Archives For Vertical integration

In the Federal Trade Commission’s recent hearings on competition policy in the 21st century, Georgetown professor Steven Salop urged greater scrutiny of vertical mergers. He argued that regulators should be skeptical of the claim that vertical integration tends to produce efficiencies that can enhance consumer welfare. In his presentation to the FTC, Professor Salop provided what he viewed as exceptions to this long-held theory.

Also, vertical merger efficiencies are not inevitable. I mean, vertical integration is common, but so is vertical non-integration. There is an awful lot of companies that are not vertically integrated. And we have lots of examples in which vertical integration has failed. Pepsi’s acquisition of KFC and Pizza Hut; you know, of course Coca-Cola has not merged with McDonald’s . . . .

Aside from the logical fallacy of cherry picking examples (he also includes Betamax/VHS and the split up of Alcoa and Arconic, as well as “integration and disintegration” “in cable”), Professor Salop misses the fact that PepsiCo’s 20 year venture into restaurants had very little to do with vertical integration.

Popular folklore says PepsiCo got into fast food because it was looking for a way to lock up sales of its fountain sodas. Soda is considered one of the highest margin products sold by restaurants. Vertical integration by a soda manufacturer into restaurants would eliminate double marginalization with the vertically integrated firm reaping most of the gains. The folklore fits nicely with economic theory. But, the facts may not fit the theory.

PepsiCo acquired Pizza Hut in 1977, Taco Bell in 1978, and Kentucky Fried Chicken in 1986. Prior to PepsiCo’s purchase, KFC had been owned by spirits company Heublein and conglomerate RJR Nabisco. This was the period of conglomerates—Pillsbury owned Burger King and General Foods owned Burger Chef (or maybe they were vertically integrated into bun distribution).

In the early 1990s Pepsi also bought California Pizza Kitchen, Chevys Fresh Mex, and D’Angelo Grilled Sandwiches.

In 1997, PepsiCo exited the restaurant business. It spun off Pizza Hut, Taco Bell, and KFC to Tricon Global Restaurants, which would later be renamed Yum! Brands. CPK and Chevy’s were purchased by private equity investors. D’Angelo was sold to Papa Gino’s Holdings, a restaurant chain. Since then, both Chevy’s and Papa Gino’s have filed for bankruptcy and Chevy’s has had some major shake-ups.

Professor Salop’s story focuses on the spin-off as an example of the failure of vertical mergers. But there is also a story of success. PepsiCo was in the restaurant business for two decades. More importantly, it continued its restaurant acquisitions over time. If PepsiCo’s restaurants strategy was a failure, it seems odd that the company would continue acquisitions into the early 1990s.

It’s easy, and largely correct, to conclude that PepsiCo’s restaurant acquisitions involved some degree of vertical integration, with upstream PepsiCo selling beverages to downstream restaurants. At the time PepsiCo bought Kentucky Fried Chicken, the New York Times reported KFC was Coke’s second-largest fountain account, behind McDonald’s.

But, what if vertical efficiencies were not the primary reason for the acquisitions?

Growth in U.S. carbonated beverage sales began slowing in the 1970s. It was also the “decade of the fast-food business.” From 1971 to 1977, Pizza Hut’s profits grew an average of 40% per year. Colonel Sanders sold his ownership in KFC for $2 million in 1964. Seven years later, the company was sold to Heublein for $280 million; PepsiCo paid $850 million in 1986.

Although KFC was Coke’s second largest customer at the time, about 20% of KFC’s stores served Pepsi products, “PepsiCo stressed that the major reason for the acquisition was to expand its restaurant business, which last year accounted for 26 percent of its revenues of $8.1 billion,” according to the New York Times.

Viewed in this light, portfolio diversification goes a much longer way toward explaining PepsiCo’s restaurant purchases than hoped-for vertical efficiencies. In 1997, former PepsiCo chairman Roger Enrico explained to investment analysts that the company entered the restaurant business in the first place, “because it didn’t see future growth in its soft drink and snack” businesses and thought diversification into restaurants would provide expansion opportunities.

