Master the Antitrust Master the Antitrust Basics Brown Bag SeriesBasics Brown Bag Series

Lesson V – Clayton Act Section 7

Thomas D. Fina

Allen Bachman

Howrey LLP

OverviewOverview Substance – Clayton Section 7

• 1992 Merger Guidelines

• Market Definition

• Competitive Effects

• Unilateral effects

• Coordinated effects

• Remedies

• Litigation

Key issue – is the transaction likely to lead to higher prices, lower quality or reduced innovation?

Focus – practical tips on how to analyze a merger

Overview cont.Overview cont.

Not going to cover in any detail:

• Market definition (see December 13, 2006, presentation by Meg Guerin Calvert)

• HSR and merger process (next month’s seminar)

Appendices

• Bibliography

• Sample merger analysis memo

• Sample data request

Clayton Act Section 7Clayton Act Section 7

Overview of Legal Standards Overview of Legal Standards

Clayton Act Section 7Clayton Act Section 7 Prohibits acquisitions of stock or assets where “the effect

of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.” 15 U.S.C. § 18 (2000).

Primary concern is the creation of market power• Power to restrain output and raise prices above competitive levels

• Power to reduce quality while maintaining prices

• Power to reduce the amount and/or pace of innovation while maintaining prices

“Horizontal” mergers, i.e., combinations of direct competitors, are far more likely to raise competitive concerns than are “Vertical” transactions.

Clayton Act Section Clayton Act Section 7 Enforcement7 Enforcement

Department of Justice Antitrust Division

Federal Trade Commission

State Attorneys General

Private Lawsuits

• (§ 4 and § 16)

Twin Pillars of Merger AnalysisTwin Pillars of Merger Analysis

FTC/DOJ Horizontal Merger Guidelines

• Guide agency review of each and every transaction

• Private Practice: satisfying the Merger Guidelines' criteria is critical to obtaining clearance without litigation.

• Agency Staff: satisfying the Merger Guidelines is a necessary part of establishing a case with the “front office.”

Judicial Decisions

• The Clayton Act itself is rather ambiguous.

• The courts have developed a large body of case law interpreting the statute.

• Courts rely on the Merger Guidelines, but are not bound by them.

Evaluating the Competitive Impact of a Evaluating the Competitive Impact of a TransactionTransaction

DOJ/FTC Horizontal Merger Guidelines

• Identify the relevant product and geographic markets and the firms participating in those markets

• Assess market concentration

• Determine the likely competitive effects

• Analyze whether entry would maintain competition

• Efficiencies

Merger Guidelines Commentary

• The analysis need not be linear. It may be appropriate to begin by analyzing the competitive effects.

Relevant Geographic MarketRelevant Geographic Market

The region in which the seller operates and to which the purchaser can practically turn for supplies

Classic examples of national markets

• Prescription Drugs

• Software

Classic examples of regional markets

• Hospitals

• Grocery Stores

• Gas Stations

Relevant Product MarketRelevant Product Market

Reasonable Interchangeability

• Compare the use and function of the merging parties’ products with other products.

• Assess the degree to which buyers are willing to substitute those similar products for the parties’ products.

Examples of Product Market Distinctions

• Chewing Tobacco vs. Moist Snuff (Swedish Match)

• Office Superstores vs. Smaller Retailers (Staples)

Market Definition – Final ThoughtsMarket Definition – Final Thoughts

Lack of clearly defined markets inhibits reliance on market share presumptions and hinders the strength of any theories of competitive harm.

• Cruise Lines

• Oracle

Market ShareMarket Share

Identify market participants

Identify each participant’s share of the relevant market

Analyze the extent to which the merger will increase concentration

Philadelphia National Bank Philadelphia National Bank PresumptionPresumption

Mergers resulting in an “undue” increase in concentration are presumed harmful.

• No clear guidance on how much is “undue”

• Market shares provide a “static analysis.”

• They offer only a “snapshot.”

• The courts and agencies have increasingly backed away from exclusive reliance on market shares.

Philadelphia National Bank Philadelphia National Bank Presumption (cont.)Presumption (cont.)

Presumption can be overcome with evidence clearly showing that the merger is not likely to have anticompetitive effects.

• Market shares are merely the starting point.

• Competitive effects analysis is “dynamic.”

• The ultimate issue remains “what will happen in the future?”

Theories of Competitive HarmTheories of Competitive Harm

Coordinated Effects

• Would post-merger market conditions make coordination on price or output more likely after the merger?

Unilateral Effects

• Would post-merger market conditions make it possible for individual firms to raise prices?

• Will the merger eliminate a constraint?

Coordinated EffectsCoordinated Effects

Will the merger increase the likelihood of explicit collusion or tacit coordination?

Examples of tacit coordination • Parallel pricing

• Output restrictions

• Arch Coal

Will the merger eliminate a maverick?

