Potential Competition Doctrine

• Pages: 341-364

CHAPTER X

POTENTIAL COMPETITION DOCTRINE

In certain transactions, a merger might reduce competition even

though only one of the merging firms is currently supplying the rel evant

market if that firm is a potential entrant, perceived or actual. The

potential competition doctrine posits that competition may be lessened

when an incumbent firm merges with a firm that is not a competitor and

eliminates its threat as a potential entrant.1

The potential competition doctrine includes two different legal

theories based on the nature of a merger and its likely effect on

competition. The “actual” potential competition theory applies to a

merger between a large incumbent and a potential entrant that is actually

in the process of entering the market, whether de novo or via the

acquisition of a smaller or “toehold” incumbent firm. Presumably,

incumbents are not behaving so as to deter entry, such that prices would

likely fall or quality, service, or innovation would likely improve in the

post-entry period due to increased competition. The merger with a

significant market participant eliminates the possibility of de novo or

toehold entry by the potential entrant, and thus eliminates any

procompetitive effects that might have resulted had the potential

competitor entered independently. 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 on the

relevant market if the independent entry is not preempted by the merger.2

1. The potential competition doctrine may be app lied to mergers,

acquisitions, and jo int ventures under Se ction 7 of the Clayton Ac t. See

United States v. Penn-Olin Chem. Co., 378 U.S.. 158, 168-172 (1964).

2. See, e.g., William J. Baer, Dir., Bureau of Competitio n, Fed. Trade

Comm’n, Report from the Bureau of Competition, Remarks before the

ABA Antitrust Section, Spring Meeting 1999 (Apr. 15, 1999), available

at http://www.ftc.gov/public-statements/1999/04/report-bureau-competi

tion (“where the Commission is trying to protect future co mpetition,

potential competition doctrine and the use of innovation markets may be

necessary for effective enforcement”).

341

342 Mergers and Acquisitions

The “perceived” potential competition theory applies to a merger

between an incumbent and a potential entrant that is not actually in the

process of entering but constrains incumbents to charge lower prices or

improve quality, service, or innovation to deter entry. By removing this

constraint, the merger will permit incumbents to raise prices in the future.

Under the perceived potential competition theory, therefore, the injury to

competition is the loss of the present procompetitive influence exerted by

the possible entrant on the relevant market. Thus, it matters little whether

the perceived entrant would in fact have entered the market as long as the

market participants believe such entry would be a reasonable possibility.

In each case, the effect of the merger is the same: whether incumbent

behavior changes after entry or fails to change, consumers are harmed in

the future. Nonetheless, the factual bases for each theory are significantly

different, and each reveals significant differences in the ways that

incumbents react with the threat of entry. In both instances, the merger

eliminates the entry threat, but there are significant differences in the

timing of the merger and the incumbents’ premerger strategy. In the case

of actual potential competition, firms do not try to discourage entry, e.g.,

by keeping prices low and merge with the potential entrant only when

entry is imminent. In the case of perceived potential entry, incumbents

react to the threat of entry, e.g., by keeping prices lower than otherwise,

and then merge with the potential entrant when there is little, if any,

indication that the firm is currently preparing to enter.

A. Origins of the Potential Competition Doctrine

The Supreme Court first addressed the potential competition doctrine

in United States v. Penn-Olin Chemical Co.3 In Penn-Olin, the

government challenged the formation of a joint venture between Pennsalt

and Olin Mathieson to market sodium chlorate in the southeastern United

States. The district court had dismissed the government’s complaint,

finding that, although both Pennsalt and Olin Mathieson produced

sodium chlorate and although expansion into sodium chlorate production

in the southeastern United States (the relevant geographic market) would

be natural for both companies, the two companies would not have both

entered the southeastern market independently.4

3. 378 U.S. 158 (1964).

4. See United States v. Penn-Olin Chem. Co., 217 F.Supp. 110 (D. Del.

1963), vacated, 378 U.S. 158 (1964).