Analysis of the European Commission’s decision in blocking the Volvo- Scania Merger Volvo/Scania merger issue 22nd September 1999: Commission receives notification AB Volvo proposes to acquire control of the whole of Scania AB by way of purchase of shares. Volvo: Registered in Sweden Primarily active in the manufacture and sale of trucks, buses, construction equipment, marine and industrial engines as well as aerospace components. 1st March, Ford Motor acquired Volvo’s automobile business, allowing the company to fully concentrate on its trucks, buses and engines businesses. Volvo’s truck business accounted for 57% of turnover, buses 13%. Scania: Swedish company Mainly active in manufacture and sale of heavy trucks, buses and marine and industrial engines. Holds 50% of Svenska Volkswagen AB (imports, markets and distributes passenger cars and light commercial vehicules in Sweden) Scania truck business accounted for 60% of turnover, buses 8%. Why do they want to merge? To support Volvo’s effort to compete in large, emerging markets for heavy trucks and buses in Asia, central Europe, the former Soviet Republic and in south America. Why is this Merger a case for the EU commission? Possible anti- competitive behaviour. Possible creation of a dominant position due to the market power and market shares of the combined entity. EU commission’s aim is to prevent unfair market condition from being created. Outline of EU commission’s merger process for Volvo/Scania 22nd September 1999: Commission receives Volvo/Scania merger notification 25th October 1999: After examining notification, concludes that notified operation falls within the scope of the merger regulation and raises serious doubts as to its compatibility with the common market. Therefore requests information relating to Volvo and Scania’s competitive position on the markets for heavy trucks and buses. (which both parties submitted after the deadline) After carefully defining the market, the commission starts its detailed analysis, which would lead to its final verdict. EU assessment of merger case Only very recently, in 2002, the Commission has proposed reforms to make its policy principles more in line with economic thinking about oligopolistic behaviour, while keeping the concept of dominance. Policy practice in the E.U. has up to now still been largely based on the assessment of market shares and qualitative criteria such as ease of entry and buyer power, with limited attention to econometric analysis Second they stress the importance of our comparative market power test, especially in the European context (as opposed to a U.S. context where markets might be more integrated). Specifically, our test essentially considers a sequence of two regional mergers, i.e. between firms that are strong in the same geographic area. We compare the market power effects from this merger sequence with the alternative of two pan-European mergers, i.e. between firms that are strong in different geographic areas. This comparison is based on the assumption that Volvo and Scania (who are both strong in the Nordic countries) would seek for partners from other geographic areas, in the event the Commission blocks their proposed merger. In our application, Stages of Merger Investigation 1. First stage • Usually asks whether the notified merger falls within the jurisdiction of the merger authority. In the European Union this includes the question whether the merger has a European dimension. If this is not the case, then the investigation is left to the individual country or countries. 2. The second stage considers the definition of the relevant market. The U.S. 1997 Horizontal Merger Guidelines explicitly state that the market definition focuses solely on demand substitution factors, i.e., possible consumer responses. Supply substitution factors do not fall under the market definition process, but are considered elsewhere. Since 1982, the Guidelines specify their approach more precisely, based on the hypothetical market power test, or SSNIP test. 3. The third stage constitutes the actual merger investigation. In the European Union, the merger investigation at the time of the Volvo- Scania Case focuses on an investigation of anti-competitive effects, without explicitly assessing beneficial effects, such as potential efficiencies. The investigation amounts to assessing the presence of dominance. Market definition: This stage considers the definition of the relevant market Trucks The truck market is classified in three categories: light duty trucks (less than 6 tons), medium duty trucks (5–16 tons) and heavy duty trucks (more than 16 tons). The heavy truck market is further subdivided into two segments: rigid trucks and tractor trucks. Rigid trucks are integrated trucks, from which no semi- trailer can be detached. Tractor trucks are detachable. While it is recognized that rigids and tractors may not be fully substitutable, The overall conclusion is that the category of heavy trucks constitutes the single relevant market. Light and medium duty trucks are thus not included. Buses The overall bus market is divided into there are three categories of buses, .e city buses, inter-city buses and touring coaches with each