Vertical Merger Guidelines Research Articles

Self-Preferencing

When markets at successive or complementary stages are imperfectly competitive, firms that operate at multiple stages typically have a strong incentive to purchase from, sell to, or otherwise coordinate with its own operations at adjacent stations compared with those of individual firms. But, to the extent that such self-preferencing eliminates double marginalization that would occur under vertical separation or otherwise facilitates coordination that is difficult to accomplish between firms, competition rules that discourage self-preferencing, such as restrictions on vertical mergers or integration, can harm consumers. In 2020, the United States Department of Justice and Federal Trade Commission issue revised vertical merger guidelines that promised enforcement that more nearly resembles how they review horizontal mergers – that is, by predicting effects on static pricing incentives. But the economics of how vertical mergers on pricing incentives is more complicated than the economics of how horizontal mergers affect pricing incentives. If U.S. enforcement is based on a consumer welfare standard, the U.S. agencies will struggle to find a robust methodology for distinguishing anticompetitive from procompetitive vertical mergers. Self-preferencing has also played a key role in allegations of anticompetitive behavior in technologically advancing industries. A review of past allegations of anticompetitive product innovation against IBM, Microsoft, and Google reveals the challenges in designing rules that limit self-preferencing without acting as a drag on innovation.

A Suggested Revision of the 2020 Vertical Merger Guidelines (Version: April 30, 2022)

The Department of Justice (DOJ)/Federal Trade Commission (FTC) Vertical Merger Guidelines (VMGs) were adopted by the FTC in June 2020 by a party-line 3-2 party line over the dissent of the Acting Chair. They were withdrawn by the FTC in September 2021. Withdrawal was appropriate because the VMGs are both incomplete and overly permissible. At this writing, the Guidelines are currently under revision, This draft is designed to aid that process and act as a supplement to the Guidelines that are adopted.

Vertical Mergers that Induce Exit

It is well understood that vertical mergers can create an incentive for the merged firm to foreclose unintegrated rivals, and that one way this foreclosure can manifest itself is by driving an unintegrated rival below its minimum viable scale and causing it to exit. The central claims of this article are (1) that exit-inducing mergers are likely to be especially harmful because they result in the elimination of a competitor and (2) that even a modest amount of foreclosure can induce exit if the rival was not too far above its minimum viable scale before the merger. I argue that exit-inducing mergers merit explicit treatment in a revised version of the DOJ/FTC Vertical Merger Guidelines, both because they are harmful and because the possibility that they may occur with only modest foreclosure has important implications for how they should be investigated.

The Vast Space in Which the Vertical Merger Guidelines Lived

The thesis of this article is that the gap left by the abandoned Vertical Merger Guidelines ( VMGs) is small, and that the gap should not be filled until a sound foundation for guidelines is built. The VMGs operated with a narrow scaffolding in a vast space of real-world decisions and a continuum of organizational forms. The illustrations in the VMGs were based on pricing models that show that anticompetitive exclusion may result from vertical mergers. But these models are incapable of generalization, and they do not account for investments, market uncertainty, contracting problems, information asymmetries, and governance issues. Perplexingly, the VMGs ignored research that considers such factors and illuminates a broad range of empirically verifiable efficiencies. The requisite foundation for effective vertical guidelines is not in place. Until it is developed, replacements will fail to screen vertical mergers that do not raise concerns and will not be of assistance when mergers are challenged. Antitrust scholars could advance the foundational work by developing authoritative briefs on topics such as anticompetitive exclusion, asset-specific investments, incomplete contracts and opportunistic behavior, information asymmetries and principal–agent problems, the purposes and effects of restrictive contracts, and the implications of network economies for the scope of firms.

Vertical Merger Guidelines and the Rule of Law

Mid-1960s Supreme Court decisions undermined the rule of law by giving the government unbridled discretion in enforcing Section 7 of the Clayton Act. Since 1968, the government has promoted the rule of law through guidelines limiting discretion. The Vertical Merger Guidelines, however, place no meaningful limits on agency discretion. They articulate theories under which mergers can be harmful but neither specific nor general standards. They set out no principles for determining when a merger harms competition, rather than a competitor, and no criteria for determining when harm to competition is likely, rather than merely possible. Nor do they convey the agencies’ general attitude toward vertical mergers.

