The Treatment of Efficiencies in Merger Review: An International Comparison

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3 The European Union

3.1 General Background

Ever since the establishment of the European Coal and Steel Community (ECSC) in April 1951 competition policy has been a central feature of European Union (EU) policy. This was reinforced in the Treaty Establishing the European Economic Community (EEC, now EC Treaty, as it will be titled throughout this report) in Rome in March 1957, which came into force in 1958. The ECSC Treaty had already contained competition rules regarding mergers, which remain in force when one or more undertakings in the coal or steel industry merge, ECSC Treaty Article 66, meaning that mergers are subject to prior authorisation by the Commission. The ECSC Treaty is still active (although officially scheduled to come to an end in 2002)⁹⁴ and runs alongside the European Atomic Energy Community and EC. Therefore, when competition issues arise in the area of either ECSC or EAEC, the EC Treaty is still applicable except when pre-empted by express lex specialis provision in the Treaties.⁹⁵

The EC Treaty did not include regulation of mergers because, at the time of implementation, Europe's industry was rather fragmented (after the Second World War), and concentrations were perceived as a means to integrate Europe.⁹⁶ By the mid 1970's debate began regarding the desirability of including mergers into the Treaty or whether to provide a separate legislation by way of a Council Regulation. Ultimately, the review of mergers was provided for in the Merger Regulation in 1989.⁹⁷

3.2 Merger Review Process

The Merger Regulation adopts a dominance test. Under Article 2 (3), a merger will be prohibited if it creates or strengthens a dominant position: ⁹⁸

Article 2 (3): A concentration which creates or strengthens a dominant position as a result of which effective competition would be significantly impeded in the common market or in a substantial part of it shall be declared incompatible with the common market.

A merger within the meaning of Article 3(1)(a) of the Merger Regulation occurs when two or more independent undertakings amalgamate into a new undertaking and cease to exist as separate legal entities. ⁹⁹

The Commission has sole competence to make any decisions for which the Merger Regulation provides.¹⁰⁰ Cases determined by the Commission are subject to review by the Court of First Instance, and subsequently the Court of Justice, but on points of law only, according to Article 225(1) of the EC Treaty.

In order for the Commission to have jurisdiction over a concentration, the concentration in question must have Community dimension. The Merger Regulation sets forth thresholds, which will identify whether a merger is of Community dimension as defined in Article 1 (2) and (3). Community dimension is subject to two tests. The first test is that the aggregate worldwide turnover of all the undertakings concerned must be more than ECU 5000 million, and the aggregate Community-wide turnover of each of at least two undertakings must be over ECU 250 million.¹⁰¹

If a merger does not come within the thresholds of this first turnover test, a second test is applied, under Council Regulation 1310/97, to establish whether the merger nevertheless is of Community dimension. These thresholds are met where:¹⁰²

• the combined aggregate worldwide turnover of all the undertakings concerned is more than ECU 2,500 million;
• in each of at least three Member States, the combined aggregate turnover of all the undertakings concerned is more than ECU 100 million;
• in each of those three Member States, the aggregate turnover of each of at least two of the undertakings concerned is more than ECU 25 million; and
• the aggregate Community-wide turnover of each of at least two of the undertakings concerned is more than ECU 100 million;
• unless each of the undertakings concerned achieves more than two-thirds of its aggregate Community-wide turnover within one and the same Member State.

Both tests are exempted if each undertaking achieves more than two-thirds of its aggregate Community-wide turnover within one and the same Member State, in which case the merger is surrendered to the competent authority in the Member State concerned.¹⁰³ This is referred to as the "one-stop shop" principle, which means that the Commission has exclusive competence to assess concentrations with Community dimension, and the merging undertakings need only make one notification within the Community.¹⁰⁴ It still leaves room for treatment of mergers by the Member State, when the great majority of the undertakings' turnover is generated only in that Member State.

Notification of a concentration with a Community dimension is mandatory within a week of the conclusion of an agreement or acquisition of a controlling interest pursuant to the Merger Regulation, Article 4(1).

