Treatment of Efficiencies in the Competition Act - Appendix B

Appendix B: Merger Efficiencies in Other Jurisdictions

United States

In the United States, the Clayton Act prohibits mergers that may substantially lessen competition or create a monopoly in any line of commerce or in any activity affecting commerce in any section of the country.⁸⁹ There is no statutory efficiencies defence in the United States.

Case Law

The United States Supreme Court ruled on efficiencies claims in three cases in the 1960s.

In 1962, in the case of Brown Shoe Co. v. United States, the court recognized that a merger of competing shoe manufacturers and retailers would generate cost efficiencies and would create benefits for consumers in the form of lower prices.⁹⁰ However, the court considered that the need to promote competition through the protection of small, local competitors outweighed any potential efficiency benefits, writing as follows:

Congress appreciated that occasional higher costs and prices might result from the maintenance of fragmented industries and market. It resolved these competing considerations in favor of decentralization. We must give effect to that decision.⁹¹

A year later, in United States v. Philadelphia National Bank⁹², the court appeared to reject the possibility of efficiencies claims, although the precise meaning of this precedent has been debated.⁹³ Then, in the 1967 Procter & Gamble case, the court explicitly ruled that efficiencies were not a defence to an anti-competitive merger, as follows:

Possible economies cannot be used as a defense to illegality. Congress was aware that some mergers which lessen competition may also result in economies but it struck the balance in favor of protecting competition.⁹⁴

Despite the court's early hostility toward efficiencies, in the years that followed a number of lower courts recognized that efficiencies were relevant to merger review. In particular, there have been numerous cases in the past decade in which U.S. courts have considered efficiencies.

The American Bar Association Antitrust Section summarizes the current state of the jurisprudence as follows:

The majority of courts have considered efficiencies as a means to rebut the government's prima facie case that a merger will lead to restricted output or increased prices. These courts, however, generally have found inadequate proof of efficiencies to sustain a rebuttal of the government's case.⁹⁵

In the United States, a prima facie case against a merger (i.e. a presumption that a merger is unlawful) may be established based on evidence of post-merger market share and concentration. This presumption may be overcome by demonstrating that no substantial lessening of competition is likely, with reference to factors such as entry and barriers to entry, remaining competition, efficiencies and others.

The U.S. courts have been willing to take efficiencies into account as an integrated part of the assessment of whether a merger will substantially lessen competition -- that is, as a factor in merger review. When applying this factor approach, the U.S. courts have also ruled that "once it is determined that a merger would substantially lessen competition, expected economies, however great, will not insulate the merger from a section 7 challenge.⁹⁶ However, the Bar Association also notes that some U.S. courts "appear to consider the possibility that efficiencies claims function as an affirmative defense to a merger already found to be anti-competitive rather than as a means of rebutting the government's prima facie case," although in no case has a court approved an otherwise anti-competitive merger based on efficiencies.⁹⁷

The U.S. courts that have considered efficiencies claims have also imposed the requirement that the cost savings associated with efficiencies be passed on to consumers in the form of decreased prices or improved quality.⁹⁸

The leading recent case on efficiencies is FTC v. H. J. Heinz and Milnot Holding Corporation.⁹⁹ This case involved a challenge by the Federal Trade Commission to the proposed merger of Heinz and Beech-Nut, two producers of baby food. The merger would have created a duopoly in the U.S. market for jarred baby food: Gerber had 65-70 percent of the market and Heinz/Beech-Nut would have had close to a 30 percent combined share. The district court accepted the parties' efficiency-related arguments, but the circuit court reversed the lower court's decision and granted a preliminary injunction blocking the merger. The circuit court explicitly recognized the possibility that efficiencies might rebut the government's prima facie case, but held that, given the high degree of market concentration involved, proof of "extraordinary" efficiencies would be required to justify the merger. In this regard, the court cited with approval the statement in the U.S. merger guidelines (see below) that "efficiencies almost never justify a merger to monopoly or near-monopoly."

The circuit court also found that the district court had not adequately scrutinized the parties' efficiency claims, and had failed to determine whether some of the claimed efficiencies were actually directly related to the merger.

Approach of U.S. Enforcement Agencies

The U.S. enforcement agencies responsible for antitrust matters have issued non-binding statements (merger guidelines) on their enforcement approach to merger cases. The U.S. Department of Justice issued guidelines in 1968 and 1982, indicating that it would only take efficiencies into account in "exceptional circumstances" (1968) or "in extraordinary cases" (1982). In 1984, however, the department revised the guidelines to incorporate a more liberal approach to efficiencies.¹⁰⁰ In 1992, the department and Federal Trade Commission issued joint guidelines that essentially reiterated the 1984 approach. In 1997, the efficiencies section of the guidelines was further revised,¹⁰¹ and it is these guidelines that currently govern U.S. enforcement practice.

Efficiencies are not a defence in the guidelines; rather, the guidelines state that efficiencies are a factor to be considered when assessing the competitive effects of a merger, along with other factors such as market share, competitive effects and entry.

Under the guidelines, the U.S. enforcement agencies will only consider "merger-specific" efficiencies — those efficiencies likely to be accomplished with the proposed merger and unlikely to be accomplished without it or another arrangement that has comparable anti-competitive effects. Moreover, efficiency claims must be substantiated and verifiable by reasonable means. The U.S. enforcement agencies will then consider whether there are "cognizable" efficiencies sufficient to reverse the merger's potential to harm consumers. In this regard, the guidelines read as follows:

Cognizable efficiencies are merger-specific efficiencies that have been verified and do not arise from anticompetitive reductions in output or service. Cognizable efficiencies are assessed net of costs produced by the merger or incurred in achieving those efficiencies.

