A theory of harm based on the elimination of a “potential competitor” has come under increased focus recently globally and at home in Australia.  This article below takes a look at what that theory of harm is and why the renewed focus on it recently; some ACCC proposals for reforming the notification thresholds to better capture for review cases that may involve this issue; and some key takeaways from two key Court decisions on what is required to prove anti-competitive effects based on this theory of harm.

What is the potential competition theory of harm?

In Australia, the CCA prohibits acquisitions of shares or assets that “would have the effect, or be likely to have the effect, of substantially lessening competition in any relevant market in Australia”. In assessing whether a proposed acquisition would have the likely effect of a substantial lessening of competition (SLC), the acquisition must be assessed by reference to a number of “merger factors”.

The potential competition theory of harm considers whether an acquirer’s acquisition of another firm which may have been a “potential” competitor (that is, a new entrant into the market) absent the merger could result in a SLC.

So, why the renewed interest in this theory of harm?

The concept is not a new one in Australia. However, it has regained prominence at home and abroad predominantly from concerns of the wave of merger and acquisition (M&A) activity in digital (also referred to as “Big Tech”) and pharmaceutical industries. These are fast-moving, dynamic industries, characterised by large incumbent players that are very active in M&A activity. A number of these acquisitions have involved the acquisition of another player in an adjacent field, or one that could be a competitor in a short period of time.

Competition authorities around the world have started raising antitrust concerns as to how “adjacent acquisitions” may have an impact on potential competition. For example a popular concern is that some of these deals may be “killer acquisitions”. First posited by a team at Yale, this theory involves the concern that certain big firms are at times acquiring another company that competes in a different but not unrelated market with the purpose or effect of “killing it” by discontinuing the target’s innovative projects and eliminating potential future rivals.^[1]

That said, it is important for competition authorities to exercise restraint and not overzealously prohibit mergers on the basis of these concerns, where there is no evidence of any likely substantial anticompetitive effect. Whilst most mergers are likely to be benign, or even beneficial, there will still remain a minority of mergers that are problematic in relation to which competition authorities need to remain vigilant. The Yale team estimated that at least 6% of pharmaceutical acquisitions each year are likely to be “killer acquisitions”, which is considered roughly informative of what level of acquisitions may also be harmful in other industries.

An added complexity is the fact that the substantive assessment requires competition authorities to try to determine the future and consider with sufficient certainty a defined counterfactual that requires belief, not in the status quo persisting, but a particular new set of circumstances coming into being in the absence of the transaction.  Such crystal ball-gazing is an inherently uncertain exercise.

To strike the right balance, there must be an appropriately calibrated set of notification thresholds that potentially problematic cases reach the competition authority’s radar. Then, the substantive analytical framework must allow appropriate and balanced consideration of the facts at hand to ultimately determine whether a SLC is likely.

To that end, the Australian Competition and Consumer Commission (ACCC) has been active in:

• proposing changes to the merger regime to capture for review more cases that may involve the elimination of potential competition, reducing the chance that such cases would slip through the review net; and
• seeking to push the boundaries, in two recent Court cases, on when an SLC can be found based on removing a potential competitor.^[2]

The notification thresholds

Some proposed narrow changes to the merger notification thresholds in Australia

The notification regime is voluntary in Australia. However, merger parties are encouraged to notify the ACCC before completing a merger where the products of the merger parties are either substitutes or complements; and the merged firm will have a post-merger market share of greater than 20 per cent in the relevant market/s.

Concerned about its ability to prevent anti-competitive mergers that involve the elimination of potential competition and limitations in the existing merger regime in doing so, the ACCC in its Digital Platforms Inquiry Final Report proposed some limited changes to the merger laws and merger notification thresholds:

1. relevantly, adding: “the likelihood that the acquisition would result in the removal from the market of a potential competitor” as a merger factor to be considered in the substantive assessment of a case (Recommendation 1); and
2. relating to notification thresholds, recommending that two large digital platforms should agree to a notification protocol, whereby they would provide advance notice to the ACCC of any proposed acquisitions potentially impacting competition in Australia. At the time the recommendations were made in 2019, it was envisaged by the ACCC that the notification protocol would specify: the types of acquisitions requiring notification (including any applicable minimum transaction value); and the minimum advance notification period prior to completion of the proposed transaction to enable the ACCC to assess the proposed acquisition. (Recommendation 2).

How have these proposed reforms panned out so far?

The proposed reforms have not been adopted at this stage.  However, arguably, the current scope of the law already permits consideration of potential competition, so renders any legislative amendment to implement Recommendation 1 unnecessary.

As for Recommendation 2, it is narrow in scope, concerning only one sector, and only two digital players within that sector, and would involve a voluntary commitment to notify all transactions by two market participants regardless of potential market effect. 

