Efficiency-Enhancing Horizontal Mergers in Spatial Competition with Network Externalities

We study horizontal mergers in a network products market with a three-firm model of spatial competition, where two merged firms become compatible at the expense of product differentiation. We consider two different approaches to modeling rational expectations: responsive and passive. The results show that the merger may reduce industry competition, since the merger-related compatibility enlarges the network scales for insiders and amplifies product differentiation between the insiders and the outsider; therefore, the proposed merger may benefit all firms, raise consumer surplus, and enhance social welfare, i.e., the merger is Pareto-improving.