Prior to its Pizza Hut and Taco Bell acquisitions, PepsiCo owned companies as diverse as Frito-Lay, North American Van Lines, Wilson Sporting Goods, and Rheingold Brewery. This further supports a diversification theory rather than a vertical integration theory of PepsiCo’s restaurant purchases. 

The mid 1990s and early 2000s were tough times for restaurants. Consumers were demanding healthier foods and fast foods were considered the worst of the worst. This was when Kentucky Fried Chicken rebranded as KFC. Debt hangovers from the leveraged buyout era added financial pressure. Many restaurant groups were filing for bankruptcy and competition intensified among fast food companies. PepsiCo’s restaurants could not cover their cost of capital, and what was once a profitable diversification strategy became a financial albatross, so the restaurants were spun off.

Thus, it seems more reasonable to conclude PepsiCo’s exit from restaurants was driven more by market exigencies than by a failure to achieve vertical efficiencies. While the folklore of locking up distribution channels to eliminate double marginalization fits nicely with theory, the facts suggest a more mundane model of a firm scrambling to deliver shareholder wealth through diversification in the face of changing competition.

On Tuesday, August 28, 2018, Truth on the Market and the International Center for Law and Economics presented a blog symposium — Is Amazon’s Appetite Bottomless? The Whole Foods Merger After One Year — that looked at the concerns surrounding the closing of the Amazon-Whole Foods merger, and how those concerns had played out over the last year.

The difficulty presented by the merger was, in some ways, its lack of difficulty: Even critics, while hearkening back to the Brandeisian fear of large firms, had little by way of legal objection to offer against the merger. Despite the acknowledged lack of an obvious legal basis for challenging the merger, most critics nevertheless expressed a somewhat inchoate and generalized concern that the merger would hasten the death of brick-and-mortar retail and imperil competition in the grocery industry. Critics further pointed to particular, related issues largely outside the scope of modern antitrust law — issues relating to the presumed effects of the merger on “localism” (i.e., small, local competitors), retail workers, startups with ancillary businesses (e.g., delivery services), data collection and use, and the like.

Steven Horwitz opened the symposium with an insightful and highly recommended post detailing the development of the grocery industry from its inception. Tracing through that history, Horwitz was optimistic that

Viewed from the long history of the evolution of the grocery store, the Amazon-Whole Foods merger made sense as the start of the next stage of that historical process. The combination of increased wealth that is driving the demand for upscale grocery stores, and the corresponding increase in the value of people’s time that is driving the demand for one-stop shopping and various forms of pick-up and delivery, makes clear the potential benefits of this merger.

Others in the symposium similarly acknowledged the potential transformation of the industry brought on by the merger, but challenged the critics’ despairing characterization of that transformation (Auer, Manne & Stout, Rinehart, Fruits, Atkinson).

At the most basic level, it was noted that, in the immediate aftermath of the merger, Whole Foods dropped prices across a number of categories as it sought to shore up its competitive position (Auer). Further, under relevant antitrust metrics — e.g., market share, ease of competitive entry, potential for exclusionary conduct — the merger was completely unobjectionable under existing doctrine (Fruits).

To critics’ claims that Amazon in general, and the merger in particular, was decimating the retail industry, several posts discussed the updated evidence suggesting that retail is not actually on the decline (although some individual retailers are certainly struggling to compete) (Auer, Manne & Stout). Moreover, and following from Horwitz’s account of the evolution of the grocery industry, it appears that the actual trajectory of the industry is not an either/or between online and offline, but instead a movement toward integrating both models into a single retail experience (Manne & Stout). Further, the post-merger flurry of business model innovation, venture capital investment, and new startup activity demonstrates that, confronted with entrepreneurial competitors like Walmart, Kroger, Aldi, and Instacart, Amazon’s impressive position online has not translated into an automatic domination of the traditional grocery industry (Manne & Stout).  

