Archives For mergers & acquisitions

Yesterday Learfield and IMG College inked their recently announced merger. Since the negotiations were made public several weeks ago, the deal has garnered some wild speculation and potentially negative attention. Now that the merger has been announced, it’s bound to attract even more attention and conjecture.

On the field of competition, however, the market realities that support the merger’s approval are compelling. And, more importantly, the features of this merger provide critical lessons on market definition, barriers to entry, and other aspects of antitrust law related to two-sided and advertising markets that can be applied to numerous matters vexing competition commentators.

First, some background

Learfield and IMG specialize in managing multimedia rights (MMRs) for intercollegiate sports. They are, in effect, classic advertising intermediaries, facilitating the monetization by colleges of radio broadcast advertising and billboard, program, and scoreboard space during games (among other things), and the purchase by advertisers of access to these valuable outlets.

Although these transactions can certainly be (and very often are) entered into by colleges and advertisers directly, firms like Learfield and IMG allow colleges to outsource the process — as one firm’s tag line puts it, “We Work | You Play.” Most important, by bringing multiple schools’ MMRs under one roof, these firms can reduce the transaction costs borne by advertisers in accessing multiple outlets as part of a broad-based marketing plan.

Media rights and branding are a notable source of revenue for collegiate athletic departments: on average, they account for about 3% of these revenues. While they tend to pale in comparison to TV rights, ticket sales, and fundraising, for major programs, MMRs may be the next most important revenue source after these.

Many collegiate programs retain some or all of their multimedia rights and use in-house resources to market them. In some cases schools license MMRs through their athletic conference. In other cases, schools ink deals to outsource their MMRs to third parties, such as Learfield, IMG, JMI Sports, Outfront Media, and Fox Sports, among several others. A few schools even use professional sports teams to manage their MMRs (the owner of the Red Sox manages Boston College’s MMRs, for example).

Schools switch among MMR managers with some regularity, and, in most cases apparently, not among the merging parties. Michigan State, for example, was well known for handling its MMRs in-house. But in 2016 the school entered into a 15-year deal with Fox Sports, estimated at minimum guaranteed $150 million. In 2014 Arizona State terminated its MMR deal with IMG and took it MMRs in-house. Then, in 2016, the Sun Devils entered into a first-of-its-kind arrangement with the Pac 12 in which the school manages and sells its own marketing and media rights while the conference handles core business functions for the sales and marketing team (like payroll, accounting, human resources, and employee benefits). The most successful new entrant on the block, JMI Sports, won Kentucky, Clemson, and the University of Pennsylvania from Learfield or IMG. Outfront Media was spun off from CBS in 2014 and has become one of the strongest MMR intermediary competitors, handling some of the biggest names in college sports, including LSU, Maryland, and Virginia. All told, eight recent national Division I champions are served by MMR managers other than IMG and Learfield.

The supposed problem

As noted above, the most obvious pro-competitive benefit of the merger is in the reduction in transaction costs for firms looking to advertise in multiple markets. But, in order to confer that benefit (which, of course, also benefits the schools, whose marketing properties become easier to access), that also means a dreaded increase in size, measured by number of schools’ MMRs managed. So is this cause for concern?

Jason Belzer, a professor at Rutgers University and founder of sports consulting firm, GAME, Inc., has said that the merger will create a juggernaut — yes, “a massive inexorable force… that crushes whatever is in its path” — that is likely to invite antitrust scrutiny. The New York Times opines that the deal will allow Learfield to “tighten its grip — for nearly total control — on this niche but robust market,” “surely” attracting antitrust scrutiny. But these assessments seem dramatically overblown, and insufficiently grounded in the dynamics of the market.

Belzer’s concerns seem to be merely the size of the merging parties — again, measured by the number of schools’ rights they manage — and speculation that the merger would bring to an end “any” opportunity for entry by a “major” competitor. These are misguided concerns.

To begin, the focus on the potential entry of a “major” competitor is an odd standard that ignores the actual and potential entry of many smaller competitors that are able to win some of the most prestigious and biggest schools. In fact, many in the industry argue — rightly — that there are few economies of scale for colleges. Most of these firms’ employees are dedicated to a particular school and those costs must be incurred for each school, no matter the number, and borne by new entrants and incumbents alike. That means a small firm can profitably compete in the same market as larger firms — even “juggernauts.” Indeed, every college that brings MMR management in-house is, in fact, an entrant — and there are some big schools in big conferences that manage their MMRs in-house.

The demonstrated entry of new competitors and the transitions of schools from one provider to another or to in-house MMR management indicate that no competitor has any measurable market power that can disadvantage schools or advertisers.

Indeed, from the perspective of the school, the true relevant market is no broader than each school’s own rights. Even after the merger there will be at least five significant firms competing for those rights, not to mention each school’s conference, new entrants, and the school itself.

The two-sided market that isn’t really two-sided

Standard antitrust analysis, of course, focuses on consumer benefits: Will the merger make consumers better off (or no worse off)? But too often casual antitrust analysis of two-sided markets trips up on identifying just who the consumer is — and what the relevant market is. For a shopping mall, is the consumer the retailer or the shopper? For newspapers and search engines, is the customer the advertiser or the reader? For intercollegiate sports multimedia rights licensing, is the consumer the college or the advertiser?

Media coverage of the anticipated IMG/Learfield merger largely ignores advertisers as consumers and focuses almost exclusively on the the schools’ relationship with intermediaries — as purchasers of marketing services, rather than sellers of advertising space.

Although it’s difficult to identify the source of this odd bias, it seems to be based on the notion that, while corporations like Coca-Cola and General Motors have some sort of countervailing market power against marketing intermediaries, universities don’t. With advertisers out of the picture, media coverage suggests that, somehow, schools may be worse off if the merger were to proceed. But missing from this assessment are two crucial facts that undermine the story: First, schools actually have enormous market power; and, second, schools compete in the business of MMR management.

This second factor suggests, in fact, that sometimes there may be nothing special about two-sided markets sufficient to give rise to a unique style of antitrust analysis.

Much of the antitrust confusion seems to be based on confusion over the behavior of two-sided markets. A two-sided market is one in which two sets of actors interact through an intermediary or platform, which, in turn, facilitates the transactions, often enabling transactions to take place that otherwise would be too expensive absent the platform. A shopping mall is a two-sided market where shoppers can find their preferred stores. Stores would operate without the platform, but perhaps not as many, and not as efficiently. Newspapers, search engines, and other online platforms are two-sided markets that bring together advertisers and eyeballs that might not otherwise find each other absent the platform. And a collegiate multimedia rights management firms is a two-sided market where colleges that want to sell advertising space get together with firms that want to advertise their goods and services.