The Agency will not challenge a merger if cognizable efficiencies are of a character and magnitude such that the merger is not likely to be anticompetitive in any relevant market . To make the requisite determination, the Agency considers whether cognizable efficiencies likely would be sufficient to reverse the merger's potential to harm consumers in the relevant market, e.g., by preventing price increases in that market. In conducting this analysis , the Agency will not simply compare the magnitude of the cognizable efficiencies with the magnitude of the likely harm to competition absent the efficiencies. The greater the potential adverse competitive effect of a merger -- as indicated by the increase in the HHI [Hirfindahl-Hirschman Index] and post-merger HHI from Section 1, the analysis of potential adverse competitive effects from Section 2, and the timeliness, likelihood, and sufficiency of entry from Section 3 --the greater must be cognizable efficiencies in order for the Agency to conclude that the merger will not have an anticompetitive effect in the relevant market. When the potential adverse competitive effect of a merger is likely to be particularly large, extraordinarily great cognizable efficiencies would be necessary to prevent the merger from being anticompetitive.

In the Agency's experience, efficiencies are most likely to make a difference in merger analysis when the likely adverse competitive effects, absent the efficiencies, are not great. Efficiencies almost never justify a merger to monopoly or near-monopoly.

The Agency has found that certain types of efficiencies are more likely to be cognizable and substantial than others. For example, efficiencies resulting from shifting production among facilities formerly owned separately, which enable the merging firms to reduce the marginal cost of production, are more likely to be susceptible to verification, merger-specific, and substantial, and are less likely to result from anticompetitive reductions in output. Other efficiencies, such as those relating to research and development, are potentially substantial but are generally less susceptible to verification and may be the result of anticompetitive output reductions. Yet others, such as those relating to procurement, management, or capital cost are less likely to be merger-specific or substantial, or may not be cognizable for other reasons.

Also of interest is footnote 37, which relates to the time frame for the agencies' analysis of whether cognizable efficiencies would likely be sufficient to reverse the merger's potential to harm consumers in the relevant market:

The result of this analysis over the short term will determine the Agency's enforcement decision in most cases. The Agency also will consider the effects of cognizable efficiencies with no short-term, direct effect on prices in the relevant market. Delayed benefits from efficiencies (due to delay in the achievement of, or the realization of consumer benefits from, the efficiencies) will be given less weight because they are less proximate and more difficult to predict.

European Union

The new European Commission Merger Regulation came into effect in the European Union on May 1, 2004.¹⁰² The regulation explicitly specifies that efficiencies will be considered as part of the assessment of whether a concentration (merger) will "significantly impede effective competition, in the common market […], in particular as the result of the creation or strengthening of a dominant position," which is the anti-competitive threshold test under sub-section 2(3). In this regard, Recital 29 of the regulation states the following:

In order to determine the impact of a concentration on competition in the common market, it is appropriate to take account of any substantiated and likely efficiencies put forward by the undertakings concerned. It is possible that the efficiencies brought about by the concentration counteract the effects on competition, and in particular the potential harm to consumers, that it might otherwise have and that, as a consequence, the concentration would not significantly impede competition, in the common market or in a substantial part of it, in particular as the result of the creation or strengthening of a dominant position. The Commission should publish guidance on the conditions under which it may take efficiencies into account in the assessment of a concentration. [emphasis added]

The European Commission, which is the institution that investigates mergers and issues decisions on the merits of merger proceedings,¹⁰³ recently published guidelines on the conditions under which it will take efficiencies into account.¹⁰⁴ Part VII of the guidelines state that the Commission will take any substantiated efficiency claims into account in the overall competitive appraisal of a merger. In other words, efficiencies are an integrated part of the analysis of competitive effects, and not a defence, in Europe.

The guidelines specify the following:

For the Commission to […] be in a position to reach the conclusion that as a consequence of efficiencies, there are no grounds for declaring a merger to be incompatible with the common market, the efficiencies have to benefit consumers, be merger-specific and be verifiable. These conditions are cumulative (para. 78).

The guidelines contain a lengthy discussion of each of these requirements. On the issue of merger specificity, efficiencies are only relevant when they are a direct consequence of the notified merger and cannot be achieved to a similar extent by less anti-competitive alternatives (para. 85). On the issue of verifiability, the guidelines indicate that the Commission must be reasonably certain that the efficiencies are likely to materialize, and that they must be substantial enough to counteract a merger's potential harm to consumers (para. 86). When possible, efficiencies and the resulting benefit to consumers should, therefore, be quantified (paras. 86-88).

The following excerpts from the guidelines outline the Commission's approach to the "consumer benefit" requirement (note that the term consumer encompasses both intermediate and ultimate consumers).

The relevant benchmark in assessing efficiency claims is that consumers will not be worse off as a result of the merger. For that purpose, efficiencies should be substantial and timely, and should, in principle, benefit consumers in those relevant markets where it is otherwise likely that competition concerns would occur.

Mergers may bring about various types of efficiency gains that can lead to lower prices or other benefits to consumers. For example, cost savings in production or distribution may give the merged entity the ability and incentive to charge lower prices following the merger. In line with the need to ascertain whether efficiencies will lead to a net benefit to consumers, cost efficiencies that lead to reductions in variable or marginal costs are more likely to be relevant to the assessment of efficiencies than reductions in fixed costs; the former are, in principle, more likely to result in lower prices for consumers. Cost reductions, which merely result from anti-competitive reductions in output, cannot be considered as efficiencies benefiting consumers.