• An unpredictable or uncooperative competitor

Unilateral EffectsUnilateral Effects

Markets with differentiated products • Products sold by different competitors are not perfect substitutes.

• Example: branded products

• Are the merging parties’ products next best substitutes?

• Sales that would have been lost to the competitor from a unilateral price increase are now retained.

• Compare McDonald’s buying Burger King vs. McDonald’s buying Pizza Hut.

Markets with undifferentiated products • Example: Commodities• Unilateral price increases are more likely when competitors cannot

respond to a reduction in output.

• Capacity

So Now What Do I Do?So Now What Do I Do?

Work “Backwards” into the Work “Backwards” into the TransactionTransaction

• What are the likely competitive effects?

• Don’t get bogged down on structural analysis

• Market definition

• Market shares

• HHIs

• Brown Shoe v. United States, 370 U.S. 294 (1962)• (upholding challenge to merger creating competitor

with 5% share)• Whirlpool / Maytag (2006)

• (DOJ permitted merger in washer/dryer industry with combined share of approximately 50-70%)

ScreensScreens

Rationale for deal?

Are customer complaints likely?

Any group of customers likely to be harmed?

Concentration level: 4 to 3 and 3 to 2 deals can be difficult.

Consumer goods or politically sensitive?

Enforcement history

Get Your Hands DirtyGet Your Hands Dirty

Developing a sound understanding of the facts is essential.

“We learned long ago that facts are stubborn things in merger enforcement. No economic theory or story-based advocacy about a merger will give you a reliable answer unless the facts firmly support it.”

Former FTC Chairman Tim Muris, August 7, 2001

Step 1 -- DocumentsStep 1 -- Documents The parties’ documents are key. What do they

say?

• Offering Memorandum (if any)

• Strategic plan (if any)

• Board / management presentations

• How does management rationalize the investment?

• SEC filings / publicly available documents

• Investor presentations

Documents cont.Documents cont.

Use the documents to identify:

• Potential overlaps

• Rationale for transaction

• Industry competitive dynamics

• Competitors

• Barriers to entry

Develop outline of questions for client

Identify “good” docs / “bad” docs

Step 2 – Identify the OverlapsStep 2 – Identify the Overlaps

Identify overlaps

• At product level

• Amount of revenue (quantity) by overlap product

Step 3 -- Interview ManagementStep 3 -- Interview Management

What is the rationale for the transaction? Typical reasons include:

• Efficiencies (Whirlpool; Arch Coal)

• Product extension (Pepsi/Quaker)

• Geographic expansion (retail)

• Defensive (airlines)

Step 3 -- Interview Management contStep 3 -- Interview Management cont..

Are customer complaints likely?

Do the complaints sound in antitrust?

• “I like my sales representative.”

vs.

• “The merger combines my two primary suppliers.”

Step 3 -- Interview Management cont.Step 3 -- Interview Management cont.

Is there any identifiable class of customers who may be injured by the transaction?

• Large customers vs. small customers

• Buyer power

• Vertical integration

• Induce new entry

• Locked in customers / group with higher switching costs?

Step 3 -- Interview Management cont.Step 3 -- Interview Management cont.

Competitors and estimated market shares

Estimated efficiencies

Entry

• Barriers?

• Recent examples?

• Ability of customers to sponsor?

Is either party a maverick?

Step 3 -- Interview Management contStep 3 -- Interview Management cont..

Unilateral effects

• Are overlapping products differentiated?

• Are merging parties next-best substitutes and/or close in competitive space?

Ability of competitors to reposition?

• Easier in industrial products

• More difficult where brands/consumer goods are involved

Step 3 -- Interview Management contStep 3 -- Interview Management cont..

Coordinated interaction

• Industry structure / concentration

• Transparency of pricing

• Ability to detect cheating

• Numerous small transactions?

• Large lumpy sales?

• Ability to punish cheating

• History of collusion in industry?

Step 4 – History of EnforcementStep 4 – History of Enforcement

Have the agencies challenged prior transactions?

Have industry conditions changed since prior enforcement actions?

Step 5 – Is There a Fix?Step 5 – Is There a Fix?

Agencies strongly prefer structural remedies to conduct remedies.

Is there a potential fix if an overlap raises competitive concerns?

ConclusionConclusion

BibliographyBibliography

ABA Section of Antitrust Law, Antitrust Law Developments (5th ed. 2002)

ABA Section of Antitrust Law, The Merger Review Process: A Step-by-Step Guide to Federal Merger Review, 3d ed. (2006)

ABA Section of Antitrust Law, Mergers & Acquisitions: Understanding the Antitrust Issues, 2d ed. (2004).

U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines, April 1992 (revised April 1997).

U.S. Department of Justice and Federal Trade Commission, Commentary on the Horizontal Merger Guidelines, March 2006.