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[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]

Earlier this week, merger talks between Uber and food delivery service Grubhub surfaced. House Antitrust Subcommittee Chairman David N. Cicilline quickly reacted to the news:

Americans are struggling to put food on the table, and locally owned businesses are doing everything possible to keep serving people in our communities, even under great duress. Uber is a notoriously predatory company that has long denied its drivers a living wage. Its attempt to acquire Grubhub—which has a history of exploiting local restaurants through deceptive tactics and extortionate fees—marks a new low in pandemic profiteering. We cannot allow these corporations to monopolize food delivery, especially amid a crisis that is rendering American families and local restaurants more dependent than ever on these very services. This deal underscores the urgency for a merger moratorium, which I and several of my colleagues have been urging our caucus to support.

Pandemic profiteering rolls nicely off the tongue, and we’re sure to see that phrase much more over the next year or so. 

Grubhub shares jumped 29% Tuesday, the day the merger talks came to light, shown in the figure below. The Wall Street Journal reports companies are considering a deal that would value Grubhub stock at around 1.9 Uber shares, or $60-65 dollars a share, based on Thursday’s price.

But is that “pandemic profiteering?”

After Amazon announced its intended acquisition of Whole Foods, the grocer’s stock price soared by 27%. Rep. Cicilline voiced some convoluted concerns about that merger, but said nothing about profiteering at the time. Different times, different messaging.

Rep. Cicilline and others have been calling for a merger moratorium during the pandemic and used the Uber/Grubhub announcement as Exhibit A in his indictment of merger activity.

A moratorium would make things much easier for regulators. No more fighting over relevant markets, no HHI calculations, no experts debating SSNIPs or GUPPIs, no worries over consumer welfare, no failing firm defenses. Just a clear, brightline “NO!”

Even before the pandemic, it was well known that the food delivery industry was due for a shakeout. NPR reports, even as the business is growing, none of the top food-delivery apps are turning a profit, with one analyst concluding consolidation was “inevitable.” Thus, even if a moratorium slowed or stopped the Uber/Grubhub merger, at some point a merger in the industry will happen and the U.S. antitrust authorities will have to evaluate it.

First, we have to ask, “What’s the relevant market?” The government has a history of defining relevant markets so narrowly that just about any merger can be challenged. For example, for the scuttled Whole Foods/Wild Oats merger, the FTC famously narrowed the market to “premium natural and organic supermarkets.” Surely, similar mental gymnastics will be used for any merger involving food delivery services.

While food delivery has grown in popularity over the past few years, delivery represents less than 10% of U.S. food service sales. While Rep. Cicilline may be correct that families and local restaurants are “more dependent than ever” on food delivery, delivery is only a small fraction of a large market. Even a monopoly of food delivery service would not confer market power on the restaurant and food service industry.

No reasonable person would claim an Uber/Grubhub merger would increase market power in the restaurant and food service industry. But, it might convey market power in the food delivery market. Much attention is paid to the “Big Four”–DoorDash, Grubhub, Uber Eats, and Postmates. But, these platform delivery services are part of the larger food service delivery market, of which platforms account for about half of the industry’s revenues. Pizza accounts for the largest share of restaurant-to-consumer delivery.

This raises the big question of what is the relevant market: Is it the entire food delivery sector, or just the platform-to-consumer sector? 

Based on the information in the figure below, defining the market narrowly would place an Uber/Grubhub merger squarely in the “presumed to be likely to enhance market power” category.

  • 2016 HHI: <3,175
  • 2018 HHI: <1,474
  • 2020 HHI: <2,249 pre-merger; <4,153 post-merger

Alternatively, defining the market to encompass all food delivery would cut the platforms’ shares roughly in half and the merger would be unlikely to harm competition, based on HHI. Choosing the relevant market is, well, relevant.

The Second Measure data suggests that concentration in the platform delivery sector decreased with the entry of Uber Eats, but subsequently increased with DoorDash’s rising share–which included the acquisition of Caviar from Square.

(NB: There seems to be a significant mismatch in the delivery revenue data. Statista reports platform delivery revenues increased by about 40% from 2018 to 2020, but Second Measure indicates revenues have more than doubled.) 

Geoffrey Manne, in an earlier post points out “while national concentration does appear to be increasing in some sectors of the economy, it’s not actually so clear that the same is true for local concentration — which is often the relevant antitrust market.” That may be the case here.

The figure below is a sample of platform delivery shares by city. I added data from an earlier study of 2017 shares. In all but two metro areas, Uber and Grubhub’s combined market share declined from 2017 to 2020. In Boston, the combined shares did not change and in Los Angeles, the combined shares increased by 1%.

(NB: There are some serious problems with this data, notably that it leaves out the restaurant-to-consumer sector and assumes the entire platform-to-consumer sector is comprised of only the “Big Four.”)

Platform-to-consumer delivery is a complex two-sided market in which the platforms link, and compete for, both restaurants and consumers. Platforms compete for restaurants, drivers, and consumers. Restaurants have a choice of using multiple platforms or entering into exclusive arrangements. Many drivers work for multiple platforms, and many consumers use multiple platforms. 

Fundamentally, the rise of platform-to-consumer is an evolution in vertical integration. Restaurants can choose to offer no delivery, use their own in-house delivery drivers, or use a third party delivery service. Every platform faces competition from in-house delivery, placing a limit on their ability to raise prices to restaurants and consumers.

The choice of delivery is not an either-or decision. For example, many pizza restaurants who have their own delivery drivers also use platform delivery service. Their own drivers may serve a limited geographic area, but the platforms allow the restaurant to expand its geographic reach, thereby increasing its sales. Even so, the platforms face competition from in-house delivery.

Mergers or other forms of shake out in the food delivery industry are inevitable. Mergers will raise important questions about relevant product and geographic markets as well as competition in two-sided markets. While there is a real risk of harm to restaurants, drivers, and consumers, there is also a real possibility of welfare enhancing efficiencies. These questions will never be addressed with an across-the-board merger moratorium.

Eric Fruits is the Chief Economist at the International Center for Law & Economics

Last July, U.S. Congressman David N. Cicilline, who serves on the House Judiciary Antitrust Subcommittee, called for a hearing on Amazon’s proposed $13.7 billion acquisition of Whole Foods. The Congressman claimed he was not “taking a position on the legality” of Amazon’s attempt to purchase Whole Foods. In fact, his letter noted that “several leading antitrust scholars” had suggested the merger would be beneficial to consumers.

