The beer industry readily falls into this category, with the United States market dominated by two players, Anheuser-Busch InBev (ABI), and MillerCoors, a joint venture between South African controlled SABMiller and Molson Coors.  The pending merger between ABI the largest global beer company, and SABMiller, the second largest global beer company, will truly leave ABI in a position in which it can crush its competitors and stifle new entry.  The Justice Department has been examining the merger but only tough comprehensive action by DOJ can prevent the significant threat of Brazilian owned ABI becoming the kingpin of the market.

Using the best lawyers, economists and lobbyists money can buy, ABI has tried to engage in a slight of hand with Congress and the DOJ.  It claims that there are simply no competitive issues from this merger because it plans to divest all of SABMiller’s U.S. operations, which are held by the MillerCoors joint venture, to Molson Coors. And, while that may appear to be correct at first glance, one doesn’t have to dig too deep to pierce this façade and see major competitive problems looming in the future for the beer industry.

ABI says that they can simply sell SABMiller’s share to Molson Coors to resolve any competitive concerns raised by the transaction as the divestiture would maintain the status quo in the United States. But that is not enough under the law. As Judge Amit Mehta said in rejecting a proposed settlement and enjoining the Sysco-US Foods Merger, “Restoring competition requires replacing the competitive intensity lost as a result of the merger rather than focusing narrowly on returning to premerger HHI levels.”

Clearly, simply changing names won’t do that. Molson Coors, while a staple in the American beer industry, is a substantially smaller company than SABMiller, and it simply lacks the financial support of a large international conglomerate. The new MillerCoors will not be as strong once it is solely owned by Molson Coors, especially considering the massive debt Molson Coors will have to take on to pay for this purchase. It will also likely have to rely on ABI in order to import foreign brands that will remain owned by SABMiller but sold by MillerCoors. This means that Molson Coors’ incentives and ability to compete won’t be the same and consumers will lose.

ABI knows how to use its dominant position to make consumers pay a mighty price.  Economic studies have demonstrated that ABI and MillerCoors tacitly collude already to increase prices in lock step fashion.  But, the greatest competition threat for this cozy duopoly comes from craft beer and imports.

To stifle their opportunities, ABI has turned to a playbook of anticompetitive conduct John D Rockefeller would be proud of, marshalling a multipronged attack – cut off avenues to distribution, acquire craft beers, and limit access to outlets. To be successful and grow, craft brewers need cost effective access to retail outlets.  Independent and open distribution has been the safety valve that keeps beer markets competitive and is key to the thriving craft beer industry because it provides craft brewers access to retailers. But, ABI is the fastest growing distributor in the United States and ABI is pursuing strategies such as acquiring distributors and craft brands and implementing distributor incentive programs designed to cut off many avenues for craft brewers to get their products to retailers. Reportedly, ABI’s distributor incentive programs discourage distributors who sell ABI’s beer from selling other brewer’s beer.

Part of the purpose of enacting the Clayton Act 102 years ago was to prevent anticompetitive conduct in its incipiency – before the conduct created substantial competitive harm. Congress recognized that attacking conduct after the fact would require long drawn out litigation that would take tremendous resources and cost. This is a problem Elizabeth Warren identified, stating that antitrust regulators “are very unlikely to force the companies to break up after the fact.” This is true “even if the companies blow off the conditions” they agreed to in order to get the deal through. The Clayton Act sought to provide tools to prevent this harm before it was fully developed in part by giving the DOJ broad powers to enjoin mergers or severely restrict anticompetitive conduct through consent decrees.

That is precisely the problem in this merger. Even, if ABI changes the nameplate on the U.S. headquarters of SABMiller, opportunities for rivals will weaken significantly. Once combined with SABMiller, ABI will add control of almost a third of global beer production to its over 45% market share domestic dominance, enabling it to impose additional substantial hardships on independent distributors and small craft brewers to reach consumers in the market. Worse, once the beer market becomes more cozy, Molson Coors might start to follow ABI’s lead in its distribution strategies. The reality is that the ABI/SABMiller combination with increased global size and scale and post-merger Molson Coors with the control of a broader portfolio of beers, will both have a greater ability and incentive to restrict smaller rivals’ access to the market through acquisitions of distributors and craft brews and implementation of distributor incentive programs that make it financially unattractive for distributors to carry rival brands.  Accordingly, the increased ability and incentive to foreclose smaller and new rivals are merger specific concerns that should be weighed by the Justice Department.

