MERGERS: A VIEW FROM THE FEDERAL TRADE COMMISSION
Mary L. Azcuenaga
Federal Trade Commission
Practicing Law Institute
25th Annual Advanced Antitrust Seminar
Coral Gables, Florida
March 15, 1995
[The views expressed are those of the Commissioner and do not necessarily reflect those of the Federal Trade Commission or any other commissioner.]
Good afternoon. I am pleased to be here today at the Practising Law Institute's 25th Annual Advanced Antitrust Seminar. The topic for the afternoon is mergers, and I will talk about merger law enforcement from my perspective as a commissioner at the Federal Trade Commission. As is customary, my remarks reflect my own views and not necessarily those of the Commission or any other commissioner.
Merger enforcement under Section 7 of the Clayton Act remains among the Commission's top antitrust enforcement priorities, as it has been for some years. According to statistics maintained by the Commission, in each year since 1988, one-half or more of all competition cases in which the Commission has taken enforcement action have involved mergers. You may be relieved to know that I will not attempt to talk about all of them. Instead, I plan today to begin with some statistics to provide an overview of the Commission's merger enforcement program. Then, because this is an advanced group of practitioners, I will highlight a few recent cases that illustrate some cutting edge issues and indicate possible new trends in enforcement.
I will begin with some current statistics on the Commission's merger enforcement program. The first set of statistics has to do with the number of transactions reported to the government. The Hart-Scott-Rodino Act requires firms that are contemplating mergers and that meet statutory thresholds to provide information to the FTC and the Department of Justice and to observe waiting periods before consummation. Most but not all of our merger cases begin with HSR filings, and the number of reported transactions provides some indication of the work load.
In fiscal year 1994, which ended September 30, 1994, 2,305 transactions were reported under the Hart-Scott-Rodino Act.(1) The number of transactions reported in 1994 is roughly halfway between 1993, when 1,846 transactions were filed, and 1989, which was the high point in the last fifteen years, when 2,883 transactions were reported. A recent article in Fortune magazine, entitled "The New Merger Boom," reported that "[d]uring the quarter ended September , the value of announced mergers and acquisitions climbed to a record $111 billion,
easily outstripping the old mark set in the fourth quarter of 1988 . . . ."(2) The number of publicly announced mergers, as reported in Fortune, and the number of transactions reported under the Hart-Scott-Rodino Act are different, of course, but both sets of statistics show a substantial increase in the number of transactions. The pace appears to be continuing: In the first five months of fiscal year 1995, through the end of February, 1,148 transactions were reported. If this rate continues, the number of transactions this year will come close to the record set in 1989.
The next set of statistics has to do with the number of mergers investigated. All of the transactions that are reported are examined to see whether enforcement interest is warranted. The great majority of transactions present no competitive issues. Of the transactions that initially appear to present competitive problems, many investigations are completed within the initial 30-day waiting period. The litigation staff focus quickly on determinative issues, obtain key documents from the parties, conduct interviews with industry participants and obtain sufficient information to show that further investigation is unwarranted. Through this focused investment of resources in the short run, the Commission is able to reduce the number of second requests it issues, thereby saving both public and private resources in the long run.
The Commission initiates full investigations of a fraction of the mergers that are reported every year. Of the 2,305 transactions reported under the Hart-Scott-Rodino Act in fiscal 1994, the Commission issued requests for additional information in 46, which is less than 2% of the total number of transactions reported. A request for additional information, familiarly known as a second request, is the first step in a formal merger investigation under the Hart-Scott-Rodino Act and signals concern about possible anticompetitive effects. In fiscal year 1995, through the end of February, the Commission issued 28 second requests, which is slightly more than 2% of the 1,148 transactions filed.
The HSR Act allows us to issue only one set of second requests, and the information provided in response often is critical to the decision whether or not to take enforcement action. As a result, second requests tend to be inclusive rather than limited. The parties to a transaction always are invited to suggest ways in which their second request might be modified, and in some cases, a "quick look" procedure, focusing on one or two dispositive issues, may be appropriate. We have in the nineteen years since the HSR Act was enacted continually worked to refine our second requests, and we always are interested in further refinements, consistent with the Commission's need for information.
The third set of statistics shows the number of enforcement actions taken. The Commission takes enforcement action in a very small percentage of reported transactions.(3) Since 1980, the number of preliminary injunction cases authorized by the Commission has exceeded seven in only one year: that was 1988, when the Commission authorized eleven preliminary injunction suits.(4)
In fiscal 1994, the Commission authorized the staff to seek preliminary injunctive relief in federal district court to block three transactions. A hospital merger in Pueblo, Colorado, was abandoned before suit was filed,(5) and a negotiated settlement was reached in a case involving three hospitals in Utah.(6) In the third case, involving hospitals in Florida, the courts have concluded that the state action doctrine protects the transaction from application of the Clayton Act.(7) The case is pending in the Court of Appeals for the Eleventh Circuit on the Commission's petition for rehearing en banc.
This fiscal year (which began October 1, 1994), the Commission has authorized four preliminary injunction actions in federal district court to challenge proposed mergers. The challenge to the proposed acquisition of American Tobacco by B.A.T. Industries was settled by a consent agreement that would require divestiture.(8) A challenge to two acquisitions by Boston Scientific was resolved late last month by a proposed consent agreement that would require licensing of patents and technology.(9) The Commission also authorized preliminary injunction suits to block hospital acquisitions in Port Huron, Michigan, a city near Detroit,(10) and in Joplin, Missouri.(11)
Let me pause in this recitation of current statistics and provide a somewhat longer view of the Commission's track record in its preliminary injunction cases. In the last six years, since the beginning of fiscal 1989, the Commission has voted to seek a preliminary injunction to block 32 transactions. Of these 32, only nine went to trial. Of the nine, the Commission obtained a preliminary injunction in six cases,(12) lost one case,(13) and two cases still are pending.(14) In the remaining 23 cases, the parties either entered into a negotiated settlement or withdrew from the transaction before a court decision on the complaint. This is a strong record that I believe speaks well for our case selection criteria and, of course, the considerable abilities of the Commission's litigating staff.
