A practical guide to efficiencies analysis in merger reviews

Draft for Public Consultation

This consultation takes place between March 20, 2018 and May 3, 2018 (30 days later).

Part 1: Introduction

Consistent with the Commissioner of Competition’s (the “Commissioner”) commitment to transparency, this document is intended to inform businesses and their advisors of the Competition Bureau’s (the “Bureau”) most recent experience conducting the trade-off analysis in accordance with section 96 of the Competition Act (the “Act”) and in what circumstances the Commissioner may exercise his discretion to not challenge an otherwise anti-competitive merger due to efficiency gainsFootnote 1. The guidance provided herein is focused on the Bureau’s internal assessment of section 96 prior to making an enforcement decision.

The vast majority of merger transactions do not raise competition concerns under the Act. The Bureau’s approach is to expeditiously identify those few transactions that may raise material competition concerns and provide quick clearance for remaining transactions to provide commercial certainty and allow parties to achieve any efficiencies as quickly as possibleFootnote 2. Only a minority of cases raise potential material competition concerns and therefore require the production of documents pursuant to a Supplementary Information Request (“SIR”) or an order of the Court pursuant to section 11 of the Act. In an even narrower subset of cases, an analysis of efficiency claims will be required. The guidance provided herein is primarily intended to apply to this small subset of cases given the significant complexity of the analysis involvedFootnote 3.

1.1 Overview of the Trade-Off Analysis

Section 92 of the Act allows the Competition Tribunal (“Tribunal”) to make an order when it finds that a merger "prevents or lessens, or is likely to prevent or lessen, competition substantially." A substantial prevention or lessening of competition (“SPLC”) results only from mergers that are likely to create, maintain or enhance the ability of the merged entity, unilaterally or in coordination with other firms, to exercise market powerFootnote 4.

Section 96 of the Act provides an efficiency exception to the provisions of section 92. Where efficiency gains that are likely to be brought about by the merger are greater than, and offset, the anti-competitive effects, the Tribunal shall not make an order under section 92. This trade-off involves a cost benefit analysis that assesses whether the alleged efficiency gains from the merger, which result from the integration of resources, outweigh the anti-competitive effects, which result from the prevention, reduction or elimination of competition caused by the mergerFootnote 5. In matters brought before the Tribunal, the Bureau bears the burden of establishing any anti-competitive effects of a merger, while the merging parties bear the burden of establishing any relevant efficiency gainsFootnote 6 and that such efficiency gains are likely to be greater than, and will offset, the likely anti-competitive effects of the mergerFootnote 7.

Although the Act is structured such that efficiency gains arising from an otherwise anti-competitive merger may be raised as a defence, where the Bureau has determined that a merger is likely to result in an SPLC and the merging parties have made efficiency claims, where possible the Bureau will seek the information necessary to perform the trade-off analysis before the Commissioner decides whether to challenge the merger, accept a remedyFootnote 8, or take no action. Practically speaking, this analysis generally means analyzing the anti-competitive effects associated with the merger, determining the appropriate remedy, and trading the anti-competitive effects off against the cognizable efficiencies that will be lost as a result of the remedy.

The decision of the Supreme Court of Canada in Tervita provides guidance on the application of section 96. Additional guidance on the application of section 96 has been provided by the Federal Court of Appeal and the Tribunal, including in the Superior Propane series of decisionsFootnote 9.

1.2 Process Considerations

In appropriate cases and when provided with timely and sufficient information validating claimed efficiencies, the Bureau may assess the trade-off internally and will not necessarily resort to the Tribunal for adjudication of the issueFootnote 10. The trade-off analysis is typically a very complex exercise and an iterative process that can have an impact on the overall timing of the Bureau’s review. Further, where the merger is being reviewed in other jurisdictions, a thorough assessment of alleged efficiency gains has the potential to result in a misalignment on timing and outcomeFootnote 11.

Parties asserting an efficiency defence are encouraged to provide their initial efficiencies submissions and available supporting information at an early stage, recognizing that additional information will be required as the Bureau’s analysis progresses. This will allow the Bureau sufficient opportunity to analyze potential effects and efficiencies concurrently. It is up to the merging parties to decide whether to assert efficiency gains from the merger, and how and when to engage with the Bureau on efficiencies. However, providing the Bureau with sufficiently detailed information regarding efficiency claims at an early stage of the process will facilitate the preparation of focused information requests and/or the targeted use of other information gathering mechanisms. The Bureau does not view the merging parties raising efficiency claims as a concession that anti-competitive effects are likely to result from the merger, and will continue its analysis of the likelihood of anti-competitive effects.

