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Timestamp: 2020-02-27 17:29:33
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Archives For non-horizontal merger guidelines
Geoffrey Manne & Kristian Stout — 7 February 2020 — Leave a comment
White: The Missing Market Definition Standard in the Draft Vertical Guidelines
Lawrence White — 7 February 2020 — Leave a comment
This post is authored by Lawrence J. White (Robert Kavesh Professor of Economics, New York University; former Chief Economist, DOJ Antitrust Division).]
The DOJ/FTC Draft Vertical Merger Guidelines establish a “safe harbor” of a 20% market share for each of the merging parties. But the issue of defining the relevant “market” to which the 20% would apply is not well addressed.
Although reference is made to the market definition paradigm that is offered by the DOJ’s and FTC’s Horizontal Merger Guidelines (“HMGs”), what is neglected is the following: Under the “unilateral effects” theory of competitive harm of the HMGs, the horizontal merger of two firms that sell differentiated products that are imperfect substitutes could lead to significant price increases if the second-choice product for a significant fraction of each of the merging firms’ customers is sold by the partner firm. Such unilateral-effects instances are revealed by examining detailed sales and substitution data with respect to the customers of only the two merging firms.
In such instances, the true “relevant market” is simply the products that are sold by the two firms, and the merger is effectively a “2-to-1” merger. Under these circumstances, any apparently broader market (perhaps based on physical or functional similarities of products) is misleading, and the “market” shares of the merging parties that are based on that broader market are under-representations of the potential for their post-merger exercise of market power.
With a vertical merger, the potential for similar unilateral effects* would have to be captured by examining the detailed sales and substitution patterns of each of the merging firms with all of their significant horizontal competitors. This will require a substantial, data-intensive effort. And, of course, if this effort is not undertaken and an erroneously broader market is designated, the 20% “market” share threshold will understate the potential for competitive harm from a proposed vertical merger.
* With a vertical merger, such “unilateral effects” could arise post-merger in two ways: (a) The downstream partner could maintain a higher price, since some of the lost profits from some of the lost sales could be recaptured by the upstream partner’s profits on the sales of components to the downstream rivals (which gain some of the lost sales); and (b) the upstream partner could maintain a higher price to the downstream rivals, since some of the latter firms’ customers (and the concomitant profits) would be captured by the downstream partner.
Sher: Implications of the Draft Vertical Merger Guidelines for Vertical Mergers Involving Technology Start-Ups
Scott Sher — 7 February 2020 — Leave a comment
This post is authored by Scott Sher (Partner, Wilson Sonsini Goodrich & Rosati) and Matthew McDonald (Associate, Wilson Sonsini Goodrich & Rosati).]
On January 10, 2020, the United States Department of Justice (“DOJ”) and the Federal Trade Commission (“FTC”) (collectively, “the Agencies”) released their joint draft guidelines outlining their “principal analytical techniques, practices and enforcement policy” with respect to vertical mergers (“Draft Guidelines”). While the Draft Guidelines describe and formalize the Agencies’ existing approaches when investigating vertical mergers, they leave several policy questions unanswered. In particular, the Draft Guidelines do not address how the Agencies might approach the issue of acquisition of potential or nascent competitors through vertical mergers. As many technology mergers are motivated by the desire to enter new industries or add new tools or features to an existing platform (i.e., the Buy-Versus-Build dilemma), the omission leaves a significant hole in the Agencies’ enforcement policy agenda, and leaves the tech industry, in particular, without adequate guidance as to how the Agencies may address these issues.
This is notable, given that the Horizontal Merger Guidelines explicitly address potential competition theories of harm (e.g., at § 1 (referencing mergers and acquisitions “involving actual or potential competitors”); § 2 (“The Agencies consider whether the merging firms have been, or likely will become absent the merger, substantial head-to-head competitors.”). Indeed, the Agencies have recently challenged several proposed horizontal mergers based on nascent competition theories of harm.
Further, there has been much debate regarding whether increased antitrust scrutiny of vertical acquisitions of nascent competitors, particularly in technology markets, is warranted (See, e.g., Open Markets Institute, The Urgent Need for Strong Vertical Merger Guidelines (“Enforcers should be vigilant toward dominant platforms’ acquisitions of seemingly small or marginal firms and be ready to block acquisitions that may be part of a monopoly protection strategy. Dominant firms should not be permitted to expand through vertical acquisitions and cut off budding threats before they have a chance to bloom.”); Caroline Holland, Taking on Big Tech Through Merger Enforcement (“Vertical mergers that create market power capable of stifling competition could be particularly pernicious when it comes to digital platforms.”)).
Thus, further policy guidance from the Agencies on this issue is needed. As the Agencies formulate guidance, they should take note that vertical mergers involving technology start-ups generally promote efficiency and innovation, and that any potential competitive harm almost always can be addressed with easy-to-implement behavioral remedies.
