unlikely that the merger will create or enhance market power or facilitate
its exercise, in light of market concentration and market shares.

1.52 Factors Affecting the Significance of Market
Shares and Concentration

The post-merger level of market concentration and the change in con-
centration resulting from a merger affect the degree to which a merger
raises competitive concerns. However, in some situations, market share
and market concentration data may either understate or overstate the likely
future competitive significance of a firm or firms in the market or the
impact of a merger. The following are examples of such situations.

1.521 Changing Market Conditions

Market concentration and market share data of necessity are based on
historical evidence. However, recent or ongoing changes in the market
may indicate that the current market share of a particular firm either under-
states or overstates the firm's future competitive significance. For example,
if a new technology that is important to long-term competitive viability is
available to other firms in the market, but is not available to a particular
firm, the Agency may conclude that the historical market share of that firm
overstates its future competitive significance. The Agency will consider rea-
sonably predictable effects of recent or ongoing changes in market condi-
tions in interpreting market concentration and market share data.

1.522 Degree of Difference Between the Products and Locations
in the Market and Substitutes Outside the Market

All else equal, the magnitude of potential competitive harm from a
merger is greater if a hypothetical monopolist would raise price within the
relevant market by substantially more than a “small but significant and non-
transitory” amount. This may occur when the demand substitutes outside
the relevant market, as a group, are not close substitutes for the products
and locations within the relevant market. There thus may be a wide gap in
the chain of demand substitutes at the edge of the product and geographic
market. Under such circumstances, more market power is at stake in the
relevant market than in a market in which a hypothetical monopolist would
raise price by exactly five percent.

17


5.2 Failing Division

A similar argument can be made for “failing” divisions as for failing
firms. First, upon applying appropriate cost allocation rules, the division
must have a negative cash flow on an operating basis. Second, absent the
acquisition, it must be that the assets of the division would exit the relevant
market in the near future if not sold. Due to the ability of the parent firm
to allocate costs, revenues, and intracompany transactions among itself and
its subsidiaries and divisions, the Agency will require evidence, not based
solely on management plans that could be prepared solely for the purpose
of demonstrating negative cash flow or the prospect of exit from the rele-
vant market. Third, the owner of the failing division also must have com-
plied with the competitively-preferable purchaser requirement of
Section 5.1.

34

wt U.S. GOVERNMENT PRINTING OFFICE: 1997 417-737/74264


1.3 Identification of Firms That Participate
in the Relevant Market

1.31 Current Producers or Sellers

The Agency's identification of firms that participate in the relevant mar-
ket begins with all firms that currently produce or sell in the relevant mar-
ket. This includes vertically integrated firms to the extent that such inclu-
sion accurately reflects their competitive significance in the relevant market
prior to the merger. To the extent that the analysis under Section 1.1 indi-
cates that used, reconditioned or recycled goods are included in the rele-
vant market, market participants will include firms that produce or sell
such goods and that likely would offer those goods in competition with
other relevant products.

1.32 Firms That Participate Through Supply Response

In addition, the Agency will identify other firms not currently producing
or selling the relevant product in the relevant area as participating in the
relevant market if their inclusion would more accurately reflect probable
supply responses. These firms are termed “uncommitted entrants.” These
supply responses must be likely to occur within one year and without the
expenditure of significant sunk costs of entry and exit, in response to a
“small but significant and nontransitory” price increase. If a firm has the
technological capability to achieve such an uncommitted supply response,
but likely would not (e.g., because difficulties in achieving product accep-
tance, distribution, or production would render such a response unprof-
itable), that firm will not be considered to be a market participant. The
competitive significance of supply responses that require more time or that
require firms to incur significant sunk costs of entry and exit will be consid-
ered in entry analysis. See Section 3.18

Sunk costs are the acquisition costs of tangible and intangible assets
that cannot be recovered through the redeployment of these assets outside
the relevant market, i.e., costs uniquely incurred to supply the relevant
product and geographic market. Examples of sunk costs may include mar-

13 {f uncommitted entrants likely would also remain in the market and would meet the entry tests of
timeliness, likelihood and sufficiency, and thus would likely deter anticompetitive mergers or deter or
counteract the competitive effects of concem (see Section 3, infra), the Agency will consider the impact
of those firms in the entry analysis.

11


complex than temporary abandonment of the terms of coordination by
other firms in the market.

Where detection and punishment likely would be rapid, incentives to
deviate are diminished and coordination is likely to be successful. The
detection and punishment of deviations may be facilitated by existing prac-
tices among firms, themselves not necessarily antitrust violations, and by
the characteristics of typical transactions. For example, if key information
about specific transactions or individual price or output levels is available
routinely to competitors, it may be difficult for a firm to deviate secretly. If
orders for the relevant product are frequent, regular and small relative to
the total output of a firm in a market, it may be difficult for the firm to devi-
ate in a substantial way without the knowledge of rivals and without the
opportunity for rivals to react. If demand or cost fluctuations are relatively
infrequent and small, deviations may be relatively easy to deter.

By contrast, where detection or punishment is likely to be slow, incen-
tives to deviate are enhanced and coordinated interaction is unlikely to be
successful. If demand or cost fluctuations are relatively frequent and large,
deviations may be relatively difficult to distinguish from these other sources
of market price fluctuations, and, in consequence, deviations may be rela-
tively difficult to deter.

In certain circumstances, buyer characteristics and the nature of the
procurement process may affect the incentives to deviate from terms of
coordination. Buyer size alone is not the determining characteristic.
Where large buyers likely would engage in long-term contracting, so that
the sales covered by such contracts can be large relative to the total output
of a firm in the market, firms may have the incentive to deviate. However,
this only can be accomplished where the duration, volume and profitability
of the business covered by such contracts are sufficiently large as to make
deviation more profitable in the long term than honoring the terms of coor-
dination, and buyers likely would switch suppliers.

In some circumstances, coordinated interaction can be effectively pre-
vented or limited by maverick firms -- firms that have a greater economic
incentive to deviate from the terms of coordination than do most of their
rivals (e.g., firms that are unusually disruptive and competitive influences in
the market). Consequently, acquisition of a maverick firm is one way in
which a merger may make coordinated interaction more likely, more suc-
cessful, or more complete. For example, in a market where capacity con-
straints are significant for many competitors, a firm is more likely to be a
maverick the greater is its excess or divertable capacity in relation to its

21


tially to lessen competition, not to describe how the Agency will conduct
the litigation of cases that it decides to bring. Although relevant in the lat-
ter context, the factors contemplated in the Guidelines neither dictate nor
exhaust the range of evidence that the Agency must or may introduce in lit-
igation. Consistent with their objective, the Guidelines do not attempt to
assign the burden of proof, or the burden of coming forward with evidence,
on any particular issue. Nor do the Guidelines attempt to adjust or reap-
portion burdens of proof or burdens of coming forward as those standards
have been established by the courts.5 Instead, the Guidelines set forth a
methodology for analyzing issues once the necessary facts are available.
The necessary facts may be derived from the documents and statements of
both the merging firms and other sources.

Throughout the Guidelines, the analysis is focused on whether con-
sumers or producers “likely would” take certain actions, that is, whether the
action is in the actor's economic interest. References to the profitability of
certain actions focus on economic profits rather than accounting profits.
Economic profits may be defined as the excess of revenues over costs
where costs include the opportunity cost of invested capital.

Mergers are motivated by the prospect of financial gains. The possible
sources of the financial gains from mergers are many, and the Guidelines
do not attempt to identify all possible sources of gain in every merger.
Instead, the Guidelines focus on the one potential source of gain that is of
concern under the antitrust laws: market power.

The unifying theme of the Guidelines is that mergers should not be per-
mitted to create or enhance market power or to facilitate its exercise.
Market power to a seller is the ability profitably to maintain prices above
competitive levels for a significant period of time.¢ In some circumstances,
a sole seller (a “monopolist”) of a product with no good substitutes can
maintain a selling price that is above the level that would prevail if the mar-
ket were competitive. Similarly, in some circumstances, where only a few
firms account for most of the sales of a product, those firms can exercise
market power, perhaps even approximating the performance of a monop-
olist, by either explicitly or implicitly coordinating their actions. Circum-
stances also may permit a single firm, not a monopolist, to exercise market

5. For example, the burden with respect to efficiency and failure continues to reside with the propo-
nents of the merger.

