Mergers in a Model with Complementarity

Abstract

Standard discrete choice models used to evaluate mergers assume that different product varieties are substitutes. However, legal defences in some recent high-profile mergers rested on demand complementarity (e.g., GE/Honeywell). Since complements tend to be priced lower by a monopolist than by a duopoly, standard models will overstate consumer harm in these mergers. We use consumer level data from AC Nielsen look at two products with natural demand complementarities and a history of regulatory activity - potato chips and carbonated soda. We propose a new estimation method for a discrete choice model which allows for demand complementarity and unobservable consumer heterogeneity. We then simulate a number of anti-trust counterfactuals in the chips and soda market. Once demand complementarity is taken into account, a merger between the chips and soda producer PepsiCo/Frito-Lay and the soda producer Dr. Pepper will increase consumer welfare. By contrast, the standard discrete choice model predicts that soda prices would always increase following the merger and welfare falls. An additional counterfactual breaking up the PepsiCo/Frito-Lay conglomerate suggests that both chip and soda prices will increase as a result.