Control of vertical concentrations in the EU and the UK: what is the situation? (2023)

I. Introduction

In recent years, there has been renewed debate about the approach competition authorities should take to vertical mergers.1These mergers (ie between companies at different levels of the supply chain) do not involve the same elimination of direct competition as horizontal mergers – but does that mean they might be viewed more favorably?

There seems to be a change in the tone of some competition authorities regarding vertical mergers. In the UK, the Competition and Markets Authority (CMA) issued updated guidance last year in which it no longer describes vertical mergers as generally benign.2In the US, the Federal Trade Commission (FTC), supported by a majority of FTC commissioners, went so far as to revoke the 2020 vertical merger guidelines, arguing that they contained an 'imperfect discussion of purported competitive advantages'.3 Meanwhile, in the EU, the most recent guidance on non-horizontal mergers dates back to 2008. However, it is widely recognized that case practice has evolved since then, moving towards a case-by-case assessment and away from the simplistic arithmetic approach described 15 years ago.4

In addition to changes in competition guidelines, several high-profile cases have highlighted the problems associated with non-horizontal mergers. In the US,AT&T/Time WarnerThe case sparked an intense debate about how to assess both the benefits and harms of vertical mergers - after the government awarded $350 million in "double margin elimination" benefits without qualifications.5In the EU, the issue of integrating the efficiency resulting from the internalization of double margins in the analysis of the effects on market competition was raised in several cases.6

This development of events raises a number of questions. First, what is our current understanding of the benefits and harms of vertical mergers? Second, what role can economics play in determining future policies and guidelines for such mergers?

II. revisiting the basics

When two direct competitors merge, there is a risk that a valuable competitive constraint will be eliminated from the market. However, there is a fundamental difference between such a horizontal merger and a vertical merger involving parties at different levels of the supply chain. At its core, this difference boils down to a difference between mergerssubstitute productsand fusion ofcomplementary products. This in turn affects the benefit and harm theories underlying any merger review.

A. Elimination of double marginalization

When firms independently optimize prices, they do not take into account the price externalities they impose on each other. If they sell substitutes, their higher prices will increase demand for the other company's products. If they sell extras, higher own prices will reduce the demand for the other company's products. Mergers allow firms to internalize such price externalities; therefore, mergers of firms that sell substitutes raise prices, and mergers of firms that sell complements push prices down. If one company supplies another in a vertical supply chain, the goods are actually complementary. By charging a margin independently, both firms impose price externalities on each other. The efficiency is therefore described as the elimination of double margins (EDM).7

This EDM is one of the most prominent efficiency gains – as highlighted, for example, by the European Commission in its 2008 Non-Horizontal Merger Guidelines:8

In vertical relationships, for example, as a result of complementarity, a reduction in margins downstream will also lead to higher demand upstream. Some of the benefits of this increase in demand will go to upstream suppliers. The integrated company will take this benefit into account. Vertical integration can therefore provide a greater incentive to lower prices and increase production, as the integrated firm can capture a larger share of the benefits. This is often called "double markup internalization".

It is important to note that EDM is an efficiency that derives solely from the internalization of price externalities. This mechanism of taking into account the effect of your pricing decision on your merger partner is exactly the same mechanism that, in a horizontal merger, leads to upward price pressure. This in turn means, conceptually, that it makes sense to integrate EDM into the overall assessment of the price effects of a concentration, rather than holding it to the same strict standard as other efficiencies in concentration assessments, which requires that the efficiency benefits consumers, is specific to the concentration, and is verifiable.9

Regardless of the appropriate standard of proof, the economics of EDM in vertical mergers have come under increased scrutiny in recent years due to the adoption and subsequent repeal of the US FTC's Vertical Merger Guidelines. In revoking the guidelines, the majority of commissioners issued a statement:10

VMG's reliance on EDM is theoretically and factually flawed. It is theoretically flawed because the economic model predicting EDM is limited to very specific factual scenarios: mergers involving a single-product monopoly buying another single-product monopoly in the same supply chain, where both charge monopoly prices before the merger and one firm's output is used as an input from by another in a fixed-rate production process.

