Archives For Merger Guidelines Symposium

Thanks to all of our participants in the Merger Guidelines Symposium.  We hope many of you, as well as our readers, will look back over the collected posts and engage in an ongoing dialogue in the comments over the many interesting ideas raised here.  You will find all of the posts from the symposium by clicking on the “merger guidelines symposium” link to the right, under the “blog symposia” heading.  For you reference, we have also collected all of the posts below.

For our friends in the agencies, we hope this symposium gives you some food for thought and a sense of where an informed subset of the antitrust community see issues meriting attention.  It is interesting to note (we received all of the submissions before any were posted) the extent to which so many of these comments focused on the problems of the structural presumption (including market definition and market share calculations), HHI thresholds and unilateral effects–all obviously related matters, most informed by a concern for aligning the Guidelines with agency practice.

Although there was not a lot of discussion of the related matter of the recent Farrell/Shapiro proposal on unilateral effects analysis without market definition, many of the posts provide a backdrop against which discussion of the proposal is sure to arise.  For my own parting thought on the issue, I would note this:  Whatever the problems with market definition in unilateral effects analysis, I hope we will not be too quick to jettison the exercise in exchange for the Farrell/Shapiro proposal (or similar).  Although imperfect, the market definition exercise exerts some check on merger enforcement that is absent from the Farrell/Shapiro proposal.  And in the absence of extremely good empirical data (as in Staples),  I fear that the UPP analysis may permit enforcers to find competitive effects in a much wider range of cases than would be desirable.  As essential background to assessing this trade-off in the modern economy, I refer our readers to the Sidak/Teece submission to the symposium and to their forthcoming paper.

Thanks again!

My sense is that there is no need to revise the DOJ/FTC Horizontal Merger Guidelines, with one exception.  As Greg Werden points out, “a thorough revision would take up to three years and occupy some of the agencies’ best people for a total of more than two thousand hours.” The current guidelines lay out the general framework quite well and any change in language relative to that framework are likely to create more confusion rather than less.  Based on my own experience, the business community has had a good sense of how the agencies conduct merger analysis.  The only exception is the Guideline’s concentration thresholds, which have been obsolete in practice since at least the mid 1990s.  Those thresholds should probably be changed to reflect actual practice.  If, however, the current administration intends to materially change the way merger analysis is conducted at the agencies, then perhaps greater revision makes more sense.  But even then, perhaps the best approach is to try out some of the contemplated changes (i.e. in actual investigations) and publicize them in speeches and the like before memorializing them in a document that is likely to have some substantial permanence to it.

Small Changes

Danny Sokol —  27 October 2009

Chairman Leibowitz in his Fordham speech last month stated “From my perspective, the current Guidelines do not explain clearly enough to businesses how the agencies review transactions.” Won’t that always be the case? In a specialized area of complex regulatory law, there is whatever guidelines an agency (or in our case agencies) will promulgate and then small group of insider lawyers who will have enough repeat business to really understand the meaning of the guidelines via their agency contacts. For others, the guidelines will remain unclear unless you create a 600 page set of merger guidelines – not a good idea.

Maybe the lack of clarity is a problem, particularly with judges. After all, judges play a role in enforcing the law. The Guidelines cover this aspect fairly early on in Section .01. However, who is the end user of the Guidelines? Is it the firms practicing before the agencies or for judges to use? If the Guidelines have a purpose for judges, there is an important institutional issue at play as we have not had a merger case before the Supreme Court for many years. This leads to a meta-question — Is the law Section 7 or is it the Guidelines as defined by the agencies at any given time?

I do have three points as to the substance of the Guidelines:

1. The Guidelines have only a brief mention of R&D (Section 4), in which they state that even if synergies are substantial, they “are generally less susceptible to verification and may be the result of anticompetitive output reductions.” This treatment seems incomplete. After all, the rise of the new economy and of a greater role for IP suggests that there should be more guidance with regard to R&D efficiencies.

2. Let us start using HHIs that have some remote relationship to actual enforcement decisions. Although HHIs are only rough preliminary screens, and other factors make the real difference, the agencies ignore the HHI thresholds in the Guidelines in making enforcement decisions. The rub is that the agencies then cite the HHIs in district court to show how bad the violation is.

3. The treatment of unilateral effects needs to be revisited. The concept as used in practice needs to be better reflected in the Guidelines.

Fix the Supply Side

Geoffrey Manne —  27 October 2009

Do the Merger Guidelines need revision? No.  Thanks for having me.

OK. Yes–and market definition/market shares, and in particular the effective incorporation of supply-side effects, seem to me like the most pressing issues in need of attention.

