NOTE E STUDI

Assonime – Criteria for merger appraisal: between economics and law

1. A lively debate and the need for a systematic approach

The discussion on the analytical framework for merger control has never been so lively in the EU since the adoption of the Merger Regulation in 1989. Following some important and controversial decisions adopted by the Commission and the related developments in the jurisprudence of the European Courts, interest in the topic, previously considered mainly in specialist circles, has risen to the point of making newspaper headlines.

Two topics have attracted the greatest attention. The first is the standard of assessment of concentrations in oligopoly markets in cases where there is no question of single-firm dominance being created or strengthened; the point at issue is the applicability of the Merger Regulation to situations of collective dominance. The second topic is the standard of appraisal of conglomerate mergers, i.e. mergers where the parties are neither actual or potential competitors nor in an actual or potential supplier-customer relationship.

In principle, the substantive criteria of merger control should satisfy three requirements: effectiveness in ensuring undistorted competition; predictability; and conformity with the proportionality principle, meaning that any burden resulting from public action is minimised and proportionate to the objective achieved.[1] Neither conglomerates nor oligopolies are a pathology, but normal features of the market process. Therefore, in order to avoid unnecessary uncertainty, it is important that the conditions in which they give rise to competition concerns justifying the prohibition of a merger be clearly identified.

There are several possible approaches to the discussion of the analytical framework for merger control. This paper adopts a de iure condito perspective, based on the existing EU legal rules and their interpretation.

The discussion should in any case take into account that merger control in the EU cannot be viewed in isolation from the rest of the world, because of economic integration and the progressive enlargement of markets. In a significant number of cases, not only do mergers have cross-border effects, but their impact on the same relevant markets is scrutinised by several competition authorities. Both competition authorities and undertakings are well aware of the international dimension of the issue. For instance, in its Green Paper on the Review of the Merger Regulation, the European Commission itself introduced the issue of substantive criteria for merger control as a comparison between the dominance test used in the European Union and the “substantive lessening of competition” test used in the United States.[2] The international comparison of standards is not restricted to their formulation in the law but extends to their interpretation, i.e. the enforcement criteria followed by competition authorities and the courts. Significantly, the analytical framework for merger control was one of the topics chosen for discussion among competition authorities from all over the world at the first meeting of the International Competition Network held in Naples on September 27 and 28, 2002.

Moreover, although our focus is on EU merger control, the issues discussed in the paper also have implications for Italian competition law. In fact, not only are the substantive criteria contained in Article 6 of Law no. 287/1990 modelled on EU law, but Article 1(4) of the Law requires the Italian competition authority to interpret the substantive provisions of Italian law in accordance with the principles of EU competition law.

The methodological viewpoint must also be considered. Three general premises to the discussion of EU substantive standards for merger control are worth making. First, merger rules cannot be considered in isolation from the other components of the EU system of competition law. The discussion of the analytical framework of merger policy requires a systematic approach.

Second, in the EU, as in most countries, mergers must be notified in advance to give competition authorities time to block those that would reduce competition if they were allowed to go forward. Any ex ante system of merger control, being based on the prediction of future market developments, requires careful consideration of the issue of the standards of proof.

Finally, in a de iure condito perspective, such as that adopted in this paper, the answer to the question “what should the criteria for merger appraisal be for an effective EU competition policy” can only be given by a combination of economic and legal analysis. Legal formalism is certainly a danger to be avoided in the enforcement of competition policy. Economics is essential to interpret the substantive rules of EU competition policy; it is important to indicate under what conditions anticompetitive outcomes are very unlikely or rather likely and also to avoid contradiction and untested assumptions. But the legitimate scope of competition policy remains defined by the law, not by economists. Legal rules, although expressed in general terms, cannot be seen as an empty box. Moreover, it is the law which ensures that prohibitions are not founded on speculation, but on adequate evidence. Law is essential to ensure that competition policy satisfies the requirements of predictability and proportionality.

2. Merger control within the system of EU competition rules

In EU competition policy, a system of ex ante control for concentrations with a Community dimension was introduced with Regulation no. 4064/89. While the Court of Justice had confirmed the Commission’s power to vet certain concentrations under Articles 81 and 82 of the Treaty, the Council was finally persuaded to adopt a system of prior notification and control of concentrations at the Community level using Article 308 (formerly 235) of the Treaty.[3] The issue could not be properly addressed through interpretation of the existing rules. The Council argued that reference to Articles 81 and 82 alone did not make it possible to control all the operations which might be incompatible with the system of “undistorted competition” envisaged in the Treaty.[4] Moreover, an ex ante control system was also intended to increase legal certainty for companies compared with an ex post system. Generally, an ex ante assessment of concentrations is less costly than ex post prohibitions and disentanglements once a merger has taken place.

