Archives For antitrust division

[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 Gregory J. Werden (former Senior Economic Counsel, DOJ Antitrust Division (ret.)) and Luke M. Froeb (William C. Oehmig Chair in Free Enterprise and Entrepreneurship, Owen School of Management, Vanderbilt University; former Chief Economist, DOJ Antitrust Division; former Chief Economist, FTC).]

The proposed Vertical Merger Guidelines provide little practical guidance, especially on the key issue of what would lead one of the Agencies to determine that it will not challenge a vertical merger. Although they list the theories on which the Agencies focus and factors the Agencies “may consider,” the proposed Guidelines do not set out conditions necessary or sufficient for the Agencies to conclude that a merger likely would substantially lessen competition. Nor do the Guidelines communicate generally how the Agencies analyze the nature of a competitive process and how it is apt to change with a proposed merger. 

The proposed Guidelines communicate the Agencies’ enforcement policy in part through silences. For example, the Guidelines do not mention several theories that have appeared in recent commentary and thereby signal that Agencies have decided not to base their analysis on those theories. That silence is constructive, but the Agencies’ silence on the nature of their concern with vertical mergers is not. Since 1982, the Agencies’ merger guidelines have always stated that their concern was market power. Silence on this subject might suggest that the Agencies’ enforcement against vertical mergers is directed to something else. 

The Guidelines’ most conspicuous silence concerns the Agencies’ general attitude toward vertical mergers, and on how vertical and horizontal mergers differ. This silence is deafening: Horizontal mergers combine substitutes, which tends to reduce competition, while vertical mergers combine complements, which tends to enhance efficiency and thus also competition. Unlike horizontal mergers, vertical mergers produce anticompetitive effects only through indirect mechanisms with many moving parts, which makes the prediction of competitive effects from vertical mergers more complex and less certain.

The Guidelines also are unhelpfully silent on the basic economics of vertical integration, and hence of vertical mergers. In assessing a vertical merger, it is essential to appreciate that vertical mergers solve coordination problems that are solved less well, or not at all, by contracts. By solving different coordination problems, a vertical merger can generate merger-specific efficiencies or eliminate double marginalization. But solving a coordination problem need not be a good thing: Competition is the ultimate coordination problem, and a vertical merger can have anticompetitive consequences by helping to solve that coordination problem.   Finally, the Guidelines are unhelpfully silent on the fundamental policy issue presented by vertical merger enforcement: What distinguishes a vertical merger that harms competition from a vertical merger that merely harm competitors? A vertical merger cannot directly eliminate rivalry by increasing market concentration. The Supreme Court has endorsed a foreclosure theory under which the merger directly causes injury to a rival and thus proximately causes diminished rivalry. Vertical mergers also might diminish rivalry in other ways, but the proposed Guidelines do not state that the Agencies view diminished rivalry as the hallmark of a lessening of competition.   

[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 Margaret E. Slade (Professor Emeritus, Vancouver School of Economics, The University of British Columbia).]

A revision of the DOJ’s Non-Horizontal Merger Guidelines is long overdue and the Draft Vertical Merger Guidelines (“Guidelines”) takes steps in the right direction. However, the treatment of important issues can be uneven. For example, the discussions of market definition and shares are relatively thorough whereas the discussions of anti-competitive harm and pro-competitive efficiencies are more vague.

Market definition, market shares, and concentration

The Guidelines are correct in deferring to the Horizontal Merger Guidelines for most aspects of market definition, market shares, and market concentration. The relevant sections of the Horizontal Guidelines are not without problems. However, it would make no sense to use different methods and concepts to delineate horizontal markets that are involved in vertical mergers compared to those that are involved in horizontal mergers.  

One aspect of market definition, however, is new: the notion of a related product, which is a product that links the up and downstream firms. Such products might be inputs, distribution systems, or sets of customers. The Guidelines set thresholds of 20% for the related product’s share, as well as the parties’ shares, in the relevant market. 

Those thresholds are, of course, only indicative and mergers can be investigated when markets are smaller. In addition, mergers that fail to meet the share tests need not be challenged. It would therefore be helpful to have a list of factors that could be used to determine which mergers that fall below those thresholds are more likely to be investigated, and vice versa. For example, the EU Vertical Merger Guidelines list circumstances, such as the existence of significant cross-shareholding relationships, the fact that one of the firms is considered to be a maverick, and suspicion that coordination is ongoing, under which mergers that fall into the safety zones are more apt to be investigated.

Elimination of double marginalization and other efficiencies

Although the elimination of double marginalization (EDM) is a pricing externality that does not change unit costs, the Guidelines discuss EDM as the principal `efficiency’ or at least they have more to say about that factor. Furthermore, after discussing EDM, the Guidelines note that the full EDM benefit might not occur if the downstream firm cannot use the product or if the parties are already engaged in contracting. The first factor is obvious and the second implies that the efficiency is not merger specific. In practice, however, antitrust and regulatory policy has tended to apply the EDM argument uncritically, ignoring several key assumptions and issues.

The simple model of EDM relies on a setting in which there are two monopolists, one up and one downstream, each produces a single product, and production is subject to fixed proportions. This model predicts that welfare will increase after a vertical merger. If these assumptions are violated, however, the predictions change (as John Kwoka and I discuss in more detail here). For example, under variable proportions the unintegrated downstream firm can avoid some of the adverse effects of the inflated wholesale price by substituting away from use of that product, and the welfare implications are ambiguous. Moreover, managerial considerations such as independent pricing by divisions can lead to less-than-full elimination of double marginalization.  

With multi-product firms, the integrated firm’s average downstream prices need not fall and can even rise when double marginalization is eliminated. To illustrate, after EDM the products with eliminated margins become relatively more profitable to sell. This gives the integrated firm incentives to divert demand towards those products by increasing the prices of its products for which double marginalization was not eliminated. Moreover, under some circumstances, the integrated downstream price can also rise.

Since violations of the simple model are present in almost all cases, it would be helpful to include a more complete list of factors that cause the simple model — the one that predicts that EDM is always welfare improving — to fail.

Unlike the case of horizontal mergers, with vertical mergers, real productive efficiencies on the supply side are often given less attention. Those efficiencies, which include economies of scope, the ability to coordinate other aspects of the vertical chain such as inventories and distribution, and the expectation of productivity growth due to knowledge transfers, can be important

Moreover, organizational efficiencies, such as mitigating contracting, holdup, and renegotiation costs, facilitating specific investments in physical and human capital, and providing appropriate incentives within firms, are usually ignored. Those efficiencies can be difficult to evaluate. Nevertheless, they should not be excluded from consideration on that basis.

Equilibrium effects

On page 4, the Guidelines suggest that merger simulations might be used to quantify unilateral price effects of vertical mergers. However, they have nothing to say about the pitfalls. Unfortunately, compared to horizontal merger simulations, there are many more assumptions that are required to construct vertical simulation models and thus many more places where they can go wrong. In particular, one must decide on the number and identity of the rivals; the related products that are potentially disadvantaged; the geographic markets in which foreclosure or raising rivals’ costs are likely to occur; the timing of moves: whether up and downstream prices are set simultaneously or the upstream firm is a first mover; the link between up and downstream: whether bargaining occurs or the upstream firm makes take-it-or-leave-it offers; and, as I discuss below, the need to evaluate the raising rivals’ costs (RRC) and elimination of double marginalization (EDM) effects simultaneously.

These choices can be crucial in determining model predictions. Indeed, as William Rogerson notes (in an unpublished 2019 draft paper, Modeling and Predicting the Competitive Effects of Vertical Mergers Due to Changes in Bargaining Leverage: The Bargaining Leverage Over Rivals (BLR) Effect), when moves are simultaneous, there is no RRC effect. This is true because, when negotiating over input prices, firms take downstream prices as given. 

On the other hand, bargaining introduces a new competitive effect — the bargaining leverage effect — which arises because, after a vertical merger, the disagreement payoff is higher. Indeed, the merged firm recognizes the increased profit that its downstream integrated division will earn if the input is withheld from the rival. In contrast, the upstream firm’s disagreement payoff is irrelevant when it has all of the bargaining power.

Finally, on page 5, the Guidelines describe something that sounds like a vertical upward pricing pressure (UPP) index, analogous to the GUPPI that has been successfully employed in evaluating horizontal mergers. However, extending the GUPPI to a vertical context is not straightforward

To illustrate, Das Varma and Di Stefano show that a sequential process can be very misleading, where a sequential process consists of first calculating the RRC effect and, if that effect is substantial, evaluating the EDM effect and comparing the two. The problem is that the two effects are not independent of one another. Moreover, when the two are determined simultaneously, compared to the sequential RRC, the equilibrium RRC can increase or decrease and can even change sign (i.e., lowering rival costs).What these considerations mean is that vertical merger simulations have to be carefully crafted to fit the markets that are susceptible to foreclosure and that a one-size-fits-all model can be very misleading. Furthermore, if a simpler sequential screening process is used, careful consideration must be given to whether the markets of interest satisfy the assumptions under which that process will yield approximately reasonable results.

[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 E. Nuechterlein (Partner, Sidley Austin LLP; former General Counsel, FTC; former Deputy General Counsel, FCC).

[Nuechterlein: I represented AT&T in United States v. AT&T, Inc. (“AT&T/Time Warner”), and this essay is based in part on comments I prepared on AT&T’s behalf for the FTC’s recent public hearings on Competition and Consumer Protection in the 21st Century. All views expressed here are my own.]

The draft Vertical Merger Guidelines (“Draft Guidelines”) might well leave ordinary readers with the misimpression that U.S. antitrust authorities have suddenly come to view vertical integration with a jaundiced eye. Such readers might infer from the draft that vertical mergers are a minefield of potential competitive harms; that only sometimes do they “have the potential to create cognizable efficiencies”; and that such efficiencies, even when they exist, often are not “of a character and magnitude” to keep the merger from becoming “anticompetitive.” (Draft Guidelines § 8, at 9). But that impression would be impossible to square with the past forty years of U.S. enforcement policy and with exhaustive empirical work confirming the largely beneficial effects of vertical integration. 

The Draft Guidelines should reflect those realities and thus should incorporate genuine limiting principles — rooted in concerns about two-level market power — to cabin their highly speculative theories of harm. Without such limiting principles, the Guidelines will remain more a theoretical exercise in abstract issue-spotting than what they purport to be: a source of genuine guidance for the public

1. The presumptive benefits of vertical integration

Although the U.S. antitrust agencies (the FTC and DOJ) occasionally attach conditions to their approval of vertical mergers, they have litigated only one vertical merger case to judgment over the past forty years: AT&T/Time Warner. The reason for that paucity of cases is neither a lack of prosecutorial zeal nor a failure to understand “raising rivals’ costs” theories of harm. Instead, in the words of the FTC’s outgoing Bureau of Competition chief, Bruce Hoffman, the reason is the “broad consensus in competition policy and economic theory that the majority of vertical mergers are beneficial because they reduce costs and increase the intensity of interbrand competition.” 

