Price, Market Definition, and the Effects of Merger: Staples-Office Depot (1997) By Melinda Fremerey & Giulia Tognacci Class: Industrial Economics

Agenda of presentation Merger Case of Staples-Office-Depot Intrduction and background The FTC‘s Case Market definition Merger‘s likely anticompetitive consequences Analysis of entry Efficiencies and price developments The defendants‘ arguments Market definition Efficiencies and price development Analysis of Entry Public and private Equities Judge‘s decision Market definition Effect on Competition Entry and Efficienies Overall conculsion Compare Merger Law in US, Germany, Italy and Poland

Introduction and Background 1996: the Office Supply Superstore (OSS) market in the United States was composed by: 1.Office Depot 2.Staples 3.OfficeMax 1996: Office Depot and Staples announce their agreement to merge 1997: The Federal Trade Commission (FTC) oppose the merger. The merging parties contest the FTC’s actions in court  but preliminary injunction was granted

The FTC‘s Case:

The FTC’s Case General Summery: Merger would lead to a harm of consumers due to: Decrease in competition in the market large and long-lasting price increases The FTC recognised that OSS prices might continue to fall after the merger, but argued that because prices would fall significantly further without the merger it would still harm the competition.

Market definition relevant product :“the sale of consumable office supplies through office superstores” Evidences supporting the FTC’s market definition: 1.OSSs offer a distinct set of product and services 2.OSSs regard each other as their primary competitors 3.Non-OSS retailers do not tightly constrain OSS pricing 4.A hypothetical merger to monopoly among all three OSSs could be expected to result in a significant increase in their prices for consumable ofice supplies

Merger’s Likely Anticompetitive Consequences Voluminous evidence supported the conclusion that the combined Staples/Office Depot entity would raise prices for office supplies: 1.Structural evidence: only three OSS chains competed  OSS market concentration would increase significantly in all local markets 2.Documentary evidence: Office Depot = main constraint to Staples prices  Staples planned to cut prices significantly over the next few years in response to current and future aggressive competitive pressures from Office Depot  merger would eliminate these pressures 3.Statistical evidence: statistical analysis predicted that, absent efficiencies, the merger could be expected to lead to large price increases 4.Financial market evidence: data from financial market indicate that investors believed merger would lead to significant higher prices, even after efficiency effects

Analysis of entry Potential competition can affect the prices of the incumbents only if: 1.The sunk costs of entry are low 2.The incumbents are not able to reduce their prices rapidly  These conditions were not satisfied in the OSS market, therefore prices of OSS products could not be affected by potential entry A chain of OSS can take advantages from: 1.Economies of scale 2.Economies of scope 3.Economies of multi-store operation

Efficiencies and price developments The efficiency claims made by the merger parties were exaggerated: Only efficiencies that are merger specific should be credited: but much of the anticipated efficiency gains were the result of the merged firm’s increased scale Lack of support by reliable evidence: the efficiency claims maid by the parties increased damatically between the time that the deal was first approved and the time that the parties submitted an efficiencies analysis to the FTC Efficiency gains are relevant only insofar as they result in a lower price to consumers: the net price effect of the merger would be: 7.3% – 0.2% = 7.1% (price increase predicted by the FTC) – (1.4%/7 = efficiency pass-through) = (net increase)

The Defendant‘s Arguments

The Defendant’s Arguments: General Summary Merge would not have anticompetitive consequences: 1.FTC’s market definition is erroneous 2.Efficiencies from merger: ease of entry to OSS retailing, and defendants’ track record of lowering prices after their past acquisition of other OSS firms all indicated that merger would not raise prices

Market Definition Critics on FCT‘s definition: Only based on the identity of the seller not on the characteristics of the product or service supplied by sellers. Better: define market by the nature of the product being retailed In reality broader market: OSS not only constrained in its pricing by other OSS firms but also by all office product retailers Rejections of: Notion that office superstore supply a distinct bundle of goods and retail services that would enable a monopoly OSS to raise OSS prices Defining OSS firms as “competitor” and “the market” Study showed that Staples stores’ sale would fall with opening a new computer superstore, Wal-Mart or Best Buy.

Efficiency and price developments Concept of OSS firms: providing low prices through large sales volume  merger: increase total volume of purchases, lower prices paid to manufacturer, lower costs of administrative, marketing, advertising and distribution  2/3 of cost reduction would be passed on to consumer  significant price cut Dispute of FTC’s arguments: Even if some of efficiencies could eventually be achieved without merger, a merger would allow efficiencies to be achieved much faster. Study: the net price effect of the merger faced by a average Staples customer would be: =0.8% – 3% = -2.2% ( price increase predicted by the defendants) – (efficiency pass-through) = (net decrease)

Analysis of Entry Entry into the office supplies business is easy: Stores can be constructed within month Low sunk costs Entry or expansion does not necessarily entail costly new store opening: also existing multiproduct retailer can enter or expand into the office supplies business

Public and private equities Blocking the merger imposes losses on both consumer and shareholders: Merged entity could expand faster than individually  higher value for customers and for US economy Cost savings not passed on consumers benefit the shareholders No need for restraining or preliminary injunction to stop merger because merger is reversible: Merged entity could always be split back into two separate companies if postmerger evidence demonstrate anticompetitive effect.

