General Electric and Honeywell Merger free essay sample

The US Department of Justice (DoJ) conducted thorough investigations and approved the merger with limited conditions (Platt Majoras, 2001, p. 3). However, the EC disagreed and decided to block the merger mainly because of vertical issues. The main concerns were (1) the strengthening of GE’s dominant position in the engine market through vertical integration of GE and Honeywell in relation to the supply of engine starters and (2) the vertical integration of aircraft purchasing, financing and leasing through GE Capital Aviation Services (GECAS) which can influence the markets in which Honeywell competes. GE appealed the case to the EU Court of First Instance (CFI). The CFI decided to uphold the commission’s decision to block the merger not because of vertical issues but horizontal ones. However, it is interesting to know why the CFI disagreed with the main reasons that contributed to the EC’s decision to block the merger in the first place. We will write a custom essay sample on General Electric and Honeywell Merger or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Vertical Merger; The theory. (Pro) Vertical integration is a state where two firms are under a single ownership and productions are regulated at every stage. Backward vertical integration is where a firm regulates subsidiary inputs for its own production and forward vertical integration involves supervising retailers selling its products (Lipczynski et al. , 2005, p. 546). The most profound argument used to support a vertical merger is to rid the market of double marginalization. By doing so, both producers and consumers enjoy higher welfare. This can be illustrated below. In a hypothetical situation, if firms A and B (both monopolist) are merged, 1 represents the total profits (producer surplus) where the wholesale price is set as the retail price and quantities of Q1 are sold while consumer surplus is represented as CS1. If firms are separated, A (upstream) sells to B (downstream) at PW. B will decide on the quantity to purchase from A, where MC = MR (PW becomes B’s MC) which is Q2. From there B will set a higher price at PH, in order to maximize profits. Here, 2 and 3 represents B and A’s profits respectively. Notably, the total profit from both firms combined, is lower than 1 resulting in reduced producer surplus because smaller quantities of products are sold. Consumer surplus, CS2, is also lower as consumers have to pay higher than the monopoly price as both firms each add a markup to its own price. Thus, derives the problem of double marginalization. Another incentive to support a vertical merger is the effects of cost savings. Cost savings can be derived from a few factors. To name a few; 1. Technological conditions; an integrated entity may achieve efficiency planning and coordination and better utilization of production runs and capacity. . Assured supply; downstream firms that are dependent on the supply from upstream firms will need to secure supplies (and stabilize cost) by integrating backwards. 3. Avoidance of tax or price controls; an integrated entity will have internal transactions to replace market transactions that are imposed by sales tax or price controls. Cons It seems that vertical mergers help create efficiencies in the market by eliminating double marginalization. The theory still applies when competition is present, though it might bring forth issues at the production or distribution stage (Lipczynski et al. 2005, p. 579). For example, the integrated firm may adopt vertical restraints like foreclosure. It is a practice of denying supply to a downstream firm or purchase from an upstream firm. There has been considerable debate amongst academics whether foreclosure would reduce competition or not. However, Bernheim and Whinston (1998)(cited in Lipczynski et al. , 2005, p. 581) argue that there is no black and white; the effects of foreclosure will vary according to conditions Krattenmaker and Salop (1986) (cited in Lipczynski et al. , 2005, p. 81) derived 3 conditions to ascertain if foreclosure harms competition. 1. Is the ability of excluded rivals to compete reduced? Competitors might face increasing costs when firms deliberately increase the price of supplies or when competitors are forced to bid for remaining inputs. However, this does not mean it will increase competitor’s cost if supplies are available from alternative suppliers. 