Merger Enforcement Guidelines

Draft for Consultation
March 2004

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Part 10 – Vertical Mergers

10.1 Generally, vertical mergers¹²² only raise concerns when they increase barriers to entry or facilitate upstream coordinated behaviour. In addition to the conditions described below, the Bureau analyzes the competitive effects of such mergers by examining market concentration, the effectiveness of remaining competition, the availability of acceptable substitutes, entry, change and innovation, and the removal of a vigorous and effective competitor.

Increased Barriers to Entry

10.2 A vertical merger may raise concerns where the elimination of an independent upstream source of supply (or downstream distribution outlet) leaves only a small amount of unintegrated capacity¹²³ at either of the stages at which one of the merging parties operates. In particular, concerns may be raised when the amount of unintegrated capacity at one stage (the secondary market) is sufficiently small that an entrant into the other stage (the primary market) will consider it necessary to simultaneously enter the secondary market. In general, where such simultaneous entry into both the primary and secondary markets involves incurring greater sunk costs than what is required to enter into the primary market alone, barriers to entry into the primary market are effectively raised.¹²⁴

10.3 Increased barriers to entry into a primary market only presents grounds for concern under the merger provisions of the Act where the degree of actual competition that remains post-merger is so low that it would be possible for a new entrant to exercise an important constraining influence on prices in the market, but for the merger.

10.4 The Bureau is not likely to conclude that a vertical merger is likely to prevent or lessen competition substantially unless:

• the merger makes it unlikely that entry into the primary market will occur on a sufficient scale to eliminate a material price increase within two years, due to the need to simultaneously enter the secondary market;¹²⁵ and,
• the exercise of market power in the primary market is likely to be facilitated by the merger in the absence of such entry.

10.5 In determining whether simultaneous entry will be more difficult or less profitable, the Bureau examines whether entrants in such circumstances are likely to face higher costs of capital than incumbents, due to greater risks involved in attempting successful two-stage entry. An assessment is also made of the difference in the levels of minimum-efficient-scale in the primary and secondary markets and whether it is likely to impose significant additional costs on a two-stage entrant.

Upstream Effects Facilitated by Forward Integration into Retail

10.6 A merger that creates or increases a high degree of vertical integration between an upstream market and a downstream retail market can facilitate coordinated behaviour by firms in the upstream market by making it easier to monitor the prices charged by rivals at the upstream level.

10.7 In general, such mergers are not likely to prevent or lessen competition substantially unless:

• the prices at which transactions are actually made at the retail level are more transparent than the prices at which upstream transactions are actually made;
• conditions in the upstream market are otherwise conducive to the coordinated exercise of market power; and,
• the percentage of upstream output that is sold through unintegrated firms is so low that post-merger sales to such firms on concealable terms are not likely to result in preventing a material price increase from being imposed and maintained for two years.

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¹²² A vertical merger involves the combination of the assets of a firm selling a product or service with a firm buying that product or service.

¹²³Unintegrated capacity refers to capacity at only one of the stages in question.

¹²⁴See Appendix I.

¹²⁵The Commissioner is unlikely to consider that second stage entry is required where post-merger sales (or purchases) by unintegrated firms in the secondary market would be sufficient to service two minimum efficient-scale operations in the primary market.