From an economic point of view, this claim is difficult to justify. A fundamental change resulting from a merger (whether vertical or not) is that firms take into account the externalities that their pricing decisions have on the merging partner. Double margins can occur whenever there is some degree of upstream and downstream market power. Therefore, while EDM may be more significant in monopoly scenarios, it can also occur in non-monopoly contexts.

However, there are settings where EDM is unlikely or where it would probably not be sufficient to compensate for the potential damage.11

• No double margins before merging— EDM cannot appear if there are no double margins before merging. Certain contractual mechanisms may eliminate double margins, so that if the parties used such margins prior to the merger, there would be no double margins to be eliminated. For example, an upstream firm may license its product to a downstream firm in exchange for a flat fee and set the unit price at marginal cost to eliminate any double markups without full vertical integration.

• diagonal joining— if the upstream share of the merger does not ensure the downstream share of the merger (ie, the merger is "diagonal"), there is no vertical cost externality to begin with. This happened, for example, inDeutsche Boerse/LSEG.12

• Full market coverage— where the overall market is unlikely to extend to the upstream firm, any increase in sales through the downstream merging firm will come at the expense of upstream sales to the downstream competitor. As long as upstream supply margins to downstream rivals are not less than upstream supply margins to the merging downstream party, the merged entity does not benefit from reducing downstream margins to increase sales. This was expected, for example, inTelia/Bonnier Broadcastingand laterLSEG/Refinitiv.13

• Strong horizontal overlap—some vertical mergers may involve a company that is already vertically integrated to some extent, so the merger would also lead to strong horizontal overlap between the merging parties. In such cases, horizontal upward price pressure can neutralize EDM's vertical downward price pressure. This concern has played a role in the recentWieland/AurubisEU merger ban.14

Furthermore, there are situations where the EDM size is reduced or even completely eliminated. For example, internal frictions may mean that the integrated firm fails to establish optimal internal transfer prices between its upstream and downstream units, so that double marginalization remains after the merger.15 However, such internal frictions also often mean that the upstream arm of the merged entity would not internalize externalities in its downstream arm in the price it charges downstream rivals and vice versa, so that any incentive to raise competitive prices (discussed in more detail below) initially it might not be a problem.

B. Other advantages of vertical mergers and the role of merger specificity

It is worth noting that, in addition to the cost efficiency of EDM, vertical mergers can lead to other efficiencies that are potentially even more important. These include the benefits of greater vertical control and certainty (eg, reduced risk of ex post contract renegotiations and "delay" issues) and effective vertical coordination. As the European Commission acknowledges:16

[...] [Further efforts to increase sales at one level (e.g., improving service or enhancing innovation) may provide a greater reward for the integrated firm that will take into account the benefits accrued at other levels.

In theory, any vertical efficiencies – including EDM – could be achieved through optimized contracts between independent firms rather than vertical mergers. For example, the problem of double margins disappears when the upstream firm prices the product at marginal cost while appropriating its share of the surplus at a fixed rate (ie, non-linear contracting).

This raises the question of whether the stated efficiencies are truly merger specific or could be achieved by other means if the merger does not occur.

However, the key point here is that optimal contracting may not always be feasible due to transaction costs. In particular, there may be relevant aspects of business relationships that simply cannot be contracted out – such as trust and reliability. Companies can therefore resort to mergers.

C. Entry and exit of the customer

Regardless of the advantages and logic of vertical mergers in favor of market competition, it is generally recognized that vertical mergers can pose risks to market competition. Theories of harm in vertical mergers focus primarily on practices that the merging parties might adopt post-merger to foreclose competitors at any level.

In particular, there are two main concerns: the merged entity may have the ability and incentive to engage in input foreclosure and/or customer foreclosure. These damages are illustrated inPicture 1

• delete entryit can occur when the merged entity increases the cost or reduces the quality of the input supplied to downstream competitors (partial input foreclosure) or when it refuses to supply them with the input at all (total input foreclosure). This could have the effect of increasing downstream rivals' costs (RRC), making it more expensive for them to access input supplies, thus reducing the downstream rivals' ability and/or incentive to compete. As a result, prices charged to consumers may increase and/or quality may decrease. However, this practice would only be effective if the merged entity has market power over the relevant input.

