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Capitol Comment

    Capitol Comment 289 - Assessing Antitrust Activism: FTC v. Staples Revisited

    10/06/2000

    As the Clinton administration draws to a close, it is appropriate to ask whether the past eight years of renewed antitrust activism have helped or harmed consumers. An excellent test case is the June 1997 preliminary injunction killing the proposed Staples-Office Depot merger, which was at the time arguably the most significant antitrust case brought by the Federal Trade Commission (FTC) during the 1990s.

    Antitrust officials believed the merger would clearly harm consumers because an insulated “submarket” for office supply superstores had only three big players (the other being OfficeMax) and no other genuine competition. The FTC also believed it had definitive evidence that prices for some items were higher in markets served by fewer chains. During litigation, the FTC boldly claimed it had shown “harm to consumers from a merger [in a way that] has never been so clear.” Others were more skeptical. Lester Thurow, former dean of the Sloan School of Management at the Massachusetts Institute of Technology, noted, “This has to set precedent. If the FTC can block the merger of these companies…they can block almost anything. What the FTC thinks it is accomplishing isn’t all clear.”

    Four years later, the FTC’s accomplishment is clear: it blocked a merger that posed no harm to consumers and would have generated, by its own most conservative estimate, at least $1 billion in efficiencies over five years. The case demonstrates why economists, lawyers, judges, and policymakers must adopt broader market definitions, understand how innovation demolishes traditional entry barriers, and recognize the importance of non-price competition to cope with the reality of dynamic competition.

    Market definition. The FTC won its case in large part because Staples and Office Depot served 67 percent of the $15 billion “office supply superstore” segment of the office supply industry. But is this really a distinct market? Sales of office supplies in the United States totaled $185 billion in 1997, giving the merger partners a meager 5.4 percent share of the entire office supply industry. At the time, other competitors included contract sellers, mail-order vendors, new Internet start-ups, and retailers ranging from independently owned shops to large chains like Wal-Mart and Best Buy.

    The FTC claimed its statistical evidence showed that prices for office supplies were higher in locations with fewer office supply superstores, and interpreted internal documents as suggesting that Staples and Office Depot did not perceive other retailers as competitors. Despite this evidence, it is clear that employees at both Staples and Office Depot regularly checked prices at other sellers. Several large retail chains submitted affidavits stating that they regarded the superstores as direct competitors.

    Since 1997, competition has only intensified. Between April and November 1999, all three superstores’ stock prices slid 40-50 percent as Wall Street punished them for their vulnerability to discount competition and the store overbuild that was resulting in part from the emergence of new Internet sales. This slide has only continued. By the summer of 2000, Merrill Lynch reported that Office Depot was struggling to keep up with discounters’ price slashing on paper, ink, and toner, and was cutting its prices specifically to keep up with Wal-Mart and Costco.

    Entry barriers. Since their introduction in 1995, Internet office supply sales have been a major new source of competition because they allow a new entrant to sell office supplies without having to build a network of large, expensive stores. Web-based suppliers typically offer products at prices 10-30 percent lower than stores. In May 2000, a pessimistic Morningstar report on Office Depot assessed the effects of increased e-commerce competition since the aborted merger: “These days, comparison shopping is easier than ever, with at least 10 office supply Web sites offering similar products…the recent competition from startups is bound to take a toll, just as it has in other industries that sell commodity products such as books, computers, CDs, and electronics.” One such company, Onvia.com, was founded in 1996 with an initial investment of $20,000 by a 24-year-old self-described ex-“surf bum” whose previous job had been selling ice cream from a truck. Superstores have created their own Web-based divisions in direct response to this demolition of barriers to entry.

    Nonprice competition. Federal antitrust guidelines for defining markets and assessing whether a firm has a monopoly usually focus almost exclusively on price competition. But electronic commerce is an especially potent competitor because it dramatically lowers the non-cash cost of obtaining office supplies. Companies of all sizes spend large amounts of money approving, processing, and/or having employees physically procure office supply orders. They typically incur $65 - $175 worth of non-cash costs to process individual orders for as little as $30 worth of supplies. E-commerce reduces these non-cash costs to $15 - $25 (80 percent to 85 percent) or less for home offices, small businesses, and corporations alike. Ignoring this kind of non-price competition seriously understated the competitive threat posed by e-commerce.

    Even the judge deciding FTC v. Staples expressed concern that “the defendants are being punished for their own successes and for the benefits they have brought to consumers.” By helping to create an innovative new way of selling office supplies, the companies made it possible for the government to argue for an unrealistically narrow definition of the market that ignored very real forms of competition involving other types of innovation. Hopefully, the next administration will learn from this mistake.

    All statistics and quotations in this document can be found in Christopher M. Grengs, Unpublished working paper, October 2000 “FTC v. Staples: Hoisted with Their Own Petards, a Case of Hamlet Without the Danish Prince.”

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    Citizens for a Sound Economy Foundation
    Capitol Comment 289:
    Assessing Antitrust Activism: FTC v. Staples Revisited
    (PDF format, 2 p. 328 Kb)