One of the primary concerns with the Proposed HMGs was that the new approach would lead to small relevant markets in order to better reflect the Agencies’ views that the traditional approach understated the importance of competition between close substitutes. I highlighted one analytical concern with this approach in a previous blog post:
The real problem arises because the Agencies now believe that narrower markets are more accurate because “the competitive significance of distant substitutes is unlikely to be commensurate with their shares in a broad market.” The value of diversion test endorsed by the new HMG tends to lead to narrower markets. Defining narrower markets will inevitably lead to circumstances in which the consumers in the narrowly defined markets are harmed, but others are benefitted. I suspect the true concern of those skeptical of the “narrow” market approach adopted by the HMGs, which has not been articulated, is that the narrower markets obscure competitive benefits of the merger that are “outside” the market. Thus, the new approach could lead to Section 7 liability for mergers that result in net increases in consumer welfare.
Consider the case when Firms A and B will merge and there is convincing evidence that harms will occur to a narrow group of customers but that prices will fall to other groups. Further assume that the benefits are significantly greater than the harms. As the new HMGs endorse narrower market definitions, this will occur more and more frequently and can be expected to arise over a broad swath of mergers involving alleged unilateral price effects. Under current merger law, the merger of A and B will violate Section 7 despite the fact that it increases consumer welfare because Philadelphia National Bank precludes counting efficiencies outside the relevant market. The merging parties cannot point to the consumer gains outside of the narrowly defined product market to defend the merger.
Note that this is not directly a problem that originates in the new HMG. Both the 1997 (Section 4, n. 36) and 2010 HMGs (Section 10, n.11) contain notes indicating that the Agencies sometimes might consider efficiencies outside the relevant market if they are “inextricably linked with it that a partial divestiture or other remedy could not feasibly eliminate the anticompetitive effect in the relevant market without sacrificing the efficiencies in the other market(s).” However, while the Philadelphia National Bank problem is nothing new, and certainly not created by either the 1992, 97 or 2010 HMGs, the value of diversion approach of drawing smaller circles around particular groups of harmed consumers is likely to dramatically increase the number of cases in which other groups of consumers benefit but those benefits are systematically excluded from merger analysis though they would otherwise meet the requirements of Section 10 (efficiencies) of the new HMGs.
In my comment to the proposed HMGs, I argued that the correct response to this issue was to move from cheap talk on prosecutorial discretion over such mergers, to a binding commitment not to bring cases where, according to the Agencies’ own economic analysis, the net effect of the merger would be pro-competitive:
Failure to incorporate “out of market” efficiencies into merger analysis flies in the face of the modern trend in favor of analyzing actual competitive effects rather than adopting simplifying and potentially misleading proxies. Further, the value of diversion approach adopted by the new HMGs is likely to increase the need for guidance on this score. This comment proposed that the new HMGs amend note 11 to make clear that they would not bring enforcement actions where the Agencies can prove anticompetitive effects in a narrower market, but where the evidence also supports the conclusion that out of market efficiencies are sufficient to eliminate consumer harm in the aggregate. A commitment to forbear from challenging mergers where out of market efficiencies outweigh anticompetitive effects merely updates the new HMGs in a manner consistent with the modern intellectual foundation of merger analysis.
So, did the New HMGs make the move from cheap talk to commitment on out of market efficiencies? The answer is below the fold.
The New HMGs read in pertinent part:
The Agencies will not challenge a merger if cognizable efficiencies are of a character and magnitude such that the merger is not likely to be anticompetitive in any relevant market.
This is exactly what the 1997 HMGs say with respect to cognizable efficiencies. The real question was what the Agencies would do with the issue of “out-of-market” efficiencies, i.e. when are out-of-market efficiencies are cognizable? Because the new market definition approach of the HMGs leads to narrower product markets, more and more frequently it will be the case that cost-savings created by mergers fall outside the relevant market in which the Agency alleges anticompetitive effects.There’s nothing new in the text — but the action is in the footnotes.
