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Cracking Down on Mergers
How a simple number shapes the future of firms and markets in the eyes of the Federal Trade Commission
Earlier this month, the Justice Department and the Federal Trade Commission jointly released a set of proposed guidelines to address potentially illegal mergers. If approved, these new guidelines will redefine how markets are understood and expand regulators' considerations when determining whether to approve or block deals. Assistant Attorney General Jonathan Kanter emphasizes that the modern economy is vastly different from what it used to be:
As markets and commercial realities change, it is vital that we adapt our law enforcement tools to keep pace so that we can protect competition in a manner that reflects the intricacies of our modern economy. Simply put, competition today looks different than it did 50 — or even 15 — years ago.
The original merger guidelines go way back to 1968, but don't let that fool you; there have been plenty of updates since then. This isn’t even the first update under the current administration. It’s just one part of the White House's broader efforts to promote competition and curb unnecessary consolidation.
The Biden administration appears determined to crack down on monopolies, appointing regulators like Kanter and FTC Chair Lina Khan, who have taken strategic legal action against corporations to limit their market power. The new merger guidelines align with the administration's commitment to safeguard market competition. As an economy grows and adapts, policymakers reconsider the methods they use to maintain competitive markets and safeguard fair competition.
But you know, some economists are concerned about the administration's presumption that almost all mergers are detrimental to the economy. They argue that industry profits might not actually be at their highest with a single firm and that this presumption of mergers ignores the potential cost savings and increased efficiency. There is also some simple theoretical support for why a single firm may not be able to maintain high profits if they’re constantly paying off other firms interested in their market.
However, the FTC and DOJ are taking a stronger stance against mergers despite their courtroom challenges. Many people have a one-sided view of monopoly power in markets. This comedy short represents how a lot of people think about monopoly power. They see only higher prices for consumers and ignore the realities of what can happen in vibrant markets:
Now, let's get to the heart of how regulators measure market concentration. They use a tool called the Herfindahl-Hirschman Index, or HHI. This measure acts as a compass for policymakers and observers to gauge market concentration. It’s not a perfect measure, but it is a simple one that provides a snapshot of the competitive landscape. Alright, but how do they calculate this HHI thing?
Calculating the HHI
The HHI is calculated by squaring the market share of each firm in the market and then adding up these squared values. The higher the HHI value, the greater the concentration and potentially less competition among firms. Less competition often implies higher prices for consumers, which has historically been the primary concern for FTC/DOJ oversight.
Perhaps a numerical example can lend some insight to the measure. Let's consider a market with four firms, each holding market shares of 25%, 20%, 30%, and 15%, respectively. The HHI would be calculated like this...
An HHI value on its own may not be all that informative. There are multiple ways to arrive at the same value depending on how many firms are in the market. The HHI can provide more insight when it’s used to measure changes in market concentration.
Let's take the same market but with the largest firm acquiring 5% previously held by the smallest firm. We’ll still have four firms in the market, but the market shares of those four change to 25%, 20%, 35%, and 10%, respectively. The new HHI would be...
The administration uses the HHI to keep an eye on changes in market concentration, especially after mergers. Our HHI value has increased by 200 points even though we still have the same number of firms. The change occurred because our largest firm got even larger and our smallest firm got smaller. The marketer became more concentrated, and the FTC would get more concerned.
While the HHI measures market concentration, it can’t explain why the market became more concentrated. The larger firm could have gained a larger share of the market by having a superior product or offering its product at lower prices. That’s not likely to be an antitrust concern, but the FTC may be concerned if the large firm gained that additional market share by purchasing some portion of the production process or by acquiring part of the smaller firm’s business. This is why the proposed guidelines are so important.
Interpreting the HHI Values
Now, let's see how the HHI relates to different market structures we often learn about in economics courses. The measure ranges from 0 to 10,000 and represents a measure of how concentrated a market is. Lower HHI values, typically from 0 to 1,000, indicate a highly competitive market with lots of players and opportunities for new firms to enter.
