Announcing mergers or acquisitions generally receive positive combined stock market revaluations

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Last updated: April 20, 2019

Although it seems likely that the significant average gains to horizontal mergers represent, at least in part, anticipated improvements in production efficiency, empirical evidence to this effect is mixed. It has also been posited that horizontal mergers might allow the merging firms to gain at the expense of other parties including suppliers and/or customers by exercising their increased market power. For example, merging firms may be able to increase their bargaining power over suppliers by pooling their purchasing. Also, merging firms may more easily collude with rival firms to coordinate production rates and prices at the expense of their customers. While these types of gains are not necessarily mutually exclusive of improved production efficiency, they are distinct in that they may arise even if no real improvements in production efficiency are realized as a result of a merger.

Further, these types of gains are expected to not only affect the post-merger performance of the merging firms but also the performance of other firms that share a product market relationship with the merging firms.In this paper, we will investigate the issues that have to be considered by the regulators in a horizontal merger in the British food retailing market.1. Description of the British food retailing industryBritain’s food retailing is the most concentrated in Europe, with the top five supermarket chains-Asda, Morrison, Safeway, Sainsbury and Tesco-controlling 70 percent of all food purchased. This trade was valued at £76.

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78 billion in 2000, an increase of 4.5 percent over the previous year. The UK also enjoys a pre-eminent position in European food manufacturing, with 13 of the top 20 continental food manufacturers being British-based.The purchasing power of these supermarket chains is such that it has forced margins down at many food suppliers. Price discounting by the large supermarkets has been passed on to suppliers, and a number of suppliers have lost contracts as supermarkets have rationalised their supply arrangements. The expansion of large supermarket outlets, often in out-of-town locations that are poorly served by public transport, has been at the expense of locally based shops, able to serve those without cars.

Industry figures record that between 1975 and 1995, the number of produce outlets fell from 30,000 to just 8,000.This powerful position of Britain’s supermarket chains has created an oligopoly, with a very few players controlling virtually all outlets for food and fresh produce, and able to dictate terms to the primary producers. These are horizontal retail alliances, where individual retail chains are powerful buyers in their own right.2.

Review of the Competition Commission report (October 2000)Although the report concluded that situations leading to a `complex monopoly’ were substantiated, it is transparent that the Competition Commission found any remedies to be equally complex and not justified on cost grounds. However, this does not mean that the report can be ignored, because some of the complexities and ramifications themselves bear unravelling. For example, in some locations, the Commission found “unsatisfied demand for some fascias”.

It is possible of course, to recall the many fascias among them Fine Fare and shoppers Paradise disappeared entirely because of market restructuring in the early 1980s.The Competition Commission further concluded that the main market was for weekly one-stop shopping within a 10 or 15 minute drive-time of a given retail centre and found that most multiples (ASDA being a notable exception) indulged in `local pricing’. Clearly, all of these comments have a local or spatial element that works against policy based on national interpretations or solutions.In short, they invite us to examine a series of interrelated questions concerning: basic concepts such as the nature of `competition’ and consumer `choice’; what types of spatial markets are more competitive than others; and how that situation changes through time.In addition to stressing the importance of local retail competition, there is an interesting temporal dimension to the Competition Commission report of 2000. Specifically, the authors of the report concluded that whilst profitability among the main parties was not excessive from 1996 to 1999 it had been higher in previous years. In fact, from around 1996, the major superstore chains had begun a retreat from their high-land-cost, expensive programmes of new store building which they had reflected in their accounting through a process of capitalisation of interest and had begun to set up systems for asset depreciation. More relevant, there were those who felt that practices such as capitalisation of interest when mixed with expensive new store build created an illusion of a higher level of profits than actually existed.

It may well be that the period from 1996 coincided with an orderly retreat back to more realistic portrayals of the profit situation among the superstore operators, thereby serving to remind us that markets are in a constant state of flux and may drift between being more competitive and less competitive through time.Indeed, it may be that markets may drift between illusions of being more competitive or less competitive through time. The underlying causes will probably be driven by macroeconomic factors (a fall in land and property prices), but they will also be mediated locally.Also, it is critical to note that a contributor to the Competition Commission report, Mark Harvey, suggested that it was difficult to compare between nations “without living and shopping in the other countries on a regular basis”. This `experiential’ view of retail competition is one with which we concur and, as the Competition Commission observed “in principle one would ideally use isochrones centred on the individual household …

