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This paper seeks to contribute thinking on how the intellectual foundations of
antitrust might be updated, based on a large body of theoretical and empirical research on
company strategy, competition, and economic development. The aim is to outline a new
direction for antitrust that can be incorporated into government policy and legal practice
and pursued in litigation and legislation, both in the United States and internationally.
This new thinking sets forth as the basic goal of antitrust policy, and
employs tools like industry structure analysis and locational analysis to evaluate potential
impacts on competition. While there appears to be broad consensus on how to deal with
much anticompetitive behavior such as deceptive practices and cartel formation, the
current fault line in antitrust is the treatment of mergers. This paper therefore focuses on
the evaluation of mergers, though the same framework can be applied to evaluating joint
ventures, other combinations, and other competitive practices. Finally, it should be noted
that this paper is concerned principally with the content of antitrust, not the many
important issues involved in structuring antitrust agencies and designing processes of
enforcement.
Section II argues that the true benefits of healthy competition are not fully articulated
in much antitrust analysis. By linking competition to a nation’s standard of living
through productivity growth, it becomes apparent that far more is at stake in protecting
competition than short-term consumer welfare defined by price-cost margins. Empirical
evidence is provided to highlight the importance of protecting the vitality of competition.
Furthermore, it is argued that local competition within a nation is particularly crucial for
competitiveness, even in the era of globalization.
Section III proposes that productivity growth become the new standard for antitrust,
and reassesses the hierarchy of antitrust goals accordingly.
Since healthy competition
will foster productivity growth, antitrust must be equipped with adequate tools and
frameworks for evaluating the health of competition. Yet frameworks broader than
current practices resting in relevant market definitions and ability to elevate price above
cost are required. So called “five forces” analysis is offered as a broader tool for
evaluating overall industry competition, while the diamond framework for locational
competitiveness is offered for evaluating the health of local competition.
In Section IV, we turn to the analysis of mergers, outlining a three-level merger
evaluation process that incorporates the productivity growth standard and the tools for
evaluating the health of competition mentioned above. Section V offers a short case
study of a merger evaluation, using the new procedure.
Finally, Section VI addresses
some recent issues more specific to U. S. antitrust policy.
The essential role of competition and antitrust policy in competitiveness is evident in
recent research on industry competition and economic development. My conviction from
working both with companies and public policymakers in many countries is that open
competition, stimulated by strict antitrust enforcement, is essential not only to national
DRAFT VERSION: 07/22/02
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prosperity, but to the health of companies themselves. Yet antitrust seems to be drifting.
Antitrust policy is being challenged by skeptics who are mounting attacks on the need for
antitrust under the guise of globalization or the requirements of the “new economy.”
Also, the theoretical and empirical literature on competition has moved beyond seller
concentration, price-cost margins, and other ideas central to current enforcement. 1
It is an important moment to reinvigorate antitrust. Not to say that antitrust
enforcement has been lax, nor that skilled practitioners have not been able to apply the
law with great sophistication. However, recent court rulings and public debate suggest
that the foundations of antitrust theory and practice are wearing thin. The goals of
antitrust and its link to society’s goals are often not convincingly articulated. The
benefits of competition that underpin antitrust have not been made clear, and the tools for
measuring impacts on competition are frequently controversial.
Too often the discussion
between business and government in antitrust proceedings concerns arcane matters such
as HHI that erodes the legitimacy of antitrust with the private sector. By relying too
heavily on narrowly conceived consumer welfare theory, antitrust analysis may be
overlooking some of the most important benefits of competition for society. Antitrust is
not living up to its full promise in deterring behavior that is not in society’s interest.
My aim here is not to offer a comprehensive treatise, settle all of the issues raised, nor
do justice to the scholarly or practitioner literature. Instead, the intention is to stimulate
further dialogue and analysis.
1 See Sections II and III.
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II. COMPETITION, COMPETITIVENESS, AND STANDARD OF
LIVING: THE ROLE OF ANTITRUST
II. 1. Competition, productivity growth, and standard of living
The stated role of antitrust policy is to promote and protect competition in the name
of consumer welfare. Yet the rationale is frequently unclear, misunderstood, or too
narrow in scope. While protecting short-run consumer welfare measured by price-cost
margins is undeniably important, the benefits of healthy competition are in fact broader
and more essential to consumers and to society.
The fundamental benefit of competition
is to drive productivity growth through innovation, where innovation is defined broadly
to include not only products, but also processes and methods of management.
Productivity growth is central because it is the single most important determinant of longterm
consumer welfare and a nation’s standard of living.
The underpinnings of economic prosperity are becoming better understood as a result
of continuing research. While sound macroeconomic policies and stable political and
legal institutions represent important preconditions for prosperity and competitiveness,
they are necessary but not sufficient conditions for a prosperous economy. Prosperity is
actually generated at the microeconomic level – in the ability of firms to create valuable
goods and services productively that will support high wages and high returns to capital. 2
The goal of economic development is to achieve long term, sustainable improvement
in a nation’s standard of living, which can be approximated by per capita national income
(GDP per capita).
3 Per capita income is determined by the productivity of a nation’s
economy, where productivity is defined as the total value of the goods and services
(products) produced per unit of the nation’s human, capital and physical resources. A
nation’s overall productivity is composed of the productivity of its firms, both those
involved in traded industries and those involved in purely local commerce. The crucial
issue, then, is how to create the conditions for rapid and sustained productivity growth in
a nation’s firms.
Since the seminal contributions of Schumpeter (1943), Solow (1956) and Abramovitz
(1956), it is widely understood that the only means of achieving sustained productivity
growth in an economy is through innovation. 4 Innovation provides products and services
2 M.
E. Porter, “The Microeconomic Foundations of Economic Development,” in The Global
Competitiveness Report 1998, 38 (Geneva: World Economic Forum, 1998). See also M. E.