The Commission's task in merger appraisals is to assess whether or not a merger is compatible or incompatible with the Common market, according to Article 2(1) of the Merger Regulation. Within one month¹⁰⁵ of the notification of a concentration, the Commission must assess and give notice whether the merger raises no competition questions, hence the merger is compatible with the Common market and can proceed,¹⁰⁶ or whether the concentration gives rise to serious doubt as to its compatibility,¹⁰⁷ in which case the Commission will investigate the merger further. The 'serious doubts' are aimed at the concentrations which "creates or strengthens a dominant position as a result of which effective competition would be significantly impeded", pursuant to Article 2 (3) of the Merger Regulation. The preamble to the Merger Regulation provides a "safe harbour": it provides that mergers with a post-merger market share of less than 25% are less likely to raise competition concerns.

In order to assess whether the initial doubts about the character of the merger are reasonable, the Commission launches an investigation that can last no longer than four months¹⁰⁸ after which time the Commission must render a decision.

Effective competition is defined as being significantly impeded if the merging firms are able to behave fairly independently of their remaining competitors, without losing market share, and there is a lack of potential entrants capable of eroding that position.¹⁰⁹ Thus, a dominant position is defined as the "power to behave to an appreciable extent independently of these competitors or to gain an appreciable influence on the determination of prices without losing market shares".¹¹⁰

While the degree of dominance is determined by more than a firm's market share, it is important to recognize that to be dominant under the Merger Regulation does not require that a firm have a monopoly or near-monopoly. A review of the cases and some of the Commission's writings suggests that dominance concerns can arise when market shares approach 50%.¹¹¹

3.3 Historical Context and Evolution of the Role of Efficiencies

As indicated, competition law has been a part of Community law since the coming into force of the EEC Treaty in 1958. The fact that competition law has a prominent place in the European Union is evident in the Preamble, where it is stated "that the removal of existing obstacles calls for concerted action in order to guarantee steady expansion, balanced trade and fair competition."¹¹² Also, the principles laid out in Part 1 of the Treaty gives the Community authorization and obligation to create "a system ensuring that competition in the internal market is not distorted", relative to Article 3(1)(g), in order to carry out the 'tasks' of Article 2.

The principles of the Treaty, as evidenced above, have an emphasis on integration to ensure the goals of the European Union, with the integration of the economies of the member states and protection of the internal market being front and centre. It is important to keep in mind the larger objectives of the European Union when examining EC Competition rules and other legislation.

Prior to the Merger Regulation's implementation in 1989, only two mergers¹¹³ had been considered pursuant to Art. 82 of the EC Treaty. The application of Article 82's monopolization provisions on mergers was very limited though as it only applied to mergers where one undertaking already held a dominant position. It did not permit consideration of cases in which a merger creates a dominant firm. It was also established that Article 81's restrictions on agreements between firms that lessen competition could be applied to mergers, though since the adoption of the Merger Regulation neither Article 81 nor 82 have been used for mergers.¹¹⁴

With formal merger review really only beginning a little over a decade ago, the historical evolution of efficiencies in mergers is not very developed. In fact, as will be seen, it is difficult to determine just what is the role of efficiencies in merger review in the EU

3.4 Definition and Measurement of Gains in Efficiency

The requirements for the assessment of mergers within the jurisdiction of the Commission are outlined in Article 2(1). This requires a broad market analysis involving, but not limited to:

"a) the need to preserve and develop effective competition within the common market in view of, among other things, the structure of all the markets concerned and the actual or potential competition from undertakings located either within or without the Community;

b) the market position of the undertakings concerned and their economic and financial power, the alternatives available to suppliers and users, their access to supplies or markets, any legal or other barriers to entry, supply and demand trends for the relevant goods and services, the interests of the intermediate and ultimate consumers, and the development of technical and economic progress provided that it is to consumers' advantage and does not form an obstacle to competition."

There is a serious question as to whether Article 2(1)(b) provides for an efficiency defence. Here, the phrase "development of technical and economic progress provided that it is to consumers' advantage and does not form an obstacle to competition" is the key. The Merger Regulation does not give any other guidance as to the meaning of the phrase, but the publication "Notes¹¹⁵ on Merger Regulation" refers to how the concept is understood in other parts of the EC Treaty, notably Article 81 (3) - suggesting that similar interpretations may be appropriate for mergers.