• execution of the buyeroccurs when the merged entity restricts the access of competing upstream suppliers to downstream customers, in favor of the upstream arm of the merged entity. If upstream rivals' access to end consumers is sufficiently reduced, this may reduce their ability and/or incentive to compete upstream. If, as a result, an upstream competitor becomes less efficient (or goes out of business), this may lead to increased costs for downstream competitors, thereby reducing the ability and/or incentive of downstream competitors to compete. As a result, prices charged to consumers may increase.

According to the European Commission Guidelines on non-horizontal mergers, the accepted framework for assessing whether there is such an enforcement risk takes into account three elements:17

• oabilityof the merging parties for foreclosure – that is, whether they control a critical entry or route to market;

• oincentivesof merging parties to break up – that is, whether the benefits of closing rivals outweigh the loss of profits from reduced sales of inputs to those rivals;18

• oIt was madein the competition of any execution - that is, if the competitive process is violated.

Whenever there is an adverse effect on competition, efficiency gains should be considered as a compensating factor. In accordance with Commission practice and its merger guidelines, while the burden of proving anticompetitive effects rests with the competition authority, the burden of proving any countervailing effectiveness lies with the merging parties. This is also the case for efficiencies arising from EDM, although the merged entity's incentive for EDM and RRC derives from the same mechanics, ie the internalization of pricing externalities imposed by the merging parties when they set prices independently. Just as increasing upstream prices for competitors benefits the merged downstream unit, lowering downstream prices benefits the merged upstream unit. As discussed below, EDM and RRC can significantly influence each other. This issue has recently been raised, for example, inLSEG/Refinitiv.

In practice, the Commission's Guidelines on non-horizontal mergers do not prevent the Commission and the parties from jointly assessing EDM and DRR, as the Guidelines make clear that capability, incentive and effects are closely intertwined and are often examined in an integrated manner.

III. EDM and RRC: Understanding the Two Price Effects

As described above, the integrated firm may face incentives to increase its downstream rival's input costs without foreclosing it entirely, i.e. creating upward price pressure. This raises an important question: How do the price effects of RRC and EDM interact and what is the resulting net effect?

A practical approach is to consider the static DRR and EDM incentives separately and then compare them to obtain the net effect. This can be done using the raw vertical price pressure index - or 'vGUPPI'.

A. vGUPPI

Like its established horizontal counterpart, the vGUPPI aims to measure the degree to which a given firm has an incentive to raise prices because of the effect this will have on its merger partner. This is done with regard toto changein the 'opportunity cost' of selling the unit as a result of the merger - ie. additional profit whichanotherthe merging party would gain if that saleit is notarise.19 A positive additional opportunity cost implies that, after the merger, the merged entity would have incentives toYesmake those marginal sales and thereby increase their price, while the additional negative opportunity cost would imply incentivesforachieve additional sales and thereby lower prices. This additional opportunity cost can then be interpreted as aactuallychange in marginal cost, which in turn leads to higher prices for the buyer after the full or partial transfer of this increase in costs (if positive, the same appliesmutatis mutandisto reduce costs).

The additional opportunity cost can then be compared to the pre-merger price level to obtain a relative price increase index. That index is vGUPPI, which provides a measure of the upward pressure resulting from a merger, both for the retail price of the downstream merging firm and for the wholesale price of the upstream merging firm charged to downstream competitors.

1. Downstream merger company

Suppose one upstream company sells to two downstream competitors and the upstream company wants to merge with one of the downstream companies. After the merger, failure to sell an additional unit through the merging downstream company due to a downstream price increase would create an additional loss to the upstream merger in the form of an upward unearned margin on this unit - which the downstream merger part did not consider prior to the merger. However, this will at the same time generate an additional gain in the form of additional upstream margin gained from sales to consumers that is diverted to the downstream competitor as a result of the merging downstream party's price increase. The additional opportunity cost to the downstream firm that was not factored in prior to the merger is then given byliquidgain — which, when divided by downstream prices, comprises the downstream vGUPPI.20 Whenever it is negative, the downstream party to the merger has an incentive to lower its price, which encompasses the incentives that drive EDM.

