On July 19, the FTC and DOJ released the draft Merger Guidelines for public comment. Among the many headlines is the displacement by case law of formal economic analysis that had characterized former guidelines. The draft guidelines begin with 13 legal principles derived from case law and banish economic techniques to appendices. The agencies justify these principles as reflecting “the law as written by Congress and interpreted by the highest courts.”
Since the Supreme Court has not decided on a substantive merger case since 1975, the cases tend to be old. (Geoff Manne has calculated that the average year of the cases cited is 1982 or 1975 when weighted by cites). Some current Supreme Court justices—particularly Justice Thomas in Baker Hughes and Justice Kavanaugh in Cigna/Anthem—have expressed the view that merger cases relying on a strong structural presumption decided before General Dynamics in 1974 may no longer state the guiding principle in light of General Dynamics’ rejection of such a presumption. In light of the draft guidelines, it surely won’t be too long before the Supreme Court tells us whether or not that view is correct.
Let’s assume that cases like Philadelphia National Bank and Brown Shoe are still good law and that the FTC and DOJ are justified in relying on them to establish merger principles. Now the issue is whether the positions in the draft guidelines are actually supported by the cited cases (and let’s note that what’s important is not what the agencies think about it, but what the courts are likely to say when litigation ensues).
As an opening salvo, let’s consider the structuralist test for vertical mergers in 6(A) of the draft guidelines. We’re first told, on the authority of Brown Shoe, that the “primary vice” of a vertical merger is market foreclosure. So far, so good, but the draft goes on to present the following structural understanding of foreclosure: “The ‘foreclosure share’ is the share of the related market that is controlled by the merged firm, such that it could foreclose rival’s access to the related product on competitive terms. If the foreclosure share is above 50 percent, that factor alone is a sufficient basis for concluding that the effect of the merger may be to substantially lessen competition, subject to any rebuttal evidence.” In support, the draft cites two cases: Brown Shoe and the Second Circuit’s Fruehauf decision.
Before getting to whether the 50% market share presumption is what Brown Shoe and Fruehauf actually say, let’s be clear on what the proposed test is saying: if either party to the merger has a 50% or greater market share in a market related to the other firm, then the merger is presumed anticompetitive and illegal, regardless of the other firm’s market share or whether the evidence suggests that there would be any foreclosure at all in an economic sense. So suppose that a regional supermarket chain with a 50% market share in some towns (considered a proper relevant geographic market) decides that it wants to create its own store label of jam and purchases a small jam producer with a market share of less than 1%, to carry out the plan. Jam production and jam retailing are vertically related, one party to the merger has a 50% or greater market share, and thus the merger is presumed anti-competitive. Or flip it the other way. A large jam producer, with a 50% market share, decides to open a retail store as a flagship for its brand, so it purchases a small specialty foods store that has less than a 1% market share in its own relevant market. That merger, also, would be presumptively illegal under the draft guidelines. To state what is hopefully obvious, in neither of these scenarios is there any reasonable possibility that the merger will foreclose any competitor from competing.
So does Brown Shoe actually make those mergers illegal? Before getting to the passage on which the agencies rely, recall that Brown Shoe is complicated by the fact that the merger between Brown Shoe and Kinney was both horizontal and vertical. Both companies manufactured and sold shoes, and although the Supreme Court discussed the vertical and horizontal effects of the merger separately —finding that the Government sustained its burden of proof on both theories— its analysis of the vertical and horizontal questions was explicitly overlapping. Thus, for example, when conducting its horizontal analysis, the Court noted that “[a] third significant aspect of this merger is that it creates a large national chain which is integrated with a manufacturing operation.”
Now consider the passage ostensibly supporting the agencies’ claim that a 50% market share in any “related” market makes a vertical merger illegal. The Court begins with the observation that “[s]ince the diminution of the vigor of competition which may stem from a vertical arrangement results primarily from a foreclosure of a share of the market otherwise open to competitors, an important consideration in determining whether the effect of a vertical arrangement ‘may be substantially to lessen competition, or to tend to create a monopoly’ is the size of the share of the market foreclosed.” It then states: “However, this factor will seldom be determinative.” Then, in the sentence critical to the agencies’ position, it states: “If the share of the market foreclosed is so large that it approaches monopoly proportions, the Clayton Act will, of course, have been violated; but the arrangement will also have run afoul of the Sherman Act.”
