1. Industrial Economics:
Prices, market definition, and the effects of merger : Staples-Office Depot (1997) case
Fanny CANON
Feruza CHAKKANOVA

2. Agenda Introduction Background FTC’s case The defendant’s arguments
Judge Hogan’s decision
Conclusion and aftermath
Questions

3. Introduction
September, 1996: 2 largest office superstore chains in US - Office Depot and Staples announced their agreement to merge
Seven month later: the Federal Trade Commision voted 4 to 1 to oppose the merger on the grounds that it would harm competition and lead to higher prices
The merging parties chose to contest the FTC’s actions in court
June, 1997, after a 7 day trial Judge Hogan of the US District Court for the DC announced the final decision on the case

4. Background
Staples first to pioneer the office superstore concept in 1986 and Staples started in 1987
Staples with 550 stores in 28 states (1997)
Office Depot 500+ stores in 38 states (1997)
The office superstore was to do for office supplies what the supermarket had done for home groceries

5. Typical superstore Area: 23K-30K square feet Stocks: 5000-6000 items
Location: urban business area

6. Market for OSS 23 competing OSS chains in the market
3 biggest OSS chains:

7. The success of OSS concept
Competitive rivalry between superstores benefited consumers
OSS slashed down prices
drowned down costs
developed innovative approaches in
marketing
distribution
store layout
one-stop shopping

8. Merger agreement
September 4, 1996 Staples and Office Depot announce agreement to merge
Staples to acquire Office Depot 1.14 Staples share for each Office Depot share; $4 billion deal
After 7-month investigation FTC decided to challenge the merger

9. Possible consequences of the merger:
The FTC’s case
Possible consequences of the merger:
decrease in competition
increase of prices
Note: Comparison between the expected merger-related changes in prices and costs with the prices and costs that would have prevailed in the absence of merger.

10. Concentration and the competitive effects of a merger
“Mergers or acquisitions should not be permitted to create, enhance, or facilitate the exercise of market power”
Two ways of gaining market power:
- Explicit/ implicit coordination of actions
- Unilateral conduct
Consequences:
- Transfer of wealth from buyer to seller
- Misallocation of resources

11. Some evidences …

12. 1. Defining the relevant market: “Consumable Office Supplies Sold Through Office Superstores”

13. Office superstores offer a distinct set of products and services
Other vendors:
Office Depot and Staples (OSS):
Broad range of consumables
Large amount of stock
=> One-stop- shopping opportunity
Limited assortment of consumables
Small amount of stock

14. OSSs regard each other as their primary competitors
According to internal documents

15. Non-OSS retailers have little effect on OSSs’ price changes
“A monopolist is distinguished not by the fact that it faces no competition, but by the fact that its closest competitors are too distant to prevent it from maintaining its price at a level significantly above cost”

16. Econometric evidence supported an OSS product market
Would a merger to monopoly among the OSS chains in a city allow the merged entity to raise the prices of consumable office supplies by 5% or more?

17. 2. The merger’s Likely anticompetitive Consequences

18. Structural evidence: the change in concentration and market power
Year
Staples only
Staples and Office Depot
Staples and  OfficeMax
All three
Total
1995
17%
29%
37%
100%
2000
12% 7%
69%

19. Empirical evidences pointing to likely price increases
Prediction of Staples Management
Direct comparisons of prices across local markets
Estimates from econometric analysis
Estimates from the prudential study
Estimates from a stock-market event-probability study

20. Prediction of Staples Management:
Empirical evidences:
Prediction of Staples Management:
Year
Staples only
Staples and Office Depot
Staples and  OfficeMax
All three
Total
1995
17%
29%
37%
100%
2000
12% 7%
69%

21. Direct comparisons of prices across local markets
Empirical evidences:
Direct comparisons of prices across local markets
Benchmark OSS Market Structure
Comparison OSS Market Structure
Price Reduction
Staples only
Staples + Office Depot
11.6%
Staples + OfficeMax
Staples + OfficeMax + Office Depot
4.9%
Office Depot Only
Office Depot + Staples
8.6%
Office Depot + Office Max
Office Depot + Office Max + Staples
2.5%

22. Estimates from econometric analysis
Empirical evidences:
Estimates from econometric analysis
Overall price effects of the proposed merger:
=> Average of 7.3%
Estimates from the prudential study
Prices are more competitive (+/- 5.8 percent lower) in a 3-player markets than in a 2-player markets.

23. Estimates from a stock-market event-probability study
Empirical evidences:
Estimates from a stock-market event-probability study
If the merger would raise prices
If the merger would low prices
The share values of the merging firms’ rivals would fall
Both merging parties would benefit from it with higher share prices
In this case : value of OfficeMax’s shares would raise by 12%.

