Merger Enforcement Guidelines

Draft for Consultation
March 2004

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Part 5 – Anti-Competitive Effects

5.1 When the above-mentioned thresholds are exceeded or when other information suggests that a merger may result in a substantial lessening or prevention of competition, the Bureau undertakes a competitive effects analysis of the merger. Such an analysis falls under the broad categories of unilateral effects and coordinated effects as described below.

5.2 When it is clear that the level of effective competition that is to remain in the relevant market is not likely to be reduced as a result of the merger, this alone generally justifies a conclusion not to challenge the merger.

5.3 To determine the ability and effectiveness of remaining competitors to constrain an exercise of market power by the merged entity, the Bureau examines existing forms of rivalry, such as discounting and other pricing strategies, distribution and marketing methods, product and packaging positioning, and service offerings.⁵⁶ The stability of market shares over time is also relevant, as is the extent to which product differentiation limits the level of direct competition among firms.⁵⁷ Furthermore, an assessment is made of whether competitors are likely to remain as vigorous and effective as prior to the merger.

5.4 The extent of excess capacity held by different firms provides useful information about their ability to respond to a potential exercise of market power.⁵⁸ Excess capacity held by rivals to the merging parties improves their ability to expand output should the merged entity attempt to exercise market power. On the other hand, if the merging parties hold a significant share of excess capacity in the relevant market, this may discourage expansion by rivals.

5.5 The competitive attributes of the acquired firm are assessed to determine whether the merger will likely result in the removal of a vigorous and effective competitor.⁵⁹ In addition to the forms of rivalry discussed above, the Bureau considers whether one of the merging firms:

• has a history of not following price leadership and other market stabilizing initiatives by competitors;
• provides unique service/warranty benefits to the market⁶⁰;
• has recently expanded capacity, or has plans to do so;
• has recently made gains in market share, or is positioned to do so; or,
• has recently acquired patents, or will soon do so.

5.6 While the removal of a vigorous and effective competitor through a merger is likely to prevent or lessen competition to some degree, it is generally not sufficient to warrant enforcement action under the Act.As described above, the Bureau also examines the extent to which remaining competition may be limited or ineffective and whether there are factors that are likely to deter or impede entry or expansion by other suppliers.

5.7 An evaluation is also made of the general nature and extent of change and innovation in a market. In addition to assessing the competitive impact of technological developments in products and processes, the Bureau examines change and innovation in relation to: distribution, service, sales, marketing, packaging, buyer tastes, purchase patterns, firm structure, the regulatory environment and the economy as a whole.

5.8 The pressures exerted by change and innovation on remaining competitors in a market (including the merged entity) may be such that a material price increase is unlikely to be sustainable, especially where a merger reduces barriers to entry or stimulates or accelerates the change or innovation in question.⁶¹ Such pressures may have important implications for efficient markets in the medium to long term. However, for the purpose of the Bureau's analysis of competitive effects, the resulting competitive pressures are relevant when they are expected to have a constraining influence within two years of a likely exercise of market power.⁶²

5.9 A merger may also facilitate the exercise of market power by impeding the process of change and innovation. For example, when a merger eliminates an innovative firm that presents a serious threat to incumbent firms, the merger itself may hinder or delay the introduction of new products, processes, marketing approaches, aggressive research and development initiatives or business methods.⁶³

Unilateral Effects

5.10 By placing pricing and supply decisions under common control, a merger can create an incentive to increase price and restrict supply or limit any other dimension of competition.A unilateral exercise of market power occurs when the merged entity can profitably impose a material price increase without regard to the accommodating responses of its rivals.

5.11 Where buyers can choose among many suppliers offering comparable products, a firm's ability to profitably increase price is limited by buyers diverting their purchases to substitute products in response to the price increase.When two firms in a market merge and the price of one firm's product(s) rise, some demand may be diverted to product(s) of the firm's merger partner, thereby increasing the overall profitability of the price increase and providing the impetus to raise the price.A price increase is more likely to be profitable when the merging firms account for a significant (even if not dominant) share of the market.

5.12 Unilateral effects can occur in different market environments that are defined by the primary characteristics that distinguish firms within those markets and determine the nature of their competition. Two types of market environments are described below.

Firms Distinguished Primarily by their Products

5.13 In markets with differentiated products, a merger may substantially enhance the ability of merging firms to exercise market power unilaterally when a significant number of buyers view the product offerings of the merging parties to be their first and second choices. In these circumstances, a post-merger price increase may be profitable because a price increase by one of the merging firms diverts demand toward its merging partner.This is particularly true when a merger removes a vigorous competitor from the market. If, on the other hand, the merged firms' products are not first and second choices for a significant number of buyers, then a material price increase in the product of one of the merging parties is less likely to be profitable when demand would be diverted almost entirely to the products of other firms in the market with available capacity.

