Non-Price Effects of Mergers

A. Non-Price Competition

Non-price competition involves activities by firms, excluding those associated with price, that alter demand for the firm’s goods or services or those of their competitors. ¹ The effects of such dynamics on consumer welfare as the prevailing standard for evaluating competitive effects in U.S. competition enforcement are attracting significant attention in the competition community. As a form of rivalry, non-price competition is ubiquitous. Firms commonly compete in imperfectly competitive markets through non-price strategies that include differences in level of quality, variety, provision of service, novelty of innovation, method of distribution, and provision of information, among other means.

B. Non-Price Effects

Related to non-price competition, the term “non-price effects” is used in antitrust to characterize the outcomes of competition and rivalry that manifest in ways other than price. Non-price effects focused on in modern U.S. merger analysis include those that relate to “quality,” “variety,” “service,” and “innovation.” ² For example, the 2010 horizontal merger guidelines explain that, in addition to price effects, “enhanced market power can also be manifested in non-price terms and conditions that adversely affect customers, including reduced product quality, reduced product variety, reduced service, or diminished innovation.” ³ Concerns for non-price effects are also present in other areas of antitrust, including monopolization concerns, where exclusionary conduct resulting from horizontal and vertical restraints can lead to reduced incentives to innovate or to compete on quality or service. ⁴

Beyond the non-price effects of quality, variety, service, and innovation; other non-price effects exist and may also be of interest in merger analysis. For example, the American Antitrust Institute (AAI) has identified potential anticompetitive outcomes relating to the resilience or sustainability of supply chains involving some markets. ⁵ For example, consolidation in the food and agriculture industries has left few sellers in markets such as processing and manufacturing, which can create a lack of diversity and instability in the event of exogenous shocks to food systems. ⁶ The AAI has also advanced the notion that “data” raises issues at the intersection of consumer protection and competition. ⁷ For example, firms in the Internet space may choose to compete on “quality” by keeping consumers’ data more private and secure than others. Importantly, just as there exist many different dimensions of non-price competition, there exist many different types of non-price effects.

C. Complexity of Effects

Because non-price effects involve the outcomes of competition (including both price and non-price competition), these effects can be complex. Several examples highlight this complexity. First, non-price effects can coexist with price effects. For example, non-price and price effects may result from competition as in the case where a merger results in effects for both price and non-price dimensions of competition. Second, non-price effects may arise in the absence of price effects as in the case where a merger impacts non-price dimensions of competition, but not price dimensions. Third, price and non-price effects can interrelate with one another in various ways. For example, quality and innovation can impact price. Higher-quality or more innovative products may be generated by increased demand, and higher prices, and vice versa. Relatedly, quality, innovation, and variety can impact one another. Innovation may impact quality where innovation involves the enhancement of product quality existing in a market. Innovation may also increase (or decrease) variety where a new product adds to the existing products in a market. Innovation may also decrease variety where the novelty of a new product cannibalizes demand for existing products. New or different services may also be considered to contribute to innovation and may further be considered part of product quality. Other interrelationships are also possible. The important point is that the nature of non-price competition is complex, and many interactions can exist between price and non-price effects as well as across the different types of non-price competition and non-price effects.

A. Economics

The economics literature long ago recognized the role and impact of non-price competition. In the 1930s, Edward Chamberlin ⁸ and Joan Robinson ⁹ contributed to the development of a theory of “monopolistic competition” to describe markets in which each firm sells a different (i.e., differentiated) product but competes with a few or many other firms. The theory predicts that in both the long run and short run, monopolistic competition is allocatively and productively inefficient. However, the theory recognizes that monopolistic competition, also known as product differentiation, can bring about greater diversity in product offerings, and this diversity can benefit consumers through greater choice.

The nature and welfare effects of non-price competition arising from product differentiation continue to be a focus in economics. Following methodological trends, this literature increasingly includes technical models and empirical research addressing the implications of product differentiation under different assumptions and considering different variables. This literature elaborates on the non-price dimensions and effects of competition, including the importance of innovation. ¹⁰ There is increasing attention in the economics domain on the different dimensions and effects of non-price competition in the form of variety, quality, and service. ¹¹

B. Business

Business research confirms that firms extensively rely upon non-price strategies of competition. In fact, much of what is written and taught about competition in business schools involves non-price competition. In strategic management, for example, only one of the three generic strategies historically identified for achieving a sustainable competitive advantage emphasizes price. ¹² Instead of a price strategy, firms may rely more heavily on non-price strategies. This includes being different in ways that are consequential to consumers (i.e., a “differentiation” strategy) and emphasizing a particular, product category, geographic area, or customer group (i.e., a “focus” strategy). More recent conceptions of strategies for achieving a sustainable advantage over competitors add to these non-price strategies by including strategies based on continuous innovation, synergism, and longer-term relationships.

