FTC/DoJ Merger Guidelines Workshop
Northwestern University Law School
December 10, 2009
Remarks on the “Efficiencies” Section of the Horizontal Merger Guidelines
John W. Treece
Partner
Sidley Austin LLP
I want to thank the Department of Justice and the Federal Trade Commission – specifically,
Molly Boast and Rich Feinstein – for arranging this Workshop and inviting me to participate.
It’s a great honor.
I also want to thank Henry Butler and the Searle Center for hosting. This is the second
conference in as many months that I’ve attended here, and recently, I received an excellent
research report from the Center. Henry has done a terrific job in a very short time to establish
the Center as a place where important work is done well, and all of us Chicagoans look forward
to seeing the Center assume an ever-greater role in our community.
Efficiencies in merger analysis. Some of my defense bar colleagues might say that empirical
evidence would suggest that if we’re talking about the role of efficiencies, it must be the last
panel of the day. And so we are.
I.
Overview
I have what I believe is a common perspective on this enterprise. I agree that it is time to revise
the Guidelines, but like many of those who have filed public comments, I think it should be done
with a light touch. The Guidelines have served us well by providing broad principles that have
permitted our understandings to evolve – to the point, in fact, where it’s now appropriate to
capture that evolution in a revised set.
But, I also believe that the revision process should have limited and well-defined objectives.
The most important, in my view, is to reflect the reality of how the Agencies do their work. That
is important not only because the Guidelines should enable the bar and their clients to predict the
government’s likely treatment of a transaction, but also because they are relied upon by the
courts to identify the right questions they should be trying to answer.
But the Guidelines should not be so detailed as to lay down prescriptive rules that try to answer
those questions in all possible factual contexts. Although some of the public comments seem to
rehash specific arguments that may have been lost at the Agencies, I think there is relatively
widespread agreement that the Guidelines should not be too detailed.
But the other side of the “no prescriptive rules” coin is that the Guidelines should not, without
very good reason, foreclose, or appear to foreclose, particular types of analyses in a way that
could hinder further evolution of our thinking. Just as the Agencies should not insert new rules
into the Guidelines that are overly prescriptive, they should also consider deleting overlyprescriptive language currently in the Guidelines.
II.
Skepticism of Agencies’ Treatment of Efficiencies and Deletion of Last Paragraph.
It is fair to say that the general perception among defense lawyers is that the Agencies are too
skeptical, and perhaps dismissive, of efficiency claims.
This perception is probably a little over-blown. After all, I assume that agency attorneys ask
themselves the same initial question we ask our clients – “why do you want this deal?” – and the
answer almost always invokes a host of consumer benefits. And, certainly efficiencies asserted
for the transaction are often inherently acknowledged in the analysis of competitive effects.
But there is nonetheless a view that the Agencies are too slow to acknowledge the efficiencies
that are usually the very reason for the deal, and that such a reluctance is even reflected in the
current Guidelines.
On the one hand, there seems to be almost universal agreement that the core notion of
“cognizable efficiencies” asks exactly the right questions:
•
Are the asserted efficiencies merger-specific?
•
Are they verifiable – and by the way, not quantifiable but verifiable?
•
And, do they arise from an anticompetitive output restriction?
But then, the last paragraph of the “efficiencies” section of the Guidelines proceed to undercut
this simplicity by suggesting that efficiencies “relating to research and development,
procurement, management, or capital costs are less likely to be verifiable, merger-specific or
substantial, or may not be cognizable for other” – and, I would point out, unexplained –
“reasons.”
This passage in the Guidelines is more fiat than logic and should be deleted, in my opinion. In
any specific case, one must determine whether R&D, procurement, management and capital cost
efficiencies are cognizable, and there is no reason to prejudge those issues.
III.
Deletion of Footnote 36 to the Guidelines
Footnote 36 to the current Guidelines, in my view, suffers the same problem. It seems to cabin
the consideration of certain cognizable efficiencies without adequate reason.