Porter,
“Attitudes, Values, Beliefs, and the Microeconomics of Prosperity,” in Culture Matters: How Values
Shape Human Progress (L. E. Harrison & S. P. Huntington eds. , 2000).
3 While income is the best available measure, other things contribute to national standard of living
besides wages and returns to capital, such as the quality of health care, the absence of extreme income
inequality, and environmental quality.
4 J. Schumpeter, Capitalism, Socialism, and Democracy (2 d ed. 1943); R.
Solow, “Technical Change
and the Aggregate Production Function,” 39 Review of Economics and Statistics 312 (1957); R. Solow,
“A Contribution to the Theory of Economic Growth,” 70 Quarterly Journal of Economics 65 (1956);
(continue)
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of ever-increasing consumer value, as well as ways of producing products more
efficiently, both of which contribute directly to productivity.
Innovation, in this broad sense, is driven by competition. While technological
innovation is the result of a variety of factors, there is no doubt that healthy competition
is an essential part. One need only review the dismal innovation record of countries
lacking strong competition to be convinced of this fact.
Vigorous competition in a
supportive business environment is the only path to sustained productivity growth, and
therefore to long term economic vitality.
Productivity growth, then, is the missing, unstated link between competition and
national standard of living. This provides the soundest explanation for why antitrust must
protect competition: it is the key to a nation’s economic prosperity. Productivity growth
thinking also makes it clear that the focus of antitrust thinking should be on the long-term
trajectory of product value and price, not just current consumer welfare measured by
short-run prices. The following sections outline how the central role of productivity in
development and societal welfare can be applied to antitrust and competition policy.
II.
2. Importance of Industry Competition: empirical evidence
Recent empirical findings verify the importance of competition to raising and
maintaining standard of living. This evidence squares well with my own experience.
Competition really matters, in the new economy and the old economy, and in all types of
countries.
One body of empirical evidence comes from The Global Competitiveness Report
2000, an annual study of competitiveness in 58 countries including all the OECD
countries as well as many developing countries. 5 Data from the report are drawn from a
survey of more than 4, 000 corporate and other leaders, including a representative sample
from each country.
The survey is qualitative, but represents a large body of expert
opinion on important dimensions of economic policy, for which there are no quantitative
measures.
Figure 1 reproduces some of the statistical findings from the Report. For all three
years in which this analysis has been conducted, the effectiveness of antitrust policy 6
proves to be one of the variables with the strongest positive association with the variation
in GDP per capita across countries. This holds even in the subsample of developing
(continued)
M.
Abramowitz, “Resource and Output Trends in the United States since 1870,” 46 American
Economic Review 5 (1956).
5 M. E. Porter, “The Current Competitiveness Index: Measuring the Economic Foundations of
Prosperity,” in The Global Competitiveness Report 2000 (Geneva: World Economic Forum, 2000).
6 In id. at 312, the effectiveness of antitrust policy was measured in a survey by responses to question
10.
14, “The anti-monopoly policy effectively promotes competition,” using a scale from 1-7, “strongly
disagree” to “strongly agree.”
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economies, an indication that antitrust is also important for poor countries, rather than
just a luxury needed only in wealthy ones. The report also includes a survey question
about the intensity of local competition. While the question is imperfect because of
possible ambiguities in its interpretation by respondents, it also has a highly significant
positive association with GDP per capita.
Figure 1 Competition and Prosperity: Findings from The Global Competitiveness
Report
Regression
Dependent Variable: 1994 – 99 GDP per capita growth
Significance Adj R 2
Measure of National Business at 95% level
Environment
Intensity of local competition at 95% level. 255
Effectiveness of Antitrust policy at 95% level.
117
Regression
Dependent Variable: 1994 – 99 GDP per capita growth
Significance Adj R 2
Measure of National Business at 95% level
Environment
Intensity of local competition at 95% level. 255
Effectiveness of Antitrust policy at 95% level. 117
Regression
Dependent Variable: 1999 GDP per capita
Significance Adj R 2
Measure of National Business at 95% level
Environment
Effectiveness of antitrust policy at 95% level. 700
Intensity of local competition at 95% level.
320
Regression
Dependent Variable: 1999 GDP per capita
Significance Adj R 2
Measure of National Business at 95% level
Environment
Effectiveness of antitrust policy at 95% level. 700
Intensity of local competition at 95% level. 320
.”.. countries where the intensity of competition is rising
showed by far the greatest improvement in GDP per capita.”
Source: M. E. Porter, “The Current Competitiveness Index: Measuring the Microeconomic Foundations of
Prosperity”, in The Global Competitiveness Report 2000 (Geneva: World Economic Forum, 2000).
Turning to analysis of the rate of growth in GDP per capita, the effectiveness of
antitrust policy and the intensity of competition are again highly significant variables and
contribute substantially to explained variance. Note that the proportion of variance in
GDP per capita growth rate that can be explained is inherently less than for the level of
GDP, because growth in GDP is more sensitive to a wide variety of shocks and shortterm
macroeconomic influences. We find that the competition / antitrust policy measures
are as or more associated with prosperity as transportation infrastructure, telecom
infrastructure, IT readiness, and the like. In a first difference analysis, countries where
the intensity of competition is rising showed registered the greatest improvement in GDP
per capita. All these findings are consistent: competition and a vigorous antitrust policy
are strongly associated with national prosperity.