& Sellers with market power also may lessen competition on dimensions other than rice, such as
Pr y pel PI
product quality, service, or innovation.


ducting this analysis,37 the Agency will not simply compare the magni-
tude of the cognizable efficiencies with the magnitude of the likely harm
to competition absent the efficiencies. The greater the potential adverse
competitive effect of a merger—as indicated by the increase in the HHI
and post-merger HHI from Section 1, the analysis of potential adverse
competitive effects from Section 2, and the timeliness, likelihood, and
sufficiency of entry from Section 3—the greater must be cognizable effi-
ciencies in order for the Agency to conclude that the merger will not
have an anticompetitive effect in the relevant market. When the poten-
tial adverse competitive effect of a merger is likely to be particularly
large, extraordinarily great cognizable efficiencies would be necessary to
prevent the merger from being anticompetitive.

In the Agency’s experience, efficiencies are most likely to make a dif-
ference in merger analysis when the likely adverse competitive effects,
absent the efficiencies, are not great. Efficiencies almost never justify a
merger to monopoly or near-monopoly.

The Agency has found that certain types of efficiencies are more like-
ly to be cognizable and substantial than others. For example, efficiencies
resulting from shifting production among facilities formerly owned sepa-
rately, which enable the merging firms to reduce the marginal cost of
production, are more likely to be susceptible to verification, merger-spe-
cific, and substantial, and are less likely to result from anticompetitive
reductions in output. Other efficiencies, such as those relating to
research and development, are potentially substantial but are generally
less susceptible to verification and may be the result of anticompetitive
output reductions. Yet others, such as those relating to procurement,
management, or capital cost are less likely to be merger-specific or sub-
stantial, or may not be cognizable for other reasons.

37 The result of this analysis over the short term will determine the Agency's enforcement decision
in most cases. The Agency also will consider the effects of cognizable efficiencies with no short-
term, direct effect on prices in the relevant market. Delayed benefits from efficiencies (due to delay
in the achievement of, or the realization of consumer benefits from, the efficiencies) will be given less
weight because they are less proximate and more difficult to predict.

32


2. The Potential Adverse Competitive
Effects of Mergers

2.0 Overview

Other things being equal, market concentration affects the likelihood
that one firm, or a small group of firms, could successfully exercise market
power. The smaller the percentage of total supply that a firm controls, the
more severely it must restrict its own output in order to produce a given
price increase, and the less likely it is that an output restriction will be prof-
itable. If collective action is necessary for the exercise of market power, as
the number of firms necessary to control a given percentage of total supply
decreases, the difficulties and costs of reaching and enforcing an under-
standing with respect to the control of that supply might be reduced.
However, market share and concentration data provide only the starting
point for analyzing the competitive impact of a merger. Before determin-
ing whether to challenge a merger, the Agency also will assess the other
market factors that pertain to competitive effects, as well as entry, efficien-
cies and failure.

This section considers some of the potential adverse competitive effects
of mergers and the factors in addition to market concentration relevant to
each. Because an individual merger may threaten to harm competition
through more than one of these effects, mergers will be analyzed in terms
of as many potential adverse competitive effects as are appropriate. Entry,
efficiencies, and failure are treated in Sections 3-5.

2.1 Lessening of Competition Through
Coordinated Interaction

A merger may diminish competition by enabling the firms selling in the
relevant market more likely, more successfully, or more completely to
engage in coordinated interaction that harms consumers. Coordinated
interaction is comprised of actions by a group of firms that are profitable
for each of them only as a result of the accommodating reactions of the
others. This behavior includes tacit or express collusion, and may or may
not be lawful in and of itself.

Successful coordinated interaction entails reaching terms of coordina-
tion that are profitable to the firms involved and an ability to detect and
punish deviations that would undermine the coordinated interaction.

18


concentration data fall outside the safeharbor regions of Section 1.5, and
the merging firms have a combined market share of at least thirty-five per-
cent, the Agency will presume that a significant share of sales in the market
are accounted for by consumers who regard the products of the merging
firms as their first and second choices.

Purchasers of one of the merging firms’ products may be more or less
likely to make the other their second choice than market shares alone
would indicate. The market shares of the merging firms’ products may
understate the competitive effect of concern, when, for example, the prod-
ucts of the merging firms are relatively more similar in their various attrib-
utes to one another than to other products in the relevant market. On the
other hand, the market shares alone may overstate the competitive effects
of concern when, for example, the relevant products are less similar in their
attributes to one another than to other products in the relevant market.

Where market concentration data fall outside the safeharbor regions of
Section 1.5, the merging firms have a combined market share of at least
thirty-five percent, and where data on product attributes and relative prod-
uct appeal show that a significant share of purchasers of one merging
firm’s product regard the other as their second choice, then market share
data may be relied upon to demonstrate that there is a significant share of
sales in the market accounted for by consumers who would be adversely
affected by the merger.

2.212 Ability of Rival Sellers to Replace Lost Competition

A merger is not likely to lead to unilateral elevation of prices of differen-
tiated products if, in response to such an effect, rival sellers likely would
replace any localized competition lost through the merger by repositioning
their product lines.23

In markets where it is costly for buyers to evaluate product quality, buy-
ers who consider purchasing from both merging parties may limit the total
number of sellers they consider. If either of the merging firms would be
replaced in such buyers’ consideration by an equally competitive seller not
formerly considered, then the merger is not likely to lead to a unilateral ele-
vation of prices.

23 The timeliness and likelihood of repositioning responses will be analyzed using the same methodol-
ogy as used in analyzing uncommitted entry or committed entry (see Sections 1.3 and 3), depending on
the significance of the sunk costs entailed in repositioning.

24


2.11 Conditions Conducive to Reaching Terms of
Coordination

Firms coordinating their interactions need not reach complex terms
concerning the allocation of the market output across firms or the level of
the market prices but may, instead, follow simple terms such as a common
price, fixed price differentials, stable market shares, or customer or territori-
al restrictions. Terms of coordination need not perfectly achieve the
monopoly outcome in order to be harmful to consumers. Instead, the
terms of coordination may be imperfect and incomplete -- inasmuch as
they omit some market participants, omit some dimensions of competition,
omit some customers, yield elevated prices short of monopoly levels, or
lapse into episodic price wars -- and still result in significant competitive
harm. At some point, however, imperfections cause the profitability of
abiding by the terms of coordination to decrease and, depending on their
extent, may make coordinated interaction unlikely in the first instance.

Market conditions may be conducive to or hinder reaching terms of
coordination. For example, reaching terms of coordination may be facili-
tated by product or firm homogeneity and by existing practices among
firms, practices not necessarily themselves antitrust violations, such as stan-
dardization of pricing or product variables on which firms could compete.
Key information about rival firms and the market may also facilitate reach-
ing terms of coordination. Conversely, reaching terms of coordination
may be limited or impeded by product heterogeneity or by firms having
substantially incomplete information about the conditions and prospects of
their rivals’ businesses, perhaps because of important differences among
their current business operations. In addition, reaching terms of coordina-
tion may be limited or impeded by firm heterogeneity, for example, differ-
ences in vertical integration or the production of another product that tends
to be used together with the relevant product.

2.12 Conditions Conducive to Detecting and Punishing
Deviations

Where market conditions are conducive to timely detection and punish-
ment of significant deviations, a firm will find it more profitable to abide by
the terms of coordination than to deviate from them. Deviation from the
terms of coordination will be deterred where the threat of punishment is
credible. Credible punishment, however, may not need to be any more

20


5. Failure and Exiting Assets

5.0 Overview

Notwithstanding the analysis of Sections 1-4 of the Guidelines, a merg-
er is not likely to create or enhance market power or to facilitate its exer-
cise, if imminent failure, as defined below, of one of the merging firms
would cause the assets of that firm to exit the relevant market. In such cir-
cumstances, post-merger performance in the relevant market may be no
worse than market performance had the merger been blocked and the
assets left the market.

