Historic Shift by the FTC on Vertical Merger Review, with More to Come

By: Steve Albertson , Thomas Ensign , Mark S. Ostrau , Elizabeth Suarez

In a departure from past enforcement priorities, the Federal Trade Commission has challenged three vertical mergers over the past year, leading the parties to abandon two of the three deals. These challenges are consistent with FTC Chair Lina Khan’s announced intention to toughen vertical merger review standards, which she contends have been overly permissive for decades. Although the Commission’s actions rely on traditional theories of harm, the new leaders at both the FTC and U.S. Department of Justice have revealed plans to abandon certain aspects of the traditional approach and to pursue novel theories of harm in future investigations.

The FTC’s Alignment with “Market Realities”

Shortly after Chair Khan’s appointment in 2021, the FTC voted 3-to-2 to withdraw its approval of the 2020 Vertical Merger Guidelines, which had been jointly issued by the FTC and DOJ to establish a common framework for analyzing transactions that combine companies at different levels of the same supply chain.

In explaining the action, the Commission’s Democratic majority expressed skepticism of the efficiencies-based arguments typically used to justify vertical deals, noting in particular that the Guidelines’ reliance on the elimination of double marginalization, which is often cited as creating downward pricing pressure and ultimately benefiting consumers, is “theoretically and factually misplaced.”

The majority emphasized that the Clayton Act provides no basis for permitting a merger that generates efficiencies if it nevertheless lessens competition. While textually accurate, efficiencies—including the elimination of double marginalization—have a prominent place in antitrust precedent and are used by courts in weighing the benefits of vertical mergers against potential harms to competition. Historically, efficiencies have played a large role in both agencies’ investigations of and challenges to vertical mergers.

The majority commissioners further explained that the FTC would employ “bright-line screens” for particular market structures that tend to lessen competition. Additionally, the agency will assess “prevalent harms” that appear in vertical mergers, accounting for the impact on labor markets and features specific to digital markets, both of which represent a divergence from the agencies’ typical analysis. The commissioners previewed a more critical review of vertical mergers, eschewing any reliance on efficiencies.

Not All Good Things Come in Threes

In each of its three challenges to vertical transactions in the past year, the FTC found proposed behavioral remedies inadequate to address their concerns and decided unanimously to sue to block the merger entirely.

Illumina / Grail: In March 2021, the FTC challenged Illumina’s proposed acquisition of Grail, a leading developer of multi-cancer early detection tests, alleging that the transaction would result in input foreclosure for competing multi-cancer early detection blood (MCED) test providers. The FTC’s complaint identified Illumina as the only supplier of next-generation sequencing platforms – a critical input for companies seeking to develop and commercialize MCED tests. The FTC argued Illumina would be able to monitor Grail competitors who use its next generation sequencing platform and would be incentivized to kill any products that would take significant business from Grail. In August 2021, Illumina completed its acquisition of Grail to avoid a deadline-based termination of the parties’ merger agreement, but the FTC administrative trial remains ongoing. The transaction is also under investigation by the European Commission, which issued a hold-separate order against Illumina pending the outcome of the review.

Nvidia / Arm: In December 2021, the FTC pursued a similar foreclosure theory in its challenge to U.S. chip maker Nvidia’s acquisition of UK chip design provider Arm. Using a “neutral, open licensing approach,” Arm licenses its processor technology, which consists of (i) designs for central processing units that Arm develops; and (ii) a central processing unit (CPU) instruction set architecture for companies that wish to create their own CPU designs. Nvidia, one of the world’s largest chip suppliers, has licensed Arm’s technology to create a range of computing products, many of which compete against products of other semiconductor firms who are Arm licensees. The FTC alleged that Nvidia would be incentivized, post-acquisition, to harm its Arm-reliant rivals by withholding, delaying or degrading access to Arm IP as it relates to specific computer processors. Similar objections had been raised by the EC and by the UK Competition and Markets Commission. Nvidia ultimately abandoned the proposed acquisition in February 2022.

Lockheed / Aerojet: In January 2022, the FTC sought to block Lockheed Martin’s proposed acquisition of Aerojet Rocketdyne. The complaint argued that Lockheed, the world’s largest defense contractor, would gain the ability to foreclose, raise costs for or otherwise disadvantage its prime rivals that rely on Aerojet’s missile propulsion technology to effectively compete. The complaint also alleged that the proposed acquisition was likely to negatively impact R&D and innovation. The FTC’s review was notable for its reported focus on potential negative impacts on a particular local labor market. However, perhaps reflecting the current even partisan split on the Commission, the FTC’s complaint did not allege any labor-related theory of harm. Like Nvidia, Lockheed announced in February 2022 that it was abandoning the proposed deal.

Eliminating a “Bifurcated” Approach

Although the DOJ has neither withdrawn from the 2020 Vertical Merger Guidelines, nor attempted to block a vertical merger this year, Assistant Attorney General Jonathan Kanter downplayed any divergence between the DOJ and FTC in the treatment of vertical mergers, and joined the FTC in announcing the launch of a comprehensive review of the Guidelines for both horizontal and non-horizontal transactions. AAG Kanter noted that the current Guidelines “have bifurcated horizontal and vertical analysis, yet often transactions don’t neatly fit into these categorizations,” suggesting that the coming revised guidelines may apply to both types of deals.

Chair Khan noted the review would assess whether the Guidelines adequately address mergers that lessen competition in labor markets, thereby harming workers. Khan also noted that the review will: (i) assess how the Guidelines analyze whether a merger may “tend to create a monopoly,” specifically looking at data-aggregation strategies by digital platforms and market consolidation efforts by private equity firms, and (ii) evaluate what types of evidence should be considered in evaluating nonprice effects.

The agencies aspire to complete their review and publish new Merger Guidelines within the next year.

So, You’re Considering a Vertical Merger?

The past year has made clear that vertical merger enforcement is a priority for the agencies, highlighting the importance of engaging antitrust counsel early in the deal process. Some key takeaways for vertical transactions include:

  • Risk shifting provisions matter. Engaging antitrust counsel early allows any potential antitrust risk to be identified and reflected appropriately in the merger agreement from the outset, thus enabling the parties to make more informed decisions in prioritizing which provisions are “non-negotiables” and when it is worth pushing back on risk shifting provisions.
  • Prepare for scrutiny on competitive effects. The antitrust authorities’ skepticism towards efficiencies demands that parties prepare to directly address potential harms to competition, even where such harms may be outweighed by efficiencies. This means proactively preparing arguments and advocacy materials and anticipating responses to a Voluntary Access Letter from the reviewing agency in order to promptly address any concerns.
  • Traditional theories of harm will remain relevant to enforcement decisions. While “novel” theories of harm will likely gain currency at DOJ and FTC, particularly once a Democratic majority on the Commission is established, traditional theories of harm will remain a primary focus, as any newer theories are untested in court. Thus, companies should continue to focus on countering concerns related to foreclosure, raising rivals’ costs, and increased potential for coordination in parallel to addressing more novel theories of harm.
  • Parties in “digital markets” should expect special attention from the agencies. Both agencies have identified “digital markets” as potentially having unique market structures. Parties to a vertical merger falling even broadly within “digital markets” should prepare for heightened scrutiny from both agencies.
  • Behavioral remedies are unlikely. Both agencies have made clear they believe the types of behavioral remedies traditionally relied on in the past to address competition concerns with vertical deals have not been adequate to that task, with the FTC having brought three actions seeking to block the deals outright rather than adopt such a remedy. This approach will likely continue for the foreseeable future.