The Merger Regulation has the same substantive legal basis as Articles 81 and 82, i.e. Article 3.g of the EC Treaty, which includes among the activities of the Community “a system ensuring that competition in the internal market is not distorted”. Moreover, the formulation of the criteria of merger appraisal contained in Article 2 of the Merger Regulation is clearly based on the same principles as the competition rules of the Treaty, with special reference to the focus on the notion of dominant position.[5]

Within the system of EU competition rules, the Merger Regulation is an autonomous tool; on the other hand, it is strictly complementary to the competition rules in the Treaty.

As for autonomy, it would be misleading to consider the Merger Regulation as an instrument which can be used to fill any perceived “gap” in the protection of competition resulting from the enforcement of Articles 81 and 82. Competition authorities often observe that the enforcement of competition law prohibitions is imperfect and that detecting and proving infringements of prohibitions is difficult. Therefore, “the need to rely on those laws is reduced by maintaining competitive conditions so that the incentive and opportunity for collusion, abuse of market dominance and other infringements are prevented from arising, at least insofar as they result from mergers”.[6] Undoubtedly merger control can play this role, but it can do so only within the limits set by the law.

The autonomous nature of the Merger Regulation also implies that the criteria for exemption of anticompetitive agreements contained in Article 81(3) of the Treaty cannot be directly used in the enforcement of the Merger Regulation.

As for the complementary relationship between Articles 81 and 82 and the Merger Regulation, it should be remembered that after a concentration has been declared compatible with the Merger Regulation, the subsequent conduct of the undertaking on the market remains subject to the prohibition of anticompetitive agreements under Article 81 and abuse of a dominant position under Article 82.

3. Article 2 of the Merger Regulation and the focus on consumers

The substantive test for the appraisal of notified concentrations set out in Articles2(2) and 2(3) of the Merger Regulation requires an assessment of whether a concentration “creates or strengthens a dominant position as a result of which effective competition would be significantly impeded in the common market or in a substantial part of it”. Article 2(1) of the Merger Regulation indicates the factors which the Commission must take into account when making the appraisal. They include “the interests of the intermediate and ultimate consumers, and the development of technical and economic progress provided that it is to consumers’ advantage and does not form an obstacle to competition”.[7]

An obvious starting point for the discussion of the analytical framework set out in Article 2 of the Merger Regulation is its focus on dominance. A dominant position had been defined by the Court of Justice, with reference to Article 82 of the Treaty, as a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market “by giving it the power to behave to an appreciable extent independently of competitors, customers and consumers”.[8]This legal notion of dominance was soon interpreted by economists in terms of market power.

Under Article 82, dominance is lawful, unless undertakings abuse thereof. The Merger Regulation puts a further constraint on dominance, providing that a concentration with a Community dimension which creates or strengthens a dominant position as a result of which effective competition would be significantly impeded in the common market or in a substantial part of it shall be declared incompatible with the common market.

The relationship between the notions of dominance in Article 82 and in the Merger Regulation is clearly illustrated by Esteva Mosso-Ryan (1999): “There is no reason to believe that the concept of dominant position in the Merger Regulation has a meaning different from the concept in Article 82 of the EC Treaty (see C-395-96P and C-396/96P Compagnie Maritime Belge and Dafra-Lines vs. Commission 29 October 1998 paras 26 and 27, opinion of Fennelly AG). However the scope and purpose of the two provisions being substantially different, this same concept is necessarily applied from different perspectives. First, while Article 82 applies to existing dominant positions, and requires fundamentally a retrospective analysis, the Merger Regulation, which assesses the possibility of a dominant position being created or strengthened, necessitates a prospective analysis. Secondly, Article 82 is not primarily concerned with the reduction of competition which results from the existence of a company occupying a dominant position, but with the abuses that this company may engage in. The Merger Regulation, on the other hand, is primarily concerned with the effects on competition of the creation or strengthening of such a dominant position”.[9]

In the background paper on the analytical framework for merger control prepared by the Office of Fair Trading for the first ICN annual conference, market power in the context of merger analysis is defined as “the ability to increase prices profitably, or reduce quality, innovation, choice or other ways in which competition may be inhibited) from pre merger levels for a significant period of time”. The increase in prices is generally recognised as the main effect of a reduction in competition.[10] Consistently, in its recent Guidelines on market analysis and the assessment of significant market power under the Community regulatory framework for electronic communications networks and services.[11] the Commission remarks that “in an ex ante environment, market power is essentially measured by reference to the power of the undertaking concerned to raise prices by restricting output without incurring a significant loss of sales or revenues” (para 73).

