Whatever the statutory differences or language differences in Guidelines between Canada and the US the application of competition rules and procedures is remarkably similar in the two countries. Recent adjustments to the role of efficiencies in merger analysis in the two countries reveal a potential departure from this claim. The Canadian Competition Bureau (the agency responsible for the implementation of competition policy in Canada) has moved from a clear and focused position on the role of efficiencies in merger analysis to one that is much less certain and focused. For its part the US agencies (Department of Justice and the Federal Trade Commission) have moved from a more ambiguous or undefined position on the role of efficiencies in merger analysis to one that is more certain and focused

Mathewson, Frank

Victoria University of Wellington

The Efficiencies Defense in Merger Analysis
in Canada and the US
Frank Mathewson
Professor (Economics), Director of the Institute for Policy Analysis (University of
Toronto), and Senior Consultant, Charles River Associates
8Whatever the statutory differences or language differences in Guidelines between
Canada and the US, the application of competition rules and procedures is remarkably
similar in the two countries.  Recent adjustments to the role of efficiencies in merger
analysis in the two countries reveal a potential departure from this claim.  The Canadian
Competition Bureau (the agency responsible for the implementation of competition
policy in Canada) has moved from a clear and focused position on the role of efficiencies
in merger analysis to one that is much less certain and focused.  For its part, the US
agencies (Department of Justice and the Federal Trade Commission) have moved from a
more ambiguous or undefined position on the role of efficiencies in merger analysis to
one that is more certain and focused.
The background for this claim on the role of efficiencies is as follows.  I begin
with Canada.  Canada’s Competition Act (the “Act”) gives explicit statutory recognition
to efficiencies, in both the introductory section (section 1.1) and the merger section
(section 96).  This latter section prohibits the Canadian Competition Tribunal from
making an order against a merger if the proposed merger would bring about gains in
efficiency that are greater than, and would offset, any prevention or lessening of
competition, provided that these gains would not likely be attained without the merger.  A
merger involving a substantial lessening of competition that might otherwise require a
remedy or even be prohibited might be permitted to proceed if the efficiency gain is large
enough.
Most observers, including most economists, believe that the appropriate metric for
balancing these offsetting effects is the standard of total surplus.  Surplus to the
8shareholders of the merging parties is the profits earned by the merged entity.  Surplus to
consumers is the value that they attach to consuming the product relative to the price that
they pay.   Total surplus is the sum of these two surpluses. A merger would pass muster if
this sum were positive.
The following is illustrative. Suppose that competitive prices prevail before a
merger.  Suppose further that each consumer buys only one unit of the product. Then the
loss of consumer surplus from a merger that increases prices above competitive levels is
the surplus lost by consumers priced out of the market. Notice that a merger that results
in a price increase transfers some surplus from consumers who continue to buy the
product to the shareholders of the merged entity.  These consumers willingly pay the
higher price for the good and this transfer is counted as neutral as the merger does not
eliminate this surplus from the economy.  The lost surplus comes from those consumers
who now no longer purchase the product when they formerly did at the pre-merger
competitive price.   It is this loss that must be balanced against any efficiencies that
uniquely result from the merger.
The confusion on the application of this metric comes from a series of
announcements from the Canadian Competition Bureau.
(i) The 1991 Canadian Merger Enforcement Guidelines state that when a
merger produces a price increase, as I outline above, the merger brings
about a neutral redistribution effect and a negative resource allocation
effect.  The efficiency gains need to be balanced against the negative
resource allocation effects.  The guidelines recognize that when a dollar is
8transferred from a buyer to a seller, there can be no determination who is
more deserving or in whose hands this dollar has greater value.
(ii) In one 1992 case (the Hillsdown case), the Competition Tribunal (the
Canadian administrative law tribunal that hears competition cases)
questioned (in an obiter) the metric that should be applied to this trade-off
in merger analysis. In response, the then head of the Competition Bureau
maintained an allegiance to the approach set out in the Merger
Enforcement Guidelines.
