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Non-Horizontal Merger Guidelines
(Originally issued as part of “U.S. Department of Justice Merger Guidelines, June 14, 1984.” For horizontal mergers see the “U.S. Department of Justice and the Federal Trade Commission Horizontal Merger Guidelines” issued April 2, 1992 and revised April 8, 1997. )
4. HORIZONTAL EFFECT FROM NON-HORIZONTAL
MERGERS
4.0 By definition, non-horizontal mergers involve firms that do not operate in the same market. It necessarily follows that such mergers pro- duce no immediate change in the level of concentration in any relevant market as defined in Section 2 of these Guidelines. Although non- horizontal mergers are less likely than horizontal mergers to create com- petitive problems, they are not invariably innocuous. This section describes the principal theories under which the Department is likely to challenge non-horizontal mergers.
4.1 Elimination of Specific Potential Entrants 4.11 The Theory of Potential Competition
In some circumstances, the non-horizontal merger^25 of a firm already in a market (the “acquired firm”) with a potential entrant to that market (the “acquiring firm”)^26 may adversely affect competition in the market. If the merger effectively removes the acquiring firm from the edge of the market, it could have either of the following effects.
4.111 Harm to “Perceived Potential Competition”
By eliminating a significant present competitive threat that constrains the behavior of the firms already in the market, the merger could result in an immediate deterioration in market performance. The economic theory of limit pricing suggests that monopolists and groups of colluding firms may find it profitable to restrain their pricing in order to deter new entry that is likely to push prices even lower by adding capacity to the market. If the acquiring firm had unique advantages in entering the market, the firms
(^25) Under traditional usage, such a merger could be characterized as either “vertical” or
“conglomerate,” but the label adds nothing to the analysis. (^26) The terms “acquired and “acquiring” refer to the relationship of the firms to the
market of interest, not to the way the particular transaction is formally structured.
in the market might be able to set a new and higher price after the threat of entry by the acquiring firm was eliminated by the merger.
4.112 Harm to “Actual Potential Competition”
By eliminating the possibility of entry by the acquiring firm in a more procompetitive manner, the merger could result in a lost opportunity for improvement in market performance resulting form the addition of a significant competitor. The more procompetitive alternatives include both new entry and entry through a “toehold” acquisition of a present small competitor.
4.12 Relation Between Perceived and Actual Potential Competition
If it were always profit-maximizing for incumbent firms to set price in such a way that all entry was deterred and if information and coordination were sufficient to implement this strategy, harm to perceived potential competition would be the only competitive problem to address. In prac- tice, however, actual potential competition has independent importance. Firms already in the market may not find it optimal to set price low enough to deter all entry; moreover, those firms may misjudge the entry advantages of a particular firm and, therefore, the price necessary to deter its entry.^27
4.13 Enforcement Standards
Because of the close relationship between perceived potential competi- tion and actual potential competition, the Department will evaluate mergers that raise either type of potential competition concern under a single structural analysis analogous to that applied to horizontal mergers. The Department first will consider a set of objective factors designed to identify cases in which harmful effects are plausible. In such cases, the Department then will conduct a more focused inquiry to determine whether the likelihood and magnitude of the possible harm justify a challenge to the merger. In this context, the Department will consider any specific evidence presented by the merging parties to show that the in- ferences of competitive harm drawn from the objective factors are unreliable. The factors that the Department will consider are as follows.
(^27) When collusion is only tacit, the problem of arriving at and enforcing the correct limit
price is likely to be particularly difficult.
the likely scale of entry, using either the firm’s own documents or the minimum efficient scale in the industry. The Department will then evaluate the merger much as it would a horizontal merger between a firm the size of the likely scale of entry and the acquired firm.