Judge‘s Decision

Market Definition Accepting the FTC‘s product market definition: Definition of relevant product market as the OSS submarket Plausible argument of FTC: small but significant increase in one superstore‘s prices would not cause a large number of its customers to switch to non-OSS but rather to another OSS. Believed in internal document as brought forward by FTC: Staple and Office Depot consider other OSS firms as their main competition

Effect on Competition Concentration statistics are a source of serious concern: Staples-Office-Depot entity would have dominant market share in many local geographic markets Entity would have a dominant market share of % in total Convincing evidence that OSS was likely to raise prices when facing less competition from other OSS firms Without merger the two firms would enter into each other markets and reduce prices  no benefits from increased competition with merger

Entry and Efficiencies Unlikely that new OSS firms would enter market and could counterbalance anticompetitive effect of merger New firm would need to open many stores and incur high sunk costs in order to achieve economies of scale and profits Especially not easy in local area because many OSS markets already saturated by existing OSS firms Efficiency constituting a viable defense is unclear under law Even if efficiencies are existing, they are not sufficient to refute anticompetitive effects Defense‘s estimate of efficiencies: unreliable, unverified and unrealistic No distinction between merger-specific and other efficiencies were made

Overall conclusion FTC‘s victory was a surprise to many observers Most of the efficiencies expected from merger have been achieved without much delay and without detrimental price effects from a merger

Compare Merger Law in US, Germany, Italy and Poland

Merger Law in US US Merger Guidelines attach a high importance to the HHI Merger Guidelines address: 1.Delineation of the market for merger to determine sizes of market shares 2.Level of seller concentration in relevant market that raise antitrust concern 3.Potential adverse effects of the merger 4.Role of entry into the market 5.Post merger market power 6.Merger-related cost savings and efficiencies Although existing, successful efficiency defenses and failing firm defenses are rare

Merger Law in Germany Focused almost exclusively on market shares - thresholds are rather low. There is no efficiency defense. “Minstererlaubnis”: If the cartel authority (Bundeskartallamt) has blocked a merger, firms can do two things: 1. Appeal at the appellate court (as in any other country as well). 2. Appeal to the Federal Minister of Economic Affairs: the Minister overrules the BKartA if there are “overarching economic advantages” from the merger which outweigh the anticompetitive effects.  in principle, efficiency defenses could be used here. Usually, the arguments acceptable in the German debate are rather: Saving of jobs R & D capabilities Creating “national champions” to build buying power

Merger Law in Italy The Law does not make any reference to an efficiency defense or to the opportunity to take into account the development of technical and economical progress to the benefit of consumers. the Law differs significantly from the EUMR in one important aspect; while the Commission only has the power to assess the adequacy of commitments offered by the parties, the Authority also has the power to “impose” remedies as a condition for clearance

Merger Law in Poland Efficiency-effect: even when concentration leads to the significant impediment to competition, it may be implemented if it contributes to economic development or technical progress. (Article 20(2)(1) of the antimonopoly act) Public interest test: The President of the Office shall issue, by way of a decision, consent for the implementation of the concentration as a result of which competition in the market will be significantly impeded, in particular by the creation or strengthening of a dominant position, in any case that the desistance from banning concentration is justifiable, and in particular it may exert a positive impact on the national economy. (Article 20(2)(2) of the antimonopoly act) Evidence and arguments of expected improvements in efficiency have been accepted in some decisions but the policy of the Polish competition authority accepting the existence of such efficiencies is very cautious.

Questions

1. Question What is the big difference between the merger law in Germany on the one hand and in US and Poland on the other hand? 1.They all accept efficiency effect arguments as a merger defense 2.The efficiency defense argument is only accepted in the US 3.In Poland and in US efficiency effect arguments are accepted whereas in Germany not 4.In no country the merger defendants are allowed to bring forward efficiency effect arguments

2. Question In general, what should the merger parties do in order to defend its merger? 1.Make the market definition as broad as possible 2.Make the market definition as narrowed as possible 3.State that entry cost would rise according to merger 4.Show evidence that a strong monopoly is created due to merger

3. Question Which is not an evidence supporting the FTC market definition? 1.OSSs offer a distinct set of product and services 2.OSSs regard each other as their primary competitors 3.Non-OSS retailers constrain OSS pricing 4.A hypothetical merger to monopoly among all three OSSs could be expected to result in a significant increase in their prices for consumable ofice supplies

4. Question How is the net price effect of the merger estimated? 1.Efficiency pass-through – price increase predicted = net price 2.Price increase predicted – efficiency pass-through = net price 3.Efficinecy pass through / price increase = net price 4.Price increase / efficiency pass-through = net price

5. Question In the merger case of Staples and Office Depot, who used this argument for its positition: “ A Study showed that Staples stores’ sale would fall with opening a new computer superstore, Wal-Mart or Best Buy” 1.The FTC 2.The Judge 3.The merging firms 4.OfficeMax (the third OSS firm which was not involved in the merger)