Cross-Border Mergers and Branding Strategies of the Multinational

Cross-Border Mergers and Branding Strategies of the Multinational Firms Toshihiro Ichida Waseda University MWIEG 2009 Penn State

Motivation • More than two-thirds of MNE's FDI flow is accounted for by the Cross-Border M&A. • In buying the local firm, MNE faces choices in its branding strategy: to keep both brands or to integrate brand names into one • Examples: Air France & KLM Royal Dutch Airlines, IHG (Inter. Continental Hotel Group) & ANA Hotels in Japan, and Nordea (European Bank)

Related Literature • • • Long and Vousden (1995 RIE) Horn and Persson (2001 JIE) Qiu and Zhou (2006 JIE) Neary (2007 RES) Lommerud, Straume, and Sorgard (2006 Rand)

Basic Model 2 regions (N and S) 3 firms (0 in N, 1 and 2 in S) We consider the consumer market in S. Assumption: entry is restricted because of firm -specific ownership advantages by 0, 1, 2 • N is advanced (cost advantage for firm 0) • Cross-Border Trade is costly (firm 0 needs to pay t to ship to firms in S) • Differentiated-Product Cournot Competition • •

Initial Setup Firm 0 MC = 0 Region N Trade Cost = t Region S Firm 1 MC = c Consumers in Region S Firm 2 MC = c

Model • Consumers in Region S: linear demand for each brand i given outputs of other brands where b is an inverse measure of the degree of product differentiation.

Merger Formation 1. 2. 3. 4. • No merger: M 0 = {0, 1, 2} One Cross-Border merger: MCB 1 = {01, 2} One Cross-Border merger: MCB 2 = {02, 1} One National merger: MN = {0, 12} If N firm merges with a firm in S, then the merged firm can save on trade cost. • If N firm merges with a firm in S, then the merged firm can reduce production cost.

No merger: M 0 = {0, 1, 2} Firm 0 MC = 0 Region N Trade Cost = t Region S Firm 1 MC = c Consumers in Region S Firm 2 MC = c

One Cross-Border merger: MCB 1 = {01, 2} Firm 0 MC = 0 Region N Trade Cost = t Region S Firm 1 MC = c Consumers in Region S Firm 2 MC = c

One Cross-Border merger: MCB 1 = {01, 2} Region N Region S Firm 01 MC = c. L < c Consumers in Region S Firm 2 MC = c

One Cross-Border merger: MCB 2 = {02, 1} Region N Symmetric! Region S Firm 02 MC = c. L < c Consumers in Region S Firm 1 MC = c

One National merger: MN = {0, 12} Firm 0 MC = 0 Region N Trade Cost = t Region S Firm 1 MC = c Consumers in Region S Firm 2 MC = c

One National merger: MN = {0, 12} Firm 0 MC = 0 Region N Trade Cost = t Region S Firm {12} MC = c Consumers in Region S

The sequence of moves: stage 1. The firm owner decides whether to merge, who to merge with, etc. 2. If there is a merged firm, it decides whether to keep 2 brand names or to integrate into one brand name. 3. The firms simultaneously and independently set quantities.

Brand Strategy of the Merged Firm • In the homogeneous product oligopoly model, the horizontal merger gives the merged firm a scale merit. (and there is no choice of brand) • In the differentiated product oligopoly model, the merged firm faces a following choice in its branding strategy: 1. Brand Integration 2. Brand Separation

Brand Strategy of the Merged Firm 1. Brand Integration • The merged firm will integrate (formerly separated) 2 brand names into one. 2. Brand Separation • The merged firm decides to keep the original 2 brand names. • The merged firm will maximize joint profit from the 2 brands.

