Developing Evidence of Conspiratorial Contacts

1
Investigating Mergers and Acquisitions
Mark Woodward African Competition Forum
Workshop March 25, 2013
2
The Goals of Merger Analysis

• The central goals of merger analysis and
  enforcement are
• To identify and prevent mergers that create or
  enhance market power
• To accomplish goal 1 without delaying or
  obstructing mergers that enhance competition and
  benefit consumers

3
U.S. Legal Background

• U.S. Law
• Clayton Act Section 7 prohibits mergers and
  acquisitions where the effect may be
  substantially to lessen competition, or to tend
  to create a monopoly
• U.S. courts develop case law interpreting Clayton
  Act Section 7
• U.S. competition agencies issue merger guidelines
  applying Section 7

4
Purpose of U.S. Horizontal Merger Guidelines

• Stated rationales
• Assist business community and antitrust
  practitioners by increasing transparency
• Assist courts in developing appropriate
  analytical framework
• Goals
• Transparency/clarity
• Predictability/certainty
• Consistency

5
2010 U.S. Horizontal Merger Guidelines

• U.S. Merger Guidelines revised in 2010
• Reject rigid interpretation of the analytical
  framework and specific standards
• Merger analysis is fact-specific process not
  limited to single methodology or tools
• New section on adverse effects evidence
• Market definition not end in itself or even
  necessary starting point
• Updated hypothetical monopolist test
• Expanded discussion on unilateral and coordinated
  effects
• New discussion on ease of entry

6
Overall Framework

• Overview ( 1)
• Evidence of Adverse Competitive Effects ( 2)
• Target Customers and Price Discrimination ( 3)
• Market Definition ( 4)
• Market Participants, Market Shares, and Market
  Concentration ( 5)
• Unilateral Effects ( 6)

• Coordinated Effects ( 7)
• Powerful Buyers ( 8)
• Entry ( 9)
• Efficiencies ( 10)
• Failure and Exiting Assets ( 11)
• Mergers and Competing Buyers ( 12)
• Partial Acquisitions ( 13)

7
Themes and Evidence

• Enhancing market power as central theme of HMG
• Mergers should not be permitted to create,
  enhance, or entrench market power or to
  facilitate its exercise.
• A merger enhances market power if the merger is
  likely to encourage one or more firms to raise
  price, reduce output, diminish innovation, or
  otherwise harm customers as a result of
  diminished competitive constraints or incentives
• Non-price effects included as potential harm

8
Themes and Evidence

• Common types of evidence (HMG Section 2.1)
• Actual effects observed in consummated mergers
• Direct comparisons based on experience
• Natural experiments historical events,
  experience in similar markets
• Market shares, level of concentration, and change
  in concentration
• May lead to rebuttable presumption of
  anticompetitive effects
• Substantial head-to-head competition between
  merging parties
• Actual or likely potential competition absent the
  merger
• Particularly relevant for evaluating unilateral
  effects
• Elimination of maverick (a firm that plays a
  disruptive role in the market to the benefit of
  consumers)

9
Themes and Evidence

• Common sources of evidence (HMG Section 2.2)
• Merging parties
• Emphasis on contemporaneous ordinary course of
  business documents
• Business decisions taken by the merging firms can
  be informative about industry conditions
• Explicit or implicit evidence about the merging
  firms post-merger plans
• Customers
• Particularly on reactions to post-merger price
  increases, attractiveness of substitutes,
  competitive effects
• Other industry participants and observers
• Suppliers, distributors, complementary product
  manufacturers, competitors, analysts

10
Market Definition (HMG Section 4)

• Market definition plays two roles
• Identifies the line of commerce and section of
  the country in which the competitive concern may
  arise
• Allows agencies to identify market participants
  and measure market shares, market concentration,
  and the increase in concentration
• Market definition is not an end in itself
• Agencies analysis need not start with market
  definition
• Evidence of competitive effects can inform market
  definition

11
Market Participants, Market Shares and
Concentration (HMG 5)

• Significance of market shares, concentration and
  changes in concentration
• Higher market shares SUGGEST market power
• Large merged firm may be able to reduce output
  and increase prices unilaterally
• Higher concentration level SUGGESTS less
  competition (fewer significant competitors)
• High concentration may make it easier to
  coordinate output reductions and price increases
• Higher changes in concentration SUGGEST greater
  merger impact

