Steven C. Salop evaluates the final version of the 2023 Merger Guidelines on vertical merger analysis and certain rebuttal arguments. He finds that the final Guidelines successfully incorporate developments in the economic scholarship and update antitrust enforcement with the tools to analyze non-horizontal mergers in an increasingly digital economy.
The final 2023 Merger Guidelines have now been released. I think that they are excellent. The Guidelines have set out new priorities for antitrust enforcement in concrete form and have made significant contributions to merger analysis. These contributions include analysis of vertical and other non-horizontal mergers, detailed analysis of acquisitions involving potential entrants and nascent competitors, acquisitions that might entrench or extend dominance into related markets, and treatment of sequential acquisitions. The Guidelines also place greater focus on buyer-side market power concerns involving workers and other input suppliers. The new Guidelines will be very useful in framing and analyzing mergers in modern digital markets and what have been characterized as “ecosystems.”
In this article, I will discuss several discrete issues. I will focus first on an area of longstanding interest of mine: the Guidelines’ analysis of issues arising in non-horizontal mergers, particularly foreclosure. I will then comment on certain rebuttal arguments.
The Guidelines take a modern approach to vertical mergers by analyzing the “ability and incentives” of the merged firm to foreclose rivals with the reasonably likely effect of achieving, enhancing, or maintaining market power. In the parlance used in parts of the Guidelines, these acquisitions may raise rivals’ costs and entry barriers, entrench dominant market power, or extend dominance into adjacent markets.
Because vertical and other non-horizontal mergers do not automatically increase concentration in the first instance, courts have not applied the Philadelphia National Bank “structural presumption” used in horizontal mergers. In this regard, the Guidelines have suggested certain structural indicia that could create an economic presumption. Having proposed such economic presumptions myself and with coauthors, I enthusiastically support this approach.
Scope of Vertical (and Other Non-Horizontal) Merger Concerns
The paradigmatic concern here can be framed as a vertical merger. However, the Guidelines are careful to make the analysis more general. Mergers of complementary products can be analyzed similarly. Applying basic vertical merger analysis here, either merging firm may be considered as upstream with the other as downstream. Concerns, such as tying, may arise in complementary product or conglomerate acquisitions as a foreclosure strategy. Bundled discounts for the merged firm’s products amount to taxes on unbundled purchases from standalone rivals. Conditional pricing would be another concern. For example, in its complaint against the Amgen acquisition of Horizon, the Federal Trade Commission was concerned that the merged firm would charge higher prices for Amgen’s popular drugs to pharmacy benefit managers or third-party payers that purchased new entrants’ products instead of Horizon’s, thereby dissipating Horizon’s monopoly power. The consent decree prohibited this type of conditional pricing.
Ability and Incentive to Foreclose Rivals
The Guidelines sometimes use the lay terminology of limiting access to the related product instead of the technical antitrust term of “foreclosure.” Either way, the concern is that the merged firm might raise the prices of upstream inputs, deny or delay their provision, or degrade their quality when selling them to some or all of the rivals of the downstream division. The merged firm also might discriminate against the rivals in other terms. In a digital market, it might reduce or eliminate interoperability, either technically or by contract. As a result, the merging firms may divert customers from these rivals and gain the power to raise or maintain prices in the relevant downstream market. Foreclosure also may raise entry barriers, including by forcing rivals to enter both market levels, which might entail substantial delays or higher costs, if the two-level entry is otherwise feasible for the entrant.
Market Structure Indicia of Substantial Vertical Merger Concerns
As noted above, vertical or complementary product mergers do not increase concentration in a market so that the structural presumption does not apply. However, other market structure factors might be applied to reach an inference of likely competitive harm that would satisfy the antitrust agency’s prima facie evidentiary burden in the case of input foreclosure concerns. In this regard, the Guidelines adopt the following three-prong market structure test in 2.5.A.2: (i) a “foreclosure share” suggesting monopoly power over the “dependent” rivals, (ii) a competitively significant input, and (iii) limited competition from other firms facing merged firm and the dependent rivals face. In supplemental comments on the draft Guidelines summarized in a ProMarket article, I suggested a similar three-prong test with a trigger of a 50% market share for the first prong and a more technical third prong involving either a hypothetical merger or a hypothetical partial ownership structure. The Guidelines’ third prong is less quantitative but has the advantage of simplicity. Sometimes, it is better to learn to walk before beginning to run. I expect that these tests will be refined over time, just a critical loss analysis of market definition has.
Competitively Sensitive Information
Vertical and other non-horizontal mergers also can lessen competition by giving the merged firm access to rivals’ sensitive competitive information, for example, when the upstream division supplies the rivals of the downstream division. That access can facilitate collusion or tacit coordination. It also can have exclusionary effects. If the merged firm gains early access to rivals’ plans, they might preempt them. Anticipation of such preemption may reduce the rivals’ incentive to innovate. The access to sensitive information also may lead the rivals to shift their input purchases to other higher cost or lower quality suppliers out of a fear of misuse of its information. This “self-foreclosure” is not truly voluntary since it results from a rational fear that its information will be misused.