Judge Posner, in the first edition of his justly celebrated Antitrust Law, noted that market definition was an unfortunate means to an end, a necessity given the inability of our analytical tools effectively to assess the effects of mergers beyond a circumscribed boundary.  As Posner noted,

The importance attached to defining a market in which to appraise the competitive effects of a challenged merger is on more example of the law’s failure to have developed a genuinely economic approach to the problem of monopoly.  If we knew the elasticity of demand facing a group of sellers, it would be redundant to ask whether the group constituted an economically meaningful market. . . . It is only because we lack confidence in our ability to measure elasticities, or perhaps because we do not think of adopting so explicitly economic an approach, that we have to define markets instead.

I doubt we would shun the approach for being too explicitly economic today, but I think a very small number of cases permit us to identify competitive effects with sufficient confidence—Staples being the paradigmatic case.  We may be stuck with market definition, but the outdated conception enshrined in the Guidelines–of measuring concentration in a static market defined essentially by demand-side elasticities–can surely be improved upon.

In the first instance, we should remove any hint of a concentration/price presumption so intimately tied to measuring market definition and HHIs.  Although the Guidelines attempt to cabin the market definition and market share analyses as “starting points,” in practice they are the beginning and end of most merger cases.  The Merger Guidelines (and, importantly, agency practice) should be revised to limit reliance on market definition and market share, at a minimum by stating explicitly that the definition of the market and the calculation of market shares are not sufficient to indicate adverse competitive effects, and perhaps also by removing HHI threshold discussions which seem to imply the same.  Even if the agencies and the Guidelines don’t mean these tools to be used in this way, courts haven’t really gotten the message.

At the same time, the Guidelines should explicitly incorporate supply side elasticity into the market definition inquiry.  There is little defense of the Guideline’s statement that “Market definition focuses solely on demand substitution factors—i.e., possible consumer responses.”  While the Guidelines and actual practice do attempt to make some allowance for supply-side effects, these allowances seem like afterthoughts, and I think it is rare that HHIs are calculated to incorporate production capacity not currently devoted to the narrowly-demand-defined product market, especially outside of the commodity realm.  Meanwhile, even a small bias against supply substitution, entry and unforeseen competitors (and/or new products) is a particular problem in fast-shifting, innovative industries where this is precisely whence the most significant competitive threat will come.

To the extent (and it is a large extent) that market definition and market share are far-removed from competitive effects, they should be more carefully circumscribed by the Guidelines.  The economic irrelevance of much of the evidence used to define markets and the general disregard for supply-side response help to ensure that market definition, while incredibly important in litigation, is not actually all that helpful.  At the same time, the general lack of correlation between concentration and unilateral effects makes reliance on the calculation of market shares (of crabbed markets, often disregarding supply-side effects) similarly misleading and prejudicial.

I’m confident that my esteemed colleagues, who have far more expertise about the merger guidelines than I, will offer all sorts of terrific ideas for revising the substance of the guidelines. While I would certainly advocate a few specific changes (i.e., revise the HHI thresholds to reflect actual agency practice), I’ll leave the devilish details to the experts and concentrate on one “modest” (quite literally!) revision:

I would encourage the antitrust agencies to clarify, within the actual text of the guidelines (i.e., not in mere commentary like that issued in 2006), that the guidelines are not the law, should not be treated as such by the courts, do not exhaustively specify when a merger will or will not be anticompetitive, and should be flexibly implemented to account for case-specific factors that cannot be specified ex ante. In short, the guidelines should explicitly acknowledge that the ultimate question in any horizontal merger case requires the application of a standard, not a rule.

A rule is a legal mandate that entails an advance determination of what conduct is permissible and leaves only factual issues for the adjudicator (e.g., “Do not drive faster than 65 m.p.h.”). A standard, by contrast, is a mandate that leaves to the adjudicator both factual issues and some judgment about what conduct is permissible (e.g., “Do not drive at an excessive speed.”). Rules provide superior guidance to the governed and the adjudicator, but they can misfire if over- or underinclusive, and they therefore require ex ante specification of all factors that might be relevant to a sound decision. Standards provide less guidance, but they are more likely to generate a correct adjudication in any particular case, for the adjudicator is free to account for unforeseen, case-specific quirks.

The legal question at issue in a horizontal merger case — “might the business combination substantially lessen competition or tend to create a monopoly?” — requires the ultimate adjudicator to apply a standard, not a rule. It is simply impossible to specify ex ante all the considerations relevant to answering this question. Accordingly, to the extent the merger guidelines are viewed by courts as rules for separating pro- from anticompetitive mergers, they are bound to generate incorrect adjudications when they inevitably misfire.

