Non-Horizontal Merger Analysis

Mark WhitenerSenior Counsel, Competition Law & PolicyGeneral Electric Company

Presented to theCompetition Commission of India delegation

U.S. Chamber of CommerceWashington, DCOctober 25-26, 2010

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Focus of Merger Analysis: Horizontal Mergers• Horizontal merger policy has extensive theoretical and

empirical support – broad consensus that some mergers between competing firms can harm competition through unilateral or coordinated effects

• Economic theory of horizontal mergers supports policies that can distinguish between procompetitive and anticompetitive mergers

• Contrast non-horizontal merger analysis:• Economic theories more complex, results

ambiguous• Theories lack empirical support• Such mergers usually lead to lower prices, greater

output

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Vertical Mergers – Economics

• Vertical integration creates powerful incentives to increase output/reduce prices

• Unlike horizontal competitors, vertically-related firms have mutual incentive to increase joint output

• Vertical mergers usually benefit consumers – especially if upstream and downstream markets are competitive, and often even where merging firms have market power

• Market power at one or both levels generally is a necessary but not sufficient condition for theories of competitive harm from vertical mergers

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Vertical Mergers – Theories of Harm

• Vertical theories focus on anticompetitive “foreclosure” of rivals – will merged firm have ability and incentive to eliminate/impair competitors by denying them access to necessary upstream inputs or downstream distribution/demand?

• Analysis typically looks at:• Market power screen – market shares, barriers to

entry• Degree of foreclosure, size of remaining market• Mechanism by which merger results in competitive

harm• Ability of rivals to respond• Efficiencies

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Vertical Mergers – Insights From Single Firm Conduct Analysis• Vertical integration strategies – conduct, mergers – usually

procompetitive even for firms that are dominant at both levels• Not sufficient to show that vertical conduct/merger harms rivals

– must show that it harms competition/consumers:• Merger forecloses a substantial portion of the market, and• Rivals will exit or be substantially impaired, and• Loss will not be replicated by other rivals, and• Foreclosure will lead to competitive harm, increased prices• Efficiencies must be factored in to determine net impact

• Enforcement issue: reconciling rivals’ complaints with interests of competition/consumers

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Conglomerate Mergers – Theories of Harm• Two main theories of possible harm from mergers between

producers of complementary products (non-horizontal, non-vertical):• Merger facilitates anticompetitive bundling, tying• Merger gives firm a portfolio of complements that confers

competitive advantage over rivals, who ultimately exit or are marginalized

• Bundling/tying merger theories raise similar issues as single-firm conduct cases – must satisfy similar threshold conditions

• Portfolio theories focus on merged firm’s advantages and initially on impact on rivals – theories of consumer harm are complex

• Both theories rely on initial conduct that is beneficial to consumers (e.g. lower prices) or ambiguous (bundling, tying)

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Conglomerate Mergers – Challenges

• Conglomerate theories face similar or greater challenges as vertical theories:• They generally posit “possible,” not likely harm• Combination of complementary products creates incentive

to increase output (with or without market power)• Very difficult to distinguish anticompetitive from

procompetitive effects – initial conduct often procompetitive; same conditions that create potential for harm also create potential for efficiencies

• Predicated on post-merger conduct that can itself be identified and, if appropriate, prohibited under competition laws – with benefit of evidence of actual market impact, and without blocking otherwise efficient transactions

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Non-Horizontal Mergers -- Policies

• Law and policy in other major jurisdictions reflects a cautious approach to non-horizontal mergers

• United States:• Vertical mergers seldom challenged; narrow

remedies• Conglomerate theories largely

discredited/abandoned• European Union:

• Somewhat more vertical enforcement than in U.S.• Conglomerate enforcement scaled back after high-

profile cases, court decisions (Tetra Laval/Sidel, GE/Honeywell)

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Non-Horizontal Mergers – Policies• EU’s 2007 Non-Horizontal Merger Guidelines:

• Recognize that such mergers are often procompetitive; aim to protect consumers and competition vs. competitors

• Recognize potential efficiencies from such mergers• Establish market power screens (>30% market shares,

>2000 HHIs)• Describe potential competitive harm theories from vertical

mergers (input and customer foreclosure) and conglomerate mergers (leveraging dominance through bundling, etc.) that cause rivals to exit and prices to rise

• Discuss other potential theories of harm: coordinated effects; information exchanges

• Move EU toward more cautious stance toward non-horizontal mergers, though still more receptive than U.S.