In other instances, merging parties have waited for a definitive conclusion as to whether or not the merger is likely to result in an SPLC before providing detailed information about efficiencies. This approach typically lengthens the Bureau’s review process since the assessment of efficiencies claims is iterative, and the provision of a submission is only the first step in this assessment. While merging parties might seek to hold back a submission until the Bureau has made determinations regarding the scope of the potential remedy or narrowed the scope of a merger that is under review, this will come at the cost of time that could have otherwise been spent engaging on the efficiencies claims. For notifiable transactions where the Bureau has concluded that the transaction will likely result in an SPLC and a consideration of efficiencies continues past the expiry of the statutory waiting period, the Commissioner will seek a commitment from merging parties to not close the transaction, enabling the Bureau to focus on the trade-off analysis rather than pursuing an application with the Tribunal to challenge the merger.

In the Bureau’s experience, in certain instances, merging parties have not been either willing or able to provide efficiencies-related information or submissions at an early stage of the review. This may arise because of information restrictions during the due diligence phase, which could result in parties having insufficient certainty relating to efficiencies to be in a position to make submissions to the Bureau at an early stage. Where this is the case, the Bureau will test efficiency claims as sufficiently detailed information becomes available; however, the Commissioner will not delay making an enforcement decision where parties have not substantiated their claims with evidence in a timely manner, particularly in the absence of a timing agreement.

1.2.1 An order under s.92

To be considered under subsection 96(1), it must be demonstrated that the efficiency gains "would not likely be attained if the order (before the Tribunal) were made."Footnote 12 This involves considering the nature of potential remedies, and assessing the anticipated efficiency gains to determine whether these gains are likely to be attained if the potential remedy is implemented.

Parties asserting an efficiency defence are encouraged to provide their initial efficiencies submissions and supporting information early in the merger review process. Practically speaking, since the relevant efficiencies depend on the nature of the remedy, in most cases efficiency claims cannot be fully assessed until the Bureau has determined whether the merger is likely to result in an SPLC and, if so, identified the appropriate remedy. Accordingly, as remedy discussions are ongoing, it will be necessary to continue the efficiencies analysis to reflect the impacts on claimed efficiencies of any proposed remedies. It is likely that further information will be required by the Bureau as this analysis is underway, as the merging parties are best placed to provide information regarding the impacts on efficiencies that any potential remedy would have.

In the Bureau’s experience, a helpful approach is to consider in an initial submission the efficiencies that would be lost in the case of a remedy involving a full block, while providing the calculations and supporting information at the most disaggregated level practicable. In many cases, this would mean providing information at the location or facility level. This will allow the Bureau and the merging parties to update the efficiencies analysis as the Bureau’s review progresses.

Another potential approach has been for the merging parties to consider potential orders and calculate the efficiencies that would be lost. This approach is typically most applicable where there are fewer product and geographic markets at issue and therefore fewer potential remedies to consider, or where the merging parties have also sought to quantify anti-competitive effects.

1.3 Quantitative versus Qualitative Evidence in the Trade-Off

Assessing the likely anti-competitive effects resulting from a merger, as well as assessing the likely efficiencies being realized from a merger, are both predictive exercises, the results of which can be supported by quantitative evidence, qualitative evidence, or both.

If the merging parties assert an efficiency defence, the Bureau will undertake to quantify, by estimation, all anti-competitive effects that are reasonably quantifiable. There are a variety of methodologies that Bureau staff and experts use to quantify anti-competitive effects. Factors such as the availability of data, the reliability of that data, particular market characteristics (e.g. specifics as to how firms are competing), theories of harm, and the availability of natural experiments or other means of identifying causal relationships from the data will dictate which quantification methodology or methodologies are used and their reliability. However, since these models are predictive, they always carry some associated margin of uncertainty. All quantification exercises can be affected by the choice of methodology, and any assumptions that, to varying extents, are subjective. Consequently, the Bureau places importance not only on the estimates themselves, but also on the legitimacy of the underlying methodology, the quality of the data, the precision of the estimates, and the robustness of the overall quantification exercise. Accordingly, qualitative evidence is also informative, even where the Bureau quantifies anti-competitive effects.

Section 96 does not require the Bureau to exhaust every option to estimate anti-competitive effects empirically. In cases where anti-competitive effects of a merger are not reasonably measurable, the Bureau may place more weight on an assessment of anti-competitive effects based on qualitative evidence, since in these cases a well-developed assessment based on qualitative evidence may be more probative than an unreliable assessment of effects based on quantitative evidence.

Efficiencies analyses, similar to analyses of anti-competitive effects, are forward looking estimations and therefore are associated with varying degrees of uncertainty. Empirical studies have found that synergies can be overstated, and/or implementation costs can be underestimatedFootnote 13. For example, integration plans may be based on the best information available to the buyer (or to the merging parties parties); however there are restrictions as to what information the buyer (or each party) has access. As a result, an efficiencies analysis often involves subjective assumptions regarding how the acquired company (or the respective merging companies) operates. Even where more complete information is attainable, unforeseen circumstances can arise such as incompatible equipment or software, difficulties in terminating supply or employment contracts, or incompatible internal cultures, that reduce the likelihood that efficiencies will be achieved in the quantum estimated, or possibly even at all in specific areas.