Economic and technical progress is also part of the assessment of block exemptions for agreements, which would otherwise have been prohibited pursuant to Article 81 (1) of the EC Treaty. Article 81 (1) prohibits agreements, which have the object or effect of preventing, restricting or distorting competition. These are typically concerted practices such as price fixing or market sharing. The exemption granted by Article 81 (3) will be given to an agreement "which contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit." This is apparently a broader set of efficiencies than that considered for mergers as it includes the phrase "improving the production or distribution of goods". Whether the Commission sees the kinds of relevant efficiencies as different in the two cases is not clear. Notice also that under Article 81(3) the agreement must not impose restrictions on the firms that are unnecessary to achieve the objectives, and must not give the firms the possibility of eliminating competition.

The Commission has published a notice on the applicability of Article 81 of the EC Treaty to horizontal agreements,¹¹⁶ which is a guideline to establish the principles for assessment of horizontal co-operation agreements that meet the requirements under Article 81(3).¹¹⁷ This may provide some guidance for the interpretation of the Merger Regulation. The notice defines economic and technical progress as static and dynamic efficiencies, which must be shown to stem from the co-operation agreement, and must not be attainable in a way that is less restrictive to competition. Also, efficiency claims must be substantiated, which means that general assertions about the economic benefits of the agreement are not sufficient. Claims of cost savings that arise from output reduction, market sharing, or mere exercise of market power will not be taken into account. An important criterion of the agreement is that if one of the participants to the agreement is, or becomes dominant as a consequence, and the agreement therefore prevents, distorts or restricts competition, the agreement cannot be exempted.¹¹⁸

The notice describes which kinds of efficiencies can be claimed, but the manner in which they are treated differ between agreements under Article 81(3) and the Merger Regulation. Under Article 81 (3) efficiencies are allowed to outweigh restrictive effects on competition as long as competition is not eliminated, and as long as consumers get "a fair share." Under the Merger Regulation, on the other hand, efficiencies must be to the "consumers' advantage". While it is certainly not obvious that this is a more difficult standard than the "fair share" standard, some commentators believe it is -- in fact that it implies that all efficiency gains must be passed on to the consumer. Whish (2001) is of this opinion, arguing that efficiencies under Article 81 (3) "can be used to 'trump' a restriction of competition, provided that the elimination of competition will not be substantial. Article 2 (1) of the Merger Regulation however seems to suggest that if competition would be affected at all, efficiency is not available as a trump card."¹¹⁹ In our view there is another possible interpretation of the "consumers' advantage" standard that sees it more like a consumers' surplus or price standard - after all, a merger that lowers prices or raises consumers' surplus even slightly would be to the "consumers' advantage" even if it created significant new market power in the process.

In its contribution to the 1996 OECD report,¹²⁰ however, the Commission makes it clear that it (in 1996 at least) does not see any kind of efficiency defence for mergers:

"there is no real legal possibility of justifying an efficiency defence under the Merger Regulation. Efficiencies are assumed for all mergers up to the limit of dominance - the 'concentration privilege'. Any efficiency issues are considered in the overall assessment to determine whether dominance has been created or strengthened and not to justify or mitigate that dominance in order to clear a concentration which would otherwise be prohibited."

In the same OECD paper¹²¹, the Commission also sees a greater role for efficiencies in Article 81(3) cases - defining the application of an efficiency defense under 81 (3) as a 'sliding scale'. Under the sliding scale the more competition is restricted, the higher the efficiency claims must be in order to grant an exemption. This is not the case for mergers, where efficiencies are assumed up to the limit of dominance. Efficiencies in mergers cannot justify or mitigate dominance.

This suggests that, with respect to mergers, the EU has adopted two of the strategies described in chapter 1: they have set high thresholds (dominance) before they intervene to assure that most mergers and their efficiencies will not be threatened; and they incorporate efficiency issues as part of the determination of whether the merger creates or strengthens dominance.

Concern that the Commission could view efficiencies as a bad thing probably stems from the Article 2(1)(b) qualification of the benefits of the "technical and economic progress" when this efficiency "does not form an obstacle to competition". This suggests that a merger generating efficiencies that make a superior competitor but hurt rivals might be disallowed, even if consumers benefit.

