Critical Efficiencies as Upward Pricing Pressure with Feedback Effects

Abstract

Farrell and Shapiro’s upward pricing pressure (‘UPP’) is widely used in merger analysis due to its intuitiveness, despite not accounting for the interdependence between the merging firms’ pricing incentives (‘feedback effects’). However, ignoring feedback effects can have an impact on the way competition authorities rank mergers. The main result of this article is that UPP with feedback effects is equivalent to Werden’s critical efficiencies. Importantly, this link allows for the derivation of an expression that combines the intuition of UPP as the ‘value of diverted sales’ with the accuracy of critical efficiencies. Throughout, the focus is on the static unilateral effects of horizontal mergers with differentiated Bertrand competition.

Mergers with Differentiated Products: Where Do We Stand?

“…For this reason, the Commission has put more emphasis on full linear simulation in its case practice, which incorporates rivals’ reactions but does not require significant additional information. 40 If we use Neurohr’s ( 2019 ) formulation, predicted price effects in the full linear model are given by Here, denotes the vector of price changes, is the post-merger pass-through matrix for linear demand (i.e., the Jacobian of prices with respect to marginal cost), and is the vector of CMCRs (with entries for non-merging firms given by zero). Similar to ( 5 ), ( 6 ) reflects the fact that price effects are determined by the pass-through of price pressure into final prices (here expressed as CMCRs passed through at the post-merger pass-through rate).…”

“…For this reason, the Commission has put more emphasis on full linear simulation in its case practice, which incorporates rivals' reactions but does not require significant additional information. 40 If we use Neurohr's (2019) formulation, predicted price effects in the full linear model are given by Crooke et al 1999. 37 E.g., see Hausman (2003) at 27 (noting that concave demand "while theoretically possible, would not be expected for most new products and services").…”

“…See Jaffe and Weyl (2013) for a formal analysis.22 For this reason,Neurohr's (2019) description of CMCRs as "full upward pricing pressure" is somewhat of a misnomer, as CMCRs generically differ from the pre-merger tax that would generate postmerger prices.23 Case M.6497 Hutchison 3G Austria/Orange Austria (Commission decision of 12 December 2012); Case M.6992 Hutchison 3G UK/Telefónica Ireland (Commission decision of 28 May 2014); Case M.7018 Telefónica Deutschland/E-plus (Commission decision of 2 July 2014); Case M.7419 TeliaSonera/Telenor/JV (withdrawn, 11 September 2015); Case M.7612 Hutchison 3G UK/Telefónica UK (Commission decision of 11 May 2016); Case M.7758 Hutchison 3G Italy/Wind/JV (Commission decision of 1 September 2016); Case M.8792 T-Mobile NL/Tele 2 NL (Commission decision of 27 November 2018).24 As noted in the introduction, the UK mobile decision was recently overturned in court in CK Telecoms v. Commission, supra note 9. 25 See Buettner (2016) for a discussion.…”

“… 22 For this reason, Neurohr’s ( 2019 ) description of CMCRs as “full upward pricing pressure” is somewhat of a misnomer, as CMCRs generically differ from the pre-merger tax that would generate post-merger prices. …”

Horizontal Merger and Upward Pricing Pressure in a Bertrand-Cournot Model

“…Also, Willig (2011) show the results when using products that change the merger and partial mergers' quality. The inclusion of feedback effects in the UPP was made by Neurohr (2017). The inclusion of cost-efficiencies and some application were made by Dutra and Sabarwal (2020).…”