Antitrust - Not So Fast: The D.C. Circuit Holds That The FTC Can Still Try To Block A “Premium, Natural and Organic” Grocers’ Merger
Introduction
On July 29, 2008, the United States Court of Appeals for the District of Columbia Circuit vacated the United States District Court for the District of Columbia’s denial of a preliminary injunction,
sought by the Federal Trade Commission (“FTC”) under 15 U.S.C. § 53(b), to block the merger of Whole Foods Market, Inc. (“Whole Foods”) and Wild Oats Markets, Inc. (“Wild Oats”), and
remanded the case for further consideration of the equities of issuing an injunction. FTC v. Whole Foods Mkt., Inc., No. 07-5276, 2008 WL 2890688 (D.C. Cir. July 29, 2008). The D.C. Circuit concluded that the district court
erred by concluding that the antitrust laws are concerned only with “marginal consumers,” rather than “core consumers” and, consequently, by concluding that the FTC failed entirely to show a sufficient
likelihood of success to justify the entry of a preliminary injunction.
The FTC’s Contentions
The FTC sought a preliminary injunction to block the merger of Whole Foods and Wild Oats on the basis that the merger would result in monopoly power for Whole Foods in violation of section 7 of the Clayton Act, 15 U.S.C. § 18.
According to the FTC, prior to their merger, Whole Foods and Wild Oats were the largest operators of “premium, natural, and organic supermarkets (“PNOS”).” 2008 WL 2890688, at *1. The FTC claimed that
Whole Foods’s monopoly power following the merger would enable it to engage in price discrimination against its “core consumers.” “Core consumers” are individuals who, for a variety of reasons,
choose PNOSs over ordinary supermarkets despite the higher prices that PNOSs charge for merchandise available at other supermarkets. The FTC alleged that “core consumers” are a distinct submarket from “marginal
consumers” – individuals who shop at PNOSs only for items that are not available from other supermarkets, but engage in cross shopping for items available at both types of supermarkets and make their purchases from
whichever source charges less for those items.
On August 16, 2007, the district court denied the FTC’s motion for a preliminary injunction, concluding that the FTC would never be able to prove a PNOS submarket. Whole Foods Mkt., Inc., 502 F. Supp. 2d 1, 17 (D.D.C.
2007). On August 17, the FTC filed an emergency motion for an injunction pending appeal, which the D.C. Circuit denied on August 23. Whole Foods and Wild Oats then completed their merger on August 28.
The D.C. Circuit Decision
At the outset, the D.C. Circuit addressed Whole Foods’s contention that jurisdiction was lacking to hear the appeal because the merger had already occurred and Whole Foods had already closed some Wild Oats stores and sold
others. The court disagreed that the merger was irreversible and noted that courts possess substantial discretion to craft remedies to redress antitrust violations, including divestiture. 2008 WL 2890688, at *2-3.
According to the D.C. Circuit, the district court erred at the beginning of its analysis by assuming that “‘the ‘marginal’ consumer, not the so-called ‘core’ or ‘committed’
consumer, must be the focus of any antitrust analysis.’” 2008 WL 2890688, at *6 (citing Whole Foods, 502 F. Supp. 2d at 17 (citing Horizontal Merger Guidelines, 57 Fed.Reg. 41,552 (1992)). The D.C. Circuit
stated that “core consumers can … be worthy of antitrust protection.” Id. (citations omitted). The court of appeals found that the district court’s “error of law led it to ignore FTC evidence
that strongly suggested Whole Foods and Wild Oats compete for core consumers within a PNOS market, even if they also compete on individual products for marginal consumers in the broader market.” Id.
The court reasoned that a broad market may contain “relevant submarkets which themselves ‘constitute product markets for antitrust purposes.’” Id. (citing Brown Shoe Company v. United States,
370 U.S. 294, 325 (1962)). The court reviewed evidence from both sides’ experts relating to the impact of the merger on core consumers. Both experts utilized the “SSNIP (‘small but significant non-transitory
increase in price’) test,” developed by the Department of Justice and the FTC. Id. The SSNIP test is used to predict whether a monopolist could profit from a small price increase. Id. (citation omitted).