The letter, however, was not so much about the merger itself. Instead it was an attempt to convince the antitrust subcommittee to jump over analysis of relevant markets, prices, and consumer welfare and go straight to speculation about small business, labor markets, and income inequality. This sort of speculation is a key component of the populist antitrust movement.

Carl Shapiro, the government’s economics expert opposing the AT&T-Time Warner merger, seems skeptical of much of the antitrust populists’ Amazon rhetoric:

Simply saying that Amazon has grown like a weed, charges very low prices, and has driven many smaller retailers out of business is not sufficient. Where is the consumer harm?

On its face, there was nothing about the Amazon/Whole Foods merger that should have raised any antitrust concerns.

  1. Both Amazon and Whole Foods comprise a small share of the retail food market;
  2. Amazon’s size and consumer reach are not a barrier to entry of new firms or expansion of existing firms;
  3. Amazon’s prioritization of its own products is no different from the behavior of every other major grocer;
  4. Amazon in not an essential facility and there is no risk of foreclosure;
  5. Stock prices provided no meaningful information regarding the competitive impacts of the merger.

While one year is too soon to fully judge the competitive impacts of the Amazon-Whole Foods merger, nevertheless, it appears that much of the populist antitrust movement’s speculation that the merger would destroy competition and competitors and impoverish workers has failed to materialize.

Both Amazon and Whole Foods comprise a small share of the retail food market

Citing the Wall Street Journal, Cicilline’s letter noted that Amazon accounts for “more than half of online food orders through its Fresh, Prime and Prime Now services.” Also in the article, but missing from Cicilline’s letter, is the observation that (1) grocery delivery accounted for less than 2 percent of food retail sales in 2016 and (2) grocery delivery is concentrated in cities and surrounding suburbs.

Over the past year, the U.S. saw $5.2 trillion in retail sales, according to the Census Bureau.

  • Whole Foods has less than 1.5 percent of the food retail market, or about 0.2 percent of total retail sales.
  • About 20 percent of Whole Foods’ sales are prepared foods and 15 percent of its revenues come from its exclusive brands such as 365 Everyday Value.
  • Amazon accounts for one-tenth of one percent of U.S. grocery sales.

Viewed as a merger of two food retailers, Amazon’s purchase of Whole Foods would be characterized correctly as a horizontal merger. With each firm comprising a small portion of the retail food market, it should have been—and was—presumed the merger would not harm competition, nor would it result in consolidation of the retail sector.

Even critics of Amazon’s size and conduct had concluded the merger would likely benefit consumers. For example researchers at the Roosevelt Institute concluded, “Amazon will likely aim to expand the reach of the Whole Foods brand by lowering prices.” Indeed, soon after the merger closed, Whole Foods slashed the price of staples such as organic produce.

Amazon’s size and consumer reach are not a barrier to entry of new firms or expansion of existing firms

Cicilline’s letter speculated Amazon’s competitive advantages in terms of size, consumer reach, and ability to absorb losses could discourage innovation and entrance of firms in the areas of grocery and food delivery.

Since United States v. Grinnell Corp., antitrust policy has given safe harbor to firms that obtained market share “as a consequence of a superior product, business acumen, or historic accident.” In can easily be argued that Amazon’s consumer reach is due in a large part to offering a superior product in the form of a easy-to-use interface for both buyers and sellers, business acumen in the development of a superior system of distribution and logistics, as well as the historic accident of being an early entrant into the market during the dot-com boom.

In economics, a barrier to entry is a condition that makes the long run costs of a new entrant into a market higher than the long run costs of the existing firms in the market. The Ninth Circuit in Rebel Oil Co. v. Atlantic Richfield Co. defined entry barriers as:

“additional long run costs that were not incurred by incumbent firms but must be incurred by new entrants,” or “factors in the market that deter entry while permitting incumbent firms to earn monopoly returns.”

The court then identifies the main sources of entry barriers as:

  1. Legal license requirements;
  2. Control of an essential or superior resource;
  3. Entrenched buyer preferences for established brands;
  4. Capital market evaluations imposing higher capital costs on new entrants; and,
  5. Economies of scale, in some situations.

The entry and growth of Instacart, Uber Eats, and Postmates, are evidence that Amazon’s size, consumer reach, and ability to absorb losses has not presented any barriers to entry of new firms or the expansion of existing firms into the retail food delivery business.

The Wall Street Journal reports that since the merger, several grocers have added online ordering while hundreds of health food stores have seen increased dollar and unit sales from a year ago. Trader Joe’s and Aldi have also experienced strong sales growth since the merger.

Amazon’s prioritization of its own products is no different from the behavior of every other major grocer

Cicilline’s letter asserted that Amazon’s purchase of Whole Foods would enable Amazon to prioritize its products and services over competitors. Critics of Amazon’s behavior claim such prioritization was already occurring before the merger. Cicilline’s letter provided no mechanism by which the merger in and of itself would increase such prioritization, or even if such an increase could be measured. Even so, the letter fails to address the key issue of whether prioritization is an anticompetitive act. If it is, then just about every major food retailer in the U.S. is behaving anticompetitively.

  • In 1997, Whole Foods launched its 365 Everyday Value line of products. Five years later, it launched its 365 Organic Everyday Value line. These products are given prominent shelf space and are often featured in promotional “end caps” in Whole Foods stores. In 2015, Whole Foods introduced 365 by Whole Foods Market, a concept store based on the 365 Everyday Value brand. The pre-merger photo below shows how Whole Foods prioritized its own brands within its stores, with placement at eye-level and in promotional islands.Prioritization-365-Everyday-ValuePrioritization-365-Everyday-Value-oils
  • Costco provides prominent shelf space to its own Kirkland branded products. Most of the products sold in Trader Joe’s stores carry the company’s private label.
  • Kroger has a number of private label brands, including Private Selection and Simple Truth as well as value brands such as Psst and Heritage Farms. Kroger frequently promotes Private Selection and Simple Truth with advertising, coupons, and other promotions including prominent shelf space.

Consumers quickly learn whether store-brand “fruit rings” are a better value than Kellogg’s Froot Loops. Promotional activities and prioritization may nudge the marginal buyer and entice a first purchase, but cannot fool consumers over the long run.

