Featured Expert Column – Antitrust/Federal Trade Commission
Andrea Agathoklis Murino, Goodwin Procter LLP
Staples, Inc. (SPLS) and Office Depot, Inc. (ODP) would be forgiven for thinking of the late Yogi Berra and wondering if this was what he meant by déjà vu all over again. In 1997, following an investigation by the Federal Trade Commission (FTC), the US District Court for the District of Columbia blocked their proposed tie-up. And now, in 2016, after more than a year-long battle with the FTC, the same court’s Judge Emmet G. Sullivan blocked SPLS’s proposed acquisition of ODP. Judge Sullivan announced the outcome on May 10, but issued his opinion only to the parties; the public needed to wait until May 17 to see his quite detailed 75-page explanation. In sum, Judge Sullivan found that the FTC had met its burden under § 7 of the Clayton Act and showed a reasonable probability that the proposed merger would substantially lessen competition in the sale and distribution of consumable office supplies to large Business-to-Business customers. With that finding in hand, the court concluded that the FTC had carried its burden of showing that a preliminary injunction preventing the proposed merger was in the public interest and that the equities weighed in favor of injunctive relief. Shortly after Judge Sullivan announced his decision, SPLS and ODP abandoned the transaction.
Procedural History and the Hearing
SPLS and ODP announced their intent to merge in February 2015. Thereafter, the FTC began an investigation into the likely competitive effects of the $6.3 billion proposed merger. On December 7, 2015, by a unanimous vote, the FTC Commissioners declared that the proposed merger would substantially lessen competition in violation of § 7 of the Clayton Act (See my WLF Legal Pulse post on that here). Section 7 prohibits mergers or acquisitions “the effect of [which] may be substantially to lessen competition, or to tend to create a monopoly,” in any “line of commerce or in any activity affecting commerce in any section of the country.” 15 U.S.C. § 18.
That same day, the FTC filed a federal lawsuit to enjoin the proposed merger pending completion of a full trial in the FTC’s in-house administrative tribunal. The court presided over an evidentiary hearing from March 21 to April 5, 2016. As expected, the FTC provided expert economic testimony, customer testimony, and documentary evidence in support of its complaint. One of the seminal moments of preliminary injunction hearing occurred when SPLS and ODP chose not to present any witnesses, instead resting at the close of the FTC’s case and arguing that the FTC had failed to carry its burden. This surprised many observers.
The Standard of Review
Section 13(b) of the Federal Trade Commission Act governed the entire lens of the preliminary injunction hearing. Because the FTC is an independent administrative agency, it operates using this unique standard that is somewhat different from a traditional preliminary injunction standard. Thus, unlike transactions being reviewed by the FTC’s sister antitrust enforcement agency, the Department of Justice’s Antitrust Division (DOJ), the SPLS/ODP injunction hearing required the FTC to show only two things to win the preliminary injunction: (i) a likelihood of success on the merits, which has been interpreted to mean the FTC must raise questions so serious, substantial, difficult, and doubtful, as to make it fertile ground for a full trial in the FTC’s administrative tribunal; and (ii) that the equities tip in favor of injunctive relief. This is in contrast to the three-part preliminary injunction test that the DOJ must use. (It’s worth noting that legislation is pending in Congress that would equalize the preliminary injunction standards as between the FTC and DOJ.)
The Court’s Opinion
The central dispute involved the definition of the proper relevant product market from which to assess the likely competitive effects of the proposed merger. Ultimately, the court sided with the FTC in most every way. For example:
- The court found that FTC had established a relevant product market of consumable office supplies sold and distributed by the defendants to large business-to-business customers.
The court held that the evidence presented did support the FTC’s allegation that the market of consumable office supplies sold and distributed by the defendants to large “business-to-business” customers is a relevant product market for antitrust purposes. (While geographic market definition is an important component of antitrust analysis, all parties had previously stipulated that the US was the relevant geographic market.)
In so concluding, the court relied on evidence presented by the FTC that:
- There is industry or public recognition of this market as a separate and distinct economic entity;
- Business-to-business customers demand distinct prices through differentiated negotiation and contracting practices, and demonstrate a high sensitivity to price changes; and
- Business-to-business customers require specialized vendors that offer value-added services, including sophisticated information-technology services, high quality and personalized customer service, and expedited next day and desktop delivery.
