Staples and Boeing: What They Say About
Merger Enforcement at the FTC
Prepared Remarks of
Chairman, Federal Trade Commission
Business Development Associates
The Madison Hotel
September 23, 1997
In the l990s, the most significant aspect of antitrust enforcement relates to the merger wave and the appropriate response to it.
The merger wave itself is remarkable. In the fiscal year that will end September 30, 1997, there will have been about 3, 500 transactions valued at more than $15 million dollars reported to the federal enforcement agencies. That is more than twice as many as just five years ago. 128 of those transactions were valued at more than $1 billion dollars. By the end of the present calendar year, approximately three quarters of a trillion dollars of assets will have been acquired in mergers and acquisitions reviewed in the United States.
Unlike the conglomerate merger wave of the late l960s, and the leveraged buyout hostile takeover junk bond activities of the l980s, this current wave of transactions on the whole does not seem to be motivated nearly as much by financial considerations or stock market manipulation. Rather a larger percentage of these transactions appear to be a response to changes in the world economy. Many are a response to the sharp increase in global competition (pharmaceuticals and auto parts), others to new economic conditions produced by deregulation (telecommunications and electric utilities) and still others to over capacity in some industries and to an effort through mergers to bring supply more in line with demand (defense industries and hospitals).
While a large portion of the mergers in this current wave appear to be motivated by a legitimate response to fast changing business conditions, a larger proportion than in the recent past seem to involve direct competitors. As a result, the threat of increased market power, and abusive effects on consumer welfare, is often present.
As to policy approaches to mergers, the enforcement agencies still rely heavily on the Merger Guidelines first adopted in 1982 and revised several times since. The main difference is that the Guidelines are enforced today more nearly as written, and some of the defenses offered by sponsors of a merger, such as the claim that supply substitution would occur if prices were increased shortly after the merger was completed, are viewed with greater caution. Partly as a result of differences in interpretation of precedent and the guidelines, the antitrust agencies - the Antitrust Division and the Federal Trade Commission - each challenged roughly three times as many mergers in the mid-1990s as each enforcement agency challenged 10 years earlier.
Merger policy was clarified in another respect. The Merger Guidelines were revised in 1997 to make it clear that efficiency claims will be taken into account and, in a close case, may demonstrate that the total competitive effect of a merger will help rather than injure competition. By integrating efficiency analysis more fully into the merger review process, those reviews will be more complicated because of the need to carefully trade off anticompetitive effects derived from increases in market power against procompetitive effects that may result from real and substantial efficiencies. Nevertheless, my view is that by taking both sides of the ledger - the dangers and benefits of a merger - more fully into account, U.S. merger policy overall, despite the costs and increased complexity, is more sensible and balanced.
At the Federal Trade Commission, the two recent merger cases that attracted the most public attention were the challenges to the proposed acquisition by Staples of Office Depot, and the decision not to challenge Boeing's acquisition of McDonnell Douglas. Merger cases are highly fact intensive and no two cases can really illustrate enforcement approaches; nevertheless, several of the most interesting aspects of current merger review can be discussed in the context of those two proceedings.
1. Staples/Office Depot
The Staples case raised a broad range of merger issues, but two of the most important were definition of relevant product market, and how to treat claims of efficiency in defense of a merger. Staples was the second largest office supply super store chain in the United States with approximately 550 retail stores and $4 billion in sales. It proposed to acquire Office Depot, the largest office supply super store chain with over 500 retail outlets and a little over $6 billion in sales. OfficeMax was the only other office supply super store firm in the United States.
a. Relevant Product Market.
The Commission's contention was that the sale of consumable office supplies (i.e. not durables like computers or office furniture) through office supply super stores was a separate relevant product market. The Commission conceded that office supply products like paper, pens, file folders and post-it notes were widely available through many outlets and did not vary in quality depending on the outlet where these supplies were purchased. On the other hand it contended that in appearance, size, format, pricing and range of inventory, these super stores were far different from small independent stationery stores and even large retailers like WalMart and KMart that carried such supplies but in a different format and inventory. In effect the Commission argued that office supply super stores are to small office supply outlets as super market food chains are to independent groceries(2) and commercial banks are to other sources of credit and financial services (3) and therefore were properly viewed as a separate product market.
The argument about anticompetitive effect in Staples turned on a single overwhelming fact: prices of office supplies could be shown on average to be substantially higher in cities where only one office supply super store chain was located than where two super store chains competed, and even higher than in cities where the three super store chains all faced each other in the market place. Several studies indicated that the difference in price between one chain cities and three chain cities was approximately 13% - an extremely large price difference in retailing where profits and profit margins are usually narrow and volume is great. Moreover, these differences persisted regardless of the presence or absence of other sources of office supplies like mail order, price clubs, large wholesalers, and independent stationers. The Commission's case was aided by the fact that the price differences to some extent were confirmed in the companies' own documents, leading the companies to characterize the cities with a single super store chain as "noncompetitive" zones.
