Archives For merger guidelines

In a recent post at the (appallingly misnamed) ProMarket blog (the blog of the Stigler Center at the University of Chicago Booth School of Business — George Stigler is rolling in his grave…), Marshall Steinbaum keeps alive the hipster-antitrust assertion that lax antitrust enforcement — this time in the labor market — is to blame for… well, most? all? of what’s wrong with “the labor market and the broader macroeconomic conditions” in the country.

In this entry, Steinbaum takes particular aim at the US enforcement agencies, which he claims do not consider monopsony power in merger review (and other antitrust enforcement actions) because their current consumer welfare framework somehow doesn’t recognize monopsony as a possible harm.

This will probably come as news to the agencies themselves, whose Horizontal Merger Guidelines devote an entire (albeit brief) section (section 12) to monopsony, noting that:

Mergers of competing buyers can enhance market power on the buying side of the market, just as mergers of competing sellers can enhance market power on the selling side of the market. Buyer market power is sometimes called “monopsony power.”

* * *

Market power on the buying side of the market is not a significant concern if suppliers have numerous attractive outlets for their goods or services. However, when that is not the case, the Agencies may conclude that the merger of competing buyers is likely to lessen competition in a manner harmful to sellers.

Steinbaum fails to mention the HMGs, but he does point to a US submission to the OECD to make his point. In that document, the agencies state that

The U.S. Federal Trade Commission (“FTC”) and the Antitrust Division of the Department of Justice (“DOJ”) [] do not consider employment or other non-competition factors in their antitrust analysis. The antitrust agencies have learned that, while such considerations “may be appropriate policy objectives and worthy goals overall… integrating their consideration into a competition analysis… can lead to poor outcomes to the detriment of both businesses and consumers.” Instead, the antitrust agencies focus on ensuring robust competition that benefits consumers and leave other policies such as employment to other parts of government that may be specifically charged with or better placed to consider such objectives.

Steinbaum, of course, cites only the first sentence. And he uses it as a launching-off point to attack the notion that antitrust is an improper tool for labor market regulation. But if he had just read a little bit further in the (very short) document he cites, Steinbaum might have discovered that the US antitrust agencies have, in fact, challenged the exercise of collusive monopsony power in labor markets. As footnote 19 of the OECD submission notes:

Although employment is not a relevant policy goal in antitrust analysis, anticompetitive conduct affecting terms of employment can violate the Sherman Act. See, e.g., DOJ settlement with eBay Inc. that prevents the company from entering into or maintaining agreements with other companies that restrain employee recruiting or hiring; FTC settlement with ski equipment manufacturers settling charges that companies illegally agreed not to compete for one another’s ski endorsers or employees. (Emphasis added).

And, ironically, while asserting that labor market collusion doesn’t matter to the agencies, Steinbaum himself points to “the Justice Department’s 2010 lawsuit against Silicon Valley employers for colluding not to hire one another’s programmers.”

Steinbaum instead opts for a willful misreading of the first sentence of the OECD submission. But what the OECD document refers to, of course, are situations where two firms merge, no market power is created (either in input or output markets), but people are laid off because the merged firm does not need all of, say, the IT and human resources employees previously employed in the pre-merger world.

Does Steinbaum really think this is grounds for challenging the merger on antitrust grounds?

Actually, his post suggests that he does indeed think so, although he doesn’t come right out and say it. What he does say — as he must in order to bring antitrust enforcement to bear on the low- and unskilled labor markets (e.g., burger flippers; retail cashiers; Uber drivers) he purports to care most about — is that:

Employers can have that control [over employees, as opposed to independent contractors] without first establishing themselves as a monopoly—in fact, reclassification [of workers as independent contractors] is increasingly standard operating procedure in many industries, which means that treating it as a violation of Section 2 of the Sherman Act should not require that outright monopolization must first be shown. (Emphasis added).

Honestly, I don’t have any idea what he means. Somehow, because firms hire independent contractors where at one time long ago they might have hired employees… they engage in Sherman Act violations, even if they don’t have market power? Huh?

I get why he needs to try to make this move: As I intimated above, there is probably not a single firm in the world that hires low- or unskilled workers that has anything approaching monopsony power in those labor markets. Even Uber, the example he uses, has nothing like monopsony power, unless perhaps you define the market (completely improperly) as “drivers already working for Uber.” Even then Uber doesn’t have monopsony power: There can be no (or, at best, virtually no) markets in the world where an Uber driver has no other potential employment opportunities but working for Uber.

Moreover, how on earth is hiring independent contractors evidence of anticompetitive behavior? ”Reclassification” is not, in fact, “standard operating procedure.” It is the case that in many industries firms (unilaterally) often decide to contract out the hiring of low- and unskilled workers over whom they do not need to exercise direct oversight to specialized firms, thus not employing those workers directly. That isn’t “reclassification” of existing workers who have no choice but to accept their employer’s terms; it’s a long-term evolution of the economy toward specialization, enabled in part by technology.

And if we’re really concerned about what “employee” and “independent contractor” mean for workers and employment regulation, we should reconsider those outdated categories. Firms are faced with a binary choice: hire workers or independent contractors. Neither really fits many of today’s employment arrangements very well, but that’s the choice firms are given. That they sometimes choose “independent worker” over “employee” is hardly evidence of anticompetitive conduct meriting antitrust enforcement.

The point is: The notion that any of this is evidence of monopsony power, or that the antitrust enforcement agencies don’t care about monopsony power — because, Bork! — is absurd.

Even more absurd is the notion that the antitrust laws should be used to effect Steinbaum’s preferred market regulations — independent of proof of actual anticompetitive effect. I get that it’s hard to convince Congress to pass the precise laws you want all the time. But simply routing around Congress and using the antitrust statutes as a sort of meta-legislation to enact whatever happens to be Marshall Steinbaum’s preferred regulation du jour is ridiculous.

Which is a point the OECD submission made (again, if only Steinbaum had read beyond the first sentence…):

[T]wo difficulties with expanding the scope of antitrust analysis to include employment concerns warrant discussion. First, a full accounting of employment effects would require consideration of short-term effects, such as likely layoffs by the merged firm, but also long-term effects, which could include employment gains elsewhere in the industry or in the economy arising from efficiencies generated by the merger. Measuring these effects would [be extremely difficult.]. Second, unless a clear policy spelling out how the antitrust agency would assess the appropriate weight to give employment effects in relation to the proposed conduct or transaction’s procompetitive and anticompetitive effects could be developed, [such enforcement would be deeply problematic, and essentially arbitrary].

To be sure, the agencies don’t recognize enough that they already face the problem of reconciling multidimensional effects — e.g., short-, medium-, and long-term price effects, innovation effects, product quality effects, etc. But there is no reason to exacerbate the problem by asking them to also consider employment effects. Especially not in Steinbaum’s world in which certain employment effects are problematic even without evidence of market power or even actual anticompetitive harm, just because he says so.

Consider how this might play out:

Suppose that Pepsi, Coca-Cola, Dr. Pepper… and every other soft drink company in the world attempted to merge, creating a monopoly soft drink manufacturer. In what possible employment market would even this merger create a monopsony in which anticompetitive harm could be tied to the merger? In the market for “people who know soft drink secret formulas?” Yet Steinbaum would have the Sherman Act enforced against such a merger not because it might create a product market monopoly, but because the existence of a product market monopoly means the firm must be able to bad things in other markets, as well. For Steinbaum and all the other scolds who see concentration as the source of all evil, the dearth of evidence to support such a claim is no barrier (on which, see, e.g., this recent, content-less NYT article (that, naturally, quotes Steinbaum) on how “big business may be to blame” for the slowing rate of startups).

The point is, monopoly power in a product market does not necessarily have any relationship to monopsony power in the labor market. Simply asserting that it does — and lambasting the enforcement agencies for not just accepting that assertion — is farcical.

The real question, however, is what has happened to the University of Chicago that it continues to provide a platform for such nonsense?

Today the International Center for Law & Economics (ICLE) Antitrust and Consumer Protection Research Program released a new white paper by Geoffrey A. Manne and Allen Gibby entitled:

A Brief Assessment of the Procompetitive Effects of Organizational Restructuring in the Ag-Biotech Industry

Over the past two decades, rapid technological innovation has transformed the industrial organization of the ag-biotech industry. These developments have contributed to an impressive increase in crop yields, a dramatic reduction in chemical pesticide use, and a substantial increase in farm profitability.

One of the most striking characteristics of this organizational shift has been a steady increase in consolidation. The recent announcements of mergers between Dow and DuPont, ChemChina and Syngenta, and Bayer and Monsanto suggest that these trends are continuing in response to new market conditions and a marked uptick in scientific and technological advances.

Regulators and industry watchers are often concerned that increased consolidation will lead to reduced innovation, and a greater incentive and ability for the largest firms to foreclose competition and raise prices. But ICLE’s examination of the underlying competitive dynamics in the ag-biotech industry suggests that such concerns are likely unfounded.

In fact, R&D spending within the seeds and traits industry increased nearly 773% between 1995 and 2015 (from roughly $507 million to $4.4 billion), while the combined market share of the six largest companies in the segment increased by more than 550% (from about 10% to over 65%) during the same period.