Similarly, in marketing, price is considered to be only one element of the “marketing mix” or the array of controllable marketing variables that firms use to pursue their goals in a target market. ¹³ Together with price, these variables include what marketer’s call the “4Ps”—product, promotion, place (i.e., distribution), and price. Recent versions of the marketing mix include a fifth “P” in the form of people to reflect the role of individuals in longer-term exchange relationships. ¹⁴ In practice, much of a marketing manager’s time is spent optimizing the marketing mix by assigning an amount of the marketing budget to be spent on each of the four Ps that maximizes total sales, profits, or other established goals. ¹⁵

Consistent with the role and importance of non-price competition and strategies in business practice, business research in strategic management, marketing and related fields applies theory and conducts empirical research to understand non-price strategies of competition and non-price effects of competition. This research includes specific examination of quality, ¹⁶ service, ¹⁷ variety, ¹⁸ and innovation. ¹⁹

C. Law

The importance of non-price competition and the applicability of the antitrust laws to non-price competition have long been recognized by the U.S. Supreme Court. Over 50 years ago, in U.S. v. Continental Can (1964), ²⁰ the Supreme Court held that rivalry on quality is “meaningful competition…of the type and quality deserving of…protection” under the antitrust laws. ²¹ In 1956, Continental Can was the second largest producer of metal containers in the U.S. (33% of all metal containers sold in the U.S.) but produced no glass containers. Haxel-Atlas Glass Company was the largest producer of glass containers (9.6% of shipments), but produced no metal containers. Continental Can acquired the Haxel-Atlas Glass Company, but that acquisition was challenged by the government as violating Section 7 of the Clayton Act.

A significant issue in the subsequent Continental Can litigation was how a relevant product market should be defined for purposes of reviewing a merger of companies that manufacture differentiated products. The case addressed non-price dimensions of competition involving product differences including quality. The Supreme Court found that glass and metal containers were in the same relevant market, despite evidence that pointed to the lack of cross-price elasticity in the case. According to the Court, the district court’s finding of separate markets “employed an unduly narrow construction of the ‘competition’ protected by §7.” ²² As described by the Court, the lack of price effects is “relevant…but not determinative,” ²³ because while rivalry on quality “may not be price competition[,]…it is nevertheless meaningful competition between interchangeable containers.” ²⁴ It is competition “of the type and quality deserving of §7 protection and therefore the basis for defining a relevant product market.” ²⁵ The case makes clear that the antitrust laws protect price as well as non-price competition. ²⁶ More recent cases further recognize the importance and role of quality as a form of non-price competition.

The nature and importance of the different forms of non-price competition (e.g., product quality, variety, service, and innovation) have also been recognized in competition policy. For example, recognizing the importance of innovation to economic growth, the National Cooperative Research Act of 1984 ²⁷ provides limited antitrust exemptions for certain joint research and development activity. More recently, antitrust scholars Neil W. Averitt and Robert H. Lande make a clear case for the role and importance of variety in antitrust more generally through their work on consumer choice. ²⁸

A. Past Guidelines

The first reference to non-price effects emerged in the 1992 merger guidelines where, despite emphasis on price effects, non-price effects in the form of product quality, service, and innovation were reserved for a footnote. ²⁹ According to the 1992 guidelines, “Sellers with market power also may lessen competition on dimensions other than price, such as product quality, service, or innovation.” ³⁰

The 1997 revisions to the efficiencies section of the merger guidelines expanded the role of non-price considerations. ³¹ The 1997 revision elaborated that

mergers have the potential to generate significant efficiencies by permitting a better utilization of existing assets, enabling the combined firm to achieve lower costs in producing a given quantity and quality than either firm could have achieved without the proposed transaction. Efficiencies generate through merge can enhance the merged firm’s ability and incentive to compete, which may result in lower prices, improved quality, enhanced service, or new products. ³²