ABI has already secured approval of the merger in all the major jurisdictions except the United States and China. Other jurisdictions, like the E.U. and South Africa, placed extensive conditions on the companies, and forced them to agree to much more than ABI originally intended. For example, the E.U. secured divestitures of $8 billion in assets over ABI’s initial $2 billion proposal and South Africa required a number of remedies to specifically protect the South African craft brewer industry.

American antitrust enforcers need to be just as tough.  DOJ needs to impose remedies to keep the market functioning and competition flourishing. Here, the Justice Department should not simply accept ABI’s divestiture proposal as a remedy when vertical foreclosure concerns exist.  Thoughtful remedies would include a requirement for ABI to divest its ownership of distributors, so that distribution can continue to be run by independent companies who sell what consumers want, not what big brewers tell them to sell. The Justice Department should also seek remedies that would prohibit or limit ABI’s and MillerCoors’ ability: to terminate or acquire distributors; to acquire craft brewers; to use distributor incentive programs that create economic disadvantages or make it financially unattractive for them to distribute rival brewers’ beer; to retaliate or discriminate against distributors for distributing rival brewers’ beers; and to engage in other conduct that would foreclose rival brewers’ ability to distribute their products to retailers.

As the Justice Departments works toward a settlement agreement with ABI, it needs to heed Senator Warren’s warnings on large monopolists and their ability to crush competitors and lock out small rivals and new entrants.  This deal must be remedied correctly to protect beer customers because as Senator Warren understands, a merger is forever.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

A straightforward merger between the two would raise antitrust alarm bells that would awaken the dead.  Together, the companies control over 70% of the U.S. market by volume and 65% of the market by sales value.[1]  Recognizing such a deal would be a nonstarter, ABI has suggested that any competitive concerns in the United States will disappear because MolsonCoors will acquire control of the MillerCoors joint venture.  Of course, the DOJ has become increasingly skeptical of negotiated attempts to restructure a market to resolve competitive concerns for deal approval – recently rejecting a massive divestiture in Comcast/Time Warner — and as we explain below they should do the same in this deal unless there are substantive amendments.

There is a tremendous amount at stake in this merger.  The increased size and scope of ABI on a global basis will likely have effects in the U.S. market.  Molson Coors taking over the control of the MillerCoors portfolio may also result in significant changes in how the business operates today.  Moreover, economic studies have shown a simple truth – increased beer consolidation leads to higher prices.[2]  The recent expansion of the high end U.S. craft beer market is remarkable in light of the 2007-2008 big brewer (ABI and MillerCoors) mergers thanks to a robust and independent distribution market which has facilitated the explosion of craft beer entry.[3]  But the craft beer segment is increasingly threatened by ABI’s acquisitions of independent craft brewers and increasing efforts to cut off distribution of competition brands within the ABI aligned distribution channels.  Not only is ABI the largest U.S. brewer, it is also the largest U.S. distributor – currently controlling over 135 million cases with $3 billion in sales across distributorships in multiple states.[4]

Regardless of the public facing attempts to firewall antitrust issues, the proposed acquisition threatens competition in wholesale beer distribution and input markets to brewing and packaging.  This deal produces far more competitive issues than ABI’s acquisition of Groupo Modelo, which was challenged by the DOJ.  At the time, Groupo Modelo commanded only 7% of U.S. market share.[5]

Consumer Harm

There is a simple truth borne out by history.  Beer mergers harm consumers.   In this case, the merger is presumed illegal under the Horizontal Merger Guidelines.[6]  The antitrust enforcement authorities measure market concentration using the Herfindahl-Hirschman Index (“HHI”).  A market with an HHI over 2,500 is considered highly concentrated and a transaction that increases HHI by more than 200 is presumed to be likely to enhance market power.  The HHI of the beer market as of 2014 is 2,751 and the acquisition of SABMiller by ABI would increase that HHI by 2,998 if there are no divestitures.[7]  Even with divestitures it would only take less than 3 points in market share gain for ABI to pass the 200 HHI threshold.