Amazon in not an essential facility and there is no risk of foreclosure

Cicilline’s letter cited Gene Kimmelman, the President of Public Knowledge, to allude that this specific merger would allow Amazon to “foreclose” competition.

In antitrust, concerns about foreclosure are tied to the concept of an essential facility. For these concerns to be valid, access to Amazon’s platform must be essential — without access, competitors would be unable to sell food and/or unable to sell food online. In addition to being essential, there must be evidence of foreclosure — competing sellers are kept off of the essential platform.

A key concept in antitrust economics is that of substitutability: whether one good or service is reasonably interchangeable with another. If there are reasonable substitutes for sales through Amazon’s platform, then the platform is not an essential facility. There are many reasonable substitutes for Amazon’s platform, including a network of retail stores and a standalone website with distribution through USPS, UPS, FedEx, and other delivery services. Indeed, Whole Foods and other grocers had and have operated profitably without selling through Amazon’s platform. Kroger provides delivery of groceries ordered online via Instacart and grocery pickup with its own service, ClickList. Safeway and Albertsons also offer home delivery of groceries ordered online. It the face of these observations, it is obvious that Amazon’s platform is not an essential facility. Thus even if Amazon keeps rival products off its platform, these competitors would not be foreclosed from selling their products.

Those who argue that Amazon is an essential facility seem to be arguing the concept of essential facility is a matter of degree: If Amazon provided more favorable terms to sellers on its platform, those sellers would would earn more profits than than they currently receive. This flies in the face of the sine qua non of the essential facility doctrine–that the facility is essential. Amazon may be a useful platform to sell products. It may be a profitable platform. But, it is not an essential platform.

No evidence that Amazon or Whole Foods pay lower wages

Cicilline’s letter also seemed to suggest that the merger would result in reduced employment and lower wages. The letter claimed that “mounting economic research” indicates that the U.S. has experienced “decades of consolidation” and that such consolidation has led to a monopsony power in labor markets leading to lower employee wages.

The letter’s reasoning echos conclusions of a report published by the Institute for Local Self-Reliance (ILSR), an advocacy group for “community-rooted” enterprise.

As pointed out by Geoffrey Manne and Jennifer Maclean:

Cobbling together statistics, anecdotes, and assumptions, the report formulates logical fallacies about Amazon’s effect on the retail job market. The title itself, Amazon’s Stranglehold: How the Company’s Tightening Grip is Stifling Competition, Eroding Jobs, and Threatening Communities, conjures a dystopian fever dream.

The ILSR report claims that “Amazon’s tightening hold on our economy…, increasing dominance …, and ability to crush smaller rivals and block new firms from entering markets … is hobbling job growth [and] propelling economic inequality.” At the same time, the report ignores how efficiencies provided by Amazon’s e-commerce platform may actually have beneficial effects on employment—and it fails to address whether, when retail jobs are negatively affected, there might be offsetting gains in other areas, like lower prices.

Manne and Maclean indicate if e-commerce platforms continue to appeal to buyers and sellers, this may mean fewer traditional retail jobs —or it could simply mean a shift in the types of activities performed by people in retail occupations. It might also mean more jobs in manufacturing, transportation, advertising, coding, and logistics, to name a few.

In fact, information from the Bureau of Labor Statistics shows that employment in warehousing and storage has grown by more than 50 percent since the pre-recession peak. Over the same period, average hourly earnings have increased by more than 20 percent. Over the past year, average hourly earnings for these workers have grown at approximately the same rate as the average across all employees.

Stock prices provided no meaningful information regarding the competitive impacts of the Amazon/Whole Foods merger

Cicilline’s letter noted that Blue Apron’s initial public offering price was reduced by a third following the announcement of the Amazon/Whole Foods merger. However, two weeks prior to the merger, market observers were predicting Blue Apron’s IPO would be a disappointment. A Forbes contributor provided three reasons investors should “gag” on Blue Apron’s IPO:  (1) unprofitable growth with costs growing faster than revenues, (2) competition from rivals including HelloFresh, Sun Basket, and Purple Carrot, and (3) weak shareholder protections associated with the two founders retaining a large portion of the voting shares of stock. Since the Amazon-Whole Foods merger, Blue Apron’s new, automated facility failed to ramp up as planned, resulting in late orders, missing ingredients, and higher costs, according to the Wall Street Journal.

Cicilline’s letter noted that the announcement that Amazon would purchase Whole Foods had a “similar effect” on what he describes as the “traditional retail grocery market.” The letter identifies Walmart, Kroger, Costco, and Target as Amazon’s competitors in this market. In this way, Cicilline appears to abandon the FTC’s view that Whole Foods operates in the “premium natural and organic supermarkets market.” Instead, the letter implicitly concludes, Whole Foods competes in a larger market that includes grocery stores, supercenters, and warehouse clubs.

Missing from Cicilline’s letter is the observation that the day before the Amazon/Whole Foods merger was announced, Kroger announced that it reduced its profit outlook by 10 percent. The same day—one day before the merger announcement–German grocer Lidl announced the locations of the first 10 stores to open in the U.S. More than a month before the Whole Foods purchase was announced, discount grocery chain Aldi described plans to invest $5 billion to open nearly 900 stores and remodel hundreds of other stores throughout the U.S. The entry of new competitors and expansion of existing competitors is at odds with speculation of consolidation in the retail grocery sector. Since the merger, Kroger’s share price has increased more that double the rate of growth of the Dow Jones Industrial Average.

One year is too soon to judge the competitive impacts of the Amazon-Whole Foods merger. Nevertheless, it appears that much of the populist antitrust movement’s speculation that the merger would destroy competition and competitors and impoverish workers has failed to materialize.

 

Last month the Wall Street Journal raised the specter of an antitrust challenge to the proposed Jos. A. Bank/Men’s Warehouse merger.

Whether a challenge is forthcoming appears to turn, of course, on market definition:

An important question in the FTC’s review will be whether it believes the two companies compete in a market that is more specialized than the broad men’s apparel market. If the commission concludes the companies do compete in a different space than retailers like Macy’s, Kohl’s and J.C. Penney, then the merger partners could face a more-difficult government review.