(iii) In September 1999, the current head of the Bureau stated that no merger to
monopoly could ever bring about gains in efficiency sufficient to offset
the effects of the merger on competition.
(iv) Recently, the Bureau has stated that a merger that creates a substantial
lessening of competition but would pass under the total surplus standard
would be passed to the Competition Tribunal to determine the appropriate
welfare metric to assess the merger.
(v) More recently, the chief economist of the Bureau proposes a two-stage
test. At stage 1, if buyers of the relevant products are similar and the
quantity that they purchase is virtually independent of the income levels of
the buyers, then the conventional surplus metric will apply.  If this is not
so, then at stage 2, the Bureau will seek to assess whether the transfers
arising from the merger can be considered to be neutral.
These statements are confusing and raise a number of concerns.  For example, a
merger to monopoly with sufficiently large cost savings unique to the merger could
8produce a reduction in price.  Would such a merger be challenged?  Consider the strategy
of referring cases to the Tribunal based on calculation of the surplus measure.   The
practical realities are that Tribunal cases are time intensive and expensive for the parties.
Referring cases to the Tribunal for a clarification of the surplus metric may encourage
parties to abandon efficiency-enhancing mergers and thus the strategy may be tantamount
to blocking the proposed merger.  This would be equivalent to rejecting the metric.   This
raises another question: what special tools and analysis lie in the hands of the members of
the Competition Tribunal (panels are drawn from members of the Federal Court
(judiciary members) and other appointed lay members) that would permit them to opine
on matters of income or wealth redistribution?   Distribution matters are traditionally left
to Parliament to determine (through social assistance plans or other initiatives).
Consider next the two-stage test.  There are serious measurement issues of
determining when demands for products are income neutral.  Even if such a
determination could be made, if the conventional welfare metric is to be avoided, should
a different welfare metric apply to merger cases where products are income neutral (say
pharmaceutical products for severe illnesses) from those where products are income
sensitive (high-end performance automobiles)?  The end result, I submit, is that the clear
and unambiguous welfare metric set out in the Canadian statute and defined in the
Merger Enforcement Guidelines has been set aside for a series of unclear and ambiguous
statements.
On April 8, 1997, US agencies revised Section 4 (on efficiencies) of the 1992 US
Horizontal Merger Guidelines. This revised section points out that competition drives
firms to achieve efficiencies.  In assessing proposed mergers, only those efficiencies that
8can be realized through the merger (merger-specific efficiencies) will be considered by
the respective enforcement agency. This is similar in spirit to the Canadian guidelines.
Both the US and Canadian Guidelines place a clear measurement burden on the merging
parties.  Efficiencies are difficult to verify and quantify as much of the data and
information required to perform such an assessment rest with the merging parties.  Only
verifiable efficiency claims will be entertained.  The US Guidelines use the term
cognizable efficiencies to refer to merger-specific efficiencies that have been verified and
do not arise from any anticompetitive reduction in output or service that might flow from
the proposed merger.   The US Guidelines spell out that the agency reviewing the merger
will ask whether these cognizable efficiencies are sufficient to reverse any
anticompetitive effect: are these efficiencies sufficiently large to cause consumer prices
not to fall?  Notice that this is a more demanding hurdle than the one set out in the
Canadian guidelines where prices can rise provided efficiencies are larger in magnitude
than the corresponding lost consumer surplus.  In the US, the efficiencies must be
sufficient to guarantee no price increase.
Commissioner Pitofsky of the US Federal Trade Commission claims
(“Efficiencies in Defense of Mergers: Two Years Later”, (1999) 7 George Mason Law
Review, 485) that the US Guidelines were revised for the benefit of the lower courts, who
were uncomfortable in merger cases with the exclusion of efficiencies in accordance with
earlier US Supreme Court doctrine.  Commissioner Pitofsky states that the revision
served 4 main objectives:
(i) The revisions tied efficiencies directly into the competitive effects
analysis;
8(ii) The revisions made clear that any efficiency claim must be attributed
uniquely to the merger at hand and the revisions committed the respective
agency to evaluate claimed efficiencies against other practical alternatives;
(iii) The revisions state that the agencies will require proof of greater
efficiencies as the likely anticompetitive effects of any proposed merger
increase;
(iv) The revisions define which efficiencies matter – cognizable efficiencies.
