(Chinese Version)

2015 is destined to be an extraordinary year in the history of the Chinese Internet industry. After various rounds of fierce price wars, lots of leading Internet companies chose to merge instead, reducing significantly the possibilities of the dynamic Internet industry. Are these companies really willing to shake hands and settle down? If not, what are their ultimate goals? These are exactly what I attempt to answer in this article:

First of all, let’s have a brief look at two best-known mergers:

Didi & Kuaidi:
On the Valentine’s Day in 2015, China's two mobile taxi-hailing service providers Didi Dache and Kuaidi Dache jointly announced their strategic merger. The new company would run on a co-CEO basis (Didi Dache’s CEO Chen Wei and Kuaidi Dache’s Lv Chuanxiong would share leadership as co-CEOs) and keep the original structure of their respective human resources. Didi and Kuaidi would continue to run their business on parallel, retain their brands, and remain independent.

MeiTuan & Dianping:
Just one day after the National Day Holiday, when the entire country was still immersed in a festive atmosphere, another piece of news shocked everyone: In a joint announcement, China's two leading group-buying sites similar to Groupon, Dianping and MeiTuan, announced that they would together form a new company and advance strategic cooperation. Zhang Tao, CEO of Dianping, and Wang Xing, CEO of Meituan, would share leadership as co-CEOs of the new company. Both Dianping and Meituan would retain their respective brands and management structure, and would independently operate their businesses.

Do these mergers constitute monopolies?

One might wonder if the mergers of top two Internet companies constitute monopolies?

Beijing-based Analysys International’s statistics suggest that as of December 2014, Didi Dache had a market share of 43.3 percent, while Kuadi Dache grabbed 56.5 percent. In this sense, the new company would account for 99.64% share of the Chinese car-hailing market. Sounds like a monopoly, isn’t it?

How about MeiTuan and Dianping, two household Chinese group-buying sites? MeiTuan stood out after the harsh fights among hundreds of group-buying sites in 2010, became the number one group-buying service provider in 2012, and achieved an overall transaction volume of over 40 billion RMB (around 6.4 billion USD) in 2014. Dianping became the second largest group-buying service provider in 2012 with the help of its wide user base from previous restaurant-review business, and achieved an overall transaction volume of over 18 billion RMB (2.8 billion USD) in 2014, three times higher than that of Nuomi, Baidu’s own group-buying service platform. Tuan800’s statistics suggest that by the end of the first half of 2015, MeiTuan accounted for 51.9% share of the market, Dianping grabbed 29.5%, while Nuomi possessed another 13.6%. In this sense, the merger between MeiTuan and Dianping would turn them into the dominant player in the market and an even stronger competitor for Nuomi.

To what degree is a market monopolized?

The Herfindahl index (also known as Herfindahl–Hirschman Index, or HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. It is defined as the sum of the squares of the market shares of the firms within the industry. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0. If there is only one company in a market, then the HHI will be 1; if there are N companies of the same size in a market, then the HHI will be 1/N.

Before Didi and Kuaidi merged, the HHI or the Chinese car-hailing market was 0.50 (56.5%2+ 43.3%2+0.2%2); after the merge, the HHI would reach 0.996 (99.8%/2+0.2%2), which means that the market was monopolized. Likewise, the merge between MeiTuan and Dianping would raise the HHI of the Chinese group-buying market from 0.337 to 0.684, an increase of almost 100%.

One might wonder since their merger did constitute monopolies, then why didn’t relevant government departments interfere in and halt their merger? On February 16th (two days after the merger), the spokesperson of the Ministry of Commerce, head of the Anti-Monopoly Bureau, stated at a routine press conference that they haven’t received any notification files from Didi and Kuaidi yet. On the same day, Didi Kuaidi’s spokesperson also suggested that they had no need to get the Anti-Monopoly Bureau’s permission before the merger. How come?

Why didn’t these mergers constitute monopolies?

The central reason is that the current laws were drafted counter monopoly among traditional companies, so they failed to catch up with the trend and couldn’t be adopted to regulate Internet companies. According to Anti-Monopoly Law of the People’s Republic of China (hereafter referred to as China's Anti-Monopoly Law), if the total turnover in China in the previous accounting year of all undertakings involved in the concentration exceeds 2 billion RMB (around 293 million USD), and at least two of such undertakings each has a turnover of more than RMB 400 million (around 59 million USD) within China in the previous accounting year, a merger notification must be filed with the Anti-Monopoly Bureau before the transaction is implemented otherwise parties can incur financial penalties. While Kuaidi once declared publicly that its transaction volume reached 12.8 billion RMB 9 (around 2.0 billion USD), Didi’s transaction wasn’t disclosed, but must have surpassed 10 billion RMB (around 1.6 billion USD). If so, why didn’t Didi and Kuaidi have to notify the Anti-Monopoly Bureau as was required in the law?

