The Treatment of Efficiencies in Merger Review: An International Comparison - Chapter 5: United States

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5 United States

Antitrust enforcement, including the review of mergers, is a complex business in the United States. Mergers may be held illegal under section 7 of the Clayton Act of 1914 (amended in 1950) where they may substantially lessen competition. In addition, notification of mergers is required under the Hart-Scott-Rodino Act of 1976 (HSR Act). What makes the US system particularly complex is that mergers can be challenged by a number of different parties: either of the two separate federal agencies -- the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC) -- state attorneys-general or affected private parties. Jurisprudence is also complicated by the fact that most adjudication is done by courts of various levels and from various districts which do not always share common views.

As a result, the U.S. system consists of a variety of case law from courts at all levels, in both matters prosecuted by the DOJ or FTC, but also in private matters, where damages can be substantial (treble damages). It is not uncommon for mergers that have not been challenged by the FTC or DOJ to be challenged by private plaintiffs or a state attorney-general, if the mergers are perceived to have local impact.¹⁶⁷ This section will focus primarily on the cases handled by the DOJ and the FTC, and their guidelines.

5.1 Merger Review Process

Mergers are subject to review under section 7 of the Clayton Act, which provides that mergers and acquisitions will not be permitted where the effect "may be substantially to lessen competition, or to tend to create a monopoly".¹⁶⁸

Notification is, as mentioned above, required under section 7A of the Clayton Act as amended by the HSR Act, when the acquiring person would hold an aggregate total amount of voting securities and assets of the acquired person in excess of $50 million. One of the parties must generally be engaged in interstate or foreign commerce in the U.S. Other thresholds apply when involving foreign firms acquiring US securities or assets.

Notification must be provided to both the DOJ and the FTC, who then between themselves decide which should have jurisdiction. After notification, the merger goes into a 30-day waiting period in which time the deal cannot be closed. If the agencies feel the need to further investigate the matter a second waiting period, also 30 days, is possible in which the agencies can request more information and documentation. When the waiting periods come to an end the parties are free to consummate the merger, although the agencies can warn the parties if a post-closing suit is likely.¹⁶⁹ The second request for information usually involves an enormous amount of information, which is why the 30-day period does not begin until all requested information is in the hands of the agency. This can hold up the process for long periods of time, and most mergers are cleared before the second request period.

If the investigating agency concludes that the merger is likely to substantially lessen competition, an injunction will be sought from the courts. For the DOJ, the appropriate court is the United States District Court, and for the FTC the appropriate court is a federal court. The injunction, if granted, will stop the merger from going ahead, until appropriate remedies or divestitures have been negotiated, or the agency has filed a suit to prohibit the merger. As soon as the merger has entered the courts, any agreements between the parties and the agency must be approved by the courts. In 2000, out of almost 5000 notifications to the DOJ and FTC only 87 went into the second request period, about half of those mergers were abandoned, and most of the rest were settled by consent decree.

5.2 Historical Context and Evolution of the Role of Efficiencies¹⁷⁰

The role of efficiencies in merger cases has evolved tremendously over the last four decades in the United States. There is no statutory efficiency defense in American competition law, but efficiencies have been analyzed in case law and discussed the Horizontal Merger Guidelines (the Guidelines). Recall that the competition test used in the US is the substantial lessening of competition test (or a tendency to monopolize) pursuant to section 7 of the Clayton Act.

Röller et al. (2000) cite two important cases as providing early Supreme Court precedents concerning efficiencies. In the infamous Brown Shoe Co (1962)¹⁷¹ case, efficiencies were viewed as contributing to the competition problem, and the court blocked the merger despite very low market shares. The Court concluded that the goal of promoting competition was best achieved by sustaining small, locally owned businesses, rather than allowing larger firms with lower costs.

Then, in Procter & Gamble (1967)¹⁷² in an often-quoted discussion, the Court said:

"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."