Firms today are consolidating in order to innovate and remain competitive in an industry replete with new entrants and rapidly evolving technological and scientific developments.

According to ICLE’s analysis, critics have unduly focused on the potential harms from increased integration, without properly accounting for the potential procompetitive effects. Our brief white paper highlights these benefits and suggests that a more nuanced and restrained approach to enforcement is warranted.

Our analysis suggests that, as in past periods of consolidation, the industry is well positioned to see an increase in innovation as these new firms unite complementary expertise to pursue more efficient and effective research and development. They should also be better able to help finance, integrate, and coordinate development of the latest scientific and technological developments — particularly in rapidly growing, data-driven “digital farming” —  throughout the industry.

Download the paper here.

And for more on the topic, revisit TOTM’s recent blog symposium, “Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries,” here.

On Thursday, March 30, Friday March 31, and Monday April 3, Truth on the Market and the International Center for Law and Economics presented a blog symposium — Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries — discussing three proposed agricultural/biotech industry mergers awaiting judgment by antitrust authorities around the globe. These proposed mergers — Bayer/Monsanto, Dow/DuPont and ChemChina/Syngenta — present a host of fascinating issues, many of which go to the core of merger enforcement in innovative industries — and antitrust law and economics more broadly.

The big issue for the symposium participants was innovation (as it was for the European Commission, which cleared the Dow/DuPont merger last week, subject to conditions, one of which related to the firms’ R&D activities).

Critics of the mergers, as currently proposed, asserted that the increased concentration arising from the “Big 6” Ag-biotech firms consolidating into the Big 4 could reduce innovation competition by (1) eliminating parallel paths of research and development (Moss); (2) creating highly integrated technology/traits/seeds/chemicals platforms that erect barriers to new entry platforms (Moss); (3) exploiting eventual network effects that may result from the shift towards data-driven agriculture to block new entry in input markets (Lianos); or (4) increasing incentives to refuse to license, impose discriminatory restrictions in technology licensing agreements, or tacitly “agree” not to compete (Moss).

Rather than fixating on horizontal market share, proponents of the mergers argued that innovative industries are often marked by disruptions and that investment in innovation is an important signal of competition (Manne). An evaluation of the overall level of innovation should include not only the additional economies of scale and scope of the merged firms, but also advancements made by more nimble, less risk-averse biotech companies and smaller firms, whose innovations the larger firms can incentivize through licensing or M&A (Shepherd). In fact, increased efficiency created by economies of scale and scope can make funds available to source innovation outside of the large firms (Shepherd).

In addition, innovation analysis must also account for the intricately interwoven nature of agricultural technology across seeds and traits, crop protection, and, now, digital farming (Sykuta). Combined product portfolios generate more data to analyze, resulting in increased data-driven value for farmers and more efficiently targeted R&D resources (Sykuta).

While critics voiced concerns over such platforms erecting barriers to entry, markets are contestable to the extent that incumbents are incentivized to compete (Russell). It is worth noting that certain industries with high barriers to entry or exit, significant sunk costs, and significant costs disadvantages for new entrants (including automobiles, wireless service, and cable networks) have seen their prices decrease substantially relative to inflation over the last 20 years — even as concentration has increased (Russell). Not coincidentally, product innovation in these industries, as in ag-biotech, has been high.

Ultimately, assessing the likely effects of each merger using static measures of market structure is arguably unreliable or irrelevant in dynamic markets with high levels of innovation (Manne).

Regarding patents, critics were skeptical that combining the patent portfolios of the merging companies would offer benefits beyond those arising from cross-licensing, and would serve to raise rivals’ costs (Ghosh). While this may be true in some cases, IP rights are probabilistic, especially in dynamic markets, as Nicolas Petit noted:

There is no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change.

In spite of these uncertainties, deals such as the pending ag-biotech mergers provide managers the opportunity to evaluate and reorganize assets to maximize innovation and return on investment in such a way that would not be possible absent a merger (Sykuta). Neither party would fully place its IP and innovation pipeline on the table otherwise.

For a complete rundown of the arguments both for and against, the full archive of symposium posts from our outstanding and diverse group of scholars, practitioners and other experts is available at this link, and individual posts can be easily accessed by clicking on the authors’ names below.

We’d like to thank all of the participants for their excellent contributions!

John E. Lopatka is A. Robert Noll Distinguished Professor of Law at Penn State Law School

People need to eat. All else equal, the more food that can be produced from an acre of land, the better off they’ll be. Of course, people want to pay as little as possible for their food to boot. At heart, the antitrust analysis of the pending agribusiness mergers requires a simple assessment of their effects on food production and price. But making that assessment raises difficult questions about institutional competence.

Each of the three mergers – Dow/DuPont, ChemChina/Syngenta, and Bayer/Monsanto – involves agricultural products, such as different kinds of seeds, pesticides, and fertilizers. All of these products are inputs in the production of food – the better and cheaper are these products, the more food is produced. The array of products these firms produce invites potentially controversial market definition determinations, but these determinations are standard fare in antitrust law and economics, and conventional analysis handles them tolerably well. Each merger appears to pose overlaps in some product markets, though they seem to be relatively small parts of the firms’ businesses. Traditional merger analysis would examine these markets in properly defined geographic markets, some of which are likely international. The concern in these markets seems to be coordinated interaction, and the analysis of potential anticompetitive coordination would thus focus on concentration and entry barriers. Much could be said about the assumption that product markets perform less competitively as concentration increases, but that is an issue for others or at least another day.

More importantly for my purposes here, to the extent that any of these mergers creates concentration in a market that is competitively problematic and not likely to be cured by new entry, a fix is fairly easy. These are mergers in which asset divestiture is feasible, in which the parties seem willing to divest assets, and in which interested and qualified asset buyers are emerging. To be sure, firms may be willing to divest assets at substantial cost to appease regulators even when competitive problems are illusory, and the cost of a cure in search of an illness is a real social cost. But my concern lies elsewhere.

The parties in each of these mergers have touted innovation as a beneficial byproduct of the deal if not its raison d’être. Innovation effects have made their way into merger analysis, but not smoothly. Innovation can be a kind of efficiency, distinguished from most other efficiencies by its dynamic nature. The benefits of using a plant to its capacity are immediate: costs and prices decrease now. Any benefits of innovation will necessarily be experienced in the future, and the passage of time makes benefits both less certain and less valuable, as people prefer consumption now rather than later. The parties to these mergers in their public statements, to the extent they intend to address antitrust concerns, are implicitly asserting innovation as a defense, a kind of efficiency defense. They do not concede, of course, that their deals will be anticompetitive in any product market. But for antitrust purposes, an accelerated pace of innovation is irrelevant unless the merger appears to threaten competition.

Recognizing increased innovation as a merger defense raises all of the issues that any efficiencies defense raises, and then some. First, can efficiencies be identified?  For instance, patent portfolios can be combined, and the integration of patent rights can lower transaction costs relative to a contractual allocation of rights just as any integration can. In theory, avenues of productive research may not even be recognized until the firms’ intellectual property is combined. A merger may eliminate redundant research efforts, but identifying that which is truly duplicative is often not easy. In all, identifying efficiencies related to research and development is likely to be more difficult than identifying many other kinds of efficiencies. Second, are the efficiencies merger-specific?  The less clearly research and development efficiencies can be identified, the weaker is the claim that they cannot be achieved absent the merger. But in this respect, innovation efficiencies can be more important than most other kinds of efficiencies, because intellectual property sometimes cannot be duplicated as easily as physical property can. Third, can innovation efficiencies be quantified?  If innovation is expected to take the form of an entirely new product, such as a new pesticide, estimating its value is inherently speculative. Fourth, when will efficiencies save a merger that would otherwise be condemned?  An efficiencies defense implies a comparison between the expected harm a merger will cause and the expected benefits it will produce. Arguably those benefits have to be realized by consumers to count at all, but, in any event, a comparison between expected immediate losses of customers in an input market and expected future gains from innovation may be nearly impossible to make. The Merger Guidelines acknowledge that innovation efficiencies can be considered and note many of the concerns just listed. The takeaway is a healthy skepticism of an innovation defense. The defense should generally fail unless the model of anticompetitive harm in product (or service) markets is dubious or the efficiency claim is unusually specific and the likely benefits substantial.

Innovation can enter merger analysis in an even more troublesome way, however: as a club rather than a shield. The Merger Guidelines contemplate that a merger may have unilateral anticompetitive effects if it results in a “reduced incentive to continue with an existing product-development effort or reduced incentive to initiate development of new products.”  The stark case is one in which a merger poses no competitive problem in a product market but would allegedly reduce innovation competition. The best evidence that the elimination of innovation competition might be a reason to oppose one or more of the agribusiness mergers is the recent decision of the European Commission approving the Dow/DuPont merger, subject to various asset divestitures. The Commission, echoing the Guidelines, concluded that the merger would significantly reduce “innovation competition for pesticides” by “[r]emoving the parties’ incentives to continue to pursue ongoing parallel innovation efforts” and by “[r]emoving the parties’ incentives to develop and bring to market new pesticides.”  The agreed upon fix requires DuPont to divest most of its research and development organization.

