HORIZONTAL ISSUES: WHAT'S HAPPENING AND WHAT'S ON THE HORIZON
Debra A. Valentine(1)
Deputy Director, Policy Planning
Federal Trade Commission
December 8, 1995
I am going to exercise some poetic license today and not discuss specific cases, as the program title for this session seems to indicate. Instead, I am going to address some basic horizontal issues that we are facing in the marketplace, in government and in scholarly thinking about how the antitrust laws are, and should be, applied in our contemporary competitive environment. As many of you may know, the FTC has been holding hearings over the past two months to determine whether broad-based changes in the global marketplace require adjustments in antitrust or consumer protection enforcement in order to keep pace with twenty-first century realities.
The Commission began its hearings with certain basic beliefs. First, the core provisions of our antitrust law do serve as effective tools against the exercise of unrestrained private economic power. Second, antitrust enforcement that results in vigorously competitive domestic markets best ensures U.S. firms' international competitiveness and their continued advancement in innovation-driven markets. Thus, what we are asking about is not the desirability of revolutionary change in antitrust enforcement but the possibility of evolutionary improvements at the margin.
One thing that the hearings confirmed is that the nature of competition in many sectors -- and often the fastest-growing sectors -- of the economy is changing. Markets and market behavior are changing, whether the impetus for that change is deregulation, as in the telecommunications and to some degree financial services areas; cost containment or budget cuts, as in defense and health care; foreign competition, as in automobile and steel industries; or more rapid innovation, as in software, computer services and pharmaceuticals. Many industries face increasingly large, up-front fixed costs; many confront network externalities; many firms are increasingly involved in joint ventures and global alliances; and many are increasingly relying on, and aggressively enforcing, intellectual property rights. Given these changes is antitrust, to paraphrase former Assistant Attorney General Baxter, asking the wrong questions yet eliciting very precise answers, or asking the right questions and getting approximately correct answers?
One of the first issues we addressed in the hearings was whether our conventional market definition techniques fully account for the increasingly global scope of competition. Typically, foreign firms are considered along with domestic firms in market definition analysis. Section 1.43 of the Guidelines states that "[m]arket shares will be assigned to foreign competitors in the same way in which they are assigned to domestic firms." The Guidelines set forth only three special caveats for foreign firms. First, where exchange rates fluctuate significantly, longer time periods than one year may be used for calculating market share. Second, an import quota will be treated as a ceiling for imports in calculating market shares (and if the quota is percentage-based, firms' actual import sales and capacity data will be reduced when calculating market share). Third, where a group of foreign firms act in coordination, their market shares may be aggregated. As a practical matter, not just tariffs, quotas and exchange rates, but also foreign government subsidies, transportation costs, the absence of environmental or safety regulations and the existence (or lack) of local distribution and technical support, may render foreign firms less or more competitive in the U.S. market in the short or long term.(2)
Some of those who appeared before us at the hearings believed that the relatively abstract and general level of the Guidelines' language with respect to foreign competition was a desirable thing. That very level of generality was, in their view, precisely what enabled the Agencies and parties to approach cases and develop law in an accretive, fact-specific, common law fashion. Others noted that even when mergers involve markets broader than the United States, our essential inquiry remains how the transaction impacts U.S. consumers. Accordingly, we need not engage in an analysis of a transaction's impacts within foreign markets in the same way and in the same detail as we do in analyzing domestic impacts. This, in turn, suggested little need for more detailed guidance on how we assess foreign supply responses (and perhaps diminished concern about any difficulties of obtaining evidence from abroad).
Others noted that other countries, such as Canada, have more elaborate guidance as to how imports will be treated in merger analysis, and that such elaboration would likewise be helpful in this country. Given the predictive and fact-specific nature of merger analysis, virtually no one advocated hard and fast rules such as that proposed over a decade ago by Landes and Posner -- that where imports constitute five percent of the relevant product market, all foreign capacity should be taken into account in calculating market shares.(3) Some did suggest, however, that if one were to "err" in making predictive judgments, it ought to be in favor of the internationalization of markets, since that is where the world is going. One final reason articulated for revisiting or amplifying upon how we analyze global markets was that most of the earlier writing and thinking in this area has focused on manufactured goods markets. In our post-industrial age, the most important international market issues may involve intellectual property, access to networks or interface standards, and political barriers may be -- notwithstanding our increasingly integrated global economy -- even more important relative to economic barriers than they were in the past.
