Following a remarkably transparent process, on August 19, 2010, the United States Department of Justice and Federal Trade Commission (collectively, the "Agencies") released revised Horizontal Merger Guidelines ("Guidelines").1 The Guidelines incorporate a number of noteworthy revisions. First, they significantly raise the concentration thresholds at which mergers warrant greater scrutiny. Second, they deemphasize the role of market definition. Third, they place greater reliance on economic models in mergers involving differentiated products.
Significant Additions and Changes to the Merger Guidelines
Significant Increase in the HHI Thresholds Used to Screen Transactions: Section 5.3 of the Guidelines significantly adjusts upward the concentration thresholds (measured by the Herfindahl-Hirschman Index, or "HHI") used to determine when mergers merit closer scrutiny. The Guidelines consider a market with an HHI below 1500 unconcentrated (an increase from 1000 in the 1992 Guidelines); a market with an HHI between 1500 and 2500 moderately concentrated (a significant change from the 1992 Guidelines range of 1000 to 1800); and a market with an HHI above 2500 highly concentrated (compared to 1800 in the 1992 Guidelines).2 These revised thresholds are more consistent than the earlier ones with agency practice.3
The Guidelines also identify different and slightly higher required changes in concentration levels before a merger will trigger a competitive concern. Mergers in unconcentrated markets and mergers that produce an increase in the HHI of less than 100 points are "unlikely to have adverse competitive effects and ordinarily require no further analysis." Mergers "resulting in moderately concentrated markets that involve an increase in the HHI of more than 100 points potentially raise significant concerns and often warrant scrutiny." Similarly, mergers resulting in highly concentrated markets that "involve an increase in the HHI of between 100 and 200 points potentially raise significant concerns," while mergers that result in highly concentrated markets that involve an increase in the HHI "of more than 200 points will be presumed likely to enhance market power." The Guidelines continue to note that this presumption may be rebutted through additional evidence.
De-Emphasis on Market Definition: The Guidelines indicate strongly that the Agencies no longer believe that a clear articulation of a relevant market is an initial, and in some cases, a necessary step in identifying a merger's likely competitive effects. Consistent with recent agency practice, the Guidelines state that direct evidence (e.g., evidence of head-to-head competition, natural experiments, and actual effects) will play a significant role in determining whether a proposed market definition is plausible. The Guidelines suggest that market definition may be unnecessary in unilateral effects cases and, in analyzing whether a merger will create or enhance the unilateral exercise of market power, the Guidelines in effect adopt the position that the merged firms are the market.
Enhanced Explanation of Unilateral Effect Concerns: The Guidelines significantly expand on the unilateral effects analysis and the analysis of mergers among firms offering differentiated products in the 1992 Guidelines. Of particular interest is the detailed discussion of the quantitative techniques the Agencies may use to show the extent of direct competition between the merging parties. This discussion covers diversion ratios4 and an economic model (and its derivations) that draws upon, but does not specifically adopt, the "upward pricing pressure" model advanced by two of the primary staff draftsmen of the Guidelines.5 Neither of these quantitative approaches requires the Agencies to define a relevant market. Recently, one federal district court expressed skepticism about the use of such models as a substitute for traditional market definition principles.6
Greater Emphasis on a Merger's Effect on Innovation and Product Variety: In the nearly two decades since publication of the 1992 Guidelines, the Agencies have significantly increased their inquiries into and analyses of whether a merger will affect the merging parties' incentives to innovate. The Guidelines incorporate this focus, and identify two distinct concerns: (1) will a merger reduce incentives to continue with existing product-development efforts or, (2) will it reduce incentives to initiate development of new products. The first concern does not require significant deviation from the standard model of anticompetitive effects— that is, whether one of the merging parties has a product "in the pipeline" that would compete with an existing product of the other party. The second concern may adopt indirectly the concept of "innovation markets" discussed in the Antitrust Guidelines for the Licensing of Intellectual Property (1995).7 There, the Agencies defined an innovation market as consisting of "the research and development directed to particular new or improved goods or processes, and the close substitutes for that research and development." With very few exceptions, the past practice of the Agencies has been to limit their focus on pure innovation concerns to mergers among pharmaceutical firms; the explicit adoption of this concern in the Guidelines may lead to an increased focus on innovation effects in mergers more generally.8
The Guidelines also note explicitly that product variety is a competitive variable, and they indicate that the withdrawal of a product can constitute harm to consumers over and above any effects on price or quality. The Guidelines recognize that a reduction in variety may not be anticompetitive, but instead an efficient consolidation of products, at least when "variety offers little in value to customers."
