M&A deals threaten innovation, leaving consumers to pay the price
The challenges associated with corporate mergers are no secret. From culture clashes and concerns around employee integration, to difficulties with strategic planning and day-to-day practical issues, it’s no surprise 70-90 per cent of M&A deals fail.
But it isn’t just employees and business leaders who suffer during a merger. Key to both economic and social development, innovation is a frequent casualty of M&A deals and consumers often end up worse off as a result.
In his role as Chief Competition Economist at the European Commission (EC), where he was seconded in 2016, Imperial College Business School’s Professor Tommaso Valletti headed up the economic analysis of all major EU antitrust, merger and state aid cases.
During his time at the EC, Professor Valletti was able to investigate how a corporation proposing a merger, with its increased market power, would approach innovation activity and price increases. This analysis would involve thinking about “counterfactuals”: considering scenarios that would take into account the incentives for the pre-merged businesses to drive innovation versus post-merger.
Innovation theory of harm
Competition drives innovation, resulting in lower prices, a wider choice for consumers and opportunities for a variety of businesses to enter the marketplace. Meanwhile, M&A deals can result in efficiencies, but also inevitably eliminate competition because the impulse to find a breakthrough product first is no longer important when a rival is part of the same business.
Professor Valletti realised there was a gap in the existing literature: the question of the effect of a merger on innovation had not received enough, or specific, attention. Through his own research, he found that certain circumstances always result in the two parties reducing their innovation efforts once a merger has been completed.
According to Professor Valletti’s innovation theory of harm, this was the case when the businesses were operating in an already concentrated industry unlikely to see any new entrants, when they had been focusing their innovation efforts on similar technologies, and when companies could protect their intellectual property to avoid beneficial spillovers to their rivals.
Competition drives innovation, resulting in lower prices and a wider choice for consumers
When this occurs, Professor Valletti discovered, the negative impact on consumers is twofold: they do not have access to as many innovative products and the drop in price competition within the industry leads to price increases both for current and for future products.
Using the theory, he went on to develop an economic framework, which can be used to assess the impact of mergers on innovation. Using this framework, he and his co-authors demonstrated both overall innovation and consumer welfare fall after a merger, establishing for the first time, the innovation theory of harm as an integral part of a merger assessment.
Thinking about innovation
Two large mergers assessed by the EC during Professor Valletti’s time there, the Dow/DuPont deal (with a combined value of $130 billion), and Bayer/Monsanto ($66 billion), helped to demonstrate the real-world impact of his research.
These mergers were approved only after significant structural solutions, such as the divestment to rivals of large R&D facilities, in line with the findings of his analytical approach. In 2018, total customer savings from merger interventions by the Commission were €15-25 billion, according to EU estimates.
Given the threat to competition posed by today’s tech giants, such as Google, Facebook, Amazon and Microsoft, competition experts have noted the salience of Professor Valletti’s work. In recent decades, these corporations have been on shopping sprees, swallowing up hundreds of companies through acquisition. It is now accepted that this approach is damaging to sector competition and has a significant impact on the pace and direction of innovation.
Despite this, Professor Valletti’s work has not been welcomed by everyone, with those involved in the large mergers he oversaw at the EC resisting the change in approach.
These discussions [around Professor Valletti's research] informed competition authorities around the world
“His work...was received at the time (predictably) with major consternation and pushback on the part of merger defendants, their consultants and the defence bar, who saw it as a threat to the convenient ignorance of regulators up to that point about the possibility that innovation itself could be harmed by a merger,” says Dr Cristina Caffarra, Vice President and Head of European Competition at Charles River Associates.
“There was significant and organised lobbying effort by pharma companies and others to push back on Professor Valletti’s research, sponsoring compliant academics to come up with attempts to undermine the result,” Caffarra goes on, adding that this did not achieve the intended effect, with rebuttals turning out to be “incomplete or reliant on biased assumptions”.
However, Professor Valletti’s work has been received positively in some quarters, with the Competition & Markets Authority (CMA) in the UK adapting its thinking regarding the impact of mergers on innovation in light of his research.
Chief Executive Andrea Coscelli points to the $360m merger between Sabre and Farelogix, two providers of global distribution systems for airline bookings. The CMA judged the deal could have resulted in less innovation, leading to fewer new features, or features being released more slowly, based on an innovation theory of harm, and killed the merger.
It is now accepted that this approach [serial acquisitions] is damaging to sector competition and has a significant impact on the pace and direction of innovation
"Professor Valletti's research has had a significant impact on the debate around innovation concerns in mergers and on the application of an IToH [innovation theory of harm] to decision making in merger control, including at the CMA," Coscelli says.
Professor Valletti’s former boss at the EC and current Vice President of the European Commission and Commissioner for Competition, Margrethe Vestager, also highlights the importance of his work: “These discussions informed competition authorities around the world and contributed to advancing the understanding of when and how mergers can be harmful for innovation.
“Given the importance of innovation for economic growth, this literature and its advancement are highly relevant for competition authorities but also from a wider economic policy perspective.”