24. 3. Entry

25. Entry
o Potential entry of other OSS firms does not constrain the incumbents
o Significant barriers to entry:
Economies of scale in advertising
Store level economies of scale
Economies of multi store operations

26. 4. Efficiencies were not sufficient to offset price increases

27. Efficiency claims made by the merger parties were exaggerated for several reasons:
The anticipated efficiency gains were the result of the merged firm’s increased scale
Efficiencies analysis that was submitted to the FTC was different (showing higher efficiencies) from the one that was submitted to Staples’s board
Only one seventh of the cost-saving would be passed through to consumers however, efficiency gains are relevant only if they result in lower prices to consumers

28. The defendant’s arguments
The FTC’s product market definition was erroneous
Reasons the merger would not raise prices
efficiencies from merger
ease of entry into OSS retailing
record of lowering prices after past acquisitions of other OSS firms

29. Efficiencies and Net Price Effect
OSS founded on the principle of providing low prices through large sales volume.
The merger would lower the costs through increase in total volume of combined purchases from manufacturers
Lower administrative, marketing, advertising, and distribution costs
Cost reduction passes on to consumers, bringing down prices after the merger

30. Econometric study by Staples
Office Depot had a small effect on Staples’ pricing
Merger would increase prices for consumable goods by only 2.4% (compared with FTC’s estimate of 7.3%)
Staples’ estimate of cost savings and efficiency gains lower the prices by 3% over all Staples’ products and stores
The net effect of the merger would bring to average Staples customer 2.2% decrease in prices

31. No Barriers to Entry and Ease of expansion
Stores can be constructed within months (e.g. Office Max)
Low sunk costs
No fashion trends in office supply products, so products do not decay
Expand by increasing shelf space for office supply items not only by new store openings (e.g.Walmart)

32. Public and Private Equities
Blocking merger would impose losses on both consumers and shareholders
Consumer benefits to be lost:
efficiencies and lower prices
faster combined company expansion create value for customers and for U.S. economy
Shareholders benefits to be lost:
extra profits due to cost savings
In case of postmerger anticompetitive effect, the entity could split back into two separate companies

33. Judge Hogan’s Decision
The court granted preliminary injunction.
Relevant product market defined as OSS submarket
Staples and Office Depot would have dominant market share 45%-100% in many geographic markets after the merger
FTC’s pricing evidence showed a reasonable likelihood of anticompetitive effect
Neither public nor private equities claimed by defendants were enough to refute the anticompetitive effects

34. Court’s comments in response to defendant’s arguments
The product Market: submarket
Likely effect on competition: dominant
Entry: no OSS entry
Efficiencies: unrealistic
Estimates: unreliable

35. Conclusion and Aftermath
The FTC’s victory in Staples came as a surprise to many observers
Staples and Office Depot together accounted for only a small percentage of the aggregate sales among many retailers of office supplies
Studies by FTC showed Office superstores - separate market, the key argument for anticompetitive effects

36. Conclusion and Aftermath
Most of efficiencies expected from merger were achieved without delay and not necessarily with price cuts
Within 3 years Staples and Depot each achieved the size of 1000 stores - the size to be achieved as a single firm in case of merger

37. As of March, 2007 Staples Expanded to 1522 office supply stores
throughout U.S and Canada
$16.1 billion sales
Office Depot
Expanded to 1200 office supply stores
throughout U.S and Canada
$15 billion sales

38. Question 1
Which of the following assumption was not used by the Federal Trade Commission to define the relevant market “office supplies sold through office superstores”?
Office superstores offer a distinct set of products and services
Non-office superstore retailers have little effect on office superstores’ price changes
Office superstores regard each other as their primary competitors
The type of customers targeted

39. Question 2 What is explicit/implicit coordination?
when firms agree to advertise a product together
when firms charge very similar prices for the same kind of products
when firms set a minimum price at which the product can be sold at
when a supplier decides to only buy its raw material from one specific producer

40. Question 3
How does the value of the share evaluate when investors predict that a merger would raise prices?
the value goes down
the value stay the same
the value goes up
it is impossible to say

41. Question 4
Which of the following can be the base for market definition?
Only the identity of the seller
The identity of the seller and the characteristics of the product or service supplied by the supplier
Size and format of the supplier
Variety of goods sold by the supplier

42. Question 5 What was the determinant of the success of the OSS concept?
Ability to provide lower prices
Innovative approaches in marketing and distribution
Store layout and convenience of one-stop shopping
All of the above