U.S. Merger Review in the Grocery Store Business

U.S. Merger Review in the Grocery Store Business ABA Section of International Law Committee on International Antitrust Law Darren S. Tucker, O’Melveny & Myers, Washington, DC May 21, 2008

U.S. Grocery Store Merger Review FTC’s Current Definition of a Supermarket “A full-line retail grocery store with annual sales of at least $2 million that carriers a wide variety of food and grocery items in particular product categories, including bread and dairy products, refrigerated and frozen food and beverage products, fresh and prepared meats and poultry, producing, including fresh fruits and vegetables, shelf-stable food and beverage products, including canned and other types of packaged products, staple foodstuffs, which may include salt, sugar, flour, sauces, spices, coffee and tea, and other grocery products, including nonfood items such as soaps, detergents, paper goods, other household products, and health and beauty aids.” — A&P/Pathmark, Docket No. C-4209. • Grocery store mergers handled by Federal Trade Commission. • State attorneys general offices frequently participate in the reviews. • FTC’s standard analysis is more structural than other industries. • Product market: supermarkets. • Supercenters part of the relevant market. • Other types of retailers not part of the relevant market because the agency believes that supermarkets rarely price check, change prices, or change price zones in response to: • Club stores1 (Sam’s Club, Costco) • Mass merchandisers (regular Wal-Marts, Targets, K-Marts) • Drug stores (CVS, Rite-Aid) 1 An exception was Wal-Mart’s acquisition of Supermercados Amigo in Puerto Rico, in which the FTC alleged a product market consisting of supermarkets and club stores.

U.S. Grocery Store Merger Review: Evidence and Remedies • FTC’s standard analysis (continued) • Geographic markets consist of local areas. • Recognition that customers shop close to where they live. • Size and shape of markets determined by local factors (demographics, driving patterns, etc.) • Store overlaps determined by identifying customer draw areas • Concentration - Strong likelihood of enforcement when local market would have 3 or fewer suppliers post-merger.

U.S. Grocery Store Merger Review: Evidence and Remedies • FTC’s standard analysis (continued) • Entry • FTC typically views entry as unlikely to occur in a timely manner to offset competitive effects. • FTC sends Civil Investigative Demands to competitors, especially Wal-Mart, regarding their expansion plans. • Competitive Effects • FTC examines closeness in format through surveys showing to what extent customers at each of the merging chains viewed the other as their second choice. • FTC also considers geographic proximity. • FTC generally requires up-front buyers when merging grocery stores agree to divest assets to resolve antitrust concerns. • The FTC has found that there is a high risk that assets will deteriorate pending divestitures in the grocery retailing business.

Whole Foods Merger • On February 21, 2007, Whole Foods (194 stores) and Wild Oats (115 stores) entered into a merger agreement. • Both companies operated high-end supermarkets with an emphasis on organic and perishable products. • On March 13, 2007, the FTC issued a Second Request in connection with the transaction. • Large document production: over 16 million pages of documents and a gigabyte of data. • 19 employees ultimately deposed. • Numerous other U.S. grocery stores also received subpoenas from FTC and a few also deposed (e.g., Trader Joe’s, Safeway).

Whole Foods Litigation • On June 6, 2007, the FTC filed a complaint in the U.S. District Court for the District of Columbia. • FTC alleged that the acquisition would substantially lessen competition for premium natural and organic supermarkets in twenty-one local markets. • Case was unusual in several respects: • FTC alleged a more narrow market definition than in prior grocery store mergers. • Key part of FTC’s case was based on the statements of the Whole Foods’ CEO to his Board. • Very short trial; few live witnesses.

Whole Foods - Market Definition • FTC alleged a product market consisting of “premium natural and organic food supermarkets.” • Significantly narrower market than alleged in prior grocery store enforcement actions. • In most geographic markets, this left only Whole Foods and Wild Oats. • In a pre-trial ruling, judge ordered the FTC to provide a better explanation of what types of stores fit into this definition. • The FTC identified 10 attributes that “generally” delineate the relevant product market. • Attributes Unique to Premium Natural and Organic Supermarkets • Generally focus on high quality perishables, specialty and natural organic produce, prepared foods, meat, fish and bakery goods • Generally have high levels of customer service • Generally target affluent and well educated customers • Generally select store sites based on the targeted customer • Generally are mission driven with an emphasis on social and environmental responsibility • Generally are a ‘third place’ • Generally provide the customers with a confidence of a ‘lifestyle brand’ • Generally provide the customer with added confidence and trust in the provision of the natural and organic products that are good for the consumer • Generally provide a ‘unique’ environment • Generally are stores that meet ‘core values’ and a ‘superior store experience’ Judge skeptical of FTC’s market definition from the start