Yet there is nothing particularly “transformative” about the outsourcing of MMR management. Credit cards, for example are qualitatively different than in-store credit operations. They are two-sided platforms that substitute for in-house operations — but they also create an entirely new product and product market. MMR marketing firms do lower some transaction costs and reduce risk for collegiate sports marketing, but the product is not substantially changed — in fact, schools must have the knowledge and personnel to assess and enter into the initial sale of MMRs to an intermediary and, because of ongoing revenue-sharing and coordination with the intermediary, must devote ongoing resources even after the initial sale.

But will a merged entity have “too much” power? Imagine if a single firm owned the MMRs for nearly all intercollegiate competitors. How would it be able to exercise its supposed market power? Because each deal is negotiated separately, and, other than some mundane, fixed back-office expenses, the costs of rights management must be incurred whether a firm negotiates one deal or 100, there are no substantial economies of scale in the purchasing of MMRs. As a result, the existence of deals with other schools won’t automatically translate into better deals with subsequent schools.

Now, imagine if one school retained its own MMRs, but decided it might want to license them to an intermediary. Does it face anticompetitive market conditions if there is only a single provider of such services? To begin with, there is never only a single provider, as each school can provide the services in-house. This is not even the traditional monopoly constraint of simply “not buying,” which makes up the textbook “deadweight loss” from monopoly: In this case “not buying” does not mean going without; it simply means providing for oneself.

More importantly, because the school has a monopoly on access to its own marketing rights (to say nothing of access to its own physical facilities) unless and until it licenses them, its own bargaining power is largely independent of an intermediary’s access to other schools’ rights. If it were otherwise, each school would face anticompetitive market conditions simply by virtue of other schools’ owning their own rights!

It is possible that a larger, older firm will have more expertise and will be better able to negotiate deals with other schools — i.e., it will reap the benefits of learning by doing. But the returns to learning by doing derive from the ability to offer higher-quality/lower-cost services over time — which are a source of economic benefit, not cost. At the same time, the bulk of the benefits of experience may be gained over time with even a single set of MMRs, given the ever-varying range of circumstances even a single school will create: There may be little additional benefit (and, to be sure, there is additional cost) from managing multiple schools’ MMRs. And whatever benefits specialized firms offer, they also come with agency costs, and an intermediary’s specialized knowledge about marketing MMRs may or may not outweigh a school’s own specialized knowledge about the nuances of its particular circumstances. Moreover, because of knowledge spillovers and employee turnover this marketing expertise is actually widely distributed; not surprisingly, JMI Sports’ MMR unit, one of the most recent and successful entrants into the business was started by a former employee of IMG. Several other firms started out the same way.

The right way to begin thinking about the issue is this: Imagine if MMR intermediaries didn’t exist — what would happen? In this case, the answer is readily apparent because, for a significant number of schools (about 37% of Division I schools, in fact) MMR licensing is handled in-house, without the use of intermediaries. These schools do, in fact, attract advertisers, and there is little indication that they earn less net profit for going it alone. Schools with larger audiences, better targeted to certain advertisers’ products, command higher prices. Each school enjoys an effective monopoly over advertising channels around its own games, and each has bargaining power derived from its particular attractiveness to particular advertisers.

In effect, each school faces a number of possible options for MMR monetization — most notably a) up-front contracting to an intermediary, which then absorbs the risk, expense, and possible up-side of ongoing licensing to advertisers, or b) direct, ongoing licensing to advertisers. The presence of the intermediary doesn’t appreciably change the market, nor the relative bargaining power of sellers (schools) and buyers (advertisers) of advertising space any more than the presence of temp firms transforms the fundamental relationship between employers and potential part-time employees.

In making their decisions, schools always have the option of taking their MMR management in-house. In facing competing bids from firms such as IMG or Learfield, from their own conferences, or from professional sports teams, the opening bid, in a sense, comes from the school itself. Even the biggest intermediary in the industry must offer the school a deal that is at least as good as managing the MMRs in-house.

The true relevant market: Advertising

According to economist Andy Schwarz, if the relevant market is “college-based marketing services to Power 5 schools, the antitrust authorities may have more concerns than if it’s marketing services in sports.” But this entirely misses the real market exchange here. Sure, marketing services are purchased by schools, but their value to the schools is independent of the number of other schools an intermediary also markets.

Advertisers always have the option of deploying their ad dollars elsewhere. If Coca-Cola wants to advertise on Auburn’s stadium video board, it’s because Auburn’s video board is a profitable outlet for advertising, not because the Auburn ads are bundled with advertising at dozens of other schools (although that bundling may reduce the total cost of advertising on Auburn’s scoreboard as well as other outlets). Similarly, Auburn is seeking the highest bidder for space on its video board. It does not matter to Auburn that the University of Georgia is using the same intermediary to sell ads on its stadium video board.

The willingness of purchasers — say, Coca-Cola or Toyota — to pay for collegiate multimedia advertising is a function of the school that licenses it (net transaction costs) — and MMR agents like IMG and Learfield commit substantial guaranteed sums and a share of any additional profits for the rights to sell that advertising: For example, IMG recently agreed to pay $150 million over 10 years to renew its MMR contract at UCLA. But this is the value of a particular, niche form of advertising, determined within the context of the broader advertising market. How much pricing power over scoreboard advertising does any university, or even any group of universities under the umbrella of an intermediary have, in a world in which Coke and Toyota can advertise virtually anywhere — including during commercial breaks in televised intercollegiate games, which are licensed separately from the MMRs licensed by companies like IMG and Learfield?

There is, in other words, a hard ceiling on what intermediaries can charge schools for MMR marketing services: The schools’ own cost of operating a comparable program in-house.

To be sure, for advertisers, large MMR marketing firms lower the transaction costs of buying advertising space across a range of schools, presumably increasing demand for intercollegiate sports advertising and sponsorship. But sponsors and advertisers have a wide range of options for spending their marketing dollars. Intercollegiate sports MMRs are a small slice of the sports advertising market, which, in turn, is a small slice of the total advertising market. Even if one were to incorrectly describe the combined entity as a “juggernaut” in intercollegiate sports, the MMR rights it sells would still be a flyspeck in the broader market of multimedia advertising.