In fiscal 1994, the Commission took action in four Section 7 cases that had been in administrative adjudication. It dismissed the administrative complaint challenging a hospital merger in California,(15) issued its decision and order in two cases, The Coca-Cola Co.(16) and Coca Cola Bottling Company of the Southwest,(17) and accepted negotiated settlements in two cases, Textron(18) and Columbia Healthcare Corporation.(19) The Commission also issued twelve final consent orders and accepted six consent orders for public comment. The cases involved such diverse markets as coating resins used in paint and other coatings;(20) industrial fuses;(21) satellites and expendable launch vehicles ("ELVs") for intermediate weight satellites;(22) aluminum polyester powder for jet engine housings;(23) computer-controlled carousel storage and retrieval systems for warehouses;(24) polymethyl methacrylate (PMMA), which is sold as acrylic plastic pellets and sheet;(25) hospitals(26) and outpatient surgical centers;(27) pharmaceuticals, including dicyclomine for irritable bowel syndrome(28) and drugs used for drug abuse testing;(29) shoe polish;(30) retail pharmacies;(31) professional illustration computer software;(32) and onion sets.(33) Two orders accepted for public comment, Tele-Communications, Inc.,(34) and First Data Corporation,(35) subsequently were withdrawn when the proposed transactions were abandoned. Both of these cases involved bidding wars: TCI's affiliate was bidding for Paramount; First Data was bidding in bankruptcy court for the consumer wire transfer business of Western Union. In both cases, when a third party prevailed in the bidding war, there was no need for the order.
So far in fiscal 1995, the Commission has issued final consent orders in six merger cases and placed an additional twenty-two negotiated orders on the public record for comment. I mentioned the settlements in B.A.T. Industries and Boston Scientific a few minutes ago, in giving fiscal 1995 statistics on federal district court cases. The Commission also settled an administrative complaint in the Red Apple case, involving supermarkets in specific neighborhoods in New York City.(36) The orders accepted for public comment in fiscal 1995 involve the defense industry, including ammunition and propellant for large caliber ammunition(37) and military aircraft, military satellites and satellite launch vehicles;(38) health care, including psychiatric hospitals(39), rehabilitation hospitals(40) and orthopaedic implants;(41) pharmaceuticals, including generic verapamil used for chronic cardiac conditions,(42) diphtheria and tetanus vaccines,(43) and prescription benefit management programs;(44) turbomolecular pumps used in making semiconductors and compact disc metallizers used in making compact discs;(45) polypropylene;(46) electronic security labels for retail goods;(47) funeral homes;(48) retail groceries;(49) cable television;(50) and consumer products, including canned cat food,(51) canned fruit,(52) and rug shampoo.(53)
I have given you a great number of statistics, because I think they are useful in demonstrating the Commission's commitment to merger enforcement and in showing that it has a strong enforcement program. Let me turn from statistics to some issues of merger analysis and some specific cases. Section 7 of the Clayton Act prohibits acquisitions that may "substantially lessen competition" or "tend to create a monopoly" "in any line of commerce in any section of the country."(54) Defining the markets in which to assess the likely competitive effects of a transaction is the first and often a determinative step in analyzing a merger. In a litigated case, if the government or private plaintiff fails to prove the relevant market, the complaint is dismissed and the case is over.(55) For example, the failure of counsel supporting the complaint to prove a relevant geographic market was the basis for the dismissal last spring of the California hospital merger case.(56)
An interesting recent development in defining markets is the allegation in a number of complaints of a research and development market, separate and distinct from other product markets. In the American Home Products case, for example, the Commission alleged a market in research and development of rotavirus vaccine.(57) Rotavirus is a diarrheal disease that affects children, for which there is no commercially available vaccine. Only three firms, including the two merging firms, allegedly had rotavirus vaccine research projects in or near clinical development; none of the three had obtained regulatory approvals to market a vaccine. The complaint alleged that the rotavirus research and development market was highly concentrated and that entry was difficult because of the time required to bring a product to clinical development and to obtain regulatory approvals for marketing.
An R&D market also was alleged in the Sensormatic Electronics case, settled by consent agreement earlier this year.(58) Sensormatic proposed to acquire patents and other intellectual property relating to electronic article surveillance ("EAS") systems that are used to protect against shoplifting. EAS labels attached to merchandise by retailers trigger an alarm at the store exit, unless neutralized by the clerk at the point of sale. The research and development market in the Sensormatic case involved competition to develop source labels that would be embedded in goods or packaging by manufacturers, i.e., at the source of the goods rather than at the point of sale to consumers. The complaint alleged a market in "research and development of disposable labels developed or used for source labelling" and of the processes for manufacturing them.
Challenging a transaction on the basis of the elimination of competition in research and development is relatively new and, to my knowledge, never litigated. From a policy perspective, identifying R&D markets may improve our analysis in some cases. Let us compare the new approach with the traditional approach as applied in the PPG Industries case in 1986, in which the Commission successfully challenged the acquisition by PPG of Swedlow.(59) The Commission in the PPG case alleged a market defined as "aircraft transparencies requiring, for want of a better term, high technology to produce, without regard to the materials of which they are fabricated."(60) Although the parties made their transparencies of different materials (glass and plastic), the court found that PPG and Swedlow competed when they bid on new aircraft designs and also "at the stage of research and development as transparency manufacturers try to influence airframe customers about types of transparencies for future generations of aircraft."(61) The relevant market apparently included competition in aircraft transparencies then on the market as well as products in some stages of research and development. The analysis might have been more clear had the Commission alleged separate product markets of existing aircraft transparencies, next generation transparencies and research and development in aircraft transparencies, but I don't think that the result would have been any different.
The result might have been different in Textron,(62) a case in which the Commission accepted a consent settlement earlier this year. We have the advantage of a well developed record in Textron, because of the unusual posture of the case: The Commission did not elect to settle the matter until after the case had been fully litigated before an administrative law judge, the appeal to the Commission had been fully briefed, oral argument had been heard, and only the Commission's opinion and order remained to be issued.
