DOJ/FTC Publish Draft Vertical Merger Guidelines

On January 10, 2020, the Department of Justice (DOJ) and the Federal Trade Commission (FTC) released draft guidelines outlining the framework that the US antitrust authorities will use to analyze vertical mergers. (Draft Vertical Merger Guidelines).¹ The Draft Vertical Merger Guidelines are intended to supplant the 1984 DOJ Non-Horizontal Merger Guidelines,² which did not reflect the actual analysis used by the DOJ and FTC in recent years. Simultaneously, the agencies officially withdrew the 1984 Guidelines.³ The agencies have announced a 30-day comment period for the Draft Vertical Merger Guidelines.

The Draft Vertical Merger Guidelines echo current agency practice and are consistent with the past speeches by FTC and DOJ officials,⁴ but they do not offer as much guidance and detail as the 2010 Horizontal Merger Guidelines. Moreover, two FTC Commissioners dissented from the decision to issue these draft guidelines,⁵ signaling the potential for dissents to the final version of the guidelines. However, the final guidelines will reflect the views of a majority of the Commission as to the agencies' analytical approach to vertical mergers and thus almost certainly will be followed by staff. Any dissents to the final version likely suggest that those Commissioners may also dissent as to the resolution of vertical transactions⁶ and the guidelines could be withdrawn if the composition of the Commission changes (or there is new leadership at DOJ).

The Draft Vertical Merger Guidelines Echo Agency Practice and Recent Agency Leadership Statements

The draft vertical guidelines "should be read in conjunction with the Horizontal Merger Guidelines" and offer "principles and analytical frameworks" to analyze vertical mergers.⁷ A transaction is characterized as vertical when the merging firms operate at different levels of the supply chain. A common vertical scenario is found when one company produces a product used as an input to make the other company's product. As the guidelines set forth, the agencies will first identify relevant markets in which the merger might lessen competition, assessing the parties’ market shares and overall concentration in the impacted markets. The authorities will assess any evidence that the transaction might cause adverse competitive effects in the impacted markets, and weigh this potential harm against any procompetitive benefit of the deal.

In assessing the impact on competition, the Draft Vertical Guidelines articulate what case law and US antitrust enforcement have long reflected—that vertical mergers typically present less risk of potential competitive harm than do transactions between competitors (i.e., horizontal mergers), and because vertical transactions "combine complementary economic functions and eliminate contracting frictions, they have the potential to create cognizable efficiencies that benefit competition."⁸ The guidelines also offer a discussion of potential benefits associated with the elimination of double marginalization. As the Draft Vertical Merger Guidelines note:

Elimination of double marginalization can occur when two vertically related firms that individually charge a profit-maximizing margin on their products choose to merge. Absent the merger, the downstream merging firm would ignore any benefit to the upstream merging firm from setting a lower downstream price and making higher sales. But if the two merge, the resulting firm will benefit from both margins on any additional sales, and capturing the upstream margin, through merger, may make the price reduction profitable even though it would not have been profitable prior to the merger. Elimination of double marginalization may thus benefit both the merged firm and buyers of the downstream product or service.⁹

At the same time, the Draft Vertical Merger Guidelines outline three theories of potential anticompetitive harms that the US authorities have long considered: (1) whether the newly combined entity would have the ability and incentive to disadvantage a rival company by withholding or increasing the price of an input or distribution channel; (2) whether the combined firm could gain access to sensitive business information about an upstream or downstream competitor; and (3) whether the transaction is likely to increase the risk of coordination and diminish competition.¹⁰ These potential concerns are largely consistent with the authorities' existing investigative focus and have formed the basis of recent vertical enforcement efforts. The potential concerns included in the new Guidelines include:

• Foreclosure. DOJ raised concerns regarding Anheuser-Busch InBev's ability to foreclose rivals' beer distribution via its 2016 acquisition of SABMiller plc and prohibited the combined company from discouraging independent distributors from working with rivals.¹¹ Similarly, in the 2011 Comcast acquisition of NBC Universal, Inc., DOJ prohibited Comcast from employing certain restrictive content licensing terms and mandated that Comcast submit to binding arbitration regarding distributors' access to NBC content.¹² FTC expressed similar concerns in its review of a 2007 joint venture between Boeing and Lockheed Martin, requiring the joint venture to provide launch services to competing space vehicle providers on a non-discriminatory basis.¹³
• Access to Confidential Information. Concerns regarding access to or exchange of confidential information were raised in Broadcom Limited's 2017 acquisition of Brocade Communication Systems, Inc,¹⁴ where FTC required the combined company to create firewalls to prevent Brocade from accessing confidential information of Broadcom's other major customer. In GrafTech's 2011 acquisition of Seadrift Coke, DOJ imposed firewalls and restrictions on the company's contracting practices to ensure that Seadrift could not access the confidential information of GrafTech's other significant supplier.¹⁵
• Less Competition Due to Coordination. In 2017, DOJ filed a complaint alleging that Danone's acquisition of WhiteWave would give the combined company an incentive to coordinate with a WhiteWave competitor that had a partnership with Danone.¹⁶ The transaction effectively brought together White Wave and that competitor, the top purchasers of raw organic milk and the producers of the leading brands of fluid organic milk. DOJ required the combined company to divest a brand, severing the Danone supply/licensing agreement.