The test in Article 2 of the Merger Regulation is formally composed of two parts: first, the assessment of whether a concentration creates or strengthens a dominant position; second, the assessment of whether, as a result, effective competition would be significantly impeded in the common market or in a substantial part of it. In some cases the assessment of the concentration was made in two steps: first its effect on dominance and then its effect on effective competition.[12] Sometimes, however, the Commission seemed to consider only the first part of the test (as if the acquisition or strengthening of the dominant position meant that, as a necessary result, effective competition would be significantly impeded in the common market or in a substantial part of it). For instance, in its “Notes on Council Regulation (EEC) 4064/89”[13] the Commission states that “If the Commission has decided to initiate proceedings because it considers that there is prima facie a real risk of creating or reinforcing a dominant position and if further investigation ... confirms this suspicion, it will declare the concentration incompatible with the common market”. The issue of whether the omission of a distinct consideration of the second part of the test has an impact on the result of the analysis depends, basically, on the meaning attributed to “dominance” and to the notion of “significant impediment to effective competition”.

Whatever the answer is to this question, the Merger Regulation seeks to prevent the analysis from focusing mainly on market shares.

First, Article 2(1) lists a plurality of factors, on the demand side and the supply side, which constrain the market power of an undertaking and which should be taken into consideration when evaluating a merger. Express reference is also made to the impact of potential competition, taking legal or other barriers to entry into account.

Second, the Commission is required to take into account “the interests of the intermediate and ultimate consumers”. On the one hand, this constraint can be read as excluding that the objective is to maximise total surplus by putting the emphasis on the consumer side. On the other hand, it can be seen as suggesting that a merger should not be prohibited unless it is against the interests of intermediate and final consumers.[14] Let us focus, for the sake of simplicity, on the impact of concentrations in terms of prices: the above consideration implies that a concentration should not normally be prohibited unless it is expected to result in a price increase.[15]

4. Is there scope for efficiency considerations under Article 2?

A related methodological issue is whether efficiency considerations should enter into the assessment of the competitive impact of a concentration or should be used as a separate defence once the concentration has been declared anticompetitive. The issue of whether an efficiency defence should be explicitly introduced in the Merger Regulation is one of the main topics raised by the Commission in its Green Paper on the review of the Merger Regulation.[16]

The answer is crucial to the working of merger control. As discussed above, the current formulation of Article 2 clearly excludes the possibility of increases in producers’ surplus compensating a worsening of consumers’ conditions. However, this does not mean that some kinds of efficiency gains cannot already be considered under Article 2. When, a concentration seems to raise serious competitive concerns, the Commission already explicitly explores whether efficiency gains are sufficient to avoid the restriction of competition.[17] The efficiency gains which may be considered in this context are those which have a positive effect on competition in the market “such that there is no reduction in rivalry despite the combination of erstwhile competitors”,[18] this may be the case when the concentration lowers the merged entity’s marginal costs. In such cases, as argued also in the recent report of the Office of Fair Trading on the analytical framework for merger control, the assessment of the merger’s efficiency benefits may be incorporated into the substantive test and there is no need to consider potential trade-offs between these benefits and the competitive detriment of the merger. In other words, if merger control is centred on a test aimed at ascertaining the impact of a concentration on prices, output and innovation in order to impede transactions harming consumers, the assessment of efficiency improvements which are directly beneficial to consumers may be included in the assessment of the competitive impact of the concentration under Article 2, and does not require a “second step”. On the other hand, EC experience with the enforcement of Article 81 of the Treaty shows how a “split” competitive assessment may lead, as an indirect effect, to a very broad interpretation of the concept of “harm to competition” in the first step of the analysis, and to shift the focus to the second step. An approach of this kind may lead to an unnecessarily “regulatory” attitude.

Article 2(1b) contains an express requirement that the development of technical and economic progress that is to the consumers’ advantage should be considered only when it does not form an obstacle to competition, apparently imposing a condition stricter than the significant impediment to effective competition. This specification may be considered linked to the caution needed in the event of a trade-off between an immediate worsening of consumer conditions (i.e. an increase in prices) and a positive impact on future consumer welfare resulting from technical and economic progress.

A different assessment is needed in cases where efficiency increases while competition is lessened. Currently, the law does not indicate conditions under which a defence would be acceptable. It remains to be seen whether these conditions should be introduced in the Regulation. The question deserves careful consideration; the answer clearly depends on the objectives assigned to merger control.

5. The timeframe

Assessment of the competitive impact of a concentration under Article 2 is necessarily made with reference to a timeframe. Once established that the focus of the analysis is on whether the concentration will result in a significant and lasting increase in prices, an important distinction still has to be made. In some cases, the concentration is expected to result in a direct increase in prices, in the near future. In other cases, while there is no evidence that prices will increase in the short term, the concentration is expected, on the basis of conjectures regarding the future conduct of the merged entity and its (actual and potential) competitors, to increase prices in the future.