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Non-Horizontal Mergers – Enforcement• Relatively few actual cases – vast majority of non-

horizontal mergers are cleared routinely• Enforcement actions typically take the form of

consent agreements with relatively narrow, conduct-based remedies that allow overall transaction to proceed

• Contested cases, outright prohibitions are rare• Case studies can illustrate whether necessary (but

not sufficient) conditions for possible competitive harm exist – to identify those few non-horizontal transactions that warrant detailed review

• As noted above, ultimate assessment of net competitive impact is complex

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Non-Horizontal Mergers – Hypothetical Vertical Case Study• Able Corp. is the leading producer of high-tech Equipment, with a 40% sales share

globally and in India. Its competitors include Baker plc with a 30% share, Charlie Co. with a 20% share, and several smaller producers each with single-digit shares

• InputCo is the leading supplier of a necessary Input into Equipment. InputCo has a 40% share of global Input sales, currently selling its output to Able, Charlie, and the smaller Equipment producers. The other suppliers of Inputs are Global Inputs, which has a 30% share and sells to Able and Charlie; and Baker plc, above, which is vertically integrated and produces Inputs for its own Equipment, giving Baker a 30% share of Input production, all of which it consumes internally

• Able proposes to acquire InputCo. Able plans to source all of its Inputs internally from InputCo post-merger, no longer purchasing from Global Inputs, and leaving none of InputCo’s production available for sale to its other current customers (Charlie and the smaller Equipment producers). Any Input may be used in any brand of Equipment. The cost of an Input is about 5% of the overall cost of a unit of Equipment

• The merger announcement results in complaints from:• Charlie and the smaller Equipment producers, who say that Able may cut them

off from supply (or raise the price) of Inputs from InputCo• Global Inputs, which says that it will be harmed because Able Corp. will stop

buying Inputs from it

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Non-Horizontal Mergers – Hypothetical Vertical Case Study• Equipment is a well-defined antitrust market – producers’ shares

globally and in India:• Able (Acquirer) 40%• Baker 30% • Charlie 20%• Other smaller firms 10%

• Input suppliers:• InputCo (Acquired) 40% Sells to Able, Charlie, smaller firms• Global Inputs 30% Sells to Able, Charlie• Baker 30% Consumes internally

• Complainants:• Charlie and smaller Equipment producers – foreclosure or price

increase for Inputs from InputCo?• Global Inputs – loss of Input purchases from Able?

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Non-Horizontal Mergers – Hypothetical Vertical Case Study – Issues for Analysis• Is there market power/dominance at one or both levels?

• Assess market definition, entry barriers• Market shares are starting point, but focus on existence of credible rivals

who can constrain merged firm, expand if necessary, etc.• Degree of potential foreclosure?

• InputCo has 40% share of Input production (higher share of “merchant” or independent sales) – all of its output will go captive to Able post-merger

• But the other Input purchasers will have another independent source of supply (Global Inputs) that can meet all of their needs

• Able has 40% share of Input consumption (higher share of “merchant” purchases) – all of its consumption will go captive to InputCo post-merger

• But the other independent Input supplier (Global Inputs) can sell to the other Equipment producers (Charlie and the smaller suppliers)

• Also need to assess role of Baker – vertically integrated firm that competes for sales to end-users

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Non-Horizontal Mergers – Hypothetical Vertical Case Study – Issues for Analysis• Will rivals be substantially impaired or exit as a result of the

merger?• Equipment rivals?

• Baker – satisfies all of its Input needs from captive production

• Charlie, smaller firms – can turn to InputCo for supply• Input rivals?

• Baker – consumes all of its Input production internally• InputCo – can sell its output to Charlie, smaller firms

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Non-Horizontal Mergers – Hypothetical Vertical Case Study – Issues for Analysis• Change the hypo: What if Global Inputs did not exist as an Inputs

supplier?• Combined firm would now be the only independent, non-vertically-

integrated supplier of Inputs – raising the prospect that the merger could in theory allow the combined firm to “foreclose” Charlie and the smaller firms from access to Inputs or raise their prices – but its incentive/ability to do so is potentially affected by numerous factors:• Baker’s continued competitive presence as vertically integrated

supplier• Able’s potential profit incentive to maximize output from InputCo

capacity by continuing to supply others• Input cost is small percentage of overall Equipment cost – may

undermine combined firm’s ability to significantly raise Equipment rivals’ costs through input price increases

• Potential efficiencies from vertical transaction may lower combined firm’s costs and profit-maximizing prices, benefit consumers

• Other investigative issues: why are competitors (really) complaining? How are end-user Equipment customers affected?