Mergers with endogenous product choice: The case of the ready-to-eat cereal industry

The analysis of mergers in industries with differentiated products has traditionally focused its attention on postmerger price changes, ignoring the effect of a new competitive landscape on the characteristics of the products firms choose to offer. This paper proposes a new analysis, which includes the product entry and assortment decisions of firms, and shows how quickly product entry in an industry offsets – or its slowdown exacerbates—the anticompetitive effect on prices of a merger. Using supermarket scanner data and historic information on product introduction in the ready-to-eat cereal market, I estimate a dynamic oligopoly model of product entry and pricing, which is used to simulate firms’ post-merger behavior and compute welfare effects. While solving the dynamic model is nearly unfeasible, due to the large number of products in the market, I recast the model using a different state space that significantly reduces the number of variables required. This approach implies using a nested logit model demand system, which I show provides similar results to the random-coefficient logit model previously estimated on the same data. The results show that, within three years from a merger, a reduction in the number of products offered has further increased the anticompetitive effects, due to product culling, and to a lower incentive of merging firms to introduce new products. Cost efficiency following from the merger may take several years to offset these effects. Moreover, if achieved gradually over time, it may require a much larger cost reduction.