12
Market Participants, Market Shares and
Concentration (HMG 5)

• Identifying market participants
• All firms that currently earn revenues in the
  relevant market
• Rapid entrants
• Firms not current producers in the relevant
  market, but that would very likely provide rapid
  supply in response to a SSNIP without incurring
  significant sunk costs
• Slower entry, and entry involving significant
  sunk costs, considered in entry analysis
• Types of rapid entrants include
• Firms that produce the relevant product but to
  not currently sell in the relevant geographic
  market and would likely enter in response to a
  SSNIP
• Firms that have the necessary assets and readily
  available capacity to begin producing the
  relevant product
• Rapid entry more likely where relevant product is
  homogeneous

13
Market Participants, Market Shares and
Concentration (HMG 5)

• Market shares measures
• Best available indicator of firms future
  competitive significance in the relevant market
• Actual or projected revenues (typically used)
• Unit sales where low-priced product can be
  substituted for a higher-priced product
• Available capacity or reserves (exclude committed
  capacity profitably employed outside the relevant
  market that it would not likely be used in
  response to a SSNIP in the relevant market)
• Annual data typically used
• Market concentration measures
• HHI principal measure of concentration adopted by
  the agencies
• HHI calculated by summing the squares of the
  individual market shares of the firms in the
  market
• Range 0 (atomistic market) to 10,000 (a monopoly)
• Increase double the product of the market
  shares of the merging firms

14
Significance of Market Concentration Measures

• Three classifications of markets
• Unconcentrated markets HHI lt 1500
• Moderately concentrated markets 1500 HHI
  2500
• Highly concentrated markets HHI gt 2500
• General standards
• Small change in concentration mergers involving
  an increase less than 100 points unlikely to
  have adverse competitive effects and ordinarily
  require no further analysis
• Unconcentrated markets merger resulting in
  unconcentrated markets unlikely to have adverse
  competitive effects and ordinarily require no
  further analysis
• Moderately concentrated markets merger resulting
  in moderately concentrated markets that involve
  an increase of more than 100 points potentially
  raise significant competitive concerns and often
  warrant scrutiny
• Highly concentrated markets mergers resulting
  in highly concentrated markets that involve an
  increase of
• 100 to 200 points potentially raise significant
  competitive concerns and often warrant scrutiny
• more than 200 points will be presumed to be
  likely to enhance market power

15
Unilateral Effects

• Unilateral effects relating to pricing of
  differentiated products
• Unilateral effects relating to bargaining and
  auctions
• Unilateral effects relating to capacity and
  output for homogeneous products
• Unilateral effects relating to innovation and
  product variety

16
Unilateral Price Effects

• Will the merged firm have the ability to
  successfully raise its prices?
• Price effects turn on ability of competing firms
  to increase production or reposition products in
  response to a price increase by the merged firm
• Generally, unilateral effects occur in
  differentiated product markets
• The products of the merging firms are viewed by
  many consumers to be better substitutes for one
  another than the products produced by other firms

17
Diversion Ratios

• What is the diversion ratio?
• The diversion ratio measures the fraction of all
  consumers currently purchasing Product A that
  switch to Product B in response to a price
  increase
• DRAB ?QB/?QA
• Our example If in response to a price increase
  for Product A, its sales fall by 10 units, and
  the sales for Product B rise by 5 units, the
  diversion ratio is 5/10 0.50 or 50
• A B C D F

18
Diversion Ratios

• Why is diversion important to unilateral effects
  analysis?
• The diversion ratio reflects the extent of direct
  competition between the products of the merging
  firms
• Post-merger, the merged firm will take into
  account the diverted sales (which it now
  recaptures) when setting price
• The higher the diversion ratio of the merging
  firms products, the more likely is significant
  harm to competition
• Significant unilateral effects may occur even
  though a non-merging product is the closest
  substitute for every merging product
• Significant unilateral effects may occur even
  where overall market concentration is low (HHI
  levels of limited predictive value)

