Publications

14 Jun 2010

Federal enforcers issue proposed new horizontal merger guidelines

Antitrust Alert

Kenneth G. Starling
Paolo Morante
Lesli C. Esposito

The Obama Administration recently acted to put its own stamp on the antitrust law governing mergers, when two federal agencies jointly released a revamped set of proposed Horizontal Merger Guidelines for public comment. 

The New HMGs, released by the Department of Justice Antitrust Division and the Federal Trade Commission, will replace the current Horizontal Merger Guidelines (Old HMGs) that were issued in 1992 and partially revised in 1997. 

The principles of merger analysis and enforcement standards articulated in the New HMGs are not entirely different from the Old HMGs, but businesses and their antitrust advisers should pay particular attention to several material changes in policy and approach.  In this summary, we discuss the differences that we believe will have the most significant impact on merger enforcement and transaction planning.

Two overarching distinctions

There are two overarching distinctions between the merger-enforcement outlooks reflected in the Old HMGs and the New HMGs:

1. The New HMGs create the illusion that the Agencies’ threshold for challenging mergers has been raised, in that the markers for low/moderate/high concentration levels have been raised to more closely approximate the levels at which transactions have actually been investigated and challenged recently, while at the same time they give notice that the number of theoretical and evidentiary pathways for pursuing cases against horizontal mergers has expanded.
2. The New HMGs provide a window (“transparency”) into the increased analytical influence over the competitive assessment of mergers and the development of enforcement initiatives that the economists at the Agencies are exercising.

In an effort to increase transparency in the way the Agencies actually conduct merger reviews, the New HMGs de-emphasize adherence to a consistent analytical framework, stressing instead the flexibility of the process, with a focus on describing investigative techniques and identifying the types of evidence likely to be useful in the analysis. 

There is significant risk in this new attempt at clarity – risk for the Agencies, the courts and the parties to mergers.  Ironically, the risk is inherent in the uncertainty that rolling out new guidelines creates for all participants in the process.  If the Old HMGs have been adopted by the courts as the proper framework for the analysis of a merger’s legality, and the courts are predisposed to apply the Old HMGs standards as the law, the Agencies run the risk of losing court challenges built upon the New HMGs (at least in the near term). 

The New HMGs purport to replace the Old HMGs.   Having accepted that the Old HMGs correctly summarize the applicable framework and standards for judging mergers, will the courts be confused, reluctant to apply predictors and indicators of adverse effects that they do not understand, or more skeptical that the Agencies have carried their burden of proof under novel theories of anticompetitive effects?  Consider that the Agencies have stated that another goal of the New HMGs is to assist the courts in developing an appropriate framework for applying antitrust law to horizontal mergers.  Does this imply that the courts’ current analytical framework, which is now embedded in merger precedents, is inappropriate?  Add to this the Agencies’ warning that the New HMGs do not describe how they will conduct their litigation or what types of evidence they may introduce in court.  This suggests that the appropriate framework that they will assist the courts to apply may not even be the way the Agencies intend to build their court cases. Transparency does not guarantee certainty. 

Following are some of the specific differences from the Old HMGs.

Analysis No Longer Necessarily Starts with Market Definition

The New HMGs depart from the conventional wisdom that merger analysis starts and may stop with the definition of relevant markets in which the likelihood of legally prohibited effects must be assessed.  The Agencies tell us that their analysis no longer necessarily starts with market definition.  Market definition is only one of a number of tools to assess whether a merger is likely to lessen competition.  Market definition “may help” to analyze competitive effects, but it is useful only to the extent that it “illuminates” the likely effects.  

A substantial portion of the New HMGs is devoted to introducing other tools for assessing competitive effects that do not rely on market definition:  for example, direct evidence that a price increase has already resulted from a reduction in the number of competitors establishes anticompetitive effects without the use of market definition.   But the New HMGs acknowledge that market definition performs several functions – it defines an arena of competition, identifies market participants and enables a measurement of shares and concentration levels.  In the assessment of the likely coordinated effects of a proposed merger, predictions of future effects may need to be inferred from those market-based factors.  Indeed, the New HMGs confirm that, at some point in merger analysis, it is always necessary to evaluate the competitive alternatives that are available to customers (in a market).  Accordingly, the New HMGs describe the methodology used by the Agencies when defining relevant product and geographic markets. 

In defining markets, there are some important differences from the Old HMGs.  Rather than trying to include in the market definition all products that are regarded by (at least some) customers as reasonable substitutes for the merging parties’ products, the Agencies will exclude the more distant substitutes.  The Agencies exclude the more distant or fringe substitutes because to include them would overstate their competitive significance; also, excluding distant substitutes more accurately reveals the extent of the competition occurring between close substitutes. 

In order to avoid defining markets too narrowly, however, the Agencies still employ the Hypothetical Monopolist Test.  That test can identify substitutes that are outside of a provisionally defined market but that offer sufficient competition to products within the provisional market to protect consumers from anticompetitive effects; under the test, the substitutes should be included in the market definition.  Although the discussion of the Hypothetical Monopolist Test is more detailed than in the Old HMGs, there is little new in it.

The New HMGs provide more discussion of price discrimination markets, which may contain fewer than all of the customers that purchase the merging firms’ products.  Market definition focuses on customers’ demand for products and substitutes.  Within a market for the products of the merging parties, there can be a subset of customers that the merging parties can target for price increases without causing them to switch away to the substitutes to which customers in the larger set would switch in response to the same price increases.  This ability of the merged firm to price-discriminate can define a narrower market in which the likely price effects can make a merger unlawful. 

