EC Approval Of Sony BMG: A Textbook Merger Review

In 2000, the European Commission voiced serious objections to a proposed merger between EMI and Warner Music. Yet a few weeks ago, stories began circulating that the Commission was prepared to approve

In 2000, the European Commission voiced serious objections to a proposed merger between EMI and Warner Music. Ultimately, the parties pulled out of the transaction, so the Commission's apparent determination to block any deal was never put to the test.

Yet a few weeks ago, stories began circulating that the Commission was prepared to approve a very similar proposed merger, this time between Sony and BMG, without any conditions.

Stephen Kinsella is the head of the Brussels office of international law firm Herbert Smith. He is also the founding editor of the EC Merger Control Reporter, published by Kluwer, and is chairman of the International Bar Assn.'s Antitrust and Trade Law Committee. Much of his work involves advising corporate clients on European competition law and representing them before the European Commission and the European Courts.
This development prompted talk of "U-turns" and howls of protest, in particular from the independent record companies' trade association, Impala. It noted that the Commission had addressed to Sony and BMG a confidential (but inevitably, heavily leaked) Statement of Objections.

The main charge in that document was apparently that reducing the number of majors from five to four would unacceptably limit competition, because the remaining majors would have the ability and incentive to align their prices. Also, it was claimed that any decision to clear Sony BMG would be inexplicable by reference to the earlier stance adopted toward Warner and EMI.

These criticisms were wrong on two fronts. First, they demonstrate a serious misunderstanding of the process by which the Commission analyzes mergers. More fundamentally, they ignore that the Commission's merger review has to be based on the facts and economic circumstances at the time, as well as the applicable legal standards, so that a past case can never be a wholly reliable indicator as to future decisions.

Dealing first with the process: Whenever the Commission wishes to conduct an in-depth review of a case -- which in turn means that one possible outcome is always a blocking decision -- it is obliged under its procedural rules to set out in writing all possible problems with the deal. These are sent to the parties in the form of a Statement of Objections, and that document always includes the Commission's "worst-case scenario."

However, the Statement of Objections is only a preliminary view, and the Commission continues examining the market, listening to the views of the parties involved and opposing third parties, and gradually defining or discarding theories.

Therefore, every Statement of Objections reads as being highly critical of the proposed deal. The fact that such documents are often selectively leaked can add to an impression that the deal is in trouble. That was true of Sony BMG, even though anybody watching closely could see from a very early stage that the merger was not likely to be blocked.

In fact, Sony BMG can be seen as a textbook example of how the procedure should work, which is that the Commission sets out the possible difficulties but continues its objective analysis and ultimately concludes that the merger will not significantly harm competition. In no sense could the ultimate clearance be described as a "U-turn."

The more interesting question is what had changed between 2000 and 2004. There are really two answers. First is that the underlying market circumstances altered significantly. Piracy is impacting sales to a far greater extent than had been accepted in 2000. The harm already caused by commercial piracy of CDs has been dwarfed by the explosion of illegal downloading, facilitated by high-speed Internet access and file-sharing software.

Record companies' sales have dropped significantly, and all are having to engage in heavy cost-cutting. To the EC, it no longer looked as though a merger of any two of the companies could automatically pose a serious and immediate threat to competition.

The second development that fundamentally improved the prospects for the merging parties is the increased interventionism of the European Court. Prior to 2002, the Commission regularly made suspect decisions, secure in the knowledge that any appeal would take years (by which time the deal in question would be dead) and was unlikely to succeed.

That changed in 2002, when the Court issued three judgments overturning Commission merger decisions. It cannot be entirely a coincidence that since those judgments, the Commission has not blocked a single merger.

In its rulings, the Court was highly critical of the Commission's reasoning and underlined that where the Commission did wish to block a transaction, it carried an extremely high burden of proof to demonstrate convincingly that competition would be significantly affected.

Essentially, what happened with Sony BMG was that the Commission case team did a thorough job and concluded that even if some concerns might be expressed, there was no compelling evidence to justify prohibiting the merger.

And that is exactly how it should be. In 1989, when the European Commission was given, after much debate, the exclusive power to vet pan-European mergers, serious limitations were imposed upon its power to do so. Underlying those restrictions was a presumption that mergers are a "good thing" because they encourage investment and lead to efficiencies and economies of scale.

Of more than 3,000 mergers that have been investigated by the Commission since 1989, fewer than 20 have been blocked, even if many others were allowed subject to conditions.

A key feature of the music market is that success is so unpredictable and ephemeral; new bands and artists are constantly emerging, and continued success depends on the ability to identify and nurture new talent.

It is therefore not surprising that the Commission should have been ultimately skeptical that a simple increase in market share would mean that one of the majors would suddenly be able to dominate the market, dictate terms to everybody else and be sure of the public's willingness to choose its records over all the alternatives.