While the revised Guidelines de-emphasize the role of market definition in the FTC’s and DOJ’s analyses of transactions, they do not represent a significant departure from the merger review process the agencies currently undertake.
On April 20, 2010, the Federal Trade Commission (FTC) released for public comment a draft revision of the Horizontal Merger Guidelines (Guidelines). The Guidelines, first issued in 1992 and revised in 1997, describe the FTC’s and U.S. Department of Justice’s (DOJ’s) methodology for analyzing the likely competitive impact of mergers and acquisitions (including partial acquisitions) between competitors. The revisions, which the FTC and DOJ jointly undertook following a series of public workshops over the past six months, aim to represent how the agencies currently review transactions.
The FTC and DOJ also intend for the revised Guidelines to give the agencies more flexibility in assessing whether a merger is likely to lessen competition. For example, the current Guidelines describe a step-by-step analytical process beginning with definition of the relevant market, then analysis of the likely competitive effects in the defined market, and then a review of market conditions that might mitigate against anticompetitive effects. However, the revised Guidelines, while maintaining all of those elements of the analysis, provide for a less rigid approach. They stress that “merger analysis does not consist of uniform application of a single methodology,” but instead, “it is a fact-specific process through which the Agencies . . . apply a range of analytical tools to the reasonably available and reliable evidence to evaluate competitive concerns in a limited period of time.” In practice, businesses contemplating transactions should not expect dramatic changes in merger analysis, but instead a process that is more adaptable to the types of evidence available to the parties and the agencies.
“Market Definition Is Not an End in Itself” – Increased Emphasis on Competitive Effects
The most significant change in the revised Guidelines is the de-emphasis on market definition and corresponding increased focus on the competitive effects created by the transaction. Market definition, at least in part, serves as a proxy for measuring the likely competitive effects of a transaction. However, where evidence of competitive effects already exists, market definition is not as crucial to the merger analysis. Indeed, the new Guidelines explain that “[m]arket definition is not an end in itself: it is one of the tools the Agencies use to assess whether a merger is likely to lessen competition.” Illustrative of this change is the fact that the new Guidelines lead with a discussion of the types of evidence of adverse competitive effects the agencies seek, whereas the current Guidelines lead with a discussion of market definition. Adverse competitive effects more directly address the central question of any merger analysis, which is whether the transaction may substantially lessen competition.
Examples of the types of evidence the agencies will consider in assessing competitive effects under the revised Guidelines include the following:
- Actual effects observed in consummated mergers
- Direct comparisons to analogous events in similar markets
- Market shares, market concentration and the increase in market concentration
- Substantial head-to-head competition between the merging parties
- Whether the merger will eliminate a market “maverick”
Under the revised Guidelines and following current practice, the agencies will look to the merging parties, customers and other industry participants for evidence of competitive effects. The new Guidelines explicitly state that the agencies will give more weight to the parties’ internal documents prepared in the ordinary course of business than transaction-related documents. Especially probative are documents that provide explicit or implicit evidence that the parties intend to raise price or reduce output, quality or innovation as a result of the transaction. In addition to the agencies’ traditional focus on prices, the revised Guidelines also make clear that they will evaluate non-price dimensions of competition.
The new Guidelines also include an expanded discussion of the agencies’ analysis of the likely competitive effects of a transaction on certain types of customers against whom sellers are able to price discriminate. To find a price discrimination “market,” the parties must be able to charge different prices to targeted customers, and customers must have only a limited ability to defeat the price discrimination by purchasing through other channels. This expanded discussion does not reflect a change in analytical practice within the agencies, but may suggest a greater willingness to challenge a transaction under this theory.
Market Definition Analysis Still Relies on Hypothetical Monopolist Test
Although the revised Guidelines place more emphasis on a transaction’s competitive effects, they do not disavow the ability of market definition to inform the likely competitive effects of a transaction.
The analytical approach toward market definition in the revised Guidelines does not differ dramatically from the current Guidelines. For example, the agencies still rely on the hypothetical monopolist test, whereby the agencies test the parameters of a market by analyzing whether purchasers would substitute a product in the face of a small but significant and non-transitory increase in price (SSNIP). The current Guidelines typically consider a 5 percent SSNIP. However, the new Guidelines refine application of the test, and raise their SSNIP to 10 percent, where explicit or implicit prices for the firms’ contribution to value can be identified, but maintain a 5 percent (or lower) SSNIP where the test is based on the price paid by customers.
The new Guidelines also recognize that the agencies may use “critical loss” analysis to corroborate their findings after reviewing evidence pointing toward a relevant market definition. Critical loss analysis examines the profitability of a price increase on the parties’ goods or services, based on margins and the likelihood that the parties may actually lose sales.
In measuring market concentration, the new Guidelines still rely on the Herfindahl-Hirschman Index (HHI), which consists of the sum of the squared market shares of each firm in the industry. For example, the HHI of a market composed of only a monopolist with 100 percent market share would be 10,000 (i.e., 1002 = 10,000), and the HHI of a market with two firms each with 50 percent share would be 5,000 (i.e., 502 + 502 = 5,000). Under the current Guidelines, the agencies will presume that a transaction increasing the HHI by more than 100 points to 1,800 or more will likely create or enhance market power. However, the new Guidelines will now require that a transaction increase the HHI by at least 200 points to 2,500 or more, before applying the presumption that the transaction will likely enhance market power.
