john kwoka teaches economics at Northeastern University. His latest book is Mergers, Merger Control and Remedies (MIT Press, 2015).
Illustrations by Kris Mukai.
Published October 20, 2017
President Teddy Roosevelt’s “Square Deal” was founded on the “three Cs” — conservation of natural resources, consumer protection and control of corporations. In his eight years as president, his administration brought a total of 44 antitrust suits for monopoly practices that harmed consumers. TR’s (Republican) successor, William Howard Taft, brought 75 such suits.
But that Progressive Era proved to be a high-water mark in monopoly control. And it stands in stark contrast to a contemporary corporate environment in which few large mergers and even fewer anticonsumer corporate practices are challenged in court.
So it is noteworthy that in the past couple of years politicians from both parties, along with many economists and certainly some consumers, have raised their voices to complain about the impact of growing market power. In airlines and cable TV, beer and pharmaceuticals, and (less visibly) industrial chemicals, food processing and myriad other industries, the prices, choices and quality of goods and services have seemed to suffer. Moreover, in addition to these market distortions, there is real concern that, as TR worried, market power is spilling over into political power, thereby threatening democracy.
The Obama administration took notice of these trends, albeit belatedly. In April 2016, the White House issued an executive order on competition, preceded by a detailed issue brief from the Council of Economic Advisers titled “Benefits of Competition and Indicators of Market Power.” The order set out a series of actions to be taken by executive branch agencies to focus attention on competition concerns in all their diverse areas of responsibility.
This new support for competition is welcome news, but raises troubling questions. How did we drift so far from the Progressive Era perspective? Why have concentration and market power been allowed to grow? Why haven’t the antitrust agencies — the Antitrust Division of the Justice Department and the Federal Trade Commission — been more successful in countering these trends?
One way of learning what has happened is to take a close look at actual merger enforcement in the present era. Here I review four major mergers over the past decade to see what competitive issues they raised, how they were analyzed by the regulators, why for the most part they were resolved without direct challenge to the merger — and with what ultimate effect.
As you’ll see, antitrust has, with time, narrowed its focus. It has reversed the Progressives’ inclination to put the burden of proof on corporations to show that increased concentration is benign. And it is resolving cases in ways that have permitted consolidation and more generally blurred its mission and agenda.
While some changes made sense in light of the evidence from economics, and many case-specific decisions may have seemed rational when examined out of the context of broader economic trends, their collective impact has been to significantly weaken Washington’s role in promoting competition. Accordingly, reinvigorating antitrust would require a sharpening of policy focus and a hardening of its edges — what I term, with a nod at TR, “squaring the deal.”
A Mini-Primer on Merger Policy
United States antitrust law prohibits mergers and acquisitions where “the effect … may be substantially to lessen competition, or to tend to create a monopoly.” The idea is to target market structures and business practices that enhance market power, which is taken to mean the ability to increase prices or otherwise adversely affect market function by reducing quality or slowing innovation. Specific mergers are analyzed for their likely effects on market power using a variety of techniques for developing evidence and drawing conclusions.
Current practice is set out in the Horizontal Merger Guidelines, last issued by the FTC and the Department of Justice in 2010. Those guidelines describe a multistep process, first defining the “antitrust market” within which the merging firms operate, then measuring the effect of the proposed merger on concentration in that market, analyzing economic evidence about its likely effects on prices, and evaluating the plausibility of offsetting factors. One potential mitigating factor is ease of market entry by would-be rivals, since the threat of entry can limit pricing power; another is the potential for reducing production and distribution costs, which can increase the economy’s productive capacity and may lead to lower prices for consumers.
All that leaves room for interpretation, and interpretation has evolved in important ways. Today’s antitrust regulators rely less on broad measures of market concentration and more on economic analysis specific to each proposed merger. They strive to understand the exact mechanism of market power that might be created by the merger. There is less attention to the potential for collusion or coordination among competitors. And there is less skepticism about the potential for efficiency gains — and generally more inclination to accept arguments that market power will be curbed by the potential for market entry.