The Merger Guidelines Commentary in 2006 went further in recognizing the role of non-price effects. ³⁵ The 2006 guidelines commentary observed that “mergers between competing firms, i.e. ‘horizontal’ mergers, are a significant dynamic force in the American economy. The vast majority of mergers pose no harm to consumers, and many produce efficiencies that benefit consumers in the form of lower prices, higher quality goods or services, or investments in innovation.” ³⁶ The 2006 commentary also indicated that “market power may be exercised, however, not only by raising price, but also, for example, by reducing quality or slowing innovation.” ³⁷ The 2006 commentary further indicated that “many mergers, moreover, enable the merged firm to reduce its costs and become more efficient, which, in turn, may lead to lower prices, higher quality products, or investments in innovation.” ³⁸ Moreover, according to the 2006 commentary, “To this end, the Agencies examine whether the merger of two particular rivals matters, that is, whether the merger is likely to affect adversely the competitive process, resulting in higher prices, lower quality, or reduced innovation.” ³⁹ The 2006 commentary went on to describe that “the Agencies may find that a proposed merger would be likely to cause significant anticompetitive effects with respect to innovation or some other form of non-price rivalry. Such effects may occur in addition to, or instead of, price effects.” ⁴⁰ The 2006 commentary further stated that “mergers also may lead to enhanced product quality or to increased innovation that results in lower costs and prices or in more rapid introduction of new products that benefit consumers.” ⁴¹ In addition the 2006 commentary repeated that “as the Guidelines state, efficiencies ‘can enhance the merged firm’s ability and incentive to compete, which may result in lower prices, improved quality, enhanced service, or new products.’” ⁴² Similarly the 2006 commentary described that

Efficiencies in the form of quality improvements also may be sufficient to offset anticompetitive price increases following a merger. Because a quality improvement involves a change in product attributes, a simple comparison of pre- and post-merger prices could be misleading. A careful analysis of the effects of changes in product attributes and prices on consumer welfare is likely to be necessary. ⁴³

B. Current Guidelines

The revised horizontal merger guidelines in 2010 go further in embracing and elaborating on non-price considerations and effects in merger analysis. The 2010 revised guidelines state at the outset that “enhanced market power can also be manifested in non-price terms and conditions that adversely affect customers, including reduced product quality, reduced product variety, reduced service, or diminished innovation. Such non-price effects may coexist with price effects, or can arise in their absence.” ⁴⁵

C. Evidence of an Increasing Enforcement Focus on Non-Price Competition

Recent enforcement actions highlight an increased focus on non-price effects such as innovation and quality. Hospital mergers are a particularly fertile area of activity. The Federal Trade Commission (FTC), for example, has looked carefully at claims that mergers of hospital will increase quality. In one retrospective, FTC economists found that in the FTC’s challenge of Evanston Northwestern Healthcare’s acquisition of Highland Park Hospital ⁴⁶ little evidence of quality improvements postmerger were found. ⁴⁷

Similarly, the U.S. Department of Justice (DOJ) has signaled that it would challenge a merger on the basis of harm to innovation competition. In Applied Materials-Toyko Electron, the DOJ rejected a proposed remedy, forcing abandonment of the proposed merger. In that case, the government noted that the merger would have combined the two largest competitors with the “necessary know-how, resources and ability to develop and supply high-volume non-lithography semiconductor manufacturing equipment.” ⁴⁸

Finally, in upholding the DOJ’s complaint challenging the merger of health insurers Anthem and Cigna, the court cited numerous times to the potential quality effects associated with a diminution in competition or in calling into question claimed efficiencies. Notably, the court stated that a promised reduction post-merger medical costs “does not result from the carriers’ or the providers’ operating more efficiently, and there has been no showing that the merger will result in increased output or enhanced quality at the same cost.” ⁴⁹ These cases signal the agencies’ attention to non-price competition in mergers.

The 2010 guidelines also begin to flesh out in greater detail the nature of non-price effects relevant to merger enforcement. For example, the guidelines state that documents and testimony from merging parties that they intend to “reduce product quality or variety, with-draw products or delay their introduction or curtail research and development efforts after the merger…can be highly informative in evaluating the likely effects of a merger.” ⁵⁰ The guidelines also make cognizable non-price-related incentives involving innovation. For example, the guidelines indicate that the agencies may consider whether a merger is likely to result in a “a reduced incentive to continue with an existing product-development effort or reduced incentive to initiate development of new products.” ⁵¹ Finally, the new guidelines detail that for purposes of merger enforcement, considerations involving market definition will be based not only on “consumers’ ability and willingness to substitute away from one product to another in response to a price increase” but also on consumers’ response to a “non-price change such as a reduction in product quality or service.” ⁵² Other references to non-price competition and non-price effects are also found in the 2010 merger guidelines.