Now I realize the merger guidelines, as currently drafted, do not purport to bind courts and do state that their “mechanical application . . . may provide misleading answers” and that they should be applied “reasonably and flexibly to the particular facts and circumstances of each proposed merger.” I don’t believe this is enough. The fact is, generalist judges asked to resolve the complicated economic disputes in a horizontal merger case are reluctant to veer beyond the guidelines’ prescribed analysis and, as a practical matter, treat the guidelines as though they are, in fact, the law. In the D.C. Circuit’s Whole Foods decision, for example, the majority chided the dissent for having incorrectly applied the merger guidelines. Given that the merger guidelines simply cannot exhaustively specify all the considerations relevant to evaluating a proposed merger, courts’ treatment of them as the final word implies that relevant considerations will get left out.

Take Whole Foods for example. A key fact in that case was that the vast majority of shoppers who buy from so-called “premium natural and organic supermarkets” (PNOS) also shop regularly at conventional grocers. Thus, if a combined Whole Foods/Wild Oats were to raise prices on items available at conventional supermarkets, buyers would likely just start buying those items on their conventional grocer outings rather than on their PNOS outings. Unfortunately, nothing in the merger guidelines calls for a consideration of “cross-shopping,” and this important argument therefore got short shrift. Had the guidelines explicitly stated: “This is not the law. We can’t state up front all relevant considerations. Courts should credit plausible arguments based on factors not stated herein,” this important argument might have gotten the attention it deserved.

Or take considerations relevant to dynamic (Schumpeterian) competition. While I am sympathetic to the Sidak/Teece arguments that the merger guidelines should account for dynamic competition concerns, I simply can’t figure out how one would write a rule that would do that. How can we specify ex ante all the considerations that are relevant to whether a business merger will enhance dynamic, though not necessarily static, competition? There may be an answer to that question — and I much look forward to hearing from Sidak and Teece on this issue — but I don’t know what it is. An alternative approach would be to free up the ultimate adjudicators — the courts — to account for dynamic competition considerations by disabusing them of the notion that they must treat the merger guidelines as law. Parties could then articulate their dynamic competition arguments on a case-by-case basis, and the courts could credit those that appear to have merit.

The main objectives of the merger guidelines, I assume, are (1) to deter combination attempts that would harm competition (i.e., those that would clearly be subject to challenge); (2) to avoid deterring combinations that would not harm competition (i.e., those within a safe harbor); and (3) to assure some consistency across the regulatory agencies and across administrations. These objectives could still be attained — and greater accuracy in outcome could be achieved — if the merger guidelines specified that the ultimate inquiry involves application of a standard rather than a rule.

  1. Yes, the Merger Guidelines should be revised; in particular:

a.  The discussion of concentration thresholds for collusion facilitating mergers must be aligned more closely with both recent case law and actual enforcement practices; otherwise they fail to provide guidance.  The current Guidelines indicate that concentrations greater than 1800 HHI and a post-merger increase exceeding 100HHI presumptively indicates a challenge. In fact, mergers with post-merger HHIs in excess of both these numbers are routinely permitted. While the standards in the current Guidelines are too aggressive, the George W. Bush administration policy was too lenient.  More fundamentally, the HHI creates an illusion of precision in coordinated effects analysis that is simply not warranted, particularly not when market definitions are ambiguous or when the merger market is subject to product differentiation.  Further, the “other factors” portion of the Guidelines tends to dominate the analysis.  A better approach is reduced reliance on the HHI and more on simpler observations about who the 3 or 4 largest firms in the market are, the effects of eliminating the acquired firm as an independent market entity, and the likely responses of rivals to an output reduction by the post-merger firm.

b.  The unilateral effects analysis requires elaboration that brings it into line with actual agency analysis.  Some of the economists would like to jettison a market definition approach and attempt to measure price increase potential more directly.  While I am sympathetic with that, there is too much water over the bridge; it could lead to courts’ simply rejecting the Guidelines.  A better approach is to write market definition criteria that permit narrower market definitions in situations where a unilateral price increase is likely.  This requires that some thought be given to situations where the merger is between one firm and its second closest rather than its closest rival.  Right now it is simply too easy for defendants to argue that the closer rival will steal sales and competition will not be affected.  So the government is currently losing cases that it should not be losing.  Finally,the Guidelines should quell discontent in lawyers’ perception about unilateral effects analysis that it is more speculative or less rigorous than traditional coordinated effects analysis.  The fact is that both types of analysis rely on many assumptions, some of which are no more than conjectures about future firm behavior.  If anything, the robustness edge belongs to the unilateral effects approach.