19
Merger to Monopoly Case Example

• Glaxo Wellcome-SmithKline Beecham (2000)
• Glaxo Wellcome and SmithKline Beecham, which
  manufactured and marketed numerous pharmaceutical
  products, proposed to merge
• For most products, the transaction raised no
  significant competitive issues, but it did raise
  competitive concerns in several product lines,
  including the market for RD, manufacture, and
  sale of second generation oral and intravenous
  antiviral prescription drugs used in the
  treatment of herpes infections
• Glaxo manufactured and sold Valtrex
• SmithKline manufactured and sold Famvir
• No other company was producing or developing a
  similar drug
• Entry barriers regulatory approval created a
  substantial entry barrier
• Merger would eliminate the only competition that
  existed in the market for second generation
  prescription oral and intravenous antiviral drugs
  for the treatment of herpes infections (i.e.,
  merger to monopoly)
• Result Consent agreement requiring divestiture
  of SmithKlines Famvir-related assets

20
Pricing of Differentiated Products Case Example

• Nestle-Dreyers (2003)
• Product market at issue super premium ice cream
• Nestle (Haagen-Dazs brand) 36.5 market share
• Dreyers (Dreamery, Godiva, and Starbucks brands)
  19.1 market share
• Unilever (Ben Jerrys brand) 42.4 market
  share
• HHIs Pre-merger 3,501 Post-merger 4,897
  Change 1,396
• Quantitative evidence of likely unilateral
  anticompetitive effects
• Econometric analysis of point of sale data showed
  the diversion ratios between the Nestle and
  Dreyers super premium brands were sufficient to
  make a significant unilateral price increase by
  the merged firm likely
• Diversion ratios with Unilevers super premium
  ice cream were sufficiently high to make a
  post-merger price increase by Unilever also
  likely
• Result Consent agreement requiring divestiture
  of two brands and key distribution assets

21
Pricing of Differentiated Products Case Example

• Fortune Brands-Allied Domecq (2005)
• Transaction Fortune Brands (owner of Knob Creek
  bourbon) proposed to acquire Allied Domecqs
  Makers Mark bourbon brand
• Candidate product market premium bourbon
• Candidate theory of harm whether the
  acquisition would create or enhance unilateral
  market power for premium bourbon
• Econometric analysis of retail scanner data
  showed
• Several other large whiskey brands, including
  bourbons, competed strongly with Knob Creek and
  Makers Mark
• Substantial cross-price elasticities among the
  several whiskey brands
• Diversion ratios among Makers Mark and Knob
  Creek were low
• Result staff closed the investigation

22
Coordinated Effects

• Will the merger facilitate coordinated price
  increases by firms in the market?
• Turns on the number of firms in the market and
  their ability to reach agreement on price or
  output and detect and punish deviations from the
  agreement

23
Core Problem for Coordination

• Collectively, firms have incentives to coordinate
  prices
• Higher prices ? Increased profits
• BUT
• Each firm has an incentive to cheat

24
Coordinated Interaction

• Factors To Consider
• Concentration
• Excess capacity
• Firm and product homogeneity
• Size of buyers
• Market stability
• Availability of information
• History of collusion

25
Coordinated Effects Case Example

• LaFarge-Blue Circle (2001)
• Three markets at issue
• Cement market in Great Lakes Region
• Merged firm 47 market share top four firms
  91 market share
• Post-merger HHI gt 3,000 with increase gt 1,000
• Cement market in Syracuse, New York Region
• Merged firm 68 market share top 2 firms
  100 market share
• Lime market in Southeastern United States
• Merged firm Blue Circle joint venture 85
  market share
• Product homogeneity cement is a homogeneous,
  highly standardized commodity over which
  producers compete principally on price
• Market transparency producers publicly
  announced price increases months in advance
• Transaction size and frequency sales
  transactions tend to be frequent, regular, and
  relatively small
• Competitive constraints high barriers to entry

26
Merger Process at FTC - Overview

1. Review pre-merger filings
2. Collect public industry information
3. Interview market participants (customers,
   competitors, merging parties)
4. If concerns, issue second request for documents
   and data
5. Review documents and data
6. Conduct hearings of merging parties, others
7. Decide whether to close, challenge, or settle

27
The Whole Foods Case
28
Whole Foods/Wild Oats Merger

• Proposed Merger (2007)
• Premium food stores focusing on natural,
  organic foods
• Whole Foods
• Wild Oats
• Other regional stores
• Other supermarkets in United States
• Safeway, Giant, Kroger, Albertsons, many others

29
Product Market

• FTC Premium Natural Organic Stores (PNOS)
• Defendants PNOS, Conventional Supermarkets,
  Trader Joes, Gourmet Stores like Wegmans, Club
  Stores, etc.

