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FTC v. STAPLES

June 30, 1997

FEDERAL TRADE COMMISSION, Plaintiff,
v.
STAPLES, INC. and OFFICE DEPOT, INC., Defendants.



The opinion of the court was delivered by: HOGAN

 Plaintiff, the Federal Trade Commission ("FTC" or "Commission"), seeks a preliminary injunction pursuant to Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b), to enjoin the consummation of any acquisition by defendant Staples, Inc. of defendant Office Depot, Inc., pending final disposition before the Commission of administrative proceedings to determine whether such acquisition may substantially lessen competition in violation of Section 7 of the Clayton Act, 15 U.S.C. § 18, and Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45 The proposed acquisition has been postponed pending the Court's decision on the motion for a preliminary injunction, which is now before the Court for decision after a five-day evidentiary hearing and the filing of proposed findings of fact and conclusions of law. For the reasons set forth below, the Court will grant the plaintiff's motion. This Memorandum Opinion constitutes the Court's findings of fact and conclusions of law.

 BACKGROUND

 The FTC is an administrative agency of the United States organized and existing pursuant to the Federal Trade Commission Act, 15 U.S.C. §§ 41-77. The Commission is responsible, inter alia for enforcing federal antitrust laws, particularly Section 7 of the Clayton Act, and Sections 5 and 13(b) of the Federal Trade Commission Act.

 Defendants are both corporations which sell office products--including office supplies, business machines, computers and furniture--through retail stores, commonly described as office supply superstores, as well as through direct mail delivery and contract stationer operations. Staples is the second largest office superstore chain in the United States with approximately 550 retail stores located in 28 states and the District of Columbia, primarily in the Northeast and California. In 1996 Staples' revenues from those stores were approximately $ 4 billion through all operations. Office Depot, the largest office superstore chain, operates over 500 retail office supply superstores that are located in 38 states and the District of Columbia, primarily in the South and Midwest. Office Depot's 1996 sales were approximately $ 6.1 billion. OfficeMax. Inc., is the only other office supply superstore firm in the United States.

 On March 10, 1997, the Commission voted 4-1 to challenge the merger and authorized commencement of an action under Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b), to seek a temporary restraining order and a preliminary injunction barring the merger. Following this vote, the defendants and the FTC staff negotiated a consent decree that would have authorized the merger to proceed on the condition that Staples and Office Depot sell 63 stores to OfficeMax. However, the Commission voted 3-2 to reject the proposed consent decree on April 4, 1997. The FTC then filed this suit on April 9, 1997, seeking a temporary retraining order and preliminary injunction against the merger pursuant to Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b), pending the completion of an administrative proceeding pursuant to Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45, and Sections 7 and 11 of the Clayton Act, 15 U.S.C. §§ 12, 21.

 Because of the urgency of this matter, the Court authorized expedited discovery and held a five-day evidentiary hearing beginning on May 19, 1997. Closing arguments were heard on June 5, 1997. In the meantime, the defendants agreed to postpone the merger pending the Court's decision on the motion for a preliminary injunction, thus making the plaintiff's motion for a temporary restraining order moot. At the hearing, the FTC called a number of live witnesses, including three industry witnesses and two economic experts, Dr. Frederick R. Warren-Boulton and Dr. Orley Ashenfelter. Defendants offered testimony from eight live witnesses, including one economic expert, Dr. Jerry Hausman, as well as an expert in retailing, Maurice Segall. In addition to these live witnesses, the plaintiff and the defendants combined submitted over six thousands exhibits including declarations from consumers, industry analysts, economic experts, suppliers, and other sellers of office supplies. Following the conclusion of the hearing, nine states filed a joint amicus brief in support of the FTC's motion. *fn1"

 DISCUSSION

 I. Section 13(B) Standard for Preliminary Injunctive Relief

 Section 7 of the Clayton Act, 15 U.S.C. § 18, makes it illegal for two companies to merge "where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly." Whenever the Commission has reason to believe that a corporation is violating, or is about to violate, Section 7 of the Clayton Act, the FTC may seek a preliminary injunction to prevent a merger pending the Commission's administrative adjudication of the merger's legality. See Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b). However, in a suit for preliminary relief, the FTC is not required to prove, nor is the Court required to find, that the proposed merger would in fact violate Section 7 of the Clayton Act. FTC v. Alliant Techsystems Inc., 808 F. Supp. 9, 19 (D.D.C. 1992); FTC v. PPG Indus., 628 F. Supp. 881, 883 n.3 (D.D.C.), aff'd in part rev'd in part, 255 U.S. App. D.C. 69, 798 F.2d 1500 (D.C. Cir. 1986). The determination of whether the acquisition actually violates the antitrust laws is reserved for the Commission and is, therefore, not before this Court. See Alliant, 808 F. Supp. at 19. The only question before this Court is whether the FTC has made a showing which justifies preliminary injunctive relief.

 Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b), provides that "upon a proper showing that, weighing the equities and considering the Commission's likelihood of ultimate success, such action would be in the public interest, and after notice to the defendant, a temporary restraining order or a preliminary injunction may be granted without bond." *fn2" Courts have interpreted this to mean that a court must engage in a two-part analysis in determining whether to grant an injunction under section 13(b): (1) First, the Court must determine the Commission's likelihood of success on the merits in its case under Section 7 of the Clayton Act; and (2) Second, the Court must balance the equities. See FTC v. Freeman Hospital, 69 F.3d 260, 267 (8th Cir. 1995); FTC v. University Health, Inc., 938 F.2d 1206, 1217-18 (11th Cir. 1991); FTC v. Warner Communications Inc., 742 F.2d 1156, 1160 (9th Cir. 1984); FTC v. Occidental Petroleum Corp., 1986-1 Trade Cas. (CCH) P67,071 (D.D.C. 1986).

 A. Likelihood of Success on the Merits

 Likelihood of success on the merits in cases such as this means the likelihood that the Commission will succeed in proving, after a full administrative trial on the merits, that the effect of a merger between Staples and Office Depot "may be substantially to lessen competition, or to tend to create a monopoly" in violation of Section 7 of the Clayton Act. The Commission satisfies its burden to show likelihood of success if it "raises questions going to the merits so serious, substantial, difficult, and doubtful as to make them fair ground for through investigation, study, deliberation and determination by the Commission in the first instance and ultimately by the Court of Appeals." FTC v. University Health, Inc., 938 F.2d 1206, 1218 (11th Cir. 1991) ("To show a likelihood of ultimate success, the FTC must 'raise [] questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination by the FTC in the first instance and ultimately by the Court of Appeals.'"); FTC v. Warner Communications, Inc., 742 F.2d 1156, 1162 (9th Cir. 1984) ("The Commission meets its burden if it 'raise[s] questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination by the FTC in the first instance and ultimately by the Court of Appeals.'"); FTC v. National Tea Co., 603 F.2d 694, 698 (8th Cir. 1979) (same language); FTC v. Alliant Techsystems Inc., 808 F. Supp. 9, 19 (D.D.C. 1992) (same language). See also FTC v. Beatrice Foods Company, 190 U.S. App. D.C. 328, 587 F.2d 1225 (D.C. Cir. 1978). *fn3"

  It is not enough for the FTC to show merely that it has a "fair and tenable chance" of ultimate success on the merits as has been argued and rejected in other cases. See FTC v. Freeman Hospital, 69 F.3d 260, 267 (8th Cir. 1995) (rejecting the Commission's argument that it need only show a "fair and tenable chance of ultimate success on the merits" in order to qualify for injunctive relief because such a standard would run contrary to Congressional intent and reduce the judicial function to a mere "rubber stamp" of the FTC's decisions.). See also FTC v. National Tea Co., 603 F.2d 694, 698 (8th Cir. 1979) (reaching the same conclusions under the same reasoning). *fn4" However, the FTC need not prove to a certainty that the merger will have an anti-competitive effect. That is a question left to the Commission after a full administrative hearing. Instead, in a suit for a preliminary injunction, the government need only show that there is a "reasonable probability" that the challenged transaction will substantially impair competition. FTC v. University Health, 938 F.2d 1206, 1218 (11th Cir. 1991) ("The government must show a reasonable probability that the proposed transaction would substantially lessen competition in the future."); Fruehauf Corp. v. FTC, 603 F.2d 345, 351 (2d Cir. 1979) ("There must be 'the reasonable probability' of a substantial impairment of competition to render a merger illegal."). See also United States v. Penn-Olin Chemical Co., 378 U.S. 158, 170-71, 12 L. Ed. 2d 775, 84 S. Ct. 1710 (1964) ("The requirements of [Section 7] . . . are satisfied when a tendency toward monopoly of the reasonable likelihood of a substantial lessening of competition in the relevant market is shown); FTC v. Great Lakes Chemical Corp., 528 F. Supp. 84, 86 (N.D. Ill. 1981) ("The government must prove not that the merger in question may possibly have an anti-competitive effect, but rather that it will probably have such as effect.").