Footnote 36 describes when efficiencies created by a merger in one market might be considered
to justify it, despite some anticompetitive effects in another. The footnote reads in relevant part:
“… [T]he Agency normally assesses competition in each relevant market affected
by the merger independently and normally will challenge the merger if it is likely
to have anticompetitive effects in any relevant market. In some cases, however,
the Agency, in its prosecutorial discretion, will consider efficiencies not strictly in
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the relevant market, but so inextricably linked with it that a partial divestiture or
other remedy could not feasibly eliminate the anticompetitive effect in the
relevant market without sacrificing the efficiencies in the other market(s).…”
A.
Concerns with Footnote 36
I want to discuss footnote 36 for three reasons.
First, if one purpose for revising the Guidelines is to clarify them, the question of cross-market
efficiencies deserves some attention because it is not immediately obvious what it means for one
market to be “inextricably linked with” another. The term has a mysteriously talismanic ring to
it, which suggests, at least to me, that the exercise of “prosecutorial discretion” may prove to be
more arbitrary and less transparent than we would like.
Second, the “inextricably linked” language seems to establish a threshold question designed
principally to foreclose consideration of legitimate efficiencies. That is, the footnote
acknowledges that a merger may create substantial and legitimate efficiencies in markets other
than those under consideration, but nonetheless suggests that for largely unexplained reasons,
they will not be seriously considered.
Third, my experience is that when antitrust rules do not accurately reflect how businesses
actually strategize about their competitive responses, then more often than not, we need to
rethink our rules and our language, rather than condemn the strategy.
In this regard, I think that antitrust lawyers and economists often tend to think narrowly in terms
of relevant markets. But businesses don’t. When they formulate competitive responses, they
look at all the tools they have, including their entire arsenal of products, business methods,
distribution channels, and R&D. The footnote fails to acknowledge this reality by continuing to
limit the consideration of efficiencies within single “relevant markets” that have often been
narrowly defined by the Agencies.
B.
Cross-Market Efficiencies Created by Economies of Scope
An easy example: economies of scope often create cross-market efficiencies.
The joint production of multiple, related but distinct products in a single facility can reduce the
cost of producing products other than the product that is in the relevant market under scrutiny.
And in fact, depending on the relative sizes of the markets or sales volumes of the products, it
may be the case that most of the efficiencies accrue to the products that fall outside the market.
Furthermore, these efficiencies would seem, in many cases, to satisfy easily the Guidelines’ test
for “cognizable efficiencies” – i.e., they are merger-specific; they are verifiable; and they don’t
flow from anticompetitive output restrictions.
Likewise, research in basic science or common R&D may support multiple product lines that are
properly deemed to be in separate markets. Spreading the fixed costs of that research across
multiple products – some of which are acquired in the merger – may not only lower the cost for
all products; it may incentivize R&D investment that would not otherwise occur. While there
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may be debate about how to allocate these savings across product lines, they do not seem to
inherently fail the “cognizable efficiency” test.
Joint sales and promotion of multiple products has the same effect. Significant savings can be
achieved when a sales force presents multiple products as they knock on doors. And the same
comment about “cognizable efficiencies” applies here as well.
These are all legitimate, and potentially significant, efficiencies, and it is hard to see why they
should not be more routinely recognized in a merger analysis.
C.
Pricing Efficiencies
In addition to cross-market efficiencies associated with economies of scope, I would argue that
recent scholarship has suggested another form of efficiency. These are pricing efficiencies,
including the effects of bundled product competition.
I think it is fair to say that we have thought a lot more about bundled competition than we did
even a few short years ago. One of the benefits of the bad decision in LePage’s has been a
proliferation of scholarship on the issue, and I see no reason why some of that learning should
not apply to some merger contexts.
Now, as a disclaimer, I am not an economist or frankly, a mergers maven, but I draw some
experience from a case that we tried to a jury in 2006 in which the evidence provided some
useful lessons.
The core fact in the trial was the significant procompetitive price effect of competition between
symmetrical bundles. Specifically, Johnson & Johnson and its rival, U.S. Surgical, together sold
more than 90% of sutures and more than 90% of medical devices called “endomechanical
products” or “endos.”
Beginning in the mid-1990s, both companies marketed their sutures and endos to hospitals,
through group purchasing organizations, in bundles. In J&J’s case, the hospital got the lowest
price if it purchased 90% of its sutures and 80% of its endos from J&J. Our expert, Kevin
Murphy, showed that as a result of this bundle-to-bundle competition, prices for sutures
remained flat for 8 years, and, as shown in the following chart, prices for endos declined about
20%.