30
(No Transcript)
31
(No Transcript)
32
(No Transcript)
33
Investigational Hearing Testimony

• John Mackey, CEO of Whole Foods
• One of the motivations is to eliminate a
  competitor. I will not deny that. That is one of
  the reasons why we are doing this deal. That is
  one of the reasons why we are willing to pay
  18.50 for a company that has lost 60 million in
  the last six years. If we cant eliminate those
  stores, then Wild Oats, frankly, isnt worth
  buying.

34
Epilogue

• FTC lost case at district court level after 2-day
  hearing
• Rejected FTCs product market definition
• Appeals court reversed, ruling for FTC
• Found FTC had met its burden of proof
• But parties had already merged
• FTC settled with Whole Foods
• Requiring certain stores be divested

35
How to Proceed Expeditiously Top 10 Tips To
clear Non-problematic Transactions To Narrow and
Refine Issues
36
TIP ONE

• Begin investigation even before receiving formal
  filing/notification from merging parties.
• Trade press
• Mass media
• Citizen complaints
• Notification courtesy copy (merging parties may
  come in for pre-notification consultations and
  provide a draft filing)

37
TIP TWO

• Start fast.
• Immediately begin gathering information to
  determine whether the transaction can be promptly
  cleared or is potentially anti-competitive.

38
TIP THREE

• Check media sources of information.
• Web sites of merging parties
• News stories
• Google
• Presentations to securities analysts

39
TIP FOUR

• Check institutional knowledge
• Experienced staff on earlier matters
• Prior written assessments of industry

40
TIP FIVE

• Check other government agencies.
• Sectoral regulators
• Other government experts
• Securities filings

41
TIP SIX

• Prioritize and focus.
• Are there competitive product and geographic
  overlaps?
• Does the available information suggest any
  compelling way the transaction poses a potential
  competitive problem?
• Is there any information that rules out a
  potential for a competitive problem, such as a
  large number of significant competitors or low
  barriers to entry?
• Are there leads for further investigation?

42
TIP SEVEN

• Contact the parties.
• Learn parties view on antitrust issues.
• What is the rationale for the transactions?
• Do they expect to generate any efficiencies?
• Have the parties business people educate you.
• Talk to the marketing people or the person that
  can tell you how prices are set or negotiated
• Ask the parties to back it up. Obtain key
  ordinary course of business document such as
• strategic and business plans
• market shares/studies
• board presentations on deal, particularly those
  describing any synergies from the transaction
• pricing plans

43
TIP EIGHT

• Interview customers, suppliers and competitors.
• Verify any facts supporting clearance or approval
  or confirm any concerns.
• Start early -- arranging interviews is
  time-consuming.
• Learn from competitors
• Product overlapshow firms compete on price,
  service or innovation.
• Entry conditionsmarket shares, market structure,
  and history
• Learn from customers
• The number and strength of competitors?
• What substitutes are available?
• Do they have any concerns?
• Are there anecdotes of past competition between
  the merging parties.

44
TIP NINE

• Develop an investigation plan
• Focus!
• Prioritize!
• Continually reevaluate! Shift the focus of the
  investigation according to the facts learned!

45
TIP TEN

• Test any competitive concerns by disclosing them
  to the parties.
• The disclosure will help you to learn the
  evidence and arguments that you will need to
  overcome in any challenge.

46
International Competition Network

• ICN has adopted two documents addressing the
  procedural aspects of merger notification and
  review
• Guiding Principles for Merger Notification and
  Review
• http//www.internationalcompetitionnetwork.org/upl
  oads/library/doc591.pdf
• Recommended Practices for Merger Notification
  Procedures
• http//www.internationalcompetitionnetwork.org/upl
  oads/library/doc588.pdf
• Non-binding aspirational statements intended as
  guidance for all members
• Incorporate best practices across ICN member
  agencies
• Agencies should seek to coordinate their review
  of mergers that may raise competitive issues of
  common concern