Chapter 9. Potential Competition Doctrine

• Pages: 321-346

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CHAPTER 9

POTENTIAL COMPETITION DOCTRINE

The potential competition doctrine addresses the question of whether

a firm that is not currently competing in a market still has a

procompetitive influence on the market because of the firm’s potential

for entry. Underlying the doctrine is the belief that a market exhibiting

high prices and profits will attract entry by additional firms, causing

production to increase and prices and profits to fall toward a competitive

level. The presence of firms outside the market with the potential to

enter provides a present and/or future constraint on incumbent firms in a

noncompetitive market, as the incumbents seek to prevent or delay new

entry and respond to entry as it occurs.

In potential competition mergers, the potential entrant acquires (or is

acquired by) a significant market participant. Such entry by acquisition

eliminates the potential entrant as an independent entity that influences

or could influence the competitive performance of the market. As a

theory for challenging a merger, the potential competition doctrine

considers whether the elimination of the potential competitor as a

separate entity violates Section 7 of the Clayton Act by removing the

entity’s procompetitive influence. The potential competition doctrine

consists of two different theories: the “actual potential competition”

theory and the “perceived potential competition” theory.

The “actual potential competition” theory reasons that, but for the

merger with the significant market participant, the acquiring firm

actually would have entered the market either de novo or by acquiring a

very small or “toehold” incumbent firm, thereby creating additional

competition that would have deconcentrated the market or produced

other long-run procompetitive benefits.1 The merger with a significant

1.Though the maximum size of a toehold firm is the subject of some

debate, the Federal Trade Commission has stated that it is “desirable to

observe a general rule in potential competition cases that firms possessing

no more than 10 percent in a target market (where, as here, the 4-firm

concentration is approximately 60 percent or more) should ordinarily be

presumed to be toehold or foothold firms.” Budd Co., 86 F.T.C. 518, 582

(1975). Lower courts likewise have generally established the threshold at

or near 10% of the market. See United States v. Black & Decker Mfg.

Co., 430 F. Supp. 729, 767-68 (D. Md. 1976) (10% presumed a toehold,

firm with more than 10% not a toehold). But see Missouri Portland

322 MERGERS AND ACQUISITIONS

market participant eliminates the possibility of de novo or toehold entry

by the potential entrant, and thus eliminates the possibility that the

market in the future will become as competitive as it otherwise might

have become if the potential competitor entered independently.2 Under

the actual potential competition theory, therefore, the injury to

competition is the loss of the procompetitive future effect that the

potential entrant would have had on the relevant market if the

independent entry had not been preempted by the merger.3

The perceived potential competition theory is based on the premise

that, if the current market participants perceive the presence of a

potential entrant on the fringe of the market, they will limit their prices

Cement Co. v. Cargill, Inc., 498 F.2d 851, 865 n.29 (2d Cir. 1974) (firm

with 10% of market is “probably too substantial” to be toehold

candidate); United States v. Phillips Petroleum Co., 367 F. Supp. 1226,

1258 (C.D. Cal. 1973) (“acquisition of a company which ranks seventh in

a concentrated market, holding a 6-7% share of the market, is simply not

small enough to constitute a mere foothold acquisition”), aff’d mem., 418

U.S. 906 (1974). The 1982 and 1984 Merger Guidelines, however,

establish the threshold at 5%. See U.S. DEP’T OF JUSTICE , MERGER

GUIDELINES, 47 Fed. Reg. 28,493 (1982) § IV(A)(3)(d), reprinted in 4

Trade Reg. Rep. (CCH) ¶ 13,102; U.S. DEP’T OF JUSTICE, MERGER

GUIDELINES, 49 Fed. Reg. 26,823 (1984) § 4.134 [hereinafter 1984

MERGER GUIDELINES], reprinted in 4 Trade Reg. Rep. (CCH) ¶ 13,103.

2.Underlying the actual potential competition theory is the assumption that

the addition of one more competitor to a concentrated market will

increase output and reduce prices. There is, however, only conflicting

empirical proof that market share and concentration are accurate

indicators of the likely competitive conditions in an industry.

Nonetheless, they remain the foundation of most merger analysis. There

has been significant debate in economics literature concerning the

empirical support for the existence of a relationship between the

structure, conduct, and performance of industries. For discussions and

summaries of the literature, see F. M. SCHERER & DAVID ROSS,

INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 57-96

(3d ed. 1990); Richard Schmalensee, Inter-Industry Studies of Structure

and Performance, in 2 HANDBOOK OF INDUSTRIAL ORGANIZATION 952-

1009 (Richard Schmalensee & Robert D. Willig, eds., 1989).

3.See, e.g., William J. Baer, Director, Bureau of Competition, FTC, Report

from the Bureau of Competition, Remarks Before the ABA Antitrust

Section, Spring Meeting 1999 (Apr. 15, 1999), at

www.ftcgov/speeches/other/baerspaba99.htm (“where the Commission is

trying to protect future competition, potential competition doctrine and

the use of innovation markets may be necessary for effective

enforcement”).