Jonathan M. Jacobson, Author at Truth on the Market Truth on the Market

Jacobson: Vertical Mergers 2020 — A Missed Opportunity to Clarify Merger Analysis

Jonathan M. Jacobson — 6 February 2020

[TOTM: The following is part of a symposium by TOTM guests and authors on the 2020 Vertical Merger Guidelines. The entire series of posts is available here.

This post is authored by Jonathan M. Jacobson (Partner, Wilson Sonsini Goodrich & Rosati), and Kenneth Edelson (Associate, Wilson Sonsini Goodrich & Rosati).]

So we now have 21st Century Vertical Merger Guidelines, at least in draft. Yay. Do they tell us anything? Yes! Do they tell us much? No. But at least it’s a start.

* * * * *

In November 2018, the FTC held hearings on vertical merger analysis devoted to the questions of whether the agencies should issue new guidelines, and what guidance those guidelines should provide. And, indeed, on January 10, 2020, the DOJ and FTC issued their new Draft Vertical Merger Guidelines (“Draft Guidelines”). That new guidance has finally been issued is a welcome development. The antitrust community has been calling for new vertical merger guidelines for some time. The last vertical merger guidelines were issued in 1984, and there is broad consensus in the antitrust community – despite vigorous debate on correct legal treatment of vertical mergers – that the ’84 Guidelines are outdated and should be withdrawn. Despite disagreement on the best enforcement policy, there is general recognition that the legal rules applicable to vertical mergers need clarification. New guidelines are especially important in light of recent high-visibility merger challenges, including the government’s challenge to the ATT/Time Warner merger, the first vertical merger case litigated since the 1970s. These merger challenges have occurred in an environment in which there is little up-to-date case law to guide courts or agencies and the ’84 Guidelines have been rendered obsolete by subsequent developments in economics.

The discussion here focuses on what the new Draft Guidelines do say, key issues on which they do not weigh in, and where additional guidance would be desirable.

What the Draft Guidelines do say

The Draft Guidelines start with a relevant market requirement – making clear that the agencies will identify at least one relevant market in which a vertical merger may foreclose competition. However, the Draft Guidelines do not require a market definition for the vertically related upstream or downstream market(s) in the merger. Rather, the agencies’ proposed policy is to identify one or more “related products.” The Draft Guidelines define a related product as

a product or service that is supplied by the merged firm, is vertically related to the products and services in the relevant market, and to which access by the merged firm’s rivals affects competition in the relevant market.

The Draft Guidelines’ most significant (and most concrete) proposal is a loose safe harbor based on market share and the percentage of use of the related product in the relevant market of interest. The Draft Guidelines suggest that agencies are not likely to challenge mergers if two conditions are met: (1) the merging company has less than 20% market share in the relevant market, and (2) less than 20% of the relevant market uses the related product identified by the agencies.

This proposed safe harbor is welcome. Generally, in order for a vertical merger to have anticompetitive effects, both the upstream and downstream markets involved need to be concentrated, and the merging firms’ shares of both markets have to be substantial – although the Draft Guidelines do not contain any such requirements. Mergers in which the merging company has less than a 20% market share of the relevant market, and in which less than 20% of the market uses the vertically related product are unlikely to have serious anticompetitive effects.

However, the proposed safe harbor does not provide much certainty. After describing the safe harbor, the Draft Guidelines offer a caveat: meeting the proposed 20% thresholds will not serve as a “rigid screen” for the agencies to separate out mergers that are unlikely to have anticompetitive effects. Accordingly, the guidelines as currently drafted do not guarantee that vertical mergers in which market share and related product use fall below 20% would be immune from agency scrutiny. So, while the proposed safe harbor is a welcome statement of good policy that may guide agency staff and courts in analyzing market share and share of relevant product use, it is not a true safe harbor. This ambiguity limits the safe harbor’s utility for the purpose of counseling clients on market share issues.

The Draft Guidelines also identify a number of specific unilateral anticompetitive effects that, in the agencies’ view, may result from vertical mergers (the Draft Guidelines note that coordinated effects will be evaluated consistent with the Horizontal Merger Guidelines). Most importantly, the guidelines name raising rivals’ costs, foreclosure, and access to competitively sensitive information as potential unilateral effects of vertical mergers. The Draft Guidelines indicate that the agency may consider the following issues: would foreclosure or raising rivals’ costs (1) cause rivals to lose sales; (2) benefit the post-merger firm’s business in the relevant market; (3) be profitable to the firm; and (4) be beyond a de minimis level, such that it could substantially lessen competition? Mergers where all four conditions are met, the Draft Guidelines say, often warrant competitive scrutiny. While the big picture guidance about what agencies find concerning is helpful, the Draft Guidelines are short on details that would make this a useful statement of enforcement policy, or sufficiently reliable to guide practitioners in counseling clients. Most importantly, the Draft guidelines give no indication of what the agencies will consider a de minimis level of foreclosure.

The Draft Guidelines also articulate a concern with access to competitively sensitive information, as in the recent Staples/Essendant enforcement action. There, the FTC permitted the merger after imposing a firewall that blocked Staples from accessing certain information about its rivals held by Essendant. This contrasts with the current DOJ approach of hostility to behavioral remedies.

