Merger Enforcement Guidelines

Draft for Consultation
March 2004

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Part 6 – Entry

6.1 A key component of the Bureau's analysis of competitive effects is whether entry by potential competitors is likely to occur on a sufficient scale and magnitude scope in response to a material price increase (or other change) in the relevant market or a substantial part of the relevant market. This is to ensure that such a price increase cannot be sustained for two years. In the absence of impediments to entry, a merged entity's attempt to exercise market power, either unilaterally or collectively through coordination with its rivals, is likely to be thwarted by entry of firms that:

• are already in the relevant market and can expand production or sales within two years;
• are not in the relevant market but operate in other markets and can switch production or sales into the relevant market within two years ⁷⁴; or
• are not in the relevant market but can start production or sales de novo in the relevant market within two years.

Conditions of Entry

6.2 Entry is only effective in constraining the exercise of market power if it is viable.⁷⁵ When entry is likely, timely and sufficient in scale and scope, an attempt to increase price is not likely to be sustainable (i.e.that is, profitable) as buyers of the product in question turn to other sources of supply.⁷⁶

Timeliness

6.3 Assessing the conditions of entry involves determining the time that it would take for a potential entrant to become an effective competitor in response to a material price increase or other change in the market brought about by a merger. In general, the longer it takes for potential entrants to become effective competitors, the lesser the likelihood that incumbent firms will be deterred from exercising market power. When a material price increase occurs in a relevant market, entrants must react and have an impact on price in a reasonable period of time. In the Bureau's analysis, the beneficial effects of entry on prices in this market must occur within a two-year period.⁷⁷

Likelihood

6.4 In assessing whether future entry is likely to occur, the Bureau's analysis generally starts with an assessment of firms that appear to have an entry advantage. While other potential sources of competition may also be relevant, typically the most important sources of potential competition include:

• fringe firms already in the market;
• firms that sell the relevant product in adjacent geographic markets;
• firms that produce products with machinery or technology that is similar to that used to produce the relevant product;
• firms that sell in related upstream or downstream markets;
• firms that sell through similar distribution channels; or
• firms that employ similar marketing and promotion methods.

6.5 The analysis seeks to determine the extent that entry is likely given the commitments that must be made by potential entrants, the time required to become effective competitors, the risks involved and the likely rewards. The Bureau considers any delay or loss that potential entrants expect to encounter before becoming effective competitors and the resulting sunk costs and risk associated with such entry that reduce the likelihood that entry will occur

6.6 A history of entry into and exit from a particular market provides insight into the likelihood of entry occurring in a timely manner and on a sufficient scale to counteract an exercise of market power by a merged entity. It is, however, not the sole determinant as to whether this will likely occur. ⁷⁸

Sufficiency

6.7 When considering whether entry is likely to be on a scale orand scope that would be sufficient to eliminate a material price increase, the Bureau examines what is required from potential competitors who choose to enter. For instance, if a competitor enters a market on a scale that is below the minimum efficient scale, accepting the cost disadvantage associated with a sub-optimal level of production, the entry is not considered sufficient to eliminate a material price increase. Entry by firms who seek to differentiate themselves by establishing a niche to avoid direct competition with the merging parties may also not be sufficient to constrain the exercise of market power.

Types of Barriers to Entry

6.8 Barriers to entry affect the timeliness, likelihood and sufficiency of entry. They can take many forms, ranging from absolute restrictions that impede entry to sunk costs and other factors that raise the cost of entry and thereby deter it.⁷⁹ While, in some cases, each individual "barrier" may be insufficient to impede entry, the Bureau considers the collective influence of all barriers, which, when taken together, can effectively deter entry.

Regulatory Barriers

6.9 The types of barriers identified in section 93(d) of the Act, namely tariff and non-tariff barriers to international trade, inter-provincial barriers to trade, and regulatory control over entry, can provide incumbents with absolute cost advantages over potential entrants, presenting considerable and in some cases insurmountable impediments to entry.⁸⁰

Sunk Costs

6.10 Sunk costs directly affect the viability likelihood of entry and, where present, constitute a significant barrier to entry. ⁸¹ Costs are sunk when they are not recoverable if the firm exits the market. In general, since entry decisions are typically made in an environment where success is uncertain, the likelihood of significant future entry decreases as the proportion of total entry costs accounted for by sunk costs increases. The Bureau's assessment of sunk costs is focused on an estimation of the rewards of entry, the time required to become an effective competitor and the probability of success and whether they justify making the investments required.

6.11 New entrants must often incur various start-up sunk costs, such as acquiring market information, developing and testing product designs, installing equipment, engaging personnel and setting up distribution systems. Potential entrants may also face significant sunk costs due to the need to:

• make investments in market specific assets and in learning how to optimise the use of these assets;
• overcome product differentiation-related advantages enjoyed by incumbents; or
• overcome disadvantages presented by the strategic behaviour of incumbents.

