FEDERAL TRADE COMMISSION HEARINGS ON
POLICY IN RELATION TO THE CHANGING NATURE OF COMPETITION
COMMENTS OF THE U.S. CHAMBER OF COMMERCE
The U.S. Chamber of Commerce ("Chamber") has long supported antitrust and trade regulation laws that have as their objective the promotion of a dynamic competitive business climate. The Chamber believes, however, that as the modern marketplace becomes more complex, and as it becomes increasingly global in its scope, there is a danger that the traditional application of these existing laws may thwart this objective. The Chamber is encouraged by the increasing sophistication with which the Antitrust Division of the U.S. Department of Justice ("DOJ") and the Federal Trade Commission ("FTC") have applied economic analysis to antitrust enforcement, and supports continued application of these principles to the realities of the modern market place.
There are some specific areas of concern which we would like to share with you.
Innovations Market Analysis
The DOJ and the FTC recently raised a new area of antitrust inquiry that exceeds the traditional price-effects oriented analysis of mergers and acquisitions when they adopted the concept of an "innovations" market, as set forth in the 1995 Antitrust Guidelines for the Licensing of Intellectual Property ("1995 Intellectual Property Guidelines").(1)
Innovations market theory establishes a formalized analytical model in which the effects of a merger, acquisition, or licensing on research and development ("R&D") and the downstream effects on future innovation of products and technologies can be expressed in traditional terms of market power.(2) The innovations market theory is based on a principal premise that innovation, as one of the primary engines of economic growth, can be constrained by a reduction in R&D by a firm with market power in an innovations market, and that firms with market power in an innovations market will reduce R&D and new product innovation when it is in their economic self interest to do so.
The Chamber believes that with the exception of a few factually unique situations, the competitive effects of mergers, acquisitions, and licensing can be effectively analyzed utilizing traditional competitive effects theory. Furthermore, the Chamber believes that it is inappropriate for the DOJ and the FTC to include the innovations market theory in merger, acquisition, and licensing analysis in that innovations market theory: (1) is based on speculative predictions of the future; (2) is counter to well established antitrust case law that states that antitrust laws apply only to products and markets currently in existence; and (3) will increase the burden of compliance with the DOJ's and FTC's review of proposed mergers and acquisitions without expanding those agencies' understanding of the competitive effects of mergers and acquisitions.
An examination of the empirical record demonstrates the oversimplification of the premise that an increase or decrease in R&D begets a corresponding increase or decrease in innovation. In fact, research to date has failed to show a significant statistical positive (or negative) correlation between aggregate R&D and innovation.(3) Innovation may be the end result of a sudden serendipitous breakthrough in R&D as well as the result of a carefully crafted program of incremental R&D. The amount of R&D conducted by a firm is only one input into that firm's successful innovation efforts along with other factors, such as efficiently directed R&D and conversion of new products into marketable products. Furthermore, R&D reductions may in fact be the result of the curtailment of redundant R&D efforts, or a more efficient allocation of R&D resources, and as such, be justified (and even desired) as welfare enhancing.
There also is no theoretical or empirical proof that the capacity to innovate can be monopolized through mergers or licensing. Most R&D inputs consist of human capital -- engineers, entrepreneurs, and research scientists -- or physical capital, such as research facilities that are relatively easy to acquire. Moreover, mergers and licensing can increase innovation and reduce prices by increasing the rate of diffusion of new products and methods of production. Mergers and licensing can increase the speed of innovation as participating firms realize greater financial returns from innovation as a result of combining complementary R&D assets, lowering per unit R&D costs, lowering the risk associated with R&D expenditures, and implementing efficiency improvements at a faster pace than could have been done independently.(4) As the entities increase their innovation efforts, their competitors must do so as well to remain competitive. The result is an increase -- rather than a decrease -- in the rate of innovation.
Innovations market theory, by definition, is concerned with products not yet produced, and markets that do not yet exist. Such focus runs counter to well established antitrust case law that states that a minimum prerequisite to any antitrust inquiry is the existence of viable markets. The starting point for any analysis of a merger or transaction has long been to identify the relevant market that will be affected by the transaction. Relevant markets do not exist where there are no buyer-seller transactions.(5) Research and development efforts, especially R&D that is "consumed" internally by a firm, generally have no such buyer-seller transactions. Furthermore, there is a substantial body of antitrust case law that states that markets cannot be found to exist unless there is current competition in those markets.(6)
The Chamber does not believe a new method of merger and licensing analysis centered on innovations market theory will further the DOJ's and FTC's understanding of the competitive effects of such transactions, even in "high-tech" or other industries in which R&D is such a large component of a firm's growth. The current analytical approaches relied on to date by the DOJ and the FTC are sufficient in the majority of transactions that include R&D and innovation.