To illustrate, suppose that the upstream merging party sets a price of €5 per unit when selling to any downstream company and makes a profit of €2.5 per unit (that is, it has a margin per unit of 50 percent); each of the downstream companies sets a price of €10 per unit and has no costs other than €5 per unit paid to the upstream company (that is, they also have a margin per unit of 50 percent); and for every 100 units the downstream merging firm loses after a price increase, the downstream rival reacquires 25 of those units (that is, there is a 25 percent slippage rate).21

In this case, the additional opportunity cost to the downstream merger party of selling an additional unit would be the result of lost sales to downstream competitors, minus the increased sales through the downstream merging company, all multiplied by the margin to the amount, i.e.|$25\%\cdot$|€2.5 €2.5 = €1875. This additional opportunity cost compared to the downward price (-€1.875/€10) would representnothing less18.75 percent, which means that the downstream merger company has an incentivereduceYour price. That's what drives EDM.22

2. Upstream merger company

An upstream firm may have an additional incentive to raise its price to a downstream competitor after a merger, as this may result in higher prices for the downstream competitor and, consequently, a diversion of downstream sales to the upstream party. The resulting upward pressure on prices is measured by the upstream vGUPPI.23

Note that this additional opportunity cost is always positive. In fact, this additional positive opportunity cost drives the RRC. The question is also not whether it is positive, but whether it can be considered high enough that there is concern about a significant reduction in competition (also in light of the potential EDM offset effect).24

To illustrate, let us again assume that, before the merger, the upstream party sets a price of €5 per unit when selling to any downstream company; the downstream party sets a price of €10 per unit and has a margin of €5 per unit; and that for every 100 fewer units sold by the upstream merging firm after a price increase to the downstream competitor, the merging firm ends up selling 40 more units (i.e.|40$\%$|some of the competitive lost sales upstream are diverted or retaken by the merged company downstream). In this case, the additional opportunity cost to the upstream company that was not factored in before the merger represents the value of the downstream sales recaptured, i.e.|$40\%\cdot$|€5 = €2. This is equal to €2 / €5 =|40$\%$|increase from the pre-merger upstream price.

This additional opportunity cost of selling to a downstream competitor can be viewed as an increase in the marginal cost to the merging upstream firm of selling to a downstream competitor. The degree to which the marginal cost to the downstream rival then increases depends even more on the degree to which the marginal cost is passed on to the upstream firm.25 The extent to which this cost increase will be passed on by the downstream firm to consumers will depend on unobservable characteristics such as the shape of downstream demand. Assuming that 50 percent of the increase in implied upstream marginal cost (€2 in the illustration above) is passed on to the downstream competitor, and the downstream competitor passes all of these marginal costs on to downstream consumers, the competitor's downstream price would rise by €10 to €11, resulting in an increase of 10 percent.26

B. Balance feedback effects

Standard quantitative tools such as UPP and GUPPI can be an attractive way to consider price movements resulting from the internalization of price externalities in a merger, as they can be expressed in terms for which data are generally available (bypassing margins and rates).

However, using these tools may not always lead to the correct conclusion. First, vGUPPI assumes that firms simply set prices to optimize their own profits. When prices are negotiated (which is often the case in a vertical context), a negotiation model may be more appropriate.27

Second, vGUPPI considers only static price effects and keeps other parameters constant, thus ignoring the important equilibrium responses of all parties. With respect to EDM and RRC effects, vGUPPI does not take into account the important feedback effect and therefore may lead to overestimation or underestimation of the relevant price effects.28 EDM and RRC do not appear independently of each other. On the contrary, they are determined together and therefore should not be evaluated separately. Estimating the net effect requires a complex analysis.