This research provides some positive evidence of the importance of strong antitrust
for prosperity. There is also ample negative evidence to be cited. For example, Japan is
a country with a history of weak antitrust enforcement, legal cartels, and extensive
government-sponsored collaborative research projects among companies. During the
height of the Japanese economic miracle, the case of Japan was a principal argument
advanced in the United States for weakening antitrust law – for example, in allowing
potentially anticompetitive collaborative activity. 7
7 M. E.
Porter, H. Takeuchi & M. Sakakibara, Can Japan Compete? (2000).
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Yet one of the major findings of a recent book is the steep price that Japan has paid
for a lax antitrust policy. 8 Our research revealed that weak antitrust enforcement did not
explain Japanese competitiveness, but was in fact an explanation for why certain
industries in Japan were uncompetitive. Industries where competition was limited by
Japanese government policy were uncompetitive.
We also collected data on all the legal
cartels in post-World War II Japan, and found that the industries in which cartels
occurred were, with few exceptions, uncompetitive. We also collected data on all
government-sponsored cooperative research projects, which involved several if not most
industry competitors. We found that those industries in which cooperative research
projects occurred were no more likely than the average industry to be competitive, and
many cooperative research projects actually worked against industry competitiveness.
There have been many collaborative projects in the West involving multiple industry
competitors growing out of the efforts to emulate the Japanese case, such as the electric
vehicle project. With few if any exceptions, these have proven disappointing.
The
notion that Japan was competitive because of weak antitrust is resoundingly rejected.
Figure 2 highlights some additional data drawn from our study of Japan. We
explored the relationship between the intensity of domestic competition and world export
share in a broad sample of Japanese industries. All of the industries considered were
global in scope.
Industries able to command a high world export share were decreed to
be highly productive.
Instead of relying on market structure measures such as seller concentration to proxy
the intensity of competition, we used the extent of fluctuations in domestic market share
among leading firms over an 18-year period. The fluctuation in market share among
leading competitors – controlling for outside shocks – provides a direct and far more
compelling indication of the intensity of competition. 9 We found that domestic market
share variability was by far the most powerful influence on Japanese world export share,
dominating conventional measures of comparative advantage such as skilled labor
intensity and capital intensity. The intensity of competition at home, then, was the
strongest influence on Japanese competitiveness abroad.
These statistical findings are
consistent with hundreds of industry case studies that have been conducted on the
determinants of competitiveness at the country level, as well as research on national and
regional economic development. 10
Interestingly, we found that seller concentration had no significant relationship with
Japanese world export share. 11 Nor was it significantly correlated with the extent of
8 Id. See also M. Sakakibara & M. E.
Porter, “Competing at Home to Win Abroad: Evidence from
Japanese Industry,” 83 Review of Economics and Statistics 310 (2001).
9 See generally R. Caves & M. Porter, “Market Structure, Oligopoly, and Stability of Market Shares,” 26
Journal of Industrial Economics 289 (1978). For a detailed application to Japan, including definitions,
sources of data, cause and effect issues, see Sakakibara & Porter, supra note 8.
10 See, e.
g. , “Clusters and Competition: New agendas for Companies, Governments, and Institutions” in
M. E. Porter, On Competition (1998), which contains an extensive bibliography.
11 Sakakibara & Porter, supra note 8.
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domestic market share fluctuations.
These results are consistent with other research
which raises doubts about the use of seller concentration as a proxy for the vitality of
competition. 12
Figure 2 Competition and International Competitiveness: Evidence from Japanese
Industry
Competitiveness Competitiveness
Local Competition Local Competition
o Measured by World Export Share
o Measured by Fluctuations in
Domestic Market Share
Sakakibara/Porter:
“We find a positive and highly
significant relationship between the
extent of market share fluctuations [a
measure of local rivalry] and trade
performance
Contrary to some popular views, our
results suggest that Japanese
competitiveness is associated with
home market competition, not
collusion, cartels, or government
intervention that stabilize it.”
Source: M. Sakakibara & M. E. Porter, “Competing at Home to Win Abroad: Evidence from Japanese
Industry”, 83 Review of Economics and Statistics 310, 318, 319 (May 2001).
II.
3. Importance of Local Competition 13: Externalities, cluster theory, and the link
between clusters and innovation
The Japanese research and other evidence suggest that, contrary to popular belief,
local competition matters in global industries. Even where firms compete across borders,
the configuration of locally based competitors and the vitality of competition in the local
market are crucial to productivity and competitiveness. Local competition creates
numerous positive externalities for industries and industry clusters, thus explaining its
significant impact on firm competitiveness.
Many industries can be considered global in competitive scope, which is often taken
to imply that a firm’s location is of no importance to the health of competition.
Yet the
actual distribution of firms belies this view. We observe a strong tendency for successful
12 See, e. g. , K. Ewing, “The Soft Underbelly of Antitrust,” Antitrust Report, Sept. 1999 at 2; B.
Harris &
D. Smith, “The Merger Guidelines v. Economics: A Survey of Economic Studies,” Antitrust Report,
Sept. 1999 at 23; C. Weller, “An Evolution of the Merger-JV Guidelines: The Productivity Paradigm
As A Positive Antitrust Policy for Competitiveness and Prosperity,” American Bar Association,
Perspectives of the Task Force on Fundamental Theory (forthcoming, 2001).
13 It should be noted that the term local can apply to geographic areas ranging from a small county to a
group of neighboring countries.
The relevant economic area depends on geographic distance and the
scope of local externalities.
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firms in a particular industry to cluster in particular countries, often along with firms in
related industries. The schematic map of the U. S. clusters in figure 3 shows that
geographic clustering can occur even in sub-national regions within countries. This
ubiquitous phenomenon reveals powerful insights into the role of location in healthy
competition.