“If a small price increase would drive consumers to an alternative product, then that product must be reasonably substitutable for those in the proposed market and must therefore be part of the market….” Id. (citation omitted).
In applying the SSNIP test, Whole Foods’s expert used a critical loss analysis. Under this approach the expert sought to predict that amount of loss that would result when marginal consumers shifted purchases from PNOSs to
ordinary supermarkets in response to a SSNIP. Id. The expert concluded that, due to the loss of marginal consumer purchases, a monopolist could not profit from a SSNIP and, therefore, conventional supermarkets must be within
the same market as PNOSs. Id.
The FTC’s expert, on the other hand, applied the critical diversion method. This method focuses on how many Wild Oats’s customers would start shopping at Whole Foods and how many would start shopping at ordinary supermarkets
if Wild Oats was closed. Id. “Whole Foods’s internal planning documents indicated at least a majority of these customers would switch to Whole Foods, thus making the closure profitable for a hypothetical PNOS
monopolist.” Id. The FTC’s expert urged that, focusing on the average loss of customers under the critical diversion method, rather than the marginal loss of sales under the critical loss method, was “appropriate
because a core of committed customers would continue to shop at PNOS stores despite a SSNIP.” Id.
The court explained that, to demonstrate further the existence of a PNOS submarket focused on core customers:
the FTC documented exactly the kind of price discrimination that enables a firm to profit from core customers for whom it is the sole supplier. [The FTC’s expert] compared the margins of Whole Foods stores in cities where they competed with Wild Oats. He found the presence of a Wild Oats depressed Whole Foods’s margins significantly. Notably, while there was no effect on Whole Foods’s margins in the product category of “groceries,” where Whole Foods and Wild Oats compete on the margins with conventional supermarkets, the effect on margins for perishables was substantial. Confirming this price discrimination, Whole Foods’s documents indicated that when it price-checked conventional supermarkets, the focus was overwhelmingly on “dry grocery,” rather than on the perishables that were 70% of Whole Foods’s business. Thus, in the high-quality perishables on which both Whole Foods and Wild Oats made most of their money, they competed directly with each other, and they competed with supermarkets only on the dry grocery items that were the fringes of their business.
Id. at *8. The court determined that the FTC’s evidence was sufficient to demonstrate a likelihood of success in being able to prove the existence of a PNOS submarket. The court concluded that the FTC:
described the core PNOS customers, explained how PNOS cater to these customers, and showed these customers provided a bulk of PNOS’s business. The FTC put forward economic evidence – which the district court ignored – showing directly how PNOS discriminate on price between their core and marginal customers, thus treating the former as a distinct market.
Id. at *9.
Because of its conclusion that the FTC could not prove a likelihood of success in demonstrating a PNOS submarket, the district court did not engage in the second part of the section 53(b) analysis, which requires balancing the likelihood of success against equities that militate against entering an injunction. The D.C. Circuit declined to engage in that analysis, instead remanding the case to the district court. Id. at *10.
Conclusion
This decision is significant in several respects – not the least of which that the D.C. Circuit first denied a stay and allowed the merger to go through, and now has remanded the case for further consideration that could conceivably lead to having the merger unwound. It has also been the subject of extremely lively discussion among practitioners on a number issues. For example, one particularly significant aspect of the Court of Appeal’s decision is that it resurrects “submarkets” and “cluster markets” as warranting antitrust protection within the framework of a merger analysis under section 7 of the Clayton Act. Although the Supreme Court did refer to “submarkets” in Brown Shoe, that analysis has often been criticized by economists as either unhelpful (in the sense that, if a “submarket” is really worth considering separately, it would be a “market”) or misleading (in that the market power it suggests does not exist in practice). Permitting the FTC to rely on anticompetitive effects on submarkets at the preliminary injunction stage presumably lowers the FTC’s burden of proof to obtain the preliminary injunction, the granting of which will typically thwart a prospective merger regardless of the outcome of the case on the merits.