The 2020 Vertical Merger Guidelines: Some Suggestions for Revision

In 2020, the Department of Justice and the Federal Trade Commission (FTC) published their Vertical Merger Guidelines (VM Guidelines). The Guidelines were intended to reveal the principal analytical techniques, practices, and enforcement policies employed by the two Agencies, but they were short-lived at the FTC. In 2021, the VM Guidelines were rescinded by the FTC. Even before they were rescinded, their general language and some of the illustrative examples were not fully specified, which made them misleading. As work begins on reconstructing the VM Guidelines, we illustrate some of the weaknesses of the 2020 version and offer some suggestions for their revision. In this article, we will demonstrate why the incomplete specification can lead to some analytical difficulties. In addition, we will offer some clarifications and corrections. Our goal is to suggest refinements to the 2020 VM Guidelines so that they will be more useful in developing future guidelines for antitrust enforcement policy.

The New Vertical Merger Guidelines: Muddying the Waters

The new U.S. Department of Justice and Federal Trade Commission Vertical Merger Guidelines focus on how vertical mergers are likely to affect static pricing incentives. While vertical mergers can create incentives to increase prices, they can also provide incentives to decrease prices. Which of the possible outcomes is likely to occur depends on details that are generally difficult to measure. Potential competition between dominant firms, the theory of potential harm to competition that the 1984 Department of Justice Merger Guidelines stressed, remains a more compelling rationale for blocking vertical mergers than the likely effect on static pricing incentives.

Vertical Mergers and Input Foreclosure Lessons from the AT&T/Time Warner Case

This article offers a practical guide to analyzing vertical mergers using the general approach to input foreclosure and raising rivals’ costs that is described in the 2020 Vertical Merger Guidelines that were issued by the U.S. Department of Justice and the Federal Trade Commission. The step-by-step analysis described here draws lessons from how that theory of harm played out in the lone vertical merger case that has been litigated by the antitrust agencies in recent decades: the 2018 challenge by the Department of Justice to the merger between AT&T and Time Warner. I testified in court as the DOJ’s economic expert in that case. I explain here how to quantify the increase in rivals’ costs and the elimination of double marginalization that are caused by a vertical merger and how to evaluate their net effect on downstream customers. I also explain how this economic analysis fits into the three-step burden-shifting approach that the courts apply to mergers under Section 7 of the Clayton Act. Based on my experience in the AT&T/Time Warner case, I identify a number of shortcomings of the 2020 Vertical Merger Guidelines.

Competitive Harm from Vertical Mergers

The antitrust enforcement Agencies’ 2020 Vertical Merger Guidelines (VMGs) introduce a nontechnical application of bargaining theory into the competitive assessment of vertical acquisitions. This bargaining theory has much in common with the theory of unilateral effects that is applied to horizontal mergers. The VMGs focus on post-merger price increases requires consideration of a vertical merger’s role in eliminating double marginalization (EDM). The problem occurs when two bargaining firms both have market power but are unable to coordinate their output. Assessing EDM bundles two themes that Ronald Coase developed in his two most well-known articles: “The Nature of the Firm” and “The Problem of Social Cost”. The first argued that the boundaries of a firm are determined by the firm’s continuous search to minimize costs. The second argued that two traders in a well-functioning market will achieve the joint-maximizing solution. Anti-interventionists rely heavily on Coasean arguments that unless high transaction costs get in the way firms will bargain to joint maximizing results. If that is true, then double marginalization will rarely provide a defense to a vertical merger. The law of vertical mergers deals largely with firms that transact with one another routinely, in legally enforceable buy-sell relationships. In a well-functioning vertical market durable double marginalization should be rare.