Enforcement claims that a merger will restrict innovation competition should be met with every bit the skepticism due defense claims that innovation efficiencies save a merger. There is nothing inconsistent in this symmetry. The benefits of innovation, though potentially immense – large enough to dwarf the immediate allocative harm from a lessening of competition in product markets – is speculative. In discounted utility terms, the expected harm will usually exceed the expected benefits, given our limited ability to predict the future. But the potential gains from innovation are immense, and unless we are confident that a merger will reduce innovation, antitrust law should not intervene. We rarely are, at least we rarely should be.

As Geoffrey Manne points out, we still do not know a great deal about the optimal market structure for innovation. Evidence suggests that moderate concentration is most conducive to innovation, but it is not overwhelming, and more importantly no one is suggesting a merger policy that single-mindedly pursues a particular market structure. An examination of incentives to continue existing product development projects or to initiate projects to develop new products is superficially appealing, but its practical utility is elusive. Any firm has an incentive to develop products that increase demand. The Merger Guidelines suggest that a merger will reduce incentives to innovate if the introduction of a new product by one merging firm will capture substantial revenues from the other. The E.C. likely had this effect in mind in concluding that the merged entity would have “lower incentives . . . to innovate than Dow and DuPont separately.”  The Commission also observed that the merged firm would have “a lower ability to innovate” than the two firms separately, but just how a combination of research assets could reduce capability is utterly obscure.

In any event, whether a merger reduces incentives depends not only on the welfare of the merging parties but also on the development activities of actual and would-be competitors. A merged firm cannot afford to have its revenue captured by a new product introduced by a competitor. Of course, innovation by competitors will not spur a firm to develop new products if those competitors do not have the resources needed to innovate. One can imagine circumstances in which resources necessary to innovate in a product market are highly specialized; more realistically, the lack of specialized resources will decrease the pace of innovation. But the concept of specialized resources cannot mean resources a firm has developed that are conducive to innovate and that could be, but have not yet been, developed by other firms. It cannot simply mean a head start, unless it is very long indeed. If the first two firms in an industry build a plant, the fact that a new entrant would have to build a plant is not a sufficient reason to prevent the first two from merging. In any event, what resources are essential to innovation in an area can be difficult to determine.

Assuming essential resources can be identified, how many firms need to have them to create a competitive environment? The Guidelines place the number at “very small” plus one. Elsewhere, the federal antitrust agencies suggest that four firms other than the merged firm are sufficient to maintain innovation competition. We have models, whatever their limitations, that predict price effects in oligopolies. The Guidelines are based on them. But determining the number of firms necessary for competitive innovation is another matter. Maybe two is enough. We know for sure that innovation competition is non-existent if only one firm has the capacity to innovate, but not much else. We know that duplicative research efforts can be wasteful. If two firms would each spend $1 million to arrive at the same place, a merged firm might be able to invest $2 million and go twice as far or reach the first place at half the total cost. This is only to say that a merger can increase innovation efficiency, a possibility that is not likely to justify an otherwise anticompetitive merger but should usually protect from condemnation a merger that is not otherwise anticompetitive.

In the Dow/DuPont merger, the Commission found “specific evidence that the merged entity would have cut back on the amount they spent on developing innovative products.”  Executives of the two firms stated that they expected to reduce research and development spending by around $300 million. But a reduction in spending does not tell us whether innovation will suffer. The issue is innovation efficiency. If the two firms spent, say, $1 billion each on research, $300 million of which was duplicative of the other firm’s research, the merged firm could invest $1.7 billion without reducing productive effort. The Commission complained that the merger would reduce from five to four the number of firms that are “globally active throughout the entire R&D process.”  As noted above, maybe four firms competing are enough. We don’t know. But the Commission also discounts firms with “more limited R&D capabilities,” and the importance to successful innovation of multi-level integration in this industry is not clear.

When a merger is challenged because of an adverse effect on innovation competition, a fix can be difficult. Forced licensing might work, but that assumes that the relevant resource necessary to carry on research and development is intellectual property. More may be required. If tangible assets related to research and development are required, a divestiture might cripple the merged firm. The Commission remedy was to require the merged firm to divest “DuPont’s global R&D organization” that is related to the product operations that must be divested. The firm is permitted to retain “a few limited [R&D] assets that support the part of DuPont’s pesticide business” that is not being divested. In this case, such a divestiture may or may not hobble the merged firm, depending on whether the divested assets would have contributed to the research and development efforts that it will continue to pursue. That the merged firm was willing to accept the research and development divestiture to secure Commission approval does not mean that the divestiture will do no harm to the firm’s continuing research and development activities. Moreover, some product markets at issue in this merger are geographically limited, whereas the likely benefits of innovation are largely international. The implication is that increased concentration in product markets can be avoided by divesting assets to other large agribusinesses that do not operate in the relevant geographic market. But if the Commission insists on preserving five integrated firms active in global research and development activities, DuPont’s research and development activities cannot be divested to one of the other major players, which the Commission identifies as BASF, Bayer, and Syngenta, or firms with which any of them are attempting to merge, namely Monsanto and ChemChina. These are the five firms, of course, that are particularly likely to be interested buyers.

Innovation is important. No one disagrees. But the role of competition in stimulating innovation is not well understood. Except in unusual cases, antitrust institutions are ill-equipped either to recognize innovation efficiencies that save a merger threatening competition in product markets or to condemn mergers that threaten only innovation competition. Indeed, despite maintaining their prerogative to challenge mergers solely on the ground of a reduction in innovation competition, the federal agencies have in fact complained about an adverse effect on innovation in cases that also raise competitive issues in product markets. Innovation is at the heart of the pending agribusiness mergers. How regulators and courts analyze innovation in these cases will say something about whether they perceive their limitations.

Ioannis Lianos is Professor of Global Competition Law and Public Policy, UCL Faculty of Laws and Chief Researcher, HSE-Skolkovo Institute for Law and Development

The recently notified mergers in the seed and agro-chem industry raise difficult questions that competition authorities around the world would need to tackle in the following months. Because of the importance of their markets’ size, the decision reached by US and EU competition authorities would be particularly significant for the merging parties, but the perspective of a number of other competition authorities in emerging and developing economies, in particular the BRICS, will also play an important role if the transactions are to move forward.

The factors of production segment of the food value chain, which has been the focus of most recent merger activity, has been marked by profound transformations the last three decades. One may note the development of new technologies, starting with deliberate hybridization to marker-assisted breeding and the most recent advances in genetic engineering or genetic editing with CRISPR/Cas technology, as well as the advent of “digital agriculture” and “precision farming”. These technologies are of course protected by IP rights consisting of patents, plant variety rights, trademarks, trade secrets, and geographical indications.

These IP rights enable seed companies to prevent farmers from saving seeds of the protected variety, sharing it with their neighbours or selling it informally (“brown bagging”), but also to prevent competing plant breeders from using a protected variety in the development of a new variety (cumulative innovation), as well as to prevent competing seed producers from multiplying and marketing the protected variety without a license or using a protected product name and logos. Seed laws requiring compulsory seed certification with the aim to police seed quality also offer some form of protection to breeders, in the absence of IPRs.

Technology-driven growth has not been the only major transformation of this economic sector. Its consolidation, in particular in the factors of production segment, has been particularly important in recent years.

The consolidation of the factors of production segment

Concentration in the world and EU markets for seeds

In the seeds sector, a number of merger waves, starting in the mid-1980s, have led to the emergence of a relatively concentrated market structure of 6 big players thirty years later (Monsanto, Syngenta, DuPont, BASF, Bayer, and Dow).

The most recent merger wave started in July 2014 when Monsanto made a number of acquisition offers to Syngenta. These offers were rejected, but the Monsanto bid triggered a number of other M&A transactions that were announced in 2015 and 2016 between the various market leaders in the factors of production segment. In November 2015, Syngenta accepted the offer of ChemChina (which owns ADAMA, one of the largest agrochemical companies in the world). In December 2015, Dupont and Dow announced their merger. In September 2016, Bayer put forward a merger deal with Monsanto. During the same month, a deal was announced between two of the leaders in the market for fertilizers, Potash Corp and Agrium. In November 2015, it was reported that Deere & Co. (the leader in agricultural machinery) had agreed to buy Monsanto’s precision farming business. This deal was opposed by the US Department of Justice as it would have led Deere to control a significant part of the already highly concentrated US high-speed precision planting systems market.

The level of concentration varies according to the geographical market and the type of crop. If one looks at the situation in Europe, with regard to the sale of seeds, the market appears to be less concentrated than the global seed market. The picture is also slightly different for certain types of crop. For instance, it is reported that the seed market for sugar beets shows the largest concentration, with the first three companies (CR3) controlling a staggering 79% of the market (HHI: 2444), while for Maize seeds CR3 is 56% (HHI: 1425). High levels of concentration are also noted in the market for tomato seeds with Monsanto controlling 20% of registered seed varieties. What is more striking, however, is the speed of this consolidation process, as the bulk of this increase in the concentration level of the industry occurred in the last twenty years, the levels of concentration in the mid-1990s being close to those in 1985.

