On August 19, 2010, the Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ) issued the final version of the Horizontal Merger Guidelines (Guidelines) that describe how the FTC and DOJ analyze mergers and acquisitions between competitors. The Guidelines are a product of public comments and a series of public workshops held over six months involving leading antitrust practitioners, enforcers, scholars and economists.
The push to revise the Guidelines (which had not been substantially updated since 1992) was spurred by the consensus from the public workshops that the 1992 Guidelines did not reflect current federal antitrust agencies’ actual merger review practice, as well as by the agencies’ goal to allow for better transparency. Much had changed since 1992; new economic theories were developed, and the agency staff relied on sources of evidence other than market definition and market shares — which were gating items in the 1992 Guidelines — to analyze the competitive effects of mergers. The final Guidelines do not adhere to the 1992 version’s rigid five-step approach to merger analysis, which started with defining a market and calculating market share and ended with market entry and efficiency analyses. Rather, the new Guidelines set forth a holistic and flexible approach to merger analysis, with a variety of techniques and tests (economic and otherwise) with which to examine a transaction’s competitive effects.
A Quick Look at the Final Guidelines
The final Guidelines reflect minor changes to the proposed Guidelines that were issued in April of last year. We take a “quick look” at the final Guidelines below.
Evidence of Adverse Competitive Effects. The Guidelines downplay the role of market shares and market concentration as indicators of potential adverse competitive effects. While still important factors, the antitrust agencies also consider, where available: “natural experiments” (e.g., empirical data assessing the impact of recent mergers, entry/expansion in the relevant or similar markets), substantial head-to-head competition between the merging parties, and the loss of a “maverick” firm (e.g., a price discounter or an innovator).
Additionally, for consummated mergers, actual effects observed in the market, such as price increases or other adverse effects on customers, will be given substantial weight. Sources of such evidence may come from the merging parties (including profit margin evidence1), customers or other industry participants (e.g., suppliers, distributors, analysts and competitors).
Price Discrimination. From time to time, the antitrust agencies employ a price discrimination theory to analyze whether a group of targeted customers exist to whom the merging parties could profitably raise prices. The theory was posed in the Whole Foods and Dean Foods cases by the FTC and DOJ, respectively. The final Guidelines offer a more thorough discussion of price discrimination theory and when it is likely to be used (e.g., when prices are individually negotiated and suppliers have information about customers that would help identify those that are likely to pay higher prices for a product or service).
Market Definition and Related Economic Theories. As noted earlier, the Guidelines de-emphasize the role of defining a relevant market; no longer is this a necessary first step for the government. However, the “hypothetical monopolist test” survives. It defines a relevant market by determining which products, if any, are substitutes for a product of the merged firm when a price increase is imposed on that product. The agencies determine whether a hypothetical monopolist could impose a profitable “small but significant and non-transitory increase in price” (SSNIP) for at least one of its products. Related theories and sources of evidence taken into account by the agencies to define a market under the hypothetical monopolist test include the following:
- “Critical loss” analysis, which assesses whether the price increase made by a hypothetical monopolist will be profitable by taking into account both the profits on sales made at the higher price, and the loss of sales as a result of customers shifting away to substitutable products. The “critical loss” is the number of lost sales that would leave the hypothetical monopolist’s profits unchanged. Important in this analysis are the merging companies’ pre-merger margins;
- Customer switching patterns and costs of switching;
- Documentary evidence as to how a seller believes a customer will act upon an increase in price; and
- “Diversion ratios,” which assess the sales lost of one product, due to an increase in price, to another product (a higher diversion ratio between the merging parties’ products indicates a more profitable price increase for the hypothetical monopolist).
Market Shares and Concentration. As expected, the final Guidelines increase the levels of the Herfindahl- Hirschman Index (HHI) that denote a market’s concentration. The lowest threshold level that constitutes a moderately concentrated market has been increased to 1,500, even though merger review statistics show that the agencies rarely challenge mergers with concentration levels below 1,800. Mergers in moderately concentrated markets that result in an increase in HHI of more than 100 points are deemed to “potentially raise significant competitive concerns and often warrant scrutiny.”