According to one calculation (by MoffettNathanson), total ad spending in the U.S. was about $191 billion in 2016 (Pew Research Center estimates total ad revenue at $240 billion) and the global advertising market was estimated to be worth about $493 billion. The intercollegiate MMR segment represents a minuscule fraction of that. According to Jason Belzer, “[a]t the time of its sale to WME in 2013, IMG College’s yearly revenue was nearly $500 million….” Another source puts it at $375 million. Either way, it’s a fraction of one percent of the total market, and even combined with Learfield it will remain a minuscule fraction. Even if one were to define a far narrower sports sponsorship market, which a Price Waterhouse estimate puts at around $16 billion, the combined companies would still have a tiny market share.

As sellers of MMRs, colleges are competing with each other, professional sports such as the NFL and NBA, and with non-sports marketing opportunities. And it’s a huge and competitive market.

Barriers to entry

While capital requirements and the presence of long-term contracts may present challenges to potential entrants into the business of marketing MMRs, these potential entrants face virtually no barriers that are not, or have not been, faced by incumbent providers. In this context, one should keep in mind two factors. First, barriers to entry are properly defined as costs incurred by new entrants that are not incurred by incumbents (no matter what Joe Bain says; Stigler always wins this dispute…). Every firm must bear the cost of negotiating and managing each schools’ MMRs, and, as noted, these costs don’t vary significantly with the number of schools being managed. And every entrant needs approximately the same capital and human resources per similarly sized school as every incumbent. Thus, in this context, neither the need for capital nor dedicated employees is properly construed as a barrier to entry.

Second, as the DOJ and FTC acknowledge in the Horizontal Merger Guidelines, any merger can be lawful under the antitrust laws, no matter its market share, where there are no significant barriers to entry:

The prospect of entry into the relevant market will alleviate concerns about adverse competitive effects… if entry into the market is so easy that the merged firm and its remaining rivals in the market, either unilaterally or collectively, could not profitably raise price or otherwise reduce competition compared to the level that would prevail in the absence of the merger.

As noted, there are low economies of scale in the business, with most of the economies occurring in the relatively small “back office” work of payroll, accounting, human resources, and employee benefits. Since the 2000s, the entry of several significant competitors — many entering with only one or two schools or specializing in smaller or niche markets — strongly suggests that there are no economically important barriers to entry. And these firms have entered and succeeded with a wide range of business models and firm sizes:

  • JMI Sports — a “rising boutique firm” — hired Tom Stultz, the former senior vice president and managing director of IMG’s MMR business, in 2012. JMI won its first (and thus, at the time, only) MMR bid in 2014 at the University of Kentucky, besting IMG to win the deal.
  • Peak Sports MGMT, founded in 2012, is a small-scale MMR firm that focuses on lesser Division I and II schools in Texas and the Midwest. It manages just seven small properties, including Southland Conference schools like the University of Central Arkansas and Southeastern Louisiana University.
  • Fox Sports entered the business in 2008 with a deal with the University of Florida. It now handles MMRs for schools like Georgetown, Auburn, and Villanova. Fox’s entry suggests that other media companies — like ESPN — that may already own TV broadcast rights are also potential entrants.
  • In 2014 the sports advertising firm, Van Wagner, hired three former Nelligan employees to make a play for the college sports space. In 2015 the company won its first MMR bid at Florida International University, reportedly against seven other participants. It now handles more than a dozen schools including Georgia State (which it won from IMG), Loyola Marymount, Pepperdine, Stony Brook, and Santa Clara.
  • In 2001 Fenway Sports Group, parent company of the Boston Red Sox and Liverpool Football Club, entered into an MMR agreement with Boston College. And earlier this year the Tampa Bay Lightning hockey team began handling multimedia marketing for the University of South Florida.

Potential new entrants abound. Most obviously, sports networks like ESPN could readily follow Fox Sports’ lead and advertising firms could follow Van Wagner’s. These companies have existing relationships and expertise that position them for easy entry into the MMR business. Moreover, there are already several companies that handle the trademark licensing for schools, any of which could move into the MMR management business, as well; both IMG and Learfield already handle licensing for a number of schools. Most notably, Fermata Partners, founded in 2012 by former IMG employees and acquired in 2015 by CAA Sports (a division of Creative Artists Agency), has trademark licensing agreements with Georgia, Kentucky, Miami, Notre Dame, Oregon, Virginia, and Wisconsin. It could easily expand into selling MMR rights for these and other schools. Other licensing firms like Exemplar (which handles licensing at Columbia) and 289c (which handles licensing at Texas and Ohio State) could also easily expand into MMR.

Given the relatively trivial economies of scale, the minimum viable scale for a new entrant appears to be approximately one school — a size that each school’s in-house operations, of course, automatically meets. Moreover, the Peak Sports, Fenway, and Tampa Bay Lightning examples suggest that there may be particular benefits to local, regional, or category specialization, suggesting that innovative, new entry is not only possible, but even likely, as the business continues to evolve.

Conclusion

A merger between IMG and Learfield should not raise any antitrust issues. College sports is a small slice of the total advertising market. Even a so-called “juggernaut” in college sports multimedia rights is a small bit in the broader market of multimedia marketing.

The demonstrated entry of new competitors and the transitions of schools from one provider to another or to bringing MMR management in-house, indicates that no competitor has any measurable market power that can disadvantage schools or advertisers.

The term “juggernaut” entered the English language because of misinterpretation and exaggeration of actual events. Fears of the IMG/Learfield merger crushing competition is similarly based on a misinterpretation of two-sided markets and misunderstanding of the reality of the of the market for college multimedia rights management. Importantly, the case is also a cautionary tale for those who would identify narrow, contract-, channel-, or platform-specific relevant markets in circumstances where a range of intermediaries and direct relationships can compete to offer the same service as those being scrutinized. Antitrust advocates have a long and inglorious history of defining markets by channels of distribution or other convenient, yet often economically inappropriate, combinations of firms or products. Yet the presence of marketing or other intermediaries does not automatically transform a basic, commercial relationship into a novel, two-sided market necessitating narrow market definitions and creative economics.

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?

Last October 26, Heritage scholar James Gattuso and I published an essay in The Daily Signal, explaining that the proposed vertical merger (a merger between firms at different stages of the distribution chain) of AT&T and Time Warner (currently undergoing Justice Department antitrust review) may have the potential to bestow substantial benefits on consumers – and that congressional calls to block it, uninformed by fact-based economic analysis, could prove detrimental to consumer welfare.  We explained:

[E]ven though the proposed union of AT&T and Time Warner is not guaranteed to benefit shareholders or consumers, that is no reason for the government to block it. Absent a strong showing of likely harm to the competitive process (which does not appear to be the case here), the government has no business interfering in corporate acquisitions.  Market forces should be allowed to sort out the welfare-enhancing transactional sheep from the unprofitable goats.  Shareholders are in a position to “vote with their feet” and reward or punish a merged company, based on information generated in the marketplace. 