The same scrutiny applied to estimates of anti-competitive effects will apply to estimates of efficiencies. Given the importance of objectivity, efficiencies claims based upon the subjective assumptions of management will typically not be sufficient to substantiate efficiencies claims. For the Bureau to decide not to challenge an anti-competitive merger or portion of a merger, it requires verifiable estimates of efficiencies with sufficient supporting information to assess their likelihood, to understand underlying assumptions, and to perform sensitivity tests on any models or forecasts used to derive the estimates. Part 3 outlines the type of information that will allow the Bureau to assess the merging parties’ estimates.

In conducting the trade-off analysis, where the bulk of the anti-competitive effects and efficiencies are quantifiable, a trade-off assessment supported by quantified evidence of effects and efficiencies will often be dispositive and a thorough analysis of non-quantifiable effects and efficiencies may not be necessary. However, in other cases there may be substantial non-quantifiable effects or efficiencies that affect the trade-off analysis, in which case the Bureau will assess both the qualitative and quantitative evidence of effects and efficiencies.

Part 2: Analysis of Anti-Competitive Effects

An SPLC finding under section 92 results from mergers that are likely to create, maintain or enhance the ability of the merged entity, unilaterally or in coordination with other firms, to exercise market powerFootnote 14. The SPLC test is therefore, not confined to assessing the likelihood of price increases. Market power can manifest in ways other than an increase in price. Determination of the relevant anti-competitive effects depends upon the particular circumstances of the merger in question and the markets affected by the merger. The Bureau examines all relevant price and non price effects, including negative effects on allocative, productive and dynamic efficiency; redistributive effects; and effects on service, quality and product choice. A non-exhaustive list of potential anti-competitive effects that can result from a merger can be found in paragraphs 12.21-12.31 of the MEGs.Footnote 15

One anti-competitive effect considered under section 96 is the deadweight lossFootnote 16 associated with a likely increase in price. While a price increase may provide evidence for a finding of an SPLC under section 92,Footnote 17 in the context of a section 96 trade-off analysis, the Bureau will, when reasonably possible, also estimate the associated deadweight loss, and socially adverse transfers associated with the price increaseFootnote 18.

Another potential anti-competitive effect may arise where the gains to one group may not offset losses to another. In those circumstances there may be a social loss to be considered in the context of a section 96 trade-off analysis, sometimes referred to as a “socially adverse wealth transfer”. The portion of the wealth transfer that may be considered as being socially adverse will depend on the specific groups which may be harmed by the merger. In addition to wealth transfers from lower income groups as considered in Superior Propane, the Bureau has, for example, considered wealth transfers from government-funded entities to constitute socially adverse wealth transfersFootnote 19. What portion of the wealth transfer may be considered socially adverse will vary from case to case.

2.1 Examples of Common Methodologies to Quantify Effects

In certain cases merging parties have also sought to quantify effects. Where parties choose to do so, they should ensure they are using the same models as the Bureau. Appendix A includes a non-exhaustive list of models that have been used by the Bureau to estimate anti-competitive effects of a merger.

2.2 Non-Price Effects

Standard models of competition focus on price and quantity. However, market power can manifest itself in a number of other ways. An SPLC resulting from a merger can lead to non-price effects in the form of a reduction in service, quality, product choice, incentives to innovate or other dimensions of competition that customers valueFootnote 20. Non-price effects can exist independently or in conjunction with price effects. The economic literature recognizes the role and impact of non-price competition in a market. Non-price competition arising from product differentiation continues to be a focus in economics.

Traditional static demand estimation and simulation techniques may in some cases be useful in quantifying non-price effects, such as the repositioning of existing products. Natural experiments may also be useful to evaluate whether differences in an indicator of quality or service could be explained by differences in competition between the parties. Some indicators of quality may be translatable into dollar terms by making use of available statistical or survey data. For example, a movie theatre may be more inclined to upgrade its seats, projectors, and sound equipment in response to competition and it may be possible to estimate what those competition-driven improvements are worth to consumers based on observed differences in sales or willingness to pay.

There may be indicators of quality that are available but may not be expressible in dollar terms. For example, the estimated response time to deliver on customer orders may be an indicator of service or quality. The Bureau may be able to do empirical analyses to assess if these indicators vary with competition between the parties, but may not always be able to translate any anti-competitive effects related non-price factors into consumer or and producer welfare terms as can be done with price effects on a dollar-for-dollar basis.

