiary of
BASF, and the Treuhandanstalt by which the potash and rock-salt businesses of K&S would
be combined with those of the former East German producer, Mitteldeutsche Kali AG
145 Alcatel/AEG Kabel, Case IV/M.0165, (1992) OJ C6/23, para 22.146 Commission decision of 22 July 1992, Nestlé/Perrier, Case IV/M.0190, (1992) OJ L356/01.147 In Società Italiana Vetro SpA and Others v. Commission, Joined Cases T-68/89, T-77/89 and T-78/89,
(1992) ECR II-1403, para 358.148 Nestlé/Perrier, Case IV/M.0190, (1992) OJ L356/01, paras 119-131.149 For detailed comment on the case see Ysewyn and Caffarra (1998) and Venit (1998).
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(MdK). The Commission150 found that the merged entity and the French producer SCPA
would hold a collective dominant position in the market for potash in the EC excluding
Germany and, hence, declared the merger compatible only subject to conditions and
obligations (offered as commitments by the parties).
On appeal of the parties, the ECJ confirmed that the Merger Regulation applies to joint
dominance and confers on the Commission "a certain discretion, especially with respect to
assessments of economic nature".151 Apart from the asymmetries between the firms and the
ability of third parties to exercise competitive constraint on the parties, the ECJ,
paradoxically, annulled the Commission's decision because of the absence of structural links
between the parties although the Commission had put most effort on proving "exceptionally"
close links between K&S and SCPA.
5.1.3 Gencor / Lonrho (1996, 1999)
The merger was the first one which was blocked completely by the Commission on grounds
of collective dominance.152 It would have brought together the platinum and rhodium mines
of two producers in South Africa (Implats, owned by Gencor, and Eastplats/Westplats,
owned by Lonrho's LPD) into a joint venture and would have led to a symmetric duopoly of
Gencor/Lonrho and Amplats with market shares for each of the duopolists of about 35% of
the world market.
The Commission's decision was entirely upheld by the CFI153 which made two important
statements: First, the CFI ended the debate about structural links and stated that the existence
of "structural links" between the remaining undertakings in a market is neither a necessary
nor sufficient condition for the existence of joint dominance after a merger.154 Second, the
market factor of (price) transparency was pointed out to be fundamental for the detection and
punishment of cheating.155
150 Commission decision of 14 December 1993, Kali&Salz/MdK/Treuhand, Case IV/M.0308, (1994) OJ
L186/38.151 Judgment of 31 March 1998, France and others v. Commission, Joined Cases C-68/94 and C-30/95, (1998)
ECR-I-1453, para 223.152 Commission decision of 24 April 1996, Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30.153 Judgment of 25 March 1999, Gencor v. Commission, Case T-102/96, (1999) CMLR 971. For comments on
the judgment see Korah (1999).154 Gencor v. Commission, Case T-102/96, para 276; see also para 273.
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5.1.4 Airtours / First Choice (1999, 2002)
In its decision in Airtours/First Choice, which led to the recent landmark judgment by the
CFI, the Commission tried to increase the scope of the concept of collective dominance in
three ways:
First, giving up its previous 'duopoly policy', the Commission, for the first time, blocked a
merger since it would have created a joint dominant position consisting of three firms. In
general, this is in line with economic theory (see above 3.4.1) and has not been criticised by
CFI.
Second, the Commission attempted to abolish the game theoretic mechanism of tacit
collusion as underlying concept of collective dominance, in particular with respect to the
punishment mechanism. Third, the concept was applied to a market which, at least at first
sight, did not lend itself easily to collusion. With regard to the last two points, the CFI
quashed the Commission's decision.
5.1.4.1 The Commission's decision (1999)156 - shifting the goalposts
The acquisition of First Choice (market share: 11%) by Airtours (21%) would have left three
major vertically integrated travel groups in the UK short-haul foreign package holiday
market, the other two being Thomson (27%) and Thomas Cook (20%). In its decision, the
Commission - in addition to the market shares - pointed out that the HHI would increase
from 1700 by more than 450 points to more than 2150 as a result of the merger.157
However, the HHI is an instrument which is derived from unilateral effects theory and which
punishes asymmetry (see above 2.1.5). As pointed out above (see 3.2.1.1), concentration
increases the scope of coordinated effects in a distinct way than it increases the scope of
unilateral effects. Hence, for unilateral effects cases, it is appropriate that the Commission
increasingly uses the HHI in addition to market shares. In coordinated effects cases,
however, the number of the firms and their (combined) market shares seem to be more
appropriate than the HHI.
Additionally, the Commission argues that the decrease in the number of major competitors
from four to three would reduce the number of competitive relationships by half - from six to
three - and that the number of bilateral links in which one of the major parties would not
participate would fall from three to one. This argument is even better suited than market
155 Gencor v. Commission, Case T-102/96, para 227.156 Airtours/First Choice, Case IV/M.1524.157 Airtours/First Choice, Case IV/M.1524, para 139.
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shares to indicate to what extent the costs of coordination and monitoring are reduced by the
merger.
Moreover, according to the Commission, First Choice would be lost as supplier and
distributor for the fringe.158 From these observations and the result of its checklist - which
included product homogeneity, low demand growth, low price sensitivity, similar cost
structures, transparency, interdependency and structural links, barriers to entry, no buyer
power, past competition - the Commission drew the conclusion that, post-merger, the
interdependency between the parties and the transparency of the market would be reinforced,
as would the incentive to coordinate.
However, an important particularity of the market is that operators' capacity plans are
typically fixed 12 to 18 months ahead of the holiday season, and few adjustments can be
made afterwards.159 Hence, the Commission's argument was essentially that, post-merger,
the major foreign package holiday operators would have an incentive to keep capacity tight
and thereby increase price: "... any decision by a tour operator to try to increase market share
by increasing capacity ... will lead to a fall in prices unless competitors reduce their share by
an equivalent amount by cutting supply."160 So far, this argument reflects the obvious insight
that every firm would like to raise prices in order to increase profits. But the decisive
question is whether firms are able to achieve this, in the case of coordination by means of the
threat of punishment.
Consequently, Airtours' economic advisors explicitly put forward that a punishment
mechanism is a necessary condition for coordination.161 However, according to Airtours,
immediate punishment is unlikely since capacity can only be increased marginally during a
season. A punishment in a later season could in principle take place through a large increase
in capacity for the following season. However, this is not very likely because it will inflict a
lower cost due to discounting and because the association between deviation and punishment
will be blurred.162
In an apparent attempt to (ab)use the discretion granted by the CFI in Gencor/Lonrho,163 the
Commission, dealing with Airtours' arguments, stated that "where, as in the present case,
158 Airtours/First Choice, Case IV/M.1524, para 140 et seq.159 Airtours/First Choice, Case IV/M.1524, paras 143, 144.160 Airtours/First Choice, Case IV/M.1524, para 66.161 Airtours/First Choice, Case IV/M.1524, para 148; D. Neven and K. Binmore acted as economic advisors to
Airtours.162 Airtours/First Choice, Case IV/M.1524, para 149.163 See e. g. Airtours/First Choice, Case IV/M.1524, footnote 94.
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there are strong incentives to reduce competitive action, coercion may be unnecessary."164
Hence, contrary to the findings of game theory, the Commission did not regard a strict
retaliation mechanism as necessary condition for collective dominance in this case.
5.1.4.2 Critique and interpretation - "collective confusion"165
The major criticism against the Airtours decision is that it dilutes the concept of collusion in
three ways: First, as just pointed out before, it attempts to abandon the necessary condition
of a punishment mechanism. Second, it puts unilateral effects arguments under the heading
of "collective dominance" (5.1.4.2.1). Third, it applies the concept of "collective dominance"
to a market which is not conducive to collusion (see the CFI's judgment, 5.1.4.3.2).