Commissioner Pitofsky assesses a set of recent US merger cases in light of the
1997 revisions.  For example, he points to the Staples case (Staples, the second largest
office supply superstore chain in the US, proposed to acquire Office Depot, the largest
office supply superstore chain.)  The district court decided that office supply superstores
constitute a separate relevant product market and that the two merging parties had high
market share. The court then examined the efficiency claims of the parties, including the
claim that the merged entity could bargain more assiduously with its suppliers for better
prices.  The inference here is that the revisions in the Guidelines legitimized the district
court’s exercise of evaluating the efficiency claims of the parties. The court rejected the
efficiency claims as (i) overstated relative to efficiency claims made in internal document
unrelated to the litigation, and (ii) increased buying power was likely to flow to both
parties even if they did not merge as both were expanding rapidly.  (Increased buying
power alone without the savings of resources is not an efficiency; it is a pecuniary effect
where one party secures a larger share of the gains from trade because of an enhanced
threat point in its bargaining position.  Both the Canadian and US Guidelines recognize
this distinction.)
8Efficiencies (and synergies) will always arise in any merger review as they form
the pro-competitive rationale to drive mergers. The merging parties somehow hope to do
something better after the merger.  Efficiencies become more critical when the merger
gives rise to a substantial lessening of competition.  The issue then becomes one of
evaluating the anticompetitive against the procompetitive effects.  There is considerable
agreement among economists on the application of a welfare metric that balances losses
and gains with dollars treated as equals.   On this matter, Canada has moved from a clear
and unambiguous policy that embraces this welfare standard to one that is clouded and
uncertain.  The US has moved to include efficiencies in the equation, although the US
price standard (that the net effect of a merger is that consumer prices cannot rise) is a
more stringent hurdle that rules out some otherwise allocatively efficient mergers.


The Efficiencies Defence in Merger Analysis in Canada and the US

ResearchArchive at Victoria University of Wellington

The Efficiencies Defense in Merger Analysisin Canada and the USFrank MathewsonProfessor (Economics), Director of the Institute for Policy Analysis (University ofToronto), and Senior Consultant, Charles River Associates8Whatever the statutory differences or language differences in Guidelines betweenCanada and the US, the application of competition rules and procedures is remarkablysimilar in the two countries.  Recent adjustments to the role of efficiencies in mergeranalysis in the two countries reveal a potential departure from this claim.  The CanadianCompetition Bureau (the agency responsible for the implementation of competitionpolicy in Canada) has moved from a clear and focused position on the role of efficienciesin merger analysis to one that is much less certain and focused.  For its part, the USagencies (Department of Justice and the Federal Trade Commission) have moved from amore ambiguous or undefined position on the role of efficiencies in merger analysis toone that is more certain and focused.The background for this claim on the role of efficiencies is as follows.  I beginwith Canada.  Canada’s Competition Act (the “Act”) gives explicit statutory recognitionto efficiencies, in both the introductory section (section 1.1) and the merger section(section 96).  This latter section prohibits the Canadian Competition Tribunal frommaking an order against a merger if the proposed merger would bring about gains inefficiency that are greater than, and would offset, any prevention or lessening ofcompetition, provided that these gains would not likely be attained without the merger.  Amerger involving a substantial lessening of competition that might otherwise require aremedy or even be prohibited might be permitted to proceed if the efficiency gain is largeenough.Most observers, including most economists, believe that the appropriate metric forbalancing these offsetting effects is the standard of total surplus.  Surplus to the8shareholders of the merging parties is the profits earned by the merged entity.  Surplus toconsumers is the value that they attach to consuming the product relative to the price thatthey pay.   Total surplus is the sum of these two surpluses. A merger would pass muster ifthis sum were positive.The following is illustrative. Suppose that competitive prices prevail before amerger.  