Availability of data is an added complication in the quantification of the non-price effects of a merger. For example, data regarding consumer preferences for particular attributes of a good may not be available.

An analysis of non-price effects was conducted on files such as McKesson/Katz, Postmedia/Quebecor, Transcontinental/Quebecor, Cineplex/Landmark/ Empire, among others. As described in greater detail in part 1.3, if a non-price anti-competitive effect is not reasonably measurable, the Bureau may assess it using qualitative evidence.

2.2.1 Dynamic Competition and Innovation

Dynamic competition refers to the successive introduction of new or better products or processes over time. Static analyses of competition take the existing set of products and market participants as given and describe competition in terms of factors that can be varied in the short term, such as pricing. In contrast, dynamic analyses of competition allow for longer term changes, such as the creation of new products or processes, and potentially also new markets. Dynamic competition can overturn the existing competitive dynamics in a market, resulting in changes to the way firms compete. As a result, effects resulting in a loss of dynamic competition by their nature may be inherently more difficult to predict and to quantify, but no less important to consider.

Economic theory generally supports the notion that competition spurs innovation because firms under competitive pressure will strive to differentiate themselves from their competitors by producing better or more cost-efficient products and services than their rivalsFootnote 21. However, economic theory also places importance on the extent to which a firm can capture the value created by its innovation, known in the literature as the “appropriability” of the innovationFootnote 22. The ability to protect the competitive advantage gained through innovation will increase the incentive to innovate. This is particularly true of markets in which competition is manifested in the development of new products and services rather than price or outputFootnote 23. While some have argued that higher market concentration may increase appropriability and innovation, more recent empirical study casts doubt on this conclusionFootnote 24. A larger market share also increases the cost to a firm of creating a product that cannibalizes its existing sales which reduces the incentive to innovate, all else being equalFootnote 25. Accordingly, dynamic competition can have impacts on both the competitive effects and efficiencies sides of the trade-off. Dynamic efficiencies will be discussed in part 3.7.

Quantifying the effects from a loss from dynamic competition can present a number of additional difficulties over and above those associated with quantifying static effects. When innovations are highly differentiated from the products already in the market it is difficult to predict the impact of the innovation. Given the difficulties of quantification, when appropriate the Commissioner may rely on qualitative evidence to assess the harm resulting from a loss of dynamic competition. As described in greater detail in part 1.3, if an anti-competitive effect is not reasonably measurable, the Bureau may assess it with qualitative evidence. An analysis of potential effects resulting from a loss of dynamic competition was conducted on Dow/DuPont.

Part 3: Analysis of Efficiencies

To conduct the trade-off analysis with sufficient rigour such that the Commissioner may make an informed enforcement decision, information supporting efficiency claims should be provided on a with prejudice basis and be sufficiently detailed to enable the Bureau to ascertain the nature, magnitude, likelihood and timeliness of the asserted gains, and to credit (or not) the basis on which the claims are being made. Further, what may be often considered a business cost saving or synergy may not be cognizable, meaning it would not be recognized as an efficiency under Act. Therefore, efficiencies submissions should explain how any claimed efficiencies pass the five cognizability screens outlined in part 3.6.

The information required to assess merging parties’ efficiencies claims will vary depending on the structures of the parties’ businesses, how they plan to integrate them and the industry. The types of information the Bureau may require to assess efficiencies is listed in Appendix B. Normally, much of this information will be set out in a submission provided to the Bureau by merging parties, describing the efficiencies they expect to realize through a transaction. Efficiencies should be quantified where reasonably possible, and supported by a clear methodology described in detail in the submission such that the Bureau has a sufficient degree of certainty that the efficiencies are likely to be achieved over the time period claimed. Parties seeking to rely on qualitative efficiencies as part of a section 96 defence will need to explain why they are not reasonably measurable.

Along with submissions, it is important that the underlying evidence is also provided to the Bureau, including all supporting documentation, models and calculations, such that the Bureau is able to verify how efficiencies were calculated and perform sensitivity tests on any models or forecasts used to derive the estimates. Information that is helpful to the Bureau in its assessment of efficiencies claims includes, but is not limited to, detailed calculations of the quantum of efficiencies (ideally in native format), and documents supporting the inputs into those calculations. Documentation supporting efficiency claims can come from a variety of sources, including any internal analysis leading to the decision to pursue a merger. This may include internal efficiencies projections, third-party studies, and any relevant due diligence materials. Where the merging parties have relied on underlying business or operational planning models in their calculations, the Bureau will require access to these models. The Bureau will also require information related to the reliability of these models, such as information regarding the past application of these models by the merging parties (or others), and their predictive success. Any assumptions being relied upon should be clearly set out and explained in detail, including why the assumptions are reasonable (or, if asserted, conservative).