Does that last sentence mean that if one of the merging parties has a market share of 50%, then foreclosure of competition is presumed? Not at all. What creates a presumption of anticompetitive effects is that 50% of the market is foreclosed, but that is very different from saying that a firm with a 50% market share necessarily forecloses 50% of the market. Note, critically, that the Court states that the phenomenon it is describing would violate not only Section 7 of the Clayton Act, but also the Sherman Act. A firm with a market share over 50% only violates the Sherman Act when it uses that share to foreclose competition. It does not foreclose competition simply by having that share. The Court’s meaning is made clear in the following paragraphs of Brown Shoe when it discusses foreclosure as being informed by tying and exclusive dealing law. Suppose a firm has a 50% market share and offers exclusive dealing contracts to 10% of its customers. The law is clear that the share of the market foreclosed is 5% (10% of 50%), not 50%. What “forecloses” the relevant market is a firm’s use of its market share to force customers to do business with itself rather than its competitors, something that cannot be inferred just from a firm’s market share. The Brown Shoe Court went on to explain exactly that on the facts of the case. The foreclosure would arise from the evidence showing that “Brown would use its ownership of Kinney to force Brown shoes into Kinney stores” with the same effect as a tying arrangement.
What about the other case cited by the agencies —Fruehauf? It’s an odd choice to cite for the structural position. The Court rejected the FTC’s challenge to a merger between a truck trailer manufacturer and a heavy-duty wheel manufacturer, finding no likely anticompetitive effect based on the economic evidence. The passage containing the reference that the agencies cite to support their structural inference is worth quoting in full:
“Although it has been suggested that a significant percentage of market foreclosure, standing alone, might constitute a sufficient “clog on competition” to amount to a violation of s
7 without more, Standard Oil Co. of Calif. v. United States, 337 U.S. 293, 314, 69 S.Ct. 1051, 93 L.Ed. 1371 (1949), no such Per se rule has been adopted, except where the share of the market foreclosed reaches monopoly proportions. See Brown Shoe, supra, 370 U.S. at 328, 82 S.Ct. 1502. The Supreme Court’s insistence that each merger challenged under s 7 be “viewed . . . in the context of its particular industry,” Brown Shoe, supra, 370 U.S. at 321-22, 82 S.Ct. at 1522; United States v. General Dynamics Corp., 415 U.S. 486, 498, 94 S.Ct. 1186, 39 L.Ed.2d 530 (1974), and that the Clayton Act protects “Competition, not Competitors,” 370 U.S. at 320, 82 S.Ct. 1502 (emphasis in original), contravenes the notion that a significant level of foreclosure is itself the proscribed effect. See FTC v. Procter & Gamble Co., 386 U.S. 568, 577, 87 S.Ct. 1224, 1229, 18 L.Ed.2d 303 (1967) (“Section 7 of the Clayton Act was intended to arrest the anticompetitive Effects of market power in their incipiency”) (emphasis added). A showing of some probable anticompetitive impact is still essential (e.g., promotion of a trend toward integration; reduction in number of potential market competitors; entrenchment of a large supplier or purchaser; increase in barriers to entry). Instead of a Per se approach, Brown Shoe mandates that when a merger is challenged under s 7 it “becomes necessary to undertake an examination of various economic and historical factors in order to determine whether the arrangement under review is the type Congress sought to proscribe.”
Although there is again a reference to market foreclosure of “monopoly proportions,” there is no suggestion that foreclosure follows automatically from a firm’s market share. The whole tenor of the quoted paragraph is that attentiveness to the particular industry context and facts concerning the merger is required, which is the very opposite of a simplistic structural presumption. Indeed, in a footnote in the middle of the paragraph, the Second Circuit notes that although Brown Shoe can be read to encourage “simplified analysis,” the Second Circuit rejects such an approach in favor of economic analysis of a merger’s probable effects. It also analogizes vertical mergers to exclusive dealing contracts—they present “the same evil.” The foreclosure arises from exclusivity or other exclusionary conduct, not simply from share.
In sum, the draft guidelines’ conflation of market share and foreclosure to create a per se structural presumption isn’t supported by the cited cases. Whatever else one may think of Brown Shoe, it doesn’t hold that whenever a party to a vertical merger has a 50% market share, the merger is illegal. If such a presumption arises, it will be a creative invention of the FTC and DOJ.
The DOJ and FTC want to demote the role of economic analysis and elevate the role of legal analysis. Fair enough, but remember that two can play that game.
|Citation: Daniel Crane, Law over Economics in the 2023 Draft Merger Guidelines, Network Law Review, Summer 2023.