Two exhaustive papers confirm that conclusion with hard empirical facts. The first was published in the International Journal of Industrial Organization in 2005 by FTC economists James Cooper, Luke Froeb, Dan O’Brien, and Michael Vita, who surveyed “multiple studies of vertical mergers and restraints” and “found only one example where vertical integration harmed consumers, and multiple examples where vertical integration unambiguously benefited consumers.” The second paper is a 2007 analysis in the Journal of Economic Literature co-authored by University of Michigan Professor Francine LaFontaine (who served from 2014 to 2015 as Director of the FTC’s Bureau of Economics) and Professor Margaret Slade of the University of British Columbia. Professors LaFontaine and Slade “did not have a particular conclusion in mind when [they] began to collect the evidence,” “tried to be fair in presenting the empirical regularities,” and were “therefore somewhat surprised at what the weight of the evidence is telling us.” They found that:

[U]nder most circumstances, profit-maximizing vertical-integration decisions are efficient, not just from the firms’ but also from the consumers’ points of view. Although there are isolated studies that contradict this claim, the vast majority support it. (p. 680) 

Vertical mergers have this procompetitive track record for two basic reasons. First, by definition, they do not eliminate a competitor or increase market concentration in any market, and they pose fewer competitive concerns than horizontal mergers for that reason alone. Second, as Bruce Hoffman noted, “while efficiencies are often important in horizontal mergers, they are much more intrinsic to a vertical transaction” and “come with a more built-in likelihood of improving competition than horizontal mergers.”

It is widely accepted that vertical mergers often impose downward pricing pressure by eliminating double margins. Beyond that, as the Draft Guidelines observe (at § 8), vertical mergers can also play an indispensable role in “eliminate[ing] contracting frictions,” “streamlin[ing] production, inventory management, or distribution,” and “creat[ing] innovative products in ways that would have been hard to achieve through arm’s length contracts.”

2. Harm to competitors, harm to competition, and the need for limiting principles

Vertical mergers do often disadvantage rivals of the merged firm. For example, a distributor might merge with one of its key suppliers, achieve efficiencies through the combination, and pass some of the savings through to consumers in the form of lower prices. The firm’s distribution rivals will lose profits if they match the price cut and will lose market share to the merged firm if they do not. But that outcome obviously counts in favor of supporting, not opposing, the merger because it makes consumers better off and because “[t]he antitrust laws… were enacted for the protection of competition not competitors.” (Brunswick v Pueblo Bowl-O-Mat). 

This distinction between harm to competition and harm to competitors is fundamental to U.S. antitrust law. Yet key passages in the Draft Guidelines seem to blur this distinction

For example, one passage suggests that a vertical merger will be suspect if the merged firm might “chang[e] the terms of … rivals’ access” to an input, “one or more rivals would [then] lose sales,” and “some portion of those lost sales would be diverted to the merged firm.” Draft Guidelines § 5.a, at 4-5. Of course, the Guidelines’ drafters would never concede that they wish to vindicate the interests of competitors qua competitors. They would say that incremental changes in input prices, even if they do not structurally alter the competitive landscape, might nonetheless result in slightly higher overall consumer prices. And they would insist that speculation about such slight price effects should be sufficient to block a vertical merger. 

That was the precise theory of harm that DOJ pursued in AT&T/Time Warner, which involved a purely vertical merger between a video programmer (Time Warner) and a pay-TV distributor (AT&T/DirecTV). DOJ ultimately conceded that Time Warner was unlikely to withhold programming from (“foreclose”) AT&T’s pay-TV rivals. Instead, using a complex economic model, DOJ tried to show that the merger would increase Time Warner’s bargaining power and induce AT&T’s pay-TV rivals to pay somewhat higher rates for Time Warner programming, some portion of which the rivals would theoretically pass through to their own retail customers. At the same time, DOJ conceded that post-merger efficiencies would cause AT&T to lower its retail rates compared to the but-for world without the merger. DOJ nonetheless asserted that the aggregate effect of the pay-TV rivals’ price increases would exceed the aggregate effect of AT&T’s own price decrease. Without deciding whether such an effect would be sufficient to block the merger — a disputed legal issue — the courts ruled for the merging parties because DOJ could not substantiate its factual prediction that the merger would lead to programming price increases in the first place. 

It is unclear why DOJ picked this, of all cases, as its vehicle for litigating its first vertical merger case in decades. In an archetypal raising-rivals’-costs case, familiar from exclusive dealing law, the defendant forecloses its rivals by depriving them of a critical input or distribution channel and so marginalizes them in the process that it can profitably raise its own retail prices (see, e.g., McWane; Microsoft). AT&T/Time Warner could hardly have been further afield from that archetypal case. Again, DOJ conceded both that the merged firm would not foreclose rivals at all and that the merger would induce the firm to lower its retail prices below what it would charge if the merger were blocked. The draft Guidelines appear to double down on this odd strategy and portend more cases predicated on the same attenuated concerns about mere “chang[es in] the terms of … rivals’ access” to inputs, unaccompanied by any alleged structural changes in the competitive landscape

Bringing such cases would be a mistake, both tactically and doctrinally

“Changes in the terms of inputs” are a constant fact of life in nearly every market, with or without mergers, and have almost never aroused antitrust scrutiny. For example, whenever a firm enters into a long-term preferred-provider agreement with a new business partner in lieu of merging with it, the firm will, by definition, deal on less advantageous terms with the partner’s rivals than it otherwise would. That outcome is virtually never viewed as problematic, let alone unlawful, when it is accomplished through such long-term contracts. The government does not hire a team of economists to pore over documents, interview witnesses, and run abstruse models on whether the preferred-provider agreement can be projected, on balance, to produce incrementally higher downstream prices. There is no obvious reason why the government should treat such preferred provider arrangements differently if they arise through a vertical merger rather than a vertical contract — particularly given the draft Guidelines’ own acknowledgement that vertical mergers produce pro-consumer efficiencies that would be “hard to achieve through arm’s length contracts.” (Draft Guidelines § 8, at 9).

3. Towards a more useful safe harbor

Quoting then-Judge Breyer, the Supreme Court once noted that “antitrust rules ‘must be clear enough for lawyers to explain them to clients.’” That observation rings doubly true when applied to a document by enforcement officials purporting to “guide” business decisions. Firms contemplating a vertical merger need more than assurance that their merger will be cleared two years hence if their economists vanquish the government’s economists in litigation about the fine details of Nash bargaining theory. Instead, firms need true limiting principles, which identify the circumstances where any theory of harm would be so attenuated that litigating to block the merger is not worth the candle, particularly given the empirically validated presumption that most vertical mergers are pro-consumer.

The Agencies cannot meet the need for such limiting principles with the proposed “safe harbor” as it is currently phrased in the draft Guidelines: 

The Agencies 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.” (Draft Guidelines § 3, at 3). 

This anodyne assurance, with its arbitrarily low 20 percent thresholds phrased in the conjunctive, seems calculated more to preserve the agencies’ discretion than to provide genuine direction to industry. 

Nonetheless, the draft safe harbor does at least point in the right direction because it reflects a basic insight about two-level market power: vertical mergers are unlikely to create competitive concerns unless the merged firm will have, or could readily obtain, market power in both upstream and downstream markets. (See, e.g., Auburn News v. Providence Journal (“Where substantial market power is absent at any one product or distribution level, vertical integration will not have an anticompetitive effect.”)) This point parallels tying doctrine, which, like vertical merger analysis, addresses how vertical arrangements can affect competition across adjacent markets. As Justice O’Connor noted in Jefferson Parish, tying arrangements threaten competition 

primarily in the rare cases where power in the market for the tying product is used to create additional market power in the market for the tied product.… But such extension of market power is unlikely, or poses no threat of economic harm, unless…, [among other conditions, the seller has] power in the tying-product market… [and there is] a substantial threat that the tying seller will acquire market power in the tied-product market.

As this discussion suggests, the “20 percent” safe harbor in the draft Guidelines misses the mark in three respects

First, as a proxy for the absence of market power, 20 percent is too low: courts have generally refused to infer market power when the seller’s market share was below 30% and sometimes require higher shares. Of course, market share can be a highly overinclusive measure of market power, in that many firms with greater than a 30% share will lack market power. But it is nonetheless appropriate to use market share as a screen for further analysis.

Second, the draft’s safe harbor appears illogically in the conjunctive, applying only “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.” That “and” should be an “or” because, again, vertical arrangements can be problematic only if a firm can use existing market power in a “related products” market to create or increase market power in the “relevant market.” 

Third, the phrase “the related product is used in less than 20 percent of the relevant market” is far too ambiguous to serve a useful role. For example, the “related product” sold by a merging upstream firm could be “used by” 100 percent of downstream buyers even though the firm’s sales account for only one percent of downstream purchases of that product if the downstream buyers multi-home — i.e., source their goods from many different sellers of substitutable products. The relevant proxy for “related product” market power is thus not how many customers “use” the merging firm’s product, but what percentage of overall sales of that product (including reasonable substitutes) it makes. 

Of course, this observation suggests that, when push comes to shove in litigation, the government must usually define two markets: not only (1) a “relevant market” in which competitive harm is alleged to occur, but also (2) an adjacent “related product” market in which the merged firm is alleged to have market power. Requiring such dual market definition is entirely appropriate. Ultimately, any raising-rivals’-costs theory relies on a showing that a vertically integrated firm has some degree of market power in a “related products” market when dealing with its rivals in an adjacent “relevant market.” And market definition is normally an inextricable component of a litigated market power analysis.

If these three changes are made, the safe harbor would read: 

The Agencies are unlikely to challenge a vertical merger where the parties to the merger have a share in the relevant market of less than 30 percent, or the related product sold by one of the parties accounts for less than 30 percent of the overall sales of that related product, including reasonable substitutes.

Like all safe harbors, this one would be underinclusive (in that many mergers outside of the safe harbor are unobjectionable) and may occasionally be overinclusive. But this substitute language would be more useful as a genuine safe harbor because it would impose true limiting principles. And it would more accurately reflect the ways in which market power considerations should inform vertical analysis—whether of contractual arrangements or mergers.

[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 Herbert Hovenkamp (James G. Dinan University Professor, University of Pennsylvania School of Law and the Wharton School).]

In its 2019 AT&T/Time-Warner merger decision the D.C. Circuit Court of Appeals mentioned something that antitrust enforcers have known for years: We need a new set of Agency Guidelines for vertical mergers. The vertical merger Guidelines were last revised in 1984 at the height of Chicago School hostility toward harsh antitrust treatment of vertical restraints. In January, 2020, the Agencies issued a set of draft vertical merger Guidelines for comment. At this writing the Guidelines are not final, and the Agencies are soliciting comments on the draft and will be holding at least two workshops to discuss them before they are finalized.

1. What the Guidelines contain

a. “Relevant markets” and “related products”

The draft Guidelines borrow heavily from the 2010 Horizontal Merger Guidelines concerning general questions of market definition, entry barriers, partial acquisitions, treatment of efficiencies and the failing company defense. Both the approach to market definition and the necessity for it are treated somewhat differently than for horizontal mergers, however. First, the Guidelines do not generally speak of vertical mergers as linking two different “markets,” such as an upstream market and a downstream market. Instead, they use the term “relevant market” to speak of the market that is of competitive concern, and the term “related product” to refer to some product, service, or grouping of sales that is either upstream or downstream from this market:

A related product is 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.

