Unilateral Effects Case Study: The Whole Foods/Wild Oats Merger

1. Unilateral Effects Case Study:The Whole Foods/Wild Oats Merger Competition Commission of India October 25-26, 2010

2. Wild Oats Whole Foods Store Locations I. IntroductionBackground to the Merger • Whole Foods Market (WFM) and Wild Oats (WO) were national supermarket chains selling organic and natural foods • WO was in financial difficulty • WFM sought to acquire WO • FTC alleged that WFM and WO competed “head to head” in 21 geographic markets and claimed that the merger would create a monopoly in “premium natural and organic supermarkets” in nearly all of those markets

3. I. IntroductionKey Antitrust Issues • Did WFM and WO constrain each others’ prices to such a degree that the merged firm would be able to profitably raise prices without fear of significant customer diversion to “conventional” supermarket chains? • Central issues • Product market definition / direct evidence of effects • FTC alleged market was “premium natural and organic supermarkets” • In a broader product market, WFM and WO had very small shares (usually <5%) • Consumers’ willingness to switch to “conventional” supermarkets • FTC contended there were many “core customers” who would not switch • Parties contended that most consumers cross-shop and many would switch, and that price discrimination against remaining “core customers” was infeasible • Ease of repositioning, expansion and entry • FTC argued supply responses would be unlikely, untimely and insufficient • Parties pointed to many examples of repositioning and entry, and event study analysis

4. II. Product Market DefinitionFTC’s Argument and Analysis • Product market is “premium natural and organic supermarkets” (PNOS) • WFM, WO and a very few local niche competitors • Qualitative evidence • WFM and WO stores looked most alike among all competitive alternatives • WFM tended to located its stores in close proximity to WO • Internal documents reflecting historical rivalry • Testimony from WFM CEO downplayed competition from “conventional” chains • Testimony that merger would avoid “nasty price wars” • Empirical evidence • When a WFM store opened near a WO, it took substantial sales away from WO • Generally supported by WFM’s internal analyses • WFM margins generally higher than “conventional” supermarkets’ margins • WFM margins tended to be lower in markets with a WO store present • FTC did not attempt formal SSNIP test, favoring Staples approach primarily focused on margins analysis (and qualitative evidence)

5. II. Product Market Definition Parties’ Argument and Analysis • Product market includes multiple other competitors — conventional supermarkets, specialty food retailers, club stores, mass merchants • Qualitative evidence • Conventional chains carried many of the same products • Internal business documents recognize competition from non-PNOS supermarkets • WFM regularly price-checked conventional supermarkets • WFM tracked entry and store remodeling by conventional supermarkets • Empirical evidence • Price analyses showed uniform regional pricing by WFM and WO: prices did not seem to vary based on WO’s presence or absence • Event studies showed no evidence of significant price responses following WFM store openings and WO store closings • Parties contrasted absence of direct price effects evidence with Staples case to argue market was much broader than PNOS

6. II. Product Market – Direct Effects Evidence Event Study Analysis • Natural experiments • Entries of WFM stores near existing WO stores and exits of WO stores near existing WFM stores • Opening a WFM store should have little effect on WO if WO’s pricing was already constrained by conventional supermarkets and great effect if it was not • Closing a WO store should have had little effect on WFM if conventional supermarkets constrained WFM’s pricing and great effect if they did not • Compare average weekly prices paid by shoppers for thousands of grocery items sold by WFM and WO before and after the entry and exit events • Compare item pricing at “treatment stores” (nearby to entries and exits) versus “control stores” (in same region, but not close to entries and exits) • Compare before vs. after prices on an item-by-item basis

7. II. Product Market – Direct Effects Evidence Price Change Comparison, Wild Oats Exits Source: Whole Foods Market http://www.wholefoodsmarket.com/ftchearingupdates/

8. II. Product Market – Direct Effects Evidence Price Change Comparison, Whole Foods Entry Source: Whole Foods Market http://www.wholefoodsmarket.com/ftchearingupdates/

9. II. Product Market Definition Discussion Issues • How useful / informative is market definition in a highly differentiated product merger? • Should direct evidence of competitive effects be viewed as a substitute or complement to formal market definition? • What are the risks to defining the market unduly narrowly – e.g., PNOS rather than “all supermarkets”? • How should quantitative evidence (data) vs. qualitative evidence (documents, testimony) be weighed and reconciled when they appear to be at tension?

