The European Commission has just published the long-awaited draft guidelines on the assessment of non-horizontal mergers. The text introduces market share and concentration level "safe harbours" for merging firms and recognises that only exceptionally will non-horizontal mergers cause competition concerns.
This text comes three years after the adoption by the Commission of the guidelines on horizontal mergers. The Commission follows to a significant extent the "economics-based approach" that is inherent in the guidelines on horizontal mergers. In doing so, the Commission draws a number of conclusions as well as lessons learned from its past jurisdictional practice, and most importantly from a number of European court judgments, most notably the 2003 Tetra Laval and the 2006 General Electric judgments. Thus, the draft guidelines codify to a large extent the Commission’s recent practice, whereby in cases of non-horizontal mergers it will only intervene in exceptional circumstances. The deadline for interested parties to submit comments is 12 May 2007.
The scope of application of the draft guidelines encompasses vertical mergers, involving mergers between firms that can have a supplier-customer relationship, and conglomerate mergers, where firms are not actual or potential competitors, nor have a vertical relationship, but rather are active on closely related markets. The Commission recognises that in principle, non-horizontal mergers are less likely to be anti-competitive, as they do not entail the loss of a direct competitor. Also, in an attempt to increase legal certainty, the text provides a—rather low—"safe-harbour" of market shares (30 per cent) and of market concentration (post-merger HHI, a measure of market concentration, of 2000), below which it is unlikely that any concerns will arise. Furthermore, it is recognised that a necessary condition for competitive harm in non-horizontal mergers is that the parties concerned have market power in at least one of the relevant markets. Finally the Commission acknowledges that in this area there is great scope for efficiencies. Indeed, the draft guidelines provide that in non-horizontal mergers efficiencies can arise through the internalisation of double mark-ups (in the case of vertical mergers) or the integration of complementary activities or products (in the case of conglomerate mergers). Thus, companies entering into non-horizontal mergers will need to identify at an early stage possible efficiencies that their transaction will bring.
The Commission breaks down its analysis of vertical mergers into non-co-ordinated effects (foreclosure) and co-ordinated effects, with the former occupying the lion’s share of the analysis.
Foreclosure is broken down into input and customer foreclosure. Input foreclosure is where the merger is likely to raise the costs of downstream rivals by restricting their access to an important input. Input here could mean goods, services or access to infrastructure/intellectual property rights. Customer foreclosure is where the merger is likely to foreclose upstream rivals by restricting their access to a sufficient customer base.
In relation to both types of foreclosure, the draft guidelines consider three main issues: the ability to foreclose access to inputs/customers; the incentive to foreclose such access; and the overall likely impact on effective competition.
Ability to Foreclose
Input foreclosure is only considered to cause competition problems if it concerns an important input for the downstream product. This might take place when the cost of this input in relation to the price of the downstream product is important or where it is considered a critical component. For input foreclosure to be a concern, the vertically integrated merged entity must have market power in the upstream market. Account should also be taken of any freeing up of capacity on the part of remaining input suppliers in the event that the merged entity intends to rely on its upstream division’s supply of inputs, as this may result in a realignment of purchasing patterns rather than an anti-competitive outcome. For customer foreclosure to occur, the merger must involve an undertaking which is an important customer in the downstream market. By deciding to source all its internal needs from its upstream division, it may stop purchasing from its upstream competitors, or reduce such purchases or make these purchases on less favourable terms. If, however, there is a sufficiently large customer base that can turn to independent suppliers, there are unlikely to be competition concerns.
Incentive to Foreclose
The incentive to foreclose will often depend on the trade off between the level of the profits the merged entity obtains upstream and downstream. In its assessment of the likely incentives of the merged firm, the Commission can take account of matters such as ownership structures, past strategies or internal strategic documents, such as business plans. As is clear from the European court judgments in the Tetra Laval and General Electric merger cases, where a specific course of conduct must be taken as an essential step in foreclosure, factors liable to reduce or eliminate those incentives (such as the possibility that the conduct would be illegal) must be taken into account by the Commission.
The overall likely impact on effective competition must also be taken into account. As regards customer foreclosure, the raising of barriers to entry is of particular concern in industries that are either opening to competition or expected to do so in the foreseeable future. This is currently a topic of concern at the EU level as regards energy liberalisation.
When competitors in a market are able to identify and pursue common objectives (without entering into an anti-competitive agreement or concerted practice) thereby avoiding normal competitive pressures by a coherent system of implicit threats, this may give rise to market co-ordination. The draft guidelines refer to the three conditions necessary for co-ordination to be sustainable. First, the parties must be able to monitor whether each party adheres to the terms of co-ordination. Generally speaking, a reduction in the number of players makes this easier as does the elimination of a maverick in the market. Second, there must be some form of credible deterrent mechanism that can be activated if deviation is detected. This is often difficult to prove in practice. Third, the reactions of outsiders should not be able to jeopardise the results of the co-ordination. In this way, the elimination of a disruptive buyer through vertical integration may enhance the risk of co-ordination between the remaining players.
Conglomerate mergers are mergers between firms that neither are competitors, nor have a vertical relationship. In the draft guidelines the Commission acknowledges that in principle such mergers are pro-competitive. As is the case with vertical mergers, the Commission identifies that potential concerns might arise as a result of non-co-ordinated and co-ordinated effects.
Regarding non-co-ordinated effects, the main concern is that post-merger, companies might be in a position to conduct foreclosure strategies against their competitors. This can be achieved by leveraging their strong position in one market into another, by means of tying, bundling or other exclusionary practices. The Commission will proceed to a three-step analysis.
First, it will assess the ability of the merging parties to foreclose their competitors, e.g., by analysing issues such as the market power of the merging parties over a certain product that is viewed by customers as particularly important, the incentives of customers to buy a range of products rather than purchase from a single supplier (portfolio effects), or the percentage of customers that tend to buy both products. The Commission will also consider whether rival firms can put in place effective counter-strategies. For instance, bundling will be less likely to have foreclosing effects if a company purchases the bundled products and profitably resells them unbundled.
Second, the Commission will assess whether the parties will have the incentives to foreclose. This will depend on the degree to which the exclusionary strategy is profitable and also on the possibility that the exclusionary practice is unlawful.
Third, the Commission will assess the harm caused not to competitors but to final customers. In this respect, the effects on competition will be assessed in the light of efficiencies which are identified and substantiated by the parties, such as the possibilities to produce economies of scope by having an advantage to supply goods together.
Finally the draft guidelines present the possibility that the merger can lead to co-ordinated effects, for instance by reducing the number of effective competitors to such an extent that tacit co-ordination will become a real possibility.
The draft text is a good illustration of how the Commission is shifting towards a more economic approach in competition matters. It is expected that the adoption of the text will provide companies active in a number of sectors—such as energy, telecommunications and consumer goods—sufficient arguments to have their mergers cleared without conditions and obligations imposed.