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United States v. Oracle Corporation

September 9, 2004

UNITED STATES OF AMERICA, ET AL, PLAINTIFFS,
v.
ORACLE CORPORATION, DEFENDANT.



The opinion of the court was delivered by: Walker, Chief Judge.

FINDINGS OF FACT, CONCLUSIONS OF LAW AND ORDER THEREON

The government, acting through the Department of Justice, Antitrust Division, and the states of Connecticut, Hawaii, Maryland, Massachusetts, Michigan, Minnesota, New York, North Dakota, Ohio and Texas, First Amended Complaint (FAC) (Doc. # 125) p 3 at 5-6, seek to enjoin Oracle Corporation from acquiring, directly or indirectly, the whole or any part of the stock of PeopleSoft, Inc. Plaintiffs allege that the acquisition would violate section 7 of the Clayton Act, 15 USC s 18. Both companies are publicly traded and headquartered in this district. Jt. Stip Fact (Doc. # 218) at 1-2. The court has subject matter jurisdiction under 15 USC s 25 and 28 USC ss 1331, 1337(a) and 1345. There is no dispute about the court's personal jurisdiction over the defendant.

Oracle initiated its tender offer for the shares of PeopleSoft on June 6, 2003. Jt. Stip of Fact (Doc. # 128) at 2; Ex. P2040. Plaintiffs brought suit on February 26, 2004. Compl. (Doc. # 1). The case was tried to the court on June 7-10, 14-18, 21-25, 28-30 and July 1, 2004, with closing arguments on July 20, 2004, and further evidentiary proceedings on August 13, 2004. Based on the evidence presented and the applicable law, the court concludes that plaintiffs have failed to carry the burden of proof entitling them to relief and, therefore, orders that judgment be entered for defendant and against plaintiffs.

INTRODUCTORY FINDINGS: INDUSTRY OVERVIEW

Products at Issue

Of the many types of computer software, such as operating system software, database software, integration software (sometimes called "middleware" in software parlance) and utilities software, this case involves only one-- application software. And within this type, the present case deals with only applications that automate the overall business data processing of business and similar entities; these applications are called "enterprise application software" (EAS). Jt. Definitions (Doc. # 332) at 6. There are three main kinds of EAS. Plaintiffs single out one.

Some EAS programs are mass market PC-based applications of fairly limited "functionality" (meaning capability). Id. (Doc. # 332) at 5. See Daniel E. O'Leary, Enterprise Resource Planning Systems at 19 (Cambridge, 2000). Other EAS programs are developed by or for a specific enterprise and its particular needs; most large organizations had such specially designed EAS (called "legacy software") prior to the advent of the products in suit. Plaintiffs focus their claims on the third, intermediate category of EAS--enterprise resource planning (ERP) system software. Jt. Sub. Definitions (Doc. # 332) at 6. ERP is packaged software that integrates most of an entity's data across all or most of the entity's activities. See O'Leary, Enterprise Resource Planning Systems at 27-38. Oracle and PeopleSoft develop, produce, market and service ERP software.

These copyrighted software programs are licensed ("sold" is the term applied to these license transactions) to end users along with a continued right to use license which usually includes maintenance or upgrades of the software. To the customer, the fees to license and maintain ERP software are generally a small part, 10 to 15 percent, of the total cost of the installation and maintenance of an ERP system. Tr. at 133:12-15 (Hatfield); 655:2-4 (Maxwell); 1385:6-11 (Gorriz). An ERP installation, because of its complexity, usually requires substantial and expensive personnel training, consulting and other services to integrate the program into the customer's pre-existing or "legacy" software. Jt. Sub. Definitions (Doc. # 332) at 6. See also O'Leary, Enterprise Resource Planning Systems at 19. ERP software vendors often provide some of those services, but they are typically also performed and augmented by the customer's own staff, obtained from providers other than ERP vendors or both.

Many ERP programs were developed to address the needs of particular industries, such as banking and finance, insurance, engineering, construction, healthcare, government, legal and so forth (in industry lingo, these are called "verticals"). See Martin Campbell-Kelly, From Airline Reservations to Sonic the Hedgehog, at 169-73 (MIT, 2003). Vertical-specific ERP programs, although well suited to the needs of firms engaged in a particular industry, often are not well suited to the needs of firms in other verticals. An enterprise that relies on vertical-specific ERP software products, but whose operations embrace more than one vertical faces the task of integrating the programs. The largest and most complex organizations face particular difficulty. "[O]nly custom-written software or carefully tailored and integrated cross-industry packages [can] handle larger firms' historically idiosyncratic accounting systems and diverse overseas operations." Id. at 172.

ERP programs have been developed to handle the full range of an enterprise's activities; these include human relations management (HRM), financial management systems (FMS), customer relations management (CRM), supply chain management (SCM), Product Life Cycle Management, Business Intelligence (BI), among many others. These are called "pillars." Although ERP encompasses many pillars, see Ex. D5572, plaintiffs assert claims with respect to only two pillars, HRM and FMS. FAC (Doc. # 125) p 23 at 12-13.

Within these two pillars, plaintiffs further limit their claims to only those HRM and FMS products able to meet the needs of large and complex enterprises with "high functional needs." Id. at p 14 at 9. Plaintiffs label HRM and FMS products capable of meeting these high function needs "high function HRM software" and "high function FMS software," respectively. Id. p 23(a)-(b) at 12-13. ERP pillars incapable of meeting these high function needs are called "mid-market" software by plaintiffs. Id. p 13 at 9.

"High function software" is a term adopted by plaintiffs to describe what they contend is the separate and distinct line of commerce in which they contend competition would be lessened by the proposed acquisition. Id. at p 23 at 13-14. Plaintiffs apply the term "high function" to both HRM and FMS. "High function software," as defined by plaintiffs, has no recognized meaning in the industry. See Tr. at 349:7-10 (Bergquist); 2298:6-20 (Elzinga).

Rather, industry participants and software vendors use the terms "enterprise" software, "up-market" software and "Tier One" software to denote ERP that is capable of executing a wide array of business processes at a superior level of performance. See Tr. at 274:24-275:7 (Bergquist); Tr. at 1771:5-1772:1 (Wilmington); Tr. at 1554:25-1555:7 (Wolfe); Tr. at 2180:22-2181:5 (Iansiti). Software vendors use these terms to focus sales and marketing initiatives. Tr. 2816:6-2818:8 (Knowles) (testifying that SAP divided mid-market and large enterprise at $1.5 billion based on SAP's sales resources and estimated amount of IT "spend" available from those customers).

Each ERP pillar consists of "modules" that automate particular processes or functions. HRM and FMS software each consists of numerous modules. Exs. P3010, P3011. Tr. at 268:8-269:11, 270:5-271:12 (Bergquist). HRM modules include such functions as payroll, benefits, sales incentives, time management and many others. Ex. P3010. FMS modules include such functions as general ledger, accounts receivable, accounts payable, asset management and many others. Ex. P3011.

"Core" HRM modules are those specific ERP modules that individually or collectively automate payroll, employee tracking and benefits administration. Core FMS modules are those ERP modules that individually or collectively track general ledger, accounts receivable, accounts payable and cash and asset management business processes. Core FMS and HRM modules are offered by all the ERP vendors that have HRM and FMS offerings. Ex. P3179 (Ciandrini 1/16/04 Dep) at Tr. 256:2-257:10. Large enterprise customers rarely, if ever, buy core HRM or FMS modules in isolation. Tr. at 3461:14-23 (Catz). Customarily, FMS and HRM software are purchased in bundles with other products. Tr. at 3807:21-3808:1 (Hausman). See also Tr. at 3813:12-13 (Hausman). Customers purchase a cluster of products such as Oracle's E-Business Suite that provide the customer with a "stack" of software and technology, which may include core HRM or FMS applications, add-on modules, "customer-facing" business applications such as CRM software, and the infrastructure components (application servers and database) on which the applications run. Tr. at 3461:14-3462:5 (Catz); Tr. at 3807:21-3808:1 (Hausman). See, e.g., Exs. P1000-P1322 (Oracle discount request forms).

ERP vendors, including Oracle and PeopleSoft, sell modules individually as well as integrated suite products. Some ERP vendors sell only one or a few modules. Individual modules are referred to as "point solutions" as they address a particular need of the enterprise. ERP vendors that sell products for only one or a limited number pillars are referred to as point solution or "best of breed" providers. A customer licensing a particular module because it fits the specific needs of the enterprise is sometimes said to be seeking a best of breed or point solution. An ERP customer that acquires best of breed or point solutions faces the task of integrating these solutions with one another and with the customer's existing ERP or legacy footprint.