The complaint challenged Textron's acquisition of Avdel, a British firm. Textron and Avdel were two of only four firms that supplied specialized blind rivets for use in aircraft and in commercial vehicles. A blind rivet is a specialized fastener that joins two or more sheets of material with access to only one side of the join. The complaint alleged that Textron and Avdel competed in the "design, manufacture and sale" of aerospace blind rivets and non-aerospace blind rivets. Aerospace blind rivets are used in aircraft; non-aerospace blind rivets are used in heavy duty land transportation vehicles. It is the aerospace blind rivet market that I want to talk about today.
The competition between Textron and Avdel in the aerospace blind rivet market, as reflected in their sales in the United States, was limited. Avdel's aerospace rivets did not obtain the necessary U.S. industry specification until 1987. Industry specifications document the performance characteristics of a product, and obtaining industry specification is a critical first step to overcoming reputational barriers with aircraft designers. At the time of the acquisition in early 1989, Avdel was beginning to establish a presence in the United States, where Textron was the dominant firm, with approximately 64% of sales. Textron had a smaller but still dominant share in the world. Under the Guidelines, the acquisition raised concerns even if Avdel's presence was measured solely on the basis of current sales, but the significant competition between the firms occurred at two "design" stages of the industry.
One stage of competition for aerospace blind rivets occurs when the aircraft is being designed. Aircraft designers specify the blind rivets to be used in a particular aircraft, and blind rivet makers compete to have their rivets, with their particular performance characteristics, such as shear strength, fatigue resistance and spindle retention, specified in the design. Once a particular blind rivet is designed into an aircraft, the possibility for substitution to other blind rivets, with different design and performance characteristics, is limited. Competition for sales of blind rivets at the procurement stage (when an aircraft manufacturer is buying the parts that have been specified for the aircraft) is similarly limited.
Textron and Avdel were two of only three firms that had developed aerospace blind rivet designs and competed in aircraft design competitions. Beginning in the late 1980's, Avdel was second only to Textron in winning design specification awards in the United States and in the world. This success was not reflected in Avdel's sales, because of the significant time lapse, often years, between winning a design award and actually making sales through the procurement process for construction of an aircraft.
A second important aspect of competition was research and development of aerospace blind rivets. Textron and Avdel were two of only three firms engaged in research and development of aerospace blind rivets. Aerospace blind rivet expertise appeared to be important for success in the commercial blind rivet industry as well. The record showed that despite a number of attempts at entry, no firm that lacked aerospace blind rivet expertise had succeeded in the commercial blind rivet market.
The consent order that the Commission accepted to settle the case provided licensing relief in the commercial blind rivet market but no relief in the aerospace blind rivet market. Focusing on competition at the procurement level, which showed Avdel with a mere .5% of sales in the United States, may have tended to obscure the more important competition between the firms in product research and development and aircraft design competitions. In both these areas, which relate to innovation, the record was clear that Avdel and Textron were the two leading firms, with only one other competitor, and that competition between Avdel and Textron should be preserved.
Competition in product research and development is important to constrain prices at the procurement level. An innovative firm need not win the design contest to affect competition. The presence of the innovator in the market will constrain the design winner from exploiting its advantage, by, for example, raising its prices during the procurement process or slowing the pace of its own R&D efforts. The courts have recognized that the possibility of competing offers keeps "existing relationships from becoming exploitative"(63) and that "[u]nsuccessful bidders are no less competitors than the successful one."(64) Like PPG, the product design markets alleged in the Textron case were precursors of the innovation markets that the Commission has alleged in recent cases.(65)
Let me give you just one more example of a case in which a research and development market was alleged, the Boston Scientific case.(66) Boston Scientific and Cardiovascular Imaging Systems ("CVIS") were the two leading firms in research and development, manufacture and sale of intravascular ultrasound ("IVUS") imaging systems, a promising new technology used in the diagnosis and treatment of cardiovascular disease. IVUS imaging systems enable cardiologists to obtain three dimensional, ultrasound pictures of the inside of the patient's veins,(67) by guiding an IVUS catheter, equipped with an ultrasound device, in the obstructed vein. IVUS imaging shows what is blocking a vein and how large it is, for example, from inside the vein.(68) Both Boston Scientific and CVIS had developed and patented products and together accounted for 90% of sales in the domestic IVUS catheter market.
The second acquisition challenged in the Boston Scientific case involved SciMed. SciMed had engaged in substantial research and development of IVUS catheters. After several years of effort, SciMed had developed a sophisticated imaging guidewire, had marketed and tested prototypes, and allegedly was within two or three years of introducing its product. The complaint alleged the acquisitions of CVIS and SciMed by Boston Scientific would eliminate SciMed as a potential entrant in the domestic intravascular ultrasound catheter market and also eliminate competition among Boston Scientific, CVIS and SciMed in the research and development of IVUS catheters.
A legal question that may arise in cases alleging research and development markets is whether the protection of Section 7 of the Clayton Act extends to this kind of competition. Some might say that there can be no line of commerce if the product is not yet on the market.(69) Even though Section 7 is prospective in nature, a plain reading of the language of the statute arguably suggests that it applies only to commerce in existence at the time of the subject acquisition. Analysis of future effects, of course, is fundamental to Section 7, but we usually mean future effects on existing markets. We have a theory of liability based on potential competition but, traditionally, potential competition theory applies to existing lines of commerce in which some firms are actually selling a product. In an R&D market, no one is selling a product yet. There is no question as a policy matter about the significance of this kind of competition, but the question of when a line of commerce comes into existence for Section 7 purposes may need to be decided someday.
