On January 10, 2020, the U.S. Department of Justice (DOJ) Antitrust Division and the Federal Trade Commission (FTC) Bureau of Competition published their Draft Vertical Merger Guidelines (Draft Guidelines). This was the first time the agencies have formally addressed vertical mergers since their 1984 merger guidelines. The joint publication reflects an effort on the part of the agencies to align their thinking on vertical merger enforcement and to provide greater transparency to companies and their antitrust counsel regarding the techniques, practices and policies the agencies will employ to evaluate a proposed transaction. The Draft Guidelines have been issued to the public in draft form and are open for public comment until February 11, 2020. While the Draft Guidelines do not represent a radical departure from traditional antitrust analysis, they may signal a new era where the agencies are more inclined to investigate and enjoin vertical mergers they believe may have substantial anticompetitive effects on competition.
Recent Investigations and Enforcement Actions
These new guidelines are reflective of the agencies’ developing experience in recent years with high-stakes vertical mergers – and most notably, the Time Warner-AT&T merger, which was the first vertical merger case the DOJ litigated to judgment in nearly 40 years. In that case, the DOJ sought to enjoin the merger and argued that the merged entity would leverage its new combined market power to enforce higher prices on non-AT&T cable providers for licensing content or block them entirely from Time Warner’s video content. While the district and appellate courts ultimately ruled in favor of the merging entities, and the deal has since been consummated, both courts acknowledged the possibility that a vertical merger could be enjoined. In particular, the district court noted “the dearth of modern judicial precedent on vertical mergers and the multiplicity of contemporary viewpoints about how they might optimally be adjudicated and enforced.” United States v. AT&T, Inc., 916 F.3d 1029, 1037 (D.C. Cir. 2019).
The 2018 Staples-Essendant transaction gave the FTC similar experience with vertical deals. While the FTC ultimately approved the transaction, it did so only after the parties agreed to establish firewalls for Staple’s access to Essendant’s retail customer data so that Essendant’s information could not impact Staple’s pricing decisions. Notably, however, the settlement was approved along party lines with Democratic FTC Commissioners Rebecca Slaughter and Rohit Chopra dissenting. In their view, the FTC should be skeptical of vertical mergers where the resulting dominant companies control more industries and where there is no guarantee of greater output and service offerings for consumers.
Nuts and Bolts of Vertical Merger Analysis
The new Draft Guidelines are meant to provide an outline of the “analytical techniques, practices, and enforcement policy” the agencies will apply to vertical merger review and to provide guidance to the courts that are analyzing the same. In addition to the Draft Guidelines, which the agencies acknowledge raise “distinct considerations,” the DOJ and FTC explain that many analytical elements outlined in the 2010 Horizontal Merger Guidelines (e.g., entry considerations, the treatment of failing firms and the acquisition of partial ownership interests) remain relevant when considering the likely economic impacts of vertical mergers.
The Draft Guidelines explain that vertical merger analysis begins with identification of the relevant markets and “related markets” (e.g., an input, a means of distribution or access to a set of customers) in which the merger could substantially lessen competition. Once these markets have been established for the purposes of antitrust analysis, the agencies will apply a preliminary screen and “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.” As with other thresholds published by the agencies, the Draft Guidelines are clear that “the purpose of these thresholds is not to provide a rigid screen to separate competitively benign mergers from anticompetitive ones. Rather they provide one way to identify some mergers unlikely to raise competitive concerns and some others for which it is particularly important to examine other competitive factors to arrive at a determination of likely competitive effects.”
After the initial screen has been applied, the DOJ and FTC will proceed with an analysis of the likely competitive effects of the proposed transaction. In addition to those factors traditionally considered in horizontal merger analysis (e.g., observed effects of similar transactions and evidence regarding the disruptive role of a merging party), considerations unique to vertical merger analysis include pre-existing contractual relationships and evidence of head-to-head competition between one merging firm and rivals that trade with that firm.
The Draft Guidelines specifically identify two non-exhaustive unilateral theories of harm that affect vertical merger analysis:
- Foreclosure and raising rivals’ costs.
- Access to competitively sensitive information.
With respect to the former theory, the agencies will analyze whether the vertical merger is likely to diminish competition “by making it profitable for the merged firm to foreclose rivals in the relevant market by denying them access to a related product” or by “increas[ing] the incentive or ability of the merged firm to raise rivals’ costs or decrease the quality of their rivals’ products or services.”
With respect to concerns about competitively sensitive information, the DOJ and FTC will analyze whether the combination will provide the resulting firm with access to information about its upstream or downstream rivals that was previously unavailable. If so, the agencies will evaluate whether that information could “be used by the merged firm to moderate its competitive response” to its rivals’ competitive actions or cause rivals to “refrain from doing business with the merged firm rather than risk that the merged firm would use their competitively sensitive business information.”
The DOJ and FTC also will address the potential elimination of double marginalization (i.e., when two vertically related firms each choose profit-maximizing prices for their respective products or services), which can encourage downstream price reductions for consumers by making such pricing more feasible for the combined firm. However, the Draft Guidelines state that this potential benefit will not be credited to the merging parties if the downstream firm cannot use the inputs from the upstream one, or if the merging parties previously engaged in contracting that aligned their respective incentives.
Potential coordinated effects resulting from the vertical merger also will be addressed. For example, a vertical merger could stunt competition by eliminating or weakening a “maverick firm” that otherwise would play a significant role in limiting competition in the relevant market.
And finally, the DOJ and FTC acknowledge that vertical mergers have the potential to create cognizable efficiencies that benefit both competition and consumers (e.g., by streamlining production, inventory management or distribution, or creating innovative products or services that would not otherwise be available in the market). As is already true under the Horizontal Merger Guidelines, the burden will remain on the merging parties to substantiate any claimed efficiencies.
A Word of Caution
While the Draft Guidelines reflect a DOJ and FTC collaboration, they may not foretell how the agencies would investigate and prosecute vertical mergers outside of a Trump administration. In particular, the FTC’s vote to publish the Draft Guidelines was 3-0-2, with Democratic Commissioners Rebecca Slaughter and Rohit Chopra issuing separate statements explaining why they each voted to abstain. Both statements express concern that the new guidelines do not go far enough to address the potential anticompetitive impacts of vertical transactions. In particular, Ms. Slaughter’s statement reflects her concerns that the new 20% threshold for vertical mergers is arbitrary and that the Draft Guidelines likely will not halt anticompetitive mergers in their incipiency. Mr. Chopra’s statement notes that the Draft Guidelines fail to reflect new economic realities, particularly with respect to market dominance and increasing barriers to entry in key markets.
These criticisms also have been reflected by many of the Democratic presidential candidates, some of whom have called for an overhauling of the antitrust agencies’ merger review process to limit the continued dominance of prominent technology companies.
Therefore, while these Draft Guidelines are not meant to express hard limits on what the antitrust agencies will or will not investigate and enjoin, it is reasonable to expect that, if a Democratic presidential nominee wins in November, the agencies may start reviewing vertical mergers with even more skepticism than is reflected in the Draft Guidelines.
The antitrust laws relating to vertical mergers are nuanced and complex, and their application to particular circumstances depends on the unique markets at play. Companies should consult with antitrust counsel for specific guidance regarding the likely application of the Draft Guidelines.