Commentators disagree as to the conclusion to be drawn. Some interpret the decision to block the acquisition as a complete rejection of an efficiency defense when competition is lessened substantially. Others interpret the Supreme Court's rejection of efficiencies as based upon the merits of the efficiencies claimed - the mere possibility of efficiencies is not sufficient to qualify as an efficiency defense.¹⁷³ Kolasky and Dick (2002) view this case to be an example of an efficiency offense.¹⁷⁴

However, the Supreme Court later, in a private action, ruled that a merger cannot be prohibited merely because it creates efficiencies that might help increase the merged firm's market share, but hurt other competitors.¹⁷⁵ The court concluded that even if the merged firm was dominant, it was in the interest of competition to have the firm engage in vigorous price competition. This conclusion is in contrast to many of the EU Commission's decisions, in which a merger to dominance might be prohibited if the dominance enables the firm to lower prices, and possibly engage in predatory prices to force competitors out of the market.¹⁷⁶ Röller et al. (2000) conclude that, while efficiencies were discussed in these American cases, an efficiency defense was never directly claimed by any parties. For this reason, the authors minimize the importance of the early Supreme Court precedents regarding the efficiency defense.

In 1968, shortly after these cases, the DOJ released the first Merger Guidelines,¹⁷⁷ which included a short paragraph on efficiencies in which we find:

10. Economies. Unless there are exceptional circumstances, the Department will not accept as a justification for an acquisition normally subject to challenge under its horizontal merger standards the claim that the merger will produce economies.

This was an important step towards breaking the courts' hostile approach to efficiencies, although it would still take some years before courts would treat efficiencies in merger cases more positively. Maybe this is not that surprising given that the 1968 Guidelines limited the use of efficiencies arguments to the very rare cases.

Two merger cases in the 1970's, which made the merger review process less structural, would thereby open up the possibilities for an efficiency defense. In General Dynamics¹⁷⁸ the Supreme Court concluded that factors other than market share affect competition in a market, indicating that factors such as efficiencies (as well as barriers to entry and other factors) can have important effects. In International Harvester,¹⁷⁹ the acquiring firm's lower cost of capital combined with a pooling of technology would allow the merged entity to better compete in the market. Previous to the acquisition the acquired firm had been at a competitive disadvantage (despite its superior technology) because of its higher cost of capital.

In this period of time, some non-merger cases were won based on efficiency, opening up the possibility for an efficiency defense in mergers in 1980's. For example, in 1977 the Supreme Court allowed the vertical restrictions Sylvania imposed on its distributors, recognizing (and in the process overruling its Schwinn decision) that the restrictions improved the ability of the manufacturer to secure efficient distribution.¹⁸⁰ Then, in the Broadcast Music case in 1979, the Court recognized that some agreements limiting competition between rival firms could be efficient, if they help the firms provide some new product or service.¹⁸¹

The 1982 Merger Guidelines did not change the paragraph on efficiencies very much. Efficiencies would only be considered in "extraordinary cases".¹⁸² In order for efficiencies to be considered, they must be clear and convincing, substantial, realized by other firms in the industry and not attainable in a less anti-competitive manner.¹⁸³ At the same time, the FTC issued a statement that it would consider "measurable operating efficiencies" in its prenotification examinations, where there was substantial evidence that the cost savings would clearly outweigh the increase in market power.

Only two years later, the DOJ revised the 1982 Guidelines with rather significant changes relating to efficiencies. The 1984 Merger Guidelines moved efficiencies from a defense to the competitive effects section, with the result that efficiencies became part of the analysis of whether a merger lessens competition substantially. The cost savings are still not to be explicitly balanced against the anti-competitive effects however. Efficiencies would be considered if they are clear and convincing and the merger is reasonably necessary to achieve the savings. In addition, the efficiencies must be significant and they must be greater than the expected competitive risks. This was a definite change in policy away from the more Chicago-oriented theory to the more efficiency sensitive Harvard school of thought. Although the FTC did not change its guidelines along with the DOJ, they, nevertheless, did follow in the change of policy and the acceptance of efficiency claims in mergers grew.

Courts seemed prepared to give more attention to efficiencies as well. In University Health¹⁸⁴ it was concluded that merging parties may use efficiencies to rebut the governments prima-facie case:

"We conclude that in certain circumstances, a defendant may rebut the government's prima facie case with evidence showing that the intended merger would create significant efficiencies in the relevant market."