You’ll be excused for recalling that the last time you bought a suit you shopped at Jos. A. Bank and Macy’s before making your purchase at Nordstrom Rack, and for thinking that the idea of a relevant market comprising Jos. A. Bank and Men’s Warehouse to the exclusion of the others is absurd.  Because, you see, as the article notes (quoting Darren Tucker),

“The FTC sometimes segments markets in ways that can appear counterintuitive to the public.”

“Ah,” you say to yourself. “In other words, if the FTC’s rigorous econometric analysis shows that prices at Macy’s don’t actually affect pricing decisions at Men’s Warehouse, then I’d be surprised, but so be it.”

But that’s not what he means by “counterintuitive.” Rather,

The commission’s analysis, he said, will largely turn on how the companies have viewed the market in their own ordinary-course business documents.

According to this logic, even if Macy’s does exert pricing pressure on Jos. A Bank, if Jos. A. Bank’s business documents talk about Men’s Warehouse as its only real competition, or suggest that the two companies “dominate” the “mid-range men’s apparel market,” then FTC may decide to challenge the deal.

I don’t mean to single out Darren here; he just happens to be who the article quotes, and this kind of thinking is de rigeur.

But it’s just wrong. Or, I should say, it may be descriptively accurate — it may be that the FTC will make its enforcement decision (and the court would make its ruling) on the basis of business documents — but it’s just wrong as a matter of economics, common sense, logic and the protection of consumer welfare.

One can’t help but think of the Whole Foods/Wild Oats merger and the FTC’s ridiculous “premium, natural and organic supermarkets” market. As I said of that market definition:

In other words, there is a serious risk of conflating a “market” for business purposes with an actual antitrust-relevant market. Whole Foods and Wild Oats may view themselves as operating in a different world than Wal-Mart. But their self-characterization is largely irrelevant. What matters is whether customers who shop at Whole Foods would shop elsewhere for substitute products if Whole Food’s prices rose too much. The implicit notion that the availability of organic foods at Wal-Mart (to say nothing of pretty much every other grocery store in the US today!) exerts little or no competitive pressure on prices at Whole Foods seems facially silly.

I don’t know for certain what an econometric analysis would show, but I would indeed be shocked if a legitimate economic analysis suggested that Jos. A. Banks and Men’s Warehouse occupied all or most of any relevant market. For the most part — and certainly for the marginal consumer — there is no meaningful difference between a basic, grey worsted wool suit bought at a big department store in the mall and a similar suit bought at a small retailer in the same mall or a “warehouse” store across the street. And the barriers to entry in such a market, if it existed, would be insignificant. Again, what I said of Whole Foods/Wild Oats is surely true here, too:

But because economically-relevant market definition turns on demand elasticity among consumers who are often free to purchase products from multiple distribution channels, a myopic focus on a single channel of distribution to the exclusion of others is dangerous.

Let’s hope the FTC gets it right this time.

In what has become an annual affair, around this time of the year, I like to make the case for law students to take antitrust. Each year, the post is edited and tweaked a little bit.  So, without further ado, here is this year’s edition of “Why Take Antitrust?”

As the start of the new academic year inches closer, and students are deciding what courses to take, I thought I’d give a little plug to antitrust law. I’ve seen enrollment in antitrust courses vary dramatically over the past 10 years or so since I was a student and now as a professor. I certainly know the three-pronged case against taking antitrust: “its not a bar course,” “you have to know a bunch of economics, right?”, and “its really difficult.”  But I hear this question from students frequently and I thought I’d share my typical answer to the titular question here:

First, antitrust is flat out interesting stuff.  We’re talking cartel arrangements in rooms filled with smoke, complex price-fixing arrangements,  rent-seeking and use of government restrictions to exclude rivals, and all forms of cutthroat competition between firms to stay alive in a competitive marketplace.  You know, movie material.  For some reason antitrust has earned the reputation of being a “boring” class for specialists who are interested in economics.  Wrong, wrong, wrong.  Sure, antitrust will force you to learn some economics because the law itself has incorporated economic concepts (see, e.g. the Merger Guidelines).  But this is a feature, not a bug.  Economics is a tool that can help one understand how the world works and provide some interesting insight on business practices that we observe in the world and impact us everyday at the gas pump, the grocery store, the computers we all work on, and just about everywhere else.  Supply and demand graphs might be boring to some, and I don’t mean to suggest that antitrust is for everyone all the time, but its fun to think about questions like how the Sirius-XM merger will impact prices, whether premium, natural and organic supermarkets are a relevant market (the issue in Whole Foods/ Wild Oats), and the economic and business organization of the National Football League, and just about every business venture involving Google, Microsoft, Apple and Yahoo.

Second, antitrust law is become an increasingly important component of the international business landscape.  Take a look at this photo (the countries in red have antitrust laws on the books). Over 100 countries currently have passed antitrust laws (see here). Having at least a passing knowledge of antitrust is increasingly an important asset for corporate lawyers generally.  With antitrust enforcement now in India, China, Hong Kong, Singapore, and the EU-US antitrust convergence/divergence debate growing in importance, challenging legal and economic debates will continue to rage in the antitrust space for years to come (Between you and I, these changing market conditions have also increased demand for antitrust law professors and economists in recent years, not to mention — and most importantly, for antitrust lawyers).   After a slowdown for a few years with the economy, some casual empiricism suggests that merger activity is starting to pick up, antitrust and consumer protection litigation is increasing, and antitrust practices are going to need to reload.

Third, the bar exam issue.  While its true that antitrust law is not going to help you on the bar, neither are a bunch of interesting courses. And one shouldn’t conflate inclusion on the bar exam with general importance in terms or, of course, intellectual interest (which so far as I can tell, is still an acceptable reason for enrolling in courses).  Besides, there is at least some evidence that courseload choices have little to do with bar passage rates.  On top of all that, in light of #2, it is a good time to pursue a career as an antitrust lawyer.

If you are a law student — and haven’t thought about adding antitrust to your dossier — give it some thought.