A Suggested Revision of the 2020 Vertical Merger Guidelines (May 2, 2021)

The DOJ/ FTC Vertical Merger Guidelines (VMGs) were adopted by the FTC in June 2020 by a party-line 3-2 party line over the dissent of the Acting Chair. One might expect that the VMGs will be withdrawn and/or revised once a Democratic majority is achieved. In my view, revision is appropriate because the VMGs are both incomplete and overly permissible. This Suggested Revision can aid that process. Rather than trying to start with the current draft, this draft begins on a clean sheet. However, it has been formulated with an eye towards the problems with the current VMGs and so provides a clear contrast with that approach. These draft VMGs include descriptions of a greater range of anticompetitive concerns, additional examples, a more rigorous approach to the parties’ required burden to establish pass-on of elimination of double marginalization, and a number of proposed anticompetitive presumptions. This is a draft, so comments and suggestions are welcomed!

Vertical Mergers and Input Foreclosure: Lessons from the AT&T/Time Warner Case

This article offers a practical guide to analyzing vertical mergers using the general approach to input foreclosure and raising rivals’ costs described in the 2020 Vertical Merger Guidelines issued by the Department of Justice and the Federal Trade Commission. The step-by-step analysis described here draws lessons from how that theory of harm played out in the lone vertical merger case litigated by the antitrust agencies in recent decades, namely the 2018 challenge by the Department of Justice to the merger between AT&T and Time Warner. I testified in court as the DOJ’s economic expert in that case, giving me a unique perspective. I explain here how to quantify the increase in rivals’ costs and the elimination of double marginalization caused by a vertical merger and how to evaluate their net effect on downstream customers. I also explain how this economic analysis fits into the three-step burden-shifting approach that the courts apply to mergers under Section 7 of the Clayton Act. Based on my experience in the AT&T/Time Warner case, I identify a number of shortcomings of the 2020 Vertical Merger Guidelines.

Competitive Harm from Vertical Mergers

The 2020 Vertical Merger Guidelines produced by the antitrust enforcement agencies introduce a nontechnical application of bargaining theory into the assessment of competitive effects from vertical acquisitions. The economics of such bargaining is complex and can produce skepticism among judges, who might regard its mathematics as overly technical, its game theory as excessively theoretical or speculative, or its assumptions as unrealistic. However, we have been there before. The introduction of concentration indexes in the Merger Guidelines was initially met with skepticism but gradually they were accepted as judges became more comfortable with them. The same thing very largely happened again when unilateral effects theories of mergers were introduced in the 1990s. The bargaining theory that drives much of vertical merger analysis today has much in common with the theory of unilateral effects. In any event, the value of a particular model depends not on its verisimilitude but rather on its testability. The theory that relates a concentration index to the risk of competitive harm from horizontal mergers involves as much conjecture as does the bargaining theory that the Nash model for vertical mergers contemplates. The concentration thresholds in the Horizontal Merger Guidelines capture a rough generalization about a large number of collusive or oligopolistic strategies, some of which are not consistent with each other. What they share in common is belief in a link between the number of firms in a market, the increase in concentration that results from the merger, and the extent of higher prices. Double marginalization as a vertical merger defense occurs when two bargaining firms each have market power but are unable to coordinate their output. Each takes a markup without considering the other, and aggregate markups are too high. Both firms as well as their purchasers would be better off if they could coordinate better. In the AT&T/Time-Warner case the defendants argued that after the merger TW would not coordinate with AT&T but would set its prices as if the merger had not occurred. In that case the merger would not have eliminated double marginalization either. The debate over the elimination of double marginalization bundles two themes that Ronald Coase developed in his two most well-known articles, The Nature of the Firm and The Problem of Social Cost. The first argued that the boundaries of a firm are determined by the firm’s continuous search to procure inputs in the most cost effective way. The second argued that two traders in a well-functioning market will achieve the joint-maximizing solution. This dual relationship is too often ignored. Anti-interventionists rely heavily on Coasean arguments that unless high transaction costs get in the way firms will bargain to joint maximizing results. If that is true, then double marginalization will rarely provide a defense to a vertical merger. The law of vertical mergers deals largely with firms that transact with one another routinely, in legally enforceable buy-sell relationships. By contrast, the actors who appear in The Problem of Social Cost do not bargain with each other regularly. In a well functioning vertical market durable double marginalization should be rare.