Consider a case like American Home Products, in which three firms are pursuing parallel projects to develop a vaccine for a particular disease. Those three firms are competing in an important way to get to market first with the best product. Surely the Commission could not ignore the reduction in competition that would result if one of the three firms acquired another. Section 7 is an incipiency statute and, at this point, I am satisfied that it applies to markets for research and development to produce products that we can identify with some degree of particularity.(70) If the Commission's use of Section 7 should ever be challenged and found wanting for research and development markets, then the Commission could challenge these same transactions under the penumbra of Section 5 of the FTC Act.(71) Indeed, one of the most promising uses I have seen of the Commission's authority under the penumbra of Section 5 was in the Vons case, which involved a course of conduct, including an acquisition, that posed a severe threat to competition but in which a serious question could have been raised, had the case been litigated, regarding the applicability of Section 7.(72)
The explicit recognition of research and development markets may improve our analysis in cases in which innovation is a prominent feature by enabling us to concentrate on the actual competitive problem. It may make our analysis more realistic and, thereby, make us less likely to err either in terms of under-enforcement or over-enforcement. Despite my enthusiasm for the promise of improving our analysis by alleging R&D markets, I think that we have yet to answer all the questions about such markets. So far, all of our R&D cases involve settlements, and it remains unknown how the allegations will fare in court. At this point, it is important to add the caveat that there may still be novel and potentially difficult issues in proving such a market. As we gain more experience, I hope we can identify and answer more questions about our policy in this area.
Pleading research and development markets is one way in which the enforcement agencies have refined the analysis of Section 7 cases, and we are always open to, indeed, in search of other ways to improve our analysis. Given the pace and the direction of change in some high technology industries, one question that has been raised is whether the current guidelines are adequate for defining markets in those industries. For example, does merger analysis underestimate the breadth of markets characterized by technological change, resulting in overenforcement of the merger laws and retarding innovation by imposing unwarranted costs?
New ideas in antitrust often come from scholars, so it may be interesting to talk about a recent scholarly proposal for revisions in the merger guidelines(73) to take account of rapid technological change. Professors Teece, Mitchell and Jorde and Dr. Hartman have suggested that rapid technological change and market power "are basically incompatible, except in rare instances," because of the alacrity with which new technology can upset the incumbents.(74) The authors are concerned that merger analysis focuses narrowly on price competition, ignoring other aspects of competition in markets characterized by technological change. They suggest that the analysis should consider the technological capacity of firms, the disciplinary effects of the R&D programs of competitors, even if new products are not yet for sale, and what the authors call "the magnitude of the creative destruction" that may result from technological change.(75)
I believe that the Commission does consider evidence of this sort. The technological capacity of firms is relevant to identify firms that participate in the market and that may be potential entrants.(76) We look to the "informed judgment"(77) of industry participants and experts to assess the industry and the likely sources of change. The disciplinary effects of competing R&D programs is competition that the Commission has recognized in cases such as American Home Products.
The authors also suggest that the 5% price test and the two-year threshold identified in the merger guidelines for identifying markets and assessing entry are unsuitable for high technology markets. They suggest that 25% and 10 years might yield more realistic answers. These are suggestions worth considering, although extending the time horizon raises some concerns. The agencies historically have been concerned about the ability to exercise market power in the short term, and we have had cases in high technology markets in which the evidence was clear that the acquisition would enhance the likelihood of the exercise of market power in the short term. As for the 5% price test, when a product still is in research and development, competition would tend to occur more on qualitative than on quantitative grounds, as the authors point out, and a literal application of the 5% test may not be helpful.
Although I do not see a need to revise the merger guidelines now, we may want to do so after we have had more experience. As I said a few minutes ago, in the context of individual cases, we are considering some of the same points that these scholars have identified. In the Wright Medical Technology case, for example, one difficult issue was determining whether a new, improved orthopaedic implant, then in the developmental stages, would be in the same market as existing implants.
Wright was by far the leading supplier of small joint orthopaedic implants used in human hands. The joints are the PIP, for the Proximal Interphalangeal Joint or mid-finger knuckle, the MCP, for the Metacarpophalangeal Joint, the one between the finger and the hand, and CMC for the Carpometacarpal Joint. That is near the wrist. The implants on the market restore the appearance of the hands but apparently not much strength. Orthomet, the acquired firm, had a license from the Mayo Foundation to develop new finger implants that would restore the functioning of the joint (not just appearance but strength). The Orthomet products are a long way from market and must undergo a long FDA regulatory approval process.
The antitrust analysis in the Wright case presented some unusual challenges. For example, in deciding whether the new implants would be in the same relevant market as the Wright implants, the 5% price test from the merger guidelines was difficult to apply. Although the price of the existing Wright finger joint implants was known, it was difficult to predict the price of the Mayo/Orthomet implants. The new implants might be so superior that virtually all patients would prefer them regardless of price. Or the new implants might have enough drawbacks that consumers would consider price a significant factor in selecting an implant. The analytical precision implied by the 5% test (or by the suggested 25% price test, for that matter) falters in the face of these uncertainties. Evidence relating to innovation in another orthopaedic implant market suggested that the price of technologically superior implants might be constrained by less sophisticated devices.
Merger analysis always attempts to predict the likely future effects of a proposed transaction, and it would be foolish to claim that our ability to predict is perfect. Although perfection is unachievable, the fact-intensive analysis of mergers takes into account the uncertainties of rapidly changing high technology markets. Weighing the facts is not unique to markets characterized by technological change but must be addressed in every Section 7 case. The flexibility of the antitrust laws that enables us to consider a wide variety of complex situations is a positive aspect of the law and should be seen as an opportunity to make the best case for your client without the constraints of detailed regulations that may not anticipate your needs.
Now let me turn to a case with a more familiar issue. The Commission's complaint in B.A.T. Industries proceeded on a collusion theory and alleged that the proposed acquisition of American Tobacco by B.A.T., the British parent of Brown & Williamson Tobacco, would increase the likelihood of collusion in the U.S. cigarette market. Collusion theory ("coordinated interaction" under the Merger Guidelines) is familiar in merger cases.(78) The likelihood of collusion as a result of an acquisition has been a matter of inference from conditions in the industry, such as the availability of pricing information, and the ability to police the collusive price and to discipline non-compliers. Evidence of ongoing collusion in the marketplace has never been necessary to demonstrate that an acquisition would enhance the likelihood of collusion in the future, but we surely would not ignore that evidence.
