The EU’s Draft Merger Guidelines and the “Innovation Shield”: Never Judge a Shield by its Cover?

Introduction

The European Commission’s draft merger guidelines represent the most significant overhaul of EU merger control in two decades. Their ambition is broad. They incorporate policy objectives like competitiveness, resilience, and sustainability, refine the treatment of efficiencies, and extend the analysis to labour markets. However, their most striking feature is an overwhelming focus on innovation and dynamic competition. The draft distinguishes between mergers’ “direct” and “dynamic” effects, builds the architecture of competitive assessment around concepts central to innovation (such as capabilities), and acknowledges that mergers can be justified by benefits to innovation.

Among the draft’s novelties is the so-called “innovation shield”. In brief, the innovation shield exempts startup acquisitions from merger intervention, subject to a few conditions. At first glance, the instrument reads as a response to the well-rehearsed concern over “killer acquisitions” – transactions in which a large acquirer purchases a smaller target to terminate its operations and pre-empt future competition. On closer inspection, that reading is misleading. The shield does signal a softer stance toward startup acquisitions, but its scope is circumscribed by criteria that considerably limit its reach. Most importantly, the usual suspects of a killer acquisition claim like dominant incumbents and digital “gatekeepers” cannot hide behind the shield. Their acquisitions are likely to be examined under a different and stricter “entrenchment” standard. Read together, these provisions transform the innovation shield from a killer of the killer acquisition theory into a tool that primarily facilitates scale-ups and catch-up acquisitions by emerging firms, while the entrenchment standard works at the opposite end by tightening scrutiny over acquisitions by leading incumbents.

This post unpacks the innovation shield as it appears in the draft, shows how its scope is mostly limited to acquisitions that enable smaller firms to scale up, and explains why the firms most associated with killer acquisition concerns are likely to fall within the entrenchment standard instead. Together, the two instruments point to a shift in merger policy: the concerns with startup acquisitions, especially in the digital sphere, are moving from a worry of target death to a concern over acquirer entrenchment.

Looks Can Be Deceiving

On its face, the innovation shield is a straightforward mechanism. The draft Guidelines provide that it exempts the acquisition of a “small innovative company” from intervention “in relation to any theory of harm” in a few specified circumstances. Once one reads into those circumstances, however, the mechanism becomes more convoluted.

First, the shield will apply if “none of the merging parties are currently active or, through their R&D project(s), expected to become active in the same relevant market, in the same innovation space, or in a relevant market or innovation space that is vertically or otherwise closely related”. One may be forgiven for reading this as conferring protection for conglomerate startup acquisitions. That reading would be mistaken. The reference to “innovation spaces” – a concept the Commission has deployed in cases such as Deutsche Börse/NYSE, Dow/DuPont, and AbbVie/Allergan – invites a forward-looking analysis that often projects competitive overlaps up to a decade. A conglomerate acquisition today may therefore generate overlaps in innovation spaces tomorrow, in which case the shield falls away. The further qualifier that the shield may not apply where the parties are “expected to become active in a relevant market or innovation space that is vertically or otherwise closely related” compounds the problem. The phrase “closely related” tracks the Commission’s reasoning in Booking/eTraveli, and one cannot discount the possibility that acquisitions designed to expand a firm’s ecosystem will be characterized as “closely related” and thus excluded from the shield.

Second, the shield will apply where “the transaction leads to an overlap between one party’s R&D project and another party’s existing activities”, provided that “(i) the merging parties do not have a market share (individually or combined) of more than 40% in the relevant market, and (ii) there are at least three other firms with R&D projects that are independent from the merging parties with competitive potential similar to those of the merged entity”.1 The logic for assessing these pipeline-to-existing mergers is structural: provided the market continues to host a sufficient number of viable competitors (here, three) and the parties do not become dominant in a structural sense, the acquisition benefits from the shield. There is, however, a further caveat. Where the transaction concerns “a start-up with an R&D project, and the acquirer being an existing firm with market presence, even if the criteria above are not met, the acquisition can still benefit from the innovation shield if the acquirer is not the largest firm in the relevant market or a gatekeeper”. This narrows the shield in some cases and expands it in others. A gatekeeper or “the largest firm in the relevant market” can only invoke the shield if the structural criteria are met; conversely, where a non-leading firm acquires a startup with an R&D project, the shield applies even if those structural criteria are not. The provision thus reads as a deliberate facilitator of scale-ups and catch-up acquisitions by followers. Think SAP, the German enterprise software firm, acquiring a cloud startup to compete more effectively with Microsoft and Amazon.

Third, where the transaction creates overlaps between the parties’ “R&D projects”, the shield applies if “there are at least three other firms with R&D projects that are independent from the merging parties with competitive potential similar to those of the merged entity”. Where the overlap concerns “R&D capabilities”, the shield applies if the parties’ combined market share remains below 25% both in the innovation space and at the industry level. The first criterion reflects a pipeline-to-pipeline analysis, while the second codifies the Commission’s practice in cases such as Dow/DuPont and Bayer/Monsanto, where overlaps were assessed at the industry level by reference to the parties’ overall R&D organisations. Notably, the “catch-up” exception is not replicated here. Accordingly, a mid-sized firm wishing to compete better with the market leader cannot bypass the structural requirements when potential competition is involved. This is a strange choice as acquisitions at earlier R&D stages can facilitate innovation and effective competition more.

