Anticipating Exclusion: Upward Pricing Pressure in Vertical Transactions

Vertical mergers and acquisitions, in which entities operate at different levels of production, face scrutiny from antitrust authorities in multiple jurisdictions.

For example, when Toyota Industries Corporation (TICO), a manufacturer of lift trucks, moved to acquire Cascade Corporation, a manufacturer of state-of-the-art lift truck attachments, the US Department of Justice (DOJ) raised concerns that the vertical transaction would result in exclusionary conduct and that Cascade might withhold its specialized attachments from TICO’s rivals or raise prices.

To assess the competitive impact of this transaction on both product markets, the DOJ developed a merger simulation model, which suggested that the transaction might result in exclusionary conduct and price increases. As an Analysis Group team successfully demonstrated, however, these findings were not only based on several factually inaccurate assumptions, they also defied past experience. Analysis Group academic affiliate and Yale School of Management Dean Edward Snyder explains that “a careful review of competitive interactions in the industry prior to the proposed merger” demonstrated “that TICO did not raise prices to competitors after that merger and that it generally left the competitive landscape unchanged.” Professor Snyder adds, “Our findings were at odds with the DOJ’s simulation.”

In a vertical merger like TICO-Cascade, the merged firm may lose sales to other manufacturers if it raises prices. President Pierre Cremieux points out that “specific factors, such as the relative prices and margins for trucks and attachments, and downstream competitors’ ability to purchase the upstream product elsewhere, can help determine whether or not the firm will have an economic incentive to exclude competitors by increasing the price.” A close examination of industry-specific factors, such as the connection types between attachments and trucks, the maturity of the technology, and limited patent protections, demonstrated that downstream purchasers could simply go elsewhere if TICO-Cascade chose to engage in anticompetitive behavior.

For regulators and interested stakeholders, analytic techniques now make it possible to quickly quantify the likely competitive effects associated with this type of vertical merger based on a methodology called the “vertical gross upward pricing pressure index” (vGUPPI) – that is, the pricing incentives of the newly merged firm and its rivals and the associated effect on final prices. In TICO-Cascade, the application of vGUPPI analysis led to the development by Analysis Group of an innovative software tool that can also be applied to other proposed vertical mergers. While this new online instrument does not offer a complete analysis – and is no substitute for the type of rigorous assessment necessary to fully evaluate a proposed merger – it does offer an initial screen or “first look” at the potential competitive effects of a vertical merger.

For interested firms, the identification of early warning signs in domestic and cross-border mergers is likely only to increase in importance. Vice President Markus von Wartburg, who was involved in TICO-Cascade and in the development of the vGUPPI online tool, argues that “the types of first-round pricing impacts measured in vGUPPI can have significant implications in related litigation. The Analysis Group vGUPPI online tool was designed to quickly determine the significance of pricing pressure in a vertical merger and anticipate potential problems.” ■

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