Expanded Discussion of Unilateral Effects
The revised Guidelines include an expanded discussion of how the agencies will analyze the potential unilateral effects of a transaction. Unilateral competitive effects can occur directly as a result of a transaction between the two parties, when, for example, they merge to monopoly. The current Guidelines focus primarily on markets involving differentiated products (i.e., products that consumers perceive as different, although they perform the same basic functions) when discussing unilateral effects. The revised Guidelines expand this discussion by describing some of the analytical tools the agencies will use to measure direct competition between the products of the parties and the unilateral competitive effects resulting from the transaction. For example, the agencies may look to diversion ratios, which measure the fraction of unit sales diverted to a second product when the price of the first product increases, because they may indicate the presence of upward pricing pressure on the first product that may result from the merger.
The revised Guidelines go further and contemplate that unilateral effects also may occur in connection with bargaining and auction industries, capacity and output for homogenous products, and innovation and product variety. The revised Guidelines also remove the presumption that a combined share of 35 percent indicates an increased threat of unilateral effects. Nevertheless, parties to a transaction must anticipate whether the agencies might find unilateral competitive effects in a broader variety of circumstances.
Coordinated effects may occur when a transaction encourages explicit or implicit cooperation by the remaining market participants. The focus of coordinated effects analysis is whether multiple firms will be able to raise price as a result of the merger. Under the revised Guidelines, the agencies are likely to challenge a merger that results in a moderately concentrated (i.e., HHI between 1,500 and 2,500) or highly concentrated (i.e., HHI above 2,500) market that shows signs of vulnerability to coordinated interaction. Evidence of vulnerability exists, for example, where firms have previously attempted to collude, prices are transparent and customers face low switching costs, among other factors.
Consistent with actual practice, the revised Guidelines acknowledge that powerful buyers may constrain the parties’ ability to raise price, but do not assume that powerful buyers, by themselves, will mitigate against other anticompetitive effects resulting from the merger. The revised Guidelines also call out the potential anticompetitive effects that may result from a transaction involving powerful buyers. The revised Guidelines clarify that the analysis of the likely competitive effects of a transaction between buyers is substantially the same as the analysis of a transaction between sellers.
Mitigating Factors to Anticompetitive Effects
Potential entry by new competitors, efficiencies resulting from the merger, and the likelihood that one of the parties will fail and exit the market are all factors that may mitigate against a finding of a transaction’s likely anticompetitive effects. The agencies’ treatment of entry in the new Guidelines does not differ substantially from their current treatment of entry. Entry must still be timely, likely and sufficient to offset the agencies’ competitive concerns. However, with respect to the timeliness of entry, the agencies have removed from the current Guidelines the requirement that entry must occur within two years of the transaction in order to count.
The new Guidelines’ discussion of efficiencies does not vary significantly from that contained in the current Guidelines, in that the parties must quantify claimed efficiencies and show that they are specific to the proposed transaction.
The revised Guidelines, like the current Guidelines, acknowledge that a transaction is unlikely to result in anticompetitive effects where the failure or exit of one of the parties is imminent. To make a credible “failing firm” claim, the parties must show that the failing firm would not be able to meet its financial obligations in the near future; would not be able to successfully reorganize under Chapter 11 of the Bankruptcy Act; and has made unsuccessful, good faith attempts to keep the assets in the market without introducing the current threat to competition that the proposed transaction may represent. Notably absent from this list of circumstances is the fourth factor from the current Guidelines, which is evidence that, absent the proposed transaction, the assets of the failing firm would exit the marketplace.
While the revised Guidelines de-emphasize the role of market definition in the FTC’s and DOJ’s analyses of transactions, they do not represent a significant departure from the merger review process the agencies currently undertake. The new Guidelines’ shift in focus seems to be a response to the agencies’ troubles proving market definition in past unsuccessful merger challenges. By placing greater emphasis on evidence of a transaction’s competitive effects, the agencies allow themselves more flexibility to avoid definition of a complicated market and instead address the central question posed by a transaction, namely whether it will result in anti-competitive effects. This means that parties will need to consider more than market definition in preparing to defend a transaction. Evidence of competitive effects also will be critical to parties that have already consummated transactions, which, as the new Guidelines make clear, remain subject to post-closing challenges.
From a practical perspective, the revised Guidelines continue to emphasize the importance of the parties’ ordinary course documents and customer opinions in the agencies’ analyses. To minimize agencies’ scrutiny of transactions, companies must continue to be careful about how they draft business and strategic plans in the ordinary course of business, as well as documents analyzing a proposed transaction. Overall, parties will need to exercise greater care in how they discuss and document competition and pricing decisions in internal documents. Nevertheless, only time will tell how much weight courts will give the revised Guidelines, especially given long-standing case law that calls for defining the relevant market as the first step in analyzing a transaction’s likely competitive effects.