For those keeping score at home, here’s the n. 36 from the 1997 Guidelines (I’ve bolded the especially relevant portion):
Accordingly, the Agency normally assesses competition in each relevant market affected by a merger independently and normally will challenge the merger if it is likely to be anticompetitive in any relevant market. In some cases, however, the Agency in its prosecutorial discretion will consider efficiencies not strictly in the relevant market, but so inextricably linked with it that a partial divestiture or other remedy could not feasibly eliminate the anticompetitive effect in the relevant market without sacrificing the efficiencies in the other market(s). Inextricably linked efficiencies rarely are a significant factor in the Agency’s determination not to challenge a merger. They are most likely to make a difference when they are great and the likely anticompetitive effect in the relevant market(s) is small.
The problem is that the n. 36 statement that inextricably linked efficiencies are “rarely a factor” is not consistent with the new approach. The Proposed HMGs, to their credit, eliminated the “rarely are a significant factor” sentence, but left the rest of the relevant language intact. And more importantly, the Proposed HMGs did not make the proposed commitment to not bring cases when the out-of-market but otherwise cognizable efficiencies outweigh the competitive harms.
How about the New HMGs? Here is the relevant footnote (n.14) (again the emphasis is mine):
The Agencies normally assess competition in each relevant market affected by a merger independently and normally will challenge the merger if it is likely to be anticompetitive in any relevant market. In some cases, however, the Agencies in their prosecutorial discretion will consider efficiencies not strictly in the relevant market, but so inextricably linked with it that a partial divestiture or other remedy could not feasibly eliminate the anticompetitive effect in the relevant market without sacrificing the efficiencies in the other market(s). Inextricably linked efficiencies are most likely to make a difference when they are great and the likely anticompetitive effect in the relevant market(s) is small so the merger is likely to benefit customers overall.
The end of the last sentence is the real change. Its something. The new language seems to get at the idea that I am talking about in my comment concerning out-of-market efficiencies (I hereby declare the bolded language to be the “Wright Amendment”), and further weakens the implication in the old note that these considerations were only relevant when the anticompetitive effects were disproportionately larger than the efficiencies. But the addendum doesn’t go far enough.
N.14 still does not reflect the same competitive realities the drafters of the HMGs and panelists stressed to emphatically on the anticompetitive side of the ledger. If relevant markets are now narrower for the purposes of evaluating potential anticompetitive effects in any single market, than it makes economic sense to incorporate the other side of the same economic reality, i.e. out-of-market efficiencies will be more prevalent and deserve greater consideration both by the Agencies and the courts. Thus, the “cheap talk” about prosecutorial discretion isn’t quite good enough.
N. 14 is also unclear about how large out-of-market efficiencies must be relative to anticompetitive effects in order to convince the Agencies to stay their hand in a particular case. N. 14 retains enough of the old language (anticompetitive effects must be “small” and efficiencies “great”) that is it unclear how one should interpret the new language (“so the merger is likely to benefit customers overall”).
One might read the language to suggest the Agencies have abandoned the disproportionate standard in favor of a decision rule under which the Agencies will exercise their discretion when the efficiencies are greater than the competitive harms. That is, when “customers benefit overall.” But the retention of the old language makes it unclear that this is the only interpretation. Put another way, if the Agencies meant that out-of-market efficiencies will render the Agency less likely to bring a case when they are likely to benefit customers overall, they could have said so. Retaining the language referencing disproportionate magnitudes required for such an effect implies that the Agencies will still bring cases when their own analysis suggests that consumers benefit on the aggregate, but the benefit is not huge, and the Agencies can prove anticompetitive effect in some market.
Relative to the old Guidelines and the Proposed HMGs, n. 14 is an improvement on an issue I think is important and will be more important in years to come when the Agencies, defense bar, and courts kick the tires on the New HMGs. But given the methodological changes on the anticompetitive side of the equation, I’m disappointed that the HMGs don’t go further to commit the Agency not to bring cases when they believe the net benefit to consumer, out-of-market efficiencies included, is positive. Nonetheless, the language does provide merging parties an avenue to present evidence to the Agencies and courts that out of market efficiencies satisfy this standard.