What the Draft Guidelines don’t say

The Draft Guidelines also decline to weigh in on a number of important issues in the debates over vertical mergers. Two points are particularly noteworthy.

First, the Draft Guidelines decline to allocate the parties’ proof burdens on key issues. The burden-shifting framework established in U.S. v. Baker Hughes is regularly used in horizontal merger cases, and was recently adopted in AT&T/Time-Warner in a vertical context. The framework has three phases: (1) the plaintiff bears the burden of establishing a prima facie case that the merger will substantially lessen competition in the relevant market; (2) the defendant bears the burden of producing evidence to demonstrate that the merger’s procompetitive effects outweigh the alleged anticompetitive effects; and (3) the plaintiff bears the burden of countering the defendant’s rebuttal, and bears the ultimate burden of persuasion. Virtually everyone agrees that this or some similar structure should be used. However, the Draft Guidelines’ silence on the appropriate burden is consistent with the agencies’ historical practice: The 2010 Horizontal Merger Guidelines allocate no burdens and the 1997 Merger Guidelines explicitly decline to assign the burden of proof or production on any issue.

Second, the Draft Guidelines take an unclear approach to elimination of double marginalization (EDM). The appropriate treatment of EDM has been one of the key topics in the debates on the law and economics of vertical mergers, but the Draft Guidelines take no position on the key issues in the conversation about EDM: whether it should be presumed in a vertical merger, and whether it should be presumed to be merger-specific.

EDM may occur if two vertically related firms merge and the new firm captures the margins of both the upstream and downstream firms. After the merger, the downstream firm gets its input at cost, allowing the merged firm to eliminate one party’s markup. This makes price reduction profitable for the merged firm where it would not have been for either firm before the merger.

The Draft Guidelines state that the agencies will not challenge vertical mergers where EDM means that the merger is unlikely to be anticompetitive. OK. Duh. However, they also claim that in some situations, EDM may not occur, or its benefits may be offset by other incentives for the merged firm to raise prices. The Draft Guidelines do not weigh in on whether it should be presumed that vertical mergers will result in EDM, or whether it should be presumed that EDM is merger-specific.

These are the most important questions in the debate over EDM. Some economists take the position that EDM is not guaranteed, and not necessarily merger-specific. Others take the position that EDM is basically inevitable in a vertical merger, and is unlikely to be achieved without a merger. That is: if there is EDM, it should be presumed to be merger-specific. Those who take the former view would put the burden on the merging parties to establish pricing benefits of EDM and its merger-specificity.

Our own view is that this efficiency is pervasive and significant in vertical mergers. The defense should therefore bear only a burden of producing evidence, and the agencies should bear the burden of disproving the significance of EDM where shown to exist. This would depart from the typical standard in a merger case, under which defendants must prove the reality, magnitude, and merger-specific character of the claimed efficiencies (the Draft Guidelines adopt this standard along with the approach of the 2010 Horizontal Merger Guidelines on efficiencies). However, it would more closely reflect the economic reality of most vertical mergers.

Conclusion

While the Draft Guidelines are a welcome step forward in the debates around the law and economics of vertical mergers, they do not guide very much. The fact that the Draft Guidelines highlight certain issues is a useful indicator of what the agencies find important, but not a meaningful statement of enforcement policy.

On a positive note, the Draft Guidelines’ explanations of certain economic concepts important to vertical mergers may serve to illuminate these issues for courts.

However, the agencies’ proposals are not specific enough to create predictability for business or the antitrust bar or provide meaningful guidance for enforcers to develop a consistent enforcement policy. This result is not surprising given the lack of consensus on the law and economics of vertical mergers and the best approach to enforcement. But the antitrust community — and all of its participants — would be better served by a more detailed document that commits to positions on key issues in the relevant debates.

Jacobson on the Apple ebooks case: It is hard to find an easier antitrust case than United States v. Apple

Jonathan M. Jacobson — 15 February 2016

by Jonathan Jacobson

Try as one may, it is hard to find an easier antitrust case than United States v. Apple.

Consider: The six leading publishers all wanted to prevent Amazon and others from offering best seller e-books at $9.99 (or other similar low prices). The problem, however, was that they had no mechanism for accomplishing that result. Then came Apple. Apple figured out that the “Amazon problem” could be fixed if the publishers changed their customer relationships from sale/resale to “agency,” all subject to an MFN with Apple that would prohibit any of the publishers – and, through the MFN, Amazon – from underselling the (higher) prices on Apple’s iBookstore. Loving this “aikido move” (in Steve Jobs’ words), all the publishers but Random House happily agreed. Prices for best seller e-books increased 30% almost overnight.

So what is this? The fact of a horizontal conspiracy among the five publishers is largely undisputed. Is it any less per se illegal because Apple was involved? Hardly; especially on these facts, where the participation by the “vertical” player was essential to make the whole scheme work. Apple’s role in no way made the conspiracy benign. It made it worse – and it couldn’t have been achieved without Apple’s active role.

