Report of the Advisory Panel on Efficiencies:- Chapter 5 Treatment of efficiencies in other jurisdictions

The Panel’s mandate required it to review the Competition Bureau’s report on the October 2004 international round table involving competition law enforcement authorities from Australia, Canada, the European Union, Mexico, the United Kingdom and the United States. The report also includes the Bureau’s summary of written submissions from Germany, Japan, Norway, Sweden and South Africa (Canada 2005). In addition, the Bureau’s 2004 consultation paper includes information about the treatment of efficiencies in the competition laws of Australia, the European Union, Mexico and the United States.

As a general rule, the Panel’s view is that convergence of Canadian laws with those of other major jurisdictions is good public policy. However, this should not prevent Canada from adopting a unique approach when the situation demands it, since Canada has maintained and fostered its own distinctive culture, despite its profound ties with the United States.

Yet, Canada’s distinctiveness should not preclude convergence. The External Advisory Committee on Smart Regulation, which tabled its report last year, took a strong stand on this issue, saying that when no specific reason justified a Canadian-specific approach to regulation, Canada should try to harmonize its approach with those of the United States and Mexico²⁸ (Canada 2004c). Daniel Schwanen, a Canadian economist who writes extensively on public policy issues, takes a similar stand in Deeper, Broader: A Roadmap for a Treaty of North America, his monograph on post-NAFTA arrangements. While recognizing the right and the importance of Canada to develop distinctive policies that respond to its unique needs, Schwanen says it is also important for Canada to take into account when drafting regulations the significant interdependence of the three North American countries. This is particularly the case in the area of economics; here, integration is most pronounced (Schwanen 2004).

The Panel’s observations on the international round table report

At the outset, it should be noted that the Panel understands that all of the countries that sent representatives to the international round table have in place legislation that allows them to review mergers to determine whether such mergers are anti-competitive. The test for determining whether a merger is anti-competitive varies from jurisdiction to jurisdiction, with some jurisdictions (including Canada, as discussed in Chapter 2) using a “substantial lessening of competition” or similar test, and others focusing on whether the merger creates or reinforces a dominant market position (e.g. Germany). The European Union recently moved from a pure dominance standard to a standard that includes both elements.

The international round table report and the September 2004 consultation paper highlight the two major enforcement approaches to efficiencies.

• Efficiencies may be treated as a factor in the analysis of whether a merger is anti-competitive. Under a factor approach, efficiencies cannot save a merger that is ultimately found to be anti-competitive. However, they may influence the determination of whether the mergers is in fact anti-competitive, particularly when they “cleanse” the merger of its harmful effects (for example, by increasing rivalry in a market or providing consumer benefits).
   
• Efficiencies may be treated as an exception or justification (commonly referred to as a defence) that allows a merger to proceed despite it being found to be anti-competitive. The defence requires a trade-off between the efficiency gains generated by a merger and the merger’s negative effects on competition.

Jurisdictions where efficiencies are a factor in merger review

In most of the jurisdictions discussed in the international round table report — namely, the European Union, Japan, Mexico, Norway and the United States — efficiencies are treated as a factor in the analysis of whether a merger is anti-competitive, although exactly how this is done varies from jurisdiction to jurisdiction.

European Union

Efficiencies are a factor relevant to the assessment of whether a merger will “significantly impede effective competition … in particular as the result of the creation or strengthening of a dominant position” (European Commission 2004). To be considered, efficiencies must benefit consumers, for example, by reducing prices, leading to the creation of new or improved products or services, or reducing incentives for coordinated conduct of competitors in a market (European Commission 2004a). The European Commission’s merger guidelines note that the incentive for the merged entity to pass efficiency gains on to consumers “is often related to the existence of competitive pressure from the remaining firms and from potential entry.” The guidelines go on to stress that it is highly unlikely that a merger to monopoly could be approved on the grounds that efficiency gains would be sufficient to counteract its anti-competitive effects (European Commission 2004a, para. 84). Efficiencies must also be merger-specific and verifiable (European Commission 2004a, para. 78).

United States

Efficiencies are considered a factor in the analysis of whether a merger substantially lessens competition. To be considered, efficiencies must be merger-specific and verifiable and must not arise from anti-competitive reductions in output or service (United States 1992). These efficiencies must also be of such a character and magnitude that they reverse a merger’s potential to harm consumers in the relevant market by, for example, preventing price increases in that market (United States 1992). Efficiencies are generally only analyzed for their short-term effects; however, efficiencies with no short-term effect on prices are considered but given less weight (United States 1992, n. 37). Efficiencies almost never justify a merger-to-monopoly or near-monopoly (United States 1992: section 4).

The U.S. Antitrust Modernization Commission is currently reviewing the treatment of efficiencies in U.S. law.

Japan

Efficiencies are considered as part of the analysis to determine whether the merger will substantially restrain competition (Canada 2005, 20).

Mexico

In the overall analysis of a merger to determine whether it will reduce, impair or prevent competition, efficiencies are considered as a pro-competitive effect. To be considered, efficiency gains must be passed on to consumers (Canada 2005, 2–3).