Elimination of Double Marginalization
The Merger Guidelines discuss the elimination of double marginalization (EDM), that is, the elimination of the input product markup between the upstream and downstream divisions, in Section 2.5 (footnote 31). They make the key point that the cost-savings from EDM may not be passed through in full (if at all) to downstream customers as a result of an “opportunity cost”: that is, such a price reduction would reduce the sales of the merged firm’s rivals in the relevant market and thereby reduce the input profits of the upstream merging firm, ceteris paribus. I would have liked the footnote also to flag one additional impediment to pass-through from the merged firm anticipating price reductions by rivals in the downstream market in response to its own price reduction. That general point is implicit in Section 2.3, but it might also have been included here for completeness.
Rebuttal Arguments
The Rebuttal Section 3 flags rebuttals based on failing firm, ease of entry, and pro-competitive efficiency benefits. Rebuttal arguments applied to complications that would deter coordination or elimination of double marginalization are contained in Section 2.3 and 2.5, respectively. In Section 2.5, they are referred to analysis to disprove or rebut the allegations. The Entrenchment and Extension Section 2.6 flags various factors that raise rebuttal possibilities.
Sufficient Ongoing Market Competition
One possible expositional gap in the Guidelines is the failure to flag in Section 3 the economic rebuttal arguments regarding sufficient ongoing market competition. While I understand that there are pros and cons regarding how much detail to provide on rebuttals, I think it would have been useful to include this issue along with discussion of evidence relevant to evaluating their validity and sufficiency, as well as any relevant limitations on those rebuttal claims. That would have made the arguments easier for courts to find and analyze.
A common rebuttal claim is that market competition among established firms is sufficiently strong that the merger will not lead to anticompetitive effects. While repositioning (changing product investment strategies in response to market developments) is mentioned in Section 3, repositioning is not the only mechanism by which rivals can maintain competition post-merger. Non-merging established competitors might take this opportunity to expand their competitive efforts to fill the competitive gap created by the merger in ways other than strictly repositioning. A threat to enter or sponsor entry might not qualify for easy entry but nonetheless might be a supplementary competitive constraint. Merging parties might argue that anticompetitive effects might be deterred or undone by counterparties with countervailing bargaining power. As noted in the 2010 Horizontal Merging Guidelines, this may be a limited constraint because the powerful buyers may only protect themselves, while other customers are harmed. And powerful buyers might even use their power to induce sellers to raise the costs of rivals. The same points apply to powerful sellers in the comparable buy-side mergers. These points would have been worth making in the rebuttal section along with the limited conditions under which this rebuttal factor would be valid. This would allow the Guidelines to flag and elucidate certain issues that otherwise might lead courts to err.
Acquisitions of Weak (But Not Failing) Competitors
Another rebuttal argument that might have deserved more discussion is the claim sometimes made by merging parties that the acquired firm is “weak” or “flailing,” such that the loss of its competition would have no substantial anticompetitive effect. Rebuttal Section 3.1 explains how the Agencies will evaluate such claims when they meet the narrow conditions required for the “failing firm defense.”
However, rebutting the allegations of lessening competition based on the claim that the acquired firm’s market share overestimates its competitive impact can be distinguished from the failing firm defense. The merging parties instead might be basing their rebuttal claim on the view in the General Dynamics case that market shares may not provide an accurate portrayal of competitive conditions. If the Guidelines intend to be skeptical of such claims, it would be worthwhile to explain why such claims tend to be overstated or why the testimony and economic evidence typically offered tends to be unreliable or lacking in credibility.
Improvements Over the Draft Guidelines
Finally, the release of draft Guidelines always raises concerns among those who prefer the previous version or just have become comfortable with it. Indeed, I am old enough to remember that the merger defense bar had misgivings about the 1982 Merger Guidelines, even though they signaled new rebuttal arguments and less enforcement. The draft Merger Guidelines attracted more attention and concern over their substantial change in structure. In my own view, a fair amount of the criticisms involved misinterpretation of the language of specific guidelines, which has now changed. For example, it was not clear to some readers that specific guidelines were focused on the agency prima facie case rather than rejecting economics-based rebuttals.
In addition to my suggested structural indicia of vertical merger concerns mentioned above, I provided more than 40 pages of comments on the draft Guidelines on a variety of other issue with the goal of improving the final version. Those comments were taken very seriously and hopefully improved the final product. In my view, thefinal Guidelines represent improvements over the earlier draft Guidelines in numerous ways. For example, I particularly liked the way that the specific Guidelines were retitled, how relevant economic effects were flagged in the Overview section, and how the judicial language was included throughout. I am intrigued by the expansion of the Entrenchment section to include ecosystems and intend to write about it later.
I also want to stress the fact that draft Guidelines are just drafts. They are circulated to obtain comments and suggestions for revisions. It is only the final version of the Guidelines that matters. As someone who thinks and refines by writing and revising many drafts, I retain the hope that my contributions are evaluated on the basis of the quality of the final draft, not the flaws in my earlier drafts that were eliminated in the final. At the same time, articles and Guidelines can always be improved. I am looking forward to participating in the next round of Guidelines revisions whenever it occurs.
Author Disclosure: Steven Salop is currently consulting with parties that have a financial stake in agency Merger Guidelines enforcement.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