Enforcement is in the hands of the DOJ and the FTC. The two agencies are notified of mergers exceeding certain size thresholds — currently about 1,500 mergers annually. Of these, 50 or so go to full investigation, and more than three-quarters of those are subject to some policy action. But those actions now overwhelmingly take the form of remedial prescriptions rather than outright challenges. Mergers go forward subject to amendments, such as divestiture of stores or lines of business, or agreement to specific limitations on conduct designed to minimize the anticompetitive impact of the merger.
Merger Policy in Practice
A closer look at just a handful of cases captures important changes in economic analysis and legal interpretation that have narrowed enforcement and facilitated consolidation.
US Airways and American Airlines
A decade ago, the market for domestic air travel consisted of six major “legacy” airlines, which existed before deregulation in 1978, plus a large low-cost competitor (Southwest) and several smaller low-cost carriers (AirTran, JetBlue and Frontier, among others). In 2008, the DOJ approved the merger of Delta and Northwest; this was followed by the mergers of United and Continental and of Southwest and AirTran in 2010, and finally of US Airways and American in 2013.
Approval of the US Airways-American merger was widely viewed as a turning point. With airlines, antitrust analysis focuses on the overlap of nonstop routes. Yet, despite their huge sizes, US Airways and American had only 12 to 15 such routes. The merger’s potential impact on prices on these routes could be predicted based on economic evidence regarding the past effect of changing numbers of carriers serving a route and the presence of low-cost carriers (known to have especially large price effects) on the route. Against these were arrayed alleged benefits from increased connectivity (more ways to get from point A to point B), greater flight frequency and improved amenities (availability of backup aircraft, better airport facilities and so on).
The merging airlines asserted that increased flight frequency and connectivity were worth a great deal to passengers, outweighing any competitive harm. The DOJ initially issued a complaint against the proposed merger, but then permitted it to go forward so long as the parties divested some takeoff slots at National Airport in Washington and gate and terminal space at a few other airports where airline entry was impeded by these constraints.
In light of subsequent public dismay with higher airline prices and declines in service, many asked whether this focus on a relatively small number of overlapping routes fully addressed concerns about the remaining carriers’ ability to coordinate their behavior more broadly, such as with respect to capacity or ancillary fees. Others asked about such matters as reduced competition on connecting routes, or on non-route effects (such as reduced competition for corporate accounts, which are contracted regionally or nationally), or non-price effects (service quality, measured in a variety of ways). Since the merger, these concerns have, if anything, increased — as have questions about the adequacy of a model for merger analysis that leads to this outcome.
Teva and Allergan
The 2015 merger of Teva and Allergan, producers of generic (out of patent) prescription drugs, stands out among the large number of pharmaceutical mergers in the past 15 years. Before the merger, Teva was the largest generics manufacturer with a portfolio of about 410 drugs, while Allergan was the third largest with 370. The merger would transform the industry from what amounted to a “triopoly” (with Novartis, the second-ranked firm) to one dominated by a single firm. However, the focus of antitrust attention was not this increase in overall concentration, but on specific overlapping product markets.
The FTC identified some 80 drugs manufactured by both companies and insisted on divestiture of one of the two overlapping products in each category. In this fashion, it reasoned, the number of independent suppliers of each drug wouldn’t change — and, on that basis, the commission approved the merger.
This resolution was tidy, but in the view of some did not resolve all competitive concerns. It seemed unlikely, for example, that an industry with a truly dominant firm would be as competitive as one with three firms of similar size, even if directly overlapping assets were divested. In addition, the 80 divested assets (drug lines) did not go to Novartis or to any other single company, which would have increased the acquirer’s competitive muscle. Rather, they were scattered among 10 much smaller firms, further ensuring Teva-Allergan’s market dominance. And finally, there was the sheer mathematical improbability that this package of 80 divestitures would fully preserve the prior level of overall competition, since that would literally require all 80 divested drug lines to succeed in the market.