This proposal stands in stark contrast to Australia’s current informal clearance process, which is voluntary and requires to parties to self-assess whether to notify, and when they would benefit from the comfort that that the ACCC would not be likely to apply to the Court for an injunction to stop a merger proceeding (pre-merger) or a divestiture order (post-merger).  A voluntary filing regime is also a hallmark of the merger review process applied by the Competition and Markets Authority (CMA), enabling parties to balance the benefit of certainty with flexibility to proceed with a merger they consider low risk.  The ACCC’s proposed Recommendation 2 would eliminate this flexibility for two significant global market participants, while maintaining it for others.

We note that other competition law regimes are grappling with similar issues.

For example, the Austrian-German new supplementary threshold (in addition to their traditional use of mandatory turnover notification thresholds) for their national regimes is instructive. In an effort to plug a similar enforcement gap, both jurisdictions recently introduced transaction value-based notification thresholds, using as a proxy for high market or competitive potential a purchase price that is a large multiple of the present turnover of the target. This new transaction threshold is coupled with a requirement that the target has “significant domestic activity” in Austria or Germany, essentially ensuring that not every single global deal that exceeds the transaction value thresholds need be notified unless the target has a nexus to the jurisdiction.

The first year of the test being in effect in Austria has indicated positive results: the authority has not been burdened with a flood of further filings triggered just on the basis of the supplementary threshold and the few that were have been spread across numerous industries.

Some learnings from recent Court decisions: there is a pretty high benchmark to prove an SLC based on eliminating a potential competitor.

A couple of recent decisions have shed some light on what it takes for the ACCC to prove a likely SLC based on the elimination of potential competition, both where one of the merger parties may be that potential competitor, or a third-party may be the potential entrant that suffers as a result of the transaction. All in all, it is a high bar to overcome.

The first decision involves Vodafone’s proposed acquisition of TPG (Vodafone Case), with the ACCC’s case being that, without the merger, there was a real chance that TPG would roll-out a fourth mobile network. Vodafone would respond to TPG’s aggressive competitive behaviours by adjusting its prices, and the response of Vodafone would, in turn, lead to a competitive response by the incumbents, Telstra and Optus.^[3]

The second decision involves the sale by Aurizon of its Acacia Ridge Terminal (ART) to Pacific National (PN) (Pacific National Case), in relation to which the ACCC alleged an anti-competitive effect in markets for certain interstate rail linehaul.^[4] The ACCC’s key concern was that, if PN owned the ART, it would have the ability and incentive to discriminate against line-haul rivals and increase barriers to new entrants seeking to compete with PN. The ACCC cited one such potential entrant.

The key lessons we can learn from these cases as to potential competition are that:

1. the s 50 SLC test requires a single evaluative judgment based on a real commercial likelihood of the counterfactual coming to pass. This is a relatively low hurdle. The balance of probabilities test in relation to either the counterfactual being likely or there being a likely SLC is not a relevant consideration;
2. the relevant timeline to take into account for a potential competitor to enter a relevant market is likely to be up to five years, or at most 10 in certain very limited circumstances (e.g. in the case of rail infrastructure);
3. when considering a transaction’s likely effect on competition, one should not focus solely on the quantity of competitors on the market, but importantly also the quality of those players that will remain post-transaction. That is, the competitive dynamic should not be assessed based only on the number of rivals that will remain in a relevant market with and without the transaction, but whether and to what extent those rivals in the market are able and willing to exert a significant competitive constraint on each other with and without the transaction. This is an especially important consideration when the elimination of a potential rival involves bringing together players in the market that are challengers to existing incumbents;
4. in considering the likely counterfactual, it is not the potential competitor’s prospects and intentions of entry that existed historically at some period of time back in history that matters and is of sole relevance; it is the forward looking position of the relevant party and state of competition that matters at the time of assessment. Therefore, the ACCC should not seek to base the counterfactual on outdated business plans, correspondence, past investments, prior Maverick like behaviours, and drivers that existed in the past, when they can no longer credibly be used a proxy or indicator of the go forward position of the party;
5. a lack of contemporaneous internal documentation supporting merger parties’ case is not fatal to a case in the face of supportive and favourable evidence from industry, circumstances of the case being consistent with the merger parties’ story, and credible testimony from senior executives;
6. when a firm argued to be a potential entrant by the ACCC is making its case in Court to the contrary, definitive comments and “opening the kimono” on its strategy in the public domain concerning bleak prospects for entry will likely be taken as persuasive and credible evidence in support of that point due to it being a serious disincentive for that merger party to turn around and decide to do otherwise; and
7. even if the ACCC can put forward a credible case that the target could enter by reference to economic modelling and other evidence, merely because the ACCC can conceive of a scenario where entry was feasible is not sufficient. There must be evidence from the company that there is a real chance of it doing so absent the merger. Modelling evidence is therefore not persuasive in the face of the merger party saying (and having other evidence to prove) it is not commercially rational and / or there is no intention or desire to enter.

What next?

The ACCC recently foreshadowed that it will put forward ideas for further changes to the merger laws in 2021.^[5] Further, the ACCC’s special leave application to appeal the Full Federal Court decision to the High Court in the Pacific National case will be heard on 8 December. Both of these future events may have a significant bearing on how the ACCC and Courts will approach the potential competition theory of harm and we will continue to watch this space.