Symposium participants more circumspect about the merger suggested that Amazon’s behavior may be laying the groundwork for an eventual monopsony case (Sagers). Further, it was suggested, a future Section 2 case, difficult under prevailing antitrust orthodoxy, could be brought with a creative approach to market definition in light of Amazon’s conduct with its marketplace participants, its aggressive ebook contracting practices, and its development and roll-out of its own private label brands (Sagers).

Skeptics also picked up on early critics’ concerns about the aggregation of large amounts of consumer data, and worried that the merger could be part of a pattern representing a real, long-term threat to consumers that antitrust does not take seriously enough (Bona & Levitsky). Sounding a further alarm, Hal Singer noted that Amazon’s interest in pushing into new markets with data generated by, for example, devices like its Echo line could bolster its ability to exclude competitors.

More fundamentally, these contributors echoed the merger critics’ concerns that antitrust does not adequately take account of other values such as “promoting local, community-based, organic food production or ‘small firms’ in general.” (Bona & Levitsky; Singer).

Rob Atkinson, however, pointed out that these values are idiosyncratic and not likely shared by the vast majority of the population — and that antitrust law shouldn’t have anything to do with them:

In short, most of the opposition to Amazon/Whole Foods merger had little or nothing to do with economics and consumer welfare. It had everything to do with a competing vision for the kind of society we want to live in. The neo-Brandesian opponents, who Lind and I term “progressive localists”, seek an alternative economy predominantly made up of small firms, supported by big government and protected from global competition.

And Dirk Auer noted that early critics’ prophecies of foreclosure of competition through “data leveraging” and below-cost pricing hadn’t remotely come to pass, thus far.

Meanwhile, other contributors noted the paucity of evidence supporting many of these assertions, and pointed out the manifest value the merger seemed to be creating by pressuring competitors to adapt and better respond to consumers’ preferences (Horwitz, Rinehart, Auer, Fruits, Manne & Stout) — in the process shoring up, rather than killing, even smaller retailers that are willing and able to evolve with changing technology and shifting consumer preferences. “For all the talk of retail dying, the stores that are actually dying are the ones that fail to cater to their customers, not the ones that happen to be offline” (Manne & Stout).

At the same time, not all merger skeptics were moved by the Neo-Brandeisian assertions. Chris Sagers, for example, finds much of the populist antitrust objection more public relations than substance. He suggested perhaps not taking these ideas and their promoters so seriously, and instead focusing on antitrust advocates with “real ideas” (like Sagers himself, of course).

Coming from a different angle, Will Rinehart also suggested not taking the criticisms too seriously, pointing to the evolving and complicated effects of the merger as Exhibit A for the need for regulatory humility:

Finally, this deal reiterates the need for regulatory humility. Almost immediately after the Amazon-Whole Foods merger was closed, prices at the store dropped and competitors struck a flurry of deals. Investments continue and many in the grocery retail space are bracing for a wave of enhancement to take hold. Even some of the most fierce critics of deal will have to admit there is a lot of uncertainty. It is unclear what business model will make the most sense in the long run, how these technologies will ultimately become embedded into production processes, and how consumers will benefit. Combined, these features underscore the difficulty, but the necessity, in implementing dynamic insights into antitrust institutions.

Offering generous praise for this symposium (thanks, Will!) and echoing the points made by other participants regarding the dynamic and unknowable course of competition (Auer, Horwitz, Manne & Stout, Fruits), Rinehart concludes:

Retrospectives like this symposium offer a chance to understand what the discussion missed at the time and what is needed to better understand innovation and competition in markets. While it might be too soon to close the book on this case, the impact can already be felt in the positions others are taking in response. In the end, the deal probably won’t be remembered for extending Amazon’s dominance into another market because that is a phantom concern. Rather, it will probably be best remembered as the spark that drove traditional retail outlets to modernize their logistics and fulfillment efforts.  

