The opinion of the court was delivered by: Thomas F. Hogan, United States District Judge
REDACTED MEMORANDUM OPINION
Pending before the Court is the Federal Trade Commission's ("FTC" or "Commission") motion for preliminary injunction pursuant to Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b). The Commission seeks to enjoin the acquisition by Swedish Match North America, Inc. ("Swedish Match") of the loose leaf chewing tobacco business of National Tobacco Company, L.P. ("National"). This injunction is sought to maintain the status quo pending final disposition before the FTC 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 by agreement of the parties, pending the Court's resolution of this motion. After thorough consideration of the parties' briefs, the exhibits presented by the parties before and during the five-day hearing held in this matter, each witness's credibility, and each party's proposed findings of fact and conclusions of law, and for the reasons set forth below, the Court will grant the plaintiff's motion. *fn1 This Memorandum Opinion constitutes the Court's findings of fact and conclusions of law.
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.
Swedish Match is a corporation organized and existing under the laws of Delaware, with its principal place of business in Virginia. Swedish Match is a wholly owned subsidiary of Swedish Match AB, a foreign corporation headquartered in Stockholm, Sweden. *fn2 Swedish Match manufactures and sells primarily loose leaf and moist snuff tobacco. It produces loose leaf and moist stuff tobacco at its plant in Owensboro, Kentucky. Swedish Match is the largest producer of loose leaf tobacco in the United States. In 1999, its loose leaf sales totaled $127 million, which constituted forty-two percent of all loose leaf sales. Swedish Match's loose leaf brands include Red Man, Red Man Golden Blend, Red Man Select, Southern Pride, J.D.'s Blend, Granger Select, Work Horse, Union Standard, Pay Car, and Red Horse. Red Man, a premium brand, is Swedish Match's leading brand of loose leaf tobacco. In 1999, Red Man had a twenty-two percent share of the loose leaf market. And together, Red Man, Red Man Golden Blend, and Red Man Select accounted for thirty-six percent of all loose leaf sales by revenue. Swedish Match is also the third largest producer of moist snuff tobacco in the United States. In 1999, its moist snuff sales totaled $54 million, which constituted three percent of all moist snuff sales. Its moist snuff brands include Timber Wolf and Renegades. Timber Wolf comes in several cuts, including natural Fine Cut, Wintergreen Long Cut, Wintergreen Cool, Wintergreen Fine Cut, and Long Cut Straight. Timber Wolf, a price-value (or everyday low price ("EDLP")) brand, is Swedish Match's leading moist snuff brand.
National is a limited partnership organized and existing under the laws of Delaware, with its principal place of business in New York. It is a wholly owned subsidiary of North Atlantic Trading Company, Inc., which is headquartered in New York City. National primarily manufactures and sells loose leaf chewing tobacco and is the third largest producer of loose leaf chewing tobacco in the United States. In 1999, its sales totaled $53 million, which constituted an eighteen percent share of the loose leaf market. National produces several brands of loose leaf chewing tobacco including Beech-Nut, Beech-Nut Wintergreen, Havana Blossom, Trophy, and Durango. Beech-Nut, a premium brand, is National's leading loose leaf brand. In 1999, Beech Nut Regular and Beech-Nut Wintergreen comprised thirteen percent of loose leaf sales. National produces its loose leaf chewing tobacco brands at its Louisville, Kentucky plant.
Other producers in the loose leaf and moist snuff markets, while not directly involved in this litigation, include Conwood Corporation ("Conwood"), Swisher International, Inc. ("Swisher"), Fred Stoker & Sons, Inc. ("Fred Stoker"), and U.S. Tobacco ("UST"). Conwood produces Levi Garrett, the second largest selling loose leaf brand. Swisher produces Lancaster and Chattanooga Chew, which are respectively the eighth and ninth leading brands of loose leaf tobacco. Fred Stoker's loose leaf brands account for approximately one percent of all loose leaf. UST is the leading producer of premium moist snuff brands, including the largest selling brand, Skoal. UST accounts for more than seventy-five percent of moist snuff sales and approximately forty percent of total smokeless tobacco sales.
