This decision may result in an increase in the number of merger challenges, but companies considering mergers involving consumer products can take several practical steps to reduce their exposure to antitrust risk
On July 29, 2008, in a stunning 2-to-1 decision, the U.S. Court of Appeals for the District of Columbia Circuit reversed the U.S. District Court for the District of Columbia’s decision denying the Federal Trade Commission’s (FTC’s) motion for preliminary injunction to halt the merger of Whole Foods Market and Wild Oats Markets, Inc. Shortly after the district court denied the FTC’s motion for preliminary injunction in 2007, the D.C. Circuit refused to stay the case pending appeal, which permitted Whole Foods and Wild Oats to consummate their merger. Now, one year later, the D.C. Circuit found that while the district court utilized the correct standard, which should have deferred more to the FTC and does not require the FTC to prove a relevant market definition, it reached the wrong conclusion with regard to the FTC’s ultimate likelihood of success. The D.C. Circuit remanded the case back to the district court for additional fact-finding to determine whether, after balancing the public equities, the district court should issue a preliminary injunction, and if so, what the appropriate remedy is in light of Whole Foods’ and Wild Oats’ subsequent integration. The D.C. Circuit’s reversal is a significant development and likely will embolden the FTC to become more aggressive in its enforcement of mergers in industries with differentiated products.
The FTC challenged the Whole Foods/Wild Oats transaction, asserting that the merger would substantially lessen competition in the alleged market for “premium natural and organic supermarkets.” Relying in large part on documents prepared by Whole Foods describing Wild Oats as a critical competitor, deposition testimony from the former CEO of Wild Oats and testimony from an economics expert, the FTC moved for a temporary restraining order to prevent Whole Foods and Wild Oats from consummating their transaction. The district court held a two-day hearing on the FTC’s motion for preliminary injunction, approximately two weeks after which the district court issued an order and opinion denying the FTC’s motion for preliminary injunction. The district court found that the FTC’s proposed market of “premium natural and organic supermarkets” was too narrow and that the relevant market “inevitably” encompassed at least all supermarkets.
The FTC appealed the district court’s decision to the D.C. Circuit and requested a stay preventing the parties from consummating the merger. The D.C. Circuit denied the FTC’s motion to stay the transaction pending its appeal, shortly after which Whole Foods and Wild Oats consummated their merger. Now, one year later, the D.C. Circuit reversed the district court’s prior decision. In analyzing the same evidence as was presented to the lower court and praising, at times, the district court’s thoughtfulness, the D.C. Circuit could not “agree with the district court that the FTC would never be able to prove a [premium natural and organic supermarkets] submarket.”
D.C. Circuit’s Analysis and Conclusions
The D.C. Circuit reversed the district court because it viewed the facts of the case differently. The D.C. Circuit found that the district court applied the correct legal standard, but simply reached the wrong conclusion regarding the FTC’s proposed market definition. The FTC sought a preliminary injunction from the district court under Section 13(b) of the FTC Act (Section 13(b)), which allows a district court to grant a preliminary injunction when the FTC’s likelihood of success in challenging the merger, balanced against the public equities (e.g., effective enforcement of the antitrust laws), warrants enjoining the challenged merger. The D.C. Circuit noted that the FTC does not have to prove the merits of its case to obtain a preliminary injunction, but simply must “raise questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation.” Notably, this standard is more lenient than the standard for motions for preliminary injunction brought by the U.S. Department of Justice (DOJ), which requires a likelihood of success based on the merits of the DOJ’s case.
Remarkably, the D.C. Circuit found that in seeking a preliminary injunction, the FTC does not need “to settle on a market definition at this preliminary stage” because preliminary injunctions sought under Section 13(b) of the FTC Act “are meant to be readily available to preserve the status quo while the FTC develops its ultimate case[.]” The result of this holding is that when seeking preliminary injunctions, “the FTC’s chances will not depend, in every case, on a threshold matter of market definition,” although the FTC will need to define the relevant market to ultimately prove that a merger violates antitrust laws.
