To centralize or decentralize: Mergers under price and quality competition

Abstract

This paper examines firms' post-merger integration (PMI) strategy under price and service-quality competition when facing either deterministic or stochastic demand. Although horizontal mergers are prevalent in practice and have been analyzed extensively in the literature, little attention has been paid to the choice of PMI level. We develop a game-theoretic model, in which multiple firms compete on price and service quality with either deterministic or stochastic demand, and two of them decide whether and how to merge. The post-merger firm can enjoy higher cost efficiency due to cost synergy and needs to choose between centralized and decentralized mergers (i.e., PMI level). A centralized merger allows centralized decision-making and inventory pooling for the two participant firms, while a decentralized merger allows decentralized decision-making and inventory transshipment between the participant firms. We highlight some interesting findings. First, under either deterministic or stochastic demand, we find that a centralized merger is not always beneficial since its collusion effect may induce the nonparticipant firm to adopt more aggressive strategies, and thus a decentralized merger may be more profitable and preferred by the post-merger firm as it allows competition between the participants and leads to a more balanced market. Second, in a decentralized merger, stronger fixed cost synergy may backfire and hurt each participant as it could intensify service-quality competition between the two participants, and risk pooling (via inventory transshipment) under stochastic demand may even reduce the participant firms' profits as it may intensify both service-quality and price competition. Third, a participant firm's service quality, price, and in-stock probability may be either improved or reduced after merging, depending on the PMI level, cost synergy, demand sensitivity, and demand uncertainty.