The Forward-Looking Nature of Merger Analysis

About the Authors:

Deborah L. Feinstein is Director, Bureau of Competition, at the Federal Trade Commission. An earlier version of this material appeared in the materials for the 2014 BLS Spring Meeting Program, “Antitrust Issues Raised in Mergers and by Restraints in Non-Merger Agreements.”

This year marks the 100th anniversary of both the Federal Trade Commission Act and the Clayton Act. Together with the Sherman Act, enacted in 1890, these laws remain a central feature of our national economic policy, setting standards for vigorous competition and preventing undue accumulation of market power that threatens consumer welfare and stymies economic growth. Despite profound changes in the American economy, the common law approach has allowed the antitrust laws to stand the test of time while taking account of changing market environments and economic analysis. 

The Clayton Act specifically prohibits mergers and acquisitions where the effect “may be substantially to lessen competition, or to tend to create a monopoly.” Congress designed Section 7 of the Clayton Act to deal directly with the evolving nature of competition and, in particular, the likely course of future competition in the aftermath of a single event: the elimination of one independent firm. As the Supreme Court noted in Brown Shoe v. United States, 370 U.S. 294, 321–22 (1962), “Congress used the words ‘may be substantially to lessen competition’ to indicate that its concern was with probabilities, not certainties.” The task of merger review is to predict with some level of confidence – but not absolute certainty – whether the merger’s likely competitive effects based on facts, economic learning, and reasoned analysis require intervention to prevent substantial harm to competition and consumers. 

The notion of incipiency imbedded in Section 7 is one of many flexible language choices in antitrust law that can confound business people and provide ample fodder for scholarly debate. These ambiguities have led courts to adopt simplifying rules and burden-shifting to give both sides of a merger case the opportunity to present and rebut evidence bearing on the likely competitive effects. The Commission’s analysis, however, does not rest on presumptions. To prevent this forward-looking analysis from veering into mere speculation, the FTC uses a variety of tools, both qualitative and quantitative, to assess the likely competitive outcome of a proposed transaction. 

This article will focus on the analytical process the FTC uses to predict the likely course of competition going forward and the impact of an acquisition on that competition. A change in one or two key facts can alter the outcome of a merger investigation. The fundamental question in any merger investigation is whether the loss of competition between the merging parties (whether that competition be current or future) is likely substantially to lessen competition. In order to conduct this assessment, we must understand what the parties’ competitive significance is likely to be in the future. We must also consider whether there are other firms likely to enter the market that will alter the competitive landscape, making competitive harm unlikely. Below we will examine how this fact-intensive inquiry applies in a variety of fact patterns, ranging from situations where merging parties are direct competitors in mature markets, to scenarios where parties are likely to compete in a future market.

Assessing What Current Competitors Will Look Like Going Forward

A typical transaction the FTC investigates is the combination of two direct competitors. Both firms currently sell products into the marketplace and affect the competitive dynamic that determines price and output to customers. The central question of merger review in this situation is whether the elimination of that direct competition is likely substantially to lessen competition. As part of that analysis, we look at whether the transaction will affect not only competition on price, but also other dimensions of competition such as quality, service, or innovation. 

To analyze such a merger, we typically start by examining historical facts. We look at what market shares have been in past years, whether the companies have marketed or bid against each other before, and what factors influenced the prices they set. In a market where competitive conditions are stable, those historical facts may provide all the information we need to feel comfortable in our predictions of the future. But where the fortunes of a competitor are likely to change – for better or for worse – we need to take a closer look. 

The classic case in which the past was not an adequate predictor of the future is U.S. v. General Dynamics, 415 U.S. 486 (1974). Both General Dynamics and the company it acquired, United Electric Coal Companies, had high shares of current coal sales. The Supreme Court found, however, that because United Electric had limited uncommitted coal reserves, its past sales were not an accurate predictor of its future competitive significance. Based on that forward-looking analysis, the Court allowed General Dynamics’ acquisition to proceed. 

Even where a competitor’s long-term prospects look dim, the Commission still must assess whether there is short-to-intermediate term competition worth protecting. The Commission’s successful challenge of Imo’s 1989 acquisition of Optic-Electronic Corporation is a good example. There the merging parties were expected to compete only once more in a final round of bids for the Department of Defense before their competing products became obsolete, ceasing competition between them. The district court pointed to the on-going DoD bid as important competition worth preserving, and granted the FTC’s request for a preliminary injunction. FTC v. Imo Industries Inc., 1992-2 Trade Cas. (CCH) § 69,943 at 68,555. 

Assessing Whether a Competitor is “In the Market”

Because Section 7 requires a forward-looking analysis, the agencies must assess whether firms not currently selling products or services should be included as “market participants” for purposes of the competitive analysis. This applies both to the merging parties and other competitors that may enter the market. For instance, as the Guidelines note, firms that are committed to entering the market in the near future can be considered market participants even if not currently deriving revenues from the market. Once we determine that a firm is in the market, we must assess its current or likely competitive impact. 