5.1.4.2.1 Unilateral effects in a collective dominance case
In its decision, the Commission states:"... it is not a necessary condition of collective dominance for the oligopolists always to behave
as if there were one or more explicit agreements ... between them. It is sufficient that the merger
makes it rational for the oligopolists, in adapting themselves to market conditions, to act -
individually - in ways which will substantially reduce competition between them, and as a result
of which they may act, to an appreciable extent, independently of competitors, customers and
consumers."166 (emphasis added)
Again, this statement misses the crucial point insofar as firms will find it rational to choose
collusive actions (whether on prices, quantities or even capacities) only if they anticipate that
a punishment awaits them if they do not so. Even more importantly, the statement refers to
unilateral action of the merged entity and the other oligopolists suggesting that the decision
to block the merger relies heavily on unilateral effects.
In an attempt to justify the decision, the case handler in Airtours/First Choice in an article
stated that, in the case,"conceptually the Commission has focused on coordinated effects rather than unilateral effects,
even though it has in reality never been decided whether collective dominance also could arise
due to unilateral effects or whether the degree of coordination in a market could be dependent on
the magnitude of some preliminary unilateral effects." (emphasis added)167
164 Airtours/First Choice, Case IV/M.1524, para 55.165 This is the subtitle of the article by Neven (2000).166 Airtours/First Choice, Case IV/M.1524, para 54.167 Christensen and Rabassa (2001). Contrary to the result of the above analysis, the authors deny the question
asked in the article's title "The Airtours decision: Is there a new Commission approach to collectivedominance?".
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This could simply be a another circumscription of the possible sequence described above
(2.3) in which the firms first adapt unilaterally to the post-merger environment by raising
prices (unilateral effects) and afterwards find it rational to collude since, with increased
concentration, the individual gains from collusion are higher and the gains from deviation
are lower.
However, if this is the correct interpretation of the above statement, two points have to be
criticised: First, it has to be insisted that still a punishment mechanism is necessary to
overcome the prisoner's dilemma situation. Second, if the Commission wants to block a
merger because of unilateral effects, it should use the concept of single dominance instead of
mixing unilateral and coordinated effects under the heading of "joint dominance".
5.1.4.2.2 Interpretation: two distortions in EC merger control
Motta (1999, 2000) and Neven (2000) suggest a 'structural' explanation for the Commission's
attempt to put unilateral effects under the heading of "collective dominance": As was pointed
out in section 2 (2.1.7), according to Motta, there is a gap in EC merger control concerning
those cases in which unilateral effects are likely, but the merged entity remains below the
40%-market-share-threshold. In his view, there is a second distortion due to the lack of an
efficiency defence.
Motta (1999, 2000) and Neven (2000) interprete the Commission's Airtours decision as the
attempt of a 'second-best solution' which takes these distortions as given: To cope with the
first distortion, the Merger Task Force may be trying to stretch (and hence dilutes) the
concept of collective dominance so that it covers not only tacit collusion, but also market-
wide168 unilateral effects.169 To avoid further distortions, in Motta's view, the Commission
should also explicitly take into account efficiency gains.
Considering the combined market share of Airtours/First Choice (32%, i. e. below the 40%-
threshold), the likelihood of market-wide unilateral effects due to the oligopolistic market
structure in the case and the Commission's reasoning, Motta's and Neven's interpretation fits.
This triggers the question whether the current EC merger regime has to be reformed.
168 Market-wide unilateral effects can arise in the Bertrand model (see above 2.2).169 Hence, in Motta's view, the Commission's decision to block the merger might be correct (because of
unilateral effects), but on the wrong grounds (coordinated effects).
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5.1.4.2.3 Solutions to eliminate the distortions
A 'first-best' merger framework should avoid a mixture of unilateral and coordinated effects
arguments and allow for a clearly separated analysis of the two effects. Considering the
alleged distortions, the Commission in its 2001 Green Paper on the Review of the Merger
Regulation itself asks whether the current substantive test has to be changed:"One of the more specific hypothetical questions that has occasionally been raised about the
reach of the dominance test in the Merger Regulation is the extent to which it would allow for
effective control in some specific situations where firms unilaterally may be able to raise price
and thus exercise market power. ... The argument goes that the SLC-test would be better adapted
to addressing such a situation, in particular if the market characteristics would not be conducive
to a finding of collective dominance." (emphasis added)170
Although the SLC-test seems generally preferable since it coincides with the economics of
unilateral and coordinated effects, it is very similar to the dominance test in its practical
application.171 Most importantly in our context, it is not necessary to introduce the SLC test
to cope with the alleged first distortion. Instead, it would be sufficient to abandon the 40%-
threshold in unilateral effects cases which is not even determined by the Merger Regulation
itself, but used by the Commission as rule of thumb. Hence, lowering the threshold would
only require the approval of the Court. To eliminate the second distortion, an efficiency
defence172 has to be introduced. This would also be a necessary corrective if the 40%-
threshold is abandoned.
Keeping the dominance test has the advantage of avoiding the costs of legal uncertainty
which would be brought about by an introduction of the SLC test in the EC. Finally,
repercussions on Article 82 EC, which rests on the dominance test, are avoided.
5.1.4.3 The CFI's ruling (2002) - shifting back and cementing the goalposts
The CFI's judgment in Airtours/First Choice can be regarded as a milestone in EC
competition law, not only because it was the first time that a European court annulled a
decision to block a merger, but also because it set boundaries to the concept of collective
dominance under the Merger Regulation.
170 Commission (2001), para 166.171 See BKartA (2001).172 For an extensive overview on and analysis of efficiency gains from mergers in theory and efficiency
defences in practice see the study of Röller, Stennek and Verboven (2000) which was carried out on behalfof the European Commission. For a discussion of how to take into account efficiencies in EC mergercontrol see Wirtz (2002).
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5.1.4.3.1 Necessary conditions for coordination
With regard to the necessity of a retaliation mechanism, the CFI states that it is not necessary
to "prove that there is a specific retaliation mechanism involving a degree of severity"
(emphasis added), i. e. the CFI does not expect the Commission to specify the retaliation
quantitatively. However, the Court does insist that the Commission "must ... establish that
deterrents exist which are such that it is not worth the while of any member of the dominant
oligopoly to depart from the common course of conduct to the detriment of the other
oligopolists",173 i. e. the Commission has to show that collusion is incentive compatible due
to a punishment mechanism.
Most importantly, the CFI sets out three necessary conditions for a finding of collective
dominance:1. "Each member of the dominant oligopoly must have the ability to know how the other
members are behaving in order to monitor whether or not they are adopting the common
policy."
2. "The situation of tacit coordination must be sustainable over time, that is to say, there must be
an incentive not to depart from the common policy on the market. ... The notion of retaliation
in respect of conduct deviating from the common policy is inherent in this condition."
3. "... the Commission must also establish that the foreseeable reaction of current and future
competitors, as well as of consumers, would not jeopardise the results expected from the
common policy."174 (emphasis added)
Conditions 1 and 2 are the same as set out in section 3 (monitoring and enforcement).
Condition 3 paraphrases barriers to entry and expansion which determine the reaction of
current and future competitors and the constraint that the fringe can put on the oligopolists.
Hence, the conditions set out by the CFI with respect to the supply side are essentially the
same as in the economic framework derived in section 3.
With regard to the reaction of the consumers, i. e. the demand side, the CFI emphasizes the
above insight (3.5.6) that a high-cross price elasticity (in combination with low barriers to
expansion) helps the fringe and entrants to destabilise collusion.