On the other hand, higher HHI values suggest a few dominant firms that wield substantial influence, potentially limiting competition. But, wait for it, the administration has made some changes to the HHI thresholds. The old threshold for considering a market concentrated was an HHI of 2,500. But the new guidelines have lowered that bar to 1,800.
They've also recommended decreasing the acceptable change threshold from 200 points to just 100 points. So, even relatively small changes in market share will now be under scrutiny. This is particularly true if a single firm has more than 30%. Regulators will raise their eyebrows and take a closer look.
The Connection between HHI and Market Structures
Now, let's explore briefly how HHI values align with different market structures that are taught in a principles course based on the new guidelines being proposed:
Perfect Competition (HHI < 100): In perfect competition, the market consists of numerous small firms, with each producing homogenous products. The HHI value in such markets is incredibly low, reflecting the presence of many players with minimal market share. When economists talk about competitive markets, this is the market they are often describing.
Monopolistic Competition (HHI: 100 to 1,000): This market structure features multiple firms offering differentiated products. While the HHI remains relatively low, it is higher than in perfect competition due to the presence of differentiated products. Selling products that are slightly different from your competitors allows a firm to have some market power if customers prefer that product to others.
Oligopoly (HHI: 1,000 to 1,800): Oligopolies are characterized by a small number of dominant firms that control a substantial portion of the market. The HHI reflects the influence of these major players.
Monopolistic (HHI > 1,800): A true monopoly market would have only one firm, which would result in an HHI of 10,000. The FTC/DOJ, however, and worried about industries becoming monopolistic when a single firm starts acquiring competitors. Setting that new bar at 1,800 implies that the administration is concerned monopolistic behavior begins at an earlier concentration level than previous administrators.
Why It Matters
It's fascinating how the HHI can provide so much information about market structures and the impact of mergers on competition. The HHI isn't just some abstract mathematical exercise; it's a powerful tool that policymakers, competition authorities, and firms use to navigate the complex merger process.
Now, you might be wondering, do these guidelines put a stop sign on mergers? Not quite. They're more like a compass, guiding the administration's approach to antitrust cases in the future. A higher HHI can be a red flag for policymakers who see an industry that they believe is becoming too monopolistic, indicating limited competition and potential abuse of market power by dominant firms. So, imagine a firm eyeing a regional competitor or contemplating a product line acquisition. With these new guidelines, they might think twice about their plans.
But the HHI isn't just a crystal ball for mergers; it's also a tool that can detect anti-competitive behavior. Is a dominant firm lowering prices to force competitors out? Well, the HHI has got that covered too. Collusion, predatory pricing, or market foreclosure—these tactics could harm consumers and stifle innovation.
This new proposal also addresses the growing influence of technology and digital transactions. The updates on based on how market concentration is measured, but on how regulators will evaluate these dynamic markets. Take multi-sided markets, for example, where different user groups interact, and value is derived from their presence. Think of newspapers selling ads while you read the news. The more people buy newspapers, the more advertising the newspaper can sell. The problem? A newspaper full of ads isn’t that appealing to customers, so newspapers must delicately balance the two sides of their market.
And that's not all. The administration is getting smarter about mergers that could eliminate future competition or give merging parties too much control over essential inputs. Plus, for the first time, the guidelines explicitly highlight the importance of protecting competition in labor markets.
These guidelines are like a playbook, ensuring mergers comply with federal antitrust laws. But it's not always smooth sailing. The FTC has faced challenges in recent trials, but they're still taking a closer look at firms' behavior. It's a bit like chess. They're thinking several moves ahead to maintain competitive markets and keep up with the ever-changing ways we participate.
The Chair of the FTC, Lina Kahn, earned her law degree from Yale in 2017 [Columbia Law School]
In 2022, there were an estimated 20,965 mergers in the U.S. and Candad worth a total value of $1.477 trillion [S&P Global]
Amazon sells 74% of all e-books sold online, and it sells 64% of all print books sold online [Open Market Institutes]
The Federal Trade Commission was created on September 26, 1914, when President Woodrow Wilson signed the Federal Trade Commission Act into law [Federal Trade Comission]
The largest acquisition in 2022 was Microsoft’s purchase of Activision for $68.7 billion [The Wall Street Journal]