Consumers may also benefit from new or improved products or services, for instance resulting from efficiency gains in the sphere of R&D and innovation. A joint venture company set up in order to develop a new product may bring about the type of efficiencies that the Commission can take into account.

In the context of coordinated effects, efficiencies may increase the merged entity's incentive to increase production and reduce prices, and thereby reduce its incentive to coordinate its market behaviour with other firms in the market. Efficiencies may therefore lead to a lower risk of coordinated effects in the relevant market.

In general, the later the efficiencies are expected to materialise in the future, the less weight the Commission can assign to them. This implies that, in order to be considered as a counteracting factor, the efficiencies must be timely.

The incentive on the part of the merged entity to pass efficiency gains on to consumers is often related to the existence of competitive pressure from the remaining firms in the market and from potential entry. The greater the possible negative effects on competition, the more the Commission has to be sure that the claimed efficiencies are substantial, likely to be realised, and to be passed on, to a sufficient degree, to the consumer. It is highly unlikely that a merger leading to a market position approaching that of a monopoly, or leading to a similar level of market power, can be declared compatible with the common market on the ground that efficiency gains would be sufficient to counteract its potential anti-competitive effects (paras. 79-84). [emphasis added, footnotes omitted]

The approach outlined in the European Commission Merger Regulation and in the guidelines is a departure from the approach taken in the previous regulation, Regulation 4064/89.¹⁰⁵ This regulation contained no explicit reference to efficiency gains, although there was a limited legal basis that permitted the Commission to take efficiency considerations into account.¹⁰⁶ In practice, the Commission was generally reluctant to do so and, in some cases, was criticized for being hostile to efficiencies.¹⁰⁷

United Kingdom

In June 2003, the Enterprise Act, 2002 was passed, significantly reforming the U.K.'s competition legislation, including the merger review regime. Merger review in the U.K. under Part III of the Enterprise Act happens in two stages. First, the Office of Fair Trading (OFT) determines whether a merger should be referred to the Competition Commission, an independent body whose members have expertise in the area of competition or related fields of law, economics, accountancy and business.¹⁰⁸ Second, the Competition Commission reviews the merger and decides what steps should be taken to remedy, mitigate or prevent an anti-competitive outcome.

Appeals of final decisions (including decisions to refer cases to the Competition Commission) are heard by the Competition Appeals Tribunal, which was established under Part II of the Enterprise Act.

Merger Review Under the Enterprise Act

The Enterprise Act adopts a "substantial lessening of competition" test similar to that in the Canadian, U.S. and Australian (see below) competition legislation. This competition-based test differs from the previous test, which focussed on the public interest (although this was interpreted as a competition test in practice).

Under the Enterprise Act, the OFT has a statutory duty to refer "relevant mergers"¹⁰⁹ to the Competition Commission when it believes that "it is or may be the case" that the merger has resulted in, or may be expected to result in, a substantial lessening of competition.¹¹⁰ The OFT is not obliged to refer a merger to the Competition Commission in the following circumstances:

• the merger is insufficiently advanced to warrant a referral;
• the markets involved are of insufficient importance to warrant a referral; or
• the merger results in relevant customer benefits that outweigh both the substantial lessening of competition and any adverse effects of the lessening of competition that follow.¹¹¹

The OFT also has the discretion to accept undertakings from the parties in lieu of a referral (section 73).

The Competition Commission reviews a "relevant merger" under section 35 (completed mergers) or section 36 (proposed mergers) of the Enterprise Act, determining whether the merger has resulted in a substantial lessening of competition, or is expected to. When a merger is found to have substantially lessened competition, the Competition Commission then determines what remedies or action should be taken, and "may, in particular, have regard to the effect of any of its actions on relevant customer benefits arising from the merger" (sub-sections 35(5) and 36(4)).

The OFT published non-binding guidelines¹¹² to help firms and their advisors who are contemplating a merger understand its current policy and practice (para. 1.4) for applying the criteria it uses determines whether to refer a merger to the Competition Commission for further review and investigation.

Efficiencies in Merger Review

Referral Analysis by the Office of Fair Trading

According to the OFT’s merger guidelines, the OFT may consider efficiency gains resulting from a merger at two junctures during merger review (para. 4.29). First, the OFT may take efficiencies into account when assessing whether a merger has caused or risks causing a substantial lessening of competition. This is because efficiency gains can actually increase rivalry in a market so that no substantial lessening would result (para. 4.30). Second, efficiencies may be considered in the balancing analysis when the OFT determines whether the customer benefits from a merger outweigh the substantial lessening of competition and its effects (para. 4.31).

Merging parties often claim that efficiencies will result from their merger in the hopes that the OFT will consider those efficiency gains in its assessment of whether a merger substantially lessens competition. But the OFT will only consider such efficiency gains when the gains will have a positive effect on rivalry (para. 4.32). The guidelines defines efficiency gains broadly, and has stated that they may include the following:

...cost savings (fixed or variable), more intensive use of existing capacity, economies of scale or scope, or demand-side efficiencies such as increased network size or product quality. Efficiencies might also encompass pro-competitive incentives, for example by capturing complementarities, e.g. R&D activity, which in turn might increase incentives to invest in product development in innovation markets (para. 4.33). [footnotes omitted]

The guidelines articulate two scenarios in which rivalry among firms may be increased as a result of the efficiencies arising from a merger:

• when two small firms merge to better compete with a larger rival (countervail) in the market; and
• when a merger stimulates the merged entity to increase its investment in research and development to increase rivalry through an improved product (para. 4.32).

