There has been much recent debate about whether antitrust agencies have been sufficiently attentive to preemptive mergers, where one firm acquires another that it expects will become a more vigorous competitor in the future. The suggestion, sometimes described in terms of “killer acquisitions” (“kill zones”) or, less graphically, “the elimination of nascent competition”, is that agencies may have allowed transactions that, while perhaps not substantially reducing competition in the short-run, deprived consumers of lower prices, better products, and more variety in the future. It has been claimed that these types of mergers have been particularly common in certain sectors, such as the tech and pharmaceutical industries, but it is an open question whether these issues arise more generally.
While these issues are important, the nature of the debate might lead people to believe that similar issues are raised by all preemptive merger cases. This paper by three economists at the FTC, available here, argues that this is wrong. It develops a typology of cases involving mergers that could be viewed as eliminating future competition, and shows how distinctions between different types of merger affect the types of economic evidence that can be brought to bear on the assessment of competitive effects.
Section II defines preemptive mergers.
Preemptive mergers are those between firms whose broadly-defined “market positions” at the time of the transaction are likely to understate how closely the firms would compete in the future absent the merger. The concept includes mergers involving two firms that already sell substitute products where, without the merger, one or both of the firms is likely to improve its market position in the future due to falling costs or improved quality. It also includes mergers where one or both firms do not yet sell the relevant products, which are still in development..
Section III outlines the typology.
The classification is organised so that it progresses towards cases where the parties are further away from competing head-to-head in a relevant product market in terms of time and the development of their products.
A first type of cases concerns situations where both merging parties already offer competing products, but one or both of the parties will likely become more significant competitors absent the merger. A good example of this is where a large incumbent firm proposes to merge with a smaller rival that is growing as its technology improves or its distribution expands. From an economist’s perspective, it is sometimes easier to show competitive effects in these cases than in ones where market shares are stable, because it may be possible to identify how the incumbent has been changing its pricing, marketing or other strategies to address the growing threat to its customer base. Three recent cases where transactions were abandoned after the FTC issued a complaint – CDK/Auto/Mate (2018), Illumina/PacBio (2019), and Edgewell/Harry’s (2020) – illustrate the issues and types of evidence that may be involved in this type of transaction. These include evidence of willingness to pay a premium over market valuation when acquiring the target; evidence of the target imposing competitive constraints on the incumbent that other market participants do not; and internal documents saying that the merger would reduce or eliminate competition.
The second type of cases concerns mergers where a firm has a product on the market, and the other merging party is about to enter that market with its own product. Unlike the first type of cases, this set requires greater projection into the future. However, this does not imply that direct evidence of competitive effects is necessarily absent. The authors use Polypore (2010), a merger between the leading US manufacturer of separators for use in a variety of types of flooded lead-acid batteries and another supplier, as an example. As regards some batteries, entry was imminent and there was already evidence of the incumbent’s pricing being constrained. As regards other products in development, however, the merger was cleared because the success of such development products was “in doubt” and there was no evidence of competitive responses from competitors. In other cases, the FTC has focused on whether the firm being acquired would find it profitable to enter the market absent the transaction, rather than whether it had the capability to do so.
A third type of cases concerns mergers where one firm has a product on the market and the other firm may enter with a well-defined product in the foreseeable future. The concerns here are that either the merger will eliminate price competition if the product in development is brought to the market, or it will lead to the development of the second product being abandoned. The FTC has required divestitures of products to address these concerns in a number of pharmaceutical mergers. While pharmaceutical merger cases have rarely been litigated, the setting is attractive for the development of quantitative economic evidence. For example, the structure of the clinical trial process provides a framework for assessing how likely it is that products will be brought to market absent the merger. Even though each possible drug overlap will have unique features, there are reasonable ways to formulate quantitative predictions of anticompetitive effects even when one firm does not yet have a product on the market.
The fourth type of cases concerns mergers between firms that both have well-defined products in development but not yet on the market. In these cases, it is sometimes necessary to understand the balance between the anticompetitive incentive to drop one of the development projects, and the possible gains that may result from combining the projects and which make it more likely that at least one product will be brought to market. In the case of generic pharmaceuticals, where the ultimate products would be identical, the anticompetitive incentive may be especially strong. Yet there also are cases where agencies have recognised the possible benefits of consolidation. A further difficulty is that the merger assessment also has to balance how the merger will affect the probabilities of different outcomes taking place.
A fifth type of cases concerns transactions where both merging firms are active in developing products, but it is unclear what form those products would ultimately take – and therefore how closely those products would compete even if the development projects were successful. The key issue for these types of cases is that predictions about future competition absent the merger require not only an analysis of future incentives, which is something that is typically done in prospective merger analysis, but also much greater speculation about how early-stage technologies and customer demand are likely to develop.
Section IV concludes.
The typology developed in this paper tries to make useful distinctions based on the types of evidence that might be used and the degree of speculation that is required about what may happen to technology and firm incentives in the future. In light of this, the differences between Types 3 to 5 are really matters of degree. In Type 3 and Type 4 cases, one needs to take a view on whether particular well-defined projects are likely to be successful – a topic on which internal documentation can prove useful. For Type 5 transactions, however, a greater degree of speculation is required about the broad capabilities of the firms and the types of products that may be developed, and here internal documentation is less likely to be of assistance
After all the theoretical discussion of the past weeks on the relevance of innovation for merger control, I think this down-to-earth discussion of how US agencies go about their business is quite refreshing. There is nothing particularly original about the paper, but the typology could be useful to understand what the challenges with dealing with potential competition are in practice. As a bonus, you get an overview of FTC merger control practice over the past decade from insiders.
Personally, I found it interesting that the types of merger where innovation concerns are expressly addressed – the third, concerning acquisition of a potential entrant in the foreseeable future, and the fourth, concerning firms about to enter the same market – mostly concerns pharmaceutical products, the go-to example of competition concerns even when a merger takes place years before prospective market entry. This is coupled with a much narrower and vaguer discussion of ‘pure’ innovation cases under Type 5. In effect, the authors even refer to the paper reviewed above, describing it as providing ‘quite convincing empirical evidence that some acquired firms’ pharmaceutical development projects have been eliminated when they overlap, in terms of therapeutic category and mechanism of action, with drugs that the acquiring firm already has on the market’ and ‘raising the important question of whether this is also true in other sectors’. The point the authors are politely making, I think, is that one cannot extrapolate without more from evidence from an economic sector into other sectors, despite the literature engaging in this rather uncritically.