4.134 The Market Share of the Acquired Firm
Entry through the acquisition of a relatively small firm in the market may have a competitive effect comparable to new entry. Small firms fre- quently play peripheral roles in collusive interactions, and the particular advantages of the acquiring firm may convert a fringe firm into a signifi- cant factor in the market.^29 The Department is unlikely to challenge a potential competition merger when the acquired firm has a market share of five percent or less. Other things being equal, the Department is increas- ingly likely to challenge a merger as the market share of the acquired firm increases above the threshold. The Department is likely to challenge any merger satisfying the other conditions in which the acquired firm has a market share of 20 percent of more.
4.135 Efficiences
As in the case of horizontal mergers, the Department will consider ex- pected efficiencies in determining whether to challenge a potential com- petition merger. See Section 3.5 (Efficiencies).
4.2 Competitive Problems from Vertical Mergers
4.21 Barriers to Entry from Vertical Mergers
In certain circumstances, the vertical integration resulting from vertical mergers could create competitively objectionable barriers to entry. Stated generally, three conditions are necessary (but not sufficient) for this prob- lem to exist. First, the degree of vertical integration between the two markets must be so extensive that entrants to one market (the “primary market”) also would have to enter the other market (the “secondary market”)^30 simultaneously. Second, the requirement of entry at the secon- dary level must make entry at the primary level significantly more difficult
(^29) Although a similar effect is possible with the acquisition of larger firms, there is an in-
creased danger that the acquiring firm will choose to acquiesce in monopolization or collusion because of the enhanced profits that would result from its own disappearance from the edge of the market. (^30) This competitive problem could result from either upstream or downstream integration,
and could affect competition in either the upstream market or the downstream market. In the text, the term “primary market” refers to the market in which the competitive concerns are being considered, and the term “secondary market” refers to the adjacent market.
and less likely to occur. Finally, the structure and other characteristics of the primary market must be otherwise so conducive to noncompetitive performance that the increased difficulty of entry is likely to affect its per- formance. The following standards state the criteria by which the Depart- ment will determine whether these conditions are satisfied.
4.211 Need for Two-Level Entry
If there is sufficient unintegrated capacity^31 in the secondary market, new entrants to the primary market would not have to enter both markets simultaneously. The Department is unlikely to challenge a merger on this ground where post-merger sales (or purchases) by unintegrated firms in the secondary market would be sufficient to service two minimum- efficient-scale plants in the primary market. When the other conditions are satisfied, the Department is increasingly likely to challenge a merger as the unintegrated capacity declines below this level.
4.212 Increased Difficulty of Simultaneous Entry of Both Markets
The relevant question is whether the need for simultaneous entry to the secondary market gives rise to a substantial incremental difficulty as com- pared to entry into the primary market alone. If entry at the secondary level is easy in absolute terms, the requirement of simultaneous entry to that market is unlikely adversely to affect entry to the primary market. Whatever the difficulties of entry into the primary market may be, the Department is unlikely to challenge a merger on this ground if new entry into the secondary market can be accomplished under the conditions stated in Section 3.3.^32 When entry is not possible under those conditions, the Department is increasingly concerned about vertical mergers as the dif- ficulty of entering the secondary market increases. The Department, however, will invoke this theory only where the need for secondary market entry significantly increases the costs (which may take the form of risks) of primary market entry. More capital is necessary to enter two markets than to enter one. Stand-
(^31) Ownership integration does not necessarily mandate two-level entry by new entrants to
the primary market. Such entry is most likely to be necessary where the primary and secon- dary markets are completely integrated by ownership and each firm in the primary market uses all of the capacity of its associated firm in the secondary market. In many cases of ownership integration, however, the functional fit between vertically integrated firms is not perfect, and an outside market exists for the sales (purchases) of the firms in the secondary market. If that market is sufficiently large and diverse, new entrants to the primary market may be able to participate without simultaneous entry to the secondary market. In consider- ing the adequacy of this alternative, the Department will consider the likelihood of predatory price or supply “squeezes” by the integrated firms against their unintegrated rivals. (^32) Entry into the secondary market may be greatly facilitated in that an assured supplier
(customer) is provided by the primary market entry.