So, for example, if a truck trailer manufacturer should acquire a maker of truck wheels and the market of concern was trailer manufacturing, the Agencies would identify that as the relevant market and wheels as the “related product.” (Cf. Fruehauf Corp. v. FTC).

b. 20% market share threshold

The Guidelines then suggest (§3) that the Agencies would be

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.

The choice of 20% is interesting but quite defensible as a statement of enforcement policy, and very likely represents a compromise between extreme positions. First, 20% is considerably higher than the numbers that supported enforcement during the 1960s and earlier (see, e.g., Brown Shoe (less than 4%); Bethlehem Steel (10% in one market; as little as 1.8% in another market)). Nevertheless, it is also considerably lower than the numbers that commentators such as Robert Bork would have approved (see Robert H. Bork, The Antitrust Paradox: A Policy at War with Itself at pp. 219, 232-33; see also Herbert Hovenkamp, Robert Bork and Vertical Integration: Leverage, Foreclosure, and Efficiency), and lower than the numbers generally used to evaluate vertical restraints such as tying or exclusive dealing (see Jefferson Parish (30% insufficient); see also 9 Antitrust Law ¶1709 (4th ed. 2018)).

The Agencies do appear to be admonished by the Second Circuit’s Fruehauf decision, now 40 years old but nevertheless the last big, fully litigated vertical merger case prior to AT&T/Time Warner: foreclosure numbers standing alone do not mean very much, at least not unless they are very large. Instead, there must be some theory about how foreclosure leads to lower output and higher prices. These draft Guidelines provide several examples and illustrations.

Significantly, the Guidelines do not state that they will challenge vertical mergers crossing the 20% threshold, but only that they are unlikely to challenge mergers that fall short of it. Even here, they leave open the possibility of challenge in unusual situations where the share numbers may understate the concern, such as where the related product “is relatively new,” and its share is rapidly growing. The Guidelines also note (§3) that if the merging parties serve different geographic areas, then the relevant share may not be measured by a firm’s gross sales everywhere, but rather by its shares in the other firm’s market in which anticompetitive effects are being tested. 

These numbers as well as the qualifications seem quite realistic, particularly in product differentiated markets where market shares tend to understate power, particularly in vertical distribution.

c. Unilateral effects

The draft Vertical Guidelines then divide the universe of adverse competitive effects into Unilateral Effects (§5) and Coordinated Effects (§7). The discussion of unilateral effects is based on bargaining theory similar to that used in the treatment of unilateral effects from horizontal mergers in the 2010 Horizontal Merger Guidelines. Basically, a price increase is more profitable if the losses that accrue to one merging participant are affected by gains to the merged firm as a whole. These principles have been a relatively uncontroversial part of industrial organization economics and game theory for decades. The Draft Vertical Guidelines recognize both foreclosure and raising rivals’ costs as concerns, as well as access to competitively sensitive information (§5).

 The Draft Guidelines note:

A vertical merger may diminish competition by allowing the merged firm to profitably weaken or remove the competitive constraint from one or more of its actual or potential rivals in the relevant market by changing the terms of those rivals’ access to one or more related products. For example, the merged firm may be able to raise its rivals’ costs by charging a higher price for the related products or by lowering service or product quality. The merged firm could also refuse to supply rivals with the related products altogether (“foreclosure”).

Where sufficient data are available, the Agencies may construct economic models designed to quantify the likely unilateral price effects resulting from the merger…..

The draft Guidelines note that these models need not rely on a particular market definition. As in the case of unilateral effects horizontal mergers, they compare the firms’ predicted bargaining position before and after the merger, assuming that the firms seek maximization of profits or value. They then query whether equilibrium prices in the post-merger market will be higher than those prior to the merger. 

In making that determination the Guidelines suggest (§4a) that the Agency could look at several factors, including:

  1. The merged firm’s foreclosure of, or raising costs of, one or more rivals would cause those rivals to lose sales (for example, if they are forced out of the market, if they are deterred from innovating, entering or expanding, or cannot finance these activities, or if they have incentives to pass on higher costs through higher prices), or to otherwise compete less aggressively for customers’ business;
  2. The merged firm’s business in the relevant market would benefit (for example if some portion of those lost sales would be diverted to the merged firm);
  3. Capturing this benefit through merger may make foreclosure, or raising rivals’ costs, profitable even though it would not have been profitable prior to the merger; and,
  4. The magnitude of likely foreclosure or raising rivals’ costs is not de minimis such that it would substantially lessen competition.

This approach, which reflects important developments in empirical economics, does entail that there will be increasing reliance on economic experts to draft, interpret, and dispute the relevant economic models.

In a brief section the Draft Guidelines also state a concern for mergers that will provide a firm with access or control of sensitive business information that could be used anticompetitively. The Guidelines do not provide a great deal of elaboration on this point.

d. Elimination of double marginalization

The Vertical Guidelines also have a separate section (§6) discussing an offset for elimination of double marginalization. They note what has come to be the accepted economic wisdom that elimination of double marginalization can result in higher output and lower prices when it applies, but it does not invariably apply.

e. Coordinated effects

Finally, the draft Guidelines note (§7) a concern that certain vertical mergers may enable collusion. This could occur, for example, if the merger eliminated a maverick buyer who formerly played rival sellers off against one another. In other cases the merger may give one of the partners access to information that could be used to facilitate collusion or discipline cartel cheaters, offering this example:

Example 7: The merger brings together a manufacturer of components and a maker of final products. If the component manufacturer supplies rival makers of final products, it will have information about how much they are making, and will be better able to detect cheating on a tacit agreement to limit supplies. As a result the merger may make the tacit agreement more effective.

2. Conclusion: An increase in economic sophistication

These draft Guidelines are relatively short, but that is in substantial part because they incorporate by reference many of the relevant points from the 2010 Guidelines for horizontal mergers. In any event, they may not provide as much detail as federal courts might hope for, but they are an important step toward specifying the increasingly economic approaches that the agencies take toward merger analysis, one in which direct estimates play a larger role, with a comparatively reduced role for more traditional approaches depending on market definition and market share.

They also avoid both rhetorical extremes, which are being too hostile or too sanguine about the anticompetitive potential of vertical acquisitions. While the new draft Guidelines leave the overall burden of proof with the challenger, they have clearly weakened the presumption that vertical mergers are invariably benign, particularly in highly concentrated markets or where the products in question are differentiated. Second, the draft Guidelines emphasize approaches that are more economically sophisticated and empirical. Consistent with that, foreclosure concerns are once again taken more seriously.

The 2020 Draft Joint Vertical Merger Guidelines:

What’s in, what’s out — and do we need them anyway?

February 6 & 7, 2020

Welcome! We’re delighted to kick off our two-day blog symposium on the recently released Draft Joint Vertical Merger Guidelines from the DOJ Antitrust Division and the Federal Trade Commission. 

If adopted by the agencies, the guidelines would mark the first time since 1984 that U.S. federal antitrust enforcers have provided official, public guidance on their approach to the increasingly important issue of vertical merger enforcement. 

As previously noted, the release of the draft guidelines was controversial from the outset: The FTC vote to issue the draft was mixed, with a dissent from Commissioner Slaughter, an abstention from Commissioner Chopra, and a concurring statement from Commissioner Wilson.

As the antitrust community gears up to debate the draft guidelines, we have assembled an outstanding group of antitrust experts to weigh in with their initial thoughts on the guidelines here at Truth on the Market. We hope this symposium will provide important insights and stand as a useful resource for the ongoing discussion.

The scholars and practitioners who will participate in the symposium are:

  • Timothy J. Brennan (Professor, Public Policy and Economics, University of Maryland; former Chief Economist, FCC; former economist, DOJ Antitrust Division)
  • Steven Cernak (Partner, Bona Law PC; former antitrust counsel, GM)
  • Eric Fruits (Chief Economist, ICLE; Professor of Economics, Portland State University)
  • Herbert Hovenkamp (James G. Dinan University Professor of Law, University of Pennsylvania)
  • Jonathan M. Jacobson (Partner, Wilson Sonsini Goodrich & Rosati) and Kenneth Edelson (Associate, Wilson Sonsini Goodrich & Rosati)
  • William J. Kolasky (Partner, Hughes Hubbard & Reed; former Deputy Assistant Attorney General, DOJ Antitrust Division) and Philip A. Giordano (Partner, Hughes Hubbard & Reed LLP)
  • Geoffrey A. Manne (President & Founder, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics) and Kristian Stout (Associate Director, ICLE)
  • Jonathan E. Nuechterlein (Partner, Sidley Austin LLP; former General Counsel, FTC; former Deputy General Counsel, FCC)
  • Sharis A. Pozen (Partner, Clifford Chance; former Vice President of Global Competition Law and Policy, GE; former Acting Assistant Attorney General, DOJ Antitrust Division), Timothy Cornell (Partner, Clifford Chance), Brian Concklin (Counsel, Clifford Chance), and Michael Van Arsdall (Counsel, Clifford Chance)
  • Jan Rybnicek (Counsel, Freshfields Bruckhaus Deringer; former attorney adviser to Commissioner Joshua D. Wright, FTC)
  • Steven C. Salop (tent.) (Professor of Economics and Law, Georgetown University; former Associate Director, FTC Bureau of Economics)
  • Scott A. Sher (Partner, Wilson Sonsini Goodrich & Rosati) and Matthew McDonald (Associate, Wilson Sonsini Goodrich & Rosati)
  • Margaret Slade (Professor Emeritus, Vancouver School of Economics, University of British Columbia)
  • Gregory Werden (former Senior Economic Counsel, DOJ Antitrust Division) and Luke M. Froeb (William C. Oehmig Chair in Free Enterprise and Entrepreneurship, Vanderbilt University; former Chief Economist, DOJ Antitrust Division; former Chief Economist, FTC)
  • Lawrence J. White (Robert Kavesh Professor of Economics, New York University; former Chief Economist, DOJ Antitrust Division)
  • Joshua D. Wright (University Professor of Law, George Mason University; former Commissioner, FTC), Douglas H. Ginsburg (Senior Circuit Judge, US Court of Appeals for the DC Circuit; Professor of Law, George Mason University; former Assistant Attorney General, DOJ Antitrust Division), Tad Lipsky (Assistant Professor of Law, George Mason University; former Acting Director, FTC Bureau of Competition; former chief antitrust counsel, Coca-Cola; former Deputy Assistant Attorney General, DOJ Antitrust Division), and John M. Yun (Associate Professor of Law, George Mason University; former Acting Deputy Assistant Director, FTC Bureau of Economics)

The first of the participants’ initial posts will appear momentarily, with additional posts appearing throughout the day today and tomorrow. We hope to generate a lively discussion, and expect some of the participants to offer follow up posts and/or comments on their fellow participants’ posts — please be sure to check back throughout the day and be sure to check the comments. We hope our readers will join us in the comments, as well.

