2016 NYSBA Antitrust Symposium. Brief Synopsis of CLE Materials for Application to Hypothetical KEY CASE LAW

Transcription

1 2016 NYSBA Antitrust Symposium Brief Synopsis of CLE Materials for Application to Hypothetical KEY CASE LAW I. FTC v. Staples (Staples II), No , 2016 WL (D.D.C. May 17, 2016) Holding In Staples II, the United States District Court for the District of Columbia held that the proposed merger between Staples and Office Depot would likely reduce competition in the Business to Business ( B-to-B ) contract space for office supplies and that regional vendors and Amazon Business would be unable to timely and sufficiently restore the lost competition that would occur as a result of the merger. No , 2016 WL , at *2 (D.D.C. May 17, 2016). The court issued a preliminary injunction, which caused the parties to terminate their effort to consummate the proposed merger. Background On February 4, 2015, Defendants Staples and Office Depot entered into a merger agreement whereby Staples would purchase Office Depot. Id. at *4. Shortly after the proposed merger was announced, the FTC launched an antitrust investigation. Id. Ultimately, the FTC filed an administrative complaint and sought a preliminary injunction to prohibit the merger, arguing that the proposed merger violated Section 7 of the Clayton Act. Id. The FTC contended that the merger would reduce competition in the large B-to-B market, where Fortune 100 companies purchased their office supplies through a request for proposal (RFP) process. Id. at *3. The FTC alleged that Staples and Office Depot sold approximately 79% of office supplies to such B-to-B customers. Id. Issues Presented The court s decision whether to grant the preliminary injunction hinged on two issues: (1) the reliability of Plaintiffs market definition and market share analysis; and (2) the likelihood that new market entrants... would be timely and sufficient to restore competition lost as a result of the merger. Id. at *1. The Relevant Markets The parties disagreed on the relevant product market definition. Id. at *7. The FTC argued that the relevant cluster market was the market for consumable office supplies, such as pens, notepads, computer paper, and other products that are used and replenished frequently. Id. Although such products are not substitutes for one another, the market shares and competitive conditions for distributing those products to large institutional customers is likely to be similar. Id. The FTC sought to define the targeted market as B-to-B customers, specifically large B-to-B customers who spend $500,000 or more on office supplies annually. Id. Defendants objected to the FTC s proposed market definition for two reasons. First, they argued that the market was too narrow because the FTC excluded ink and toner as

2 well as beyond office supplies ( BOSS ) products from the market definition. Id. at *9. Second, they argued that B-to-B customers should not be treated as a market separate from average retail customers. Id. The district court ruled in favor of the FTC s market definition for four reasons. First, the court credited evidence that vendors in the office supply industry, including Staples and Office Depot themselves, identified customers based on how much they spent yearly on supplies and recognized B-to-B customers as a distinct group. Id. Second, the court determined that, as a result of their bargaining power, large B-to-B customers were able to obtain distinct prices and had a high sensitivity to price changes that made them a separate market from average retail customers. Id. Third, the court determined that large B-to-B customers were able to obtain value-added services that other customers were not, including technology services, personalized and high quality customer service, and next day and desktop delivery. Id. at *11. The court concluded that those unique qualities of B-to-B customers supported a finding that they constituted a separate target market. Id. Finally, the court applied the Hypothetical Monopolist Test ( HMT ) to assess whether a hypothetical monopolist in the alleged market could impose a small but significant and non-transitory increase in price ( SSNIP ) and found that such an increase in price could be sustained such that the relevant product market should be defined as the sale and distribution of consumable office supplies to larger B-to-B customers. Id. at *12. The court then rejected Defendants arguments against the FTC s market definition. The court concluded that ink, toner, and BOSS items were properly excluded from the product market definition because they were subject to distinct competitive conditions. Id. at *14. Due to the rise of Managed Print Services ( MPS ), which bundle the sale of ink and toner with the maintenance of printers and copy machines, large B-to-B companies had more options in how they would purchase ink and toner than they did with respect to general consumable office supplies. Id. The MPS vendors compete with one another as well as with office supply vendors like Staples and Office Depot for the business of large companies seeking to buy toner and ink. Id. Similarly, customers also contracted with furniture and janitorial companies for BOSS products. Id. On the other hand, Staples and Office Depot typically compete only with one another in providing consumable office supplies to B-to-B customers. Id. Thus, B-to-B customers do not view any alternative sources for bulk procurement of basic office supplies that would retain the current competitive conditions of the market, whereas such alternatives do exist for products like toner, ink, furniture, and cleaning supplies. Id. Therefore, the court concluded that consumable office supplies were not part of the same market as ink, toner, and BOSS products. Id. at 15. Market Share Analysis The district court then analyzed whether the merger would unduly increase market concentration in the relevant market that it found that the FTC had sustained. Id. The court accepted the FTC s expert s analysis, which looked at data collected from 81 Fortune 100 companies that used Staples and Office Depot as their primary office supplies vendors. Id. at - 2 -