To intuitively understand this shared decision, it is useful to look at how EDM can affect incentives for DRR. EDM causes the merged entity's downstream price to decrease, which in turn increases the consumer's sensitivity to demand facing downstream competitors (in technical terms, their residual demand curve shifts inward and its own price elasticity increases). This means that downstream competitive demand decreases more in response to a price increase. As such, the upstream merging firm's incentive to increase the price of its inputs to its downstream competitor will be lower. Indeed, under certain conditions, the upstream party to the merger may even have an incentive to lower its price to its downstream competitors, rather than raise it.29

However, other types of feedback effects tend to increase incentives for DRR and/or decrease incentives for EDM. The net price effect will depend on the shape of the demand curve, but also on the degree of upstream bargaining power – both of which can be difficult to assess in practice. As such, standard quantitative tools can either overestimate or underestimate the overall price effect of a vertical merger.30

The feedback effect between RRC and EDM can be assessed using more complex quantitative techniques, such as full fusion simulation. Competition policy practitioners may be reluctant to use these techniques due to their complexity and sensitivity to assumptions (eg the demand pattern used or the negotiation model) and may therefore prefer simpler static tools such as those described above. In fact, simpler static tools like vertical arithmetic and vGUPPI produce an informed proxy and therefore provide an informed reference point. The risk of Type I or Type II errors can then be assessed based on the size of this proxy and the reliability of the underlying assumptions, as discussed above.

However, the important lesson for practitioners is that no quantitative static analysis - no matter how valuable - should distract from the bigger picture which may include more difficult quantifiable considerations.31 Although European authorities in practice do not impose impossible standards of evidence to prove EDM,32 No vertical merger was approved on the basis that the benefits of EDM outweighed the concerns of the RRC.

4. Towards dynamic effects or away from standard techniques?

Focusing on price effects in vertical mergers can distract from potentially more important dynamic effects. Competition authorities may also need to consider the reaction of existing competitors and/or potential entry, which increases uncertainty. In this sense, it will be interesting to see how the Commission concludes its investigationEnlighten/Grail.33

In Great Britain,Facebook/GiphyThe merger led to one of the first major bans on large technology mergers - a decision upheld by the Competition Appeal Tribunal in June 2022. The CMA's guidelines have recently been revised to reflect more flexible thinking about how enforcement can occur. References to specific techniques for assessing ability, incentives and exclusionary effects (eg vertical arithmetic) have been removed – recognizing that their applicability can be highly context dependent.

The increased attention paid to dynamic damage and long-term trading strategies, as well as the equilibrium feedback effects between EDM and RRC, does not mean that quantitative tools such as vertical arithmetic or vGUPPI are no longer relevant. Internal documents can help clarify the reasons for the merger, and thus the long-term business strategies and possible damages, but they are neither sufficient nor necessary to conclude that the vertical merger is likely to lead to a significant impediment to effective competition. These documents describing long-term business strategies may not exist or, if they do, may reflect internal communications rather than actual plans. As such, economics is key to conceptually thinking about possible and likely future movements in markets, assuming the merger goes through and, in the absence of a merger, to clarifying internal documents. Simple quantitative tools such as vertical arithmetic and vGUPPI can also provide useful indicators of the likely impact of a vertical merger, along with a more qualitative assessment based on internal documents, economic conceptual thinking and market research results.

1

The issues discussed in this article are relevant to all mergers involving complementary products, including vertical mergers.

2

Competition and Markets Authority, 'Guidance on the Valuation of Concentrations' (2021) CMA129, 18 March. The previous 2010 guidance stated: “Non-horizontal mergers do not involve a direct loss of competition between firms in the same market, and it is a well-established principle that most are benign and do not raise competition concerns. However, some may weaken competition and result in SLC.' See Competition and Markets Agency, 'Guidelines for the Assessment of Mergers' (2010) para. 5.6.1.

3

US Department of Justice and Federal Trade Commission, 'Vertical Merger Guidelines' (2020) 30 June; Federal Trade Commission, Press Release 'Federal Trade Commission Withdraws Guidance and Comments on Vertical Mergers' (2021), September 15. For a wider discussion of recent developments in US (vertical) mergers and competition policy, see especially C Shapiro, 'Antitrust: What Went Wrong and How To Fix It' (2021) 35:3 Antitrust 33–45; and C Shapiro, 'Vertical Mergers and Input Foreclosure: Lessons from the AT&T/Time Warner Case' (2021) 59:2 Review of Industrial Organization 303–41.