Ticketmaster and Live Nation
Ticketmaster and Live Nation have long dominated distinct parts of the live music performance business. Ticketmaster sat astride the market for ticketing services, while Live Nation was pre-eminent in concert promotion and concert venues. In 2008, after a contract dispute with Ticketmaster, which had been servicing its venues, Live Nation started doing its own ticketing and then offered the new service to others. The owner of two major venues quickly switched, threatening the loss of a considerable part of Ticketmaster’s business — at which point Ticketmaster offered to buy Live Nation.
The antitrust issues seemed straightforward: the merger would eliminate a significant new competitor in ticketing services, the first in a generation, and so seemed a clear threat to competition. It would also solidify the “vertical chain” by combining Ticketmaster’s dominant ticketing services and leading artist management company, with Live Nation’s parallel position in venues and in promotion. The parties claimed this vertical integration would yield various efficiencies and new technologies. But others were concerned about the combined company’s ability to leverage its dominant businesses.
For example, an independent venue owner that needed Ticketmaster’s ticketing services might find itself pressed to book artists managed by the combined company. Independent promoters, for their part, were concerned that Ticketmaster’s information on their customers could be used by the combined company to steal their business.
The DOJ nonetheless approved the merger, albeit subject to a complicated remedy. The horizontal market concern — that Live Nation was being eliminated as a competitor in ticketing services — was addressed primarily by requiring Ticketmaster to license its technology to a large concert promoter so as to permit it to get into the ticketing business. But the licensee promptly abandoned the technology, and, eight years later, Ticketmaster remains dominant in ticketing services.
The DOJ order also sought to prohibit the combined company from exploiting its vertical integration — for example, by demanding that independent rivals utilize more of its businesses than they might want, or by transferring data from ticketing services to non-ticketing parts of the integrated company. Skeptics noted that these provisions seemed easy to evade and unenforceable, ultimately offering little protection to independents.
AT&T and T-Mobile
The antitrust review of the 2011 proposed merger of AT&T and T-Mobile, two of the four wireless carriers with national networks, offers a useful contrast. The parties claimed that the merger would alleviate bottleneck capacity constraints on their networks, allowing them to compete more vigorously with third parties and driving down prices in their service markets. They further argued that their customer bases were not all that similar, that there were many regional competitors to choose from and that their different pricing and other practices would prevent any postmerger coordination.
Telecom and related mergers are reviewed by the Federal Communications Commission as well as by the DOJ. In this case, the FCC determined that the parties’ efficiency argument was specious, with cost savings resting on implausible assumptions. In addition, the agency concluded that their economic model was flawed, both because of the unrealistic cost-savings estimates and because it relied on misleading data. The FCC signaled its opposition to the merger, as did the DOJ — at which point the parties abandoned it.
The upshot of this merger-that-did-not-happen was the preservation of an industry with four national network players — and in particular of a company (T-Mobile) that would go on to play the role of the maverick for years to come. After the merger collapse, T-Mobile upgraded its network, marketed a fuller line of handsets and initiated aggressive pricing and service bundling practices. The other three major carriers had to respond, meaning that all wireless consumers benefited from the competition that T-Mobile brought to this market.
These four cases can hardly capture an entire era of merger policy. They do, however, suggest that regulators have been inclined to avoid outright challenges, finding reasons to clear mergers when accompanied by ever-more-elaborate remedies. In these respects, they are apt examples since this trend captures much of what has happened to policy.
The FTC’s own data show striking changes in its enforcement record. While the agency has consistently challenged mergers at the highest concentration levels, in the mid-to-high range of concentration just below it had been reducing enforcement for at least 15 years. Whereas beginning in 1996 it challenged 36 percent of mergers with five-to-eight surviving competitors, by 2008 it had ceased enforcement actions against such mergers altogether. There were literally no court challenges and no approvals subject to remedies of any type in the 2008-11 reporting period for mergers that left at least four firms in the game. In that range, mergers got a free pass.
