United States: United States v. UPM-Kymmene Oyj: A New Emphasis on Coordinated Effects in U.S. Merger Review

In June of this year, the District Court for the Northern District of Illinois rendered its decision concerning the Department of Justice’s ("DOJ") suit to enjoin the combination of two manufacturers in the labelstock industry.¹ The decision ended a ten-month long investigation by the Department of Justice, beginning shortly after UPM-Kymmene Oyj ("UPM"), parent of labelstock manufacturer Raflatac, Inc. ("Raflatac") agreed on August 20, 2002 to purchase Morgan Adhesive Company ("MACtac") from Bemis Company, Inc. ("Bemis") for $420 million. The closing of the transaction was to occur as soon as the parties obtained the European Commission’s approval and U.S. Hart-Scott-Rodino clearance.² While the European Commission approved the transaction on October 16, 2002, the DOJ ultimately filed suit to prevent the transaction, arguing that the merger would have anticompetitive effects.

Raflatac and MACtac produce pressure-sensitive labelstock,³ which is sold primarily to companies called label "converters" for use in making self-adhesive, or pressure-sensitive, labels for a broad range of consumer and commercial labeling applications. UPM and MACtac are the second and third largest North American producers of bulk labelstock⁴ used to make pressure-sensitive paper labels for VIP and prime labeling applications,⁵ each with approximately 12 percent of 2002 sales of bulk paper labelstock produced and sold for VIP applications, and about 8 and 12 percent, respectively, of sales of bulk paper labelstock pro-duced and sold for prime labeling applications.⁶ The transaction would have left Raflatac, and fellow labelstock manufacturer Avery Dennison ("Avery") with about 70% of the sales of certain kinds of labelstock. Avery itself had about 50% of sales.

The trial before the District Court lasted approximately two weeks. The court’s analysis of the DOJ’s claims and the merging parties’ defenses addressed several issues. In particular, the court granted the government’s request for an injunction based upon the court’s deter-mination that, due to changed incentives resulting from the transaction, there was a substantial likelihood that competitors would coordinate pricing and output decisions post-merger. The court considered the significance of the merged firm’s market share, industry concentration, excess capacity, ease of entry into the labelstock industry, the vertical supply relationship between competitors, as well as the standard for preliminary relief.

In addition to the merging parties, the court specifically identified ten U.S. manufacturers of pressure-sensitive labelstock. While a twelve to eleven merger ordinarily would not be viewed by the agencies as presenting the potential for anticompetitive effects, the majority of the manufacturers were considered to be "fringe" competitors, not able to stand up to the few industry giants.⁷ Thus, the DOJ took the view that the industry should more properly be viewed as being comprised of three or four large manufacturers of bulk labelstock, with a competitive fringe of smaller manufacturers more suited to producing specialty label-stock.⁸

The court found the paper label industry at the time of trial to be "highly competitive," noting that "[t]he entry of Raflatac into the United States contributed to historically low prices and significant erosion in profitability among labelstock suppliers."⁹ Nonetheless, the district court enjoined the acquisition of MACtac by UPM, focusing on the likelihood of coordinated interaction among the three largest post-acquisition competitors—market leader Avery, Raflatac, and Green Bay Packaging.¹⁰

The DOJ claimed that the acquisition might substantially lessen competition in the market for pressure-sensitive labelstock because "[w]ith the purchase of MACtac, Raflatac will have reached its plan goal [of securing about 20 percent of the market] and will have no particular incentive to go after Avery at least for a while."¹¹

The DOJ argued that MACtac’s pre-merger excess production capacity restrains anticompetitive price increases by its rivals. Allowing Raflatac to acquire MACtac "takes the capacity out of the equation by which prices are determined."¹² The government asserted that where "there is not much excess capacity and [post-acquisition] two suppliers sell 70% of the product, [the merged company] may have the ability to raise prices and make its raise stick."¹³ The district court agreed, finding:

Although the acquisition of MACtac would have allowed Raflatac to "more effectively compete against Avery,"¹⁵ the court refused to allow a potentially harmful acquisition to alter the competitive landscape of the market. Rather, the court concluded "[i]nstead of buying market share, they can earn it the customary way."¹⁶

The DOJ alleged that UPM’s acquisition of MACtac would result in changed and aligned incentives among the various labelstock manufacturers, resulting in harm to competition. The government claimed that UPM had already altered its business plans in favor of reduced competition. In particular, "[p]rior to entering into the proposed transaction, UPM set and pursued aggressive labelstock volume growth targets"¹⁷ (in each of the past two years, UPM’s paper labelstock sales grew by more than 30 percent, and its plans called for continued aggressive rates of growth over the following years). However, the DOJ asserted that after entering into the proposed transaction to acquire MACtac, UPM abandoned its aggressive growth targets. As described in a letter to the U.S. government, UPM advised that it "projects no increases in sales growth or market share in North America for 2003 apart from those associated with the MACtac acquisition."¹⁸ The government alleged that UPM’s altered strategic plans were a result of anticipated post-acquisition alignment of incentives among the industry leaders. 

