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Power Buyers: A Potential Defense to Merger Enforcement

August 17, 2017
Imagine a manufacturer of widgets, let’s call them Widget Corporation, which commands a forty percent share of the widget supply market.  After assessing the market, Widget Corporation decides to acquire its closest competitor, Widgets-R-Us, which represents thirty-five percent of the market. Post-acquisition, the combined company would have a seventy-five percent share of the widget supply market. An acquisition which results in such a high market-share concentration would likely raise red flags to U.S. government antitrust enforcement agencies, the Department of Justice and the Federal Trade Commission, as it may substantially lessen competition in the widget market.

Mergers that cause a significant increase in concentration and result in highly concentrated markets are deemed presumptively anticompetitive; however, these mergers may still be lawful if the merging parties can establish that market shares do not fully reflect the reality of competition in the market. [1] One way that the combined firm of Widget Corporation and Widgets-R-Us can mitigate the presumption of illegality of their merger is to demonstrate that the widget market contains powerful buyers which would discipline an exercise of market power by the combined company, or, assert the so-called, “power buyer defense.” [2]

Image: Political cartoon capturing contemporary sentiment about Standard Oil Company, which the U.S. Supreme Court ruled was in violation of the Sherman Antitrust Act and ordered its dissolution in 1911. Source: Library of Congress.

Image: Political cartoon capturing contemporary sentiment about Standard Oil Company, which the U.S. Supreme Court ruled was in violation of the Sherman Antitrust Act and ordered its dissolution in 1911. Source: Library of Congress.

The power buyer defense rose in popularity in the early 1990s as a new defense to merger cases. [3] The defense asserts that a merger of suppliers should not raise competitive concerns when the purchasers of a relevant product are large and/or sophisticated companies because these “power buyers” can ensure that the combined firm acts competitively. [4] A buyer is considered a “power buyer” if it has the ability to exert countervailing power against the combined company or, the ability to mitigate or preclude the adverse effects of suppliers who attempt to monopolize or collude in a market. [5]

Power buyers exercise countervailing power against suppliers in two specific ways: (1) the buyer secures competitive pricing by playing suppliers off one another or, (2) in the absence of available competitive pricing, the buyer has the ability to vertically integrate or sponsor a new entrant. [6] In theory, these methods force suppliers with market power to compete more vigorously with each other. [7] In practice, the presence of large and/or sophisticated buyers does not ensure that suppliers will act competitively and a great deal has been written questioning the economic theory behind the defense. [8]

Although the Supreme Court has not given clear guidance on the power buyer defense in merger cases to date, the lower courts have helped define the outer limits of its applicability. Under the legal standard, in order for a power buyer defense to succeed, the relevant market must (1) not be monopolized on the supplier side so buyers can shift their orders between suppliers to secure competitive prices, (2) allow for vertical integration or sponsored entry by the power buyer, and (3) not contain small or mid-size buyers who could face price discrimination at the hands of the combined supplier firm. [9]

In order for a court to recognize the existence of power buyers as a mitigating factor to a merger that raises a presumption of illegality, the supply side cannot be monopolized. In explaining its refusal to enjoin a long-term agreement between two companies involved in the manufacture and sale of high fructose corn syrup (“HFCS”), the Iowa Southern District Court, in United States v Archer-Daniels-Midland Co., identified a number of tactics that the power buyers in the HFCS market, such as Pepsi-Cola and Coca-Cola, utilized in order to obtain competitive prices including “swinging large volume back and forth among suppliers to show each supplier that it better quote a lower price to obtain and keep large volume sales.” [10] This mechanism of countervailing power, the court reasoned, would discipline any potential exercise of market power by a combined seller.

