FRAND Remedies in China’s Merger Control: An Economic Perspective

Despite these threats to competition, mergers can also benefit the affected industry. In a horizontal merger, the merging parties can complement each other’s technologies, share their resources and experience in R&D, and develop a new generation of products that integrate the strengths of each party. In a vertical merger, the upstream and downstream companies can better communicate their understanding of current technology R&D directions. The upstream company can share its existing technologies and future R&D plans with the downstream company while the downstream company can make targeted requests to the upstream company’s R&D. Thus, mergers have the potential to expand a company’s scope of innovation and enhance R&D efficiency. From a cost perspective, mergers can be an effective strategy to achieve cost-savings through, for example, the elimination of duplicate functions within the merging parties, economies of scale, and better resource utilization. In this way, mergers can potentially generate significant efficiency gains.

Regulators in multiple jurisdictions have turned to FRAND merger commitments as an alternative to structural remedies, which often require merging parties to divest business or assets entirely and sell them to a third party. For example, FRAND commitments have been used extensively by the competition authority of China as a part of merger remedies. While divestiture often successfully mitigates foreclosure effects, it also diminishes the R&D productivity benefits of mergers. FRAND remedies define commitments by the merging entities to mitigate foreclosure effects without this imposition on innovation.

To protect against the merged entity using its market power to significantly increase prices, FRAND remedies usually set requirements regarding the merged entity’s product supply to third-party customers. For example, the remedy may restrict the merged entity’s ability to raise prices or may set standards for quality of service to these customers based on pre-merger performance. Additionally, FRAND remedies often require comparability of treatment between third-party customers and the downstream merging entity. Because the nature of contract terms and service provision varies drastically across industries, remedies are designed on a case-by-case basis.

Application of the FRAND principle to merger-control cases

China frequently uses FRAND commitments in merger control. As early as 2009, in the case of GM’s acquisition of Delphi Corporation, the Ministry of Commerce (MOFCOM), which was then responsible for merger review, first proposed a remedy requiring GM to continue to follow the principles of multiple sourcing and non-discrimination in the procurement of its automotive parts post-merger, and not to specifically set unreasonable conditions that would benefit Delphi to the detriment of other suppliers. In that proposal, though MOFCOM did not explicitly propose a FRAND requirement, it did use the phrases “without discrimination” and “non-discriminatory principle.”

In recent years, the State Administration for Market Regulation (SAMR) has used the FRAND commitments explicitly more frequently in merger remedies, citing the principle of “fairness, reasonableness and non-discrimination.” From 2018 to 2022, 22 merger cases have been approved by the SAMR with conditions, with 18 merger approvals including FRAND commitments as a remedy. These 18 merger cases involved optical eyewear, IT, aerospace parts, semiconductors, and many other fields, mainly in high-tech and emerging industry-related fields. The following table summarizes selected merger cases with conditional approvals since 2018 in which FRAND commitments have been adopted by the SAMR:

Table 1. Selected merger cases with conditional approval by China’s SAMR involving FRAND commitments since 2018

_{* Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Merger Case of Essilor International and Luxottica Group S.p.A. Approved with Additional Restrictive Conditions, State Administration of Market Regulation (July 25, 2018), https://www.samr.gov.cn/cms_files/filemanager/samr/www/samrnew/fldes/tzgg/ftj/202204/t20220424_342128.html.}

_{** Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Equity Interests in Rockwell Collins, Inc. by United Technologies Corporation Approved with Additional Restrictive Conditions, State Administration of Market regulation (November 23, 2018), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_16e078c25bc54ca9aa0c604b3a7103b4.html.}

_{*** Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Equity Interests in Orbotech Ltd. by KLA-Tencor Corporation Approved with Additional Restrictive Conditions, State Administration of Market regulation (February 13, 2019), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_151b76b3ed9d494d9b33e4076d61a6be.html.}

_{† Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Equity Interests in Wabco Holdings Inc. by ZF Friedrichshafen AG Approved with Additional Restrictive Conditions, State Administration of Market regulation (May 15, 2020), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_dbe96a455431475987d84599ee80705d.html.}

_{†† Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Part of the Business of Intel Corporation by SK Hynix Inc. Approved with Additional Restrictive Conditions, State Administration of Market regulation (December 19, 2021), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_f03608bf1b8042b78705f412e3948588.html.}

_{††† Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Equity Interests in Xilinx, Inc. by Advanced Micro Devices, Inc. Approved with Additional Restrictive Conditions, State Administration of Market regulation (January 21, 2022), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_e617e2ca632b4743aced14fe1bf34bf0.html.}