Although the production cost of ERP applications is negligible, vendors bear significant development and marketing expenses and substantial costs of pre-and postsales support and ongoing maintenance and enhancement. ERP vendors employ and bear substantial costs of account managers, technical sales forces and personnel for user training, product documentation and post-sale support.

Customers at Issue

"Large Complex Enterprises" (LCE) is a term adopted by plaintiffs to describe the ERP customers that have "high function software" needs. Based on the testimony described hereafter, the court finds that industry participants and software vendors do not typically use this term and it has no widely accepted meaning in the industry.

While many in the software industry differentiate between large customers and mid-market customers, there is no "bright line" test for what is a "large" or "up-market" customer. Tr. 348:23-349:3 (Bergquist) (acknowledging "different parties tend to define it differently"); Tr. 2033:1-12 (Iansiti); Ex. P3032 (Henley 5/4/04 Dep) at Tr. 98:20-25. Likewise, there is no "bright line" test for what is a "mid-market" customer. Tr. at 2820:9-19 (Knowles) (SAP executive noting that the separation between mid-market and large enterprise customers is "not an exact science"); Ex. D7174 (Pollie 5/26/04 Dep) at Tr. 54:14-55:3 (testifying that the meaning of the term mid-market "varies from, from everyone you talk to"); Ex. P3191 (Block 12/16/03 Dep) at Tr. 88:12-21, 94:19-95:3 (noting the term mid-market is used in many different ways by many different people). ERP vendors, analysts, systems integrators and others in the industry define the mid-market variously. Compare Tr. at 864:19-865:2 (Keating) (noting variability of definitions and that Bearing Point generally refers to mid-market as customers in its General Business Group, which is synonymous with companies having less than $2 billion in revenue) with Tr. at 1846:17-1847:15 (Wilmington) (PeopleSoft formerly defined mid-market as less than $500 million revenue, but after acquiring J D Edwards, it raised mid-market to include companies with less than $1 billion revenue).Prior to Oracle's tender offer, PeopleSoft used a proxy of $500 million in revenue to distinguish mid-market customers from large customers. Tr. at 348:5-18 (Bergquist). SAP defines its "large enterprise" market as companies with more than $1.5 billion in revenues. Tr. at 2819:12-20 (Knowles). Oracle segments the market based on the customers' revenue level or number of employees. Ex. P3070 (Prestipino 5/18/04 Dep) at Tr. at 21:5-23:11.

Plaintiffs failed to show ERP vendors distinguish mid-market customers from large customers on the amount of money spent in an ERP purchase. Yet, as discussed below, this was the basis on which plaintiffs attempted to quantify the ERP market.

Vendors at Issue

Many firms develop, produce, market and maintain ERP software. Ex. 5543 at 8- 17. Some ERP software vendors, notably Oracle, PeopleSoft and a German company, SAP AG, developed cross-industry applications or "suites" of "generalized integrated software that could be customized for virtually any large business," Campbell-Kelly, From Airline Reservations to Sonic the Hedgehog at 172. It is to the products of these three vendors that plaintiffs direct their allegations. Although not alone in the ERP business, these three firms have the most comprehensive ERP software offerings.

Oracle. Oracle is headquartered in Redwood Shores, California. Oracle has over 41,000 employees and offices in 80 countries and sells product in over 120 countries. Tr. at 3485:10-12, 3486:16-18 (Catz). Oracle's E-Business suite is a fully integrated suite of more than 70 modules for FMS, internet procurement, BI, SCM, manufacturing, project systems, HRM and sales and service management. Ex. P2209 at xiv. As of December 2002, Oracle had over 5000 customers of its E-Business Suite, Release lli. Ex. P2208 at ORLIT-EDOC-00244117; Ex. P3038. Oracle's ERP products have enjoyed success with telecommunications and financial services customers. Oracle is a major producer of relational database software which accounts for a much larger share of its revenue than its ERP business.

PeopleSoft. PeopleSoft is headquartered in Pleasanton, California and has 8300 employees. PeopleSoft sells software "in most major markets." Ex. 7149 at 7. It has offices in Europe, Japan, Asia-Pacific, Latin America and other parts of the world. Id. PeopleSoft was formed in 1987 to develop an HRM product, and it continues to enjoy widespread customer acceptance of its HRM offerings. PeopleSoft now sells, in addition to HRM products, FMS, SCM and CRM products and related consulting services. Jt. Stip Fact (Doc. # 218) at 2. In 2003, Peoplesoft generated about $1.7 billion in revenue, derived almost entirely from ERP-related business. PeopleSoft v8 is PeopleSoft's current integrated suite offering. It competes with Oracle's E-Business suite, Release lli.

SAP. SAP AG is headquartered in Waldorf, Germany. SAP AG has global operations, including major business operations in more than a dozen countries and customers in more than 120 countries around the globe. Tr. at 2805:20- 2806:2 (Knowles). SAP AG has over 30,000 employees and sells a product called MySAP ERP Suite, which includes HRM, FMS, corporate controlling and corporate services.

Tr. at 2811:7-13 (Knowles). SAP AG offers a product called All-in-One, which is "essentially a scaled-down version of MySAP ERP with a lot of functionality turned off." Tr. at 2813:20-2814:2 (Knowles). All-in-One is marketed both through an indirect channel of resellers to the $200 million-and-below customer revenue segment and by SAP's direct sales force. Tr. at 2813:20-2814:2 (Knowles). SAP AG also offers a product called Business One, which is a "packaged software offering" targeting the $200 million-and-below customer revenue segment and sold through an indirect channel of resellers. Tr. at 2813:10-17 (Knowles). SAP has six sales regions worldwide. SAP America, Inc is responsible for sales in the United States and Canada. Tr. at 2808:16-19 (Knowles). SAP America sells software solutions created by SAP AG. Tr. at 2808:8-15, 2806:16-17 (Knowles). In addition to selling software solutions created by SAP AG, the largest price discounts offered by SAP America must be approved by SAP AG. Tr. 2836:22-24 (Knowles). SAP products have won wide acceptance in the aerospace and petroleum industries. Tr. at 899:9- 900:19, 947:10-21 (Keating).

Lawson. Lawson is headquartered in Saint Paul, Minnesota and has 1700 employees. Lawson was founded in the mid-1970s and has 2000 customers, mostly in North America and Europe. Lawson offers FMS, HRM, procurement products, merchandising products, enterprise performance management (EPM), service automation and a unique function called surgery instrument management. Tr. at 3591:5-10 (Coughlan). In 2003, Lawson generated more than $360 million in annual revenue. Tr. at 3589:19 (Coughlan). Lawson has tended to do extremely well in the healthcare and retail verticals. Tr. at 3591:1-2 (Coughlan). As Professor Jerry Hausman testified, and the court will hereafter find, although Lawson does not now compete in all the industry verticals in which Oracle, PeopleSoft and SAP compete, Lawson has sufficient resources and capabilities to reposition to any industry vertical it so chooses. Tr. at 3841:3-13 (Hausman).

AMS. AMS is an ERP vendor that was recently acquired by CGI, headquartered in Montreal, Quebec, with offices in North America, Europe and Asia-Pacific. As an ERP vendor, AMS offers FMS, HRM, procurement, tax and revenue software, CRM, CMS, environmental compliance software, performance management and budgeting and contracting software to government entities. See P3034 (Morea 5/7/04 Dep) at Tr. 14:19-23. AMS has been successful in its sales to state and federal governmental agencies, often competing head to head with commercial ERP vendors. Tr. at 972:6-15 (Keating) (agreeing that AMS is a "viable competitor for large and complex federal procurements"). In fact, only a short time after this action was initiated, the United States Department of Justice chose AMS FMS over the FMS offerings of Oracle, PeopleSoft and SAP. See D7166 (Morea 5/7/04 Dep) at Tr. 21:22-22:7.