The vast majority of merger and acquisition investigations in which the DOJ or FTC alleged potential harmful effects in an innovations market would have resulted in the same outcome (i.e., a decision to challenge as originally contemplated) if the agencies had relied on traditional theories alone (i.e., focusing on actual and/or potential competition). In the GM/ZF Friedrichshafen case, for example, the DOJ alleged a threat to innovation in the design and improvement of automatic transmissions for heavy-duty trucks and buses.(7) The DOJ also alleged the merger posed sufficient harm due to high entry barriers, high product market shares (approximately 78% combined market share in bus transmissions and nearly 100% combined share of heavy refuse truck transmissions), and inadequate substitutes, for transmissions in which there was a current horizontal overlap. Clearly, the DOJ could have challenged the merger on these market shares alone.
Those mergers in which there is no current competition in the relevant product market, but in which potential foreseeable competition does exist, can be effectively analyzed using the concept of potential competition. The acquisition by Boston Scientific of Cardiovascular Imaging Systems ("CVIS") and SCHIMED case demonstrates this.(8) The FTC alleged that Boston Scientific's acquisitions of the companies would lessen competition in the research and development of intravascular ultrasound ("IVUS") catheters, and allowed the transaction on the condition that Boston Scientific enter into a consent decree under which Boston Scientific would license any of Boston Scientific's, CVIS's, or SCHIMED's IVUS patent portfolios and the non-patented technology of either CVIS or SCIMED. The FTC could have reached the same outcome, however, by alleging that SCIMED was the only potential entrant into a highly concentrated market. Boston Scientific and CVIS had a combined market share of 90% for existing IVUS products. While SCIMED did not produce IVUS products at the time of its proposed acquisition by Boston Scientific, the company had developed an IVUS prototype which was approximately 2-3 years from receiving FDA approval.
The Chamber is concerned that the use of the innovations market approach will result in burdensome investigations and inconsistent decisions. Unlike traditional product market analysis that involves the potential effects of a merger on the production of current goods and services, or even on technology, i.e., the effect of a merger on the goods produced downstream of the technology market, an innovations market analysis cannot measure market shares or price effects of a merger -- the traditional forms of measuring the degree of competitive harm resulting from a merger or acquisition.
As such, innovations market analysis represents a significant departure from the historical concern the DOJ and the FTC have had regarding the effect of transactions on goods and technology markets on prices. The lack of empirical and theoretical basis for innovations market analysis may result in DOJ and FTC investigators undertaking reviews of mergers and acquisitions on an ad hoc basis with a greater likelihood that undue enforcement actions will result. The Chamber is concerned that such a change will result in a more subjective and specious examination than is found in traditional price-effects merger and acquisition analysis.
The Chamber recognizes that the innovations market theory genie will not likely be put back in the bottle; however the Chamber believes that the DOJ and the FTC should make it explicit that the application of an innovations market analysis in the merger context is to be utilized sparingly and in unique factual circumstances. At a minimum, the DOJ and the FTC should provide a clear description of what innovations market analysis involves. We hope that this will lead to the development of policy pronouncements regarding when actual and potential market analysis are insufficient, requiring innovations market analysis.
The efficiency defense is one asserted to justify a merger, a joint venture or other form of contractual arrangement between competitors or between parties within the vertical chain of supply, production and distribution, that may otherwise be challenged because the joint conduct creates or enhances market power.
The FTC and the DOJ, have, in their separate and joint Guidelines, recognized that they should consider "efficiencies" in making enforcement decisions. Thus, the jointly issued 1993 Antitrust Enforcement Policy Statements in the Health Care Field recognize the role of efficiencies in evaluating mergers,(9) joint ventures,(10) and joint purchasing arrangements.(11) The 1995 Intellectual Property Guidelines recognize that efficiencies are also relevant in analyzing intellectual property licensing restraints.(12)
The most sweeping statement as to how the federal enforcement agencies will consider "efficiencies" is that set forth in the 1992 Merger Guidelines (and the DOJ's and FTC's separately issued 1984 Merger Guidelines(13) to the extent that they still govern non-horizontal mergers) (collectively the "Merger Guidelines").(14) In those Merger Guidelines, the agencies recognize that some mergers "may be reasonably necessary to achieve significant net efficiencies."(15) The Chamber generally endorses this approach, however, the conditions pursuant to which the government enforcement agencies will consider efficiencies are overly restrictive.