Case law is very limited on the treatment of efficiencies in merger cases. Griffin & Sharp (1996) speculate that the limited case law can be due to the lack of guidance from the Merger Regulation, the uncertainty of the effect of an efficiencies defence when dominance is found, and the general difficulties in quantifying efficiencies. Some commentators go so far as suggesting that even if there is reference to efficiency gains by parties to a merger the Commission does not "attempt to evaluate their significance, let alone to quantify their importance."¹²² Whish (2001) summarises the Commission's decisions in which efficiencies have been claimed, assigning them to three categories.

(i) the Commission determines that the merger does not create or strengthen a dominant position, and therefore considers evaluation of efficiencies is unnecessary;

(ii) the Commission renders determinations which, without much detail, dismiss the parties' efficiency claims; and

(iii) the Commission has found that efficiencies are not likely to be passed on to consumer and has not allowed the merger.

Most notably, the Commission had never concluded, that a merger could be cleared based on efficiencies, despite the creation or strengthening of a dominant position.

In a report commissioned by the Commission,¹²³ Ilzkovitz and Meiklejohn (2001) express quite a harsh view of the Commission's and the Merger Regulation's treatment of efficiencies, stating that the Merger Regulation and the case law are more consistent with an "efficiencies offense". First, they see significant differences due to the fact that the Merger Regulation, contrary to art. 81(3), only includes technical and economic progress - not improvements to production and distribution. The authors conclude that the omission of production and distribution improvements is a narrow construction of efficiencies to only include gains through innovation, which clearly are harder to measure than economies of scale. Second, the difference of the application of consumer welfare in art. 81(3) and the Merger Regulation makes the latter harder to interpret. In art. 81(3) a fair share must be passed on to the consumer - there is no such requirement in the Merger Regulation. The authors speculate that this could be interpreted in two ways. First, that any efficiency gains are sufficient (until dominance is achieved) or second, that all efficiency gains must be passed on to consumers (which would render a merger useless to the shareholders). Finally, the authors comment that requiring that technical and economic progress must not form an obstacle to competition, makes an efficiencies defense impossible, since gains in efficiency are likely to enhance the firms' market power. This is what the authors refer to as the 'efficiency offense'. Danish Crown/Vestjyske Slagterier is mentioned as the clearest case portraying the Commission's views:

"As far as those efficiencies are concerned, it should be noted that under Article 2(1)(b) of the Merger Regulation the Commission may take account of the development of technical and economic progress only to the extent that it is to consumers' advantage and does not form an obstacle to competition. The creation of a dominant position in the relevant markets identified above, therefore, means that the efficiencies argument put forward by the parties cannot be taken into account in the assessment of the present merger." ¹²⁴

Other commentators define the 'efficiency offense' as stemming from Commission decisions which appear to view efficiencies as amplifying the finding of a dominant position. That is, efficiencies can be viewed as giving the merged firm an advantage over other firms in the market, which could allow the merged firm to abuse that position.¹²⁵ Although efficiencies were dismissed as being insignificant in de Havilland¹²⁶ (see also below), the Commission concluded that efficiencies along with a dominant position would likely result in the merged firm adopting a predatory pricing strategy to force the remaining competitors off the market.

Ilzkovitz and Meiklejohn's views are stronger than most other commentators on this topic, but illustrate the range of opinions on these questions. At the other end of the spectrum, Commissioner Monti, while implicitly agreeing that no efficiency defence exists, disagrees with the suggestion that there is an "efficiencies offense":

"Many respondents consider that the Commission should, as part of a sound economics-based merger control policy, take efficiencies into account in conducting its analysis of the overall effects likely to be produced by a proposed merger. In other words, they consider that there should be an "efficiency defence" that could mitigate a finding of dominance. I share this approach? I have said this before, but let me clarify it once and for all: there is no such thing as a so-called "efficiency offence" in EU merger control law and practice."¹²⁷

3.5 The Methodology and Welfare Standard Employed

In the EU, claimed efficiencies must be to the consumers' advantage, pursuant to Article 2 (1)(b). However, it is uncertain whether this means that all progress must be passed onto the consumers in a lower price, or whether it means that price cannot rise due to the merger. As will be shown below, in the EU case law, it does not appear that claiming efficiencies can be considered a defence for a merger that hinders competition. Even if progress were to be passed on to consumers, it is highly unlikely that a merger that creates or strengthens a dominant position would be allowed based on claimed efficiencies. This approach is consistent with the consumers' surplus standard or the price standard as defined in Chapter 1 above.

