Firms often consolidate industries through horizontal mergers and acquisitions to

There is a long-standing debate in the economics and finance literatures on the motives for horizontal mergers. While managers of firms undertaking horizontal mergers usually cite expected improvements in productive efficiencies, i.e., synergies, as the key rationale behind such moves, antitrust authorities frequently express concern that horizontal mergers may increase market power vis-à-vis customers and suppliers of the merging firms’ industry. The latter view is also often supported in discussions in the business press pertaining to specific deals, as evidenced by the quote above. Academic research has extensively examined the effect of horizontal acquisitions on market power vis-à-vis customers and arrived at conflicting conclusions.3

There is, however, a major selection bias inherent in studies that look for signs of selling power created by horizontal mergers. The bias arises due to the fact that horizontal mergers expected to increase selling power and result in higher prices for customers will be anticipated to be blocked by antitrust authorities. Thus, mergers which clearly enhance selling power may never be observed when one looks for evidence in product or stock markets. The same logic, however, does not hold so far as the impact on suppliers is concerned. Horizontal mergers that increase buying power may contribute to lower costs of production downstream. Moreover, enhanced buying power downstream may counteract established selling power upstream and force suppliers to charge competitive prices. In fact, antitrust authorities may very well look upon such mergers favorably. Consequently, we examine the possible creation of buying power through horizontal acquisitions by studying their impact on suppliers. An auxiliary motivation for looking at the effect of horizontal mergers on supplier industries is that the industrial organization literature already shows the importance of being a large buyer: buyer size and buyer industry concentration have long been known to be correlated with lower seller profits.4 Yet, the upstream effects of a major corporate event – industry consolidation through mergers – that can create large buyers and increase buyer industry concentration remain largely unexamined.5 Thus, the objective of this paper is to ask one overarching question: do horizontal mergers create buying power?

We answer this question by first examining the effect of horizontal mergers on profits and product prices in the supplier industry. We use a relatively large, cross-industry sample to examine whether horizontal mergers bring about a decline in the profits of supplier industries and whether such a decline can be attributed to a decline in prices at which supplier industries sell. Using mergers and acquisitions (M&A) data from 1984 to 2003, we construct a sample of industries that experienced a significant jump in horizontal merger activity in a specific quarter. Having identified these downstream merger events, we ask whether supplier industries more dependent on the downstream merging industry experience greater adverse changes in profits and output prices after the event. We find that supplier industries selling a larger fraction of their output to the downstream consolidating industry have lower cash-flow margins following downstream consolidation. The abnormal cash-flow margin of dependent supplier industries after downstream consolidation is, on average, 3% lower than that of non-dependent supplier industries. Thus, we confirm Fee and Thomas’s (2004) finding that some supplier industries suffer declines in operating profits after a horizontal merger downstream.

However, we recognize that a decline in supplier profit margins may also result from changes unrelated to the creation of market power downstream. To attribute deterioration in profit margins upstream to an increase in buying power downstream, we need to also show a decline in upstream selling prices. As a result, we use the Producer Price Index (PPI) as a measure of selling prices to examine changes in selling prices in dependent supplier industries. Controlling for changes in input prices and demand shocks faced by the supplier industry, we first establish that prior to downstream consolidation, changes in the PPI of dependent and non-dependent supplier industries over a three-year period are statistically indistinguishable. In contrast, dependent supplier industries exhibit significantly larger declines in PPI in the three years following downstream consolidation. The differential impact is of the order of 0.1% per month, translating to a difference of up to 3.6% over the three years following downstream consolidation. Our results are robust to alternative regression methods. A difference-in-differences test in the pooled data lends further confirmation of dependent suppliers performing significantly worse than non-dependent suppliers, but only in the post-merger period. To show that such declines are not due to secular time trends independent of downstream consolidation, we create random ‘event dates’ and use them as break points to further examine the evolution of supplier selling prices. We find that there is no difference in the selling prices of dependent suppliers before and after such random event dates. Based on this battery of tests, we conclude that the decline in supplier selling prices may, indeed, be attributed to consolidation downstream.

While a decline in supplier prices after downstream consolidation is consistent with the creation of buying power, it may also be consistent with merger-induced improvements in efficiency. For example, if downstream consolidation created production efficiencies resulting in a decline in the demand for inputs, this could also lead to lower supplier selling prices. The existence of such a straightforward alternative explanation, therefore, requires us to design additional tests to attribute the decline in selling prices upstream to enhanced buying power downstream.

To this end, we draw on Galbraith’s (1952) theory of countervailing acquisitions where he argues that economic power is held in check by the countervailing power of those who are subject to it. Thus, if sellers earn non-competitive rents due to small numbers (oligopoly), practical barriers to entry, or explicit collusion, buyers have an incentive to develop the power with which they can defend themselves.6 In Snyder (1996, 1998), mergers between buyers can intensify competition among colluding sellers leading to lower prices. If suppliers held prices above competitive levels prior to downstream consolidation – either unilaterally or through collusion – countervailing theory implies that increased purchasing power created by downstream consolidation would force them to start competing more aggressively on price. Thus, the selling prices of previously non-competitive suppliers would be more adversely affected by downstream consolidation. We test this implication of the countervailing power hypothesis by regressing the change in supplier industry prices after downstream consolidation on empirical proxies of the level of price competition in an industry.