Figure 3 Selected Regional Clusters of Competitive U. S. Industries
Omaha
Telemarketing
Hotel Reservations
Credit Card Processing
Wisconsin / Iowa / Illinois
Agricultural Equipment
Detroit
Auto
Equipment
and Parts
Rochester
Imaging
Equipment
Western Massachusetts
Polymers
Boston
Mutual Funds
Biotechnology
Software and
Networking
Venture
Capital
Hartford
Insurance
Providence
Jewelry
Marine Equipment
New York City
Financial Services
Advertising
Publishing
Multimedia
Pennsylvania / New Jersey
Pharmaceuticals
North Carolina
Household Furniture
Synthetic Fibers
Hosiery
Dalton, Georgia
Carpets
South Florida
Health Technology
Computers
Nashville /
Louisville
Hospital
Management
Baton Rouge /
New Orleans
Specialty Foods
Southeast Texas
/ Louisiana
Chemicals
Dallas
Real Estate
Development
Wichita
Light Aircraft
Farm Equipment
Los Angeles Area
Defense Aerospace
Entertainment
Silicon Valley
Microelectronics
Biotechnology
Venture Capital
Cleveland / Louisville
Paints & Coatings
Pittsburgh
Advanced Materials
Energy
West Michigan
Office and Institutional
Furniture
Michigan
Clocks
Carlsbad
Golf Equipment
Minneapolis
Cardio-vascular
Equipment
and Services
Warsaw, Indiana
Orthopedic Devices
Colorado
Computer Integrated Systems / Programming
Engineering Services
Mining / Oil and Gas Exploration
Phoenix
Helicopters
Semiconductors
Electronic Testing Labs
Optics
Las Vegas
Amusement /
Casinos
Small Airlines
Oregon
Electrical Measuring
Equipment
Woodworking Equipment
Logging / Lumber
Supplies
Seattle
Aircraft Equipment and Design
Boat and Ship Building
Metal Fabrication
Boise
Sawmills
Farm Machinery
Firms cluster in particular locations not because of traditional comparative advantages
stemming from natural resources or pools of cheap labor. Rather, they obtain competitive
advantages by locating in areas benefiting from the strong presence of other firms in the
industry, firms in related industries, and the presence of specialized inputs, information,
and institutions.
The explanation for geographic clustering is that local competition
provides an exceptional stimulus to productivity growth that is extremely valuable to
firms. The two major contributions of local competition are:
1. Incentive and Informational Benefits: The immediate presence of a rival
stimulates greater comparison, improvement, and upgrading versus competing
with a firm in a foreign country. Companies that compete at home are better
prepared to compete with foreign rivals abroad.
2. Positive Externalities: Geographic proximity of rivals generates otherwise
unattainable positive externalities, such as a specialized labor pools,
knowledge spillovers, specialized supplier formation, etc.
discussed below.
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The Positive Externalities of Local Rivalry. Competition creates positive externalities for
the local business environment that boost productivity for the entire industry, and often
for related and supporting industries in the same location as well. A group of competing
local rivals tends to spawn a base of local suppliers and providers of specialized support
services.
This boosts productivity by reducing transactions costs, facilitating the
exchange of information, increasing flexibility, and speeding innovation. Local rivalry
also works to increase the local availability of specialized skills, infrastructure, scientific
and technical resources, and other assets and institutions that boost productivity and raise
the rate of productivity growth. As these externalities deepen, they can foster new entry
and spinoffs, coming full circle to reinforce local rivalry. Such externalities are what
give rise to what I term clusters, or geographic concentrations of interconnected
companies and institutions in a particular field.
California wine provides a good example of a cluster (see figure 4). There are
hundreds of wineries in California, but also thousands of independent growers of grapes.
All the inputs, production equipment, and services required to grow grapes and produce
wine are available locally. Local universities and other institutions provide ample skilled
labor and technological information. As a result, the productivity of California as a wine producing
region in terms of yield per acre appears to be the highest in the world, and
firms command high prices per bottle for their premium-quality products. The rate of
productivity growth has been rapid, as California wine companies upgraded from jug
wine to super premium segments.
Figure 4 The California Wine Cluster
Educational, Research, & Trade
Organizations (e. g.
Wine Institute,
UC Davis, Culinary Institutes)
Educational, Research, & Trade
Organizations (e. g. Wine Institute,
UC Davis, Culinary Institutes)
Growers/Vineyards Growers/Vineyards Wineries/Processing
Facilities
Wineries/Processing
Facilities
Grapestock Grapestock
Fertilizer, Pesticides,
Herbicides
Fertilizer, Pesticides,
Herbicides
Grape Harvesting
Equipment
Grape Harvesting
Equipment
Irrigation Technology Irrigation Technology
Winemaking
Equipment
Winemaking
Equipment
Barrels Barrels
Labels Labels
Bottles Bottles
Caps and Corks Caps and Corks
Public Relations and
Advertising
Public Relations and
Advertising
Specialized Publications
(e. g. , Wine Spectator,
Trade Journal)
Specialized Publications
(e. g.
, Wine Spectator,
Trade Journal)
Food Cluster Food Cluster
Tourism Cluster Tourism Cluster California
Agricultural Cluster
California
Agricultural Cluster
State Government Agencies
(e. g. , Select Committee on Wine
Production and Economy)
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Page 10
Source: M. E. Porter, On Competition (1998), at ch.
7.
Other well-known examples of U. S. clusters include the Silicon Valley IT cluster, the
Houston oil and gas cluster, and the Boston area biopharmaceuticals and mutual fund
clusters.
The Global Competitiveness Report includes measures of the quality and quantity of
local suppliers and, in the 2000 report the extent of clusters in a national economy. All
three variables have a strong positive association with GDP per capita.