5.1 Failing Firm

A merger is not likely to create or enhance market power or facilitate
its exercise if the following circumstances are met: 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 Il of the
Bankruptcy Act;38 3) it has made unsuccessful good-faith efforts to elicit
reasonable alternative offers of acquisition of the assets of the failing firm?
that would both keep its tangible and intangible assets in the relevant mar-
ket and pose a less severe danger to competition than does the proposed
merger; and 4) absent the acquisition, the assets of the failing firm would
exit the relevant market

38 11U.S.C. §§ 1101-1174 (1988)
39 Any offer to purchase the assets of the failing firm for a price above the liquidation value of those

assets — the highest valued use outside the relevant market or equivalent offer to purchase the stock of
the failing firm -- will be regarded as a reasonable alternative offer.

33


exceed the amount of shipments by such firms allowed under the quota.1¢
In the case of restraints that limit imports to some percentage of the total
amount of the product sold in the United States (i.e., percentage quotas), a
domestic price increase that reduced domestic consumption also would
reduce the volume of imports into the United States. Accordingly, actual
import sales and capacity data will be reduced for purposes of calculating
market shares. Finally, a single market share may be assigned to a country
or group of countries if firms in that country or group of countries act in
coordination.

1.5 Concentration and Market Shares

Market concentration is a function of the number of firms in a market
and their respective market shares. As an aid to the interpretation of mar-
ket data, the Agency will use the Herfindahl-Hirschman Index (“HHI”) of
market concentration. The HHI is calculated by summing the squares of
the individual market shares of all the participants.17_ Unlike the four-firm
concentration ratio, the HHI reflects both the distribution of the market
shares of the top four firms and the composition of the market outside the
top four firms. It also gives proportionately greater weight to the market
shares of the larger firms, in accord with their relative importance in com-
petitive interactions.

The Agency divides the spectrum of market concentration as measured
by the HHI into three regions that can be broadly characterized as uncon-
centrated (HHI below 1000), moderately concentrated (HHI between 1000
and 1800), and highly concentrated (HHI above 1800). Although the
resulting regions provide a useful framework for merger analysis, the
numerical divisions suggest greater precision than is possible with the avail-
able economic tools and information. Other things being equal, cases
falling just above and just below a threshold present comparable competi-
tive issues.

16 The constraining effect of the quota on the importer’s ability to expand sales is relevant to the eval
uation of potential adverse competitive effects, See Section 2.

17 For example. a market consisting of four firms with market shares of 30 percent. 30 percent, 20
percent and 20 percent has an HHI of 2600 (302 + 302 + 202 + 202 = 2600). The HHI ranges
from 10,000 (in the case of a pure monopoly) to a number approaching zero (in the case of an atomistic
market). Although it is desirable to include all firms in the calculation, lack of information about small
firms is not critical because such firms do not affect the HHI significantly.

15


(2) evidence that sellers base business decisions on the prospect of
buyer substitution between products in response to relative changes in price
or other competitive variables;

(3) the influence of downstream competition faced by buyers in their
output markets; and

(4) the timing and costs of switching products.

The price increase question is then asked for a hypothetical monopolist
controlling the expanded product group. In performing successive itera-
tions of the price increase test, the hypothetical monopolist will be assumed
to pursue maximum profits in deciding whether to raise the prices of any or
all of the additional products under its control. This process will continue
until a group of products is identified such that a hypothetical monopolist
over that group of products would profitably impose at least a “small but
significant and nontransitory” increase, including the price of a product of
one of the merging firms. The Agency generally will consider the relevant
product market to be the smallest group of products that satisfies this test.

In the above analysis, the Agency will use prevailing prices of the prod-
ucts of the merging firms and possible substitutes for such products, unless
premerger circumstances are strongly suggestive of coordinated interaction,
in which case the Agency will use a price more reflective of the competitive
price.10 However, the Agency may use likely future prices, absent the
merger, when changes in the prevailing prices can be predicted with rea-
sonable reliability. Changes in price may be predicted on the basis of, for
example, changes in regulation which affect price either directly or indirect-
ly by affecting costs or demand.

In general, the price for which an increase will be postulated will be
whatever is considered to be the price of the product at the stage of the
industry being examined.!!_ In attempting to determine objectively the
effect of a “small but significant and nontransitory” increase in price, the
Agency, in most contexts, will use a price increase of five percent lasting
for the foreseeable future. However, what constitutes a “small but signifi-
cant and nontransitory” increase in price will depend on the nature of the

10 The terms of sale of all other products are held constant in order to focus market definition on the
behavior of consumers. Movements in the terms of sale for other products, as may result from the
behavior of producers of those products, are accounted for in the analysis of competitive effects and
entry. See Sections 2 and 3.

11 For example, in a merger between retailers, the relevant price would be the retail price of a product
Pr Pr

to consumers. In the case of a merger among oil pipelines, the relevant price would be the tariff - the

price of the transportation service.


ple, where the concern is unilateral price elevation as a result of a merger
between producers of differentiated products, entry, in order to be suffi-
cient, must involve a product so close to the products of the merging firms
that the merged firm will be unable to internalize enough of the sales loss
due to the price rise, rendering the price increase unprofitable.

4. Efficiencies

(Revised Section 4 Horizontal Merger Guidelines
Issued by the U.S. Department of Justice and the
Federal Trade Commission April 8, 1997)

Competition usually spurs firms to achieve efficiencies internally.
Nevertheless, mergers have the potential to generate significant efficien-
cies by permitting a better utilization of existing assets, enabling the com-
bined firm to achieve lower costs in producing a given quantity and quali-
ty than either firm could have achieved without the proposed transaction.
Indeed, the primary benefit of mergers to the economy is their potential
to generate such efficiencies.

Efficiencies generated through merger can enhance the merged
firm’s ability and incentive to compete, which may result in lower prices,
improved quality, enhanced service, or new products. For example,
merger-generated efficiencies may enhance competition by permitting
two ineffective (e.g., high cost) competitors to become one effective (e.g.,
lower cost) competitor. In a coordinated interaction context (see Section
2.1), marginal cost reductions may make coordination less likely or effec-
tive by enhancing the incentive of a maverick to lower price or by creat-
ing a new maverick firm. In a unilateral effects context (see Section 2.2),
marginal cost reductions may reduce the merged firm’s incentive to ele-
vate price. Efficiencies also may result in benefits in the form of new or
improved products, and efficiencies may result in benefits even when
price is not immediately and directly affected. Even when efficiencies
generated through merger enhance a firm’s ability to compete, however,
a merger may have other effects that may lessen competition and ulti-
mately may make the merger anticompetitive.

The Agency will consider only those efficiencies likely to be accom-
plished with the proposed merger and unlikely to be accomplished in the
absence of either the proposed merger or another means having compa-
rable anticompetitive effects. These are termed merger-specific efficien-

30


scale. Entry may not be sufficient, even though timely and likely, where the
constraints on availability of essential assets, due to incumbent control,
make it impossible for entry profitably to achieve the necessary level of
sales. Also, the character and scope of entrants’ products might not be
fully responsive to the localized sales opportunities created by the removal
of direct competition among sellers of differentiated products. In assessing
whether entry will be timely, likely, and sufficient, the Agency recognizes
that precise and detailed information may be difficult or impossible to
obtain. In such instances, the Agency will rely on all available evidence
bearing on whether entry will satisfy the conditions of timeliness, likelihood,
and sufficiency.

3.1 Entry Alternatives

The Agency will examine the timeliness, likelihood, and sufficiency of
the means of entry (entry alternatives) a potential entrant might practically
employ, without attempting to identify who might be potential entrants.
An entry alternative is defined by the actions the firm must take in order to
produce and sell in the market. All phases of the entry effort will be con-
sidered, including, where relevant, planning, design, and management; per-
mitting, licensing, and other approvals; construction, debugging, and oper-
ation of production facilities; and promotion (including necessary introduc-
tory discounts), marketing, distribution, and satisfaction of customer testing
and qualification requirements.26 Recent examples of entry, whether suc-
cessful or unsuccessful, may provide a useful starting point for identifying
the necessary actions, time requirements, and characteristics of possible
entry alternatives.

