The New DOJ/FTC Horizontal Merger Guidelines

Last August, the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC) issued revisions to their joint Horizontal Merger Guidelines (HMG). The new HMG represent a substantial departure from the old HMG, and they change in important ways how companies seeking merger clearance (or seeking to influence merger clearance for deals involving suppliers, competitors, or customers) should make their presentations to the agencies. At the risk of over-generalizing, a standard approach to getting merger clearance under the old HMG was to argue that the proposed merger would do no competitive harm. Under the new HMG, merging companies should consider doing more to make the affirmative case for the merger; and doing so might involve greater involvement by those involved in planning for the merger might be necessary.

Background

For those not familiar with merger review, some basic background might help. Section 7 of the Clayton Antitrust Act makes it illegal for one company to acquire another, or for two companies to merge, if the effect “may be substantially to lessen competition, or to tend to create a monopoly.” When it was passed, merger challenges occurred only after the merger had been consummated. That changed in 1974. Because of the difficulty of “unscrambling the eggs,” Congress enacted the Hart-Scott-Rodino Act, which provided for pre-merger antitrust review. The Antitrust Division of the DOJ and the FTC share responsibility for merger review in most industries.

The mergers most likely to be challenged are so-called “horizontal mergers,” or mergers of competitors. For example, if Intel and AMD were to try to merge, the reviewing agency would almost surely challenge it and almost as surely prevail in court. “Vertical mergers,” which are those between companies in a buyer-seller relationship, sometimes generate intervention. (For example, the DOJ imposed conditions on Ticketmaster's recent acquisition of LiveNation.) But such examples are relatively rare. Challenges to conglomerate mergers (which are mergers that are neither horizontal nor vertical) are even more rare. Most of the action in the DOJ's and FTC's merger review concerns mergers of competitors.

In their pre-merger analysis, the antitrust agencies try to predict whether a proposed merger poses a substantial risk of increasing prices or reducing competition in some other way. The traditional approach to this analysis was to determine whether the merger would result in a significant increase in market concentration. At first, that might seem obvious. When only two firms compete in a market, a merger between the two of them is likely to pose a significant risk to competition. In contrast, a merger of two firms in a market with 100 firms of roughly equal size is unlikely to do so. But assessing how a merger will affect market concentration requires defining precisely what the market is; and the answer is not always obvious. Consider, for example, Whole Foods' 2007 acquisition of Wild Oats. If “the relevant market” is for grocery stores, they were both small players. But if the high-end niche in which they competed constitutes a distinct market, the merger consolidated the only two competitors in some areas.

The DOJ issued the first Merger Guidelines in 1968. The section on horizontal mergers ' those guidelines covered vertical and conglomerate mergers as well ' consisted of four double-spaced pages that laid out presumptively permissible shares for the acquiring and target firms as a function of the level of concentration (as measured by the combined market shares of the four leading firms, or the “four-firm concentration ratio”). The 1968 Merger Guidelines were silent, however, on principles of market definition. The 1982 DOJ Merger Guidelines revolutionized merger review by laying out principles for market definition. Drawing heavily on input from economists, the 1982 Guidelines introduced the so-called SSNIP test for market definition. SSNIP stands for “Small, but Significant, Non-transitory Increase in Price.” Based on a SSNIP test, a relevant antitrust market is a product and a geographic area within which a hypothetical monopolist would find it profitable to increase price by a small, but significant, non-transistory amount, typically taken to be 5%. (The 1982 Guidelines changed the measure of concentration from the four-firm concentration ratio to the “Herfindahl-Hirschman Index” or “HHI.” While a technical improvement, that change did not alter the fundamental logic.) While the DOJ (subsequently in collaboration with the FTC) revised its Horizontal Merger Guidelines in 1984, 1992, and 1997, both the centrality of market definition and the SSNIP test approach to it remained in tact.

