The U.S. Department of Justice and U.S. Federal Trade Commission published proposed vertical merger guidelines (vertical guidelines) on January 10, 2020. These are designed to increase the transparency of the agencies' analysis of mergers and acquisitions between firms that operate at different stages of the supply chain—for example, the acquisition by a manufacturer of finished products of a vendor of components incorporated in those products. The vertical guidelines are modeled after and explicitly linked to the analysis included in the agencies' 2010 Horizontal Merger Guidelines. The new guidelines reflect the agencies' current analysis and do not signal increased enforcement against vertical mergers. To the contrary, the vertical guidelines provide a safe harbor for deals in which neither firm holds a 20% or larger share of its product market.

The vertical guidelines have been released in draft form for public comment by February 11, 2020.

Key Concepts

Building on the traditional antitrust concept of "relevant product market," the vertical guidelines introduce the concept of a "related product," which is a product or service vertically related to the product in the relevant market. For example, a component sold to manufacturer A by component vendor B and incorporated in A's finished product would be a "related product."

The vertical guidelines recognize that vertical mergers can have anticompetitive effects. For example, the post-merger firm could refuse to provide the related product (here the component) to manufacturer A's rivals, thus foreclosing them from the market. Alternatively, the post-merger firm could provide the component to A’s rivals at a higher price, thus raising those rivals' costs.

Acquisition by manufacturer A of vendor B may also provide access to confidential business information about vendor B's other customers, including manufacturer A's competitors. Access to this information may permit manufacturer A to coordinate its pricing of finished products with those of its competitors.

The vertical guidelines also recognize, however, the potential procompetitive benefits of vertical mergers, primarily the elimination of "double marginalization." This is a phenomenon that occurs when, in our example, both manufacturer A and vendor B have each been charging a profit maximizing price. The post-merger consolidation of margins may eliminate this double marginalization and provide an opportunity for the post-merger firm to lower the prices of A's finished products.

Safe Harbor

The agencies will generally not challenge transactions where each merging firm has less than a 20% share of its respective market. Returning to our example, assume manufacturer A represents 25% of sales in the finished product market, but vendor B has historically accounted for only 15% of the supply of components to the manufacturers in that market. Although, with a 25% share, manufacturer A has a "competitively significant share," vendor B represents less than 20% of the components sold to A and its rivals. Because vendor B's sales to the manufacturers as a group are not "sufficiently competitively significant,” the agencies are unlikely to challenge the transaction.

The safe harbor may not apply, however, in cases where a vendor's components have competitively significant characteristics that distinguish them from those of rival component vendors.

Takeaway

Although vertical mergers will continue to be scrutinized by the agencies, mergers between vertically related firms that have insubstantial shares of their product markets are unlikely to be challenged.

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