Last week, the Department of Justice and Federal Trade Commission released for public comment proposed updated guidelines for vertical merger enforcement.1 A vertical merger involves two companies that operate at different stages in the supply chain (e.g., hospitals and insurers, manufacturers and distributors, or suppliers and retailers). Historically, the courts and antitrust enforcers viewed vertical mergers as rarely violating the antitrust laws and much less likely to threaten competition than mergers between competitors (co-called horizontal mergers). But that view has changed in recent years. Since 2015, the agencies have brought a number of vertical merger enforcement actions including against AT&T/Time Warner, CVS/Aetna, United/DaVita, and Staples/Essendant. With the number of vertical merger challenges increasing, the agencies recognized that the last guidelines on the subject—issued in 1984—were outdated and inconsistent with the agencies’ enforcement actions and learning over the past 35 years.
The updated guidelines signal the agencies intend to continue to devote attention and resources to vertical mergers. The guidelines suggest that some vertical mergers may pose serious threats to competition and thus require serious scrutiny. Similar to the well-known Horizontal Merger Guidelines, the draft Vertical Merger Guidelines require market definition and consideration of shares and concentration statistics in defined relevant markets, focus on anticompetitive effects from post-merger unilateral and coordinated behavior, and consider cognizable merger-specific efficiencies to offset any potential harm. The draft guidelines, however, do contain some unique features, including:
- Safety zone for firms with less than 20% share in each market within a supply chain. Per the Guidelines, 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% and the related product is used in less than 20% of the relevant market.” There’s no explanation for why the agencies used 20% for the threshold and, in our view, the safe harbor should be set higher to save time, money, and resources from investigations of mergers that are unlikely to raise antitrust concerns. As to how much higher, the District of Columbia Court of Appeals in U.S. v. Microsoft indicated two decades ago that a 40% threshold should be set to weed out vertical restraints unlikely to cause harm to competition.2 Ultimately, the current safety zone shouldn’t impact the FTC’s ability to investigate vertical mergers involving firms with low market shares. The agencies generally do not devote significant resources to investigating vertical mergers with market shares below 20% except in unusual circumstances. The guidelines also state that the agencies may still investigate such transactions in rare circumstances, such as when a company has a new product that is rapidly gaining share.
- No presumption of harm. The Horizontal Merger Guidelines presume a transaction produces anticompetitive effects if it produces HHI concentration levels of at least 2500 points with a change of at least 200 points. The Vertical Merger Guidelines contain no similar presumption for vertical mergers in highly concentrated markets. This suggests the agencies understand that vertical mergers are often procompetitive and that, absent some specific theory of harm, these transactions may be procompetitive even with relatively high market shares.
- Identify competitive risks unique to vertical mergers. The Vertical Merger Guidelines identify three risks of vertical mergers that the agencies will investigate: (1) refusals to supply other firms (i.e., “foreclosure”), (2) raising rivals’ costs through discriminatory behavior, and (3) access to competitors’ sensitive information. Of interest, the new guidelines do not include evasion of regulation as a risk even though the FTC brought an enforcement action based on that theory in 2008, and it was included in the 1984 Non-Horizontal Merger Guidelines.3 In our view, such a theory may be foreclosed as a basis for finding antitrust liability by the Supreme Court’s 1998 decision in NYNEX v. Discon, Inc.4
- Elimination of double marginalization mitigates harm from vertical mergers. Although debated in academia, the agencies will credit efficiencies claims from eliminating the need to charge two profit-maximizing margins. The fact that the agencies gave unique attention to this factor suggests it could carry significant evidentiary weight to obtain clearance for a vertical merger.
The vertical merger guidelines also fail to address two issues (single monopoly profit and firewalls), which may mitigate the potential anticompetitive effects from vertical mergers. Single monopoly profit suggests that a company which has a monopoly in one product cannot use that power to increase its profits in a related market. This theory implies that a vertical merger where one company already has a monopoly over its product will not produce higher prices in the related product. The agencies have raised this issue in their investigation of vertical mergers, but the guidelines remain silent on its relevance to future investigations. Similarly, the guidelines do not mention the use of firewalls to mitigate concerns about access to competitors’ sensitive information. The agencies may have some disagreement about the extent to which firewalls mitigate concerns; historically, the agencies have accepted the use of firewalls and other “behavioral” remedies, although under Assistant Attorney General Makan Delrahim the DOJ has expressed some skepticism about these solutions to the identified concerns. And the agencies have used firewalls in consent decrees to address these types of concerns from recent vertical mergers (e.g., Staples/Essendant and Northrop Grumman/Orbital).
Overall, the Vertical Merger Guidelines provide more clarity for companies to accurately assess the antitrust risk associated with these mergers and to understand the theories of harm the agencies are likely to investigate. But the guidelines leave open the possibility that the agencies may investigate vertical mergers even when there is little likelihood of anticompetitive harm and the possibility of significant efficiencies. Moreover, two of the FTC commissioners abstained from the vote to approve the draft guidelines, criticizing the new guidelines for not being aggressive enough.