The Merger Guidelines distinguish between "cognizable" and "claimed" efficiencies. "Cognizable efficiencies" which the agencies seem more readily willing to consider, include "achieving economies of scale, better integration of production facilities, plant specialization, lower transportation costs, and similar efficiencies relating to specific manufacturing, servicing, or distribution operations of the merger firms." "Claimed efficiencies" which the agencies "may consider" but which in their view "may be difficult to demonstrate" include "reductions in general selling, administrative, and overhead expenses, or ... otherwise do not relate to manufacturing, servicing, or distribution operations of the merging firms."
The Chamber is of the opinion that "claimed efficiencies," which includes the less tangible but equally important long-term synergistic benefits of mergers that may be hard to describe and quantify but which may ultimately permit innovative and cost-reduction solutions both in new and existing markets, should not be accorded any less consideration than "cognizable efficiencies" by the enforcement agencies in their analysis.(16)
The Chamber also questions the requirement in the Merger Guidelines (and all of the other Guidelines), that the net efficiencies be "significant" before they are deemed to outweigh the competitive risks. The requirements that there not only be "net" efficiencies but that they be "significant" is hard to understand. If the "net" result of a transaction is efficiency enhancing, then prudent public policy dictates that such a transaction not be blocked by government action. The result of the "netting" arrangement under the currently articulated standard appears to consistently result in a rejection of the efficiencies defense.(17)
Finally, the Chamber believes that, as the Health Care Guidelines demonstrate, the government agencies should make explicit that their approach to efficiencies in the merger context is applicable to non-merger situations as well, such as joint ventures and other cooperative arrangements between competitors and others.(18) In this era of increasingly global technological interdependence, it is essential for United States firms' continuing competitiveness in the world marketplace to be able to form all types of alliances with a view to achieving or maintaining their long-term competitive edge.
The U.S. Chamber appreciates the opportunity to present our views on these issues to the Commission. As with the testimony presented by the Chamber during hearings on small business issues related to antitrust law in the global economy, we remain willing to answer any questions you may have regarding these comments. Similarly, the Chamber may wish to supplement these comments with additional comments at a future date.
In the meantime, should you have any questions, please do not hesitate to contact David W. Kemps in the Domestic Policy Division at (202) 463-5513.
Jeffrey H. Joseph
(1) U.S. Department of Justice and Federal Trade Commission Antitrust Guidelines for the Licensing of Intellectual Property (1995), reprinted in 4 Trade Reg. Rep. (CCH) ¶13,132 [hereinafter "1995 Intellectual Property Guidelines"]. Innovation markets are defined by the 1995 Intellectual Property Guidelines, as "the research and development directed to particular new or improved goods or services, and the close substitutes for that research and development" as well as the capacity to engage in R&D. (1995 Intellectual Property Guidelines § 3.2.3).
(2)The "traditional" definition of market power analysis is found in the U.S. Department of Justice and Federal Trade Commission Horizontal Merger Guidelines (1992), reprinted in 4 Trade Reg. Rep. (CCH) ¶13,104 (April 2, 1992) [hereinafter "1992 Merger Guidelines"] where market power is defined as the ability to effectuate a small but significant nontransitory price increase. (Section 0.1 ). By analogy, market power in innovations market theory is viewed as the ability of a firm to effectuate a small but significant nontransitory decrease in research and development. See Richard J. Gilbert & Steven C. Sunshine, Incorporating Dynamic Efficiency Concerns in Merger Analysis: the Use of Innovation Markets, 63 Antitrust L.J. 569 (1995).
(6) See Brown Shoe v. United States 370 U.S. 294, 326 (1962)("The boundaries of the relevant market must be drawn [to] recognize competition where, in fact, competition exists."); see also SCM Corp. v. Xerox Corp., 645 F.2d 1195 (2nd Cir. 19 ), cert. denied 455 U.S. 1016 (1982)(a violation of § 7 of the Clayton Act as a result of Xerox's acquisition of plain paper copier related patents could not have occurred when the commercial market for plain paper copiers was years away at the time the patents were acquired); Crucible, Inc. v. Stora Kopparberrgs Bergslags AB, 701 F.Supp. 1157, 1162-63 (W.D. Pa 1988) (absence of a market in an identified product at the time an alleged Clayton Act § 7 violation takes place precludes the applicability of § 7).