Restructured Framework for Identifying Coordinated Effects: Apparently relying in part on the Antitrust Division's experience in its criminal investigations, the new Guidelines use a three-pronged test for determining whether the Agencies will challenge a merger based on a coordinated effects theory. Specifically, "the Agencies are likely to challenge a merger if the following three conditions are all met: (1) the merger would significantly increase concentration and lead to a moderately or highly concentrated market; (2) that market shows signs of vulnerability to coordinated conduct; and (3) the Agencies have a credible basis on which to conclude that the merger may enhance that vulnerability." The Guidelines continue to discuss in significant detail the evidence used to demonstrate vulnerability to coordinated conduct, including the following factors: previous instances of express collusion among firms in the same or similar market; the transparency of "significant competitive initiatives" such as price and output changes; the number of firms in the market; the homogeneity of products; and the ability of customers to switch between suppliers and move a significant share of purchases between firms.
Greater Acceptance of Fixed Cost Efficiencies, But Skepticism of Efficiencies Identified "Outside the Usual Business Planning Process": The Guidelines suggest greater acceptance than before of a wider variety of efficiencies, including that fixed cost savings can benefit consumers in the long run. They also indicate that the burden on the merging parties to show efficiencies that would trump an otherwise anticompetitive merger remains quite high. They further suggest deep skepticism about "projections of efficiencies . . . generated outside of the usual business planning process," citing the potential evidentiary limitations of efficiency calculations developed in conjunction with lawyers, economists, and other consultants well after the decision to merge has been made.
Introduction of a "Power Buyer" Defense: In a significant addition, the Guidelines recognize that certain customers, identified as "powerful buyers," can constrain the merging parties from raising price post-merger. (Canada and the European Union earlier incorporated this concept into their merger guidelines.) The Guidelines provide some examples: customers of the merging parties may have the ability and incentive to integrate upstream or to sponsor entry, and the presence and conduct of large buyers may undermine the ability of the firms to engage in coordinated conduct. But mere size is not sufficient, and "the Agencies do not presume that the presence of powerful buyers alone forestall adverse competitive effects." In addition, the Guidelines note that the Agencies will consider whether market power can be exercised against other buyers, even when some buyers can protect themselves.
More Focus on Monopsony: The Guidelines incorporate concerns that mergers may give the combined firm market power on the buying side—that is, the power to obtain a price below the competitive level. The Guidelines state that "market power on the buy side is not a significant concern if suppliers have numerous attractive outlets for their goods and services," and they note that the Agencies will distinguish between effects that arise from a lessening of competition and those that allow the merged firm to take advantage of reductions in transaction costs or volume- based discounts. The Agencies have not alleged often that a merger will have monopsony effects, but such concerns may arise in markets in which there are a large number of sellers and only a few purchasers, e.g., agricultural markets and certain health care markets.
Identification of a Framework for Analyzing Partial Acquisitions: In another addition, the Guidelines identify a framework for analyzing whether acquisitions of only a partial or minority interest in a competitor will raise competitive concerns. (A partial acquisition does not eliminate completely the competition between the merging parties.) The Guidelines identify three means by which a partial acquisition may affect competition. First, does the partial acquisition give the acquiring firm the ability to influence the target firm's conduct through voting rights or governance provisions? Can the acquiring firm use its influence to induce the target to compete less aggressively or to encourage coordination? Second, will the economic incentive of the acquiring firm to compete against the partially acquired firm diminish because it shares in any losses of the acquired firm? The analysis is similar to a unilateral effects analysis, but is tempered by the fact that ownership is partial and recoupment is less direct. Finally, does the acquiring firm gain access to non-public, competitively sensitive information of the partially acquired firm that would allow the firms to coordinate their competitive behavior more effectively? The Guidelines also state that the Agencies will consider efficiencies associated with the partial acquisition, but note that partial acquisitions usually do not result in many of the efficiencies associated with mergers. Nevertheless, partial ownership interests often give the parties greater incentives to share complementary resources, such as distribution networks or intellectual property.
A More Evidence-Based Entry Analysis: The Guidelines eliminate the 1992 Guidelines two year timeliness standard for entry sufficient to counteract the effects of a merger. The revised Guidelines require that entry be sufficiently rapid to "make unprofitable" the competitive effects of a merger, or to counter any effects so that "customers are not significantly harmed by the merger." In practice, the Agencies have not used the two year standard, but did require merging parties to show that entry had occurred in recent years and that the conditions supporting entry had not changed, or that another firm was currently in the late stages of entering the relevant market.
