Espresso Exclusivity?

Keith Sharfman —  25 September 2006

Belvi Coffee and Tea Exchange cannot be serious. The firm is suing Starbucks for exclusive dealing in the Seattle and Bellevue, Washington real estate markets.

The suit alleges that Starbucks has leased real estate at above-market prices in exchange for commitments by the landlords to exclude other coffee shops from the building.

Let’s take Belvi’s allegations at face value and assume that Starbucks has a 73% share of the U.S. coffee shop industry, even though such a narrow product market definition seems implausible, given that Starbucks and other coffee shops compete for customers with many other types of shops, lounges, and restaurants. People buy coffee (and many of the other products that Starbucks sells) in all sorts of places besides coffee shops. Dunkin’ Donuts sells coffee and cake. So does McDonald’s. So does pretty much every diner and restaurant in the country.

But as I say, let’s take Belvi’s allegation of a 73% market share at face value. So what? The issue in this case is not whether Starbucks has monopoly or market power in the coffee shop market. That’s not in the least bit relevant. What matters is whether Starbucks has market power in real estate. And there’s not even an allegation of that here, much less any evidence.

Nothing stops Belvi from opening up as many shops as it wants to in any neighborhood where Starbucks is located, and if Starbucks charges too much people could always swing on over to Belvi. Surely it isn’t necessary for Belvi to be located in the very same building as Starbucks in order for Belvi to compete. (Has there ever been an antitrust case involving a retail industry in which the relevant geographic market is defined as a single building? I’m not aware of any.) Suppose that instead of leasing Starbucks owns the building. Would antitrust law require Starbucks to lease space to its competitor? That doesn’t seem very likely. A building isn’t an “essential facility” like a railroad track whose owner may be compelled to deal with a competitor. If outright ownership would entitle Starbucks to refuse to deal, why should an exclusive lease be treated any differently? It’s hard to see what would make an exclusive lease different from an outright sale.

Note the plausible procompetitive justification for the exclusivity that Starbucks obtains through these leases. Starbucks probably does lots of market research when deciding where to locate its stores. Why must Starbucks allow Belvi to free ride on that research?

If Starbucks had gotten an entire neighborhood to agree not to lease to other coffee shops, I could see Belvi’s point. But so long as Starbucks lacks the power and anyway has done nothing to prevent Belvi from locating next door, the case seems ludicrous and ought to be dismissed.

16 responses to Espresso Exclusivity?

  1. 

    Harry asks:

    “If, as a number of other commentators have suggested, competition is not hampered because other venues for coffee shops are readily available for Starbucks’ rivals, is Starbucks paying hard cash for an illusory benefit?”

    Nope. It simply does not logically follow from the proposition competition (in the coffee market, to be clear) is not hampered by the exclusive leases that Starbucks must be paying for an illusory benefit. There is, as Harry knows, a voluminous literature on the efficiency-enhancing properties of exclusivity (and de facto exclusivity) that have nothing to do w. anticompetitive exclusion. Firms with market power and firms with little or zero market power in highly competitive markets adopt exclusive arrangements throughout the economy for a variety of reasons.

    While that literature is too voluminous to do justice to in a post, and I hope that Harry does not accuse me (again) of “blithely” ingoring important disputes. I do not think it is difficult to think of pro-competitive explanations for Starbucks’ desire to not have rival coffee shops in the immediate vicinity. The bottom line is that exclusive arrangements can increase the joint surplus earned by the landlord/ SB combination and that these premiums represent a sharing of the premium — not Starbucks’ ignorance.

  2. 

    Harry–
    You’re right that a Section 2 maintenance claim against Starbucks can only work if Starbucks is a monopolist in the coffee market. (Though of course, even without monopoly power, attempted monopolization would still be a cognizable allegation under section 2.)

    But as your comment recognizes, it makes no difference how powerful Starbucks is in coffee if it doesn’t have market power in real estate. That is the sense in which I mean that the extent of Starbucks’ market power in real estate is the relevant inquiry here. Sure, if one could show market power in real estate (which, as you recognize, is quite a hurdle) it then might be relevant under Section 2 whether Starbucks is a monopolist in coffee (itself a dicey proposition) or at least in a properly defined market in “high end coffee” (which is also unlikely).

    I like your second point about the rent premium. Yes, either there is one or there isn’t one. I guess David’s point was that it’s doubtful whether there’s a premium at all. But even if there is a premium, Geoff and Josh have explained that it’s the landlord that has the market power in the building lobby “micro market” (if I may coin such a term), not Starbucks, and if the landlord selects Starbucks rather than some other coffee store as sole coffee shop tenant, that discretionary amenity choice is itself the product of a fiercely competitive real estate leasing market.

  3. 

    I must agree that the allegations in the complaint do seem a bit far fetched. However, I must take issue with one point in the original post. Keith says that the allegation that Starbucks has a 73% market share in the alleged high end coffee shop market (as I said the allegations are a bit far fetched) is “irrelevant.” What matters is whether Starbucks has monopoly power in the real estate market. This is simply wrong. The plaintiff is claiming that Starbucks has monopoly power in the high end coffee shop market (hence the 73% market share claim) and that it has obtained, maintains or extends that power through the monopolizing conduct of cutting off its rivals from a resource needed for competition–desirable real estate space. Again, I express no opinion on either the factual accuracy of the claims or their legal sufficiency (e.g., whether Starbucks conduct should be considered “monopolizing conduct” even if it is proven).