But the existence of a relatively concentrated market constitutes the tip of a much bigger consolidation iceberg between the market leaders that takes various forms: joint ventures, various cross-licensing and trait licensing agreements between the “Big Six”, distribution agreements, collaborations, research agreements and R&D strategic alliances, patent litigation settlements, to which one may add the recently concluded post-patent genetic trait agreements. Furthermore, one may not exclude the possibility of consolidation by stealth, in view of the important growth in common ownership in various sectors of the economy, as institutional investors simultaneously hold large blocks of other same-industry firms.

Which concentration level will be considered for merger purposes?

Market structure and concentration is, of course, just one step in the assessment of mergers and should be followed by a more thorough analysis of the possible anticompetitive effects and efficiencies, if the level of concentration resulting from the merger raises concerns. While the EU market for seeds could not be characterized as highly concentrated before this most recent merger wave, if one applies the conventional HHI measure, it remains possible that if the mergers first notified to the European Commission are approved without conditions with regard to seed markets, the concentration level that the Commission will consider when assessing the following notified merger will respectively increase. One may project that, as the Dow/Dupont merger has been recently cleared without conditions relating to the seed industry, it will be more difficult for the ChemChina/Syngenta merger to be approved without conditions, and even more so for the Bayer/Monsanto merger that will be the last one examined. Indeed, as the Commission made clear in its press release announcing its decision on the Dow/Dupont transaction,

The Commission examines each case on its own merits. In line with its case practice, the Commission assesses parallel transactions according to the so-called “priority rule” – first come, first served. The assessment of the merger between Dow and DuPont has been based on the currently prevailing market situation.

The assessment as to whether a merger would give rise to a Significant Impediment of Effective Competition (SIEC) is based on a counterfactual analysis where the post-merger scenario is compared to a hypothetical scenario absent the merger in question. The latter is normally taken to be the same as the situation before the merger is consummated. However, the Commission may take into account future changes to the market that can “reasonably be foreseen”. The identification of the proper counterfactual can be complicated by the fact that there can be more than one merger occurring in parallel in the same relevant market. Under the mandatory notification regime, the Commission does not factor into the counterfactual analysis a merger notified after the one under assessment. On the basis of the identified counterfactual, the Commission then proceeds with the definition of the relevant product and geographic market. That means that when assessing the Dow/Dupont merger, the Commission did not take into account the (future) market situation that would result from the notified merger between ChemChina and Syngenta, which was a known fact during the period of the assessment of the Dow/Dupont merger, as this was notified a few months after the notification of the Dow/Dupont transaction.

Explaining concentration levels

The consolidation of the industry may be explained by various factors at play. One may put forward a “natural” causes explanation, in view of the existence of endogenous sunk costs that may lead to a reduction in the number of firms active in this industry. John Sutton has famously argued that high concentration may persist in many manufacturing industries, even in the presence of a substantial increase in demand and output, when firms in the industry decide to incur, in addition to “exogenous sunk costs”, that is the costs that any firm will have to incur upon entry into the market, “endogenous sunk costs”, which include cost for R&D and other process innovations, with the aim to increase their price-cost margin. If all firms invest in endogenous sunk costs, in the long run this investment will produce little or no profit, as the competitive advantage gained by each firm’s investment will be largely ineffective if all other firms make a similar investment. This may lead to a fall in the industry’s profitability in the long-term and to a concentrated market. The recent consolidation movement in the industry may also be understood as a way to deal with externalities arising out of the expansion of the IP protection in recent decades.

Consolidation may also occur because of the merging companies’ quest for market share by purchasing potential competition, acquiring local market leaders or companies with diversified distribution networks and an established customer base. Market leaders may also strive to constitute one-stop shop platforms for farmers, combining an offering of seeds, traits, and chemicals, that would enhance the farmers’ technological dependence vis-à-vis large agrochemical and seed companies.

These large agro-chem groups forming a tight oligopoly will be able to exploit eventual network effects that may result from the shift towards data-driven agriculture and to block new entry in the factors of production markets. It is increasingly clear that market players in this industry have made the choice of positioning themselves as fully integrated providers, or the orchestrators/partners of an established network, offering a package of genetic transformation technology and genomics, traits, seeds, and chemicals. One may argue that this package of ‘complementary’ products and technologies may form a system competing with other systems (‘systems competition’). A question that would need to be tackled, when assessing the plausibility of the “system competition” thesis, would be to determine the existence of distinct relevant markets affected by the mergers. Could research, breeding and development/marketing of the various kinds of seeds be considered as part of the same or of different relevant markets? I address this question and the effects of these mergers on output, prices, and consumer choice in more detail in a separate paper (I. Lianos & D. Katalevsky, Merger Activity in the Factors of Production Segments of the Food Value Chain: A Critical Assessment (forthcoming)).

Theories and assessment of harm to innovation

Because of space constraints, I will only focus here on the assessment of the possible effects of these mergers on innovation. The emergence of integrated technology/traits/seeds/chemicals platforms may place barriers to new entry, as companies wishing to enter the market(s) would need to offer an integrated solution to farmers. This may stifle disruptive innovation if, in the absence of the merger, firms were able to enter one or two segments of the market (e.g. research and breeding) without the need to offer an “integrated” platform product. One should also take note of the fact that although traditional breeding methods required important resources and a considerable investment of time (because of long breeding cycles) and thus provided large economies of scale leading to the emergence of large market players, the latest genome-editing technologies, particularly CRISPR/Cas, may constitute more efficient and less resource intensive and time-consuming breeding methods, that offer opportunities for the emergence of more competitive and less integrated market structures in the traits/seeds segment(s).

Assessing the effects on innovation will be a crucial part of the merger assessment, for the European Commission as well as for all other competition authorities with jurisdiction to examine the specific merger(s). It is true that the EU market is mainly a conventional seed market, and not a GM seeds market, but it is also clear that all of the Big Six have an integrated strategy for R&D for all types of crops, working on “traditional” marker-assisted breeding, or the more recent forms of predictive breeding that have become commercially possible with the reduction of the cost of genome sequencing and the use of IT, but also on genetically engineered seeds. Assessing the possible effects of each merger on innovation will be a quite complex exercise in view of the need to focus not only on existing technologies but also on the possibility of new technologies emerging in the future.

Competition authorities may use different methodologies to assess these future effects: the definition of innovation markets as it is the case in the US, or a more general assessment of the existence of an effect on innovation constituting a SIEC in Europe. In its recent decision on the Dow/Dupont merger, the European Commission found that the merger may have reduced innovation competition for pesticides by looking to the ability and the incentive of the parties to innovate. The Commission emphasised that this analysis was not general but was based on “specific evidence that the merged entity would have lower incentives and a lower ability to innovate than Dow and DuPont separately” and “that the merged entity would have cut back on the amount they spent on developing innovative products”. That said, the Commission also mentioned the following, which I think may be of relevance to the competition assessment of the other pending mergers:

Only five companies (BASF, Bayer, Syngenta and the merging parties) are globally active throughout the entire R&D process, from discovery of new active ingredients (molecules producing the desired biological effect), their development, testing and regulatory registration, to the manufacture and sale of final formulated products through national distribution channels. Other competitors have no or more limited R&D capabilities (e.g. as regards geographic focus or product range). After the merger, only three global integrated players would remain to compete with the merged company, in an industry with very high barriers to entry. The number of players active in specific innovation areas would be even lower than at the overall industry level.

This type of assessment looks close to the filter of the existence of at least four independent technologies that constitute a commercially viable alternative, in addition to the licensed technology controlled by the parties to the agreement, that the Commission usually employs in its Transfer of Technology Guidelines in order to exclude the possibility that a licensing agreement may restrict competition and thus infringe Article 101 TFEU. There is no reason why the Commission would apply a different approach in the context of merger control. The above indicate that the Commission may view more negatively mergers that lead to less than four or three independent technologies in the relevant market(s).

Hidden/Not usually considered social costs

One may also assess the mergers in the seeds and agro-chem market from a public interest perspective, in view of the broader concerns animating public policy in this context and the existence of a nexus of international commitments with regard to biodiversity, sustainability, the right to food, as well as the emphasis put by some competition law regimes on public interest analysis (e.g. South Africa). The aim will be to assess the full social costs of these transactions, to the extent, of course, this is practically possible. This may be more achievable in merger control regimes where it is not courts that make the final decisions to clear, or not to clear, the merger, as there may be limits to the adjudication of certain broader public interest concerns, but integrated competition law agencies, or branches of the executive power, as it is formally the case in the EU.

Although public interest considerations do not form part of the substantive test of EU merger control, Article 21(4) EUMR includes a legitimate interest clause, which provides that Member States may take appropriate measures to protect three specified legitimate interests: public security, plurality of the media and prudential rules, and other unspecified public interests that are recognised by the Commission after notification by the Member State. If a Member State wishes to claim an additional legitimate interest, other than the ones listed above, it shall communicate this to the Commission. And the Commission must then decide, within 25 working days, whether the additional interest is compatible with EU law, and qualifies as an article 21(4) legitimate interest. This should not be excluded a priori, in particular in view of the importance of biodiversity, environmental protection, and employment in the EU treaties as well as broader international commitments to the right to food.

