Vertical Mergers

• Pages: 365-404

CHAPTER XI

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

source. See 10 PHILL IP E. AREEDA & HERBERT HOVENKAMP, ANTITRUST

LAW ¶ 1000 (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);

SIMON BISHOP ET AL., THE EFFICIENCY-ENHANCING EFFECTS OF NON-

365

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

HORIZONTAL MERGERS 9 (2005); DENNIS W. CARLTON & JEFFREY M.

PERLOFF, MODERN INDUSTR IAL ORGANIZATION 21 (4th ed. 2005).

4. See ROBERT H. BORK, THE ANTITRUST PARADOX 228-30 (1978).

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

useful.

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 COMM’N, REPORT ON

CORPORATE MERGERS AND ACQUISITIONS 168 (1955) (citing the

legislative history of the 1950 amendments to § 7).