Efficiency gain that affect marginal or variable costs are more likely to influence the OFT in its analysis, since they are the type of gains likely to be passed on to customers in the form of lower prices, although the guidelines acknowledge that fixed cost savings may play an important role in long-term price formation and, in some cases, in short-term price formation (e.g. when competition takes place via auctions, and bids reflect both the fixed and variable costs of the tendered service) (footnote 27).

For the OFT to consider the efficiencies to improve competition, the efficiencies must be demonstrable, specific to the merger and likely to be passed on to consumers (para. 4.34). The guidelines outline these requirements in the following terms.

• First, demonstrable efficiencies are efficiencies that can be shown to arise clearly and are very likely to arise: prospective efficiency gains are more easily claimed than achieved.
• Second, efficiency gains must be a direct consequence of the merger, i.e. they must be merger-specific. The key issue is that the analysis is incremental analysis, so that efficiencies must be judged relative to what would have happened without the merger.
• Third, the OFT must also be satisfied that there will continue to be sufficient post merger rivalry within the market to ensure that the merged entity has an incentive not only to pursue the claimed cost savings but also to pass on to consumers a reasonable share of benefits.

To meet these criteria, parties claiming that pro-competitive efficiencies will result from their merger bear the burden of demonstrating that such efficiencies will arise, based on evidence that may include planning and strategy documents that show estimates and trace the origins of the cost savings, and objective accounting information (para. 4.35).

The provisions of the Enterprise Act that govern when the Office of Fair Trading must refer a case to the Competition Commission contain several exceptions to that obligation. One such obligation is when customer benefits outweigh a substantial lessening of competition. The Act describes customer benefits are as including the following:

(i) lower prices, higher quality or greater choice of goods or services in any market in the United Kingdom (whether or not the market or markets in which the substantial lessening of competition concerned has, or may have, occurred or (as the case may be) may occur); or

(ii) greater innovation in relation to such goods or services.

The customers to whom these benefits are expected to accrue are those of the merging parties or those in a chain beginning with customers of the merging parties, and may include future customers.¹¹³

Efficiencies are considered in this context, and there is no need for efficiencies to result in the enhancement of competition in the market at this stage in the analysis. For an efficiency gain to be considered an offsetting customer benefit, the merging parties must show that the merged entity will have a continuing incentive to pass at least a portion of benefits gained from the merger on to its customers (para. 7.8).

The guidelines set out the following three examples of benefits likely to be passed on to customers to offset the lessening of competition from a merger (para. 7.8).

• Lower prices . A merger may, despite leading to a substantial lessening of competition, give clear scope for large cost savings through a reduction in marginal costs of production. In these circumstances, the merged firm -- even if it is a monopolist -- is likely to pass on some of this reduction in the form of lower prices to its customers. ¹¹⁴
• Greater innovation . A merger might, in rare cases, facilitate innovation through R&D that could only be achieved thorough a certain critical mass, especially where larger fixed (and) sunk costs are involved. Exceptionally, the benefits likely to be passed through to customers from such innovation might outweigh the substantial lessening of competition.
• Greater choice or higher quality . One situation in which benefits of this kind might arise is where a merger increases the size of a network, and thus its value to customers.

The guidelines state that for efficiencies to be considered as a customer benefit, customers need to be better off with the merger than without, despite the fact that the OFT believes that the merger might substantially lessen competition (para. 7.10). The guidelines also acknowledge that it will be rare that the customer benefits resulting from efficiencies will offset a lessening of competition, since, ordinarily, the OFT would expect competition in the market to deliver lower prices, higher quality and greater customer choice (para. 7.10).

Although the OFT has assessed customer benefit arguments, to date it has never declined to refer a case to the Competition Commission based on the customer benefit exception.

Merger Analysis by the Competition Commission

The Competition Commission has its own set of merger guidelines,¹¹⁵ under which the Commission considers efficiencies in two stages: as a factor in the Commission's determination of whether there has been a substantial lessening of competition, and as a potential customer benefit taken into account in the Commission's decision on the appropriate remedy for an anti-competitive merger.¹¹⁶

The Competition Commission only considers efficiencies that enhance rivalry among remaining firms in the market in determining whether there is a substantial lessening of competition (para. 3.26). The Commission requires that the efficiencies considered be a direct consequence of the merger, and occur within a short period of time (para. 3.27).

Under the Enterprise Act, the Competition Commission may, when deciding the question of remedies, "[...] in particular, have regard to the effects of any action on any relevant customer benefits in relation to the creation of the relevant merger situation."¹¹⁷ The intention is that in designing a remedy, the Competition Commission should, to the extent possible, preserve the customer benefits arising from the merger (para. 4.45).

Section 30(1)(a) of the Enterprise Act states that customer benefits are limited to benefits in the form of the following:

(i) lower prices, higher quality or greater choice of goods or services in any market in the United Kingdom (whether or not the market or markets in which the substantial lessening of competition concerned has, or may have, occurred or (as the case may be) may occur); or

(ii) greater innovation in relation to such goods or services.

The Commission's guidelines cite the following examples of possible relevant customer benefits (paras. 4.41-4.44):

• lower prices attributable to economies of scale that reduce production costs;
• innovation enhanced by a merger through economies of scale, specialization in research and development and/or risk pooling;
• benefits for mergers in network industries, such as larger geographic scope or improved connections; and
• efficiencies created by vertical mergers, resulting in lower prices or improved quality.

