Vertical Mergers

A merger is characterized as “vertical” when the merging firms
produce goods (or provide services) at different stages in the production
chain. Typically, one product is an input used at a succeeding (or
downstream) stage to produce the other.1 Examples include a merger
between a firm that makes rubber and one that makes automobile tires,
and a merger between a petroleum refiner and a firm operating a chain of
retail gasoline stations. Accordingly, vertical merger cases tend to
involve parties that are in a customer-supplier relationship.
Economics and the law suggest that vertical mergers typically raise
different competitive concerns than horizontal mergers,2 and the theories
of competitive harm from vertical mergers are generally more complex.
Although under some circumstances, vertical mergers may have an
anticompetitive effect in a market by foreclosing competitors’ access to
or increasing the price of an input, or by raising competitors’ costs of
entry, vertical mergers can also result in greater output and lower prices.
The complexity in determining a vertical merger’s likely competitive
effects is related to the distinctions between substitute and
complementary products. These distinctions are important for the
analysis of likely competitive effects, including the realization of
efficiencies. 3
1. Economists draw an analogy between successive stages of production and
the course of a river: the initial production stage is deemed to be
“upstream” from successive stages, which are “downstream” from the
LAW1000 (2014).
2. For general discuss ions analyzing vertical mergers, see James
Langenfeld, Non-Horizontal Merger Guidelines in the United States and
the European Commission: Time for the United States to Catch Up?,
16 GEO. MASON L. REV. 851 (2009); Paul Yde, Non-Horizontal Merger
Guidelines: A Solution in Search of a Problem?, ANTITRUST, Fall 2007,
at 74.
3. See, e.g., Michael H. Riordan & Steven C. Salop, Evaluating Vertical
Mergers: A Post-Chicago Approach, 63 ANTITRUS T L.J. 513 (1995);
366 Mergers and Acquisitions
Two products are substitutes if an increase in the price of one
product leads to an increase in the quantity demanded of the other
product as buyers switch from the higher priced to the lower priced good.
Two products are complements, however, if an increase in the price of
one product leads to a decrease in the quantity demanded of both
products. This relationship may arise when buyers use significant
quantities of each product together in fixed or variable portions. In effect,
consumers may implicitly or explicitly treat the bundle as a separate
product—for example, when copper and tin are used to make bronze or
when vodka and vermouth are used to make martinis. As a result, if an
increase in the price of copper causes the price of bronze to rise,
consumers will purchase less bronze, and the demand for both tin and
copper will fall. Even if the price increase is profitable for copper
suppliers, tin suppliers’ profits will fall.
A commonly cited procompetitive motivation for vertical mergers is
the desire to eliminate the exercise of market power at successive
production stages, which is called “double marginalization.” When
inputs are complements and used in fixed proportions, an increase in the
price of one product may reduce the demand for the other, and an
increase in the price of both products may reduce demand for the final
product more than if the price of only one product had gone up. As a
result, when firms at two different production stages exercise market
power at the same time, total market output likely will be lower, and the
price paid by consumers likely will be higher than if market power were
exercised at only one stage or the other. In addition, the combined profits
of the firms at both stages typically will be lower than the combined
profits would be if market power were exercised at only one stage, but
not both. In many instances, mergers between firms at different stages of
the vertical chain can result in an increase in output, a reduction in the
price of the final good, and an increase in the combined profits of the
merging firms.
Some commentators have observed that, as long as the inputs
involved are used in fixed proportions, a merger combining firms with
market power at different vertical stages will benefit customers (by
lowering price and increasing output) as well as suppliers (by increasing
joint profits).4 With fixed proportions and only one firm with market
Vertical Mergers 367
power, however, a vertical merger is unlikely to affect prices, output, or
products because there is only one monopoly rent to be extracted from
the sale of the final product.
The analysis can become more complex if the products at each stage
are used in variable proportions. In this case, economists argue that the
so-called “one monopoly rent” result does not hold.5 A monopolist at one
stage of production can increase profits by vertically integrating into
another, perfectly competitive stage, but doing so may result in a higher
price for the final product.
Current antitrust treatment of vertical mergers tends to be fact
specific, with emphasis on whether a likelihood of harm to competition
can be demonstrated in the particular transaction. However, because the
analytical framework applied to vertical mergers has evolved over time,
an understanding of the historical development of the legislative,
jurisprudential, and economic underpinnings of vertical merger law is
A. Early Treatment of Vertical Mergers
Vertical mergers originally were thought to be immune from
challenge in the United States under Section 7 of the Clayton Act
(Section 7).6 The original Clayton Act, enacted in 1914, prohibited
acquisitions of stock that would tend “to substantially lessen
competition” between the acquiring and the acquired companies in any
line of commerce.7 The prevailing view of this language was that it did
not “preclude the acquisition of stock in any corporation other than a
direct competitor.”8
5. Riordan & Salop, supra note 3, at 517-18.
6. 15 U.S.C. §18.
7. Section 7 originally read, in part, that a corporation shall not acquire the
stock of another corporation “where the effect of such acquisition may be
to substantially lessen competition between the cor poration whose stock
is so acquired and the corporation making the acquisition, or to restrain
such commerce in any section or community, or tend to create a
monopoly of any line of commerce.” Ch. 323, § 7, 38 Stat. 731 (1914)
(current version at 1 5 U.S.C. § 18).
8. Brown Shoe Co. v. United States, 370 U.S. 294, 313 (1962); see also
United States v. E.I. du Pont de Nemours & Co., 353 U.S. 586, 615-17
(1957) (Burton, J ., dissenting); FED. TRADE COMMN, REPORT ON
legislative history of the 1950 amendments to § 7).

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