It’s all beer and games

I’ve been a fan of Adam Davidson of NPR’s Planet Money for a long time. His work is smart and I always enjoy reading his column in the New York Times magazine. And this week’s column is no exception.

It’s all about how Justice Department economists are using game theory to contest Anheuser-Busch InBev’s purchase of the rest of Grupo Modelo. Here are some details:

So I was surprised to learn that the Justice Department is worried that Anheuser-Busch InBev, the conglomerate that owns Bud, is on the cusp of becoming an abusive monopoly. In January, the department sued AB InBev to prevent it from buying the rest of Mexico’s Grupo Modelo, a company in which it already carries a 50 percent stake. The case is not built on any leaked documents about some secret plan to abuse market power and raise prices. Instead, it’s based on the work of Justice Department economists who, using game theory and complex forecasting models, are able to predict what an even bigger AB InBev will do. Their analysis suggests that the firm, regardless of who is running it, will inevitably break the law.

For decades, they argue, Anheuser-Busch has been employing what game theorists call a “trigger strategy,” something like the beer equivalent of the Mutually Assured Destruction Doctrine. Anheuser-Busch signals to its competitors that if they lower their prices, it will start a vicious retail war. In 1988, Miller and Coors lowered prices on their flagship beers, which led Anheuser-Busch to slash the price of Bud and its other brands in key markets.

And, as Davidson writes, this is completely legal.

Since that dust-up in the late ’80s, the huge American beer makers have moved in tandem to keep prices well above what classical economics would predict. (According to the logic of supply and demand, competing beer makers should pursue market share by lowering prices to just above the cost of production, or a few cents per bottle.) Budweiser’s trigger strategy has been thwarted, though, by what game theorists call a “rogue player.” When Bud and Coors raise their prices, Grupo Modelo’s Corona does not. (As an imported beer, Corona is also considered to have a higher value.) And so, according to the Justice Department, AB InBev wants to buy Grupo Modelo not because it thinks the company makes great beer, or because it covets Corona’s 7 percent U.S. market share, but because owning Corona would allow AB InBev to raise prices across all of its brands. And if the company could raise prices by, say, 3 percent, it would earn around $1 billion more in profit every year. Imagine the possibilities. The Justice Department already has.

This column is smart for many reasons, especially because Davidson found a new way to analyze these big mergers that have recently been announced. Companies from airlines to office supply retailers are announcing mergers and will have to be scrutinized by the Justice Department. But Davidson says it better:

These firms are among the many preparing for a global market several times larger than any that has ever existed. This helps explain why we have seen so many mergers in the past few months. The Justice Department recently approved the marriage of Penguin and Random House, and is expected to do the same with American Airlines and US Airways. Office Depot and OfficeMax are planning a merger of their own. These megamergers, however, do not inevitably create destructive monopolies. Carl Shapiro, the former chief economist at the Justice Department, told me that large mergers improve competition. Together, Penguin and Random House may be able to better stave off Amazon; American Airlines and US Airways can contend with Delta. Similarly, Office Depot and OfficeMax, once merged, may finally be large enough to really scare Staples. Fear, Shapiro says, is the key. Markets work best, he says, when “everyone has to watch their back.”

Either way, other reporters should take note of Davidson’s observations. Economists at the Justice Department might make great sources and they could hold the key to many mergers going forward.

Although, Davidson’s final argument is that the Justice Department might not hold sway for long. Some countries could be making moves to block competition.

China’s National People’s Congress approved its first antimonopoly law in 2008, which, many economists fear, could be used to block foreign competitors and to promote local giants. India’s version, which went into effect in 2009, is even less clear. It’s quite possible that the true monopolistic battles of the 21st century will not be among massive corporations but among the self-interested governments. We can only hope that they don’t engage in a trigger strategy of their own.

Either way, it’s an interesting take on the new round of merger news.