For a complete rundown of the arguments both for and against, the full archive of symposium posts from our outstanding and diverse group of scholars, practitioners, and other experts is available at this link, and individual posts can be easily accessed by clicking on the authors’ names below.

We’d like to thank all of the participants for their excellent contributions!

 

What actually happened in the year following the merger is nearly the opposite: Competition among grocery stores has been more fierce than ever. “Offline” retailers are expanding — and innovating — to meet Amazon’s challenge, and many of them are booming. Disruption is never neat and tidy, but, in addition to saving Whole Foods from potential oblivion, the merger seems to have lit a fire under the rest of the industry.
This result should not be surprising to anyone who understands the nature of the competitive process. But it does highlight an important lesson: competition often comes from unexpected quarters and evolves in unpredictable ways, emerging precisely out of the kinds of adversity opponents of the merger bemoaned.

Continue Reading...

So why this deal, in this symposium, and why now? The best substantive reason I could think of is admittedly one that I personally find important. As I said, I think we should take it much more seriously as a general matter, especially in highly dynamic contexts like Silicon Valley. There has been a history of arguably pre-emptive, market-occupying vertical and conglomerate acquisitions, by big firms of smaller ones that are technologically or otherwise disruptive. The idea is that the big firms sit back and wait as some new market develops in some adjacent sector. When that new market ripens to the point of real promise, the big firm buys some significant incumbent player. The aim is not. just to facilitate its own benevolent, wholesome entry, but to set up hopefully prohibitive challenges to other de novo entrants. Love it or leave it, that theory plausibly characterizes lots and lots of acquisitions in recent decades that secured easy antitrust approval, precisely because they weren’t obviously, presently horizontal. Many people think that is true of some of Amazon’s many acquisitions, like its notoriously aggressive, near-hostile takeover of Diapers.com.

Continue Reading...

Amazon offers Prime discounts to Whole Food customers and offers free delivery for Prime members. Those are certainly consumer benefits. But with those comes a cost, which may or may not be significant. By bundling its products with collective discounts, Amazon makes it more attractive for shoppers to shift their buying practices from local stores to the internet giant. Will this eventually mean that local stores will become more inefficient, based on lower volume, and will eventually close? Do most Americans care about the potential loss of local supermarkets and specialty grocers? No one, including antitrust enforcers, seems to have asked them.

Continue Reading...

The gist of these arguments is simple. The Amazon / Whole Foods merger would lead to the exclusion of competitors, with Amazon leveraging its swaths of data and pricing below costs. All of this begs a simple question: have these prophecies come to pass?

The problem with antitrust populism is not just that it leads to unfounded predictions regarding the negative effects of a given business practice. It also ignores the significant gains which consumers may reap from these practices. The Amazon / Whole foods offers a case in point.

Continue Reading...

Even with these caveats, it’s still worth looking at the recent trends. Whole Foods’s sales since 2015 have been flat, with only low single-digit growth, according to data from Second Measure. This suggests Whole Foods is not yet getting a lift from the relationship. However, the percentage of Whole Foods’ new customers who are Prime Members increased post-merger, from 34 percent in June 2017 to 41 percent in June 2018. This suggests that Amazon’s platform is delivering customers to Whole Foods.

Continue Reading...

The negativity that surrounded the deal at its announcement made Whole Foods seem like an innocent player, but it is important to recall that they were hemorrhaging and were looking to exit. Throughout the 2010s, the company lost its market leading edge as others began to offer the same kinds of services and products. Still, the company was able to sell near the top of its value to Amazon because it was able to court so many suitors. Given all of these features, Whole Foods could have been using the exit as a mechanism to appropriate another firm’s rent.

Continue Reading...