The existence of any of these benefits may cause the Competition Commission to alter the remedy it would otherwise apply to mitigate the anti-competitive effects of a merger. Factors affecting whether the remedy will in fact be modified include "the size and nature of the expected benefit and how long the benefit is expected to be sustained [... and] whether as a result of the reduction of competitive pressure in the market, any immediate benefit to customers will be eroded in the future" (para. 4.45). The Competition Commission also considers the differing impacts of the merger on different customers (para. 4.45).

The Commission's guidelines acknowledge the possibility that the expected relevant customer benefits could "be of such significance as to lead the Commission to permit the merger without taking any action, notwithstanding that it has failed the SLC [substantial lessening of competition] test"(para. 4.45) (although the guidelines also state that "[i]t would not normally be expected that a merger resulting in an SLC would lead to benefits for consumers") (para. 4.35). However, the Commission may choose a course of action short of prohibition or complete divestment that "reduces the detrimental effects of the substantial lessening of competition while preserving all or most of the customer benefits" (para. 4.45).¹¹⁸ In lieu of making an order, the Competition Commission may also accept undertakings to reduce the effects of a substantial lessening of competition.

In a decision under the pre-Enterprise Act public interest regime to allow a merger of VNU and Book Data, the only two suppliers of commercial data and transaction services to the U.K. book industry, the Competition Commission appears to have been persuaded to permit the two-to-one merger due to a number of factors, including both productive and dynamic efficiencies. With regard to dynamic efficiencies, in response to concerns raised about the disappearance of competition in the bibliographic data market, the Commission stated that, "[t]he merger offers the prospect of some benefits, particularly from the expectation that the merged entity will be better able to fund investment in improving and developing its products than either VNU or Book Data was able to previously." ¹¹⁹

Australia

In Australia, the federal Trade Practices Act, 1974, governs competition and all aspects of the marketplace. The Australian Competition and Consumer Commission (ACCC) administers and enforces the Act, including the merger provisions. The Australian Competition Tribunal has the power to review certain ACCC decisions. The Federal Court of Australia also has specific enforcement and remedial powers under the merger provisions of the Act.

There are two distinct processes relevant to merger review under the Trade Practices Act. The first involves the assessment of whether a merger substantially lessens competition in a substantial market in Australia, within the meaning of section 50. The second involves the consideration by the ACCC of an "application for authorisation" under section 88, to determine whether a potentially anti-competitive agreement or practice, including a merger, that substantially lessens competition may be permitted to proceed because it will result in a sufficient public benefit.

Each of these processes is outlined in detail below.

Review of Whether a Merger Substantially Lessens Competition

Section 50 of the Trade Practices Act sets out the threshold for merger challenges, stating the following:

(1) A corporation must not directly or indirectly:

(a) acquire shares in the capital of a body corporate; or
(b) acquire any assets of a person;

if the acquisition would have the effect, or be likely to have the effect, of substantially lessening competition in a market.

(2) A person must not directly or indirectly:

(a) acquire shares in the capital of a corporation; or
(b) acquire any assets of a corporation;

if the acquisition would have the effect, or be likely to have the effect, of substantially lessening competition in a market.

The word market refers in this provision to a substantial market for goods or services in Australia, a state or territory, or a region of Australia. A lessening of competition includes preventing or hindering competition. Sub-section 50(3) contains a non-exhaustive list of factors that the ACCC must take into account when determining whether there is a substantial lessening of competition, as follows:

50(3)(a) the actual and potential level of import competition in the market;

(b) the height of barriers to entry to the market;

(c) the level of concentration in the market;

(d) the degree of countervailing power in the market;

(e) the likelihood that the acquisition would result in the acquirer being able to significantly and sustainably increase prices or profit margins;

(f) the extent to which substitutes are available in the market or are likely to be available in the market;

(g) the dynamic characteristics of the market, including growth, innovation and product differentiation;

(h) the likelihood that the acquisition would result in the removal from the market of a vigorous and effective competitor;

(i) the nature and extent of vertical integration in the market.

Section 50A is a parallel provision to section 50 that applies to acquisitions of controlling interests made outside Australia (i.e. indirect acquisitions of control). The criteria in section 50(3) also apply to mergers reviewed under section 50A.¹²⁰

The ACCC has jurisdiction to determine whether a proposed merger would likely breach section 50, in what is known as an informal review process. Most proposed mergers are cleared with the ACCC on a voluntary basis, prior to implementation. When the ACCC finds that a merger is likely to breach section 50, it may ask the parties to abandon the merger or to agree to court enforceable undertakings to address the substantial lessening of competition. When the parties do not agree to modify or abandon the merger, the ACCC has exclusive jurisdiction to apply to the Federal Court for an injunction or, when the transaction has closed, to challenge the merger.

In rare cases when the ACCC determines that a completed merger has substantially lessened competition, it may pursue penalties in court against those involved, and may also apply to the Federal Court for a divestiture order.¹²¹

Applications for Authorization on Public Benefit Grounds

The authorization process under the Trade Practices Act reflects the policy that the public interest may not always be met by the operation of competitive markets.¹²² The process allows the ACCC to grant exemptions from many of provisions of the Act. Authorization confers immunity from court action.

Authorization applies to a range of transactions and trade practices, including agreements that substantially lessen competition, covenants affecting competition, primary and secondary boycotts, anti-competitive exclusive dealing, resale price maintenance and mergers that substantially lessen competition.¹²³ Only a small percentage of applications for authorization relate to mergers (on average one merger application every year or two).

