US regulators have vertical integration in their sights

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Vertical integration is all the rage as companies scramble to compete in artificial intelligence and decarbonisation. They believe that exerting more sway over suppliers and sales channels will help them speed innovation and cope with geopolitical disruption. But is it better to buy the necessary supplies and smarts, develop them in-house or find some way to strike a partnership?

Last year, General Motors purchased a lithium mine to secure crucial minerals for its electric vehicles. Chinese rival BYD already controls most of its supply chain, down to the ships that transport its cars and it is reportedly on the hunt for acquisitions as it looks to expand.

Apple this week announced a partnership with OpenAI to integrate ChatGPT into its devices. It is seeking to catch up with rival Microsoft, which got in early with the AI start-up and has now put in $13bn and incorporated its technology into multiple products. Meanwhile, Google owner Alphabet, an early AI leader because of its 2014 purchase of DeepMind, is building its own large language models and recently bumped up development of proprietary chips to power its offerings.

Many companies have very good reasons for vertical combinations beyond seeking to command and profit from cutting-edge technology. Tight connections often increase efficiency and the ability to recover from supply chain disruptions. Direct ownership also makes it easier to monitor for labour abuses, overseas bribery and other regulatory violations, while simplifying the calculation of carbon emissions.

But competition watchdogs are growing concerned that vertical integration can also further less laudable goals. In areas where technology is still developing, powerful companies may try to steal a march on rivals — and independent entrepreneurs — by using their power over key inputs or sales channels to foreclose competition.

For years, US enforcers primarily focused on horizontal deals, where harm to competition is easier to prove because they involve combinations of direct rivals. To the extent that they expressed concern when big companies moved up or down the value chain, these were largely allayed by promises not to abuse market power, as with concert promoter Live Nation’s 2010 purchase of Ticketmaster.

But that has begun to change. Under chair Lina Khan, the Federal Trade Commission tried to stop Microsoft, which makes gaming consoles, from buying game group Activision, and block Meta from taking over Within, a virtual reality company. Those challenges failed, but the FTC had more success when it sought to block biotech group Illumina from buying Grail, which makes cancer screening tests.

A federal appeals court agreed the FTC was right to worry that Illumina’s dominance in DNA sequencing tests gave it too much power over potential competitors to Grail in the still nascent screening market. EU enforcers were even tougher, hitting Illumina with a €432mn fine for completing the merger without Brussels’ OK. Illumina’s chief executive lost his job and the company plans to spin Grail back out again in an initial public offering this month.

More cases are in the works, including some that reconsider earlier leniency. The justice department last month sued to break up Live Nation, saying it now suffocates competition because it manages musical acts and controls arenas while also dominating concert ticketing.

Corporate executives should be wary of seeing this as a brief Biden administration blip that will go away if Donald Trump retakes the presidency in November. His justice department started this trend when it brought the first vertical merger court case in more than 40 years, seeking to block AT&T’s purchase of Time Warner.

Although that lawsuit failed, Republican-appointed judges have proved to be sympathetic to some of the other claims. The Illumina decision author was appointed by George HW Bush. “Courts are a lot more receptive . . . than people think they are. This is not only a right-left issue,” says Rebecca Allensworth, a Vanderbilt law professor. “I don’t see this all going away.”

Chief executives hoping to stay out of the regulatory crosshairs would do well to remember a simple rule: not all vertical integration is the same. Companies that innovate generally avoid criticism unless they abuse existing power by illegally tying two products together. And buying an already successful business to deny access to competitors is quite different than licensing the technology.

Total control has its advantages. Freedom from antitrust scrutiny is not one of them.

brooke.masters@ft.com

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