10. II. Product Market – Direct Effects EvidenceFurther Readings • Carlton Varner and Heather Cooper,“Product Markets in Merger Cases: The Whole FoodsDecision,” Antitrust Source October 2007 http://www.abanet.org/antitrust/at-source/07/10/Oct07-Varner.pdf • Jonathan B. Baker and David Reitman, “Research Topics in Unilateral Effects Analysis,” http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1504863 • FTC Unilateral Effects Analysis and Litigation Workshop, February 12, 2008 transcripthttp://www.ftc.gov/bc/unilateral/transcript.pdf

11. III. Consumers’ Willingness to Switch FTC’s Argument and Analysis • WFM and WO marketed themselves to a core clientele • “Core customers” would not switch to non-PNOS competitors • Products and services were highly differentiated • Even if many consumers would switch, core customers would be subject to price discrimination • Higher prices? • Reduced shopping convenience?

12. III. Consumers’ Willingness to Switch Parties’ Argument and Analysis • Parties contended that consumers cross–shop widely • WFM and WO documents • Consumer survey findings • Observations from the real world • No identifiable mechanism to price discriminate against “core” customers • Conditions to support price discrimination were absent • “Critical loss analysis” • Calculate minimum loss of sales needed to make a post-merger price increase unprofitable • Qualitative evidence on whether “enough” consumers would switch or divert their purchases to make the price increase unprofitable

13. III. Consumers’ Willingness to Switch Issues for Discussion • Who defines the relevant market – the core customer or the marginal customer? • The marginal customer determines price, absent price discrimination • The marginal customer defines the boundaries of the market, absent price discrimination • What needs to be proven to support price discrimination markets? • Identify targeted buyers with inelastic demand • Charge higher prices to targeted customers • Prevent re-sale (arbitrage) from low-price to high-price buyers • Prevent customer diversion to substitute products

14. III. Consumers’ Willingness to Switch Further Reading • Sumanth Addanki and Alan J. Daskin, “Who Defines the Relevant Market – The Core Customer or the Marginal One?,”NERA Antitrust Insights, Summer 2008 http://lawprofessors.typepad.com/antitrustprof_blog/files/insights_summer_2008.pdf • Charles J. Biggio, “Whole Foods’ Impact on Unilateral Effects,” Global Competition Policy, September 2008 http://www.wsgr.com/PDFSearch/wholefoods0908.pdf

15. IV. Repositioning, Expansion and EntryFTC’s Argument and Analysis • Barriers to supply-side responses • Reputational barriers • Conventionals would need to “abandon” their own “core” customers • WFM/WO “core” customers would not switch • Likelihood, timeliness, sufficiency • Unlikely – see above • Not timely – reputational barriers? • Insufficient – past examples were limited and did not elicit significant responses from WFM or WO • Elasticities should already reflect the effects of repositioning on the likelihood of a unilateral post-merger price increase

16. IV. Repositioning, Expansion and EntryParties’ Argument and Analysis • No barriers to supply-side responses • Competitors had strong motive and means to enter/expand • Uncommitted entry was feasible • Multiple significant entries had taken place and were ongoing • Conventional stores’ private labels • Stores within a store • New store concepts and banners

17. IV. Repositioning, Expansion and EntryEmpirical Analysis • Direct effects evidence also can come from analyzing other events – entries, expansions, repositioning by competitors alleged to be outside of the product • Supply-side responses by non-market participants should not affect prices by firms within the alleged market • Event studies • Conventional entries and remodelings affected WFM and WO prices ―oftentimes by more than WFM entries and WO exits

18. IV. Repositioning, Expansion and EntryIssues for Discussion • How high are the evidentiary hurdles to assess likely, timely and sufficient supply responses? • How probative are case examples of past entry? • How should the possibility of post-merger repositioning by the merging firms be factored into the unilateral effects analysis?

19. IV. Repositioning, Expansion and EntryFurther Reading • Peter Boberg and John Woodbury, “Repositioning and the Revision of the Horizontal Merger Guidelines,” Antitrust SourceDecember 2009 http://www.abanet.org/antitrust/at-source/09/12/Dec09-Boberg12-17f.pdf • Amit Gandhi, Luke Froeb, Steven Tschantz and Gregory J. Werden, “Post-Merger Product Repositioning,” Journal of industrial Economics 2008

20. V. Relevant Case Materials Further Reading • Complaint http://www.ftc.gov/os/caselist/0710114/070605complaint.pdf • FTC’s economic expert reports http://www.ftc.gov/os/caselist/0710114/070823murphy.pdf http://www.ftc.gov/os/caselist/0710114/070823rebutmurphy.pdf http://www.ftc.gov/os/caselist/0710114/070823rebutmurphy.pdf • District Court opinion http://www.ftc.gov/os/caselist/0710114/0710114dcopinpub.pdf • Court of Appeals opinion http://www.ftc.gov/os/caselist/0710114/080729wholefoodsopinion.pdf