Sub-section 88(9) of the Act sets out the authorization process for mergers and specifies that, while an authorization remains in effect, sections 50 and 50A do not apply to mergers. Sub-sections 90(9) and 90(9A) provide the test for authorising a merger. These provisions read as follows:

90 (9) The Commission shall not make a determination granting an authorisation under subsection 88(9) in respect of a proposed acquisition of shares in the capital of a body corporate or of assets of a person or in respect of the acquisition of a controlling interest in a body corporate within the meaning of section 50A unless it is satisfied in all the circumstances that the proposed acquisition would result, or be likely to result, in such a benefit to the public that the acquisition should be allowed to take place.

(9A) In determining what amounts to a benefit to the public for the purposes of subsection (9):

(a) the Commission must regard the following as benefits to the public (in addition to any other benefits to the public that may exist apart from this paragraph):

(i) a significant increase in the real value of exports;
(ii) a significant substitution of domestic products for imported goods; and

(b) without limiting the matters that may be taken into account, the Commission must take into account all other relevant matters that relate to the international competitiveness of any Australian industry.

The Role of Efficiencies in the Merger Review and Authorization Processes

The ACCC’s merger guidelines, last updated in 1999, outline the ACCC’s enforcement policy for dealing with mergers under the Trade Practices Act. The guidelines include the factors the ACCC considers when reviewing mergers under section 50, and in connection with the authorization process under sub-sections 88(9) and 90(9). The guidelines are neither legally binding nor determinative of breaches of the Act; however, they contain references to court and Competition Tribunal decisions that are legally binding, and inform the ACCC’s enforcement position.

Section 50 Analysis

Given the availability of the authorization process, in which efficiencies are a primary focus, limited scope is given to efficiencies as a factor in the analysis of whether a merger substantially lessens competition for purposes of section 50 of the Trade Practices Act. The merger guidelines state that efficiencies may be considered as a factor when determining whether a merger substantially lessens competition, but only insofar as they enhance competition in the market (para. 5.171). The guidelines state that efficiencies generally arise as a question of public benefit in an application for authorization under sub-sections 88(9) and 90(9) (para. 5.16 and 5.171). The ACCC directs parties that wish to rely on efficiencies as a primary argument to do so as part of an application for authorization.

The guidelines outline two types of efficiencies that are most likely to have positive impact on competition: efficiencies that create “a new or enhanced competitive constraint on the unilateral conduct of other firms in the market [… or] undermine the conditions for coordinated conduct” (para. 5.172) and efficiencies that are “likely to result in lower (or not significantly higher) prices, increased output and/or higher quality goods or services […]” (para. 5.173).

The guidelines also cite with approval a U.S. Federal Trade Commission publication that emphasizes that consumer benefits are a relevant consideration in the assessment of efficiencies, as follows:

The weight and significance accorded to different types of efficiencies should be a function of their magnitude and probability, the degree to which they likely will enable the merged firm not only to be a better competitor but to enhance (or not lessen) competition and thus benefit consumers, and the delay with which these consumer benefits are to be realized.¹²⁴

Section 90(9) Applications for Authorization

As noted previously, the authorization process applies to a variety of practices and transactions, with mergers only accounting for a small percentage of these. Parties to a merger only apply for authorization when they believe they can satisfy the onus of establishing that the proposed¹²⁵ merger will result in a “net public benefit,” and when they are willing to expose their merger to public review (including registration of their merger, consultations, publication of the draft public interest decision, and, sometimes, conferences).

After an application for authorization is filed, the ACCC consults interested parties and conducts a balancing analysis in which it weighs detriments against benefits to determine whether an overall net public benefit exists.

The Trade Practices Act does not define the term public benefit. The only mandatory factors that the ACCC is required to consider as public benefits are those specified in sub-section 90(9A): “(i) a significant increase in the real value of exports; and (ii) a significant substitution of domestic products for imported goods.” The general interpretation of the term benefit arises from the Competition Tribunal’s decision in one particular case, which describes a benefit as “[…] anything of value to the community generally, any contribution to the aims pursued by the society including as one of its principal elements […] the achievement of the economic goals of efficiency and progress,” accruing to the Australian public.¹²⁶ The ACCC and the Tribunal have recognized a range of public benefits of an economic nature, including economic development of natural resources, fostering business efficiency, industrial harmony, industry rationalization resulting in more efficient resource allocation and lower unit production costs, increased employment, assistance to efficient small business, improvement in the quality or safety of goods, supply of better information to consumers, promotion of equitable dealing and import replacement.¹²⁷

The ACCC and Tribunal have also considered various non-economic benefits, including environmental protection, public safety, facilitating deregulation and promoting fitness and recreation, among other things, to be public benefits.¹²⁸

The guidelines state that the public benefits that are most important in applications for merger authorization are those that give rise to increased efficiency and better resource usage, resulting in lower unit costs (para. 6.39). These may comprise economies of scale and scope, more efficient technology resulting in reduced input or energy costs, or combined complementary research and development facilities (para. 6.39). Efficiencies are also a primary consideration in applications for authorization of strategic alliances.

Mergers that only result in a wealth transfer rather than resource savings for the community are not considered to have independent public benefit.¹²⁹ The ACCC has acknowledged, however, that when cost savings or efficiencies arise from countervailing power created by a merger, they may actually enhance competition and therefore be relevant to the analysis (para. 6.40).

Public detriments must also be weighed against public benefits. Although anti-competitive effects are the primary consideration, the notion of public detriments also takes other detriments into account (para. 6.32).