B.A.T. looked like a textbook case in what we might call an old fashioned product market. B.A.T. and American Tobacco were the third and fifth largest manufacturers of cigarettes in the U.S. in a market comprising only 6 firms. The acquisition would increase concentration, as measured by the Herfindahl-Hirschman Index, by more than 100 points in a highly concentrated market, and after the acquisition, the top three firms would control the lion's share of cigarette sales in the United States. None of these issues was in dispute.(79) The Commission also alleged that entry was difficult and unlikely, demand was inelastic, and competitive price information was readily available.
One of B.A.T.'s defenses was based on the opinion of the Supreme Court in the Brooke v. Brown & Williamson case.(80) In the Brooke case, you will recall, Liggett & Myers sued for treble damages, claiming that Brown & Williamson had engaged in predatory pricing. An essential part of Liggett's case was proving that Brown & Williamson could later recoup the losses of its predatory pricing by raising prices. Recoupment would have been possible only through tacit price coordination with the other cigarette firms and, the Court said, "the situation facing the cigarette companies in the 1980's would have made such tacit coordination unmanageable."(81) B.A.T.'s argument in the Commission's case was that the conclusion in Brooke concerning the likelihood of tacit collusion to recoup losses from predation also established that collusion was unlikely in the cigarette industry in the context of Section 7 of the Clayton Act.
The asserted defense was inadequate on the facts and the law, in my opinion. The elements of a predatory pricing case, below-cost pricing and the market power subsequently to raise prices sufficiently both to recoup losses and to reap additional profits, are very different from those of a merger case, in which the concern is the ability of industry members collectively to raise prices above competitive levels. In addition, industry conditions in the early 1980's, the relevant period of time in the Brooke case, were atypical of the cigarette industry and appeared very different from conditions ten to fifteen years later, at the time of the Commission's suit against B.A.T. Indeed, the Court observed in Brooke that "[t]he introduction of generic cigarettes in 1980 represented the first serious price competition in the cigarette market since the 1930's."(82)
The Commission's most recent preliminary injunction action is a challenge to a merger of two hospitals in Joplin, Missouri, with elements reminiscent of the Elders Grain case. In Elders Grain, the parties consummated their transaction on a Sunday, apparently hoping to preempt a Commission suit for a preliminary injunction. The Commission voted the following Monday to challenge the deal. The district court issued a preliminary injunction and required the transaction to be rescinded.(83) The Court of Appeals for the Seventh Circuit affirmed. This apparently was the first case in which rescission was ordered under Section 13(b) of the FTC Act.
In the Joplin case, the parties had not yet merged when the Commission brought suit for a preliminary injunction. The federal district court denied the Commission's request for a temporary restraining order and preliminary injunction and the Commission's application for a stay pending appeal. The Commission appealed, and the Court of Appeals for the Eighth Circuit enjoined the proposed consolidation of the hospitals and remanded the case to the district court with instructions to conduct an evidentiary hearing on the Commission's motion for a preliminary injunction. The order of the court of appeals was entered on the afternoon of March 1. The next day, March 2, the Joplin Globe reported that the hospital merger had been consummated and quoted the defendants' counsel, as follows:
The stay order -- it's too late. It preserves the status quo. The merger is done. It [the order] does not affect the merger. It is much more difficult for the court to undo a transaction than to prevent one from occurring. . . . The eggs are scrambled now and they cannot put everything back together the way it was. That's life. They lost.
On March 3, in response to the Commission's emergency motion, the Court of Appeals enjoined the defendants "from consolidation of their hospitals or assets from and after 9:00 a.m., February 28, 1995." The court also "specifically directed" the defendants "to immediately rescind any purported actions taken to merge defendant hospitals on March 1, 1995 . . . ."(84) The hospitals now have applied for a stay of the order to rescind, and this motion was argued before the Court of Appeals yesterday.
Let me turn now to vertical mergers. The 1984 vertical merger guidelines of the Department of Justice provide guidance on how the agencies analyze vertical mergers.(85) The 1984 guidelines anticipate competitive harm from vertical mergers on a horizontal level in a well defined antitrust market, on several distinct theories. The first theory is concerned with vertical integration that increases the difficulty of entry so that entrants to one market would need to enter on both levels. The second theory is that vertical integration, for example, by upstream firms into retail sales, may facilitate collusion in the upstream market by making price monitoring easier. The third theory is concerned with the evasion of rate regulation by a regulated monopolist. For example, a regulated monopolist that acquires a supplier may be able to raise the price for internal transfers and pass the price increase through to consumers.
Another theory of harm from vertical mergers that does not appear in the guidelines is market foreclosure. Some economists suggest that vertical mergers can harm non-integrated firms by foreclosing their sources of supply or their customers, ultimately reducing output and raising prices.(86) Foreclosure is not a new theory.(87) In Brown Shoe Co. v. United States,(88) for example, the Supreme Court observed that vertical integration forecloses competitors from the opportunity to compete. In the twenty years after Brown Shoe, a number of government enforcement cases focused on foreclosure theories.(89)
By 1980, vertical foreclosure merger theory was in some difficulty. Some scholars were critical of the theory,(90) and the courts were increasingly skeptical about its application. In Freuhauf Corp. v. FTC,(91) for example, the Court of Appeals for the Second Circuit declined to enforce the Commission's order based on a foreclosure theory. "Absent very high market concentration or some other factor threatening a tangible anticompetitive effect," the court said, "a vertical merger may simply realign sales patterns."(92) A few years later, in Alberta Gas,(93) the Court of Appeals for the Third Circuit was more explicit about the likelihood of efficiencies from vertical integration. A vertically integrated firm will engage in self-dealing when it is profitable, the court said; "post-merger self dealing could result in efficiencies reflected in lower prices to the ultimate consumer," and a "competitor's losses would spring from the efficient aspects of the merger."(94)
The Alberta Gas case was a private treble damages action by a competitor of one of the merging firms, to be distinguished from a Commission law enforcement action based on the public interest. Still, the case serves as a caution about the appropriate weight to be given to complaints by competitors and theories of harm based solely on possible harm to competitors of the merging firms.