[M]arket transactors are better placed and better incentivized than bureaucrats to uncover and apply the information needed to yield an efficient allocation of resources.

In short, government meddling in mergers in the absence of likely market failure (and of reason to believe that the government’s actions will yield results superior to those of an imperfect market) is a recipe for a diminution in—not an improvement in—consumer welfare.

Furthermore, by arbitrarily intervening in proposed mergers that are not anti-competitive, government disincentivizes firms from acting boldly to seek out new opportunities to create wealth and enhance the welfare of consumers.

What’s worse, the knowledge that government may intervene in mergers without regard to their likely competitive effects will prompt wasteful expenditures by special interests opposing particular transactions, causing a further diminution in economic welfare.

Unfortunately, the congressional critics of this deal are still out there, louder than ever, and, once again, need to be reminded about the dangers of unwarranted antitrust interventions – and the problem with “big is bad” rhetoric.  Scalia Law School Professor (and former Federal Trade Commissioner) Joshua Wright ably deconstructs the problems with the latest Capitol Hill  criticisms of this proposed merger, set forth in a June 21 letter to the Justice Department from eleven U.S. Senators (including Elizabeth Warren, Al Franken, and Bernie Sanders).  As Professor Wright explains in a June 26 article published by The Hill:

Over the past several decades, there has been resounding and bipartisan agreement — amongst mainstream antitrust economists, practitioners, enforcement agencies, and even politicians — that while mergers between vertically aligned companies, like AT&T and Time Warner, can in rare circumstances harm competition, they usually make consumers better off. The opposition letter is a call to disrupt that consensus with a “new” view that vertical mergers are presumptively a bad deal for consumers and violate the antitrust laws.

The call for an antitrust revolution with respect to vertical mergers should not go unanswered. Revolution actually overstates things. The “new” antitrust is really a thinly veiled attempt to return to the antitrust approach of the 1960s where everything “big” was bad and virtually all deals, vertical ones included, violated the antitrust laws. That approach gained traction in part because it is easy to develop supporting rhetoric that is inflammatory and easily digestible. . . .

[However,] [a]s a matter of fact, the overwhelming weight of economic analysis and empirical evidence serves as a much-needed dose of cold water for the fiery rhetoric in the opposition letter and the commonly held intuition that all mergers between big firms make consumers worse off. . . .

[C]onsider the conclusion of a widely cited summary of dozens of studies authored by Francine LaFontaine and Margaret Slade, two very well respected industrial organization economists (one who served as director of the U.S. Federal Trade Commission’s bureau of economics during the Obama administration). It found that “consumers are often worse off when governments require vertical separation in markets where firms would have chosen otherwise.” Or consider the conclusion of four former enforcement agency economists reviewing the same body of evidence that “there is a paucity of support for the proposition that vertical restraints [or] vertical integration are likely to harm consumers.”

This evidence by no means suggests vertical mergers are incapable of harming consumers or violating the antitrust laws. The data do suggest an evidence-based antitrust enforcement approach aimed at protecting consumers will not presume that they are harmful without careful, rigorous, and objective analysis. Antitrust analysis is — or at least should be — a fact-specific exercise. Weighing concrete economic evidence is critical when assessing mergers, particularly when assessing vertical mergers where procompetitive virtues are almost always present. . . .

The economic and legal framework for analyzing vertical mergers is well understood by the U.S. Department of Justice’s antitrust division and its staff of expert lawyers and economists. The antitrust division has not hesitated to determine an appropriate remedy in the rare instance where a vertical merger has been found likely to harm competition. The [Senators’] opposition letter is correct that a careful and rigorous analysis of the proposed acquisition is called for — as is the case with all mergers. That review process should, however, be guided by careful and objective analysis and not the fiery political rhetoric [of the Senators’ letter].

Under the leadership of soon-to-be U.S. Assistant Attorney General Makan Delrahim, an experienced antitrust lawyer and antitrust enforcement agency veteran, the Justice Department antitrust division staff will be empowered to conduct precisely that type of analysis and reach a decision that best protects competition and consumers.

Professor Wright’s excellent essay merits being read in full.

I’ll be participating in two excellent antitrust/consumer protection events next week in DC, both of which may be of interest to our readers:

5th Annual Public Policy Conference on the Law & Economics of Privacy and Data Security

hosted by the GMU Law & Economics Center’s Program on Economics & Privacy, in partnership with the Future of Privacy Forum, and the Journal of Law, Economics & Policy.

Conference Description:

Data flows are central to an increasingly large share of the economy. A wide array of products and business models—from the sharing economy and artificial intelligence to autonomous vehicles and embedded medical devices—rely on personal data. Consequently, privacy regulation leaves a large economic footprint. As with any regulatory enterprise, the key to sound data policy is striking a balance between competing interests and norms that leaves consumers better off; finding an approach that addresses privacy concerns, but also supports the benefits of technology is an increasingly complex challenge. Not only is technology continuously advancing, but individual attitudes, expectations, and participation vary greatly. New ideas and approaches to privacy must be identified and developed at the same pace and with the same focus as the technologies they address.

This year’s symposium will include panels on Unfairness under Section 5: Unpacking “Substantial Injury”, Conceptualizing the Benefits and Costs from Data Flows, and The Law and Economics of Data Security.

I will be presenting a draft paper, co-authored with Kristian Stout, on the FTC’s reasonableness standard in data security cases following the Commission decision in LabMD, entitled, When “Reasonable” Isn’t: The FTC’s Standard-less Data Security Standard.

Conference Details:

  • Thursday, June 8, 2017
  • 8:00 am to 3:40 pm
  • at George Mason University, Founders Hall (next door to the Law School)
    • 3351 Fairfax Drive, Arlington, VA 22201

Register here

View the full agenda here

 

The State of Antitrust Enforcement

hosted by the Federalist Society.

Panel Description:

Antitrust policy during much of the Obama Administration was a continuation of the Bush Administration’s minimal involvement in the market. However, at the end of President Obama’s term, there was a significant pivot to investigations and blocks of high profile mergers such as Halliburton-Baker Hughes, Comcast-Time Warner Cable, Staples-Office Depot, Sysco-US Foods, and Aetna-Humana and Anthem-Cigna. How will or should the new Administration analyze proposed mergers, including certain high profile deals like Walgreens-Rite Aid, AT&T-Time Warner, Inc., and DraftKings-FanDuel?