I’m confident that my esteemed colleagues, who have far more expertise about the merger guidelines than I, will offer all sorts of terrific ideas for revising the substance of the guidelines. While I would certainly advocate a few specific changes (i.e., revise the HHI thresholds to reflect actual agency practice), I’ll leave the devilish details to the experts and concentrate on one “modest” (quite literally!) revision:

I would encourage the antitrust agencies to clarify, within the actual text of the guidelines (i.e., not in mere commentary like that issued in 2006), that the guidelines are not the law, should not be treated as such by the courts, do not exhaustively specify when a merger will or will not be anticompetitive, and should be flexibly implemented to account for case-specific factors that cannot be specified ex ante. In short, the guidelines should explicitly acknowledge that the ultimate question in any horizontal merger case requires the application of a standard, not a rule.

A rule is a legal mandate that entails an advance determination of what conduct is permissible and leaves only factual issues for the adjudicator (e.g., “Do not drive faster than 65 m.p.h.”). A standard, by contrast, is a mandate that leaves to the adjudicator both factual issues and some judgment about what conduct is permissible (e.g., “Do not drive at an excessive speed.”). Rules provide superior guidance to the governed and the adjudicator, but they can misfire if over- or underinclusive, and they therefore require ex ante specification of all factors that might be relevant to a sound decision. Standards provide less guidance, but they are more likely to generate a correct adjudication in any particular case, for the adjudicator is free to account for unforeseen, case-specific quirks.

The legal question at issue in a horizontal merger case — “might the business combination substantially lessen competition or tend to create a monopoly?” — requires the ultimate adjudicator to apply a standard, not a rule. It is simply impossible to specify ex ante all the considerations relevant to answering this question. Accordingly, to the extent the merger guidelines are viewed by courts as rules for separating pro- from anticompetitive mergers, they are bound to generate incorrect adjudications when they inevitably misfire.

Now I realize the merger guidelines, as currently drafted, do not purport to bind courts and do state that their “mechanical application . . . may provide misleading answers” and that they should be applied “reasonably and flexibly to the particular facts and circumstances of each proposed merger.” I don’t believe this is enough. The fact is, generalist judges asked to resolve the complicated economic disputes in a horizontal merger case are reluctant to veer beyond the guidelines’ prescribed analysis and, as a practical matter, treat the guidelines as though they are, in fact, the law. In the D.C. Circuit’s Whole Foods decision, for example, the majority chided the dissent for having incorrectly applied the merger guidelines. Given that the merger guidelines simply cannot exhaustively specify all the considerations relevant to evaluating a proposed merger, courts’ treatment of them as the final word implies that relevant considerations will get left out.

Take Whole Foods for example. A key fact in that case was that the vast majority of shoppers who buy from so-called “premium natural and organic supermarkets” (PNOS) also shop regularly at conventional grocers. Thus, if a combined Whole Foods/Wild Oats were to raise prices on items available at conventional supermarkets, buyers would likely just start buying those items on their conventional grocer outings rather than on their PNOS outings. Unfortunately, nothing in the merger guidelines calls for a consideration of “cross-shopping,” and this important argument therefore got short shrift. Had the guidelines explicitly stated: “This is not the law. We can’t state up front all relevant considerations. Courts should credit plausible arguments based on factors not stated herein,” this important argument might have gotten the attention it deserved.

Or take considerations relevant to dynamic (Schumpeterian) competition. While I am sympathetic to the Sidak/Teece arguments that the merger guidelines should account for dynamic competition concerns, I simply can’t figure out how one would write a rule that would do that. How can we specify ex ante all the considerations that are relevant to whether a business merger will enhance dynamic, though not necessarily static, competition? There may be an answer to that question — and I much look forward to hearing from Sidak and Teece on this issue — but I don’t know what it is. An alternative approach would be to free up the ultimate adjudicators — the courts — to account for dynamic competition considerations by disabusing them of the notion that they must treat the merger guidelines as law. Parties could then articulate their dynamic competition arguments on a case-by-case basis, and the courts could credit those that appear to have merit.

The main objectives of the merger guidelines, I assume, are (1) to deter combination attempts that would harm competition (i.e., those that would clearly be subject to challenge); (2) to avoid deterring combinations that would not harm competition (i.e., those within a safe harbor); and (3) to assure some consistency across the regulatory agencies and across administrations. These objectives could still be attained — and greater accuracy in outcome could be achieved — if the merger guidelines specified that the ultimate inquiry involves application of a standard rather than a rule.

The witch hunt is over.

Last evening, the FTC announced that it would drop its antitrust action against high-end grocer Whole Foods in exchange for the chain’s agreement to sell 32 stores and to give up the rights to Wild Oats’ name. FTC Chairman Jon Leibowitz proclaimed that “[a]s a result of this settlement, American consumers will see more choices and lower prices for organic foods” — you know, those ubiquitous food products that are available at, among other places, Wal-Mart and that the FTC insisted were not the focus of its Whole Foods challenge, which was purportedly aimed at protecting competition in the provision of grocery store formats, not particular types of products. Mr. Leibowitz also announced that the settlement of this surreal antitrust action “allows the FTC to shift resources to other important matters.” Can’t wait to see what those will be.

It’ll be interesting to see what happens to Whole Foods’ stock price now that it’s no longer a monopolist in the market for “premium natural and organic supermarkets.” Absent the ability to earn supracompetitive profits as a monopolist — a power that, according to the FTC, it has had since it consummated the Wild Oats merger in August 2007 — its expected free cash flows will certainly drop, as will its stock price. Maybe, though, it will actually fare better once it gives up its PNOS monopoly. Indeed, the company’s stock price (reflective of expected profits) has been badly battered since the company became a monopolist, falling from $44.26 when the monopoly was attained, to around $22 just before the D.C. Circuit initially reversed the trial court’s decision permitting the merger to proceed (July 2008), to $10-12 in the last few weeks (see chart here). While the overall stock market has fallen by about one half during this same period, Whole Foods’ drop is substantially steeper, and it began soon after Whole Foods attained its monopoly position, well before broader market’s drop. Maybe returning competition to the company’s market will actually improve the company’s lot.

Or maybe, as my co-blogger Geoff so eloquently put it, the notion of a separate market for premium natural and organic supermarkets is bulls**t. If that’s the case, then Whole Foods hasn’t been a monopolist, able to earn supracompetitive profits, since August 2007. If Whole Foods has actually been competing in a broader market, one that would include, say, this Safeway Lifestyle Store (and gazillions of other conventional grocery stores like it), then it’s battered stock price probably just suggests that consumers are turning away from its high-priced offerings and toward the same products that are available at the conventional grocery stores at which the vast majority of Whole Foods shoppers also shop.