Microsoft. Microsoft is headquartered in Redmond, Washington, and sells a wide range of software products. In 2001 Microsoft acquired Great Plains Software and renamed it Microsoft Great Plains. Microsoft now has a division called Microsoft Business Solutions (MBS), which was created in 2002 when Microsoft Great Plains acquired the Danish software company Navison. Tr. at 2972:19- 2973:9, 2973:8-9 (Burgum). MBS has four existing ERP product lines: Navison, Great Plains, Axapta and Solomon. Tr. at 2996:16 (Burgum). Great Plains offers FMS, HRM, E-commerce, retail management, CRM, analytics and reporting. See http://www.microsoft.com/BusinessSoluions/GreatPlains/default.aspx. Solomon provides FMS only. Tr. at 2998:4 (Burgum). Navison offers FMS, SCM, CRM and E-commerce. See http:// www.microsoft.com/BusinessSolutions/Navison/default.aspx. Finally Axapta offers FMS, HRM, SCM, E-commerce, CRM and analytics. See http:// www.microsoft.com/BusinessSolutions/Axapta/default.aspx.Best of breed vendors. Ninety percent of ERP sales are purchases of software "bundles" containing several pillars; rarely does a consumer purchase a single pillar. Tr. at 3815:10-13 (Hausman). FMS and HRM pillars typically are sold in a bundle along with additional kinds of ERP, such as CRM or SCM. Further, the discounts that are offered to potential consumers are based on the value of the entire bundle, not simply based upon the presence of an HRM or FMS pillar. Tr. at 3813:23-3814:1 (Hausman). Accordingly, when Oracle or PeopleSoft offers a discount on a bundle, it is doing so in order to ensure that the customer purchases all the pillars from Oracle or PeopleSoft, rather than turn to a best of breed vendor that specializes in selling a single kind of pillar. One best of breed vendor, Siebel, sells individual pillars of CRM. Testimony suggests Siebel is recognized industry-wide as selling high-quality CRM, equal to or better than the CRM pillars in Tier One software. Tr. at 3814:15-17 (Hasuman).

Outsourcing. Because of the extensive amount of training and maintenance involved in implementing ERP packages purchased from ERP vendors, some companies have chosen an alternative solution--outsourcing. Outsourcing occurs when a company hires another firm to perform business functions, often HRM functions. Tr. at 2198:15-2198:3 (Elzinga). A company may outsource a single HRM function, such as benefits, pensions or payroll, or it may choose to outsource its entire continuum of HRM needs. Tr. at 1648:14-22 (Bass). Many firms have outsourcing capabilities. Some of the outsourcers discussed at trial include: Accenture, Fidelity, ADP, Mellon, Exult, Hewitt, Aon and Convergys. Outsourcing firms may process a company's HR data using HRM software manufactured by an ERP vendor, such as Oracle, but some outsourcing firms use internally created HRM software (such as Fidelity using HR Access). Tr. at 3152:18-3153:23 (Sternklar).

In addition to individual vertical success, ERP vendors have tended to enjoy varying degrees of success in different geographic regions. SAP, for example, has been more successful at selling ERP to financial institutions in Europe than in North America. Tr. at 996:20-997:15 (Keating).

The FMS and HRM software sold to large customers is the same as that sold to mid-market customers. Tr. at 819:8-11 (Allen); Tr. at 1787:25-1788:2 (Wilmington); Tr. at 3436:24-3437:11 (Catz); Ex. D7166 (Morea 5/17/04 Dep) at Tr. 18:15-19:2(AMS); Ex. P3179 (Ciandrini 1/16/04 Dep) at Tr. 235:15-22. All the vendors--- including Oracle, SAP, and PeopleSoft--have a single product "and that one product is sold up and down the line" to customers of all sizes. Ex. P3171 (Ellison 1/20/04 Dep) at Tr. 148:10-151:15. While some ERP vendors have introduced special licensing packages of FMS and HRM that are marketed to smaller customers, the actual software code in the FMS and HRM products sold to both large and mid-market customers is not different. Ex. P3070 (Prestipino 5/18/04 Dep) at Tr. 35:19-36:10 (Oracle); Tr. at 3437:5-9 (Catz). Oracle has recently launched its E-Business Suite Special Edition to appeal to its smallest customers--those who can use only 50 seats or less. It contains the same code as the software sold to the largest and middle-sized customers, but it arrives pre-configured by the consulting organization. Tr. at 3436:24-3438:5 (Catz). It contains a subset of the modules found in Oracle's E-Business Suite, including FMS but excluding HRM. Tr. at 3437:5-11 (Catz); Ex. P3070 (Prestipino 5/18/04 Dep) at Tr. 25:5-22, 32:19-33:19.

Despite the identity of code in each company's ERP packaged product, ERP product offerings are not homogeneous. Whlie the ERP products offered by Oracle and PeopleSoft and other vendors perform the same or similar functions, these products are not uniform in their architecture, scalability, functionality or performance characteristics. Tr. at 897:23-899:3, 899:9- 900:19, 901:6-902:15, 903:6-15, 946:18-20, 947:4-9, 992:23-993:7, 993:16-994:2, 996:20-997:15 (Keating). The product of each vendor possesses certain features or qualities so that none is a perfect substitute for any other. As the testimony indicated, and the court finds, no vendor is capable of meeting all of the high function needs, as defined by plaintiffs, of all customers. Tr. at 2085:3-5 (Iansiti).

Furthermore, because each packaged ERP product must be customized and configured to fit the software footprint of the customer, a packaged ERP product may, as fitted to one customer's information technology footprint, differ significantly from the same packaged ERP product fitted to another customer's footprint. Because of these facts, the court finds the ERP products in suit to be differentiated products.

The court also finds that ERP software is highly durable and, therefore, regarded by customers as a capital good. Campbell demo # 5,6,19; see also Tr. at 189:12-18 (Hatfield); Tr. at 1107:16-19 (Cichnowicz); Tr. at 1572:14-18 (Wolfe).

Customers almost always purchase a cluster of products such as Oracle's E-Business Suite that provide the customer with a stack of software and technology, which may include core HRM or FMS applications, add-on modules, customer-facing business applications such as CRM software and the infrastructure components (application servers and database) on which the applications run. Tr. at 3461:14-3462:5 (Catz); Tr. at 3807:21-3808:1 (Hausman). See, e.g., Exs. P1000-P1322 (Oracle discount request forms).

Plaintiffs' Claim of Threatened Injury to Competition

Plaintiffs allege that the HRM and FMS sold by Oracle, PeopleSoft and SAP are the only HRM and FMS products that can appropriately be deemed "high function HRM and FMS." FAC (Doc. # 125) p 9 at 8.

Plaintiffs allege that these "high function" HRM and FMS products have the "scale and flexibility to support thousands of simultaneous users and many tens of thousands of simultaneous transactions and the ability to integrate seamlessly into bundles or 'suites' of associated HRM and FMS functions." Id. p 14 at 9. Plaintiffs allege that "high function" HRM and FMS products compete in a market that is separate and distinct from that of all other ERP products, such as SCM, CRM or mid-market HRM and FMS, the latter being HRM or FMS products designed for organizations having less demanding needs. These mid-market products include Oracle's E-Business Suite Special Edition, SAP's MySAP and All-in-One, PeopleSoft's PeopleSoft EnterpriseOne and the products of ERP vendors such as Lawson and AMS.

Moreover, plaintiffs allege that this competition is geographically confined to the United States. Id. at pp 24, 26 at 13. Within this narrowly defined product and geographic market, plaintiffs allege that with limited and specially explained exceptions, only Oracle, PeopleSoft and, to a lesser degree, SAP's United States arm, SAP America, are in effective competition. The proposed merger would therefore, in plaintiffs' view, constrict this highly concentrated oligopoly to a duopoly of SAP America and a merged Oracle/PeopleSoft.

Oracle, predictably enough, contends that plaintiffs' market definition is legally and practicably too narrow. Oracle contends that (1) "high function" HRM and FMS software does not exist; "high function" is simply a label created by plaintiffs; (2) there is just one market for all HRM and FMS ERP products; (3) many firms other than the three identified by plaintiffs compete in the business of developing, producing, marketing and maintaining HRM and FMS ERP software; (4) this competition plays out in many more products than those in the HRM and FMS pillars; (5) price competition comes from sources in addition to ERP software vendors and includes competition from firms that provide outsourcing of data processing, the integration layer of the "software stack" and from the durability and adaptability of enterprises' installed base or legacy systems; (6) the geographic area of competition is worldwide or, at the very least, the United States and Europe; (7) the knowledgeable and sophisticated customers of ERP software would impede the exercise of any market power by a merged Oracle/PeopleSoft; and (8) potential entrants are poised to enter into competition, so that the proposed merger will not have an anticompetitive effect.