In 1997, Swedish Match and National unsuccessfully attempted to solidify a joint operation agreement, under which Swedish Match would manufacture National's brands in its Owensboro facility. *fn3 In 1999, however, Swedish Match and National came to the table again, this time discussing an asset purchase arrangement rather than a joint operation agreement. On February 10, 2000, they entered into an asset purchase agreement under which Swedish Match would acquire the loose leaf tobacco brands and certain related assets of National for approximately $165 million. According to the defendants, the purpose of this asset purchase agreement is to utilize better Swedish Match's significant and increasing excess capacity. National seeks to alleviate the difficulties created by its own excess capacity and inability to compete with U.S. Tobacco-the leading moist snuff producer-in an environment of declining moist snuff prices.
Pursuant to the Hart-Scott-Rodino Improvements Act of 1976, 15 U.S.C. § 18a, Swedish Match and National filed Premerger Notification and Report forms with the FTC on February 18, 2000. By a vote of 5-0 on June 22, 2000, the FTC authorized its staff to seek a temporary restraining order or preliminary injunction to prevent this merger under Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b). The defendants subsequently agreed that they would not effectuate the asset purchase agreement during the pendency of the preliminary injunction proceedings, obviating the need for a temporary restraining order. The FTC filed this suit on June 23, 2000, seeking a 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.
The Court held a five-day evidentiary hearing beginning on September 5, 2000, and closing arguments were heard on September 27, 2000. At the hearing, the FTC called several witnesses, including six industry witnesses and two economic experts, Dr. John Simpson and Dr. Orley Ashenfelter. The defendants offered testimony from several witnesses, also including two economic experts, Dr. Lawrence Wu and Dr. Kenneth Train. In addition to these witnesses, the plaintiff and the defendants have submitted several hundred exhibits.
Section 7 of the Clayton Act, 15 U.S.C. § 18, prohibits a corporation from acquiring "the whole or any part of the assets of another [corporation] engaged also in commerce or in any activity affecting commerce, 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." The FTC is authorized by Section 13(b) of the Federal Trade Commission Act to seek a preliminary injunction to block an acquisition pending a full administrative proceeding before the Commission when the Commission has reason to believe that a corporation is violating, or is about to violate, Section 7 of the Clayton Act. 15 U.S.C. § 53(b).
Section 13(b) of the Federal Trade Commission Act, 15 U.S.C. § 53(b), authorizes the Court to grant injunctive relief to the Commission if it finds "[u]pon a proper showing that, weighing the equities and considering the FTC'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." In other words, to obtain a preliminary injunction under Section 13(b), the FTC must demonstrate: (1) a likelihood of success on the merits in its case under Section 7 of the Clayton Act; and (2) the equities weigh in favor of granting an injunction. See FTC v. Weyerhaeuser Co., 665 F.2d 1072, 180-83 (D.C. Cir. 1981); FTC v. Cardinal Health, Inc., 12 F. Supp.2d 34, 44 (D.D.C. 1998); FTC v. Staples, Inc., 970 F. Supp. 1066, 1070 (D.D.C. 1997); see also 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).
A. Likelihood of Success on the Merits
To meet the first requirement-to show a likelihood of success on the merits-the Commission must demonstrate the likelihood that it will succeed in proving, after a full administrative trial on the merits, that the effect of Swedish Match's acquisition of National's loose leaf brands "may be substantially to lessen competition, or to tend to create a monopoly" in violation of Section 7 of the Clayton Act. 15 U.S.C. § 18. This does not mean that the Commission must prove at this stage that the proposed merger would in fact violate Section 7 of the Clayton Act. See Cardinal Health, 12 F. Supp.2d at 45; Staples, 970 F. Supp. at 1070-71; FTC v. Alliant Techsystems, Inc., 808 F. Supp. 9, 19 (D.D.C. 1992). Rather, "[t]he determination of whether the acquisition actually violates the antitrust laws is reserved for the Commission and is, therefore, not before this Court." Staples, 970 F. Supp. at 1071; see Cardinal Health; 12 F. Supp.2d at 45; Alliant, 808 F. Supp. at 19. The question before this Court is whether the FTC has made a showing that " `raises 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 Commission in the first instance and ultimately by the Court of Appeals.' " Staples, 970 F. Supp. at 1071 (quoting FTC v. University Health, Inc., 938 F.2d 1206, 1218 (11th Cir. 1991); FTC v. Warner Communications, Inc., 742 F.2d 1156, 1162 (9th Cir. 1984); FTC v. National Tea Co., 603 F.2d 694, 698 (8th Cir. 1979); Staples, 970 F. Supp. at 1071; FTC v. Alliant Techsystems Inc., 808 F. Supp. 9, 19 (D.D.C. 1992)). Under this standard, it is insufficient for the Commission to show merely that it has a "fair and tenable chance" of ultimate success on the merits. Rather, the Commission must show that there is a "reasonable probability" that the challenged acquisition will substantially lessen competition. FTC v. University Health, 938 F.2d 1206, 1218 (11th Cir. 1991) ("[T]he government must show a reasonable probability that the proposed transaction would substantially lessen competition in the future."); Freuhauf 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."); Cardinal Health, 12 F. Supp.2d at 45 ("While some would dispute what this standard means, it is well settled in the case law that for the government to succeed, it `must show a reasonable probability that the proposed transaction would substantially lessen competition in the future.' "); Staples, 970 F. Supp. at 1072 ("[I]n 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.").