A. Do the U.S. Merger Guidelines Sufficiently Recognize Non-Price Considerations and Effects?

One important question is whether the current guidelines adequately recognize non-price competition and effects. Assessments of the 2010 merger guidelines suggest that the guidelines could go further. A forceful advocate of this view was former FTC Commissioner and past AAI Advisory Board member Tom Rosch. ⁵⁴ According to his assessment, “The new Guidelines did not go far enough” in their recognition of non-price competition and effects, and “the overwhelming impression from the revised guidelines is that price effects remain paramount.” ⁵⁵ Similar views have been expressed by others as well.

Commissioner Rosch observes that, other than a new section on innovation and product variety, the 2010 guidelines are relatively silent on non-price forms of competition in their discussion of unilateral and coordinated effects. ⁵⁶ Mr. Rosch also describes that in some contexts (most notably in regard to inferences to be drawn from high price margins), the revision takes a step backward and relies even more on prices and margins in some contexts. ⁵⁷ Similar views are also held by others including authors Dennis Carlton and Mark Israel, who contend through their assessment that there is a “failure to emphasize properly the importance of non-price competition” in the 2010 Merger Guidelines. ⁵⁸ According to these authors, “Relative to the attention paid to price competition, the current Guidelines could be interpreted as placing too little emphasis on non-price competition.” ⁵⁹ Going forward, questions for consideration in this realm include the following:

Do the U.S. merger guidelines adequately recognize the importance and role of non-price competition and effects in the analysis of a merger?

B. Should Non-Price Effects Beyond Product Quality, Variety, Service, and Innovation Be Considered?

Another important question is whether in the future additional non-price effects should be considered in the analysis of a merger. At present the U.S. merger guidelines focus on non-price effects involving product quality, variety, service, and innovation. Each of these effects is described in various ways. A useful future discussion involves whether there are other non-price effects of importance to competition and antitrust, and therefore of interest to the analysis of a merger. ⁶⁰ It is important that a systematic approach be developed for identifying and distinguishing non-price effects that merit future interest in antitrust. Important questions in this realm include the following:

What non-price effects arise from competition?

C. Is the Current Approach for Analyzing a Merger Adequate When Considering Non-Price Competition and Effects?

A further question is whether going forward the current approach for analyzing a merger is adequate when considering non-price dimensions and effects of competition. According to Commissioner Rosch a challenge with the merger guidelines is that they “lack a clear framework for analyzing non-price considerations.” ⁶¹ The guidelines do acknowledge that “enhanced market power can be manifested in non-price terms and conditions that adversely affect customers, including reduced product quality, reduced product variety, reduced service, or diminished innovation.” ⁶² However, for simplicity of exposition and based on economic theory, the guidelines take the position that they will “generally discuss the analysis of such effects in terms of price effects.” ⁶³ Such analysis captures the effects of a merger on consumer welfare, which can be affected by both the price and non-price effects of a merger.

Consequently, when considering whether a merger may lead to a substantial lessening of non-price competition, the agencies describe that they will “employ an approach analogous to that used to evaluate price competition.” ⁶⁴ This approach involves several steps: defining the relevant market (i.e., Market Definition), analyzing the market’s structure (i.e., Market Participants, Market Shares, and Market Concentration), evaluating applicable theories of harm (i.e., Unilateral Effects, Coordinated Effects), assessing relevant circumstances (i.e., Powerful Buyers, Entry, etc.), and appraising cognizable efficiencies (i.e., Efficiencies). An important question is whether non-price dimensions and effects of competition can be properly understood and assessed through this price-based lens. Other important questions in this realm include the following:

Does an approach analogous to evaluations of price competition suffice for evaluating non-price competition?