3 *18. The data revealed that Staples controlled 47.3% and Office Depot controlled 31.6% of the relevant market. Id. A merger would increase the Herfindahl-Hirschmann Index (HHI) from 3,270 to 6,250, converting the relevant market from a duopoly with a competitive fringe to a market containing one dominant firm with a competitive fringe. Id. The increased concentration made the merger presumptively illegal. Id. The court examined other evidence of anticompetitive harm. Internal documents revealed that Staples and Office Depot viewed themselves as each other s closest competition. Id. at *21. B-to-B customers testified that they feared that the proposed merger would result in a loss of leverage that would force large customers to pay higher prices for office supplies. Id. Based on this evidence, the court determined that the FTC had satisfied its prima facie case in establishing the anticompetitive effects of the proposed merger. Defendants Response At trial, Staples and Office Depot chose not to present any facts or witnesses and argued solely that the FTC failed to establish its prima facie case that the merger violated Section 7. Id. at *2. Yet the court considered two possible reasons that the merger would not be anticompetitive, which it rejected. First, Defendants argued that a competitor, Amazon Business, would expand to provide B-to-B customers with a competitive alternative to the merged entity. Id. at *21. Amazon Business is an online marketplace for selling office supplies to business customers. Id. at *5. In closing arguments, for example, Staples counsel discussed the Amazon threat. Closing Argument Transcript at 145:5, FTC v. Staples, No. 15-cv (D.D.C. Apr. 19, 2016). According to Staples argument, the online retailer was selling to major customers already, and about to launch a feature that s going to blow the doors off the industry. Id. at 145:2-4. Staples closing argument also emphasized the specter of previous instances in which the FTC failed to anticipate coming trends. For example, Staples argued that, in opposing the Hollywood Video-Blockbuster Video Merger, the FTC failed to anticipat[e] the very real threat of video streaming. Id. at 156: In the wake of that failed merger and the subsequent downfall of the former video rental giants, according to Staples counsel, the FTC Commissioner recognized a need to be careful when we evaluate fast-changing industries to really understand what s happening in terms of changing business models and consumer preferences. Id. 157:1-5 (internal quotations omitted). Staples counsel argued that the FTC had not done that in this case. Id. at 157:5. The court determined that Amazon Business faced many disadvantages that cast doubt on its ability to restore competition that would be lost due to the merger of Staples and Office Depot. Staples II at *22. Those disadvantages included a lack of RFP experience, a lack of dedicated customer service agents dedicated to B-to-B space, and a lack of product variety and breadth. Id. The court thus concluded that Defendants did not meet their burden of showing that Amazon Business would restore competition to the market within three years. Id. at *24. Second, the court rejected the argument that WB Mason and other regional office supply companies could fill the competition gap produced by the merger, as WB Mason s CEO - 3 -