Let Sleeping Dogs…

Dan Crane —  27 October 2009

I feel no great urgency to revise the Guidelines.  True enough, they’re more of an analytical thought experiment than an accurate description of how merger review takes place in the agencies, but who’s really fooled?  Perhaps some business people think that the Guidelines are a computer program waiting for the introduction of the relevant data to spit out the answer, but most sophisticated executives contemplating a merger will understand that the Guidelines are just a beginning point for conversation.

Could the beginning point be clearer or conform more closely to agency practice?  Sure, but that doesn’t mean that revision of the Guidelines is justified.  With hindsight, the First Amendment could be a little better worded, but no one wants to tinker with it now–who knows what would result?  I’m sufficiently satisfied with current merger practice in the agencies that I don’t care that much what’s in the Guidelines and I am worried about the unpredictable results that could obtain if we started tinkering.  Let sleeping dogs . . .

But if we are going to revise, then my pet issue is the asymmetrical treatment of the probabilities on anticompetitive effects and offsetting efficiencies–a point on which Joe Simons and I are planning a fuller analysis.  The Guidelines seem to suggest that if the probability of anticompetitive effects of magnitude 100 is 50% and the probability of offsetting efficiencies of magnitude 100 is 50%, then the merger should be challenged, since a greater quantum of proof is required for efficiencies than for anticompetitive effects.  This makes no sense to me–everything else being equal, efficiencies that would be passed on to consumers and market power increases should be given equal weight and not assigned separate probability standards.

1.  Do the Merger Guidelines Need Revision?

Yes.  Conceptually, the current Guidelines incorporate multiple strands of intellectual and legal history with respect to merger analysis that have been layered one upon the other over time, but never effectively integrated.  This now encumbers the application of the Guidelines and may be inhibiting the government’s capacity to effectively and efficiently initiate merger challenges.

The current Guidelines remain strongly tethered to the “structural” school, with roots in the 1950s.  The influence of the structural school was evident in both the Philadelphia National Bank presumption and the 1968 Guidelines, and the 1982-97 Guidelines have retained the essential features of that tradition — reliance on market definition, market share calculation, and inferences about market power drawn from those shares.

The 1982 Guidelines also began the process of layering on top of that tradition, injecting elements of the “new learning,” which focused largely on expanding upon General Dynamics and the various bases for rebutting a structural case, and oligopoly theory.  As the Guidelines further evolved through 1997, various dimensions of oligopoly theory were added, especially in the sections on anticompetitive effects, reflecting the work of Stigler, Nash, Cournot, and Bertrand.  Yet additional economic thinking was inserted in the revised and expanded discussions of entry and efficiencies.  Today’s Guidelines, therefore, are an intellectual collage of various traditions in law and economics.

2. If yes, what is the most important revision that you would recommend and why?

Although it is a tall order, the agencies could undertake to clarify the overall conceptual framework of the Guidelines.  Currently, even though it does not describe actual agency practice, the Guidelines are perceived by courts as outlining a linear process, in which its five steps are mechanically undertaken in sequence, each proceeding only after the previous step is completed.  This in effect makes structural analysis a prerequisite to the evaluation of every merger and it impairs reliance on any other approach to evaluating likely anticompetitive effects or efficiencies more directly.  This approach wrongly elevates the status of market definition above competitive effects, which is the core concern of merger analysis – indeed of all antitrust analysis.

A related goal would be to harmonize the intellectual underpinnings of merger analysis with other areas of antitrust law.  This is especially important with respect to courts’ willingness to rely on direct effects evidence since the Supreme Court’s decisions in NCAA and Indiana Fed’n of Dentists.  Depending on the kind of evidence available, unilateral effects theory can be understood as an application of the direct effects approach to mergers.  In cases like Staples, for example, where natural experiments provided a basis for predicting the likely future effects of the merger, it is a sort of “predicted actual effects” doctrine.  As with NCAA and Indiana Fed’n of Dentists, in such cases defining markets and inferring market power indirectly should be understood as a surrogate that is unnecessary when more direct and more reliable indications of future market power are available.

A third and also related goal might be to more openly acknowledge that the Guidelines influence how courts assign burdens of production and proof.  It has become tradition for all government Guidelines to pronounce that they are not intended to specify burdens of proof or production; that instead, they simply outline the government’s internal processes for exercising prosecutorial discretion. But these assertions are at odds with actual practice once the government enters the courthouse.  The Merger Guidelines have been read to specify burdens: Steps 1 and 2 (market definition and anticompetitive effect) shift the burden to the defendant, who can then seek to rebut the prima facie case based on entry, efficiencies, or a failing firm defense.  And courts such as the D.C. Circuit in Baker Hughes and Heinz, have promoted the use a “sliding scale” to establish variable-strength presumptions and to evaluate burdens, often relying heavily on structural evidence as a burden shifter, a tradition rooted in Philadelphia Nat’l Bank.  Given that the Guidelines are applied this way, the agencies should consider saying a bit more about what should be sufficient to shift a burden of production in either direction and whether certain kinds and quantities of evidence shift a burden more emphatically than others.