Food production is, of course, an area of great economic and geopolitical importance. According to UN estimates, by 2050 the world population will increase to nine billion, and catering to this additional demand would require an increase of 70% more food. This puts a strong pressure to increase output, which intensifies even more environmental impact, given increasing sustainability challenges (degradation of soil and reduction of arable land due to urban sprawl, water scarcity, biofuel consumption, climate change, etc.). Food security becomes an increasingly important issue on the agenda of the developing world.

The projected mergers in the seed and agro-chem industry will greatly affect the future control of food production and innovation in order to improve yields and feed the world. One may ask if such important decisions should be based on a narrowly confined test that mostly focuses on effects on output, price and to a certain extent innovation, or if one should adopt a broader consideration of the full social costs of such transactions, to the extent that these may be assessed and eventually quantified.

This may have the additional benefit to enable the participation in the merger process as third parties of a number of NGOs representing broader citizens’ interests in environmental protection and biodiversity, which is currently impossible with the quite narrow procedural requirements for third party intervenors in EU merger control (as the test for admission as third party intervenors is usually met only by competitors, suppliers, and customers). I think that all the affected interests and stakeholders should be offered an opportunity to participate in the decision-making process, thus increasing its efficiency (if one takes a participation-centred approach) and legitimacy, in particular for matters of major social importance as is the control of the global food supply chain(s).

It may be argued, if one takes a pessimistic, Malthusian perspective, that we are doomed to face famine and malnutrition, unless considerable amounts of investment are made in R&D in this sector. In view of the fall of public investments and the important role private investments have played in this area, one may argue that higher levels of consolidation in the sector could lead to higher profitability (at the expense of farmers) without necessarily leading to immediate effects on food prices, as the farming segment is driven by atomistic competition in most markets, and therefore farmers will not have the ability to pass on, at least in the short term, the eventual overcharges to the final consumers. Of course, such an approach may not factor in the effects of these mergers to the livelihood of around half a billion farmers in the world and their families, most of whom do not benefit from subsidies guaranteeing an acceptable standard of living.

It also assumes that higher profitability would lead to higher investments in R&D, a claim that has been recently questioned by research indicating that large firms prefer to retain earnings and distribute them to shareholders and the management rather than invest them in R&D. But, more generally, a simple question that one may ask is “are the projected mergers necessary in order to promote innovation in this sector”? Answering this question may bring a great sense of clarity as to the various dimensions of these mergers competition authorities would need to take into account. And the burden of proof to provide a convincing answer to this question remains on the notifying parties!

Diana L. Moss is President of the American Antitrust Institute

Innovation Competition in the Spotlight

Innovation is more and more in the spotlight as questions grow about concentration and declining competition in the U.S. economy. These questions come not only from advocates for more vigorous competition enforcement but also, increasingly, from those who adhere to the school of thought that consolidation tends to generate procompetitive efficiencies. On March 27th, the European Commission issued its decision approving the Dow-DuPont merger, subject to divestitures of DuPont’s global R&D agrichemical assets to preserve price and innovation competition.

Before we read too much into what the EU decision in Dow-DuPont means for merger review in the U.S., remember that agriculture differs markedly across regions. Europe uses very little genetically modified (or transgenic) seed, whereas row crop acreage in the U.S. is planted mostly with it. This cautions against drawing major implications of the EU’s decision across jurisdictions.

This post unpacks the mergers of Dow-DuPont and Monsanto-Bayer in the U.S. and what they mean for innovation competition.

A Troubled Landscape? Past Consolidation in Agricultural Biotechnology

If approved as proposed, the mergers of Dow-DuPont and Monsanto-Bayer would reduce the field of Big 6 agricultural biotechnology (ag-biotech) firms to the Big 4. This has raised concerns about potentially higher prices for traits, seeds, and agrichemicals, less choice, and less innovation. The two mergers would make a 3rd wave of consolidation in the industry since the mid-1980s, when transgenic technology first emerged. Past consolidation has materially affected the structure of the markets. This is particularly true in crop seed, where relative to other agricultural input sectors, the level of concentration (and increases in concentration) over time is the highest.

Growers and consumers feel the effects of these changes. Consumers pay attention to their choices at the grocery store, which have arguably diminished and for which they pay prices that have risen at rates in excess of inflation. And the states in which agriculture is a major economic activity worry about their growers and the prices they pay for transgenic seed, agrichemicals, and fertilizers. Farmers we spoke to note, for example, that weeds that are resistant to the herbicide Roundup have evolved over time, making it no longer as effective as it once was. Dependence on seed and chemical cropping systems with declining effectiveness (due to resistance) has been met by the industry with newer and more expensive traited seed and different agrichemicals. With consolidation, these alternatives have dwindled.

These are not frivolous concerns. Empirical evidence shows that “technology fees” on transgenic corn, soybean, and cotton seed make up a significant proportion of total seed costs. The USDA notes that the prices of farm inputs, led by crop seed, generally have risen faster over the last 20 years than the prices farmers have received for their commodities. Moreover, seed price increases have outpaced yield increases over time. And finally, the USDA has determined that increasing levels of concentration in agricultural input markets (including crop seed) are no longer generally associated with higher R&D or a permanent rise in R&D intensity.

Putting the Squeeze on Growers and Consumers

The “squeeze” on growers and consumers highlights the fact that ag-biotech innovation comes at an increasingly higher price – a price that many worry will increase if the Dow-DuPont and Monsanto-Bayer mergers go through. These concerns are magnified by the structure of the food supply chain where we see a lot of growers and consumers at either end but not a lot of competition in the middle. In the middle are the ag-biotech firms that innovate traits, seeds, and agrichemicals; food processors such as grain millers and meatpackers; food manufacturers; distributors; and retail grocers.

Almost every sector has been affected by significant consolidation over the last two decades, some of which has been blocked, but a lot of which has not. For example, U.S. antitrust enforcers stopped the mergers of beef packers JBS and National Beef and broadline food distributors Sysco and USFoods. But key mergers that many believed raised significant competitive concerns went through, including Tyson-Hillshire Brands (pork), ConAgra-Horizon Mills (flour), Monsanto-Delta & Pine Land (cotton), and Safeway-Albertsons (grocery).

Aside from concerns over price, quality, and innovation, consolidation in “hourglass” shaped supply chains raises other issues. For example, it is often motivated by incentives to bulk up to bargain more effectively vis-a-vis more powerful input suppliers or customers. As we have seen with health care providers and health insurers, mergers for this purpose can trigger further consolidation, creating a domino effect. A bottlenecked supply chain also decreases resiliency. With less competition, it is more exposed to exogenous shocks such as bioterrorism or food-borne disease. That’s a potential food security problem.

Innovation Competition and the Agricultural Biotechnology Mergers

The Dow-DuPont and Monsanto-Bayer merger proposals raise a number of issues. One is significant overlap in seed, likely to result in a duopoly in corn and soybeans and a dominant firm (Monsanto) in cotton. A second concern is that the mergers would create or enhance substantial vertical integration. Where some arguments for integration can carry weight in a Guidelines analysis, here there is economic evidence from soybeans and cotton indicating that prices tend to be higher under vertical integration than under cross-licensing arrangements.

Moreover, the “platforms” resulting from the mergers are likely to be engineered for the purpose of creating exclusive packages of traits, seeds, and agrichemicals that are less likely to interoperate with rival products. This could raise entry barriers for smaller innovators and reduce or cut off access to resources needed to compete effectively. Indeed, one farmer noted the constraint of being locked into a single traits-seeds-chemicals platform in a market with already limited competition “[I] can’t mix chemicals with other companies’ products to remedy Roundup resistance.”

A third concern raised by the mergers is the potential elimination of competition in innovation markets. The DOJ/FTC Horizontal Merger Guidelines (§6.4) note that a merger may diminish innovation competition through curtailment of “innovative efforts below the level that would prevail in the absence of the merger.” This is especially the case when the merging firms are each other’s close competitors (e.g., as in the DOJ’s case against Applied Materials and Tokyo Electron). Dow, DuPont, Monsanto, and Bayer are four of only six ag-biotech rivals.

Preserving Parallel Path R&D Pipelines

In contrast to arguments that the mergers would combine only complementary assets, the R&D pipelines for all four firms show overlaps in major areas of traits, seeds, and crop protection. This supports the notion that the R&D pipelines compete head-to-head for technology intended for commercialization in U.S. markets. Maintaining competition in R&D ensures incentives remain strong to continue existing and prospective product development programs. This is particularly true in industries like ag-biotech (and pharma) where R&D is risky, regulatory approvals take time, and commercial success depends on crop planning and switching costs.

Maintaining Pro-Competitive Incentives to Cross-License Traits

Perhaps more important is that innovation in ag-biotech depends on maintaining a field of rivals, each with strong pro-competitive incentives to collaborate to form new combined (i.e., “stacked”) trait profiles. Farmers benefit most when there are competing stacks to choose from. About 60% of all stacks on the market in 2009 were the result of joint venture cross-licensing collaborations across firms. And the traits innovated by Dow, DuPont, Monsanto, and Bayer account for over 80% of traits in those stacks. That these companies are important innovators is apparent in GM Crop Database data for genetic corn, soybean and cotton “events” approved in the U.S. From 1991-2014, for example, the four companies account for a significant proportion of innovation in important genetic events.