The agencies’ draft vertical merger guidelines
The Draft Guidelines outline the following principles that the Agencies will apply when analyzing vertical mergers:
Market definition. The Agencies will identify a relevant market and one or more “related products.” (§ 2) This is a product that is supplied by the merged firm, is vertically related to the product in the relevant market, and to which access by the merged firm’s rivals affects competition in the relevant market. (§ 2)
Safe harbor. Unlike horizontal merger cases, the Agencies cannot rely on changes in concentration in the relevant market as a screen for competitive effects. Instead, the Agencies consider measures of the competitive significance of the related product. (§ 3) The Draft Guidelines propose a safe harbor, stating that the Agencies are unlikely to challenge a vertical merger “where the parties to the merger have a share in the relevant market of less than 20 percent, and the related product is used in less than 20 percent of the relevant market.” (§ 3) However, shares exceeding the thresholds, taken alone, do not support an inference that the vertical merger is anticompetitive. (§ 3)
Theories of unilateral harm. Vertical mergers can result in unilateral competitive effects, including raising rivals’ costs (charging rivals in the relevant market a higher price for the related product) or foreclosure (refusing to supply rivals with the related product altogether). (§ 5.a) Another potential unilateral effect is access to competitively sensitive information: The combined firm may, through the acquisition, gain access to sensitive business information about its upstream or downstream rivals that was unavailable to it before the merger (for example, a downstream rival of the merged firm may have been a premerger customer of the upstream merging party). (§ 5.b)
Theories of coordinated harm. Vertical mergers can also increase the likelihood of post-merger coordinated interaction. For example, a vertical merger might eliminate or hobble a maverick firm that would otherwise play an important role in limiting anticompetitive coordination. (§ 7)
Procompetitive effects. Vertical mergers can have procompetitive effects, such as the elimination of double marginalization (“EDM”). A merger of vertically related firms can create an incentive for the combined entity to lower prices on the downstream product, because it will capture the additional margins from increased sales on the upstream product. (§ 6) EDM thus may benefit both the merged firm and buyers of the downstream product. (§ 6)
Efficiencies. Vertical mergers have the potential to create cognizable efficiencies; the Agencies will evaluate such efficiencies using the standards set out in the Horizontal Merger Guidelines. (§ 8)
Implications for vertical mergers involving nascent start-ups
At present, the Draft Guidelines do not address theories of nascent or potential competition. To the extent the Agencies provide further guidance regarding the treatment of vertical mergers involving nascent start-ups, they should take note of the following facts:
First, empirical evidence from strategy literature indicates that technology-related vertical mergers are likely to be efficiency-enhancing. In a survey of the strategy literature on vertical integration, Professor D. Daniel Sokol observed that vertical acquisitions involving technology start-ups are “largely complementary, combining the strengths of the acquiring firm in process innovation with the product innovation of the target firms.” (p. 1372) The literature shows that larger firms tend to be relatively poor at developing new and improved products outside of their core expertise, but are relatively strong at process innovation (developing new and improved methods of production, distribution, support, and the like). (Sokol, p. 1373) Larger firms need acquisitions to help with innovation; acquisition is more efficient than attempting to innovate through internal efforts. (Sokol, p. 1373)
Second, vertical merger policy towards nascent competitor acquisitions has important implications for the rate of start-up formation, and the innovation that results. Entrepreneurship in technology markets is motivated by the opportunity for commercialization and exit. (Sokol, p. 1362 (“[T]he purpose of such investment [in start-ups] is to reap the rewards of scaling a venture to exit.”))
In recent years, as IPO activity has declined, vertical mergers have become the default method of entrepreneurial exit. (Sokol, p. 1376) Increased vertical merger enforcement against start-up acquisitions thus closes off the primary exit strategy for entrepreneurs. As Prof. Sokol concluded in his study of vertical mergers:
When antitrust agencies, judges, and legislators limit the possibility of vertical mergers as an exit strategy for start-up firms, it creates risk for innovation and entrepreneurship…. it threatens entrepreneurial exits, particularly for tech companies whose very business model is premised upon vertical mergers for purposes of a liquidity event. (p. 1377)
Third, to the extent that the vertical acquisition of a start-up raises competitive concerns, a behavioral remedy is usually preferable to a structural one. As explained above, vertical acquisitions typically result in substantial efficiencies, and these efficiencies are likely to overwhelm any potential competitive harm. Further, a structural remedy is likely infeasible in the case of a start-up acquisition. Thus, behavioral relief is the only way of preserving the deal’s efficiencies while remedying the potential competitive harm. (Which the Agencies have recognized, see DOJ Antitrust Division, Policy Guide to Merger Remedies, p. 20 (“Stand-alone conduct relief is only appropriate when a full-stop prohibition of the merger would sacrifice significant efficiencies and a structural remedy would similarly eliminate such efficiencies or is simply infeasible.”)) Appropriate behavioral remedies for vertical acquisitions of start-ups would include firewalls (restricting the flow of competitively sensitive information between the upstream and downstream units of the combined firm) or a fair dealing or non-discrimination remedy (requiring the merging firm to supply an input or grant customer access to competitors in a non-discriminatory way) with clear benchmarks to ensure compliance. (See Policy Guide to Merger Remedies, pp. 22-24)
To be sure, some vertical mergers may cause harm to competition, and there should be enforcement when the facts justify it. But vertical mergers involving technology start-ups generally enhance efficiency and promote innovation. Antitrust’s goals of promoting competition and innovation are thus best served by taking a measured approach towards vertical mergers involving technology start-ups. (Sokol, pp. 1362–63) (“Thus, a general inference that makes vertical acquisitions, particularly in tech, more difficult to approve leads to direct contravention of antitrust’s role in promoting competition and innovation.”)