Once again, welcome!

Truth on the Market is pleased to announce its next blog symposium:

The 2020 Draft Joint Vertical Merger Guidelines: What’s in, what’s out — and do we need them anyway?

February 6 & 7, 2020

Symposium background

On January 10, 2020, the DOJ Antitrust Division and the Federal Trade Commission released Draft Joint Vertical Merger Guidelines for public comment. If adopted by the agencies, the guidelines would mark the first time since 1984 that U.S. federal antitrust enforcers have provided official, public guidance on their approach to the increasingly important issue of vertical merger enforcement: 

“Challenging anticompetitive vertical mergers is essential to vigorous enforcement. The agencies’ vertical merger policy has evolved substantially since the issuance of the 1984 Non-Horizontal Merger Guidelines, and our guidelines should reflect the current enforcement approach. Greater transparency about the complex issues surrounding vertical mergers will benefit the business community, practitioners, and the courts,” said FTC Chairman Joseph J. Simons.

As evidenced by FTC Commissioner Slaughter’s dissent and FTC Commissioner Chopra’s abstention from the FTC’s vote to issue the draft guidelines, the topic is a contentious one. Similarly, as FTC Commissioner Wilson noted in her concurring statement, the recent FTC hearing on vertical mergers demonstrated that there is a vigorous dispute over what new guidelines should look like (or even if the 1984 Non-Horizontal Guidelines should be updated at all).

The agencies have announced two upcoming workshops to discuss the draft guidelines and have extended the comment period on the draft until February 26.

In advance of the workshops and the imminent discussions over the draft guidelines, we have asked a number of antitrust experts to weigh in here at Truth on the Market: to preview the coming debate by exploring the economic underpinnings of the draft guidelines and their likely role in the future of merger enforcement at the agencies, as well as what is in the guidelines and — perhaps more important — what is left out.  

Beginning the morning of Thursday, February 6, and continuing during business hours through Friday, February 7, Truth on the Market (TOTM) and the International Center for Law & Economics (ICLE) will host a blog symposium on the draft guidelines. 

Symposium participants

As in the past (see examples of previous TOTM blog symposia here), we’ve lined up an outstanding and diverse group of scholars to discuss these issues, including:

  • Timothy J. Brennan (Professor, Public Policy and Economics, University of Maryland; former Chief Economist, FCC; former economist, DOJ Antitrust Division)
  • Steven Cernak (Partner, Bona Law PC; former antitrust counsel, GM)
  • Luke M. Froeb (William C. Oehmig Chair in Free Enterprise and Entrepreneurship, Vanderbilt University; former Chief Economist, DOJ Antitrust Division; former Chief Economist, FTC)
  • Eric Fruits (Chief Economist, ICLE; Professor of Economics, Portland State University)
  • Douglas H. Ginsburg (Senior Circuit Judge, US Court of Appeals for the DC Circuit; Professor of Law, George Mason University; former Assistant Attorney General, DOJ Antitrust Division)
  • Herbert Hovenkamp (James G. Dinan University Professor of Law, University of Pennsylvania)
  • Jonathan M. Jacobson (Partner, Wilson Sonsini Goodrich & Rosati)
  • William J. Kolasky (Partner, Hughes Hubbard & Reed; former Deputy Assistant Attorney General, DOJ Antitrust Division)
  • Tad Lipsky (Assistant Professor of Law, George Mason University; former Acting Director, FTC Bureau of Competition; former chief antitrust counsel, Coca-Cola; former Deputy Assistant Attorney General, DOJ Antitrust Division) 
  • Geoffrey A. Manne (President & Founder, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics)
  • Jonathan E. Nuechterlein (Partner, Sidley Austin LLP; former General Counsel, FTC; former Deputy General Counsel, FCC)
  • Sharis A. Pozen (Partner, Clifford Chance; former Vice President of Global Competition Law and Policy, GE; former Acting Assistant Attorney General, DOJ Antitrust Division) 
  • Jan Rybnicek (Counsel, Freshfields Bruckhaus Deringer; former attorney adviser to Commissioner Joshua D. Wright, FTC)
  • Steven C. Salop (tent.) (Professor of Economics and Law, Georgetown University; former Associate Director, FTC Bureau of Economics)
  • Scott A. Sher (Partner, Wilson Sonsini Goodrich & Rosati)
  • Margaret Slade (Professor Emeritus, Vancouver School of Economics, University of British Columbia)
  • Kristian Stout (Associate Director, ICLE)
  • Gregory Werden (former Senior Economic Counsel, DOJ Antitrust Division)
  • Lawrence J. White (Robert Kavesh Professor of Economics, New York University; former Chief Economist, DOJ Antitrust Division)
  • Joshua D. Wright (University Professor of Law, George Mason University; former Commissioner, FTC)
  • John M. Yun (Associate Professor of Law, George Mason University; former Acting Deputy Assistant Director, FTC Bureau of Economics)

We want to thank all of these excellent panelists for agreeing to take time away from their busy schedules to participate in this symposium. We are hopeful that this discussion will provide invaluable insight and perspective on the Draft Joint Vertical Merger Guidelines.

Look for the first posts starting Thursday, February 6!

Source: Benedict Evans

[N]ew combinations are, as a rule, embodied, as it were, in new firms which generally do not arise out of the old ones but start producing beside them; … in general it is not the owner of stagecoaches who builds railways. – Joseph Schumpeter, January 1934

Elizabeth Warren wants to break up the tech giants — Facebook, Google, Amazon, and Apple — claiming they have too much power and represent a danger to our democracy. As part of our response to her proposal, we shared a couple of headlines from 2007 claiming that MySpace had an unassailable monopoly in the social media market.

Tommaso Valletti, the chief economist of the Directorate-General for Competition (DG COMP) of the European Commission, said, in what we assume was a reference to our posts, “they go on and on with that single example to claim that [Facebook] and [Google] are not a problem 15 years later … That’s not what I would call an empirical regularity.”

We appreciate the invitation to show that prematurely dubbing companies “unassailable monopolies” is indeed an empirical regularity.

It’s Tough to Make Predictions, Especially About the Future of Competition in Tech

No one is immune to this phenomenon. Antitrust regulators often take a static view of competition, failing to anticipate dynamic technological forces that will upend market structure and competition.

Scientists and academics make a different kind of error. They are driven by the need to satisfy their curiosity rather than shareholders. Upon inventing a new technology or discovering a new scientific truth, academics often fail to see the commercial implications of their findings.

Maybe the titans of industry don’t make these kinds of mistakes because they have skin in the game? The profit and loss statement is certainly a merciless master. But it does not give CEOs the power of premonition. Corporate executives hailed as visionaries in one era often become blinded by their success, failing to see impending threats to their company’s core value propositions.

Furthermore, it’s often hard as outside observers to tell after the fact whether business leaders just didn’t see a tidal wave of disruption coming or, worse, they did see it coming and were unable to steer their bureaucratic, slow-moving ships to safety. Either way, the outcome is the same.

Here’s the pattern we observe over and over: extreme success in one context makes it difficult to predict how and when the next paradigm shift will occur in the market. Incumbents become less innovative as they get lulled into stagnation by high profit margins in established lines of business. (This is essentially the thesis of Clay Christensen’s The Innovator’s Dilemma).

Even if the anti-tech populists are powerless to make predictions, history does offer us some guidance about the future. We have seen time and again that apparently unassailable monopolists are quite effectively assailed by technological forces beyond their control.

PCs

Source: Horace Dediu

Jan 1977: Commodore PET released

Jun 1977: Apple II released

Aug 1977: TRS-80 released

Feb 1978: “I.B.M. Says F.T.C. Has Ended Its Typewriter Monopoly Study” (NYT)

Mobile

Source: Comscore

Mar 2000: Palm Pilot IPO’s at $53 billion

Sep 2006: “Everyone’s always asking me when Apple will come out with a cellphone. My answer is, ‘Probably never.’” – David Pogue (NYT)

Apr 2007: “There’s no chance that the iPhone is going to get any significant market share.” Ballmer (USA TODAY)

Jun 2007: iPhone released

Nov 2007: “Nokia: One Billion Customers—Can Anyone Catch the Cell Phone King?” (Forbes)

Sep 2013: “Microsoft CEO Ballmer Bids Emotional Farewell to Wall Street” (Reuters)

If there’s one thing I regret, there was a period in the early 2000s when we were so focused on what we had to do around Windows that we weren’t able to redeploy talent to the new device form factor called the phone.

Search

Source: Distilled

Mar 1998: “How Yahoo! Won the Search Wars” (Fortune)

Once upon a time, Yahoo! was an Internet search site with mediocre technology. Now it has a market cap of $2.8 billion. Some people say it’s the next America Online.

Sep 1998: Google founded

Instant Messaging

Sep 2000: “AOL Quietly Linking AIM, ICQ” (ZDNet)

AOL’s dominance of instant messaging technology, the kind of real-time e-mail that also lets users know when others are online, has emerged as a major concern of regulators scrutinizing the company’s planned merger with Time Warner Inc. (twx). Competitors to Instant Messenger, such as Microsoft Corp. (msft) and Yahoo! Inc. (yhoo), have been pressing the Federal Communications Commission to force AOL to make its services compatible with competitors’.

Dec 2000: “AOL’s Instant Messaging Monopoly?” (Wired)

Dec 2015: Report for the European Parliament

There have been isolated examples, as in the case of obligations of the merged AOL / Time Warner to make AOL Instant Messenger interoperable with competing messaging services. These obligations on AOL are widely viewed as having been a dismal failure.

Oct 2017: AOL shuts down AIM

Jan 2019: “Zuckerberg Plans to Integrate WhatsApp, Instagram and Facebook Messenger” (NYT)

Retail

Source: Seeking Alpha

May 1997: Amazon IPO

Mar 1998: American Booksellers Association files antitrust suit against Borders, B&N

Feb 2005: Amazon Prime launches

Jul 2006: “Breaking the Chain: The Antitrust Case Against Wal-Mart” (Harper’s)

Feb 2011: “Borders Files for Bankruptcy” (NYT)

Social

Feb 2004: Facebook founded

Jan 2007: “MySpace Is a Natural Monopoly” (TechNewsWorld)

Seventy percent of Yahoo 360 users, for example, also use other social networking sites — MySpace in particular. Ditto for Facebook, Windows Live Spaces and Friendster … This presents an obvious, long-term business challenge to the competitors. If they cannot build up a large base of unique users, they will always be on MySpace’s periphery.

