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Sunglasses & Market Power.

A key principle of microeconomics is that of market competition. This is essentially a question of barriers to entry, where industries with high barriers to entry generally have higher profit margins than businesses with low barriers to entry. On one end of the spectrum we have monopolies (eg Monsanto – seed & pesticide multinational) and on the other we have businesses in perfect competition (eg gas station or corner stores.)

As a general rule, we can say that businesses with less competition have more market power, giving them the ability to inflate prices, push margins, and can thus be more profitable. For this reason we can see why it would be beneficial for a business to decrease competition within its industry, and inversely, why it is beneficial for consumers for company market share to be limited.

Luxxotica.

Not necessarily a brand name you know, but you likely own something which they produce. In the late 1980s Luxxotica began purchasing the rights to produce sunglasses for luxury brand names including Armani, Oakley, Ray-Bans and literally dozens of others. In the early 2000s it was estimated  that Luxxotica controlled up to 80% of the sunglasses market, although this exact number was questions by Euromoniter, the world’s largest business monitor,  who disagreed with this saying they only controlled approximately 10% of the world’s 950 Million pairs of glasses produced annually. Though their is some ambivalence and secrecy about the exact market share of Luxxotica, what is clear is that they are the largest producer in the market by a measure of magnitude, which can lead to price gouging – especially in areas where consumer demand is not flexible, such as prescription glasses.

The Essilor Merger.

In the past week it was announced that Luxxotica has planned $49Billion merger with Essilor, a French lens manufacturer.  Normally, business mergers like this are commonplace, as both companies can take advantage of the synergy between the two businesses – which make the businesses more valuable to each other than they would be to a non-related business. In this example Luxxotica benefits by receiving cheaper lens’ (and thus increasing profits) and Essilor benefits by becoming the go-to lens manufacturer for Luxxotica, no doubt also increasing their profits. Here are some numbers which explain the idea:

For a non-related company:

Company value = annual profit / % required return

Essilor Value = 5B/12.5% = 40B

For a company with synergy:

Company Value = (annual profit / % required return) + (annual value of synergy)/%required return.

Essilor Value = 5B/12.5% + 1B/12.5% = 48B

Though these synergy-mergers make a lot of sense, when you start dealing with companies of this size consumers can come out significantly worse off. Over the next 6 months the two companies both require regulatory approval, as well as shareholder approval. Largely this will rest on whether the companies are doing this to increase market size, and thus gain pricing leverage, or if they can indeed prove that synergy exists between the two companies to an extent where shareholders will benefit without significant pricing increases to consumers. So who knows, this time next year your Ray-Bans may no longer bare the Luxxotica mark, but rather the EssilorLuxxotica mark. Thanks for reading.

 

 

 

 

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