Judged by their influence, the 1982 Merger Guidelines were a staggering success. Despite the heavy reliance on economics, many lawyers came to view them as providing a clear framework that made merger review predictable. Similarly, courts relied on the guidelines because they presented a disciplined approach to evaluating cases the agencies brought and because they fit with existing case law that continued to give heavy (albeit not exclusive) weight to market definition. And the success of the 1982 Merger Guidelines extended well beyond the borders of the United States. Virtually every jurisdiction with antitrust laws has guidelines that base market definition on a SSNIP test and numerical guidelines based on the HHI. (Indeed, most use the numerical standards that markets with HHIs above 1800 are “Highly Concentrated,” markets with HHIs between 1000 and 1800 are “Moderately Concentrated,” and markets with HHIs below 1000 are “Unconcentrated.” To gauge what those numbers mean, an HHI of 1,800 is less concentrated than a market with five equally sized firms, which would have an HHI of 2,000. A market with 10 equally sized firms would have an HHI of 1,000.)

Evolving Merger Review and Its Problems

As the agencies gained experience in implementing the Guidelines, it became increasingly clear that the SSNIP test was not the panacea for all problems with merger review. Even when it is based on an economically sound approach, market definition necessarily entails drawing lines in which substitutes are treated as being entirely in or entirely out of the market. Such a sharp delineation can be arbitrary when substitutes for a good are imperfect and candidates for inclusion in the relevant market vary more or less continuously with respect to how closely substitutable they are.

Moreover, as techniques for defining markets evolved, the agencies came to realize that market definition is sometimes completely unnecessary. Market definition is a tool for assessing whether anticompetitive effects are possible. In some cases, however, an agency has proved a market by directly demonstrating effects. A famous example was the proposed merger between Staples and Office Depot in 1997. The market definition issue in the case was whether consumable office supplies sold in office super stores were a distinct market. Because office supplies sold at office super stores are generally available elsewhere (such as WalMart), there was a great deal of skepticism that goods sold within a particular retailing format could be a relevant antitrust market. But the FTC, which challenged the merger, demonstrated that office superstores charged higher prices in areas without competing office superstores than in areas with them. That fact was arguably sufficient to establish the likelihood of anticompetitive harm from the merger. At that point, defining the market, and measuring concentration and the change in concentration in it was merely a formality.

Implementing the New HMG

One of the central points of the new HMG is that market definition plays less central a role in agency merger review than one would expect based on the previous HMG. Instead, the agencies plan to focus their inquiries more directly on the likely competitive effect of a proposed merger. This point is not news. Not only do people who make a living making presentations to the agencies understand it, the agencies themselves made many of the same points when they issued Commentaries on the Horizontal Merger Guidelines in 2006. A problem with the Commentaries was, however, that the old HMG remained in place even though the Commentaries described a merger review process that was at odds in important ways with their own HMG.

A significant source of uncertainty with respect to the new HMG is how courts will react. The HMG do not in and of themselves change the existing case law, which places heavy emphasis on market definition. Moreover, a common criticism of the new HMG is that, because they appear so unstructured, they seem to give too much discretion to the agencies. However, the courts have taken guidance from previous versions of the HMG, and they may do so with these as well.

Conclusion

Independent of how the courts react to the new HMG, parties making presentations to the agencies should take them seriously. For merging parties, it is far better to convince the agencies not to seek to block a merger than it is to defeat the agencies in court. In my opinion, companies should put more effort into making the affirmative case for their proposed mergers (by demonstrating efficiencies) than they often do. The basis for this recommendation is not that the new HMG create a rebuttable presumption that horizontal mergers are anticompetitive. They do not. To block a merger, the agencies still have to demonstrate a risk of a substantial lessening of competition. Still, when a company pays a premium to acquire another company (as is typically the case in an acquisition), or even when merging parties plan to put two companies through a difficult consolidation, they do so with the expectation that the merger or acquisition will have some effect. When the anticipated benefit is cost-savings or product improvement, the effect is beneficial to competition. Convincing the agencies of these benefits can be a more reliable way to obtain clearance than arguing that the deal is competitively neutral because the relevant market is broad.

Michael A. Salinger is a managing director in consulting firm LECG's Cambridge, MA, office and a professor of economics at the Boston University School of Management, where he has served as chairman of the department of finance and economics. Prior to joining LECG, Dr. Salinger served two years as director of the Bureau of Economics with the FTC. He can be reached at [email protected].