Join us for a lively luncheon panel discussion that will cover these topics and the anticipated future of antitrust enforcement.

Speakers:

  • Albert A. Foer, Founder and Senior Fellow, American Antitrust Institute
  • Profesor Geoffrey A. Manne, Executive Director, International Center for Law & Economics
  • Honorable Joshua D. Wright, Professor of Law, George Mason University School of Law
  • Moderator: Honorable Ronald A. Cass, Dean Emeritus, Boston University School of Law and President, Cass & Associates, PC

Panel Details:

  • Friday, June 09, 2017
  • 12:00 pm to 2:00 pm
  • at the National Press Club, MWL Conference Rooms
    • 529 14th Street, NW, Washington, DC 20045

Register here

Hope to see everyone at both events!

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.

Geoffrey A. Manne is Executive Director of the International Center for Law & Economics

Dynamic versus static competition

Ever since David Teece and coauthors began writing about antitrust and innovation in high-tech industries in the 1980s, we’ve understood that traditional, price-based antitrust analysis is not intrinsically well-suited for assessing merger policy in these markets.

For high-tech industries, performance, not price, is paramount — which means that innovation is key:

Competition in some markets may take the form of Schumpeterian rivalry in which a succession of temporary monopolists displace one another through innovation. At any one time, there is little or no head-to-head price competition but there is significant ongoing innovation competition.

Innovative industries are often marked by frequent disruptions or “paradigm shifts” rather than horizontal market share contests, and investment in innovation is an important signal of competition. And competition comes from the continual threat of new entry down the road — often from competitors who, though they may start with relatively small market shares, or may arise in different markets entirely, can rapidly and unexpectedly overtake incumbents.

Which, of course, doesn’t mean that current competition and ease of entry are irrelevant. Rather, because, as Joanna Shepherd noted, innovation should be assessed across the entire industry and not solely within merging firms, conduct that might impede new, disruptive, innovative entry is indeed relevant.

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

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

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

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

As Katz and Shelanski note:

To assess fully the impact of a merger on market performance, merger authorities and courts must examine how a proposed transaction changes market participants’ incentives and abilities to undertake investments in innovation.

At the same time, they point out that

Innovation can dramatically affect the relationship between the pre-merger marketplace and what is likely to happen if the proposed merger is consummated…. [This requires consideration of] how innovation will affect the evolution of market structure and competition. Innovation is a force that could make static measures of market structure unreliable or irrelevant, and the effects of innovation may be highly relevant to whether a merger should be challenged and to the kind of remedy antitrust authorities choose to adopt. (Emphasis added).

Dynamic competition in the ag-biotech industry

These dynamics seem to be playing out in the ag-biotech industry. (For a detailed look at how the specific characteristics of innovation in the ag-biotech industry have shaped industry structure, see, e.g., here (pdf)).  

One inconvenient truth for the “concentration reduces innovation” crowd is that, as the industry has experienced more consolidation, it has also become more, not less, productive and innovative. Between 1995 and 2015, for example, the market share of the largest seed producers and crop protection firms increased substantially. And yet, over the same period, annual industry R&D spending went up nearly 750 percent. Meanwhile, the resulting innovations have increased crop yields by 22%, reduced chemical pesticide use by 37%, and increased farmer profits by 68%.

In her discussion of the importance of considering the “innovation ecosystem” in assessing the innovation effects of mergers in R&D-intensive industries, Joanna Shepherd noted that

In many consolidated firms, increases in efficiency and streamlining of operations free up money and resources to source external innovation. To improve their future revenue streams and market share, consolidated firms can be expected to use at least some of the extra resources to acquire external innovation. This increase in demand for externally-sourced innovation increases the prices paid for external assets, which, in turn, incentivizes more early-stage innovation in small firms and biotech companies. Aggregate innovation increases in the process!

The same dynamic seems to play out in the ag-biotech industry, as well:

The seed-biotechnology industry has been reliant on small and medium-sized enterprises (SMEs) as sources of new innovation. New SME startups (often spinoffs from university research) tend to specialize in commercial development of a new research tool, genetic trait, or both. Significant entry by SMEs into the seed-biotechnology sector began in the late 1970s and early 1980s, with a second wave of new entrants in the late 1990s and early 2000s. In recent years, exits have outnumbered entrants, and by 2008 just over 30 SMEs specializing in crop biotechnology were still active. The majority of the exits from the industry were the result of acquisition by larger firms. Of 27 crop biotechnology SMEs that were acquired between 1985 and 2009, 20 were acquired either directly by one of the Big 6 or by a company that itself was eventually acquired by a Big 6 company.

While there is more than one way to interpret these statistics (and they are often used by merger opponents, in fact, to lament increasing concentration), they are actually at least as consistent with an increase in innovation through collaboration (and acquisition) as with a decrease.

For what it’s worth, this is exactly how the startup community views the innovation ecosystem in the ag-biotech industry, as well. As the latest AgFunder AgTech Investing Report states:

The large agribusinesses understand that new innovation is key to their future, but the lack of M&A [by the largest agribusiness firms in 2016] highlighted their uncertainty about how to approach it. They will need to make more acquisitions to ensure entrepreneurs keep innovating and VCs keep investing.

It’s also true, as Diana Moss notes, that

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…. 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.

And yet collaboration and licensing have long been prevalent in this industry. Examples are legion, but here are just a few significant ones:

  • Monsanto’s “global licensing agreement for the use of the CRISPR-Cas genome-editing technology in agriculture with the Broad Institute of MIT and Harvard.”
  • Dow and Arcadia Biosciences’ “strategic collaboration to develop and commercialize new breakthrough yield traits and trait stacks in corn.”
  • Monsanto and the University of Nebraska-Lincoln’s “licensing agreement to develop crops tolerant to the broadleaf herbicide dicamba. This agreement is based on discoveries by UNL plant scientists.”

Both large and small firms in the ag-biotech industry continually enter into new agreements like these. See, e.g., here and here for a (surely incomplete) list of deals in 2016 alone.

At the same time, across the industry, new entry has been rampant despite increased M&A activity among the largest firms. Recent years have seen venture financing in AgTech skyrocket — from $400 million in 2010 to almost $5 billion in 2015 — and hundreds of startups now enter the industry annually.