In assessing the evidence presented to the district court, the D.C. Circuit found the FTC’s proposed market definition of premium natural and organic supermarkets (PNOS) plausible enough to “raise questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation.” The distinction between the two courts’ analyses hinged on their respective treatments of “marginal” and “core” customers. The D.C. Circuit found that the district court erroneously focused on “marginal customers” instead of “core customers” in holding that the FTC’s proposed market of PNOS was too narrow.
Pursuant to the FTC and DOJ’s Horizontal Merger Guidelines, the agencies define provisional relevant markets according to the smallest group of products from which customers will not switch when confronted with a small but significant non-transitory increase in price (usually 5 to 10 percent). The customers that would switch when faced with a price increase are considered the marginal customers, while the core customers are those whose demand is so strong or unique that they will not switch when confronted with higher prices. In this context, the D.C. Circuit viewed marginal customers as those that would cross-shop between PNOS and conventional supermarkets, while so-called core customers were those that would only shop at PNOS such as Whole Foods and Wild Oats.
Analysis of Evidence
The D.C. Circuit characterized the district court’s analysis as assuming that only the marginal customer, and not the core customer, must be at the center of its antitrust analysis. The D.C. Circuit found that “a PNOS submarket catering to a core group of customers” could reasonably exist within a broader market of supermarkets. In reaching its conclusions, the D.C. Circuit maintained that the district court ignored the following evidence:
Pricing Evidence. Price margins for Whole Foods stores in cities where a Wild Oats was also present were significantly depressed. However, while the effect on margins for perishable products, which comprise approximately 70 percent of Whole Foods’ business, was substantial, there was no effect on Whole Foods’ margins on dry good “groceries.” This reinforced the D.C. Circuit’s finding that Whole Foods and Wild Oats compete against each other for core customers, as evidenced by the effect Wild Oats had on Whole Foods’ price margins for the products core customers buy most: high quality perishables. Conversely, the D.C. Circuit found that Whole Foods and Wild Oats competed with conventional supermarkets with regard to the types of products marginal customers purchase—dry goods—as confirmed by evidence that when Whole Foods price-checked conventional stores, Whole Foods focused on dry goods. Further, because Whole Foods prices for perishable items are higher than those of conventional supermarkets, the D.C. Circuit inferred that there must be some group of core customers that do not find conventional supermarkets interchangeable with PNOS.
Internal Company Documents. Internal Whole Foods documents projected that if a Wild Oats near a Whole Foods were to close, the majority, if not all, of Wild Oats’ customers would switch to Whole Foods rather than a conventional supermarket.
Market Research. Market research presented by both the FTC and Whole Foods suggested that there is a significant group of core customers that shop exclusively at PNOS. The court cited market research that states “68% of Whole Foods customers are core customers who share the Whole Foods ‘core values.’” In light of this, the D.C. Circuit spurned the evidence of cross-shopping by some consumers that the district court found so compelling in finding a broader market for all supermarkets. The D.C. Circuit maintained that evidence of cross-shopping by marginal customers was consistent with its finding of a core group of PNOS customers that comprise a relevant submarket.
In a concurring opinion, Judge David S. Tatel highlighted other evidence supporting the D.C. Circuit’s decision. Judge Tatel cited the report prepared by the FTC’s economic expert, which found that the opening of a new Whole Foods store near an existing Wild Oats store “dramatically” reduced Wild Oats’ sales. Also, Whole Foods’ and Wild Oats’ “peculiar characteristics” distinguished them from conventional supermarkets. Judge Tatel criticized the significance of the pricing study presented by Whole Foods’ economic expert. The study found that Whole Foods’ “prices did not differ based on the presence or absence of a Wild Oats in the area.” However, Judge Tatel observed that the study examined Whole Foods’ prices on a single day several months after Whole Foods announced its intent to acquire Wild Oats. Judge Tatel opined that Whole Foods’ study should, therefore, be given little weight because Whole Foods had “every incentive to eliminate price differences . . ., not only to avoid antitrust liability, but because the company was no longer competing with Wild Oats.”