The case concerned a merger between two non-profit hospitals. The Court concluded that the parties had failed to present sufficient evidence of how efficiencies would be created and maintained, and denied the merger. The Court did indicate that the efficiencies must benefit competition and consumers.

In 1992, the FTC and DOJ joined forces and issued the first joint Guidelines. The efficiencies section was left pretty much unchanged with one important exception - the sentence that indicated that the agency would not consider efficiencies unless they were "established by clear and convincing evidence" was dropped. As a result, the standard of proof was lowered, and efficiency arguments were to be more easily made.

5.3 Definition and Measurement of Gains in Efficiency

In 1997 the Guidelines were amended with the addition of a separate chapter on efficiencies. They came about in part because of concern the agencies were not giving efficiencies adequate respect. An FTC staff report, prepared after a series of hearings held in 1995 and 1996, had endorsed a more complete integration of efficiencies into the competitive effects analysis in merger cases.¹⁸⁵ The agencies claimed that the changes to the Guidelines made in 1997 did not represent a policy change, but rather a more complete explanation of the agencies' treatment of efficiency claims. The agencies will consider efficiencies under the following conditions:

• Efficiencies must be merger specific, meaning that they must be unlikely accomplished in the absence of either the proposed merger or another means having comparable anticompetitive effects. Only alternatives that are practically attainable in the business situation faced by the firm will be considered.
• Efficiencies must be substantiated in order to be verified by the agencies. The verification goes to the likelihood and magnitude of the efficiencies.
• The timeline for achieving the efficiencies must be verified, along with an explanation of how the proposed efficiencies would enhance the merged entity's ability and incentive to compete.
• Efficiencies must be calculated by subtracting any cost of merging and of achieving the said efficiencies.
• Cost savings that are attributable to a reduction in output or services will not be considered.

The type of efficiency claimed might have an influence on the outcome of the case. The Guidelines specify that cost savings that actually decrease marginal cost are more likely to be cognizable and substantial. It is not required that efficiencies be quantified in all circumstances. Additionally, it is accepted that although R&D cost reductions might be substantial, they are less likely to qualify as efficiencies that are cognizable and verifiable.¹⁸⁶

5.4 The Methodology and Welfare Standard Employed

The welfare standard that the US employs becomes clear in the Merger Guidelines' emphasis on consumers. Specifically, the 1997 Guidelines state that:

"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? the greater must be cognizable efficiencies in order for the Agency to conclude that the merger will not have an anticompetitive effect in the market."¹⁸⁷ (emphasis added)

"Cognizable efficiencies" are explained to be "(1) merger specific efficiencies that (2) have been verified and (3) do not arise from anticompetitive reductions in output or service." The Guidelines went on to explain that efficiencies are unlikely to matter when the lessening of competition is great:

"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. (emphasis added).¹⁸⁸

From the above, it is clear the Guidelines adopt a price or consumer surplus standard. In a recent speech, Assistant Attorney General Charles A. James¹⁸⁹ indicated that it is his (and the EU Commission's) "view that the ultimate goal of antitrust policy must be consumer welfare?"

It is important to point out, however, that the Guidelines did open the door to consideration of efficiencies in situations that might not have been acceptable previously. First, they indicate that the agencies may consider efficiencies that will return benefits to consumers only in the future: "The Agency will consider the effects of cognizable efficiencies with no short-term, direct effect on prices in the relevant markets." Kolasky and Dick (2002, pp. 31-32) are of the view that this makes the welfare standard for tradeoffs between efficiencies and anticompetitive effects "more of a hybrid consumer/total welfare model".