3.2 Timeliness of Entry

In order to deter or counteract the competitive effects of concern,
entrants quickly must achieve a significant impact on price in the relevant
market. The Agency generally will consider timely only those committed
entry alternatives that can be achieved within two years from initial plan-
ning to significant market impact.2?7_ Where the relevant product is a

26 Many of these phases may be undertaken simultaneously.

27


1. Market Definition, Measurement and
Concentration

1.0 Overview

A merger is unlikely to create or enhance market power or to facilitate
its exercise unless it significantly increases concentration and results in a
concentrated market, properly defined and measured. Mergers that either
do not significantly increase concentration or do not result in a concentrat-
ed market ordinarily require no further analysis.

The analytic process described in this section ensures that the Agency
evaluates the likely competitive impact of a merger within the context of
economically meaningful markets -- i.e., markets that could be subject to
the exercise of market power. Accordingly, for each product or service
(hereafter “ product”) of each merging firm, the Agency seeks to define a
market in which firms could effectively exercise market power if they were
able to coordinate their actions.

Market definition focuses solely on demand substitution factors — i.e.,
possible consumer responses. Supply substitution factors -- i.e., possible
production responses -- are considered elsewhere in the Guidelines in the
identification of firms that participate in the relevant market and the analy-
sis of entry. See Sections 1.3 and 3. A market is defined as a product or
group of products and a geographic area in which it is produced or sold
such that a hypothetical profit-maximizing firm, not subject to price regula-
tion, that was the only present and future producer or seller of those prod-
ucts in that area likely would impose at least a “small but significant and
nontransitory” increase in price, assuming the terms of sale of all other
products are held constant. A relevant market is a group of products and a
geographic area that is no bigger than necessary to satisfy this test. The
“small but significant and nontransitory” increase in price is employed sole-
ly as a methodological tool for the analysis of mergers: it is not a tolerance
level for price increases.

Absent price discrimination, a relevant market is described by a product
or group of products and a geographic area. In determining whether a
hypothetical monopolist would be in a position to exercise market power, it
is necessary to evaluate the likely demand responses of consumers to a
price increase. A price increase could be made unprofitable by consumers
either switching to other products or switching to the same product pro-
duced by firms at other locations. The nature and magnitude of these two


power through unilateral or non-coordinated conduct -- conduct the success
of which does not rely on the concurrence of other firms in the market or
on coordinated responses by those firms. In any case, the result of the
exercise of market power is a transfer of wealth from buyers to sellers or a
misallocation of resources.

Market power also encompasses the ability of a single buyer (a
“monopsonist”), a coordinating group of buyers, or a single buyer, not a
monopsonist, to depress the price paid for a product to a level that is below
the competitive price and thereby depress output. The exercise of market
power by buyers (“monopsony power”) has adverse effects comparable to
those associated with the exercise of market power by sellers. In order to
assess potential monopsony concerns, the Agency will apply an analytical
framework analogous to the framework of these Guidelines.

While challenging competitively harmful mergers, the Agency seeks to
avoid unnecessary interference with the larger universe of mergers that are
either competitively beneficial or neutral. In implementing this objective,
however, the Guidelines reflect the congressional intent that merger
enforcement should interdict competitive problems in their incipiency.

0.2 Overview

The Guidelines describe the analytical process that the Agency will
employ in determining whether to challenge a horizontal merger. First, the
Agency assesses whether the merger would significantly increase concen-
tration and result in a concentrated market, properly defined and mea-
sured. Second, the Agency assesses whether the merger, in light of market
concentration and other factors that characterize the market, raises con-
cern about potential adverse competitive effects. Third, the Agency
assesses whether entry would be timely, likely and sufficient either to deter
or to counteract the competitive effects of concern. Fourth, the Agency
assesses any efficiency gains that reasonably cannot be achieved by the
parties through other means. Finally the Agency assesses whether, but for
the merger, either party to the transaction would be likely to fail, causing its
assets to exit the market. The process of assessing market concentration,
potential adverse competitive effects, entry, efficiency and failure is a tool
that allows the Agency to answer the ultimate inquiry in merger analysis:
whether the merger is likely to create or enhance market power or to facili-
tate its exercise.


1.51 General Standards

In evaluating horizontal mergers, the Agency will consider both the
post-merger market concentration and the increase in concentration result-
ing from the merger.!8 Market concentration is a useful indicator of the
likely potential competitive effect of a merger. The general standards for
horizontal mergers are as follows:

a) Post-Merger HHI Below 1000. The Agency regards markets in this
region to be unconcentrated. Mergers resulting in unconcentrated markets
are unlikely to have adverse competitive effects and ordinarily require no
further analysis.

b) Post-Merger HHI Between 1000 and 1800. The Agency regards
markets in this region to be moderately concentrated. Mergers producing
an increase in the HHI of less than 100 points in moderately concentrated
markets post-merger are unlikely to have adverse competitive conse-
quences and ordinarily require no further analysis. Mergers producing an
increase in the HHI of more than 100 points in moderately concentrated
markets post-merger potentially raise significant competitive concerns
depending on the factors set forth in Sections 2-5 of the Guidelines.

c) Post-Merger HHI Above 1800. The Agency regards markets in this
region to be highly concentrated. Mergers producing an increase in the
HHI of less than 50 points, even in highly concentrated markets post-
merger, are unlikely to have adverse competitive consequences and ordi-
narily require no further analysis. Mergers producing an increase in the
HHI of more than 50 points in highly concentrated markets post-merger
potentially raise significant competitive concerns, depending on the factors
set forth in Sections 2-5 of the Guidelines. Where the post-merger HHI
exceeds 1800, it will be presumed that mergers producing an increase in
the HHI of more than 100 points are likely to create or enhance market
power or facilitate its exercise. The presumption may be overcome by a
showing that factors set forth in Sections 2-5 of the Guidelines make it

18 The increase in concentration as measured by the HHI can be calculated independently of the over-
all market concentration by doubling the product of the market shares of the merging firms. For exam-
ple, the merger of firms with shares of 5 percent and 10 percent of the market would increase the HHI
by 100 (5 x 10 x 2 = 100). The explanation for this technique is as follows: In calculating the HHI before
the merger. the market shares of the merging firms are squared individually: pr + (b)2. After the
merger, the sum of those shares would be squared: (a + b)? , which equals a2 + 2ab + b2. The
increase in the HHI therefore is represented by 2ab.

16


1.1 Product Market Definition

The Agency will first define the relevant product market with respect to
each of the products of each of the merging firms. 8

1.11 General Standards

Absent price discrimination, the Agency will delineate the product mar-
ket to be a product or group of products such that a hypothetical profit-
maximizing firm that was the only present and future seller of those prod-
ucts (“monopolist”) likely would impose at least a “small but significant and
nontransitory” increase in price. That is, assuming that buyers likely would
respond to an increase in price for a tentatively identified product group
only by shifting to other products, what would happen? If the alternatives
were, in the aggregate, sufficiently attractive at their existing terms of sale,
an attempt to raise prices would result in a reduction of sales large enough
that the price increase would not prove profitable, and the tentatively iden-
tified product group would prove to be too narrow.

Specifically, the Agency will begin with each product (narrowly defined)
produced or sold by each merging firm and ask what would happen if a
hypothetical monopolist of that product imposed at least a “small but signif-
icant and nontransitory” increase in price, but the terms of sale of all other
products remained constant. If, in response to the price increase, the
reduction in sales of the product would be large enough that a hypothetical
monopolist would not find it profitable to impose such an increase in price,
then the Agency will add to the product group the product that is the next-
best substitute for the merging firm’s product.9

In considering the likely reaction of buyers to a price increase, the
Agency will take into account all relevant evidence, including, but not limit-
ed to, the following:

(1) evidence that buyers have shifted or have considered shifting pur-
chases between products in response to relative changes in price or other
competitive variables;

8 Although discussed separately, product market definition and geographic market definition are inter-
related. In particular, the extent to which buyers of a particular product would shift to other products in
the event of a “small but significant and nontransitory” increase in price must be evaluated in the con-
text of the relevant geographic market.

9 Throughout the Guidelines, the term “next best substitute” refers to the altemative which, if available

in unlimited quantities at constant prices, would account for the greatest value of diversion of demand in
response to a “small but significant and nontransitory” price increase.