    I find one point particularly interesting. Landlords seem to be demanding a premium for exclusivity. This makes sense because the landlords are narrowing their potential universe of leasees. Allegedly, Starbucks is paying the premium. What does Starbucks get out of the deal? If, as a number of other commentators have suggested, competition is not hampered because other venues for coffee shops are readily available for Starbucks’ rivals, is Starbucks paying hard cash for an illusory benefit?

  4. 

    Adam:

    The question is whether this distinction makes any difference for the competitive analysis, which is I addressed in my comment (as did Geoff’s analysis of why a landlord might desire such a term, which might be read as making the case that this distinction cuts in favor of a pro-competitive interpretation of SB’s conduct).

    Pro-competitive justifications aside, the question is whether Starbucks’ exclusive dealing contracts can harm competition by foreclosing rivals from access to real estate. The point I made above, which I will now reiterate, is that the necessary conditions for such harm are highly unlikely to be satisfied here. The alternative argument, that any given building is an essential facility and therefore the exclusive should be a violation of AT law whether or not there is substantial foreclosure, is absurd (there is a lot of real estate that can potentially be used as a coffee shop should SB’s would-be supra-competitive prices attract entry…). Perhaps these lease terms are of such a scope as to actually prevent rival coffee shops from entering into agreements to obtain retail space in sufficient magnitude to prevent entry throughout a well-defined market. But I doubt it.

  5. 

    I’m not sure I understand the distinction that Adam is making. What’s the difference whether it’s a single building or a multi-building complex? Either way, the owner may have perfectly good reasons for limiting the number of coffee shops via exclusivity in the lease. And (as Josh explains) any coffee shop firm is free to compete with Starbucks to become the exclusive coffee shop tenant for any building where the landlord desires such an arrangement.

  6. 

    The allegation is that Starbucks is entering into leases that prohibit competing coffee shops both in and around the same building, such as when a single landlord or property manager controls contiguous or connected buildings.

    This is a distinction with at least some relevance to this discussion.

  7. 

    Excellent points Geoff. You’re right that it should not make any difference for antitrust purposes what Starbucks pays for the space. And you’re also right that the building owner has a property right to exploit the space in a revenue maximizing way, including by means of exclusion. The amount that Starbucks (or any coffee shop) would be willing to pay to lease the space is a function, in part, of how many other coffee shops locate there. The smaller the number of coffee shops on the premises, the more Starbucks should be willing to pay for the space. Specifying that number in the lease performs the socially valuable function of reducing uncertainty about how valuable the space is. And if the building wants that number to be one, it has that right.

  8. 

    For what it’s worth, a slightly different way to think about this interesting issue is this: The building owner almost certainly determines the optimal mix of retail establishments to take up the scarce space in its building. The building owner (at least in Seattle and Bellevue) operates in an extremely competitive environment. In most cases, it seems likely that this optimal mix includes only one coffee shop. The building owner, in its effort to optimize its space allocation, thus imposes a restriction that creates a limited monopoly for whichever coffee shop ends up leasing its space. But to the extent this allocation would confer a limited locational monopoly on the coffee shop owner, why shouldn’t the building owner receive some or all of the increased value of the lease? In other words, why shouldn’t Starbucks or whomever else takes the lease pay more (so-called “above-market prices”) for its limited monopoly? The point here is that, concevied from the building owner’s perspective, the decision to grant the limited monopoly is a competitive one, driven by the building owner’s motivation to offer its consumers the optimal mix of retail establishments. It is, in a sense, incidental that it results in “above-market” lease payments.

  9. 

    These are excellent comments. Many thanks to all of you. One of the students in my antitrust class told an interesting story today backing up what each of us has said here. She lives in a building that used to lease space to an independent coffee shop that wasn’t very good. After tenants complained about the shop’s quality, the lease was not renewed. Now Starbucks occupies the space. This seems to be a fairly clear example of how a building’s choice of Starbucks over an independent competitor can be procompetitive.

  10. 

    Nice post Keith. The relevant inquiry, assuming market definition and even market power, is whether Starbucks’ leases can foreclose rivals substantially foreclose rivals from achieving minimum efficient scale. Clearly, they do not. To illustrate the point, try to imagine all of the real estate space that could be used by a rival or potential entrant in the the coffee-shop market. The Starbucks leases do not, and cannot possibly, “tie up” more than a trivial fraction of this real estate. Such foreclosure is a necessary condition of this type of claim and is clearly absent. Competition for favorable locations for coffee shops, even when it includes exclusivity terms in the leases for good reason, is competition on the merits.

  11. 

    If Starbucks paid an “above-market rate” to lease real estate in exchange for exclusivity, wouldn’t that “above-market rate” become “market rate”? Moreover, Starbucks is paying for something, and that something has value. For example, let’s say Starbucks was offered a lease of 1000 square feet for $1000 per month – which was the rate for similar spaces in the same building/location (numbers chosen to make the math easy – they are obviously too low). Starbucks countered with a lease for $1100 and an agreement that the landlord would not rent any space in its building to other coffee stores. What’s wrong with that? Such a restriction clearly costs the landlord (because there are fewer potential tenants for other leases) and benefits Starbucks. Assuming that $100 is fair market value for such a restriction, then the $1100 lease is, in fact, market rate.

    (Of course, is $100 is market rate for such a restriction, but Starbucks offered, say, an additional $500 on top of the $1000 lease, then the rate might be above market rate. Even then, one encounters the barriers highlighted in the post.)

  12. 

    Exclusivity is very common in multi-tenant real estate, at least for the small neighborhood centers starbucks tends to locate in. Does a 4-6 unit building really need 2 coffee shops? All this is the same from the landlord’s point of view, not just the tenant.

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