category provides a different service The different requirements of different types of transport service mean that buses are heterogeneous products. The Commisson considered it appropriate to assess the competitive impact of the notified transaction on the basis of separate markets for city buses, inter-city buses and touring coaches. Market definition cont. The Commission analysed the geographic market for buses and trucks: There are substantial price and mark-up differences across countries, prices for similar model of truck vary by on average by 10-20% Second, the models and technical configurations differ considerably, because of local consumer preferences and national technical requirements (e.g., the cab crash test in Sweden, right hand drive Uk) The truck market is considered national rather that European due to the existence of after-sales network offered by truck manufacturer when purchasing trucks Purchasing is done nationally and purchasing habits and demand differ between Member States for buses and truck The comission concluded the proposed merger between Volvo and Scania is essentially a regional one. That the national markets constitute the relevant geographic market in the regions most affected. Market share analysis For assessing the creation or strengthening of a dominant position the uses traditional market power proxies such as market share analysis The investigation is limited to the five countries where the creation of a dominant position is found (Sweden, Norway, Finland and Ireland), or where this is found to be likely (Denmark). the Commission takes the market shares as the starting point of the assessment. Finds that the joint market share of Volvo and Scania is the largest in precisely the five countries where dominance is found (in the 49–91% range). This reveals that the Decision attached a high weight to the merging firms’ joint market share in assessing dominance. In its market share analysis the Commission stresses that the merging firms’ joint market share remained stable, and showed no tendency to decline. The Commission points out the large difference between the joint market share of the merging parties and the market share of the largest remaining competitor in most of the five countries. in 1998 provided by Volvo in the notification, DaimlerChrysler is the European leader with 20.6% of the EEA market, Scania ranks second with 15.6%, Volvo third with 15.2%, and then four producers (MAN, Paccar/DAF, RVI and Iveco) have EEA-level market shares between 10.4% and 12.6%13 The proposed concentration would create Europe's largest producer of heavy trucks and second largest manufacturer of buses Market share Market analysis The commission also investigated qualitative factors of the market : brand loyalty and the customer structure : for most of the five investigated countries, the Commission finds indicators of considerable brand loyalty and of to keep in mind that the truck industry has an extremely fragmented customer structure with the large majority of transport companies owned by small operators little customer purchasing power to compensate for the increased market power by the merging firms. the likelihood of entry : The entry costs are calculated to be high, especially in light of the small size of the markets and the low population density. The cab crash test in Sweden is mentioned as an additional entry barrier. Conclusion the proposed concentration would create a dominant position on the markets for heavy trucks in Sweden, Norway, Finland, and Ireland. There are strong indications that this would also be the case in Denmark. The proposed concentration would create a dominant position on the markets for touring coaches in Finland and the United Kingdom, as well as on the markets for city and inter-city buses in Sweden, Finland, Norway and Denmark as well as on the Irish city bus market. Econometric Study The authors formulated and estimated a suitable empirical oligopoly model with differentiated products The study creates a nested logit model that test the probability of customer (maximizing utility) buying a prodcut (trucks) The hypothesis that trucks within the same group (rigid or tractor) are perfect substitutes can be rejected As market size increases consumers substitute more easily out of new trucks when all prices increase, so that the estimated anticompetitive effects from a merger will be smaller the implied price elasticity mostly varies between 0.5 and _0.6, depending on the country. In the second scenario, the elasticities of market demand increase to the range of _1.0 and _1.5. The European Commission provided us their estimates obtained from industry sources, reporting that the price elasticity is around 0.9 for heavy trucks above 16 tons, and 0.4 for trucks above 24 tons. we are able to reject the hypothesis that brands within a nest are perfect substitutes hypothetical market power test computes the profitability of unilateral and nontrivial price increases by the merging firms - Hypothetical power test shows profit increase in several countries at price increase of 5,10 and 15 % the actual market power test, which imposes more specific assumptions about firm behavior after the merger.