Taking up this dispute, the court first discusses the applicable law and economic principles that underlie its decision and then describes the parties' contentions and evidence along with the court's resolution of the disputed factual issues not previously discussed. This begins with the parties' sharply differing definitions of the product and geographic markets and whether there is a level of concentration sufficient to trigger the presumption under United States v. Philadelphia Nat. Bank, 374 U.S. 321, 83 S.Ct. 1715, 10 L.Ed.2d 915 (1963), that the proposed transaction will lead to a substantial lessening of competition under the principles set forth in the Department of Justice and Federal Trade Commission Horizontal Merger Guidelines (Apr 2, 1992, as revised Apr 8, 1997) ("Guidelines"). The court then turns to an efficiency defense offered by Oracle before setting forth its conclusions of law.

In brief summary, for the reasons explained at length herein, the court's findings and conclusions are as follows:

. plaintiffs have not proved that the product market they allege, high function HRM and FMS, exists as a separate and distinct line of commerce;
. plaintiffs have not proved the geographic market for the products of the merging parties is, as they allege, confined to the United States alone;
. plaintiffs have not proved that a post-merger Oracle would have sufficient market shares in the product and geographic markets, properly defined, to apply the burden shifting presumptions of Philadelphia Nat Bank;
. plaintiffs have not proved that the post-merger level of concentration (HHI) in the product and geographic markets, properly defined, falls outside the safe harbor of the Horizontal Merger Guidelines (Guidelines);
. plaintiffs have not proved that the ERP products of numerous other vendors, including Lawson, AMS and Microsoft, do not compete with the ERP products of Oracle, PeopleSoft and SAP and that these other vendors would not constrain a small but significant non-transitory increase in price by a post-merger Oracle;
. plaintiffs have not proved that outsourcing firms, such as Fidelity and ADP, would not constrain a small but significant non-transitory increase in price by a post-merger Oracle;
. plaintiffs have not proved that the ability of systems integrators to adapt, configure and customize competing ERP vendors' products to the needs of the group of customers that plaintiffs contend constitute a separate and distinct product market would not constrain a small but significant non-transitory increase in price by a post-merger Oracle;
. plaintiffs have not proved that a post-merger Oracle and SAP would likely engage in coordinated interaction as the products of Oracle and SAP are not homogeneous, but are differentiated products, and that the pricing of these products is not standardized or transparent;
. plaintiffs have not proved localized product or geographic competition between Oracle and PeopleSoft that will be lessened as a result of the proposed merger as the merger would not create a dominant firm occupying a product or geographic space in which there is no serious competition;
. assuming that localized product or geographic competition exists between Oracle and PeopleSoft, plaintiffs have not proved that SAP, Microsoft and Lawson would not be able to reposition themselves in the market so as to constrain an anticompetitive price increase or reduction in output by a post-merger Oracle;
. plaintiffs have proved that products in the integration layer of the computer software industry and the presence of incumbent ERP systems would not constrain anticompetitive conduct on the part of a post-merger Oracle;
. Oracle has not proved efficiencies from the proposed merger sufficient to rebut any presumption of anticompetitive effects; should the court's principal findings and its conclusion that plaintiffs have not proved the proposed merger will likely lead to a substantial lessening of competition not be upheld on appeal, Oracle's efficiency defense should not require further trial court proceedings.

HORIZONTAL MERGER ANALYSIS

Section 7 of the Clayton Act prohibits a person "engaged in commerce or in any activity affecting commerce" from acquiring "the whole or any part" of a business' stock or assets if the effect of the acquisition "may be substantially to lessen competition, or to tend to create a monopoly." 15 USC s 18. The United States is authorized to seek an injunction to block the acquisition, 15 USC s 25, as are private parties and the several states, California v. American Stores Co., 495 U.S. 271, 110 S.Ct. 1853, 109 L.Ed.2d 240 (1990); Hawaii v. Standard Oil Co. of Cal., 405 U.S. 251, 258-59, 92 S.Ct. 885, 31 L.Ed.2d 184 (1972), and district courts have jurisdiction over such actions. 15 USC s 25; 28 USC s 1337(a). Plaintiffs have the burden of proving a violation of section 7 by a preponderance of the evidence.

To establish a section 7 violation, plaintiffs must show that a pending acquisition is reasonably likely to cause anticompetitive effects. See United States v. Penn-Olin Chem. Co., 378 U.S. 158, 171, 84 S.Ct. 1710, 12 L.Ed.2d 775 (1964) (noting that a section 7 violation is established when "the 'reasonable likelihood' of a substantial lessening of competition in the relevant market is shown"); United States v. Marine Bancorp., Inc., 418 U.S. 602, 622-23, 94 S.Ct. 2856, 41 L.Ed.2d 978 (1974); FTC v. H J Heinz Co., 246 F.3d 708, 713, 719 (D.C.Cir.2001). " 'Congress used the words "may be substantially to lessen competition" (emphasis supplied) to indicate that its concern was with probabilities, not certainties.' " Id. at 713 (quoting Brown Shoe Co. v. United States, 370 U.S. 294, 323, 82 S.Ct. 1502, 8 L.Ed.2d 510 (1962)). "Section 7 does not require proof that a merger or other acquisition [will] cause higher prices in the affected market. All that is necessary is that the merger create an appreciable danger of such consequences in the future." Hospital Corp. of Am. v. FTC, 807 F.2d 1381, 1389 (7th Cir.1986). Substantial competitive harm is likely to result if a merger creates or enhances "market power," a term that has specific meaning in antitrust law. See Eastman Kodak Co v. Image Tech. Services Inc., 504 U.S. at 451, 464 (1992); Rebel Oil Co. v. Atlantic Richfield Co., 51 F.3d 1421, 1434 (9th Cir.1995).

Market Definition

In determining whether a transaction will create or enhance market power, courts historically have first defined the relevant product and geographic markets within which the competitive effects of the transaction are to be assessed. This is a "necessary predicate" to finding anticompetitive effects. United States v. E. I. du Pont & Co., 353 U.S. 586, 593, 77 S.Ct. 872, 1 L.Ed.2d 1057 (1957). Market definition under the case law proceeds by determining the market shares of the firms involved in the proposed transaction, Philadelphia Nat. Bank, 374 U.S. 321, 83 S.Ct. 1715, 10 L.Ed.2d 915, the overall concentration level in the industry and the trends in the level of concentration. United States v. Aluminum Co. of Am., 377 U.S. 271, 277-79, 84 S.Ct. 1283, 12 L.Ed.2d 314 (1964); United States v. Von's Grocery Co., 384 U.S. 270, 272-74, 86 S.Ct. 1478, 16 L.Ed.2d 555 (1966). A significant trend toward concentration creates a presumption that the transaction violates section 7. United States v. Baker Hughes Inc., 908 F.2d 981, 982-83 (D.C.Cir.1990) (Thomas, J). See also United States v. Citizens & Southern Nat. Bank, 422 U.S. 86, 120-22, 95 S.Ct. 2099, 45 L.Ed.2d 41 (1975). In other words, plaintiffs establish a prima facie case of a section 7 violation by "show[ing] that the merger would produce 'a firm controlling an undue percentage share of the relevant market, and [would] result [ ] in a significant increase in the concentration of firms in that market.' " Heinz, 246 F.3d at 715 (quoting Philadelphia Nat. Bank, 374 U.S. at 363, 83 S.Ct. 1715) (alterations in original). Under Philadelphia Nat Bank, a post-merger market share of 30 percent or higher unquestionably gives rise to the presumption of illegality. 374 U.S. at 364, 83 S.Ct. 1715 ("Without attempting to specify the smallest market share which would still be considered to threaten undue concentration, we are clear that 30% presents that threat.").

To rebut this presumption, defendant may "show that the market-share statistics give an inaccurate account of the merger's probable effects on competition in the relevant market." Heinz, 246 F.3d at 715 (internal quotation marks and alterations omitted). See also Baker Hughes, 908 F.2d at 987; California v. Am. Stores Co., 872 F.2d 837, 842-42 (9th Cir.1989), rev'd on other grounds, 495 U.S. 271, 110 S.Ct. 1853, 109 L.Ed.2d 240 (1990); FTC v. Warner Communications, 742 F.2d 1156, 1164 (9th Cir.1984); Olin Corp. v. FTC, 986 F.2d 1295, 1305-06 (9th Cir.1993). Arguments related to efficiencies resulting from the merger may also be relevant in opposing plaintiffs' case. See FTC v. Tenet Health Care Corp., 186 F.3d 1045, 1054- 55 (8th Cir.1999); FTC v. Staples, Inc., 970 F.Supp. 1066, 1088 (D.D.C.1997). " 'If the defendant successfully rebuts the presumption [of illegality], the burden of producing additional evidence of anticompetitive effects shifts to [plaintiffs], and merges with the ultimate burden of persuasion, which remains with the government at all times.' " Heinz, 246 F.3d at 715 (quoting Baker Hughes, 908 F.2d at 983) (first alteration in original).