6


sales or its total capacity, and the lower are its direct and opportunity costs
of expanding sales in the relevant market.19 This is so because a firm's
incentive to deviate from price-elevating and output-limiting terms of coor-
dination is greater the more the firm is able profitably to expand its output
as a proportion of the sales it would obtain if it adhered to the terms of
coordination and the smaller is the base of sales on which it enjoys elevated
profits prior to the price cutting deviation.2° A firm also may be a maver-
ick if it has an unusual ability secretly to expand its sales in relation to the
sales it would obtain if it adhered to the terms of coordination. This ability
might arise from opportunities to expand captive production for a down-
stream affiliate.

2.2 Lessening of Competition Through Unilateral
Effects

A merger may diminish competition even if it does not lead to
increased likelihood of successful coordinated interaction, because merging
firms may find it profitable to alter their behavior unilaterally following the
acquisition by elevating price and suppressing output. Unilateral competi-
tive effects can arise in a variety of different settings. In each setting, par-
ticular other factors describing the relevant market affect the likelihood of
unilateral competitive effects. The settings differ by the primary character-
istics that distinguish firms and shape the nature of their competition.

2.21 Firms Distinguished Primarily by Differentiated
Products

In some markets the products are differentiated, so that products sold
by different participants in the market are not perfect substitutes for one
another. Moreover, different products in the market may vary in the

19 But excess capacity in the hands of non-maverick firms may be a potent weapon with which to
punish deviations from the terms of coordination.

20 Similarly, in a market where product design or quality is significant, a firm is more likely to be an
effective maverick the greater is the sales potential of its products among customers of its rivals, in rela-
tion to the sales it would obtain if it adhered to the terms of coordination. The likelihood of expansion
responses by a maverick will be analyzed in the same fashion as uncommitted entry or committed entry
(see Sections 1.3 and 3) depending on the significance of the sunk costs entailed in expansion.

22


Horizontal
Merger
Guidelines

U.S. Department of Justice
and the
Federal Trade Commission

Issued: April 2, 1992
Revised: April 8, 1997



region would profitably impose at least a “small but significant and nontran-
sitory” increase in price, holding constant the terms of sale for all products
produced elsewhere. That is, assuming that buyers likely would respond to
a price increase on products produced within the tentatively identified
region only by shifting to products produced at locations of production out-
side the region, what would happen? If those locations of production out-
side the region were, in the aggregate, sufficiently attractive at their existing
terms of sale, an attempt to raise price would result in a reduction in sales
large enough that the price increase would not prove profitable, and the
tentatively identified geographic area would prove to be too narrow.

In defining the geographic market or markets affected by a merger, the
Agency will begin with the location of each merging firm (or each plant of
a multiplant firm) and ask what would happen if a hypothetical monopolist
of the relevant product at that point imposed at least a “small but signifi-
cant and nontransitory” increase in price, but the terms of sale at all other
locations remained constant. If, in response to the price increase, the
reduction in sales of the product at that location would be large enough
that a hypothetical monopolist producing or selling the relevant product at
the merging firm’s location would not find it profitable to impose such an
increase in price, then the Agency will add the location from which produc-
tion is the next-best substitute for production at the merging firm’s location.

In considering the likely reaction of buyers to a price increase, the
Agency will take into account all relevant evidence, including, but not limit-
ed to, the following:

(1) evidence that buyers have shifted or have considered shifting pur-
chases between different geographic locations in response to relative
changes in price or other competitive variables;

(2) evidence that sellers base business decisions on the prospect of
buyer substitution between geographic locations in response to relative
changes in price or other competitive variables;

(3) the influence of downstream competition faced by buyers in their
output markets; and

(4) the timing and costs of switching suppliers.

The price increase question is then asked for a hypothetical monopolist
controlling the expanded group of locations. In performing successive iter-
ations of the price increase test, the hypothetical monopolist will be
assumed to pursue maximum profits in deciding whether to raise the price


industry, and the Agency at times may use a price increase that is larger or
smaller than five percent.

1.12 Product Market Definition in the Presence of Price
Discrimination

The analysis of product market definition to this point has assumed that
price discrimination -- charging different buyers different prices for the
same product, for example -- would not be profitable for a hypothetical
monopolist. A different analysis applies where price discrimination would
be profitable for a hypothetical monopolist.

Existing buyers sometimes will differ significantly in their likelihood of
switching to other products in response to a “small but significant and non-
transitory” price increase. If a hypothetical monopolist can identify and
price differently to those buyers (‘targeted buyers”) who would not defeat
the targeted price increase by substituting to other products in response to
a “small but significant and nontransitory” price increase for the relevant
product, and if other buyers likely would not purchase the relevant product
and resell to targeted buyers, then a hypothetical monopolist would prof-
itably impose a discriminatory price increase on sales to targeted buyers.
This is true regardless of whether a general increase in price would cause
such significant substitution that the price increase would not be profitable.
The Agency will consider additional relevant product markets consisting of
a particular use or uses by groups of buyers of the product for which a
hypothetical monopolist would profitably and separately impose at least a
“small but significant and nontransitory” increase in price.

1.2 Geographic Market Definition

For each product market in which both merging firms participate, the
Agency will determine the geographic market or markets in which the
firms produce or sell. A single firm may operate in a number of different
geographic markets.

1.21 General Standards

Absent price discrimination, the Agency will delineate the geographic
market to be a region such that a hypothetical monopolist that was the
only present or future producer of the relevant product at locations in that


Sources of sales opportunities available to entrants include: (a) the out-
put reduction associated with the competitive effect of concern,32
4b) entrants’ ability to capture a share of reasonably expected growth in
market demand,33 _ (c) entrants’ ability securely to divert sales from incum-
bents, for example, through vertical integration or through forward con-
tracting, and (d) any additional anticipated contraction in incumbents’ out-
put in response to entry.34 Factors that reduce the sales opportunities
available to entrants include: (a) the prospect that an entrant will share in a
reasonably expected decline in market demand, (b) the exclusion of an
entrant from a portion of the market over the long term because of vertical
integration or forward contracting by incumbents, and (c) any anticipated
sales expansion by incumbents in reaction to entry, either generalized or
targeted at customers approached by the entrant, that utilizes prior irre-
versible investments in excess production capacity. Demand growth or
decline will be viewed as relevant only if total market demand is projected
to experience long-lasting change during at least the two year period fol-
lowing the competitive effect of concern.

3.4 Sufficiency of Entry

Inasmuch as multiple entry generally is possible and individual entrants
may flexibly choose their scale, committed entry generally will be sufficient
to deter or counteract the competitive effects of concern whenever entry is
likely under the analysis of Section 3.3. However, entry, although likely,
will not be sufficient if, as a result of incumbent control, the tangible and
intangible assets required for entry are not adequately available for entrants
to respond fully to their sales opportunities. In addition, where the compet-
itive effect of concern is not uniform across the relevant market, in order
for entry to be sufficient, the character and scope of entrants’ products
must be responsive to the localized sales opportunities that include the out-
put reduction associated with the competitive effect of concern. For exam-

32 Five percent of total market sales typically is used because where a monopolist profitably would
pe typically polist pr ly

raise price by five percent or more across the entire relevant market, it is likely that the accompanying

reduction in sales would be no less than five percent

33 Entrants’ anticipated share of growth in demand depends on incumbents’ capacity constraints and
irreversible investments in capacity expansion, as well as on the relative appeal, acceptability and repu-
tation of incumbents’ and entrants’ products to the new demand.

34 For example, in a bidding market where all bidders are on equal footing, the market share of
incumbents will contract as a result of entry.

29


durable good, consumers, in response to a significant commitment to
entry, may defer purchases by making additional investments to extend the
useful life of previously purchased goods and in this way deter or counter-
act for a time the competitive effects of concern. In these circumstances, if
entry only can occur outside of the two year period, the Agency will consid-
er entry to be timely so long as it would deter or counteract the competitive
effects of concern within the two-year period and subsequently.

3.3 Likelihood of Entry

An entry alternative is likely if it would be profitable at premerger
prices, and if such prices could be secured by the entrant.28 The commit-
ted entrant will be unable to secure prices at premerger levels if its output is
too large for the market to absorb without depressing prices further. Thus,
entry is unlikely if the minimum viable scale is larger than the likely sales
opportunity available to entrants.