Feb 2007: “Will Myspace Ever Lose Its Monopoly?” (Guardian)

Jun 2011: “Myspace Sold for $35m in Spectacular Fall from $12bn Heyday” (Guardian)

Music

Source: RIAA

Dec 2003: “The subscription model of buying music is bankrupt. I think you could make available the Second Coming in a subscription model, and it might not be successful.” – Steve Jobs (Rolling Stone)

Apr 2006: Spotify founded

Jul 2009: “Apple’s iPhone and iPod Monopolies Must Go” (PC World)

Jun 2015: Apple Music announced

Video

Source: OnlineMBAPrograms

Apr 2003: Netflix reaches one million subscribers for its DVD-by-mail service

Mar 2005: FTC blocks Blockbuster/Hollywood Video merger

Sep 2006: Amazon launches Prime Video

Jan 2007: Netflix streaming launches

Oct 2007: Hulu launches

May 2010: Hollywood Video’s parent company files for bankruptcy

Sep 2010: Blockbuster files for bankruptcy

The Only Winning Move Is Not to Play

Predicting the future of competition in the tech industry is such a fraught endeavor that even articles about how hard it is to make predictions include incorrect predictions. The authors just cannot help themselves. A March 2012 BBC article “The Future of Technology… Who Knows?” derided the naysayers who predicted doom for Apple’s retail store strategy. Its kicker?

And that is why when you read that the Blackberry is doomed, or that Microsoft will never make an impression on mobile phones, or that Apple will soon dominate the connected TV market, you need to take it all with a pinch of salt.

But Blackberry was doomed and Microsoft never made an impression on mobile phones. (Half credit for Apple TV, which currently has a 15% market share).

Nobel Prize-winning economist Paul Krugman wrote a piece for Red Herring magazine (seriously) in June 1998 with the title “Why most economists’ predictions are wrong.” Headline-be-damned, near the end of the article he made the following prediction:

The growth of the Internet will slow drastically, as the flaw in “Metcalfe’s law”—which states that the number of potential connections in a network is proportional to the square of the number of participants—becomes apparent: most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.

Robert Metcalfe himself predicted in a 1995 column that the Internet would “go spectacularly supernova and in 1996 catastrophically collapse.” After pledging to “eat his words” if the prediction did not come true, “in front of an audience, he put that particular column into a blender, poured in some water, and proceeded to eat the resulting frappe with a spoon.”

A Change Is Gonna Come

Benedict Evans, a venture capitalist at Andreessen Horowitz, has the best summary of why competition in tech is especially difficult to predict:

IBM, Microsoft and Nokia were not beaten by companies doing what they did, but better. They were beaten by companies that moved the playing field and made their core competitive assets irrelevant. The same will apply to Facebook (and Google, Amazon and Apple).

Elsewhere, Evans tried to reassure his audience that we will not be stuck with the current crop of tech giants forever:

With each cycle in tech, companies find ways to build a moat and make a monopoly. Then people look at the moat and think it’s invulnerable. They’re generally right. IBM still dominates mainframes and Microsoft still dominates PC operating systems and productivity software. But… It’s not that someone works out how to cross the moat. It’s that the castle becomes irrelevant. IBM didn’t lose mainframes and Microsoft didn’t lose PC operating systems. Instead, those stopped being ways to dominate tech. PCs made IBM just another big tech company. Mobile and the web made Microsoft just another big tech company. This will happen to Google or Amazon as well. Unless you think tech progress is over and there’ll be no more cycles … It is deeply counter-intuitive to say ‘something we cannot predict is certain to happen’. But this is nonetheless what’s happened to overturn pretty much every tech monopoly so far.

If this time is different — or if there are more false negatives than false positives in the monopoly prediction game — then the advocates for breaking up Big Tech should try to make that argument instead of falling back on “big is bad” rhetoric. As for us, we’ll bet that we have not yet reached the end of history — tech progress is far from over.

 

[TOTM: The following is the third in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here.

This post is authored by Douglas H. Ginsburg, Professor of Law, Antonin Scalia Law School at George Mason University; Senior Judge, United States Court of Appeals for the District of Columbia Circuit; and former Assistant Attorney General in charge of the Antitrust Division of the U.S. Department of Justice; and Joshua D. Wright, University Professor, Antonin Scalia Law School at George Mason University; Executive Director, Global Antitrust Institute; former U.S. Federal Trade Commissioner from 2013-15; and one of the founding bloggers at Truth on the Market.]

[Ginsburg & Wright: Professor Wright is recused from participation in the FTC litigation against Qualcomm, but has provided counseling advice to Qualcomm concerning other regulatory and competition matters. The views expressed here are our own and neither author received financial support.]

The Department of Justice Antitrust Division (DOJ) and Federal Trade Commission (FTC) have spent a significant amount of time in federal court litigating major cases premised upon an anticompetitive foreclosure theory of harm. Bargaining models, a tool used commonly in foreclosure cases, have been essential to the government’s theory of harm in these cases. In vertical merger or conduct cases, the core theory of harm is usually a variant of the claim that the transaction (or conduct) strengthens the firm’s incentives to engage in anticompetitive strategies that depend on negotiations with input suppliers. Bargaining models are a key element of the agency’s attempt to establish those claims and to predict whether and how firm incentives will affect negotiations with input suppliers, and, ultimately, the impact on equilibrium prices and output. Application of bargaining models played a key role in evaluating the anticompetitive foreclosure theories in the DOJ’s litigation to block the proposed merger of AT&T and Time Warner Cable. A similar model is at the center of the FTC’s antitrust claims against Qualcomm and its patent licensing business model.

Modern antitrust analysis does not condemn business practices as anticompetitive without solid economic evidence of an actual or likely harm to competition. This cautious approach was developed in the courts for two reasons. The first is that the difficulty of distinguishing between procompetitive and anticompetitive explanations for the same conduct suggests there is a high risk of error. The second is that those errors are more likely to be false positives than false negatives because empirical evidence and judicial learning have established that unilateral conduct is usually either procompetitive or competitively neutral. In other words, while the risk of anticompetitive foreclosure is real, courts have sensibly responded by requiring plaintiffs to substantiate their claims with more than just theory or scant evidence that rivals have been harmed.

An economic model can help establish the likelihood and/or magnitude of competitive harm when the model carefully captures the key institutional features of the competition it attempts to explain. Naturally, this tends to mean that the economic theories and models proffered by dueling economic experts to predict competitive effects take center stage in antitrust disputes. The persuasiveness of an economic model turns on the robustness of its assumptions about the underlying market. Model predictions that are inconsistent with actual market evidence give one serious pause before accepting the results as reliable.

For example, many industries are characterized by bargaining between providers and distributors. The Nash bargaining framework can be used to predict the outcomes of bilateral negotiations based upon each party’s bargaining leverage. The model assumes that both parties are better off if an agreement is reached, but that as the utility of one party’s outside option increases relative to the bargain, it will capture an increasing share of the surplus. Courts have had to reconcile these seemingly complicated economic models with prior case law and, in some cases, with direct evidence that is apparently inconsistent with the results of the model.

Indeed, Professor Carl Shapiro recently used bargaining models to analyze harm to competition in two prominent cases alleging anticompetitive foreclosure—one initiated by the DOJ and one by the FTC—in which he served as the government’s expert economist. In United States v. AT&T Inc., Dr. Shapiro testified that the proposed transaction between AT&T and Time Warner would give the vertically integrated company leverage to extract higher prices for content from AT&T’s rival, Dish Network. Soon after, Dr. Shapiro presented a similar bargaining model in FTC v. Qualcomm Inc. He testified that Qualcomm leveraged its monopoly power over chipsets to extract higher royalty rates from smartphone OEMs, such as Apple, wishing to license its standard essential patents (SEPs). In each case, Dr. Shapiro’s models were criticized heavily by the defendants’ expert economists for ignoring market realities that play an important role in determining whether the challenged conduct was likely to harm competition.

Judge Leon’s opinion in AT&T/Time Warner—recently upheld on appeal—concluded that Dr. Shapiro’s application of the bargaining model was significantly flawed, based upon unreliable inputs, and undermined by evidence about actual market performance presented by defendant’s expert, Dr. Dennis Carlton. Dr. Shapiro’s theory of harm posited that the combined company would increase its bargaining leverage and extract greater affiliate fees for Turner content from AT&T’s distributor rivals. The increase in bargaining leverage was made possible by the threat of a post-merger blackout of Turner content for AT&T’s rivals. This theory rested on the assumption that the combined firm would have reduced financial exposure from a long-term blackout of Turner content and would therefore have more leverage to threaten a blackout in content negotiations. The purpose of his bargaining model was to quantify how much AT&T could extract from competitors subjected to a long-term blackout of Turner content.

Judge Leon highlighted a number of reasons for rejecting the DOJ’s argument. First, Dr. Shapiro’s model failed to account for existing long-term affiliate contracts, post-litigation offers of arbitration agreements, and the increasing competitiveness of the video programming and distribution industry. Second, Dr. Carlton had demonstrated persuasively that previous vertical integration in the video programming and distribution industry did not have a significant effect on content prices. Finally, Dr. Shapiro’s model primarily relied upon three inputs: (1) the total number of subscribers the unaffiliated distributor would lose in the event of a long-term blackout of Turner content, (2) the percentage of the distributor’s lost subscribers who would switch to AT&T as a result of the blackout, and (3) the profit margin AT&T would derive from the subscribers it gained from the blackout. Many of Dr. Shapiro’s inputs necessarily relied on critical assumptions and/or third-party sources. Judge Leon considered and discredited each input in turn. 

The parties in Qualcomm are, as of the time of this posting, still awaiting a ruling. Dr. Shapiro’s model in that case attempts to predict the effect of Qualcomm’s alleged “no license, no chips” policy. He compared the gains from trade OEMs receive when they purchase a chip from Qualcomm and pay Qualcomm a FRAND royalty to license its SEPs with the gains from trade OEMs receive when they purchase a chip from a rival manufacturer and pay a “royalty surcharge” to Qualcomm to license its SEPs. In other words, the FTC’s theory of harm is based upon the premise that Qualcomm is charging a supra-FRAND rate for its SEPs (the“royalty surcharge”) that squeezes the margins of OEMs. That margin squeeze, the FTC alleges, prevents rival chipset suppliers from obtaining a sufficient return when negotiating with OEMs. The FTC predicts the end result is a reduction in competition and an increase in the price of devices to consumers.

Qualcomm, like Judge Leon in AT&T, questioned the robustness of Dr. Shapiro’s model and its predictions in light of conflicting market realities. For example, Dr. Shapiro, argued that the

leverage that Qualcomm brought to bear on the chips shifted the licensing negotiations substantially in Qualcomm’s favor and led to a significantly higher royalty than Qualcomm would otherwise have been able to achieve.

Yet, on cross-examination, Dr. Shapiro declined to move from theory to empirics when asked if he had quantified the effects of Qualcomm’s practice on any other chip makers. Instead, Dr. Shapiro responded that he had not, but he had “reason to believe that the royalty surcharge was substantial” and had “inevitable consequences.” Under Dr. Shapiro’s theory, one would predict that royalty rates were higher after Qualcomm obtained market power.

As with Dr. Carlton’s testimony inviting Judge Leon to square the DOJ’s theory with conflicting historical facts in the industry, Qualcomm’s economic expert, Dr. Aviv Nevo, provided an analysis of Qualcomm’s royalty agreements from 1990-2017, confirming that there was no economic and meaningful difference between the royalty rates during the time frame when Qualcomm was alleged to have market power and the royalty rates outside of that time frame. He also presented evidence that ex ante royalty rates did not increase upon implementation of the CDMA standard or the LTE standard. Moreover, Dr.Nevo testified that the industry itself was characterized by declining prices and increasing output and quality.