The specification of burdens also has implications for the welfare standard being used to assess mergers.  This is most obvious in the efficiencies discussion, which currently tries to nuance the issue.  The text strongly suggests a commitment to a consumer welfare standard defined as giving greater weight to consumer surplus.  But there is a hint of equivocation in footnote 37, which contains some support for the argument that aggregate welfare may be a relevant consideration.  More clearly specifying the relative burdens of production could eliminate any remaining ambiguity regarding the welfare standard.  Although it is unlikely that very many cases would be influenced by the choice of a consumer welfare or aggregate welfare standard, the courts have generally applied the consumer welfare approach now dominant in the Guidelines and this should be more clearly acknowledged.

Finally, post-consummation merger challenges have become more common and yet the Guidelines are focused entirely on making predictions about likely future effects.  The agencies might consider either adding a section on post-consummation mergers or generating a separate guidance document that would do so.  The goal would be to explain how the post-consummation analysis of a merger might differ from those done pre-merger.  This again highlights the need to integrate thinking about the role of actual effects evidence, which becomes more central in post-consummation challenges.  Such a discussion also could include consideration of limited reliance on abbreviated or “quick look” types of analysis to shift burdens in appropriate post-consummation cases and reduce the costs of merger review.

Yes, the Merger Guidelines should be revised.

The Guidelines primary purpose is to “articulate the analytical framework the Agency applies in determining whether a merger is likely substantially to lessen competition.”   While the Guidelines have been very successful in articulating a useful economic framework for analyzing mergers, their performance in terms of satisfying that goal has been largely mediocre.   If the goal articulated by the Guidelines is an important one, and I do believe that providing some modicum of legal certainty to businesses contemplating merger decisions is valuable goal, then the Merger Guidelines do need revising in order to fulfill their purpose.

The mere fact that agency practice is much more predictable now than it used to be does not warrant inaction when one considers the Guidelines in light of their primary purpose.  Indeed, that the agencies consistently apply different standards to the Clayton Act 7 standard than what appears in the Guidelines is no more a defense of the Guidelines than the fact that nobody cites Vons Grocery or Pabst is an argument for keeping those decisions on the books.

So in my view, the Guidelines ought to be revised with an eye  toward changes that will bring the Guidelines in line with actual agency practice and update the Guidelines to reflect modern economic thinking and empirical evidence.

What is the first revision I’d make and why?

Following these principles, I think revision discussions should focus on low hanging fruit that satisfies these criteria.  There are a number of areas that arguably qualify, but let me start with one simple one:  The Agencies should revise the Guidelines to affirmatively abandon use of the structural presumption to demonstrate a substantial lessening of competition.  Of course, the Guidelines tell us that they are not designed to inform parties “how the Agency will conduct the litigation of cases that it decides to bring,” use of the structural presumption is fundamentally about economics and not litigation strategy.

Indeed, in its formulation in Philadelphia National Bank,the Supreme Court held that:

A merger which produces a firm controlling an undue percentage share of the relevant market, and results in a significant increase in the concentration of firms in that market is so inherently likely to lessen competition substantially that it must be enjoined in the absence of evidence clearly showing that the merger is not likely to have such anticompetitive effects.

While the structural presumption has been eroded from the days of Philadelphia National Bank when it was invoked in the context of a merger creating a firm with 30% share of the market, it also has not disappeared.  And it is important to note that the justification for the presumption was its economic content.  Indeed, the Court noted that the size of mergers above the presumptive level of concentration made them “inherently suspect” and that the test was “fully consistent with economic theory,” and forged “common ground among most economists.”

There are two important reasons why the Agencies should formally reject the structural presumption.

The first is that it is an an explicitly economic test that is no longer justified by modern economics.  Modern economic learning and empirical evidence does not support the notion that mergers that generate post-merger firm with greater than 30 percent share substantially lessen competition.  It is a convenient litigation tool to shift the burden to defendants when courts are not persuaded by a competitive effects story.  But that is no excuse.  If the Agencies believe the best available evidence does not support the economic foundation of the structural presumption, they should abandon it.

