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Article Excerpt
One of the most maligned antitrust decisions in history involved a merger of grocery store chains. Indeed, even those voices inclined toward substantial antitrust intervention believe the U.S. Supreme Court erred in its 1966 Von's Grocery decision, which condemned the merger of the third- and sixth-largest grocery store chains in Los Angeles. For example, the president of the reliably interventionist American Antitrust Institute conceded that the Supreme Court "probably went too far" and acknowledged that "if Von's Grocery had remained the rule, all of our industries would be highly fragmented and consumers would have lost out on many cost-cutting efficiencies." The fact is, grocery retailing involves huge scale economies and low barriers to entry--a combination that renders most consolidations beneficial to consumers.
Despite the apparent consensus on Von's Grocery, federal antitrust regulators seem determined to repeat its mistakes. Last summer, the Federal Trade Commission shocked the business community by seeking to block the merger of two high-end grocery chains, Whole Foods Markets and Wild Oats Markets. Fortunately for consumers, cooler heads prevailed--the federal court hearing the FTC's merger challenge rejected the agency's motion for preliminary injunction. But while things turned out all right this time, the incident reveals a number of deficiencies in the merger review process. This article describes the Whole Foods debacle and catalogues four lessons regulators and courts should draw from the incident.
THE FTC'S CHALLENGE
In February 2007, Whole Foods and Wild Oats entered an agreement under which Whole Foods would acquire Wild Oats for approximately $670 million. Four months later, after collecting 20 million documents from the two companies (but almost no pricing data), the FTC sued to block the merger. The agency claimed the merger would constitute an anticompetitive combination of the top two competitors in the highly concentrated market for "premium natural and organic supermarkets."
According to the FTC's complaint, such supermarkets constitute a separate market from conventional supermarkets because they "offer a distinct set of products and services to a distinct group of customers in a distinctive way." With respect to their product offerings, premium natural and organic supermarkets are distinct in that they "focus on perishable products, offering a vast selection of very high-quality fresh fruits and vegetables--including exotic and hard-to-find items--and other perishables." Customers of premium natural and organic supermarkets are also distinct: in the FTC's words, they're "affluent, well-educated, health-oriented, quality food oriented people." Finally, the FTC asserted, premium natural and organic supermarkets provide a distinctively higher level of service: more amenities, a more knowledgeable staff, branding that promotes a healthy lifestyle and ecological sustainability, and a place for shoppers to "gather, interact, and learn." Because of those distinguishing characteristics, the FTC maintained, premium natural and organic supermarkets, of which Whole Foods and Wild Oats are the only national chains, compete in a separate market from such conventional supermarkets as Safeway and Kroger. A merger of the two chains would virtually eliminate competition in that distinct market, thereby harming consumers by causing higher prices or reduced levels of service.
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Of course, a narrow market definition was crucial to the FTC's challenge. If the market in which Whole Foods and Wild Oats participate includes conventional grocers like Kroger and Safeway (or maybe even the nation's largest grocer, Wal-Mart, which now carries an extensive collection of organic products), then consolidation of the two firms would have little competitive effect; there would still be substantial competition in the market after the consolidation of the two chains into one. Thus, the FTC's challenge could go nowhere unless the market were defined to exclude conventional supermarkets and other retailers of food and groceries.
To support its narrow market definition--the lynchpin of its case--the FTC initially relied almost entirely on Whole Foods' own characterization of its market in its internal documents. For example, the FTC's complaint pointed to a statement lifted from Whole Foods' announcement of its fourth quarter 2006 earnings: "Whole Foods Market is about much more than just selling 'commodity' natural and organic products. We are a lifestyle retailer and have created a unique shopping environment built around satisfying and delighting our customers." That statement and others like it formed the primary basis for the FTC's allegation that premium natural and organic supermarkets like Whole Foods and Wild Oats constitute a distinct antitrust market.
WRONG QUESTION Not until it had filed its complaint and put a temporary hold on the merger did the FTC try to build an economic case for a distinct market consisting of premium natural and organic supermarkets. To do so, the agency needed evidence concerning cross-elasticities of demand--i.e., the degree to which consumers would switch to other sources of supply in response to a price increase. Under the FTC's own horizontal merger guidelines, the contours of a market are determined entirely on the basis of such elasticities. Specifically, a market is defined by lumping together the narrowest possible grouping of products or services that could constitute the market (say, a single brand of the product or service) and asking whether a hypothetical single seller of those goods or services could profitably impose a "small but significant non-transitory increase in price"--usually a 1-5 percent price increase for a one-year period. If the price increase would not be profitable because it would induce too many consumers to switch to alternatives, then the collection is expanded to include the next-best product or service, and the question is repeated. This process continues until it reveals a grouping of products or services for which a price increase would be profitable. That grouping constitutes the relevant market. In the Whole Foods/Wild Oats case, then, the key question would be whether a price increase by so-called premium natural and organic supermarkets would drive so many consumers to conventional supermarkets that the price increase would not be profitable.
In light of this economic approach to defining markets--an approach that turns entirely on how customers respond to price changes--it is astounding that the agency collected no...
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