Dr. Shapiro’s model in Qualcomm appears to suffer from many of the same flaws that ultimately discredited his model in AT&T/Time Warner: It is based upon assumptions that are contrary to real-world evidence and it does not robustly or persuasively identify anticompetitive effects. Some observers, including our Scalia Law School colleague and former FTC Chairman, Tim Muris, would apparently find it sufficient merely to allege a theoretical “ability to manipulate the marketplace.” But antitrust cases require actual evidence of harm. We think Professor Muris instead captured the appropriate standard in his important article rejecting attempts by the FTC to shortcut its requirement of proof in monopolization cases:

This article does reject, however, the FTC’s attempt to make it easier for the government to prevail in Section 2 litigation. Although the case law is hardly a model of clarity, one point that is settled is that injury to competitors by itself is not a sufficient basis to assume injury to competition …. Inferences of competitive injury are, of course, the heart of per se condemnation under the rule of reason. Although long a staple of Section 1, such truncation has never been a part of Section 2. In an economy as dynamic as ours, now is hardly the time to short-circuit Section 2 cases. The long, and often sorry, history of monopolization in the courts reveals far too many mistakes even without truncation.

Timothy J. Muris, The FTC and the Law of Monopolization, 67 Antitrust L. J. 693 (2000)

We agree. Proof of actual anticompetitive effects rather than speculation derived from models that are not robust to market realities are an important safeguard to ensure that Section 2 protects competition and not merely individual competitors.

The future of bargaining models in antitrust remains to be seen. Judge Leon certainly did not question the proposition that they could play an important role in other cases. Judge Leon closely dissected the testimony and models presented by both experts in AT&T/Time Warner. His opinion serves as an important reminder. As complex economic evidence like bargaining models become more common in antitrust litigation, judges must carefully engage with the experts on both sides to determine whether there is direct evidence on the likely competitive effects of the challenged conduct. Where “real-world evidence,” as Judge Leon called it, contradicts the predictions of a bargaining model, judges should reject the model rather than the reality. Bargaining models have many potentially important antitrust applications including horizontal mergers involving a bargaining component – such as hospital mergers, vertical mergers, and licensing disputes. The analysis of those models by the Ninth and D.C. Circuits will have important implications for how they will be deployed by the agencies and parties moving forward.

Last week, the DOJ cleared the merger of CVS Health and Aetna (conditional on Aetna’s divesting its Medicare Part D business), a merger that, as I previously noted at a House Judiciary hearing, “presents a creative effort by two of the most well-informed and successful industry participants to try something new to reform a troubled system.” (My full testimony is available here).

Of course it’s always possible that the experiment will fail — that the merger won’t “revolutioniz[e] the consumer health care experience” in the way that CVS and Aetna are hoping. But it’s a low (antitrust) risk effort to address some of the challenges confronting the healthcare industry — and apparently the DOJ agrees.

I discuss the weakness of the antitrust arguments against the merger at length in my testimony. What I particularly want to draw attention to here is how this merger — like many vertical mergers — represents business model innovation by incumbents.

The CVS/Aetna merger is just one part of a growing private-sector movement in the healthcare industry to adopt new (mostly) vertical arrangements that seek to move beyond some of the structural inefficiencies that have plagued healthcare in the United States since World War II. Indeed, ambitious and interesting as it is, the merger arises amidst a veritable wave of innovative, vertical healthcare mergers and other efforts to integrate the healthcare services supply chain in novel ways.

These sorts of efforts (and the current DOJ’s apparent support for them) should be applauded and encouraged. I need not rehash the economic literature on vertical restraints here (see, e.g., Lafontaine & Slade, etc.). But especially where government interventions have already impaired the efficient workings of a market (as they surely have, in spades, in healthcare), it is important not to compound the error by trying to micromanage private efforts to restructure around those constraints.   

Current trends in private-sector-driven healthcare reform

In the past, the most significant healthcare industry mergers have largely been horizontal (i.e., between two insurance providers, or two hospitals) or “traditional” business model mergers for the industry (i.e., vertical mergers aimed at building out managed care organizations). This pattern suggests a sort of fealty to the status quo, with insurers interested primarily in expanding their insurance business or providers interested in expanding their capacity to provide medical services.

Today’s health industry mergers and ventures seem more frequently to be different in character, and they portend an industry-wide experiment in the provision of vertically integrated healthcare that we should enthusiastically welcome.

Drug pricing and distribution innovations

To begin with, the CVS/Aetna deal, along with the also recently approved Cigna-Express Scripts deal, solidifies the vertical integration of pharmacy benefit managers (PBMs) with insurers.

But a number of other recent arrangements and business models center around relationships among drug manufacturers, pharmacies, and PBMs, and these tend to minimize the role of insurers. While not a “vertical” arrangement, per se, Walmart’s generic drug program, for example, offers $4 prescriptions to customers regardless of insurance (the typical generic drug copay for patients covered by employer-provided health insurance is $11), and Walmart does not seek or receive reimbursement from health plans for these drugs. It’s been offering this program since 2006, but in 2016 it entered into a joint buying arrangement with McKesson, a pharmaceutical wholesaler (itself vertically integrated with Rexall pharmacies), to negotiate lower prices. The idea, presumably, is that Walmart will entice consumers to its stores with the lure of low-priced generic prescriptions in the hope that they will buy other items while they’re there. That prospect presumably makes it worthwhile to route around insurers and PBMs, and their reimbursements.

Meanwhile, both Express Scripts and CVS Health (two of the country’s largest PBMs) have made moves toward direct-to-consumer sales themselves, establishing pricing for a small number of drugs independently of health plans and often in partnership with drug makers directly.   

Also apparently focused on disrupting traditional drug distribution arrangements, Amazon has recently purchased online pharmacy PillPack (out from under Walmart, as it happens), and with it received pharmacy licenses in 49 states. The move introduces a significant new integrated distributor/retailer, and puts competitive pressure on other retailers and distributors and potentially insurers and PBMs, as well.

Whatever its role in driving the CVS/Aetna merger (and I believe it is smaller than many reports like to suggest), Amazon’s moves in this area demonstrate the fluid nature of the market, and the opportunities for a wide range of firms to create efficiencies in the market and to lower prices.

At the same time, the differences between Amazon and CVS/Aetna highlight the scope of product and service differentiation that should contribute to the ongoing competitiveness of these markets following mergers like this one.

While Amazon inarguably excels at logistics and the routinizing of “back office” functions, it seems unlikely for the foreseeable future to be able to offer (or to be interested in offering) a patient interface that can rival the service offerings of a brick-and-mortar CVS pharmacy combined with an outpatient clinic and its staff and bolstered by the capabilities of an insurer like Aetna. To be sure, online sales and fulfillment may put price pressure on important, largely mechanical functions, but, like much technology, it is first and foremost a complement to services offered by humans, rather than a substitute. (In this regard it is worth noting that McKesson has long been offering Amazon-like logistics support for both online and brick-and-mortar pharmacies. “‘To some extent, we were Amazon before it was cool to be Amazon,’ McKesson CEO John Hammergren said” on a recent earnings call).

Treatment innovations

Other efforts focus on integrating insurance and treatment functions or on bringing together other, disparate pieces of the healthcare industry in interesting ways — all seemingly aimed at finding innovative, private solutions to solve some of the costly complexities that plague the healthcare market.

Walmart, for example, announced a deal with Quest Diagnostics last year to experiment with offering diagnostic testing services and potentially other basic healthcare services inside of some Walmart stores. While such an arrangement may simply be a means of making doctor-prescribed diagnostic tests more convenient, it may also suggest an effort to expand the availability of direct-to-consumer (patient-initiated) testing (currently offered by Quest in Missouri and Colorado) in states that allow it. A partnership with Walmart to market and oversee such services has the potential to dramatically expand their use.

Capping off (for now) a buying frenzy in recent years that included the purchase of PBM, CatamaranRx, UnitedHealth is seeking approval from the FTC for the proposed merger of its Optum unit with the DaVita Medical Group — a move that would significantly expand UnitedHealth’s ability to offer medical services (including urgent care, outpatient surgeries, and health clinic services), give it a significant group of doctors’ clinics throughout the U.S., and turn UnitedHealth into the largest employer of doctors in the country. But of course this isn’t a traditional managed care merger — it represents a significant bet on the decentralized, ambulatory care model that has been slowly replacing significant parts of the traditional, hospital-centric care model for some time now.

And, perhaps most interestingly, some recent moves are bringing together drug manufacturers and diagnostic and care providers in innovative ways. Swiss pharmaceutical company, Roche, announced recently that “it would buy the rest of U.S. cancer data company Flatiron Health for $1.9 billion to speed development of cancer medicines and support its efforts to price them based on how well they work.” Not only is the deal intended to improve Roche’s drug development process by integrating patient data, it is also aimed at accommodating efforts to shift the pricing of drugs, like the pricing of medical services generally, toward an outcome-based model.

Similarly interesting, and in a related vein, early this year a group of hospital systems including Intermountain Health, Ascension, and Trinity Health announced plans to begin manufacturing generic prescription drugs. This development further reflects the perceived benefits of vertical integration in healthcare markets, and the move toward creative solutions to the unique complexity of coordinating the many interrelated layers of healthcare provision. In this case,

[t]he nascent venture proposes a private solution to ensure contestability in the generic drug market and consequently overcome the failures of contracting [in the supply and distribution of generics]…. The nascent venture, however it solves these challenges and resolves other choices, will have important implications for the prices and availability of generic drugs in the US.

More enforcement decisions like CVS/Aetna and Bayer/Monsanto; fewer like AT&T/Time Warner

In the face of all this disruption, it’s difficult to credit anticompetitive fears like those expressed by the AMA in opposing the CVS-Aetna merger and a recent CEA report on pharmaceutical pricing, both of which are premised on the assumption that drug distribution is unavoidably dominated by a few PBMs in a well-defined, highly concentrated market. Creative arrangements like the CVS-Aetna merger and the initiatives described above (among a host of others) indicate an ease of entry, the fluidity of traditional markets, and a degree of business model innovation that suggest a great deal more competitiveness than static PBM market numbers would suggest.

This kind of incumbent innovation through vertical restructuring is an increasingly important theme in antitrust, and efforts to tar such transactions with purported evidence of static market dominance is simply misguided.

While the current DOJ’s misguided (and, remarkably, continuing) attempt to stop the AT&T/Time Warner merger is an aberrant step in the wrong direction, the leadership at the Antitrust Division generally seems to get it. Indeed, in spite of strident calls for stepped-up enforcement in the always-controversial ag-biotech industry, the DOJ recently approved three vertical ag-biotech mergers in fairly rapid succession.

As I noted in a discussion of those ag-biotech mergers, but equally applicable here, regulatory humility should continue to carry the day when it comes to structural innovation by incumbent firms:

But it is also important to remember that innovation comes from within incumbent firms, as well, and, often, that the overall level of innovation in an industry may be increased by the presence of large firms with economies of scope and scale.

