It is possible for market competition to be reduced through corporate mergers.

Not ALL mergers are anti-competitive, though, and some are even efficiency enhancing.

Let's take a look at three categories of mergers:

1.

CONGLOMERATE mergers are mergers between companies with unrelated output.

For example, in 1967, the Campbell Soup Company acquired Godiva Chocolate.

Did this merger affect competition in the soup market?

No.

Did it affect competition in the candy market?

No.

Conglomerate mergers do not reduce competition in either market, since the products are unrelated,

so the US government allows them.

2.

VERTICAL mergers are "input-output" mergers.

This means that a firm that produces a product merges with a firm that produces a resource

used in that product.

For example, what if the soup company acquires, say, the company that makes the cans that

the soup comes in?

This is actually cost-reducing, i.e., efficiency-enhancing, because (among other reasons), it cuts out

the costs of the "middle-man" -- the soup company doesn't have to continually re-negotiate

contracts with the can producers.

Because vertical mergers make production more cost-effective, the government typically has

no problem with them.

The one exception would be if a company was trying to acquire the sole producer of a resource,

since that would result in a monopoly in the product market.

For example, in 1999, there were two major competing bookstore chains on the East Coast

-- Borders, and Barnes & Noble.

Barnes & Noble put in a bid to acquire a book wholesaler, Ingram, but the government rejected

the request, because Ingram was the only major book distributor on the East Coast.

Approval of the merger would leave the competitor, Borders, without a distributor, effectively

driving them out of business.

The government rejected this merger because of the monopoly that would result from it.

3.

HORIZONTAL mergers are mergers between companies that sell the same output.

These are the mergers that undergo the greatest scrutiny by the government; if the merger

doesn't noticeably alter competition in the industry, it is approved, but if it DOES affect

competition, it is rejected.

There is a big difference between two small companies (say, each has 1% market share)

merging, vs. two large companies (say, one has 15%, and the other has 25%) merging.

The government uses "industry concentration" data to evaluate merger requests.

The Herfindahl-Hirschman Index uses the sum of the squares of each firm's market share

(or the largest 50 firms, if there are more than 50) to measure industry concentration.

For example, if the industry is a monopoly, then there is only 1 firm, which has 100%

of the industry, so H = (100)2, or H = 10,000.

Thus 10,000 represents the highest possible index number, or the highest level of industry

concentration.

An industry with two firms, each having 50% of the market, would have H = (50)2 + (50)2,

or H = 5,000.

What about an industry with 100 firms, each having 1% of the industry?

Then H, the sum of the squared shares of the top 50 firms, would be 50.

A Herfindahl-Hirschman Index of less than 100 indicates a "highly competitive" industry;

an HHI below 1500 indicates "unconcentrated;" and HHI between 1500 and 2500 is considered

"moderately concentrated;" and an HHI above 2500 indicates a "highly concentrated" industry.

2500 is the Us threshold for mergers.

One potential weakness in using the HHI is that the index can vary based on how the applicant

may "define" the industry in the request for merger.

For example, in 1997, McDonnell-Douglas and Boeing merged.

You would think that, being the two largest aerospace companies in the US, such a merger

would be rejected, but the companies argued that the applicable market was global, not

just domestic, so that foreign companies constituted part of the market in question.

Thus the Federal Trade Commission said that Boeing's acquisition of McDonnell-Douglas

would "not substantially lessen competition or tend to create a monopoly in either defense

or commercial aircraft markets," and the merger passed the "industry concentration" hurdle.

NEXT TIME: MARKET FAILURES.