An application of the burden-shifting approach requires the court to determine (1) the "line of commerce" or product market in which to assess the transaction; (2) the "section of the country" or geographic market in which to assess the transaction; and (3) the transaction's probable effect on competition in the product and geographic markets. See Marine Bancorporation, 418 U.S. at 618-23, 94 S.Ct. 2856; FTC v. Harbour Group Investments LP, 1990 WL 198819 at *2 n. 3 (D.D.C.1990). See also FTC v. Swedish Match, 131 F.Supp.2d 151, 156 (D.D.C.2000); FTC v. Cardinal Health, Inc., 12 F Supp 2d 34, 45 (D.D.C.1998); Staples, 970 F.Supp. at 1072.

Both the Supreme Court and appellate courts acknowledge the need to adopt a flexible approach in determining whether anticompetitive effects are likely to result from a merger. Reflecting their "generality and adaptability," Appalachian Coals v. United States, 288 U.S. 344, 360, 53 S.Ct. 471, 77 L.Ed. 825 (1933), application of the antitrust laws to mergers during the past half-century has been anything but static. Accordingly, determining the existence or threat of anticompetitive effects has not stopped at calculation of market shares. In Hospital Corp of Am the court upheld the FTC's challenge to the acquisition of two hospital chains, but noted that "the economic concept of competition, rather than any desire to preserve rivals as such, is the lodestar that shall guide the contemporary application of the antitrust laws, not excluding the Clayton Act." 807 F.2d at 1386. Hence, the court held that it was appropriate for the FTC to eschew reliance solely on market percentages and the "very strict merger decisions of the 1960s." Id. at 1386. In addition to market concentration, probability of consumer harm in that case was established by factors such as legal barriers to new entry, low elasticity of consumer demand, inability of consumers to move to distant hospitals in emergencies, a history of collusion and cost pressures creating an incentive to collude. 807 F.2d at 1388-89.

In United States v. Waste Management, 743 F.2d 976 (2d Cir.1984), the court of appeals reversed a finding of a section 7 violation based on market shares and prima facie illegality under Philadelphia Nat Bank, one made even though there were few barriers to new entry into the market. The trial court had erroneously ignored the Supreme Court's holding in United States v. General Dynamics, 415 U.S. 486, 94 S.Ct. 1186, 39 L.Ed.2d 530 (1974), that a prima facie case may still be rebutted by proof that the merger will not have anticompetitive effects. A finding of market shares and consideration of the Philadelphia Nat Bank presumptions should not end the court's inquiry.

The trend in these cases away from the "very strict merger decisions of the 1960s," Hospital Corp. of Am., 807 F.2d at 1386, is also reflected in the Guidelines. The Guidelines view statistical and non-statistical factors as an integrated whole, avoiding the burden shifting presumptions of the case law. The Guidelines define market power as "the ability profitably to maintain prices above competitive levels for a significant period of time." Guidelines s 0.1. Five factors are relevant to the finding of market power: (1) whether the merger would significantly increase concentration and would result in a concentrated market, properly defined; (2) whether the merger raises concerns about potential adverse competitive effects; (3) whether timely and likely entry would deter or counteract anticompetitive effects; (4) whether the merger would realize efficiency gains that cannot otherwise be achieved; and (5) whether either party would likely fail in the absence of the merger. Guidelines, s 0.2.

In defining the market, the Guidelines rely on consumer responses. Starting with the smallest possible group of competing products, the Guidelines then ask "whether 'a hypothetical monopolist over that group of products would profitably impose at least a "small but significant and nontransitory" [price] increase ["(SSNIP)"],' " generally deemed to be about five percent lasting for the foreseeable future. United States v. Sungard Data Sys., Inc., 172 F Supp 2d 172, 182 (D.D.C.2001) (quoting Guidelines s 1.11). If a significant number of customers respond to a SSNIP by purchasing substitute products having "a very considerable degree of functional interchangeability" for the monopolist's products, then the SSNIP would not be profitable. E.I. du Pont, 351 U.S. at 399, 76 S.Ct. 994. See Guidelines s 1.11. Accordingly, the product market must be expanded to encompass those substitute products that constrain the monopolist's pricing. The product market is expanded until the hypothetical monopolist could profitably impose a SSNIP. Id. s 1.11. Similarly, in defining the geographical market, the Guidelines hypothesize a monopolist's ability profitably to impose a SSNIP, again deemed to be about five percent, in the smallest possible geographic area of competition. Id. s 1.21. If consumers respond by buying the product from suppliers outside the smallest area, the geographic market boundary must be expanded. Id.

Once the market has been properly defined, the Guidelines set about to identify the firms competing in the market and those likely to enter the market within one year. Guidelines s 1.32. Following these steps, the Guidelines calculate the market share of each participant, followed by the Herfindahl-Hirschman Index (HHI) concentration measurement for the market as a whole. Guidelines s 1.5. The HHI is calculated by squaring the market share of each participant, and summing the resulting figures. Id. The concentration standards in the Guidelines concern the (1) pre-merger HHI (HHI1), (2) the post-merger HHI (HHI2) and (3) the increase in the HHI resulting from the merger, termed delta HHI ([ ]HHI). See Andrew I Gavil, William E Kovacic and Jonathan B. Baker, Antitrust Law in Perspective; Cases, Concepts and Problems in Competition Policy, 480-84 (Thomson West, 2002). The Guidelines specify safe harbors for mergers in already concentrated markets that do not increase concentration very much. For example if the post-merger HHI is between 1000 and 1800 (a moderately concentrated market) and the [ ]HHI is no more than 100 points, the merger is unlikely to be presumed illegal. Guidelines s 1.51. Likewise, if the post-merger HHI is above 1800 (a highly concentrated market) and the [ ]HHI is no more than 50 points, the merger will not be presumed illegal. Id.

Notwithstanding these statistical data, the Guidelines next focus on the likely competitive effects of the merger. Guidelines s 2.0; Baker Hughes, 908 F.2d at 984 ("Evidence of market concentration simply provides a convenient starting point for a broader inquiry into future competitiveness * * *."). The Guidelines recognize that anticompetitive effects may arise in two contexts. First, the Guidelines address the lessening of competition through coordinated interaction between the merged firm and remaining rivals. Guidelines s 2.1. Second, the Guidelines address the anticompetitive effects based on unilateral action. Id. s 2.2.

Anticompetitive Effects

Coordinated Effects

In analyzing potential coordinated effects, a court is concerned that the merger may diminish competition by "enabling the firms * * * more likely, more successfully, or more completely to engage in coordination interaction." Guidelines s 2.1. This behavior can be express or tacit (implied by silence), and the behavior may or may not be lawful in and of itself. Id. The Guidelines explicitly recognize that successful coordinated interaction "entails reaching terms of coordination that are profitable to the firms involved and an ability to detect and punish [cheating]." Id. s 2.1. See also FTC v. Elders Grain, Inc., 868 F.2d 901, 905 (7th Cir.1989); Hospital Corp. of Am., 807 F.2d at 1386-87. Examples of "terms that are profitable" include common pricing, fixed price differentials, stable market shares and customer or territorial restrictions. Guidelines s 2.11

Factors that increase the likelihood of coordination include product homogeneity, pricing standardization and pricing transparency. Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 238, 113 S.Ct. 2578, 125 L.Ed.2d 168 (1993); Elders Grain, 868 F.2d at 905. Plaintiffs do not contend that any of those conditions are presented in the proposed merger which must, therefore, be analyzed for unilateral anticompetitive effects.

Unilateral Effects

There is little case law on unilateral effects merger analysis. Few published decisions have even discussed the issue, at least using the term "unilateral effects." See, e.g., Swedish Match, 131 F Supp 2d at 168; New York v. Kraft Gen. Foods, Inc., 926 F.Supp. 321, 333-35 (S.D.N.Y.1995); Guidelines s 2.2. But, as the court demonstrates below, "unilateral effects" is primarily a new term to address antitrust issues that courts have in other contexts considered for quite some time.

