Merger Challenges Under A Coordinated Interaction Theory - ABA YLD 101 Practice Series

By Erin Peters

In a merger investigation, the federal antitrust agencies are concerned about two types of competitive harm that may arise after of a merger: coordinated interaction and unilateral effects. When the combined entity, acting alone, is able to successfully exercise market power to profitably raise prices or reduce output beyond what normally occurs in a competitive market, this is known as unilateral competitive effects. When groups of firms act collectively to first agree upon a price or level of output and then enforce those terms, this is known as competitive effects, or coordinated interaction. The government will analyze which type of competitive effects is more likely to occur, given the unique characteristics of the merger and industry at issue. This article focuses on the analysis the government undertakes when it examines whether a merger is likely to lead to coordinated interaction.

The DOJ/FTC Horizontal Merger Guidelines (Merger Guidelines) define coordinated interaction as "actions by a group of firms that are profitable for each of them only as a result of the accommodating reactions of the others." Merger Guidelines, § 2.1. The concern with coordinated interaction is that post-merger, firms will be able to either increase prices or reduce output through express or tacit coordination among the remaining firms in the relevant market. In a coordinated interaction analysis, courts and the federal antitrust agencies first examine the particular facts in each merger. The agencies and courts then, by fitting each fact into a framework of structural market factors established by the Merger Guidelines and prior cases, reach a decision about whether the merger increases the likelihood of future coordinated action occurring within the established relevant market. Successful coordination requires that competitors reach terms of profitable coordination and be able to detect and punish any deviations from the agreed upon terms.

Under the Merger Guidelines and in a series of cases, courts and the agencies have determined that the following factors are relevant in a coordinated interaction analysis: the number of firms in the market; barriers to entry; the transparency of competitive information; the frequency, size and nature of transactions; the elasticity of market demand; degree of product homogeneity; history of industry cooperation; buyer size; existence of substitutes; capacity constraints; loss of a maverick; and the predictability of supply and demand. Further explanation of the application of these factors follows.

The fewer competitors in the market, the easier it is to coordinate pricing without committing detectable price fixing violations of section 1 of the Sherman Act. Hospital Corp. of America v. FTC, 807 F.2d 1381, 1387 (7th Cir. 1986). For example, in FTC v. Elders Grain, 868 F.2d 901, 905 (7th Cir. 1989), the court found that the market for industrial dry corn was highly concentrated thus making it easier for members to collude on price and output. It should be noted, though, that collusion is not inevitable simply because there are only a handful of firms in the market. See Jonathan B. Baker, Mavericks, Mergers and Exclusion: Proving Coordinated Competitive Effects Under the Antitrust Laws, 77 N.Y.U. L. Rev. 135, 159 (2002).

A market with high barriers to entry may facilitate the creation or enhancement of market power. High entry barriers make it easier for participants to collude without the fear of a new competitor entering the market and undercutting the agreed upon price or output restraint. See also Elders Grain, 868 F.2d, at 905 (finding that because entry was slow - it took three to nine years to design, build, and start operating a new mill - sellers could collude without fear that their agreement would be nullified by a new entrant); Hospital Corp. of America, 807 F.2d, at 1387 (determining that the ability of outsiders to enter the market was hindered by a certificate of need law, and would enable current participants to delay any competitive entry by a new firm). Under the Merger Guidelines, entry that is timely, likely and sufficient in its magnitude, character and scope, can deter an anticompetitive merger (from unilateral or coordinated effects) in its incipiency. Merger Guidelines, § 3.0.

Coordination is more likely to occur in a transparent market. When key market information relating to other competitors is available, such as industry reports, trade reports, governmental filings, public announcements, and merger and joint venture negotiations, coordination among competitors becomes more feasible. FTC v. Arch Coal, 329 F.Supp.2d 109, 138 (D.D.C. 2004). This is because competitors can communicate pricing plans, expansion plans, or cost structures, all of which aid collusion by making it easier to form an agreement and to monitor and deter any deviations from the agreement. Conversely, a sealed bidding process can frustrate coordination by making it difficult to detect deviations from the agreed upon terms.

Markets with low demand elasticity are more conducive to coordinated interaction because the less elastic the demand for a good or service is, the easier it becomes for firms to collude on pricing and increase profits. Hospital Corporation of America, 807 F.2d at 1388. Elasticity in demand refers to the change in demand that occurs with the change in price. Therefore, if a good is highly inelastic, demand does not fluctuate with price changes and by colluding on a higher price, suppliers can capture greater profits. The greater the profits, the more incentive providers have to collude. Similarly, a lack of substitutes can also make a market conducive to collusion because sellers can raise prices above competitive levels without fear of immediately losing all or most of their sales to producers of similar items.

When products are standardized and homogenous, it is easier for sellers to agree on a common price to charge for them. This makes reaching terms of coordination easier for competitors. Competitors are likely to have similar cost incentives because the products are standardized. The court in Arch Coal recognized that "heterogeneity of products and producers limit or impede the ability of firms to reach terms of coordination." Arch Coal, 329 F.Supp.2d at 140. Also, the Merger Guidelines state that firm and product heterogeneity can make it hard for firms to reach terms of coordination because of differences in vertical integration or production. Merger Guidelines, § 2.11.

A market in which competitors have previously cooperated makes it easier for firms to collude in the future because mutual trust and forbearance have already been established, lessening any temptation to cheat. The temptation to cheat in a cartel and undercut competitors to increase one's own profits is great - trust is a necessary predicate to any successful cartel. A record of anticompetitive behavior is a "plus" factor for collusion.

Small, dispersed, and unsophisticated buyers have little buying power or control over the suppliers and can exert little price pressure. In Elders Grain, the court explained that a concentrated and knowledgeable buyer makes collusion by sellers more difficult because sellers are more "tempted to cheat when they can augment their profits by a single large sale," and sophisticated buyers may be able to bargain for discounts which can disrupt a cartel. Elders Grain, 868 F.2d at 905.

Excess capacity in a market can make collusion more likely or can disrupt any potential cartel activity, depending on whether the excess capacity is industry wide, or within an individual firm. Excess capacity industry-wide discourages new entrants, which can facilitate collusion. However, excess capacity in one firm means that the firm with the excess capacity may have more temptation to cheat because it can make additional sales at a price slightly below the cartel price, for little additional cost. On the other hand, the excess capacity could also be used to force adhesion to the agreement because the firm could threaten to flood the market as a means of punishing any cheaters.

The acquisition of a maverick firm that was previously acting as a constraint on prices can make coordination more likely. Maverick firms are those firms who have a greater economic incentive to deviate from the terms of coordination and are competitive influences. See Merger Guidelines § 2.12. Without the presence of a disruptive maverick in the market, competitors may be more likely to collude on prices or output.

In order for producers to coordinate production, producers need to determine a reliable reference point so they can reach agreement. Supply and demand needs to be easily estimable. In a market where this is difficult, reaching terms of coordination will also be difficult.

Coordinated interaction analysis is fact-specific and very much dependent on the unique characteristics of a particular merger and relevant market. No particular factor is dispositive, rather courts and the agencies examine the universe of factors to determine the likelihood that a market will become conducive to coordinated interaction.

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About the Author

Erin Peters is an associate in the Washington, D.C. office of Akin Gump Strauss Hauer & Feld LLP.

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