While there is no requirement that efficiencies generated by a merger be passed on to consumers, efficiencies that flow through to consumers seem to carry greater weight than others. For example, in a case involving an application by Qantas and Air New Zealand for authorization of a strategic alliance, the ACCC wrote the following:

[w]here benefits are not passed on to consumers this may be symptomatic of a lack of competitive pressure that would otherwise cause such benefits to endure and be passed through. Such benefits are likely to be accorded a lower weight by the Commission.¹³⁰

In the Howard Smith case, the Competition Tribunal found the following:

If a merger is likely to result in the achievement of economies and a considerable cost saving in the cost of supplying a good or service this might well constitute a substantial benefit to the public, even though the cost saving is not passed on to consumers in the form of lower prices. Nevertheless, if such a merger benefited only a small number of shareholders of the applicant corporations through higher profits and dividends, this might be given less weight by the Tribunal, because the benefits are not being spread widely among members of the community.¹³¹

In the Australian Pharmaceutical case, the ACCC denied an application for authorization, concluding that efficiencies would likely “be retained by the merged entity for its benefit, and the benefit of its shareholders.” ¹³²

Allan Fels, a former chairman of the ACCC, has expressed a view on the applicable standard by which efficiencies are assessed in Australia, writing, “[w]hile cost savings from productive efficiencies are regarded as a benefit there is some bias to consumer surplus.”¹³³ Based on a review of the cases in which authorizations have been considered, Fels drew a number of conclusions:

• Anti-competitive effects in some areas that are outweighed by the benefits or efficiencies from rationalization and increased competition generated by the merger that apply in wider areas justify the granting of authorization.
• Productive efficiencies, which enhance competitiveness and are likely to be passed on to consumers, have been accepted as public benefits to justify authorization.
• International competitiveness has been accepted as a reason to allow mergers when that benefit exceeds the anti-competitive detriment. Such a benefit is closely scrutinized and is not accepted, when it cannot be substantiated.
• The anti-competitive effect is taken very seriously when weighing the detriments against claimed benefits.¹³⁴

While it may be theoretically possible for a merger to monopoly to proceed under the authorization process in Australia,¹³⁵ the likelihood of a public benefit being so substantial to justify it is very slim. The ACCC has never authorised a merger to monopoly based on public benefit considerations (although mergers to effective monopoly have been permitted to proceed based on the strong threat of import competition).¹³⁶ Also, the ACCC gives x-inefficiency¹³⁷ considerable weight in its efficiency analysis, and it would likely be a primary factor in defeating a merger to monopoly.

The ACCC is currently updating its guidelines on public benefit authorizations. The guidelines are available on the ACCC Web site (www.accc.gov.au).

---

89. §7 Clayton Act, 15 U.S.C. § 18.

90. 370 U.S. 294 (1962), p. 344.

91. Ibid.

92. 374 U.S. 321 (1963).

93. For a detailed discussion of the efficiency-related portions of this case, refer to R. Schlossberg, ed., Mergers and Acquisitions: Understanding the Antitrust Issues, 2nd ed. (American Bar Association Publishing, 2004), pp. 179–180. See also the discussion of this case in FTC v. University Health Inc., 938 F. 2d (11^th Circ. 1991), p. 1222.

94. FTC v. Procter & Gamble Co. 386 U.S. 568 (1967), p. 580. In the same vein, refer also to the U.S. Supreme Court’s decision in U.S. vs. Philadelphia National Bank, n. 31, p. 371.

95. Schlossberg, n. 93, p. 185.

96. FTC v. University Health Inc., n. 93, p. 1222, note 29. In U.S. v. Country Lake Foods, Inc., 754 F. Supp. 669 (D. Minn. 1990), pp. 675–680, efficiencies were one of several factors taken into account in determining that the government was not likely to succeed in a merger challenge

97. Schlossberg, n. 93, pp. 187–188.

98. Ibid, p. 191 and the cases discussed on pp. 191–195.

99. 2001-1 Trade Cas. (CCH) P73, 243 (U.S. Court of Appeals for the District of Columbia).

100. U.S. Department of Justice, Merger Guidelines (1984), reprinted in Antitrust & Trade Regulation Report 4 (CCH) 13,103, as discussed in W. J. Kolasky and A. R. Dick, “The Merger Guidelines and the Integration of Efficiencies in Antitrust Review of U.S. Mergers,” Antitrust Law Journal 71(207) (2003), pp. 220–222, at p. 219. This paper contains a comprehensive review of the treatment of efficiencies over time in U.S. enforcement practice.

101. U.S. Department of Justice and Federal Trade Commission, Merger Guidelines (1992), with April 2, 1997 revisions to section 4, “Efficiencies,” reprinted in Antitrust & Trade Regulation Report 4 (CCH) 13,104.

102. Council Regulation (EC) No. 139/2004 of 20 January 2004 on the control of concentrations between undertakings, O.J. L 24/1.

103. The Commission’s decisions on competition matters may be appealed to the European Court of First Instance (and further appealed to the European Court of Justice), but appeals rarely occur.

104. This guidance is contained in the Commission’s Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings, 2004/C 31/03, O.J. C 31/5 (5.2.2004).

105. Council Regulation 4064/89/EC (as amended), OJ L780/97, erratum in OJ L 40/98.

106. The language in section 2(1)(b) of Regulation 4064/89, in particular the requirement that the Commission consider “the development of technical and economic progress provided that it is to consumers’ advantage and does not form an obstacle to competition,” provided a legal basis for the consideration of efficiency gains. This language is also part of the new European Commission Merger Regulation, and is explicitly referred to in the efficiencies section of the guidelines.

