In big antitrust news, the Federal Trade Commission and Department of Justice Antitrust Division released a draft of an update to the 1984 Vertical Merger Guidelines (VMG) on January 10, 2020. Only three of the five FTC commissioners voted to release the draft with Democratic Commissioners Rebecca Kelly Slaughter and Rohit Chopra abstaining but issuing separate statements. The agency will accept public comments on the draft through February 11, 2020.
These vertical merger guidelines make extensive references to the Horizontal Merger Guidelines, most recently issued in 2010 (HMG). Like the HMG, the VMG are guidelines only, not law, and are meant to provide the merging parties some understanding of the analysis the reviewing agency will use. Because nearly all merger reviews begin and end with these agencies, however, the HMG have become both influential and persuasive for courts. The VMG rely on the HMG for much of the analysis and so, at nine pages, are much shorter and seem to break little new ground besides updating the outdated 1984 version.
We highlight the key takeaways below:
Market definition back in front
The 2010 HMG tried to de-emphasize the traditional reliance on market definition in merger reviews by moving that step back from its traditional position as the first step in the analysis to focus the analysis on competitive effects. The VMG, by contrast, reverts to the traditional order and starts with the market definition question. Perhaps the agencies realized that even though analyzing competitive effects is the goal, the analysis accepted by courts always begins with market definition to get there. So the draft vertical guidelines recognize that reality.
The agencies will begin the analysis by defining a market using the methods described in the HMG but then continue to also identify any “related products.” A related product can be, for example, “an input [or] means of distribution.” That is, if a retailer were to merge with a manufacturer of cleaning products, the relevant market could be the supply of cleaning products to retail customers while the related product could be the supply of cleaning products by manufacturers to retailers.
A 20% sort-of safe harbor
The vertical guidelines depart from the horizontal guidelines by putting greater emphasis on the shares of the markets and related products held by the parties before analyzing competitive effects. Indeed, the VMG states that “the Agencies are unlikely to challenge a vertical merger where the parties to the merger have a share in the relevant market of less than 20 percent, and the related product is used in less than 20 percent of the relevant market.”
Of course, the VMG then clarifies that the 20 percent level is not iron-clad—mergers that generate lower figures might still be challenged and mergers with higher figures might still be cleared. Still, Commissioner Slaughter challenged even this uncertain safe harbor in her statement as bereft of any support.
So the 20/20 safe harbor—fitting for this year—is something that antitrust-merger counselors will certainly reference, discuss, and cite, but isn’t an invitation to completely relax once you finish your HSR filing.
Unilateral effects, sensitive information, and coordination
The VMG then turns to competitive effects and, like the HMG, buckets them into unilateral and coordinated effects. Here, the term “unilateral effects” means diminishing “competition between one merging firm and rivals that trade with, or could trade with, the other merging firm.”
The main unilateral effect is the threat that one of the merging parties could completely foreclose its rivals’ access to a related product or substantially raise the rival’s cost of obtaining that product.
The VMG is also concerned that the merger will allow one of the merging parties access to sensitive information of one of its rivals who is dealing or could deal with the other merging party. If your supplier merges with your competitor, you may, for example, worry that your rival will now have sensitive information that you needed to provide your supplier to work effectively together. That could distort otherwise procompetitive business relationships and actions, according to the VMG.
Finally, as with the HMG, the agencies are concerned with any coordinated effects where the merger somehow makes it easier for the merged party and the remaining competitors to coordinate.
The antitrust agencies will consider the elimination of double marginalization
On the positive side for merging parties, the elimination of double marginalization is often a key justification for vertical mergers and so the VMG, unlike the HMG, actually addresses it.
What is double marginalization? A firm’s price for a product or service will often incorporate a profit-maximizing margin. Before a merger, two firms in a vertical relationship—maybe a supplier and a retailer—each may charge a price that includes a profit-maximizing margin. So the ultimate consumer of the product pays a price that includes this double marginalization.
One of the potential benefits of a vertical merger is that when, in this example, the supplier and the retailer merge, they may instead charge a single profit-maximizing price with a margin lower than the sum of the margins when the two companies were separate. That ultimately lowers the price for the consumer and may increase the total sales. So it is common for parties to vertical mergers to cite the elimination of double marginalization as a major benefit.
To its credit, the VMG is clear in recognizing this significant potential benefit. The VMG states that the agencies “will not challenge a merger if the net effect of elimination of double marginalization means that the merger is unlikely to be anticompetitive in any relevant market.” The VMG clarifies, however, that the burden is on the parties to show such a positive effect and lists some of the ways in which a vertical merger might not lead to the elimination of double marginalization.
According to the agencies, elimination of double marginalization doesn’t come with all vertical mergers. Commissioner Wilson, in her separate statement supporting release of the VMG, seeks comments about whether the VMG’s analysis of double marginalization is correct.
No mention of behavioral remedies
As a joint effort of the FTC and DOJ Antitrust Division, the VMG make no mention of an apparent difference in perspective between the two agencies: the wisdom of behavioral remedies for problematic mergers.
In a horizontal merger, the only way to stop the anti-competitive behavior of a merged party is to prevent the merger. Under US antitrust law, a single party unilaterally charging a high price is not, by itself, an antitrust violation. In a vertical merger, the agencies theoretically would have the opportunity to stop the anti-competitive behavior of the merged party—say, for example, a party with market power foreclosing a rival from an essential input—after the merger.
To obtain the consumer benefits of the merger while avoiding the need to later take action to stop bad actions, the agencies often have allowed vertical mergers to proceed only with behavioral remedies—extracting a promise from the parties to forego particular actions that might be anti-competitive. For instance, the FTC a year ago allowed the Staples/Essendant merger to proceed only after the parties agreed to certain firewalls that would prevent the transmission of sensitive information from Essendant’s customers to Staples, a competitor of those customers. By contrast, the DOJ Antitrust Division publicly rejected behavioral remedies as appropriate for anti-competitive concerns in the AT&T/Time Warner merger and unsuccessfully sued to block the merger.
Given the current differences between the two agencies on behavioral remedies and the strong objections to the VMG by two of the five FTC commissioners, these Guidelines do not provide as much guidance and transparency as they otherwise might and as the HMG do; however, both agencies and the pundits agree that they are an improvement on the outdated 1984 Guidelines. Any further clarification will have to await the agencies’ reaction to comments on the draft and finalization of the VMG.