Competition maximizes the potential for numerous collaborations. It also minimizes incentives to refuse to license, to impose discriminatory restrictions in technology licensing agreements, or to tacitly “agree” not to compete. Such agreements could range from deciding which firms specialize in certain crops or traits, to devising market “rules,” such as cross-licensing terms and conditions. All of this points to the importance of maintaining multiple, parallel R&D pipelines, a notion that was central to the EU’s decision in Dow-DuPont.

Remedies or Not? Preserving Innovation Competition

The DOJ has permitted two major ag-biotech mergers in the last decade, Monsanto’s mergers with DeKalb (corn) and Delta & Pine Land (cotton). In crafting remedies in both cases, the DOJ recognized the importance of innovation markets by fashioning remedies that focused on licensing or divesting patented technologies. The proposed mergers of Dow-DuPont and Monsanto-Bayer appear to be a different animal. They would reduce an already small field of large, integrated competitors, raise competitive concerns that have more breadth and complexity than in previous mergers, and are superimposed on growing evidence that transgenic technology has come at a higher and higher a price.Add to this the fact that a viable buyer of any divestiture R&D asset would be difficult to find outside the Big 6. Such a buyer would need to be national, if not global, in scale and scope in order to compete effectively

Add to this the fact that a viable buyer of any divestiture R&D asset would be difficult to find outside the Big 6. Such a buyer would need to be national, if not global, in scale and scope in order to compete effectively post-merger. Lack of scale and scope in R&D, financing, marketing, and distribution would necessitate cobbling together a package of assets to create and potentially prop up a national competitor. While the EU managed to pull this off, it is unclear whether the fact pattern in the U.S. would support a similar outcome. What we do know is that past mergers in the food and agriculture space have squeezed growers and consumers. Unless adequately addressed, these mega-deals stand to squeeze them even more.

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

Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries

March 30 & 31, 2017

Earlier this week the European Commission cleared the merger of Dow and DuPont, subject to conditions including divestiture of DuPont’s “global R&D organisation.” As the Commission noted:

The Commission had concerns that the merger as notified would have reduced competition on price and choice in a number of markets for existing pesticides. Furthermore, the merger would have reduced innovation. Innovation, both to improve existing products and to develop new active ingredients, is a key element of competition between companies in the pest control industry, where only five players are globally active throughout the entire research & development (R&D) process.

In addition to the traditional focus on price effects, the merger’s presumed effect on innovation loomed large in the EC’s consideration of the Dow/DuPont merger — as it is sure to in its consideration of the other two pending mergers in the agricultural biotech and chemicals industries between Bayer and Monsanto and ChemChina and Syngenta. Innovation effects are sure to take center stage in the US reviews of the mergers, as well.

What is less clear is exactly how antitrust agencies evaluate — and how they should evaluate — mergers like these in rapidly evolving, high-tech industries.

These proposed mergers present a host of fascinating and important issues, many of which go to the core of modern merger enforcement — and antitrust law and economics more generally. Among other things, they raise issues of:

  • The incorporation of innovation effects in antitrust analysis;
  • The relationship between technological and organizational change;
  • The role of non-economic considerations in merger review;
  • The continued relevance (or irrelevance) of the Structure-Conduct-Performance paradigm;
  • Market definition in high-tech markets; and
  • The patent-antitrust interface

Beginning on March 30, Truth on the Market and the International Center for Law & Economics will host a blog symposium discussing how some of these issues apply to these mergers per se, as well as the state of antitrust law and economics in innovative-industry mergers more broadly.

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:

  • Allen Gibby, Senior Fellow for Law & Economics, International Center for Law & Economics
  • Shubha Ghosh, Crandall Melvin Professor of Law and Director of the Technology Commercialization Law Program, Syracuse University College of Law
  • Ioannis Lianos,  Chair of Global Competition Law and Public Policy, Faculty of Laws, University College London
  • John E. Lopatka (tent.), A. Robert Noll Distinguished Professor of Law, Penn State Law
  • Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Diana L. Moss, President, American Antitrust Institute
  • Nicolas Petit, Professor of Law, Faculty of Law, and Co-director, Liege Competition and Innovation Institute, University of Liege
  • Levi A. Russell, Assistant Professor, Agricultural & Applied Economics, University of Georgia
  • Joanna M. Shepherd, Professor of Law, Emory University School of Law
  • Michael Sykuta, Associate Professor, Agricultural and Applied Economics, and Director, Contracting Organizations Research Institute, University of Missouri

Initial contributions to the symposium will appear periodically on the 30th and 31st, and the discussion will continue with responsive posts (if any) next week. We hope to generate a lively discussion, and readers are invited to contribute their own thoughts in comments to the participants’ posts.

The symposium posts will be collected here.

We hope you’ll join us!

I just posted a new ICLE white paper, co-authored with former ICLE Associate Director, Ben Sperry:

When Past Is Not Prologue: The Weakness of the Economic Evidence Against Health Insurance Mergers.

Yesterday the hearing in the DOJ’s challenge to stop the Aetna-Humana merger got underway, and last week phase 1 of the Cigna-Anthem merger trial came to a close.

The DOJ’s challenge in both cases is fundamentally rooted in a timeworn structural analysis: More consolidation in the market (where “the market” is a hotly-contested issue, of course) means less competition and higher premiums for consumers.

Following the traditional structural playbook, the DOJ argues that the Aetna-Humana merger (to pick one) would result in presumptively anticompetitive levels of concentration, and that neither new entry not divestiture would suffice to introduce sufficient competition. It does not (in its pretrial brief, at least) consider other market dynamics (including especially the complex and evolving regulatory environment) that would constrain the firm’s ability to charge supracompetitive prices.

Aetna & Humana, for their part, contend that things are a bit more complicated than the government suggests, that the government defines the relevant market incorrectly, and that

the evidence will show that there is no correlation between the number of [Medicare Advantage organizations] in a county (or their shares) and Medicare Advantage pricing—a fundamental fact that the Government’s theories of harm cannot overcome.

The trial will, of course, feature expert economic evidence from both sides. But until we see that evidence, or read the inevitable papers derived from it, we are stuck evaluating the basic outlines of the economic arguments based on the existing literature.

A host of antitrust commentators, politicians, and other interested parties have determined that the literature condemns the mergers, based largely on a small set of papers purporting to demonstrate that an increase of premiums, without corresponding benefit, inexorably follows health insurance “consolidation.” In fact, virtually all of these critics base their claims on a 2012 case study of a 1999 merger (between Aetna and Prudential) by economists Leemore Dafny, Mark Duggan, and Subramaniam Ramanarayanan, Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry, as well as associated testimony by Prof. Dafny, along with a small number of other papers by her (and a couple others).

Our paper challenges these claims. As we summarize:

This white paper counsels extreme caution in the use of past statistical studies of the purported effects of health insurance company mergers to infer that today’s proposed mergers—between Aetna/Humana and Anthem/Cigna—will likely have similar effects. Focusing on one influential study—Paying a Premium on Your Premium…—as a jumping off point, we highlight some of the many reasons that past is not prologue.

In short: extrapolated, long-term, cumulative, average effects drawn from 17-year-old data may grab headlines, but they really don’t tell us much of anything about the likely effects of a particular merger today, or about the effects of increased concentration in any particular product or geographic market.

While our analysis doesn’t necessarily undermine the paper’s limited, historical conclusions, it does counsel extreme caution for inferring the study’s applicability to today’s proposed mergers.

By way of reference, Dafny, et al. found average premium price increases from the 1999 Aetna/Prudential merger of only 0.25 percent per year for two years following the merger in the geographic markets they studied. “Health Insurance Mergers May Lead to 0.25 Percent Price Increases!” isn’t quite as compelling a claim as what critics have been saying, but it’s arguably more accurate (and more relevant) than the 7 percent price increase purportedly based on the paper that merger critics like to throw around.

Moreover, different markets and a changed regulatory environment alone aren’t the only things suggesting that past is not prologue. When we delve into the paper more closely we find even more significant limitations on the paper’s support for the claims made in its name, and its relevance to the current proposed mergers.

The full paper is available here.

As regulatory review of the merger between Aetna and Humana hits the homestretch, merger critics have become increasingly vocal in their opposition to the deal. This is particularly true of a subset of healthcare providers concerned about losing bargaining power over insurers.

Fortunately for consumers, the merger appears to be well on its way to approval. California recently became the 16th of 20 state insurance commissions that will eventually review the merger to approve it. The U.S. Department of Justice is currently reviewing the merger and may issue its determination as early as July.

Only Missouri has issued a preliminary opinion that the merger might lead to competitive harm. But Missouri is almost certain to remain an outlier, and its analysis simply doesn’t hold up to scrutiny.

The Missouri opinion echoed the Missouri Hospital Association’s (MHA) concerns about the effect of the merger on Medicare Advantage (MA) plans. It’s important to remember, however, that hospital associations like the MHA are not consumer advocacy groups. They are trade organizations whose primary function is to protect the interests of their member hospitals.