One Cross-Border merger: MCB 1 = {01, 2} Firm 0 MC = 0 Region N Trade Cost = t Firm 0 and Firm 1 will merge Brand 0 Region S Firm 1 Firm 2 MC = c Brand 1 Brand 2 Consumers in Region S

One Cross-Border merger: MCB 1 = {01, 2} + Brand Integration Region N Firm {01} Region S MC = c. L Firm 2 MC = c Brand {01} Brand 2 Consumers in Region S

One Cross-Border merger: MCB 1 = {01, 2} + Brand Separation Region N Merged firm maintains 2 brand lines Firm {01} Region S MC = c. L Firm 2 MC = c Output coordination Brand 1 Brand 2 Brand 0 Consumers in Region S

One National merger: MN = {0, 12} Firm 0 MC = 0 Region N Firm 1 and Firm 2 will merge Trade Cost = t Region S Firm 1 MC = c Brand 0 Brand 1 Consumers in Region S Firm 2 MC = c Brand 2

One National merger: MN = {0, 12} + Brand Integration Firm 0 MC = 0 Region N Trade Cost = t Region S Firm {12} MC = c Brand 0 Brand {12} Consumers in Region S

One National merger: MN = {0, 12} + Brand Separation Firm 0 MC = 0 Region N Trade Cost = t Merged firm maintains 2 brand lines: 1 & 2 Region S Firm {12} MC = c Output coordination Brand 0 Brand 1 Consumers in Region S Brand 2

Export or Not • For M 0 (No merger) case and MN (National merger) case, firm 0 (of region N) may or may not serve the consumer market in region S. • Firm 0 must export its outputs by paying trade cost t. The govt. can control part of t. • The government of region S may be able to foreclose its market from foreign firm 0 by setting the tariff level if it is beneficial.

No merger: M 0 = {0, 1, 2} Firm 0 MC = 0 Region N Foreclosure condition Trade Cost = t Region S Firm 1 MC = c Consumers in Region S Firm 2 MC = c

One National merger: MN = {0, 12} + Brand Integration Firm 0 MC = 0 Foreclosure condition Region N Trade Cost = t Region S Firm {12} MC = c Brand 0 Brand {12} Consumers in Region S

One National merger: MN = {0, 12} + Brand Separation Firm 0 MC = 0 Region N Foreclosure condition Trade Cost = t Region S Firm {12} MC = c Output coordination Brand 0 Brand 1 Consumers in Region S Brand 2

Size of trade cost t Foreclosure or import from N a More differentiated Identical 0 1 An inverse measure of the degree of product differentiation b

Foreclosure or import from N Size of trade cost t No merger case a Foreclosure Allow import by 0 0 1 An inverse measure of the degree of product differentiation b

Size of trade cost t Foreclosure or import from N a One national merger with Brand Separation Foreclosure Output coordination effect → higher prices with the same number of brand lines Allow import by 0 0 1 An inverse measure of the degree of product differentiation b

Size of trade cost t Foreclosure or import from N a One national merger with Brand Integration Foreclosure Reduction of brand lines Allow import by 0 0 1 An inverse measure of the degree of product differentiation b

Cross-Border Merger case • Firm 0 of region N will merge with one of the firms in region S (firm 1 or 2). • WLOG, we look at the case of MCB 1 = {01, 2}. • The merged firm {01} will compete with firm 2 in the consumer market in region S. • The merged firm {01} locates now in S, so it need not pay trade cost t anymore. • The merged firm {01} has lower production cost c. L < c.

Cross-Border Merger case • The merged firm {01} will compete with firm 2 in the consumer market in region S. • The branding strategy of the firm {01}: 1. Brand Integration: brand {01} vs. brand 2 2. Brand Separation: brand 0 and 1 vs. brand 2 (where firm {01} will control output levels of two brand lines jointly. )

One Cross-Border merger: MCB 1 = {01, 2} + Brand Integration Region N Firm {01} Region S MC = c. L Firm 2 MC = c Brand {01} Brand 2 Consumers in Region S

One Cross-Border merger: MCB 1 = {01, 2} + Brand Separation Region N Merged firm maintains 2 brand lines Firm {01} Region S MC = c. L Firm 2 MC = c Output coordination Brand 1 Brand 2 Brand 0 Consumers in Region S

Optimal Brand Strategy in MCB 1 Proposition 3 (after cross-border merger) There exist a threshold value b* which does not depend on the parameters of the model (such as a, c, & c. L) such that for b ≥ b* ↔ πBI{01} ≥ πBS{01}. and for b < b* ↔ πBI{01} < πBS{01}. And b* ≈ 0. 72082.

Conclusion • The paper looked at merger incentives and brand strategy after the merger. • The analysis is still preliminary. I did not conduct global comparison of different merger types yet. • Need to look at comparison of welfare (vary t) • Trade cost is composed of t = t. U + τ where t. U is uncontrollable part of trade cost and τ is tariff level.