Last August, the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC) issued revisions to their joint Horizontal Merger Guidelines (HMG). The new HMG represent a substantial departure from the old HMG, and they change in important ways how companies seeking merger clearance (or seeking to influence merger clearance for deals involving suppliers, competitors, or customers) should make their presentations to the agencies. At the risk of over-generalizing, a standard approach to getting merger clearance under the old HMG was to argue that the proposed merger would do no competitive harm. Under the new HMG, merging companies should consider doing more to make the affirmative case for the merger; and doing so might involve greater involvement by those involved in planning for the merger might be necessary.

Background

For those not familiar with merger review, some basic background might help. Section 7 of the Clayton Antitrust Act makes it illegal for one company to acquire another, or for two companies to merge, if the effect “may be substantially to lessen competition, or to tend to create a monopoly.” When it was passed, merger challenges occurred only after the merger had been consummated. That changed in 1974. Because of the difficulty of “unscrambling the eggs,” Congress enacted the Hart-Scott-Rodino Act, which provided for pre-merger antitrust review. The Antitrust Division of the DOJ and the FTC share responsibility for merger review in most industries.

The mergers most likely to be challenged are so-called “horizontal mergers,” or mergers of competitors. For example, if Intel and AMD were to try to merge, the reviewing agency would almost surely challenge it and almost as surely prevail in court. “Vertical mergers,” which are those between companies in a buyer-seller relationship, sometimes generate intervention. (For example, the DOJ imposed conditions on Ticketmaster's recent acquisition of LiveNation.) But such examples are relatively rare. Challenges to conglomerate mergers (which are mergers that are neither horizontal nor vertical) are even more rare. Most of the action in the DOJ's and FTC's merger review concerns mergers of competitors.

In their pre-merger analysis, the antitrust agencies try to predict whether a proposed merger poses a substantial risk of increasing prices or reducing competition in some other way. The traditional approach to this analysis was to determine whether the merger would result in a significant increase in market concentration. At first, that might seem obvious. When only two firms compete in a market, a merger between the two of them is likely to pose a significant risk to competition. In contrast, a merger of two firms in a market with 100 firms of roughly equal size is unlikely to do so. But assessing how a merger will affect market concentration requires defining precisely what the market is; and the answer is not always obvious. Consider, for example, Whole Foods' 2007 acquisition of Wild Oats. If “the relevant market” is for grocery stores, they were both small players. But if the high-end niche in which they competed constitutes a distinct market, the merger consolidated the only two competitors in some areas.

The DOJ issued the first Merger Guidelines in 1968. The section on horizontal mergers ' those guidelines covered vertical and conglomerate mergers as well ' consisted of four double-spaced pages that laid out presumptively permissible shares for the acquiring and target firms as a function of the level of concentration (as measured by the combined market shares of the four leading firms, or the “four-firm concentration ratio”). The 1968 Merger Guidelines were silent, however, on principles of market definition. The 1982 DOJ Merger Guidelines revolutionized merger review by laying out principles for market definition. Drawing heavily on input from economists, the 1982 Guidelines introduced the so-called SSNIP test for market definition. SSNIP stands for “Small, but Significant, Non-transitory Increase in Price.” Based on a SSNIP test, a relevant antitrust market is a product and a geographic area within which a hypothetical monopolist would find it profitable to increase price by a small, but significant, non-transistory amount, typically taken to be 5%. (The 1982 Guidelines changed the measure of concentration from the four-firm concentration ratio to the “Herfindahl-Hirschman Index” or “HHI.” While a technical improvement, that change did not alter the fundamental logic.) While the DOJ (subsequently in collaboration with the FTC) revised its Horizontal Merger Guidelines in 1984, 1992, and 1997, both the centrality of market definition and the SSNIP test approach to it remained in tact.