In fact, the American Hospital Association (AHA) has mounted continuous opposition to the deal. This is itself a good indication that the merger will benefit consumers, in part by reducing hospital reimbursement costs under MA plans.

More generally, critics have argued that history proves that health insurance mergers lead to higher premiums, without any countervailing benefits. Merger opponents place great stock in a study by economist Leemore Dafny and co-authors that purports to show that insurance mergers have historically led to seven percent higher premiums.

But that study, which looked at a pre-Affordable Care Act (ACA) deal and assessed its effects only on premiums for traditional employer-provided plans, has little relevance today.

The Dafny study first performed a straightforward statistical analysis of overall changes in concentration (that is, the number of insurers in a given market) and price, and concluded that “there is no significant association between concentration levels and premium growth.” Critics never mention this finding.

The study’s secondary, more speculative, analysis took the observed effects of a single merger — the 1999 merger between Prudential and Aetna — and extrapolated for all changes in concentration (i.e., the number of insurers in a given market) and price over an eight-year period. It concluded that, on average, seven percent of the cumulative increase in premium prices between 1998 and 2006 was the result of a reduction in the number of insurers.

But what critics fail to mention is that when the authors looked at the actual consequences of the 1999 Prudential/Aetna merger, they found effects lasting only two years — and an average price increase of only one half of one percent. And these negligible effects were restricted to premiums paid under plans purchased by large employers, a critical limitation of the studies’ relevance to today’s proposed mergers.

Moreover, as the study notes in passing, over the same eight-year period, average premium prices increased in total by 54 percent. Yet the study offers no insights into what was driving the vast bulk of premium price increases — or whether those factors are still present today.  

Few sectors of the economy have changed more radically in the past few decades than healthcare has. While extrapolated effects drawn from 17-year-old data may grab headlines, they really don’t tell us much of anything about the likely effects of a particular merger today.

Indeed, the ACA and current trends in healthcare policy have dramatically altered the way health insurance markets work. Among other things, the advent of new technologies and the move to “value-based” care are redefining the relationship between insurers and healthcare providers. Nowhere is this more evident than in the Medicare and Medicare Advantage market at the heart of the Aetna/Humana merger.

In an effort to stop the merger on antitrust grounds, critics claim that Medicare and MA are distinct products, in distinct markets. But it is simply incorrect to claim that Medicare Advantage and traditional Medicare aren’t “genuine alternatives.”

In fact, as the Office of Insurance Regulation in Florida — a bellwether state for healthcare policy — concluded in approving the merger: “Medicare Advantage, the private market product, competes directly with Traditional Medicare.”

Consumers who search for plans at Medicare.gov are presented with a direct comparison between traditional Medicare and available MA plans. And the evidence suggests that they regularly switch between the two. Today, almost a third of eligible Medicare recipients choose MA plans, and the majority of current MA enrollees switched to MA from traditional Medicare.

True, Medicare and MA plans are not identical. But for antitrust purposes, substitutes need not be perfect to exert pricing discipline on each other. Take HMOs and PPOs, for example. No one disputes that they are substitutes, and that prices for one constrain prices for the other. But as anyone who has considered switching between an HMO and a PPO knows, price is not the only variable that influences consumers’ decisions.

The same is true for MA and traditional Medicare. For many consumers, Medicare’s standard benefits, more-expensive supplemental benefits, plus a wider range of provider options present a viable alternative to MA’s lower-cost expanded benefits and narrower, managed provider network.

The move away from a traditional fee-for-service model changes how insurers do business. It requires larger investments in technology, better tracking of preventive care and health outcomes, and more-holistic supervision of patient care by insurers. Arguably, all of this may be accomplished most efficiently by larger insurers with more resources and a greater ability to work with larger, more integrated providers.

This is exactly why many hospitals, which continue to profit from traditional, fee-for-service systems, are opposed to a merger that promises to expand these value-based plans. Significantly, healthcare providers like Encompass Medical Group, which have done the most to transition their services to the value-based care model, have offered letters of support for the merger.

Regardless of their rhetoric — whether about market definition or historic precedent — the most vocal merger critics are opposed to the deal for a very simple reason: They stand to lose money if the merger is approved. That may be a good reason for some hospitals to wish the merger would go away, but it is a terrible reason to actually stop it.

[This post was first published on June 27, 2016 in The Hill as “Don’t believe the critics, Aetna-Humana merger a good deal for consumers“]

A number of blockbuster mergers have received (often negative) attention from media and competition authorities in recent months. From the recently challenged Staples-Office Depot merger to the abandoned Comcast-Time Warner merger to the heavily scrutinized Aetna-Humana merger (among many others), there has been a wave of potential mega-mergers throughout the economy—many of them met with regulatory resistance. We’ve discussed several of these mergers at TOTM (see, e.g., here, here, here and here).

Many reporters, analysts, and even competition authorities have adopted various degrees of the usual stance that big is bad, and bigger is even badder. But worse yet, once this presumption applies, agencies have been skeptical of claimed efficiencies, placing a heightened burden on the merging parties to prove them and often ignoring them altogether. And, of course (and perhaps even worse still), there is the perennial problem of (often questionable) market definition — which tanked the Sysco/US Foods merger and which undergirds the FTC’s challenge of the Staples/Office Depot merger.

All of these issues are at play in the proposed acquisition of British aluminum can manufacturer Rexam PLC by American can manufacturer Ball Corp., which has likewise drawn the attention of competition authorities around the world — including those in Brazil, the European Union, and the United States.

But the Ball/Rexam merger has met with some important regulatory successes. Just recently the members of CADE, Brazil’s competition authority, unanimously approved the merger with limited divestitures. The most recent reports also indicate that the EU will likely approve it, as well. It’s now largely down to the FTC, which should approve the merger and not kill it or over-burden it with required divestitures on the basis of questionable antitrust economics.

The proposed merger raises a number of interesting issues in the surprisingly complex beverage container market. But this merger merits regulatory approval.

The International Center for Law & Economics recently released a research paper entitled, The Ball-Rexam Merger: The Case for a Competitive Can Market. The white paper offers an in-depth assessment of the economics of the beverage packaging industry; the place of the Ball-Rexam merger within this remarkably complex, global market; and the likely competitive effects of the deal.

The upshot is that the proposed merger is unlikely to have anticompetitive effects, and any competitive concerns that do arise can be readily addressed by a few targeted divestitures.

The bottom line

The production and distribution of aluminum cans is a surprisingly dynamic industry, characterized by evolving technology, shifting demand, complex bargaining dynamics, and significant changes in the costs of production and distribution. Despite the superficial appearance that the proposed merger will increase concentration in aluminum can manufacturing, we conclude that a proper understanding of the marketplace dynamics suggests that the merger is unlikely to have actual anticompetitive effects.

All told, and as we summarize in our Executive Summary, we found at least seven specific reasons for this conclusion:

  1. Because the appropriately defined product market includes not only stand-alone can manufacturers, but also vertically integrated beverage companies, as well as plastic and glass packaging manufacturers, the actual increase in concentration from the merger will be substantially less than suggested by the change in the number of nationwide aluminum can manufacturers.
  2. Moreover, in nearly all of the relevant geographic markets (which are much smaller than the typically nationwide markets from which concentration numbers are derived), the merger will not affect market concentration at all.
  3. While beverage packaging isn’t a typical, rapidly evolving, high-technology market, technological change is occurring. Coupled with shifting consumer demand (often driven by powerful beverage company marketing efforts), and considerable (and increasing) buyer power, historical beverage packaging market shares may have little predictive value going forward.
  4. The key importance of transportation costs and the effects of current input prices suggest that expanding demand can be effectively met only by expanding the geographic scope of production and by economizing on aluminum supply costs. These, in turn, suggest that increasing overall market concentration is consistent with increased, rather than decreased, competitiveness.
  5. The markets in which Ball and Rexam operate are dominated by a few large customers, who are themselves direct competitors in the upstream marketplace. These companies have shown a remarkable willingness and ability to invest in competing packaging supply capacity and to exert their substantial buyer power to discipline prices.
  6. For this same reason, complaints leveled against the proposed merger by these beverage giants — which are as much competitors as they are customers of the merging companies — should be viewed with skepticism.
  7. Finally, the merger should generate significant managerial and overhead efficiencies, and the merged firm’s expanded geographic footprint should allow it to service larger geographic areas for its multinational customers, thus lowering transaction costs and increasing its value to these customers.

Distinguishing Ardagh: The interchangeability of aluminum and glass

An important potential sticking point for the FTC’s review of the merger is its recent decision to challenge the Ardagh-Saint Gobain merger. The cases are superficially similar, in that they both involve beverage packaging. But Ardagh should not stand as a model for the Commission’s treatment of Ball/Rexam. The FTC made a number of mistakes in Ardagh (including market definition and the treatment of efficiencies — the latter of which brought out a strenuous dissent from Commissioner Wright). But even on its own (questionable) terms, Ardagh shouldn’t mean trouble for Ball/Rexam.

As we noted in our December 1st letter to the FTC on the Ball/Rexam merger, and as we discuss in detail in the paper, the situation in the aluminum can market is quite different than the (alleged) market for “(1) the manufacture and sale of glass containers to Brewers; and (2) the manufacture and sale of glass containers to Distillers” at issue in Ardagh.