 In order to determine whether the Commission has met its burden with respect to showing its likelihood of success on the merits, that is, whether the FTC has raised questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination by the FTC in the first instance and ultimately by the Court of Appeals and that there is a "reasonable probability" that the challenged transaction will substantially impair competition, the Court must consider the likely competitive effects of the merger, if any. Analysis of the likely competitive effects of a merger requires determinations of (1) the "line of commerce" or product market in which to assess the transaction; (2) the "section of the country" or geographic market in which to assess the transaction; and (3) the transaction's probable effect on competition in the product and geographic markets. See United States v. Marine Bancorporation, 418 U.S. 602, 618-23, 41 L. Ed. 2d 978, 94 S. Ct. 2856 (1974); FTC v. Harbour Group Investments, L.P., 1990-2 Trade Cas. (CCH) P69,247 at 64,914 n. 3 (D.D.C. 1990).

 II. The Geographic Market

 One of the few issue about which the parties to this case do not disagree is that metropolitan areas are the appropriate geographic markets for analyzing the competitive effects of the proposed merger. A geographic market is that geographic area "to which consumers can practically turn for alternative sources of the product and in which the antitrust defendant faces competition." Morgenstern v. Wilson, 29 F.3d 1291, 1296 (8th Cir. 1994), cert. denied, 513 U.S. 1150, 130 L. Ed. 2d 1068, 115 S. Ct. 1100 (1995). In its first amended complaint, the FTC identified forty-two such metropolitan areas *fn5" as well as future areas which could suffer anti-competitive effects from the proposed merger. *fn6" Defendants have not challenged the FTC's geographic market definition in this proceeding. Therefore, the Court will accept the relevant geographic markets identified by the Commission.

 III. The Relevant Product Market

 In contrast to the parties' agreement with respect to the relevant geographic market, the Commission and the defendants sharply disagree with respect to the appropriate definition of the relevant product market or line of commerce. As with many antitrust cases, the definition of the relevant product market in this case is crucial. In fact, to a great extent, this case hinges on the proper definition of the relevant product market.

 The Commission defines the relevant product market as "the sale of consumable office supplies through office superstores," *fn7" with "consumable" meaning products that consumers buy recurrently, i.e., items which "get used up" or discarded. For example, under the Commission's definition, "consumable office supplies" would not include capital goods such as computers, fax machines, and other business machines, or office furniture, but does include such products as paper, pens, file folders, post-it notes, computer disks, and toner cartridges. The defendants characterize the FTC's product market definition as "contrived" with no basis in law or fact, and counter that the appropriate product market within which to assess the likely competitive consequences of a Staples-Office Depot combination is simply the overall sale of office products, of which a combined Staples-Office Depot accounted for 5.5% of total sales in North America in 1996. In addition, the defendants argue that the challenged combination is not likely "substantially to lessen competition" however the product market is defined. After considering the arguments on both sides and all of the evidence in this case and making evaluations of each witness's credibility as well as the weight that the Court should give certain evidence and testimony, the Court finds that the appropriate relevant product market definition in this case is, as the Commission has argued, the sale of consumable office supplies through office supply superstores.

 The general rule when determining a relevant product market is that "the outer boundaries of a product market are determined by the reasonable interchangeability of use [by consumers] or the cross-elasticity of demand between the product itself and substitutes for it." Brown Shoe v. United States, 370 U.S. 294, 325, 8 L. Ed. 2d 510, 82 S. Ct. 1502 (1962); see also United States v. E.I. Du Pont de Nemours and Co., 351 U.S. 377, 395, 100 L. Ed. 1264, 76 S. Ct. 994 (1956). Interchangeability of use and cross-elasticity of demand look to the availability of substitute commodities, i.e. whether there are other products offered to consumers which are similar in character or use to the product or products in question, as well as how far buyers will go to substitute one commodity for another. E.I. Du Pont de Nemours, 351 U.S. at 393. In other words, the general question is "whether two products can be used for the same purpose, and if so, whether and to what extent purchasers are willing to substitute one for the other." Hayden Pub. Co. v. Cox Broadcasting Corp., 730 F.2d 64, 70 n. 8 (2d Cir. 1984).

