Tuesday, July 29, 2008

D.C. Circuit Reverses Ruling That Allowed Whole Foods Merger with Wild Oats

The U.S. Court of Appeals for the D.C. Circuit issued an opinion today finding that Whole Foods Market's merger with Wild Oats was likely anticompetitive, concluding that there was some likelihood of success in a Clayton Act § 7 case, and remanding for further proceedings.

Preliminary Injunction Denied Below - The FTC had opposed the merger on the grounds that it would eliminate competition in numerous local markets across the country for what the FTC called "premium, natural, and organic supermarkets," as mentioned in this earlier blog post. The district court denied the FTC's motion for a preliminary injunction, finding that premium, natural, and organic supermarkets were not a distinct product market. See FTC v. Whole Foods Market, Inc., 502 F. Supp. 2d 1, 28 (D.D.C. 2007).

D.C. Circuit Had Previously Denied an Emergency Motion - The FTC sought an emergency motion for a preliminary injunction pending appeal, which the D.C. Circuit denied on August 23, 2007. The merger was then consummated on August 28, 2007. The emergency motion previously before the D.C. Circuit was subjected to a stringent standard of review, namely, "such a substantial indication of probable success that there would be justification for the court's intrusion into the ordinary processes of judicial review."

Lessened Standard of Review - In the appeal of the preliminary injunction, the standard of review was lower than for the emergency motion – namely, that such action would be in the public interest, weighing the equities and considering the FTC's likelihood of ultimate success. As the D.C. Circuit stated, "preliminary injunctions are meant to be readily available to preserve the status quo while the FTC develops its ultimate case."

D.C. Circuit Finds Evidence That the Merger Could Substantially Lessen Competition Among Core Consumers – In arguing that the merger would substantially lessen competition, the FTC had relied on its market definition, arguing that there was a distinct line of commerce for premium natural and organic supermarkets, and that the merger would substantially lessen competition in this market. On appeal, the appellate court stated that market definition is not always crucial to proving a violation of § 7 of the Clayton Act, and that the marginal consumer does not always have to be the focus of an antitrust analysis as the district court had assumed. Rather, the D.C. Circuit found that core customers or submarkets can be worthy of antitrust protection.

When focusing on core customers, the D.C. Circuit found that the evidence strongly suggested that Whole Foods and Wild Oats compete for core consumers in the premium foods market, even if they compete with conventional grocery stores for marginal consumers. The court found that Whole Foods and Wild Oats distinguished themselves based on a package of goods and services, including higher customer service, a unique environment, a greater concentration of perishables, and a focus on consumers values such as health and ecological sustainability. The Court suggested that, for a core group of consumers, it is possible that only the total package will suffice, and that these consumers would pay monopoly prices rather than switch to a competitor that did not offer the same package. The court pointed to evidence that the profit margins on perishables sold by Whole Foods dropped substantially when there was a competing Wild Oats in the same market, and that their competition with conventional supermarkets was focused on "dry grocery." There was also evidence introduced that if a Wild Oats near a Whole Foods closed, the majority of its consumers would switch to Whole Foods rather than a conventional supermarket.

Concurring Opinion – In a concurring opinion, Judge Tatel agreed that the lower court erred in focusing only on marginal consumers, but argued that Whole Foods and Wild Oats occupy a separate market of premium natural and organic supermarkets.

Dissent – In a dissenting opinion, Judge Kavanaugh argued that the Whole Foods and Wild Oats compete with conventional supermarkets, and the preliminary injunction was properly denied. He pointed out that conventional grocery stores have been aggressively competing for consumers who buy fresh, natural, and organic products. He also argued that it is too late to undo the merger that has already taken place.

Commentary – The D.C. Circuit Court's opinion comes as a surprise. First, the fact that the Circuit Court allowed the merger to proceed and is now requiring the merger to be undone is highly unusual. "Unscrambling the eggs" (as defense counsel typically refer to undoing a consummated merger) is difficult and can be very disruptive. Because of this disruption, courts typically enjoin consummation of a merger when there is a substantial probability that the merger may tend to be anticompetitive. That did not happen here, which many assumed signified that the D.C. Circuit Court would affirm the district court's decision.