Second, an important footnote in the Guidelines addresses the question of how the agencies would deal with a merger that has efficiencies in one market but net anticompetitive effects in another. This is an interesting question because it goes to the agency's willingness to accept harm to some consumers as long as this harm is balanced by gains to other consumers. While the agencies say that they would normally challenge such a merger, they might accept it if the efficiencies are "inextricably linked" to the anticompetitive harm and if the imbalance is substantial (i.e. the efficiencies are great and the anticompetitive effects small).¹⁹⁰

5.5 Efficiencies and Consumers' Welfare

It appears that efficiencies are not required to be passed on to consumers, but that consumer welfare must not be lessened. On these points the Supreme Court's precedents (Brown Shoe Co, Procter & Gamble and Philadelphia National Bank) on efficiency claims in mergers are not conclusive. Röller et al. (2000) states that the three cases, when read in their context seems to preclude an efficiency defense, but also that it must be kept in mind that an efficiency defense was never directly raised in court. Furthermore, Röller et al. concludes that 'the decisions are based in large part on the understanding of legislative history and formalistic rules rather than on economic theory.¹⁹¹

As a result of the confusion about the Supreme Court's position, the lower courts' treatment of efficiency claims are particularly relevant. Rowley and Baker (2001) suggest that lower courts have become increasing sensitive to efficiency arguments.¹⁹²

In University Health¹⁹³ , as discussed above, the District Court determined that a defendant may, in certain circumstances, rebut the government's prima facie case with evidence of efficiencies. However, the court found that, in this case, the parties had "not presented sufficient evidence to support the claim that the intended merger would produce efficiencies benefiting consumers." The decision appears to take a positive view of efficiencies, if the parties can prove the benefits to consumers. The parties' claims had, according to the court, been 'speculative'.

In FTC v. Tenet Health Care Corp., the Court of Appeal reversed a preliminary injunction blocking a merger, in part because it believed that the district court had committed an error by refusing to consider "evidence of enhanced efficiency in the context of the competitive effects of a merger".¹⁹⁴

In U.S. v. Long Island Jewish Medical Center¹⁹⁵, the court found that efficiencies were significant and that they would ultimately benefit consumers. The cost savings amounted to $25-30 million a year. The court's reasoning for finding in favor of the merging parties rebuttal of the prima facie case, was the fact the hospitals were not-for-profit, and would therefore likely pass on cost savings to consumers. Also, the parties had entered into an agreement with the New York Attorney General stating that they would pass on to the community any substantial cost savings that would be achieved.¹⁹⁶ The Government had in this case argued that the merger would be to monopoly, but the court found the definition of relevant market too narrow.¹⁹⁷

At least one district court has recognized that efficiencies can make for a more successful competitor and this might ultimately benefit consumers. In U.S. v. Country Lakes Foods, Inc., the District Court found that the merger would enable the merged firm "to compete directly with the market leader" and thereby "enhance competition".¹⁹⁸

5.6 Merger Specificity and Attainability in a less anti-competitive Manner

In one of the more subtle changes between the 1992 and 1997 Merger Guidelines, the new guidelines determined that merger-specific efficiencies were "efficiencies likely to be accomplished with the proposed merger and unlikely to be accomplished in the absence of either the proposed merger or another means having comparable anticompetitive effects." While the previous guidelines had required that the efficiencies could not be achieved in less anticompetitive ways, the 1997 revisions required only that they would not likely be achieved in a less anticompetitive way.

In Heinz¹⁹⁹ the appeal court concluded that the district court (which had denied an FTC request for an injunction against the merger) had erroneously failed to explain why the parties could not achieve comparable efficiencies absent the merger. This was a merger between two of only three producers of baby food in a market where market entry was considered unlikely. The court also indicated that the very high concentration levels required 'proof of extraordinary efficiencies'.²⁰⁰

Courts have found cases in which efficiencies could be achieved in a less anticompetitive manner and therefore rejected efficiency claims made in support of a merger. In Staples²⁰¹ the court held that the merging parties were expanding rapidly, and did not need to merge in order to benefit from claimed efficiencies related to buyer power. The merger involved the two largest office supply 'superstores', and would have resulted in a monopoly situation in some markets, and duopolies in others.

In Ivaco (a joint venture)²⁰² the court commented that the parties had not seriously considered less anticompetitive alternatives, nor explained why the alternatives were impractical or unattractive. The case concerned a full joint venture between the two leading manufacturers of automatic railroad tampers.