There is no doubt that an increasingly integrated and deregulated global marketplace has unleashed powerful forces of competition that have pressured businesses to focus on obtaining efficiencies and cost reductions. This leads to another focus of the hearings -- how antitrust can maximize the likelihood of realizing beneficial efficiencies and minimize the likelihood of injuring consumers when analyzing mergers -- or joint ventures -- that have apparent efficiencies. We heard again and again how foreign rivals, shareholders and other forces were driving U.S. firms to achieve efficiencies. But there was no evidence or suggestion that there is anything fundamentally incompatible between our antitrust laws and the efficient operation of American business. Rather, we were encouraged to keep our antitrust policy up-to-date and competitive with the competition policy regimes of other major industrial nations by reevaluating how we apply our antitrust principles to efficiencies, not by rejecting those principles.
On the very first day former Assistant Attorney General Jim Rill reminded us of how far we have come from the 1968 Merger Guidelines which, picking up on the Supreme Court decisions of Brown Shoe and Philadelphia National Bank,(4) were avowedly hostile to efficiencies. Nonetheless, he noted that while the 1992 Guidelines were designed to allay any concern that the government maintained continued hostility to efficiency-enhancing mergers, those Guidelines failed to address efficiencies with the detail or depth they accorded to the competitive effects or entry sections. Significantly, he noted that the 1992 Guidelines did not undertake to articulate how efficiencies might be identified and weighed. Others, perhaps somewhat more bluntly, proffered the view that the efficiencies section of the Guidelines is notably uninformative and effectively unrepresentative of the de facto decision-making process that they believe takes place at the Agencies.
Starting with Jim Rill himself, we received a plethora of suggestions about how we should treat efficiencies or why we should be more hospitable to them. Some suggested that the Agencies should articulate an analytical framework for treating merger-related efficiencies that is consistent with the model utilized in reviewing non-merger horizontal restraints, presumably along the lines of the Supreme Court's BMI decision.(5) Others believed that the FTC should articulate more specifically the types of efficiencies that it would consider. And others maintained that we should be more hospitable to more types of efficiencies. In this regard, there was a range of views as to which efficiencies were most important and which should qualify for agency consideration in the merger context. There was relatively widespread consensus on the importance of production and innovation economies. Some made distinctions between pecuniary economies, such as tax savings, which they would not recognize, and non-pecuniary economies, which should matter. Others would not be inclined to recognize capital-raising economies. Yet others advocated recognition of a broad range of economies, including scale economies, transactional economies, informational economies, promotional economies and, among some, managerial economies.
Some valued specific efficiencies, such as innovation efficiencies, because they tend to compound themselves, both through adoption by other firms in the industry and through the economy generally, thereby greatly contributing to our future economic growth. Others believed that a wide range of efficiency improvements, although initially introduced for private gain, stimulated competition and thereby caused a diffusion of cost savings to rivals, which led to significant spillover benefits for consumers. But the debate over how to value or identify efficiencies was not without its perplexities -- often different people could look at the same transaction, such as the GM-Toyota joint venture, and characterize its efficiencies in different terms, either as ones of managerial technique, production or innovation.
With respect to another aspect of efficiency analysis, several commentators stated that we should not require proof that efficiencies be passed directly on to consumers, at least in the short run. Some espousing this position pointed to the first sentence in the efficiency section of the current Guidelines as suggesting that passing on of efficiency cost savings to consumers over time might be appropriate. (That sentence reads: "The primary benefit of mergers to the economy is their efficiency-enhancing potential, which can increase the competitiveness of firms and result in lower prices to consumers.") Others noted that with the changing demographics of stock ownership in this country in the second half of the twentieth century, it is no longer valid to assume that a clean line can be drawn between stockholders who may benefit and consumers who may suffer from a post-merger price increase. That is, with the growth of, among other things, pension funds, we are all increasingly both stockholders and consumers.
Another perspective cautioned that it would be illusory to think that one could accurately accomplish a case-by-case analysis that traded off losses from increased market power and gains from merger-related efficiencies. While acknowledging that mergers often generate efficiencies, this viewpoint maintains that it is notoriously difficult to predict which mergers will give rise to efficiencies, what their magnitude is likely to be and how they will affect the behavior of the merging firms or their competitors. Instead of investing additional agency and corporate costs in unreliable efficiency analyses, this perspective would raise the numerical thresholds in the Merger Guidelines. Assuming that one hits the right threshold, this approach would presumably allow the most efficiency creating mergers to transpire while preventing those with the most deleterious market power effects.
