Mar 04 2013
“Drinking games” – Why a Budweiser / Corona merger would seriously bum out, like, a ton of frat boys
Facts: 65% of all the beer bought in the United States is produced by one of two companies: Anheuser Busch / InBev or Miller. 7% is produced by a company called Grupo Modelo. 72% of all the beer bought comes from these three companies. Much of the remaining market is shared by thousands of “micro-breweries” of varying sizes.
While there are literally thousands of beer makers in the US, technically speaking, the market is oligopolistic, since such a large share of the market (72%) is dominated by just three firms. To be classified as an oligopoly, a market must be dominated by a few large firm selling a differentiated (and sometimes a homogeneous) product. Firms are interdependent on one another and they tend to compete for consumers using “non-price competition”, which may include improving the quality of their product and offering customers a wider variety to choose from, and especially through advertising. A final characteristic of oligopoly is that high barriers to entry exist.
In the case of the beer market, there are minimal economies of scale, since anyone with a $200 home brewing kit can technically “enter the market”. But other barriers to entering the national market for beer are significant, which explains why the market is dominated by three huge firms. Notably, brand recognition poses a barrier to entry to the thousands of small brewers in America. The brands owned by the big three firms are well-established and liked among consumers, making it difficult for smaller brewers to gain share in the market.
In the Planet Money podcast below, we hear the story two of these “big three” beer makers. Anheuser Busch / InBev is attempting to merge with Grupo Modelo, a transaction that would reduce the “big three” to the “big two”, which would give the new single firm a truly dominant position in the market, and increase the two-firm concentration ratio from 65% to 72%. The podcast explains how competition in the market for beer benefits consumers, and how a decrease in competition will harm consumers. Below, I will provide a graphical analysis of the situation.
As the podcast explains, the competition between the big three beer producers has several benefits for consumers, not least of which is the huge variety of beers available across the three firms, each trying to capture a larger share of the market by offering consumers beers that appeal to their diverse tastes. In addition, however, the nature of competition in oligopolistic markets tends to result in stable prices over time. Here’s why:
Imagine Anheuser Busch / InBev, which wishes to raise its price from P1 to P2 in the graph below. If AB/InBev raises its prices, while Modelo and Miller keep theirs unchanged, the demand for AB/InBev’s beer is likely to be highly elastic, meaning that even a small price increase will cause the quantity demanded to fall dramatically (from Q1 to Q2). Due to the high elasticity of demand above P1, such a price hike will lead to lower revenues for AB/InBev. Conclusion? A price hike is a bad idea.
So what if AB/InBev decides to lower its prices? The graph below shows that at any price below P1, demand will most likely be highly inelastic, because a price cut will most likely be matched by Modelo and Miller, who would have to cut their prices to avoid losing a significant number of consumers to AB/InBev. If all three firms lower their prices, then each firm will see hardly any increase at all in their total sales. A price decrease by AB/InBev will set off a “price war” and the firm will see its revenues fall.
What we end up with is what is known as a “kinked” demand curve for AB/InBev’s beers.
The firm has almost no incentive to raise or lower its prices, since a change in either direction will cause revenues to decline. Therefore, beer consumers enjoy stable prices, and the firms choose to compete through product differentiation, innovation and, of course, advertising!
So how would a merger between two of the big three beer makers change the situation in the market? What if just TWO firms controlled 72% of the market instead of three? The fear is that AB/InBev, once it owns Modelo, will be less interdependent on the actions of Miller. In other words, it will care less whether Miller ignores its price increases or matches its price decreases. Since there will be fewer substitutes for the gigantic firm’s dozens (or hundreds?!) of beer brands, demand for them overall will be more inelastic. This would give AB/InBev more price making power, and essentially make the market look more like a monopoly.
When a firm has monopoly power, as we can see, a large increase in price (from P1 to P2) leads to a relatively smaller decrease in sales (from Qt to Q2). If AB/InBev and Modelo were to merge the firm would be able to get away with raising the price of all of its beer brands, as consumers are less likely to switch to the competition, since a big chunk of the competition would be owned by the firm itself!
The amount of competition that exists in a market has major bearings on the consumers, as this podcast demonstrates and our graphs illustrate. With just three big firms making 72% of the beer in the US, it may not seem like that big a deal if two of them merge. But even the loss of one firm in a highly concentrated market like beer could lead to higher prices for dozens of the top selling beers in the country; hence the US government’s hesitance to give AB/InBev a green light in its plan to acquire Grupo Modelo!
- How can a market with thousands of individual sellers be considered oligopolistic?
- Why is “brand recognition” considered a barrier to entry into the beer market?
- Explain why prices in oligopolistic markets tend not to increase or decrease very often.
- Why is “non-price competition” so important for beer makers in the US? What are some forms of non-price competition that they practice?
- What is meant by the statement that “monopoly price is higher and output is lower than what is socially optimal.” Would this apply to the beer market if the AB/InBev and Modelo merger were to proceed?