So let’s see — which story makes more sense: that attaining a monopoly tends to drive one’s profits (and thus one’s stock price) downward, or that Whole Foods never actually had a monopoly because it faced vigorous competition from conventional grocery stores? Tough one.

Oh well. I’ll give the FTC some credit for tenacity. It’s pretty impressive that the Commissioners were willing to stand their ground in the face of evidence that Whole Foods wasn’t earning monopoly profits, that numerous grocery retailers are moving toward the Whole Foods format, that there are obvious economies of scale in grocery retailing (so that the combined Whole Foods/Wild Oats would have lower per unit costs), and that Whole Foods’ customers typically cross-shop at conventional grocery stores and could thus easily respond to any merger-induced increase in Whole Foods’ prices. (See here.) Why bother with real-world facts when you’ve got a handful of inflammatory emails?

So congrats on the victory, guys (and Ms. Jones Harbour). On behalf of the nation’s grocery shoppers, I’d like to thank you for protecting us from a premium natural and organic monopolist (and we just won’t worry about any economies of scale Whole Foods will sacrifice in order to comply with this consent decree).

On a personal note, I’d like to thank you for making my own job so much easier.

Thom kicked off discussion of the FTC and Whole Foods’ settlement on a critical note:

It’s pretty impressive that the Commissioners were willing to stand their ground in the face of evidence that Whole Foods wasn’t earning monopoly profits, that numerous grocery retailers are moving toward the Whole Foods format, that there are obvious economies of scale in grocery retailing (so that the combined Whole Foods/Wild Oats would have lower per unit costs), and that Whole Foods’ customers typically cross-shop at conventional grocery stores and could thus easily respond to any merger-induced increase in Whole Foods’ prices. (See here.) Why bother with real-world facts when you’ve got a handful of inflammatory emails?

So congrats on the victory, guys (and Ms. Jones Harbour). On behalf of the nation’s grocery shoppers, I’d like to thank you for protecting us from a premium natural and organic monopolist (and we just won’t worry about any economies of scale Whole Foods will sacrifice in order to comply with this consent decree).

Geoff hasn’t pulled many punches either.  But what about the settlement itself?

Marc Schildkraut (Howrey) is quoted with some interesting comments on the WSJ Law Blog highlighting some interesting features of the settlement and concluding that “neither side really had a complete victory”:

For starters, he says, the structure of the deal doesn’t guarantee that a Wild Oats-type competitor to Whole Foods will emerge. The deal doesn’t require the trustee in charge of selling the earmarked stores to sell to a single buyer. “The FTC didn’t insist that the trustee sell to a chain,” he says. “That could mean that a lot of the stores go to single-store operators, which isn’t always the best way to guarantee competition.”

Secondly, while Whole Foods has to give up its intellectual property rights in Wild Oats, there’s no guarantee that the buyer of the IP rights won’t be a smaller operator than Wild Oats. So the value of the Wild Oats name could ultimately fall quite a bit.

Lastly, Schildkraut questions whether the trustee will even find buyers for the stores, especially those that are already closed. “And they won’t necessarily come cheap,” he adds. “The new buyers will in most cases have to pick up existing leases. These aren’t pennies-on-the dollar deals.”

So does Schildkraut think it was a total win for Whole Foods? Not necessarily. “I’m sure they would have preferred not to go through two years of litigation and preferred not to divest the stores and the Wild Oats name and preferred not to have the competition that the FTC will try to generate,” he says. “But it could have been a lot worse.”

Interesting.  The critique brings to mind Elzinga’s classic study, The Antimerger Law: Pyrrhic Victories? 12 J. LAW & ECON. 43 (1969), concluding that pre-HSR were not effective in restoring pre-merger competition.  But see the FTC’s own Divestiture Study in the late 1990’s (in which I participated one summer as a Bureau of Economics intern in 1995!) concluding that the FTC had become more effective in designing divestitures by 1990 or so. Perhaps in the spirit of the Commission’s recent interesting self-study, it will do a rigorous evaluation of post-merger competition resulting from this settlement.

Being a “glass is half-full” type of guy, I figured there was no way the D.C. Circuit’s decision on Whole Foods’ petition for rehearing en banc could turn out poorly: Either the court would grant the motion and correct the panel’s mistakes, or the court would deny the motion, setting up an attractive opportunity for the Supreme Court, which hasn’t decided a significant merger case since 1974 and badly needs to update its doctrine (see, e.g., Brown Shoe, upon which the D.C. Circuit heavily relied in Whole Foods).

It seems my optimism was unwarranted. On November 21, the July 29 panel decision was amended and reissued so that Judge Tatel no longer joins Judge Brown’s former majority opinion. Although the two judges agree that the FTC did present evidence that could establish a separate antitrust market of “premium natural and organic supermarkets” (“PNOS”) and that the district court’s denial of the FTC’s preliminary injunction of the Whole Foods/Wild Oats merger must therefore be reversed (and remanded for a weighing of equities), their grounds for reaching those conclusions differ. There is thus no majority opinion from the panel (the third judge, Judge Kavanaugh, dissented), and the other D.C. Circuit judges apparently reasoned that rehearing en banc would therefore be unwarranted. (See the statement of Judges Sentelle and Ginsburg here.)

The good news is that neither of the two opinions in favor of the FTC commanded a majority of the panel, so neither stands as authoritative precedent. That’s cold comfort, though, for the panel holding has precedential effect, and, under the Marks rule, any common principles contained in the Brown and Tatel opinions and necessary to their conclusions will have such effect. Moreover, so few published decisions address merger challenges that those opinions — regardless of precedential effect — are likely to have substantial influence. That’s highly unfortunate, for both opinions contain fundamental mistakes, as I elaborate below the fold. Continue Reading…

The DC Circuit has reversed the district court in the Whole Foods case.  The opinion is here.  [HT:  Danny Sokol]

As regular readers know, we have covered this case extensively on this blog, including most recently this great, lengthy post from Thom on the proper standard of review.  I wouldn’t be surprised if Thom is disappointed with the standard adopted by the DC Circuit in its appeal, and I look forward to his thoughts.

