Competition
Law:
The Role of
Efficiency in Merger Analysis
©
Sahil Gupta
15 July 2002. All Rights Reserved.
Efficiency -
it is
an improvement in the utilization of existing assets that enables the combined
firm to achieve lower costs in producing a given quantity and quality of goods
and services. Efficiencies may result from achieving economies of scale,
combined production plants, integrating procurement, transportation and
distribution facilities, and pooling research and development resources.
Efficiency -
it is
an improvement in the utilization of existing assets that enables the combined
firm to achieve lower costs in producing a given quantity and quality of goods
and services. Efficiencies may result from achieving economies of scale,
combined production plants, integrating procurement, transportation and
distribution facilities, and pooling research and development resources.
Introduction
Efficiency
considerations have assumed an important role in antitrust analysis over the
last two decades. Although traditional rule of reason analysis has long entailed
a balancing of anticompetitive effects of a course of conduct against the
procompetitive benefits (or efficiencies) associated with the conduct or
transaction, it was only after the Chicago revolution in the late 1970’s that
efficiencies came to occupy a central role in antitrust analysis. The
efficiencies that are realized by the merger between firms can increase the
firm’s incentive and ability to compete and may result in lower prices for
consumers. Mergers may also harm the economy if the post-merger firm acquires
sufficient market power to restrict output and restrain competition. As a
result, Antitrust policies have struggled to accommodate the
efficiency-generating benefits of mergers while striving to prevent firms from
acquiring anticompetitive market power.
In industries in
which scale economies are significant, the agencies have routinely and correctly
adjusted the numerical presumptions of the Merger Guidelines to accommodate the
scale of enterprises needed to attain efficient scale, whether that scale is
based on research and development efficiencies, production efficiencies, or even
administrative and overhead efficiencies. This approach has allowed the agencies
to circumvent in most cases the difficult problems of proof and yet accommodate
in some fashion the need to credit the efficiency side of the ledger.
Efficiency
considerations in merger analysis
The obstacles to
the acceptance of the efficiency rationale appear to arise in some measure from
the constraints of stare decisis, from uncertainty about what constitutes a gain
in efficiency, and from uncertainty about whether efficiency gains are in
reality procompetitive. Supreme Court’s 1977 Sylvania decision is a landmark
opinion as it brought efficiency considerations into the forefront of antitrust
analysis and declared that efficiencies were central to an understanding of the
competitive significance of the practice. Supreme Court has reaffirmed the
central role of efficiencies in a spectrum of cases ranging from BMI
to Northwest Wholesale Stationers.
The BMI court held that the blanket copyright at issue, which by nature is sold
only a few, instead of thousands, of times leads to a substantial lowering of
costs, a strong endorsement of the transaction cost efficiencies that the
license offered.
Let us now evaluate some of the benefits which could be considered while
weighing the merger procompetitive benefits:-
1.
Simple economic analysis indicates that most vertical integration is
efficient in that it reduces the costs of the integrating firm.
a) Production Cost Savings
Sometimes
vertically integrated firms can achieve production costs savings by taking
advantage of technologies that are not available to firms that are not
vertically integrated. The steel mill combined with the rolling mill (which
forms hot steel into sheets) is an example of such savings.
b) Transaction Cost Savings
Transaction costs are the costs of using the market. The vertically integrated
firm can reduce these costs by eliminating the need for market transactions. The
potential for vertical integration to reduce transaction costs is generally
greater than its potential to reduce production costs.
c) The Problem of Market Power Held by Other Firms
A
firm is always better off if the firms with which it deals behave competitively.
Often a firm will integrate vertically in order to avoid dealing with a
monopolist or perhaps a cartel at a different level of production or
distribution. By vertically integrating the monopolist can eliminate a monopoly
output reduction in another part of the distribution chain. Otherwise it can
transfer someone else’s monopoly profits to itself.
d) Optimum Product Distribution
Finally, a firm can use vertical integration to ensure that its product is
distributed in the best way. By vertically integrating to the retail level, for
example, a manufacturer may obtain the best control over how its product is
marketed and priced.
2.
