Carl Shapiro Critiques the FTC’s Withdrawal of 2020 Vertical Merger Guidelines

“When the Federal Trade Commission investigates vertical mergers, will it dismiss elimination of double marginalization (EDM) in cases that do not fit the very narrow fact pattern which the majority (incorrectly) believes to be the only one in which EDM applies? That could lead to enforcement errors and the prospect of embarrassing losses in court.”
—Carl Shapiro, from “How Will the FTC Evaluate Vertical Mergers?”

In a new article, “How Will the FTC Evaluate Vertical Mergers?,” UC Berkeley economics professor Carl Shapiro argues that the Federal Trade Commission’s (FTC) recent withdrawal of its 2020 Vertical Merger Guidelines is incorrect as a matter of microeconomic theory and is contrary to an extensive economic literature about vertical integration.

Professor Shapiro focuses his critique on the FTC’s handling of “elimination of double marginalization” (EDM)—the theory that a vertical merger can promote competition by eliminating double markups that occur when two independent firms sell and then resell a product.

In explaining its withdrawal of the 2020 Vertical Merger Guidelines, the FTC asserted that the guidelines’ reliance on EDM is theoretically flawed because EDM creates downward pricing pressure only under specific factual scenarios: (a) mergers that involve one single-product monopoly buying another single-product monopoly in the same supply chain; (b) both charge monopoly prices pre-merger; and (c) the product from one firm is used as input by the other in a fixed-proportion production process.

The following excerpts from “How Will the FTC Evaluate Vertical Mergers?” highlight some of Professor Shapiro’s concerns about the FTC’s statement.

EDM and Vertical Merger Inquiry

EDM applies (a) to multi-product firms, (b) regardless of whether the firms at either level have monopoly power or charge monopoly prices, and (c) regardless of whether the downstream production process involves fixed proportions. All of this has been included in economics textbooks for decades, building on a seminal 1950 paper by Joseph Spengler.

While EDM does not save every vertical merger, it should be a part of any vertical merger inquiry and is not nearly as limiting as the [FTC] majority’s statement suggests.

Our view is that Vertical Merger Guidelines should make clear that the merging parties bear the burden of establishing EDM, just as they bear the burden of establishing all efficiencies in horizontal as well as vertical mergers.

On the Competitive Harm of Mergers

The FTE’s statement is contrary to a broad consensus among economists going back at least to a seminal 1968 article by Oliver Williamson. In many cases a merger (horizontal or vertical) will do no competitive harm because its efficiencies will completely offset any threatened anticompetitive effects. But this is a factual query.

Further, the FTC’s statement is flatly inconsistent with the Horizontal Merger Guidelines issued by the Department of Justice and the FTC. Ironically, the aggressive antitrust enforcer and FTC Chair Robert Pitofsky recognized the need to include efficiencies in the merger guidelines and in fact did so in 1997.

Merger Review is Not Just About Price Effects

Merger review is not just about price effects. Often the effect of a merger on product quality and innovation is far more important.

In vertical mergers, EDM receives a lot of attention because it is well understood and amenable to quantification. But we find it very helpful to think of EDM as just one example of a far more general concept: some supply chains are handled more efficiently within a single firm than through contract.

An extensive economic literature about vertical integration and “make or buy” decisions teaches us that vertical integration can spur innovation and greatly benefit consumers, especially when new methods require risky investments and coordination throughout the supply chain. Oliver Williamson won a Nobel Prize in 2009 for his work on these issues.

Read the full article on TAP: “How Will the FTC Evaluate Vertical Mergers?,” by Carl Shapiro and Herbert Hovenkamp.

Further Reading:

“Vertical Mergers and Input Foreclosure: Lessons from the AT&T/Time Warner Case,” by Carl Shapiro (Springer Nature, July 2021)