3.6 Efficiencies Gains and Consumers

From the case law it appears that claims of efficiencies must benefit the consumer, either through lower prices, increased product choice or improved product quality.

It is said directly in the Merger Regulation art. 2(1)(b) that technical and economic progress must be to the consumers' advantage, and in cases the Commission has looked for evidence that consumers will benefit. In de Havilland¹²⁸ the Commission found the claimed efficiencies to be insubstantial (0.5%), and found that even if such gains existed, it was not proved that it would be to the consumers' benefit. Rather, the gains in efficiencies could help strengthen a dominant position. De Havilland concerned Aerospatiale's (a French company) and Alenia's (an Italian company) joint acquisition of de Havilland. Aerospatiale and Alenia together were the world's largest regional aircraft manufacturer, and de Havilland, the second largest. The acquisition would have given the merged firm a world market share of 50%, with the nearest competitor holding only a 19% share. The Commission also concluded that the merger would significantly reduce the consumer's choice of products on the market. The merger was blocked, and created a lot of discussion regarding the Commission's market definition, which some thought was too narrow.

Accor/Wagon-Lits¹²⁹ concerned the merger of freeway restaurant services. The efficiencies claimed were related to improved training of personnel and modernization, which the Commission found were insufficiently proven. Efficiencies would also have been insufficient to overcome any anticompetitive concerns, and due to inelasticity of demand of the services, the benefits would not likely have been passed on to consumers. The merger was ultimately allowed subject to undertakings.

3.7 Merger Specificity and Attainability in a Less Anti-competitive Manner

It appears that the EU clearly demands that efficiencies be merger specific, and that they not be attainable in a less anti-competitive manner.

In de Havilland¹³⁰ the claimed efficiencies were not considered to be merger specific, and the Commission concluded that they would be attainable through other means.

Nordic Satellite Distribution¹³¹ concerned a joint venture for the distribution of satellite television to the Nordic area. The joint venture was prohibited although it created significant efficiencies. It was decided that the efficiencies could be achieved in a less anti-competitive manner.

Mercedes-Benz/Kassbohrer¹³² was a merger between bus manufacturers, which ultimately was allowed conditional on certain undertakings. The Commission briefly rejected efficiencies, because it was not sufficiently proven that they were a result of the merger.

3.8 Whether Gains in Efficiencies can "Justify/Offset" the Elimination or Near Elimination of Competition

Gains in efficiencies cannot justify or offset the elimination of effective competition. Dominance is the upper limit on limits to competition. If dominance is the consequence of a merger, the merger will not be allowed, regardless of any efficiencies. In MSG Media Service¹³³ an efficiency claim was rejected because the joint venture would create a dominant position. The joint venture merged three large German companies providing digital pay television. The Commission stated that regardless of contributions to technical and economic progress, no obstacle must be formed to competition.

In many cases, where the Commission denies the merger due to a creation of dominance, the issue of efficiencies are never raised, or at least never reported in the case summaries.

3.9 Policy Statements or Guidelines on the Treatment of Gains in Efficiency in the Review of Mergers

The Green Paper on the Merger Regulation of 11.12.2001 opens up a discussion of review of efficiencies claims in the Merger Regulation. The Commission, as noted above, acknowledges the lack of emphasis on efficiencies in merger cases so far, and that the "precise scope for taking such consideration into account may not have been fully developed."¹³⁴ The Commission supports ongoing debate on how, and to which extent, efficiencies should be incorporated into EU competition policy, but it seems rather unlikely that there will be any decisions in this regards in the near future. In the same report the Commission discusses the implications of switching from the dominance test to a substantial lessening of competition test, as it is used in Canada, the United States and Australia. One argument for changing to a substantial lessening of competition test is the rise in mergers that affects multiple jurisdictions around the world, and calls for closer co-operation between competition authorities. Using the same test would make the co-operation easier.¹³⁵

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⁹⁴ ECSC Article 97. It is still unknown what will happen to the Treaty, whether it will be renewed or simply be incorporated into the EC Treaty.

⁹⁵ Lane (2000), p. 21.

⁹⁶ Lane (2000), p. 256-7.

⁹⁷ Council Regulation 4064/89 as amended by Council Regulation 1310/97.