4 claimed the company could not expand nationwide, even with divestitures by Defendants. Id. at *25. Furthermore, WB Mason purchased from wholesalers rather than manufacturers, which made their costs higher than large office supply stores like Staples and Office Depot. Id. EC Proceedings The European Commission had conducted its own review of the merger. As in the U.S, much of the European regulator s focus was on contracts with large companies, as the Commission found that the merging parties were two of only three companies capable of entering into international supply contracts for large business customers in Europe. Press Release, European Commission (Feb. 10, 2016), available at (emphasis in original). The EC found that using a series of national contracts was not an attractive alternative for large businesses, and it was skeptical that national suppliers could engage in international expansion. Id. The EC found that Amazon was not a meaningful competitor of Staples and Office Depot with respect to large businesses because Amazon engaged only in online sales. Id. However, unlike in the United States, the merging parties were able to gain approval for the merger by promising to divest the whole of Office Depot's contract distribution business in the European Economic Area (EEA) and Switzerland, as well as Office Depot s Swedish operations. Id. II. FTC v. Staples Inc. (Staples I), 970 F. Supp (D.D.C. 1997) Holding In Staples I, the United States District Court for the District of Columbia held that the FTC showed a likelihood of success that it could prove at a trial on the merits that a proposed merger between Staples and Office Depot would substantially lessen competition in the submarket for consumable office supplies sold by superstores. 970 F. Supp. 1066, 1093 (D.D.C. 1997). Background In September 1996, Staples and Office Depot entered into a planned merger agreement whereby one of Staples subsidiaries would merge into Office Depot, and Office Depot would become a wholly owned subsidiary of Staples. Id. at The FTC opposed the plan and voted to seek a temporary restraining order and preliminary injunction barring the merger. Id. at Issue Presented The case turned primarily on (1) whether the FTC s market definition the sale of consumable office supplies through office superstores was correct; and (2) whether new entrants to the market or efficiencies resulting from the merger would offset the merger s anticompetitive effects

5 Relevant Product Market Staples and Office Depot challenged the FTC s product market definition as being contrived with no relevant basis in law or fact and argued that all retailers who sold office supplies should be included in the product line market. Id. at The court found that functional interchangeability alone was insufficient to determine the relevant product market. Id. at The court also considered the responsiveness of the sales of one product to the price changes of another. Id. A number of factors led the court to hold that a submarket existed for consumable office supplies sold by superstores as opposed to other retailers. First, the FTC provided evidence showing that Staples and Office Depot s respective prices were higher in geographic markets where they were the only office supplies superstore than when they were in regions with other superstores. Id. at The court found that, despite the high degree of interchangeability between products sold in office superstores and those sold in other retailers, a SSNIP would not cause customers to switch from office superstores to other retailers. Id. at The court also noted that superstores were different in scale and appearance from other retailers and attracted a different customer base. Id. at In that regard, the Court found that superstores appealed to small businesses with under 20 employees and consumers with home offices, while larger businesses tended to utilize other sources, such as mail-order suppliers. Id. at Finally, based on such evidence as planning documents by the merging parties themselves, the court determined that suppliers considered superstores as a separate market. Id. at Anticompetitive Effects The FTC provided evidence that the proposed merger would have anticompetitive effects. The court found that the evidence demonstrated that the merger would result in Staples eliminating its only competition in many geographic regions, which would permit price increases. Id. at The court rejected claims by the merging parties that new entrants would counter any anticompetitive effects of the merger, finding that the market had been tending toward greater, not lesser, concentration. Id. at The court also deemed unreliable Defendants data showing that savings would be passed on to consumers. Id. at II. United States v. Am. Express Co., 838 F.3d 179 (2d Cir. 2015) Holding In United States v. Am. Express Co., the Second Circuit reversed the United States District Court for the Eastern District of New York and held that American Express ( Amex ) did not unreasonably restrain trade in violation of Section 1 of the Sherman Act by entering into contracts containing nondiscriminatory provisions ( NDPS ). 838 F.3d 179, 184 (2d Cir. 2015). Significantly, the Second Circuit criticized the district court for not considering the net effect that NDPs had on both merchants and cardholders. Background - 5 -