Whole Foods - Bad Documents “By buying [Wild Oats] … we eliminate forever the possibility of Kroger, Super Value, or Safeway using their brand equity to launch a competing national/organic food chain rival to us.” • FTC relied extensively on Whole Foods and Wild Oats documents indicating that the parties saw each other as their closest competitor and that the transaction would allow Whole Foods to raise prices. • FTC revealed that Whole Foods’ CEO had posted anonymous messages on Internet financial message boards critical of Wild Oats. • Documents widely cited in press coverage of case. By buying Wild Oats “we will … avoid nasty price wars … [that] will harm gross margins and profitability.” Wild Oats “may not be able to defeat us but they can still hurt us.” Documents were a key form of evidence for the FTC

Whole Foods - The Result • On August 16, 2007, the district court denied the FTC’s request for a preliminary injunction. • Court relied heavily on the testimony of the defendants’ economic expert, as well as declarations submitted by the defendants. • Court’s opinion largely ignored the company documents cited by the FTC. • Court rejected FTC’s “premium natural and organic food supermarkets” product market. • Extensive cross-shopping for natural and organic foods. • When Whole Foods enters a new market, most of its sales are taken from traditional supermarkets, not “premium” supermarkets. • Majority of natural and organic foods sold at conventional supermarkets. • Traditional supermarkets offering more natural and organic products, including private labels. • Whole Foods price checks against conventional supermarkets. • Whole Foods considers all supermarket chains when it enters a new market. “[T]his case hinges—almost entirely—on the proper definition of the relevant market.” – District Court

Whole Foods - The Result • The next day, the FTC filed an emergency motion to the Court of Appeals for an injunction pending a full appeal. • On August 23, 2007, the court of appeals denied the FTC’s motion. • “Although the FTC has raised some questions about the district court’s decision, it has failed to make a ‘strong showing that it is likely to prevail on the merits of its appeal.’” — Appellate Court • With the injunction dissolved, the merger closed on August 28, 2007.

Whole Foods - The Appeal • On October 22, 2007, the FTC filed briefs stating that it would continue with its appeal. • FTC hopes to halt Whole Foods’ plan to close or sell dozens of Wild Oats stores. • The first time in more than a decade that the agency has continued to appeal a merger case after the Circuit Court has refused to issue an emergency injunction • Briefing on the appeal was completed March 12; oral argument was held on April 23. • FTC’s administrative action against Whole Foods remains stayed pending the outcome of the federal court litigation.

Whole Foods Case in Perspective • FTC’s district court loss in Whole Foods case is not unusual. Agency had lost its last three preliminary injunction hearings in merger cases. • Equitable Resources/The Peoples Natural Gas Company – Merger of natural gas utilities in Pittsburgh area. • Western Refining/Giant Industries – Merger of bulk gasoline suppliers in northern New Mexico • Arch Coal/Triton Coal – Merger of coal mine companies in Wyoming. • The short trial benefited the merging parties. • Court focused on the economic evidence to the exclusion of the FTC’s documentary evidence. • FTC overplayed its hand with the bad documents. • Cases rarely turn on “hot docs.” • Defendants also had documents to support their case.

Whole Foods Case in Perspective • FTC’s choice of venue was questionable. • FTC brought case in Washington, D.C. • D.C. was not an area of alleged harm; no Wild Oats stores in the region. • Judge did not visit the different retail formats (compare FTC v. Staples). • Courts are critical of agencies asserting inconsistent market definitions (see also Western Refining).

Postscript – A Return to Traditional Supermarket Analysis? • On November 27, 2007, the FTC challenged a new supermarket merger between the Great Atlantic & Pacific Tea Company, Inc.’s (A&P) and Pathmark Stores, Inc. • The FTC alleged that the relevant product market was “supermarkets.” • An apparent return to conventional agency analysis. • The FTC alleged that the proposed acquisition would result in reduced competition between the two supermarket firms in Staten Island, New York and Shirley, Long Island, New York. • Under the terms of a consent order settling the FTC’s charges, the companies agreed to sell four of A&P’s Waldbaum’s supermarkets and one Pathmark supermarket in Staten Island, as well as one Waldbaum’s supermarket in Shirley, Long Island, to FTC-approved buyers by January 10, 2008.

U.S. Merger Review in the Grocery Store Business