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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.


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[1] to Northwest Wholesale Stationers[2]. 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.


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.

back to Lex e-Scripta© Sahil Gupta 15 July 2002. All Rights Reserved.

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