The DOJ asserted, and the district court agreed, that the merger would eliminate the incentives of both Raflatac and MACtac to behave as industry "mavericks" disciplining attempts at anticompetitive price increases. According to the government, in an effort to build a customer base and expand sales volume of its recent North American manufacturing facility, "UPM ha[d] been an aggressive and disruptive competitor . . . . substantially contributing to market- wide erosion of prices and producer profitability."¹⁹ As a recent market entrant, Raflatac had the incentive to compete with low prices in order to increase its market share.

While the defendant argued that MACtac is a "weakened and declining"²⁰ labelstock producer, the district court nonetheless recognized the pre-acquisition incentive of MACtac to also behave as a maverick, constraining coordinated pricing or output among the labelstock manufacturers.²¹ Similar to UPM, MACtac also had the incentive to compete with low prices due to its excess capacity. However, after the merger, the incentives of the combined entity would be more aligned with the incentives of its competitors. Considering the probability of post-acquisition coordinated interaction, the court concluded:

In addition, "[t]he remaining competitors all with small market shares have an incentive to go along with price increases."²³ Relying on United States v. Rockford Memorial Corp.,²⁴ the district court reasoned that three competitors, i.e., Raflatac, Green Bay and the market leader Avery, "could raise prices within a reasonable limit and avoid transaction costs and risks of exposure that might result from trying to coordinate with smaller competitors."²⁵

The DOJ also asserted that post-acquisition, UPM would have "diminished incentives" to compete for sales to "[Avery’s] customers, because it would stand to lose proportionally more business than otherwise if [Avery] retaliated by competing for UPM customers"²⁶

—rather, UPM would instead have the incentive to cooperate with Avery. "Indeed, shortly after announcement of the [proposed acquisition], MACtac’s CEO," slated to manage UPM’s post-acquisition labelstock business, "advised a securities analyst that the transaction should bring pricing ‘discipline’ to UPM."²⁷ In addition, "senior UPM officials advised at least two labelstock customers about UPM’s plans to increase prices after the transaction."²⁸

Noting the period of low prices and continually declining profit margins, the court reasoned that "[a] period of peaceful coexistence serves the interest of, Raflatac 2nd, its parent UPM, and Avery."²⁹ The court concluded, while "Raflatac 2nd and Avery will eventually go head to head on prices . . . . this will not . . . happen for at least a year, and antitrust law does not permit this period of anticompetitive conduct simply because competition will return after it is over."³⁰

The district court further recognized the increased likelihood of post-acquisition collusion due to the vertical relationship between UPM and Avery. The court found significant the fact that UPM supplied paper, the primary input into the manufacture of the relevant product, to Avery, the competitor of UPM’s Raflatac subsidiary.

UPM is a major producer of various types of paper used to produce labelstock (known as "label papers"). UPM produces label papers both for its Raflatac subsidiary and for sale to other labelstock manufacturers.³¹ In its complaint, the DOJ noted that Avery is UPM’s largest customer of label papers, and UPM is one of Avery’s largest suppliers. The government alleged that this vertical supply relation-ship provides UPM and Avery with the "motivations, opportunities, and means to coordinate on price, monitor adherence, punish cheating, and engage in side payments that can be hidden in label paper transactions."³²

The court recognized the softening of competition likely to occur between Raflatac and Avery as a result of the supply relationship between UPM and Avery, and concluded that absent the acquisition, "UPM will not have the leverage to force Avery to buy paper and, without that leverage, [will have] no reason not to compete."³³

The DOJ alleged in its complaint that prior attempts at collusion on the part of labelstock manufacturers evidenced increased likelihood of post-merger coordinated interaction. The government asserted that "UPM and [Avery] have already attempted to limit competition between them-selves, as reflected in written and oral communications to each other through high level executives regarding explicit anticompetitive understandings . . . ."³⁴

The DOJ pointed to a memo to the head of UPM’s labelstock business worldwide in which the executive in charge of UPM’s North American operations noted that his organization did not regard Avery as its main competitor. Nonetheless, as UPM expanded its North American market share, pricing erosion ensued, and UPM and Avery could not avoid clashing in the marketplace. In June 2001, in response to Avery’s complaints about UPM’s aggressively competitive behavior, a senior UPM executive who had overall operational responsibilities for both UPM’s labelstock and label papers worldwide, wrote to a senior manager of Avery:

