The Unconvincing Antitrust Case Against Wal-Mart

Josh Wright —  10 July 2006

I recently picked up a copy of the July Harper’s Magazine to read an essay by Barry C. Lynn entitled, “Breaking the Chain: The Antitrust Case Against Wal-Mart.” If you can’t tell from the title, the basic point is that antitrust authorities should break up Wal-Mart and put an end to the immense havoc that the retail giant has caused the economy. There is very little in the way of actual analysis in the article. It is mostly hand waving about retail consolidation without economic coherence, with some dramatic parade-of-horribles-type hyberbole mixed in. A few examples of the hyperbolic rhetoric before I move on to the merits of Lynn’s antitrust case against Wal-Mart:

“For a generation, big firms have enjoyed almost a complete license to use brute economic force to grow only bigger. And so today we find ourselves in a world dominated by immense global oligopolies that every day further limit the flexibility of our economy and our personal freedom within it.”

Whoa. Personal freedom? Really? Here’s some more:

“The ultimate danger of monopsony is that, over time, it tends to destroy the machines and skills on which we all rely.”

Or my favorite:

“If, however, we choose the path of the free market, and of individual freedom within the market; if we choose to ensure the health and flexibility of our economy and our industrial systems and our society; if we choose to protect our republican way of government, which depends on the separation of powers within our economy just as our political system–then we have only one choice. We must restore antitrust law to its central role in protecting the economic rights, properties, and liberties of the American citizen, and first use that power to break Wal-Mart into pieces.”

Wow. There is a lot to talk about here. Let me first summarize the Lynn’s argument and then discuss why they are entirely wrong as a matter of economics and sensible antitrust policy below the fold. Here are the basic moves in Lynn’s case against WM:

First, Wal-Mart is a monopsonist. Lynn writes that one in five of every American retail sales occurs at WM, and WM is dominating its retail rivals.

Second, WM leverages its monopsony power in a manner which antitrust law should prohibit. Lynn seems to have two antitrust harms in mind here.

The first is that WM has “changed the game” with respect to bargaining between supplier and retailers. WM dominates upstream suppliers by demanding lower prices, and using its own in-house brands to discipline suppliers, resulting in shrinking manufacturer profit margins. The article discusses WM’s reputation as a hard-nosed, no nonsense negotiator and cites examples of negotiations with Coca-Cola and Kraft. Lynn points to the use of “category management,” a practice where retailers delegate shelf space display decisions to a manufacturer (called the “category captain”) within a product category (say, sodas or soups).

Of category management, Lynn alleges without any substantiation that the practice has resulted in collusion by suppliers as well as retailers:

“one common result is that many producers simply stop competing head to head . . . . in many instances, a single firm ends up controlling 70% or more of US sales in an entire product line . . .. In exchange, its competitor will expect that firm to yield 70% or more of some other product line, say, snacks or spices. Such sharing out of markets by oligopolies is taking place throughout the non-branded economy . . . but nowhere is it more visible than in the aisles of Wal-Mart.”

Note the tension between the claim of supplier collusion and shrinking supplier margins. However, more importantly is the notion that category management and other changes in the bargaining relationships are necessary bad on antitrust grounds. There has been very little economic analysis of category management As a side note, Benjamin Klein, Kevin M. Murphy and are working on a paper entitled “Exclusive Dealing and Category Management in Retail Distribution,” which analyzes the economics of these arrangements as well as exclusive dealing contracts in retail (I will post a draft to SSRN when it is ready). From an antitrust perspective, it is difficult to imagine why category management would be any more of a concern than exclusive dealing, which is analyzed under the rule of reason and violates the Sherman Act when a number of conditions are satisfied (monopoly power, substantial foreclosure, barriers to entry, etc.). Category management only grants the manufacturer the right to favor his own product, and can be terminated by the retailer at any time, whereas exclusive dealing completely forecloses rivals from shelf space.

The fundamental point here, however, is that Lynn does nothing more than make assertions about the presence of collusion. Assertions that contradict evidence about profit margins earned by both retailers and suppliers over the past 20 years.

The second antitrust harm Lynn points to is equally unconvincing. Lynn writes that even if WM is efficient, increased concentration in retail represents a “gathering of power unchecked and unaccountable,” and those who would defend efficiency must “view the American citizen not as someone who yearns to decide for himself or herself what to buy and where to work in a free market but to say, instead, ‘let them eat Tastykake.'”

There are so many problems with this analysis that it is difficult to know where to start. But I sketch out a response below the fold.

Here are some of the basic flaws in Lynn’s case.

