1. Non-Horizontal Merger Policy: A U.S. Perspective Paul Yde

2. 1 Focus of U.S./E.U. Merger Control: Horizontal Mergers Horizontal Merger Policy: Based on extensive and robust economic theory and empirical support U.S. Horizontal Merger Guidelines: Central premises are not controversial Loss of direct competition through merger may facilitate a unilateral price increase by the acquiring firm Increased concentration in a relevant market increases the probability of coordinated price increases Despite controversy regarding specific rules and standards adopted to identify anticompetitive horizontal mergers, there is a broad consensus that: Horizontal mergers can harm competition; and Economic theory permits regulators to distinguish anticompetitive from procompetitive horizontal mergers based on observable market criteria —Not easy, but theoretically possible Therefore, possible to develop general guidelines and to make enforcement decisions based on objective criteria and accepted economic theory

3. 2 In Contrast: Non-Horizontal Merger Policy No good economic foundation for a general vertical merger policy Vertical merger analysis is more complex and results more ambiguous: Vertical mergers generally tend to enhance output and reduce prices Fundamental difference between horizontal and vertical relationships: Two horizontal competitors have a mutual incentive to restrict their joint output Two vertically-related companies have a mutual incentive to expand their joint output Consensus among economists: A vertical merger between a firm with market power upstream and a firm with market power downstream generally increases output and reduces prices Pre-merger: each firm charges a margin reflecting its market power Vertical merger eliminates the second margin, and yields lower prices for consumers Consensus among economists: A vertical merger involving firms in competitive upstream and downstream markets is also beneficial to consumers If both markets are competitive, a vertically-merged firm will continue to sell to, and buy from, non-integrated firms if doing so is more efficient and socially beneficial If both markets are competitive, the vertically-merged firm would be unable to restrict output because non-integrated firms could deal with one another

4. 3 “Post-Chicago” Vertical Merger Theory Reacting to the new consensus that vertical mergers generally are socially beneficial, some economists developed models that identify theoretical conditions under which vertical mergers might be anticompetitive. But these models share many problems: The models are not general: They describe possible effects and do not predict likely effects The models do not match any realistic factual settings because they are based on highly stylized assumptions The models do not account for efficiencies – even though these efficiencies are intrinsic to vertical mergers The conditions under which vertical mergers might harm competition are exactly the conditions in which efficiencies and price reductions are most likely The models do not permit regulators to distinguish between an output-increasing vertical merger that benefits consumers and one that harms consumers The models have no empirical support: No empirical work supports these models or otherwise demonstrates that vertical mergers have been anticompetitive

5. 4 Conglomerate Merger Policy The problems of vertical merger policy apply equally to mergers between producers of complementary products: General consensus among economists: Economic theory does not provide a basis for predictions of anticompetitive conglomerate mergers based on general and observable conditions Two types of theories: —Merger creates opportunities for tying, bundling, or complement foreclosure —Merger creates a broad portfolio of complements that gives the merged firm a competitive advantage Theories are highly complex and results ambiguous —A merger involving complementary products entails an intrinsic incentive to increase output – an increase in demand for one product will increase demand for a complementary product —This output-enhancing incentive exists where both firms have market power and where they do not have market power —A prediction of initial consumer benefit (lower prices) is a predicate to a prediction of later consumer harm (higher prices)

6. 5 Conglomerate Merger Policy Under most conglomerate merger theories, the conduct that is alleged to arise from the merger – e.g., tying or bundling – is not unambiguously anticompetitive Tying presumes an initial increase in the sale of both complements Portfolio effects presume greater demand for the combined products, indicating greater consumer benefit from access to the broader portfolio Distinguishing the output increase that is procompetitive from the output increase that ultimately might be anticompetitive is extremely difficult. the conditions that create the possibility of anticompetitive foreclosure are precisely the conditions that create the possibility for substantial efficiencies predictions of anticompetitive effects depend critically on predictions of output increases (not output restrictions) therefore, it is dangerous to predict that a merger of complementary products will be anticompetitive Even if the predicted anticompetitive conduct occurs, however, it can be addressed more directly under alternative laws. A more effective and efficient policy is to focus on post-merger conduct, after essential facts are revealed

7. 6 European Commission’s Report on Non-Horizontal Merger Policy The European Commission’s economists report: Surveyed a variety of highly stylized models that indicate the possibility that a conglomerate or vertical merger could lead to an anticompetitive price increase despite the generalized incentive of the merged firm to reduce prices Concluded that these models do not provide an adequate foundation for predictive guidance: they do not lend themselves to general presumptions or predictions of price increases based on observable market conditions Models attempting to predict anticompetitive effects from vertical and conglomerate mergers are not sufficiently general are highly sensitive to changes in their highly restrictive assumptions do not account for intrinsic and other efficiencies, and rarely account for competitor or customer counter-strategies An effort to establish general standards for challenging non-horizontal mergers would be essentially unguided by economic theory

8. 7 Guidelines and Transparency As a result of the general consensus on these points, devising general policies or guidelines on non-horizontal mergers would be difficult The European Commission (EC) has issued guidelines, to describe the existing enforcement practices and to encourage consistency among the Member States The EC’s “objectives” tend to minimize intervention: (1) protecting consumer welfare as its objective; and (2) protecting competition, rather than competitors The EC adopted minimum share/concentration thresholds and recognizes the implicit efficiencies in non-horizontal mergers, also limiting intervention Thus, the EC has provided transparency on its standards and has indicated that it will exercise caution in bringing cases under its Guidelines Nevertheless, the EC Guidelines may be harmful if they lead to more non-horizontal merger enforcement

9. 8 Case-Specific Enforcement and Transparency Even case-by-case non-horizontal merger enforcement is difficult and potentially dangerous, so such cases should be pursued with great caution If such any case is pursued, however, a detailed public explanation of the relevant analysis, standards, and conclusions is very important to sound development of policy Each case establishes precedent, for the enforcement agency and for companies Ensuring disciplined and rigorous analysis in the enforcement agency Ensuring transparency for companies contemplating non-horizontal mergers Given the inherent complexity of non-horizontal merger analysis, detailed explanation regarding a non-horizontal merger challenge is even more important than regarding a horizontal merger challenge Some of the critical questions: What are the relevant markets? What is each party’s share in those markets? What are the primary theories of anticompetitive effects? How do those theories relate to the economic literature (i.e., what economic models were applied, if any)? What weight was given the efficiencies intrinsic to the merger? How and why were the inherent output increases discounted or disregarded relative to the potential for anticompetitive output restrictions?

10. 9 Conclusions Non-horizontal merger enforcement carries risks and costs that suggest caution: a significant risk of challenging or deterring socially beneficial mergers an unknown risk of permitting anticompetitive mergers large direct costs of enforcement, given the difficulty of distinguishing anticompetitive from procompetitive non-horizontal mergers While non-horizontal merger enforcement has developed differently in the US and EU, both jurisdictions have converged on the several points: the appropriate objective of enforcement are (1) promoting consumer welfare and (2) protecting competition, not protecting competitors application of sound, general economic theory is the only effective means of identifying merger effects on competition and consumer welfare, the economic theories that predict anticompetitive effects of non-horizontal mergers are complex, ambiguous, and largely unrealistic very few, if any, non-horizontal mergers will be amenable to a prediction of anticompetitive effects.

11. 10 © Freshfields Bruckhaus Deringer US LLP 2009 This material is for general information only and is not intended to provide legal advice.