Norway

Norway considers efficiencies as part of the factor analysis of a merger. Under the Norwegian Competition Act, special consideration must be given to the interests of consumers; therefore, efficiency gains must benefit consumers in some way to be of decisive relevance in a case. The Norwegian enforcement authority will approve a merger that is likely to result in a price increase and efficiency gains when the merger increases a weighted sum of the consumer surplus and the producer surplus, with more weight being given to consumer surplus.²⁹ In other words, the Norwegian authority takes into account the income transfer that results from the post-merger price increase and acknowledges that the loss of income to consumers should be given more weight than the increase of income to producers. This balancing exercise is complex, and the Norwegian competition authority does not operate with explicit or precise weights.

Jurisdictions with an efficiency defence

Germany

Efficiencies play a limited role in merger review in Germany. The Federal Cartel Agency reviews mergers based on competition criteria. Germany has in place a special authorization process that allows mergers that benefit the economy as a whole. This process is reserved for exceptional cases based on non-competition grounds. To be allowed, a merger must bring benefits that will outweigh the restraints on competition. Efficiencies may be considered to be a public benefit (Canada 2005, 20). Note that the German law only applies to local mergers. The European Commission deals with mergers that meet European law enforcement thresholds using a factor approach.

South Africa

The South African Competition Act is similar in many regards to its Canadian counterpart. It is thus not surprising that South Africa shares with Canada an explicit legislative efficiency defence. The South African Competition Commission or Competition Tribunal must consider two things when determining whether a merger that may lessen or prevent competition should be allowed to proceed: whether technological, efficiency or pro-competitive gains are greater than and offset a prevention or lessening of competition; and whether the merger can be justified on substantial public interest grounds. “Public interest grounds” are assessed in light of industrial policy factors. These include the effect that the merger will have on a particular industry or region, employment, the ability of small businesses or firms owned by historically disadvantaged persons to become competitive, and the ability of national industries to compete in international markets. Interestingly, the Competition Commission of South Africa’s comments on the Competition Bureau’s September 2004 consultation paper state that a factor approach to efficiencies would be preferable in Canada, even though South Africa itself has an efficiency defence (South Africa 2004, para. 9).

Hybrid regimes

In Australia and the United Kingdom, the legislative framework incorporates elements of both the factor and defence approaches.

Australia

Australia’s public interest authorization process operates similarly to an efficiency defence in the merger context. The authorization process applies broadly to various types of transactions and trade practices, not just mergers. The authorization process allows the Australian Consumer and Competition Commission (or the Competition Tribunal under proposed changes to the law) to grant immunity to a merger that substantially lessens competition but is found to generate a “net public benefit.” The Australian Merger Guidelines state that the public benefits most important to merger authorizations are efficiencies (Australia 1999, para. 6.39). Other economic and non-economic (e.g. social, environmental, safety-related) benefits may also be considered. Parties seeking authorization must be willing to subject their merger to public review (registration of the merger, public consultations, publication of the draft public interest decision and, sometimes, conferences).

When parties do not seek authorization, but merely submit their merger for review on the basis that it does not substantially lessen competition, the Commission also considers efficiencies as a factor in its review, but only to the limited extent that those efficiencies would enhance competition in the market following the merger (Australia 1999, paras 5.16 and 5.171). Parties that want to make efficiencies the focus of their merger review are directed to rely on the public interest immunity authorization process — that is, the efficiency defence approach.

United Kingdom

In the normal course of things in the United Kingdom, efficiencies are a factor in the review to determine whether a merger substantially lessens competition. However, they are also separately considered when assessing the customer benefits a merger would generate, and may operate as a form of defence in that assessment.

In the assessment of efficiencies as a factor, only efficiencies with a positive effect on rivalry are relevant (United Kingdom 2003: para. 4.32). Rivalry is seen to be the essence of competition and the means by which benefits to customers are generated. The Merger Guidelines state that the Office of Fair Trading must be satisfied that there will continue to be sufficient post-merger rivalry within the market to ensure that the merged entity has an incentive not only to pursue the claimed cost savings but also to pass on to consumers a reasonable share of benefits (United Kingdom 2003: para. 4.34).

When the Office of Fair Trading believes that a merger has, or may be expected to, substantially lessen competition, it has a duty, subject to certain exceptions, to refer the matter to the Competition Commission. The Commission performs its own analysis of whether the merger substantially lessens competition, taking into account various factors, including rivalry-enhancing efficiencies (United Kingdom 2003a: para. 3.27). If the Competition Commission finds that a merger substantially lessens competition it may block the merger or impose remedies.

An exception to the duty of the Office of Fair Trading to refer mergers to the Competition Commission exists when customer benefits (including those generated by efficiencies) “outweigh both the substantial lessening of competition and any adverse effects of the lessening of competition that follow.” Additionally, the Commission is empowered to take customer benefits into effect when designing a remedy. This means that it may attempt to remedy competition problems while preserving the customer benefits generated (or decline to order any remedy in order to preserve customer benefits, including efficiencies). The Competition Commission’s guidelines explicitly refer to certain types of efficiencies as being consumer benefits (United Kingdom 2003a: paras. 4.41–4.44). These may (in theory at least) serve as efficiencies-based defences when efficiencies give rise to significant customer benefits.