Brandeis is back, with today’s neo-Brandeisians reflexively opposing virtually all mergers involving large firms. For them, industry concentration has grown to crisis proportions and breaking up big companies should be the animating goal not just of antitrust policy but of U.S. economic policy generally. The key to understanding the neo-Brandeisian opposition to the Whole Foods/Amazon mergers is that it has nothing to do with consumer welfare, and everything to do with a large firm animus. Sabeel Rahman, a Roosevelt Institute scholar, concedes that big firms give us higher productivity, and hence lower prices, but he dismisses the value of that. He writes, “If consumer prices are our only concern, it is hard to see how Amazon, Comcast, and companies such as Uber need regulation.” And this gets to the key point regarding most of the opposition to the merger: it had nothing to do with concerns about monopolistic effects on economic efficiency or consumer prices.  It had everything to do with opposition to big firm for the sole reason that they are big.

Continue Reading...

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. 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.

Continue Reading...

Viewed from the long history of the evolution of the grocery store, the Amazon-Whole Foods merger made sense as the start of the next stage of that historical process. The combination of increased wealth that is driving the demand for upscale grocery stores, and the corresponding increase in the value of people’s time that is driving the demand for one-stop shopping and various forms of pick-up and delivery, makes clear the potential benefits of this merger. Amazon was already beginning to make a mark in the sale and delivery of the non-perishables and dry goods that upscale groceries tend to have less of. Acquiring Whole Foods gives it a way to expand that into perishables in a very sensible way. We are only beginning to see the synergies that this combination will produce. Its long-term effect on the structure of the grocery business will be significant and highly beneficial for consumers.

Continue Reading...

A number of blockbuster mergers have received (often negative) attention from media and competition authorities in recent months. From the recently challenged Staples-Office Depot merger to the abandoned Comcast-Time Warner merger to the heavily scrutinized Aetna-Humana merger (among many others), there has been a wave of potential mega-mergers throughout the economy—many of them met with regulatory resistance. We’ve discussed several of these mergers at TOTM (see, e.g., here, here, here and here).

Many reporters, analysts, and even competition authorities have adopted various degrees of the usual stance that big is bad, and bigger is even badder. But worse yet, once this presumption applies, agencies have been skeptical of claimed efficiencies, placing a heightened burden on the merging parties to prove them and often ignoring them altogether. And, of course (and perhaps even worse still), there is the perennial problem of (often questionable) market definition — which tanked the Sysco/US Foods merger and which undergirds the FTC’s challenge of the Staples/Office Depot merger.

All of these issues are at play in the proposed acquisition of British aluminum can manufacturer Rexam PLC by American can manufacturer Ball Corp., which has likewise drawn the attention of competition authorities around the world — including those in Brazil, the European Union, and the United States.

But the Ball/Rexam merger has met with some important regulatory successes. Just recently the members of CADE, Brazil’s competition authority, unanimously approved the merger with limited divestitures. The most recent reports also indicate that the EU will likely approve it, as well. It’s now largely down to the FTC, which should approve the merger and not kill it or over-burden it with required divestitures on the basis of questionable antitrust economics.

The proposed merger raises a number of interesting issues in the surprisingly complex beverage container market. But this merger merits regulatory approval.

The International Center for Law & Economics recently released a research paper entitled, The Ball-Rexam Merger: The Case for a Competitive Can Market. The white paper offers an in-depth assessment of the economics of the beverage packaging industry; the place of the Ball-Rexam merger within this remarkably complex, global market; and the likely competitive effects of the deal.

The upshot is that the proposed merger is unlikely to have anticompetitive effects, and any competitive concerns that do arise can be readily addressed by a few targeted divestitures.

The bottom line

The production and distribution of aluminum cans is a surprisingly dynamic industry, characterized by evolving technology, shifting demand, complex bargaining dynamics, and significant changes in the costs of production and distribution. Despite the superficial appearance that the proposed merger will increase concentration in aluminum can manufacturing, we conclude that a proper understanding of the marketplace dynamics suggests that the merger is unlikely to have actual anticompetitive effects.

