Since Assistant Attorney General Delrahim’s inaugural remarks on vertical mergers (covered here), the business press has been atwitter about the antitrust enforcement agencies’ views of those mergers. Bruce Hoffman, the acting director of the Federal Trade Commission Bureau of Competition, recently delivered a speech explaining that the FTC will continue to review vertical mergers as part of its enforcement efforts, and providing insight into the FTC’s current analysis of proposed vertical mergers.
As background, Hoffman described that the FTC applies the same broad analysis to vertical mergers that it does to horizontal mergers: it defines the relevant markets, tests theories of harm, and examines the efficiencies created by the merger. But vertical mergers pose analytical challenges that horizontal mergers do not. Horizontal mergers combine competitors, which necessarily reduces competition by removing substitute goods from the market. Although a horizontal merger may create efficiencies or other pro-competitive effects, they are not a natural consequence.
By contrast, Hoffman further described, vertical mergers often involve complementary products, or integrating steps in the production, distribution, and sales processes, and thus are likely to create efficiencies that benefit the consumer. A vertical merger also may restrict competition in some way, but those restrictions are generally not a natural consequence of a vertical merger.
Those natural characteristics of a vertical merger, “while not necessarily large or dispositive in all cases, render the starting point for [the FTC’s] analysis of vertical mergers more challenging than horizontal mergers.” Measuring any potential harm to the consumer often depends on predicting the future conduct of the merged firm, or trying to forecast the effect on prices. As Hoffman explained, “there are plenty of theories of anticompetitive harm from vertical mergers[, b]ut the problem is that those theories don’t generally predict harm from vertical mergers; they simply show that harm is possible under certain conditions.”
Potential harms that lead enforcement agencies to consider action
Hoffman identified three potential harmful effects that the FTC considers in deciding whether to act against a proposed vertical merger.
Reduced likelihood of beneficial entry. Historically, the FTC’s primary concern about vertical mergers was that they could foreclose or hinder competitive entry because, post-merger, a potential competitor would have to enter at both stages of the market, a two-stage entry. Now, the FTC is also concerned that a vertical merger may prevent or discourage the merging firms from entering one another’s market. In particular, the FTC considers whether something about the markets, such as assets, know-how, or reputation, makes entry by the merging firms easier compared to new entrants, meaning the proposed vertical merger would eliminate the most likely new market entrant.
As an example, Hoffman explained that the FTC opposed the vertical merger between Digene Corp. and Cytyc Corp. because of concerns over both types of competitive entry. At the time of the proposed merger, Digene was the sole provider of a DNA test for the human papillomavirus (HPV), the leading cause of cervical cancer. Cytyc had 93 percent of the United States market for the principal screening test for cervical cancer, which incorporated the Digene DNA test. The FTC voted to block the merger because it would remove any incentive (1) for Digene to cooperate with any new market entrant that would compete with Cytyc in producing cervical cancer screening tests, meaning a new entrant would have to make a two-stage entry; and (2) for Cytyc to develop its own DNA test for the HPV virus and compete with Digene, meaning the merger would remove one of the most likely entrants into the market for HPV DNA tests.
Input foreclosure or customer foreclosure. The FTC is also concerned that vertical mergers may cause input foreclosure or customer foreclosure. Input foreclosure occurs where, premerger, the upstream firm supplies both the downstream merger partner and the partner’s rivals with a product or input that the downstream firms require to compete. Post-merger, the upstream firm could foreclose supply by refusing to sell to any firm except its merger partner, or to sell only on discriminatory terms. Similarly, customer foreclosure occurs where, premerger, the downstream merger partner purchases supplies from the upstream firm as well as the upstream firm’s competitors. Post-merger, the downstream firm could refuse to purchase from those firms competing with its upstream merger partner.
Hoffman cautioned that the potential for input foreclosure or customer foreclosure is not dispositive. The FTC weighs any potential foreclosure against the competitive benefit that likely will occur from reducing transaction costs between the upstream firm and the downstream firm post-merger. Even so, Hoffman acknowledged, the FTC has opposed mergers in the past based on these foreclosure concerns.
Anticompetitive sharing of information about a competitor. The FTC also examines whether a vertical merger will enable one of the merging firms to obtain competitively sensitive information about a competing firm. As an example, Hoffman referred to a situation where a manufacturer acquires its distributor that also does business with the manufacturer’s competitor. This, the FTC fears, might enable the acquiring manufacturer to obtain competitive insight about its competitor’s business and marketing plans.
Hoffman also discussed the potential remedies the FTC may require if it initiates action over a vertical merger. He emphasized that the FTC prefers to implement structural remedies: “First and foremost, it’s important to remember that the FTC prefers structural remedies to structural problems, even with vertical mergers.” The FTC prefers structural remedies because they “eliminate both the incentive and the ability to engage in harmful conduct, which eliminates the need for ongoing intervention.”
All the same, Hoffman said, the FTC will impose behavioral remedies where it believes they can prevent competitive harm while allowing the benefits of integration. For example, in the manufacturer-acquiring-its-distributor situation, rather than implement a structural remedy, the FTC may impose a firewall within the distributor precluding its employees engaged with the acquiring manufacturer from sharing competitively sensitive information with its employees engaged with the acquiring manufacturer’s competitors.
Hoffman acknowledged that conduct remedies may be more acceptable for vertical mergers than for horizontal mergers. But he concluded his speech by warning that the FTC still may impose a structural remedy when it is determined necessary for a vertical merger viewed as anticompetitive.
Hoffman’s speech provided valuable insight into the FTC’s current analysis and priorities in reviewing proposed vertical mergers. Antitrust counselors should be prepared to address the concerns set out in his speech.
 D. Bruce Hoffman, Acting Director, Fed. Trade Comm’n, Remarks at Credit Suisse 2018 Washington Perspectives Conference: Vertical Merger Enforcement at the FTC (Jan. 10, 2018) (“Hoffman Remarks”).
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