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Federal Trade Commission and the Department of Justice Issue Revised Horizontal Merger Guidelines for Public Comment
Federal Trade Commission and the Department of Justice Issue Revised Horizontal Merger Guidelines for Public Comment
First published in Antitrust News & Notes, May 2010
By William R. Vigdor| Read more articles from Antitrust News & Notes, May 2010 here. |
On April 20, 2010, the Department of Justice and the Federal Trade Commission (collectively the “Agencies”) jointly issued revised horizontal merger guidelines (the “Proposed Guidelines”) for public comment. The Agencies explain that the
Proposed Guidelines more accurately reflect current Agency enforcement practice than the horizontal guidelines issued in 1992 (revised in 1997) (the “Existing Guidelines”) and the latest economic analysis.
There are several notable aspects of the Proposed Guidelines. First, they no longer identify a four step approach to merger analysis; rather, they describe a less structured, fact specific merger analysis based on the reasonably available and reliable evidence. Second, the Proposed Guidelines appear to diminish the role of formal economic models by making clear that the Agencies will rely on economic theory, business documents, customer statements, and industry participant views more than formal models. Third, the Agencies are increasingly focusing on subsets of customers that may be targeted by the merging parties. Fourth, the role of market definition and share depends on the competitive effects analysis: playing a small role in differentiated products mergers and continuing to play a large role in all other merger analyses. Fifth, the Agencies continue to view efficiencies with skepticism, accepting a relatively small set of efficiencies and imposing a relatively large burden on the parties to “prove” the efficiencies.
These changes seem to enhance the likelihood of increased merger enforcement. Yet, the recent enforcement record by the Agencies does not suggest that merger challenges have increased dramatically. We therefore do not see the issuance of the Proposed Guidelines as a major shift in merger enforcement policy. Public comments are due on June 4.
Summary of the Proposed Merger Guidelines
Overview | Evidence of Adverse Competitive Effects | Targeted Customers and Price Discrimination | Market Definition | Market Participants, Market Shares, and Market Concentration | Unilateral Effects | Coordinated Effects | Powerful Buyers | Entry | Efficiencies | Failure and Existing Assets | Mergers of Competing Buyers | Partial Acquisitions
Overview
The Proposed Guidelines outline the “principal analytical techniques, practices and enforcement policy” of the Agencies. There is no single uniform analytical structure used to evaluate all horizontal mergers. Rather, it is a fact specific process that incorporates a range of analytical tools based on the “reasonably available and reliable evidence.” The “unifying theme” of the Proposed Guidelines is that “mergers should not be permitted to create, enhance or entrench market power or facilitate its exercise.” Market power is the ability to increase price, reduce output, reduce product quality and variety, reduce innovation and, in a newly added description, make it more likely that firms will profitably and effectively engage in exclusionary conduct. The Proposed Guidelines make clear that concerns may arise when direct customers or consumers or both are harmed, as compared to the Existing Guidelines that tend to focus on consumers.
Evidence of Adverse Competitive Effects
This section of the Proposed Guidelines summarizes the key evidence used by the Agencies and its sources. In consummated mergers, the Agencies use the same analytical techniques that they use in analyzing non-consummated mergers and the Agencies believe they can challenge such a transaction even if anticompetitive effects have not manifested themselves.
The Agencies explain that they look to “natural experiments” when analyzing mergers. A natural experiment is, for example, the effect of recent entry, exit, expansion, or contraction in the relevant or a comparable market. Other evidence includes market shares and market concentration, historical head-to-head competition between the merging parties, and the disruptive role of one of the parties. Sources of evidence include the merging parties, industry participants (with additional weight being given to customers), and other industry sources.
Targeted Customers and Price Discrimination
The Proposed Guidelines add this section and highlight that the effects of a merger on classes of customers will be considered if targeted customers can be charged a different price for a product than other customers (price discrimination). For this condition to exist, there must be a class of customers that suppliers can identify and charge a different price and favored customers cannot resell discounted products to disfavored customers.
Market Definition
Markets are defined to determine the area of competition in which to analyze the merger and it has a product and geographic component. The Proposed Guidelines maintain the hypothetical monopolist test, which asks if the only seller of the products in a candidate market “likely would impose at least a small but significant and non-transitory increase in price [a SSNIP] on at least one product in the market, including at least one product sold by one of the merged firms.” The SSNIP typically involves a 10 percent increase over prevailing prices. Historically, the agencies have used less than 10 percent in many energy industries, including gasoline marketing (1 cent per gallon), terminal services (50 basis points per gallon), and pipelines (based on the pipeline fees, not delivered product price).
If the Agencies believe that there is a subset of customers for whom a hypothetical monopolist can impose a SSNIP, the Agencies may define the market around that class of customers. The Agencies also may define markets more narrowly when sellers and buyers negotiate prices. For geographic market, the Agencies will define markets around the location of the sellers, unless sellers set different prices based on geographic location, in which case the market will be defined based on the location of the customers.
Market Participants, Market Shares, and Market Concentration
The Agencies may calculate shares and concentration using the Herfindahl-Hirschman Index or HHI. The HHI is the sum of the squared market share of each competitor. The Agencies typically investigate mergers in which the change in the HHI is greater than 100, and the post-merger HHI is greater than 1500 (six or fewer equally sized firms). The Agencies will presume the merger is likely to enhance market power if the merger increases the HHI by more than 200 points and the post-merger HHI is greater than 2500 (four or fewer equally sized firms). Shares are assigned to existing competitors, vertically integrated firms (to the extent the shares reflect their competitive significance), firms that have previously committed to entering and firms that “would very likely provide rapid supply responses with direct competitive impact” in response to a SSNIP.