When questions relate to business rationales or integration planning, as well as internal accounting methodologies and financial analysis, it may be helpful to have relevant business people address the efficiency claims. In addition to engaging with merging parties, and experts retained by the merging parties, the Bureau also may use its own outside experts to advise on potential efficiencies arising from the merger or may test these types of efficiency claims with market contacts. Outside experts may include industry, economic or accounting experts.

The efficiencies claimed must be net of the cost of achieving them, including integration costs, severance costs, and agreement (such as lease agreement) break fees. Submissions should also clearly set out the projected timing over which efficiencies will be realized as well as when the associated implementation costs that will be incurred.

3.1 Past Transactions

Submissions will often cite synergies from past transactions of varying relevance to defend their projections. However, an analysis of a previous transaction is not determinative on its own. Such an analysis is more likely to be compelling when the previous transaction is comparable to the merger in question (or to the aspect of the merger impacted by a remedy in cases where a partial order may be sought). Analyses of synergies achieved in previous transactions are more persuasive when they include information about the methodology and data used to measure those synergies. Prior transactions that involve similar parties, are relatively recent, or involve analogous product and geographic markets will also tend to be more persuasive. Analyses of synergies in previous transactions can only support, rather than replace, efficiencies estimates based on specific integration plans arising from the transaction in question.

An assessment of management’s performance in achieving synergies in previous transactions may provide support for efficiency claims, or may raise doubts as to the likelihood that efficiencies will be achieved depending on their success rate.

3.2 Access to Key Employees

The merging parties bear the burden of proof for any claimed efficiencies and are uniquely situated to provide this information as only they have access to the information necessary to estimate and evaluate projections, including access to company employees who are responsible for planning and implementing the merger integration. Where appropriate, the Bureau may interview these employees voluntarily or through an order of the Court pursuant to section 11 of the ActFootnote 26.

3.3 Buyer Costs

Costs that would be incurred by a likely buyer of the assets related to the remedy are not considered to be efficiencies that would be lost as a result of an order. Cognizable efficiencies are those that arise through the integration of resources between the merging firms, through the act of merging. Any other costs associated with the implementation of a remedy are not forgone efficiencies that are to be counted in the trade-off as they are not attributable to the merger, but rather to the implementation of the divestiture order.

3.4 Gains from Trade

Section 96(2) requires the Tribunal to consider whether the claimed efficiency gains will result in a significant increase in the real value of exports; or a significant substitution of domestic products for imported products. To assist this analysis, firms operating in markets that involve international trade should provide the Bureau with information that establishes that the merger will lead them to increase output owing to greater exports or import substitutionFootnote 27.

3.5 X-inefficiency

"X inefficiency" typically refers to the difference between the maximum (or theoretical) productive efficiency achievable by a firm and actual productive efficiency attained. Mergers that prevent or lessen competition substantially can also reduce productive efficiency, as resources are dissipated through x inefficiency and other distortions. For instance, x inefficiency may arise when firms, particularly in monopoly or near monopoly markets, are insulated from competitive market pressure to exert maximum efforts to be efficient. Subject to availability of data, when the Bureau is considering the potential for x-inefficiency effects resulting from a proposed merger it may study previous, analogous mergers.

3.6 Cognizability Screens

Parties should explain how the claimed efficiencies pass the five cognizability screens outlined below and provide supporting evidence. The evidence required to support such claims varies between different efficiencies, and so it is important that submissions explain how each group of efficiencies claimed passes each screen. While certain of the screens could in some cases be satisfied with simple explanations, certain others will require support from the merging parties’ internal documents or analyses from the merging parties’ experts. Typically, the Bureau will ask detailed and transaction-specific follow-up questions to probe how the claimed efficiencies pass the screens.

3.6.1 Categories of Efficiencies

To be cognizable under the Act, efficiencies must be productive, dynamic or allocative. Productive efficiencies are those that lower the cost of producing a given level of output, such as plant or location rationalization, distribution and transportation savings, administrative cost savings, overhead savings, or the elimination of redundant staffFootnote 28. The majority of efficiencies raised by merging parties are productive. Dynamic efficiencies, as discussed in part 3.7, arise from the introduction of new or improved products or production processes arising from the merger. Allocative efficiencies involve an improvement in the allocation of society’s resources due to the merger. This could include, for example, output enhancing efficiencies, meaning efficiencies that result in an increase in output from the same number of inputsFootnote 29.

3.6.2 Likely to be brought about by the merger

The second screen narrows the claimed efficiencies to those that the Bureau is satisfied are likely to be brought about by the merger. Efficiencies that are uncertain or speculative may either be discounted or excluded at this stage. If some or all of the efficiencies are not “merger specific”, meaning that they are likely to be achieved in the absence of the merger, they do not pass this screen.