107. For a detailed discussion of how efficiencies were treated under the old European Commission Merger Regulation, refer to A.-B. Everett and T. W. Ross, The Treatment of Efficiencies in Merger Review: An International Comparison, n. 2, pp. 46–59.

108. The Enterprise Act significantly diminishes the Secretary of State’s involvement in the merger review process. The Secretary of State retains a very limited parallel power to refer special merger cases to the Competition Commission, including those involving newspapers and the public interest.

109. A relevant merger, as defined in section 23, is one in which the parties cease to operate as distinct entities, and the target’s annual turnover (i.e. revenue) in the U.K. exceeds £70 million, or is one that will result in the merged entity supplying one quarter of goods or services in a market.

110. Enterprise Act, section 22 (completed mergers); section 33 (proposed mergers).

111. Enterprise Act, sub-section 22(2) (completed mergers); sub-section 33(2) (proposed mergers).

112. This and all subsequent references in this section come from Office of Fair Trading, Mergers — Substantive Assessment Guidance (May 2003), unless otherwise indicated.

113. Enterprise Act, section 30(4) (relevant customers); Office of Fair Trading, merger guidelines, para. 7.9.

114. Footnote 34 of the guidelines specifies that this is because a reduction in the monopolist’s marginal costs will, assuming no change in the demand curve (or marginal revenue curve), increase its profit-maximizing level of output, leading to a reduction in price.

115. This and all subsequent references in this section come from Competition Commission, Merger References: Competition Commission Guidelines (June 2003), unless otherwise indicated.

116. Enterprise Act, sub-sections 35(5) and 36(4) (remedies).

117. Ibid.

118. The guidelines provide the example of a remedy designed to facilitate or encourage competition from other firms or new entrants.

119. Competition Commission: A report on the acquisition by VNU Entertainment Media UK Limited of Book Data Limited (07/03/03), para. 2.131. Refer also to the Summary of Report, which states the following: “The substantial cost savings available from the merger, as a result of the elimination of duplicated costs, help to explain why two competing suppliers would have difficulty in earning an adequate return in this market.”

120. References in this section of the appendix to merger review under section 50 of the Trade Practices Act should be understood to include merger review under section 50A as well.

121. Note that private parties can also apply to the Federal Court for a declaration and a divestiture or, when suffering losses due to a section 50 breach, apply for damages. (Australian Competition and Consumer Commission Merger Guidelines (1999), p. 2).

122. Allan Fels AO, The Public Benefit Test in the Trade Practices Act 1974, paper prepared for the National Competition Policy Workshop, Melbourne, Australia (July 12, 2001), p. 1. For a comprehensive overview of the authorization process in its historical context, see Allan Fels AO and T. Grimwade, “Authorisation: Is it still relevant to Australian competition law?” Competition and Consumer Law Journal 11 (2003), p. 187.

123. Fels, The Public Benefit Test, ibid, pp. 2–3.

124. Para. 5.17 of the merger guidelines, citing Anticipating the 21^st Century: Competition Policy in the New High-Tech, Global Marketplace, Volume 1, A Report by the Federal Trade Commission Staff, Antitrust & Trade Regulation Report 70(1765), Special Supplement (June 6, 1996), p. S-36.

125. Note that according to para. 6.5 of the merger guidelines, parties may not seek authorization for an acquisition that has already occurred.

126. Re Queensland Co-operative Milling Association Ltd and Defiance Holdings Ltd (1976), ATPR 40–012, p. 17,245..

127. Fels, The Public Benefit Test, n. 61, pp. 6–7.

128. Ibid, pp. 7–9.

129. Wattyl (Australia) Pty Ltd, Courtaulds (Australia) Pty Ltd & Ors. (1996), ATPR 50–232.

130. Acquisition by Qantas Airways Limited of ordinary shares in Air New Zealand Limited and cooperative arrangements between Qantas, Air New Zealand and Air Pacific Limited (September 9, 2003), available at the ACCC Web site ( www.accc.gov.au/authAndNotif/currauth_docs/q_air_nz_final_det.pdf), para. 13.65.

131. Re Howard Smith Industries Pty Ltd (1977), ATPR 40–023, p. 17,334.

132. A.-B. Everett and T. Ross, n. 2, citing Re Australian Pharmaceutical Industries limited and Sigma Company Limited, A30215, (September 11, 2002).

133. Allan Fels AO, Merger Law in Australia, paper prepared for the Analytical Framework Sub-Group of the International Competition Network Working Group (September 11, 2002), p. 7.

134. Ibid, p. 9.

135. A.-B. Everett and T. Ross, n. 2, pp. 43–44, conclude that “the elimination of competition in one or more markets may be allowed if the associated efficiencies enable the merged firm to better compete in other markets, either domestically or internationally.” Everett and Ross base this conclusion on a review of relevant case law and a 2002 speech in which ACCC Commissioner Ross Jones stated that in granting authorization, the ACCC “is allowing firms to substantially lessen competition, and thereby gain substantial market power, even monopoly power.”

136. See, for example, ACCC not to oppose Caroma’s Fowler acquisition, press release (March 26, 1997), available on the ACCC’s Web site (www.accc.gov.au/content/index.phtml/itemId/87131/fromItemId/378004 ).

137. X-inefficiency typically refers to the difference between the maximum (or theoretical) efficiency achievable by a firm and the actual efficiency attained.