As a result, the court agreed that the relevant market could be established by focusing on sales of a cluster of goods (i.e., consumable office supplies, consisting of an assortment of office supplies such as pens, paper clips, notepads, and copy paper that are used and replenished frequently) to a targeted set of customers (i.e., large business-to-business customers who spend $500,000 or more on office suppliers annually). Tellingly, the court stressed that the “[a]ntitrust laws exist to protect competition, even for a targeted group that represents a relatively small part of an overall market” and that there was overwhelming evidence presented by the FTC that such large business-to-business customers constituted a market that SPLS and ODP could target for price increases if they were allowed to merge.
- The court found that the FTC had established its prima facie case by demonstrating that the merger would result in an increase in market concentration above competitive levels.
The court next held that the FTC had met its burden of showing that the merger would result in undue concentration in the relevant sale and distribution of consumable office supplies to large Business-to-business customers in the US. SPLS allegedly captured ~47% and ODP allegedly had ~32% market share of Fortune 100 customers, for a potential combined postmerger total of 79% market share. Indeed, the relevant Herfindahl-Hirschmann Index (“HHI”)—a tool economists use to measure changes in market concentration—in this case purportedly would have risen nearly 3000 points, from 3270 to 6265, which far exceeded the levels deemed to raise a presumption that the merger was illegal.
- The court found that the FTC had established that the merger would eliminate important head-to-head competition between close competitors resulting in lessening of competition.
In addition to considering market concentration, the court also reviewed substantial evidence suggesting that the companies were critical head-to-head competitors for large Business-to-Business accounts. Principally, the court:
- Examined SPLS’ and ODP’s win-loss and bid data and found that it demonstrated that they won large Business-to-Business customer bids more frequently from each other than other bidders;
- Found that SPLS’ and ODP’s own documents created in the ordinary course of business showed that they viewed only themselves as the most viable office-supply vendors for large businesses in the US; and
- Accepted witness testimony from large Business-to-Business customers who stated their views that SPLS and ODP were their best options for nationwide sale and delivery of consumable office supplies and that, absent an independent ODP, they would lose tremendous leverage and likely have to pay higher prices for consumable office supplies.
- The court did not find persuasive the SPLS/ODP argument that the merger was not anticompetitive because of potential entry from Amazon Business or others.
The court rejected arguments that Amazon Business and other local and regional office supply companies would restore the competition lost postmerger. The court reasoned that while Amazon Business may someday become a behemoth in office supplies, it currently faces a multitude of challenges that prevent it from being on equal footing to the offerings of SPLS and ODP, including: a lack of request-for-proposal experience, no commitment to guaranteed pricing, lack of ability to control third-party agent pricing and delivery, inability to provide customer-specific pricing, lack of dedicated customer service agents in the business-to-business space, no desktop delivery, no proven ability to provide detailed utilization and invoice reports, and a lack of product variety and breadth. As a result, large business-to-business customers did not view Amazon Business as a viable alternative to SPLS and ODP. Similarly, the court rejected the notion that regional competitors such as WB Mason had the desire or wherewithal to expand to take on SPLS and ODP on a large, national scale.
- The court concluded that the public and private equities favored enjoining the merger.
Lastly, the court found that, because it was clear the merger would likely lessen competition in the relevant market, the public interest in antitrust enforcement also weighed heavily in favor of enjoining the merger pending the full trial in the FTC’s administrative tribunal. Essentially, the court found that preserving the FTC’s ability to order effective relief also weighed in favor of enjoining the proposed merger.
Countless observers in the legal and business community watched the hearing. In fact, upon receiving a multitude of calls on the day the decision was due to be announced, Judge Sullivan issued a minute order asking the public to stop calling his chambers and explaining that the decision would not be released before 4:30pm. The outcome’s ripple effects will impact SPLS/ODP shareholders and employees, antitrust practitioners assessing risks in unrelated transactions, and academics who will study the state of federal antitrust enforcement. We are also reminded that the Obama Administration’s aggressive enforcement of the antitrust laws is bound to continue even in the waning days before the 2016 election. Yet who knows: perhaps for SPLS/ODP, third time will be the charm?