as it is individual’s travel for groceries that one is seeking to unravel” (emphasis added). In fact, a remarkably similar approach was taken in Waterlooville, Hampshire by Hallsworth (1988) almost two decades ago, in research where respondent households were chosen precisely because they lived at the point of maximal overlap in the isochrones of two superstores.Not only were those stores located in extremely close proximity, but also they opened within six weeks of one another. Thus, whilst the Competition Commission report notably eschews the challenge of describing the `Perfect Market’, theWaterlooville case study might arguably approximate it. Note, too, that the Competition Commission report very much concentrates upon inter superstore rivalry. It discovered that hard discounters were not considered to be viable alternatives to their first-choice store by superstore patrons.Of course, Competition Commission reports tend to be initiated only when, in a `snapshot of time’, the market is considered to be uncompetitive or has the appearance of being uncompetitive or when the `Greek choruses’ are especially loud.

In this instance, the twenty-seven buying practices that were thought by the report to need remedy through a code of practice probably led the way. That said, the Competition Commission also returned to policy that crossed over into land-use planning with its suggestion that if any one of the `big five’ grocery retailers wanted to expand or build anew within a 15-minute drive time of an existing store then this should be `called in’ for scrutiny by a unit at the Office of Fair Trading (OFT) more than a passing wave at US Federal Trade Commission policy one might think. Such a regulatory development, however, would clearly have the potential to conflict with DETR policies though current land-use planning policy for large stores was not overtly criticised by the Competition Commission. Indeed, the report stated that “We have found no reason to suggest any change in the balance of interests now pursued through the planning system”.The overall conclusion, then, is that the Competition Commission report of October 2000 has not totally upset the retail status quo though it has illustrated how complex the retail market is and how policy can crossover into the jurisdictions of other civil service departments. Crucially, both the DETR and the Competition Commission have now given the strongest possible steer that more retail decentralisation would be unwelcome.3. General issues about the mergerThe main question that has to be answered by the regulators is: what is the extent to which market concentration would increase as a result of the merger?It is not only the fact that the merger involved the number one and three organisations, but that the market already appeared to be highly concentrated prior to the merger.

This observation naturally begs the question at what levels of market concentration and market share should authorities block retail mergers? For example, would, say, a merger be generally acceptable if it involved firms not ranked in the top three places? Alternatively, would an acquisition by a leading firm be generally acceptable if the target was not a leading firm (e.g. not in the top 5)?Equally, a further critical factor, apart from the effect on absolute levels of market concentration, and relevant to merger proposals involving smaller rivals, must be a view on the extent to which the market is naturally concentrating and whether the combination of two smaller rivals can yield more effective competition to the leading firms. Clearly, it is not the rankings of firms per se which the issue is, but the extent to which mergers between the very largest firms creates asymmetries in the market which might allow for the exploitation of market power which competition from (smaller) rivals might not be able to check. These concerns may of course be allayed when it is anticipated that considerable economies of scale and general cost-savings will materialise from the merger.Consequently, the regulators will want to look at how big a market share any ‘new’ business might command. They will certainly look very carefully at any bid involving Tesco as they already have over 25% of the market. They will also want to be assured that the new company will act in the public interest.

So, they will look at market share and market capitalisation.Besides, regulators should look at such business policies as pricing and make certain that no discrimination is taking place. They would also look at evidence to stop any predatory pricing, vertical price squeezing (where a vertically integrated firm controls the supply of a good and charges a higher price for that input to rivals) and tie in sales (where a firm controlling the supply of a first product insists that its customers buy a second product from it rather that its rivals).4. Where to look?Hence, there are several issues that have to be examined by the regulators before approving a merger.The first problem confronting a competition authority is determining the appropriate definition of the market, and specifically how narrowly or broadly this is defined. There are two key dimensions which need consideration: the geographic extent of the market and the substitutability between products offering similar services.

In fact, regulators have especially to investigate the supermarkets’ drive into the non-food market and the impact any acquisition would have on small and convenience stores. For instance, Tesco and Asda generate substantial sales from home wares and clothing and have been developing that side very significantly. Tesco and Asda have been pouring investment into non-food merchandise, which generates much higher margins than the traditional food lines. Also, Sainsbury is following their lead and plans a big non-food launch in September. It’s therefore essential to ask whether there are any impacts that relate to the non-grocery offering.