Further, Judge Tatel relied on statements by Whole Foods’ CEO that suggested the parties’ rationale for merging. In one e-mail, Whole Foods’ CEO identified Wild Oats as “the only existing company that has the brand and number of stores to be a meaningful springboard for another player to get into this space. Eliminating them means eliminating this threat forever, or almost forever.” In another e-mail, Whole Foods’ CEO explained to Whole Foods’ board that buying Wild Oats would allow Whole Foods “to avoid nasty price wars.” Judge Tatel acknowledged that intent is not an element in assessing whether a merger violates antitrust laws, but intent can be a useful factor in predicting the parties’ future conduct and the effects of a merger.
Next Steps: More Fact-Finding and Possible Remedies
The D.C. Circuit remanded the case back to the district court for additional fact-finding on the question of whether the public equities, when balanced against the FTC’s likelihood of success, tip for or against issuing a preliminary injunction. If the district court finds that the FTC’s likelihood of success and the public equities weigh in favor of issuing a preliminary injunction, the court will have to address the question of an appropriate remedy since the parties have already merged. The majority and concurring opinions offer several alternatives, including an order to hold the Wild Oats and Whole Foods assets separately, enjoining further integration of the companies, or ordering the merger partially or entirely rescinded. However, the D.C. Circuit acknowledged it did not have enough facts to determine which possible remedy would be appropriate should the district court issue a preliminary injunction on remand.
Guidance for Companies Considering Mergers Involving Consumer Products
While the effect of the D.C. Circuit’s decision on Whole Foods remains to be seen, there are some immediate implications for companies in consumer goods industries contemplating mergers. First, as a result of the D.C. Circuit’s explanation that the standard the FTC must meet to obtain a preliminary injunction pursuant to Section 13(b) does not require “settl[ing] on a market definition,” the decision will likely invigorate the FTC to challenge mergers before it has fully developed its theories of competitive harm. Second, the decision establishes precedent for the possibility of narrower submarkets based on a distinct class of customers within a broader market. This may affect the analysis of mergers between companies that manufacture and/or sell differentiated products. Although this decision may result in an increase in the number of merger challenges, there are some practical ways companies can reduce their exposure to antitrust risk.
Companies must remain mindful of their internal documents, particularly those that discuss their competitors, competition, pricing decisions or the rationale for any transactions they pursue. Documents that discuss, for example, a variety of competitors that the merging parties seriously consider in making business, strategic or pricing decisions, or anecdotes of customers switching among products offered by the merging parties and other competitors’ products, will enhance the merging parties’ arguments that the transaction will not have anticompetitive effects. Conversely, documents that suggest only a few, if any, viable competitors exist in the marketplace, or that suggest the transaction will insulate the surviving party from competition, will diminish the merging parties’ ability to rebut at the preliminary injunction stage the FTC’s likelihood of success.
Pricing Data and Economic Evidence
As evidenced by the D.C. Circuit’s majority and concurring opinions, pricing data and economic evidence remain important evidentiary keys to merger challenges. For example, pricing data that suggests the merging parties only price-check against competitors with respect to certain categories of products may lead the FTC to argue in favor of a narrow sub-market within a broader product market. Likewise, evidence that one party’s prices fall or rise with the respective entry or exit from the marketplace of the other party—despite the presence of other potential competitors—suggests those other would-be competitors do not pose significant competitive restraints on the merging parties. However, the pedigree of the data is equally important as the evidence itself. In giving little weight to Whole Foods’ presentation of pricing data, the D.C. Circuit revealed that it will look closely at the provenance of data when weighing it against other, contradictory evidence.