Some firms must expend more effort, either in terms of time or sunk costs, to begin making sales in the relevant market. The competitive significance of such firms will depend on their progress in the variety of concrete steps needed to begin actual sales and the likelihood such entry will occur. Section 9 of the Guidelines identifies various elements of an entry effort: “planning, design, and management; permitting, licensing, or other approvals; construction, debugging, and operation of production facilities; and promotion (including necessary introductory discounts), marketing, distribution, and satisfaction of customer testing and qualification requirements.” 

It is relatively easy to predict the nature of competition going forward when an existing competitor in one geographic market is months away from entering a new geographic market. In In the Matter of Pinnacle Entertainment, Inc. and Ameristar Casinos, Inc., Dkt. 9355 (May 29, 2013), there were competitive concerns in the Lake Charles, Louisiana, casino market where Pinnacle already had a casino operating and Ameristar had begun building a new casino scheduled to open by the third quarter of 2014. It was not difficult to predict that significant head-to-head competition would exist in the near future absent the acquisition. To address the Commission’s concerns, Pinnacle agreed to sell all of the assets associated with the development and construction of Ameristar’s new casino to an entity that would continue the development and compete with Pinnacle. 

In other cases, a more detailed inquiry into whether a company is likely to be a competitor going forward is required. The Commission’s recent decision in In the Matter of Polypore, Dkt. 9327 (Dec. 13, 2010), discusses the evidence needed to determine whether a firm not currently making sales should nevertheless be considered a market participant. The Commission found that Microporous, the company Polypore acquired, was a market participant in the starter, lighting, and ignition (SLI) battery separator market because it had not only engaged in R&D projects, but made concrete efforts towards supplying a product, which elicited a competitive reaction from Polypore. In contrast, the Commission found Microporous’s R&D work in the uninterruptible power source (UPS) separator market insufficient to make it a market participant in that market, since it had no commercially viable product and there was no evidence that Polypore perceived, or reacted to, Microporous as a threat. 

Competitive Concerns in Mergers that Eliminate a Future Entrant

A question of competitive harm also arises in mergers in which one of the firms is in the process of entering the market but has not yet had a meaningful effect on the competitive environment. In this scenario, the acquisition may substantially lessen competition by eliminating a future competitor whose entry, once complete, would have a beneficial impact on competition. Considering the future significance of such a firm involves more than just an assessment that market conditions are conducive to entry, such that one of the merging firms could enter. In Polypore, the firm in question had already identified the market opportunity, and was expending resources to begin to supply customers in the market. 

There is often no clear line – and often more semantics than analytical difference – between a committed entrant, a likely entrant, a potential entrant and a future entrant. Where companies are taking steps to enter, there can always be some question as to whether they will in fact enter the market. But a fact-based analysis allows us to predict whether a firm is sufficiently likely to enter that its acquisition will harm competition. 

This fact-based approach is also used to determine whether meaningful entry by third parties will be timely, likely, and sufficient. We look at such evidence as the circumstances that led to past entry, whether conditions are conducive to entry, and what the most likely entrants say they would do in the face of a changed market environment. In the recent Bazaarvoice decision, the parties argued that a number of formidable firms – Amazon, Facebook, Twitter, and Google – had the resources and market position from which to launch a product to compete with Bazaarvoice. Yet, the court dismissed the likelihood of each of these companies’ entry into the market, mainly because they had not taken any steps toward entry. As the court summarized, “The companies just discussed have the size and strength to enter virtually any technology market and become strong competitors. But there is no credible evidence that any of them are considering entry into the R&R platform market in the U.S.” U.S. v. Bazaarvoice, Inc., 13-cv-00133-WHO, slip op. (N.D. Cal., Jan. 8, 2014). 

The Quintessential Likely Entry Story: FDA Pipeline Cases 

The Commission has required relief in numerous pharmaceutical markets. In many of these cases, the concern was that the transaction involved a firm without a commercially available product but which would likely provide important competition in the near future. Pharmaceutical products must be approved for use by the Food and Drug Administration. As a result, the path to introducing a new product is clear, well-defined, and often long. There are identifiable stages and timeframes that provide a degree of transparency and predictability as to on-going efforts for those firms developing a product. Information from the FDA as to which firms have filed applications for product approval is a useful starting point to assess the likely status of and timing of a firm’s entry into the market. Yet the inquiry does not begin and end there. We look at all the available evidence to assess the likely future competitive landscape of a market. Moreover, the Commission’s experience in studying competition in pharmaceuticals markets provides a sound basis for projecting the likely price effect that the introduction of the next competing product would bring. 

Many FTC matters occur at a stage in which one of the merging firms has the only branded drug approved by the FDA to treat a particular condition, and the other firm is at some stage in the process of obtaining FDA approval, whether in clinical trials or, for a generic product, at an earlier stage. Typically, the expiration of patent protection stimulates investment in developing generic formulations of branded drugs, which must be approved by the FDA. As a result, the Commission has required divestitures to preserve future competition from the likely first generic supplier. 

