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Search Costs, Demand-Side Economies and the Incentives to Merge under Bertrand Competition

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  • Moraga-González, José-Luis
  • Petrikaite, Vaiva

Abstract

We study the incentives to merge in a Bertrand competition model where firms sell differentiated products and consumers search sequentially for satisfactory deals. In the pre-merger symmetric equilibrium, consumers visit firmsrandomly. However, after a merger, because insiders raise their prices more than the outsiders, consumers start searching for good deals at the non-merging stores, and only when they do not find a satisfactory product there they visit the merging firms. As search costs go up, consumer traffic from the non-merging firms to the merged ones decreases and eventually mergers become unprofitable. This new merger paradox can be overcome if the merged entity chooses to stock each of its stores with all the products of the constituent firms, which generates sizable search economies. We show that such demand-side economies can confer the merging firms a prominent position in the marketplace, in which case their price may even be lower than the price of the non-merging firms. In that situation, consumers start searching for a satisfactory good at the merged entity and the firms outside the merger lose out. When search economies are sufficiently large, a merger is beneficial for consumers too, and overall welfare increases.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9374.

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Date of creation: Mar 2013
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Handle: RePEc:cpr:ceprdp:9374

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Keywords: consumer search; demand-side economies; economies of search; insiders; long-run; mergers; orders of search; outsiders; prominence; sequential search; short-run;

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  1. Jidong Zhou, 2009. "Ordered Search in Differentiated Markets," EERI Research Paper Series EERI_RP_2009_28, Economics and Econometrics Research Institute (EERI), Brussels.
  2. Simon P. Anderson & Regis Renault, 1999. "Pricing, Product Diversity, and Search Costs: A Bertrand-Chamberlin-Diamond Model," RAND Journal of Economics, The RAND Corporation, vol. 30(4), pages 719-735, Winter.
  3. Mark Armstrong & John Vickers & Jidong Zhou, 2008. "Prominence and Consumer Search," Economics Series Working Papers 379, University of Oxford, Department of Economics.
  4. Kohn, Meir G. & Shavell, Steven, 1974. "The theory of search," Journal of Economic Theory, Elsevier, vol. 9(2), pages 93-123, October.
  5. Mark Armstrong & Jidong Zhou, 2011. "Paying for Prominence," Economic Journal, Royal Economic Society, vol. 121(556), pages F368-F395, November.
  6. Marco A. Haan & Jose Luis Moraga-Gonzalez, 2009. "Advertising for Attention in a Consumer Search Model," Tinbergen Institute Discussion Papers 09-031/1, Tinbergen Institute.
  7. Zhou, Jidong, 2009. "Prominence and Consumer Search: The Case With Multiple Prominent Firms," MPRA Paper 12554, University Library of Munich, Germany.
  8. Maria Arbatskaya, 2007. "Ordered search," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 119-126, 03.
  9. Salant, Stephen W & Switzer, Sheldon & Reynolds, Robert J, 1983. "Losses from Horizontal Merger: The Effects of an Exogenous Change in Industry Structure on Cournot-Nash Equilibrium," The Quarterly Journal of Economics, MIT Press, vol. 98(2), pages 185-99, May.
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