Efficiencies as theories of harm in European merger control

Efficiencies as theories of harm in European merger control

Legal professional with strong interest in antitrust, strategy and new technology.

In his 1968 paper, Economies as an Antitrust Defense: The welfare tradeoffs, Oliver Williamson famously warned that ignoring efficiencies that arise from horizontal mergers could be irrational where the gain to producer surplus through cost savings outweighs the loss of consumer surplus arising from the merger.1 For example, consider a merger between two coffee bean suppliers. Suppose that, as a result of the merger, the merged entity raises the price of a bag of coffee from £1.00 to £1.20 due to the elimination of competition in the market. This causes a deadweight loss to society. However, suppose that the merger reduces the merged entity’s marginal cost of production through cost efficiencies, from £1.00 to £0.50. Now there is a trade-off between the size of the deadweight loss to society and the efficiency gains resulting from the merger: if the latter offsets the former, the merger results in a net gain to society and the merger should be cleared.

Recital 29 of the Merger Regulation and with it the Horizontal and Non-Hoirzontal Merger Guidelines acknowledge the role of efficiencies as integral to merger analyses. Examples include cost savings, one-stop shopping, packaged discounts, volume discounts and R&D strategies. However, there is an inherent danger that competition authorities will view certain efficiencies as rendering the merged entity so efficient, through cost savings, product quality or otherwise, that existing competitors will be unable to keep up and thus will exit the market. This has been referred to as the “efficiency offence”.2

Take, for example, a vertical merger that results in cost savings by eliminating double-marginalisation and that allows the firm to charge lower prices than its non-integrated rivals. If these cost savings are sufficient to counteract any harms arising from the merger in terms of customer or input foreclosure, the merger should be cleared even if the merged entity is, as a result, uniquely placed to compete in the market and gain additional market power. This is competition on the merits. The merger should not be challenged absent proof that the merged firm intends or has the capacity to engage in predatory pricing or commit some other abuse of its newfound market power (and why, given its ability to compete successfully on price, would it do so?). This could not possibly constitute a theory of harm or reason to block the merger, even where an undercutting subsequently raises its price after its competitors exit, as this reflects everyday competitive market behaviour.

This was indeed the holding of the General Court in easyJet v Commission, where it found that a merger “may give rise to consequent competitive advantages that may benefit consumers.”3 The Court held that mergers which create or strengthen a dominant position should not be prohibited absent a merged entity’s ability or incentive to restrain effective competition. In this case, “[t]he ability as a result of the merger to offer passengers services at a better price could only constitute evidence of the creation or strengthening of a dominant position in limited cases, for example where the merged entity intends or has the capacity to operate a predatory pricing policy.” Again, question why a firm that is in a position to charge a price that is above its marginal costs, but below the prices of its competitors, would have the incentive to engage in predatory pricing.

Indeed, it is written in the non-horizontal merger guidelines that “the fact that rivals may be harmed because a merger creates efficiencies cannot in itself give rise to competition concerns”4 and there is good evidence that the Commission, at least since it issued its horizontal merger guidelines in 2004, does not turn the notion of efficiencies on its head in this way. Although the Commission has never cleared an otherwise anticompetitive merger on the basis of proven efficiencies, it has accepted efficiencies in principle in a limited number of cases. Notably, in some cases the Commission has accepted efficiencies both where i) the efficiencies are merger-specific, such that non-integrated firms cannot benefit from them; and ii) the product/service offered as a result of the efficiency at a given market price is not widespread in the industry. This implies that the merged entity gains market power through the merger, as a result of either attaining a dominant position or differentiating its offering further from the competition (or both).

For example, in TomTom-Tele Atlas5 the Commission unconditionally cleared the combination of a leading producer of navigation systems with a digital maps provider, which raised vertical concerns. The Commission considered two purported efficiencies. First, the Commission recognized that the removal or reduction of double-marginalization met the legal test for efficiencies, and that in this case these efficiencies were merger specific. However, it was not necessary to precisely estimate the magnitude of these likely efficiencies given the proposed transaction’s lack of anticompetitive effect. Notably, there was no mention of these cost savings having the potential to foreclose competitors by undercutting their monopoly prices without the merged entity having to price at below cost.