2. Is the market increased by exclusion? Firms may not necessarily gain market power if it has powerful competitors or if entry is possible. This may harm competitors but not necessarily competition. 3. Is the exclusion profitable? Profit increase from enhanced market power doesn’t necessarily counterbalance the loss in revenue. *coloured sentences represent linkage of theory to the case. Vertical Merger; The case. Honeywell is a leading supplier of engine starters (upstream) where its inputs are necessary for the production of engines that GE (downstream) produces. GE’s CEO, Jack Welch strongly believed the merger would have provided consumers better prices, quality and services. As stated in his biography †I felt we could do so much more with Honeywell’s assets by doing what we’ve done with GE: pushing more aggressively into services, and adding Six Sigma and e-business initiatives to Honeywell’s operations. †(Welch and Byrne, 2001, p262)(cited in Grant and Neven, 2005, p. 621). The merger was estimated to contribute a total of $2. 5 billion in cost savings annually (Rimmer, 2001). Post merger, GE would have been able to integrate the production of engine starters and engines with efficient planning and coordination to create potential cost savings. The result of the merger could have eliminated double marginalization to a certain extend where the company could provide special discounts to consumers (Anwar, 2005, p. 611). These factors contribute in creating a more efficient market for both producers and consumers. However, the EC disapproved the merger because they were primarily concerned with two vertical foreclosure issues regarding Honeywell’s engine starters and GE’s leasing company GECAS. 1. Honeywell engine starters. GE, Pratt amp; Whitney (Pamp;W) and Rolls-Royce (RR) were the only independent suppliers of large commercial aircraft engines which required engine starters as a necessary component to manufacture engines. There are only two main manufacturers producing engine starters in the market, namely Honeywell and Hamilton Sundstrand (HS), holding more than 90% market share as can be seen in the table above (COMP/M. 2220, 2001, p. 84). However, HS is not considered as a competitor of Honeywell in this ma rket because it only supplies starters to Pratt amp; Whitney (Pamp;W) and not sold elsewhere in the market. Therefore, making Honeywell the dominant supplier of engine starters. The EC argued that the monopoly effect Honeywell has over competing engine manufacturers could have been an incentive to create a disadvantage for GE’s rivals particularly to RR (Vives and Staffiero, 2008, p. 8). The EC postulated that GE-Honeywell could disrupt or delay supplies and raise prices to reduce competitors’ ability to compete. The commission stated that HS would not have the incentive to supply engine starters to RR in consideration of the profits made by the group they belonged to. The parties’ responded that other starter competitors are able to supply starters to RR if they would behave as such. However, the EC argued this would not be a feasible alternative. Proposing RR to produce its own engine starters is also out of the question as barriers to entry are extremely high. Furthermore, market entry for new engine starter suppliers is difficult because of high switching costs for both engine manufacturers and aircraft operators. In this situation, RR is left at a disadvantage in competing for future engine contracts with GE, particularly in financing terms. In aircraft engine development, huge amounts of long-term investments are required. RR’s market capitalization of USD 5 billion (as of June 2001) is a far cry from GE’s USD 485 billion. With this limitation, RR is unable to provide similar funding to airframe manufacturers to secure exclusivity of its products (COMP/M. 2220, 2001, p. 52). It seems that RR cannot impose competitive constraints on GE without risking harm to its own aircraft engine activities. Thus, the argument escalated that the merger would have resulted in further foreclosure of competitors the engine market and the strengthening of GE’s already dominant position (COMP/M. 220, 2001, p. 102). Consequently, GE would have a monopoly effect on the market at the expense of consumers paying a higher price. However, Platt Majoras (2001, p. 5) argued that EU did not provide any evidence to support their claim that RR and Pamp;W no longer had the power to constrain GE’s behavior. On the contrary, these competitors were enjoying