 Whether there are other products available to consumers which are similar in character or use to the products in question may be termed "functional interchangeability." See e.g., E.I. Du Pont de Nemours, 351 U.S. at 399 (recognizing "functional interchangeability" between cellophane and other flexible wrappings); United States v. Archer-Daniels-Midland Co., 866 F.2d 242, 246 (8th Cir. 1988) (discussing "functional interchangeability" between sugar and high fructose corn syrup), cert. denied, 493 U.S. 809, 107 L. Ed. 2d 20, 110 S. Ct. 51 (1989). This case, of course, is an example of perfect "functional interchangeability." The consumable office products at issue here are identical whether they are sold by Staples or Office Depot or another seller of office supplies. A legal pad sold by Staples or Office Depot is "functionally interchangeable" with a legal pad sold by Wal-Mart. A post-it note sold by Staples or Office Deport is "functionally interchangeable" with a post-it note sold by Viking or Quill. A computer disk sold by Staples-Office Deport is "functionally interchangeable" with a computer disk sold by CompUSA. No one disputes the functional interchangeability of consumable office supplies. However, as the government has argued, functional interchangeability should not end the Court's analysis.

 The Supreme Court did not stop after finding a high degree of functional interchangeability between cellophane and other wrapping materials in the E. L. Du Pont de Nemours case. Instead, the Court also found that "an element for consideration as to cross- elasticity of demand between products is the responsiveness of the sales of one product to price changes of the other." Id. at 400. For example, in that case, the Court explained, "if a slight decrease in the price of cellophane causes a considerable number of customers of other flexible wrappings to switch to cellophane, it would be an indication that a high cross-elasticity of demand exists between [cellophane and other flexible wrappings]; [and therefore] that the products compete in the same market." Id. Following that reasoning in this case, the Commission has argued that a slight but significant increase in Staples-Office Depot's prices will not cause a considerable number of Staples-Office Depot's customers to purchase consumable office supplies from other non-superstore alternatives such as Wal-Mart, Best Buy, Quill, or Viking. On the other hand, the Commission has argued that an increase in price by Staples would result in consumers turning to another office superstore, especially Office Depot, if the consumers had that option. Therefore, the Commission concludes that the sale of consumable office supplies by office supply superstores is the appropriate relevant product market in this case, and products sold by competitors such as Wal-Mart, Best Buy, Viking, Quill, and others should be excluded.

 The Court recognizes that it is difficult to overcome the first blush or initial gut reaction of many people to the definition of the relevant product market as the sale of consumable office supplies through office supply superstores. The products in question are undeniably the same no matter who sells them, and no one denies that many different types of retailers sell these products. After all, a combined Staples-Office Depot would only have a 5.5% share of the overall market in consumable office supplies. Therefore, it is logical to conclude that, of course, all these retailers compete, and that if a combined Staples-Office Depot raised prices after the merger, or at least did not lower them as much as they would have as separate companies, that consumers, with such a plethora of options, would shop elsewhere.

 The Court acknowledges that there is, in fact, a broad market encompassing the sale of consumable office supplies by all sellers of such supplies, and that those sellers must, at some level, compete with one another. However, the mere fact that a firm may be termed a competitor in the overall marketplace does not necessarily require that it be included in the relevant product market for antitrust purposes. The Supreme Court has recognized that within a broad market, "well-defined submarkets may exist which, in themselves, constitute product markets for antitrust purposes." Brown Shoe Co. v. United States, 370 U.S. 294, 325, 8 L. Ed. 2d 510, 82 S. Ct. 1502 (1962); see also Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 253 U.S. App. D.C. 142, 792 F.2d 210, 218 (D.C. Cir. 1986)(Bork, J.), cert. denied, 479 U.S. 1033, 93 L. Ed. 2d 834, 107 S. Ct. 880 (1987). With respect to such submarkets, the Court explained "because Section 7 of the Clayton Act prohibits any merger which may substantially lessen competition 'in any line of commerce,' it is necessary to examine the effects of a merger in each such economically significant submarket to determine if there is a reasonable probability that the merger will substantially lessen competition. If such a probability is found to exist, the merger is proscribed." Id. There is a possibility, therefore, that the sale of consumable office supplies by office superstores may qualify as a submarket within a larger market of retailers of office supplies in general.