Unilateral effects result from "the tendency of a horizontal merger to lead to higher prices simply by virtue of the fact that the merger will eliminate direct competition between the two merging firms, even if all other firms in the market continue to compete independently." Carl Shapiro, Mergers with Differentiated Products, 10 Antitrust 23, 23 (Spring 1996). Unilateral effects are thought to arise in primarily two situations, only the second of which is alleged in this case. See Roscoe B Starek III & Stephen Stockum, What Makes Mergers Anticompetitive?: "Unilateral Effects" Analysis Under the 1992 Merger Guidelines, 63 Antitrust LJ 801, 803 (1995); Guidelines ss 2.21, 2.22; Phillip E Areeda, Herbert Hovenkamp & John L. Solow, 4 Antitrust Law p 910 (Aspen, rev ed 1998) (subdividing unilateral effects theories into four categories).

The first situation involves a "dominant firm and a 'fringe' of competitors producing a homogeneous product." Starek & Stockum, 63 Antitrust LJ at 803. In this situation, the dominant firm has a substantial cost advantage over the fringe competitors and, therefore, can restrict output to obtain an above-marginal cost price.

The second situation, and the one here applicable, concerns differentiated products. Starek & Stockum, 63 Antitrust LJ at 803; Guidelines s 2.21. Competition in differentiated product markets, such as ERP products, is often described as "monopolistic competition." There is a notable and interesting literature on this subject commencing with the path-breaking and independent insights of two notable economists. See Edward Chamberlin, The Theory of Monopolistic Competition (Harvard, 1933, 1938), Joan Robinson, The Theory of Imperfect Competition (St Martin's, 1933, 2d ed 1969). The admirably clear exposition found in Paul A. Samuelson & William D. Nordhaus, Economics 187-89 (McGraw-Hill, 17th ed 2001) makes apparent this nomenclature.

The market demand curve shows the quantity of a good that would be purchased in the market at each price, other things being equal. Id. at 760. A seller's "own," or "residual," demand curve shows the quantity of the good offered by the seller that would be purchased from the seller at each price, other things being equal. Under perfect competition, the individualseller faces a horizontal (each additional unit brings the same revenue), or perfectly elastic, demand curve because nothing the seller can do alters demand for the seller's product. Id. at 148. The seller is a price taker. Because the seller's demand curve is horizontal, the seller's marginal revenue curve is also horizontal and the seller continues to produce until its marginal cost is equal to the market price or average revenue and profits, as economists define them, are zero. See id. fig 8-2 and text at 148-50.

[Editor's Note: Figure Not Available]

The adjacent figure, borrowed from Samuelson & Nordhaus, Economics fig 9-4 at 178, illustrates the different picture facing the monopolist. Its demand curve is not horizontal but reflects the inverse relationship between price and the quantity demanded. Because it is the only seller of the product, the pure or natural monopolist faces not the horizontal demand curve of the perfectly competitive firm, but the sloping demand curve of the entire market. In the graph, the monopolist is able to maximize profit at the intersection of marginal cost and revenue by reducing output to 4 and raising the price to $120, which exceeds marginal cost. The monopolist thus derives a "monopoly rent" equal to the number of units sold times the difference between the market price (G) and the monopolist's average cost (F), algebraically, (G--F) x 4. It is this reduction in output and elevation of price that has been the historic concern of antitrust.

[Editor's Note: Figure Unavailable]

Firms in perfect competition "produce homogeneous product" so that "price is the only variable of interest to consumers, and no firm can raise its price above marginal cost without losing its entire market share." Jean Tirole, The Theory of Industrial Organization at 277 (MIT, 1988). Differentiated products are imperfect substitutes representing as they do different features or characteristics that appeal variously to different customers. Because no product is a perfect substitute of another in a differentiated products market, each seller continues to face a downward sloping demand curve. Like a pure monopolist, the seller of a differentiated product, facing a downward sloping, or less than perfectly elastic, demand curve, maximizes its profit by pricing above marginal cost. See Samuelson & Nordhaus, Economics fig 10-3 and text at 188-89.

[Editor's Note: Figure Unavailable]

Like a seller in a perfectively competitive market, however, sellers in a "competitive" differentiated products market do not obtain monopoly rents. In differentiated product markets with few barriers to entry, firms will introduce products that are increasingly close, although not perfect substitutes, for the other products in the market. The introduction of additional products causes the demand curve faced by each seller to shift downward and leftward until, at long run equilibrium, the demand curve intersects the average cost curve of the seller (defined as economists define costs to include a reasonable profit) eliminating the monopolistic rent (ACGB). See id. fig 10-4 and text at 188-89.

Editor's Note: Figure Unavailable]

Differentiated product markets hence share some characteristics of both a pure monopoly and perfect competition, in that "prices are above marginal costs but economic profits have been driven down to zero." Id. at 189 (describing "economic profits" as supra-normal profits or monopoly rents). Firms selling differentiated products have some "market power" in that they are able to exert some control over the prices they obtain although this does not rise to the level of "monopoly power." See Shapiro, 63 Antitrust LJ 24 n. 4 (citing the economic literature).

The Guidelines provide some instruction on the necessary elements of a unilateral effects claim involving differentiated products under section 7.

Substantial unilateral price elevation in a market for differentiated products requires that there be a significant share of sales in the market accounted for by consumers who regard the products of the merging firms as their first and second choices, and that repositioning of the non-parties' product lines to replace the localized competition lost through the merger be unlikely.

Guidelines s 2.21.

Although the Guidelines' discussion quoted above may be a helpful start, the factors described therein are not sufficient to describe a unilateral effects claim. First, the Guidelines' discussion, at least in section 2.21, emphasizes only the relative closeness of a buyer's first and second choices. But the relative closeness of the buyer's other choices must also be considered in analyzing the potential for price increases. The Guidelines later acknowledge as much in section 2.212, which recognizes that if a buyer's other options include "an equally competitive seller not formerly considered, then the merger is not likely to lead to a unilateral elevation of prices." Accordingly, a plaintiff must prove not only that the merging firms produce close substitutes but also that other options available to the buyer are so different that the merging firms likely will not be constrained from acting anticompetitively.

Second, the Guidelines require only a demonstration of some "significant share of sales in the market accounted for by customers" that rank the merging firms first and second. Id. s 2.21. "Measures of the 'closest substitutes' or 'second choices' of inframarginal purchasers of Product A are only relevant to the degree that inframarginal and marginal consumers have similar preferences. However, essentially by definition, marginal and inframarginal consumers do not share similar preferences." Christopher A. Vellturo, Creating an Effective Diversion: Evaluating Mergers with Differentiated Products, 11 Antitrust 16, 18 (Spring 1997); Gregory J. Werden & George A. Rozanski, The Application of Section 7 to Differentiated Products Industries: The Market Definition Dilemma, 8 Antitrust 40, 41 (Summer 1994) ("[T]here is no reason why the shares in any delineated market in a differentiated products industry are indicative of the relative importance of each merging firm as a direct competitor of the other.").

In sum, it appears that four factors make up a differentiated products unilateral effects claim. First, the products controlled by the merging firms must be differentiated. Products are differentiated if no "perfect" substitutes exist for the products controlled by the merging firms. See Samuelson & Nordhaus, Economics at 187-89; Areeda, Hovenkamp & Solow, 4 Antitrust Law p 914d ("By 'significant' we mean product differentiation that goes to fairly fundamental differences in product design, manufacturing costs, technology, or use of inputs."). Second, the products controlled by the merging firms must be close substitutes. Products are close substitutes if a substantial number of the customers of one firm would turn to the other in response to a price increase.

Third, other products must be sufficiently different from the products controlled by the merging firms that a merger would make a small but significant and non-transitory price increase profitable for the merging firms. Finally, repositioning by the non-merging firms must be unlikely. In other words, a plaintiff must demonstrate that the non-merging firms are unlikely to introduce products sufficiently similar to the products controlled by the merging firms to eliminate any significant market power created by the merger. These four factors substantially track the analysis in Areeda, Hovenkamp and Solow. Areeda, Hovenkamp & Solow, 4 Antitrust Law p 914f at 68-69.

The essential elements of such a differentiated products unilateral effects claim are quite similar to those in "standard" antitrust analysis. In standard antitrust analysis, the court considers both "demand elasticity" and "supply elasticity" in determining whether anticompetitive effects are likely. Rebel Oil, 51 F.3d at 1436. In other words, courts determine the degree to which price increases will cause marginal buyers to turn to other products or marginal suppliers to increase output of the product.

Considerations of demand and supply elasticity also motivate the factors outlined by the court for a differentiated products unilateral effects analysis. The factors considering the relative substitutability of the products of the merging and non-merging firms, factors 1 to 3, essentially address demand-side substitutability and the repositioning factor, factor 4, essentially addresses supply-side substitutability.