In order to determine whether the FTC has met its burden with respect to showing its likelihood of success on the merits, the Court must consider the likely competitive effects of the merger. 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 (1974); FTC v. Harbour Group Investments, L.P., 1990-2 Trade Cas. (CCH) ¶ 69,247 at 64,914 n. 3 (D.D.C. 1990). See, e.g., Cardinal Health, 12 F. Supp.2d at 45; Staples, 970 F. Supp. at 1072.
1. The Relevant Product Market
Merger analysis begins with defining the relevant product market. See Brown Shoe Co. v. United States, 370 U.S. 294, 324 (1962). "Defining the relevant market is critical in an antitrust case because the legality of the proposed mergers in question almost always depends upon the market power of the parties involved." Cardinal Health, 12 F. Supp.2d at 45. Not only is the proper definition of the relevant product market the first step in this case, it is also the key to the ultimate resolution of this type of case because of the relative implications of market power. See, e.g., Staples, 970 F. Supp. at 1073 ("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 argues that loose leaf tobacco constitutes a distinct relevant product market, which does not include moist snuff. Under this narrower view of the market, the acquisition in this case would create a combined entity consisting of the first and third largest sellers of loose leaf tobacco that would be twice as large as its nearest competitor and would control sixty percent of all loose leaf sales. Moreover, the top two firms in the loose leaf market would control over ninety percent of the market. Thus defined, as is discussed in greater detail below, a significant hurdle is erected before the defendants to show that such increased concentration of the market will not likely result in substantial impairment of competition. Swedish Match and National rejoin that the relevant market is a broader, smokeless tobacco market, which includes moist snuff as well as loose leaf tobacco. Under their view, the concentration of the smokeless tobacco market and any increase to it caused by this acquisition are minimal. This view rests upon the premise that companies such as UST, who dominates the moist snuff industry, are vibrant competitors with significant market power. After careful review of the evidence presented in this case and its relative merit, the Court finds the relevant product market in this case to be, as the Commission contends, loose leaf chewing tobacco.
The Supreme Court has articulated the general rule for determining a relevant product market: "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, 370 U.S. at 325; see also United States v. E. I. du Pont de Nemours & Co., 351 U.S. 377, 395 (1956). Interchangeability of use and cross-elasticity of demand look to the availability of products that are similar in character or use to the product in question and the degree to which buyers are willing to substitute those similar products for the product. See E. I. du Pont de Nemours, 351 U.S. at 393; see also Hayden Pub. Co. v. Cox Broadcasting Corp., 730 F.2d 64, 70 n. 8 (2d Cir. 1984) (framing the question as "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"). The Court must determine whether moist snuff is similar in character or use to loose leaf, and if so, whether sufficient moist snuff substitution occurs to defeat loose leaf price increases. If moist snuff is sufficiently similar to loose leaf that it induces adequate substitution to defeat loose leaf prices increases, then it should be included in the relevant product market, because of its ability to constrain prices and maintain a competitive marketplace. See, e.g., Cardinal Health, 12 F. Supp.2d at 46 ("In other words, when one product is a reasonable substitute for the other, it is to be included in the same relevant product market even though the products themselves are not the same. A product is construed to be a `reasonable substitute for another when the demand for it increases in response to an increase in the price for the other.' ").