The tricky thing is that China’s Anti-Monopoly Law limits the total turnover of companies, not transaction volume. Didi and Kuaidi’s transaction volume might have surpassed 10 billion RMB, but their total turnover remains low: passengers and drivers don’t have to pay for their services via Didi and Kuaidi, while they are showered with Didi and Kuaidi’s red envelops. That’s why Didi and Kuaidi’s merger wasn’t subject to the law and why they didn’t have to file merger notification before their merger was implemented. Although their merger raised the HHI of the market a lot, the current China’s Anti-Monopoly Law couldn’t be adopted to regulate burgeoning Internet companies whose total turnover remained low but transaction volume soared in the early stage of their development.

Will consumers suffer from these mergers?

Now that we’ve figured out why these newly-merged companies didn’t have to file merge notification to the Anti-Monopoly Bureau, I shall go one step further and answer if these mergers will suffer from these new mergers, theoretically and practically.

Bertrand competition is a model of competition used in economics that describes interactions among firms (sellers) that set prices and their customers (buyers) that choose quantities at the prices set.

Bertrand competition model

The model rests on very specific assumptions. Suppose there are two firms in a market. They produce a homogeneous (undifferentiated) product and can’t cooperate in any way. These two firms compete by setting prices simultaneously and consumers want to buy everything from a firm with a lower price (since the product is homogeneous and there are no consumer search costs). If both firms set the same price above unit cost and share the market, then each firm has an incentive to undercut the other by an arbitrarily small amount and capture the whole market and almost double its profits. The firms setting the higher price will earn nothing (the lower priced firm serves all of the customers). Hence the only equilibrium in the Bertrand model occurs when both firms set price equal to unit cost (the competitive price), when consumers demand will be split evenly between them.

On the surface, the Chinese group-buying and car-hailing service market looks like a perfect market assumed in the Bertrand competition model: all the group-buying and car-hailing service providers have basically the same unit cost, provide similar services, are competing fiercely and can’t cooperate in any way, while consumers are always price sensitive. In this perfect competitive market, consumers won’t necessarily suffer from mergers.

In reality, however, these markets are not perfect at all. First of all, these newly-merged companies will become so dominant that some consumers might suffer. For example, when every driver is willing to pick up passengers via Didi Kuaidi (laterd changed into Didi Chuxing), senior citizens who are unfamiliar with Internet technologies might find it really hard to a hail a car on the road. Secondly, newly-emerged companies might turn to unfair competition with their monopolized position. For example, after MeiTuan and Dianping emerged, some restaurant owners found that MeiTuan would increase the percentage of commission from 8% to 12% if they cooperated with group-buying service providers other than MeiTuan and Dianping. Likewise, after Didi and Kuaidi merged together and became so dominant in the market, all other car-hailing service providers find it hard to attract drivers and passengers to use their services, while Didi Kuaidi felt free to raise the price. Even so, passengers might find it pretty hard to hail a car via Didi Kuaidi in rush hour. Thirdly, other factors, such as a platform’s user retention rate, user base, scope of services, will also influence consumers’ price awareness. For example, although the same groupon vouchers might be cheaper on Nuomi, many consumers still chose to the newly merged MeiTuan & Dianping since their platform were more comprehensive and widely used.

To wrap up, newly-emerged companies might at a huge advantage over other competitors with their enormous user base and influence. If they finally dominate the market and outperform every other competitor, then time has come for them to do harm to consumers’ rights and interests.

What can the legislative and administrative divisions do to crack down on monopolies?

As is discussed above, consumers will certainly suffer from these new mergers. In this case, what can the legislative and systems do to crack down on monopolies?

First of all, the legislative and systems should amend the current Anti-Monopoly Law and evaluate if a merger constitute a monopoly based on various factors, such as the total turnover, transaction volume, market share, etc.

Secondly, a series of anti-monopoly investigation should be conducted to evaluate if the newly-merged companies constitute monopolies. The government should break these monopolies into smaller companies, and limit the productivity, price of those that can’t be or aren’t appropriate to be broken as punishment.

For example, to crack down on monopolies in the Chinese petroleum industry, National Development and Reform Commission (NDRC) has already been invited to take charge and set the price of refined oil based on International standards, though the average price remains higher than that of the International refined oil. Nevertheless, without NDRC’s control, the price could have gone higher.

Thirdly, Chinese government can punish monopolies that violate Anti-Unfair Competition Laws.This method has been widely adopted to crack down on monopolies in foreign countries. For example, Microsoft has been fined tens of millions of dollars for bundling other software together with its operating system. Likewise, Google was also under investigation by several countries and organizations for potential unfair competition behavior in bundling Google’s apps in Android-based smartphones, and was going to be fined 10% of its total turnover if the charge was confirmed.

Besides MeiTuan & Dianping, a few more couples of top Internet companies, such as Didi & Kuaidi, 58 & Ganji, Ctrip & Elong, have all merged together in 2015. These newly-merged companies will certainly do harm to consumers’ rights and interests with their monopolistic position. It’s high time relevant legislative and administrative divisions should carry out effective policies and approaches accordingly to better protect consumers.

[The article is published and edited with authorization from the author @Su Meng, please note source and hyperlink when reproduce.]

Translated by Levin Feng (Senior Translator at ECHO), working for TMTpost.