 The Court in Brown Shoe provided a series of factors or "practical indicia" for determining whether a submarket exists including "industry or public recognition of the submarket as a separate economic entity, the product's peculiar characteristics and uses, unique production facilities, distinct customers, distinct prices, sensitivity to price changes, and specialized vendors." Id. Since the Court described these factors as "practical indicia" rather than requirements, subsequent cases have found that submarkets can exist even if only some of these factors are present. See, e.g., Beatrice Foods Co. v. FTC, 540 F.2d 303 (7th Cir. 1976) (finding submarket based on industry recognition, peculiar characteristics of the product, and differences in production methods and prices); International Telephone and Telegraph Corp. v. General Telephone & Electronics Corp., 518 F.2d 913, 932 (9th Cir. 1975) (explaining that Brown Shoe's practical indicia were meant as "practical aids . . . rather than with the view that their presence or absence would dispose, in talismanic fashion, of the submarket issue").

 The Commission discussed several of the Brown Shoe "practical indicia" in its case, such as industry recognition, and the special characteristics of superstores which make them different from other sellers of office supplies, including distinct formats, customers, and prices. Primarily, however, the FTC focused on what it termed the "pricing evidence," which the Court finds corresponds with Brown Shoe's "sensitivity to price changes" factor. First, the FTC presented evidence comparing Staples' prices in geographic markets where Staples is the only office superstore, to markets where Staples competes with Office Deport or OfficeMax, or both. Based on the FTC's calculations, in markets where Staples faces no office superstore competition at all, something which was termed a one firm market during the hearing, prices are 13% higher than in three firm markets where it competes with both Office Depot and OfficeMax. The data which underly this conclusion make it compelling evidence. Prices were compared as of January 1997, which, admittedly, only provides data for one specific point in time. However, rather than comparing prices from only a small sampling or "basket" of goods, the FTC used an office supply sample accounting for 90% of Staples' sales and comprised of both price sensitive and non-price sensitive items. The FTC presented similar evidence based on Office Depot's prices of a sample of 500 items, also as of January 1997. Similarly, the evidence showed that Office Depot's prices are significantly higher, well over 5% higher, *fn8" in Depot-only markets than they are in three firm markets.

 Other pricing evidence presented by the FTC is less convincing on its own, due to limitations in the underlying data. For example, relatively small samplings or "baskets" of goods may have been used or it may not be clear how many stock keeping units ("SKUs") of supplies were included. For example, the FTC also presented evidence comparing Staples' prices in Staples-only markets with Staples' prices in three-firm markets for four different time periods, August 1994, January 1995, August 1995, and May 1996. The result is startlingly similar to that found in the first two examples. Where Staples does not compete with other office superstores, it charges prices well over 5% higher than where it does so compete. While having the advantage of showing a trend over time, the Court recognizes that this evidence has some problems. These particular calculations were made based on a "basket" or sample of supplies comprised of supplies used by Staples to price check against Office Depot. The number of SKUs in the sample was not provided to the Court, and it appears that the components of the baskets may have changed over time. Therefore, the Court would not give much weight to this evidence standing alone. However, since additional evidence supports the same conclusion, the Court credits this evidence as confirmation of the general pricing trend.

 The FTC also pointed to internal Staples documents which present price comparisons between Staples' prices and Office Depot's prices and Staples' prices and OfficeMax's prices within different price zones. *fn9" The comparisons between Staples and Office Depot were made in August 1994, January 1995, August 1995, and May 1996. Staples' prices were compared with OfficeMax's prices in August 1994, July 1995, and January 1996. For each comparison, Staples' calculations were based on a fairly large "basket" or sample of goods, approximately 2000 SKUs containing both price sensitive and non-price sensitive items. Using Staples' data, but organizing it differently to show which of those zones were one, two, or three firm markets, the FTC showed once again that Staples charges significantly higher prices, more than 5% higher, where it has no office superstore competition than where it competes with the two other superstores.

 The FTC offered similar price comparison evidence for Office Depot, comparing Office Depot's prices across Staples' zones. The comparisons were made in August 1994, January 1995, August 1995, and May 1996. Again, a large sample, approximately 2000 SKUs, was considered. The results of this analysis are slightly less favorable to the FTC's position. Price differentials are significantly smaller and there are even a few instances where Office Depot's prices appear to be higher in one of its three firm markets than prices in its two firm markets and at least one point where prices in one of the Depot-only zones were lower than prices in one of the ...


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