Whether moist snuff tobacco is similar in character or use to loose leaf tobacco 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). The Commission argues here that loose leaf and moist snuff are not functionally interchangeable. Under its view, the products have distinct characteristics ranging from packaging, price, and consumption to taste, texture, and tobacco plant composition. Loose leaf tobacco is sold in three-ounce pouches, while moist snuff is sold in smaller, 1.2-ounce round plastic containers. Users consume loose leaf by chewing and manipulating the tobacco leaves to extract the flavor, while moist snuff users place "a pinch" of snuff between the gums and cheek, passively absorbing the flavor and nicotine into the mouth. Users chew loose leaf primarily outdoors because of the need to spit frequently, while users consume moist snuff indoors as well as outdoors. Loose leaf is less expensive than moist snuff. While premium loose leaf retails at a mean price of $1.95, premium moist snuff retails at a mean price of $3.50. Loose leaf has a distinct customer base. Loose leaf users are typically older, blue-collar males who live in rural areas in the southeastern United States, while moist snuff users are younger white-collar as well as blue-collar individuals who are more evenly dispersed through the United States.
The defendants counter that loose leaf and moist snuff are reasonably interchangeable because they are similar products, used largely for the same purposes, and any purported differences are merely superficial. Both forms of tobacco are smokeless and consumed through the mouth to extract tobacco flavor and nicotine. And both forms of tobacco yield what consumers call "tobacco satisfaction." Users consume one can of moist snuff at about the same rate as consumers use one pouch of loose leaf tobacco. Loose leaf and moist snuff are sold in the same convenience stores, gas stations, large retail chains, supermarkets, discount outlets, and specialty tobacco shops. Loose leaf and moist snuff generally share the same customers, who tend to be white, blue-collar males, often fishers and hunters. Many smokeless tobacco consumers not surprisingly are therefore "dual users"; that is, they use loose leaf and moist snuff interchangeably.
The Court finds loose leaf and moist snuff to be functionally interchangeable. The determination of functional interchangeability depends to some degree upon the level of generality used to evaluate the products at issue in cases such as this. On one hand, the Commission is correct that at a more specific level loose leaf and moist snuff are not identical. There are differences between loose leaf and moist snuff that are not merely superficial including, inter alia, the tobacco plant varieties used to produce each product, the different additives used in their production, and the different packaging utilized in their distribution. More important, consumers consistently report specific differences in texture and taste between them. At a more general level, on the other hand, loose leaf and moist snuff share a smokeless tobacco form, are consumed through absorption within the user's mouth, require frequent spitting, and yield tobacco satisfaction. And despite specific differences in taste, there is no doubt that at least some consumers are willing to use both loose leaf and moist snuff, as is evidenced by the rising population of dual users. *fn4 Thus, while loose leaf and moist snuff tobacco are not identical, in light of substantial similarities between them and in light of the rising trend in dual usage by consumers, the Court ultimately finds the products to be functionally interchangeable for the purpose of outlining the relevant product market.
Finding two products to be functionally interchangeable, however, does not end the analysis. The Supreme Court did not stop after finding a high degree of functional interchangeability between cellophane and other wrapping materials in the E. I. 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." E. I. du Pont de Nemours & Co., 351 U.S. at 400. The Court explained further that "[i]f 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. Likewise, in Staples, the consumable office products at issue were identical and therefore perfectly interchangeable. 970 F. Supp. at 1074. Yet this Court proceeded to an analysis of cross-elasticity and price constraints in defining the relevant market, ultimately finding the sale of consumable office supplies by office superstores to be a submarket within a larger market of retailers of office supplies in general. See id. at 1074, 1080. As with the wrapping materials in E. I. du Pont de Nemours and the consumable office supplies in Staples, smokeless tobacco constitutes a broader market in this case, comprised of both loose leaf and moist snuff which at some level compete with one another. But as stated by this Court in Staples, "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." 970 F. Supp. at 1075.
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, 370 U.S. at 325; see also Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 792 F.2d 210, 218 (D.C. Cir. 1986), cert. denied, 479 U.S. 1033 (1987). With respect to such submarkets, the Court explained, "[b]ecause 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 ...