Unilateral Effects Analysis. Some mergers may be anticompetitive because of the loss of competition between the merging parties. Several theories analyzing the price and non-price unilateral effects of transactions, are set forth in the Guidelines, including the following:
- Theories specifically related to differentiated products.
- The level of diversion ratio between the merging parties’ products;
- The extent of head-to-head competition between the merging parties’ differentiated products;
- The “Upward Pricing Pressure” test, which takes into account the margins of the competing products as well as their diversion ratio to determine the incentive of the merged firm to raise the price of at least one of the products post merger; and
- The extent to which the merging parties’ products are “next best substitutes.”
- The extent to which buyers play off the merging parties against each other in price negotiations, or the extent to which the merging parties are the first and second choices of buyers; and
- Whether innovation and product variety would be diminished (e.g., whether one of the merging parties is attempting to introduce new products that would compete directly with products from the other merging firm).
Coordinated Effects Analysis. Some mergers limit competition by making it easier for firms in the market to coordinate on price or other competitive initiatives. To assess the risk of post-merger coordinated interaction under the Guidelines, the agencies will take into account, among other things, the market concentration level, whether a “maverick” firm is eliminated as a result of the merger, whether the market had been subject to prior collusion (or attempted collusion), the existence of homogenous products and price transparency, and the market elasticity of demand. The likelihood of a merger challenge is greater if: market concentration levels are moderately to highly concentrated; the market is vulnerable to coordinated conduct; and, there is evidence that the merger may enhance that vulnerability.
Entry. To combat any potential anticompetitive effects of a merger, entry must still be timely, likely (i.e., profitable) and sufficient. The final Guidelines eliminate the two-year test for “timeliness.” Instead, entry must be “rapid.” Entry by a single firm is deemed “sufficient” if it “will replicate at least the scale and strength of one of the merging firms.” Sufficiency of entry will also depend on any competitive disadvantages faced by new entrants.
Efficiencies. The Guidelines note that the agencies will only consider merger-specific efficiencies, and those that can be substantiated by prior experience are given the most credit. Further, the agencies note that in order to combat potential adverse competitive effects of a merger, efficiencies must be passed through to customers.
New Sections. The agencies have added new sections to the Guidelines discussing innovation and whether a merger is likely to diminish innovation, power buyers, mergers between competing buyers (monopsony), partial acquisitions, and potential challenges against previously consummated mergers.
Commissioner Rosch’s Statement
The Guidelines were approved by the FTC with a vote of 5-0, with Chairman Jon Leibowitz and Commissioner J. Thomas Rosch issuing separate statements. While Commissioner Rosch supported the change in the Guidelines’ focus from market shares and market definition to a merger’s competitive effects on the market, he disapproved of the Guidelines’ “overemphasis on economic formulae and models based on price theory.”
In his opinion, the drafters’ emphasis on economic theory came at the expense of transparency into the agencies’ merger review process. Given the increase in challenging mergers in preliminary injunction and administrative proceedings, Commissioner Rosch stated that the FTC staff focuses on empirical evidence of anticompetitive effects that can be used at trial, rather than on economic evidence. He noted that, “most courts have relied on empirical evidence … and have considered economic evidence as corroborative … if they have considered it at all.” Thus, Commissioner Rosch concluded that the Guidelines’ focus on economic formulae does not accurately reflect the merger review process of the staff during a typical merger investigation.
One effect of the revised final Guidelines will be to increase the costs of defending mergers prior to and during the initial premerger waiting period. Given the Guidelines’ emphasis on economic theory, it is likely that merging parties will need to retain an economist early in the investigative process. Further, the more flexible approach of the Guidelines means that antitrust counsel must be ready to defend a merger on additional new “fronts.” Early defense preparation and risk assessment remain instrumental to protect the parties from a Second Request for information.
However, the real impact of the Guidelines will play out on a different battlefield — the courtroom. Over much of the last two decades, courts have used the five-step process set forth in the 1992 Guidelines as a rigid tool to analyze mergers. The first step has always been to define a relevant product and geographic market. Only after establishing a relevant market, could the Government move on to prove its case. Whether courts will choose to use the new flexible Guidelines and economic theories and formulae, with no precedent for doing so, remains to be seen.2