Friday, May 8, 2009

Horizontal Merger Paradox

One of the important topics in both Industry Analysis, Industrial Organization and the MBA Managerial Economics course revolves around the economic impact of horizontal mergers. At the most basic level, when firms act consistent with Cournot behavior, it is theoretically difficult to show that horizontal merging firms (firms in the same product or service market) can post-merger be more profitable than the aggregate of the pre-merger firm's profits, if the merger is not a merger to monopoly.

While I am not making any predictions in the recent Hollywood Talent merger that took place will in fact be less profitable, I am saying that the ingredients for the horizontal merger paradox to occur are ripe with this merger.

Why do I suspect this merger to be plagued by the horizontal merger paradox? Take a look at this quote from the Financial Times article, "[t]alent representation is notoriously competitive in Hollywood and WME’s rivals will be watching closely, eager to pick off any stars that may be disgruntled at not receiving the attention they feel they deserve." In other words, since the new firm WME cannot commit to maintaining their current level of talent - they cannot guarantee that they will keep all of their existing clients - then some are likely to leave for other talent agencies. This would reduce the profits from the newly merged firm (WME) and increase the profits to the existing but un-merged talent firms as predicted by the horizontal merger paradox model.

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