Antitrust Enforcement Agencies Adopt Final Vertical Merger Guidelines

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On June 30, 2020, the Antitrust Division of the Justice Department and the Federal Trade Commission (FTC) adopted Vertical Merger Guidelines (Vertical Guidelines) to fill a long-standing gap in the competition agencies’ published merger enforcement standards. But even after extensive public comments, the Vertical Guidelines leave as many questions open as they resolve. It remains to be seen whether the Vertical Guidelines will eventually gain the same level of public and judicial acceptance as the agencies’ widely cited Horizontal Merger Guidelines (Horizontal Guidelines).

For over 50 years, the agencies have relied on the Horizontal Guidelines as authoritative criteria for analyzing mergers of competing firms. By tirelessly invoking the Horizontal Guidelines in litigation, the agencies persuaded courts to treat them as distillations of the legal standards for applying Section 7 of the Clayton Act, the principal merger statute. The Horizontal Guidelines became the lingua franca of merger analysis; mergers that exceed the Horizontal Guidelines’ market share and concentration thresholds are often referred to as “violations,” even though the Horizontal Guidelines have no legal effect.

The Horizontal Guidelines feature an arithmetic formula to identify mergers that cause competitive concern. That formula uses an index to measure the level of concentration in product and geographic markets. If post-merger markets remain below a specified level of concentration or if the transaction produces only a small increase, the Horizontal Guidelines say that the transaction “ordinarily requires no further analysis.” If, however, post-merger markets are highly concentrated and the transaction causes a substantial increase in concentration, the Horizontal Guidelines say that the transaction “will be presumed to enhance market power . . . unless rebutted by persuasive evidence.” That conclusion often leads to an in-depth investigation and potential challenge. Simplistic reliance on these calculations can result in false positives or negatives, but this cookbook approach is a comprehensible threshold basis for evaluating antitrust risk.

Unlike horizontal mergers, vertical mergers have been enforcement stepchildren. The agencies bring few vertical cases; the great majority of merger cases are horizontal. The Vertical Guidelines acknowledge this reality with an awkward double negative: “While the agencies more often encounter problematic horizontal mergers than problematic vertical mergers, vertical mergers are not invariably innocuous.” The Vertical Guidelines eschew the numerical approach of the Horizontal Guidelines, likely making the Vertical Guidelines’ application less predictable and more ambiguous.

In 2017, the Justice Department sued to prevent the vertical acquisition of Time Warner, a leading creator of video content, by AT&T, a leading content distributor. The case was the first litigated challenge to a vertical acquisition by either the Justice Department or the FTC in decades. The case, which the Justice Department lost after a lengthy trial and appeal, dramatized the absence of meaningful vertical merger guidelines, although it is doubtful that the outcome would have been different if vertical guidelines were in place.

The Vertical Guidelines identify nonexhaustive examples of harm to competition from vertical mergers:

  • Foreclosure and raising rivals’ costs.

An acquisition can enable the merged firm to refuse to supply rivals with “related products” the rivals need to compete effectively. The Vertical Guidelines say: “A related product is a product or service that is supplied or controlled by the merged firm and is positioned vertically or is complementary to the products and services in the relevant market. For example, a related product could be an input, a means of distribution, access to a set of customers, or a complement.” An acquisition can enable the merged firm to increase the price of related products that it sells to rivals, or to accomplish a similar result by lowering the quality of products or services that rivals buy from it.

The Vertical Guidelines give the example of a firm that produces oranges merging with a downstream firm that produces orange juice. If rival orange juice producers lack the ability to source oranges from alternative producers, the merged firm can profitably raise its prices to other orange juice firms and make those firms less competitive. The Vertical Guidelines, however, could have offered more guidance in this example and many similar examples by answering the question: What is it about this marketplace that makes it more profitable for the orange producer to engage in an acquisition rather than simply raising the price of oranges across the board?

A related example is a vertical merger that creates the necessity for two-level entry. The Vertical Guidelines hypothesize a company that makes an active ingredient needed for a drug product, which it sells to a manufacturer of the drug. Another drug manufacturer is considering entering the market. If the incumbent drug manufacturer acquires the ingredient maker, then the merged firm has an incentive to refuse to supply the ingredient to the new entrant, forcing the entrant to enter both the market for the finished drug and the market for the ingredient. The Vertical Guidelines say: “This two-level entry may be more costly and riskier than entering the relevant market alone, and thus may deter [the new entrant drug manufacturer] from entering.”

  • Access to competitively sensitive information.

An acquisition can provide a firm access to competitors’ sensitive business information if (for example) the firm acquires a distributor that resells the competitors’ products, giving the acquiring firm insight into the competitors’ prices, levels of output or product strategies.

The Vertical Guidelines say: “In a vertical merger, the transaction may give the combined firm access to and control of sensitive business information about its upstream or downstream rivals that was unavailable to it before the merger. For example, a downstream rival to the merged firm may have been a premerger customer of the upstream firm. Post-merger, the downstream component of the merged firm could now have access to its rival’s sensitive business information.” The potential harm is twofold: The acquiring firm can eliminate its uncertainty about its competitors’ initiatives, and the competitors’ incentive to take procompetitive actions can be dampened by its inability to keep those actions secret.

The agencies brought several cases on this basis prior to the issuance of the Vertical Guidelines and resolved them by consent orders that required the walling-off of sensitive information within the merged firm. There is a tension, however, between this approach and the agencies’ strongly expressed preference for structural rather than behavioral remedies. It may continue to be the case – although the Vertical Guidelines do not delve into the subject – that the agencies will be more willing to accept behavior remedies in vertical mergers than in horizontal mergers.

The Vertical Guidelines give the impression, at least, of more openness to efficiencies arguments than the Horizontal Guidelines, although they repeat the Horizontal Guidelines’ insistence on efficiencies being merger-specific and strongly verified: “Vertical mergers combine complementary economic functions and eliminate contracting frictions, and therefore have the capacity to create a range of potentially cognizable efficiencies that benefit competition and consumers.” The Vertical Guidelines do highlight one efficiency of vertical mergers, the elimination of some of the margin that two independent vertically related companies charge (double marginalization). In fact, the elimination of double marginalization in vertical mergers may be the reason that the agencies have accepted behavioral remedies in vertical mergers more than in horizontal mergers.

The final Vertical Guidelines eliminate a controversial statement in the proposed Guidelines that the Justice Department and the FTC are unlikely to challenge a vertical merger where the parties to the merger have a share in the relevant market of less than 20 percent, and the related product is used in less than 20 percent of the relevant market. Commenters criticized this statement as creating an unwarranted safe harbor, and the final Vertical Guidelines omit it. Despite the omission of the 20 percent bright line, one would not expect the agencies to bring a vertical challenge in unconcentrated markets. That being said, the deletion of the only specific threshold in the Vertical Guidelines moves them even farther away from the more concrete guidance in the Horizontal Guidelines.

Two of the five FTC commissioners dissented from the issuance of the Vertical Guidelines on both substantive and procedural bases. Among other things, they deemed the Vertical Guidelines too hospitable to arguments asserting the potential benefits of vertical mergers, and also maintained that the final Vertical Guidelines differed so substantially from the proposed guidelines that the agencies should have invited a second round of public comments before final adoption.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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