Note that the United Kingdom law only applies to local mergers. The European Commission deals with mergers that meet European law enforcement thresholds using a factor approach.

Treatment of dynamic efficiencies in other jurisdictions

As discussed in Chapter 4, Canada and other industrialized nations are more concerned today about innovation or dynamic efficiency than they were in 1969. Most industrialized countries recognize that innovative capacity and performance are key to economic prosperity.

Given the increasing international focus on innovation, it is not surprising that many merging parties have referred to anticipated improvements in dynamic efficiency as motivating factors for their mergers. Canada’s Merger Enforcement Guidelines (both the 1991 and 2004 versions) (Canada 1991, Appendix 2; Canada 2004, para. 8.15) identify dynamic efficiency as one of the two categories of efficiency gains likely to be generated by a merger (the other category being productive efficiencies). The 2004 Guidelines include the following commentary on the treatment of dynamic efficiencies in the Bureau’s merger enforcement practice.

• The Bureau also examines claims that the merger has or is likely to result in gains in dynamic efficiency, including those attained through the optimal introduction of new products, the development of more efficient productive processes, and the improvement of product quality and service. It is recognized that attaining dynamic efficiency is crucial to both the general evolution of competition and the international competitiveness of Canadian industries. Because dynamic efficiency is extraordinarily difficult to measure, the Bureau generally relies on documents prepared in the ordinary course of business to assess the validity of such claims. Such efficiencies are generally considered from a qualitative perspective (Canada 2004, para. 8.15).

The Panel contacted enforcement authorities in several major jurisdictions to discuss how they consider dynamic efficiency. In general, while all these officials said they would be willing to entertain dynamic efficiency claims in merger review, they added that they would use caution when assessing such claims. For example, claims that a merger will contribute to increased innovation are difficult to quantify and prove. Qualitative analysis of such claims is therefore required. Some enforcement officials pointed out that there is no clear evidence that increased market share or concentration contributes to innovation, and stated that absent evidence of a link, they would be very cautious about giving any material weight to dynamic efficiency claims. They also rejected the notion that dynamic efficiency should be given special treatment in merger review.

Assessment of international regimes

The Panel’s review has revealed that there is a wide spectrum of approaches to efficiencies around the world. While the terms factor and defence refer to broadly similar enforcement approaches, there is significant variation within them, and no two factor or defence regimes are identical. Australia and the United Kingdom incorporate elements of both the factor and defence approaches, yet their regimes are by no means identical. Moreover, contrary to some opinions expressed during the Bureau’s consultations, the use of an efficiency defence is not condemned internationally, as evidenced by the fact that a number of major jurisdictions have a defence (or hybrid) regime.

The Mergers Working Group of the International Competition Network has observed that “a merger efficiencies defence appears to be more prevalent in small open-trading economies where domestic markets may not permit a large number of firms to achieve economies of scale” (International Competition Network 2004, para. 19). This would seem to be true in the case of Canada, Australia (hybrid regime) and South Africa; however, there are also very significant differences among the regimes in place in these jurisdictions.

The Panel also notes that some jurisdictions that employ a defence (such as the United Kingdom, which has a hybrid regime) do not fall into the “small open economy” category. The United Kingdom’s economy is integrated with that of the broader European Union. The International Competition Network study points out that Brazil and Ireland have forms of the efficiency defence. (International Competition Network 2004: paras. 24–25) Ireland’s situation mirrors Canada’s to some extent. Ireland is, at least it has become so in recent years, a small open economy at the periphery of a much larger market, in this case the European Union. Brazil is in the situation that Canada was in the late 1960s: it is a trade-oriented country with significant “national champion” industrial policies that may distort the efficiency of the economy.

The Bureau’s report on the international round table summarizes comments made by participating jurisdictions on the small market economy argument, as follows.

• One participant indicated that putting extraneous considerations in merger review is not appropriate. For example, a “small market” argument, which would support high degrees of concentration, may not be the best way to promote the Canadian economy. In general, high concentration levels and lack of competition is a disservice to any economy on a long-term basis. That participant indicated that competitive markets or markets with rigorous competition are likely to generate the greatest efficiencies. On the other hand, a participant indicated that in the context of a small economy, international competitiveness becomes a relevant element that can be considered in the analysis (Canada 2005, 19).

The International Competition Network’s Mergers Working Group concluded that there is no “one size fits all” solution to the treatment of efficiencies in merger review, a conclusion toward which the Panel leans (International Competition Network 2004, 2). At the same time, the Panel favours convergence with the United States, unless there is an objective reason for maintaining a distinct Canadian approach. The Panel’s conclusions respecting the regime that is most appropriate for Canada in light of the objective characteristics of its economy are found in Chapter 6.