Suppose further that each consumer buys only one unit of the product. Then theloss of consumer surplus from a merger that increases prices above competitive levels isthe surplus lost by consumers priced out of the market. Notice that a merger that resultsin a price increase transfers some surplus from consumers who continue to buy theproduct to the shareholders of the merged entity.  These consumers willingly pay thehigher price for the good and this transfer is counted as neutral as the merger does noteliminate this surplus from the economy.  The lost surplus comes from those consumerswho now no longer purchase the product when they formerly did at the pre-mergercompetitive price.   It is this loss that must be balanced against any efficiencies thatuniquely result from the merger.The confusion on the application of this metric comes from a series ofannouncements from the Canadian Competition Bureau.(i) The 1991 Canadian Merger Enforcement Guidelines state that when amerger produces a price increase, as I outline above, the merger bringsabout a neutral redistribution effect and a negative resource allocationeffect.  The efficiency gains need to be balanced against the negativeresource allocation effects.  The guidelines recognize that when a dollar is8transferred from a buyer to a seller, there can be no determination who ismore deserving or in whose hands this dollar has greater value.(ii) In one 1992 case (the Hillsdown case), the Competition Tribunal (theCanadian administrative law tribunal that hears competition cases)questioned (in an obiter) the metric that should be applied to this trade-offin merger analysis. In response, the then head of the Competition Bureaumaintained an allegiance to the approach set out in the MergerEnforcement Guidelines.(iii) In September 1999, the current head of the Bureau stated that no merger tomonopoly could ever bring about gains in efficiency sufficient to offsetthe effects of the merger on competition.(iv) Recently, the Bureau has stated that a merger that creates a substantiallessening of competition but would pass under the total surplus standardwould be passed to the Competition Tribunal to determine the appropriatewelfare metric to assess the merger.(v) More recently, the chief economist of the Bureau proposes a two-stagetest. At stage 1, if buyers of the relevant products are similar and thequantity that they purchase is virtually independent of the income levels ofthe buyers, then the conventional surplus metric will apply.  If this is notso, then at stage 2, the Bureau will seek to assess whether the transfersarising from the merger can be considered to be neutral.These statements are confusing and raise a number of concerns.  For example, amerger to monopoly with sufficiently large cost savings unique to the merger could8produce a reduction in price.  Would such a merger be challenged?  Consider the strategyof referring cases to the Tribunal based on calculation of the surplus measure.   Thepractical realities are that Tribunal cases are time intensive and expensive for the parties.Referring cases to the Tribunal for a clarification of the surplus metric may encourageparties to abandon efficiency-enhancing mergers and thus the strategy may be tantamountto blocking the proposed merger.  This would be equivalent to rejecting the metric.   Thisraises another question: what special tools and analysis lie in the hands of the members ofthe Competition Tribunal (panels are drawn from members of the Federal Court(judiciary members) and other appointed lay members) that would permit them to opineon matters of income or wealth redistribution?   Distribution matters are traditionally leftto Parliament to determine (through social assistance plans or other initiatives).Consider next the two-stage test.  There are serious measurement issues ofdetermining when demands for products are income neutral.  Even if such adetermination could be made, if the conventional welfare metric is to be avoided, shoulda different welfare metric apply to merger cases where products are income neutral (saypharmaceutical products for severe illnesses) from those where products are incomesensitive (high-end performance automobiles)?  The end result, I submit, is that the clearand unambiguous welfare metric set out in the Canadian statute and defined in theMerger Enforcement Guidelines has been set aside for a series of unclear and ambiguousstatements.On April 8, 1997, US agencies revised Section 4 (on efficiencies) of the 1992 USHorizontal Merger Guidelines. This revised section points out that competition drivesfirms to achieve efficiencies.  