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


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