It is difficult to understate these competitive concerns.  In 2008, the DOJ permitted Miller and Coors to form a joint venture.  A careful and thorough econometric study has demonstrated that, since then, tacit collusion between ABI and Miller/Coors has increased over time, substantially increasing the cost of beer to consumers.[8]  The study discovered that prices were stable leading up to the consummation of the joint venture but the prices of ABI and MillerCoors sharply increased after the merger.  The study concluded that tacit collusion best explained the price data.

This tacit collusion is likely to increase now that Molson will take ownership of MillerCoors.  At least with the joint venture, there were two equal voting partners to keep each other honest.  Now, that Molson is taking over MillerCoors, its management incentives may change.  Both Molson and ABI will have significant debts as a result of these acquisitions and could face pressure to increase prices.  Additionally, the U.S. market may exhibit even more characteristics of a duopoly now that MillerCoors is united under a single leadership, meaning that MillerCoors may be more likely to follow ABI on its strategies including price, dealings with suppliers, and dealings with distributors.

Harm to Craft Brewers

One of the biggest concerns of the proposed merger is whether it will lead to a decrease in small brewers’ access to distributors.  The beer market in the United States is a predominantly a three tiered system because state regulation in most states generally requires that the brewer sell to a distributor who then sells to retailers.  This distribution has become the safety valve that keeps beer markets competitive – as the DOJ demonstrated in its challenge to ABI/Modelo, “[e]ffective distribution is important for a brewer to be competitive in the beer industry.”[9]  However, large companies can use their market power to exert a tremendous amount of influence over what beer brands distributors carry.

This is important because ABI and MillerCoors have so far pursued different strategies when it comes to their dealings with distributors.  ABI has pursued a strategy of exclusivity, and has in the past given more favorable terms to distributors who only sell brands owned by ABI.  The 100% share of mind strategy has led ABI to pressure distributors to drop other brewers’ brands.[10]  Recently, the DOJ opened an investigation into ABI’s practices and acquisition of two distributors in the San Jose and Oakland markets.[11]  On the other hand, to date, MillerCoors has been more tolerant of its distributors carrying rival brands.[12]  However, there are no guarantees or provisions in this deal to even require this open practice to remain in place.

In fact, there is a good chance that a 100% Molson owned MillerCoors will follow ABI’s lead in its dealings with distributors.  A Molson owned MillerCoors may have new incentives to adopt different policies towards distributors.  Before the MillerCoors joint venture, SABMiller and Molson Coors successfully shared distributorships and recognized the importance of being open to many suppliers.  Likely, they chose this strategy, because each had relatively small market share compared to ABI.  MillerCoors kept this same strategy as it was under the management of SABMiller and Molson.  Given the change in management and Molson’s new increased size and scope in the U.S. market, Molson’s management may have different incentives.    For example, Molson could change its policy and pressure distributers to stop carrying white beers that compete with Blue Moon, which Molson will get U.S. rights over in this deal.

This problem is further compounded by the fact that ABI is currently the largest distributor in the United States, with $3 billion in sales and 135 million in case volume, and the largest beer supplier with 44.7% of the market.[13]  After the transaction, Molson will have monolithic control over 26% of beer sales.  That’s more than the next 8 largest brewers combined.

Abusive Buyer Power

ABI’s new global scale gives it increased leverage over commodities used in brewing and many other facets of the beer industry that could affect competition in the U.S. market.  ABI and SABMiller are responsible for 21% and 9.6% of world beer production respectively.[14]  The proposed merger would greatly increase ABI’s buyer power by potentially controlling over 30% of total worldwide beer production.[15] The combined ABI –SABMiller entity would have 58% of the global beer profit pool which far outweighs its next closest global competitor Heineken (11%).[16]  Antitrust enforcement agencies are increasingly looking at buyer power and leverage when examining deals.[17]  Abusive buyer power can harm not only input sellers, but also other buyers.

Smaller buyers can be disadvantaged by abusive buyer power due to the “waterbed effect.”[18]  A powerful buyer demanding lower prices or other concessions from suppliers can cause suppliers to increase prices to smaller buyers or otherwise worsen their terms.  The beer industry is particularly vulnerable to waterbed effects due to capacity issues of many inputs involved in the brewing and packaging of beer.

