Anthony W. Swisher is a Partner in the Washington, DC office of Baker Botts LLP and serves as the WLF Legal Pulse blog’s Featured Expert Contributor on Antitrust & Competition Policy — U.S. Department of Justice.

In January the FTC and DOJ put forth for comment draft Vertical Merger Guidelines (VMGs), offering guidance on a topic last addressed by the Non-Horizontal Merger Guidelines in 1984.  Vertical merger matters have, of course, taken on increased prominence in recent years following the DOJ Antitrust Division’s unsuccessful challenge to the vertical AT&T/Time Warner transaction.  The FTC has had at least two recent high-profile vertical matters itself, in Northrop Grumman/Orbital and Staples/Essendant.  In the wake of these cases, and following a great deal of public commentary, the agencies published a draft of the VMGs that appears likely to be the blueprint for future vertical enforcement.

The draft VMGs are significantly shorter and less detailed than the Horizontal Merger Guidelines, but they lay out a basic framework of how the agencies propose to approach their review of vertical transactions.  Much of the commentary surrounding the draft VMGs has lauded the agencies for increasing transparency around their vertical enforcement priorities.  Other pieces have noted the VMGs’ lack of detail and have suggested that the agencies missed an opportunity to provide more detailed guidance on vertical enforcement theories.  Still others have suggested that the proposed VMGs are not “tough” enough and argue that the agencies should take a harder line against vertical mergers.

Much of this commentary understates the importance of the newly issued VMGs, however.  Granted, the VMGs do not contain a wealth of detail, and at first blush do not seem to advance vertical enforcement theory all that much.  But dig a little deeper, and they might be more significant than they first seem, even potentially ushering in a major change in approach to vertical mergers.

First, the mere fact that the antitrust enforcement agencies thought vertical merger enforcement was an important enough topic to warrant new guidelines signals that the agencies’ recent interest in vertical issues is not likely to decline in the near future.  The recent increase in vertical enforcement has spurred a wealth of commentary on vertical antitrust issues, with several scholars and commentators calling for an approach to vertical mergers more in line with the traditional enforcement view of horizontal mergers.  An article in Antitrust magazine by professors Baker, Rose, Salop, and Morton is illustrative.  There, the authors called for an approach to vertical merger enforcement that utilizes similar presumptions as horizontal mergers, limits the role of safe harbors, and critically evaluates claimed efficiencies.  The current version of the VMGs may not go as far as some commentators perhaps would have preferred, but they are a stepping-off point, and lay the foundation for future enforcers to expand the role of vertical enforcement.

Second, particularly as to efficiencies, the draft VMGs take an approach that is similar in practice to provisions of the Horizontal Merger Guidelines.  The VMGs note that vertical mergers “have the potential” to create “cognizable efficiencies” through the elimination of “contracting frictions” and the combination of “complementary economic functions.”  What the VMGs characterize as “potential,” however, some commenters and economic scholars have taken as an inherent feature of vertical combinations.  As Professor Carl Shapiro noted during the FTC’s hearings on Competition and Consumer Protection in the 21st Century, there is a fundamental difference between vertical and horizontal transactions, with the former being inherently likely to result in efficiencies.  “[W]e are hearing from panels about these inherent efficiencies, which economists would agree with, including me.”  That the VMGs do not appear to credit the inherently beneficial nature of vertical transactions, or even to view vertical mergers as necessarily all that different than horizontal mergers, is a noteworthy and seemingly significant development.

Characterizing vertical efficiencies as “cognizable efficiencies” and referencing horizontal merger practice treats vertical efficiencies as a defense to an allegedly anticompetitive merger.  Rather than being benefits of vertical mergers that naturally flow from the combination of firms at different levels of distribution, under the draft VMGs efficiencies must be proven by the parties, tested for cognizability, and be subject to scrutiny as to whether they might offset some alleged harm flowing from the vertical merger.  This view of efficiencies is reflected in the VMGs’ explicit incorporation of the approach taken in Section 10 of the Horizontal Merger Guidelines.  Section 10 applies when merging parties are attempting to rebut a finding that a merger is anticompetitive.  “The greater the potential adverse competitive effect of a merger, the greater must be the cognizable efficiencies, and the more they must be passed through to customers, for the Agencies to conclude that the merger will not have an anticompetitive effect in the relevant market.”

This is not to say that the agencies’ approach to efficiencies in the horizontal merger context is incorrect.  Rather, the point is that the proposed VMGs appear to take the same approach with vertical mergers, which is an entirely different context.  Because vertical mergers by definition do not involve competitors, the agencies do not – yet – get to rely upon presumptions of anticompetitive effects derived from the structural characteristics of the market.  Importing into the vertical context an efficiencies model developed in the context of horizontal mergers potentially marks an important development in merger enforcement.

Perhaps more importantly, under current doctrine the antitrust enforcement agencies arguably have the burden of disproving the efficiencies implied in a vertical merger.  In particular, the elimination of double-marginalization (or “EDM”), is widely accepted as an inherent benefit of vertical integration.  In Judge Leon’s decision in the AT&T/Time Warner matter, he characterized EDM as a “standard benefit” of vertical merger transactions, and the government conceded its applicability.  Compare that with the language of the draft VMGs, which state that the agencies will “rely on the parties to identify and demonstrate whether and how the merger eliminates double marginalization.”

In sum, the draft VMGs may be short, and may not be particularly detailed, but they have the potential to be a very significant development in vertical merger enforcement.  As Commissioner Wilson discussed in a speech last February, there are fundamental differences between horizontal and vertical mergers that make the wholesale adoption of horizontal concepts in the vertical context potentially problematic.  As Commissioner Wilson recognized, “We know that vertical mergers present competitive dynamics that differ from those presented by horizontal mergers, and that these differences make vertical mergers systematically less likely to be anticompetitive.”  Whether the draft VMGs signal an intent by the agencies to apply horizontal concepts to vertical mergers remains to be seen.  It will bear watching to see what changes the agencies make to the published draft in response to comments, and especially to see how the new VMGs hold up in practice.