A New Merger Tool Protects Consumers from Limits of the Cournot Effect

By: Alessandro S. Kadner-Graziano (ProMarket)

In theory, mergers of complements can benefit firms and consumers through the Cournot effect. The theoretical model on competition which 19th century French mathematician Antoine Augustin Cournot used to derive this effect presumes that there are two monopolist suppliers of complementary inputs (for example, copper and zinc). The suppliers each set the unit price for their respective input (for example, to a downstream manufacturer of brass) at a point that maximizes their own profit. Each supplier disregards the negative externality it exerts on the other: the higher its input price, the higher a manufacturer’s consumer price, the lower the quantity sold and, consequently, the lower the profit of the other supplier. If the suppliers merge (in what is called a merger of complements), they internalize the negative externality and reduce input prices to increase sales. All thereby benefit: the merging parties, the downstream firm, and consumers. This positive merger outcome is the Cournot effect.

The Cournot effect is widely accepted and thought to apply generally to mergers of complements. In actuality, it applies only to very particular circumstances.

The limitation of Cournot’s model is that Cournot modeled suppliers as monopolists. Such monopolists set high prices. But what about scenarios where competition led the merging parties to set much lower prices pre-merger? In these situations, the merged entity finds it unprofitable to decrease its already low prices because it earns little profit on any additional units sold. Instead, a merged entity that faces sufficiently strong competition wants to increase prices: it may use the merger to pursue strategies aimed at weakening competitive constraints and raising prices. There are various such anti-competitive strategies, in particular tying or bundling.

The conclusion that mergers of complements are more likely to raise subsequent input prices when the pre-merger market is more competitive may seem surprising as it differs from  intuitions based on another type of merger: horizontal mergers (where two direct competitors merge). Indeed, Valletti and Zenger find that horizontal “mergers are more likely to cause competitive concerns the higher firms’ pricing power is to begin with.”

Given the unsettled literature, how does one identify, in practice, whether the Cournot effect materializes in the case of mergers of complements? A new merger tool I developed resolves this problem by identifying if suppliers are sufficiently constrained pre-merger to rule out a price decrease post-merger…

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