As one example of the challenge, the guidelines indicate that questions of market definition involve the willingness of customers to substitute away from one product to another in response to a price increase “or a corresponding non-price change such as a reduction in product quality or service.” ⁶⁵ However, the guidelines provide “no explanation” of how to apply the price-based hypothetical monopolist market definition test, or its operationalization through the so-called SSNIP test, to non-price changes.” ⁶⁶ Beyond considerations of price, the guidelines do not elaborate on how to operationalize market definition through the lens of non-price changes involving reductions in product quality or service, and reduced variety or diminished innovation. Other aspects of the current approach present similar challenges.

D. Do the Guidelines Offer Satisfactory Guidance for Understanding and Evaluating the Harms and Benefits of a Merger in Respect to Each Non-Price Effect?

More particular questions concern whether the guidelines offer adequate guidance for understanding and evaluating the harms and benefits of a merger in respect to product quality, variety, service and innovation. These questions direct attention to (1) what is “known” about non-price dimensions of competition and (2) the application of this knowledge to understanding a merger’s effects.

Applying traditional fields of economics, research at the intersection of antitrust and economics offers market and organizational-level insights about non-price competition and recently has cultivated individual-level insights through behavioral economics. However, relevant insights may also be found outside of economics. For example, organizational and managerial-level insights are found in the business disciplines (e.g., strategic management, marketing, finance, accounting, etc.). Relevant insights are also found in other areas of inquiry (e.g., complexity science, systems dynamics, etc.). It is important that these insights be identified and applied to analyze non-price competition and effects in a merger. ⁶⁷ Questions in this realm include the following:

What is specifically meant in the merger guidelines when referencing non-price effects involving product quality? Variety? Service? Innovation?

Related questions concern the application of what is known about non-price competition into the analysis of a merger. This involves incorporation of what is known about competition involving product quality, variety, service, and innovation into each step of the analysis of a merger. ⁶⁸ Importantly, this includes theories of the harms and benefits of a merger. The two most relevant economic theories of harm in a merger are unilateral effects ⁶⁹ and coordinated effects. ⁷⁰ According to Commissioner Rosch, other than a new section on innovation and product variety, the guidelines are “silent” ⁷¹ with respect to non-price forms of competitive harm and, but for the guideline’s statement that it will employ an approach analogous to that used to evaluate price competition, there is “scant guidance” ⁷² for how to assess a merger’s harmful effects on product quality or service. Despite offering a framework for analyzing the loss of product variety and a merger’s effects on innovation (both harms and benefits), this framework also requires “significant fleshing out” ⁷³ and “leave[s] many questions unanswered.” ⁷⁴

Going forward, it will be important that these challenges be addressed. In this respect, an approach that draws upon market, organizational, managerial, and individual-level insights could prove beneficial. Insights from the business disciplines are likely to be of particular benefit. A hallmark of the business literatures is their development of managerial-level frameworks for understanding and aiding business decision-making. These frameworks offer potential to benefit existing guidance through elaborating on the managerial considerations and decisions associated with non-price competition involving product quality, ⁷⁵ variety, ⁷⁶ service, ⁷⁷ and innovation. ⁷⁸

It is also important to consider how non-price effects factor into any analysis, per the guidelines, of merger-specific and cognizable efficiencies. Cost savings resulting from marginal cost reductions can lead to lower prices to consumers, if passed on by the merged company. Such savings may result from economies of scale or scope. ⁷⁹ However, mergers are also justified on the basis of claimed efficiencies relating to non-price-related consumer benefits. These include new or better quality products and services, bringing products and services faster to market, and other improvements that are difficult to predict and quantify. While these benefits also affect consumer welfare in a more dynamic context, they have been elusive at best. Moreover, the antitrust agencies have no way to hold merging parties “feet to the fire” on delivering on non-price-related efficiencies. Recent proposed legislation would raise accountability for claimed efficiencies. ⁸⁰

E. Is There a Need for Clarity in the Treatment of Conflicts in the Assessment of Price and Non-Price Effects?

Beyond the aforementioned questions, there are also questions about whether the guidelines sufficiently address conflicts that emerge in the assessment of price and non-price effects. According to Rosch, “There may be cases where the predicted price effects of the merger suggest one enforcement outcome, but the innovation [or other non-price] effects suggest a different enforcement outcome.” ⁸¹ An important inquiry regards how these conflicts should be resolved? There are also likely other questions as well. For example, in regard to presumptions, at what point should a structural presumption play a role in analyzing non-price effects such as found in innovation based markets. Important questions in this realm include the following:

How should relationships between price and non-price effects be approached when evaluating a merger?