5.7 Efficiencies and Other Competitive Restraints

Efficiency considerations now play an important role in the analysis of horizontal agreements in the U.S. The review process for these agreements is spelled out in the FTC - DOJ Antitrust Guidelines for Collaborations between Competitors, issued in April 2000. At the outset, the existence of efficiencies determine whether or not the agreement will be assessed under the strict per se rule, or under the more flexible rule of reason. If no efficiencies or benefits to the consumer can be found, and competition is harmed, the agreement will be challenged as per se illegal. Such agreements include price fixing, bid rigging and sharing of markets. On the other hand, if at the outset it appears that the agreement brings about benefits (i.e. efficiencies) that might be pro-competitive, all aspects of the agreement are more carefully considered. Such agreements can include collaboration on research and development, and joint-production agreements, which can realize economies of scale or scope. The benefits to consumers arising from such agreements can include a reduction of prices, expanding output, enhanced quality or service, and greater innovation.²⁰³

In order for efficiency claims to be considered they must be verifiable, potentially procompetitive, reasonably necessary and not attainable by less restrictive alternatives. Although the agencies (DOJ and FTC) recognizes the difficulty in verifying and quantifying efficiencies, the parties must describe:

"how and when each would be achieved; any costs of doing so; how each would enhance the collaboration's or its participants' ability and incentive to compete; and why the relevant agreement is reasonably necessary to achieve the claimed efficiencies. Efficiency claims are not considered if they are vague or speculative or otherwise cannot be verified by reasonable means."²⁰⁴

If the parties have fulfilled these requirements, the agencies will consider whether the efficiencies would be sufficient to offset the potential harm to consumers in the relevant market. The more delayed the benefits of the efficiencies are in reaching the consumers, the less weight will they be given. As the anticompetitive effects of the agreement increases, the parties must establish a greater level of efficiencies.

Similarly, as discussed above, as a result of decisions like that in GTE Sylvania, the enforcement agencies and courts have become much more sympathetic to efficiency arguments in cases involving potentially anticompetitive vertical agreements.

It is probably fair to say, however, that the agencies and courts do not use efficiencies to balance off against anticompetitive effects in any sort of total surplus calculation. In each case it would seem the focus is very much on whether the agreement or restriction ultimately provides benefits to consumers.

5.8 NAAG Guidelines

As mentioned above, state attorneys-general will, in some cases, become involved in antitrust matters. In part as a reaction to the perceived lower levels of federal antitrust enforcement in the Reagan administration, the National Association of Attorneys-General (NAAG) issued its own guidelines.²⁰⁵ In general, the NAAG Guidelines are tougher on mergers, presuming anticompetitive effects in cases in which the FTC and DOJ would not. Significantly, these guidelines appear somewhat less sympathetic to efficiencies. The NAAG Guidelines explicitly reject efficiencies as a defense to an otherwise unlawful merger and they will not consider efficiencies if the market is highly concentrated (which may be a lower standard than monopoly or near monopoly).

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¹⁶⁷ Rowley & Baker (2000), p. 64-4 and 64-38.

¹⁶⁸ See appendix D for the full text of Section 7 of the Clayton Act.

¹⁶⁹ Rowley & Baker (2001), p. 64-46.

¹⁷⁰ The section on evolution of efficiencies in merger cases is based primarily on Kolasky and Dick (2002). The paper was presented at the celebration of the 20th anniversary of the 1982 US Merger Guidelines.

¹⁷¹ Brown Shoe Co. v. U.S., 370 U.S. 294 (1962)

¹⁷² FTC v. Procter & Gamble Co. 386 U.S. 568 (1967)

¹⁷³ See also U.S. v. Philadelphia National Bank, 374 U.S. 321 (1963) for the same conclusion.

¹⁷⁴ Kolasky and Dick (2002), p. 6. See also Areeda et al. (1998).

¹⁷⁵ Cargill, Inc. v. Monfort of Colorado, Inc. 479 U.S. 104 (1986)

¹⁷⁶ See the chapter on EU merger review above.

¹⁷⁷ U.S. Dep't Of Justice, Merger Guidelines (1968). Efficiencies are mentioned in §10.

¹⁷⁸ U.S. v. General Dynamics Co., 415 U.S. 486 (1974). General Dynamics acquired Material Services, in the process becoming the nation's sixth largest coal producer and the largest producer in the Midwest.