_{‡ Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Equity Interests in Coherent, Inc. by II‐VI Incorporated Approved with Additional Restrictive Conditions, State Administration of Market regulation (June 28, 2022), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_84c993b8e2dc4d02b1cea10e36b3f827.html.}

_{‡‡ Announcement of the Decision of the State Administration of Market Regulation on the Antitrust Review of the Case of the Acquisition of Equity Interests in Silicon Motion Technology Corporation by MaxLinear, Inc. Approved with Additional Restrictive Conditions, State Administration of Market regulation (July 26, 2023), https://www.samr.gov.cn/fldes/tzgg/ftj/art/2023/art_a685ac0dd85647b3898dff75f68fa2c4.html.}

The FRAND remedies used by SAMR in merger control can be divided into two main types. The first type involves fair, reasonable, and non-discriminatory use and authorization of technology and IPRs, which is closer to the original attributes of the FRAND principle in SEP licensing. The second type involves the non-discriminatory supply and procurement of relevant products.

The first type of FRAND commitment is used in cases where the merging parties hold patented technologies or other IPRs that are crucial in the industry. In such cases, SAMR requires the merging parties and the merged entity to license to third parties based on the FRAND principle after the completion of the merger. For example, in the case of the merger between Essilor International S.A. and Luxottica, SAMR required the merging parties and the merged entity to provide all willing and legitimate Chinese optical stores with the necessary trademark licenses for frame and lens products within the brand portfolio of both parties and the merged entity after the completion of the transaction.

The scope of the second type of FRAND commitment is broader. The merger can increase the market power of both parties in their relevant markets. To prevent the merged entity from, for example, discriminating against downstream rivals, SAMR requires the merging parties to continue supplying relevant products post-merger to all customers. For example, in the case of the proposed joint venture between Hunan Corun, Toyota (China), PEVE, Xinzhongyuan and Toyota Tsusho in 2014, MOFCOM (which was responsible for merger review at that time) broadly required the joint venture to follow the FRAND principle and sell its products widely to third-party customers. In more recent years, the Chinese antitrust authorities have increasingly refined their requirements for FRAND commitments. For example, in the cases of KLA Tencor/Orbotech, ZF AG’s acquisition of Wabco Holdings, and AMD’s acquisition of Xilinx, SAMR made specific provisions in terms of price, service, duration, and business model to promote effectiveness and enforceability of the FRAND commitment.

FRAND commitments have also been used in other jurisdictions. For example, in the European Union, FRAND has been used to address foreclosure issues arising from vertical mergers, including both input foreclosure and customer foreclosure. One special feature in EU FRAND remedies is that the European Commission introduced a “fast track dispute resolution” and an arbitration mechanism for possible disputes. In some cases, independent industry experts have been introduced to determine whether the supply contract terms comply with FRAND commitments in order to better monitor compliance with FRAND remedies.

Mechanisms for monitoring FRAND commitments in merger-control contexts

FRAND remedies often involve several key restrictions. The remedy may require that the price terms in new contracts should not be higher than the average price of the same product or comparable products measured over a certain pre-merger period. Alternatively, or in addition to pricing requirements, the remedy may require that commercial terms are not worse than in the pre-merger period. Additionally, FRAND remedies often require that the merging parties commit to offering the same commercial terms to third-party customers that they offer to the merged partner. While these requirements may be straightforward in principle, in practice a myriad of complicating factors must be addressed to enact feasible FRAND remedies.

A set of economic analysis tools is available for FRAND compliance assessment. For example, price pass-through models can be used to calculate a price pass-through range for changes in input costs or inflation. Hedonic models can be used to determine a reasonable price change range in response to changes in product characteristics. Also, econometric models (i.e., regression analysis) can be used to assess whether the contract terms are fair and non-discriminatory. We address these three economic methods below.

Use price pass-through models to determine reasonable price range. A FRAND requirement for post-merger pricing is one of the commonly used FRAND remedies. However, price restrictions may excessively burden the merging party if changing market conditions, such as inflation or rising input costs, put upward pressure on prices independent of the merger. As a flexible behavioral remedy, FRAND remedies often take into account external changes in the market and allow the committing party to make fair and reasonable adjustments to commercial terms, including price, in the future.

A price pass-through model can help determine a range of prices that is consistent with market factors, and therefore can be considered reasonable. Economists can construct a price pass-through model based on market demand, cost structure, and market structure. Through the model, a reasonable price pass-through range due to external factors like input price and inflation can be calculated. Thus, the model can be used to assess whether a price change of the relevant product is within the reasonable price adjustment range in compliance with the FRAND principle when external factors change.

