On August 21, 2007, the U.S. District Court for the District of Columbia released its decision denying the Federal Trade Commission’s (FTC) motion for a preliminary injunction to halt the merger of Whole Foods Market and Wild Oats Markets, Inc. This was the same district that blocked the proposed merger between Staples and Office Depot 10 years ago (Federal Trade Commission v. Staples, Inc.). In Whole Foods, the court rejected the FTC’s narrow market definition, whereas in Staples it accepted the FTC’s narrow market definition. Citing Staples, the Whole Foods decision noted that “[a]s with many antitrust cases, the definition of the relevant product market in this case is crucial. In fact, to a great extent, this case hinges on the proper definition of the relevant product market.” Comparing the opinions in the Whole Foods and Staples cases provides useful insight into how courts may resolve product market definition in merger cases involving “differentiated” products (i.e., products that consumers perceive as different, although they perform the same basic functions). Parties in industries with differentiated products can gain insight into how to evaluate potential acquisitions from the antitrust enforcement perspective, and how to avoid unnecessarily delaying the review of their transactions.
The FTC challenged the Whole Foods/Wild Oats transaction because it believed the merger would substantially lessen competition in the alleged market for “premium natural and organic supermarkets.” Relying in large part on documents prepared by Whole Foods describing Wild Oats as a critical competitor, and deposition testimony from the former CEO of Wild Oats, the FTC moved for a temporary restraining order, to prevent Whole Foods and Wild Oats from consummating their transaction. On July 31 and August 1, 2007, the court held a hearing on the FTC’s motion for preliminary injunction. The only witnesses who testified were the parties’ expert economists, Kevin Murphy, Ph.D., from the University of Chicago on behalf of the FTC, and David Scheffman, Ph.D., with LECG on behalf of Whole Foods and Wild Oats. The judge also considered deposition testimony and declarations from multiple lay witnesses and five expert witnesses, numerous documents submitted by the parties and the written and oral arguments presented by the parties’ counsel. Judge Paul Friedman issued an order and opinion denying the FTC’s motion for preliminary injunction approximately two weeks after the conclusion of the hearing. The FTC appealed Judge Friedman’s decision to the U.S. Court of Appeals for the District of Columbia Circuit and requested a stay preventing the parties from consummating the merger. The D.C. Circuit denied the FTC’s motion to stay the transaction pending its appeal.
Factors in the Court’s Rejection of the FTC’s Narrow Product Market in Whole Foods
In Whole Foods, the FTC identified several features that allegedly distinguish “premium natural and organic supermarkets” from conventional supermarkets, and supported a separate market. According to the FTC, “premium natural and organic supermarkets” generally focus on “high-quality perishables, specialty and natural organic produce, prepared foods, meat, fish and bakery goods;” have “high levels of customer services;” “target affluent and well-educated customers;” are “mission driven with an emphasis on social and environmental responsibility;” “provide customers with the confidence of a ‘lifestyle’ brand;” and “provide a ‘unique’ environment.”
Applying the FTC and the Department of Justice’s (DOJ) Horizontal Merger Guidelines, the district court found that the FTC’s proposed market of “premium natural and organic supermarkets” was too narrow, and that the relevant market “inevitably” encompassed at least all supermarkets. The basic facts on which the court relied include the following:
- Event studies/pricing data. There was no significant economic proof that prices were lower in areas where Whole Foods and Wild Oats were both present (as opposed to only one of them being present). Also, there was no strong evidence that entry of a second “premium natural and organic supermarket” into an area had any effect on prices.
- Cross-shopping. Because conventional supermarkets are increasing the number of natural and organic products they offer, the court found that many of Whole Foods’ and Wild Oats’ customers could and did exercise shopping alternatives by cross-shopping among various supermarkets and retailers, looking for the best prices on their desired products. Whole Foods customers were shopping in conventional supermarkets as often as once a week, and Wild Oats customers do the majority of their shopping at conventional supermarkets. The incidence of cross-shopping demonstrates that price-sensitive customers have the simple choice of buying the products they would buy at Whole Foods or Wild Oats wherever they do the rest of their shopping. In other words, “premium natural and organic supermarkets” are not only competing with themselves, but with conventional supermarkets as well.