Antitrust analysis of differentiated product markets is hardly new. See, e.g., E. I. du Pont, 351 U.S. at 392-93, 76 S.Ct. 994 (describing the concepts of monopolistic competition and differentiated product markets); Areeda, Hovenkamp & Solow, 4 Antitrust Law p 914c (suggesting that early railroad merger cases could be viewed as unilateral effects cases). Indeed, as noted above, defining a geographic market involves exactly same concept of localized competition that motivates differentiated products unilateral effects analysis.

Areeda, Hovenkamp and Solow persuasively contend that "the appropriate conclusion [under a unilateral effects analysis] is that the merger has facilitated the emergence of a new grouping of sales capable of being classified as a relevant market." Id. p 913b.

This "new grouping of sales" is one "in which the merging firms have either a monopoly or else a dominant share." Id p 914f at 69. In an example of two merging firms, B and C, Areeda, Hovenkamp and Solow state that "the merger does not create such a market because a cartel of firms B and C would also have been able to increase price profitably, indicating that B and C were already a relevant market." Id. p 914a at 60. But of course, "before their union, B and C felt one another's competition, as well as that of other firms, more significantly than after the merger." Id. Areeda, Hovenkamp and Solow also later note that "the sufficiently similar output of other firms must be included" in the relevant market. Id. p 914f at 70.

In a unilateral effects case, a plaintiff is attempting to prove that the merging parties could unilaterally increase prices. Accordingly, a plaintiff must demonstrate that the merging parties would enjoy a post-merger monopoly or dominant position, at least in a "localized competition" space.

Unilateral effects analysis shares many similarities with standard coordinated effects antitrust analysis. But there are also notable differences.

Relevant markets defined in terms of "localized competition" may be much narrower than relevant markets defined in typical cases in which a dominant position is required. Judicial experience cautions against the use of qualitative factors to define narrow markets. This judicial experience arises, in part, from the rise (and fall) of the "submarkets" doctrine.

In Brown Shoe, the Supreme Court stated that submarkets may constitute relevant product markets. "The outer boundaries of a product market are determined by the reasonable interchangeability of use or the cross-elasticity of demand between the product itself and substitutes for it. However, within this broad market, well-defined submarkets may exist which, in themselves, constitute product markets for antitrust purposes." Brown Shoe, 370 U.S. at 325, 82 S.Ct. 1502 (citing E. I. du Pont, 353 U.S. at 593-95, 77 S.Ct. 872) (footnote omitted).

Properly construed, Brown Shoe suggests merely that the technical definition of a relevant market in an antitrust case may be smaller than a layperson would normally consider to be a market. The use of the term "submarket" may be useful in "overcom[ing] the first blush or initial gut reaction" to a relatively narrowly defined market. See Staples, 970 F.Supp. at 1074 (defining the relevant market as "the sale of consumable office supplies through office supply superstores").

Focusing on "submarkets" may be misleading, however, because "the same proof which establishes the existence of a relevant product market also shows (or * * * fails to show) the existence of a product submarket." H J. Inc. v. International Tel. & Tel. Corp., 867 F.2d 1531, 1540 (8th Cir.1989). See also Olin, 986 F.2d at 1301. Defining a narrow "submarket" tends to require a relatively long laundry list of factors, which creates the danger of narrowing the market by factors that have little economic basis. Courts and commentators suggest that the use of the submarkets doctrine has, in fact, misled courts into "identify[ing] artificially narrow groupings of sales on the basis of non-economic criteria having little to do with the ability to raise price above cost." Areeda, Hovenkamp & Solow, 4 Antitrust Law p 914a at 60. See also Allen-Myland, Inc. v. IBM, 33 F.3d 194, 208 n. 16 (3d Cir.1994); Satellite Television & Associated Resources v. Continental Cablevision of Va., Inc., 714 F.2d 351, 355 n. 5 (4th Cir.1983).

The similarities between the submarkets doctrine generally and localized competition in unilateral effects cases are difficult to miss. Indeed, commentators have been quick to note the potential for "localized competition" analysis to devolve into an unstructured submarket-type analysis. See Areeda, Hovenkamp & Solow, 4 Antitrust Law p 914a at 60; Starek & Stockum, 63 Antitrust LJ at 814-15 (arguing that the Guidelines' focus on localized competition should not "be used as a tool for rehabilitating discredited 'submarket' analysis").

Furthermore, judicial rejection of markets narrowly defined to a single manufacturer's product has been even more pronounced than judicial skepticism about narrowly defined submarkets. See, e.g., E. I. du Pont, 353 U.S. at 592-93, 77 S.Ct. 872 (refusing to define a market limited to cellophane); TV Communs. Network, Inc. v. Turner Network Television, Inc., 964 F.2d 1022, 1025 (10th Cir.1992) (refusing to define a market limited to TNT cable provision in the greater Denver area); Town Sound & Custom Tops, Inc. v. Chrysler Motors Corp., 959 F.2d 468, 479-80 (3d Cir.1992) (en banc) (refusing to define a market limited to Chrysler products); Gall v. Home Box Office, Inc., 1992 WL 230245 at *4 (S.D.N.Y.) ("[T]he natural monopoly every manufacturer has in its own product simply cannot serve as the basis for antitrust liability."). Cf. Eastman Kodak, 504 U.S. at 481-82, 112 S.Ct. 2072 (upholding denial of summary judgment in an installed base context).

As emphasized in E. I. du Pont:[O]ne can theorize that we have monopolistic competition in every nonstandardized commodity with each manufacturer having power over the price and production of his own product. However, this power that, let us say, automobile or soft-drink manufacturers have over their trademarked products is not the power that makes an illegal monopoly. Illegal power must be appraised in terms of the competitive market for the product.

351 U.S. at 393, 76 S.Ct. 994 (footnotes omitted).

Merely demonstrating that the merging parties' products are differentiated is not sufficient. Instead, a plaintiff must demonstrate product differentiation sufficient to sustain a small but significant and non-transitory price increase.

Additionally, defining markets in terms of "localized competition" may result in markets defined so narrowly that one begins to question whether the market constitutes a "line of commerce" as required by section 7. One concern is that the market is defined so narrowly that it encompasses an insubstantial amount of commerce. In Philadelphia Nat Bank, the Supreme Court found a "workable compromise" between a geographic market narrowly defined in terms of bank offices in the immediate neighborhood or more expansively defined to include the banks available only to large borrowers. 374 U.S. at 360-61, 83 S.Ct. 1715. Another concern is that the market is defined so narrowly it fails to capture the potential effects of the merger. For example, it might be inappropriate to focus on a single city in analyzing the effects of a merger between sellers who compete on a much larger scale. Cf. Staples, 970 F.Supp. at 1073 nn. 5-6 (analyzing the likelihood of anticompetitive effects in forty-two metropolitan areas).

Even if a narrow market definition would be appropriate, it may be more difficult to identify "clear breaks in the chain of substitutes" sufficient to justify bright-line market boundaries in differentiated products unilateral effects cases. The conventional ideal market boundary divides products within the market, which are freely substitutable with one another, from products outside the market, which are poor substitutes for the products within the market. See United States v. Rockford Memorial Corp., 717 F.Supp. 1251, 1260 (N.D.Ill.1989) (emphasis added), aff'd, 898 F.2d 1278 (7th Cir.1990). In differentiated products unilateral effects cases, a "spectrum" of product differences, inside and outside the market boundary, is more likely. In re Super Premium Ice Cream Distribution Antitrust Litig., 691 F.Supp. 1262 (N.D.Cal.1988), aff'd. sub. nom., Haagen-Dazs Co. v. Double Rainbow Gourmet Ice Creams, Inc., 895 F.2d 1417, 1990 WL 12148 (9th Cir.1990) (table). In discussing unilateral effects, Shapiro has written:

[A]ny attempt to make a sharp distinction between products "in" and "out" of the market can be misleading if there is no clear break in the chain of substitutes: if products "in" the market are but distant substitutes for the merging products, their significance may be overstated by inclusion to the full extent that their market share would suggest; and if products "out" of the market have significant cross-elasticity with the merging products, their competitive significance may well be understated by their exclusion.

Shapiro, 10 Antitrust at 28. See also Edward Chamberlin, Product Heterogeneity and Public Policy, 40 Am. Econ Rev. (Papers & Procs.) 85, 86-87 (1950).