I’m sure all of us will have more to say about the case in due course.  For now I want to highlight one incredible aspect of the decision:  The claim that relevant market definition can turn on average or “core” customer effects.  Yes, throw out 30-odd years of antitrust economics and the very concept of the marginal consumer.  Here’s the court’s theory:  If a bunch of inframarginal consumers really like products X and Y but not similar-but-slightly-different-and-cheaper product Z, a merger between X and Y would enable the combined firm to gouge the inframarginal consumers, regardless of the effect on the marginal folks.  Sure the marginal guys will shop at Safeway if the price rises too much–but who cares?  There’s always a “core” of super premium and organic supermaket addicts to take advantage of–folks who just can’t resist all those free samples and faux-wood floors! 

OK.  Except–correct me if I’m wrong–if price discrimination were possible before the merger as well as after (and there’s no reason why this would change), the core folks were already being gouged!  Effective product differentiation may make the market price higher for a subset of goods–but this higher market price would prevail even with lots of competition. 

The court here claims that the real damage will occur in prices of perishables, because organic produce bought at a Whole Foods is qualitatively different than organic produce bought at Safeway, and this is what the core shoppers bought at the premium stores.  But if that were true post-merger, it would be tru pre-merger, as well, right?  There aren’t any merger-specific effects that I am aware of.  Again–correct me if I’m wrong–but I don’t think any of the evidence in the case suggested that there could be a significant non-transitory effect on the price of “PNO” produce.  Yes, some evidence suggests produce prices are higher at PNOS’s than at typical grocery stores, but is there evidence that the price could be even higher if Wild Oats exited a market?  The concurrence points to the FTC’s supposition that enough people would be diverted from Wild Oats to Whole Foods to sustain a 5% price increase, but I’m not sure that there was any evidence to support this claim (particularly since the FTC’s economist didn’t look at prices, but rather at profit margins).

Manwhile, if price discrimination is not possible, way more than 30 years of economics tells us that the seller will price to the marginal consumer–the ones who would decamp to Product Z if prices rise too much.  The claim here, however, is that, even if evidence indicates that Whole Foods and Wild Oats compete not only with each other but also many other stores, they are each other’s only competitor for some consumers.  Yes, Virginia, there are inframarginal consumers.  So what?  Did the court forget its Econ 101?  Profit is maximized where marginal revenue equals marginal cost.  Absent price discrimination, it’s a bummer the seller can’t capture the surplus from all those inframarginal shoppers, but profit is still maximized by pricing to the marignal consumer.  There is no reason (other than a new ability to price discriminate) that the post-merger entity would sacrifice profits by jettisoning the marginal shopper just to gouge its regular clientelle.   

Perhaps even more fundamentally–as we have pointed out on this blog before–the differential effect via price discrimination story (if true) suggests a far, far simpler solution:  Better relevant market definition.  If the inframarginal consumers at the grocery store are consuming radically different products than the marginal consumers, perhaps the relevant market is not “premium natural and organic supermarkets” but rather “organic foods,” for example.  In other words, perhaps the relevant market is the products being consumed, not the channel of distribution.  But I would guess that this market definition would have condemned the case from the start given Walmart’s extensive entry into this market, so it wasn’t in the cards. 

“But wait!,” you say.  Some people have idiosyncratic preferences.  They preferer buying organic tomatoes, zucchini and grapes from premium natural stores–it’s a combination, you see, not only of the food being consumed but also the channel of distribution.  These poor sots will be gouged without competition between Whole Foods and Wild Oats, because they don’t want to shop for produce at Safeway.  And Whole Foods without Wild Oats would easily overcharge these 17 or 18 people in any given market.

Yes, indeed.  One can always define a market by focusing on idiosyncratic preferences or product variations.  This is what Justice Fortas decried in his dissent in Grinnell:  

The trial court’s definition of the “product” market even more dramatically demonstrates that its action has been Procrustean – that it has tailored the market to the dimensions of the defendants. It recognizes that a person seeking protective services has many alternative sources. It lists “watchmen, watchdogs, automatic proprietary systems confined to one site, (often, but not always,) alarm systems connected with some local police or fire station, often unaccredited CSPS [central station protective services], and often accredited CSPS.” The court finds that even in the same city a single customer seeking protection for several premises may “exercise its option” differently for different locations. It may choose accredited CSPS for one of its locations and a different type of service for another.

But the court isolates from all of these alternatives only those services in which defendants engage. It eliminates all of the alternative sources despite its conscientious enumeration of them. Its definition of the “relevant market” is not merely confined to “central station” protective services, but to those central station protective services which are “accredited” by insurance companies.

There is no pretense that these furnish peculiar services for which there is no alternative in the market place, on either a price or a functional basis. The court relies solely upon its finding that the services offered by accredited central stations are of better quality, and upon its conclusion that the insurance companies tend to give “noticeably larger” discounts to policyholders who use accredited central station protective services. This Court now approves this strange red-haired, bearded, one-eyed man-with-a-limp classification.

Tailoring market definition to inframarginal consumers who may be willing to pay more than market prices for certain product characteristics is neither sound economics nor sound antitrust doctrine.

Stay tuned.

UPDATE:  A great post from Manfred Gabriel at Antitrust Review makes much the same case.  A couple of really good parts:

Maybe I shouldn’t be surprised by this. But the passage does more than accept that, given the difficulties of economic analysis, we can supplement it with some common-sense heuristic insights to come up with markets. This approach seems to undermine the acceptance of the theoretical foundations of economic analysis. 

* * *

I read this to mean that the “practical indicia” have become the trump card to beat economic analysis.

* * *

The only economic evidence of price discrimination between core and marginal customers cited in the opinion is the fact that Whole Foods stores enjoyed lower margins (not prices!) in cities where they competed with Wild Oats stores. One would have hoped for a discussion of how Whole Foods identifies core customers (the ones in Birkenstocks, perhaps?) and manages to charge them higher prices than the marginal customers (in wingtips and high heels).

It appears that the FTC is moving to stop the proposed Whole Foods/Wild Oats merger.  Says the FTC:

If Whole Foods is allowed to devour Wild Oats, it will mean higher prices, reduced quality, and fewer choices for consumers [in the premium natural and organic supermarkets market]. That is a deal consumers should not be required to swallow.