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I’ve illustrated in the next three charts, one way (among several) in which we explained to the
jury why bundle-to-bundle competition is so powerful. First, we asked who would likely win a
suture contract in a single-product line competition in the circumstance illustrated in the
following chart?
Who Will Win The Contract?
Pre-Contract Market Shares in GPO X
Sutures
J&J
US Surgical
70%
30%
While one can’t confidently predict a winner, J&J certainly seems to have an edge. Then, who
would likely win an endo contract in a single-product line competition in the following situation?
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Who Will Win The Contract?
Pre-Contract Market Shares in GPO X
Endos
J&J
US Surgical
30%
70%
Here, U.S. Surgical has a clear edge. Finally, we asked the jury, who would win a combined
suture/endo contract?
Who Will Win The Contract?
Pre-Contract Market Shares in GPO X
J&J
US Surgical
Sutures
70%
30%
Endos
30%
70%
By creating a multi-product bundle, the financial risk of losing the contract increases, the
advantages that one company has over the other diminish, the companies’ product offerings
become more homogenous, uncertainty increases, bidding becomes more competitive, and prices
decline.
The price-lowering effects of this bundle-to-bundle competition were all predictable. Even
commentators who tend to find bundling anticompetitive, like Professor Nalebuff, are very clear
about the procompetitive effects of bundle-to-bundle competition. Professor Hovenkamp has
commented that bundled pricing, even by a monopolist, should be per se legal if any other firm
in the industry could offer a competing bundle of the same or nearly the same products – even if
none of them are currently doing so.
And in our case, we had testimony about how customers reacted when U.S. Surgical expanded
its suture business through an acquisition that laid the groundwork for the bundle-to-bundle
competition I just described. That transaction can be roughly characterized by the next two
charts. The first shows pre-merger shares.
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Pre-Merger Suture Shares
Sutures Share
Endos Share
J&J
70%
30%
U.S. Surgical
10%
70%
Suture Co.
15%
---
And, the next shows the post-merger structure.
A 3-to-2 Cause to Celebrate!
Sutures Share
Endos Share
J&J
70%
30%
U.S. Surgical +Suture Co.
25%
70%
One of our witnesses had worked in the purchasing department at a hospital buying group. He
testified that when they heard that U.S. Surgical had bought another suture company, they
flooded out of their offices and danced in the halls! Not because U.S. Surgical’s expanded suture
business would constrain J&J’s suture prices, but because the hospitals could constrain U.S.
Surgicals’ endo price increases by threatening not to buy its sutures – a business in which it had
just invested heavily.
In short, what the Agencies might see as a suspect, 3-to-2 merger in the sutures market
empowered hospitals to pit two more relatively symmetrical bundles against each other,
countering each company’s relative strength.
Now, I submit that if a hospital purchasing department knows enough to dance in the halls to
celebrate this glorious development, the Agencies should be keen on noting the benefits of this
merger to the endo market, even when the suture market might be asserted to be the “relevant
market” for this analysis.
I tell this story not because I think that any revised Guidelines should frame rules about how to
consider the price-lowering effects in one market that are occasioned by a merger in another.
That would be a serious mistake. Rather, the story illustrates the fact that our thinking about
how markets work – here, our thinking about how bundling works – continues to evolve. And,
any revised Merger Guidelines should not foreclose, or appear to foreclose, consideration of all
effects of a transaction.
In sum, I would suggest deleting the last paragraph of the “Efficiencies” section of the
Guidelines and ending Footnote 36 before the mention of “extricably linked” markets.
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IV.
Final Comment
I’d like to make one final comment, about process.
I would encourage the agencies to make a draft of revised Guidelines available for public
comment, which I understand was not done in connection with the 1997 revisions.
First, a draft would naturally elicit more focused comments.
Second, I am concerned that antitrust practice is increasingly seen as an insular, inside-theBeltway practice – and for that reason, I applaud the Agencies for holding this Workshop here in
the Midwest. Exposing a draft revision of the Guidelines to public comment would help to
ameliorate that perception by making their development more transparent.
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