In sum, and to paraphrase Olympia Dukakis’ character in Moonstruck: “what [we] don’t know about [the relationship between innovation and market structure] is a lot.”

What we do know, however, is that superficial, concentration-based approaches to antitrust analysis will likely overweight presumed foreclosure effects and underweight innovation effects.

We shouldn’t fetishize entry, or access, or head-to-head competition over innovation, especially where consumer welfare may be significantly improved by a reduction in the former in order to get more of the latter.

A few weeks ago I posted a preliminary assessment of the relative antitrust risk of a Comcast vs Disney purchase of 21st Century Fox assets. (Also available in pdf as an ICLE Issue brief, here). On the eve of Judge Leon’s decision in the AT&T/Time Warner merger case, it seems worthwhile to supplement that assessment by calling attention to Assistant Attorney General Makan Delrahim’s remarks at The Deal’s Corporate Governance Conference last week. Somehow these remarks seem to have passed with little notice, but, given their timing, they deserve quite a bit more attention.

In brief, Delrahim spent virtually the entirety of his short remarks making and remaking the fundamental point at the center of my own assessment of the antitrust risk of a possible Comcast/Fox deal: The DOJ’s challenge of the AT&T/Time Warner merger tells you nothing about the likelihood that the agency would challenge a Comcast/Fox merger.

To begin, in my earlier assessment I pointed out that most vertical mergers are approved by antitrust enforcers, and I quoted Bruce Hoffman, Director of the FTC’s Bureau of Competition, who noted that:

[V]ertical merger enforcement is still a small part of our merger workload….

* * *

Where horizontal mergers reduce competition on their face — though that reduction could be minimal or more than offset by benefits — vertical mergers do not…. [T]here are plenty of theories of anticompetitive harm from vertical mergers. But the problem is that those theories don’t generally predict harm from vertical mergers; they simply show that harm is possible under certain conditions.

I may not have made it very clear in that post, but, of course, most horizontal mergers are approved by enforcers, as well.

Well, now we have the head of the DOJ Antitrust Division making the same point:

I’d say 95 or 96 percent of mergers — horizontal or vertical — are cleared — routinely…. Most mergers — horizontal or vertical — are procompetitive, or have no adverse effect.

Delrahim reinforced the point in an interview with The Street in advance of his remarks. Asked by a reporter, “what are your concerns with vertical mergers?,” Delrahim quickly corrected the questioner: “Well, I don’t have any concerns with most vertical mergers….”

But Delrahim went even further, noting that nothing about the Division’s approach to vertical mergers has changed since the AT&T/Time Warner case was brought — despite the efforts of some reporters to push a different narrative:

I understand that some journalists and observers have recently expressed concern that the Antitrust Division no longer believes that vertical mergers can be efficient and beneficial to competition and consumers. Some point to our recent decision to challenge some aspects of the AT&T/Time Warner merger as a supposed bellwether for a new vertical approach. Rest assured: These concerns are misplaced…. We have long recognized that vertical integration can and does generate efficiencies that benefit consumers. Indeed, most vertical mergers are procompetitive or competitively neutral. The same is of course true in horizontal transactions. To the extent that any recent action points to a closer review of vertical mergers, it’s not new…. [But,] to reiterate, our approach to vertical mergers has not changed, and our recent enforcement efforts are consistent with the Division’s long-standing, bipartisan approach to analyzing such mergers. We’ll continue to recognize that vertical mergers, in general, can yield significant economic efficiencies and benefit to competition.

Delrahim concluded his remarks by criticizing those who assume that the agency’s future enforcement decisions can be inferred from past cases with different facts, stressing that the agency employs an evidence-based, case-by-case approach to merger review:

Lumping all vertical transactions under the same umbrella, by comparison, obscures the reality that we conduct a vigorous investigation, aided by over 50 PhD economists in these markets, to make sure that we as lawyers don’t steer too far without the benefits of their views in each of these instances.

Arguably this was a rebuke directed at those, like Disney and Fox’s board, who are quick to ascribe increased regulatory risk to a Comcast/Fox tie-up because the DOJ challenged the AT&T/Time Warner merger. Recall that, in its proxy statement, the Fox board explained that it rejected Comcast’s earlier bid in favor of Disney’s in part because of “the regulatory risks presented by the DOJ’s unanticipated opposition to the proposed vertical integration of the AT&T / Time Warner transaction.”

I’ll likely have more to add once the AT&T/Time Warner decision is out. But in the meantime (and with apologies to Mark Twain), the takeaway is clear: Reports of the death of vertical mergers have been greatly exaggerated.

As has been rumored in the press for a few weeks, today Comcast announced it is considering making a renewed bid for a large chunk of Twenty-First Century Fox’s (Fox) assets. Fox is in the process of a significant reorganization, entailing primarily the sale of its international and non-television assets. Fox itself will continue, but with a focus on its US television business.

In December of last year, Fox agreed to sell these assets to Disney, in the process rejecting a bid from Comcast. Comcast’s initial bid was some 16% higher than Disney’s, although there were other differences in the proposed deals, as well.

In April of this year, Disney and Fox filed a proxy statement with the SEC explaining the basis for the board’s decision, including predominantly the assertion that the Comcast bid (NB: Comcast is identified as “Party B” in that document) presented greater regulatory (antitrust) risk.

As noted, today Comcast announced it is in “advanced stages” of preparing another unsolicited bid. This time,

Any offer for Fox would be all-cash and at a premium to the value of the current all-share offer from Disney. The structure and terms of any offer by Comcast, including with respect to both the spin-off of “New Fox” and the regulatory risk provisions and the related termination fee, would be at least as favorable to Fox shareholders as the Disney offer.

Because, as we now know (since the April proxy filing), Fox’s board rejected Comcast’s earlier offer largely on the basis of the board’s assessment of the antitrust risk it presented, and because that risk assessment (and the difference between an all-cash and all-share offer) would now be the primary distinguishing feature between Comcast’s and Disney’s bids, it is worth evaluating that conclusion as Fox and its shareholders consider Comcast’s new bid.

In short: There is no basis for ascribing a greater antitrust risk to Comcast’s purchase of Fox’s assets than to Disney’s.

Summary of the Proposed Deal

Post-merger, Fox will continue to own Fox News Channel, Fox Business Network, Fox Broadcasting Company, Fox Sports, Fox Television Stations Group, and sports cable networks FS1, FS2, Fox Deportes, and Big Ten Network.

The deal would transfer to Comcast (or Disney) the following:

  • Primarily, international assets, including Fox International (cable channels in Latin America, the EU, and Asia), Star India (the largest cable and broadcast network in India), and Fox’s 39% interest in Sky (Europe’s largest pay TV service).
  • Fox’s film properties, including 20th Century Fox, Fox Searchlight, and Fox Animation. These would bring along with them studios in Sydney and Los Angeles, but would not include the Fox Los Angeles backlot. Like the rest of the US film industry, the majority of Fox’s film revenue is earned overseas.
  • FX cable channels, National Geographic cable channels (of which Fox currently owns 75%), and twenty-two regional sports networks (RSNs). In terms of relative demand for the two cable networks, FX is a popular basic cable channel, but fairly far down the list of most-watched channels, while National Geographic doesn’t even crack the top 50. Among the RSNs, only one geographic overlap exists with Comcast’s current RSNs, and most of the Fox RSNs (at least 14 of the 22) are not in areas where Comcast has a substantial service presence.
  • The deal would also entail a shift in the companies’ ownership interests in Hulu. Hulu is currently owned in equal 30% shares by Disney, Comcast, and Fox, with the remaining, non-voting 10% owned by Time Warner. Either Comcast or Disney would hold a controlling 60% share of Hulu following the deal with Fox.

Analysis of the Antitrust Risk of a Comcast/Fox Merger

According to the joint proxy statement, Fox’s board discounted Comcast’s original $34.36/share offer — but not the $28.00/share offer from Disney — because of “the level of regulatory issues posed and the proposed risk allocation arrangements.” Significantly on this basis, the Fox board determined Disney’s offer to be superior.

The claim that a merger with Comcast poses sufficiently greater antitrust risk than a purchase by Disney to warrant its rejection out of hand is unsupportable, however. From an antitrust perspective, it is even plausible that a Comcast acquisition of the Fox assets would be on more-solid ground than would be a Disney acquisition.

Vertical Mergers Generally Present Less Antitrust Risk

A merger between Comcast and Fox would be predominantly vertical, while a merger between Disney and Fox, in contrast, would be primarily horizontal. Generally speaking, it is easier to get antitrust approval for vertical mergers than it is for horizontal mergers. As Bruce Hoffman, Director of the FTC’s Bureau of Competition, noted earlier this year:

[V]ertical merger enforcement is still a small part of our merger workload….

There is a strong theoretical basis for horizontal enforcement because economic models predict at least nominal potential for anticompetitive effects due to elimination of horizontal competition between substitutes.

Where horizontal mergers reduce competition on their face — though that reduction could be minimal or more than offset by benefits — vertical mergers do not…. [T]here are plenty of theories of anticompetitive harm from vertical mergers. But the problem is that those theories don’t generally predict harm from vertical mergers; they simply show that harm is possible under certain conditions.

On its face, and consistent with the last quarter century of merger enforcement by the DOJ and FTC, the Comcast acquisition would be less likely to trigger antitrust scrutiny, and the Disney acquisition raises more straightforward antitrust issues.

This is true even in light of the fact that the DOJ decided to challenge the AT&T-Time Warner (AT&T/TWX) merger.

The AT&T/TWX merger is a single data point in a long history of successful vertical mergers that attracted little scrutiny, and no litigation, by antitrust enforcers (although several have been approved subject to consent orders).

Just because the DOJ challenged that one merger does not mean that antitrust enforcers generally, nor even the DOJ in particular, have suddenly become more hostile to vertical mergers.

Of particular importance to the conclusion that the AT&T/TWX merger challenge is of minimal relevance to predicting the DOJ’s reception in this case, the theory of harm argued by the DOJ in that case is far from well-accepted, while the potential theory that could underpin a challenge to a Disney/Fox merger is. As Bruce Hoffman further remarks:

I am skeptical of arguments that vertical mergers cause harm due to an increased bargaining skill; this is likely not an anticompetitive effect because it does not flow from a reduction in competition. I would contrast that to the elimination of competition in a horizontal merger that leads to an increase in bargaining leverage that could raise price or reduce output.

The Relatively Lower Risk of a Vertical Merger Challenge Hasn’t Changed Following the DOJ’s AT&T/Time Warner Challenge

Judge Leon is expected to rule on the AT&T/TWX merger in a matter of weeks. The theory underpinning the DOJ’s challenge is problematic (to say the least), and the case it presented was decidedly weak. But no litigated legal outcome is ever certain, and the court could, of course, rule against the merger nevertheless.

Yet even if the court does rule against the AT&T/TWX merger, this hardly suggests that a Comcast/Fox deal would create a greater antitrust risk than would a Disney/Fox merger.