Can maker, Crown Holdings, has recently reportedly dropped both new and existing small craft beer customers and lengthened lead times, implying that they are becoming capacity limited.[19]  Hops shortages occur frequently.  Hops can only be grown in a limited geographic area and requires a lot of water to grow.  Hop growing also has high startup costs and high quality hop plants can take years before they hit full production.  These factors lead to frequent hops shortages that disproportionately impact craft brewers.[20]

Hops come in many varieties that can be roughly divided into two categories: bitter hops used in traditional lagers and aroma hops used predominantly by craft brewers to make more flavorful beers.  ABI is a powerful buyer in the bitter hops market, which is highly commoditized, but does not yet have much market power in the aroma hops market.[21]  The deal could depress prices in the bitter hops market due to ABI’s buyer power and other purchasers who put pressure on their suppliers to compete with ABIs lower costs.  An interesting side effect of this could see more U.S. farmers abandoning the bitter hops market in favor of more profitable aroma hops, further decreasing the ability of other buyers to compete on lager style beers.[22]

ABI’s increased buyer power means that it is more likely to get the inputs it wants, in the quantities it wants, and at the terms it wants.  This is likely to disadvantage input providers, as ABI is notorious for demanding extremely favorable terms like 120 day payment terms.[23]  ABI’s increased monopsony power could also mean worse terms for every other buyer in the market, not just because suppliers may need to raise prices to make up lost profits, but because it may be necessary due to capacity issues.  Smaller buyers could experience delays, poorer terms, or even unavailability.  ABI would also be able to exert its buyer power strategically to disadvantage rivals in this way.

The Proposed Remedies Are Inadequate

Mergers and acquisitions are subject to the Section 7 of the Clayton Act, which prohibits the acquisition of stock or assets where “the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.”[24]  Mergers and acquisitions that would ordinarily violate Section 7 can sometimes proceed if a remedy is crafted that would restore the competition lost.[25]  But the law is unequivocal that any remedy must fully restore the competition lost from the merger.  Structural remedies, such as divestiture, are preferred over behavioral remedies.[26]

Typically, merging companies work with antitrust enforcement agencies to identify areas of concern and agree to appropriate remedies to ensure that the merger can proceed without harming consumers.  Unfortunately, this has not been the case with ABI.  ABI proposed inadequate remedies after its announced plan to purchase Grupo Modelo.[27]  The DOJ had to take ABI to court in order to obtain adequate remedies.  Like here, ABI believed that all problems could be solved simply by selling Modelo’s share of Crown to Crown’s joint venture partner Constellation.[28]

The proposed remedies in this transaction, like Modelo, simply aren’t enough to prevent a disastrous loss of competition.  There are two simple and compelling reasons.  First, no remedy would be complete that did not fully maintain independent distribution and prevent ABI from attacking independent distribution in the future.  ABI’s control of distribution, through ownership and exclusivity arrangements, greatly jeopardizes competition, limits the rivalry of craft beers and leads to higher prices.  This is a problem that many states recognize by prohibiting brewer ownership of distributors.  Craft brewers especially need access to distributors in order to innovate, enter and thrive.  Any remedy should include the sale of ABI owned distribution, a prohibition on exclusivity pressures on distributors, and a moratorium on distributor purchases.  Molson’s purchase of the remaining share of MillerCoors should also be conditioned on remedies that protect independent distribution.

Protection of the distribution channel has already proven to be essential in beer mergers.  In the Modelo transaction, the DOJ imposed conditions on ABI that included barring ABI from using a Distributor Incentive Program to harm Modelo and giving Constellation the right to transfer rights of distribution for Modelo beer from ABI owned distributors to distributors of their choosing.[29]  The judgment also increased reporting requirements for future acquisitions.[30]

Additionally, ABI and Molson will command even greater positions as worldwide input buyers.  As the dominant buyers they will be in the cat bird’s seat, able to manipulate these markets to raise costs to rivals, particularly craft brewers.  This has an immediate impact on the bitter hops market, which will be dominated by ABI and Molson.  ABI and Molson will be able to command the prices and terms they want on a greater percentage of the worldwide hops yield and other competitors will face higher costs impairing their ability to compete.  This problem will be exacerbated by future supply constraints.  Any remedies should take account of this increased purchasing power.

Sometimes the right answer is to say no.  That’s the right answer for the DOJ in this case to the deal as currently proposed.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com