5.1.4.3.2 Market characteristics
Overall, the Commission's findings concerning its market factor checklist seem to be guided
by the aim to block the merger, not by the persuasiveness of its evidence. Hence, examining
the Commission's findings in detail, the CFI dissented with the Commission in nearly every
173 Airtours v. Commission, Case T-342/99, para 193.174 Airtours v. Commission, Case T-342/99, para 62.
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point. Two further examples for the Commission's flawed economic analysis shall be
presented:
5.1.4.3.2.1 Product homogeneity
In its decision, the Commission stated that (short-haul) package holiday products are
"fundamentally similar" since they all involve the packaging of the two key elements travel
and accomodation and they all depend on bulk buying to produce economies of scale and
scope.175 In contrast, the CFI rightly found that package holiday products are differentiated
by destination, departure date and airport, aircraft model, type and quality of accomodation
and length of stay.176
5.1.4.3.2.2 Market transparency
The Commission distinguished between transparency in the planning period when capacity
decisions are made and in the selling season. Capacity levels in the planning period were
believed by the Commission to be transparent due to factors such as that the major tour
operators were publicly quoted companies and would not be able to keep substantial capacity
additions secret, and also that they were likely to be in contact with the same hotels and
shared discussions concerning seat requirements and availability.177 If these arguments
constituted sufficient evidence for transparency, nearly every market would be transparent
enough for coordination.
The CFI held that transparency in the selling season is irrelevant since the crucial capacity
decisions - over which allegedly the collusion took place on - are taken in the planning
period.178 With very detailed arguments179, the CFI quashed the Commission's finding that
the market was transparent: First, taking into account the considerable degree of product
differentiation (there are various categories of package holidays), the CFI doubts the
Commission's allegation that coordination would take place with regard to the total number
of package holidays offered by each operator (para 167). Second, it states that in a market in
which demand is on the whole increasing, but volatile from one year to the next, an
integrated tour operator will have difficulty in interpreting accurately capacity decisions
taken by the other operators.
175 Airtours/First Choice, Case IV/M.1524, para 88.176 Airtours v. Commission, Case T-342/99, para 167.177 Airtours/First Choice, Case IV/M.1524, para 105.178 Airtours v. Commission, Case T-342/99, para 180.179 Airtours v. Commission, Case T-342/99, paras 157-180.
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5.1.4.3.3 Implications for future policy
Analysing the CFI's judgment, three general points can be made: First, the CFI reduces the
Commission's discretion with respect to economic considerations considerably. Second,
according to the judgment, it is necessary to set out how the interaction of the various
market factors may create or strengthen a position of collective dominance rather than
'ticking' them. Third, the CFI itself tries to relate its arguments on market factors to the
necessary conditions of collusion as the economic framework in section 3 suggests. Hence,
the judgment also insofar sets standards for further collective dominance cases.
5.1.5 UPM-Kymmene / Haindl and Norske Skog / Parenco / Walsum (2001):
coordination on other parameters than price or output? - the case of capacity
coordination180
Although the Commission has made allegations of coordination over capacity in
Airtours/First Choice181 and a number of other past collective dominance investigations, the
main focus in these cases remained on arguments about coordination of prices or output
decisions. In the recent cases of UPM-Kymmene/Haindl and Norske
Skog/Parenco/Walsum182, two parallel mergers in the newsprint and magazine paper market,
the Commission has carried out for the first time a detailed assessment of the possibility of
capacity coordination.183 The crucial question was whether firms can succeed in coordinating
on the installation of new plants and thereby ensure that capacity remains tight - and prices
high - even if coordination of prices (or output) is unlikely.184
Taking the paper industry as an example, it becomes clear that coordination over capacities
is unlikely at least in certain industries: Paper plant and machinery represent massive
investments.185 An oligopoly would need to find some 'rota' system as a way of coordinating
on the decision which firm is to build the next machine. If anyone deviates, i. e. builds a
machine 'out of rota', rivals would have to punish, i. e. designate someone to bear the
180 See Lexecon (2002).181 In its judgment on Airtours/First Choice, the CFI did not dismiss generally the possibility of capacity
coordination.182 Cases IV/M.2498 and IV/M.2499.183 has to be distinguished from above discussion where capacity constraints were factor that facilitated or
made more difficult collusion.184 The coordination on the installation of new plants has to be clearly distinguished from coordination on
prices or output with the possibility of investing in the installation of a plant like in some truly dynamicmodels (see above 3.3.1.1).
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investment cost of carrying out the punishment, including low profits for the whole industry.
This threat of retaliation is not credible because the deviating firm is irreversibly commited
to its capacity and, hence, the best response for rivals to the deviation is not to start
punishment by an 'investment war', but to accomodate the deviator.
Hence, coordination of capacities is unlikely if an industry is characterised by large and
irreversible investments, most importantly industries producing commodities, such as steel
or chemicals. This reasoning was accepted by the Commission in the above cases.
5.2 Approach to collective dominance
According to the Commission's contribution to the OECD (1999, p. 216) which corresponds
with other statements and the recent case law, the assessment of whether a merger will lead
to the creation or strengthening of a joint dominant position involves three steps:
1. analysis of the market structure and identification of the oligopolists (5.2.1),
2. analysis of the structural characteristics of the market in order to check whether the
market is conducive to coordination (5.2.2),
3. analysis of the impact of the merger on the competitive relationship between the
oligopolists (5.2.3).186
5.2.1 Identification of the oligopolists and initial screening test
The oligopoly includes all those firms which as a group have the ability to raise prices above
the competitive level and which, if left out, would make it impossible for the others to
achieve the anti-competitive outcome. In order to determine which firms are part of the
oligopoly and which ones part of the fringe, the Commission uses market shares and
differences in market shares as indicators.187
Having analysed the market structure in that way, the Commission appears to apply an initial
screening test based on the number of significant firms and on their combined market shares
in order to find out whether it should spend ressources on a detailed assessment of the next
two steps.
185 E. g. in the newsprint segment, a Euro 300-500 million machine is needed only about once every three to
four years, and machines have very long lives.186 Compare the very similar steps of the BKartA as outlined by Mestmäcker/Veelken in
Immenga/Mestmäcker, § 36 GWB, 172.187 A textbook example would be a market consisting of three large firms with a market share of 25% each and
the rest of the supply is accounted for by ten small suppliers each with 2-3% market share.
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So far, there is no official statement determining a maximum number of firms and a market
share threshold. However, in Price Waterhouse/Coopers the Commission stated that "from a
general viewpoint, collective dominance involving more than three or four suppliers is
unlikely simply because of the complexity of the interrelationships involved, and the
consequent temptation to deviate ..."188 (emphasis added). This tentative upper-bound of four
coincides with answers from theory (see above 3.4.1). Moreover, in past oligopoly cases, the
collectively dominant firms have generally held at least 60-70% of the market.
5.2.2 Structural market characteristics
Considering both its contribution to the OECD189, statements of (former) members of the
MTF190 and the recent case law, the Commission's checklist contains all market factors
presumably facilitating collusion which were set out in the economic framework above (3.5):
5.2.2.1 Homogeneous goods
Concerning the homogeneity of goods, the Commission's decisions reflect economic theory
(see above 3.5.2). The classification of products as homogeneous is clearest when these refer
to commodities as in Kali&Salz191 and Gencor/Lonrho192. In other cases, the Commission
tried to qualify the degree of homogeneity. It found, e. g., X-ray films to be "essentially
homogeneous" in Agfa-Gevaert and audit services to be "relatively homogeneous" in Price
Waterhouse/Coopers.
The Commission has acknowledged that products can be differentiated by advertising and
branding even where these seem physically homogeneous. However, e. g. in Nestlé/Perrier,
the Commission regarded brand loyalty only as barrier to entry. The Commission did not
examine how brand loyalty might alter consumers' perceptions of the homogeneity which, in
turn, define the degree of homogeneity and, hence, affect the likelihood of coordination by
making it harder to reach an equilibrium or by clouding market transparency.
5.2.2.2 Market transparency
The Commission uses both structural and behavioural characteristics to establish the level of
transparency on a market. For example in Gencor/Lonhro, the Commission established that,
188 Price Waterhouse/Coopers&Lybrand, Case IV/M.1016, (1998) OJ L50/27, para 103.189 OECD (1999), pp. 217-219.190 Briones and Padilla (2001); Christensen and Rabassa (2001), pp. 231-234.191 Kali&Salz/MdK/Treuhand, Case IV/M.0308, (1994) OJ L186/38, para 57.192 Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, para 138a.
