Comment on intended O2, E-Plus merger [German market for cellular networks]
Background: There exist four cellular network providers in Germany. Market leader T-Mobile Germany (33% market share by clients) and runner up Vodafone GmbH (30,50%) are considered to have the best network quality and coverage. In summer 2013 the fourth largest carrier O2 (Telefónica Germany) announced its intentions to merge with number three E-Plus (owned by KPN) to create Germany’s biggest network provider (36,50% market share by clients). Ceteris paribus the merged company would still trail T-Mobile in revenues. O2 and in particular E-Plus are positioned to compete for consumers with lower valuations and both compete with one another in prices as their network quality and coverage is inferior to that of T-Mobile and Vodafone.
Proponents of the merger, that is expected to create synergies worth €5bn until 2019, argue that both firms individually would find it difficult to raise enough money for upcoming auctions for cellular network licences in 2017 and needed investments in infrastructure as smartphone sales and demand for mobile internet increase. They argue that for competition in the long run it is vital to have a third big competitor as the gap to the two front-runners is increasing and fan fears of a (harmful) duopoly of T-Mobile and Vodafone in the future that both O2 and E-Plus cannot compete with individually. A consolidated network of O2’s and E-Plus’ network might be able to compete in quality as well as coverage with the two market leaders. As Telefónica Germany’s CEO puts it: “We are confident that the authorities will allow the merger as a third strong player promotes competition in the interest of the German consumer.”
If the merger were to be allowed there would exist an oligopoly consisting of three (very) homogeneous firms with similar amounts of costumers, network quality and coverage. The large investments needed to obtain licences in combination with an almost equally divided market between the three incumbents would make further entry highly improbable. As a result pricing pressure will most likely drop as the provider with the lowest prices (E-Plus) would be incorporated in the new company. Overall the above facts facilitate collusion among the providers and are most likely to be harmful to the consumer.
Let us first consider the case in which the merger is not allowed. Then there exist two possibilities: The first possibility is that the status quo with four companies remains the same. The decision not to allow the merger was the ex-post right decision in this case. The second possibility is that E-Plus and/or O2 can’t keep up with the two big providers and eventually go bankrupt. In this case the decision of forbidding the merger might have been wrong as in return a duopoly of T-Mobile and Vodafone are the only companies in the market. Though there is the possibility that a new competitor with the needed capital acquires one of the bankrupt firms or their infrastructure. If the result was a homogeneous duopoly in the future forbidding the merger might have been wrong ex-post.
The second case in which the merger is allowed is desirable if O2 and E-Plus would otherwise drop out of the market. As barriers to entry are large due to costs for network licences and reaching a critical mass of consumers to make the business profitable is difficult as there might also be networking effects for consumers, T-Mobile and Vodafone would most likely share the market between themselves for years to come.
One thing is sure: If the merger were to be allowed it would have to be allowed subject to structural remedies. As network licences are awarded subject to “independence in competition” the conditions may include a partial restitution of network licences owned by the new firm that then were to be reserved for potential entrants. This is a reasonable measure as the new firm would be better positioned with licences for the competition in the next years opposed to Vodafone and T-Mobile who are scarce on that resource.
As T-Mobile and Vodafone are not dramatically protesting against the proposed merger and only demand conditions as the above explained restitution of licences my personal feeling is that the merger should not be allowed as market concentration would increase drastically and the soft reaction of T-Mobile demonstrates that the company might expect competition to soften and anticipate collusive behaviour in a stable oligopoly consisting of three firms in the future. Then the stated €5bn as efficiency gain of the merger over the next 5 years might not outweigh the losses for consumers. With a market share above 25% but below 40% the new firm would not necessarily hold a dominant position – also considering the competitors it is faced with. Though the joint dominance of three homogeneous network providers must be considered. Further the Herfindahl–Hirschman Index would c.p. exceed 3000 while any number above 2000 raises concerns according to EC Guidelines on the assessment of horizontal mergers (2004/C 31/03).
The decision by the European Commission on whether to allow the merger or not is pending and expected for May 2014.
An easy example to consider are offers that include free calls to all numbers within one provider’s network.