A single successful challenge to a vertical merger — what would be, in fact, the first successful vertical merger challenge in four decades — doesn’t mean that the courts are becoming hostile to vertical mergers any more than the DOJ’s challenge means that vertical mergers suddenly entail heightened enforcement risk. Rather, it would simply mean that that, given the specific facts of the case, the DOJ was able to make out its prima facie case, and that the defendants were unable to rebut it.  

A ruling for the DOJ in the AT&T/TWX merger challenge would be rooted in a highly fact-specific analysis that could have no direct bearing on future cases.

In the AT&T/TWX case, the court’s decision will turn on its assessment of the DOJ’s argument that the merged firm could raise subscriber prices by a few pennies per subscriber. But as AT&T’s attorney aptly pointed out at trial (echoing the testimony of AT&T’s economist, Dennis Carlton):

The government’s modeled price increase is so negligible that, given the inherent uncertainty in that predictive exercise, it is not meaningfully distinguishable from zero.

Even minor deviations from the facts or the assumptions used in the AT&T/TWX case could completely upend the analysis — and there are important differences between the AT&T/TWX merger and a Comcast/Fox merger. True, both would be largely vertical mergers that would bring together programming and distribution assets in the home video market. But the foreclosure effects touted by the DOJ in the AT&T/TWX merger are seemingly either substantially smaller or entirely non-existent in the proposed Comcast/Fox merger.

Most importantly, the content at issue in AT&T/TWX is at least arguably (and, in fact, argued by the DOJ) “must have” programming — Time Warner’s premium HBO channels and its CNN news programming, in particular, were central to the DOJ’s foreclosure argument. By contrast, the programming that Comcast would pick up as a result of the proposed merger with Fox — FX (a popular, but non-essential, basic cable channel) and National Geographic channels (which attract a tiny fraction of cable viewing) — would be extremely unlikely to merit that designation.

Moreover, the DOJ made much of the fact that AT&T, through DirectTV, has a national distribution footprint. As a result, its analysis was dependent upon the company’s potential ability to attract new subscribers decamping from competing providers from whom it withholds access to Time Warner content in every market in the country. Comcast, on the other hand, provides cable service in only about 35% of the country. This significantly limits its ability to credibly threaten competitors because its ability to recoup lost licensing fees by picking up new subscribers is so much more limited.

And while some RSNs may offer some highly prized live sports programming, the mismatch between Comcast’s footprint and the FOX RSNs (only about 8 of the 22 Fox RSNs are in Comcast service areas) severely limits any ability or incentive the company would have to leverage that content for higher fees. Again, to the extent that RSN programming is not “must-have,” and to the extent there is not overlap between the RSN’s geographic area and Comcast’s service area, the situation is manifestly not the same as the one at issue in the AT&T/TWX merger.

In sum, a ruling in favor of the DOJ in the AT&T/TWX case would be far from decisive in predicting how the agency and the courts would assess any potential concerns arising from Comcast’s ownership of Fox’s assets.

A Comcast/Fox Deal May Entail Lower Antitrust Risk than a Disney/Fox Merger

As discussed below, concerns about antitrust enforcement risk from a Comcast/Fox merger are likely overstated. Perhaps more importantly, however, to the extent these concerns are legitimate, they apply at least as much to a Disney/Fox merger. There is, at minimum, no basis for assuming a Comcast deal would present any greater regulatory risk.

The Antitrust Risk of a Comcast/Fox Merger Is Likely Overstated

The primary theory upon which antitrust enforcers could conceivably base a Comcast/Fox merger challenge would be a vertical foreclosure theory. Importantly, such a challenge would have to be based on the incremental effect of adding the Fox assets to Comcast, and not on the basis of its existing assets. Thus, for example, antitrust enforcers would not be able to base a merger challenge on the possibility that Comcast could leverage NBC content it currently owns to extract higher fees from competitors. Rather, only if the combination of NBC programming with additional content from Fox could create a new antitrust risk would a case be tenable.

Enforcers would be unlikely to view the addition of FX and National Geographic to the portfolio of programming content Comcast currently owns as sufficient to raise concerns that the merger would give Comcast anticompetitive bargaining power or the ability to foreclose access to its content.

Although even less likely, enforcers could be concerned with the (horizontal) addition of 20th Century Fox filmed entertainment to Universal’s existing film production and distribution. But the theatrical film market is undeniably competitive, with the largest studio by revenue (Disney) last year holding only 22% of the market. The combination of 20th Century Fox with Universal would still result in a market share only around 25% based on 2017 revenues (and, depending on the year, not even result in the industry’s largest share).

There is also little reason to think that a Comcast controlling interest in Hulu would attract problematic antitrust attention. Comcast has already demonstrated an interest in diversifying its revenue across cable subscriptions and licensing, broadband subscriptions, and licensing to OVDs, as evidenced by its recent deal to offer Netflix as part of its Xfinity packages. Hulu likely presents just one more avenue for pursuing this same diversification strategy. And Universal has a history (see, e.g., this, this, and this) of very broad licensing across cable providers, cable networks, OVDs, and the like.

In the case of Hulu, moreover, the fact that Comcast is vertically integrated in broadband as well as cable service likely reduces the anticompetitive risk because more-attractive OVD content has the potential to increase demand for Comcast’s broadband service. Broadband offers larger margins (and is growing more rapidly) than cable, and it’s quite possible that any loss in Comcast’s cable subscriber revenue from Hulu’s success would be more than offset by gains in its content licensing and broadband subscription revenue. The same, of course, goes for Comcast’s incentives to license content to OVD competitors like Netflix: Comcast plausibly gains broadband subscription revenue from heightened consumer demand for Netflix, and this at least partially offsets any possible harm to Hulu from Netflix’s success.

At the same time, especially relative to Netflix’s vast library of original programming (an expected $8 billion worth in 2018 alone) and content licensed from other sources, the additional content Comcast would gain from a merger with Fox is not likely to appreciably increase its bargaining leverage or its ability to foreclose Netflix’s access to its content.     

Finally, Comcast’s ownership of Fox’s RSNs could, as noted, raise antitrust enforcers’ eyebrows. Enforcers could be concerned that Comcast would condition competitors’ access to RSN programming on higher licensing fees or prioritization of its NBC Sports channels.

While this is indeed a potential risk, it is hardly a foregone conclusion that it would draw an enforcement action. Among other things, NBC is far from the market leader, and improving its competitive position relative to ESPN could be viewed as a benefit of the deal. In any case, potential problems arising from ownership of the RSNs could easily be dealt with through divestiture or behavioral conditions; they are extremely unlikely to lead to an outright merger challenge.

The Antitrust Risk of a Disney Deal May Be Greater than Expected

While a Comcast/Fox deal doesn’t entail no antitrust enforcement risk, it certainly doesn’t entail sufficient risk to deem the deal dead on arrival. Moreover, it may entail less antitrust enforcement risk than would a Disney/Fox tie-up.

Yet, curiously, the joint proxy statement doesn’t mention any antitrust risk from the Disney deal at all and seems to suggest that the Fox board applied no risk discount in evaluating Disney’s bid.

Disney — already the market leader in the filmed entertainment industry — would acquire an even larger share of box office proceeds (and associated licensing revenues) through acquisition of Fox’s film properties. Perhaps even more important, the deal would bring the movie rights to almost all of the Marvel Universe within Disney’s ambit.

While, as suggested above, even that combination probably wouldn’t trigger any sort of market power presumption, it would certainly create an entity with a larger share of the market and stronger control of the industry’s most valuable franchises than would a Comcast/Fox deal.

Another relatively larger complication for a Disney/Fox merger arises from the prospect of combining Fox’s RSNs with ESPN. Whatever ability or incentive either company would have to engage in anticompetitive conduct surrounding sports programming, that risk would seem to be more significant for undisputed market leader, Disney. At the same time, although still powerful, demand for ESPN on cable has been flagging. Disney could well see the ability to bundle ESPN with regional sports content as a way to prop up subscription revenues for ESPN — a practice, in fact, that it has employed successfully in the past.   

Finally, it must be noted that licensing of consumer products is an even bigger driver of revenue from filmed entertainment than is theatrical release. No other company comes close to Disney in this space.

Disney is the world’s largest licensor, earning almost $57 billion in 2016 from licensing properties like Star Wars and Marvel Comics. Universal is in a distant 7th place, with 2016 licensing revenue of about $6 billion. Adding Fox’s (admittedly relatively small) licensing business would enhance Disney’s substantial lead (even the number two global licensor, Meredith, earned less than half of Disney’s licensing revenue in 2016). Again, this is unlikely to be a significant concern for antitrust enforcers, but it is notable that, to the extent it might be an issue, it is one that applies to Disney and not Comcast.

Conclusion

Although I hope to address these issues in greater detail in the future, for now the preliminary assessment is clear: There is no legitimate basis for ascribing a greater antitrust risk to a Comcast/Fox deal than to a Disney/Fox deal.

One of the hottest antitrust topics of late has been institutional investors’ “common ownership” of minority stakes in competing firms.  Writing in the Harvard Law Review, Einer Elhauge proclaimed that “[a]n economic blockbuster has recently been exposed”—namely, “[a] small group of institutions has acquired large shareholdings in horizontal competitors throughout our economy, causing them to compete less vigorously with each other.”  In the Antitrust Law Journal, Eric Posner, Fiona Scott Morton, and Glen Weyl contended that “the concentration of markets through large institutional investors is the major new antitrust challenge of our time.”  Those same authors took to the pages of the New York Times to argue that “[t]he great, but mostly unknown, antitrust story of our time is the astonishing rise of the institutional investor … and the challenge that it poses to market competition.”

Not surprisingly, these scholars have gone beyond just identifying a potential problem; they have also advocated policy solutions.  Elhauge has called for allowing government enforcers and private parties to use Section 7 of the Clayton Act, the provision primarily used to prevent anticompetitive mergers, to police institutional investors’ ownership of minority positions in competing firms.  Posner et al., concerned “that private litigation or unguided public litigation could cause problems because of the interactive nature of institutional holdings on competition,” have proposed that federal antitrust enforcers adopt an enforcement policy that would encourage institutional investors either to avoid common ownership of firms in concentrated industries or to limit their influence over such firms by refraining from voting their shares.

The position of these scholars is thus (1) that common ownership by institutional investors significantly diminishes competition in concentrated industries, and (2) that additional antitrust intervention—beyond generally applicable rules on, say, hub-and-spoke conspiracies and anticompetitive information exchanges—is appropriate to prevent competitive harm.

Mike Sykuta and I have recently posted a paper taking issue with this two-pronged view.  With respect to the first prong, we contend that there are serious problems with both the theory of competitive harm stemming from institutional investors’ common ownership and the empirical evidence that has been marshalled in support of that theory.  With respect to the second, we argue that even if competition were softened by institutional investors’ common ownership of small minority interests in competing firms, the unintended negative consequences of an antitrust fix would outweigh any benefits from such intervention.

Over the next few days, we plan to unpack some of the key arguments in our paper, The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms.  In the meantime, we encourage readers to download the paper and send us any comments.

The paper’s abstract is below the fold. Continue Reading…