We find that supplier industries with a higher Herfindahl index or a higher four-firm concentration ratio prior to consolidation downstream experience larger price declines post-consolidation. A similar result obtains when we use capital intensity and capital expenditures to proxy for higher barriers to entry upstream. Using proxies for changes in supplier industry concentration prior to downstream consolidation, we find that the post-consolidation decline in supplier selling prices is higher when there is a prior increase in the four-firm concentration upstream. Similarly, suppliers experiencing increased horizontal merger activity prior to downstream consolidation suffer larger price declines post-consolidation. These results are all consistent with the creation of buyer power through downstream consolidation to countervail upstream market power.

Our results give rise to several questions about the possible time-series pattern of horizontal merger activity across industries sharing product market relationships. Is downstream consolidation activity exogenous or is it triggered by prior consolidation in supplier industries? Do supplier industries respond to a loss in pricing power by subsequently undertaking horizontal acquisitions of their own? These intriguing questions have not been explored in prior M&A research. Consequently, we make an exploratory attempt to answer these questions using the data on horizontal mergers within industries in the 1984–2003 period. We find that suppliers’ horizontal merger activity in a given year is positively related to consolidation activity in main customer industries over the prior four years. This finding is consistent with the Becker and Thomas (2009) result that changes in customer industry concentration are positively related to subsequent changes in dependent supplier industry concentration, and is in line with the finding in Ahern and Harford (2009) that merger waves propagate along connected industries.7 Although it is hard to definitively establish causality, our result suggests that consolidation by suppliers arises as a reaction to downstream consolidation, consistent with the pattern exposited by our opening quote from the Wall Street Journal. In contrast, we find no statistically significant relationship between consolidation activity in customer industries and past merger activity in their main supplier industries.

Our results confirm the Fee and Thomas (2004) finding that supplier operating performance deteriorates after downstream consolidation, but we are also able to attribute such deterioration to adverse price changes. The results are also consistent with Shahrur’s (2005) finding that more concentrated suppliers have poorer announcement returns when a downstream merger occurs. Combined, these prior results already point to the possibility of downstream mergers creating buying power. Our paper, in contrast, provides direct evidence that supplier selling prices themselves decline after downstream consolidation. We are also able to attribute this decline to a shift in market power in favor of the downstream merging industry. Our paper is also the first to show that supplier industries subsequently undertake horizontal acquisitions of their own and suggests that such consolidating acquisitions can propagate across industries sharing product market relationships. Finally, in addition to contributing to our understanding of the market power effects of horizontal acquisitions, this paper adds to existing evidence that merger activity is determined by industry-level factors (see Mitchell and Mulherin, 1996; Andrade, Mitchell, and Stafford, 2001).

The paper is organized as follows: Section 2 briefly discusses related research. Section 3 motivates the empirical tests. Section 4 contains methodology, data sources, and results. Section 5 addresses issues of robustness. Section 6 concludes.

Existing literature

Two approaches have been employed in the empirical literature to examine whether horizontal mergers create market power. The indirect approach, commonly found in the finance literature, examines the stock price reactions of merging firms, their rivals, suppliers, and corporate customers to M&A announcements. In this event-study based approach, efficient stock prices are assumed to correctly reflect the anticipated effects of horizontal mergers on factor and output prices. For example, if

Hypothesis development

Merged firms can exercise buying power in different ways. They can, for example, pool purchases to obtain quantity discounts from suppliers, or increase profit margins by squeezing suppliers. Insofar as these actions promote greater efficiency on the part of suppliers, Fee and Thomas (2004) label these as evidence of efficiency-increasing buying power. A merged firm may also exercise buying power by restricting purchases to monopsony levels causing input prices to fall below marginal cost (see

Data construction

We begin by constructing a sample of industries that experienced an identifiable increase in consolidation activity in order to obtain distinct pre- and post-merger periods. We obtain from Securities Data Company (SDC) Platinum all acquisitions announced between 1984 and 2003 that meet the following criteria: (i) the target and acquirer both were U.S.-based, (ii) the target and acquirer shared the same primary four-digit Standard Industrial Classification (SIC) code, (iii) the announced

Robustness issues

Our results are robust with respect to alternate methods of sample construction. Our measure of a merger event in the main analysis uses the ratio of merger transaction value to industry total assets to identify significant consolidation activity. Since the transaction value data use market values obtained from SDC, they should ideally be scaled by the market value of industry assets. Unfortunately, such scaling produces significant data loss as the Compustat main files often provide data

Conclusion

This paper conducts the first comprehensive, cross-industry tests of the product market impact of horizontal acquisitions on supplier industries through their effects on profits and prices. We find strong evidence that horizontal mergers do, in fact, create buying power and impact the performance of dependent suppliers. Dependent suppliers suffer significant declines in both their profits and their selling prices in the three years following major downstream consolidation activity, consistent

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