Judged by their influence, the 1982 Merger Guidelines were a staggering success. Despite the heavy reliance on economics, many lawyers came to view them as providing a clear framework that made merger review predictable. Similarly, courts relied on the guidelines because they presented a disciplined approach to evaluating cases the agencies brought and because they fit with existing case law that continued to give heavy (albeit not exclusive) weight to market definition. And the success of the 1982 Merger Guidelines extended well beyond the borders of the United States. Virtually every jurisdiction with antitrust laws has guidelines that base market definition on a SSNIP test and numerical guidelines based on the HHI. (Indeed, most use the numerical standards that markets with HHIs above 1800 are “Highly Concentrated,” markets with HHIs between 1000 and 1800 are “Moderately Concentrated,” and markets with HHIs below 1000 are “Unconcentrated.” To gauge what those numbers mean, an HHI of 1,800 is less concentrated than a market with five equally sized firms, which would have an HHI of 2,000. A market with 10 equally sized firms would have an HHI of 1,000.)

Evolving Merger Review and Its Problems

As the agencies gained experience in implementing the Guidelines, it became increasingly clear that the SSNIP test was not the panacea for all problems with merger review. Even when it is based on an economically sound approach, market definition necessarily entails drawing lines in which substitutes are treated as being entirely in or entirely out of the market. Such a sharp delineation can be arbitrary when substitutes for a good are imperfect and candidates for inclusion in the relevant market vary more or less continuously with respect to how closely substitutable they are.

Moreover, as techniques for defining markets evolved, the agencies came to realize that market definition is sometimes completely unnecessary. Market definition is a tool for assessing whether anticompetitive effects are possible. In some cases, however, an agency has proved a market by directly demonstrating effects. A famous example was the proposed merger between Staples and Office Depot in 1997. The market definition issue in the case was whether consumable office supplies sold in office super stores were a distinct market. Because office supplies sold at office super stores are generally available elsewhere (such as WalMart), there was a great deal of skepticism that goods sold within a particular retailing format could be a relevant antitrust market. But the FTC, which challenged the merger, demonstrated that office superstores charged higher prices in areas without competing office superstores than in areas with them. That fact was arguably sufficient to establish the likelihood of anticompetitive harm from the merger. At that point, defining the market, and measuring concentration and the change in concentration in it was merely a formality.

Implementing the New HMG

One of the central points of the new HMG is that market definition plays less central a role in agency merger review than one would expect based on the previous HMG. Instead, the agencies plan to focus their inquiries more directly on the likely competitive effect of a proposed merger. This point is not news. Not only do people who make a living making presentations to the agencies understand it, the agencies themselves made many of the same points when they issued Commentaries on the Horizontal Merger Guidelines in 2006. A problem with the Commentaries was, however, that the old HMG remained in place even though the Commentaries described a merger review process that was at odds in important ways with their own HMG.

A significant source of uncertainty with respect to the new HMG is how courts will react. The HMG do not in and of themselves change the existing case law, which places heavy emphasis on market definition. Moreover, a common criticism of the new HMG is that, because they appear so unstructured, they seem to give too much discretion to the agencies. However, the courts have taken guidance from previous versions of the HMG, and they may do so with these as well.

Conclusion

Independent of how the courts react to the new HMG, parties making presentations to the agencies should take them seriously. For merging parties, it is far better to convince the agencies not to seek to block a merger than it is to defeat the agencies in court. In my opinion, companies should put more effort into making the affirmative case for their proposed mergers (by demonstrating efficiencies) than they often do. The basis for this recommendation is not that the new HMG create a rebuttable presumption that horizontal mergers are anticompetitive. They do not. To block a merger, the agencies still have to demonstrate a risk of a substantial lessening of competition. Still, when a company pays a premium to acquire another company (as is typically the case in an acquisition), or even when merging parties plan to put two companies through a difficult consolidation, they do so with the expectation that the merger or acquisition will have some effect. When the anticipated benefit is cost-savings or product improvement, the effect is beneficial to competition. Convincing the agencies of these benefits can be a more reliable way to obtain clearance than arguing that the deal is competitively neutral because the relevant market is broad.

Michael A. Salinger is a managing director in consulting firm LECG's Cambridge, MA, office and a professor of economics at the Boston University School of Management, where he has served as chairman of the department of finance and economics. Prior to joining LECG, Dr. Salinger served two years as director of the Bureau of Economics with the FTC. He can be reached at [email protected].