- Company competitive plans/strategies. The company and third party testimony and materials cited by the court demonstrated that Whole Foods faces significant competition from conventional supermarkets. The testimony from third parties, i.e., conventional supermarkets, showed that they are repositioning their stores to compete more effectively with Whole Foods. There was no evidence that Whole Foods uniquely competed with Wild Oats, or that the firms competed with each other differently than they competed with conventional supermarkets. For example, Whole Foods and Wild Oats are not pricing solely against one another. Whole Foods priced based on grocery stores and not based on Wild Oats, and that they price-checked against other stores, but generally not against Wild Oats.
- Customer draw/loss patterns. The court also found that the stores primarily drew business from conventional supermarkets, rather than from each other, when entering a new area.
In light of this type of evidence, the court found that the FTC’s proposed product market was not appropriate. Applying the Merger Guidelines Small but Significant Non-transitory Increase in Price, or SSNIP test, the court found that a small price increase by “premium natural and organic supermarkets” would be unprofitable, because customers could readily shift purchases to other stores. The court found that the FTC improperly equated the unique characteristics of Whole Foods and Wild Oats stores with a unique relevant product market. The court noted that there may well be differences between conventional supermarkets and “premium natural and organic supermarkets,” but the relevant question was whether customers would switch to conventional supermarkets if Whole Foods, post-merger, were to raise prices or reduce quality.
Factors in the Court’s Acceptance of the FTC’s Narrow Product Market in Staples
A comparison with Staples is instructive because the issues were similar, but the proof and outcome were different. The FTC argued that the proposed merger of Staples and Office Depot would substantially lessen competition in the market for “the sale of consumable office supplies through office superstores.” As in Whole Foods, the FTC identified unique characteristics that differentiated office supply superstores from other retailers—for example, distinct store formats, different sets of customers and dissimilar pricing. However, unlike Whole Foods, in Staples the FTC presented significant pricing data and other evidence in support of its proposed market definition. Applying the market definition analysis set forth in Brown Shoe Co. v. United States, the court agreed with the FTC’s assertions, relying on the following evidence:
- Event studies/pricing data. Unlike Whole Foods, in Staples the FTC presented strong pricing data, which demonstrated that in areas where Staples was the only office superstore, its prices were 13 percent higher than in areas where there also was an Office Depot or Office Max. In areas where Office Depot was the only office superstore, its prices were more than 5 percent higher than in areas where other office superstores existed. Despite the presence of other retailers (such as Wal-Mart and Best Buy) in Staples-only or Office Depot-only markets, Staples and Office Depot still consistently charged higher prices than in markets where there were two or three office superstores. The FTC also presented evidence that when another office superstore entered a one-firm market, the incumbent office superstore lowered its prices, but it did not respond to entry by other non-office superstore retailers.
- Unique characteristics. The court found that, when considered in conjunction with other evidence presented by the FTC, the unique characteristics of office superstores distinguish them from other retailers. Office superstores are large in size and scale, and devote more floor space to consumable office supplies than other retailers. Also, the customer base of office superstores (primarily small businesses and consumers with home offices) differs from the customer bases of other retailers and mail order firms.
- Company competitive plans/strategies. Unlike Whole Foods, in Staples there was significant evidence that Staples and Office Depot uniquely competed against one another. Staples’ and Office Depot’s internal documents showed that the merging companies (and Office Max) regarded only other office superstores as their competition, making business decisions vis-à-vis other office superstores, and not other retailers and mail order firms. Staples’ internal business documents also confirmed that its localized zone pricing policy called for higher prices in areas where it was the lone office superstore than in those geographic markets where it faced competition from other office superstores. Also, Staples and Office Depot price-checked against other office superstores far more frequently than they price-checked against other retailers.
