L9 - Horizontal Mergers Case Studies

Question 1

Background on Sainburys and ASDA?

Answer 1

• Was going to bring together the 3rd and 2nd largest supermarkets in the UK
• Sainsbury’s –> much larger than ASDA
  
  • 1,428 grocery stores (including 647 supermarkets and 781 convenience stores) 314 petrol filling stations
  • an online grocery business (offering click & collect and home delivery)
  • sells general merchandise (including toys, electricals and clothing) in-store & online
  • operates Argos (general merchandise) and Habitat (furniture)
• Asda
  
  • 641 grocery stores (including 582 supermarkets and 59 convenience stores) 321 petrol filling stations
  • an online grocery business (offering click & collect and home delivery)
  • sells general merchandise (including toys, electricals and clothing) in-store & online
  • 33 Asda Living stores (focused on non-grocery products including clothing)

Question 2

Summary of the timeline of the merger?

Answer 2

• April 2018
  
  • Sainbury’s and Asda publicly announce intention to merge
  • Achieve over £500m in efficiencies; lower prices by 10% for many products
  • (Sainsbury’s CEO caught singing “We’re in the money!” before interview)
• August 2018: CMA formally launches merger investigation
  
  • Phase 1 investigation started on 23 August and lasted about 2-3 weeks
  • The parties asked for fast-track reference to Phase 2 –> both knew there was going to be some contention about the merger anyways
• February 2019: CMA announces provisional findings
  
  • CMA raises concerns about a substantial lessening of competition
  • The parties question the findings and propose a package of remedies
• April 2019:
  
  • final decision CMA prohibits merger
    
    • After which they admitted that the efficiencies were actually greater than they expected and some of the problems that they thought the merger was going to crease were unlikely to materialise

Question 3

What is the competition in the main market?

Answer 3

• The combination of the two would actual create the largest firm in the market
• In comparison to 2008:
  
  • Aldi and Lidl gained a huge chuck on market share in a short amount of time
  • Online shopping for groceries became more prevalent
  • Less weekly shops - more weekly and often
  • Believe that there was more of a national dimension to competition in the groceries market, not just a local one
    
    • As prices was set nationally

Question 4

What other parts of the market did the CMA look at?

Answer 4

• Online delivered groceries
  
  • Three near-national players: Tesco, Sainsbury’s, and Asda (CR3=[70-80]%) Ocado—focused on the South of England—has a comparable national share
  • Grocery prices same as in-store prices set nationally online-ordering services were same across UK; delivery prices varies locally
• Convenience stores
  
  • Sainsbury’s had a much larger group of convenience stores
    
    • pricing being set at a local level
  • Asda’s convenience stores located at petrol stations (with prices same as in-store)
• Supply of fuel
  
  • Sainsbury’s and Asda together operate 7.5% of all UK petrol stations
  • Competitors: Tesco and Morrisons; and oil majors (BP, Esso, Shell, Texaco, and Gulf)
  • Fuel prices set locally

Question 5

What did the CMA think would happen to competition if the merger went through?

Answer 5

• UNILATERAL EFFECTS
  
  • ● National: In-store groceries would have higher prices (or lower quality) (
    
    • This affects every local area where either party operated a supermarket and online groceries and in Asda’s convenience stores)
  • ● Local: Competition harmed at 40% of Sainsbury’s supermarkets and 50% of Asda’s (500 of their combined stores)
    
    • Market-power concerns in convenience stores for 18 local areas
    • Market-power concerns in fuel for 127 local areas
• COORDINATED EFFECTS
  
  • Online delivered groceries had an increased the likelihood of tacit collusion
  • (In-store groceries was not conducive to increase likelihood of collusion)
    
    • But they believed that it would the be delivery prices that would be higher due to Tacit collusion

Question 6

So why did the CMA go for prohibition rather than opting for the remedies offered?

Answer 6

• The CMA considered two potential structural remedies:
  
  • (a) prohibition of the merger; and
  • (b) divestiture to suitable parties of assets sufficient to address concerns
• After provisional findings, the parties proposed a package of remedies of
  
  • ● Structural (sell off asset to change the market structure): divest around 125-150 supermarkets, “potentially” a number of convenience stores, and a number of petrol stations
  • ● Behavioural (restriction of behaviour that would not encourage competition) : reduce prices; cap on S’s fuel margins & maintain A’s pricing strategy; S to pay suppliers promptly
• The CMA thought this proposal was insufficient and considered its own - although both firms said they would not consider any remedy package but their own :
  
  • Structural remedies risky due to difficultly of finding a buyer (evidence that the buyer leaving the market after the purchase as they cannot keep up running all of the businesses)
  • Behavioural remedies impractical due to complexity of the parties’ operations
    
    • CMA try and avoid these as they have to invest their resources and time into making them work

Question 7

Unilateral: What is the Gross Upward Pricing Pressure Index (GUPPI)?

Answer 7

• Look at how market power is changed in relation to the Lerner Index
• GUPPI percentage shows
  
  • The percentage change in the price-cost ratio of firm i, from the merger with j
    *

Question 8

Unilateral: Calculating GUPPI?