The data don’t match the theory. Taking Lynn’s antitrust theories on their own terms, perhaps the best place to start is that the data simply don’t agree. Retail margins have remained nearly constant for the past twenty years (in my paper on slotting contracts with Ben Klein, we present some evidence of this). This makes sense. Barriers to entry at retail are negligible, and because supracompetitive profits are dissipated through competition, payments to retailers are ultimately passed through to consumers.

What about prices? Lynn talks a great deal about the good old days of antitrust before the Reagan administration where the “goal was to enforce a balance of power among economic actors of all sizes, to maintain some degree of liberty at all levels within the economy.” The essay is essentially an ode to these discredited days of antitrust when consumer welfare took a back seat to attacking concentration for its own sake. For example, Lynn describes comments by then AG William French Smith that “bigness is not necessary badness” as “radical” and “astounding.” Really? Not to any undergraduate student of industrial organization. But what about prices? Does Lynn consider any of the competitive benefits of Wal-Mart, or is the antitrust case against Wal-Mart to be made at the expense of the consumer in the name some fuzzy principle of antitrust populism? Lynn’s essay says very little about prices except the following:

“to defend Wal-Mart for its low prices is to claim that the most perfect form of economic organization more closely resembles the Soviet Union in 1950 than 20th century America. It is to celebrate rationalization to the point of complete irrationality.”

Does anyone really believe that a retailer who earns 30% retail market share by competing vigorously for consumers is the equivalent to a central planner? I hope not. Retail competition is incredibly robust, as is easily observed by watching retail profit margins over the past 20 years in which concentration has increased substantially. To describe Wal-Mart’s negotiations with large manufacturers like Coca-Cola and Kraft as analogous to central planning activity is ridiculous.

Luckily, there is economic evidence that Wal-Mart is in fact very good for consumers. For example, Jerry Hausman and Ephraim Leibtag’s econometric analysis of the impact of Wal-Mary entry on consumer welfare. Lynn seems to be more concerned with the distribution of profits between manufacturers and retailers rather than the outcomes for consumers, but does not address this significant cost of his proposal to break up Wal-Mart and revive antitrust policy based on equalizing bargaining power rather than protecting consumers. Lest one think that the 3.75% average increase in consumer welfare after the entry of Wal-Mart is small potatoes, here is a quote from Jerry Hausman:

“Getting a 3.75 percent improvement in consumer welfare is greater than any tax reform or other policies. And while Wal-Mart pays its employees less — which does affect local wages — you still can’t beat that 3.75 percent. If economists could improve consumer welfare by that much, we’d all be heroes.”

Lynn has a response to those who would use Wal-Mart’s efficiency to mount an antitrust defense. He writes that a society with dominant suppliers is far better off than one dominated by retailers because the former “were geared to build more” and “to raise price faster than cost,” whereas the latter is designed to “cut cost faster than price?” He goes on to assert that “the effects of this change are clear: we see them in the collapsing profit margins of the firms caught in Wal-Mart’s system.” Huh? Only in some sort of bizarro world of antitrust (e.g., Von’s Grocery and Brown Shoe) would one see this type of rhetoric about the benefits of high prices. Pardon me if I do not shed a tear for the shrinking profit margins of Coca-Cola, Kraft, P & G, and other suppliers as I reap the benefits in lower prices!

This isn’t really about antitrust, is it? There is good reason that modern antitrust focuses on efficiency and consumer welfare rather than the egalitarian concerns that Lynn expresses regarding the relationship between manufacturers and retailers. Antitrust economists, and not just Chicago-types, support an antitrust policy based on maximizing efficiency. Some argue about what weights should be attached to consumer versus producer surplus, but very few if any would support the type of regime Lynn advocates in this essay. Case in point, the Antitrust Modernization Committee’s recommendation to repeal the Robinson-Patman Act which openly and plainly purports to defend the populist notions described by Lynn.

At the end of the day, Lynn’s case against Wal-Mart has very little to do with antitrust principles. One might dislike Wal-Mart for all sorts of reasons. While I do not find any of these reasons persuasive, the antitrust attack against the retailer that has been a boon to consumers is incredibly misguided because it invokes the wrong tool (antitrust law) to engineer a market structure that will certainly harm consumers without any meaningful benefits. The Antitrust Feds ought to leave Wal-Mart to its consumer welfare increasing ways and focus on endeavors that are more likely to help consumers than hurt them.

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    […] I have written in this space before about the unconvincing antitrust case against Wal-Mart. This suit against generics appears to fall in the same category as the general lament against competition and low prices appearing in Barry C. Lynn’s essay in Harper Magazine (to which I respond in this post): “Breaking the Chain: The Antitrust Case Against Wal-Mart,” “to defend Wal-Mart for its low prices is to claim that the most perfect form of economic organization more closely resembles the Soviet Union in 1950 than 20th century America. It is to celebrate rationalization to the point of complete irrationality.” […]