4

European Commission, "Guidelines on the assessment of non-horizontal mergers under the Council Regulation on the control of mergers between companies" (2008) 2008/C 265/07; L. Karlinger, D. Magos, P. Régibeau and H. Zenger, "Recent Developments in the Competition Authority: 2019/2020" (2020) 57:4 Review of Industrial Organization 783–814.

5

See, for example, J Kwok and M Slade, "Second Thoughts on Double Marginalization" (2020) 34:2 Antitrust 51.

6

See, for example,Refinitiv/London Stock Exchange Group, Process M.9564, 26 February 2021.

7

JJ Spengler, 'Vertical Integration and Antitrust Policy' (1950) 58:4 Journal of Political Economy 347–52.

8

European Commission, "Guidelines on the assessment of non-horizontal mergers under the Council Regulation on Merger Control" (2008) 2008/C 265/07, para. 13.

9

In practice, the European Commission has recognized the elimination of double margins (EDM) as a separate efficiency. See, for example, M.4854TomTom/Tele Atlas. However, even if not formally recognized in its decision-making practice, we understand that the Commission may, in some cases, also integrate the EDM into its overall assessment of the price effects of the concentration together with the RRC, rather than first assessing the RRC and then offsetting it with the EDM effect , adhering to strict efficiency standards. For example, we understand that an integrated assessment such as this may have played a role in the recent M.9569EssilorLuxottica/GrandVisionFusion.

10

See Federal Trade Commission, “Statement by Chairwoman Lina M. Khan, Commissioner Rohit Chopra, and Commissioner Rebecca Kelly Slaughter on Withdrawal of Vertical Merger Guidelines” (2021), Commission Docket No. P810034, September 15, p. 4.

11

Ver também J Kwoka and M Slade, 'Second Thoughts on Double Marginalization' (2020) 34:2 Antitruste 51–6; e H Zenger, 'Analyzing vertical mergers' (2020) CPI Antitrust Chronicle outubro, p. 1–8.

12

European Comission,Deutsche Boerse/London Stock Exchange, Process M.7995, 29 March 2017.

13

European Comission,Telia Company/Bonnier Broadcasting, Process M.9064, April 24, 2020; It isRefinitiv/London Stock Exchange Group, Case M.9564, 26 February 2021. This full market coverage argument assumes that upstream margins for a downstream partner are no greater than those of a downstream rival and that the upstream firm cannot raise its prices upstream until demand becomes elastic again.

14

European Comission,Wieland/Aurubis/Laminated heavy metal products, Process M.8900, 5 February 2019.

15

For empirical studies of internal transfer pricing, see GS Crawford, RS Lee, MD Whinston and A Yurukoglu, 'The welfare effects of vertical integration in multichannel television markets' (2018) 86:3 Econometrica 891–954; and C Michel and S Weiergraeber, “Assessing Industry Behavior in Differentiated Product Markets” (2018) unpublished.

16

European Commission, "Guidelines on the assessment of non-horizontal mergers under the Council Regulation on Merger Control" (2008) 2008/C 265/07, para. 13.

17

European Commission, "Guidelines on the assessment of non-horizontal mergers under the Council Regulation on the control of mergers between companies" (2008) 2008/C 265/07.

18

A simple way to assess the incentive to foreclose is to look at so-called vertical arithmetic, which asks: would the merging parties make more profit by foreclosing a competitor and diverting some customers to the merging parties, given that doing so also means giving up any profits made through that rival? For example, suppose that the merging parties earn €20 when they sell through their downstream entity and €10 when they sell through their downstream rival. In this case, it is worth excluding the downstream competitor only when it is guaranteed that more than 50% of its customers will switch to the downstream concentration company.