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structurally, the commodity nature of platinum and the fact that it is traded in a world metal
exchange showed conclusively that its price was transparent.193 In Nestlé/Perrier, regarding
conduct, it found that the major suppliers published standardised price lists that could be
easily compared and also implemented a regular exchange of information.194
5.2.2.3 Mature market
The Commission, in line with economic theory (3.5.4), has drawn a strong link between a
stable level of demand and the likelihood of collective dominance. In Gencor/Lonrho, the
Commission explicitly stated that "a fairly stable market will not encourage new entry or
aggressive moves to capture the growth of the market"195 citing this factor when justifying
its decision. In past cases, collective dominance has been found in markets with low growth
rates of 2-4%.196
Vice versa, also in line with theory, the decline of the size of the potash market in Kali&Salz
led the Court to reason that there would be incentives to compete. At the opposite end,
similar incentives to compete were found by the Commission in a high growth market in
France Telecom/Orange.197 These incentives, inter alia, were regarded to be sufficient to
outweigh the increased likelihood of collusion due to high concentration.
5.2.2.4 Low rate of product and/or process innovation
Similarly, the Commission assumes industries with high rates of product and/or process
innovation unlikely to be conducive to oligopolistic dominance.198
However, according to (former) members of the MTF, product or process innovations which
happen in most markets to a certain extent (like, e. g., the increased use of computer
technology in an industry as an adaption to the normal technological development) are
usually not considered to remove a concern about collective dominance. Instead,
technological changes normally have to be quite fundamental to eliminate the Commission's
concern.199
193 Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, para 144.194 Nestlé/Perrier, Case IV/M.0190, (1992) OJ L356/1, paras 121, 122.195 Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, para 151.196 Christensen and Rabassa (2001), p. 231.197 France Telecom/Orange, Case IV/M.2016, para 40.198 See its contribution to the OECD (1999), p. 218; Christensen and Rabassa (2001), pp. 231-232;
Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, para 151.199 Christensen and Rabassa (2001), p. 232.
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5.2.2.5 Symmetry of costs and market shares
With regard to symmetry, the Commission tries to gather information not only on
similarities of market shares, but also on similarities of cost structures.200 This approachs is
correct since the latter fundamentally determine the degree of similarity of incentives and
retaliation possibilities. The scale of operations and, hence, market shares depend on these
parameters, but only to some extent. Hence, market shares are only a biased indicator of
costs.
The Commission explicitly relied on an analysis of cost structures in, e. g., Nestlé/Perrier201,
Gencor/Lonrho202 and Airtours/First Choice203.
However, an assessment of costs cannot be found in each case.204 This might be explained
by the fact that, first, gathering and assessing data on costs is much more costly than the
simple comparison of market shares and, second, that there is asymmetric information
between the firms and the competition authority concerning costs (moral hazard) that the
MTF might take into account.205
5.2.2.6 Structural links
After the CFI's judgment in Gencor/Lonrho, structural links between the oligopolists - in line
with theory - are not viewed as necessary condition for coordination, but as facilitating
factor. However, structural links still seem to feature prominently in the Commission's
checklist. One reason for that might be that the condition of cutting such links can be used as
remedy (see above 3.6.2).
In Exxon-Mobil,206 the Commission distinguished the following effects of a structural link
between the competitors:
1. It reduces the incentive to compete,
2. it can give access to commercially sensitive information,
3. it gives a possibility to influence the strategic choices of the competitor, and
4. it can be a vehicle for retaliation.
200 See OECD (1999), p. 218; Christensen and Rabassa (2001), p. 232.201 Nestlé/Perrier, Case IV/M.0190, (1992) OJ L356/1.202 Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, paras 182-185.203 Airtours/First Choice, Case IV/M. 1524.204 E. g. in AKZO Nobel/Hoechst Roussel Vet, Case IV/M.1681, the Commission assessed only the symmetry
of market shares.205 This asymmetric information problem might be smaller than in "single-party" cases (e. g. (alleged)
predatory pricing) since not only the merging party has to submit data on costs, but also the otheroligopolist(s). Hence, if they want to convince the competition authority that their costs are asymmetric,they have to coordinate their submissions, thus facing a cartel problem.
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Moreover, the Commission seems to qualify the different types of links with regard to their
significance: Ownership ties207 such as cross-holdings are regarded as forming a tighter link
and, hence, more dangerous than membership of a trade association208 or commercial links.
5.2.2.7 Other factors
Other factors which might be assessed include
- excess capacity and its distribution209,
- a low price elasticity of demand210,
- multi-market contact211 and
- the nature of market transactions (i. e. infrequent, non-standard and secret transactions
versus smaller contracts on a frequent and on-going basis)212.
5.2.3 Impact of the merger
Having analysed the environment in which a proposed merger takes place, the Commission
then focuses on the change which would be brought about by the proposed merger, i. e. its
effects on the likelihood of collusion.
5.2.3.1 Past level of competition
The assessment of the merger's impact starts with the past level of competition in order to
determine whether a collective dominant position already existed in the pre-merger market.
If so, the merger might strengthen such a position. If not, the analysis of past competition
serves as starting point for the prognosis whether the merger creates joint dominance. Such
an analysis usually includes
1. past movements in market shares and prices,
2. the past existence of excess capacity and
3. a past history of cooperative behaviour.
With regard to the first point, the Commission, e. g. in AKZO Nobel,213 established that in
some of the affected markets the fluctuating market shares were evidence of competition.
206 Case IV/M.1383, para 480.207 See Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, para 156.208 In Price Waterhouse/Coopers, the Commission found that the parties were linked through their membership
and running of the institutions self-regulating the auditing sector.209 Christensen and Rabassa (2001), p. 232, quote the article of Compte et al.210 See OECD (1999), p. 218.211 See e. g. Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30.212 See Christensen and Rabassa (2001), p. 232.
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Concerning the last point, the Commission, in Kali&Salz214 and Gencor/Lonrho215, found
that parties had coordinated in the past and that conditions were in place for this to be
repeated in the future. However, evidence of past behaviour has to be applied with caution
(see above 3.6.1) since the analysis in merger cases is prospective in nature. This was also
emphasized by the Court in its ruling on the Commission's Kali&Salz decision.216
5.2.3.2 Impact of merger on competition between the oligopolists
On the basis of the analysis of the past level of competition, the Commission tries to forecast
the effects of the merger on competition between the oligopolists. The Commission
acknowledges the variety of mechanisms through which a merger might influence the
likelihood of collusion (see above 3.2.1) including the absorption of a maverick firm.217
5.2.4 External competitive constraints on the oligopoly
The role of both supply and demand side constraints on the oligopoly was highlighted by the
CFI which demanded that "the Commission must establish that the foreseeable reaction of
current and future competitors, as well as of consumers, would not jeopardise the results" of
collusion (third necessary condition according to the CFI, see above 5.1.4.3.1).
5.2.4.1 Competitors
The Commission assesses the role of mavericks and other fringe firms which are already
competing in the market as well as the role of potential competitors:
5.2.4.1.1 Fringe firms and mavericks
With respect to fringe firms, the Commission in particular asks whether they would be
capable of increasing their supply sufficiently to offset a restriction of supply by the
oligopolists after the merger (i. e. whether there are barriers to expansion, see above 3.4.2.2).
For example in Nestlé/Perrier, Kali&Salz and Airtours/First Choice, the Commission found
that the fringe would not be powerful enough to upset collusive behaviour.
