European Court Clarifies the Scope for Conglomerate Effects Theories in Mergers
December 16, 2005
On 14 December 2005, the European Court of First Instance (CFI) issued its long-awaited judgment in relation to the appeal of the decision of the European Commission (Commission) in GE/Honeywell. The judgment provides valuable guidance to companies on the standard of proof required of the Commission when seeking to prohibit mergers on the basis of conglomerate (portfolio) effects. The CFI found that the Commission had failed to justify its findings in relation to conglomerate effects resulting from the proposed transaction but upheld the Commission on other grounds.
The clarification provided by the CFI is good for businesses as it will be more difficult for the Commission to prohibit mergers or acquisitions involving complementary products or services. The judgment sets out the framework against which the Commission must analyse conglomerate effects and it greatly assists businesses in effectively reviewing this aspect of proposed mergers.
The judgment provides valuable guidance on the application of conglomerate effects theories in merger cases, in addition to clarifying a number of other substantive and procedural issues. The judgment builds on the previous judgment of the European Court of Justice (ECJ) in Commission v TetraLaval (see 22 February 2005 On the Subject, "European Court Raises Bar on the Commission’s use of Novel Theories in Merger Cases"). In that case, the ECJ held that the Commission must exercise great care in undertaking a prospective analysis of the likely effects of a merger. This will assist businesses contemplating the likely treatment of mergers by the European Commission and by national merger control authorities in the EU.
Conglomerate Effects
The Commission based its analysis of the conglomerate effects arising from the transaction on two theories—"share shifting" and "bundling".
Share-Shifting
This theory analyses the ability of a merged entity to enhance its market power by using its strength and position in a given market as leverage to promote the sale of other products.
In its decision, the Commission claimed that the financial strength of the merged entity together with its vertically integrated subsidiaries would enable it to encourage customers to purchase its avionics and non-avionics products instead of competing products. The CFI held that to rely on this theory, the Commission would need to provide convincing evidence not only that the merged entity would have the ability to promote its avionics and non-avionics products, but also that it was likely to engage in such conduct. The CFI stated that the Commission could not rely exclusively on evidence of previous related conduct but that evidence of future intent is required. Such evidence could include the form of minutes of meetings of the board of directors or other strategic documents, or an economic assessment showing that such behaviour would be in the parties’ commercial interests. As there was no such compelling evidence, the CFI annulled this part of the Commission’s decision.
Bundling
The CFI judgment provides a detailed examination of the "bundling" theories applied by the Commission and it provides some clarity in an area which has been controversial.
The CFI draws a distinction between "pure bundling", "technical bundling" and "mixed bundling". "Pure bundling" and "technical bundling" occur when a company ties purchases of products or services in one market (the tying products) to purchases of products or services in another market (the tied products), either for purely commercial reasons ("pure bundling") or for technical reasons ("technical bundling"). "Mixed bundling" occurs where a package of products or services is offered at a lower price than when the products or services are offered individually.
Pure Bundling
In examining whether a merged entity would have the ability or incentive to engage in "pure bundling", the CFI confirmed that one of the products must be a vital component which the merged entity could refuse to sell independently of its other products. In addition, the CFI recognised that the Commission must consider the counterbalancing, harmful commercial effects that the merged entity would suffer by engaging in such conduct. For example, such conduct could result in customers switching away from the merged entity. The CFI stated that the Commission failed to consider whether customers could retaliate against this conduct and annulled the Commission’s findings in this regard.
Technical Bundling
In relation to "technical bundling", the CFI concluded that the Commission had not adequately established that the merged entity would have the ability to engage in tying based on technical requirements. The CFI stated that a specific analysis of the likely evolution of each market would be required to establish this.
Mixed Bundling
The CFI considered that a package of products offered at discount prices ("mixed bundling") would only have anticompetitive effects if accepted by customers, if customers did not demand an unbundled offering and if competitors could not provide a comparable competitive offering. The CFI stated that the onus was on the Commission to show that the merged entity would be able to engage in such conduct and that there was a likelihood that the merged entity would do so. The CFI annulled this part of the Commission’s decision holding that the Commission failed to provide convincing evidence that the merged entity would engage in anticompetitive "mixed bundling".
The CFI held that the Commission’s reliance on evidence of past "mixed bundling" practices in unrelated markets was of little relevance as such conduct could equally be pro-competitive. In addition, the CFI criticised the Commission for failing to provide a comprehensive empirical analysis applying the economic theory adopted—a brief mention of an economic theory was not sufficient. Finally, the CFI held that the Commission failed to provide evidence suggesting that the merged entity would make the strategic decision to sacrifice profits in the short term with a view to reaping larger profits in the future. Internal board minutes or other strategic documents would be required for this purpose.
The CFI rejected the Commission’s arguments on "bundling"—the mere fact that the merging parties would have a wider range of products than its competitors, without compelling evidence as to the likelihood of the effects, is not sufficient to justify a prohibition decision.
