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”).
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).

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