According to the DOJ, the minutes of subsequent internal deliberations among high level UPM executives demonstrated that UPM recognized strategic value in appeasing Avery. The minutes note that UPM’s acquisition of MACtac "for [Avery] . . . would be a clearly pleasant alter-native."³⁶ In addition, minutes of a meeting among the Raflatac Americas Management Board stated "[The] Raflatac board dictates that we may follow a price decline but may not lead it. We need to gain market share on our quality and not on price."³⁷ Further, a Raflatac monthly report declared, "[t]he good news is that [Avery] seems to have taken our signal not to go below $0.20/msi [a label-stock unit price]."³⁸

The above documentary communications, along with UPM’s October 9, 2002 letter to the U.S. government projecting "no increases in sales growth or market share in North America for 2003 apart from the MACtac acquisition" appeared to evidence an abandonment of the company’s aggressive expansion goals in favor of cooperation with Avery. In light of UPM’s prior attempts at industry collusion, the DOJ viewed this change of strategy as a means of furthering UPM and Avery’s desire to bring pricing "stability" to the market. Interestingly, the district court made no mention of this evidence of prior collusion in its opinion.³⁹

The defendant’s arguments regarding ease of entry into the labelstock industry failed to convince the district court to deny the motion for preliminary injunction. The court noted the defendants’ assertion that, in the event of increased prices, some customers will vertically integrate into the manufacture of pressure-sensitive labelstock and "buy or use their own coating machines and bypass their suppliers entirely."⁴⁰ The court recognized the availability of new coating machines from a number of equipment manufacturers, as well as the wide range of coating equipment carried in stock by used coater resellers. The defendants argued that some customers "would also be able to bypass the products themselves." Defendants asserted that "[i]f paper labels become too costly, the ultimate consumer—the customers of the converter—could" turn to a number of alternatives, including "film labels, glued paper labels and, in the case of VIP labels, no label at all (the information can be printed directly on the product, e.g., the subscriber label on the cover of a magazine)."⁴¹ Notwithstanding the number of alternatives available to labelstock customers, the court concluded that customers would not switch to the alternatives in sufficient amounts to defeat a post-merger anticompetitive price increase.

In addition, while noting the availability of new and used coating equipment, the court recognized the significant barrier to entry raised by the poor economic condition of the labelstock industry, including excess capacity and "price"⁴² and "profit margins that have continually declined."⁴³ In particular, as noted above, the court found that "[t]he entry of Raflatac into the United States contributed to historically low prices and significant erosion in profitability . . . ."⁴⁴ This depressed state of the industry was a detriment to further entry which bolstered the DOJ’s claim that post-merger competitors would be able to coordinate pricing and out-put.⁴⁵

While defendants’ acknowledged that they were not espousing a "failing firm" defense, they argued that the court is permitted to consider the "weakened" and "declining" competitiveness of MACtac.⁴⁶ In response, the government asserted that while the weakened state of a competitor can be a consideration, it "’certainly cannot be the primary justification’ for permitting a merger"⁴⁷ and it "should not vitiate the standards for the failing firm or fail ing division defense."⁴⁸ In considering the defendant’s "weakened-competitor" argument, the district court noted that the reasons that companies are found to be failing are generally found in "economic conditions or management errors made in the good faith attempt to do well."⁴⁹ However, "[h]ere, MACtac is viable, and it is non-competitive simply because its parent has decided not to compete."⁵⁰

The court noted the "bad policy"⁵¹ inherent in justifying an otherwise anticompetitive merger because the parent of a viable company does not like its return on investment. Consistent with the antitrust policy of protecting competition, not competitors, the district court concluded that the company’s "declining condition will either be reversed or its slack will be taken up by other producers—the existing price competition will be diminished little or not at all."⁵²

The district court also addressed the "sliding scale"⁵³ analysis used in determining whether the government had met its burden with respect to obtaining a preliminary injunction. "[T]he Government must first ‘meet the threshold burden of establishing (1) some likelihood of prevailing on the merits; and (2) that in the absence of the injunction, [it] will suffer irreparable harm for which there is no adequate remedy at law.’"⁵⁴ Having met these requirements, the court applied the sliding scale analysis by "balancing the harms to the parties and the public interest."⁵⁵ The court balanced the government’s likelihood of success against its showing of harm as follows:

After finding that plaintiffs had shown a substantial likelihood of success, the court reasoned that "[a] wrongful denial of injunction would, for a year or more, inflict irreparable damage on consumers and, in all probability, leave us with a [merged company] that could not be divided back into the entities from which it was formed."⁵⁷ On the other hand, "[a] wrongful grant of injunction leaves [the acquiring company] no worse off than it is now."⁵⁸ Based on this analysis, the court granted plaintiff’s request for a preliminary injunction.⁵⁹

Remaining abreast of current agency thinking is critical to merger planning and litigation strategy. While the agencies for a number of years relied primarily on the unilateral effects theory of harm in preventing potentially anticompetitive transactions,⁶⁰ they have recently begun refocusing on coordinated effects as the means by which to identify transactions that will result in harm to consumers.⁶¹ The out-come of United States v. UPM-Kymmene Oyj, emphasizes the significance now attributed by the agencies to post-merger alignment of incentives and the likelihood of coordinated interaction in evaluating mergers and acquisitions. While the defendants in UPM identified a "highly competitive" market consisting of a dozen labelstock manufacturers, a handful of alternative products, and the likelihood of post-merger vertical integration into the manufacture of the relevant product by current purchasers, the defendants were unable to overcome the presumption that the combined share of capacity among the three post-merger competitors would align their incentives and result in anticompetitive consequences. The outcome of United States v. UPM-Kymmene Oyj therefore demonstrates the importance of recognizing current agency philosophy, and applying it appropriately during merger planning and analysis.

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"On August 18, 2003, [UPM] received a grand jury subpoena in connection to the U.S. Department of Justice investigation into the U.S. labelstock industry." Id.

40 UPM-Kymmene, 2003 U.S. Dist. LEXIS 12820, at *19.

41 Id. "To make labels, converters cut labelstock to the sizes desired by their end-user customers, and depending on the end-use application, may also print information or images on the labels. The labels are peeled off the release liner and then applied to various surfaces by pressure." Id. at *5.

42 Id. at *17.

43 Id. at *23.

44 Id. at *12.

45 See James Speech re Coordinated Effects ("There are many different market conditions that can facilitate coordinated interaction. In the context of merger review, of course, a fundamental issue is how one or more market conditions could interact with a change in market structure to increase the likelihood and success of post-merger coordinated interaction.")

46 UPM-Kymmene, 2003 U.S. Dist. LEXIS 12820, at *29-30.

47 Id. at *29. (quoting Kaiser Aluminum & Chemical Corp. v. Federal Trade Commission, 652 F.2d 1324, 1341 (7th Cir. 1981)) (the weakened state of a competitor "certainly cannot be the primary justification.")

48 Id. at *29.

49 Id. at *30.

50 Id.

51 Id.

52 Id. at *36.

53 Id. at *33.

54 Id. (quoting AlliedSignal, Inc. v. B.F. Goodrich Co., 183 F.3d 568, 573 (7th Cir. 1999)) (brackets in original).

55 Id. (quoting AlliedSignal, Inc. v. B.F. Goodrich Co., 183 F.3d 568, 573 (7th Cir. 1999)) (brackets in original).

56 Id. at *33-34 (quoting FTC v. Elders Grain, Inc., 868 F.2d 901, 903 (7th Cir. 1989)).

57 Id. at *36.

58 Id.

59 On July 25, 2003, the day that the district court approved the permanent injunction, UPM and Bemis terminated their agreement concerning the proposed sale of MACtac to UPM, and announced their plans to not appeal the district court decision. See UPM Press Release, UPM-Kymmene’s MACtac acquisition was rejected in the United States, June 26, 2003, available at ^{http://w3.upm-kymmene.com/gho/internet/ghointern2.nsf/News/News_1?OpenDocument&2BB2743CDB42D 4EEC2256D6F00223692_1; See also} Bemis Press Release, Bemis, UPM-Kymmene Terminate Purchase and Sale Agreement for Pressure Sensitive Materials Business Segment, July 25, 2003, available at ^{http://www.corporate-ir.net/ireye/ir_site.zhtml?ticker=bms&script=410&layout=0&item_id=43538.}

60 See, e.g., James Speech re Coordinated Effects (While "[t]he case law of Section 7 largely has developed on a coordinated effects model, and courts appear to be more comfortable addressing merger issues based upon the traditional approach … [O]ne interesting side-effect of the 1992 Guidelines has been the emergence of unilateral effects as the predominant theory of economic harm pursued in government merger investigations and challenges.")

61 Id. ("If we reach too quickly for unilateral effects theories to the exclusion of meaningful coordinated effects analysis, we might miss important cases that should be brought or craft our relief too narrowly in cases that we actually pursue.")

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