This article begins by examining the origins and development of potential competition concerns, expressed mainly in the Clayton Act. Historically, ideas about potential competition reflected fundamental divisions over how wide a net antitrust policy should cast. Then, this article moves to mergers, the area in which potential competition concerns most explicitly appear in antitrust doctrine. One thing that dominates that debate is the balance of factfinding and speculation needed to address potential competition concerns. On the one hand, Section 7 of the Clayton Act expresses a prophylactic (“where the effect . . . may be”) standard for judging mergers, requiring probability rather than certainty. On the other hand, many of the theories involve considerable speculation about future events. During the brief period (1964–1974) in which the Supreme Court developed the potential competition merger doctrine, its attitude moved from optimistic enthusiasm to harsh skepticism. The dominating figure was Justice William O. Douglas, who became the Court’s strongest proponent of aggressive use of the potential competition doctrine. The Court’s declining enthusiasm is important, because after a 40-year hiatus, the government has now issued Merger Guidelines that attempt to revitalize the potential competition merger doctrine, with few modifications from the Supreme Court’s prior articulation more than a half century ago.
One important feature of potential competition is that it is dynamic. Some movement must occur before potential competitors can become actual competitors. In extreme cases, even the sole seller of a product cannot anticipate monopoly profits. Any attempt to charge a price above cost would lead to immediate and effective entry by others. A concern of antitrust merger policy is that by acquiring a potential competitor, a firm can remove a threat of actual competition that might emerge later. In other cases, the fear of new entry by potential competitors could force a firm to keep its prices lower or—on the other side—to take exclusionary action against potential rivals. That is, potential competition can foster both beneficial and harmful behavior.
Another important feature of potential competition is its relationship to antitrust law’s fundamental structural concerns. Identifying potential competition is often linked to market definition and identification of entry barriers. A firm that is just inside the market is an actual competitor, while a firm that is just outside is merely a potential competitor. As a result, defining a market more broadly or narrowly might instantly transform a firm from a “potential” to an “actual” competitor, or vice versa. For example, if we define a market as “automobiles,” Kia and Mercedes might be competitors. By contrast, if we conclude that the market is “luxury automobiles,” then we might end up placing them in different markets. This makes proper location of the market boundary critical, especially if the substantive analysis to be applied differs significantly for actual and potential competitors.
A merger of two competitors increases the merged firm’s market share and also market concentration, which are important determinants of competitive threat. Once we place the acquired firm slightly outside the market boundary, however, the merger does not increase the post-merger firm’s market share nor concentration. So, we have to rely on other theories of competitive harm that are often less well developed or empirically robust. As I note later, since the 1970s, market definition has become a more dynamic query under the hypothetical monopolist test, and in the process it can blur the distinction between actual and potential competition.
The distinction between actual and potential competition also becomes less pronounced if market power is assessed “directly,” by econometric methods, rather than through a process of market definition. Existing potential competition merger doctrines depend on identifying a bright line between those in the market and those outside. Econometric methods that meter rates of substitution in response to varying price changes rarely generate such bright lines.
The idea of potential competition has occupied a place in United States antitrust policy at least since the debates over the Clayton Act in the 1910s. One camp, which was more influenced by classical political economy, tended to see potential competition as a powerful force that was always present to discipline firms who attempted to assert monopoly control. As a result, they were not particularly concerned about monopoly. At the other extreme were those who had almost no faith in potential competition, believing that only actual rivals could effectively discipline a firm bent on monopoly.
In the middle was a group of progressives that grew out of the marginalist revolution in economics. Marginalist Richard T. Ely ridiculed the classical idea that “capital and labor move with perfect ease from place to place . . . without the slightest loss.” Like other marginalists, they were more concerned with metrics and rates of change. John Bates Clark, the economist who very likely had more influence than any other on the drafting of the Clayton Act, believed that potential competition was a valuable presence for disciplining monopoly, but that it could be manipulated by incumbent firms in ways that could exclude rivals or delay their entry. Stanford economist Eliot Jones wrote in defense of the Clayton Act about dominant firms’ use of tying arrangements, exclusive dealing, and patents to prevent potential competition from turning into actual competition. The Clayton Act addressed all of these.
Continue reading the full text of this article in PDF format.