According to the classic theory of industrial organization, price pass-through depends crucially on the cost structure of the firm, market demand, and the market structure. To analyze a specific pass-through mechanism, economists develop theoretical models tailored to the specific industry and firm to describe the competition in the market and derive equilibrium changes in the industry. The theoretical model is used in combination with industry-level and firm-level data to compare the actual price change with the simulated reasonable pass-through range in order to assess whether a price change is reasonable.

Price pass-through models have well-established applications in a number of industries such as automobiles and electricity. For example, in the automobile industry, it has been shown that different types of cost shocks can affect prices to different degrees, and different manufacturers face different cost shocks. In the electricity sector, cost pass-through mechanisms have been shown to exhibit significant variation across markets. Based on the industry and market conditions, as well as the details of the relevant FRAND remedy clause, the specific settings of price pass-through models can be tailored to more accurately describe the mechanisms by which factors such as input costs affect final product prices. While price pass-through is a complex economic problem, appropriate models can help in the estimation of a reasonable price pass-through range to assess compliance with FRAND remedies.

Use hedonic price models to determine a reasonable range of price changes when product features change. The FRAND remedy often, in practice, requires that the commercial terms in the new contract should not be worse than those applicable to comparable pre-merger products. However, merging parties’ product portfolios tend to change with upgrades or updates, resulting in significant changes in some product characteristics. In such a case, it may be difficult to find a sufficiently comparable pre-merger benchmarking product. In this case, if one can quantify the new feature’s contribution of value to the customer, it would be feasible to determine whether the pricing of the new product is fair and reasonable. Several well-developed econometric methods, such as a hedonic price model, can provide a scientific solution and are widely used in practice.

A hedonic price model is an economic method that deconstructs the price of a good or service into its constituent components to estimate the value or demand of each component. The model is “trained” on a baseline set of data, such as transaction data prior to the merger, and estimates the price contribution of selected product features. These estimates are used to calculate a FRAND price benchmark against which to assess actual prices after the merger. The hedonic model is often used in research to study the relationship between product prices and product features, and has a wide range of applications in different industries such as automotive, high-tech products, or real estate. The hedonic model is most successful in contexts with relatively standard product characteristics, and typically requires detailed data regarding pricing and product features.

Statistical test of the fairness and non-discrimination using regression models. The FRAND remedy often requires that the merging parties make a commitment to fair and non-­discriminatory treatment, such as not imposing commercial terms that favor their own business over third-party customers under the same circumstance. However, it can be difficult to find identical circumstances for different transactions. Therefore, even if differences in the contract terms exist for different customers, it is not straightforward to conclude that the merged entity engaged in discriminatory treatment. How “under the same circumstance” and “discriminatory treatment” manifest themselves in different cases can be analyzed and assessed using economic tools.

Regression analysis is a viable tool in this regard. Through a regression model, economists can evaluate whether customer identity has a statistically significant effect on key commercial terms in a contract, after controlling for other factors. For example, in evaluating whether the pricing of products is non-discriminatory, one should first recognize that factors such as product characteristics, service quality, and market conditions can all affect the price. In a regression analysis, all of these factors can be included as control variables. If no statistically significant effect on customer identity is detected after properly controlling for other factors, the evidence would not suggest that the merged entity implements discriminatory pricing across different customers.

If terms differ across contracts in ways that are not easily identifiable, regression analysis could allow for a more comprehensive comparison of contracts. Such an approach can identify differences that may appear to be discriminatory in isolation but instead are attributable to substantive differences in contract terms. Identifying and controlling for relevant factors in the regression analysis helps avoid misattribution and thus improves the rigor and credibility of the results in evaluating the compliance with fairness and non-discrimination requirements under a FRAND remedy.

Conclusion

The FRAND principle has expanded its application beyond SEP licensing into the context of merger remedies. Several jurisdictions have actively used FRAND commitments as a remedy in merger control to address competition concerns, with China being the most frequent user of this approach. From an economic perspective, using FRAND commitments as a behavioral remedy can effectively reduce the potential foreclosure effect of a merger while imposing less burden on innovation than would a structural remedy. In practice, it is often complex to assess whether the merged entity is operating in strict compliance with the requirements of FRAND commitments since many factors can complicate the assessment. A series of economic analytical tools provide for scientific and effective assessments of FRAND remedy compliance, tools that we anticipate will play important roles in ongoing and future compliance assessments.