The pending mergers

Today’s pending mergers are consistent with this characterization of a dynamic market in which structure is being driven by incentives to innovate, rather than monopolize. As Michael Sykuta points out,

The US agriculture sector has been experiencing consolidation at all levels for decades, even as the global ag economy has been growing and becoming more diverse. Much of this consolidation has been driven by technological changes that created economies of scale, both at the farm level and beyond.

These deals aren’t fundamentally about growing production capacity, expanding geographic reach, or otherwise enhancing market share; rather, each is a fundamental restructuring of the way the companies do business, reflecting today’s shifting agricultural markets, and the advanced technology needed to respond to them.

Technological innovation is unpredictable, often serendipitous, and frequently transformative of the ways firms organize and conduct their businesses. A company formed to grow and sell hybrid seeds in the 1920s, for example, would either have had to evolve or fold by the end of the century. Firms today will need to develop (or purchase) new capabilities and adapt to changing technology, scientific knowledge, consumer demand, and socio-political forces. The pending mergers seemingly fit exactly this mold.

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

The key is that integrated knowledge is essential to making this process function. Developing seed traits to work well with (i.e., to withstand) certain pesticides requires deep knowledge of the pesticide’s chemical characteristics, and vice-versa. Processing huge amounts of data to determine when to apply chemical treatments or to predict a disease requires not only that the right information is collected, at the right time, but also that it is analyzed in light of the unique characteristics of the seeds and chemicals. Increased communications and data-sharing between manufacturers increases the likelihood that farmers will use the best products available in the right quantity and at the right time in each field.

Vertical integration solves bargaining and long-term planning problems by unifying the interests (and the management) of these functions. Instead of arm’s length negotiation, a merged Bayer/Monsanto, for example, may better maximize R&D of complicated Ag/chem products through fully integrated departments and merged areas of expertise. A merged company can also coordinate investment decisions (instead of waiting up to 10 years to see what the other company produces), avoid duplication of research, adapt to changing conditions (and the unanticipated course of research), pool intellectual property, and bolster internal scientific capability more efficiently. All told, the merged company projects spending about $16 billion on R&D over the next six years. Such coordinated investment will likely garner far more than either company could from separately spending even the same amount to develop new products. 

Controlling an entire R&D process and pipeline of traits for resistance, chemical treatments, seeds, and digital complements would enable the merged firm to better ensure that each of these products works together to maximize crop yields, at the lowest cost, and at greater speed. Consider the advantages that Apple’s tightly-knit ecosystem of software and hardware provides to computer and device users. Such tight integration isn’t the only way to compete (think Android), but it has frequently proven to be a successful model, facilitating some functions (e.g., handoff between Macs and iPhones) that are difficult if not impossible in less-integrated systems. And, it bears noting, important elements of Apple’s innovation have come through acquisition….

Conclusion

As LaFontaine and Slade have made clear, theoretical concerns about the anticompetitive consequences of vertical integrations are belied by the virtual absence of empirical support:

Under most circumstances, profit–maximizing vertical–integration and merger decisions are efficient, not just from the firms’ but also from the consumers’ points of view.

Other antitrust scholars are skeptical of vertical-integration fears because firms normally have strong incentives to deal with providers of complementary products. Bayer and Monsanto, for example, might benefit enormously from integration, but if competing seed producers seek out Bayer’s chemicals to develop competing products, there’s little reason for the merged firm to withhold them: Even if the new seeds out-compete Monsanto’s, Bayer/Monsanto can still profit from providing the crucial input. Its incentive doesn’t necessarily change if the merger goes through, and whatever “power” Bayer has as an input is a function of its scientific know-how, not its merger with Monsanto.

In other words, while some competitors could find a less hospitable business environment, consumers will likely suffer no apparent ill effects, and continue to receive the benefits of enhanced product development and increased productivity.

That’s what we’d expect from innovation-driven integration, and antitrust enforcers should be extremely careful before thwarting or circumscribing these mergers lest they end up thwarting, rather than promoting, consumer welfare.

Nicolas Petit is Professor of Law at the University of Liege (Belgium) and Research Professor at the University of South Australia (UniSA)

This symposium offers a good opportunity to look again into the complex relation between concentration and innovation in antitrust policy. Whilst the details of the EC decision in Dow/Dupont remain unknown, the press release suggests that the issue of “incentives to innovate” was central to the review. Contrary to what had leaked in the antitrust press, the decision has apparently backed off from the introduction of a new “model”, and instead followed a more cautious approach. After a quick reminder of the conventional “appropriability v cannibalizationframework that drives merger analysis in innovation markets (1), I make two sets of hopefully innovative remarks on appropriability and IP rights (2) and on cannibalization in the ag-biotech sector (3).

Appropriability versus cannibalization

Antitrust economics 101 teach that mergers affect innovation incentives in two polar ways. A merger may increase innovation incentives. This occurs when the increment in power over price or output achieved through merger enhances the appropriability of the social returns to R&D. The appropriability effect of mergers is often tied to Joseph Schumpeter, who observed that the use of “protecting devices” for past investments like patent protection or trade secrecy constituted a “normal elemen[t] of rational management”. The appropriability effect can in principle be observed at firm – specific incentives – and industry – general incentives – levels, because actual or potential competitors can also use the M&A market to appropriate the payoffs of R&D investments.

But a merger may decrease innovation incentives. This happens when the increased industry position achieved through merger discourages the introduction of new products, processes or services. This is because an invention will cannibalize the merged entity profits in proportions larger as would be the case in a more competitive market structure. This idea is often tied to Kenneth Arrow who famously observed that a “preinvention monopoly power acts as a strong disincentive to further innovation”.

Schumpeter’s appropriability hypothesis and Arrow’s cannibalization theory continue to drive much of the discussion on concentration and innovation in antitrust economics. True, many efforts have been made to overcome, reconcile or bypass both views of the world. Recent studies by Carl Shapiro or Jon Baker are worth mentioning. But Schumpeter and Arrow remain sticky references in any discussion of the issue. Perhaps more than anything, the persistence of their ideas denotes that both touched a bottom point when they made their seminal contribution, laying down two systems of belief on the workings of innovation-driven markets.

Now beyond the theory, the appropriability v cannibalization gravitational models provide from the outset an appealing framework for the examination of mergers in R&D driven industries in general. From an operational perspective, the antitrust agency will attempt to understand if the transaction increases appropriability – which leans in favour of clearance – or cannibalization – which leans in favour of remediation. At the same time, however, the downside of the appropriability v cannibalization framework (and of any framework more generally) may be to oversimplify our understanding of complex phenomena. This, in turn, prompts two important observations on each branch of the framework.

