Conference Agenda

This paper studies how horizontal mergers affect market competition and firms’ incentives to invest in cost-reducing innovation when firms are asymmetric in marginal costs. A large part of the modern merger debate, especially in technology and digital markets, implicitly relies on symmetric-firm benchmarks, in which reduced rivalry after a merger tends to raise prices and weaken incentives to innovate. Recent theoretical work (notably Motta and Tarantino, 2021) formalizes this logic in a general framework with symmetric firms: absent efficiency gains, horizontal mergers typically reduce investment incentives and harm consumer surplus. We revisit these predictions in an environment where firms differ in cost levels ex-ante and can invest to reduce marginal costs. Our core question is: Can cost asymmetry overturn the standard “anti-competitive merger” prediction, so that a profitable horizontal merger may increase total investment and improve consumer welfare, even without efficiency gains?

The model

We develop a tractable triopoly model with Bertrand competition in differentiated products. Demand is derived from a quadratic quasi-linear utility (Shubik–Levitan type) with a parameter capturing the degree of substitutability between products. Each firm has an ex-ante marginal cost and can invest in R&D to reduce its marginal cost, investment costs are quadratic. The key asymmetry is introduced through a simple cost ladder: the three firms’ ex-ante marginal costs differ by a common gap, governed by an asymmetry parameter. This structure is chosen both for interpretability and to allow clean comparative statics on asymmetry and product substitutability.

The analysis proceeds in three steps. First, we solve the pre-merger equilibrium in prices and investments under simultaneous choice. Second, we characterize post-merger equilibria for each possible two-firms merger (three cases), keeping the technology unchanged to isolate the role of market structure and asymmetry (i.e., no synergies and no cost savings from the merger itself). Third, we compare pre- and post-merger outcomes in (i) individual firms’ prices and investments, (ii) total industry investment, and (iii) consumer surplus. In addition, we consider an extension in which the merged entity may shut down the higher-cost insider’s product if it is privately optimal to do so.

Main results

In the symmetric benchmark (without cost asymmetry), our model reproduces the standard pattern highlighted by Motta and Tarantino (2021): after a merger, insiders soften competition by increasing prices and reducing investments to limit cannibalization between their products, while the outsider responds by investing more and pricing more aggressively. However, the outsider’s pro-competitive response is not strong enough to offset the insiders’ softening, so total investment and consumer surplus fall relative to pre-merger levels.

Cost asymmetry changes this logic in a systematic way. A merger can trigger a reallocation of investment toward the more efficient insider, which may become substantially more aggressive post-merger if the firms’ cost differences are sufficiently large. Intuitively, the high-cost insiders tend to raise prices and cut investment after merging. This can increase the marginal reward to cost reduction for the low-cost insider (and sometimes the outsider), who can then expand market share by investing more, lowering his marginal cost, and ultimately reducing its price. In the merger between highly asymmetric firms (e.g., highest cost with lowest cost), we show that the low-cost insider may increase investment enough that average market prices fall, and both total industry investment and consumer surplus can rise, even though the merger is profitable for the insiders. In other merger pairings, pro-competitive effects can still emerge, but typically require stronger conditions (e.g., certain ranges of product substitutability and/or cost asymmetry), and the identity of the outsider is pivotal.

Discussion and policy implications

The main contribution of the paper is to clarify how cost asymmetry can reverse standard merger predictions on innovation incentives and welfare. Policy wise, the results suggest that merger assessments based solely on symmetric benchmarks or concentration metrics can be misleading in markets where firms are structurally asymmetric (as is common in digital industries due to data advantages, learning effects, or technology gaps). A key implication is that authorities should pay close attention to which firms merge (not only how many) and to the interaction between asymmetry and demand substitutability when predicting post-merger investment and pricing incentives. Future work will extend the framework to richer dynamics (e.g., multi-period investment), entry, and endogenized merger choice, and further explore robustness beyond triopoly.