For example, if the party being acquired was undergoing or was likely to undergo a restructuring, certain headcount reductions claimed as efficiencies would likely have occurred absent the merger. Another example is, where the party being acquired was sold through a competitive bidding process, and the likely alternative winning bidder would not raise the same competition concerns, but would achieve some or all of the claimed efficiencies, the efficiencies that would be achieved by the alternate buyer would likely be achieved in the absence of the merger.

Where productive efficiency claims arise from transferring superior production techniques and know-how from one merging party to the other, merging parties must demonstrate that they would not likely be sought and attained through alternate meansFootnote 30.

3.6.3 Redistribution of Income

The third screen filters out claimed efficiency gains that would be brought about by reason only of a redistribution of income between two or more persons. To be cognizable under the Act efficiencies must represent a gain to the Canadian economy, as opposed to a gain to one party at the expense of another, or a “redistribution of wealth”. For example, tax savings may be a synergy that the business expects to achieve through a merger, but would not be an efficiency under the Act in some cases owing to the fact that it likely constitutes a redistribution of wealth between the merging firms and a government body. However, if the reduction in taxes is as a result of consuming fewer resources the tax reduction may pass the cognizability screen. Similarly, the ability to extract volume discounts from suppliers due merely to greater bargaining leverage is not cognizable since this is a transfer of wealth between two companies. However, if the merger results in a supplier incurring lower costs, savings passed on to the merged entity may be valid efficiencies since this would represent an actual resource saving to the economy.

Efficiencies that result solely from a reduction in output, service, quality or product choice will not be counted as they are a redistribution of wealth from the consumer to the merging parties. For example, in industries where products are delivered, if the centralization of dispatching functions results in longer delivery times or the elimination of valued services, such as emergency or next day delivery, they may not be considered as efficiencies.

3.6.4 Accrue to Canada

Under the fourth screen the Bureau will exclude efficiency gains that are achieved outside Canada, unless parties can establish that these efficiencies will accrue to Canada, for example to Canadian customers or shareholders. Savings related to operations in Canada that ultimately benefit foreign shareholders will not be accepted. Further, efficiency gains cannot simply relate to a product that is sold in Canada. The Bureau will focus on testing whether a sufficient nexus between claimed efficiencies and benefits to the Canadian economy exists.

3.6.5 Order-specific

Frequently, efficiencies relating to selling, general, and administrative expenses or overhead type savings are not “order specific” where the SPLC relates only to a particular business segment; however, the Bureau recognizes that this may not always be the case. Submissions that go beyond attributing efficiencies to a business segment based on revenue, capacity, or another general measure would be most effective to address this issue. For example, if it is claimed that efficiencies related to head office staff would be lost as a result of a potential divestiture, it is recommended that merging parties provide an analysis of why specific head office redundancies would no longer persist as a result of an order due to the specific role or reporting requirements of the employees concerned, rather than submissions based on the total claimed efficiencies prorated to the relative size of the business unit to be divested.

Lastly, it is important to note that when a more narrow remedy is sufficient to remedy the SPLC, the order specific screen may rule out a significant portion of head office and overhead efficiencies.

3.7 Dynamic Efficiencies

Mergers can create dynamic efficiencies which can offset anti-competitive effects, thus allowing an otherwise anti-competitive merger to go forward on the basis of future product or process innovation. In this context, a merger may encourage the introduction of new products, the development of more efficient productive processes, and the improvement of product quality or service.The particular set of facts will vary in each case and therefore needs to be assessed on a case-by-case basis.

Dynamic efficiencies are inherently less certain than productive efficiencies. This is particularly true where the new product or production process is highly differentiated from what already exists in the market. Certain types of information may be helpful to the Bureau's assessment of a merger's impact on innovation as they relate to, for example, verifiability, likelihood of success, and timeliness. This would include projections from documents regarding the anticipated timelines of achieving the efficiencies, the steps involved, and any risks and costs of achieving them. Further, historical information on the effect of previous mergers in the industry on similar dynamic efficiencies may be informative to corroborate the likelihood and potential timelines associated with achieving dynamic efficiencies. Such information may relate to a merger's impact on the nature and scope of research and development activities, innovation successes relating to new or existing products or production processes, and the enhancement of dynamic competition.

In merger transactions, most dynamic efficiency claims relate to complementarities. Such claims hold that the combination of different and complementary assets and/or abilities will likely result in the introduction of new products or production processes that would not likely have been achieved absent the merger. In considering the cognizability of dynamic efficiencies related to claims of complementarities the Bureau will assess the appropriability of the innovation (i.e., the extent to which the innovator will fully capture the gains from its innovation). Practically, that means the Bureau will assess how a merger creates the incentive for the merged entity to engage in certain innovative activities that the firms independently would not otherwise undertake. In that regard, the Bureau will take into consideration documents demonstrating that parties recognize the complementarities in their capabilities and have taken steps to assess the likelihood of realizing those complementarities and appropriating their value outside of a full merger.