I do not intend to provide a comprehensive review of the case law relating to foreclosure or of scholarly progress in the field, but I will hazard the observation that vertical foreclosure theory, which has not enjoyed the solid consensus that underlies horizontal merger theory, now is experiencing something of a renaissance. Let me give you some examples. The Commission's complaint in the TCI Communications case alleged a vertical foreclosure theory.(95) The case involved a proposed acquisition by QVC of Paramount Communications, a major movie studio. The QVC group of businesses included a major cable TV programmer, Liberty Media, and the nation's largest cable TV operator, TCI. The complaint alleged that QVC's acquisition of Paramount could reduce the quality and output of premium movie cable TV channels, that is, that competitors could be foreclosed from Paramount as a source of movies.
Foreclosure theory also is alleged in the Commission's proposed complaint challenging Eli Lilly's acquisition of PCS Health Systems, a prescription management business.(96) The complaint in the Eli Lilly case alleges, among other things, that the acquisition would foreclose from the PCS formulary the products of drug manufacturers other than Lilly. The proposed consent agreement was on the public record for 60 days and now is pending before the Commission.
The analysis of mergers is demanding, and I think the Commission consistently has met the challenge by developing and applying sophisticated modes of analysis. No doubt merger analysis will continue to evolve as we gain new insights about the workings of competition and markets. I think the Commission will continue to meet the challenge.
1. 15 U.S.C. 18a.
2. Pare, "The New Merger Boom, Fortune, Nov. 28, 1994, at 95; see also "Making a meal of mergers," The Economist, Sept. 10, 1994, at 87; "Merger Mania: 1994 Nears Record," USA Today, Dec. 27, 1994, at B4.
3. An investigation may not be resolved in the same year in which a transaction is reported, so an enforcement action does not necessarily occur in the year in which the transaction was reported.
4. Section 13(b) of the FTC Act, 15 U.S.C. 53(b), authorizes the Commission to seek preliminary injunction relief in federal court, pending completion of administrative proceedings.
5. Parkview Episcopal Medical Center, File 931-0125 (Jan. 31, 1994).
6. HealthTrust, Inc., Docket C-3538 (Oct. 20, 1994) (preliminary injunction suit announced March 22, 1994), Commissioner Yao dissenting.
7. FTC v. Lee Memorial Hospital, 1994-1 Trade Cas. (CCH) 70,593 (M.D. Fla.), aff'd, 1994-1 Trade Cas. (CCH) 70,803 (11th Cir.), petition for rehearing en banc filed, Civ. No. CV-137-CIV-FTM-25D (11th Cir. Dec. 15, 1994). Commissioners Azcuenaga and Owen dissented from the decision to take enforcement action (April 26, 1994).
8. B.A.T. Industries, p.l.c., Docket 9271 (settlement announced Dec. 22, 1994).
9. Boston Scientific Corp., File 951-0002 (settlement announced Feb. 24, 1995), Commissioner Azcuenaga concurring in part and dissenting with respect to the agreement to abbreviate the public comment period.
10. Port Huron Hospital, File 941-0076 (Nov. 11, 1994), Commissioner Azcuenaga dissenting.
11. Freeman Hospital, File 941-0115 (Feb. 21, 1995). The case now is in litigation. FTC v. Freeman Hospital, No. 95-1448 (8th Cir. March 3, 1995) (rescission ordered).
12. University Health, Inc., 938 F.2d 1206 (11th Cir. 1991); Columbia Hospital Corp., 1993-1 Trade Cas. (CCH) 70,209 (M.D. Fla. 1993); Alliant Techsystems, 808 F. Supp. 9 (D.D.C. 1992); Harbour Group Investments, LP, 1990-2 Trade Cas. (CCH) 69,247 (D.D.C. 1990); Imo Industries, Inc., 1992-2 Trade Cas. (CCH) 69,943 (D.D.C. 1989); Textron Inc. (D.D.C. March 9, 1989) (order entered on stipulation).
13. FTC v. R.R. Donnelley & Sons Co., 1990-2 Trade Cas. (CCH) 69,239 (D.D.C. 1990). The matter now is in administrative adjudication. See R.R. Donnelley & Sons Co. v. FTC, 931 F.2d 430 (7th Cir. 1991) (denying request to direct FTC to dismiss administrative complaint).
14. FTC v. Lee Memorial Hospital, note 7 supra; FTC v. Freeman Hospital, note 11 supra.
15. Adventist Health System, Docket 9234 (April 15, 1994), Commissioners Owen & Yao concurring.
16. The Coca-Cola Co., Docket 9207 (June 30, 1994), Commissioners Azcuenaga & Starek recused, appeal filed, Nos. 94-1595 & 94-1596 (D.C. Cir. Aug. 26, 1994).
17. Docket 9215 (Aug. 31, 1994), Commissioners Azcuenaga & Starek recused, appeal filed, No. 94-41224 (5th Cir. Nov. 2, 1994).
18. Docket 9226 (May 6, 1994), Commissioner Azcuenaga dissenting from partial dismissal of the complaint.
19. Docket 9256 (May 5, 1994), Commissioner Azcuenaga concurring.
20. Valspar Corp., Docket C-3478 (Jan. 21, 1994) (settlement announced Oct. 21, 1993), Commissioner Owen dissenting.
21. Cooper Industries, Inc., Docket C-3469 (Oct. 26, 1993), Commissioner Azcuenaga dissenting on the ground that relief was inadequate.
22. Martin Marietta Corp., Docket C-3500 (Sept. 23, 1994), Commissioner Owen dissenting (settlement announced March 25, 1994).