All told, and as we summarize in our Executive Summary, we found at least seven specific reasons for this conclusion:

  1. Because the appropriately defined product market includes not only stand-alone can manufacturers, but also vertically integrated beverage companies, as well as plastic and glass packaging manufacturers, the actual increase in concentration from the merger will be substantially less than suggested by the change in the number of nationwide aluminum can manufacturers.
  2. Moreover, in nearly all of the relevant geographic markets (which are much smaller than the typically nationwide markets from which concentration numbers are derived), the merger will not affect market concentration at all.
  3. While beverage packaging isn’t a typical, rapidly evolving, high-technology market, technological change is occurring. Coupled with shifting consumer demand (often driven by powerful beverage company marketing efforts), and considerable (and increasing) buyer power, historical beverage packaging market shares may have little predictive value going forward.
  4. The key importance of transportation costs and the effects of current input prices suggest that expanding demand can be effectively met only by expanding the geographic scope of production and by economizing on aluminum supply costs. These, in turn, suggest that increasing overall market concentration is consistent with increased, rather than decreased, competitiveness.
  5. The markets in which Ball and Rexam operate are dominated by a few large customers, who are themselves direct competitors in the upstream marketplace. These companies have shown a remarkable willingness and ability to invest in competing packaging supply capacity and to exert their substantial buyer power to discipline prices.
  6. For this same reason, complaints leveled against the proposed merger by these beverage giants — which are as much competitors as they are customers of the merging companies — should be viewed with skepticism.
  7. Finally, the merger should generate significant managerial and overhead efficiencies, and the merged firm’s expanded geographic footprint should allow it to service larger geographic areas for its multinational customers, thus lowering transaction costs and increasing its value to these customers.

Distinguishing Ardagh: The interchangeability of aluminum and glass

An important potential sticking point for the FTC’s review of the merger is its recent decision to challenge the Ardagh-Saint Gobain merger. The cases are superficially similar, in that they both involve beverage packaging. But Ardagh should not stand as a model for the Commission’s treatment of Ball/Rexam. The FTC made a number of mistakes in Ardagh (including market definition and the treatment of efficiencies — the latter of which brought out a strenuous dissent from Commissioner Wright). But even on its own (questionable) terms, Ardagh shouldn’t mean trouble for Ball/Rexam.

As we noted in our December 1st letter to the FTC on the Ball/Rexam merger, and as we discuss in detail in the paper, the situation in the aluminum can market is quite different than the (alleged) market for “(1) the manufacture and sale of glass containers to Brewers; and (2) the manufacture and sale of glass containers to Distillers” at issue in Ardagh.

Importantly, the FTC found (almost certainly incorrectly, at least for the brewers) that other container types (e.g., plastic bottles and aluminum cans) were not part of the relevant product market in Ardagh. But in the markets in which aluminum cans are a primary form of packaging (most notably, soda and beer), our research indicates that glass, plastic, and aluminum are most definitely substitutes.

The Big Four beverage companies (Coca-Cola, PepsiCo, Anheuser-Busch InBev, and MillerCoors), which collectively make up 80% of the U.S. market for Ball and Rexam, are all vertically integrated to some degree, and provide much of their own supply of containers (a situation significantly different than the distillers in Ardagh). These companies exert powerful price discipline on the aluminum packaging market by, among other things, increasing (or threatening to increase) their own container manufacturing capacity, sponsoring new entry, and shifting production (and, via marketing, consumer demand) to competing packaging types.

For soda, Ardagh is obviously inapposite, as soda packaging wasn’t at issue there. But the FTC’s conclusion in Ardagh that aluminum cans (which in fact make up 56% of the beer packaging market) don’t compete with glass bottles for beer packaging is also suspect.