Appropriability and IP rights

Any antitrust agency committed to promoting competition and innovation should consider mergers in light of the degree of appropriability afforded by existing protecting devices (essentially contracts and entitlements). This is where Intellectual Property (“IP”) rights become relevant to the discussion. In an industry with strong IP rights, the merging parties (and its rivals) may be able to appropriate the social returns to R&D without further corporate concentration. Put differently, the stronger the IP rights, the lower the incremental contribution of a merger transaction to innovation, and the higher the case for remediation.

This latter proposition, however, rests on a heavy assumption: that IP rights confer perfect appropriability. The point is, however, far from obvious. Most of us know that – and our antitrust agencies’ misgivings with other sectors confirm it – IP rights are probabilistic in nature. There is (i) 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. Arrow himself called for caution, noting that “Patent laws would have to be unimaginably complex and subtle to permit [such] appropriation on a large scale”. A thorough inquiry into the specific industry-strength of IP rights that goes beyond patent data and statistics thus constitutes a necessary step in merger review.

But it is not a sufficient one. The proposition that strong IP rights provide appropriability is essentially valid if the observed pre-merger market situation is one where several IP owners compete on differentiated products and as a result wield a degree of market power. In contrast, the proposition is essentially invalid if the observed pre-merger market situation leans more towards the competitive equilibrium and IP owners compete at prices closer to costs. In both variants, the agency should thus look carefully at the level and evolution of prices and costs, including R&D ones, in the pre-merger industry. Moreover, in the second variant, the agency ought to consider as a favourable appropriability factor any increase of the merging entity’s power over price, but also any improvement of its power over cost. By this, I have in mind efficiency benefits, which can arise as the result of economies of scale (in manufacturing but also in R&D), but also when the transaction combines complementary technological and marketing assets. In Dow/Dupont, no efficiency argument has apparently been made by the parties, so it is difficult to understand if and how such issues have played a role in the Commission’s assessment.

Cannibalization, technological change, and drastic innovation

Arrow’s cannibalization theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fails to capture that successful inventions create new technology frontiers, and with them entirely novel needs that even a monopolist has an incentive to serve. This can be understood with an example taken from the ag-biotech field. It is undisputed that progress in crop protection science has led to an expanding range of resistant insects, weeds, and pathogens. This, in turn, is one (if not the main) key drivers of ag-tech research. In a 2017 paper published in Pest Management Science, Sparks and Lorsbach observe that:

resistance to agrochemicals is an ongoing driver for the development of new chemical control options, along with an increased emphasis on resistance management and how these new tools can fit into resistance management programs. Because resistance is such a key driver for the development of new agrochemicals, a highly prized attribute for a new agrochemical is a new MoA [method of action] that is ideally a new molecular target either in an existing target site (e.g., an unexploited binding site in the voltage-gated sodium channel), or new/under-utilized target site such as calcium channels.

This, and other factors, leads them to conclude that:

even with fewer companies overall involved in agrochemical discovery, innovation continues, as demonstrated by the continued introduction of new classes of agrochemicals with new MoAs.

Sparks, Hahn, and Garizi make a similar point. They stress in particular that the discovery of natural products (NPs) which are the “output of nature’s chemical laboratory” is today a main driver of crop protection research. According to them:

NPs provide very significant value in identifying new MoAs, with 60% of all agrochemical MoAs being, or could have been, defined by a NP. This information again points to the importance of NPs in agrochemical discovery, since new MoAs remain a top priority for new agrochemicals.

More generally, the point is not that Arrow’s cannibalization theory is wrong. Arrow’s work convincingly explains monopolists’ low incentives to invest in substitute invention. Instead, the point is that Arrow’s cannibalization theory is narrower than often assumed in the antitrust policy literature. Admittedly, Arrow’s cannibalization theory is relevant in industries primarily driven by a process of cumulative innovation. But it is much less helpful to understand the incentives of a monopolist in industries subject to technological change. As a result of this, the first question that should guide an antitrust agency investigation is empirical in nature: is the industry under consideration one driven by cumulative innovation, or one where technology disruption, shocks, and serendipity incentivize drastic innovation?

Note that exogenous factors beyond technological frontiers also promote drastic innovation. This point ought not to be overlooked. A sizeable amount of the specialist scientific literature stresses the powerful innovation incentives created by changing dietary habits, new diseases (e.g. the Zika virus), global population growth, and environmental challenges like climate change and weather extremes. In 2015, Jeschke noted:

In spite of the significant consolidation of the agrochemical companies, modern agricultural chemistry is vital and will have the opportunity to shape the future of agriculture by continuing to deliver further innovative integrated solutions. 

Words of wisdom caution for antitrust agencies tasked with the complex mission of reviewing mergers in the ag-biotech industry?

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!

Michael Sykuta is Associate Professor, Agricultural and Applied Economics, and Director, Contracting Organizations Research Institute at the University of Missouri.

The US agriculture sector has been experiencing consolidation at all levels for decades, even as the global ag economy has been growing and becoming more diverse. Much of this consolidation has been driven by technological changes that created economies of scale, both at the farm level and beyond.

Likewise, the role of technology has changed the face of agriculture, particularly in the past 20 years since the commercial introduction of the first genetically modified (GMO) crops. However, biotechnology itself comprises only a portion of the technology change. The development of global positioning systems (GPS) and GPS-enabled equipment have created new opportunities for precision agriculture, whether for the application of crop inputs, crop management, or yield monitoring. The development of unmanned and autonomous vehicles and remote sensing technologies, particularly unmanned aerial vehicles (i.e. UAVs, or “drones”), have created new opportunities for field scouting, crop monitoring, and real-time field management. And currently, the development of Big Data analytics is promising to combine all of the different types of data associated with agricultural production in ways intended to improve the application of all the various technologies and to guide production decisions.

Now, with the pending mergers of several major agricultural input and life sciences companies, regulators are faced with a challenge: How to evaluate the competitive effects of such mergers in the face of such a complex and dynamic technology environment—particularly when these technologies are not independent of one another? What is the relevant market for considering competitive effects and what are the implications for technology development? And how does the nature of the technology itself implicate the economic efficiencies underlying these mergers?

Before going too far, it is important to note that while the three cases currently under review (i.e., ChemChina/Syngenta, Dow/DuPont, and Bayer/Monsanto) are frequently lumped together in discussions, the three present rather different competitive cases—particularly within the US. For instance, ChemChina’s acquisition of Syngenta will not, in itself, meaningfully change market concentration. However, financial backing from ChemChina may allow Syngenta to buy up the discards from other deals, such as the parts of DuPont that the EU Commission is requiring to be divested or the seed assets Bayer is reportedly looking to sell to preempt regulatory concerns, as well as other smaller competitors.