Guidance for Companies Considering Mergers Involving Consumer Products
The Whole Foods and Staples decisions outline the types of data and evidence that enforcement agencies expect from parties trying to get deals through either the FTC or DOJ, particularly in industries involving differentiated products. Collecting and analyzing this data in preparation for a proposed transaction will be critical to avoiding a protracted government investigation.
Pricing data will be critical for parties trying to get deals through FTC or DOJ investigations. To avoid a lengthy government investigation, parties contemplating transactions involving competitors should consider gathering pricing data and reviewing it with outside lawyers and economists in advance of any discussions with the FTC or DOJ. Knowing in advance whether the pricing data is favorable or not will allow the parties to prepare thoroughly for any questions the agencies might have.
- Pricing data that shows the merging parties price against a wide variety of competitors and not just each other argues in favor of a broader market definition encompassing a number of competitors.
- Pricing data that shows higher prices in areas where only one of the merging parties operates and shows lower prices where both of the merging parties operate argues in favor of a narrower product market, and likely indicates that the merging parties are each other’s closest competitors.
Company Competitive Plans/Strategies
The enforcement agencies continue to rely heavily on internal documents discussing business strategy, competition and the effects of transactions. Careful drafting of business and strategic plans in the ordinary course of business, as well as documents analyzing a proposed transaction, is crucial so as not to provide the agencies with any statements the parties later must spend time and money trying to disprove. For example, in trying to prove the potential anticompetitive effects of the Whole Foods/Wild Oats merger, the FTC relied heavily on the internal e-mails Whole Foods CEO John Mackey sent to members of Whole Foods’ board declaring that merger would enable Whole Foods “to avoid nasty price wars” and would reduce the risk that a conventional grocery retailer could acquire Wild Oats and reposition itself to compete more effectively against Whole Foods. These unhelpful documents, which apparently overstated the competitive significance of Wild Oats, likely drew the FTC’s interest in pursuing litigation to stop the transaction.
- Documents that discuss a wide variety of competitors that the merging parties seriously consider when making business and strategic decisions may argue in favor of a broader product market.
- Documents that only discuss a handful of competitors, including the other merging party, that the company considers when making business and strategic decisions may argue in favor of a narrower product market.
- Documents that discuss how the proposed transaction will insulate the surviving party from price competition or allow the surviving party to raise prices, may attract increased scrutiny from the enforcement agencies. Because they suggest the merging parties are each other’s closest competitors, such documents also may argue in favor of a narrower product market.
Customer Purchasing Patterns
Particularly in mergers involving differentiated products, demonstrating that customers switch among the products offered by the merging parties and those offered by other companies is critical to illustrate that the merging parties are not each other’s closest competitors and that they operate within a broader product market. Such data is important because if the enforcement agencies believe the merging parties are each other’s closest competitors, the proposed transaction may be subject to increased government scrutiny. Parties contemplating transactions should collect and review existing customer data with their counsel to prepare for possible questions from the FTC or DOJ. If data showing customer purchasing patterns does not exist, parties should consider commissioning customer studies or surveys. Any data collected should be gathered by or at the direction of counsel, to protect the information as privileged.
- Customer data showing that consumers rely on a variety of companies (and not the merging parties exclusively) to supply the products at issue demonstrates that the merging parties are not each other’s closest competitors and argues in favor of a broader market.
- Customer data showing that customers rely primarily on the merging parties for the products at issue indicates that the merging parties are likely each other’s closest competitors, and argues in favor of a narrower product market.
McDermott’s Antitrust & Competition Group regularly provides guidance to clients in defending transactions before the FTC and DOJ, using the types of evidence analyzed in Whole Foods and Staples to assist in completing transactions.