Similarly to horizontal restraints, horizontal mergers are mergers between firms that directly compete — take the Discovery and Capital One merger from just a few days ago. Firms compete, in turn, if customer view the firms’ products as substitutes (diversion being the principal metric there).
Firms may horizontally merge to increase or protect their market power, which is defined as P-C, or simply the price they can charge over their costs. More generally, the ability to do anything not possible (at least, rational) in a perfectly competitive market correlates with market power. The more the market power, the easier it is for firms to increase prices, offer fewer or lower quality goods, collude, hurt rivals, and so on. The FTC/DOJ said this about merging to enhance market power:
“A merger enhances market power if it is likely to encourage one or more firms to raise price, reduce output, diminish innovation, or otherwise harm customers as a result of diminished competitive constraints or incentives… a merger can enhance market power simply by eliminating competition between the merging parties… the unifying theme of these Guidelines is that mergers should not be permitted to create, enhance, or entrench market power or to facilitate its exercise. For simplicity of exposition, these Guidelines generally refer to all of these effects as enhancing market power.”
Alternatively, firms may merge because of efficiencies. Efficiencies are the cost reductions associated with economies of scale, managerial efficiencies, vertical integration, and so on, which often happen as the result of a horizontal merger. For example, two cereal companies that merge might be able to merge their supply chains, bringing cost from $2 to $1.6 per unit, e.g., a $.40 efficiency. The FTC/DOJ said this about merging for efficiencies:
“Competition usually spurs firms to achieve efficiencies internally… nevertheless, a primary benefit of mergers to the economy is their potential to generate significant efficiencies and thus enhance the merged firm’s ability and incentive to compete, which may result in lower prices, improved quality, enhanced service, or new products… for example, merger-generated efficiencies may enhance competition by permitting two ineffective competitors to form a more effective competitor, e.g., by combining complementary assets. In a unilateral effects context, incremental cost reductions may reduce or reverse any increases in the merged firm’s incentive to elevate price. Efficiencies also may lead to new or improved products, even if they do not immediately and directly affect price.”
As a final reason for merging, one firm may be rescuing another that is bankrupt, on its way to bankruptcy, subject to scrutiny of some sort, or otherwise in trouble. Note the FTC/DOJ’s statement:
“A merger is not likely to enhance market power if imminent failure, as defined below, of one of the merging firms would cause the firm to exit the relevant market [if the merger did not occur]….. If [a merging firm] would otherwise exit the market, customers are not worse off after the merger than they would have been had the merger been enjoined [blocked].”
Generally, horizontal mergers that increase market power (as nearly all do) have both anti-competitive and pro-competitive effects; higher prices and efficiencies being an example. Because no two mergers are the same, Courts and Agencies have to apply Rule of Reason, which was introduced in my horizontal restraints article, to weigh pros and cons.
As a whole, horizontal mergers are usually challenged under Section 7 of the Clayton act, though they are sometimes challenged under Section 1 of the Sherman Act. Note this excerpt from Section 7 of the Clayton Act:
“That no corporation engaged in commerce shall acquire, directly or indirectly, the whole or any part of the stock or other share capital of another corporation engaged also in commerce where the effect of such acquisition may be to substantially lesson competition or to restrain such commerce in any section or community or tend to create a monopoly of any line of commerce.”
Horizontal mergers and the effects of such can be graphed and visually demonstrated via the Williamson Model. Generally, the types of horizontal mergers that increase prices the most are those where the merging firms’ products are close substitutes.
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