Increased investment is not necessarily an efficiency, and can in fact result in allocative inefficiencies if the increased investment is made in the place of other opportunities that would generate greater returns to society. In order to quantify the impact of a proposed investment and/or efficiency, parties are encouraged to demonstrate the predicted impact on producer and consumer surplus. A quantification based on the cost of the investment is unlikely to be persuasive.

The same basic cognizability screens apply in assessing dynamic efficiencies as for assessing productive efficiencies, with a particular focus on the likelihood of achieving the dynamic efficiencies, and whether the dynamic efficiencies would be realized absent the merger or if an order were made short of a prohibition or dissolution of the merger.

Where quantification is reasonably possible, it should demonstrate that an innovative production process would reduce the merged entity’s costs, or that an innovative new product made possible by the merger would increase total surplus.

Paragraph 12.18 of the MEGs contains additional detail on the types of information that can substantiate dynamic efficiency claims.

Part 4: Conducting the Trade-Off Analysis

While the court in Tervita prescribed a multi-stage test with distinct steps governing the process to be followed, when the Bureau is conducting the trade-off internally, the process followed is typically highly iterative and integrated with the assessment of effects and efficiencies. In the Bureau’s experience, the trade-off may initially consist of assessing ranges of both efficiencies and anti-competitive effects. There may be a range of anti-competitive effects estimates that vary based on, for example, a reasonable range of elasticity estimates. For efficiencies, there may be ranges based on the relative certainty that each type of claimed efficiencies will be achieved in light of the evidence made available to the Bureau or information available to the merging parties’ experts at that time. The estimates are updated over time as the trade-off analysis is refined and more information becomes available, including information regarding the potential remedies.

Depending on the industry, and the assets being sold as part of the transaction, the manner in which the trade-off is conducted can vary. As a simplistic example, you could imagine a scenario where a transaction relates only to the sale of one asset resulting in an SPLC and the appropriate remedy is a full block of the transaction. In those circumstances, the appropriate estimates to compare would be the totality of the anti-competitive effects resulting from that asset being sold, with the totality of the efficiencies generated by the merger. However, in practice transactions are typically much more complex than this simple example, and so, the trade-off process will vary based on the particular assets involved. As a result, conducting the trade-off is much more nuanced in practice, and therefore will vary based on the specific fact scenario being assessed in relation to a particular transaction.

As a more realistic illustration of the trade-off, one approach the Bureau has previously taken where a merger involved multiple geographic markets was to identify the markets in which there was a likely SPLC, and then identify the anti-competitive effects and cognizable efficiencies in each of those marketsFootnote 31. The Bureau did not require a remedy in respect of the markets where the efficiencies were clearly greater than and offset the effects. To the extent that the merging parties were able to demonstrate that efficiencies outside of a particular product or geographic market will be lost as a result of an order pertaining to that market, such as for example some head-office level efficiencies, the Bureau included those efficiencies in the trade-off. This approach maximized the total surplus arising from the merger. However, in this case, the majority of both the anti-competitive effects and efficiencies were highly divisible due to the nature of the assets and geographic markets, making a local market specific trade-off analysis possible. This will not always be the case and each such assessment will require specific consideration based on the particular industry and assets involved.

4.1 Marginal Cost Savings

In some cases there may be cost reductions, or other efficiencies likely to be attained through a merger that may increase competition in certain ways, such as by enabling the merged entity to better compete with its rivals. In the case of a marginal cost reduction, there should be no “double counting” of such efficiencies when it is determined that the merger in question is likely to prevent or lessen competition substantially and a trade-off assessment is then conducted under section 96. By incorporating an explicit exception for efficiency gains, Parliament has indicated that the assessment of the competitive effects of the merger under section 92 of the Act is to be segregated from the evaluation of efficiency gains under section 96.

4.2 Anti-competitive Effects in the Trade-off

In estimating the anti-competitive effects that are weighed against efficiencies in the trade-off analysis the Bureau considers the totality of the effects resulting from the merger. The Bureau does not limit the effects included in the trade-off analysis to the portion of effects that would remove the substantiality of the lessening or prevention of competition. This approach follows the language in section 96 which refers to “the effects of any prevention or lessening of competition that will result or is likely to result from the merger or proposed merger” [emphasis added].

4.3 Temporal Differences

To enable appropriate comparisons to be made, timing differences between measured future anticipated efficiency gains and measured anti-competitive effects are addressed by discounting to the present valueFootnote 32.