In assessing proposed mergers, only those efficiencies that8can be realized through the merger (merger-specific efficiencies) will be considered bythe respective enforcement agency. This is similar in spirit to the Canadian guidelines.Both the US and Canadian Guidelines place a clear measurement burden on the mergingparties.  Efficiencies are difficult to verify and quantify as much of the data andinformation required to perform such an assessment rest with the merging parties.  Onlyverifiable efficiency claims will be entertained.  The US Guidelines use the termcognizable efficiencies to refer to merger-specific efficiencies that have been verified anddo not arise from any anticompetitive reduction in output or service that might flow fromthe proposed merger.   The US Guidelines spell out that the agency reviewing the mergerwill ask whether these cognizable efficiencies are sufficient to reverse anyanticompetitive effect: are these efficiencies sufficiently large to cause consumer pricesnot to fall?  Notice that this is a more demanding hurdle than the one set out in theCanadian guidelines where prices can rise provided efficiencies are larger in magnitudethan the corresponding lost consumer surplus.  In the US, the efficiencies must besufficient to guarantee no price increase.Commissioner Pitofsky of the US Federal Trade Commission claims(“Efficiencies in Defense of Mergers: Two Years Later”, (1999) 7 George Mason LawReview, 485) that the US Guidelines were revised for the benefit of the lower courts, whowere uncomfortable in merger cases with the exclusion of efficiencies in accordance withearlier US Supreme Court doctrine.  Commissioner Pitofsky states that the revisionserved 4 main objectives:(i) The revisions tied efficiencies directly into the competitive effectsanalysis;8(ii) The revisions made clear that any efficiency claim must be attributeduniquely to the merger at hand and the revisions committed the respectiveagency to evaluate claimed efficiencies against other practical alternatives;(iii) The revisions state that the agencies will require proof of greaterefficiencies as the likely anticompetitive effects of any proposed mergerincrease;(iv) The revisions define which efficiencies matter – cognizable efficiencies.Commissioner Pitofsky assesses a set of recent US merger cases in light of the1997 revisions.  For example, he points to the Staples case (Staples, the second largestoffice supply superstore chain in the US, proposed to acquire Office Depot, the largestoffice supply superstore chain.)  The district court decided that office supply superstoresconstitute a separate relevant product market and that the two merging parties had highmarket share. The court then examined the efficiency claims of the parties, including theclaim that the merged entity could bargain more assiduously with its suppliers for betterprices.  The inference here is that the revisions in the Guidelines legitimized the districtcourt’s exercise of evaluating the efficiency claims of the parties. The court rejected theefficiency claims as (i) overstated relative to efficiency claims made in internal documentunrelated to the litigation, and (ii) increased buying power was likely to flow to bothparties even if they did not merge as both were expanding rapidly.  (Increased buyingpower alone without the savings of resources is not an efficiency; it is a pecuniary effectwhere one party secures a larger share of the gains from trade because of an enhancedthreat point in its bargaining position.  Both the Canadian and US Guidelines recognizethis distinction.)8Efficiencies (and synergies) will always arise in any merger review as they formthe pro-competitive rationale to drive mergers. The merging parties somehow hope to dosomething better after the merger.  Efficiencies become more critical when the mergergives rise to a substantial lessening of competition.  The issue then becomes one ofevaluating the anticompetitive against the procompetitive effects.  There is considerableagreement among economists on the application of a welfare metric that balances lossesand gains with dollars treated as equals.   On this matter, Canada has moved from a clearand unambiguous policy that embraces this welfare standard to one that is clouded anduncertain.  The US has moved to include efficiencies in the equation, although the USprice standard (that the net effect of a merger is that consumer prices cannot rise) is amore stringent hurdle that rules out some otherwise allocatively efficient mergers.

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The Efficiencies Defence in Merger Analysis in Canada and the US

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