Taking into account the essential benefits of local competition leads to the conclusion
that antitrust analysis should weigh not just the generalized benefits of rivalry for
productivity growth but also the systemic benefits of local rivalry. When local rivalry is
muted, a nation pays a double price. Not only will companies face less pressure to be
productive, but the business environment for all local companies in the industry, their
suppliers, and firms in related industries will become less productive. This demonstrates
in particular the danger in arguments about the creation of “national champions” in an
industry in the home country in order to gain the scale to compete internationally. Unless
a firm is forced to compete at home, it will usually quickly lose its competitiveness
abroad. Local competition matters for productivity and productivity growth, even in
industries whose geographic scope is global.
14
Note that no mention has been made of the ownership of the locally based firms.
This is because ownership has much less importance for externalities than the nature of
the activities undertaken in a given location. All firms in a given location must be
considered part of the cluster, not merely the domestic ones. Special weight for
competition derives from locally based entities that have significant development,
production, and other activities located in a nation. These offer far greater potential for
externalities than does competition from imports.
Trade is not a full substitute for local
competition.
14 See, e. g. , The Global Competitiveness Report 1998 (various authors) (Geneva: World Economic
Forum, 1998); The Global Competitiveness Report 1999 (various authors) (Geneva: World Economic
Forum, 1999); The Global Competitiveness Report 2000 (various authors) (Geneva: World Economic
Forum, 2000).
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III – THE GOALS AND TOOLS OF ANTITRUST POLICY
III.
1. New Standard for Antitrust: Productivity Growth
Since the role of competition is to increase a nation’s standard of living and long-term
consumer welfare via rising productivity growth, the new standard for antitrust should be
productivity growth, rather than price / cost margins or profitability. All combinations or
practices scrutinized in antitrust should be subjected to the following question: how will
they affect productivity growth? If a merger, joint venture, or other arrangement will
significantly enhance productivity growth, it is probably good for society and for
consumers (as well as the firms involved). Transactions with dubious benefits for
productivity growth, or those that offer only a one-time productivity benefit, are likely to
be net negatives for society if they pose any risk to the overall health of competition.
This is because competition is a primary determinant of future long-term productivity
growth.
How would the productivity growth standard affect antitrust? The current explicit and
implicit goals of U. S. antitrust policy fall roughly into the following hierarchy (see figure
5). Drawing on Welfare theory, the primary focus in U. S.
antitrust for the last twenty
years has been on limiting price / cost margins or firm profitability (allocative inefficiency)
as the most important outcome for consumers. Market power is seen as giving firms the
ability to elevate prices and sustain high margins. Hence, limiting market power is the
major focus of attention.
Figure 5 Goals of Antitrust Policy
Traditional View Alternative View
Profitability / Price-Cost Margins
(allocative efficiency)
Cost reduction
(static efficiency)
Cost
(static efficiency)
Innovation
(dynamic efficiency)
Innovation
(dynamic efficiency)
Value improvement
(static productivity)
Profitability / Price-cost margin
standard
Productivity growth standard
Profitability / Price-Cost Margins
(allocative efficiency)
Second in importance in antitrust evaluations has been cost or technical efficiency.
The efficiency justification can be used to offset a finding of market power to elevate
DRAFT VERSION: 07/22/02
Page 12
margins. At the bottom of the current hierarchy is innovative ness, or the rate of dynamic
improvement.
The effect of mergers or competitive practices on the overall rate of
innovation is usually only paid lip service.
If these three goals are tested against the productivity growth standard, it becomes
clear that the traditional hierarchy of goals should be reversed.
Because of its direct effect on productivity growth, the most important goal for
society is a healthy process of dynamic improvement, which requires innovations in
products, processes, or ways of managing. If the rate of dynamic improvement is
healthy, over time this dominates static technical and allocative efficiency concerns. For
example, a faster rate of innovation in new approaches overwhelms static economies of
scale in existing approaches, particularly in an age where knowledge-based competition
is the rule.
A productivity growth standard suggests that technical (static) efficiency should be
the second most important goal, but that it must be assessed with more subtlety.
While
antitrust analysis tends to focus on cost justifications, equal attention should be paid to
product or service value. Roughly speaking, productivity is price times quantity divided
by the quantity of labor or capital involved. It can be divided into two distinct
components: the prices that products command in the marketplace (which reflect value)
and the efficiency with which a unit of product can be produced. Thus, productivity is
enhanced not just by efficiency improvements, but also by improvements in product
quality, features, and services. Product variety is also an essential component of value,
giving customers more choices to better meet their particular needs.
High-value products provide the consumer with superior performance and features,
and therefore justify higher prices.
With a focus on price / cost margins, however, high
prices are often seen as inherently undesirable for consumers. Higher prices should be a
danger sign in antitrust analysis only if they are not justified by rising customer value.
Limiting short-term price / cost margins or profitability is a dubious goal for antitrust.
Firm profitability is a good thing if it reflects truly superior products or significant
advantages in process technology or operating efficiency. It is a bad thing if it occurs in
the absence of a healthy rate of dynamic improvement. In a typical industry, average
price-cost margins and profitability will vary significantly among competitors, reflecting
varying levels of fundamental competitiveness.
Short-term consumer welfare measured by price, then, is a dubious goal on two
levels. First, it fails to measure true consumer welfare by ignoring product value.
Second, we care much more about the long-term trajectory of value, prices, and costs
than we do about consumer welfare in the short run or immediately after a merger.
Moreover, a productivity growth standard is entirely consistent with the language of the
main antitrust laws.