In antitrust, doj, Efficiencies, error costs, federal trade commission, ftc, market definition, merger guidelines, truth on the market, tying, tying, tying and bundling, vertical merger guidelines symposium	blog symposium, DOJ Antitrust Division, foreclosure, ftc, non-horizontal merger guidelines, raising rivals' cost, Vertical Merger Guidelines, vertical mergers
Sharis Pozen — 7 February 2020 — Leave a comment
Jonathan M. Jacobson — 6 February 2020 — Leave a comment
Werden and Froeb: The Conspicuous Silences of the Proposed Vertical Merger Guidelines
Greg Werden and Luke Froeb — 6 February 2020 — Leave a comment
This post is authored by Gregory J. Werden (former Senior Economic Counsel, DOJ Antitrust Division (ret.)) and Luke M. Froeb (William C. Oehmig Chair in Free Enterprise and Entrepreneurship, Owen School of Management, Vanderbilt University; former Chief Economist, DOJ Antitrust Division; former Chief Economist, FTC).]
The proposed Vertical Merger Guidelines provide little practical guidance, especially on the key issue of what would lead one of the Agencies to determine that it will not challenge a vertical merger. Although they list the theories on which the Agencies focus and factors the Agencies “may consider,” the proposed Guidelines do not set out conditions necessary or sufficient for the Agencies to conclude that a merger likely would substantially lessen competition. Nor do the Guidelines communicate generally how the Agencies analyze the nature of a competitive process and how it is apt to change with a proposed merger.
The proposed Guidelines communicate the Agencies’ enforcement policy in part through silences. For example, the Guidelines do not mention several theories that have appeared in recent commentary and thereby signal that Agencies have decided not to base their analysis on those theories. That silence is constructive, but the Agencies’ silence on the nature of their concern with vertical mergers is not. Since 1982, the Agencies’ merger guidelines have always stated that their concern was market power. Silence on this subject might suggest that the Agencies’ enforcement against vertical mergers is directed to something else.
The Guidelines’ most conspicuous silence concerns the Agencies’ general attitude toward vertical mergers, and on how vertical and horizontal mergers differ. This silence is deafening: Horizontal mergers combine substitutes, which tends to reduce competition, while vertical mergers combine complements, which tends to enhance efficiency and thus also competition. Unlike horizontal mergers, vertical mergers produce anticompetitive effects only through indirect mechanisms with many moving parts, which makes the prediction of competitive effects from vertical mergers more complex and less certain.
The Guidelines also are unhelpfully silent on the basic economics of vertical integration, and hence of vertical mergers. In assessing a vertical merger, it is essential to appreciate that vertical mergers solve coordination problems that are solved less well, or not at all, by contracts. By solving different coordination problems, a vertical merger can generate merger-specific efficiencies or eliminate double marginalization. But solving a coordination problem need not be a good thing: Competition is the ultimate coordination problem, and a vertical merger can have anticompetitive consequences by helping to solve that coordination problem. Finally, the Guidelines are unhelpfully silent on the fundamental policy issue presented by vertical merger enforcement: What distinguishes a vertical merger that harms competition from a vertical merger that merely harm competitors? A vertical merger cannot directly eliminate rivalry by increasing market concentration. The Supreme Court has endorsed a foreclosure theory under which the merger directly causes injury to a rival and thus proximately causes diminished rivalry. Vertical mergers also might diminish rivalry in other ways, but the proposed Guidelines do not state that the Agencies view diminished rivalry as the hallmark of a lessening of competition.
In antitrust, antitrust division, barriers to entry, doj, Efficiencies, error costs, exclusionary conduct, exclusive dealing, federal trade commission, ftc, market definition, merger guidelines, truth on the market, tying, tying, tying and bundling, vertical merger guidelines symposium, vertical restraints	blog symposium, DOJ Antitrust Division, foreclosure, ftc, non-horizontal merger guidelines, raising rivals' cost, Vertical Merger Guidelines, vertical mergers
Josh Wright, Doug Ginsburg, Tad Lipsky, and John Yun — 6 February 2020 — Leave a comment