Unilateral Effects
In the recent past, most mergers have been challenged under this theory. Perhaps this is why the section has been expanded substantially. Unilateral effects result from the elimination of competition between the two merging firms. The Proposed Guidelines identify four possible unilateral situations: differentiated products; bargaining and auctions; homogeneous products; and reductions in innovation and product variety. The key concern in a merger among differentiated products producers is that the parties produce products that the customers believe are the closest substitutes for each other, and industry members cannot or will not reposition their products to replace the lost competition. In such mergers, the Agencies do not rely on the HHI but on the value of sales diverted from one merging party to another in response to a price increase.
Unilateral effects may occur in a bargaining or auction situation when the merging firms are often the leading and runner-up bidders. Output suppression will occur, according to the Proposed Guidelines, in homogeneous goods markets, the merged firms have large shares, a large share of their output will benefit from the price increase, margin on the suppressed output is low, rivals are unlikely to react by expanding output, and demand elasticity is low. This theory is often applied in power generator mergers.
The reduction in innovation is most likely to occur when a merger combines “two of a very small number of firms with the strongest capabilities to successfully innovate in a specific direction.” Similarly, the Agencies will examine whether a merger would reduce redundant product variety or reduce the product variety to the detriment of consumers.
Coordinated Effects
Coordinated effects analysis focuses on market-wide responses to a merger that result in blunting of incentives to cut prices or enhancement of the incentives to accommodate rivals. The Agencies likely will identify coordinated effects from a merger when concentration levels are moderate or high, the market at issue is vulnerable to coordination, and the Agencies identify a plausible theory as to how the merger would reduce competition. “Plausible theories” are not described. While the Proposed Guidelines articulate when markets are vulnerable to coordination (e.g., transparency of transactions terms and customers; homogeneous products; use of meeting competition clauses; easy customer switching among suppliers; small and frequent sales; and inelastic demand), the Agencies will presume the market is vulnerable to coordination if there is a history of express coordination or unsuccessful invitations to collude.
Powerful Buyers
The Proposed Guidelines explain how the Agencies reaction to the “power buyer defense.” Parties often assert that mergers cannot increase prices when customers are large because such customers can protect themselves. The Proposed Guidelines state that the Agencies will not presume that buyer size alone forestalls anticompetitive effects from a merger. Rather, the Agencies examine the choices available to buyers to protect themselves. Even if powerful buyers have ways of protecting themselves, the Agencies will examine the effects of the merger on smaller customers.
Entry
According to the Proposed Guidelines, a merger is unlikely to reduce competition if entry is “timely, likely and sufficient in its magnitude, character and scope to deter or counteract the competitive effects of concern.” The Agencies will consider the history of entry and exit and their effect on competition in the market. Entry analysis considers the necessary scale to compete (typically called minimum viable scale) and all the steps necessary to enter, including planning, designing, permitting, construction, and market acceptance. To be timely, entry must rapid, although “rapid” is not defined and the two year time frame of the Existing Guidelines has been omitted. The likelihood of entry depends on the “assets, capabilities, and capital” needed to enter the market and risks of entry, including the cost of exit. In examining sufficiency, the Agencies normally look to ensure that entry will replicate the size and strength of at least one of the merged firms.
Efficiencies
The Agencies continue to credit efficiencies that are substantiated, merger specific (i.e., cannot be obtained through practical means other than the merger), and are not inextricably linked to anticompetitive effects. The Agencies note that the greater the anticompetitive effect, the greater the parties’ burden to substantiate the efficiencies, the greater the size the efficiencies must be, and the larger share of the efficiencies that must be shared with customers. Efficiencies must be disproportionately large relative to the anticompetitive effect in mergers to monopoly or with very high concentration levels. Marginal cost savings continue to carry the greatest weight.
Failure and Existing Assets
Acquisitions of failing firms may be approved by the Agencies if the parties show:
(1) the allegedly failing firm would be unable to meet its financial obligations in the near future; (2) it would not be able to reorganize successfully under Chapter 11 of the Bankruptcy Act; and (3) it has made unsuccessful good-faith efforts to elicit reasonable alternative offers that would keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed merger.
Mergers of Competing Buyers
The Proposed Guidelines add a section discussing mergers between competing buyers. The Agencies apply the same analysis to these transactions as with mergers between sellers, but do not evaluate buy-side issues based “strictly, or even primarily, on the basis of effects in the downstream markets in which the merging parties sell.”
Partial Acquisitions
The final section of the Proposed Guidelines discusses partial acquisitions. Such transactions have been more common as private equity and hedge funds acquire interests in businesses. In evaluating partial acquisitions, the Agencies examine whether the transaction would reduce competition by: (1) allowing the acquirer to control or influence decisions of its rival; (2) reducing the incentive to compete against an affiliate, even absent the acquisition of control or influence; and (3) sharing information.
For more information, please contact Vinson & Elkins lawyer William R. Vigdor. Visit our website to learn more about V&E's Antitrust practice. Get a .pdf of this issue of Antitrust News & Notes e-newsletter here.
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