Benefits of a Productivity Growth Standard. Why is the productivity growth standard
different and important for antitrust? First, it is a positive standard that relates directly to
DRAFT VERSION: 07/22/02
Page 13
competitiveness, a nation’s standard of living, and long-term consumer value, while
price / cost margins and technical efficiency are theoretically suspect. Productivity growth
is also more understandable and palatable to managers. Imagine how much more
constructive it would be for corporations and their attorneys to debate whether a merger
will boost productivity growth rather than continuing to debate the size of HHI.
Second, a productivity growth standard would shift antitrust away from a narrow
focus on static, short-term consumer welfare to a dynamic and more all-encompassing
view of competition and its benefits to consumers, firms, and society as whole. Defining
the goal of antitrust in terms of price / cost margins and profitability creates a zero-sum
game between firms and consumers.
If consumers are to benefit from lower prices, firms
must earn lower profits. In contrast, a productivity growth standard raises no inevitable
trade-off. If productivity is growing, consumers can enjoy better products and / or lower
prices, companies can earn attractive returns on capital, and workers can enjoy rising
wages. A productivity growth standard, then, unites the perspectives of consumers,
workers, and companies. It embodies a positive sum rather than a zero-sum view of
competition. An approach to competition based on productivity growth will lead to
outcomes that benefit consumers far more than a shortsighted concern with static
profitability.
Finally, productivity growth addresses the reality of high-technology industries and
the so-called new economy by highlighting the fundamental importance of innovation.
While there are few true conceptual differences between the “new” and “old” economies,
the apparent mismatch between the static focus of antitrust and the rapid change in
technology-intensive industries has undermined antitrust’s legitimacy. Since innovation
is the basic driver of productivity growth, promoting and protecting it should be central.
III. 2. Analysis of competition
How would the productivity standard be applied in practice? The best way to attain
maximal productivity growth in an industry is to ensure that industry competition is
healthy, since competition determines long-term productivity growth.
It is possible to
measure past productivity growth in various ways, and we advocate that this become part
of antitrust analysis. However, predicting future productivity growth is more difficult.
Hence, there is a need for tools to assess the likely future health of competition, since this
will be the single most important factor in whether future gains in productivity will reach
their potential.
III.
2. 1. Measuring the health of industry competition: Five Forces Analysis
To measure the health of competition in practice, we agree with those who believe
that seller concentration, the number of firms in a market, and profitability are not very
good indicators. 15 They capture only part of a complex phenomenon and divert analyses
15 See, e. g. , Ewing, supra note 12; Harris & Smith, supra note 12; Weller, supra note 12.
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of competition to much less productive debates over where to draw relevant market
boundaries. Instead, a broader approach is necessary. One such approach with
acceptance in business practice is the “five forces” analysis of the intensity of
competition.
The Five Forces Model.
16 The five forces model is a dynamic approach to analyzing
industry structure, based on five competitive forces acting in an industry or sub-industry:
threat of entry, threat of substitution, bargaining power of buyers, bargaining power of
suppliers, and rivalry among current competitors. 17
This approach, with roots in industrial economics but moving beyond its narrower
interpretations, posits that competition in an industry is broader than price, and includes
product features, services, and processes. Competition is also seen as driven by many
influences. The five forces framework seeks to encompass all the important dimensions
of competition (see figure 6). It embodies the notion that competition is much broader
than just rivalry, where seller concentration (HHI) analysis is focused. Any of the five
forces can be significant in determining the health of competition, depending on the
particular industry.
For example, the power of customers to push down price or pressure
improvements in service can be just as important to productivity growth as the number
and size distribution of competitors in the market. 18
Five forces theory also argues that for any one of the competitive forces, the causes of
competitive intensity are multidimensional. In assessing the intensity of rivalry, for
example, seller concentration does have a role, although our interpretation would focus
more on the balance of competitors (the more balanced, the more rivalry). But the
intensity of rivalry also depends on a series of other dimensions, including, for example,
the industry cost structure. Where variable costs are low, strong pressures are created to
cut price in order to contribute to fixed cost. With such a cost structure, even a
concentrated industry can exhibit strong rivalry.
Switching costs are another important
influence on rivalry. Where it is easy for customers to shift from one supplier to another,
the effect of concentration is mitigated.
The five forces methodology involves analysis on an industry-by-industry basis, and
does not rest on the determination of the relevant market. Every industry is different,
16 There is an extensive literature on five forces analysis that is beyond the scope of this article to
summarize here. The early references are M. E.
Porter, Inter brand Choice, Strategy, and Bilateral
Market Power (1976); M. E. Porter, Competitive Strategy: Techniques for Analyzing Industries and
Competitors (1980).
17 Brandenburger and Nalebuff have appropriately stressed the role of complementary products in
competition, and some have suggested complementary products as a sixth force (A. Brandenburger &
B.
Nalebuff, Co-o petition, (1996) ). However, complementary products do not directly influence the
health of competition, but affect it indirectly through the influence of complements on the five forces.
The presence of a complementary product is neither good nor bad for competition per se. It depends
on how the complement influences, for example, barriers to entry or the power of the customer.
18 There is substantial empirical support for the importance of this broader set of industry attributes for
competition.
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both in terms of the relative influence of the forces and the array of drivers of each force.
This approach, which squares with actual industry competition, has been well accepted in
corporate practice and in management consulting firms to assess the nature of industry
competition.
Figure 6 Assessing the Health of Competition: Five Forces Framework
Threat of Substitute
Products or
Services
Threat of New
Entrants
Rivalry Among
Existing
Competitors
Bargaining Power
of Suppliers
Bargaining Power
of Buyers
Source: M. E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors 187
(1980).
Many of the elements of the five forces approach have been known to or used in
economics for a long time. Also, many of the considerations raised in the five forces
model appear somewhere in current merger analysis.