Another somewhat innovative proposal for evaluating an efficiencies defense was to take the legitimate business justification paradigm that has developed in the context of assessing a monopolist's alleged refusal to deal and apply it in the merger context. Under this proposal, the parties must first prove the efficiencies to be "legitimate," that is, they must enhance competition for the benefit of consumers. Certain efficiencies claims -- those to be gained from merging firms with closely related products or complementary production processes -- would be considered because they have the potential for lowering costs, stimulating rivalry, improving allocation of resources and ultimately benefitting the competitive process. Other claims of efficiencies -- such as tax savings -- that do not result in enhanced competition would not be cognizable. Second, parties must prove that their claims not be "pretextual," that is, the documents and contemporaneous statements of the parties to the merger must support their claims of anticipated efficiencies. Another aspect of this approach is that it attempts to avoid a precise balancing of anticompetitive effects and efficiency gains. It would allow a defendant, where post-merger concentration was moderate, to assert as a complete defense a substantial, competition-enhancing savings, unique to a merger, that will inure, in some part and in some fashion, to consumers. In highly concentrated markets, no efficiencies defense would be permitted under this scenario.
Perhaps the only continually repeated theme that was heard with respect to efficiencies was that they should be accorded a role in merger analysis and that the parties should bear the burden of proving them.
Another topic addressed at the Commission hearings was the failing firm defense and its progeny, flailing firm and distressed industry issues. As you know, the failing firm defense exempts an otherwise anticompetitive merger from Section 7 challenge where the only alternative for a failing company is elimination from the relevant market. The Supreme Court first accepted the failing firm defense in International Shoe(6) and further articulated it in Citizen Publishing.(7)
The Merger Guidelines recognize the defense in Section 5.1, enumerating four requirements that must be met. The allegedly failing firm must first be unable to meet its financial obligations in the near future and, second, be unable to reorganize successfully under Chapter 11. Third, unsuccessful good-faith efforts to elicit reasonable alternative offers to acquire the failing firm's assets must have been made. Fourth, absent the acquisition, the firm's assets would exit the market. These requirements are strict. They are rarely all satisfied, and as a result, the defense is seldom successfully invoked. In fact, the Supreme Court has not upheld its application since its 1930 International Shoe decision.
Yet today we face a global restructuring of industries that many believe is the most significant economic change in 100 years. In addition to fierce competition from imports and, at times, severe overcapacity in some industries, companies also are grappling with the quickened pace of technological change. Given these wrenching transformations, it seemed useful to ask whether the failing firm defense, with its stringent requirements and consequent limited use, was still appropriate. For instance, should the failing firm defense be adjusted to enable the rationalization of overcapacity in industries affected by change? Would shareholders, creditors, workers and consumers be better off if the Agencies, in analyzing mergers, tried to facilitate the transition of salvageable firms to a stronger market position -- perhaps particularly when the companies involved compete in foreign markets or face vigorous foreign competition in domestic markets? We received a variety of thoughtful proposals that ranged, in essence, from moderately adjusting the defense to eliminating it altogether.
Some suggested that the current failing firm defense is appropriately articulated but analytically superfluous. That is, any firm that met the defense's strict requirements likely would not raise competitive concerns under the Guidelines' competitive effects analysis in the first instance. According to this view, the factors currently employed to analyze a failing firm situation should simply be part of the competitive effects analysis.
Others suggested that the rigidity of the failing firm doctrine should be somewhat loosened. They pointed to economic thinking which indicates that it generally is preferable to allow a merger rather than have assets exit the market, because output is reduced when assets exit. They proposed reducing the likelihood that assets will exit absent the merger from the current standard of virtual certainty to something in the 50 to 80 percent range.
Others suggested modifying the alternative purchaser requirement. Currently, "[a]ny offer to purchase the assets of the failing firm for a price above the liquidation value of those assets . . . will be regarded as a reasonable alternative."(8) In their view, by rating the least anticompetitive alternative in liquidation value terms, the doctrine is biased in favor of non-market participants. Any efficiencies that a potential competitor-purchaser might generate from the merger may be unnecessarily sacrificed. Further, a non-market participant may not want to operate as an effective competitor by investing in the future; it may simply want to harvest a revenue stream.