Second, and more broadly, the Circuit Court's product market analysis will almost certainly have sweeping ramifications. If other courts follow the D.C. Circuit Court's logic and focus product market analyses in the retail industry on "core" consumers rather than "fringe" consumers (i.e., consumers willing to shop outside of a premium grocery channel following a modest price increase), antitrust jurisprudence may no longer recognize a fundamental business reality: the blurring of traditional retail channels. The retail industry has traditionally been segmented into four separate channels: (1) grocery (e.g., Kroger, Meijer, Winn Dixie, HEB), (2) mass (e.g., Wal-Mart, Target, Kmart), (3) drug (e.g., CVS, Walgreens, and Rite Aid), and (4) club (e.g., Costco, Sam's Club, and BJ's Wholesale). At least since the late 1990s, these channels have been blurring, as consumers increasingly have compared product prices, and made purchases, across channels. A diaper promotion at CVS may attract purchases from Wal-Mart; milk on sale at Kroger may attract purchases from Costco; etc. As a result of this channel blurring, retailers are now tracking prices across channels and competing – at least for many products – across channels.

But all retailers also have "core" consumers dedicated to the specific channel within which they shop. For instance, some elderly consumers find the size of the parking lots and stores at large retail outlets (such as club stores) intimidating, difficult to navigate, and not worth a modest price discount relative to smaller retail outlets, such as drug stores. Other consumers may be loyal to traditional grocers' meat and vegetable focus (i.e., focus on a store's perimeter) and relegate their purchases to that channel. Of course, the increase in gas prices is almost certainly offsetting price discounts at larger retail outlets (such as club stores), which in turn leads to more "core" (i.e., dedicated) consumers at channels located close to their home or work.

The fundamental question stemming from the Whole Foods opinion – which the Circuit Court does not squarely address – is how many core consumers of a specific channel are needed to render purchases within that channel a separate product market (or sub-market) for antitrust purposes? Fifty percent? Sixty-five percent? Eighty-five percent? Going forward, the answer to that question will be important in assessing the legal risk of business practices within the retail industry. If purchases within the drug channel, for instance, constitutes a distinct product market (or sub-market), market shares of some consumer goods manufacturers that focus primarily on the channel could be high and give rise to monopolization (or attempted monopolization) concerns. Similarly, if purchasing within the drug channel is a separate market than the club channel, then consumer goods manufacturers may not face serious Robinson-Patman risks by awarding club stores higher discounts than drug stores.

In light of the D.C. Circuit Court's decision, industry stakeholders may want to revisit assessing the legal risk of specific business practices that – before the decision – may have seemed a bit more straightforward.

Related Post: FTC Approves A&P, Schering-Plough Mergers After Divestitures

Saturday, July 26, 2008

Justice Scalia and Bryan Garner Offer Advocacy Tips

I attended a seminar yesterday on legal advocacy by Justice Scalia and legal-writing guru Bryan Garner, which Garner touted on his website as "The CLE Event of 2008."

Justice Scalia lamented that "lawyers are generally lousy writers," and that it catches a judge's attention when a brief is well-written. He and Garner offered a number of ideas for how to write and argue in a manner that is most likely to sway judges.

There was witty banter and disagreement between the two presenters over such topics as the use of contractions and the use of footnotes. At one point when Garner was speaking, for example, Justice Scalia interrupted, asking pointedly "What are you talking about?," which prompted Garner to move on to his next point. Justice Scalia also questioned the usefulness of amicus briefs, especially those by academics, stating that scholarship and advocacy do not go hand in hand. He added that, "if you think I read all amicus briefs, you're crazy," though he stated that his law clerks would read them all.

Throughout the seminar, Garner interspersed a number of insightful video clips of Justices and Judges he had interviewed. The videos of Garner's interviews with all the Supreme Court Justices (except Justice Souter) are available here.

Overall, I agree with the assessment of Tony Mauro, who described the seminar in a Legal Times article as being "full of funny asides and useful tips." Mauro's article offers a more detailed description of the seminar.

For those who missed it, the same insights offered at the seminar are available in a book by Justice Scalia and Garner, titled Making Your Case: The Art of Persuading Judges. Garner also stated that the seminar was being filmed and that a one-hour highlight video would eventually be made available for free to the public.