Five forces analysis is different in
how, when and why the model is applied. Current antitrust analysis first determines the
relevant geographic and product market, then uses its tools to analyze competitive effects.
Current analysis starts with seller concentration as the principal metric. Other
considerations are brought in, both only later and secondarily. Five forces analysis, on
the other hand, avoids the first step by going straight to analyzing competitive effects in
any and all submarkets deemed relevant by customers and competitors. It views seller
concentration as only one and not the most important determinant of rivalry.
It brings in
all five forces as equally important. Finally, it does not rely heavily on price and quantity
as the principal indicators of welfare.
By assessing competition beyond existing rivals, the need is reduced for debates on
where to draw industry boundaries, or the relevant market in antitrust terms. Any
definition of a market is essentially a choice of where to draw the line between
established competitors and substitute products, between existing firms and potential
entrants, and between existing firms and suppliers and buyers. If these influences on
competition are all recognized, and their relative impact assessed, as they are in five
forces analysis, then where the lines are actually drawn becomes more or less irrelevant
to strategy formulation and, I suggest, the antitrust analysis of competition. Latent
sources of competition will not be overlooked, nor will key dimensions of competition.
The need to determine the relevant market is eliminated.
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While there is a systematic approach to market definition defined in the Merger
Guidelines, it begins with the questionable premise that a single market definition is a
meaningful concept. Moreover, the approach to market definition relies heavily on price
effects which are an incomplete measure of social benefit, not to mention a largely shortterm
and static one.
Productivity Growth and Forms of Competition. The multidimensional nature of
rivalry is important for understanding the link between rivalry and productivity.
Some
forms of rivalry are more productivity-enhancing than others, and thus are more valued
socially.
For example, one can array types of rivalry along a spectrum including the following
(see also figure 7):
1. Competition based on imitation / price discounting
2. Competition based on strategic positioning.
The first type of competition is on operational effectiveness, or the extent to which
companies approach best practices in areas such as production processes, technologies,
marketing methods, and management techniques. The second, and more fundamental to
success in an advanced economy, is competition to create different value propositions for
customers, a function of the degree to which companies have distinctive strategies.
Figure 7 Rivalry and Productivity Growth
Imitation and Price
Discounting
Strategic
Rivalry
o Homogeneous products / services
at low prices
o Multiple, different value
propositions
– e. g.
, features, services,
processes, price levels
o Different approaches to design,
operations, marketing, etc.
“Zero sum competition”Positive sum competition”
o Incremental cost improvements o Potential for fundamental process
improvements
o Lots of customer choice
o Expanded market
o Little true customer choice
o Imitate best practices
Assessing the two according to the productivity growth standard gives very different
results. Imitation-based competition leads to similar products among rivals and strong
pressures for price discounting. Strategic competition occurs when rivals pursue different
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value propositions: some firms offer low prices producing stripped down products, others
have higher prices but provide better service, while still others concentrate on various
segments of the market, tailoring their products and value chains accordingly.
If price / cost margins are used as the metric of social benefit, then imitation and price
discounting seem ideal.
Customers get the benefit of low prices, and the ability to play
one company against others. From a productivity growth standpoint, however, this form
of competition may lead to slower dynamic improvement. Competition on strategic
positioning can foster increased variety and greater choices for customers in terms of the
product that best meets their needs, not to mention more innovation in products and
processes. In strategic competition, markets often expand as new needs are met and new
customers are drawn into the market. It is important to note that internationally
competitive, advanced nations have more innovation- and differentiation-based
competition, while less competitive nations tend to compete on imitation and price. 19
This analysis leads to the controversial conclusion that holding down profitability is
the wrong issue for society.
Profitability has a contingent relationship with productivity
growth. The American software industry is far more profitable than the software
industries in other countries, but it is also far more productive and internationally
competitive. High profits are fine, provided competition is healthy and there are strong
pressures for dynamic improvement. The productivity growth standard, then, casts new
light on how we assess competition. It reveals the importance of understanding the kind
of competition a nation should really be looking for.
III.
2. 2. Measuring the health of local competition: The Diamond framework
As has been argued, it is not sufficient to consider only industry competition
generally. We must also have a means of gauging the health of local competition.
Here,
one such approach to assessing the potential productivity of a local business environment
is embodied in the so-called diamond framework. 20
The productivity of a national business environment can be modeled using four
interacting components that can be depicted as a diamond (see figure 8). These are:
1. Context for firm strategy and rivalry
2. Factor (input) conditions
3. Demand conditions
19 For supporting statistical findings, see Porter, supra note 5.
Results are similar in previous years’
reports. See the full The Global Competitiveness Reports for 1998, 1999 & 2000; and Porter, Takeuchi
& Sakakibara, supra note 7.
20 M. E. Porter, The Competitive Advantage of Nations (1990). For the empirical application of Diamond
theory to 59 countries, see The Global Competitiveness Report 2000, at 40-58, 101-221, including data
definitions and sources at 223-333.
For 1998 and 1999, see The Global Competitiveness Report for
those years. For an extensive empirical application of Diamond theory to Japan, see Porter, Takeuchi
& Sakakibara, supra note 7.
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4. Related and supporting industries
Like the five forces, this framework aims to capture the many influences on the
productivity of the local business environment in an industry or overall.
Rivalry among
locally based competitors is not only important to productivity growth directly but also
creates positive externalities for the local business environment. A group of competing
local rivals helps customers become more knowledgeable and competitive, encourages
more specialized suppliers to develop, and enhances the local supply of high-quality,
specialized inputs. This gives rise to a series of new questions that must be addressed in
analyzing the impact on competition of a merger or other competitive practice, which will
be discussed below.