5.14 In order to assess whether a merger among suppliers of differentiated products is likely to enhance the ability of the merged entity to unilaterally exercise market power, the Bureau examines product purchase and pricing information to determine whether the products of the merging firms are first and second choices for a significant number of buyers.Evidence of past buyer switching behaviour in response to changes in relative prices is particularly useful, including information based on buyer preference surveys, own-price and cross-price elasticities, purchasing patterns and diversion ratios. ⁶⁴

5.15 The Bureau also considers whether other firms in the market are likely to re-position their products to replace any competition lost as a result of the merger.⁶⁵ Consideration is also given to existing suppliers that may only occupy a particular niche within the relevant market and whether they provide competition for a sufficient number of buyers.

Firms Distinguished Primarily by their Capacities

5.16 A post-merger price increase may be profitable if the merger removes a supplier that buyers would otherwise turn to in response to a price increase. In markets where firms are distinguished primarily by their capacities, Ssuch a price increase is likely to be profitable if other suppliers offering close substitutes are not able to absorb the demand that is diverted from the merged entity. This is possible only ifoccurs when the remaining suppliers have insufficient capacity to absorb this demand, or if capacity can cannot be expanded quickly and at low cost. Therefore, the Bureau examines whether capacity constraints limit the effectiveness of remaining suppliers by impeding their ability to make their products available in sufficient quantities to counter an exercise of market power by the merged entity.⁶⁶

Coordinated Effects

5.17 A merger may result in coordinated effects when a group of firms (that includes the merging parties) is able to profitably coordinate its behaviour because of each firm's accommodating reactions to the conduct of others.The Bureau assesses whether a merger makes such coordinated behaviour among firms more likely or effective.⁶⁷

5.18 Coordinated behaviour can involve tacit understandings on price, service levels, allocation of customers or territories, or any other dimension of competition.⁶⁸ Tacit understandings arise from individual yet mutual recognition that, post-merger and under certain market conditions, firms can benefit from competing less aggressively with one another.

5.19 Coordinated (or accommodating) behaviour is sustainable when:

• firms are able to monitor one another's conduct;
• firms are able to respond to any deviations from the terms of coordination through credible deterrent mechanisms;⁶⁹ and
• coordination will not be threatened by external factors such as the reactions of existing and potential competitors not part of the coordinating group of firms or by the reactions of buyers.

5.20 High market concentration and barriers to entry are two necessary but not sufficient conditions for a merger to substantially lessen or prevent competition through coordinated effects.⁷⁰ Firms find it easier and less costly to limit competition if there are a small number of firms accounting for a large proportion of total market output. Coordinated behaviour among competitors in a concentrated market is unlikely to be sustainable if raising prices would lead to rapid and significant entry.

5.21 In addition to market concentration and barriers to entry, the Bureau examines whether other market conditions exist that may facilitate the ability of firms to individually recognize mutually beneficial terms of coordination, detect deviations from coordinated behaviour, and impose credible punishments. The presence of certain market conditions (often referred to as facilitating factors) may suggest the ability of firms to overcome impediments to coordinated behaviour. With the exception of high market concentration and barriers to entry, no factor is a precondition for coordinated behaviour.Also, neither the absence nor the presence of any factor determines whether there is likely to be a substantial lessening or prevention of competition.

5.22 The following are among the factors considered by the Bureau in its analysis of coordinated effects:

• Homogeneous products:recognizing terms of coordination that all firms find profitable is easier when products are homogeneous. On the other hand, complex products and differences in product offerings make it more difficult for firms to reach profitable terms of coordination.Similarly, markets with rapid and frequent product innovations are less conducive to coordinated behaviour.
• Cost symmetries:it is easier for firms to coordinate behaviour that each finds profitable when such firms have similar cost structures.
• Stability of underlying costs:when costs fluctuate, it may be difficult to detect whether a price change represents a deviation from coordinated behaviour or whether it is a response to a change in cost conditions, which in turn makes effective coordination less likely.
• Market transparency:when information about prices, rival firms and market conditions is readily available to market participants ⁷¹, it is easier to monitor coordinated behaviour, which in turn makes effective coordination more likely.The existence of industry organizations that facilitate communication and dissemination of information among market participants may also facilitate coordinated behaviour ⁷²
• Many small buyers making frequent purchases:when individual sales are large and infrequent relative to total market demand, deviations from the coordinated behaviour are more profitable, making effective coordinated behaviour less likely.
• Multi-market exposure:when firms participate in multiple geographic or product markets, there are greater opportunities to discourage firms from deviating from the coordinated behaviour because there is broader scope for punishing deviations.
• Inelasticity of demand: the profits available from coordinated behaviour are higher for products with inelastic demand, making effective coordinated behaviour more likely.
• Limited excess capacity:excess capacity provides firms with an incentive and an ability to deviate from coordinated behaviour by selling products below the agreed price.
• A history of collusion/cooperation:previous and sustained collusive or cooperative behaviour indicates firms have successfully overcome the hurdles to effective coordinated behaviour in the past.

