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More and more, merging parties argue that their merger does not raise competition concerns because they are not each other’s closest competitors. Parties have advanced this argument even in markets where there will be only two or three remaining firms post-transaction, including the merged firm. This argument is not new, and it often misunderstands merger analysis.

For any merger involving direct competitors – firms that are actively bidding against one another or vying for the same customers – the key question is whether the elimination of competition between the merging parties increases opportunities for anticompetitive unilateral or coordinated conduct in the post-merger market. While removal of the closest competitor likely eliminates the most significant source of competitive pressure on the merging firm, the Bureau’s analysis does not end merely because the merging parties are not each other’s most intense rivals. Instead, the Bureau routinely examines mergers that do not involve the two closest competitors in a market because a merger that removes a close (though not closest) competitor also may have a significant effect on the competitive dynamics in the post-merger market—that is, it too may “substantially lessen competition” in violation of Section 7. This is consistent with the discussion in the Horizontal Merger Guidelines § 6.1 regarding competition between differentiated products, and is especially true if the acquired firm plays the role of a disruptor or innovator in the market. These firms often ‘punch above their weight,’ having an out-sized impact on market dynamics despite a small market share.

For more recent real world guidance, merging parties need look no further than two of the Commission’s recent merger challenges: In re CDK Global, Inc. (CDK) and In re Otto Bock HealthCare North America, Inc. (Otto Bock). Last year, the Commission challenged the proposed merger of CDK and Auto/Mate, providers of dealer management systems for car dealerships. As the Commission stated in its Complaint, CDK and Reynolds & Reynolds were the two dominant players in the U.S. market, while Auto/Mate was an “innovative, disruptive challenger” that engaged in aggressive pricing. Although Auto/Mate was far from being CDK’s closest competitor, the Commission nonetheless determined that Auto/Mate was poised to become an even stronger competitive threat in the future and that existing, current competition between the parties understated the most likely anticompetitive effects of this transaction. After the Commission issued a complaint and authorized staff to seek a PI, the parties abandoned their transaction.

Even more illuminating is this year’s Commission Opinion analyzing Otto Bock’s acquisition of Freedom Innovations, two manufacturers of microprocessor prosthetic knees (MPKs). Similar to Auto/Mate, Freedom was a smaller, but more innovative and aggressive competitor than the two larger prosthetic manufacturers, Otto Bock and Össur. Otto Bock argued that the transaction was unlikely to result in competitive harm because Össur, not Freedom, was its closest competitor. The Commission disagreed, emphasizing in its Opinion that, “a merger can cause unilateral effects even if the merging products are not each other’s closest competitors” and noting that it is sufficient if “a significant fraction of the customers purchasing that product view products formerly sold by the other merging firm as their next-best choice”—and that a “significant fraction . . . need not approach a majority.”  Applying this principle, the Commission found sufficient evidence of closeness of competition because Otto Bock and Freedom competed vigorously before the merger and, at the time of the acquisition, Freedom was preparing to introduce a new MPK that it expected would take significant share away from Otto Bock.

As the CDK and Otto Bock matters demonstrate, parties that continue to focus on showing that the merging firms are not each other’s closest competitor may be ignoring the full analysis necessary to convince the Bureau and the Commission that the merger does not raise competitive concerns. Because that fact is not dispositive, counsel should address all the ways in which the parties are important competitive constraints on each other (or other market participants) such that the merger, by removing this constraint, would allow the merged firm to raise prices, reduce quality, reduce innovation, or coordinate more effectively with remaining competitors. Merger review is not so myopic as to dismiss the impact of all but the closest competitor.