The Welfare Effects of Vertical Mergers and Their Remedies

This paper extends Williamson’s (1968) classic framework of the welfare effect of mergers to the case of vertical mergers, and in particular to those in which the imposition of merger conditions (remedies) may allow an otherwise anticompetitive merger to proceed. While similarities to the case of horizontal mergers without a remedies option are present, differences also arise. Most notably, for prototypical vertical mergers remedies may yield post-merger economic welfare which is higher than pre-merger levels. This suggests that remedies directed toward vertical mergers hold the promise of a more beneficial approach than in the case of horizontal mergers. This finding leads to an examination of merger remedies policy and practice. We find that antitrust enforcers historically have implicitly recognized both the economic welfare framework and the more robust role for remedies in vertical merger cases, particularly through the application of remedies aimed at preventing identified anticompetitive conduct while facilitating merger-related efficiencies. The 2020 Vertical Merger Guidelines illuminate the basis for the U.S. antitrust agencies’ substantive analysis of vertical mergers, but do not address remedies. This paper discusses principles that may be useful in formulating much-needed guidance that would unify, clarify and reinforce the agencies’ policies for remedies in vertical merger cases.

The 2020 Vertical Merger Guidelines: A Suggested Revision

The FTC and DOJ requested comments on their draft Vertical Merger Guidelines in January 2020. This article is a complete alternative set of suggested Vertical Merger Guidelines that reflects and supplements the approach explained in the comments submitted by the author along with Jonathan. Baker, Nancy Rose and Fiona Scott Morton, as well as their other comments, and might be read in conjunction with those comments. This suggested revision of the Agencies’ draft expands the list of potential competition harms and provides illustrative examples. It expands and unifies the discussion and treatment of potential competitive benefits. It deletes the quasi-safe harbor and suggests the circumstances under which competitive harms raise lessened concerns on the one hand and heightened concerns on the other.

Recommendations and Comments on the Draft Vertical Merger Guidelines

These recommendations and comments respond to the request by the Federal Trade Commission and the Department of Justice’s Antitrust Division for public comment on the draft 2020 Vertical Merger Guidelines. We commend the agencies for updating the 1984 non-horizontal merger guidelines by recognizing the substantial advances in economic thinking about vertical mergers in the thirty-five years since those guidelines were issued. Our comments emphasize four issues: (i) the treatment of the elimination of double marginalization (“EDM”), particularly that the draft vertical merger guidelines appear inappropriately to make proof of cognizability part of the agencies burden and that they appear to inappropriately treat the merging firm’s failure to have eliminated double marginalization pre-merger as proof that the merger would lead to EDM and that the post-merger EDM would be merger-specific; (ii) the seemingly arbitrary and inappropriately permissive safe harbor; (iii) the inappropriate (though perhaps unintended) apparent requirement that harms be quantified; and (iv) the inappropriate (though perhaps unintended) apparent requirement that the agencies show that foreclosure would not have been profitable before the merger. We are concerned that these features of the draft Guidelines will lead to under-enforcement and false negatives (including under-deterrence).

Quantifying the Increase in 'Effective Concentration' from Vertical Mergers that Raise Input Foreclosure Concerns: Comment on the Draft Vertical Merger Guidelines

This comment responds to the request by the Federal Trade Commission and the Department of Justice’s Antitrust Division for public comment on the draft 2020 Vertical Merger Guidelines. In this comment, we show that there is an inherent loss of an indirect competitor and competition when a vertical merger raises input foreclosure concerns. We also show that it then is possible to calculate an effective increase in the HHI measure of concentration for the downstream market. We refer to this “proxy” measure as the “dHHI.” We derive the dHHI measure by comparing the pricing incentives and associated upward pricing pressure (“UPP”) involved in two alternative types of acquisitions: (i) vertical mergers that raise unilateral input foreclosure concerns (and the associated vertical GUPPI measures), and (ii) horizontal acquisitions of partial ownership interests among competitors that raise unilateral effects concerns (and the associated modified GUPPI and modified HHI measures).

DOJ/FTC Draft 2020 Vertical Merger Guidelines Comment of the Global Antitrust Institute, Antonin Scalia Law School, George Mason University

This comment is submitted by the Global Antitrust Institute (GAI) at the Antonin Scalia Law School, George Mason University to the Federal Trade Commission and Department of Justice regarding the draft 2020 Vertical Merger Guidelines. The GAI Competition Advocacy Program provides a wide range of recommendations to facilitate adoption of economically sound competition policies.