5.23 When assessing how the merger changes the competitive dynamic in the market, the Bureau identifies the constraints on coordinated behaviour that existed pre-merger to determine if the merger reduces or eliminates those constraints.

5.24 In highly concentrated markets, effective coordination may be constrained by the activities of one or a few firms.A merger could remove this constraint by reducing the number of rivals to a level at which the profitability of coordination makes it a more attractive strategy relative to competition.For example, because excess capacity may provide firms with an incentive and an ability to deviate from coordinated behaviour, a merger may enable the firms to limit excess capacity to improve the prospects for effective coordination.

5.25 When firms differ greatly relative to one another, effective coordination may be constrained by the inability of firms to behave in a way that each finds profitable.If the effect of the merger is to reduce or eliminate asymmetries between the merged firm and its rivals, firms may find it easier to coordinate their behaviour in a way that is profitable to all participants post-merger.Conversely, a merger may increase asymmetries between the merged firm and its rivals thereby making coordinated behaviour less profitable and hence less likely.

5.26 Pre-merger, effective coordination may be constrained by the activities of a particularly vigorous and effective competitor (that is, a "maverick"). ⁷³ An acquisition of a maverick may remove this constraint on coordination by reducing incentives to behave in an aggressive manner. This increases the likelihood that coordinated behaviour will be effective.

5.27 Alternatively, a merger may not remove the maverick but instead may inhibit a maverick's expansion or entry, or marginalize its competitive significance, thereby increasing the likelihood of effective coordination.

5.28 The Bureau also examines the extent to which firms outside the coordinating group have the ability to make the relevant product available in the relevant geographic market in sufficient quantities to thwart a coordinated exercise of market power.

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⁵⁶ Considerations that are particularly relevant to foreign competition include the factors that are examined in delineating relevant markets or determining what firms participate in the relevant market.

⁵⁷ See for example, Superior Propane at¶ 227-228.

⁵⁸ See Canadian Waste at ¶ 196 and 210.

⁵⁹ A firm that is a vigorous and effective competitor often plays an important role in pressuring other firms to extend the limits of competition toward new frontiers, and often makes an important contribution toward maintaining a higher level of competition than would exist in the absence of the merger. A firm does not have to be among the larger competitors in a market in order to be a vigorous and effective competitor. Small firms can exercise an influence on competition that is disproportionate to their size.

⁶⁰ See for example, Superior Propane at¶ 218.

⁶¹ When a merger is likely to enhance existing market power, representations regarding how the merger may be likely to give rise to innovation-related synergies and other efficiencies will be considered pursuant to section 96, as will information that a merger could impede the introduction or dissemination of technology.

⁶² See for example The Competition Bureau's Letter to the CIBC and TD Bank, December 11, 1998 and The Competition Bureau's Letter to the Royal Bank and Bank of Montreal, December 11, 1998.

⁶³ See for example Bayer/Aventis Statement of Agreed Facts at¶ 125.

⁶⁴ The diversion ratio between firms A and B measures the proportion of total sales lost by firm A that is captured by firm B when firm A raises the price of the relevant product.

⁶⁵ This requires a determination of whether repositioning or product line extension will likely be deterred by risk, sunk costs or other entry barriers.

⁶⁶ In the presence of existing import quotas or "voluntary" restraint agreements where the limit permitted by such restraints is already met prior to the merger, foreign suppliers will be constrained and unable to increase supply to Canada beyond the quota or restraint agreement in the face of any price increase.

⁶⁷ A merger that changes the competitive dynamic among a small number of firms may lead to coordinated behaviour where none existed pre-merger or may materially increase the level of coordination in a market already characterized by coordinated behaviour.

⁶⁸ If the Bureau becomes aware of explicit understandings, agreements or arrangements among competitors, it will generally commence a criminal investigation into the matter.

⁶⁹ These responses, typically known as punishments, may take the form of low prices in the relevant market or in other markets.

⁷⁰ See for example, News Release "Loblaw Companies Limited - Acquisition of certain assets of The Oshawa Group Limited in Atlantic Canada", October 16, 1998 and News Release "Divestitures Key To Resolving Competition Concerns In Loblaw Transactions", August 12, 1999.

⁷¹ This includes information about levels of service, innovation initiatives, product quality, product variety, levels of advertising, etc.

⁷² Market transparency is typically increased by: delivered or basing point pricing schemes; posted pricing; circulation of price books; product, service or packaging standardization; exchanges of information (whether through a trade association, trade publication, or otherwise) regarding matters such as pricing, output, innovation, bids won and lost, and advertising levels; public disclosure of this information by buyers or through government sources; and "meet the competition" or "most favored nation" clauses in contracts.

⁷³ See footnote 59.