19

Technically, (v)GUPPI captures the first-order state change (derived from the profit-price function, equal to zero) as a result of the merger, estimated at the previous optimal price. S Moresi and SC Salop, 'vGUPPI: Scoring Unilateral Price Incentives in Vertical Mergers' (2013) 79 Antitrust Law Journal 185–212; Oxera, 'Watch out for vGUPPI! A New Approach to Vertical Mergers in Local Markets (2018) Agenda June 29; H Zenger, 'Analyzing Vertical Mergers' (2020) CPI Antitrust Chronicle, October, p. 1–8. Recent cases where vGUPPIs have been considered includeEssilorLuxottica/GrandVisionna UE eTesco/BookereCooperative/Nisanot UK.

20

For the downstream fusion part, vGUPPI is expressed as|$vGUPP{I}_D=({D}_{DU}\cdot{M}_{UR}-{M}_{UD})/{p}_D$|⁠, where|${D}_{DU}$|is the "vertical" rate of deviation from the downstream merging company to the upstream merging company,|${M}_{UR}$|the (absolute) margin of the upstream merging company relative to the downstream competitor,|${M}_{UD}$|the margin from the upstream merging company to the downstream merging company, i|${P}_D$|the price of the downstream company in the merger.

21

This assumes that for any unit of downstream sales, downstream firms require a unit of upstream input. The joint assumption of upstream monopoly and fixed shares in upstream and downstream units means that no substitution of inputs by downstream firms is possible. However, the analysis changes when there is the possibility of input substitution. In effect, this input swap works to reduce any upward pressure - increasing EDM and decreasing RRC. A detailed analysis and derivation of vGUPPI in the case of input substitution is provided by S Moresi and SC Salop, 'vGUPPI: Scoring Unilateral Price Incentives in Vertical Mergers' (2013), 79 Antitrust Law Journal 185–212.

22

This numerical illustration follows S Moresi and SC Salop, 'vGUPPI: Scoring Unilateral Price Incentives in Vertical Mergers' (2013) 79 Antitrust Law Journal 185–212. Notice, first, yes|$vGUPP{I}_D$|can also be positive, but only when the upstream margin for the downstream competitor is sufficiently greater than the margin for the downstream merging firm (i.e.|${M}_{UR}>{M}_{UD}$|⁠), and vertical deviation|${D}_{DU}$|it's loud enough. Second, if market demand is perfectly inelastic with respect to price (so that any sales bypassed by the downstream merging firm end up with one or more downstream competitors, i.e.|${D}_{DU}=1$|⁠), and the upstream company earns the same when selling to any downstream company (i.e.|${M}_{UR}={M}_{UD}$|⁠) then|$vGUPP{I}_D=0$|⁠. This also implies that, in the case of complete market coverage, EDM will occur only if|${M}_{UR}<{M}_{UD}$|⁠.

23

For the upstream fusion part, vGUPPI is expressed as|$vGUPP{I}_U=({D}_{UD}\cdot{M}_D)/{p}_{UR}$|⁠, where|${D}_{UD}$|is the rate of vertical deviation from the upstream merging firm to the downstream merging firm,|${M}_D$|the party's margin in the downstream merger, i|${p}_{UR}$|the price an upstream company charges its downstream competitor. keep in mind that|$vGUPP{I}_U$|it does not include the margin that the upstream company enjoys when selling to the downstream company in the merger. This is because vGUPPI (and GUPPI) only considersto changeinto an opportunity cost as a consequence of the merged parties, taking into account the effect on the earnings of the other party. The margin that the upstream company earns by selling to the downstream company in the merger has already been considered by the upstream company before the merger.

24

|$vGUPP{I}_U$|it can be substantial, especially if it is an upstream price|${p}_{UR}$|it is especially small compared to the downstream margin|${M}_D$|(for example, when|${M}_D$|it's €5 but|${p}_{UR}$|is only €0.5 - where|$vGUPP{I}_U$|can reach 400 percent). However, this effect disappears when the price downstream to the final consumer is considered. For example, when|${D}_{UD}$|is 40 percent,|${M}_D$|is €5 and|${p}_{UR}$|is 0.5€,|$vGUPP{I}_U$|is 400 percent (as derived above); but then|$vGUPP{I}_R$|still at most 10 percent while|${p}_R$|is at least €10 (as|400$\%\cdot 50\%\cdot 0,5/10=0,1$|⁠) — since the upstream input price represents only a small fraction of the total downstream costs and therefore the increase does not affect downstream prices as much.