growing revenues and profits while heavily investing in the development of new engines. In addition, RR publicly announced its install based would expand twice as much in the next five years due to market share gain. The CFI also acknowledged that GE-Honeywell could potentially disrupt supplies of engine starters to competitors as a small increase in the market share for large commercial aircraft engines can make up for the loss in profits from the starters. Nevertheless, the CFI stated that the EC failed to take into account in their assessment, â€Å"the effect of Article 82 of the Treaty: the disruption of supply of engine starters of the merged entity would be a clear abuse of dominant position. † (Vives and Staffiero, 2008, p. 9). Thus it is not likely to occur or be sustained for long. With that, the CFI struck down the EC’s argument on these grounds. . G. E. Capital Aviation Services (GECAS). GECAS is GE’s subsidiary unit that provides various financing services to airlines including leasing planes, which GECAS purchased itself (Caffarra and Pflanz, 2002, p. 4). The role of GECAS was the main reason the Commission made the final decision to block the merger (Grant and Neven, 2005, p. 612). Being a subsidiary of GE, GECAS adopts a GE procurement policy in selecting its purchases whenever available. Based on this, the Commission’s theory revolves around this policy. The EC believed that GE would have had an anticompetitive impact on aircraft engine and systems market through GECAS. The EC argued that GECAS had the ability and incentive to constraint competition in aircraft systems market (in which Honeywell competes) by shifting aircraft preferences of downstream consumers (Emch, 2004, p 235). However, this argument was heavily dependent on unconventional assessments using â€Å"Archimedean leveraging† theory exhibited by complainants (Caffarra and Pflanz, 2002, p. 4). The commission argued that post merger; the â€Å"GE-only† policy would be extended to Honeywell products, securing its SFE products on new platforms. GECAS would then exert influence in promoting Honeywell’s SFE products, reducing revenues of competitors and denying them returns for future investment and innovation (COMP/M. 2220, 2001, p. 84). Therefore, leading to the foreclosure of competitors and Honeywell gaining a dominant position in the avionics and non-avionics market. While the EC claims GECAS to be the largest purchaser of new aircrafts and having the largest single fleet of aircrafts in service, they failed to mention GECAS’s low market share in the niche competitive market. Additionally, the EC states that GECAS market share was about 10%, while Nalebuff (2003) rebutted that it was approximately 7% over the past 5 years (Grant and Neven, 2005, p. 614). Evidence was provided that although GECAS was â€Å"GE-only†, other leasing competitors continued to support RR and Pamp;W. There was also evidence that customers purchased relevant products based on merit as the commission discovered itself when it stated â€Å"although packages of avionics and non-avionics have existed, they nevertheless are rare† (Patterson et al. , 2001, p. 19). Platt Majoras (2001, p. 1) argued that the EC claims were not credible. The DoJ investigated that GE’s rivals were flourishing and were in the position to maintain their competitive advantages even if GE had a higher market share. She continued to argue that Boeing and Airbus (that did not disapprove the merger) were capable of implementing policies to protect their own interests. The CFI recognizes that G ECAS did promote GE’s dominance, but acknowledged that there was insufficient evidence that GE-Honeywell had the incentive to impose â€Å"GE-only† policy to Honeywell products (Vives and Staffiero, 2008, p. ). It is worth to note that there is no aircraft that contains all Honeywell components (Nalebuff, 2003 ; Grant and Neven, 2005, p. 617). Enforcing this policy was not feasible if it jeopardizes profits from engines. Vives and Steffiero (2008) argued that the EC lacked a detailed analysis in the different markets for avionics and non-avionics products and therefore the claim that the practice of â€Å"GE-only† would have lead to GE’s dominance was questionable. Conclusion Notably, the EC and DoJ may have different concerns when assessing merger cases. Also, the EC and DoJ adopted different methodology in assessing this case. The DoJ team comprises of professional staffs, 50 PhD economists and section chiefs