23. Sulzer Ltd., Docket C-3559 (Feb. 23, 1995) (settlement announced Sept. 27, 1994).
24. Alvey Holdings, Inc., Docket C-3488 (March 30, 1994) (settlement announced Dec. 7, 1993).
25. Imperial Chemical Industries, PLC, Docket C-3473 (Nov. 29, 1993), Commissioner Owen dissenting.
26. Columbia Healthcare Corp. (HCA), Docket C-3505 (July 5, 1994) (settlement announced Feb. 7, 1994), Commissioner Azcuenaga concurring in part and dissenting in part, and Commissioner Owen dissenting; Dominican Santa Cruz Hospital, Docket C-3521 (Aug. 18, 1994) (settlement announced March 10, 1993), Chairman Steiger concurring, and Commissioners Azcuenaga & Yao dissenting; Columbia Hospital Corp. (Galen), Docket C-3472 (Nov. 19, 1993).
27. Columbia Healthcare Corp., Docket C-3544 (Dec. 6, 1994) (settlement announced Sept. 14, 1994).
28. Dow Chemical Corp., Docket C-3533 (Sept. 23, 1994) (settlement announced June 20, 1994), Commissioner Azcuenaga dissenting on the ground that relief was insufficient.
29. Roche Holding Ltd., Docket C-3542 (Nov. 22, 1994) (settlement announced Aug. 29, 1994).
30. Kiwi Brands, Inc., Docket C-3523 (Aug. 24, 1994) (settlement announced June 29, 1994).
31. TCH Corporation, Docket C-3519 (Aug. 16, 1994) (settlement announced Feb. 24, 1994), Commissioner Owen concurring in part and dissenting in part; Revco D.S., Inc., Docket C-3540 (Oct. 31, 1994) (published for comment July 14, 1994); Rite Aid Corp., Docket C-3546 (Dec. 15, 1994) (published for comment Aug. 31, 1994).
32. Adobe Systems, Inc., Docket C-3536 (Oct. 18, 1994) (settlement announced July 26, 1994), Commissioner Owen dissenting.
33. McCormick & Co., Inc., Docket C-3468 (Oct. 25, 1993).
34. File 941-0008 (withdrawn March 16, 1994), Commissioners Azcuenaga & Owen dissenting.
35. File 931-0090 (withdrawn Nov. 7, 1994).
36. Red Apple Companies, Inc., Docket 9266 (Feb. 28, 1995).
37. Alliant Techsystems, Inc., File 941-0123 (published for comment Nov. 11, 1994), Commissioner Azcuenaga concurring.
38. Lockheed Corp., File 951-0005 (published for comment Jan. 10, 1995), Commissioner Starek concurring.
39. Charter Medical Corp., Docket C-3558 (Feb. 14, 1995) (published for comment Nov. 10, 1994).
40. HealthSouth Rehabilitation Corp., File 951-0007 (published for comment Dec. 28, 1994).
41. Wright Medical Technology, Inc., File 951-0015 (published for comment Dec. 7, 1994).
42. IVAX Corp., File 951-0001 (published for comment Dec. 22, 1994).
43. American Home Products Corp., Docket C-3557 (Feb. 14, 1995) (published for comment Nov. 10, 1994), Commissioner Azcuenaga concurring and questioning adequacy of relief.
44. Eli Lilly & Co., File 941-0102 (published for comment Nov. 3, 1994), Chairman Steiger & Commissioner Varney concurring, Commissioner Azcuenaga dissenting & Commissioner Starek recused.
45. Oerlikon-Buhrle Holding AG, Docket C-3555 (Feb. 1, 1995) (published for comment Oct. 26, 1994).
46. Royal Dutch Petroleum Co., File 941-0043 (published for comment Jan. 10, 1995).
47. Sensormatic Electronics Corp., File 941-0126 (published for comment Dec. 28, 1994), Commissioner Azcuenaga concurring in part and dissenting in part.
48. Service Corporation International, File 951-0012 (published for comment Feb. 28, 1995).
49. Penn Traffic Co., File 951-0009 (published for comment Jan. 18, 1995); Schnucks Markets, Inc., File 941-0131 (published for comment March 8, 1995); Schwegmann Giant Supermarkets, Inc., File 941-0130 (published for comment March 8, 1995).
50. Tele-Communications, Inc., File 941-0132 (published for comment Jan. 25, 1995).
51. Nestle Food Co., File 941-0124 (published for comment Dec. 28, 1994).
52. Del Monte Corp., File 921-0071 (published for comment Jan. 9, 1995), Commissioner Starek concurring.
53. Reckitt & Colman PLC, File 951-0013 (published for comment Dec. 22, 1994).
54. 15 U.S.C. 18.
55. United States v. E.I. duPont de Nemours & Co., 353 U.S. 586, 593 (1957) ("determination of the relevant market is a necessary predicate to a finding of a violation of the Clayton Act, because . . . [competitive effects] can be determined only in terms of the market affected").
56. Adventist Health System, Docket 9234 (April 15, 1994), Commissioners Owen & Yao concurring.
57. American Home Products Corp., Docket C-3557 (Feb. 14, 1995), Commissioner Azcuenaga concurring in part and dissenting in part, on the ground that the order was inadequate to remedy the alleged competitive harm.
58. Sensormatics Electronics Corp., File 941-0126 (Jan. 26, 1995), Commissioner Azcuenaga concurring in part and dissenting in part.
59. FTC v. PPG Industries, Inc., 798 F.2d 1500 (D.C. Cir. 1986), rev'g 628 F. Supp. 881 (D.D.C. 1986).
60. Id. at 1502, quoting 628 F. Supp. at 884.
61. Id. at 1505.
62. Textron Inc., Docket 9226 (May 6, 1994), Commissioner Azcuenaga dissenting from partial dismissal of the complaint.
63. FTC v. Elders Grain, Inc., 868 F.2d 901, 907 (7th Cir. 1989).
64. Grumman Corp. v. LTV Corp., 665 F.2d 10, 13 (2d Cir. 1981).
65. The Commission also alleged R&D markets in Boston Scientific and Wright Medical Technology, discussed below. See also Royal Dutch Petroleum Co., File 941-0043 (Jan. 10, 1995); Roche Holding Ltd., Docket C-3542 (Aug. 24, 1994).
66. Boston Scientific Corp., File 951-0002 (settlement announced Feb. 24, 1995), Commissioner Azcuenaga concurring in part and dissenting with respect to the abbreviated public comment period.