25

Rather, when interpreting|$vGUPP{I}_U$|as the percentage increase in marginal cost paid by the upstream firm, the percentage increase in marginal cost to the downstream competitor becomes|$vGUPP{I}_R= vGUPP{I}_U\cdot PT{R}_U\cdot{p}_{UR}/{p}_R$|⁠, where|$vGUPP{I}_U$|is as defined earlier,|$PT{R}_U$|the rate of upward transition of the firm's marginal costs,|${p}_{UR}$|the price an upstream company charges its downstream competitor, i|${p}_R$|downstream competitor's price.

26

Moresi and Salop (2013) suggest using a 50% pass-through rate to assess the effect of wholesale price increases on retail price: S Moresi and SC Salop, 'vGUPPI: Scoring Unilateral Price Incentives in Vertical Mergers' (2013) 79 Journal of Antimonopoly Law.

27

See, for example, the European Commission,Telia Company/Bonnier Broadcasting, Process M.9064, April 24, 2020; as well as A Rubinstein, 'Perfect Equilibrium in a Bargaining Model' (1982) 50 Econometrica 97-110; K. Binmore, A. Rubinstein and A. Wolinsky, 'The Nash Favorable Solution in Economic Modelling' (1986) 17 RAND Journal of Economics 176–88; and A Nevo, 'Mergers That Increase Trading Leverage' (2014) Remarks at Stanford Institute for Economic Policy Research, 22 January.

28

GB Domnenko and DS Sibley, “Simulated Vertical Mergers and the Vertical GUPPI Approach” (2020) available at SSRN 3606641.

29

Vidi, posebno, G Das Varma i M De Stefano, 'Equilibrium Analysis of Vertical Mergers' (2020) 65:3 The Antitrust Bulletin 445–58.

30

Other recent works that consider breakeven effects in vertical mergers include P Choné, L Linnemer and T Vergé, 'On Double Marginalization and Vertical Integration' (2021) CEPR Discussion Paper No. DP15849; and U Akgün, C Caffarra, F Etro and R Stillman, 'On the Welfare Impact of Complementary Mergers: Increasing Rivalry Costs versus Eliminating Double Marginalization' (2020) 195 Economics Letters 109429.

31

The argument that a focus on static price effects in vertical mergers risks 'muddying the waters' and diverting attention from other more important considerations is made (for example) in MA Salinger, 'New Directions for Vertical Mergers: Mudying the Waters' (2021) 59 :2 Review of Industrial Organization 161–76.

32

See, for example, M.4854TomTom/Tele Atlas.

33

As of this writing, the European Commission has announced its banEnlighten/Grailcontract on September 6, 2022. Illumina is likely to appeal this decision. In the US, on September 12, 2022, an administrative law judge dismissed the Federal Trade Commission's (FTC) challenge to the settlement. The FTC can, however, bring suit to enjoin the business.

Author's notes

Senior consultant, Oxera Consulting LLP, Amsterdam, and professor at Utrecht University. E-mail:t.klein@uu.nl.

An earlier version of this article was published as Oxera (2022), 'The ups and downs of vertical merger control: what's the current state of play?',daily routine, May 27. We acknowledge the valuable discussions on this topic with the Oxera Economics Council on 10 May 2022 in Brussels and would like to thank its chairman, Sir John Vickers, all members and our guests Julie Bon, Etienne Chantrel and Hans Zenger for their contributions, as well as our colleagues in Oxera for discussions in preparation of the Oxera Economic Council, especially Ilaria Fanton, Matthew Johnson and Bertram Neurohr. Oxera advises clients on EU and UK merger control procedures. We received no funding or in-kind support in the preparation of this article and have no further interests to disclose. Any opinions or errors in this article are our own.

© Author(s) 2022. Published by Oxford University Press.