The regulators may look at all parts of the market, including c-stores and taking in the impact of non-food sales, petrol sales and Internet home shoppingAnother issue related to market definition is whether to consider one-stop superstore shopping and convenience store shopping as two separate markets or not. Regulators have to look for any adverse impacts a grocery merger would have on small and convenience stores. This is illustrated by the fact that Tesco and Sainsbury are both expanding into neighbourhood stores and Tesco’s commitment to the sector was underlined last year when it bought the 860-strong T&S stores group, grabbing 5% of the corner-shop marketOther investigations should concern: buyer’s power, impact on the information systems, impact on customers and communities.> Buyer’s powerA firm with complete buyer power might be able to reduce the purchase of inputs to below the (more economically efficient) competitive level. This power can be seen as the ‘mirror image’ of seller market power: both involve a net loss to the economy as a result of a restriction in output.Then, the merger could create an issue of buyer’s power and distort competition.

So, the regulator has to identify the related mechanisms. For instance, one mechanism is the ‘spiral effect’ which stems from volume-related discounts. The greater size of the merged firm would lead to a larger volume-related discount. This would enable it to offer lower prices, undercutting those offered by smaller rivals. This in turn would increase the merged firm’s market share, which in turn would raise the volume of its purchases, which would enhance its buyer power through a higher volume-related discount and so on.The second mechanism is the ‘threat point’. This is defined as the maximum share of revenues that a supplier can afford to lose without a very serious risk of being driven to bankruptcy.

Survey evidence indicated an average threshold of 22%. The regulator could argue that a supplier is in a position of ‘economic dependence’ on a buyer when this threshold is exceeded as loss of this business could lead to bankruptcy.So, buyer power can give rise to competition concerns, in concentrated retail markets and the behaviour of large buyers should be investigated by the competition authorities. In fact, there are several ways in which purchasing behaviour by large firms can have adverse effects on competition. One example is powerful retailers making purchase conditional on the supplier not providing the same product to a downstream price discounter.

Another is buyer behaviour which increases entry barriers at the supplier levelSo, British producers might be constrained in their options of through whom they could sell their products given that there were only four major retailers, jointly controlling around 70% of the market. Also, they may switch to supply markets in other EU countries, but the credibility of this option should be investigated. In fact, this problem might not be so significant when producers can more readily switch to neighbouring geographic markets, but will remain an impediment when sunk investments are required in establishing logistics/distribution systems to supply domestic retailers.Consequently, there is considerable potential for retailers exploiting the vulnerable position of producers (principally for those producers that had invested in plant and production capacity, as opposed to those simply exporting to the country), facilitating the exercise of monopsony power (that’s reducing buying price and suppress output of suppliers with upward-sloping cost curves) and so detrimentally affect the long term viability of competitive suppliers.The Competition Commission should see if the new merger could lead to unfair trading practices with suppliers especially farmers.

> Impact on the information systems ( ECR)In the food sector, the whole nature of distribution has been changed by the information technology revolution. Information systems have enabled companies to adopt more tightly managed and efficient business practices whilst adapting commercial relationships with both customers and suppliers. The adoption of “just-in-time” (JIT) principles by manufacturing industry, and refinements such as quick response logistics (QR), has promoted a shift from “manufacturer push” to “consumer pull” in the supply chain with reduced stock levels as a consequence of more synchronised production and distribution, relying on information from electronic data interchange (EDI) and electronic point-of-sale (EPOS) systems. The more recent evolution of these concepts in retailing is called efficient consumer response (ECR) which aims to provide customers with the best possible value, service and variety of products through a collaborative approach to improving the supply chain.

However, concern has been expressed that these developments, whilst widely welcomed for reducing costs and improving efficiency, are not without (potential) costs to competition.Firstly, these systems favour large firms which have access to the considerable resources required, which once implemented put them at a competitive advantage over their smaller rivals, in many cases forcing the latter to exit the market. But apart from tending to increase the rate of market consolidation, the introduction of ECR may have other effects. For instance, the European Commission (1997) notes that modern distribution techniques “copper fasten” the position of the number one and two brands in the market, where less strong brands are delisted and replaced by the retailer’s own brands. Given that the large retailers account for a very significant part of sales, this can represent a very significant barrier to entry for other producers seeking to enter the market.In addition, concern is expressed by the Commission (1997) that modern distribution techniques are “copper fastening” the nationalistic structure of markets.

The Commission’s point is that where there is increased cooperation between suppliers and distributors through the use of information technology and a close coordination of logistics, there is a greater investment in the relationship between the parties. This means that the purchaser is less likely to put that relationship in jeopardy to buy goods in the parallel market, unless the price differential in question is great and the potential duration of the supplies is significant.In other words, the increased cooperation can act as a barrier to entry for third party suppliers and reduces the ability to profit from parallel trade.

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