67. Wall Street Journal, Jan. 20, 1995, at B8.
68. See Elliott, "Mending a Heart," The Washingtonian, Dec. 1993, at 68, 94.
69. Cf. SCM Corp. v. Xerox Corp., 645 F.2d 1195, 1210-11 (2d Cir. 1981), cert. denied, 455 U.S. 1016 (1982) (finding that acquisition of patents not unlawful when relevant product not introduced until 4 years later and relevant market did not exist until 8 years after acquisition).
70. See U.S. Department of Justice Antitrust Guidelines for the Licensing and Acquisition of Intellectual Property 3.2.3 ("Firms compete in research and development that may result in new or improved products or processes.") (Draft Aug. 8, 1994).
71. See Azcuenaga, "Shimmers in the Penumbra of Section 5 and Other News," Remarks before the National Economic Research Associates, Inc., 13th Annual Antitrust Trade Regulation Seminary, Santa Fe, New Mexico, July 9, 1992.
72. The Vons Companies, Inc., Docket C-3391 (Aug. 7, 1992), Commissioner Azcuenaga concurring on Section 5 but not Section 7.
73. Department of Justice & Federal Trade Commission 1992 Horizontal Merger Guidelines (April 2, 1992), reprinted in 4 Trade Reg. Rep. (CCH) 13,104.
74. Hartman, Teece, Mitchell & Jorde, "Assessing Market Power in Regimes of Rapid Technological Change," 2 Industrial & Corporate Change 317 (1993) (hereafter "Hartman"). To account for both price and performance competition, the authors suggest a 25% threshold and 4-year period for defining markets to supplement the existing 5% and 1- and 2-year periods.
75. Hartman at 322-23.
76. See 1992 Merger Guidelines 1.32 & 3 (firms that have the technological capacity to produce or sell the relevant product considered as market participants or potential entrants, depending on likely cost and time of supply response).
77. Hartman at 340.
78. See, e.g., Occidental Petroleum Corp., Docket 9205 (Dec. 22, 1992); order modified & appeal dismissed by stipulation (2d Cir. Jan. 12, 1994); Hospital Corporation of America, 106 F.T.C. 361, 499 (1985), aff'd, 807 F.2d 1381 (7th Cir. 1986), cert. denied, 107 S. Ct. 1975 (1987);
79. See Plaintiff's Response to Defendant's Memorandum of Law in Opposition to the Federal Trade Commission's Motion for a Preliminary Injunction 1, in FTC v. B.A.T. Industries, Inc., 94 Civ. 7849 (MP) (S.D.N.Y. Dec. 4, 1994).
80. Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 113 S. Ct. 2578 (1993).
81. 113 S. Ct. at 2596.
82. 113 S. Ct. at 2596.
83. FTC v. Elders Grain, Inc., 1988-2 Trade Cas. (CCH) 68,191 (N.D. Ill. 1988), aff'd, 1989-1 Trade Cas. (CCH) 68,411 (7th Cir. 1989).
84. FTC v. Freeman Hospital, No. 95-1448WMS (8th Cir. March 3, 1995).
85. 1984 Merger Guidelines 4.2, reprinted in 4 Trade Reg. Rep. (CCH) 13,103, at 20,565. The 1992 Merger Guidelines refer to the 1984 guidelines as the source for guidance on the analysis of vertical mergers.
86. See, e.g., Riordan & Salop, "Evaluating Vertical Mergers: A Post-Chicago Approach," 63 Antitrust L.J. ___ (1995); see also Reiffen & Vita, "Is There New Thinking On Vertical Mergers? A Comment," upcoming in Antitrust L.J.
87. The merger guidelines suggest that the likelihood of a "supply squeeze" by an integrated firm against its unintegrated rivals is relevant to whether single level entry is possible in vertically related markets. 1984 Merger Guidelines 4.211 n.31.
88. 370 U.S. 294, 323-24 (1962).
89. E.g., Ford Motor Co. v. United States, 405 U.S. 562 (1972); Ash Grove Cement Co. v. FTC, 85 F.T.C. 1123 (1975), aff'd, 577 F.2d 1368 (9th Cir.), cert. denied, 439 U.S. 982 (1978).
90. See, e.g., P. Areeda & D. Turner, IV Antitrust Law 1004, at 221 (1980) ("Only where foreclosure has reached monopolistic proportions . . . does it become troublesome, and even then . . . will not be detrimental unless entry barriers are increased or competitive pricing is threatened . . . ."); R. Bork, The Antitrust Paradox 226, 237 (1978) ("[F]oreclosure theory is not merely wrong, it is irrelevant."); R.A. Posner, Antitrust Law: An Economic Perspective 200 (1976) ("[T]he case for prohibiting vertical mergers is very weak, except possibly where one of the parties to the merger has a monopoly."); Page, "Antitrust Damages and Economic Efficiency," 47 U. Chi. L. Rev. 467, 495 (1980).
91. 603 F.2d 345 (2d Cir. 1979).
92. 603 F.2d at 352 n.9, citing II P. Areeda & D. Turner, Antitrust Law 527a (1978). The court also said that a "showing of some probable anticompetitive impact is still essential," although "there were no precise formulas for determining whether a vertical merger may probably lessen competition." Id. at 353.
93. Alberta Gas Chemicals v. E.I. duPont de Nemours & Co., 826 F.2d 1235 (3d Cir. 1987), cert. denied, 486 U.S. 1059 (1988).
94. 826 F.2d at 1244-45.
95. TCI Communications, Inc., File 941-0008 (published for comment Nov. 15, 1993), Commissioners Azcuenaga and Owen dissenting. The Commission subsequently withdrew the proposed order after the parties abandoned the transaction. See also United States v. Tele-Communications, Inc., Civ. Action No. 94-0948 (D.D.C. April 28, 1994) (alleging that acquisition may limit access to programming by competitors to cable systems).
96. Eli Lilly & Co., File 941-0102 (proposed consent order announced Nov. 3, 1994), Commissioner Azcuenaga dissenting & Commissioner Starek recused.