Figure 8 The Externalities of Rivalry: Locational Determinants of Productivity
and Productivity Growth
Related and
Supporting
Industries
Related and
Supporting
Industries
o Open and vigorous competition
among locally based rivals
o Rivalry among locally-based competitors is not only important directly but also creates positive
externalities for the local business environment
Context for
Firm
Strategy
and Rivalry
Context for
Firm
Strategy
and Rivalry
Factor
(Input)
Conditions
Factor
(Input)
Conditions
o Sophisticated and demanding
local customer (s) whose needs
anticipate those elsewhere
o Unusual local demand in
specialized segments that can be
served globally
o Presence of capable, locally based
suppliers and firms in related fields
Demand
Conditions
Demand
Conditions
o A local context that encourages
investment and sustained upgrading
o Availability of high quality
and specialized
inputs
Source: M. E. Porter, The Competitive Advantage of Nations 133 (1990).
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IV. EVALUATING MERGERS AND JOINT VENTURES
IV. 1. Why mergers should be of particular concern for antitrust
Where productivity growth is the central goal of antitrust, it becomes clear that
mergers should be treated with special caution compared to other corporate growth
strategies. This is true for five reasons:
First, mergers raise almost inevitable issues for the health of competition by removing
independent competitors from the market. The question is not whether there is a risk to
competition, but how much.
This risk stems from the potential lessening of competitive
pressure among firms in the industry, the potential reduction in product choice and
variety, and the reduction in the number of different approaches being pursued to
product / process development and hence the likelihood of innovation.
Second, a merger requires no “skill, foresight, and industry,” 21 only financial
resources. It demands no new strategy, and yields no automatic productivity
improvements. By contrast, introducing a new product, changing a distribution model, or
building a new plant are far more likely to boost productivity. Society, then, should be
biased in favor of independent company actions over mergers.
Third, the empirical evidence is striking that mergers have a low success rate.
A wide
range of studies finds that most mergers do not meet expectations, and most of the profits
are captured by the seller, not the buyer.
Fourth, the strategy literature suggests that smaller, focused acquisitions are more
likely to improve productivity than mergers among leaders. When a large company buys
a small company and integrates it into its strategy, major productivity gains are possible.
Mergers among large companies appear to rarely yield such benefits, though they may
produce reduction in joint overhead and eliminate major competitors from a market.
Fifth, there are strong financial market pressures favoring mergers over other growth
strategies. These arise at least in part from agency problems afflicting both investment
managers compensated based on near term stock price appreciation, and company
executives given incentives with stock options.
Finally, accounting rules make merger a vehicle for distorted performance
measurement, creating artificial pressures for companies to merge.
We cannot assume that a merger will be efficient and profitable just because
companies propose it. Companies make mistakes. Every merger needs to be weighed
against the productivity growth standard.
Indeed, a positive antitrust policy based on
21 U. S. v. Aluminum Co. of America, 148 F. 2 d 416, 430 (2 d Cir.
1945) (Hand, J. ).
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productivity growth might actually enhance both the performance of companies and
consumer welfare, which would be even better for society.
IV. 2. Towards a New Merger Evaluation Process
In dealing with a proposed merger, the primary concern for antitrust should be how
the merger, if allowed, would affect productivity growth.
We must consider both likely
future productivity growth in the industry, as well as the near term productivity impact on
the merged firms. The effect of the merger on the health of competition will be central to
its likely productivity impact, net of any direct positive productivity growth impacts that
can be convincingly demonstrated.
Three Levels of Analysis. In analyzing a merger or joint venture then, the three basic
levels of analysis needed are:
1.
Merger significance and baseline productivity growth analysis.
2. The effect of the transaction on the health of competition using the five forces
and the diamond framework in all significant markets and submarkets that are
relevant based on industry and customer practice.
3. A risk / reward analysis of the merger, where its effect on the health of
competition is weighed against proposed direct benefits using the productivity
growth standard.
IV.
2. 1. Significance and Baseline Productivity Growth Analysis
This analysis can be broken up into three principal tasks: (1) identifying the set of
relevant markets and submarkets and the relevant geographic area; (2) determining
whether or not the firm meets a predetermined combined market share cutoff in the
relevant markets and submarkets; and if so, (3) establishing the baseline productivity
performance of the industry and the firms party to the transaction.
Step 1. Rather than going through the lengthy and controversial exercise of trying to
define the market affected by a merger, this new merger evaluation process is applied to
all relevant markets and submarkets.
There are usually a number of economically
relevant market definitions, and each of these is considered. In determining plausible
markets or submarkets, three practical criteria can be helpful:
1. How the industry itself defines submarkets
2. How consumers segment the market
3.
Whether there is a competitor focused on the submarket (i. e. , a focused
company dedicated only to serving the submarket, which suggests that it is a
viable array of products, varieties, and customers with distinct needs)
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Once all plausible markets and submarkets have been identified, the geographic area
over which local externalities apply is determined. Note that the relevant geographic area
is not based on the geography of sales, but on the externalities in production. The starting
assumption is that the geographic unit is the national economy.
In some industries, the
relevant geographic area can be smaller than a nation. Clusters occur within a region or
metropolitan area. In some cases, externalities can cross national borders of immediate
neighboring countries.
Step 2. To invest the resources required to investigate a particular merger or joint
venture, some significance threshold is inevitable.
We advocate a relatively low
minimum market share threshold of, say, 25 percent combined share in any submarket
(discussed below). Such a threshold will conserve resources and screen out transactions
where the probability of material impact on competition is small.
There is no contradiction between this cut-off level and our rejection of seller
concentration as a measure of market power. We use concentration solely as a
significance indicator. A merger involving a small portion of any submarket is unlikely
to raise important a.