A merger occurs when two firms join together to form one bigger company. Therefore, the new company will have an increased market share. However, this higher market share will have significant problems. The competition commission will be especially concerned because the new firm is likely to have more than 25% of the market share, which is the legal definition of a monopoly. (about 45% between the two supermarkets
Problems of Merger
Firstly, with an increase in monopoly power there will be less competition and consumers will have less choice. With little competition, demand will be inelastic; therefore, firms will be able to increase their profits by increasing their prices.
This will cause a fall in consumer surplus
With less competition firms will have less incentives to develop better quality services; therefore, as firms will not respond to consumer preferences there will be an increase in allocative inefficiency.
Also, the firms will have less incentive to cut costs; therefore this could lead to average costs becoming higher than in competitive markets. This will increase productive inefficiency.
If a supplier is dealing with a Monopoly firm it will have difficulty in selling goods at a higher price. Therefore, a Monopoly firm will be able to make increased profits at the expense of suppliers. Therefore, a merger between Tesco’s and Sainsburys is likely to cause lower prices and profits for British farmers.
The new firm will be able to make a higher level of supernormal profits, this could be harmful because they may use it to subsidise predatory pricing to force rivals out of business. However, predatory pricing and selling below cost are outlawed
Despite these disadvantages there are potential advantages. Firstly, the new firm may benefit from economies of scale and therefore the bigger company will have lower average costs. For example, the new larger firm may benefit from greater bulk buying economies of scale; e.g. if it buys larger quantities of supplies it will get a lower average cost because of more efficient transport. Also, the firm could benefit from financial and organisational economies of scale.
However, the firms are already big and there may not be much scope for more economies of scale, indeed if it gets too big it may suffer from diseconomies of scale.
If Tescos is already at the lowest point on the LRAC a merger will not lead to any further economies of scale but could cause diseconomies of scale.
The new firm will get more supernormal profits and therefore could use this to invest in research and development to develop better checkouts and delivery systems. However, there is perhaps limited scope for research in the retail industry; this argument would be more relevant in the pharmaceutical industry.
In conclusion, a merger between 2 companies can give potential benefits such as economies of scale and more research; however, it is unlikely that this particular merger would lead to much more economies. It is more likely that the disadvantages outweigh the advantages. With the reduction in competition it is likely that consumers will face higher prices, less choice and perhaps more inefficiency production from the new company.
Commentary:
- This essay is primarily about the costs and benefits of an increase in Monopoly power.
- It is important to be able to give both advantages and disadvantages of this merger
- It is a good exam technique to evaluate each point mentioned for example Research and development is a potential advantage but in the case I thought it was unlikely to be important