Importantly, the FTC found (almost certainly incorrectly, at least for the brewers) that other container types (e.g., plastic bottles and aluminum cans) were not part of the relevant product market in Ardagh. But in the markets in which aluminum cans are a primary form of packaging (most notably, soda and beer), our research indicates that glass, plastic, and aluminum are most definitely substitutes.

The Big Four beverage companies (Coca-Cola, PepsiCo, Anheuser-Busch InBev, and MillerCoors), which collectively make up 80% of the U.S. market for Ball and Rexam, are all vertically integrated to some degree, and provide much of their own supply of containers (a situation significantly different than the distillers in Ardagh). These companies exert powerful price discipline on the aluminum packaging market by, among other things, increasing (or threatening to increase) their own container manufacturing capacity, sponsoring new entry, and shifting production (and, via marketing, consumer demand) to competing packaging types.

For soda, Ardagh is obviously inapposite, as soda packaging wasn’t at issue there. But the FTC’s conclusion in Ardagh that aluminum cans (which in fact make up 56% of the beer packaging market) don’t compete with glass bottles for beer packaging is also suspect.

For aluminum can manufacturers Ball and Rexam, aluminum can’t be excluded from the market (obviously), and much of the beer in the U.S. that is packaged in aluminum is quite clearly also packaged in glass. The FTC claimed in Ardagh that glass and aluminum are consumed in distinct situations, so they don’t exert price pressure on each other. But that ignores the considerable ability of beer manufacturers to influence consumption choices, as well as the reality that consumer preferences for each type of container (whether driven by beer company marketing efforts or not) are merging, with cost considerations dominating other factors.

In fact, consumers consume beer in both packaging types largely interchangeably (with a few limited exceptions — e.g., poolside drinking demands aluminum or plastic), and beer manufacturers readily switch between the two types of packaging as the relative production costs shift.

Craft brewers, to take one important example, are rapidly switching to aluminum from glass, despite a supposed stigma surrounding canned beers. Some craft brewers (particularly the larger ones) do package at least some of their beers in both types of containers, or simultaneously package some of their beers in glass and some of their beers in cans, while for many craft brewers it’s one or the other. Yet there’s no indication that craft beer consumption has fallen off because consumers won’t drink beer from cans in some situations — and obviously the prospect of this outcome hasn’t stopped craft brewers from abandoning bottles entirely in favor of more economical cans, nor has it induced them, as a general rule, to offer both types of packaging.

A very short time ago it might have seemed that aluminum wasn’t in the same market as glass for craft beer packaging. But, as recent trends have borne out, that differentiation wasn’t primarily a function of consumer preference (either at the brewer or end-consumer level). Rather, it was a function of bottling/canning costs (until recently the machinery required for canning was prohibitively expensive), materials costs (at various times glass has been cheaper than aluminum, depending on volume), and transportation costs (which cut against glass, but the relative attractiveness of different packaging materials is importantly a function of variable transportation costs). To be sure, consumer preference isn’t irrelevant, but the ease with which brewers have shifted consumer preferences suggests that it isn’t a strong constraint.

Transportation costs are key

Transportation costs, in fact, are a key part of the story — and of the conclusion that the Ball/Rexam merger is unlikely to have anticompetitive effects. First of all, transporting empty cans (or bottles, for that matter) is tremendously inefficient — which means that the relevant geographic markets for assessing the competitive effects of the Ball/Rexam merger are essentially the largely non-overlapping 200 mile circles around the companies’ manufacturing facilities. Because there are very few markets in which the two companies both have plants, the merger doesn’t change the extent of competition in the vast majority of relevant geographic markets.

But transportation costs are also relevant to the interchangeability of packaging materials. Glass is more expensive to transport than aluminum, and this is true not just for empty bottles, but for full ones, of course. So, among other things, by switching to cans (even if it entails up-front cost), smaller breweries can expand their geographic reach, potentially expanding sales enough to more than cover switching costs. The merger would further lower the costs of cans (and thus of geographic expansion) by enabling beverage companies to transact with a single company across a wider geographic range.

The reality is that the most important factor in packaging choice is cost, and that the packaging alternatives are functionally interchangeable. As a result, and given that the direct consumers of beverage packaging are beverage companies rather than end-consumers, relatively small cost changes readily spur changes in packaging choices. While there are some switching costs that might impede these shifts, they are readily overcome. For large beverage companies that already use multiple types and sizes of packaging for the same product, the costs are trivial: They already have packaging designs, marketing materials, distribution facilities and the like in place. For smaller companies, a shift can be more difficult, but innovations in labeling, mobile canning/bottling facilities, outsourced distribution and the like significantly reduce these costs.  

“There’s a great future in plastics”

All of this is even more true for plastic — even in the beer market. In fact, in 2010, 10% of the beer consumed in Europe was sold in plastic bottles, as was 15% of all beer consumed in South Korea. We weren’t able to find reliable numbers for the U.S., but particularly for cheaper beers, U.S. brewers are increasingly moving to plastic. And plastic bottles are the norm at stadiums and arenas. Whatever the exact numbers, clearly plastic holds a small fraction of the beer container market compared to glass and aluminum. But that number is just as clearly growing, and as cost considerations impel them (and technology enables them), giant, powerful brewers like AB InBev and MillerCoors are certainly willing and able to push consumers toward plastic.

Meanwhile soda companies like Coca-cola and Pepsi have successfully moved their markets so that today a majority of packaged soda is sold in plastic containers. There’s no evidence that this shift came about as a result of end-consumer demand, nor that the shift to plastic was delayed by a lack of demand elasticity; rather, it was primarily a function of these companies’ ability to realize bigger profits on sales in plastic containers (not least because they own their own plastic packaging production facilities).

And while it’s not at issue in Ball/Rexam because spirits are rarely sold in aluminum packaging, the FTC’s conclusion in Ardagh that

[n]on-glass packaging materials, such as plastic containers, are not in this relevant product market because not enough spirits customers would switch to non-glass packaging materials to make a SSNIP in glass containers to spirits customers unprofitable for a hypothetical monopolist

is highly suspect — which suggests the Commission may have gotten it wrong in other ways, too. For example, as one report notes:

But the most noteworthy inroads against glass have been made in distilled liquor. In terms of total units, plastic containers, almost all of them polyethylene terephthalate (PET), have surpassed glass and now hold a 56% share, which is projected to rise to 69% by 2017.

True, most of this must be tiny-volume airplane bottles, but by no means all of it is, and it’s clear that the cost advantages of plastic are driving a shift in distilled liquor packaging, as well. Some high-end brands are even moving to plastic. Whatever resistance (and this true for beer, too) that may have existed in the past because of glass’s “image,” is breaking down: Don’t forget that even high-quality wines are now often sold with screw-tops or even in boxes — something that was once thought impossible.

The overall point is that the beverage packaging market faced by can makers like Ball and Rexam is remarkably complex, and, crucially, the presence of powerful, vertically integrated customers means that past or current demand by end-users is a poor indicator of what the market will look like in the future as input costs and other considerations faced by these companies shift. Right now, for example, over 50% of the world’s soda is packaged in plastic bottles, and this margin is set to increase: The global plastic packaging market (not limited to just beverages) is expected to grow at a CAGR of 5.2% between 2014 and 2020, while aluminum packaging is expected to grow at just 2.9%.

A note on efficiencies

As noted above, the proposed Ball/Rexam merger also holds out the promise of substantial efficiencies (estimated at $300 million by the merging parties, due mainly to decreased transportation costs). There is a risk, however, that the FTC may effectively disregard those efficiencies, as it did in Ardagh (and in St. Luke’s before it), by saddling them with a higher burden of proof than it requires of its own prima facie claims. If the goal of antitrust law is to promote consumer welfare, competition authorities can’t ignore efficiencies in merger analysis.

In his Ardagh dissent, Commissioner Wright noted that:

Even when the same burden of proof is applied to anticompetitive effects and efficiencies, of course, reasonable minds can and often do differ when identifying and quantifying cognizable efficiencies as appears to have occurred in this case.  My own analysis of cognizable efficiencies in this matter indicates they are significant.   In my view, a critical issue highlighted by this case is whether, when, and to what extent the Commission will credit efficiencies generally, as well as whether the burden faced by the parties in establishing that proffered efficiencies are cognizable under the Merger Guidelines is higher than the burden of proof facing the agencies in establishing anticompetitive effects. After reviewing the record evidence on both anticompetitive effects and efficiencies in this case, my own view is that it would be impossible to come to the conclusions about each set forth in the Complaint and by the Commission — and particularly the conclusion that cognizable efficiencies are nearly zero — without applying asymmetric burdens.

The Commission shouldn’t make the same mistake here. In fact, here, where can manufacturers are squeezed between powerful companies both upstream (e.g., Alcoa) and downstream (e.g., AB InBev), and where transportation costs limit the opportunities for expanding the customer base of any particular plant, the ability to capitalize on economies of scale and geographic scope is essential to independent manufacturers’ abilities to efficiently meet rising demand.

Read our complete assessment of the merger’s effect here.