The merger case between General Electric Co. (GE) and Honeywell Inc. has sparked considerable debate between US antitrust agencies, economists and scholars since the announcement of its unsuccessful attempt by the European Commission (EC). GE is a corporation active in aircraft engines, financial services, and transportation systems while Honeywell is a manufacturing company producing aerospace products and is the leading supplier for engine starters. Both parties are from the US.
In Oct 2000, GE and Honeywell agreed to merge and Honeywell was to become a wholly owned subsidiary of GE. The US Department of Justice (DoJ) conducted thorough investigations and approved the merger with limited conditions (Platt Majoras, 2001, p. 3). However, the EC disagreed and decided to block the merger mainly because of vertical issues. The main concerns were (1) the strengthening of GE’s dominant position in the engine market through vertical integration of GE and Honeywell in relation to the supply of engine starters and (2) the vertical integration of aircraft purchasing, financing and leasing through GE Capital Aviation Services (GECAS) which can influence the markets in which Honeywell competes.
GE appealed the case to the EU Court of First Instance (CFI). The CFI decided to uphold the commission’s decision to block the merger not because of vertical issues but horizontal ones. However, it is interesting to know why the CFI disagreed with the main reasons that contributed to the EC’s decision to block the merger in the first place.
Vertical Merger; The theory. (Pro)
Vertical integration is a state where two firms are under a single ownership and productions are regulated at every stage. Backward vertical integration is where a firm regulates subsidiary inputs for its own production and forward vertical integration involves supervising retailers selling its products (Lipczynski et al., 2005, p. 546).
The most profound argument used to support a vertical merger is to rid the market of double marginalization. By doing so, both producers and consumers enjoy higher welfare. This can be illustrated below.
In a hypothetical situation, if firms A and B (both monopolist) are merged, 1 represents the total profits (producer surplus) where the wholesale price is set as the retail price and quantities of Q1 are sold while consumer surplus is represented as CS1.
If firms are separated, A (upstream) sells to B (downstream) at PW. B will decide on the quantity to purchase from A, where MC = MR (PW becomes B’s MC) which is Q2. From there B will set a higher price at PH, in order to maximize profits. Here, 2 and 3 represents B and A’s profits respectively.
Notably, the total profit from both firms combined, is lower than 1 resulting in reduced producer surplus because smaller quantities of products are sold. Consumer surplus, CS2, is also lower as consumers have to pay higher than the monopoly price as both firms each add a markup to its own price. Thus, derives the problem of double marginalization.
Another incentive to support a vertical merger is the effects of cost savings. Cost savings can be derived from a few factors. To name a few;
1. Technological conditions; an integrated entity may achieve efficiency planning and coordination and better utilization of production runs and capacity.
2. Assured supply; downstream firms that are dependent on the supply from upstream firms will need to secure supplies (and stabilize cost) by integrating backwards.
3. Avoidance of tax or price controls; an integrated entity will have internal transactions to replace market transactions that are imposed by sales tax or price controls.
It seems that vertical mergers help create efficiencies in the market by eliminating double marginalization. The theory still applies when competition is present, though it might bring forth issues at the production or distribution stage (Lipczynski...