In other cases, transactions may combine existing generics, an existing generic with a company developing a generic product, or two companies both developing generic products. Where the combination involves two of only a few companies developing a generic product, that combination is highly likely to lessen competition. Recently, the Commission required divestitures in a number of pharmaceutical markets threatened by Watson Pharmaceutical’s acquisition of Actavis. In part, the Commission charged that the transaction would have reduced future competition in generic markets that did not yet exist, but where generic development was underway and generic entry was imminent. 

There is an important time element in assessing competitive consequences of a merger and the sufficiency of entry by either the parties or a third party. It is of course easier to obtain evidence on what is likely to occur in the near-term. Nevertheless, where the facts show two firms likely to compete in the future – even if their products will not be on the market for some number of years – there may be concerns that such a combination could adversely affect competition. In other instances, we may conclude with great certainty that entry by a third party (either already committed entry or new entry as a result of the transaction) is almost certain to occur and that such entry would have a meaningful impact on competition once the entering firm began selling product. Yet if there is an intervening time period when harm is likely to occur from a transaction, the Commission will take action. 

Of course, this is a fact-specific inquiry. There are certainly instances in which an entrant not yet making sales can have an effect on the marketplace. If the period of theorized competitive harm in this scenario were very short, we might decide that our ability to predict the timing of entry was insufficiently precise. In such cases, we might decline to take action. 

Taking Account of the Impact of Market Innovators

The pharmaceutical cases described above involve the introduction of a generic product that offers significant price savings, but does not result in marketplace innovation in the classic sense of developing something beyond what exists today. A transaction between an existing competitor and a future entrant working on a product that customers would likely view as superior to existing products can be particularly problematic. Such was the case in 2009, when the Commission authorized litigation to block Thoratec Corporation’s proposed acquisition of rival medical device maker HeartWare International, Inc. Thoratec was the only firm with a commercial left ventricular assist device (LVAD) in the United States. HeartWare was engaged in clinical trials for what many considered to be a superior device, with FDA approval expected by 2012. Although the path to regulatory approval of these devices is challenging, there was ample evidence that HeartWare’s device was the most likely future competitor to Thoratec’s. The Commission alleged that no other firm had the ability to replace the current and future competition eliminated by the merger. The parties abandoned the transaction in the face of the Commission challenge. 

Of course, there are instances in which the innovation emerges from firms other than the merging parties. In May 2010, the Commission closed its investigation of Google’s acquisition of AdMob. Google and AdMob were leading competitors in the then-nascent market for mobile advertising networks. During the investigation, Apple acquired Quattro Wireless, the then third-largest mobile advertising network and subsequently announced – and launched – its own mobile advertising network, iAd. The Commission closed its investigation because it lacked reason to believe that the transaction would result in a lessening of competition. It reasoned that as a result of Apple’s entry, AdMob’s historical success on the iPhone platform was unlikely to be an accurate predictor of AdMob’s competitive significance going forward, regardless of its acquisition by Google. 

Transactions that Eliminate Competition in Future Markets

The Commission has applied a similar fact-intensive analysis where neither of the merging firms has a commercially available product yet both are among only a few likely entrants into a future market. Where the merging firms are the only, the most likely, or the furthest along in developing a new product, the Commission will likely take action where:

  • Each firm is likely to be a competitor going forward;
  • The merging companies are two of only a very few firms likely to develop successfully a future product; and/or
  • Other firms are significantly behind the efforts of either merging party such that the combination is likely to delay the emergence of real competition in the market for the new product. 

Those were the facts in the Commission’s recent action involving Nielsen and Arbitron. Both companies were developing cross-platform audience measurement services, which measure viewership across TV, the Internet, and other platforms. The firms had developed plans, invested money and reached out to customers to begin marketing those products, albeit in beta form. Customers believed that Nielsen and Arbitron would compete – and that the two companies were the best positioned to develop a new cross-platform measurement product. Each firm was approaching a complete solution from its unique competitive position. Based on these independent efforts, customers believed that Nielsen and Arbitron eventually would compete directly in any national syndicated cross-platform measurement services. The Commission based its decision not on crystal-ball gazing about what might happen, but on evidence from the merging firms about what they were doing and from customers about their expectations of those development plans. From this fact-based analysis, the Commission concluded that each company could be considered a likely future entrant, and that the elimination of the future offering of one would likely result in a lessening of competition. 

In investigations involving future markets, the Commission will look to the same sources of evidence that inform the contours of competition in existing markets: What are firms doing? Are they developing new products? What do the firms’ documents say about those developments? What are third parties doing? Compared to the merging parties, are third parties advantaged or disadvantaged in their efforts to develop a product and then compete in the future? What do customers say about competition in the future based on what they want in next-gen products and what they know about firms’ ability to develop them? What is the timeline for these entry developments? 

We use a fact-based approach to answer these questions. Ultimately, while we are mindful of limitations on the ability to predict too far out into the future – or in markets that are rapidly changing – Section 7 of the Clayton Act requires that we do as much.

Additional Resources

For other materials on this topic, please refer to the following. 

BLS Program Materials Library 

Antitrust Issues Raised in Mergers and by Restraints in Non-Merger Agreements (PDF)
2014 Spring Meeting
Presented by: Antitrust Law, Corporate Compliance, Corporate Counsel, Mergers and Acquisitions

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