• Change You Should Believe In? New U.S. Merger Guidelines Downgrade Market Definition
  • May 5, 2010 | Author: Richard J. Wegener
  • Law Firm: Fredrikson & Byron, P.A. - Minneapolis Office
  • Many antitrust law tenants have remained constant throughout the years. For example, at the annual spring meeting of the Antitrust Section of the American Bar Association, government enforcers can be counted on to make one or more “major announcements.” Second, courts analyzing mergers first define the relevant market as a “necessary predicate” to finding anticompetitive effects.1 The former remained true again last week as the Department of Justice and the Federal Trade Commission announced revisions to the Horizontal Merger Guidelines (“Guidelines”) at the spring meeting. However, market definition took a smack in the chops as enforcers announced that “Market definition is not an end in itself; it is one of the tools that the agencies use to assess whether a merger is likely to lessen competition.” Why the dramatic change in the government’s approach to market definition? For the answer, we must take a few steps back and start somewhere near the beginning.

    The Established Role of Market Definition in Antitrust Analysis

    Throughout U.S. antitrust history, the outcome of more cases has turned on market definition than on any other substantive issues. Market definition is often the most critical step in evaluating market power and determining whether business conduct has or likely will have anticompetitive effects.2 Without defining the relevant market, there is no meaningful context within which to assess the merger’s competitive effects.3 The emphasis on market definition remains as critical today as in years past. Within the previous 50 days, four court decisions have each uniformly reaffirmed the need to define markets properly in antitrust cases.4

    With respect to merger analysis, the essential first step - and often the step which dictates the outcome of the analysis - is to define the “relevant market” in two dimensions: (1) the relevant product market,5 and (2) the relevant geographic market.6 Market definition has been viewed as an absolute necessity in order to assess pre- and post-merger market concentration, which can lead to a judgment as to the prima facie lawfulness of the transaction.7 Mergers that either do not significantly increase concentration in the relevant market or do not result in a concentrated market typically require no further analysis.8

    What Makes A Merger Anticompetitive?

    Antitrust’s emphasis is on consumer welfare. Accordingly, the agencies ask “how will the acquisition affect competition and consumers?” There are two broad theories of competitive harm in the Guidelines. The first is that firms in concentrated markets may be able to tacitly or explicitly coordinate their actions, and coordination will lead to higher prices or reduced output - results that in either instance will harm consumers. The second theory of harm - unilateral effects - assumes that prices may rise in ways other than tacit collusion or price leadership. The focus is on whether the loss of competition between the merging firms alone creates a unilateral incentive to raise the price of its products. This analysis of unilateral effects turns primarily on two factors: diversion ratios (i.e., how much business the firms take from one another) and their gross margins (i.e., profitability) on the businesses. 

    For example, consumers view Brand A and Brand B as their first and second choices of superpremium ice cream. After merging, if the merged firm raised prices for one of these popular ice creams, and people shifted away from that brand, but most shifted to the other, a price increase could be profitable.9

    Market Definition No Longer Is The Necessary First Step In Government Merger Analysis

    Although the Supreme Court has stated in no uncertain terms that market definition is a necessary predicate to merger analysis, the agencies are now openly moving away from the Court’s established holdings. According to the new Guidelines, defining markets and measuring market share may not be the most efficient starting point. Why the change?  

    Reliance upon unilateral effects is much easier to accomplish if the agencies are not burdened with first having to define a relevant market. Market definition can be challenging in a unilateral effects case and has been a troublesome first hurdle for the agencies in some of their biggest court losses in recent years, many of which failed at the district court level on market definition issues despite the government’s belief that it had shown convincing evidence of anticompetitive effects.10

    Why This Matters

    While the new Guidelines point out in a footnote that they are “not intended to describe how the agencies will conduct the litigation of the cases they decide to bring,” the government’s decision to essentially toss relevant markets under the bus whenever they want remains a troubling development when few mergers are resolved by the courts.

    The problem with finding anticompetitive effect without first defining a market is that Section 7 does not prohibit mergers that “lessen competition,” but only mergers that are likely to “substantially lessen competition.” It is not easy to quantify substantiality without reference to a defined market against which the effects of the proposed transaction can be analyzed. The agencies’ delight in removing market definition from its accepted position atop the analytical process and moving directly to consider anticompetitive effects has the capacity to eliminate Section 7’s substantiality requirement.

    The agencies enjoy the ability to advocate moving the law in any direction that they wish. However, advocating change and actually adopting and applying change to real world transactions are two different things. Merger review has become a predominantly administrative function conducted without a systematic disclosure of decisions to allow mergers, and the public record of challenged mergers provides inconsistent clues as to which mergers will be allowed. Government bureaucrats, through tools such as the Guidelines, are more important than the case law in an environment where litigated cases are few and far between, and the threat of a second request gives the agencies the power to stop mergers that they might not be able to block in court.