Another way in which the Draft Vertical Merger Guidelines remain consistent with existing practice is by closely hewing to the approach of the Horizontal Merger Guidelines. The Draft Vertical Merger Guidelines specifically discuss employing the analytical tools of the Horizontal Merger Guidelines and make clear that the Draft Vertical Merger Guidelines "should be read in conjunction with the Horizontal Merger Guidelines" and that the "principles and analytical frameworks used to assess horizontal mergers apply to vertical mergers."¹⁷

Notably, one theory of harm identified in the 1984 Guidelines—that a vertical merger might allow a public utility to circumvent rate regulation¹⁸—is not included in the new Guidelines.¹⁹

A Number of Open Questions Remain:

The Draft Vertical Merger Guidelines leave open some important issues relating to the analysis of vertical transactions, including:

• 20% Market Share "Presumption"? The Draft Vertical Merger Guidelines state that the FTC and DOJ are unlikely to challenge a vertical merger where the market share of the relevant products is less than 20%. The "unlikely" language is less definitive than "absent extraordinary circumstances" language seen in other agency guidance.²⁰ Moreover, the 20% market share standard is significantly less forgiving than: (1) the European Union vertical merger guidelines, which offer a safe harbor at a 30% share;²¹ (2) US Supreme Court precedent indicating that exclusive dealing at a 30% share does not raise Sherman Act Section 1 problems;²² and (3) US case law in vertical cases reflecting the view that market power is unlikely to exist for companies with less than a 30% share.²³ Notably, the 1984 Guidelines implied that supply foreclosure concerns could not present a problem in a vertical merger involving an upstream supplier with less than a 33% market share.²⁴ Further, the 20% threshold appears to be significantly lower than the shares held by companies in vertical mergers that have been challenged by the authorities in the past, which have tended to implicate "highly concentrated" markets.²⁵
• Remedies. FTC Commissioner Wilson, in an early 2019 speech, highlighted her desire for vertical guidelines that cover potential remedies,²⁶ but the Vertical Merger Guidelines are silent on the question of potential remedies to address issues created by vertical mergers. Thus, an important question that the Draft Vertical Guidelines leave unanswered is whether, and under what circumstances, the authorities might be willing to consider behavioral or conduct remedies for transactions that implicate vertical issues.²⁷
• Double Marginalization. The Vertical Merger Guidelines anticipate that the authorities will evaluate the "net effect" of a transaction, taking into account both potential price incentive changes as well as the potential benefits associated with the elimination of double marginalization.²⁸ The agencies note that they: "will not challenge a merger if the net effect of elimination of double marginalization means that the merger is unlikely to be anticompetitive in any relevant market."²⁹ In her concurring statement, FTC Commissioner Christine Wilson sought comments on a number of other questions related to double marginalization, including a query as to whether or not the authorities should expect that the procompetitive benefit of eliminating double marginalization will be obtained as often as the potential anticompetitive effect associated with raising a rival's cost.³⁰
• Innovation Effects. Over the last several years some commentators and agency representatives have voiced concerns that antitrust enforcement was not sufficiently protecting and encouraging innovation.³¹ Although the Vertical Merger Guidelines reference the potential impact of vertical foreclosure on competitor innovation, the Guidelines do not delve into the topic in detail. This omission is notable, as the potential impact of vertical mergers on industry innovation has been raised recently by agency leadership³² and past merger enforcement has noted potential concerns associated with the impact of vertical transaction on innovation and entry.³³

What to Expect Next

There is now a thirty-day period, ending on February 11, 2020, during which comments on the draft guidelines can be submitted by members of the public. While the final guidelines may reflect some changes based on the comments, unless those changes are significant it seems unlikely that the final guidelines will garner the unanimous support of the FTC Commissioners.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.