Over the last 12-18 months, aggressive merger enforcement activity has continued with the US antitrust agencies challenging—and successfully stopping—a number of transactions. The most recent, the Federal Trade Commission’s (FTC) challenge to Staples’ acquisition of Office Depot, not only demonstrates the agencies’ continued resolve to stop transactions that they believe are anticompetitive, but also highlights three significant recent enforcement trends:
- narrow, price-discrimination markets (i.e., markets centering on a specific type of customer);
- reluctance to accept arguments relying on speculative expansion/entry, even by large and successful companies, where there is no evidence of likely success in the market at issue; and
- more stringent divestiture requirements, including a reluctance to accept complex and piecemeal divestiture packages.
Almost 20 years after its original attempt to purchase Office Depot was blocked, on February 4, 2015, Staples, the largest vendor and distributor of consumable office supplies in the US, announced it had agreed to acquire Office Depot, the second largest distributor, for US$6.3 billion. After investigating for close to a year, in December 2015, the FTC filed a lawsuit in the US District Court for the District of Columbia and an administrative action to block the merger of the two companies.
Much had changed during the intervening years, including, in particular, the FTC’s decision to permit Office Depot’s acquisition of OfficeMax without any divestitures in 2013. In the Office Depot/OfficeMax transaction, the FTC found that the market for office supplies had been reshaped by the growth of mass merchants (e.g., Wal-Mart, Target), club stores (e.g., Costco), and online retailers.
The FTC’s analysis of the latest Staples/Office Depot transaction, however, focused on “large business-to-business customers” (B-to-B customers) who require “a single vendor with a broad geographic footprint.” The FTC alleged that the combined entity would constrain competition in the market for the sale of office supplies to B-to-B customers, a market which, the FTC alleged, online providers did not adequately serve.
On May 10, 2016, after a two-week trial, in which Staples and Office Depot rested without putting on a case, the court granted a preliminary injunction enjoining the consummation of the merger, pending an administrative litigation before the FTC. The parties abandoned the transaction shortly after the court’s decision.
The decision to grant the injunction “hing[ed]” on the “critical issues” of market definition and timely entry of new competitors, primarily online competitor Amazon Business. Interestingly, because the merging parties did not present affirmative evidence, including not having their own economist testify, once the court determined the FTC’s market definition was appropriate, the court found the presumption of harm in the relevant market arising from high market share was left unrebutted, and declined to consider the divestiture remedy proposed by the merging parties.
Narrowly Defined/Price Discrimination Markets
The antitrust authorities typically have defined markets narrowly and the 2010 Horizontal Merger Guidelines specifically discussed evaluation of “price discrimination markets,” noting that anticompetitive effects from a merger might vary significantly for different customers purchasing similar products, particularly if the seller can discriminate by profitably raising prices to certain customers but not others. The District Court’s decision to accept the FTC’s market definition in Staples/Office Depot, as well as the District Court’s similar decision in the recent Sysco/US Foods merger, more firmly establishes the validity of narrowly defined and price discrimination markets.
The FTC’s central concern in Staples/Office Depot (and Sysco/US Foods) was that only the merging parties had the geographic footprint and customer service needed to supply large, national customers. The FTC alleged that the proposed transaction would eliminate direct competition between Staples and Office Depot for B-to-B customers buying “consumable office supplies,” such as pens, staplers, notepads, and copy paper, while excluding ink and toner, because many B-to-B customers purchase ink and toner separately from other consumable office supplies, frequently directly from the manufacturer.The FTC also argued the parties were the only suppliers that had the national delivery footprint and “value add” services that customers purchasing nationally require, such as next-day delivery and sophisticated IT systems for e-procurement. The “high level of customer service” provided by Staples/Office Depot was a key distinction for the FTC. According to the FTC, the combined firm would account for 70% of the B-to-B office supply market post-close and the deal should be presumed to be anticompetitive.
The defendants criticized the FTC’s B-to-B market as “concoct[ed]” and “gerrymander[ed].” In particular, the parties argued: (1) smaller or medium-sized B-to-B customers (those purchasing less than US$500,000 in office supplies annually) should be included in the market, and (2) the FTC’s definition of “office supplies” improperly excluded ink and toner. Similarly, the defendants criticized the FTC’s focus on a national market, arguing that many national customers used “decentralized procurement" strategies, purchasing from regional or local competitors.
Ultimately, the court agreed with the FTC’s market definition. The court found that the basket of goods in the FTC’s market definition was a properly defined “cluster market”—the competitive dynamics for ink and toner were distinct because there was evidence of more competition for these products from equipment vendors. The court was persuaded that a market based on customer spend also was appropriate, in part, because the parties themselves grouped accounts in this fashion in the ordinary course of business. Because there was evidence that the parties had grouped and targeted large, national B-to-B customers differently than other customers in the past, the court concluded the parties “could target [them] for price increases if they are allowed to merge.”
Limitations on Entry and Expansion Arguments
Another critical issue was whether regional or potential competitors would be able to replace competition lost through the merger. While entry is a factor considered under the Horizontal Merger Guidelines, that entry needs to be “timely, likely, and sufficient” to deter or counteract any competition lost through the merger.
The FTC not only argued that Staples and Office Depot were the only two competitors able to serve national customers, but also that potential competitors, such as Amazon, would not be able to successfully enter and constrain the merging parties in the B-to-B market. The parties argued that the FTC erroneously ignored the strong regional competitor W.B. Mason and recent industry entrant Amazon Business, both of which the parties argued were likely to replace any lost competition post-merger.