Although DC does not have a continuing legal education requirement, I try to attend seminars like this as frequently as possible. Even for seasoned litigators, there are always new insights to be learned and absorbed, and Scalia and Garner have done a commendable job of compiling substantial wisdom into a concise book.

Thursday, July 10, 2008

Channel-Stuffing Lawsuit Settled for $137.5 M

Settlement - Coca-Cola recently announced that it has agreed to settle a class action shareholder lawsuit for $137.5 million, as reported by the AP, Reuters, and WSJ. The suit alleged that Coca Cola had artificially inflated its earnings in 1999 by forcing bottlers to purchase hundreds of millions of dollars in unnecessary beverage concentrate at the end of a reporting period in order to make its sales seem higher. As reported in this article, Coca-Cola settled a similar issue in 2005 over the sales of excess beverage concentrate to bottlers in Japan between 1997 and 1999.

Legal Risks - Most consumer packaged goods corporations are publicly traded and face intense pressure to meet earnings expectations at the end of reporting periods. "Channel stuffing" or "trade loading" – the practice that Coca-Cola allegedly engaged in – sometimes occurs as publicly traded corporations try to meet (or exceed) earnings expectations or a sales force tries to meet sales quotas. The Securities Exchange Commission has previously prosecuted manufacturers that have engaged in channel stuffing and retailers that have participated in schemes to help manufacturers artificially inflate sales. The government has also indicted executives that engaged in channel stuffing as reported here. Industry stakeholders should be aware of the risk of initiating or participating in activities that can be perceived as a channel stuffing scheme.

Business Issues - In addition to raising legal concerns, channel stuffing is simply bad business. It creates supply chain inefficiencies, creates inventory backlogs, and often diminishes manufacturers' margins (as substantial discounts are often required to generate sales surges). Moreover, once a channel stuffing practice is initiated, it's difficult to stop: a surge in sales at the end of one reporting period is typically followed by soft sales in the following period as wholesalers and retailers work to sell-through expanded inventory.

The Coca-Cola securities case is captioned Carpenters Health & Welfare Fund v. Coca-Cola Co., No. 1:00-cv-2838 (N.D. Ga.). The order approving the settlement is available here; a 2004 order partially denying a motion to dismiss here.

Monday, July 7, 2008

FLOORgraphics’ Suit Against News America Marketing Set for Trial October 1

Reconsideration Denied - On June 23, News America Marketing's motion for reconsideration of the denial of its summary judgment motion in Floorgraphics, Inc. v. News America Marketing In-Store Services, Inc., No. 04-3500 (D.N.J.) was denied, setting the stage for trial, which has been set for October 1, 2008.

Evidence of Causation - News America's original summary judgment motion was denied on April 24, as discussed in this previous post. News America sought reconsideration of that ruling, arguing that, after the exclusion of one of its experts, FGI lacked admissible evidence of causation for its claim for tortious interference with a prospective business relation. Plaintiff FGI responded that sufficient evidence was presented through its experts and News America documents, relying on, for example:

  • A 2003 letter from News to CPGs claimed that FGI installed only 49% of its customer ads, and that News installed 90% of its ads. News made similar representations in 2003 to Safeway, which switched to News in 2004;
  • An FGI expert concluded that lawful competition could not explain the abrupt decline in FGI revenues;
  • Another FGI expert concluded that, assuming the evidence of News' bad acts to be true, the result caused FGI's customer base to erode rapidly and significantly.

The court concluded that "Plaintiff has submitted sufficient evidence that could lead a jury to believe, that, if there had been no interference, there was a reasonable probability that Plaintiff would have received anticipated economic benefits from CPGs and retailers."

Trial Date – On July 3, the court issued an order setting trial for October 1, with trial to follow thereafter.

Tips / Suggestions - I have received a number of helpful tips and suggestions from readers of this blog related to News America Marketing. These tips have been very helpful and I am continuing to follow up on some of the leads you have provided. I encourage readers to continue sending me their thoughts and insights about News America and any other topic at dlow@kotchen.com.

Related Post: Summary Judgment Motion Denied in FGI v. News America Marketing.


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