A power buyer’s countervailing power also relies on the ability of the buyer to integrate vertically or entice a new entrant to enter the market. In United States v. Country Lake Foods, the Minnesota District Court cited the presence of powerful milk buyers and the possibility that they could vertically integrate as a factor in its refusal to enjoin the merger of a number of corporations involved in the processing and selling of fluid milk in the Minneapolis-St. Paul Metropolitan Statistical Area (“MSP/MSA”). The court reasoned that milk buyers in this market would ensure competition because they could “quickly seek milk suppliers outside of the MSP/MSA if their current suppliers attempted to increase their prices” and they had the “capability to vertically integrate” should milk prices become noncompetitive and other sources not be available. [11] In the MSP/MSA market, where the milk buyers accounted for more than 90% of industry sales, the court accepted the defendant’s claim that this mechanism of countervailing power would prevent the combined firm from unjustifiably raising prices. [12]

Furthermore, the presence of power buyers does not prevent sellers in a concentrated industry from finding a way to discriminate among buyers. In a market with buyers of different size, smaller buyers will likely face higher prices as they lack the mechanisms of countervailing power available to power buyers in the market. The court in United States v. United Tote, rejected the argument that the presence of some power buyers in the totalisator market would be sufficient to offset the anticompetitive effects of a merger due to the presence of smaller, less influential buyers. [13] The court concluded that even if larger buyers were not likely to suffer the effects of a lack of competition, smaller customers in the market did not have the same bargaining power and would likely face price discrimination by the combined company.

Returning to our hypothetical, if the combined Widget Corporation and Widgets-R-Us could successfully assert a power buyer defense of its merger by demonstrating (1) that the remaining twenty-five percent of the market represents suppliers which would offer a competitive alternative for widget buyers, (2) entry into the widget market is easy and there is a history of buyers vertically integrating, and (3) the buyer side of the market only contains large buyers with significant mechanisms of countervailing power at their disposal. While the reviewing court would have to weigh the totality of the circumstances of competition in the widget market before ruling on the matter, a successful assertion of the power buyer defense can mitigate anticompetitive concern in the merger of sellers.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

References

  [1] Horizontal Merger Guidelines, issued August 19, 2010, https://www.justice.gov/atr/horizontal-merger-guidelines-08192010.

  [2] Lawrence A. Sullivan & Warren S. Grimes, Law of Antitrust: An Integrated Handbook (St. Paul, Minn.: West Group, 2000), 612-613.

  [3] Mary Lou Steptoe, “Programs from the 1992 Annual Meeting: The New Merger Guidelines: Have They Changed the Rules of the Game: The Power-Buyer Defense in Merger Cases,” Antitrust Law Journal 61, issue 2 (1993): 493-94.

  [4] Herbert Hovenkamp, “Essay: Mergers and Buyers,” Virginia Law Review 77 (1991): 1369-71.

  [5] John B. Kirkwood, “Powerful Buyers and Merger Enforcement,” Boston University Law Review 92 (2012): 1500.

  [6] ABA Section of Antitrust Law, Mergers & Acquisitions: Understanding the Antitrust Issues, 2d Edition, ed. Robert Schlossberg (2004), 160-163.

  [7] “The New Kid on the Block: Buyer Power,” American Antitrust Institute, October 6, 2008, http://www.antitrustinstitute.org/files/Buyer%20Power%20Chapter%20from%20%20AAI%20Transition%20Report_100520082108.pdf.

  [8] Dennis W. Carlton & Mark Israel, Proper Treatment of Buyer Power in Merger Review, Review of Industrial Organization 39 (2011): 132-134. See also Herbert Hovenkamp, “Essay: Mergers and Buyers,” Virginia Law Review 77 (1991): 1369-71.

  [9] See United States v. Baker Hughes, Inc., 908 F. 2d 981, 983 (D.C. Cir. 1990); United States v. Archer-Daniels-Midland Co., 781 F. Supp. 1400, 1422-23 (S.D. Iowa 1991); United States v. United Tote, Inc., 768 F. Supp. 1064 (D. Del. 1991); United States v. Country Lake Foods, 754 F. Supp. 669, 675 (D. Minn. 1990); United States v. Country Lake Foods, Inc., 754 F. Supp. 669, 674 (D. Minn. 1990); FTC v. Cardinal Health, 12 F. Supp. 2d 34, 58-59 (D.D.C. 1998).

  [10] United States v. Archer-Daniels-Midland Co., 781 F. Supp. 1400, 1418 (S.D. Iowa 1991).

  [11] United States v. Country Lake Foods, 754 F. Supp. 669, 674-5 (D. Minn. 1990).

  [12] Id.

  [13] United States v. United Tote, Inc., 768 F. Supp. 1064, 1085 (D. Del. 1991).

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