(8) Boston Scientific Corp., File 951-0002, proposed consent order (Feb. 24, 1995), 5 Trade Reg., Rep. (CCH) ¶23,774, 60 Fed. Reg. ¶12,948 (Mar. 9, 1995), order entered (Apr. 28, 1995), 60 Fed. Reg. ¶32,323 (June 21, 1995).
(9) 4 Trade Reg. Rep. (CCH) ¶13,151 at 20,758 (1993) (hospital mergers often will not result in substantial lessening of competition when "the merger would allow the hospitals to realize significant cost savings that could not otherwise be realized").
(10) Id. ("Most hospital joint ventures to purchase, operate, and market the services of high technology or other expensive medical equipment ... create procompetitive efficiencies that benefit consumers. These efficiencies include the provision of services at lower cost or the provision of service that would not have been provided absent the joint venture." Similarly physician network joint ventures will not be challenged under a rule of reason analysis "either if the physicians in the joint venture share substantial financial risk or if the combining of the physicians into a joint venture enables them to offer a new product producing substantial efficiencies").
(11) Id. (joint purchasing arrangements "typically allow the participants to achieve efficiencies that will benefit consumers ... [t]hrough such joint purchasing arrangements, the participants frequently can obtain volume discounts, reduce transaction costs, and have access to consulting advice that may not be available to each participant on its own").
(12) The Guidelines state that the Department will consider efficiencies arguments noting the "qualitative nature" of this analysis -- that "[a]s the expected anticompetitive effects in a particular licensing arrangement increase, the Agencies will require evidence establishing a greater level of expected efficiencies. (Section 4.2). The Agencies will consider the existence of practical and significantly less restrictive alternatives, the duration of the restraint, and the market context. Id.
(14) The 1992 Merger Guidelines expressly do not supersede the 1984 Merger Guidelines for non-horizontal mergers. (n. 4). The 1984 Merger Guidelines says the following about vertical efficiencies: "As in the case of horizontal mergers, the Department will consider expected efficiencies in determining whether to challenge a vertical merger. See Section 3.5. An extensive pattern of vertical integration may constitute evidence that substantial economies are afforded by vertical integration. Therefore, the Department will give relatively more weight to expected efficiencies in determining whether to challenge a vertical merger than in determining whether to challenge a horizontal merger." (Section 4.24). The other form of non-horizontal merger covered by the 1984 Merger Guidelines is "potential entrant (actual and potential) mergers" -- the DOJ's Guidelines indicate that the Department will apply the same analysis as it applied to horizontal mergers. (Section 4.135).
(15) "Net efficiencies" are defined as efficiencies net of the transaction costs associated with the acquisition. In order to be considered, any efficiencies must be greater than the likely anticompetitive effects, must be passed on to consumers, must be achieved only through the merger, rather than, e.g. through joint ventures, subcontracting or a merger with another party raising less anticompetitive risk. In addition, the more significant the competitive risk that is associated with a merger, the greater the expected efficiencies must be.
(16) See, e.g., In the Matter of Eli Lilly & Co., Dkt No. C-3594, [Current] (CCH) Trade Reg. Rep. ¶23,873), 1994 FTC LEXIS 225 (July 28, 1995) (consideration of innovative new distribution arrangement).
(17) See, e.g., In the Matter of Coca Cola Bottling Co. of the Southwest, Dkt. No. 9215, 1994 FTC LEXIS 185 (August 31, 1994); In the Matter of Dominican Santa Cruz Hospital, Dkt No. C-3521, 1994 FTC LEXIS 156 (August 18, 1994); In the Matter of Columbia Healthcare Corp., Dkt. No. C-3505, 1994 FTC LEXIS 113 (July 5, 1994); In the Matter of Healthtrust, Inc. - The Hospital Co., File No. 941-0020, 1994 FTC LEXIS (July 14, 1994). See also, First Data Corp., [Current] Trade Reg. Rep. ¶23,899 (1995).
(18) Horizontal and vertical cooperative arrangements that are efficiency enhancing have been subject to a rule of reason analysis and upheld where those efficiencies outweigh the potential anticompetitive effects. Broadcast Music Inc. v. CBS, 441 U.S. 1 (1979); Northwest Wholesale Stationers, Inc. v. Pacific Stationary & Printing Co., 472 U.S. 284 (1985).