The last time the Department of Justice’s Antitrust Division and the Federal Trade Commission (the Agencies) published formal guidance on vertical mergers, Ronald Reagan was in the middle of his first presidential campaign, Ghostbusters was leading box office sales, cell phones were the size of a lunch box, and the Dow Jones Industrial Average was just north of 1,000.
On January 10, 2020, the Agencies released a draft of their 2020 Vertical Merger Guidelines for public comment (Draft Vertical Guidelines). The Draft Vertical Guidelines describe the principles and analytical framework the Agencies use to evaluate whether vertical mergers violate antitrust law. Vertical mergers combine entities providing different but complementary services, operating at different points of the same supply chain (such as AT&T and Time Warner, or CVS and Aetna), as opposed to horizontal mergers, which combine entities typically competing to offer the same or substantially similar services (such as T-Mobile and Sprint, or Disney and Fox). Horizontal mergers tend to attract more scrutiny from regulators, likely in recognition of their more obvious effect on competition; the Agencies have revised their Horizontal Merger Guidelines (Horizontal Guidelines) three times since the 1984 version that addressed both horizontal and “non-horizontal” mergers. In recent years, however, the Agencies have started to focus on vertical mergers, and the Draft Vertical Guidelines are in part a response to requests from the business community and antitrust bar for guidance.
The Draft Vertical Guidelines should be read in conjunction with the Horizontal Guidelines. While adopting a similar substantive framework, the Draft Vertical Guidelines differ from their horizontal counterpart and address the “distinct considerations” vertical mergers raise, such as related products, market foreclosure, and access to competitively sensitive information.
Market definition—the specific line(s) of commerce in which the Agencies evaluate a merger’s competitive effects—for vertical mergers will include an additional step of identifying one or more “related products,” described as “a product or service that is supplied by the merged firm, is vertically related to the products and services in the relevant market, and to which access by the merged firm’s rivals affects competition in the relevant market.” In other words, the competitive landscape includes not only the relevant stream(s) of commerce and their participants, but also related products that may feel the merger’s effect. The example in the Draft Vertical Guidelines identifies the supply of oranges as a related product in a relevant market defined as the wholesale supply of orange juice in a specific region, where the vertical merger entails the acquisition of an orange grove by an orange juice wholesaler.
The identification and consideration of related products plays into the Agencies’ evaluation of market shares and concentration. While the Draft Vertical Guidelines incorporate the HHI measure of concentration described in the Horizontal Guidelines, the Agencies also assess the competitive significance of related products in the relevant market(s). Where the merged entity controls only a small share of the related product(s), for example, the merger is less likely to violate antitrust law. The Draft Vertical Guidelines go so far as to identify a safe harbor of sorts, stating the Agencies are unlikely to challenge a vertical merger resulting in a combined share of less than 20 percent in the relevant market and where “the related product is used in less than 20 percent of the relevant market.” Caveats to that guidance include where the related product is new and/or rapidly expanding, in which case its competitive significance might be understated by a market share snapshot.
The Draft Vertical Guidelines also describe issues unique to vertical mergers that may prompt or prolong an Agency investigation. Principal concerns related to the potential anticompetitive acts of the combined entity itself (i.e., unilateral effects) include foreclosure of, and/or raising costs for, a related product on which the combined firm’s actual or potential competitors rely to compete in the relevant market. For example, if the orange juice wholesaler cuts off its rivals’ access to oranges from its newly acquired orange grove, competition in the relevant market for wholesale orange juice would likely suffer. Another identified concern related to vertical mergers is gaining access to competitively sensitive information about one of the merging party’s rivals. If the orange juice wholesaler’s acquisition of the orange grove provides access to the price terms afforded to the grove’s other customers (i.e., the wholesaler’s competitors), for example, the vertical merger might result in either less procompetitive actions by the combined firm (with the knowledge of its rivals’ actions) or decisions by downstream rivals avoid business with the combined firm’s upstream business for fear of disclosing its competitively sensitive information to the combined firm.
Vertical mergers also present the potential for participants in the relevant market to coordinate their actions or behaviors (i.e., coordinated effects). The Draft Vertical Guidelines state that a vertical merger may “enhance the market’s vulnerability to coordination by eliminating or hobbling a maverick firm that otherwise plays or would play an important role in preventing or limiting anticompetitive coordination in the relevant market.” In addition, a vertical merger’s impact on market structure may make it easier for participants to coordinate actions, such as unlawful agreements or monitoring/enforcing compliance with such agreements.
The Draft Vertical Guidelines recognize the countervailing effect of elimination of double marginalization that may stem from a vertical merger. Double marginalization refers to the decision of each independent company in a supply chain to charge a profit-maximizing margin on its sales. When a vertical merger combines two firms in that supply chain and thereby internalizes production, the combined entity may find it more profitable to decrease its prices to consumers (as a means to increase sales volume) rather than maintain a price inclusive of the separate margins that existed prior to merger. As with the Horizontal Guidelines, the Draft Vertical Guidelines also promise to evaluate merger-specific efficiencies resulting from a transaction.
Issuance of the Draft Vertical Guidelines signals the Agencies’ renewed interest in and focus on vertical mergers. They are open to public comment for 30 days. Once finalized, the 2020 Vertical Merger Guidelines will inevitably serve as a primary tool for businesses, attorneys, regulators, and judges alike in the application of antitrust law to proposed vertical mergers (as the standing Horizontal Guidelines (last revised as of 2010) do for proposed horizontal mergers).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
