Let’s Get Vertical

Jonathan Sallet
Jonathan Sallet

In the wake of the government’s setback in the AT&T/Time Warner case, it’s natural enough to ask: what will be that case’s impact on the government’s ability to challenge vertical mergers in the future? I think the answer is “very little if anything.” But to understand why requires a quick turn through antitrust law.

To simplify, imagine two kinds of mergers. The first involves two direct competitors – say two computer manufacturers that join together as one. This kind of “horizontal” merger may or may not be beneficial, but it portends the inherent loss of a competitor.

The government could take steps to build a foundation for the review of vertical mergers in the future

By contrast, a “vertical” merger often involves two companies that do not compete, but that do business together. For example, a company that manufactures specialized airplanes might acquire the only company that makes (and can make) engines for this particular kind of aircraft. A lot of commentators have argued that vertical mergers are inherently good – in this example, they might say that the costs of making and distributing airplanes would go down as operations are combined, and the lower costs would mean lower prices for customers.

But the Department of Justice (DoJ) and the Federal Trade Commission (FTC) have over the last years demonstrated that harm can nonetheless arise. Suppose there are two manufacturers of this kind of aircraft (the “downstream market”), but only one company that makes the engines used in those aircraft (the “upstream market”). The vertical merger could mean that the merged company raises the prices of engines to its competitor, making the market for engines less competitive and thus limiting competition for customers who buy this specialized aircraft in the downstream market. A number of cases have been settled where the antitrust agencies have concluded that control of an input threatens competitive harm, but, before the AT&T/Time Warner case, it had been forty years since litigation of a vertical merger by the antitrust agencies.

This “input” theory was presented in the AT&T-Time Warner case. But even as that case may continue in the court of appeals, the government could take steps to build an even stronger foundation for the review of vertical mergers in the future. Here are some suggestions.

First, the current 1984 guidelines on the treatment of vertical (technically, non-horizontal) transactions should be withdrawn. These kinds of guidelines can be very helpful (the guidelines dealing with horizontal mergers have been influential on the courts).  But antitrust officials in the last two Administrations, from both antitrust agencies, have explained that the current non-horizontal guidelines are not good law. But they have never been repealed and so the courts continue to look to them.

Second, new vertical guidelines should be created. There’s been a lot of thinking on this subject, perhaps most notably by Professor Steven Salop, but I think the antitrust agencies should convene a working group to identify the learnings that are sufficiently robust to support new guidelines – and their application in court. Experts should come from the economic and legal professions, but also should reflect practical business experience in topics like negotiations, the ability to actually obtain (or exceed) projected efficiencies, and the understanding of corporate strategies. And, of course, consumer perspectives on the real impact on customers (pro and con) should be represented.

The working group would help ground the new guidelines in the best thinking of economics, law, and business. That would help courts understand the reasoning behind and the importance of the guidelines despite the dearth of litigated cases.

Suppose the working group could complete its work in six months. Then the agencies could consider whether they have enough to stand on to issue a full set of vertical guidelines. That would be optimal but, if not, then new guidance could be provided on an issue-by-issue basis.

To be effective, new guidelines need to demonstrate how the antitrust agencies will analyze both the potential benefits and the potential harms from vertical transactions. But here are five additional, specific topics that I think are worthy of consideration:

  1. Concentrated Markets: Should the presence of concentrated markets make a difference? The traditional use of concentration measures is in horizontal mergers (where we look to see if the new firm will have a big market share). But is it possible that vertical analysis also be informed by concentration in upstream and/or downstream markets?
  2. Bargaining Leverage: Bargaining leverage is at the heart of the aircraft example – the new company would control how much customers must pay for aircraft engines. There’s been a lot of great economic analysis, from Aviv Nevo’s speech when he was at the Department of Justice to the May 2018 article by Scott Hemphill and Nancy Rose in the Yale Law Journal. But I think more work can be done to demonstrate for a generalist audience (including generalist judges) how those economic principles shape corporate strategy. How can we better demonstrate the theoretical and factual basis for identifying when mergers increase bargaining leverage?
  3. Powerful Inputs: As a related topic, the agencies would be well-served by providing greater detail on how to tell whether the control of an input will distort competition. Sometimes the label “must have” is attached to an input, for example, but the phrase may not entirely capture the competitive significance of the incentive and ability to use ownership of an input to thwart competitive rivals.
  4. Coordinated Effects: There is more work to be done on so-called coordinated effects. These arise when the antitrust agencies believe that a merger will result in remaining competitors being, to use the vernacular, too cozy with each other.
  5. Remedies. The antitrust agencies have offered guidance on the use of structural and behavioral remedies in a series of speeches in 2016, 2017, and 2018, but this guidance could be synthesized and codified.

Neither the creation of new vertical guidelines nor any of these points would be part of any appeal in the AT&T/Time Warner case. But beyond this case, there is, I think, useful work to do, starting now, as the antitrust agencies face more and more vertical transactions in the coming years.

Jonathan Sallet is a Benton Senior Fellow. He works to promote broadband access and deployment, to advance competition, including through antitrust, and to preserve and protect internet openness. He is the former-Federal Communications Commission General Counsel (2013-2016), and Deputy Assistant Attorney General for Litigation, Antitrust Division, US Department of Justice (2016-2017). 

By Jonathan Sallet.