Many markets of modern economies are segmented by product variety or customer type. Such market segments may arise for many reasons, but perhaps the most common segmentation dimension is quality. Quality submarkets emerge due to factors on the demand and the supply side. On the demand side, there typically are differences in the ability or willingness to pay for product quality, as it can be the case in the provision of health services. On the supply side, there are commonly differences in costs associated with producing different quality varieties. The presence of quality segments naturally affects firms¿ strategies and in particular also their pricing choices.
In this project we aim to study the incentives of firms operating in quality-segmented markets to coordinate their quantities and prices as well as, when profitable, even merging in larger units.
Specifically, through the construction of a theoretical model and testing it econometrically using appropriately defined data sets on European hospitals, we intend to address questions such as: In what segments (say high, medium, low) of a given market (as for instance that of health services) is the incentive to collude or to merge stronger? How does this depend on demand and supply conditions? What would be the major effects of industry-wide or partial mergers in terms of quantities, offered services as well as social welfare?
The relationship between collusion and vertical product differentiation was formerly analyzed by Hackner (1994). In his work, the key question is whether price collusion is more likely to arise when products are close substitutes or, rather, highly differentiated. Along the same research line, Ecchia and Lambertini (1997) study how the stability of price collusion in a duopoly setting is affected by the introduction of a minimum quality standard.
There are two common traits in these works. First, (i) the degree of product differentiation does not change after a coalition has formed, since the collusive behavior is restricted to pricing. This assumption is a natural entry point in the literature on cartel stability under product differentiation, as it enables to disentangle the effect of quality gap on the stability of a cartel. Still, it leaves unexplored a companion question, namely the effect of the cartel on product differentiation.
Secondly, (ii) the market is populated by two firms so that it turns out to be fully monopolized by a grand coalition in the case of cooperation between firms. However, casual observations show that there exist circumstances under which firms choose to form a partial merger (i.e. one including a subset of firms in the market) rather than the grand coalition. In any partial merger, colluding firms compete against some rivals outside the coalition, so that a noncooperative behavior is still preserved. Thus, the effects of a partial merger are not equivalent to those observed when all agents merge and mimic a monopolist.
The aim of our work is to complement the above analysis and describe the incentive of firms to merge when (i) the degree of differentiation may change once a coalition has formed and (ii) the market is populated by more than two firms. The former feature of our approach somehow puts our contribution close to Lommerud and Sorgard (1997) and, within the literature on horizontally differentiated products, to Gandhi et al. (2008) and Brekke et al. (2014). Indeed, although all these authors do not consider quality as the main source of product differentiation, their analysis centers around the price-quality post-merger re-positioning which is our main aim. Of course, the mechanics of mergers in markets with horizontally differentiated products is quite different from that in markets with vertically differentiated products. In a vertically differentiated market, under partial collusion, defining the optimal set of products to market requires to put in balance the cannibalization effect that a variant produced by the coalition may exert within the coalition with the possibility that this variant steals consumers from the rival firm (henceforth stealing effect). In an Hotelling setting, the equilibrium configuration is also (and strongly) determined by trans- port costs. Still, we can borrow from them several economic intuitions on the role of strategic motives for withdrawing product. For example, under horizontal differentiation, when transport costs are extremely high, firms behave like local monopolists and the cannibalization is weak. In contrast, as transport costs tends to zero, the market with horizontally differentiated goods tends to mimic market with homogeneous products where firms do not have market power. In this alternative case, the cannibalization effect is likely to be more significant than the incentive to satisfy heterogeneous preferences so that firms can decide to remove some goods from the market in the post-merger scenario. The interaction between transport costs and cannibalization provides some useful insights to the relationship between the incentive to withdraw variants and their quality gap, in the case of vertically differentiated products. Finally, we innovate theoretically because we look at the effects of mergers in a quantity game occurring in a vertically differentiated market, one where also the firms' costs are sensitive to the quality of the good produced. This is still under-explored in the current literature both theoretically and econometrically.
References:
Brekke, K. R., Siciliani, L., Straume, O. R. (2014). "Horizontal Mergers and Product Quality", NHH Discussion Paper, February 2014.
Ecchia, G., Lambertini, L. (1997), "Minimum Quality Standards and Collusion," Journal of Industrial Economics, 45, 1, 101-13.
Lommerud, K. and Sorgard, L. (1997). "Merger and Product Range Rivalry", International Journal of Industrial Organization, 16, 1, 21-42.