Some participants suggested that by simply giving more credence and weight to efficiencies in the failing firm context, we could accommodate any perceived need to make the defense itself more flexible. Indeed, some surmised that in the failing firm context antitrust enforcers had overestimated the frequency with which companies bet that increased concentration will result in prices high enough to cover a failing firm's costs.
Finally, some participants pointed to Supreme Court antitrust precedent which, albeit inconsistent, at times has endorsed some consideration of social costs.(9) Notwithstanding the general consensus that the antitrust statutes are designed to protect consumer welfare, some noted that nowhere are social concerns specifically excluded from antitrust jurisdiction. Participants distinguished among the social concerns that a more flexible failing firm defense might recognize; for example, job concerns might be worthy of protection, bond holder investment concerns might be ignored. But there was difficulty determining the extent of social costs in a failing firm context and how to account for them. To begin with, jobs may be lost whether a merger is blocked or allowed to proceed. If a merger is blocked and a company fails, the lost jobs obviously stem from plant closure. But if a competitively problematic merger is allowed to proceed, according to oligopoly theory, jobs may be lost when the industry raises prices and reduces output. The difference is that job loss is widely distributed and incremental in the latter instance and can be harsh, drastic and localized when a community's major employer is lost. Moreover, major shareholder losses occur only in the case of liquidation (or bargain basement sales). Thus, some thought that, on balance, there may be net social costs from firm failure.
Yet no one advocated attempting the virtually impossible task of balancing social costs with economic costs and benefits on a case-by-case basis. Rather, it was thought that a greater willingness to consider a risk of firm failure short of virtual certainty and a greater willingness to credit the acquiring firm's efficiencies, as a general matter, might be an effective way of implicitly accommodating broader social concerns.
A near relative of the failing firm defense is the so-called failing industry defense. The Guidelines do not recognize a failing industry defense, and the Supreme Court rejected it long ago in Socony-Vacuum.(10) Commentators generally were dubious of a special antitrust exemption for certain industries. Many expressed reservations about how to determine when an industry was failing as opposed to simply on a downward cycle. Others again suggested that competitive effects analysis was sufficiently flexible to take into account factors such as general industry distress, overcapacity or transition. Several did note, however, that the Defense Science Board Task Force on Antitrust Aspects of Defense Industry Consolidation had framed a thoughtful perspective for defense industry mergers and that its insights and analysis might be profitably applied to other industries.
While I cannot begin to capture adequately in this short time the many issues addressed in the hearings and the many serious proposals voiced, I will note that you have until mid to late January to file any comments on these issues with the Commission.
1. The views expressed are mine and do not necessarily reflect the views of the Federal Trade Commission or any individual Commissioner.
2. Compare Olin Corp., 5 Trade Reg. Rep. (CCH) 22,857, at 22,540 (July 12, 1990) (although imports comprised significant amount of domestic consumption, FTC discounted significance of foreign firms for several reasons, including political factors, exchange rate fluctuations and constrained ability to divert any excess capacity) with B.F. Goodrich Co., 110 F.T.C. 207 (1988) (strength of historical imports apparently discounted because influenced by "extraordinary" increase in value of dollar).
3. Landes & Posner, Market Power in Antitrust Cases, 94 Harv. L. Rev. 937, 963-69 (1981). This theory applies only where the foreign firm: (1) sells products that are truly comparable; (2) makes persistent sales in the United States over time; and (3) has an available capacity which it could divert to the U.S. market. Nonetheless, it presupposes that generally all foreign capacity could be profitably diverted to U.S. markets.
4. Brown Shoe Co. v. United States, 370 U.S. 294 (1962); United States v. Philadelphia Nat'l Bank, 374 U.S. 321 (1963).
5. Broadcast Music, Inc. v. Columbia Broadcasting System, Inc., 441 U.S. 1 (1979).
6. International Shoe v. FTC, 280 U.S. 291, 302 (1930).
7. Citizen Publishing Co. v. United States, 394 US. 131 (1969).
8. Horizontal Merger Guidelines, Section 5.1 n.36 (Apr. 2, 1992).
9. See, e.g., International Shoe v. FTC, 280 U.S. 291, 302 (1930); U.S. v. General Dynamics Corp., 415 U.S. 486 (1974).
10. United States v. Socony-Vacuum Oil Co., 310 U.S. 150 (1940).