Mergers also can create substantial economies for the post-merger firm.
For this reason, horizontal mergers are not illegal per se. In fact, most
are legal. These economies include:
a) Economies of Plant size, which result when a merger permits the
post-merger firm to engage in more specialized production in a single plant.
b) Multi-plant Economies, which occur because firms that run large
numbers of plants and can often coordinate purchasing or production in ways
that are unavailable to the single-plant firm. This is particularly true of
advertising and research and development.
Such efficiency
defences should be weighed against the anticompetitive aspects of the merger.
But skeptics of the efficiency principle emphasize that efficiencies are
extremely difficult, if not impossible, to quantify and hence, anything short of
clear and convincing evidence of alleged beneficial efficiency should not
outweigh a finding of increased market power or lessening of competition
resulting from the merger. As a result, the agencies have required merging
parties to submit rigorous proof of the efficiencies that a transaction is
likely to produce and to establish that the efficiencies are ‘merger-specific’.
Proving an
efficiency defense
The
acceptability of efficiency defense should rest on a showing that the merger
will produce a more competitive market. The proponent thus needs to demonstrate
that the merger will produce a firm better able to compete and that the
resulting fim’s competitive enhancement will produce a more comepetitive market
along with passing the benefits to consumers with immediate effect. A showing
that other entrants have premerger cost or size advantages which are lessened
or eliminated by the combination is then a necessary step for an efficiency
defense. Further, proof of premerger scale diseconomies must be required of both
merging firms.
A successful
efficiency defense must establish that the combination produces a more efficient
competitor whose enhanced competitive capabilities outweigh the elimination of
competition between the merging firms.
Efficiency
treatment in United States and European Union
In the
United States,
the 1992 Merger Guidelines recognize efficiencies under paragraph 4. Cognizable
efficiencies inculde, but not limited to, achieving economies of scale, better
integration of production facilities, plant specialization, lower transport
costs and similar efficiencies relating to manufacturing, servicing,
distribution operations of the merging firm. Efficiency claims have been often
rejected on evidentiary grounds. The US has been criticized for its Courts and
Agencies resisiting the incorporation of an efficiency defense to merger
enforcement. Although the Courts looked at the economic efficiency for the first
time in Sylvania Case (1977), there is no clear judicial treatment or
application of efficiencies arguments and efficiency considerations continue to
be theoretically available in US merger analyses.
In the
European Union, Article 81(3) specifically includes conditions of improving
production, distribution or promoting technical and economic progress and these
fall under the “efficiency gains” category. Most decisions look to efficiency
and consumer welfare considerations in interpreting this condition. The
ECJ has held that for maintaining “effective competition”, the more competition
is restricted by the challenged conduct, the higher the efficiency gains must be
in order to justify an exemption. E.g. BT/MCI involved the creation of a
joint-venture company for the provision of advanced telecommunications services
to multinational businesses. The parties involved included British Telecom (BT),
the former U.K. monopolist telecommunications operator, and MCI, the
second-largest long-distance operator in the United States. Although the
Commission found that the joint venture would result in a restriction of
competition, it concluded that competition would not be eliminated and the
benefits resulting from the operation would outweigh the anticompetitive
effects. The joint venture would offer new global services more quickly and of a
more advanced standard than BT or MCI could offer alone. The joint venture also
would reduce substantially the costs and risks inherent in offering the proposed
services on such a large global scale.
Conclusion
No matter what
efficiency approach is used, efficiencies traditionally have played a role
solely in antitrust analysis as a defense, a way of rebutting and potentially
offsetting anticompetitive explanations for proposed transactions. The treatment
of merger-engendered efficiencies should be considered under the rule of reason
just as efficiencies are with respect to other non-per se restraints. The
viability of the defense ultimately depends on the willingness of courts to make
qualitative judgements about prospective efficiency gains measured against the
likely anticompetitive effects of increased market shares. Although the contrast
of these counterbalancing factors is acute, their resolution requires nothing
more of the judiciary than does the rule of reason in antitrust proceedings
generally.
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©
Sahil Gupta
15 July 2002. All Rights Reserved.
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