Appendix A: Examples of Common Methodologies to Quantify Effects

Price-Competition Regressions

Regression analysis can be used to estimate the relationship between prices and competition, controlling for other variables that may affect prices. This approach was prominently used in the United-States Federal Trade Commission’s Staples / Office Depot case (1997)Footnote 33. Regressions comparing prices under different market conditions, such as different market structures across geographic markets or changes in market structure over time, can provide an important predictor of the effect of a merger. To calculate anti-competitive effects with this type of estimation, assumptions need to be made regarding the empirical specification of demand. This type of estimation methodology was used on files such as Canadian Tire/Pro Hockey Life, Loblaw/Shoppers, and BCE/MTS among others.

Merger Simulation

A merger simulation predicts the impact of a merger by specifying and estimating a model of the industry, changing certain parameters (most notably firm ownership) to reflect post-merger conditions, and then obtaining the implied post-merger equilibrium prices and quantities. With estimates of price and quantity changes, as well as marginal costs, changes in consumer surplus and total surplus (i.e. deadweight loss) can be calculated assuming the form of demand.

Different models can describe different industry characteristics, such as markets with firms setting prices or markets where prices are set in auctions. Differences can also arise based on how the models are estimated. Notably, patterns of customer substitution may be calibrated from pre-merger conditions such as candidate market shares or own- and cross-price elasticities may be estimated from the data.

The Bureau has used a variety of approaches, including estimating a merger simulation model in First Air/Can North/Calm Air, and Heinz/Kraft; calibrating a merger simulation model in an auction market in Iron Mountain/Recall; and calibrating a merger simulation model in a price setting market in Superior / Canwest, Couche Tard/CST/Parkland, and Parkland/Pioneer.

Appendix B: Potential Information Requirements to Quantify Effects

Information required to quantify effects will primarily be gathered through the Bureau’s investigation, including its market contacts and information provided by the merging parties, including documents and data provided pursuant to the SIR. The requirement for the Commissioner to quantify anti-competitive effects wherever reasonably possible increases the likelihood that the Commissioner will need to seek third-party information during merger reviews. The Bureau will seek information from third parties by formal means when it considers it appropriate to do so. Considerations may include the timeliness and reliability of information available by other means, and the value of the third-party information to an accurate quantification of effects.

The types of data generally sought from parties and third parties in order to quantify the effects of a merger include the following:

  1. asset and location lists;
  2. transaction level prices, quantities, costs and characteristics;
  3. customer characteristics (often found in loyalty data, e.g. age, income, geographic location, etc.);
  4. product characteristics (e.g., SKU-level differences, size and type);
  5. customer preferences (e.g. surveys and internal studies);
  6. information to estimate “diversion ratios” between firms (e.g. customer retention, win-loss data);
  7. quality measures (e.g. delivery times, customer satisfaction studies); and
  8. product and geographic market level financial statements.

This list is not exhaustive as data requirements are largely dictated by the specifics of each merger review as well as the theory of harm being evaluated.

In addition to data from merging parties and third parties, the Bureau case team will often obtain and construct data on market characteristics (e.g., distribution of relevant demographic variables) from publicly available sources (e.g., Statscan).

With respect to non-horizontal mergers that potentially raise serious competition issues, the Bureau will typically model the related markets in which the merging parties participate in order to quantify the effects of the merger.

Appendix C: Potential Information Requirements to Quantify Efficiencies

The information obtained through SIRs and voluntary requests for information may not be sufficient for the Commissioner to make an enforcement decision on a case where the merging parties are likely to claim efficiency gains. In such circumstances, it may be necessary for the Commissioner to seek an order of the Court pursuant to section 11 of the Act. The information required for this exercise varies from industry to industry and transaction to transaction, depending on the structure of the merging parties’ businesses and how they plan to integrate them.

The types of information underlying efficiencies submissions that the Bureau has received from merging parties and their experts include the following:

  • integration plans, such as presentations to the Board, including all underlying data and calculations
  • an understanding of what is driving the merger, possibly including public sources such as analyst and industry reports;
  • a detailed description of the merging parties’ assets and their locations (including relative distances between each location), capacity utilization by facility, constraints on production, and product mix;
  • where inputs are sourced;
  • headcount and information about roles and responsibilities of relevant employees;
  • the nature of expenses by facility;
  • past integrations;
  • industry specifics, such as the particulars of typical customer and supplier agreements;
  • industry models or forecasts;
  • models or other analyses that quantify the efficiencies, as well as support for the assumptions underlying those analyses; and
  • forward-looking costing (fixed vs variable) and capital expenditures.

Importantly, information from the merging parties may need to be sourced at the location or facility level.

This list is not exhaustive as data requirements are largely dictated by the efficiency claims being raised by the merging parties on a particular case.

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