    In our system of government, we are all expected to follow the “rules of the road” as developed by the courts - shouldn’t that same expectation be applied to those bureaucrats who are entrusted to enforce the law? As long as the law requires market definition as a “necessary predicate” to liability under Section 7,11 allowing the agencies to peruse an alternative path permits them to avoid doing what they are supposed to do in our system - apply established judicial precedent to proven facts in order to decide whether a law has been violated.12

    1 United States v. Oracle Corp., 331 F.Supp.2d 1098, 1110 (N.D. Cal. 2004), 87 ATRR 269, citing United States v. E. I. du Pont & Co., 353 U.S. 586, 593, 77 S.Ct. 872, 1 L.Ed.2d 1057 (1957). The Antitrust Division failed to demonstrate that the proposed consolidation of Oracle Corp. and PeopleSoft Inc. would offend Clayton Act §7. The court concluded that DOJ and the complaining state attorneys general failed to prove their product market and geographic market allegations, among other things.

    2 Robert Pitofsky, New Definitions of Relevant Market and the Assault on Antitrust, 90 Colum. L. Rev. 1805, 1807 (1990) (“Knowledgeable antitrust practitioners have long known that the most important single issue in most enforcement actions ¿ because so much depends upon it - is market definition.”)

    3 As a result, “[c]ourts generally have held that proof of defendants market power is an absolute prerequisite for a plaintiff seeking to use market analysis to satisfy its burden of proving likely anticompetitive effect.” ABA Section of Antitrust Law, Antitrust Law Developments, 5th ed. (Chicago: ABA Publishing, 2002) pp.67-68.

    4 In the first case, the U.S. Court of Appeals for the Third Circuit decided that a horticultural products distributor could not show that it provided sufficient evidence of product and geographic markets to move forward with its conspiracy claims against the product’s manufacturer and a competing distributor. The disfavored distributor’s evidence of a product market was legally insufficient because it failed to refer “to the rule of reasonable interchangeability and cross-elasticity of demand.” U.S. Horticultural Supply v. Scotts Co., 2010 WL 729498 (3d Cir. 2010), 98 ATRR 303. In the second case, the U.S. Court of Appeals for the Ninth Circuit ruled that the testimony of a Las Vegas lounge operator’s two experts—to support a proposed market definition of “cocktails and hors d’oeuvres in an entertainment atmosphere” within a given resort was excluded properly by the district court, which could not find sufficient evidence to sustain a verdict on its proposed market definition. Plush Lounge Las Vegas, LLC v. Hotspur Resorts Nevada, Inc., 2010 WL 893495 (9th Cir. 2010), 98 ATRR 340. In the third case, where there was a failure to plead antitrust injury, the U.S. District Court for the District of New Jersey held that defendants in a patent infringement suit could not support antitrust counterclaims asserted against the patent holder because they failed to adequately define a relevant geographic market or the basis for inferring that there was a dangerous probability of achieving monopoly power in that relevant market. Dicar, Inc. v. Stafford Corrugated Products, Inc., 2010 WL 988548 (D.N.J. 2010), 98 ATRR 359. In the fourth case, the district court in the DOJ’s Section 7 case against Dean Foods declined to dismiss the complaint. Dean had contended that DOJ and the three state plaintiffs did not sufficiently plead a relevant geographic market for fluid milk, and it urged the court to dismiss the second count of the complaint or to require DOJ and the states to submit a more definite statement. The district court would not countenance dismissal of the complaint at this stage of the litigation. It determined that it “simply has no basis to impose the type of highly specific pleading standard&dsqu; urged by Dean. U.S. v. Dean Foods Co., (E.D. Wis., No. 10-CV-59, 4/7/10) 98 ATRR 427.

    5 The relevant product market is defined as all products the competing firms sell and products that consumers regard as “reasonable substitutes” for the competing firms products. E.g., Brown Shoe Co. v. United States, 370 U.S. 294 (1962).

    6 The relevant geographic market is the area to which consumers can reasonably turn for supplies of the merging firms’ products or substitutes for those products. E.g., Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320 (1961).

    7 Since the 1980s, agencies and the courts generally have used the Herfindahl-Hirschman Index (HHI) to measure market concentration. The proposed revisions to the Guidelines also reflect a change in HHI levels. The HHI thresholds for determining when a merger in a highly concentrated market will be presumed to enhance market power have been increased from a post-merger HHI of 1800 with a delta HHI of 100 to a post-merger HHI of 2500 with a delta HHI of 200.

    8 This reflects the conclusion that firms without sufficient market share lack market power, i.e., the ability to raise prices or exclude competition.

    9 E.g., Nestle S.A., FTC File No. 012-0174, ATRR 84 (June 27, 2003): 653.

    10 For example, see FTC v. Whole Foods Market, 502 F.Supp.2d 1 (D.D.C. 2007). Whole Foods and Wild Oats competed with other supermarkets in selling food to consumers, but they specialized in the sale of premium natural and organic foods. The FTC alleged that the sale of premium natural and organic foods composed a separate market, and that ordinary supermarkets did not compete in this market. Under the FTC’s theory, the transaction would enable the newly formed entity to raise its prices, and still profit because there were no other competitors to constrain its prices. The court disagreed with the Commission’s market definition, concluding that Whole Foods and Wild Oats competed with other supermarkets and that no separate market for premium natural and organic foods existed. Based on this broader market definition, the court held that the FTC failed to show a likelihood of anticompetitive effects.

    11 United States v. E. I. du Pont & Co., 353 U.S. 586, 593, 77 S.Ct. 872, 1 L.Ed.2d 1057 (1957).

    12 The primacy of relevant market analysis have been a cornerstone of the Guidelines since their 1982 introduction, and has been continued by every Assistant Attorney General and FTC Chairman of both parties until now.