The loss of a maverick was discussed in the decision France Telecom/Orange in which the
Commission regarded the takeover of Orange in the Belgium market for telecommunication
213 AKZO Nobel/Hoechst Roussel Vet, Case IV/M.1681.214 Kali&Salz/MdK/Treuhand, Case IV/M.0308, (1994) OJ L186/38, para 57.215 Gencor/Lonrho, Case IV/M.0619, (1997) OJ L11/30, paras 168-172.216 France v. Commission, Case C 68/94, para 163.217 OECD (1999), p. 220; Christensen and Rabassa (2001), p. 234.
86
services as putting an end to the role of Orange in breaking up the duopolistic pricing
behaviour that had characterised the market before.218
5.2.4.1.2 Potential competitors
The Commission has - in line with the economic theory (3.4.2.1) - considered the presence
of barriers to entry as important factor in the assessment of collective dominance because of
the possibility of a "hit and run" entry. First, the Commission assesses the size of barriers to
entry (i. e. the contestability of the market) and, second, the likelihood of entry of new
competitors within a reasonable period of time. The second step involves scanning the
industry for potential entrants.219
For instance in Ciba-Geigy/Sandoz,220 the Commission found a duopoly with a market share
of 70-80% on the Greek and Spanish markets for seeds. However, entry barriers were
considered low for these two markets for other established producers of seeds with the
consequence that collective dominance was denied.
5.2.4.2 Buyer power
The strategic position of highly concentrated buyers that allows them to exercise competitive
pressure on suppliers has been taken into account by the Commission in several cases: For
example, in Pilkington/SIV221, the tendency to single sourcing by car manufacturers for each
piece of glass, the importance of each single order by major car manufacturers and their
technical capability to monitor their supplier's manufacturing costs was judged to confer a
strong countervailing purchasing power to the demand side. In SNECMA/TC222, buyer
power was considered a leading factor excluding oligopolistic dominance by suppliers of
landing gears for aircraft, because the three main constructors of aircraft accounted for over
three quarters of the world market, had a non-transparent procurement policy and a
preference for long term contracts which involved large quantities in each negotiation.
However, generally, the Commission has been cautious in its assessment of countervailing
buyer power and has only in exceptional cases accepted that buyer power without additional
countervailing factors could motivate the clearance of a case.223 This is in line with the
218 France Telecom/Orange, Case IV/M.2016.219 See Venit (1998).220 Case IV/M.0737, (1997) OJ L201/01.221 Case IV/M.0358.222 Case IV/M.0368.223 See Christensen and Rabassa (2001), p. 233.
87
framework in section 3 which regards the absence of buyer power not as necessary condition
of collusion (see above 3.5.5), but seems to conflict with the CFI's judgment in Airtours (see
above 5.1.4.3.1).
5.3 The future after Airtours: Merger Guidelines
Overall, both the Commission's general approach to collective dominance under the Merger
Regulation and its checklist of market characteristics are largely in line with the framework
set out in section 3 except three points which also have been highlighted by the CFI in its
Airtours judgement (see above 5.1.4.3.1 and 5.1.4.3.3): First, barriers to entry are not only a
market factor that just facilitates collusion, but a necessary condition of collusion. Second,
the market characteristics should be related to the necessary conditions of collusion (inter
alia, to make the economic analysis more transparent). Third, the economic analysis should
work out the interaction of the different market characteristics.
Both future decisions of the Commission and its Guidelines (see below 7.3) will have to
meet these standards.
88
6 COORDINATED EFFECTS IN U.S. MERGER CONTROL
"... both the [EC] Commission's analytical framework and the factors it considers in determining whether a
market is conducive to coordinated interaction are very similar to our's. ... the most important differences that
remain between us in this area relate not to the analytical framework we use, but to process issues ..."
William J. Kolasky, Deputaty Assistant Attorney General, Antitrust Division, DoJ (2002)224
In contrast to the stagnant coordinated effects concept, new developments in economic
theory have provided tools, in particular econometric and simulation techniques, which are
used to generate estimates of unilateral price effects of horizontal mergers. Hence, whereas,
in the past, U.S. merger policy has always been mainly concerned with the effects of mergers
on the likelihood of collusion, it is now in fact moving in the opposite direction, increasingly
focusing on the unilateral effects of mergers rather than on collusion.225 Assuming that
additional costs due to collection of the necessary input data for the unilateral effects
analysis are more than outweighed by the increase in quality of the analysis which
substantially reduces error costs, this shift in ressources of the U.S. antitrust agencies (the
Antitrust Division of the DoJ and the FTC) seems logic. Nevertheless, the agencies see it as
a major objective of merger policy to prevent the more tacit forms of collusion because, in
their opinion, these are difficult (i. e. more costly) to deal with under the other antitrust
statutes (compare above 3.2.2).
6.1 Difference in substance: the SLC test
When discussing the alleged distortions of EC merger control (see above 2.1.7 and
5.1.4.2.2), it has already been pointed out that U.S. merger control does not rely on a
dominance test. Instead, section 7 Clayton Act, 15 U.S.C § 18, prohibits mergers or
acquisitions"... where in any line of commerce or in any activity affecting commerce in any section of the
country, the effect of such acquisition may be substantially to lessen competition, or to tend to
create a monopoly." (emphasis added)
224 Speech with the apt title "Coordinated Effects in Merger Review: From Dead Frenchmen to Beautiful
Minds and Mavericks", held before the American Bar Association, Section of Antitrust Law, WashingtonD.C., 24 April 2002, pp. 21, 23.
225 See Baker (1997).
89
The 1992 Horizontal Merger Guidelines (issued by both agencies) interprete the notion of
"substantial lessening of competition" (SLC) by distinguishing between coordinated and
unilateral effects.226 Similar to Germany and the EC, the standard for the predictive analysis
is whether the merger creates an unreasonable risk of anticompetitive effects.227
6.2 Difference in procedure: ex-ante review
As indicated by the introductory quotation, there is a major procedural difference between
the U.S. on the one side and Germany and EC on the other side which is probably even more
important than the difference in the general tests: Whereas in Germany and the EC decisions
to block a merger or to impose conditions and obligations can be reviewed by courts only ex
post (without time limit), the DoJ and the FTC have to apply for an injunction by a court to
stop a merger, i. e. there is a review ex ante.
Hence, the BKartA and even more the Commission (due to a period of between 2-3 years
between appeal and the judgment by the CFI) have a relatively strong "bargaining" position
towards the merging firms since they can use the 'threat' to stop the merger de facto for some
time. This threat is especially effective in cases where the acquisition is financed by an
exchange of stock options and, hence, depends on volatile prices of shares. This was
highlighted by the Commission's 1999 Airtours decision which was annulled by the CFI
three years later. Analysts suggested that the companies have changed role since 1999:
MyTravel, the former Airtours, is now seen as target for First Choice.228 Hence, despite the
legal defeat, the Commission had de facto stopped the merger.
In contrast, due to the ex-ante-review, the U.S. agencies have to argue more carefully and
detailed to win the case not only legally, but also de facto. This incentive is especially useful
with respect to coordinated effects cases where a careful economic analysis is necessary and
might be one of the explanations for the fact that U.S. agencies typically carry out a more
rigorous economic analysis.
226 Since the Guidelines are not legally binding, it should be mentionned that the distinction between unilateral
and coordinated effecs has been endorsed by the courts.227 United States v. Philadelphia Nat'l Bank, 347 U.S. 321, 362 (1963); Hospital Corp. of America v. FTC, 807
F.2d 1381, 1389 (7th Cir. 1986), cert denied, 481 U. S. 1038 (1987) ("appreciable danger" standard); FTCv. University Health, 938 F.2d 1206, 1218 (11th Cir. 1991) (government must show "reasonablepropability" that the proposed transaction would substantially lessen competition in the future).