who reviewed all their work twice. The Commission on the other hand, relied on economic models provided by complaints’ of the merger (Grant and Neven, 2005, p. 628) In the first argument, the EC suggested that Honeywell could potentially refuse to supply starters to RR. The facts that EC presented did address Krattenmaker and Salop’s conditions for competitive harm to occur and made their argument very convincing. However, the CFI dismissed the argument as they failed to account for the treaty. The fact that mergers are judged based on the future, it would have been difficult to detect possible foreclosure. Secondly, the EC based its assessment of the case on the â€Å"Archimedean leveraging† theory submitted by complainants instead of using conventional methods. It is questionable whether the theory could present biased arguments in favor of the competitors. That aside, Nalebuff, GE’s economist presented evidence that the EC exaggerated the market share and the impact GECAS had over Honeywell’s market. In addition, the CFI also concluded that there was insufficient evidence of GE-Honeywell having the incentive to behave the way the EC had asserted. In conclusion, the arguments presented by the EC were rather speculative (Weitbrecht and Flanagan, 2007, p. 299) and provided insufficient prove that the merger would have affected rivals and consumers negatively. The EC might have also overlooked significant efficiencies the merger might have brought. It also appears that the nonconventional approach the EC adopted may have resulted in inequitable appraisal of the case. Taking into account all the counter arguments and evidence presented against the EC and the efficiencies that Welsh publically announced, it seems that the merger could have benefitted the market in terms of positive overall welfare without the expense of GE and Honeywell rivals. Therefore, this case should not have been blocked mainly because of vertical issues. The DoJ’s original decision to allow the merger with conditions addressing horizontal issues should be deemed reasonable. Reference: Anwar, S. T. , 2005. EU’s Competition Policy and the GE-Honeywell Merger Fiasco: Transatlantic Divergence and Consumer and Regulatory Issues. Thunderbird International Business Review [e-journal] 47 (5) pp. 601-626. Available through: Wiley InterScience [Accessed 16 November 2012]. Caffarra, C. and Pflanz, M. , 2002. The economics of G. E. /Honeywell. European Competition Law Review [e-journal] 23 (3) pp. 115-121. Available through: Sweet and Maxwell [Accessed 7 December 2012]. Case No COMP/M. 2220 n General Electric/ Honeywell, 2001. [online] Available at: http://ec. europa. u/competition/mergers/cases/decisions/m2220_en. pdf. [Accessed 16 November 2012]. Emch, E. , 2004-2005. GECAS AND THE GE/HONEYWELL MERGER: A RESPONSE TO REYNOLDS AND ORDOVER. Antitrust L. J. [e-journal] 72 pp. 233. Available through: HeinOnline [Accessed 20 November 2012]. Grant, J. , and Neven, J. D, 2005. THE ATTEMPTED MERGER BETWEEN GENERAL ELECTRIC AND HONEYWELL: A CASE STUDY OF TRANSATLANTIC CONFLICT. Journal of Competit ion Law and Economics [e-journal] 1 (3) pp. 595-633. Available through: HeinOnline [Accessed 16 November 2012]. Lipczynski, J. , Wilson, J. and Goddard, J. , 2005. Industrial Organization: Competition, Strategy, Policy. 2nd ed. England: Pearson Education Limited. Majoras D. P. , 2001. GE-Honeywell: The U. S. Decision. [ONLINE] Available at:https://www. justice. gov/atr/public/speeches/9893. htm. [Accessed 16 November 12]. Patterson, D. E. and Shapiro, C. , 2001. Transatlantic Divergence in GE/Honeywell: Causes and Lessons. [online] Available at: http://faculty. haas. berkeley. edu/shapiro/divergence. pdf. [Accessed 20 November 2012]. Rimmer, D. , 2001. Honeywell Acquisition Creates Billions in Cost Savings. Business amp; Commercial Aviation [journal article] 88 (1) pp. 16. Available through: Business Source Premier [Accessed 8 December 2012]. Vives, X. , and Staffiero, G. , 2008. The GE-Honeywell Merger in the EU. [online] Available at: http://blog. iese. edu/xvives/files/2011/09/GEHW-Final-prot. pdf. [Accessed 7 December 2012]. Weitbrecht, A. and Flanagan, R. , 2007. The Control of Vertical and Conglomerate Mergers Before and After GE/Honeywell – The Commission’s Draft Guidelines for Non-Horizontal Mergers. [online] Available at: http://www. lw. com/upload/pubcontent/_pdf/pub1918_1. pdf. [Accessed 20 November 2012].

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