In the last two years, the Federal Trade Commission (FTC) and the Antitrust Division of the US Department of Justice (DOJ) brought, and won, several litigated merger cases by establishing narrow markets comprised of a subset of customers for a product. This narrow market theory, known as price discrimination market definition, allowed the agencies to allege markets in which the merging parties faced few rivals and, therefore, estimate high post-merger market shares. By their nature, price discrimination markets can lead to a challenge of a high-value deal where only a small number of the merging parties’ customers are allegedly harmed. Given the increased usage by the agencies and now judicial acceptance of the theory, counsel for merging parties must consider the potential for price discrimination market definition in assessing the antitrust risks for transactions.
Price discrimination markets have gained increasing focus in each iteration of the Horizontal Merger Guidelines (Guidelines) published by the FTC and the DOJ. In § 1.12 of the 1992 Horizontal Merger Guidelines, the agencies discussed the possibility of a narrow price discrimination market in two paragraphs of a much larger section devoted to market definition. When the Guidelines were revised in 2010, the agencies decided that price discrimination markets deserved their own section.
This new Section 3 of the Guidelines addresses the possibility of price discrimination markets in detail and indicates that price discrimination markets may impact not only market definition, but also the calculation of market shares and the evaluation of competitive effects. Section 3 states that “[w]hen examining possible adverse competitive effects from a merger, the Agencies consider whether those effects vary significantly for different customers purchasing the same or similar products.” Essentially the agencies are looking to determine whether the merged entity can raise prices on a select group of customers who, unlike other customers, cannot find reasonable substitutes. When the agencies find that price discrimination is possible, they will consider the impact of the merger on the targeted customers separately.
While price discrimination markets have long been part of the agency review process, this past year has seen them in a starring role in three high-profile litigations: Sysco/US Foods, GE/Electrolux, and Staples/Office Depot.
In Sysco/US Foods, the FTC challenged a proposed merger between the nation’s two largest broadline foodservice distributors. On June 26, 2015, the US District Court for the District of Columbia granted the FTC’s motion for preliminary injunctive relief. FTC v. Sysco Corp., 113 F. Supp. 3d 1 (D.D.C. 2015). In its opinion, the court found two relevant product markets: one for broadline foodservice distribution to local customers and a second for broadline foodservice distribution to national customers. The narrow market here was distribution to national customers because, the court found, national customers have a smaller set of options for distribution since they “typically contract with a broadline foodservice distributor that has distribution centers proximate to all (or virtually all) of their locations.” Sysco, 113 F. Supp. 3d at 38. While the court recognized the controversy concerning price discrimination market definition, it concluded that the evidence presented supported a market for broadline foodservice distribution to national customers. Just three days after the court announced its opinion, the parties abandoned the transaction.
In GE/Electrolux, the DOJ filed a complaint seeking to block the transaction between two manufacturers of cooking appliances. The DOJ complaint alleged a distinction between the retail sales channel for cooking appliances and the contract sales channel for cooking appliances. Complaint at 2-3, United States v. AB Electrolux, No. 15-cv-01039 (D.D.C. July 1, 2015). Contract-channel customers include homebuilders, property managers, hotels/motels and government entities, all of whom individually negotiate the prices charged by appliance suppliers. Id. at 6. These customers “demand delivery directly from the appliance supplier, in significant quantities, and on a specific schedule dictated by the contract-channel purchaser,” as well as a wide variety of products. Id. at 6-7. The DOJ alleged that contract-channel customers could be independently harmed due to their individual negotiations with suppliers and these customers could not avoid price increases due to their unique needs. Id. at 8-9. Thus, even though the defendants sold the same appliances to retailers, DOJ alleged that those retail sales were in a different relevant product market from contract channel sales. After four weeks of trial, General Electric walked away from the transaction and collected a $175 million termination fee.
Similarly, in Staples/Office Depot, the FTC challenged a merger between the nation’s two largest office supplies vendors. On May 10, 2016, the District of Columbia district court granted the FTC’s motion for a preliminary injunction. FTC v. Staples, Inc., No. 15-2115, slip op. (D.D.C. May 10, 2016). The court concluded that the proposed merger would reduce competition in the business-to-business (B2B) contract space for office supplies sold to very large purchasers. Id. at 4. In this case, the FTC only alleged harm to a targeted group of customers and did not allege harm to the parties’ retail customers or to smaller business customers (who had more viable supply options than the large customers). The court agreed with this narrow market definition because the large B2B customers individually negotiated contracts for their office suppliers, were more price sensitive, and required unique service from their office supplies vendors, including IT capabilities, personalized customer service, and next day and desktop delivery. Id. at 25-30. Less than a week after the court’s decision was announced, the parties terminated the merger agreement and Staples paid Office Depot a $250 million termination fee.
With these cases establishing a strong precedent, especially in the District of Columbia district court, the antitrust agencies will continue to use price discrimination markets to shape their analysis of future mergers. Therefore, in order to determine the extent of the antitrust risk posed by a potential transaction, counsel for parties seeking to merge must determine whether a price discrimination market may exist. The Merger Guidelines lay out two conditions that must be met for price discrimination to be feasible. The first question the agencies will ask is whether the supplier can identify a group of customers to whom prices can be increased. Examples of relevant distinctions might be large buyers versus small buyers, customers with different end uses for the same product or customers with different geographic locations. If the agencies can determine a distinct group to whom prices can be increased, they will then determine whether those targeted customers could defeat a potential post-merger price increase through arbitrage, or purchasing the good from other purchasers that are not part of the narrow price discrimination customer set and therefore would not be subject to the price increase.
The agencies will utilize this framework to assess the evidence they gather in a merger investigation. This evidence will include merging party documents and testimony, as well as the documents and testimony of the competitors and customers of the merging parties. In order to assess the antitrust risks of the deal, counsel for the merging parties should also review this evidence. Questions to keep in mind during this review include:
- Has price discrimination taken place in the past?
- Does the supplier currently sub-divide its customers in any way?
- Are certain customers individually negotiating their price for the product?
- Do certain customers demand unique characteristics from a supplier that only certain competitors are capable of offering?
- Are the merging firms only bidding against each other for a subgroup of customers?
Price discrimination markets lead to narrower markets, generally with higher market shares. This may lead to agency challenges where the merger appears lawful if markets are defined more broadly. Counsel should work with the client early in the process to determine whether an issue exists, whether it will be raise a concern for the agencies, and whether it can be fixed. Sometimes the price discrimination market may be a relatively small portion of the parties’ businesses, but a relatively small problem can break up a much larger deal if the concerns cannot be easily remedied through divestiture. To aid in adequately evaluating these issues, it is important to involve expert antitrust counsel early in the transaction process.