Minimum viable scale is the smallest average annual level of sales that
the committed entrant must persistently achieve for profitability at pre-
merger prices.2? Minimum viable scale is a function of expected revenues,
based upon premerger prices,30 and all categories of costs associated with
the entry alternative, including an appropriate rate of return on invested
capital given that entry could fail and sunk costs, if any, will be lost.31

27 Firms which have committed to entering the market prior to the merger generally will be included
in the measurement of the market. Only committed entry or adjustments to pre-existing entry plans
that are induced by the merger will be considered as possibly deterring or counteracting the competitive
effects of concern

28 Where conditions indicate that entry may be profitable at prices below premerger levels, the
Agency will assess the likelihood of entry at the lowest price at which such entry would be profitable.

29 ‘The concept of minimum viable scale (“MVS") differs from the concept of minimum efficient scale
("MES"). While MES is the smallest scale at which average costs are minimized, MVS is the smallest
scale at which average costs equal the premerger price.

30 The expected path of future prices, absent the merger, may be used if future price changes can be
predicted with reasonable reliability.

31 The minimum viable scale of an entry alternative will be relatively large when the fixed costs of
entry are large, when the fixed costs of entry are largely sunk, when the marginal costs of production
are high at low levels of output, and when a plant is underutilized for a long time because of delays in
achieving market acceptance.

28


types of demand responses respectively determine the scope of the product
market and the geographic market.

In contrast, where a hypothetical monopolist likely would discriminate
in prices charged to different groups of buyers, distinguished, for example,
by their uses or locations, the Agency may delineate different relevant mar-
kets corresponding to each such buyer group. Competition for sales to
each such group may be affected differently by a particular merger and
markets are delineated by evaluating the demand response of each such
buyer group. A relevant market of this kind is described by a collection of
products for sale to a given group of buyers.

Once defined, a relevant market must be measured in terms of its par-
ticipants and concentration. Participants include firms currently producing
or selling the market’s products in the market's geographic area. In addi-
tion, participants may include other firms depending on their likely supply
responses to a “small but significant and nontransitory” price increase. A
firm is viewed as a participant if, in response to a “small but significant and
nontransitory” price increase, it likely would enter rapidly into production
or sale of a market product in the market's area, without incurring signifi-
cant sunk costs of entry and exit. Firms likely to make any of these supply
responses are considered to be “uncommitted” entrants because their sup-
ply response would create new production or sale in the relevant market
and because that production or sale could be quickly terminated without
significant loss.7_ Uncommitted entrants are capable of making such quick
and uncommitted supply responses that they likely influenced the market
premerger, would influence it post-merger, and accordingly are considered
as market participants at both times. This analysis of market definition and
market measurement applies equally to foreign and domestic firms.

If the process of market definition and market measurement identifies
one or more relevant markets in which the merging firms are both partici-
pants, then the merger is considered to be horizontal. Sections 1.1
through 1.5 describe in greater detail how product and geographic markets
will be defined, how market shares will be calculated and how market con-
centration will be assessed.

7 Probable supply responses that require the entrant to incur significant sunk costs of entry and exit are
not part of market measurement, but are included in the analysis of the significance of entry. See
Section 3. Entrants that must commit substantial sunk costs are regarded as “committed” entrants
because those sunk costs make entry irreversible in the short term without foregcing that investment;
thus the likelihood of their entry must be evaluated with regard to their long-term profitability.

5


Detection and punishment of deviations ensure that coordinating firms will
find it more profitable to adhere to the terms of coordination than to pur-
sue short-term profits from deviating, given the costs of reprisal. In this
phase of the analysis, the Agency will examine the extent to which post-
merger market conditions are conducive to reaching terms of coordination,
detecting deviations from those terms, and punishing such deviations.
Depending upon the circumstances, the following market factors, among
others, may be relevant: the availability of key information concerning
market conditions, transactions and individual competitors; the extent of
firm and product heterogeneity; pricing or marketing practices typically
employed by firms in the market; the characteristics of buyers and sellers;
and the characteristics of typical transactions.

Certain market conditions that are conducive to reaching terms of
coordination also may be conducive to detecting or punishing deviations
from those terms. For example, the extent of information available to
firms in the market, or the extent of homogeneity, may be relevant to both
the ability to reach terms of coordination and to detect or punish deviations
from those terms. The extent to which any specific market condition will
be relevant to one or more of the conditions necessary to coordinated
interaction will depend on the circumstances of the particular case.

It is likely that market conditions are conducive to coordinated interac-
tion when the firms in the market previously have engaged in express collu-
sion and when the salient characteristics of the market have not changed
appreciably since the most recent such incident. Previous express collusion
in another geographic market will have the same weight when the salient
characteristics of that other market at the time of the collusion are compa-
rable to those in the relevant market.

In analyzing the effect of a particular merger on coordinated interac-
tion, the Agency is mindful of the difficulties of predicting likely future
behavior based on the types of incomplete and sometimes contradictory
information typically generated in merger investigations. Whether a merg-
er is likely to diminish competition by enabling firms more likely, more suc-
cessfully or more completely to engage in coordinated interaction depends
on whether market conditions, on the whole, are conducive to reaching
terms of coordination and detecting and punishing deviations from those
terms.

19


2.22 Firms Distinguished Primarily by Their Capacities

Where products are relatively undifferentiated and capacity primarily
distinguishes firms and shapes the nature of their competition, the merged
firm may find it profitable unilaterally to raise price and suppress output.
The merger provides the merged firm a larger base of sales on which to
enjoy the resulting price rise and also eliminates a competitor to which cus-
tomers otherwise would have diverted their sales. Where the merging firms
have a combined market share of at least thirty-five percent, merged firms
may find it profitable to raise price and reduce joint output below the sum
of their premerger outputs because the lost markups on the foregone sales
may be outweighed by the resulting price increase on the merged base of
sales.

This unilateral effect is unlikely unless a sufficiently large number of the
merged firm’s customers would not be able to find economical alternative
sources of supply, i.e., competitors of the merged firm likely would not
respond to the price increase and output reduction by the merged firm with
increases in their own outputs sufficient in the aggregate to make the uni-
lateral action of the merged firm unprofitable. Such non-party expansion is
unlikely if those firms face binding capacity constraints that could not be
economically relaxed within two years or if existing excess capacity is signif-
icantly more costly to operate than capacity currently in use.24

3. Entry Analysis
3.0 Overview

A merger is not likely to create or enhance market power or to facili-
tate its exercise, if entry into the market is so easy that market participants,
after the merger, either collectively or unilaterally could not profitably main-
tain a price increase above premerger levels. Such entry likely will deter an
anticompetitive merger in its incipiency, or deter or counteract the compet-
itive effects of concern.

Entry is that easy if entry would be timely, likely, and sufficient in its
magnitude, character and scope to deter or counteract the competitive

24 The timeliness and likelihood of non-party expansion will be analyzed using the same methodology
as used in analyzing uncommitted or committed entry (see Sections 1.3 and 3) depending on the signifi-
cance of the sunk costs entailed in expansion.

25


0. Purpose, Underlying Policy Assumptions
and Overview

These Guidelines outline the present enforcement policy of the
Department of Justice and the Federal Trade Commission (the “Agency”)
concerning horizontal acquisitions and mergers (“mergers”) subject to sec-
tion 7 of the Clayton Act,! to section 1 of the Sherman Act,? or to section
5 of the FTC Act.3 They describe the analytical framework and specific
standards normally used by the Agency in analyzing mergers.’ By stating
its policy as simply and clearly as possible, the Agency hopes to reduce the
uncertainty associated with enforcement of the antitrust laws in this area.

Although the Guidelines should improve the predictability of the
Agency’s merger enforcement policy, it is not possible to remove the exer-
cise of judgment from the evaluation of mergers under the antitrust laws.
Because the specific standards set forth in the Guidelines must be applied
to a broad range of possible factual circumstances, mechanical application
of those standards may provide misleading answers to the economic ques-
tions raised under the antitrust laws. Moreover, information is often incom-
plete and the picture of competitive conditions that develops from historical
evidence may provide an incomplete answer to the forward-looking inquiry
of the Guidelines. Therefore, the Agency will apply the standards of the
Guidelines reasonably and flexibly to the particular facts and circumstances
of each proposed merger.