Ordinarily in antitrust analysis, market power is measured by examining the characteristics of a given set of products or markets, defining differences between that set and actual or potential competitors, and then predicting that prices could be raised a substantial amount without losing sufficient business to make the price rise unprofitable. In Staples, the Commission argued that there were differences in business format between office supply super stores and its rivals, and argued further that prices responded primarily to the presence of other office supply super stores. The Court accepted this view. In effect, it found that the various office supply super stores had raised prices a significant amount over a substantial period of time, in those cities where one chain faced no other super store competition, and had not lost sufficient business to other kinds of rivals to make those price increases unprofitable.
An interesting question for future debate is what to make of this difference in approach between predicting price effects, as opposed to using economic data to show what price effects were across markets. Some have suggested that a useful way to think about the case is to regard all sources of consumable office supplies as rivals but recognize, as a result of the price studies, that the three office supply super stores were the closest substitutes to each other. Proceeding along that line, any prediction that prices would increase as a result of the merger is a variation on a "unilateral effects theory." There surely will be cases in the future where that sort of analysis is the most illuminating. I do not believe, however, that it is essential or appropriate to the Staples case, and it is clear that the District Judge, in deciding the case, relied on a more conventional form of analysis.
In my view, the Court appropriately found that office supply super stores do business in a sufficiently special way that they constitute a separate product market - not a submarket but a market. The econometric evidence showed that there was cross elasticity of demand among customers of the various super stores - hence prices were lowest when super stores met each other in the same geographic market - but there was relatively little cross elasticity between the super stores and other sources of consumable office supplies. In that view, the econometric evidence demonstrated the existence of a separate relevant market, and was not a technique whereby the government could avoid its obligation to demonstrate the existence of a market. And of course once that narrow market was established, market shares were extremely high, including HHI's of 10,000 in those cities where the merger resulted in two office supply super stores combining into one, with the result that the merger was illegal under the most conventional form of merger analysis.
Finally, while the District Court opinion cited the Supreme Court's Brown Shoe opinion at several critical points(4) and even cited the Brown Shoe set of factors for determining relevant product market(5), it is clear from reading the entire opinion that the critical factor in the Court's view was high cross elasticity of demand between office supply super stores, and low cross elasticity of demand between super stores and other sources of consumable office supplies -- not the factors cited in Brown Shoe and sometimes criticized as only marginally relevant(6).I believe the Court took what is best in Brown Shoe and applied it is a sensible way to a kind of data rarely available when Brown Shoe was decided.
Because of the vast increase in the availability of data as a result of the computerization of the business world, it almost certainly will be true that the kind of price comparisons across markets, both product and geographic, that was accomplished in the Staples case will be available to enforcement agencies in the future. Will parties in future litigation usually have such a rich source of economic data about prices and price elasticity as in Staples? Almost certainly not. When such data is available, however, it surely offers a more reliable description of the "competitive arena" in which rivalry occurs than we have sometimes seen in past merger cases.
b. Efficiency Analysis.
Staples contention throughout the litigation was that even if prices might rise slightly as a result of the merger in some markets, those price increases resulting from market power would be overwhelmed by the substantial efficiencies that would be generated by the combination of firms. The Court could have disposed of that argument by concluding that the Supreme Court allows District Judges no authority to balance efficiency claims against market power effects, citing the 1967 decision in FTC v. Procter & Gamble Co.(7) to the effect that "possible economies cannot be used as a defense to illegality in Section 7 merger cases."(8) The District Court instead noted that the revised DOJ - FTC Merger Guidelines now allow limited scope for efficiency claims, and examined the efficiency issue as several district court judges have done in recent years.
There is little question in my mind that debate over the existence and magnitude of efficiencies associated with a merger will become an important element of future merger review and merger enforcement.
Staples pointed to many efficiencies as a result of the combination of Staples and Office Depot stores, but the principal one was that the combined firm would have augmented purchasing power and could extract better prices from its various vendors. The District Court rejected the efficiency claims essentially on two grounds. First, it found that the claims were not based on "creditable evidence," and appeared to be grossly exaggerated. For example, it noted that the cost savings estimate submitted to the Court exceeded by almost 500% the figures presented to the Boards of Directors of the two firms when they approved the transaction less than a year earlier. More important, the Court noted that the efficiencies were not merger specific. Both parties to the merger were expanding rapidly by opening new stores, as many as 100 or 150 new stores per year for each, so that increased buying power, even assuming it could be used to extract better prices from vendors, would have occurred as a result of internal expansion in any event. If there was an efficiency, it involved moving to a larger enterprise immediately rather than over a period of 3 or 4 years, but those efficiencies would have been temporary and declining in significance. The merger, on the other hand, and its anticompetitive effects, would have been permanent.