90
6.3 The role of concentration
With regard to both coordinated and unilateral effects, the U.S. agencies - like the BKartA
and the Commission - start the assessment of a merger by examining the effect on market
concentration. Interestingly, the presumption rules based on the HHI and �HHI (see above
table 2.1) are used both for coordinated and unilateral effects although, as has been already
pointed out, concentration has diffent functions concerning unilateral and coordinated
effects. However, the Guidelines are well aware of these different functions.229
Moreover, the weight which is afforded to the traditional presumption of illegality, created
by a significant increase in market concentration due to the proposed merger, has been
lessened in coordinated effects cases since courts have been more receptive than in the past
to non-market share evidence.230 The agencies themself see market share and concentration
data only as starting point for the analysis of the competitive impact of a merger.231 Hence,
concentration no longer serves as a proxy against which other evidence is tested. This has
two implications: First, the U.S. approach with regard to concentration fits in with the
analytical framework set out in section 3 which regards few firms and high concentration as
necessary, but not sufficient condition of collusion. Second, the courts' increasing demand
for non-market share evidence seems to have led to a more cautious approach to the use of
coordinated effects theory.
However, in contrast to Germany and the EC, the U.S. antitrust agencies still challenge even
5-4 mergers.232
6.4 Coordinated effects under the 1992 Horizontal Merger Guidelines
Section 2.1 of the Horizontal Merger Guidelines233 sets out the approach of the DoJ and the
FTC towards the "lessening of competition through coordinated interaction". According to
228 See Financial Times: "Brussels' veto over Airtours is censured", 7 June 2002, p. 1.229 Section 2.0: "Other things being equal, market concentration affects the likelihood that one firm, or a small
group of firms, could successfully exercise market power. The smaller the percentage of total supply that afirm controls, the more severely it must restrict its own output in order to produce a given price increase,and the less likely it is that an output restriction will be profitable. If collective action is necessary for theexercise of market power, as the number of firms necessary to control a given percentage of total supplydecreases, the difficulties and costs of reaching and enforcing an understanding with respect to the controlof that supply might be reduced." (emphasis added)
230 See ABA Antitrust Section (1997), pp. 326-327.231 1992 Horizontal Merger Guidelines, Section 2.0.232 A recent case was the merger of the two leading U.S. aluminium producers, Alcoa and Reynolds (see below
6.4.2).233 The Merger Guidelines are available on the Internet: <http://www.ftc.gov/bc/docs/horizmer.htm>.
91
the Guidelines and the agencies' contributions to the OECD, the FTC and the DoJ, after the
concentration screen, typically look for and analyse respectively
1. the susceptibility of the market to coordination (see below 6.4.1),
2. evidence of prior conduct or ongoing-price fixing or other collusive conduct (6.4.3),
3. evidence that the proposed acquisition would remove a substantial impediment to
coordination, such as by eliminating a maverick firm (above 3.2.1.3),
4. the likelihood of entry in response to oligopolistic situations (6.4.4) and
5. efficiencies (Section 4 of the Guidelines and above 2.1.3).
6.4.1 Market factors
According to the Guidelines, the agencies will examine, "depending on the circumstances",
the following market factors:
- the availability of key information concerning market conditions, transactions and
individual competitors (i. e. transparency),
- the extent of firm and product heterogeneity,
- pricing or marketing practices typically employed by firms in the market (i. e. facilitating
practices),
- the characteristics of buyers (i. e. buyer power) and sellers and
- the characteristics of typical transactions (e. g. long-term high-volume contracting vs. a
spot market).234
Other factors like demand fluctuations are mentionned implicitly in the Guidelines when
describing the mechanism of collusion (Sections 2.11 and 2.12) and explicitly in the
contributions to the OECD.
Comparing these factors with the German and the European checklist, there are (aside from
the explicit emphasis on facilitating practices) no substantial differences.
6.4.2 Relating the market factors to the necessary conditions of coordination
However - in contrast to the 1984 Guidelines235, the German checklist and the unofficial
European statements - the 1992 Guidelines isolate the market factors regarded as conducive
to reaching terms of coordination, those conducive to detecting deveations from those terms
and those conducive to punishing deviations, i. e. each factor is put in the context of the
234 1992 Horizontal Merger Guidelines, Section 2.1.235 Compare 1984 Guidelines Sections 3.41 and 3.42 with 1992 Guidelines Sections 2.11 and 2.12.
92
specific element of the analysis to which it relates. Taking this as model, the framework set
out in section 3 was developed.
Moreover, according to the DoJ's chief antitrust economist, the U.S. authorities will focus on
two aspects in the assessment of coordinated effects in the future:236 First, instead of looking
at factors individually, which make a market conducive to coordinated effects, the U.S.
authorities will rather concentrate on the interaction among the different factors. Second, the
analysis will be tied to how a merger changes those factors and the likelihood of tacit
collusion. Especially the first point has been also highlighted by the CFI in its Airtours
judgment (see above 5.1.4.3.3). Since the future EC Merger Guidelines meet the standards
set by the judgment (see below 7.3), there will also be convergence concerning the aspect of
interaction.
6.4.3 Evidence of prior or current coordination
In both the Guidelines and the contributions to the OECD, the DoJ and the FTC emphasize
the importance of evidence of prior or current current coordination. The U.S. view seems to
be that it would be difficult to substantiate coordinated effects where there remained four or
more firms in the market unless there was some clear facilitating device or practice which
could be argued to be the vehicle for tacit collusion.
The U.S. authorities are well aware of the restrictions (see above 3.7) with which such
evidence has to be applied.237
6.4.4 Analysis of entry
In the U.S. Horizontal Merger Guidelines, a whole section (Section 3: "Entry Analysis")
deals with barriers to entry. Summarising the role of barriers to entry in merger analysis, the
Guidelines state:"A merger is not likely to create or enhance market power or to facilitate its exercise, if entry into
the market is so easy that market participants, after the merger either collectively or unilaterally
could not profitably maintain a price increase above premerger levels."
According to the three-step approach set out by the Guidelines, the agencies assess whether
1. entry can achieve significant market impact within a timely period,
236 Interview with Michael Katz, American Bar Association Section of Antitrust Law "Brown Bag Program", 5
December 2001 (available at <http://www.antitrustsource.com>).237 See the interview with Michael Katz, the DoJ's chief antitrust economist, American Bar Association Section
of Antitrust Law "Brown Bag Program", 5 December 2001 (available at<http://www.antitrustsource.com>), pp. 16-17.
93
2. commited entry would be a profitable and, hence, a likely response to a merger having
competitive effects of concern and
3. timely and likely entry would be sufficient to return market prices to their premerger
levels.
Both the analysis and the significant role of barriers to entry the assessment of mergers with
coordinated effects fit in with the framework set out in section 3 which finds barriers to entry
as necessary condition for collusion.
6.4.5 The relationship between coordinated and unilateral effects
In contrast to the practice of the BKartA and the EC Commission, the U.S. authorities in
some cases ascribe both unilateral and coordinated effects to a merger.238 E. g. in its
complaint against the proposed merger of WorldCom and Sprint (2000), the DoJ alleged
coordinated as well as unilateral effects in, inter alia, the U.S. market for long distance
telephony services. In this market, AT&T, WorldCom and Sprint accounted for 80% of the
market with the next largest competitor having only 3% of the market. The DoJ noted that
competition from Sprint provided a significant constraint on the prices charged by
WorldCom: "The proposed acquisition, by eliminating this competition from Sprint, will
permit the merged entity profitably to charge higher prices than it could profitably charge
absent the merger". Moreover, the DoJ stated that "the merger will also facilitate coordinated
or other collusive pricing ... by the merged entity and AT&T" (emphasis added).239
There are two reasons why the U.S. authorities may allege both effects, one substantive and
one procedural argument: First, as was pointed out above (2.3), in reality there might be a
sequence with unilateral effects first and coordinated effects afterwards. Second, in
comparison to German and EC ex-post review, the ex-ante review by courts in the U.S.
increases the incentive to 'do everything' to win the case (see above 6.2). This explains why
the U.S. authorities "plead in the alternative".
