Capabilities: the next step for the economic construction of competition law

US and EU competition laws embody incomplete provisions. Both sets of rules implicitly or explicitly rely on economic insights for the construction of the law. In the US, a ‘Consumer Welfare’ (‘CW’) standard helps draw the line between lawful and unlawful business conduct and transactions. EU competition law relies on an ‘effects based approach’. The US economic rule of construction favours defendants in antitrust cases. The EU rule yields less deterministic outcomes. US antitrust law has been influenced by the Chicago School, EU law is post-Chicagoan. Both are economics-minded.

Recent years have witnessed calls to abandon the economic construction of competition law. In the US, ‘structuralists’ want to revive per se rules against business conduct or transactions that limit the number of firms engaged in market competition, regardless of effects on CW. In the EU, ‘formalists’ want to limit the economic investigation of the effects of business conduct or transactions on market competition by recourse to presumptions of monopoly power or per se conduct bans. Both views favour a ‘pro enforcement’ philosophy. The belief of reformers on both sides of the Atlantic is that societies are better off with simpler and tougher enforcement of competition law.

Rolling back the economic construction of competition law represents intellectual regression. However, maintaining the economic construction of competition law still leaves unfinished business. Two examples drive the point home. First, competition law lacks a framework protecting the entry of new firms with high dynamic efficiency or new product innovation potential. Under current abuse of dominance doctrine, monopolists can lawfully foreclose entrants that investors do not allow to price based on their lower costs at the long-term minimum efficient scale (‘MES’). Except for well-funded entrants like Amazon, Uber, or OpenAI, nascent rivals remain at the mercy of dominant firms’ financial, reputational, or rent-seeking exclusion.

Second, competition might benefit from a merger rule that recognizes ‘innovation potential’ from a transaction. Under current doctrine, merger agencies study prospective losses of ‘innovation competition’. The accepted intuition is that bringing several rival innovation processes within a single firm weakens incentives to maintain all of them. The magnitude of that effect depends on the closeness of the parties’ innovation trajectories. But mergers can enable a pro-competitive reallocation of (non-sunk) resources to invention or to innovation adoption. Unfortunately, few firms risk raising these issues as a defence in merger proceedings. And when they do, the innovation gains from mergers are often deemed immaterial.

What appears to be missing from the economic analysis deployed in antitrust and merger cases is a fine-grained study of competing and merging firms’ capabilities. In the single firm conduct scenario, the relevant question that the economic construction of competition law ought to ask is whether excluded rivals possess demonstrable product building and technological design potential. In the merger case, what is needed is inquiry into whether one or more of the parties have an established track record of reorienting innovation processes, moving resources around, or scaling products.

All these issues and many others fall into are what business and management scholars discuss under the rubric of ‘capabilities’. Ordinary capabilities are firm specific competences, skills, knowledge, and experience that complement capital equipment. They include activities like new product development, alliancing, and brand and demand building. Dynamic capabilities are also firm specific. But instead of making and delivering products, these capabilities are critical to figuring out what products and services to offer now and in the future. These are the capabilities that help drive companies to invest or disinvest and to release or redeploy assets. Ordinary and superordinary capabilities are embedded in best practices, routines, and protocols. For example, firms have guidelines for planning, acquiring, and integrating target companies. Dynamic capabilities may not be as codified. For example, managers of acquisitive companies embody valuable tacit knowledge about the selection of M&A targets.

Firm-level capabilities are the omitted variables of the economic approach to competition law. The concept is neither new nor nebulous. A whole intellectual subfield in business and management science has developed theoretical and empirical tools to study firm-level capabilities, whether ordinary, superordinary, or dynamic.

But would a study of firms’ capability profiles change anything in antitrust practice? The costs of increased diagnostic accuracy may sometimes exceed its benefits. And, as we often hear, there is no definitive evidence that competition cases would be decided differently if a capability lens was introduced. The paucity of evidence is, however, not fatal. The Herfindahl-Hirschman Index (“HHI”) index did not exist when antitrust agencies and courts started to focus on economic concentration. And yet, a large consensus supported the introduction and development of analytical tools to improve the evaluation of product market competition. The field ended up with HHIs and critical ranges for merger control.

Besides history, old merger decisions like Facebook/Instagram or Google/DoubleClick are contested today precisely because the fact-finding process did not focus on firm-level capabilities. The analytical framework centred the investigation on only one part of the question: does the target have an actual or potential (competing) product? By contrast, there was cursory engagement with the other important issue: does the target have a viable business model, the management team, and the financial resources to grow absent the merger? These sins of omission undermine the legitimacy of contemporary merger interventions in cases like Adobe/Figma, Facebook/Giphy, or Amazon/iRobot.

The costs of capabilities evaluations need not be a barrier. Antitrust institutions routinely practice some kind of informal capability analyses when they select suitable purchasers for divested assets in merger cases. There is much learning in the study of merger divestitures as a possible proof of concept for introducing or improving capability assessments in antitrust law.

Today’s conversations around competition policy are conservative. Too often, so it seems, there are calls to restore approaches discredited by historical economic evidence like structural presumptions. The better approach is to incrementally raise legal certainty, rationality, and legitimacy by opening a process of disciplined heterodoxy, as competition law did when it imported price theory, transaction cost economics, game theory, and behavioural economics. This time, the natural progression lies in importing the business and management science literature on organizational and managerial capabilities. What ought to result is an approach which is rooted in real-world competition. The economic construction of competition law is dead. Long live the economic construction of competition law.

Author notes