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Staples-Office Depot Case

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Staples-Office Depot Case

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  1. Staples-Office Depot Case Yiyi Chen, Will Thompson, Caroline Fedora

  2. INTRODUCTION • On September 4, 1996 Staples and Office Depot, the two largest office supply stores announced their agreement to merge • 7 months later the FTC voted 4 to 1 to oppose the merger because it would likely harm competition and lead to higher prices in “the market for the sale of consumable office supplies sold through office superstores” • Staples and Office Depot chose to contest the FTC’s actions in court

  3. INTRODUCTION • After a 7 day trial, Judge Thomas F. Hogan of the US District Court for the District of Columbia agreed with the FTC and granted a preliminary injunction, thus dooming the merger • Antitrust enforcement agencies had traditionally focused on the increased probability of collusion following a merger, but Staples highlighted the potential for mergers to have “unilateral effects”

  4. DEFINING THE MARKET • The FTC argued that Staples and Office Depot were sufficiently different from other suppliers of office products, and sufficiently close competitors to each other, that the “sale of office supplies through office superstores” could be defined as a market separate from the sale of office supplies in general. • The FTC relied primarily on direct estimates of the merger’s effect on prices, rather than just predicting an increase in seller concentration would cause significant price increases

  5. DEFINING THE MARKET • The FTC’s evidence on price effects included a large-scale econometric model that predicted the effect of the merger on prices • The FTC also used an “event study” that used stock market data to calculate the effects of the merger on shareholders and the financial market’s implicit estimate of the effect of the merger on the prices charged by office superstores

  6. BACKGROUND • Staples became the first office superstore in 1986 • Within months, Office Depot launched their office superstore • At the time of the merger Staples operated approximately 550 stores in 28 states generating $4 billion in revenue • Office Depot operated over 500 stores in 38 states generating $6.1 billion in sales • The typical superstore is 23,000-30,000 square feet and stocks 5,000-6,000 products

  7. BACKGROUND • About ½ of their revenue came from office supplies, and the other half came from computers, office furniture, and other business related items • Both chains purchased in bulk directly from the manufacturer, which lead them to charge dramatically lower prices (30-70% below the manufacturer’s suggested retail price) • Office superstores reached a peak of 23, but at the time of the merger the only other remaining office superstore was OfficeMax (a spinoff of K-Mart) • Office superstores drove thousands of independent stationers out of business

  8. BACKGROUND • The competition between superstores greatly benefitted the consumer because it led them to slash prices and expand their offerings • Staples announces that it would acquire Office Depot by exchanging 1.14 Staples shares for each outstanding Office Depot share, an approximately $4 billion dollar deal. After a 7 month investigation, the FTC decided to challenge the merger.

  9. THE FTC’S CASE Concentration and the Competitive Effects of a Merger • Merger policy states that mergers or acquisitions should not be permitted to create, enhance, or facilitate the exercise of market power, defined as the ability to profitably maintain prices above competitive levels for a significant period of time. • Mergers can lead to higher prices in 2 ways: coordinated interaction and unilateral effects • When only a few firms account for most of the sales of a certain product, those firms can sometimes exercise market power by either explicitly or implicitly coordinating their actions

  10. THE FTC’S CASE Defining the Relevant Market: “Consumable Office Supplies Sold Through Office Superstores” • The FTC supported this market definition by with four main points.

  11. THE FTC’S CASE 1) OSSs offer a distinct set of products and services • the FTC argued that OSS firms were different from other office supply vendors because they carry a broad range of products and maintain a large amount of stock on hand • this one-stop-shopping opportunity was not provided by other retailers • each visit to a store involves cash costs (price of goods) and noncash costs (value of time required to visit the store, gather info on products, prices and shop) • since each visit to a store involves a fixed cost, consumers prefer to purchase bundles of goods, especially low cost consumer goods • OSSs devote significant shelf space to consumable office products and maintain a large inventory to ensure the convenience of one-stop shopping

  12. THE FTC’S CASE 2) OSSs regard each other as their primary competitors • In internal documents, Staples defined “competitive” and “noncompetitive” markets based solely on the presence or absence of other OSSs, and referred to its participation in an “office superstore industry” • Office Depot had similar internal documents

  13. THE FTC’S CASE 3) Non-OSS retailers do not tightly constrain OSS pricing • “a monopolist is distinguished not by the fact that it faces no competition, but by the fact that its closest competitors are too distant to prevent it from maintaining its price at a level significantly above cost.” • While warehouse stores such as Wal-Mart may serve as competition to Staples in geographic regions without other OSSs, such non-OSS rivals are not significant competitors to staples in geographic markets where Staples faces other OSS competitors, which is the market that the FTC thought was relevant to the merger • this was backed up with the econometric analysis

  14. THE FTC’S CASE 4) Econometric evidence supported an OSS product market • The model measured how Staples’ prices differed among stores depending upon the number of nearby OSSs • The FTC’s analysis predicted that a merger to monopoly in markets where all 3 OSS firms were present would raise the price of office supplies sold in those markets by 8.49% • This increase would not be possible if OSS firms were constrained by other retailers

  15. THE FTC’S CASE The Merger’s Anticompetitive Consequences OSS concentration increase Increase in market power Large price increase

  16. THE FTC’S CASE • Evidences: • Structural Evidence • increase in concentration and market power • Leaving either two OSS firms or a monopoly