¹⁷⁹ U.S. v. International Harvester Co., 564 F.2d 769 (7th Cir. 1977).

¹⁸⁰ Continental TV Inc. v. GTE Sylvania Inc. 433 U.S. 36 (1977), United States v. Arnold Schwinn & Company, 388 U.S. 365 (1967).

¹⁸¹ Broadcast Music, Inc. v. Columbia Broadcasting System, Inc. 441 U.S. 1 (1979).

¹⁸² U.S. dep't. of Justice, Merger Guidelines (1982) § 10.A.

¹⁸³ Kolasky and Dick (2002), p. 16.

¹⁸⁴ FTC v. University Health, Inc. 938 F.2d 1206 (11th Cir. 1991).

¹⁸⁵ Federal Trade Commission, Anticipating the 21st Century: Competition Policy in the New High-Tech, Global Marketplace: A Report by the Federal Trade Commission Staff (1966). The report suggested that efficiencies should "constitute a rebuttal (to a market-share-based prima facie case), not an affirmative defense." (Ch. 2 at 25)

¹⁸⁶ Horizontal Merger Guidelines 1997, Department of Justice and the Federal Trade Commission, section 4.

¹⁸⁷ Horizontal Merger Guidelines 1997, Department of Justice and the Federal Trade Commission, section 4.

¹⁸⁸ This part of the Guidelines was referred to by the D.C. District Court of Appeals decision in the Heinz case when it argued that very high levels of concentration required, on rebuttal, "proof of extraordinary efficiencies". FTC v. Heinz Co. 346 F. 3d 708 (D.C. Cir. 2001) at 720.

¹⁸⁹ Presented at the Program on Antitrust Policy in the 21st Century. Sponsored by the Directorate General for Competition at the European Commission and the U.S. Mission to the European Union, Brussels, Belgium, May 15, 2002.

¹⁹⁰ Footnote 36. On this, see also Kolasky and Dick (2002) p. 32.

¹⁹¹ See also OCDE/GD(96)65 from the OECD, p. 41, and Röller et al. (2000), para. 5.1.3.1.

¹⁹² The Court of Appeals in the Heinz case also noted, when discussing the possibility of an efficiency defense, that "the trend among lower courts is to recognize the defense." FTC v. H. J. Heinz Co. 246 F.3d 708 (D.C. Cir. 2002) at 720.

¹⁹³ FTC v. University Health, Inc. 938 F.2d 1206 (11th Cir. 1991) at 1223.

¹⁹⁴ 186 F. 3d 1045 (8th Cir. 1999) at 1054.

¹⁹⁵ U.S. v. Long Island Jewish Medical Center, 938 F. Supp. 121 (E.D.N.Y 1997)

¹⁹⁶ Röller et al. (2000), p. 77.

¹⁹⁷ See, e.g., Muris (1999) for an analysis of this case.

¹⁹⁸ 754 F. Supp. 669 (D. Minn. 1990) at 680. Kolasky and Dick (2002) at pp. 38-39 claim that this is "the only litigated non-hospital case in which an efficiencies defense has prevailed."

¹⁹⁹ FTC v. H. J. Heinz Co. 246 F.3d 708 (D.C. Cir. 2001).

²⁰⁰ See Kolasky and Dick (2002).

²⁰¹ FTC v. Staples, Inc. 970 F. Supp. 1066 (D.D.C 1997).

²⁰² United States v. Ivaco, Inc., 704 F. Supp. 1409, 1420 (W.D. Mich. 1989). See OCDE/GD(96)65 from the OECD, footnote 19.

²⁰³ Antitrust Guidelines for Collaborations Among Competitors, DOJ and FTC, April, 2000, chapter 2.

²⁰⁴ Antitrust Guidelines for Collaborations Among Competitors, DOJ and FTC, April, 2000, para. 3.36.

²⁰⁵ National Association of Attorneys-General, Horizontal Merger Guidelines, issued March 30, 1993, 4 Trade Reg. Rep. (CCH) 13,406 . NAAG is not itself an enforcement agency and individual states may choose whether or not to follow its guidelines.