A central question for regulators in the merger review process is whether an integrated firm would have an incentive to restrict or discontinue supplying inputs to its downstream competitors following vertical integration. Vertical arithmetic is a tool often used to assess foreclosure incentives in vertical mergers by weighing the potential gains from foreclosing a downstream competitor against the lost upstream profits the firm would give up from the foreclosed downstream firms.
In “Rethinking Vertical Arithmetic: Uncertainty, Diversification, and Foreclosure Incentives,” published in the October issue of the ABA’s The Antitrust Source, Senior Consultants Mark Ponder and Veronica Postal consider how uncertainty about future profits can affect this trade-off. They focus on the value an integrated firm may place on maintaining multiple routes to market, including continuing to supply downstream competitors as a way to diversify its sales channels.
Dr. Ponder and Dr. Postal show that incorporating uncertainty can change the assessment of foreclosure incentives compared with traditional vertical arithmetic. Their analysis highlights the importance of considering the value of diversification, the timing of a foreclosure decision, and the economic conditions facing the integrated firm when evaluating the potential competitive effects of vertical transactions. Failing to account for these dynamics can lead practitioners and regulators to overestimate foreclosure incentives and incorrectly reject transactions that are pro-competitive.
Key Takeaways
Profit uncertainty can affect foreclosure incentives. Maintaining multiple sales channels may allow a vertically integrated firm to diversify its exposure to changing market conditions.
Traditional vertical arithmetic may not fully capture the value of continuing to supply downstream competitors. Under uncertainty, preserving alternative routes to market can influence the firm’s decision about whether and when to foreclose.
Failing to account for the role of uncertainty can lead practitioners and regulators to overestimate foreclosure incentives and incorrectly reject transactions that are pro-competitive.
How NERA Can Help
NERA helps clients evaluate the competitive effects of vertical transactions through rigorous economic analysis grounded in the facts and economics of each matter. Our experts assess foreclosure incentives, evaluating whether a vertically integrated firm would have the ability and economic incentive to restrict competitors’ access to critical inputs. They have experience analyzing changing market conditions and considering how uncertainty in margins, demand, and sales channels may affect the profitability of alternative strategies. NERA also evaluates vertical-merger methodologies, testing the assumptions underlying vertical arithmetic and other economic analyses used to assess potential competitive effects.