With respect to W.B. Mason, the court rejected its significance to the competitive analysis. The company represented less than 1% of the relevant market and was found to be “at a competitive disadvantage because [it] do[es] not have the resources to serve large customers nationwide.” Moreover, W.B. Mason’s CEO testified that the company did not even have the desire to expand to compete with the merging parties outside of its existing regional footprint.
Similarly the court was not persuaded by the defendants’ arguments that Amazon Business was likely to enter and act as a significant competitive constraint. The court was troubled by the fact that Amazon had never actually won a bid in response to a B-to-B customer’s Request for Proposal (RFP), and concluded that it would be “sheer speculation” to expect Amazon to compete on par with Staples/Office Depot within three years. The court also expressed concern that the structure of Amazon—a marketplace with third party vendors who each controlled their own product price—would make it difficult for the retailer to bid for large corporate contracts. Although the defendants claimed that Amazon would “fundamentally change” the B-to-B marketplace, the court concluded that the Amazon Business model was “at odds” with the RFP method customers use to purchase products in the B-to-B industry, which further undermined its relevance to the competitive analysis.
This treatment of online competition differs from the FTC’s last consideration of a merger in the office supplies industry, but that difference hinges on the FTC’s market definition. In the 2013 Office Depot/Office Max merger, the FTC focused on the retail sales of office supplies, and when it evaluated the impact of online retailers, it concluded that the “explosive growth of online commerce…had a major impact on this market.” As a result, the agency cleared the transaction without any divestitures. In particular, the FTC highlighted that stores were losing sales to online retailers and frequently were forced to match the lower prices offered by online retailers.Thus, the key distinction between the two cases is that by 2013, Amazon already had significant success in the retail office supply market, but in the present Staples/Office Depot case, Amazon had not yet won a B-to-B RFP.
The Agencies Are Scrutinizing Remedies Very Closely
As noted, the court declined to consider arguments about the merging parties’ attempt to “litigate the fix” (i.e., treat their divestiture proposal as part of the transaction to be considered), because they declined to put on an affirmative case. Nonetheless, the FTC’s criticisms of the proposed remedy are instructive, especially in the context of other recent transactions where the agencies did not accept the parties’ proposed remedies.
Recently, the antitrust agencies appear to be more skeptical of proposed divestitures. For example, in the recent Halliburton/Baker Hughes litigation, although the parties committed to divestitures up to US$7.5 billion in sales, the Department of Justice (DOJ) found the proposal “wholly inadequate.” The DOJ argued that the assets would have lower market share, be less efficient, have less research and development, be less able to offer integrated solutions, and “otherwise fail to replicate the competition.” Similarly in Sysco/US Foods, the FTC was skeptical of the parties’ proposed divestiture of eleven distribution centers and related assets to existing regional competitor Performance Food Group (PFG). The FTC found that PFG would be, at best, an “an inferior competitor,” and insufficient to replace the lost US Foods competition for national customers.
In Staples/Office Depot, the FTC rejected the parties’ “substantial” offer to divest more than US$1.25 billion in large corporate contracts, information technology assets, and transition services for a combined value of US$22.5 million to wholesaler Essendant. The FTC stated that the proposed remedy would be “woefully inadequate, and was troubled that many of the contracts Staples proposed to transfer to Essendant were short-term, allowing customers the option to return to Staples/Office Depot when the contracts expired. The FTC also noted that Essendant did not currently serve any B-to-B customers, and that historically, wholesalers such as Essendant were not able to compete effectively for B-to-B business. The FTC ultimately concluded that Essendant would be unable to compete “on day one” with the combined Staples/Office Depot.
The Staples/Office Depot merger offers several useful lessons for future merger advocacy.
- The agencies will look at various ways to define a market, including around narrow, price-discrimination markets. Through their recent enforcement actions, the agencies have demonstrated that they are not reluctant to define markets around particular sub-groups of customers that could be subject to price discrimination and potentially harmed by a transaction. Indeed, the court in Staples/Office Depot noted that: “antitrust laws exist to protect competition, even for a target group that represents a relatively small part of an overall market.” Thus, even where the customers are large corporations and arguably can protect themselves, the FTC successfully has blocked mergers by defining the relevant market around the provision of products and services to such customers and focusing on price-discrimination markets.
- Parties should carefully consider potential entrants and whether there has been any demonstrable competitive success in the customer segments at issue. Even when merging parties point to large, successful companies (e.g., Amazon) as competitive constraints, if those companies have not shown an express interest or demonstrated an ability to compete for the business at issue, the agencies are likely to give entry and expansion arguments less weight.
- Some transactions are difficult to remedy. The agencies will look closely at any proposed remedy to ensure the competition lost from the transaction is replaced by a proposed divestiture. That includes scrutiny of both the assets that will be sold and divestiture buyer’s ability to effectively replace the lost competition. Where a divestiture package would not create a competitor able to compete in product scope and service offerings for the particular product and geographic markets at issue, the agencies are unlikely to accept that divestiture as a fix for any competitive concerns. Moreover, where assets are cobbled together and the divestiture does not position the proposed divesture buyer to compete on “day one” and beyond, the agencies seem less likely to accept the proposed remedy.