6.12 As more fully described in Appendix I, these potential sources of sunk costs can create significant impediments to entry when they require that potential entrants factor greater costs into their decision-making relative to incumbents who can ignore such costs in their pricing decisions because they have already made their sunk cost commitment.

6.13 The investment required in establishing a reputation as a reliable or quality supplier are is also a sunk cost and it can constitutes a barrier to entry when it is a crucial element in attracting buyers, particularly in industries where services are an important element of the product. Under these circumstances, the time to gain a reputation may make profitable entry more difficult and hence delays the competitive impact that an entrant may have in the marketplace.⁸²

6.14 Long-term exclusive contracts with automatic renewals, rights of first refusal and termination fees constitute a barrier to entry. Contracts with attributes that limit buyer switching may make it difficult for firms to gain a sufficient buyer base to be profitable in one or more markets (even when barriers to entry in the industry are otherwise relatively low) and can thus make entry unattractive.⁸³ The deterring effects of such contracts are more pronounced when economies of density are important because they make it difficult for new or smaller firms to achieve minimum efficient scale of operations.⁸⁴

Other Entry-Deterring Factors

6.15 In markets where economies of scale are significant, entry on a small scale may be difficult unless the entrant can successfully exploit a niche. Conversely, entry in such markets on a large scale may expand available capacity to supply beyond market demand, thereby depressing market prices and making entry less attractive.⁸⁵

6.16 Market maturity can also impede entry. Entry is less difficult and time consuming in the start-up and growth stages of a market, where the dynamics of competition generally change more rapidly. Mature markets exhibit flat demand, making it more difficult for potential entrants to profitably enter the business because the entrants' sales have to come from existing rivals.⁸⁶

6.17 Other cost advantages for incumbents that may deter entry include: transportation costs, control over access to scarce or non-duplicable resources such as technology, land, natural resources and distribution channels, and capital costs.⁸⁷

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⁷⁴ Throughout these Guidelines, the term "entry" also refers to expansion by existing firms. The same factors that constrain new entrants also often constrain significant expansion by fringe firms, even though in some cases expansion costs for existing firms may be lower than entry costs for a new entrant.

⁷⁵ As noted in Superior Propane at ¶ 128, "evidence of commencement of operations, per se, is insufficient to establish the competitive constraint on a supra-competitive price or a likely exercise of market power". See also Canada (Director of Investigation and Research) v. Southam Inc., et al. CT-1990/001, (Comp.Trib.) "Reasons and Order", June 2, 1992 (hereinafter "Southam") at p. 212 and at p 219.

⁷⁶ Poised entry can in some circumstances provide a disciplining effect on an incumbent contemplating an exercise of market power. See for example Hillsdown, at page 74.

⁷⁷ See for example Superior Propane, at ¶ 128 and Hillsdown, at page 66.

⁷⁸ See for example Superior Propane, at ¶ 312 where the Tribunal found that past entry, which had occurred on a small scale, did not have a demonstrable effect on incumbents' market share, and thus questioned entrants' penetration in the market.

⁷⁹ As noted in Canada (Director of Investigation and Research) v. Laidlaw Waste Systems Ltd., CT-1991/002 (Comp. Trib.) "Reasons for Order", January 20, 1992, (hereinafter "Laidlaw") at page 44, 75, while entering commencing a business may in some cases be easy, new entrants may find it difficult to survive for a variety of reasons, including the strategic behaviour of incumbents. See Appendix 1 for further discussion on strategic behaviour. See also Southam at p. 212 and at p 219.

⁸⁰ See for example Bayer/Aventis Statement of Agreed Facts at ¶ 57-59 and Canadian Waste at ¶ 122.

⁸¹ See for example Superior Propane at ¶ 172-175 and Canadian Waste at ¶ 122.

⁸² See for example Superior Propane at 157. See also, Canada (Competition Act, Director of Investigation and Research) v.Tele-Direct (Publications) Inc., CT-1994/003, (1997) C.C.T.D. No. 8, at p.128.

⁸³ See for example Laidlaw at p. 3193; Superior Propane at ¶ 150.

⁸⁴ See for example Laidlaw at p. 31105; Superior Propane at ¶ 134-135.

⁸⁵ See for example Director v.The NutraSweet Company Company, CT-1989-002 and Southam at p.215-216.

⁸⁶ See for example Superior Propane at ¶ 160.

⁸⁷ While it is recognized that capital costs alone may not be an absolute barrier to entry, the need to raise capital may have a significant impact on the timeliness of entry.