  17. THE FTC’S CASE • Empirical Evidence 5 strong and direct evidences showing likely price increases 1) Predictions of Staple’s Management • Intense competition forces it to lower prices • 40% of retail margins decline due to competition with Office Depot in total decline

  18. THE FTC’S CASE 2) Local markets • Price significantly lower when confronting each other • Restraining effect Average price differentials for office superstore products, differing market structures

  19. THE FTC’S CASE 3) Econometric analysis • Estimate how prices differed across markets depending on the number and identity of firms • Result: 7.3% overall price effects for the markets where the merger partners were both present. 4) Prudential study • Pricing survey comparing a three-player market and a two-player market • Result: price is 5.8% lower in three-player market 5) Stock-Market Event-Probability Study • would raise value of OfficeMax’s share by 12%

  20. THE FTC’S CASE • Entry Barriers • New OSS supplier is not a threat • High sunk cost and ability for incumbents to reduce prices • Conclusion: not affected by potential entry • Significant barriers to entry • Economies of scale in advertising Staple’s strategy to deter entry: spread costs to total number of stores • Saturated market makes insufficient demand to new OSS

  21. THE FTC’S CASE • Efficiencies Claims not sufficient • Economics of scale • Scale-related efficiencies could be attained through internal growth • Procurement cost reductions can be achieved by expanding sales rather than expanding retail • Staples and Office Depot already large enough • No reliable evidence • No likely price reduction

  22. The Defendants’ Arguments The merger would not have anticompetitive consequences 1) FTC’s market definition incorrect • FTC’s claim based on identity of sellers • Should be defined by characteristics of products/services • OSS firms part of a broad market for selling office supplies in which they held a low share • Products sold by OSSs were not different than other retailers • Retail format of OSSs was a good way of competing • OSS pricing constrained by all office product retailers and OSSs • Rejected claim that OSSs supplied a distinct bundle of goods that would allow a monopoly OSS to raise OSS prices

  23. The Defendants’ Arguments • Also rejected use of internal documents for market definition • Different meaning of the term “market” for an antitrust agency and a company • Other passages in same documents: “market” included non-OSSs • Exhibits: • Regularly checked prices of non-OSS firms • Study showing sales of a Staples store would decrease with openings of new office supply retailers like Wal-Mart and Best Buy • Showed intense competition between OSSs and non-OSSs

  24. The Defendants’ Arguments 2) Merger would not raise prices • Efficiencies from merger: • Increase total volume of products purchased and decrease prices paid to manufacturers • Lower administrative, marketing, advertising, distribution costs • Pass on to consumer 2/3 of cost reductions, so would be able to cut prices significantly • Disagreed that much of efficiencies could be claimed absent of merger • Even if some from internal expansion, would be achieved faster

  25. The Defendants’ Arguments • Econometric study for efficiencies: • Office Depot had relatively small effect on Staples’ pricing • Absent efficiencies, merger would increase prices of consumable office supplies at Staples stores by only: 0.8% when averaged over all products and all Staples stores • Efficiency gains alone would decrease prices by 3% over all products and Staples stores • Net effect of merger: reduce prices by 2.2% for the average Staples customer (0.8%-3.0%)=-2.2% (FTC: 7.1% net increase)

  26. The Defendants’ Arguments • No barriers to entry • Stores constructed within months • Low sunk costs • Ease of expansion by existing firms • OfficeMax had increased planned new store openings in 1997 • Increasing shelf space allowed existing multiproduct retailers to enter/expand into office product market with low costs • Losses from blocked merger: • Consumers: efficiencies and lower prices • Shareholders: any cost savings not passed on to consumers • Merged OSS firm could expand faster than if separate

  27. The Defendants’ Arguments Final arguments: • No need for preliminary injunction to stop merger • Merger reversible if anticompetitive effects

  28. The Decision Granted the preliminary injunction • By law, FTC only had to show reasonable probability of harm to competition • Reversing merger in future not a good option • Relevant product market: OSS firms only • Sale of consumable office supplies by OSSs a submarket within a larger market of office supply retailers • Admitted goods sold by OSSs and non-OSSs seemed identical • Small increase in prices of one OSS would not cause a large number of customers to switch to a non-OSS retailer, but to another OSS • OSSs very different from other retailers: format, number of items • Internal documents: considered other OSSs as main competition even though included non-OSSs

  29. The Decision • Anticompetitive Effects: • Merged OSS would have a dominant market share • OSS likely to raise prices when less competition from other OSSs • Without merger, entry into each other’s markets and reduce prices • Entry: • For new OSS to be profitable, need economies of scale • Need many new stores: high sunk costs • Not easy to achieve at local level: saturated by existing OSSs • Unlikely entry of new OSS or expansion of non-OSS could counteract anticompetitive effects • Efficiencies: • Not shown to be sufficient enough to counteract consequences • Unreliable estimates, not merger-specific • Unrealistic that 2/3 cost savings to go to consumers • Gains by consumers and shareholders not sufficient to counteract

  30. Aftermath • Within 3 years of abandonment, both firms achieved size they would have if merger had been approved • As shown in pre-merger strategy documents, many of new stores in overlap markets • Most efficiencies achieved quickly and without price increases • Internet has allowed some entry and expansion • Since the case, antitrust agencies and merger applicants have used direct evidence on the closeness of merging competitors and the expected size of the price effects to define the market and predict the effect of the merger on consumer welfare