0.1 Purpose and Underlying Policy Assumptions

of the Guidelines

The Guidelines are designed primarily to articulate the analytical frame-
work the Agency applies in determining whether a merger is likely substan-

115 U.S.C. § 18 (1988). Mergers subject to section 7 are prohibited if their effect “may be substan-
tially to lessen competition, or to tend to create a monopoly.

2 15US.C. §1 (1988). Mergers subject to section 1 are prohibited if they constitute a “contract,
combination . . ., of conspiracy in restraint of trade.

3 15 US.C. § 45 (1988). Mergers subject to section 5 are prohibited if they constitute an “unfair
method of competition.”

4 ‘These Guidelines update the Merger Guidelines issued by the U.S. Department of Justice in 1984
and the Statement of Federal Trade Commission Concerning Horizontal Mergers issued in 1982. The
Merger Guidelines may be revised from time to time as necessary to reflect any significant changes in
enforcement policy or to clarify aspects of existing policy.

1


ket-specific investments in production facilities, technologies, marketing
(including product acceptance), research and development, regulatory
approvals, and testing. A significant sunk cost is one which would not be
recouped within one year of the commencement of the supply response,
assuming a “small but significant and nontransitory” price increase in the
relevant market. In this context, a “small but significant and nontransitory”
price increase will be determined in the same way in which it is determined
in product market definition, except the price increase will be assumed to
last one year. In some instances, it may be difficult to calculate sunk costs
with precision. Accordingly, when necessary, the Agency will make an
overall assessment of the extent of sunk costs for firms likely to participate
through supply responses.

These supply responses may give rise to new production of products in
the relevant product market or new sources of supply in the relevant geo-
graphic market. Alternatively, where price discrimination is likely so that
the relevant market is defined in terms of a targeted group of buyers, these
supply responses serve to identify new sellers to the targeted buyers.
Uncommitted supply responses may occur in several different ways: by the
switching or extension of existing assets to production or sale in the rele-
vant market; or by the construction or acquisition of assets that enable pro-
duction or sale in the relevant market.

1.321 Production Substitution and Extension: The Switching or
Extension of Existing Assets to Production or Sale in the
Relevant Market

The productive and distributive assets of a firm sometimes can be used
to produce and sell either the relevant products or products that buyers do
not regard as good substitutes. Production substitution refers to the shift by
a firm in the use of assets from producing and selling one product to pro-
ducing and selling another. Production extension refers to the use of those
assets, for example, existing brand names and reputation, both for their
current production and for production of the relevant product. Depending
upon the speed of that shift and the extent of sunk costs incurred in the
shift or extension, the potential for production substitution or extension

12


which likely would be devoted to the relevant market in response to a
“small but significant and nontransitory” price increase. Market shares can
be expressed either in dollar terms through measurement of sales, ship-
ments, or production, or in physical terms through measurement of sales,
shipments, production, capacity, or reserves.

Market shares will be calculated using the best indicator of firms’ future
competitive significance. Dollar sales or shipments generally will be used if
firms are distinguished primarily by differentiation of their products. Unit
sales generally will be used if firms are distinguished primarily on the basis
of their relative advantages in serving different buyers or groups of buyers.
Physical capacity or reserves generally will be used if it is these measures
that most effectively distinguish firms.15 Typically, annual data are used,
but where individual sales are large and infrequent so that annual data may
be unrepresentative, the Agency may measure market shares over a longer
period of time.

In measuring a firm’s market share, the Agency will not include its sales
or capacity to the extent that the firm’s capacity is committed or so prof-
itably employed outside the relevant market that it would not be available to
respond to an increase in price in the market.

1.42 Price Discrimination Markets

When markets are defined on the basis of price discrimination (Sections
1.12 and 1.22), the Agency will include only sales likely to be made into,
or capacity likely to be used to supply, the relevant market in response to a
“small but significant and nontransitory” price increase.

1.43 Special Factors Affecting Foreign Firms

Market shares will be assigned to foreign competitors in the same way
in which they are assigned to domestic competitors. However, if exchange
rates fluctuate significantly, so that comparable dollar calculations on an
annual basis may be unrepresentative, the Agency may measure market
shares over a period longer than one year.

If shipments from a particular country to the United States are subject
to a quota, the market shares assigned to firms in that country will not

15 Where all firms have, on a forward-looking basis, an equal likelihood of securing sales, the Agency
will assign firms equal shares

14


Table of Contents

oO.

Purpose, Underlying Policy Assumptions,
and Overview .....0.....00 00000. c ee eee ee

0.1

0.2

Purpose and Underlying Policy Assumptions of the
Guidelines 26...
Overview .6 6.6

Overview ...... 2... eee
Product Market Definition ... .
Geographic Market Definition ...
Identification of Firms That Participate in

the Relevant Market .................00000-0005
Calculating Market Shares... 02.0.2... eee
Concentration and Market Shares ..............

The Potential Adverse Competitive Effects
of Mergers ............... bbe eee eee eee

2.0
2.1

2.2

Overview 60... eee
Lessening of Competition Through Coordinated
Interaction .... 26.2. ee
Lessening of Competition Through Unilateral

Effects 2.00...

Entry Analysis ..........0.0.0.00.. 00.0000 c eee eee

Overview ...........
Entry Alternatives
Timeliness of Entry ....
Likelihood of Entry lees :
Sufficiency of Entry ..... 0... eee

Efficiencies (Revised: April 8, 1997) ................

Failure and Exiting Assets.........................

5.0
5.1
5.2

Overview ..........0..0000005 bocce eee
Failing Firm 2.2.0.0... 00.000. e cece eee
Failing Division ........ 0.202 eee



degree of their substitutability for one another. In this setting, competition
may be non-uniform (i.e., localized), so that individual sellers compete more
directly with those rivals selling closer substitutes.21

A merger between firms in a market for differentiated products may
diminish competition by enabling the merged firm to profit by unilaterally
raising the price of one or both products above the premerger level. Some
of the sales loss due to the price rise merely will be diverted to the product
of the merger partner and, depending on relative margins, capturing such
sales loss through merger may make the price increase profitable even
though it would not have been profitable premerger. Substantial unilateral
price elevation in a market for differentiated products requires that there be
a significant share of sales in the market accounted for by consumers who
regard the products of the merging firms as their first and second choices,
and that repositioning of the non-parties’ product lines to replace the local-
ized competition lost through the merger be unlikely. The price rise will be
greater the closer substitutes are the products of the merging firms, i.e., the
more the buyers of one product consider the other product to be their next
choice.

2.211 Closeness of the Products of the Merging Firms

The market concentration measures articulated in Section 1 may help
assess the extent of the likely competitive effect from a unilateral price ele-
vation by the merged firm notwithstanding the fact that the affected prod-
ucts are differentiated. The market concentration measures provide a mea-
sure of this effect if each product’s market share is reflective of not only its
relative appeal as a first choice to consumers of the merging firms’ prod-
ucts but also its relative appeal as a second choice, and hence as a competi-
tive constraint to the first choice.22 Where this circumstance holds, market

21 Similarly, in some markets sellers are primarily distinguished by their relative advantages in serving
different buyers or groups of buyers, and buyers negotiate individually with sellers. Here, for exampl2,
sellers may formally bid against one another for the business of a buyer, or each buyer may elicit individ-
ual price quotes from multiple sellers. A seller may find it relatively inexpensive to meet the demands of
particular buyers or types of buyers, and relatively expensive to meet others’ demands. Competition,
again, may be localized: sellers compete more directly with those rivals having similar relative advan-
tages in serving particular buyers or groups of buyers. For example, in open outcry auctions, price is
determined by the cost of the second lowest-cost seller. A merger involving the first and second lowest-
cost sellers could cause prices to rise to the constraining level of the next lowest-cost seller.

22 Information about consumers’ actual first and second product choices may be provided by market-

ing surveys, information from bidding structures, or normal course of business documents from industry
participants.