6.5 Cases240
Both cases which are presented in the following highlight two general points:
238 E. g. in the (proposed) mergers of Coca-Cola/Dr. Pepper (FTC, 1994), Cargill/Continental Grain (DoJ, July
1999), Alcoa/Reynolds Metals (DoJ, May 2000), Heinz/BeechNut (see below 6.5.2).239 WorldCom/Sprint, available at <http://www.doj.gov>.240 For other U.S. merger cases see OECD, pp. 45-46.
94
First, if the BKartA or the EC Commission or German or EC courts had dealt with the cases
under the concept of collective dominance, it would have been very likely that the
assessment would have been similar to the assessment of the U.S. agencies and courts except
the consideration of efficiencies. Hence, there is considerable convergence of the analytical
frameworks (see below 7.1).
Second, although the analytical framework in coordinated effects cases in abstracto is clear,
there is much discretion for competition authorities and courts in using evidence for the
different factors and in weighing the different factors concerning a specific case (this
becomes especially clear in the case Heinz/Beech-Nut).
6.5.1 Union Pacific / Southern Pacific
In 1996, the DoJ (like many states) opposed the proposed merger of the Union Pacific and
Southern Pacific railroads, two of the three major rail carriers in the western United States,
since it would have reduced the number of rail carriers on major routes from three to two,
creating a duopoly that would facilitate coordinated price increases.
However, the court which had jurisdiction, the Surface Transportation Board (STB), allowed
the merger to proceed over these objections.241 While accepting that coordination is more
likely in a duopoly than in a market with three players, the STB identified a number of
factors which argued against significant coordinated effects, inter alia
- the heterogeneity of rail transportation service,
- the lack of transparency of rail prices and services,
- the extensive use of long-term, individually-negotiated contracts by large shippers,
- the significant economies of density and scope which created an incentive for railroads to
compete for all profitable volumes rather than to collude, and
- the relatively high elasticity of demand for rail service due to intermodal competition with
trucks and barges.
In addition, the STB found that the disappearance of Southern Pacific was not likely to
increase the probability of coordination because Southern Pacific was a relatively weak,
high-cost third bidder, whose presence did not significantly constrain its larger rivals' prices.
Finally, the STB found that the "small risk of coordination" was outweighed by the
substantial efficiencies of the merger due to significant cost savings.
241 Union Pacific Co./Southern Pacific Transportation Co. 1996 WL 467636 (S.T.B. 1996).
95
6.5.2 Heinz / Beech-Nut242
In the market for jarred baby food in the U.S., the market leader Gerber had a market share
of at least 65%, Heinz accounted for 17.4%, and Beech-Nut's share was 15.4% with Heinz
and Beech-Nut competing for the "second slot" on retailers' shelves. The acquisition of
Beech-Nut by Heinz would have raised the HHI by more than 500 points to a level in excess
of 5000. This would have represented a substantial increase in concentration in an already
concentrated market, reducing the number of significant sellers from three to two.
The FTC's primary competitive effects theory was that the merger would facilitate tacit
collusion.243 The FTC alleged that Heinz and Beech-Nut could not collude successfully with
Gerber pre-merger because the two second brands would have a too great incentive to cheat
through more aggressive shelf-space competition. If, e. g., Heinz went along with a high
price, Beech-Nut would approach supermarkets with a lower price to replace Heinz on the
shelf expecting to profit by taking business away from Gerber by a lower retail price. After
the merger, however, the wholesale competition between Heinz and Beech-Nut, which the
FTC saw as the key obstacle to tacit collusion, would be removed.
In contrast, Heinz claimed that, due to the merger, substantial efficiencies would be obtained
in the production, and that these efficiencies would be used to compete with Gerber.244
The district court rejected the FTC's arguments emphasizing two coordination problems:245
first, the difficulty of deterring cheating, given the time it would take for rivals to detect and
respond price cutting, and, second, the difficulty the merged firm would have in reaching a
consensus with Gerber given the combined firm's incentive to disrupt coordination by
expanding share at Gerber's expense. The court held that the defendants had rebutted the
FTC's prima facie presumption based on market concentration. It also accepted Heinz's
contention that the efficiencies from the merger would promote competition in the market.
The appeals court, the D.C. Circuit, disagreed with the district court, and remanded the case
with an order that a preliminary injunction should be entered. It held that the defendants had
failed to show that the difficulties of overcoming "cartel problems" were "so much greater in
the baby food industry than in other industries that they rebut the normal presumption" that
242 See Baker (2002), pp. 182-185.243 The FTC also alleged a unilateral effects theory arguing on appeal that the loss of wholesale competition
between the merging firms should be an independent basis for finding a violation.244 Baker as Heinz's economic expert testified that "the merged firm ... would disrupt coordination, make it
more difficult for the firms to coordinate." (see Heinz, 116 F. Supp. 2d).245 116 F. Supp. 2d 190 (D.D.C. 2000).
96
would apply in reviewing a merger to duopoly.246 In finding that the defendants had not met
this burden, the D.C. Circuit, in contrast to the district court, noted that policing and
monitoring a collusive agreement would be relatively easy because information on
supermarket prices and sales were highly transparent due to the availability of industry-wide
scanner data and that there was a history of price leadership in the industry. Moreover, the
court found that the claimed efficiencies were both overstated and not merger-specific.
Finally, it rejected the argument that the merged Heinz/Beech-Nut, which would still be only
half of Gerber's size, would have an increased incentive to behave as a maverick due to the
efficiencies the merger would generate.
246 FTC v. H.J. Heinz, 246 F.3d 708 (D.C. Cir. 2001).
7 COMPARISON, POLICY SUGGESTIONS AND LOOK INTO THE
FUTURE
"... the two jurisdictions have moved closer, if not to absolute convergence, because of a shared
appreciation that mergers that contribute substantially to concentration can produce cartel-like effects
(hence the EC has moved to expand its zone of challenge), but those effects will occur only if there is
relatively high concentration, significant barriers to entry and conditions that facilitate collusion or non-
collusive coordination (hence the U. S. has narrowed its range of targets). I wonder if ten years from now
observers will be able to detect significant differences in the way the U.S. and the EC address the
combined market share of mergers that are likely to have oligopolistic effects."
Robert Pitofsky, Chairman of the Federal Trade Commission (2000)247
The overall development over the last ten years was that the EC and the U.S. approach
towards horizontal mergers have converged substantially, with the U.S. agencies and
courts paying increasing attention to unilateral effects and the European Commission
and courts similarly paying more attention to coordinated effects.248
7.1 'Soft' convergence
With regard to coordinated effects, the above statement of the FTC's Chairman has been
confirmed by sections 5 and 6: Although the underlying general tests are still different
(i. e. the law has not been changed), the analytical frameworks and checklists of the EC
Commission and the FTC and the DoJ have converged substantially. From this point of
view, the Commission's decision in Airtours can be even regarded as "overshooting".
Except for the legal(istic) distinction between internal and external competition which
the GWB determines as starting point of the analysis, the German approach to collective
dominance - as set out in the revised Merger Guidelines and as applied in practice - is
largely comparable to the EC and U.S. approach. The insights from economic theory
and the findings concerning the assessment of coordinated effects under the three
merger regimes are summarised in the following table:
247 Speech with the title "EU and U.S. Approaches to International Mergers - Views from the U.S. Federal
Trade Commission", held at the EC Merger Control 10th Anniversary Conference in Brussels on 14/15September 2000, p. 2.
248 See the speech of William J. Kolasky, Deputy Assistant Attorney General at the DoJ's AntitrustDivision with the title "Coordinated Effects in Merger Review: From Dead Frenchmen to BeautifulMinds and Mavericks", held before the American Bar Association, Section of Antitrust Law,Washington D.C., 24 April 2002, p. 1.
98
Economic theory Germany EC (so far) U.S.