4.22 Facilitating Collusion Through Vertical Mergers
4.221 Vertical Integration to the Retail Level
A high level of vertical integration by upstream firms into the associated retail market may facilitate collusion in the upstream market by making it easier to monitor price. Retail prices are generally more visible than prices in upstream markets, and vertical mergers may increase the level of ver- tical integration to the point at which the monitoring effect becomes significant. Adverse competitive consequences are unlikely unless the upstream market is generally conducive to collusion and a large percentage of the products produced there are sold through vertically integrated retail outlets. The Department is unlikely to challenge a merger on this ground unless
- overall concentration of the upstream market is above 1800 HHI (a somewhat lower concentration will suffice if one or more of the factors discussed in Section 3.4 indicate that effective collusion is particularly like- ly), and 2) a large percentage of the upstream product would be sold through vertically-integrated retail outlets after the merger. Where the stated thresholds are met or exceeded, the Department’s decision whether to challenge a merger on this ground will depend upon an individual evaluation of its likely competitive effect.
4.222 Elimination of a Disruptive Buyer
The elimination by vertical merger of a particularly disruptive buyer in a downstream market may facilitate collusion in the upstream market. If upstream firms view sales to a particular buyer as sufficiently important, they may deviate from the terms of a collusive agreement in an effort to secure that business, thereby disrupting the operation of the agreement. The merger of such a buyer with an upstream firm may eliminate that rivalry, making it easier for the upstream firms to collude effectively. Adverse competitive consequences are unlikely unless the upstream market is generally conducive to collusion and the disruptive firm is significantly more attractive to sellers than the other firms in its market. The Department is unlikely to challenge a merger on this ground unless
- overall concentration of the upstream market is 1800 HHI or above (a somewhat lower concentration will suffice if one or more of the factors discussed in Section 3.4 indicate that effective collusion is particularly like-
ly), and 2) the allegedly disruptive firm differs substantially in volume of purchases or other relevant characteristics from the other firms in its market. Where the stated thresholds are met or exceeded, the Department’s decision whether to challenge a merger on this ground will depend upon an individual evaluation of its likely competitive effect.
4.23 Evasion of Rate Regulation
Non-horizontal mergers may be used by monopoly public utilities sub- ject to rate regulation as a tool for circumventing that regulation. The clearest example is the acquisition by a regulated utility of a supplier of its fixed or variable inputs. After the merger, the utility would be selling to itself and might be able arbitrarily to inflate the prices of internal transac- tions. Regulators may have great difficulty in policing these practices, par- ticularly if there is no independent market for the product (or service) pur- chased from the affiliate.^35 As a result, inflated prices could be passed along to consumers as “legitimate” costs. In extreme cases, the regulated firm may effectively preempt the adjacent market, perhaps for the pur- pose of suppressing observable market transactions, and may distort resource allocation in that adjacent market as well as in the regulated market. In such cases, however, the Department recognizes that genuine economies of integration may be involved. The Department will consider challenging mergers that create substantial opportunities for such abuses.^36
4.24. Efficiencies
As in the case of horizontal mergers, the Department will consider ex- pected efficiencies in determining whether to challenge a vertical merger. See Section 3.5 (Efficiencies). An extensive pattern of vertical integration may constitute evidence that substantial economies are afforded by ver- tical integration. Therefore, the Department will give relatively more weight to expected efficiencies in determining whether to challenge a ver- tical merger than in determining whether to challenge a horizontal merger.
(^35) A less severe, but nevertheless serious, problem can arise when a regulated utility acquires
a firm that is not vertically related. The use of common facilities and managers may create an insoluable cost allocation problem and provide the opportunity to charge utility customers for non-utility costs, consequently distorting resources allocation in the adjacent as well as the regulated market. (^36) Where a regulatory agency has the responsibility for approving such mergers, the Depart-
ment may express its concerns to that agency in its role as competition advocate.