23


Note: Section 4 of these Guidelines, relating to Efficiencies, appears as it was
issued in revised form by the Department of Justice and the Federal Trade
Commission on April 8, 1997; and the footnotes in Section 5 of the
Guidelines have been renumbered accordingly. The remaining portions of the
Guidelines were unchanged in 1997, and appear as they were issued on
April 2, 1992.


cies.35 Only alternatives that are practical in the business situation faced
by the merging firms will be considered in making this determination; the
Agency will not insist upon a less restrictive alternative that is merely the-
oretical.

Efficiencies are difficult to verify and quantify, in part because much
of the information relating to efficiencies is uniquely in the possession of
the merging firms. Moreover, efficiencies projected reasonably and in
good faith by the merging firms may not be realized. Therefore, the
merging firms must substantiate efficiency claims so that the Agency can
verify by reasonable means the likelihood and magnitude of each asserted
efficiency, how and when each would be achieved (and any costs of
doing so), how each would enhance the merged firm’s ability and incen-
tive to compete, and why each would be merger-specific. Efficiency
claims will not be considered if they are vague or speculative or otherwise
cannot be verified by reasonable means.

Cognizable efficiencies are merger-specific efficiencies that have
been verified and do not arise from anticompetitive reductions in output
or service. Cognizable efficiencies are assessed net of costs produced by
the merger or incurred in achieving those efficiencies.

The Agency will not challenge a merger if cognizable efficiencies are
of a character and magnitude such that the merger is not likely to be anti-
competitive in any relevant market.3¢ To make the requisite determina-
tion, the Agency considers whether cognizable efficiencies likely would be
sufficient to reverse the merger’s potential to harm consumers in the rel-
evant market, e.g., by preventing price increases in that market. In con-

35 The Agency will not deem efficiencies to be merger-specific if they could be preserved by practi-
cal alternatives that mitigate competitive concerns, such as divestiture or licensing. If a merger
affects not whether but only when an efficiency would be achieved, only the timing advantage is a
merger-specific efficiency

36 Section 7 of the Clayton Act prohibits mergers that may substantially lessen competition “in any
line of commerce . . . in any section of the country.” Accordingly, the Agency normally assesses
competition in each relevant market affected by a merger independently and normally will challenge
the merger if it is likely to be anticompetitive in any relevant market. In some cases, however, the
Agency in its prosecutorial discretion will consider efficiencies not strictly in the relevant market, but
so inextricably linked with it that a partial divestiture or other remedy could not feasibly eliminate the
anticompetitive effect in the relevant market without sacrificing the efficiencies in the other market(s).
Inextricably linked efficiencies rarely are a significant factor in the Agency's determination not to
challenge a merger. They are most likely to make a difference when they are great and the likely
anticompetitive effect in the relevant market(s) is small

31


effects of concern. In markets where entry is that easy (i.e., where entry
passes these tests of timeliness, likelihood, and sufficiency), the merger
raises no antitrust concern and ordinarily requires no further analysis.

The committed entry treated in this Section is defined as new competi-
tion that requires expenditure of significant sunk costs of entry and exit.25
The Agency employs a three-step methodology to assess whether commit-
ted entry would deter or counteract a competitive effect of concern.

The first step assesses whether entry can achieve significant market
impact within a timely period. If significant market impact would require a
longer period, entry will not deter or counteract the competitive effect of
concern.

The second step assesses whether committed entry would be a prof-
itable and, hence, a likely response to a merger having competitive effects
of concern. Firms considering entry that requires significant sunk costs
must evaluate the profitability of the entry on the basis of long term partici-
pation in the market, because the underlying assets will be committed to
the market until they are economically depreciated. Entry that is sufficient
to counteract the competitive effects of concern will cause prices to fall to
their premerger levels or lower. Thus, the profitability of such committed
entry must be determined on the basis of premerger market prices over the
long-term.

A merger having anticompetitive effects can attract committed entry,
profitable at premerger prices, that would not have occurred premerger at
these same prices. But following the merger, the reduction in industry out-
put and increase in prices associated with the competitive effect of concern
may allow the same entry to occur without driving market prices below pre-
merger levels. After a merger that results in decreased output and
increased prices, the likely sales opportunities available to entrants at pre-
merger prices will be larger than they were premerger, larger by the output
reduction caused by the merger. If entry could be profitable at premerger
prices without exceeding the likely sales opportunities - opportunities that
include pre-existing pertinent factors as well as the merger-induced output
reduction ~ then such entry is likely in response to the merger

The third step assesses whether timely and likely entry would be suffi-
cient to return market prices to their premerger levels. This end may be
accomplished either through multiple entry or individual entry at a sufficient

25 Supply responses that require less than one year and insignificant sunk costs to effectuate are ana-
lyzed as uncommitted entry in Section 1.3.

26


at any or all of the additional locations under its control. This process will
continue until a group of locations is identified such that a hypothetical
monopolist over that group of locations would profitably impose at least a
“small but significant and nontransitory” increase, including the price
charged at a location of one of the merging firms.

The “smallest market” principle will be applied as it is in product mar-
ket definition. The price for which an increase will be postulated, what
constitutes a “small but significant and nontransitory” increase in price, and
the substitution decisions of consumers all will be determined in the same
way in which they are determined in product market definition.

1.22 Geographic Market Definition in the Presence of
Price Discrimination

The analysis of geographic market definition to this point has assumed
that geographic price discrimination -- charging different prices net of
transportation costs for the same product to buyers in different areas, for
example -- would not be profitable for a hypothetical monopolist.
However, if a hypothetical monopolist can identify and price differently to
buyers in certain areas (“targeted buyers”) who would not defeat
the targeted price increase by substituting to more distant sellers in
response to a “small but significant and nontransitory” price increase for
the relevant product, and if other buyers likely would not purchase the rele-
vant product and resell to targeted buyers,!2_ then a hypothetical monopo-
list would profitably impose a discriminatory price increase. This is true
even where a general price increase would cause such significant substitu-
tion that the price increase would not be profitable. The Agency will con-
sider additional geographic markets consisting of particular locations of
buyers for which a hypothetical monopolist would profitably and separately
impose at least a “small but significant and nontransitory” increase in price.

12 This arbitrage is inherently impossible for many services and is particularly difficult where the prod-
uct is sold on a delivered basis and where transportation costs are a significant percentage of the final
cost.

10


may necessitate treating as market participants firms that do not currently
produce the relevant product.14

If a firm has existing assets that likely would be shifted or extended into
production and sale of the relevant product within one year, and without
incurring significant sunk costs of entry and exit, in response to a “small but
significant and nontransitory” increase in price for only the relevant prod-
uct, the Agency will treat that firm as a market participant. In assessing
whether a firm is such a market participant, the Agency will take into
account the costs of substitution or extension relative to the profitability of
sales at the elevated price, and whether the firm’s capacity is elsewhere
committed or elsewhere so profitably employed that such capacity likely
would not be available to respond to an increase in price in the market.

1.322 Obtaining New Assets for Production or Sale of the
Relevant Product

A firm may also be able to enter into production or sale in the relevant
market within one year and without the expenditure of significant sunk
costs of entry and exit, in response to a “small but significant and nontran-
sitory” increase in price for only the relevant product, even if the firm is
newly organized or is an existing firm without products or productive assets
closely related to the relevant market. If new firms, or existing firms with-
out closely related products or productive assets, likely would enter into
production or sale in the relevant market within one year without the
expenditure of significant sunk costs of entry and exit, the Agency will treat
those firms as market participants.

1.4 Calculating Market Shares

1.41 General Approach

The Agency normally will calculate market shares for all firms (or
plants) identified as market participants in Section 1.3 based on the total
sales or capacity currently devoted to the relevant market together with that

14 Under other analytical approaches, production substitution sometimes has been reflected in the
description of the product market. For example, the product market for stamped metal products such
as automobile hub caps might be described as “light metal stamping,” a production process rather than
a product. The Agency believes that the approach described in the text provides a more clearly focused
method of incorporating this factor in merger analysis. If production substitution among a group of
products is nearly universal among the firms selling one or more of those products, however, the
Agency may use an aggregate description of those markets as a matter of convenience.

13