On June 30, 2020, the Federal Trade Commission (“FTC”) and U.S. Department of Justice, Antitrust Division (“DOJ”) jointly issued the final version of their highly anticipated Vertical Merger Guidelines over the dissents of two Democratic Commissioners. The Vertical Guidelines lay out a framework for analysis by the agencies of transactions involving firms at two different levels of a supply chain.
By way of background, these new Vertical Guidelines replace portions of DOJ’s 1984 Merger Guidelines that were widely viewed as outdated and not reflective of the agencies’ current enforcement thinking for vertical transactions. The new Vertical Guidelines complement the agencies’ Horizontal Merger Guidelines, last updated in 2010, that have been widely influential on courts and commentators in shaping analysis of transactions between head-to-head competitors. It remains to be seen, however, if the Vertical Guidelines will attain the same level of broad acceptance—and dissenting views from two FTC Commissioners highlight how enforcement priorities could suddenly shift under a new administration.
A Framework for Analysis of Vertical Transactions
While antitrust analysis of any particular transaction is intensely fact-specific, the Vertical Guidelines offer a structure of what DOJ or FTC analysis would look like and give some indication of the types of facts that might convince the agencies not to challenge a transaction. First, as with transactions involving direct horizontal competition, the agencies begin by identifying “one or more relevant markets in which the merger may substantially lessen competition.” (Guidelines at 5.) But unlike horizontal deals, the agencies will also look for “related products,” meaning products or services offered by the combined firm that are complementary to the “relevant product” and could be leveraged against competing suppliers.
The Vertical Guidelines discuss several potential theories of harm that may raise antitrust concerns in vertical deals: foreclosure (or “raising rivals’ costs”), access to competitively sensitive information, and the risk of facilitating collusion between competitors. The main focus is clearly on foreclosure of rivals, with examples and discussion of that topic comprising fully half of the Vertical Guidelines. The two key factors on whether a vertical deal raises foreclosure concerns are ability and incentive:
- Ability to foreclose rivals depends on control over a related product on which rivals depend and for which they have few alternatives. For example, an orange juice supplier cornering the supply of oranges might have the ability to disadvantage rival juice sellers.
- Incentive to foreclose rivals depends on whether an attempt to disadvantage rivals would actually be profitable for the combined firm. To continue the example, the agencies will try to estimate whether gains from reduced competition for orange juice would outweigh the losses from lower sales of oranges for the combined firm.
The agencies will also consider whether vertical integration will give a firm access to sensitive information from its competitors through its new role as a trading partner. Without safeguards in place, that access may allow the combined firm “to moderate its competitive response to its rival’s competitive actions” or cause rivals to “refrain from doing business with the merged firm” altogether. (Guidelines at 12.)
Relatedly, the Vertical Guidelines discuss various ways in which a transaction might make it easier for competitors to forge or enforce anti-competitive agreements with one another. For example, the transaction could allow the combined firm to stymie competition from a “maverick” firm in the relevant market, or access to sensitive information could make it easier to detect and punish “cheating” on a price-fixing or output-reduction arrangement. (Guidelines at 10-11.)
Key Changes from the Draft Guidelines
The Vertical Guidelines are also notable for the significant changes from the draft version released for comment in January 2020. The examples of potential foreclosure and raising rivals’ costs were expanded considerably, as was the discussion of ability and incentive to foreclose that now features prominently in the Vertical Guidelines’ section on potential anticompetitive effects. The final Vertical Guidelines also remove a provision that some commentators interpreted as providing a 20 percent market share “safe harbor” for transactions between vertically-related firms.
The final Vertical Guidelines repeatedly refer to the potential benefit from the elimination of “double marginalization”—the effect of upstream and downstream suppliers each setting their prices to include a profit margin. This concept had its own brief section in the draft guidelines, but it now makes appearances in the introduction and throughout the examples of foreclosure analysis and coordinated effects, and is central to the discussion of procompetitive effects from vertical transactions. Perhaps most strikingly, the final Vertical Guidelines even discuss how the agencies may “independently attempt to quantify [this] effect” and appear to soften the usual requirement that these benefits only be attainable through a merger, emphasizing that the agencies “do not . . . reject the merger specificity of the elimination of double marginalization solely because it could theoretically be achieved but for the merger.” (Guidelines at 14.) Taken together, these statements indicate that a showing of reduced input costs will likely be a strong first line of defense against agency enforcement actions in vertical deals.
Voices of Dissent
The Vertical Guidelines were issued with some controversy among the leadership at the FTC, with the two Democratic Commissioners dissenting from the vote to approve them as final. Both Commissioner Slaughter and Commissioner Chopra had procedural concerns, arguing that the significant changes between the draft and final versions merited another round of public comment. But more significantly, both Commissioners argued that the Vertical Guidelines did not go far enough in recognizing certain potential harms from vertical transactions, including making entry more difficult (Chopra Dissent at 4-6), effects on workers (Chopra Dissent at 8; Slaughter Dissent at 7), and the possibility of regulatory evasion (Slaughter Dissent at 7). Both also took aim at the increased emphasis on the elimination of double marginalization, citing public comments that they say describe the theory as “controversial, speculative, and unproven,” (Chopra Dissent at 7) and warning that the Guidelines are “overly optimistic that [it] will be achieved and translate into benefits” for consumers (Slaughter Dissent at 4).
These dissenting voices raise the substantial possibility that the vertical merger enforcement priorities reflected in the new Guidelines could change dramatically if the current minority becomes a majority in the next administration.
ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm of approximately 725 lawyers practicing throughout a network of 13 offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy and technology sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.