I would have added two less significant points in addressing the efficiency issue. First, the anticompetitive effect was so great (13% at retail in many markets), and the creditable efficiencies so modest, that the efficiencies couldn't possibly lead overall to consumer benefits. Second, in cities where Staples and Office Depot operated, but Office Max was not present, the merger would have led to monopoly or near monopoly. In those circumstances, the view of the new merger guidelines, and the appropriate approach in my view, is that efficiencies cannot trump anticompetitive effects. Efficiencies should turn the tide in the marginal case, for example, where a merger reduces players in a properly defined relevant market from five to four, but except in extremely rare circumstances should not be a justification for monopoly.
Despite the enormous amount of public attention paid to Boeing's acquisition of McDonnell Douglas, the FTC's decision not to challenge the transaction broke no new ground. As many have noted, the proposed merger on its face did appear to raise serious antitrust concerns in connection with the commercial aircraft sector because Boeing accounts for roughly 60% of the sales of large commercial aircraft and McDonnell Douglas, while its market share was slightly below 5%, was a non-failing direct competitor. Airbus Industrie was the only other significant rival and barriers to entry were exceptionally high.
The critical question under U.S. law was whether Douglas Aircraft, McDonnell Douglas' commercial arm, had prospects of playing a significant competitive role in the commercial aircraft market in the future. Had the Commission elected to challenge the transaction, it would have found itself in court facing the virtually unanimous testimony of about 40 purchasers of aircraft that Douglas' prospects for future aircraft sales were close to zero. In a sense the merger did not reduce existing players from three to two; rather the market already consisted of only two significant players. Moreover, the Commission staff's unusually extensive investigation failed to turn up any evidence that McDonnell Douglas could be expected rationally to invest the vast amounts necessary to create even the possibility that it could turn itself around, nor was there any other player in the market ready to purchase all or part of Douglas and compete in the future. Following the teaching of General Dynamics (9) - that future market potential is a critical factor rather than past market shares - the Commission had little basis to mount a challenge.
The proposed merger attracted enormous worldwide attention because the European Commission, in interpreting its antitrust laws, took the view that the acquisition was anticompetitive in the commercial aircraft sector and extracted various concessions from Boeing before clearing the deal. Many factors contributed to this divergence of view between the U.S. and the E.C., and I do not propose to discuss all of them here. I would offer one thought in connection with antitrust review of the transaction. Many do not appreciate that antitrust authorities in Brussels and in Washington are enforcing two different statutes with modestly different emphases. In Europe, the concern is with mergers that increase the leverage that can be exercised by a dominant firm and the possible impact of the merger on competitors. That is not an approach that was conjured up by the European Commission in order to block the Boeing transaction but rather was reflected in the de Havilland decision some 6 years ago.(10) In that case, the European Commision challenged the combination of French, Italian and Canadian manufacturers of commuter aircraft whose market shares increased from 46 to 63%, and it was concluded the higher market shares would give the combined firms advantages in pricing flexibility (for example, the ability to offer a joint price on a wider range of models) and the ability to offer a wider range of product models with similar technology (which could make switches to other suppliers more expensive). Several of the "anticompetitive effects" identified by the E.C. in that case would not be given much weight in an American court; indeed, they might be regarded today as an efficiency rather than an anticompetitive effect. But the precedent obviously would influence European enforcement. In the United States, the emphasis is less on competitors and "competitive leverage," and more on the effect of a merger on future prices. As a result, Douglas future potential as a viable competitor is critical since the merger would only have a future substantial effect if Douglas, standing alone or in the hands of a different purchaser than Boeing, would be likely to be an effective competitor. That too is not a limit on enforcement dreamed up by the FTC in order to clear the Boeing transaction, but is rooted in many decisions, including General Dynamics, decided over 20 years ago.
This is not the place to explore all the differences in European and U.S. merger enforcement that led to different attitudes in reviewing the Boeing transaction, but only to note that, to some extent, those differences might be explained by the different statutes, precedent and enforcement authority of the two jurisdictions.
1. The views expressed are those of the Chairman and do not necessarily reflect the views of the Federal Trade Commission or any other Commissioner or staff.
2. United States v. Vons Grocery Co., 384 U.S. 270 (1966).
3. United States v. Philadelphia National Bank, 374 U.S. 321 (1963).
4. Brown Shoe v. United States, 370 U.S. 294 (1962).
5. In Brown Shoe, the Supreme Court listed a roster of factors to determine discreet markets: "[T]he boundaries of such a submarket may be determined by examining such practical indicia as industry or public recognition of the submarket as a separate economic entity, the product's peculiar characteristics and uses, unique production facilities, distinct customers, distinct prices, sensitivity to price changes, and specialized vendors." 370 U.S. at 325.
6. Among many critiques, see Robert Pitofsky, New Definitions of Relevant Market and the Assault on Antitrust, 90 Colum. L. Rev. 1805, 1815 (1990).
7. 386 U.S. 568 (1967).
8. Id. at 579.
9. United States v. General Dynamics, 415 U.S. 486, 503 (1974).
10. Aerospatiale-Alenia/de Havilland, 1991 O.J. (L334) 42.