6 On October 4, 2010, the United States and seventeen plaintiffs sued Amex, Visa, and MasterCard for unreasonably restraining trade in violation of Section 1 of the Sherman Antitrust Act. Id. at 192. Plaintiffs alleged that the credit card companies included antisteering provisions in their agreement with merchants that were designed to discourage merchants from convincing customers to use credit cards that were less expensive to merchants. Id. They argued that these anti-steering provisions, which included Amex s NDPs, suppressed interbrand competition by blocking competition from rival credit card networks and removing incentives for networks to reduce card fees charged to merchants. Id. In 2011, Visa and MasterCard entered into consent judgments and voluntarily rescinded their anti-steering provisions, but Amex proceeded to a bench trial. After trial, the U.S. district court concluded that Amex s NDPs violated Section 1 because they create[d] an environment in which there is nothing to offset credit card networks incentives... to charge merchants inflated prices for their services. Id. Critical to the district court s holding was how it defined the relevant market. The district court determined that the relevant market for its antitrust analysis was the market for network services, whereby credit card companies competed with one another to sell card acceptance services to merchants. Id. This market definition excluded the card issuance market, in which Amex competed with MasterCard and Visa issuing banks for cardholders. The district court found that the NDPs prevented merchants from encouraging customers to use cards with lower merchant fees, thus stifling price competition between Amex and rival networks. Id. at 193. Issue Presented The central issue in this case was whether the district court erred in defining the relevant market by excluding the market for cardholders from its definition, thus ignoring one side of an interdependent two-sided market. Relevant Market Definition The Second Circuit found that a payment-card network market is an interdependent two-sided market, where both merchants and cardholders benefit from widescale price changes. Id. at 186. The district court s market definition was fatal to its determination that Amex s NDPs violated Section 1. Id. at 196. The court held that analyzing the effect of Amex s vertical restraints on the market for network services while ignoring their effect on the market for general purpose cards ignores the two markets interdependence and could cause output-expanding activities to be penalized. Id. at 198. By not accounting for a two-sided market, the district court failed to consider the effects that higher merchant fees would have on cardholder demand, which would in turn have feedback effects on merchant demand. Id. at 200. The Second Circuit found that, because the district court failed to account for such interdependent effects, its market definition was too narrow. Market Power The Second Circuit also held that the district court erroneously found that Amex had sufficient market power to control prices or exclude competition. The district court premised its market power conclusions on cardholder insistence, finding that a segment of - 6 -

7 Amex cardholders would choose to shop at other merchants rather than use another card. Id. at 202. The Second Circuit determined that cardholder insistence results not from market power, but instead from competitive benefits on the cardholder side of the platform and to the concomitant competitive benefits to merchants who choose to accept Amex cards. Id. Cardholder insistence resulted from Amex s rewards program, which increased the card s prestige in the eyes of cardholders. Id. at 204. The rewards were equivalent to a decrease in price to cardholders, which in turn decreased the price across the entire platform. Id. The purpose of the NDPs was to protect the rewards program and prestige, and outlawing the NDPs would reduce the protection and likely increase the market shares of MasterCard and Visa. Id. Thus, the NDPs likely promoted rather than harmed competition. The Second Circuit determined that Plaintiffs did not meet their initial burden of demonstrating anticompetitive effects in the relevant market because Plaintiffs failed to show how the NDPs made all Amex consumers on both sides of the platform i.e., both merchants and cardholders worse off overall. Id. at 205 (emphasis in original). To prove a Sherman Act violation, Plaintiffs needed to demonstrate that the NDPs had an actual adverse effect on competition as a whole in the relevant market. Id. (quoting K.M.B. Warehouse Distribs., Inc. v. Walker Mfg. Co., 61 F.3d 123, 127 (9th Cir. 1995)). The procompetitive effects that the NDPs had on cardholders had no bearing on Plaintiffs initial burden under the rule of reason to show the anticompetitive effects that the NDPs would have on the whole market. Am. Express Co., 838 F.3d at 205. The initial burden under the Sherman Act that the Second Circuit described in Amex differs from a plaintiff s initial burden under the Clayton Act, as described in the Staples II. There, the district court noted that merger law provides that a plaintiff meets its initial burden by showing only that a proposed merger will result in a significant market share and an undue increase in concentration in the relevant market. Staples II, 2016 WL at *17. Such a structural, historical showing itself establishes a presumption of illegality and shifts the burden to a defendant to demonstrate, based on market dynamics, that such a concentration will not unduly lessen competition. Id. Conclusion Given the District Court's explicit finding that neither party provided reliable evidence of Amex's costs or profit margins accounting for consumers on both sides of the platform, and given evidence showing that the quality and output of credit cards across the entire industry continues to increase, the court concluded that Plaintiffs failed to carry their burden to prove a 1 violation. Am. Express, 838 F.3d at