Pre-Merger

Answer 8

• Work of the GUPPI my comparing the Lerner index, pre and post-merger
• Assumption of demand
  
  • Demand for firm i will be downwards sloping (1st derivative)
  • Both have substitutable products –> if Firm i increases their prices, consumers will go to Firm j (2nd derivative)
• a monopoly’s price cost ratio is equal to its own price elasticity of demand

Question 9

Unilateral: Calculating GUPPI?

Post-Merger

Answer 9

• the merged entity will now consider the price of both product i and product j and how they will effect the profit of each other
• The second term in the Lerner Index after the reciprocal of elasticity
  
  • THE GUPPI FOR FIRM I

Question 10

Unilateral: Calculating the GUPPI?

Finding Firm i’s GUPPI

Answer 10

• The thing in the modulus –> represents the diversion ratio
  
  • numerator: extent to which firm j’s demand goes up due to the increase in firm i’s price
  • denominator: extent to which firm i’s demand goes down because of an increase in its price
• Increasing in the diversion ratio –> if there is a greater increase in those buying from firm J, the firm has more incentive to increase prices as overall their not losing out if customers go and by from J instead —> seen as they own both firms
• if J’s price-cost ratio is high firms aren’t worried about losing demand from Firm i

Question 11

GUPPI calculation for the Sainbury’s/ASDA merger?

Answer 11

• Price cost ratio –> probably used that firm’s own Lerner Index
• The controversial use of the GUPPI:
  
  • Instead of using it to identify potential problem market its was used as a threshold, if which either of their firm’s GUPPI was over it the merger would be prohibited
  • Also did a national survey of 100 markets
    
    • they did not look closely at the local market which we know is the other side of the coin of competition when it comes to the Supermarket industry
  • GUPPI
    
    • Sainburys: 2.5%
    • ASDA : 3.3%

Question 12

Coordinated: Framework for assessing the coordination that could occur?

Answer 12

• CMA had to took a really formulaic approach to assessing coordination –> this is because the theory of collusion leads them down this route as, unlike unilateral effects, there is no easier indicator to rely on
• The framework for assessing coordination is in the merger assessment guidelines
• The CMA should:
  
  • ● specify what form of coordination it considers most likely
    
    • Who is likely to collude, What strategic variable they are likely to be colluding over, what geographic markets they are going to collude and how it is going to arise
  • ● consider whether firms in the market were coordinating pre-merger
  • ● analyse the conduciveness of market to coordination pre-and post-merger
• Necessary conditions:
  
  • The CMA should analyse whether the following conditions are met:
    
    • (a) Firms are able to reach (and monitor) a common understanding
      
      • How easily would they be able to coordinate and collude
      • Can they monitor changes in prices of each other
    • (b) Coordination is internally sustainable among the coordinating group
      
      • If firm’s were to deviate, is there a sufficiently large enough punishment to deter them from doing that and to collude forever
    • (c) Coordination is externally sustainable
      
      • Are there firm outside the collusive group that could undermine them

Question 13

Coordinated: What did the CMA have to say about the Coordination of in-store groceries?

Answer 13

• Hypothetical form of coordination:
  
  • Most likely coordinating group = Sainsbury’s, Asda, Tesco and Morrisons Focus of coordination = Prices of all products or those not sold by Aldi and Lidl
  • Where? = National
  • How? = Trial and error
• Pre-existing coordination: evidence more consistent with competition
  
  • Firms spent a large amount of money monitoring each other
  • stable market shares
  • There had already been collusion 20-30 years ago in the dairy market
  • The Competition Commission in 2004 found the Safeway-Morrison merger would actually create coordinated effects
• Pre-merger conduciveness: Condition (a) not met (too difficult to create a collusive group) , so others not considered relatively stable, transparent market and the similarity in business models
  
  • no evidence of pricing alignment; great complexity of coordinating many products
• The effect of the merger: Condition (a) still not met
  
  • A reduced number of firms and increased symmetry makes coordination easier
  • But complexity remains! So, coordination not ‘more likely than not’ post-merger

Question 14

Coordinated: What did the CMA have to say about the Coordination of online groceries?

Answer 14

• Believe that coordinated effects would arise in this market
• Hypothetical form of coordination:
  
  • Most likely coordinating group = Sainsbury’s, Asda, and Tesco
  • Focus of coordination = delivery pricing (including slot length, min basket size)
  • Where? = in postcode areas where Ocado not active
  • How? Trial and error
• Pre-existing coordination: not sufficient evidence of coordination
  
  • Always monitoring each other
  • Looked at internal documents of the companies –> found that they all used different pricing strategies for their online business and that there was no pricing alignment
• Pre-merger conduciveness: Condition (a) not met, but both (b) and (c) met
  
  • Reaching agreement difficult: pricing deliveries –> Asda prices nationally, others locally
    
    • Tesco and Sainbury’s raised their prices during peak demand whereas Asda could not
  • Coordination internally/externally sustainable: gain from deviating short-lived
    
    • externally sustainable as their only other competitor was Ocado but their whole aim was to operate in the market outside where they serviced
• The effect of the merger: Condition (a) met, (b) increased and (c) not decreased
  
  • Easier to reach an agreement if Asda prices locally –> condition a) now met
  • internally sustainable –> now only two symmetrical players (easier to coordinate)
  • externally sustainable –> no outside firm to effect them colluding
  • Thus, SLC due to coordinated effects in 20% of UK postcodes