Dow-DuPont is perhaps the most head-to-head of the three mergers in terms of R&D and product lines. Both firms are in the top five in the US for pesticide manufacturing and for seeds. However, the Dow-DuPont merger is about much more than combining agricultural businesses. The Dow-DuPont deal specifically aims to create and spin-off three different companies specializing in agriculture, material science, and specialty products. Although agriculture may be the business line in which the companies most overlap, it represents just over 21% of the combined businesses’ annual revenues.

Bayer-Monsanto is yet a different sort of pairing. While both companies are among the top five in US pesticide manufacturing (with combined sales less than Syngenta and about equal to Dow without DuPont), Bayer is a relatively minor player in the seed industry. Likewise, Monsanto is focused almost exclusively on crop production and digital farming technologies, offering little overlap to Bayer’s human health or animal nutrition businesses.

Despite the differences in these deals, they tend to be lumped together and discussed almost exclusively in the context of pesticide manufacturing or crop protection more generally. In so doing, the discussion misses some important aspects of these deals that may mitigate traditional competitive concerns within the pesticide industry.

Mergers as the Key to Unlocking Innovation and Value

First, as the Dow-DuPont merger suggests, mergers may be the least-cost way of (re)organizing assets in ways that maximize value. This is especially true for R&D-intensive industries where intellectual property and innovation are at the core of competitive advantage. Absent the protection of common ownership, neither party would have an incentive to fully disclose the nature of its IP and innovation pipeline. In this case, merging interests increases the efficiency of information sharing so that managers can effectively evaluate and reorganize assets in ways that maximize innovation and return on investment.

Dow and DuPont each have a wide range of areas of application. Both groups of managers recognize that each of their business lines would be stronger as focused, independent entities; but also recognize that the individual elements of their portfolios would be stronger if combined with those of the other company. While the EU Commission argues that Dow-DuPont would reduce the incentive to innovate in the pesticide industry—a dubious claim in itself—the commission seems to ignore the potential increases in efficiency, innovation and ability to serve customer interests across all three of the proposed new businesses. At a minimum, gains in those industries should be weighed against any alleged losses in the agriculture industry.

This is not the first such agricultural and life sciences “reorganization through merger”. The current manifestation of Monsanto is the spin-off of a previous merger between Monsanto and Pharmacia & Upjohn in 2000 that created today’s Pharmacia. At the time of the Pharmacia transaction, Monsanto had portfolios in agricultural products, chemicals, and pharmaceuticals. After reorganizing assets within Pharmacia, three business lines were created: agricultural products (the current Monsanto), pharmaceuticals (now Pharmacia, a subsidiary of Pfizer), and chemicals (now Solutia, a subsidiary of Eastman Chemical Co.). Merging interests allowed Monsanto and Pharmacia & Upjohn to create more focused business lines that were better positioned to pursue innovations and serve customers in their respective industries.

In essence, Dow-DuPont is following the same playbook. Although such intentions have not been announced, Bayer’s broad product portfolio suggests a similar long-term play with Monsanto is likely.

Interconnected Technologies, Innovation, and the Margins of Competition

As noted above, regulatory scrutiny of these three mergers focuses on them in the context of pesticide or agricultural chemical manufacturing. However, innovation in the ag chemicals industry is intricately interwoven with developments in other areas of agricultural technology that have rather different competition and innovation dynamics. The current technological wave in agriculture involves the use of Big Data to create value using the myriad data now available through GPS-enabled precision farming equipment. Monsanto and DuPont, through its Pioneer subsidiary, are both players in this developing space, sometimes referred to as “digital farming”.

Digital farming services are intended to assist farmers’ production decision making and increase farm productivity. Using GPS-coded field maps that include assessments of soil conditions, combined with climate data for the particular field, farm input companies can recommend the types of rates of applications for soil conditioning pre-harvest, seed types for planting, and crop protection products during the growing season. Yield monitors at harvest provide outcomes data for feedback to refine and improve the algorithms that are used in subsequent growing seasons.

The integration of digital farming services with seed and chemical manufacturing offers obvious economic benefits for farmers and competitive benefits for service providers. Input manufacturers have incentive to conduct data analytics that individual farmers do not. Farmers have limited analytic resources and relatively small returns to investing in such resources, while input manufacturers have broad market potential for their analytic services. Moreover, by combining data from a broad cross-section of farms, digital farming service companies have access to the data necessary to identify generalizable correlations between farm plot characteristics, input use, and yield rates.

But the value of the information developed through these analytics is not unidirectional in its application and value creation. While input manufacturers may be able to help improve farmers’ operations given the current stock of products, feedback about crop traits and performance also enhances R&D for new product development by identifying potential product attributes with greater market potential. By combining product portfolios, agricultural companies can not only increase the value of their data-driven services for farmers, but more efficiently target R&D resources to their highest potential use.

The synergy between input manufacturing and digital farming notwithstanding, seed and chemical input companies are not the only players in the digital farming space. Equipment manufacturer John Deere was an early entrant in exploiting the information value of data collected by sensors on its equipment. Other remote sensing technology companies have incentive to develop data analytic tools to create value for their data-generating products. Even downstream companies, like ADM, have expressed interest in investing in digital farming assets that might provide new revenue streams with their farmer-suppliers as well as facilitate more efficient specialty crop and identity-preserved commodity-based value chains.

The development of digital farming is still in its early stages and is far from a sure bet for any particular player. Even Monsanto has pulled back from its initial foray into prescriptive digital farming (call FieldScripts). These competitive forces will affect the dynamics of competition at all stages of farm production, including seed and chemicals. Failure to account for those dynamics, and the potential competitive benefits input manufacturers may provide, could lead regulators to overestimate any concerns of competitive harm from the proposed mergers.

Conclusion

Farmers are concerned about the effects of these big-name tie-ups. Farmers may be rightly concerned, but for the wrong reasons. Ultimately, the role of the farmer continues to be diminished in the agricultural value chain. As precision agriculture tools and Big Data analytics reduce the value of idiosyncratic or tacit knowledge at the farm level, the managerial human capital of farmers becomes relatively less important in terms of value-added. It would be unwise to confuse farmers’ concerns regarding the competitive effects of the kinds of mergers we’re seeing now with the actual drivers of change in the agricultural value chain.