On March 19, 2018, the Federal Trade Commission (“FTC”) filed an administrative complaint to block CDK Global’s ( “CDK”) proposed acquisition of Auto/Mate. The FTC alleged that the deal would violate Sections 5 of the FTC Act and 7 of the Clayton Act. The parties to the deal abandoned the deal after being faced with a lawsuit.
CDK and Auto/Mate supply dealer management systems (“DMS”) software to franchise new car dealerships. Car dealerships use DMS software, a mission-critical business software to manage nearly every aspect of their business including payroll, accounting, financing and inventory. They track their services, prices, and other crucial functionalities. The top two DMS software providers, CDK, which had 41% and Reynolds & Reynolds (“Reynolds”), which had 29%, combined for about a 70% share of the DMS software market. The big two are the highest priced, and have similar business models, which include long-term contracts and significant initial and monthly fees for third-party applications (app) vendors to integrate with their respective DMS. Dealertrack, Autosoft and Auto/Mate also had competitive DMS offerings as well as others. Auto/Mate was a very small competitor with only 6% of the market. After the deal, CDK’s market share would have been 47%.
Despite this market structure with numerous competitors and the target firm having a very small share, the FTC believed that Auto/Mate was on the cusp of becoming a “much more important and vibrant competitor” so the market share understated its current competitive and future competitive significance. Indeed, the FTC alleged that Auto/Mate is an innovative, disruptive challenger to the two market leaders. It offers franchise dealerships low pricing, an agnostic platform for third-party applications, extensive OEM certifications, short contracts, free software upgrades and training, and a reputation for high-quality customer service. In recent years, Auto/Mate became a competitive threat in the franchise DMS market, including by specifically targeting CDK customers. Auto/Mate expanded its customer base and revenues through both aggressive pricing putting pressure on CDK’s pricing and margins. Auto/Mate was disproportionately taking customers and market share away from CDK.
Indeed, CDK’s internal documents identified Auto/Mate as a current and emerging threat. “We are so serious about acquiring new customers that we bought the DMS [Auto/Mate] that has been kicking our butts.” According to the complaint, CDK significantly increased its bid for Auto/Mate when it realized “that other well-financed, credible bidders recognized Auto/Mate’s competitive strengths and were seriously interested in buying the company,” perceiving that “if Auto/Mate fell into the hands of a well-financed buyer willing to invest additional resources, Auto/Mate would become an even more aggressive and effective competitor.” The parties abandoned the merger two days after the FTC’s complaint.
The FTC’s block of CDK’s proposed purchase of Auto/Mate demonstrates that it is willing to challenge companies that seek to acquire small nascent rivals in technology markets. The FTC viewed the transaction as part of an emerging trend of large technology firms acquiring nascent competitors to keep them from emerging as full-fledged rivals. Large technology firms have been buying start-ups or small competitors, which in some circumstances could be foreclosing the development of emerging rivals. While we believe that the FTC may take these cases seriously going forward, we also tend to believe that the evidence in this particular case led the FTC to this decision. The inquiry into whether a small nascent firm has the ability to become a stronger competitor in the future will need to be demonstrated through internal company documents and economic analysis. There needs to be some basis to determine that the acquired firm will in a short time frame be a significant competitor. Otherwise, the agencies would simply be making arbitrary decisions to block deals that shouldn’t be blocked. Indeed, there are dangers to blocking an acquisition of a start-up with a good idea. For instance, the larger company may have the wherewithal to actually help that start-up’s innovative product actually reach consumers. So, we do not anticipate that the FTC will bring many of these types of cases without the strong evidence that existed in this challenge.