For aluminum can manufacturers Ball and Rexam, aluminum can’t be excluded from the market (obviously), and much of the beer in the U.S. that is packaged in aluminum is quite clearly also packaged in glass. The FTC claimed in Ardagh that glass and aluminum are consumed in distinct situations, so they don’t exert price pressure on each other. But that ignores the considerable ability of beer manufacturers to influence consumption choices, as well as the reality that consumer preferences for each type of container (whether driven by beer company marketing efforts or not) are merging, with cost considerations dominating other factors.

In fact, consumers consume beer in both packaging types largely interchangeably (with a few limited exceptions — e.g., poolside drinking demands aluminum or plastic), and beer manufacturers readily switch between the two types of packaging as the relative production costs shift.

Craft brewers, to take one important example, are rapidly switching to aluminum from glass, despite a supposed stigma surrounding canned beers. Some craft brewers (particularly the larger ones) do package at least some of their beers in both types of containers, or simultaneously package some of their beers in glass and some of their beers in cans, while for many craft brewers it’s one or the other. Yet there’s no indication that craft beer consumption has fallen off because consumers won’t drink beer from cans in some situations — and obviously the prospect of this outcome hasn’t stopped craft brewers from abandoning bottles entirely in favor of more economical cans, nor has it induced them, as a general rule, to offer both types of packaging.

A very short time ago it might have seemed that aluminum wasn’t in the same market as glass for craft beer packaging. But, as recent trends have borne out, that differentiation wasn’t primarily a function of consumer preference (either at the brewer or end-consumer level). Rather, it was a function of bottling/canning costs (until recently the machinery required for canning was prohibitively expensive), materials costs (at various times glass has been cheaper than aluminum, depending on volume), and transportation costs (which cut against glass, but the relative attractiveness of different packaging materials is importantly a function of variable transportation costs). To be sure, consumer preference isn’t irrelevant, but the ease with which brewers have shifted consumer preferences suggests that it isn’t a strong constraint.

Transportation costs are key

Transportation costs, in fact, are a key part of the story — and of the conclusion that the Ball/Rexam merger is unlikely to have anticompetitive effects. First of all, transporting empty cans (or bottles, for that matter) is tremendously inefficient — which means that the relevant geographic markets for assessing the competitive effects of the Ball/Rexam merger are essentially the largely non-overlapping 200 mile circles around the companies’ manufacturing facilities. Because there are very few markets in which the two companies both have plants, the merger doesn’t change the extent of competition in the vast majority of relevant geographic markets.

But transportation costs are also relevant to the interchangeability of packaging materials. Glass is more expensive to transport than aluminum, and this is true not just for empty bottles, but for full ones, of course. So, among other things, by switching to cans (even if it entails up-front cost), smaller breweries can expand their geographic reach, potentially expanding sales enough to more than cover switching costs. The merger would further lower the costs of cans (and thus of geographic expansion) by enabling beverage companies to transact with a single company across a wider geographic range.

The reality is that the most important factor in packaging choice is cost, and that the packaging alternatives are functionally interchangeable. As a result, and given that the direct consumers of beverage packaging are beverage companies rather than end-consumers, relatively small cost changes readily spur changes in packaging choices. While there are some switching costs that might impede these shifts, they are readily overcome. For large beverage companies that already use multiple types and sizes of packaging for the same product, the costs are trivial: They already have packaging designs, marketing materials, distribution facilities and the like in place. For smaller companies, a shift can be more difficult, but innovations in labeling, mobile canning/bottling facilities, outsourced distribution and the like significantly reduce these costs.  

“There’s a great future in plastics”

All of this is even more true for plastic — even in the beer market. In fact, in 2010, 10% of the beer consumed in Europe was sold in plastic bottles, as was 15% of all beer consumed in South Korea. We weren’t able to find reliable numbers for the U.S., but particularly for cheaper beers, U.S. brewers are increasingly moving to plastic. And plastic bottles are the norm at stadiums and arenas. Whatever the exact numbers, clearly plastic holds a small fraction of the beer container market compared to glass and aluminum. But that number is just as clearly growing, and as cost considerations impel them (and technology enables them), giant, powerful brewers like AB InBev and MillerCoors are certainly willing and able to push consumers toward plastic.

