The Path to Profitability: Reinvigorating the Neglected Phase of Merger Analysis

Abstract

This article reviews every litigated federal merger case since 1992, when the federal enforcement agencies revised the entry section of their merger guidelines. This review, unprecedented in the literature, shows that courts continue to neglect the entry phase of merger analysis, the phase that addresses whether, if the merged firm raised prices, new firms would enter the market and restore competition. In determining whether new entry is likely, most courts do not ask whether it would be profitable, but whether the market is protected by entry barriers. This “yes or no” approach is flawed, for all markets have some barriers and the real question is whether the barriers are so high that an investment in entry would not pay off.

While some commentators suggest that the issue is beyond the capacity of generalist judges, we believe that courts simply need a firmer grasp of the underlying economics and a more practical methodology for assessing the profitability of entry. To that end, this article summarizes the relevant economics and proposes a new approach to litigating the issue. If defendants contend that entry is easy, they would have to identify a “path to profitability” – a concrete business plan that would enable a new entrant to achieve profitability and drive prices back to the competitive level within a reasonable time period. This new requirement would place the emphasis where it belongs: on whether the prospects for financial success are sufficiently encouraging to entice a substantial new player into the market, correcting the competitive problem.

Keywords: mergers, entry barriers, antitrust law