Note that I’m not saying that the Agencies could not discuss alternative presumptions based on sound economics.  Perhaps economic theory and empirical evidence provide the basis of alternative bright line standards which can appropriately be made the basis of a presumption that a particular merger will substantially lessen competition and harm consumers.  But the presumption as it currently exists no longer comports with modern economics or Agency thinking about merger analysis and should be abandoned.

The second reason to explicitly abandon the presumption is that it is far too sensitive to the market definition exercise.   I think its important to note the tension between the movement toward and sometimes celebration of unilateral and coordinated effects analysis at the Agencies and away from market definition (even if not completely) and use of the structural presumption which depends so heavily on the identification of the relevant market.  The market definition exercise may well have its virtues in constraining agencies from bringing cases with overly narrow markets.  However, when the critical lesson of the modern economic approaches to mergers is that post-merger change in pricing incentives and competitive effects are what matters, it is difficult to justify the structural approach either with reference to the Guidelines articulate purpose or modern economics.

When it comes to the structural presumption, the Agencies should not get to have it both ways.  If we’re going to take the modern economics of mergers seriously, and reduce the importance of market definition in favor of competitive effects, we should also do away with the structural presumption.  The Supreme Court is not likely to take a merger case any time soon and do away with the presumption themselves.  It is up to the Agencies to eliminate the presumption as it currently exists in order to restore consistency with economic learning and empirical evidence.

The merger guidelines should be revised, not only to provide clearer guidance, but because the current version makes it harder for the agencies to win cases when they do challenge a merger.  The reason is that the guidelines often don’t fit actual agency practice or modern economic theory.  For example, part of the reason the DOJ lost the Oracle/Peoplesoft merger case was that its guidelines on unilateral effects do not match modern practice or theory.  Such a mismatch makes it harder to convince judges that merger enforcement satisfies traditional rule of law concerns about providing advance notice of legal standards that are clear enough to guide private conduct and meaningfully constrain legal discretion.  Here are the areas on which I would focus.

Unilateral Effects. The unilateral effects portion of the merger guidelines should be rewritten because the economics on unilateral effects have no connection to the HHI or 35% market share thresholds used in the guidelines.  For example, given that unilateral price effects were established in Staples, it really shouldn’t have mattered whether the court concluded Staples and Office Depot operated in an office superstore market or were simply close to each other in a differentiated office supply market.  Their market share was only 5.5% under the latter market definition, but market labels don’t alter the price effects, and why should a merger that significantly increases consumer prices be tolerated just because we can define a large market?

Market Definition. The guidelines thus should not suggest that market definition is required in unilateral effects cases, but should instead provide an alternative methodology for proving such effects.  The guidelines could rely directly on diversion ratios, as suggested by Professors Farrell and Shapiro in their prior academic roles.  Or, to use an alternative that would look more familiar to courts used to market definitions, the agencies could posit a product space around the merging parties and directly measure the relevant demand elasticities from that space to other spaces, and the supply elasticities within and into that space, and predict price effects directly.

Indeed, this approach seems better than market definition even in oligopoly effect cases because market definitions rest on all or nothing assessments that distort the economic analysis.  For example, market definition equates substitutes that could constrain prices increases of 6% with having no substitute at all, and equates substitutes that could constrain price increases of 4% with having a complete substitute, when neither is really accurate.  In practice, courts and agencies adjust the weight given to HHI or market share calculations based on judgments about the extent to which buyers could switch to outside the market and the extent to which rivals could enter or expand.  But those judgments are simply subjective assessments about demand and supply elasticities that would be better to make openly, and once we make them we don’t really need market definition to predict price effects.

Oligopoly Effects. The guidelines now provide a lot of guidance on when a market is likely to engage in oligopolistic coordination, but little guidance on when a merger is likely to worsen coordination, other than for mergers that involve the acquisition of a maverick.  Thus, the guidelines lend themselves to Catch-22 effect.  If the guidelines indicate coordination is unlikely, then courts conclude the merger cannot produce oligopoly effects.  But if the guidelines indicate coordination is likely, then courts sensibly ask why coordination isn’t equally likely before the merger, in which case the merger won’t worsen anything.  The guidelines need to be clearer about defining the incremental increase in coordination caused by mergers.

Partial ownership. Although the agencies sometimes challenge acquisitions of partial stock ownership, we don’t have any clear guidelines about when partial ownership will count as sufficiently active to be assessed as a merger.  Further, some enforcement actions have made noises about challenging partial stock acquisitions on the theory that they might lessen firm incentives to compete with each other.  This later theory could apply even when the investment is entirely passive, but so far has not been, and we don’t have any guidelines clearly indicating whether this theory would ever be applied in a case where the investment is entirely passive or what the criteria would be for distinguishing how much passive ownership is too much.  Without such advance guidelines, it is hard to imagine winning an enforcement case based on such a theory.