Truly, all one needs to know about the case is in the attached video clip from the iPad launch event. Asked by the Wall Street Journal why anyone would pay $14.99 for a book from the iBookstore when it could be had for $9.99 on Amazon, Steve Jobs said: “Well, that won’t be the case.” Asked to explain, he added: “The prices will be the same.”

So we have a horizontal conspiracy to fix and raise e-book prices, made operational only through Apple’s aggressive involvement, that immediately raised prices by 30%. If that’s not an antitrust violation, we’re all in trouble.

Joshua Wright’s Dissenting Statements on Merger Efficiencies

Jonathan M. Jacobson — 24 August 2015

by Jonathan Jacobson, partner & Ryan Maddock, associate, Wilson Sonsini Goodrich & Rosati

Excluding the much talked about Section 5 policy statement, Commissioner Wright’s tenure at the FTC was highlighted by his numerous dissents. If there is one unifying theme in those dissents it is his insistence that rigorous economic analysis be at the very core of all the Commission’s decisions. This theme was perhaps most evident in his decision to dissent in the Ardaugh/Saint-Gobain and Sysco/US Foods mergers, two cases that presented interesting questions about how the Commission and courts should balance a merger’s likely anticompetitive effects with its procompetitive efficiencies.

In April of 2014 the Commission announced that it had accepted a consent decree in Ardaugh/Saint-Gobain that remedied its competitive concerns related to the merger of the second and third largest firms in the market for “glass containers sold to beer and wine distributors in the United States.” The majority, which consisted of Commissioners Ramirez, Ohlhausen, and Brill, argued that the merger would lead to both coordinated and unilateral anticompetitive effects in the market and further stated that “the parties put forward insufficient evidence showing that the level of synergies that could be substantiated and verified would outweigh the clear evidence of consumer harm.” Commissioner Wright, who was the lone dissenter, strongly disagreed with the majority’s conclusions and found that the merger’s cognizable efficiencies were “up to six times greater than any likely unilateral price effect,” and thus the merger should have been approved without requiring a remedy.

Commissioner Wright also used his Ardaugh dissent to discuss whether the merging parties and Commission face asymmetric burdens of proof regarding competitive effects. Specifically, Commissioner Wright asked whether the “merging parties [must] overcome a greater burden of proof on efficiencies in practice than does the FTC to satisfy its prima facie burden of establishing anticompetitive effects?” Commissioner Wright stated that the Commission has acknowledged that in theory the burdens of proof should be uniform; however, he argued that the only way the majority could have found that the Ardaugh/Saint-Gobain merger would generate almost no cognizable efficiencies is by applying asymmetric burdens. He explained that the majority’s approach “embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other.”

Commissioner Wright, who was joined by Commissioner Ohlhausen, also dissented from the Commission’s decision to challenge the Sysco/US Foods merger. While the Commissioners did not issue a formal dissent because of the FTC’s then pending litigation, Commissioner Wright tweeted that he had “no reason to believe the proposed Sysco/US Foods transaction violated the Clayton Act.” The lack of a formal dissent makes it challenging to ascertain all of Commissioner Wright’s objections, but a reading of the Commission’s administrative complaint provides insight on his likely positions. For example, Commissioner Wright undoubtedly disagreed with the complaint’s treatment the parties’ proffered efficiencies:

Extraordinary Merger-specific efficiencies are necessary to outweigh the Merger’s likely significant harm to competition in the relevant markets. Respondents cannot demonstrate cognizable efficiencies that would be sufficient to rebut the strong presumption and evidence that the Merger likely would substantially lessen competition in the relevant markets.

Commissioner Wright’s Ardaugh dissent makes it clear that he does not believe that the balancing of anticompetitive effects and efficiencies should be an afterthought to the agency’s merger analysis, which is how the majority’s complaint appears to treat it. This case likely represents another instance where Commissioner Wright believed that the majority of commissioners applied asymmetric burdens of proof when balancing the merger’s competitive effects.

Commissioner Wright is not the first person to ask whether current merger analysis favors anticompetitive effects over efficiencies; however, that does not detract from the question’s importance. His views reflect a belief shared by others that antitrust policy should be based on an aggregate welfare standard, rather than the consumer welfare standard that the agencies and the courts have for the most applied over the past few decades. In Commissioner Wright’s view, by applying asymmetric burdens–which is functionally the same as discounting efficiencies–antitrust agencies could harm both total welfare and consumers by increasing the chance that a procompetitive merger might be blocked. It stands in contrast to the majority view that a merger that raises prices requires efficiencies, specific to the merger, of a magnitude sufficient to defeat any increase in consumer prices–and that, because the efficiency information is in the hands of the proponents, shifting the burden to them is appropriate.

While his tenure at the FTC has come to an end, expect to continue to see Commissioner Wright at the front and center of this and many other important antitrust issues.

In Antitrust & Competition, Federal Trade Commission, Merger Guidelines, Platforms, Section 5, Symposium Honoring the Honorable Joshua Wright, Twitter Clayton Act, Efficiencies, Federal Trade Commission, ftc, joshua wright, Symposium

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