1 Substantive issues
1.1 Underlying test
SLC test preferable
in abstracto: identi-
fiable with econo-
mics of unilateral/
coordinated effects
dominance test
=> collective
dominance
dominance test
=> collective
dominance
SLC test
=> coordinated
effects
1.2 (Market) factors which are assessed in coordinated effects cases
Few firmsSelten: 4
Farrell: 3
3-2 and 4-3
mergers
3-2 and 4-3
mergers
3-2, 4-3 and
5-4 mergers
Concentration (in terms of
market shares, concen-
tration ratios, HHI)
++++
++++
lower bound:
C3�50%
(presumption
rule)
++++
lower bound:
C4�60%
(no presumption
rule)
++++
1. HHI>1000 and
�HHI>100
2. HHI>1800 and
�HHI>50
(presumption
rules)
Barriers to expansion and
entry (=no actual competi-
tion by the fringe and no
potential competition)
++++ ++++
- Commission so
far: +++
- CFI: ++++
++++
(No loss of a) maverick +++ ++ ++ +++
Stable demand conditions +++ ++(+) ++(+) ++(+)
Homogeneous products +++ +++ +++ +++
Market transparency +++ +++ +++ +++
Low buyer power +++ +++ CFI: ++++ +++
Low price elasticity ++ ++ ++ ++
Symmetry ++ ++ ++ +
Structural links ++ +++ +++ ?
Facilitating practices ++ + + ++
Past collusion++, if used
correctly++ ++ +++
Multi-market contact + + + +
2 Procedural issues
Guidelines
Increase transpa-
rency and consti-
tute self-binding
yes (2000) draft (2002) yes (1992)
Review by courts ex ante ex post ex post ex ante
++++ = considered to be a necessary condition of collusion; +++ = very important factor;
++ = important factor; + = factor that is only additionally assessed;
( ) = no clear-cut statement possible; ? = no statement by competition authority or court
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7.2 Differences and resulting suggestions for reform from a European point of view
Although there has been considerable convergence overall, the table shows that there
are still differences between the three merger regimes concerning the assessment of
coordinated effects:
First, still different weight appears to be attached to certain market factors. Second, in
contrast to German and U.S. merger control, the EC approach does not use presumption
rules based on market concentration. Due to the importance of non-market share
evidence and due to the complexity of the analysis, it does not seem to be appropriate in
coordinated effects cases to reverse the burden of proof. Instead, concentration
measures should only be used to provide for safe harbours.
Third, the SLC test coincides with the economics of unilateral and coordinated effects.
Hence, it is clearest about the underlying economic mechanisms.
Fourth, the ex-ante review by U.S. courts appears to be the better solution to the
question of checks-and-balances in merger cases than ex-post review with the
possibility of interim orders. Hence, in particular the EC should start thinking about the
introduction of such an ex-ante review by the Court to end the debate about the
Commission's executive, legislative and de facto judicial power in the field of merger
control. Internal "due process", as currently debated, is not sufficient to solve the
problem of the Commission's bargaining position.249
Fifth, another general institutional difference, which makes a difference with respect to
the quality of the economic analysis especially in complex coordinated effects cases,
lies in the simple fact that particularly the FTC already maintains a large staff of
Industrial Organization economists and econometricians. In contrast, DG IV is currently
still considering to expand its economics section.250
249 For a discussion of an internal reform of DG IV after the Airtours judgment see the Economist, "Will
the real Mario Monti please stand up? A court ruling has given Europe's competition authority aunique chance to reform itself. Will it take it?", 15 June 2002, pp. 65-66.
250 See the speech of William J. Kolasky with the title "Coordinated Effects in Merger Review" heldbefore the American Bar Association, Section of Antitrust Law, Washington D.C., 24 April 2002, p.23.
100
7.3 The European Commission’s proposals for a reform of EC merger control
On 11 December 2002, the European Commission has adopted a proposal for a revised
Merger Regulation (which requires approval by the Council) and a draft Notice on the
appraisal of horizontal mergers under the Merger Regulation.251
The revised Merger Regulation will contain a new definition of “dominance” in Article
2(2)
“For the purpose of this Regulation, one or more undertakings shall be deemed to be in a
dominant position if, with or without coordinating, they hold the economic power to
influence appreciably and sustainably the parameters of competition, in particular, prices,
production, quality of output, distribution or innovation, or appreciably to foreclose
competition.”252
This definition distinguishes between three main merger scenarios:
7.3.1 Single dominance: One undertaking having market power without
coordinating
The first category - one undertaking having market power without coordinating - can be
identified with the current notion of “single dominance”: A horizontal, vertical or
conglomerate merger creates or strengthens the market position of a single entity. This
category is described as follows in the draft Guidelines on horizontal mergers (para 11,
see also paras 19-24):
“(a) A merger may create or strengthen a paramount market position. A firm in such a
position will often be able to increase prices without being constrained by actions of its
customers and its actual or potential competitors.”
7.3.2 Collective dominance: More undertakings having market power with
coordinatin (collusive oligopolies)
The second category given by the draft Article 2(2) MR - more undertakings having
market power with coordinating - incorporates collective or joint dominance into the
Merger Regulation and, hence, eliminates the current “blind spot” in the text of the
Regulation. The creation or strengthening of a collective dominant position is described
as follows in the Guidelines (para 11):
251 Commission Notice on the appraisal of horizontal mergers under the Council Regulation on the control
of concentrations between undertakings; both drafts are available at: <http://www.europa.eu.int/comm/competition/ mergers/review/>.
252 See also the proposed new recital 21.
101
“(c) A merger may change the nature of competition in an oligopolistic market so sellers,
who previously were not co-ordinating their behaviour, now are able to co-ordinate and
therefore raise prices. A merger may also make co-ordinating easier for sellers who were
co-ordinating prior to the merger.”
In the draft Notice (paras 40-69), the Commission makes clear that it has learned its
lesson from the Airtours decision. It explicitly quotes the three basic conditions for co-
ordination to be sustainable which have been worked out by the judgment (see para 44):
1. monitoring (paras 55-60),
2. a deterrent mechanism (paras 61-68) and
3. the inability of outsiders (competitors and customers) to jeopardise the results
expected from the co-ordination (paras 69).
Moreover, the Notice relates these conditions to the market factors which feed into these
conditions.
7.3.3 More undertakings having market power without coordinating (non-collusive
oligopolies)
By introducing the third category of “more undertakings having market power without
coordinating”, the Commission equips itself with an instrument to deal with a situation
like in Airtours, i. e. a pre-merger market structure with three or four firms which all
have less than 40 % market share where a merger might have relevant unilateral effects.
This category is described as follows in the draft Guidelines on horizontal mergers (para
11):
“(b) A merger may diminish the degree of competition in an oligopolistic market by
eliminating important competitive constraints on one or more sellers, who consequently
would be able to increase their prices.”253
Hence, the first distortion (unilateral effects under the heading of collective dominance)
will be prevented from in the future. Inspired by the U. S. Guidelines, the draft Notice,
for such situations, explicitly introduces the HHI (paras 26-29) and distinguishes
between Cournot (paras 30-33) and Bertrand markets (paras 34-38).
102
7.3.4 ‘Hard’ convergence
Hence, under the future Merger Regulation, the term “dominance” will be interpreted by
the economics of unilateral (one or more undertakings having market power without
coordinating) and coordinated effects (more undertakings having market power with
coordinating).
Moreover, the draft Notice explicitly deals with entry (paras 78-86) and introduces an
efficiency defence (paras 87-95), which is very similar to the respective defence under
the U.S. Merger Guidelines, thus eliminating the second distortion of the current Merger
Regulation. Hence, overall, there will be no important substantive differences between
U.S. and EC merger control in the future.
The above analysis has demonstrated the 'victory' of the economics of coordinated
effects in merger control which was reached - to some extent - by mutual learning of
competition authorities.
253 Para 11.
103
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