On June 5, 2018, the Federal Trade Commission (“FTC”) announced that Northrop Grumman’s (“Northrop”) $7.8 billion acquisition of aerospace and defense contractor Orbital ATK, a vertical merger that combined a supplier with its customer, could proceed so long as the Northrop agreed to certain behavioral remedies.
According to the complaint, Northrop is one of four companies capable of supplying the U.S. government with missile systems, including tactical missiles, strategic missiles and missile defense interceptors. Orbital ATK is the premier supplier of solid rocket motors (“SRMs”), which propel missiles to their intended targets and are an essential input for missile systems. The FTC’s complaint alleges that Northrop’s proposed acquisition of Orbital ATK would have reduced competition in the market for missile systems purchased by the U.S. government, resulting in less innovation and higher prices. The FTC was concerned that Northrop could raise prices on the motors on competitors or withhold them altogether, both of which the agency said would give the merged firm a clear advantage for missile contracts. Additionally, “the acquisition creates a risk that the proprietary, competitively sensitive information of a rival (solid rocket motor) supplier supporting Northrop’s missile system business could be shared with Northrop’s vertically integrated SRM business.”
To resolve the vertical competition concerns, the FTC required several behavioral or conduct remedies. First, Northrop was required to supply SRMs to competitors on a non-discriminatory basis. Second, Northrop was required to separate the operation of its SRM business from the rest of the company’s operations with a firewall. Third, the settlement agreement provides for the U.S. Department of Defense (“DOD”) to appoint a compliance officer to oversee Northrop’s conduct pursuant to the settlement. Fourth, the FTC required the merging parties to implement a compliance program and create regular compliance reports, to be submitted to the FTC, the DOD and the compliance officer. The FTC said that by ensuring that other missile suppliers can continue to compete, the settlement preserves the procompetitive benefits of the transaction while addressing the potential anticompetitive harms.
The FTC noted that while the Bureau of Competition typically disfavors behavioral remedies, given the special characteristics of the defense industry, it accepted such a remedy. Specifically, the defense industry has a single buyer, DOD, with distinct procurement processes. In addition, the DOD requires sophisticated products, such as SRMs, that are a part of complex systems subject to winner-take-all competition for programs that can last decades. Because they can last decades, the consent decree term is 20 years. The Bureau of Competition has issued a statement accompanying the decision that explains in more detail the context for the remedy and how it will preserve the procompetitive benefits of the transaction while also addressing the potential anticompetitive harms.
The enforcement action illustrates that, despite the FTC’s preference for structural remedies, the FTC is willing to consider conduct remedies in vertical deals under certain circumstances. In particular, the FTC put a lot of weight on the fact that the federal government, the DOD, was the buyer. The DOD has a lot leverage in negotiations and supported the transaction so that made the FTC more willing to accept behavioral conditions. It is also worth point out that the FTC will not be the one monitoring compliance rather the DOD will be involved in the day to day monitoring of the behavioral conditions. Efficiencies from the vertical combination also appear to be an important factor in the FTC’s review as it stated that the behavioral conditions will preserve the procompetitive benefits of the transaction.