Case 2: Staples-Office Depot Merger Issues: Product Market Definition Unilateral vs. Coordinated Acts

Background Merger Announced: Sept. 4, 1996 Federal Court Decision: June 30, 1997 Staples Invented “Office Superstore” 1986 550 Stores in 28 states 1996 revenues $4 b., stock value $3 b. Office Depot 500 stores in 38 states 1996 revenues $6.1 b,; stock $2.2 b. Office Max – Only other close rival 575 stores in 48 states 1996 revenues $3.2 billion

Market Definition Product Market Geographic Markets FTC: Office supplies sold thru Office Superstores Defendants: Broad market for retailing office supplies Geographic Markets Cities and/or metropolitan areas The parties appear to have agreed on geographic markets

FTC’s Evidence: Product Market Office Superstores offer distinct products and services OSS stock up to 7500 items; others 500 (Kmart) to 2400 (Walmart) items Parties’ internal documents considered OSS’s main competitors Staples defined “competitive” and “non-competitive” markets on presence of other OSS’s Non-OSS retailers have little effect on OSS prices in “competitive” markets A survey for Detroit found that all OSS’s priced a basket of products within 2% of eachother, while Best Buy charged prices 18-19% higher Non-competitive markets suffer Cellophane Fallacy: monopolists create competitors by pricing high

FTC’s Evidence: Product Market Econometric Evidence Large-scale econometric model Explain Staples’ stores pricing as a function of nearby OSS’s as well as potential non-OSS rivals Weekly prices for 18 months covering over 400 Staples stores in more than 40 cities Model predicts merger to monopoly in areas where all 3 OSS’s compete raises OSS prices by 8.49% (> 5% test under Merger Guidelines)

Defendants Evidence: Product Market Market defined by characteristics of product, not identity of seller All office supply retailing regardless of store Other internal documents used the term “market” to refer to non-OSS’s Staples and Office depot regularly checked prices at Walmart, Best Buy, Comp USA and other non-OSS’s Study shows a Staples store’s sales fall by 1.4% to 7.2% after opening of a non-OSS retailer

Concentration OSS market Reduce 3 firms to 2 in 69% of geo mkts; 27 cities: combined S-OD share > 45% Reduce 2 firms to 1 in 7% of geo mkts Combined share 100% in 15 metro areas Pre-merger HHI’s ranged from 3600 to 7000 Average change in HHI: 2715 All office supply retailing markets were unconcetrated

Entry Conditions OSS market All office supplies market: Easy entry Economies of Scale in Advertising allow incumbents to “saturate” markets and deter entry Company documents suggested that most major US markets were saturated: no room for new entrant at Minimum Efficient Scale (MES) Sunk costs (advertising) and ability to change prices rapidly make “limit-pricing” strategies unlikely: potential entry does not constrain incumbent pricing All office supplies market: Easy entry Non-OSS’s can easily expand OS items No sunk costs: nonperishable items, no fashion crazes Expansion by Office Max shows OSS entry ease

Competitive Effects FTC Defendants Prices increase 8.6% to 11.6% in S-OD only markets; 2.5% to 5.9% in 3-firm markets S & OD management documents Direct comparison of prices in local markets Econometric Analysis Prudential Securities pricing survey Stock Market Event Study Merger raises Office Max share price 12% No effect on non-OSS retailers Defendants Prices increase 2.4% in S-OD markets; 0.8%-1.3% average over all Staples stores Econometric Study

Efficiencies FTC Defendants Scale efficiencies already realized w/o merger or would be soon thru growth Parties efficiency estimates increased greatly after boards approved merger Efficiencies too small to offset 7.3% average price increase 1.4% cost-saving x 0.15 pass thru = 0.2% reduction in price Defendants Efficiencies more than offset 0.8% price increase 4.5% cost saving x 0.67 pass thru = 3% price reduction

Equities Defendants Stopping merger will delay cost savings and benefits to consumers and stockholders of S & OD Merger is reversible – no need for preliminary injunction

Court Decision: Grant FTC Request for P. I. Product Market OSS “submarket” within larger market of all office supply retailers Competitive Effects Merged firm “dominant” in many local markets Prices likely higher due to OD’s elimination both as a direct and a potential competitor Entry Entry by new OSS extremely unlikely Efficiencies Not viable legal defense Estimates unreliable & 0.67 pass-thru rate too high Equities “unscrambling the eggs” not realistic

Aftermath Within 3 years both Staples and Office Depot achieved the size (1000 stores) they could achieve by merger Many new stores in “overlap” markets Most scale related efficiencies reached quickly Without anticompetitive price effects