Up or Down? The Price Effects of Market Intermediary Mergers

Intermediaries purchase from input suppliers and sell to consumers. Given the positioning of intermediaries in the middle of supply chains, the impact of a merger of intermediaries on the prices in output markets may depend on the impact of the merger in input markets, and vice versa. Making sense of a merger of intermediaries therefore requires a comprehensive analysis that ties together the potential effects in both sides of the market. Suppose that a merger of two intermediaries allows them to obtain cognizable input price reductions. An antitrust claim against this merger might focus on the input price effect. But it is more than likely that the claim would also consider the impact on output prices. In this paper, we show how to adapt the widely used Upward Pricing Pressure (UPP) methodology to study this problem. As in Ho and Lee (2017), we tailor the model to situations where intermediaries bargain with upstream suppliers. This characterizes the upstream healthcare market, in which insurers bargain with providers, but is also common in other markets, such as cable, construction, and apparel. It is important to distinguish bargaining markets from traditional posted price upstream markets. In traditional monopsony markets, the monopsonist restricts input purchases, which necessarily leads to output restrictions and higher consumer prices. When bargaining occurs in upstream markets, powerful intermediaries may secure lower prices from input suppliers without necessarily restricting the amount of inputs that they purchase. We develop a model that accounts for a merger’s impact on bargaining leverage with input suppliers as well as the merger’s impact on sell-side market power, and the interactions between the two sides. We consider two ways in which a merged intermediary might negotiate with a supplier: separate or all-or-nothing bargaining. In separate bargaining, if the intermediary fails to reach an agreement with one of the input suppliers, the input supplier may still contract with the other merged intermediary. In the all-or-nothing bargaining, if the intermediary fails to reach an agreement with one of the input suppliers, the supplier cannot contract with either intermediary. Under separate bargaining, we find that without cognizable cost reductions unrelated to the input price, increased bargaining leverage cannot offset the upward price pressure from the loss of sell-side competition. Under all-or-nothing bargaining, however, we find that the direction and magnitude of the output price effect depends on substitution patterns and market power. Downward pressure on input prices from increased bargaining leverage can offset upward pressure on output prices if input suppliers have a lot of market power relative to the merging intermediaries prior to the merger, and consumer substitution between the merging intermediaries and non-merging intermediaries is low. Otherwise, increased bargaining leverage does not offset the upward price pressure from the loss of sell-side competition. There are three main conclusions from our analysis. First, when input and output market interactions are considered together, the amount of substitution or diversion between the merging intermediaries is less important. This is because the effect of diversion between the merging intermediaries on the buy-side and sell-side largely cancels itself out. Higher diversion between the merging intermediaries means larger increases in sell-side and buy-side market power. Second, under all-or-nothing bargaining, the amount of substitution or diversion between the merged intermediary and other intermediaries is important. A merger of intermediaries is more likely to result in a lower output price if substitution between the merged intermediary and other intermediaries is low. This is because if substitution between the merged intermediary and other intermediaries is low, the merger will result in a larger shift in bargaining leverage, and therefore more downward pressure on the merged intermediary’s input price. Third, under all-or-nothing bargaining, how market power is distributed along the supply chain prior to the merger is important. A merger of intermediaries is more likely to result in a lower output price when the intermediary and input markets are both concentrated prior to the merger. In this case, the merged intermediary uses its additional “countervailing” buyer power to eat into the sellers’ high margins, which puts downward pressure on the merged intermediary’s input price and translates into lower output prices.