The Horizontal Merger Guidelines are the intellectual cornerstone of modern antitrust law, yet they contain little discussion of innovation or dynamic competition. Although the Merger Guidelines do not constitute law merely by virtue of their promulgation by the agencies, the courts previously have accepted the revised principles that the agencies have advocated. By embracing the reasoning in the Merger Guidelines promulgated several decades ago by the Antitrust Division and the Federal Trade Commission, the federal courts have caused antitrust case law to ossify around a decidedly static view of antitrust. Put differently, in the years since 1980 the Division and the FTC have successfully persuaded the courts to adopt a more explicitly economic approach to merger analysis, yet one that has a static view of competition. The result is not a mere policy preference. It is law. To change that law to have a more dynamic view of competition will therefore require a sustained intellectual effort by the enforcement
agencies (as well as by scholars and practitioners) that, once more, engages the courts to reexamine antitrust law as they did in the late 1970s during the ascendancy of the Chicago School, when antitrust law became infused with its current, static understanding of competition. It appears that, before the Obama Administration took office, the Antitrust Division was attempting to incorporate more dynamic analysis, but the result was inconsistent across different mergers and different doctrinal areas of antitrust law.

Put succinctly, competition policy rooted in static economic analysis sees the policy goal as minimizing the Harberger (deadweight loss) triangles from monopoly. A new competition policy, recognizing the special power of dynamic competition, would advance the availability of new products and the co-creation of new markets that allows latent demand (and hence new amounts of consumer surplus associated with new demand curves) to be realized by consumers. It would also recognize cost savings flowing from innovation as an indicator of likely future consumer welfare gains. Put differently, the focus of a revised competition policy and merger-guideline framework would still very much be on the consumer, but it would be future-oriented and would recognize that certain business practices might lead to market creation (or at least co-creation) that would yield new demand curves with large gains in consumer surplus (because demand for new products could be satisfied). The minimization of Harberger deadweight loss triangles would be a secondary focus. Where minimizing Harberger triangles today stands in the way of creating new and significant future demand curves, a new competition policy would likely favor the future and recognize the welfare benefits associated with creating or co-creating new markets.

To develop policy prescriptions that do more good than harm, economists and antitrust scholars and practitioners need to inquire into the determinants of innovation and the impact of antitrust activity (including merger policy) on innovation. Rapid technological change advances dynamic competition. The problem is that the analytical framework that economists most commonly embrace adheres stubbornly to the view that market structure-and little else-determines the rate of technological change. We develop these ideas in much greater detail, with specific proposals to amend the Merger Guidelines, in “Dyanamic Competition in Antitrust Law,” forthcoming in the Journal of Competition Law & Economics.

Of course, the Merger Guidelines need to be updated.  Except for efficiencies, they haven’t been updated in 17 years.   Lawyers and economists with a regular antitrust practice may not require an update in light of their knowledge of the 2006 Commentary, speeches and agency experience.  But, the rest of the antitrust world does.  The most obvious audience is the courts, who should know what the agencies believe is best practice.  Moreover, as FTC Commissioner Kovacic has stressed, the world marketplace for antitrust ideas needs to have the guidance of the US enforcement agencies.  They should not have to ferret it out from commentaries and speeches.  The Merger Guidelines have been the most emulated feature of US antitrust enforcement worldwide.  It would be shame to squander the leadership role.

The “most important” revision is harder to identify.  I am caught here between market definition and unilateral effects – and, clearly, revisions to either issue will have important implications for how the agencies and practitioners approach the other issue.  Of course, coordinated effects and entry could use some work too.  But, let me stick just with the first two and just a sampling of issues there.

The hypothetical monopolist SSNIP test is an elegant but complicated and imperfect methodology.   I think it should be explicitly conceded in the Guidelines that market definition is a very imperfect exercise in practice in which the “appropriate” market definition is often controversial and there may not convincing evidence for a single “most appropriate” market.  That concession would continue the process of downgrading the perceived importance of market definition in antitrust and focusing the courts more on the bottom line issue of competitive effects.  After all, market definition is mainly valued for helping to analyze competitive effects.  The imperfections of market definition and the implications for merger analysis have been made by Katz & Shelanski and should be made explicit in the update.   In fact, I’d like the Guidelines to start with a “first principles” overview of competitive effects and fit market definition into that framework, not the reverse.

