The Development: The U.S. Department of Justice ("DOJ") and a divided Federal Trade Commission ("FTC") released the final version of their Vertical Merger Guidelines, the first revision in more than 35 years. The Guidelines outline the types of competitive harm that can result from vertical transactions and describe how the agencies will evaluate them.
The Result: For the most part, and consistent with our experience, the final Guidelines reflect how the agencies analyze the relatively small number of transactions that raise vertical antitrust issues. Among other things, the Guidelines acknowledge that "vertical mergers often benefit consumers" but caution that such transactions "are not invariably innocuous." Nonetheless, their release and the inclusion of concepts discussed below contribute to the recent agency focus on vertical merger enforcement.
Looking Ahead: Given the lack of consensus about the Guidelines, we will have to pay close attention to how the agencies implement them. One area to watch in particular is the agencies' treatment of nontraditional vertical transactions, i.e., companies not strictly in the same distribution chain. Those transactions, which were carved out of the first draft, involve either "complementary" or "diagonal" businesses at different stages of competing supply chains.
What Do the Guidelines Say?
Although the Guidelines do not offer bright-line rules to distinguish anticompetitive and procompetitive (or at least competitively benign) vertical mergers, they summarize the types of harm that the agencies consider when making enforcement decisions: foreclosure, raising rivals' costs, access to competitively sensitive information, and increased risk of marketplace coordination.
- Foreclosure occurs if a vertically merged company refuses to supply an input to competitors in a downstream market, those competitors cannot find alternative suppliers, and, as a result, there is less downstream competition. For example, a manufacturer of wireless headphones that acquires the only manufacturer of Bluetooth chips might have the incentive and ability to stop supplying Bluetooth chips to competing headphone manufacturers. Competitors of the headphone division may struggle to compete without Bluetooth chips.
- Even if the merged Bluetooth/headphone company continues to sell Bluetooth chips, it may have the incentive to raise rivals' costs by selling chips at a higher price or decreasing the quality of products or services sold to headphone competitors.
- Without proper controls in place, the merged Bluetooth/headphone company might use competitively sensitive information received from Bluetooth sales to headphone competitors to advantage its headphone division.
- A vertical merger might increase the likelihood of industry coordination because a vertically merged company has information about its rivals' products and sales or because it eliminates or reduces competition from a maverick company that benefits consumers.
The Guidelines also outline how vertical mergers can be procompetitive, for example by: streamlining production, inventory management, and distribution; facilitating creation of new products; and resulting in cost savings, such as eliminating "double marginalization" ("EDM"). Double marginalization refers to the margins that each company in a supply chain earns when making a sale. A vertical merger can lower the merged company's costs if it self-supplies the input, eliminating the margin that the formerly independent supplier charged before the deal. EDM features prominently in the Guidelines and should be a central part of most defense strategies. Evaluating the net effect of potential harms and benefits can involve a deep dive into company documents and data and economic modeling.
No Safe Harbor
The Guidelines remove a 20% market share screen that was in the draft. Although few issues received as much attention as the proposed screen in public comments, in practice, the agencies rarely have challenged vertical mergers unless the parties' upstream and downstream market shares were substantial, often above 50%. In public statements, DOJ and FTC leaders have said they intend the Guidelines to be descriptive of existing agency practice. The lack of a safe harbor, therefore, likely does not signal a meaningful change in enforcement priorities.
Vertical Does Not Mean Only Vertical
While the draft Guidelines covered only vertical mergers (two companies operating at different levels of the same supply chain), the final Guidelines also include complementary and diagonal transactions.
- Products are complements if they are not inputs to each other, their demand rises and falls together, and a price increase of one product decreases the demand for the other product. For example, if the price of electric-car batteries increases, car manufacturers might purchase fewer electric motors too. The agencies may investigate whether a merged company can disadvantage rivals by increasing the price or decreasing the quality of a complementary product to customers that do not buy both.
- Diagonal mergers combine an input supplier and a downstream rival of the input supplier that does not use the input; for example, a manufacturer of gasoline-powered cars acquires a manufacturer of electric-car batteries. The agencies may investigate whether the transaction reduces competition if the acquired technology (batteries) is incompatible with the buyer's products (cars), and redesigning the buyer's products to incorporate the technology would neither lower costs nor improve quality.
Although the agencies occasionally have investigated complementary or diagonal issues, they have been the subject of few settlements and no litigated mergers in modern times. These cases often included claims that competitors could not match a combined company's scale or product portfolio, that the transaction would result in product incompatibility or unlawful tying or bundling of complementary products. U.S. enforcers have been reluctant to pursue these types of claims because of concerns that enforcement could discourage efficient combinations or bundling that benefit customers. Enforcers in Europe and China have shown a greater willingness to demand settlements on the basis of such claims.
The Only Consensus Is No Consensus
While there was broad consensus in favor of updated Guidelines, there was little consensus about what they should say. The agencies received more than 70 comments from the private bar, economists, state enforcers, and academia, contending that the draft Guidelines were either too anti- or too pro-enforcement. The final Guidelines include features that appeal to (and cause concern for) both camps. Regardless, the FTC's two Democratic commissioners dissented, arguing among other things that the final Guidelines overemphasize the benefits of vertical mergers and omit other potential harms.
Five Key Takeaways
- Responding to feedback, the final Guidelines are a more thorough explanation of harm that can occur in vertical mergers. However, despite improvement, they remain heavy on theory and could be criticized as less practical than other agency guidelines. Companies would benefit from guidance about what facts are more or less likely to raise concerns-for example, what market shares typically trigger concern and why, the level of proof required to substantiate efficiencies (particularly EDM), and acceptable remedies.
- Apart from drawing attention to diagonal and complementary mergers, the Guidelines do not, on their face, signal a meaningful change to the agencies' vertical merger analysis. What will matter more is how they are implemented from here.
- Although the agencies have investigated complementary and diagonal mergers in the past, including them in written Guidelines is notable. Companies with strong market positions should take note, prepare for a potential agency investigation (especially for global deals reviewed in Europe/Asia), consider support for efficiencies, and evaluate the effect on deal documents and timing.
- Although the Guidelines might have some persuasive effect on courts, they are not binding. The sole litigated agency challenge to a vertical merger in more than 40 years-DOJ's failed attempt to block the AT&T/Time Warner merger-demonstrates that agencies likely face an uphill battle in litigation, absent strong evidence of anticompetitive effects and a weak efficiencies or EDM defense.
- The last two administration changes resulted in repeals of antitrust guidance. The Obama Administration repealed the Bush Administration's monopolization guidance, and the Trump Administration repealed the Obama Administration's guidance on merger remedies. Given the vigorous dissent of the two Democratic FTC commissioners, an administration change in 2021 could lead to withdrawn or revised Guidelines or an uptick in scrutiny of vertical mergers.
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