Conglomerate effects and the incentive to deal reasonably with other providers of complementary products [Ag-Biotech Symposium]

Allen Gibby —  30 March 2017 — 2 Comments

Allen Gibby is a Senior Fellow at the International Center for Law & Economics

Modern agriculture companies like Monsanto, DuPont, and Syngenta, develop cutting-edge seeds containing genetic traits that make them resistant to insecticides and herbicides. They also  develop crop protection chemicals to use throughout the life of the crop to further safeguard from pests, weeds and grasses, and disease. No single company has a monopoly on all the high-demand seeds and traits or crop protection products. Thus, in order for Company A to produce a variety of corn that is resistant to Company B’s herbicide, it may have to license a trait patented by Company B in order to even begin researching its product, and it may need further licenses (and other inputs) from Company B as its research progresses in unpredictable directions.

While the agriculture industry has a long history of successful cross-licensing arrangements between agricultural input providers, licensing talks can break down (and do so for any number of reasons), potentially thwarting a nascent product before research has even begun — or, possibly worse, well into its development. The cost of such a breakdown isn’t merely the loss of the intended product; it’s also the loss of the other products Company A could have been developing, as well as the costs of negotiation.

To eschew this outcome, as well as avoid other challenges such as waiting years for Company B to fully develop and make available a chemical before it engages in in arm’s length negotiations with Company A, one solution is for Company A and Company B to merge and combine their expertise to design novel seeds and traits and complementary crop protection products.

The potential for this type of integration seems evident in the proposed Dow-DuPont and Bayer-Monsanto deals where, of the companies merging, one earns most of its revenue from seeds and traits (DuPont and Monsanto) and the other from crop protection (Dow and Bayer).

Do the complementary aspects inherent in these deals increase the likelihood that the merged entities will gain the ability and the incentive to prevent entry, foreclose competitors, and thereby harm consumers?  

Diana Moss, who will surely have more to say on this in her post, believes the answer is yes. She recently voiced concerns during a Senate hearing that the Dow-DuPont and Bayer-Monsanto mergers would have negative conglomerate effects. According to Moss’s testimony, the mergers would create:

substantial vertical integration between traits, seeds, and chemicals. The resulting “platforms” will likely be engineered for the purpose of creating exclusive packages of traits, seeds and chemicals for farmers that do not “interoperate” with rival products. This will likely raise barriers for smaller innovators and increase the risk that they are foreclosed from access to technology and other resources to compete effectively.

Decades of antitrust policy and practice present a different perspective, however. While it’s true that the combined entities certainly might offer combined stacks of products to farmers, doing so would enable Dow-DuPont and Bayer-Monsanto to vigorously innovate and compete with each other, a combined ChemChina-Syngenta, and an increasing number of agriculture and biotechnology startups (per AgFunder, investments in such startups totaled $719 million in 2016, representing a 150% increase from 2015’s figure).

More importantly, the complaint assumes that the only, or predominant, effect of such integration would be to erect barriers to entry, rather than to improve product quality, offer expanded choices to consumers, and enhance competition.

Concerns about conglomerate effects making life harder for small businesses are not new. From 1965 to 1975, the United States experienced numerous conglomerate mergers. Among the theories of competitive harm advanced by the courts and antitrust authorities to address their envisioned negative effects was entrenchment. Under this theory, mergers could be blocked if they strengthened an incumbent firm through increased efficiencies not available to other firms, access to a broader line of products, or increased financial muscle to discourage entry.

While a nice theory, for over a decade the DoJ could not identify any conditions under which conglomerate effects would give the merged firm the ability and incentive to raise price and restrict output. The DoJ determined that the harms of foreclosure and barriers to smaller businesses were remote and easily outweighed by the potential benefits, which include

providing infusions of capital, improving management efficiency either through replacement of mediocre executives or reinforcement of good ones with superior financial control and management information systems, transfer of technical and marketing know-how and best practices across traditional industry lines; meshing of research and distribution; increasing ability to ride out economic fluctuations through diversification; and providing owners-managers a market for selling the enterprises they created, thus encouraging entrepreneurship and risk-taking.

Consequently, the DoJ concluded that it should rarely, if ever, interfere to mitigate conglomerate effects in the 1982 Merger Guidelines.