The SSNIP test definitely needs some renovation after all these years.  There is considerable controversy today over the proper way to implement the test. For example, standard critical loss analysis often used by economic experts in testimony generally focuses just on the profitability of a SSNIP, whereas the Guidelines focus on whether a SSNIP is profit-maximizing.  It also may ignore relevant information.  Articles by Katz & Shapiro and O’Brien & Wickelgren (“KSOW”) have proposed a methodology that takes into account the information about demand elasticity contained in the price/cost margins of profit-maximizing Bertrand competitors.  This is a step in the right direction.

This KSOW methodology does tend to lead to narrower markets than often are found now.  So, the agencies need to decide whether this is the desired outcome or whether they should raise the SSNIP level, or downgrade the importance of market shares and concentration, to compensate.

The “smallest market principle” should be erased.  First, the SMP erroneously suggests that a careful application of the ssnip test will identify one and only one relevant market.   That outcome is not the case in practice.  Depending on the starting point (and there is no unique starting point), the algorithm does not lead to a unique “smallest” market.  And, once price discrimination is taken into account (in a negotiated price market, for example) the smallest market may well be a single customer.

The principle also makes no sense as a matter of policy.  Suppose there were a narrow market for premium baby food comprised of just Gerber, Beechnut, and organic brands.  That finding should not imply that a merger between Gerber and Heinz necessarily would be free of significant competitive issues.

Moving on to unilateral effects, it is clear that the Unilateral Effects section also needs work.  One need go no further than the garbled description of the impact of a 35% combined market share.  After this part is revised and clarified, I will mourn the lost opportunity of reading it to my students.  What a fabulous example of drafting by a committee in conflict!  But, the offsetting benefit is that my students, the courts and others may actually understand the enforcement intentions of the agencies, including the issue of whether or not there is a safe harbor.

The Unilateral Effects section also needs to clarify the role of the repositioning.  The 2006 Merger Commentary suggests that repositioning is seldom, if ever, sufficient to eliminate concerns.  Coupled with tight agency standards towards cognizable efficiency benefits, this has led to a longstanding concern among commentators that virtually every differentiated products merger could be said to raise a significant danger of adverse unilateral effects.  I think that this is mainly an evidence issue.   If there has been repositioning in the pre-merger market, claims of a post-merger repositioning constraint are more credible.   Otherwise it needs to be explained why repositioning would not been observed as the market has been evolving over time.

More attention also must be paid to gauging the magnitude of the predicted unilateral effects, both at the screening stage and in the ultimate inquiry.  Greg Werden, O’Brien & Salop, and Farrell & Shapiro each have proposed variants of “upward price pressure indices” (“UPPIs”).  These UPPIs rely on information about diversion ratios, margins and efficiency benefits.  They could be made an explicit part of the analysis.  They also could form the basis for an initial screen that would make more economic sense for unilateral effects than the HHI, which at best is related to coordinated effects.  I have heard criticism that the UPPIs cannot be derived rigorously from a general oligopoly model without making certain additional limiting assumptions.  True enough, but neither can the HHI!

Formulating an initial screen or safe harbor UPPI will take some work.  Should there be an explicit “efficiency credit?” Or, should the agencies simply set a critical level for the UPPI, based on expertise, experience and policy preferences?  (In this regard, the HHI thresholds of 1000 and 1800, and the Delta-HHI threshold of 100 were never really justified.)  If there is a formal credit, how should it be formulated – as a fraction of cost or price or both?  Should the efficiency credit be a “standard deduction” or a “personal exemption?” That is, should cognizable efficiencies proven by the parties be added to the credit (as with a personal exemption), or replace the credit (as itemized deductions replace the standard deduction)?

And, how should the efficiency credit take into account optimal deterrence, including the goal of allowing well-functioning markets for the sale of property and corporate control, two general efficiencies noted in the previous versions of the Guidelines?  In addition, what does “incipiency” mean in today’s world — does it mean that the agencies and courts should set standards tilted more towards a concern with false negatives?  In my view, optimal deterrence is the most important issue of all, but clearly one of the hardest and most controversial.

The UPPIs also need to be connected up to market definition.  The UPPI is a close cousin of the KSOW form of critical loss analysis.  Indeed, this connection serves as a reminder that market definition generally has reduced importance in unilateral effects.  This does not mean that market definition is irrelevant.  Market definition analysis provides a focus on closeness of substitutes, which is central to unilateral effects analysis.  The importance of the cross-elasticity of demand was even noted by the Court in its notorious DuPont decision.  Market definition also is relevant for coordinated effects – to define a possible coordinating group of firms.  And, of course, Section 7 makes it clear that a market must be defined.  So, it is clear that market definition cannot be dispensed with, but only downgraded in importance.