Meanwhile soda companies like Coca-cola and Pepsi have successfully moved their markets so that today a majority of packaged soda is sold in plastic containers. There’s no evidence that this shift came about as a result of end-consumer demand, nor that the shift to plastic was delayed by a lack of demand elasticity; rather, it was primarily a function of these companies’ ability to realize bigger profits on sales in plastic containers (not least because they own their own plastic packaging production facilities).

And while it’s not at issue in Ball/Rexam because spirits are rarely sold in aluminum packaging, the FTC’s conclusion in Ardagh that

[n]on-glass packaging materials, such as plastic containers, are not in this relevant product market because not enough spirits customers would switch to non-glass packaging materials to make a SSNIP in glass containers to spirits customers unprofitable for a hypothetical monopolist

is highly suspect — which suggests the Commission may have gotten it wrong in other ways, too. For example, as one report notes:

But the most noteworthy inroads against glass have been made in distilled liquor. In terms of total units, plastic containers, almost all of them polyethylene terephthalate (PET), have surpassed glass and now hold a 56% share, which is projected to rise to 69% by 2017.

True, most of this must be tiny-volume airplane bottles, but by no means all of it is, and it’s clear that the cost advantages of plastic are driving a shift in distilled liquor packaging, as well. Some high-end brands are even moving to plastic. Whatever resistance (and this true for beer, too) that may have existed in the past because of glass’s “image,” is breaking down: Don’t forget that even high-quality wines are now often sold with screw-tops or even in boxes — something that was once thought impossible.

The overall point is that the beverage packaging market faced by can makers like Ball and Rexam is remarkably complex, and, crucially, the presence of powerful, vertically integrated customers means that past or current demand by end-users is a poor indicator of what the market will look like in the future as input costs and other considerations faced by these companies shift. Right now, for example, over 50% of the world’s soda is packaged in plastic bottles, and this margin is set to increase: The global plastic packaging market (not limited to just beverages) is expected to grow at a CAGR of 5.2% between 2014 and 2020, while aluminum packaging is expected to grow at just 2.9%.

A note on efficiencies

As noted above, the proposed Ball/Rexam merger also holds out the promise of substantial efficiencies (estimated at $300 million by the merging parties, due mainly to decreased transportation costs). There is a risk, however, that the FTC may effectively disregard those efficiencies, as it did in Ardagh (and in St. Luke’s before it), by saddling them with a higher burden of proof than it requires of its own prima facie claims. If the goal of antitrust law is to promote consumer welfare, competition authorities can’t ignore efficiencies in merger analysis.

In his Ardagh dissent, Commissioner Wright noted that:

Even when the same burden of proof is applied to anticompetitive effects and efficiencies, of course, reasonable minds can and often do differ when identifying and quantifying cognizable efficiencies as appears to have occurred in this case.  My own analysis of cognizable efficiencies in this matter indicates they are significant.   In my view, a critical issue highlighted by this case is whether, when, and to what extent the Commission will credit efficiencies generally, as well as whether the burden faced by the parties in establishing that proffered efficiencies are cognizable under the Merger Guidelines is higher than the burden of proof facing the agencies in establishing anticompetitive effects. After reviewing the record evidence on both anticompetitive effects and efficiencies in this case, my own view is that it would be impossible to come to the conclusions about each set forth in the Complaint and by the Commission — and particularly the conclusion that cognizable efficiencies are nearly zero — without applying asymmetric burdens.

The Commission shouldn’t make the same mistake here. In fact, here, where can manufacturers are squeezed between powerful companies both upstream (e.g., Alcoa) and downstream (e.g., AB InBev), and where transportation costs limit the opportunities for expanding the customer base of any particular plant, the ability to capitalize on economies of scale and geographic scope is essential to independent manufacturers’ abilities to efficiently meet rising demand.

Read our complete assessment of the merger’s effect here.