Mergers and Product Repositioning: Theory and Empirical Evidence

Abstract

Mergers often induce firms to modify both product quality and variety. The impact of such changes has received scant attention in merger literature, which mostly focuses on price changes. We develop a game-theoretical model to investigate the changes of quality, variety, and price after a merger and their impacts on firms and consumers. In the case when the merged firm continues to offer the same number of products, we find that the merged firm reduces both product qualities and prices. Although consumers benefit from the lower prices, they are still worse off because of the lower qualities. In the case when the merged firm consolidates product offerings to achieve cost savings, the product quality and price may also be reduced. Due to the reduced quality, consumers can be hurt by such a merger even though they pay a lower price after the merger. These findings are in sharp contrast to the merger literature that studies price alone, which predicts that consumers benefit from a merger if price is reduced after a merger. By comparing the two cases with different numbers of products provided by the merged firm, we find that cost savings from consolidating the products benefit the merged firm, but might hurt consumers. We then find empirical evidence by employing a multi-period difference-in-differences model to investigate the quality and price changes after mergers, using observational data from the airline industry. The empirical findings are consistent with our theoretical results on the merging firms' quality and price changes, which further confirm that a merger must be evaluated in an integrated way by examining its impact on product quality and variety as well as price.

Keywords: Noncooperative game, econometric analysis, horizontal merger, vertical differentiation