U.S. Vertical Merger Guidelines: Recommendations and Thoughts on EDM and Merger Specificity

This article offers the following recommendations, focusing on #3 and 6: 1. Specifics on how the Agencies will implement the principles set forth in the Guidelines. The Guidelines state throughout that the Agencies “may consider” certain factors; this language should be revised to say “will” or “usually will” consider. 2. An explicit recognition that empirical evidence indicates that vertical mergers are generally procompetitive or benign and, as the Agencies have previously stated, “vertical mergers merit a stronger presumption of being efficient than do horizontal mergers.” 3. A clear statement that the government has the burden on EDM given that such calculations are part of the math of the raising rivals costs (RRC) argument and the two cannot be analyzed in isolation before evaluating their net effect. In other words, EDM can prevent RRC, not just net it out. The prima facie case should not, however, extend to netting the two out, but rather to showing that the merger is likely to result in RRC. 4. An explicit statement that the relevant inquiry for RRC is the effect on downstream competition and that raising the cost of an upstream input with no downstream effects does not warrant intervention. While examples in the Guidelines seem to suggest that the Agencies will follow this principle, an explicit statement would be helpful. 5. Explicitly requiring both the incentive and the ability to engage in anticompetitive conduct given that, without the ability there can be no harm, and lack of incentives is a strong indication that there are legitimate business reasons for the deal. 6. A recognition of the coordination problem presented by vertical dealing and that achieving EDM (and other efficiencies) through contracting presents challenges given the costly process of forming, administering, and enforcing contracts with independent suppliers. 7. Replacing the 20% market-share language with a clear safe harbor and increasing the relevant market share threshold (but not necessarily the “related product” threshold) from 20% to at least 30%.

Five Principles for Vertical Merger Enforcement Policy

There seems to be consensus that the Department of Justice’s 1984 Vertical Merger Guidelines do not reflect either modern theoretical and empirical economic analysis or current agency enforcement policy. Yet widely divergent views of preferred enforcement policies have been expressed among agency enforcers and commentators. Based on our review of the relevant economic literature and our experience analyzing vertical mergers, we recommend that the enforcement agencies adopt five principles: (i) The agencies should consider and investigate the full range of potential anticompetitive harms when evaluating vertical mergers; (ii) The agencies should decline to presume that vertical mergers benefit competition on balance in the oligopoly markets that typically prompt agency review, nor set a higher evidentiary standard based on such a presumption; (iii) The agencies should evaluate claimed efficiencies resulting from vertical mergers as carefully and critically as they evaluate claimed efficiencies resulting from horizontal mergers, and require the merging parties to show that the efficiencies are verifiable, merger-specific and sufficient to reverse the potential anticompetitive effects; (iv) The agencies should decline to adopt a safe harbor for vertical mergers, even if rebuttable, except perhaps when both firms compete in unconcentrated markets; (v) The agencies should consider adopting rebuttable anticompetitive presumptions that a vertical merger harms competition when certain factual predicates are satisfied. We do not intend these presumptions to describe all the ways by which vertical mergers can harm competition, so the agencies should continue to investigate vertical mergers that raise concerns about input and customer foreclosure, loss of a disruptive or maverick firm, evasion of rate regulation or other threats to competition, even if the specific factual predicates of the presumptions are not satisfied.

Revising the US vertical merger guidelines: policy issues and an interim guide for practitioners

While the Horizontal Merger Guidelines issued by US antitrust enforcement agencies have been periodically revised since their first publication in 1968, the Vertical Merger Guidelines were last the subject of modification in 1984. Moreover, there appears to be little appetite within the agencies for revision; so interested parties are for the moment left with guidance which does not reflect contemporary economic theory, agency practice or the 2010 Horizontal Merger Guidelines. The aim of this article is to partially fill the gap left by this divergence, by providing both a modern analytical framework for the assessment of vertical mergers and illustrative examples of recent antitrust agency enforcement actions upon which practitioners and agency staff alike may rely. The article also identifies a number of legal and policy issues which would need to be considered were the Vertical Merger Guidelines to be revised. We hope that this article will facilitate a more rapid revision.