Secondly, and more importantly, the parties claimed that the merger would lead to efficiencies in the form of superior product offerings “due to the integration of TomTom’s data to improve Tele Atlas’s map databases.” Citing Paragraph 57 of the Non-Horizontal Merger Guidelines, the Commission accepted that such efficiencies were likely in this case, finding that “end-customers would certainly benefit from the more frequent and comprehensive map database updates made possible by the merger”. The Commission accepted the integration-efficiency in principle and did not raise the accusation that it could make the merged entity’s product so good as to prevent other providers from competing. This is despite the fact that: i) the Commission found that this efficiency was merger specific because “[s]uch investments are risky for the non-integrated company since they are very specific to the particular relationship and hence subject to a so-called hold-up problem”; i.e. non-vertically integrated competitors would struggle to offer a competing service; and ii) it appears from the Commission’s discussion of alternative sources of supply in the downstream market that vertical integration was not the industry norm, affirming the ability of the merged entity to offer a superior product as the result of the integration-efficiency. That said, the Commission ultimately did not draw hard conclusions on this efficiency because the case did not raise anticompetitive concerns.

Similarly, UPS/TNT Express6 concerned a merger between global integrators UPS and TNT which the Commission blocked due to horizontal overlaps. The parties submitted that the horizontal concerns would be offset by efficiencies generated by the combination of the UPS and TNT businesses in the form of i) the generation of “very significant efficiencies of density and of scope”; ii) improvement in service quality; and iii) the production of transactional efficiencies by combining complementary networks. Relatedly, the parties claimed significant cost savings arising from the merger. The Commission found the integration to be merger-specific as outsourcing arrangements could bring significant additional costs, less flexibility and more risk. Here too, the fact that the Commission accepted network integration efficiencies in principle despite the fact that “no agreements of this scale exist[ed] in the market” shows that a unique ability to compete arising from a merger is a legitimate efficiency, and not a theory of harm. In older cases, the ability to offer superior products or services as a result of a merger could constitute a legitimate theory of harm rather than a potential reason to clear the merger. Instead, the Commiscior in more recent cases adheres to the criteria laid down in the Merger Guidelines, namely merger-specificity, verifiability and consumer pass-on, even if the merger results in additional market power in the long or short run. As such, in the recent case of FedEx/TNT Express,7 the Commission found that the merger of FedEx and TNT Express gave rise to verifiable, merger-specific efficiencies as a result of savings on network costs that would ultimately benefit consumers. Again, at no point does the Commission raise the point that such cost savings may allow the merged entity to compete more effectively than other couriers and drive them from the market.

However, in discussing the Commission’s approach to merger efficiencies, one cannot ignore the ghosts of its past. The Commission has been known to treat merger-specific efficiencies as unjustified threats to the parties’ competitors. For example, in MSG Media Service,8 Bertelsmann Ag, Taurus Beteiligungs GmbH and Deautsche Bundespost Telekom sought to establish a joint venture, “MSG Media Service”. The Commission found that the proposed concentration would have created a dominant position for Bertelsmann, parent company of the leading German media group, and Kirch, parent company of Taurus and leading German supplier of feature films and television programmes, on the pay-TV market in Germany. It also found that the concentration would have given the JV a durable dominant position on the market for technical and administrative services in Germany. The Commission examined the parties’ proposed efficiency that “the rapid acceptance of digital television will be promoted by the services offered by MSG”. The Commission pointed out that “the successful spread of digital television presupposes a digital infrastructure and hence that an enterprise with the business object of MSG can contribute to technical and economic progress”, but ultimately found that “the foreseeable effects of the proposed concentration suggest that it will lead to a sealing-off of and early creation of a dominant position on the future market for technical and administrative services and to a substantial hindering of effective competition on the future market for pay-TV.” As such, despite MSG’s unique ability to contribute to the improvement of digital television, the successful development of that medium would he hindered rather than promoted by the limiting effect on new entry which would be the result of the dominant position the joint venture would quickly gain.