In the Dow-DuPont and Bayer-Monsanto deals, there are no overwhelming factors that would contradict the presumption that the conglomerate effects of improved product quality and expanded choices for farmers outweigh the potential harms.

To find such harms, the DoJ reasoned, would require satisfying a highly attenuated chain of causation that “invites competition authorities to speculate about what the future is likely to bring.” Such speculation — which includes but is not limited to: weighing whether rivals can match the merged firm’s costs, whether rivals will exit, whether firms will not re-enter the market in response to price increases above pre-merger levels, and whether what buyers gain through prices set below pre-merger levels is less than what they later lose through paying higher than pre-merger prices — does not inspire confidence that even the most clairvoyant regulator would properly make trade-offs that would ultimately benefit consumers.

Moss’s argument also presumes that the merger would compel farmers to purchase the potentially “exclusive packages of traits, seeds and chemicals… that do not ‘interoperate’ with rival products.” But while there aren’t a large number of “platform” competitors in agribusiness, there are still enough to provide viable alternatives to any “exclusive packages” and cross-licensed combinations of seeds, traits, and chemicals that Dow-DuPont and Bayer-Monsanto may attempt to sell.

First, even if a rival fails to offer an equally “good deal” or suffers a loss of sales or market share, it would be illogical, the DoJ concluded, to condemn mergers that promote benefits such as resource savings, more efficient production modes, and efficient bundling (i.e., bundling that benefits customers by offering them improved products, lower prices or lower transactions costs due to the purchase of a combined stack through a “one-stop shop”). As Robert Bork put it, far from “frightening smaller companies into semi-paralysis,” conglomerate mergers that generate greater efficiencies will force smaller competitors to compete more effectively, making consumers better off.

Second, it is highly unlikely these deals will adversely affect the long-standing prevalence of cross-licensing arrangements between agricultural input providers. Agriculture companies have a long history of supplying competitors with products while simultaneously competing with them. For decades, antitrust scholars have been skeptical of claims that firms have incentives to deal unreasonably with providers of complementary products, and the ag-biotech industry seems to bear this out. This is because discriminating anticompetitively against complements often devalues the firm’s own platform. For example, Apple’s App Store is more valuable to iPhone users because it includes messaging apps like WeChat, WhatsApp, and Facebook Messenger, even though they compete directly with iMessage and FaceTime. By excluding these apps, Apple would devalue the iPhone to hundreds of millions of its users who also use these apps.

In the case of the pending mergers, not only would a combined Dow-DuPont and Bayer-Monsanto offer their own combined stacks, their platforms increase in value by providing a broad suite of alternative cross-licensed product combinations. And, of course, the combined stack (independent of whether it’s entirely produced by a Dow-DuPont or Bayer-Monsanto) that offers sufficiently increased value to farmers over other packages or non-packaged alternatives, will — and should — win in the end.

The Dow-DuPont and Bayer-Monsanto mergers are an opportunity to remember why, decades ago, the DoJ concluded that it should rarely, if ever, interfere to mitigate conglomerate effects and an occasion to highlight the incentives that providers of complementary products have to deal reasonably with one another.

 

Trackbacks and Pingbacks:

  1. Ag-biotech merger symposium wrap-up [Ag-Biotech Symposium] « Truth on the Market - April 5, 2017

    […] Allen Gibby […]

  2. Innovation-driven market structure in the ag-biotech industry [Ag-Biotech Symposium] « Truth on the Market - March 31, 2017

    […] As Allen Gibby notes, these mergers are essentially vertical combinations of disparate, specialized pieces of an integrated whole. Take the proposed Bayer/Monsanto merger, for example. Bayer is primarily a chemicals company, developing advanced chemicals to protect crops and enhance crop growth. Monsanto, on the other hand, primarily develops seeds and “seed traits” — advanced characteristics that ensure the heartiness of the seeds, give them resistance to herbicides and pesticides, and speed their fertilization and growth. In order to translate the individual advances of each into higher yields, it is important that these two functions work successfully together. Doing so enhances crop growth and protection far beyond what, say, spreading manure can accomplish — or either firm could accomplish working on its own. […]

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