Without knowing more about the specific cases, it is impossible to determine how many of these approvals were problematic in terms of impact on competition. But as it happens, there is now some evidence on this question — although for a different set of mergers. In my own research, I have compiled a database of all the high-quality economic studies of specific mergers and their outcomes.
I found that, on average, they have resulted in price increases of about 7 percent, with more than four-fifths of them producing some price increase. Mergers have generally been anticompetitive, and antitrust remedies have not been much help. Divestiture remedies analogous to that used in Teva-Allergan, for example, have resulted in price increases greater than 5 percent, a bit less than for mergers overall but hardly consistent with the claim that they would preserve competition. Even more troublesome, conduct remedies are associated with price increases of about 13 percent — although the data here are pretty sparse.
All in all, too few mergers seem to have been challenged, and of those that have been, too many were resolved with remedies that proved ineffective. And this “soft” merger control policy is plainly taking a toll. The Council of Economic Advisers’ issue brief on competition cited data showing that concentration throughout the economy has been trending upward, a phenomenon confirmed by several other studies. What’s more, research has linked this rise in concentration to various socioeconomic ills beyond higher prices.
A fair amount of evidence suggests, for example, that mergers and higher concentration generally result in no improvement, and often a decline, in service quality and in the pace of technological innovation. Other studies have linked rising concentration to reduced opportunities for entry by business start-ups, to increased income inequality and to the concentration of political power.
Increased economic concentration is certainly not the only cause of these ills. On the other hand, there is little evidence suggesting that greater concentration actually favors economic and social goals like rapid technological change and easy entry to markets that virtually everyone claims to support. It would be fair to say that the retreat of antitrust has contributed directly to rising concentration and higher prices, and in so doing indirectly to other unwelcome outcomes.
Merger Policy: Squaring the Deal
The adverse effects of concentration, ranging from the price effects to broad concerns about political power, are very much the issues that prompted Teddy Roosevelt to undertake his aggressive antitrust policy more than a century ago. Few doubt what his view of present antitrust policy would be.
No one advocates turning back the clock to 1910. But the path of least political resistance has been in the opposite direction, narrowing the focus of antitrust, accelerating the problematic rise in concentration. Here we draw on our review of the four merger cases plus the broader economic evidence to identify several aspects of current merger control policy that deserve reconsideration.
The first is the tendency to underestimate the importance of concentration per se. The antitrust agencies do not rely on the presumption stated in the Merger Guidelines and endorsed in a previous generation’s judicial opinions that a significant merger in an already concentrated market is so inherently likely to undermine competition that little further analysis is required. Rather, the agencies appear to believe (as do the courts) that they must specify a causal mechanism for the anticompetitive behavior that will lead to harm in each case. But that is a difficult task if held to a rigorous standard, even if the likely harm is not difficult to anticipate.
This search for explicit causation between mergers and economic ills has handicapped antitrust enforcement. It has also led to an undue preference for bringing so-called “unilateral effects” cases rather than traditional coordination cases. In unilateral effects theory, a merger is treated as a method by which a firm captures some fraction of otherwise lost business that now goes to the acquired direct competitor, and as a result is more likely to raise prices. Such mergers, of course, often do occur, but it’s the ability to model this motivation for merger that makes unilateral effects theory seemingly objective and more appealing. This has resulted in de-emphasis of the alternative “coordinated effects” situation — agreements or understandings among firms that are often at the heart of competitive concerns. Indeed, the so-called structural presumption, which is directed toward coordinated effects, would simultaneously rebalance policy and simplify enforcement.
A second and related emphasis that often leads the process astray is the very heavy focus on narrow “antitrust markets,” which are defined by consumer substitution patterns — as in, “Are movies really in the same market as video games?” — but may sometimes miss important competitive concerns. Among the latter are the myriad other ways in which a merged company can gain, exploit and defend its market power through bundling, marketing, distribution, innovation, vertical control and entry deterrence. While the regulators do their best to examine such issues, these are areas in which economic analysis is more complicated, guidelines less helpful and (partly as a consequence) court opinions uneven in their holdings.