Very punny.  I’d be laughing hysterically if I didn’t find this conception of market definition ludicrous almost beyond belief.  I haven’t seen anything so absurd since the allegation (by the reliably-interventionist AAI, at least; not the DOJ) that front- and top-loading washing machines are in different markets.

I would think that the triumphant entry of Wal-Mart alone into the natural and organic foods market (ooh–but not premium natural and organic! Some people just won’t buy their pesticide-free bok choy at Wal-Mart, you know) would save this merger.

But notice something important.  The FTC doesn’t claim that the relevant market is the market for natural and organic food.  The market is for natural and organic supermarkets.  The agencies have been down this road before, mistaking channels of distribution for relevant markets.  On the same grounds it stopped the Libbey/Anchor-Hocking merger and the Staples/Office Depot merger, to say nothing of a number of other grocery store mergers.  Now, in some cases, it may be that the market is defined by the merging distributors (as many would say was true in the Staples case).  But because economically-relevant market definition turns on demand elasticity among consumers who are often free to purchase products from multiple distribution channels, a myopic focus on a single channel of distribution to the exclusion of others is dangerous.

In other words, there is a serious risk of conflating a “market” for business purposes with an actual antitrust-relevant market.  Whole Foods and Wild Oats may view themselves as operating in a different world than Wal-Mart.  But their self-characterization is largely irrelevant.  What matters is whether customers who shop at Whole Foods would shop elsewhere for substitute products if Whole Food’s prices rose too much.  The implicit notion that the availability of organic foods at Wal-Mart (to say nothing of pretty much every other grocery store in the US today!) exerts little or no competitive pressure on prices at Whole Foods seems facially silly.  

Market definition is thorny, and it has (unfortunately) become the end point, rather than the starting point, of merger analysis at the agencies.  I don’t know what a hard look at the data would show in this case, but my strong suspicion is that the FTC is choking on its organic, locally-grown edamame with this one.   

(By the way–for an extended meditation on these issues, see my article with Marc Williamson, Hot Docs vs. Cold Economics).

John Mackey posts a remarkable public response to the FTC, including the complete text and extended exegesis of one of the inflammatory hot docs that prompted the FTC’s action.  But most amazing of all is this comment:

The claims that the FTC makes in the above two paragraphs [from the FTC press release] are simply astounding because they have ZERO evidence to support several of the statements. Let’s start with the pricing issue: The FTC claims that if we “devour” Wild Oats it will mean “higher prices” and “Whole Foods likely would be able to raise prices unilaterally”. What is so interesting about this statement is that the FTC did not bother to actually gather any pricing information from Whole Foods or Wild Oats. Let me repeat that last statement because it is so important: the FTC did not bother to actually gather any pricing information from Whole Foods or Wild Oats. Why am I emphasizing this by repetition? Because the FTC did not go to the trouble of actually comparing prices in any of our markets. Nor did they ask either Whole Foods or Wild Oats for any pricing information . They asked for 20 million Whole Foods’ documents, but didn’t ask us for any pricing information! Pretty incredible in my opinion!

Now, it is possible that the FTC gathered scanner data from Nielsen or some other source, but I’m not certain that that data would be complete enough for the proper analysis.  If true, I find this ommission astounding.  I’ve been waiting all along for the empirical data to support the FTC’s bluster.  It would be remarkable to find that data absent!

Mackey does note that the FTC (of course) gathered gross profit information for both chains.  But, as I said before and as Mackey’s extended discussion confirms, that data may show nothing more than shifting market share–it does not necessarily tell you anything at all about prices to consumers.

There is much more in Mackey’s blog post, including an interesting discussion of market definition, highlighting these simple and compelling points (emphasis mine):

The fact that Whole Foods has successfully created a distinct retailing strategy and category for ourselves does not give us any kind of “monopoly” or “market dominance” that prevents other food retailers from successfully copying us or competing with us in other ways. The truth, of course, is that supermarkets all over the United States are copying many different aspects of Whole Foods successful retailing strategy—selling more and more natural and organic products, improving customer service, and upgrading the look and feel of their stores.

The creation of a unique business strategy or a unique category doesn’t force consumers to shop with us. Most successful businesses attempt to differentiate themselves from their competitors in various ways. This has certainly been one of Whole Foods competitive strategies. Although Whole Foods has been successful and has created differentiation in the marketplace the simple truth is that very few customers do all of their shopping at our stores. In fact, most of our customers shop at multiple food stores, meeting some of their needs and desires at Whole Foods and various other needs and desires at other stores. Just ask yourself this question: “Do you do all your shopping at Whole Foods or do you shop at different supermarkets”? The answer is obvious: most people shop at a variety of different food stores. Differentiation in the marketplace doesn’t guarantee customer acceptance or success. Successful differentiation also creates imitation and more competition in the future.

There are no legal “barriers to entry” to compete with Whole Foods Market on price, products, quality, service, or store experience. Whole Foods has no technological patents that preclude anyone from competing with us. Whole Foods has been successful primarily because we simply execute in many facets of the retail food business better than most of our competitors do.

Can anyone understand why the FTC brought this case? 

(HT, for the link to Mackey’s blog, Hanno Kaiser and Randy Picker)

An article from yesterday’s W$J sheds some light on the organic community’s anger over Wal-Mart’s decision to begin selling organic products. A few weeks ago, I accused Wal-Mart’s critics of wanting to keep price-sensitive consumers out of the organic “club.� The article in yesterday’s Journal suggests that that’s part of the story, but that the critics might also have a legitimate gripe. Examined closely, though, even that concern is unfounded.

To be sure, much of the opposition to Wal-Mart’s foray into organics is motivated by a desire to exclude. Consider, for example, the remarks of Michael Pollan, author of The Omnivore’s Dilemma and a leading Wal-Mart critic. Regarding Wal-Mart’s plan to sell organics at a small mark-up over conventionally grown food, Pollan writes: “To say you can sell organic food for 10 percent more than you sell irresponsibly priced food suggests that you don’t really get it.�

That statement just reeks of elitism. What is “irresponsibly priced food�? (Food that poor people can afford?) And what do these price-slashers “not get�? (That the organic label is largely just a status symbol?) Pollan’s focus on Wal-Mart’s pricing suggests that his real concern is to keep the hoi polloi from enjoying “responsibly priced� (i.e., expensive) organic food.

But the Journal article suggests there’s more to the story. Continue Reading…