Concentration and Coordinated Effects

The New HMGs adjust the market concentration thresholds of the Herfindahl-Hirschman Index (HHI) upward to more closely reflect the levels at which the Agencies actually express concern, conduct extended investigations or challenge mergers.  Now, no merger resulting in an HHI increase of less than 100 points will be of concern, nor will mergers resulting in HHIs below 1,500.  At 1,500, markets will be considered “moderately concentrated,” and mergers resulting in increases of more than 100 points to levels above 1,500 may raise significant concerns.  At 2,500, markets will be regarded as “highly concentrated”; mergers resulting in increases of 100 to 200 points to levels above 2,500 will raise concerns, and mergers resulting in increases greater than 200 points to levels above 2,500 will be presumed to yield anticompetitive effects.  This is consistent with the current concentration analysis and enforcement standards of the Agencies with respect to coordinated effects. 

The New HMGs also make clear that the agencies will consider evidence of a market’s vulnerability to anticompetitive coordination, including evidence of prior collusion in the industry, the transparency of each firm’s competitive conduct, the homogeneity of the competitors’ offerings and other market structural considerations.  There is not much new in this with respect to the Agencies’ actual practice in merger review.

Unilateral Effects

A more significant difference appears in the New HMGs’ analytical approach to the unilateral effects of certain mergers.  Unilateral (or dominant-firm) effects analysis has evolved substantially since the Old HMGs were issued.  That analysis concerns the market-power effects of a merger of two firms that are regarded as each other’s closest demand-substitutes by a significant cohort of their customers.  These effects can be inferred or predicted without a market definition.  Devoting materially greater attention to unilateral-effects analysis than the Old HMGs, the New HMGs describe the effects that can arise in four distinct competitive contexts (differentiated products, auctions, homogeneous products and innovations/variety). 

In differentiated-products markets, after a merger of firms whose products are regarded by customers as very close substitutes (with few other close substitutes), the merged firm can achieve monopoly-level profits in sales to those customers.  Pre-merger, if only one firm raised its price, the result would be a “diversion” of significant sales away from the price-increasing firm to the other; absent a merger, the threat of this loss would constrain the pricing of the first firm.  Post-merger, the merged firm has the incentive to raise the price of one product (called upward pricing pressure); sales will still be diverted away from that product, but if a substantial share of sales is diverted to the close substitute, the merged firm will still capture those revenues and profits.  The closer the substitutes in the view of customers, the greater the ability of the firm to raise the price of one or both products without constraint from distant substitutes.

The New HMGs open a window into the internal Agency use of new economic modeling tools in this area.  The analysis uses metrics such as sales-diversion ratios, critical-loss limits, upward pricing pressure and merger simulations to predict anticompetitive unilateral effects without the necessity of market definition.  This approach to unilateral effects is different from the methodology of the Old HMGs, which employed presumptions based on the combined market share of the merging firms (in a defined market) and some limited empirical consumer research on the closeness of the firms as substitutes.  At this point, it is not clear how much the Agencies will rely on the new analytical metrics and merger simulations for establishing the unilateral competitive effects of mergers in differentiated-product markets.  (One impediment to the broad use of these new techniques is that the modeling apparently requires extensive amounts of data.)  It is likely, however, that the Agencies will encounter skepticism in the courts and possibly outright rejection of these new predictors or indicators of anticompetitive effects in narrow but undefined markets.

Entry

Another difference in the New HMGs is a more demanding standard for establishing that entry conditions would mitigate against the occurrence of competitive harm.  The current standard is that a merger is not likely to create or enhance market power if entry into the market is so easy that market participants, after the merger, could not profitably maintain a price increase above premerger levels.  Under the New HMGs, the requirement for crediting the timeliness of new entry is that the entrants must have a procompetitive effect so quickly that customers are not significantly harmed by the merger despite any anticompetitive pricing that occurs post-merger but prior to the entry.  This seems to require that entry will drive prices down not only to (“not above”) premerger levels but to price levels that will allow customers to recoup any higher prices that they paid post-merger and prior to the entry.

Buyer Power

The New HMGs also make more explicit the Agencies’ approach to issues relating to powerful buyers. 

First, the New HMGs acknowledge expressly that the existence of powerful customers of the merging parties may constrain a merger’s anticompetitive effects.  But they also emphasize that the Agencies will not presume that the presence of powerful customers will necessarily do so.  Under the New HMGs, a powerful-customer defense is likely to be effective only when the post-merger marketplace offers even powerful customers a sufficient number of viable alternatives to the merging parties (including new entry sponsored by a powerful customer). 

In addition, the New HMGs make clear that the presence of powerful customers does not necessarily eliminate the need for the Agencies to examine the merger’s effects upon less powerful customers, particularly when there is evidence that the merging parties could engage in price discrimination among various categories of customers.  Second, the New HMGs acknowledge that a merger of competing buyers can have anticompetitive effects by enhancing monopsony power, and state expressly that the Agencies will investigate such mergers by applying techniques similar to those used in the context of mergers between competing sellers.  These acknowledgements are consistent with pre-existing Agency practice and add little beyond increased transparency.

Partial Acquisitions 

Finally, the Agencies have added a discussion of the assessment of “partial acquisitions” to the HMGs.  Partial acquisitions are acquisitions of minority (non-controlling) interests in competing firms or competing joint ventures.  The substance of this guidance is not new, but it has been located elsewhere.  This new section contains portions of the analysis described in the separate Antitrust Guidelines for Collaborations Among Competitors, issued by the FTC and Justice in 2000.