Related to this problematic focus on narrow overlapping products for the definition of the relevant market is the insufficient attention paid to mergers that eliminate a potential competitor — that is, a firm waiting in the wings whose threat to enter very possibly constrains the incumbents. When a firm already in the market acquires or merges with such a potential entrant, there is no overlap and hence no increase in standard measures of market concentration. Nonetheless, by eliminating the possibility of future entry, the merger relaxes a constraint on raising prices and other adverse outcomes linked to market power.
Many mergers between “nearby” but not “overlapping” competitors take this form. And the failure to proceed aggressively against such mergers reduces both actual and potential competition in many markets.
A third area of concern is the role of offsetting positive effects to an otherwise anticompetitive merger. The merger guidelines state that acceptable efficiency gains need to be not otherwise achievable as well as verifiable. But these criteria are not always clear and certainly do not provide any disincentive for parties to make endless claims of varying validity.
Furthermore, as the regulatory agencies have become more skilled in evaluating (and challenging) claims of efficiency gains, the benefits alleged by merging parties more often seem to involve the potential for better service and quality. These claims are more difficult to assess than those alleging straightforward cost savings, and may well tilt the process toward acceptance of mergers.
Similar concerns arise with the idea that ease of entry resolves all potential sins. The last revision of the merger guidelines toughened the analysis of entry that qualified as an offsetting factor, but in practice the agencies often seem to treat ease of entry as a reliable path to merger approval. FTC data show that the agency has never taken an enforcement action against any merger, regardless of how high the resulting market concentration, where entry was judged to be “easy.” While entry is a legitimate consideration in analyzing the impact of a merger, this seemingly surefire escape avenue has encouraged merging parties to assert that entry is easy, adding to the burden of proof for the reviewing agency.
Finally, remedies that are intended to make mergers more competitive seem to be used too often in place of outright challenges to the combination. Divestitures and conduct remedies can, in principle, be useful tools, but the evidence is that they are often ineffective. The reasons are clear: they are difficult to write and often unenforceable in practice. Not surprisingly, then, they have commonly resulted in price increases. Reliance on remedies generally, and conduct remedies in particular, should be reconsidered.
The liberal application of remedies in mergers, in conjunction with narrow definitions of relevant antitrust markets, has contributed to the growth of large firms. By subjecting mergers of large companies to only modest divestitures in narrowly defined overlapping products, this approach allows the remainder of the companies to consolidate. The result is often the creation of most of what the merging parties sought in the first place: greater size and control across a number of related products and markets.
In passing the Sherman Act of 1890, Congress declared that first antitrust statute to be “a comprehensive charter of economic liberty aimed at preserving free and unfettered competition as the rule of trade.” The merger control provisions were set out in 1914 and strengthened in a 1950 law, which was subsequently interpreted by the Supreme Court as intending to “arrest … a trend toward concentration in its incipiency, before that trend developed to the point that a market was left in the grip of a few big companies.”
But the force of this opinion is not matched by the current government merger guidelines and the resulting enforcement practice. Current guidelines and practice do not seem oriented toward aggressive oversight and control of concentration. If there is to be any hope of going back to the future — and it would take considerable political will — current antitrust enforcement would need a serious makeover.
Successful reform would turn on several changes. Regulators would need to be given the resources to do their jobs in a more determined fashion. Reform would also require modest revisions of the antitrust statutes to counter the drift from decades of lax enforcement. It would require policymakers with the vision and determination to make all of this happen. And not least of all, it would require Americans across the political spectrum to grasp the importance of these issues and to support vigorous antitrust enforcement.
In this manner, pubic policy and practice could serve to control corporate power and restore the benefits of competitive markets to all Americans.