Innovation and Dynamic Efficiencies in Merger Review

Prepared By:
Andrew Tepperman and Margaret Sanderson
CRA International

Date: April 9, 2007
CRA Project No. D09208-00

6. Conclusion

We have sought in this report to provide a sound general grounding for the incorporation of innovation and dynamic efficiency effects in merger review.  Recognizing that innovation and dynamic competition are critical drivers of economic growth, our discussion has relied in large part on two fundamental principles.  First, promotion of dynamic efficiency, and thus productivity growth over the long term, normally requires tolerating some degree of static allocative efficiency over the short term.  It is this effect that will lead to a real trade-off in many merger situations: should a merger that is expected to raise prices be allowed to proceed, provided that it supports increased innovation?  Second, we have suggested that on balance, the incentives created for innovation in a market economy are likely to be insufficient, and that as a result increased innovation—and not just increased R&D—should generally be regarded as desirable.

Analyzing whether a given transaction is likely to lead to increased innovation is difficult from a practical perspective.  We pointed to a number of issues that should remain in the foreground during any actual analysis.  With these in mind, we proposed a method for incorporating innovation issues into merger analysis that focuses on effects in future product markets.  This method is appealing to us because it does not rely on somewhat hazy concepts such as “innovation markets.”  Nonetheless, applying it to any real situation would not necessarily be easy, and in particular, the set of factual information on the markets and firms involved would require careful analysis.

Finally, we examined incorporation of sources of dynamic efficiency into the merger review process.  In our view, based on the existing economic literature, there are quite a number of plausible, defensible dynamic efficiency claims that can be made.  Of course, firms face a daunting challenge substantiating these in any given case.  It may be especially difficult to quantify the gains that can be realized from future surplus as against any expected anticompetitive effects from increased prices, beyond providing rough orders of magnitude.  Nonetheless, we do not believe the burden of proof should be shifted.  It rightfully should remain with the merging firms, as they have the greatest information available to substantiate any claims of dynamic efficiency.  A more relaxed quantitative burden might be provided to those merging firms that are able to adequately demonstrate plausible and likely qualitative improvements in dynamic efficiencies resulting from the merger.

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