Statement of FTC Commissioner J. Thomas Rosch
While voting for the Guidelines, FTC Commissioner J. Thomas Rosch issued a statement criticizing the significant reliance the Guidelines place on economic concepts and models that he believes do not reflect how the FTC and the courts analyze mergers. He argues that "these Guidelines do not describe the way that the Bureau of Competition and enforcement staff at the Commission proceed" in their analysis of mergers. He states, however, that he voted for the Guidelines because "they make at least one monumental contribution" by focusing on direct evidence of competitive effects rather than evidence inferred from market structure, shares, and market definition. In 1992, then-FTC Commissioner Mary Azcuenaga issued a similar statement criticizing the Guidelines issued at that time because she also questioned whether they "accurately express[ed] what the Commission does now or is likely to do in analyzing mergers."
Conclusion
The new Guidelines extensively revise the 1992 Guidelines. Most of the changes reflect current agency practice: less emphasis on market share, market concentration, and market definition and a greater focus on identifying potentially anticompetitive effects through a detailed inquiry into industry and firm behavior and use of economic models. Nevertheless, by placing greater emphasis on direct evidence of possible anticompetitive effects and downplaying the importance of market definition, the revised Guidelines reflect an attempt to regain ground lost over the last decade because the courts continued to rely heavily on the 1992 Guidelines framework well after the Agencies had departed from reliance on that framework. We expect the courts to struggle with the tensions between the Section 7 case law and the revised Guidelines framework. This is not a new issue, as the 1982 Merger Guidelines and the 1992 Guidelines created the same tensions because they also went beyond, and in some cased, rejected, the case law. At the same time, because economic evidence and theory must be plausible and understandable to non-specialist judges, the courts will remain an independent check on the Agencies' review of these transactions.
Endnotes
1 The revised Guidelines are available at http://www.justice.gov/atr/public/guidelines/hmg-2010.html. The extensive effort to revise the Guidelines is recounted at an earlier O'Melveny client alert, available at http://www.omm.com/federal-trade-commission-issues-proposed-changes-to-the-horizontal-merger-guidelines-04-21-2010.
2 The economic literature did not support the lower thresholds in the 1992 Guidelines as good indicators of likely competitive effects. See Paul Pautler, Evidence on Mergers and Acquisition, 48 ANTITRUST BULLETIN 119 (Spring 2003), and studies cited therein; Richard Schmalensee, Inter-Industry Studies of Structure and Performance, in Richard Schmalensee and Robert D. Wíllíg, II HANDBOOK OF INDUSTRIAL ORGANIZATION (1989, Elsevier Science Publishers, B.V.).
3 Investigation and enforcement data for 1996 through 2007,
covering administrations of both political parties, showed clearly
that the FTC did not adhere to the thresholds articulated in the
1992 Guidelines. See Timothy J. Muris and Bilal Sayyed, Three Key
Principles for Revising the Horizontal Merger Guidelines, (Dec. 7,
2009), available at http://www.ftc.gov/os/comments/horizontalmergerguides/545095-00052.pdf.
4 The diversion ratio is the fraction of unit sales lost by the first product due to an increase in its price that would be diverted to the second product.
5 See Carl Shapiro and Joseph Farrell, Antitrust Evaluation of Horizontal Mergers: An Economic Alternative to Market Definition (Feb. 15, 2010), available at http://ssrn.com/abstract=1313782.
6 City of New York v. Group Health, Inc., 2010 U.S. Dist.
Lexis 60196, No. 06-Civ. 13122 (S.D.N.Y. May 11, 2010) ("The
Court notes that its research has not revealed a single decision of
a federal court adopting [the "upward pricing pressure"]
test. In light of the case law's clear requirement that a
Plaintiff allege a particular product market in which competition
will be impaired, this absence of authority is hardly
surprising.").
7 Of course, antitrust case law has, for a long time,
recognized that one benefit of competition is the stimulation of
innovation. See, e.g., United States v. Aluminum Co. of Am., 148
F.2d 416, 427 (2d Cir. 1945) (the "possession of unchallenged
economic power deadens initiative, discourages thrift and depresses
energy .... [I]mmunity from competition is a narcotic, and rivalry
is a stimulant, to industrial progress.")
8 For a discussion of the FTC's analysis of innovation concerns in pharmaceutical mergers and the proper evidentiary burden the Agencies should face, see Statement of Timothy J. Muris, Chairman, Federal Trade Commission, In the Matter of Genzyme Corporation / Novazyme Pharmaceuticals, Inc., available at http://www.ftc.gov/os/2004/01/murisgenzymestmt.pdf.
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