⁹⁸ Council Regulation (EEC) No 4064/89 of 21 December 1989 on the control of concentrations between undertakings (hereinafter called the Merger Regulation). See appendix B for the full text of Article 2 of the Merger Regulation.

⁹⁹ Commission Notice on the concept of concentration, para. 6.

¹⁰⁰ Council Regulation 4064/89, Article 21(1).

¹⁰¹ Council Regulation 4064/89, Article 1(2)

¹⁰² See Rowley and Baker (2001), p. 17-18.

¹⁰³ Council Regulation 4064/89 Article 1(2) and (3), and Article 9.

¹⁰⁴ Community Merger Control, Green Paper on the Review of the Merger Regulation, 1996, p. 6.

¹⁰⁵ Council Regulation 4064/89, Article 10(1).

¹⁰⁶ Council Regulation 4064/89, Article 2(2) and 6(1b).

¹⁰⁷ Council Regulation 4064/89, Article2(3) and 6(1c), as amended by 1310/97.

¹⁰⁸ Council Regulation 4064/89, Article 10 (3)

¹⁰⁹ Brittan (1991), pp. 36-38.

¹¹⁰ Case No IV/M004 - Renault/Volvo, Date 07.11.1990.

¹¹¹ OCDE/GD(96)65, p. 54. The minimum threshold for dominance may be lower. Griffin and Sharp (1996) p. 664 report the view that a market share of 40% may be sufficient to raise suspicions of dominance.

¹¹² EC Treaty Preamble

¹¹³ See Europemballage and Continental Can v. Commission (6/72), ECR 215 and Commission Decision in Tetra Pak I, 26.7.1988, L 272/27.

¹¹⁴ Rowley and Baker (2001), pp. 17-44.

¹¹⁵ Notes on Council Regulation 4064/89, http://www.europa.eu.int./comm/competition/mergers/legislation/regul ation/notes.html

¹¹⁶ Commission Notice: Guidelines on the applicability of Article 81 of the EC Treaty to horizontal cooperation agreements (2001/C 3/02). Published in the Official Journal C 3 of 06.01.2001, p. 2

¹¹⁷ See Commission Regulations 2658/2000, the specialization block exemption Regulation and 2659/2000, the R & D block exemption Regulation.

¹¹⁸ Commission Notice (2001/C 3/01), para. 36.

¹¹⁹ Whish (2001), pp. 778-779.

¹²⁰ OCDE/GD(96)65 "Competition Policy and Efficiency Claims in Horizontal Agreements".

¹²¹ OCDE/GD(96)65 "Competition Policy and Efficiency Claims in Horizontal Agreements", p. 53.

¹²² Nevens, Papandropoulous & Seabright (1998), p. 106.

¹²³ Ilzkovitz & Meiklejohn (2001), pp. 13-15.

¹²⁴ Commission Decision 2000/42/EC of 9 March 1999 (OJ L 20, 25.1.2000).

¹²⁵ Frédéric Jenny (a member of the French Competition Council) expressed the view that "not only is there no 'efficiency defense' in EEC Merger Regulation, but?there can be cases of 'efficiency attack'". Jenny (1992) p. 597.

¹²⁶ Aerospatiale-Alenia/de Havilland, Commission Decision 91/619/EEC of October 2nd 1991.

¹²⁷ Monti (2002) in speech at the conference on Reform of European Merger Control.

¹²⁸ Aerospatiale-Alenia/de Havilland, Commission Decision 91/619/EEC of October 2nd 1991.

¹²⁹ Case No. IV/M.126, 1992 O.J.. (L2041) 1; 5 C.M.L.R. M13 (1993).

¹³⁰ Aerospatiale-Alenia/de Havilland, Commission Decision 91/619/EEC of October 2nd 1991.

¹³¹ Case No. IV/M.490, 5 C.M.L.R. 258 (1995).

¹³² Case IV/M.477 (Feb. 14, 1995), (1995) O.J. L211/1.

¹³³ Case No IV/M.469 - MSG Media Service, para. 100-101.

¹³⁴ Green Paper on the Review of Council Regulation (EEC) No 4064/89, Brussels, 11.12.2001, COM(2001) 745/6 final, para. 170.

¹³⁵ Green Paper on the Review of Council Regulation (EEC) No 4064/89, Brussels, 11.12.2001, COM(2001) 745/6 final, para. 159-169.