Additionally, to the extent that clear breaks are difficult to identify, attempts to create defensible market boundaries are likely to be based on relatively vague product characteristics. Product characteristics that are too vague do not meet section 7's requirement that the relevant market be "well-defined." See Tenet Health Care, 186 F.3d at 1052.

A closer look at product differentiation demonstrates further difficulties in defining the relevant market in differentiated product unilateral effects cases. Price is one, but only one, of many ways in which to differentiate a product. A market of homogeneous goods can be seen as a market in which sellers have only one dimension in which to differentiate their product. One expects sellers in such a market to "differentiate" their products by lowering the price until price equals marginal cost. On the other hand, a differentiated product "market" is a market in which sellers compete along more dimensions than price. As a result, products competing against one another in a differentiated product market may have widely different prices. That products with widely different prices may, in fact, be in the same market complicates market definition considerably.

The "Cellophane fallacy" may complicate matters even further. This phenomenon takes its name from an error in the Supreme Court's logic E.I. du Pont. In E. I. du Pont, the plaintiff was the primary manufacturer of cellophane. The Supreme Court held that the relevant market included "all flexible wrappings" because cross-price elasticities of demand indicated that an increase in the price currently charged for cellophane would cause a significant number of purchasers to turn to other flexible wrapping products.

The error in the logic of E. I. du Pont is that " '[t]he existence of significant substitution in the event of further price increases or even at the current price does not tell us whether the defendant already exercises significant market power.' " Eastman Kodak, 504 U.S. at 471, 112 S.Ct. 2072 (quoting Phillip Areeda & Louis Kaplow, Antitrust Analysis p 340(b) (Aspen, 4th ed 1988)). Stated slightly differently, because a monopolist exercises market power by increasing price until the cross-price elasticity of demand is so high that a further price increase would be unprofitable, a high cross-price elasticity of demand at current prices, by itself, does not demonstrate that the seller lacks market power.

The implications of the Cellophane fallacy on market definition in differentiated product market cases would seem to suggest caution. Courts should be wary of defining markets so broadly that a seller's existing market power is missed. On the other hand, in differentiated product markets, some measure of market power is inherent and an unduly narrow product market definition proves too much. In merger analysis, the court is concerned primarily with determining whether the merger would enhance market power, not whether market power currently exists.

In sum, defining the relevant market in differentiated product markets is likely to be a difficult task due to the many non-price dimensions in which sellers in such markets compete. Further, it may be difficult to determine currently existing market power and separate this from enhanced market power due to the merger.

The inability clearly to define a market suggests that strong presumptions based on mere market concentration may be ill-advised in differentiated products unilateral effects cases. As noted by Starek and Stockum, "it is generally misleading to suggest that a firm "controls" a certain market share in the absence of an analysis beyond market concentration." Starek & Stockum, 63 Antitrust LJ at 804. See also Jerry A. Hausman & Gregory K. Leonard, Economic Analysis of Differentiated Products Mergers Using Real World Data, 5 Geo. Mason L. Rev. 321, 337-39 (1997). Such a concern applies with equal force to differentiated products unilateral effects claims. Furthermore, in differentiated products unilateral effects cases, the merging parties' combined market shares relative to competitors may be less relevant than the size of their market shares in determining whether anticompetitive effects are likely. See Gregory J. Werden & Luke M. Froeb, The Effects of Mergers in Differentiated Products Industries: Logit Demand and Merger Policy, 10 J. L. Econ. & Org. 407, 413 (1994).

Accordingly, a strong presumption of anticompetitive effects based on market concentration is especially problematic in a differentiated products unilateral effects context.

Despite the problems with qualitative analyses, modern econometric methods hold promise in analyzing differentiated products unilateral effects cases. Merger simulation models may allow more precise estimations of likely competitive effects and eliminate the need to, or lessen the impact of, the arbitrariness inherent in defining the relevant market. For example, some merger simulation methods compensate for potential errors in market definition. A model advanced by Werden and Froeb uses a set of "inside goods" and a set of "outside goods." Id. at 410. The model contains a parameter, beta, that controls for the substitutability among the inside goods and another parameter, epsilon, that controls for the substitutability between the inside and outside goods. Id. To the extent the set of goods considered as "inside goods" is defined narrowly, epsilon increases. Id. at 424-25. The increase in epsilon increases the predicted amount of substitution to outside goods. Accordingly, error in defining the product market too narrowly will be offset, at least to some extent, by the increase in epsilon.

In sum, differentiated products unilateral effects analysis shares many similarities to "standard" antitrust analysis. The primary differences are that the relevant market is likely to be smaller and more difficult to define and that quantitative analyses may be robust.

In analyzing antitrust claims, courts have considered both "circumstantial" and "direct" evidence of anticompetitive effects.

See Rebel Oil, 51 F.3d at 1434. Even though "direct" evidence of the potential for anticompetitive harm from a merger is not literally available, merger analyses range from highly qualitative ("circumstantial") to highly quantitative ("direct"), depending on the data available for a particular market. Qualitative analyses of antitrust claims are most often structural. In a structural analysis, anticompetitive effects are presumed if a plaintiff demonstrates undue concentration in a well-defined market. See Philadelphia Nat. Bank, 374 U.S. at 363, 83 S.Ct. 1715; Baker Hughes, 908 F.2d at 982. A relevant market may be defined by reference to Brown Shoe 's "practical indicia." 370 U.S. at 325, 82 S.Ct. 1502. Once the relevant market is defined, market shares are calculated and inferences are drawn from the degree of concentration.

The Guidelines adopt a structural approach for addressing unilateral effects claims that closely mirrors traditional structural analysis. See Guidelines s 2.211. The biggest weakness in the Guidelines' approach appears to be its strong reliance on particular market share concentrations. Under the Guidelines, anticompetitive effects are presumed "[w]here market concentration data fall outside the safeharbor regions of Section 1.5, the merging firms have a combined market share of at least thirty-five percent, and where data on product attributes and relative product appeal show that a significant share of purchasers of one merging firm's product regard the other as their second choice," unless "rival sellers likely would replace any localized competition lost through the merger by repositioning their product lines." Id. at ss 2.211, 2.212.

A presumption of anticompetitive effects from a combined share of 35% in a differentiated products market is unwarranted. Indeed, the opposite is likely true. To prevail on a differentiated products unilateral effects claim, a plaintiff must prove a relevant market in which the merging parties would have essentially a monopoly or dominant position. In Rebel Oil, the Ninth Circuit noted that a market share of 30% is "presumptively insufficient to establish the power to control price." 51 F.3d at 1438.

Market definitions, statistical presumptions and likelihood of unilateral anticompetitive effects are all issues on which the parties contended vigorously and presented much evidence. To these, the court now turns.

CONTENTIONS, EVIDENCE AND FINDINGS

"Defining the relevant market is critical in an antitrust case because the legality of the proposed merger[ ] in question almost always depends upon the market power of the parties involved." Cardinal Health, 12 F.Supp.2d at 45. Yet the precise characteristics that plaintiffs have used to describe the line of commerce allegedly affected by the proposed transaction changed throughout the course of this litigation. And the evidence of market shares presented to enable the court to apply the Philadelphia Nat Bank presumptions or make the HHI calculations of the Guidelines is, given the mountain of evidence plaintiffs presented, startling sparse.

Plaintiffs' Proposed Product Market Definition

Plaintiffs offer a product market of high function HRM and FMS and a geographic market of the United States.

Four elements constitute plaintiffs' definition of high function HRM software as alleged in the FAC: " Human Resource Management (HRM) software and accompanying services that can be integrated into suites of associated functions from a single vendor with performance characteristics that meet the demands of multifaceted organizations with high-level functional needs." FAC (Doc. # 125) p 23(a) at 12.

Likewise, four elements constitute plaintiffs' definition of high function FMS software as alleged in the FAC: " Financial Management Services (FMS) software and accompanying services that can be integrated into suites of associated functions from a single vendor with performance characteristics that meet the demands of multifaceted organizations with high-level functional needs." Id. p 23(b) at 12-13.

The FAC also notes certain performance characteristics of high function software:

Customers with high-level functional needs ("enterprise customers") require products that can support their ongoing business processes and reporting requirements that may stretch across multiple jurisdictions (often requiring support for foreign languages and reporting requirements), multiple legal entities or divisions within the organization and multiple lines of business. These products must have the scale and flexibility to support thousands of simultaneous users and many tens of thousands of simultaneous transactions, and the ability to integrate seamlessly into bundles or "suites" of associated HRM and FMS functions. Most importantly, these ...

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