The Entrenchment Theory of Harm

The shield’s formulation suggests that it will rarely apply to acquisitions by leading firms. A new theory of harm – “entrenchment” – confirms this. According to the draft Guidelines, entrenchment occurs when “the merged firm gains control over certain assets [like products, services, resources, and capabilities] in a way that structurally creates or reinforces existing barriers to entry and expansion resulting in reduced market contestability”. The standard applies where “one of the merging firms is dominant in one or several closely related markets”. Dominance is, of course, a multi-faceted concept, but the draft (and the Commission’s antitrust practice) indicates that it is often presumed at market shares above 40-50% (para. 112). Since 40% also represents the ceiling for the innovation shield’s applicability, leading firms and “gatekeepers” are unlikely to benefit from the shield in the first place, and find their acquisitions scrutinized under “entrenchment”.

The entrenchment standard then goes further. The draft links entrenchment to harm to innovation (by foreclosing future entry) as well as to the consolidation of positions across core and “closely related” markets, with “ecosystems” singled out as a paradigmatic concern.2 This answers a question raised earlier: acquisitions internal to a firm’s ecosystem are unlikely to benefit from the innovation shield, and the Commission is more likely to assess them under entrenchment. The draft attempts to limit the scope of this scrutiny by stating that “assets that have no plausible connection to the core market cannot credibly reinforce the merged firm’s position on it”, but the legal standard of “no plausible connection” will be difficult to satisfy in practice. As the Commission itself acknowledges, the “dynamic capabilities of providers to expand across markets” can readily make two assets appear connected, particularly in innovation-driven acquisitions.

One may go further still. The entrenchment standard can in fact be read as codifying the killer acquisition concern into soft law. The draft notes that entrenchment gains particular salience where “the acquired assets are important to effectively compete” because they are “unique, scarce, or otherwise strategically important for competition”, or where the merger threatens to “eliminate a potential competitor active in a related market with scarce or special capabilities or value propositions that effectively threaten the acquirer’s market position”. These formulations restate the killer acquisition concern as traditionally understood: the elimination of an upcoming rival whose distinctive capabilities or business models pose a credible threat to the incumbent. The draft also gestures toward an adjacent concept, observing that the acquisition of a potential competitor may “also affect rivals’ ability and incentive to compete in the core market as such potential competitors are often strongly incentivized pre-merger to facilitate entry and expansion of other firms to the core market”. This echoes the familiar “kill zone” argument.

Conclusion: No Rest for the Wicked?

From the perspective of “gatekeepers” and leading firms, the draft Guidelines resemble a wolf in sheep’s clothing. The innovation shield catches the eye, but its limited scope, combined with the new entrenchment standard, in fact tightens the scrutiny applied to startup acquisitions by dominant incumbents.

What, then, will be the effect of these new instruments? If the draft is adopted in its current form, the innovation shield will mostly protect acquisitions aimed at scaling up smaller firms or enabling trailing competitors to catch up with leading incumbents. The entrenchment standard, in turn, will tighten scrutiny over acquisitions by leading firms and digital gatekeepers.

Neither logic is, strictly speaking, new. Take the innovation shield’s effort to promote scale-ups by trailing firms. Since the entry into force of the 2004 Merger Regulation – and arguably before – the Commission has tended to view favorably mergers that strengthen an emerging firm’s ability to compete with the market leader. Viewed in this light, the introduction of the innovation shield amounts in significant part to a codification of existing practice. The shield’s inapplicability to leading firms is not without precedent either. In the specific context of “gatekeepers”, the instrument continues an earlier trend in EU digital regulation: the asymmetric distribution of regulatory consequences. Where the Digital Markets Act imposes obligations asymmetrically by size and reach, and the Data Act asymmetrically deprives “gatekeepers” of benefits (they cannot be recipients of data portability), the draft Guidelines deny the innovation shield asymmetrically: a gatekeeper or leading firm cannot be the beneficiary. Similar conclusions can be derived for the entrenchment standard too. Concerns about leading firms’ acquisitions across related markets have been a feature of EU debate at least since the 2019 Crémer report, which observed that, in startup acquisitions by large firms, “the project of the bought up start-up is integrated into the ‘ecosystem’ of the acquirer or into one of their existing products”.

But the familiarity of objectives should not preclude caution. Whether the innovation shield and the entrenchment standard will achieve their intended goals is a separate question from whether they accurately describe current policy. By largely excluding gatekeepers from its scope, the innovation shield makes it harder for prolific deal-makers from using acquisitions to enter new markets quickly. Given that gatekeepers frequently enter each other’s markets and compete aggressively with established incumbents, the limitation may end up softening, rather than sharpening, cross-market competitive pressures. Similar caution applies to entrenchment. Serial acquisition activity by a large firm may indeed harm long-term competition by bringing innovative capabilities under unitary control, but, as the Crémer report itself observed, many such acquisitions “are different from killer acquisitions as the integration of innovative complementary services often has a plausible efficiency rationale. In these cases, the theory of harm becomes more complex”. Sharpening some of the more open-ended features of the entrenchment standard would help the Commission avoid throwing the baby out with the bathwater.

Postdoctoral Researcher, Department of Law, European University Institute (EUI); Research Fellow, Haas School of Business, University of California, Berkeley. Contact: [email protected].

• 1A similar criterion applies to acquisitions that create overlaps in “upstream, downstream, or otherwise closely related markets”. In these cases, too, the shield applies if the parties’ combined market share does not exceed 40%. The other structural criterion (at least three competitors must remain) is omitted.
• 2As an example of “closely related” markets, the Commission mentions the relationship between hardware and software that function together. To illustrate “ecosystems”, it cites the Google (Android) case, which concerned Google’s mobile operating system.