Famously, in 2001 the Commission blocked the acquisition by GE (which was active in, among other things, large jet aircraft engines) of Honeywell (which had a leading position in aerospace component markets). The parties had argued that price efficiencies brought about by the transaction could take the form of various packaged deals offerings. The parties would be able to grant discounts on packaged deals enabling the merged entity to market complementary products together at a lower price than separately. This, however, was a reason to block the merger rather than to let it proceed. According to the Commission “[t]he ability of the merged entity to cross-subsidise its various complementary activities and to engage in profitable forms of packaged sales will have an adverse effect on the profitability of competing producers of avionics and non-avionics products, as a result of market share erosion.” The Commission emphasized the inability of the merged entity’s competitors to compete while maintaining prices at a level above their average variable cost, and in so doing blocked a merger that would have resulted in lower prices for consumers through packaged discounts. Critics argue that such efficiency gains, although harming competitors, create incentives for them to reduce their own costs or improve their own product offerings.9

Similarly, in BaByliss v Commission, where BaByliss appealed the Commission decision clearing a merger between SEB and Moulinex (both manufacturers of household appliances), the General Court held that the concentration enabled the merged entity to “make economies of scale and implement various rationalisation measures, thus generating a reduction in costs of which it could take advantage to reduce prices or allow retailers a bigger margin in order to increase its market share.”10 It was for this reason, among others, that the General Court annulled the Commission’s decision. And ,in DeBeers/LVMH, justifications for a joint venture, such as efficiencies and cost reductions in diamond production, were treated negatively by the Commission in allowing the JV to become a market leader in branded high-end jewellery.11

These competitor-orientated cases were not extraordinary in the 1990s and early 2000s. However, such an approach may have been confined to the history hooks after the advent of the horizontal and non-horizontal merger guidelines, which introduced a new age of economics-based and consumer-welfare orientated reasoning in merger control. Even in 2002 then Competition Commissioner Mario Monti publicly distanced the Commission from the accusation that it was analysing efficiencies as theories of harm, stating that “there is no such thing as a so-called ‘efficiency offence’ in EU merger control law and practice. In other words, the Commission does not rely on the fact that efficiencies resulting from a merger are likely to have the effect of reducing or eliminating competition in the relevant market (for example, by enabling lower prices to be charged to customers), as a ground for opposing a proposed transaction”.12

That said, parties should not assume in all cases that the Commission will look at merger-specific efficiencies as inherently beneficial to the market if they reduce competitors’ ability to effectively compete. For example, in 2012, the Commission prohibited the merger between NYSE Euronext and Deutsche Borse (both involved in cash listing services, cash trading services, derivatives trading and clearing services).13 The parties argued that users of their cash and derivatives exchanges would benefit from reduced costs stemming from greater liquidity and reduced collateral required to clear transactions. However, the parties’ competitors complained, and the Commission accepted, that the merged entity would be able to “suck in liquidity” because of “vastly lower collateral costs for customers”. This would drive competitors from the market and allow the merged entity to subsequently raise its commission fees as a result of its newfound dominance. Though this analysis forms a small part of the prohibition decision, it does present lower prices as a theory of harm without showing that the firm would have the incentive to price below its average variable costs. As a result, parties should remain alert to the Commission’s past practice of sympathizing with competitors and taking a long term view of the market, where efficiencies, despite their ability to bring benefits in the form of lower prices and better product or service quality, can also endow a merged entity with a competitive edge so substantial as to reduce rivals’ ability to compete effectively.

  1. Oliver Williamson, Economies as an Antitrust Defense: The welfare tradeoffs, The American Economic Review, Vol. 58, No. 1 (March 1968), pp. 18–36
  2. See e.g. A. Jorge Padilla and Andrea Renda, Conglomerate Mergers, Consumer Goods and the ‘Efficiency Offense’ Doctrine, 2003.
  3. Case T-177/04 easyJet v Commission, para. 72
  4. Para 16 of the non-horizontal merger guidelines.
  5. Case COMP/M.4854 – TomTom-Tele Atlas.
  6. Case M.6570 UPS/TNT Express.
  7. Case M.7630 Fedex/TNT Express.
  8. Case No IV/M.469 MSG Media Service.
  9. See e.g. Matthias Pflanz and Cristina Caffara, The Economics of GE/Honeywell, European Competition Law Review, 23(3), p. 115 (2002).
  10. BaByliss v Commission, para 360.
  11. Case M.2333 De Beers/LVMH.
  12. Mario Monti, European Commission Commissioner, “Review of EC Merger Regulation — Roadmap for the reform project,” Speech/02/252, 4 June 2002.
  13. Case No. COMP/M.6166 Deutsche Borse/NYSE Euronext.

Antitrust Economics Efficiencies European Commission Mergers