In 1997, office supply superstores (or OSSs) Staples and Office Depot tried to merge, but the deal was challenged on antitrust grounds by the Federal Trade Commission. The companies tried to fight the FTC in court and lost. Fast forward almost twenty years to 2016 and they tried again to merge. Again their deal was blocked by the FTC, again they tried to fight and again they lost.
This is one of few instances–if not the only–in which the same two businesses tried to merger twice, were challenged both times and then lost in court both times. The two cases will be compared and contrasted countless times by antitrust lawyers and economists across American to study how commerce and law has evolved. This blog post examines why it is rare to see the same merger fail twice, why it happened here and what lessons can be gleaned from the experience.
Why is this rare?
For starters, it is relatively infrequent that deals are challenged, let alone litigated and then abandoned, even the first time they are proposed. Over the last ten years, the U.S. antitrust agencies have closed more than 95% of their investigations into reportable mergers within 30 days taking no action. The agencies allow an even greater percentage of reportable mergers to ultimately consummate, either as proposed or with conditions. Through years of evolving experience among the small community of antitrust lawyers and economists who work for the government and in private practice, the boundaries of what mergers are acceptable from an antitrust perspective are in general commonly understood. As a result, many contemplated mergers that would be blocked by the agencies are pre-emptively blocked by lawyers in private practice who look to spare their clients the expenses, uncertainty, bad press and resulting business losses that they would otherwise endure by undergoing a lengthy and doomed merger review.
For a previously failed deal to be tried a second time, the private practice lawyers counseling the parties would need to have a compelling reason to believe that the second attempt would enjoy a different outcome from the first. Most of the time, innovation and new competition renders the old business models either obsolete or of limited competitive concern. Since 1997, American consumers have been introduced to cell phones, smart phones, wireless networks, broadband, high-speed internet, social media and the variety of other innovations that have brought about the virtual demise of video rental, book and music stores, and enabled previously unpalatable consolidation in other retail industries. This new reality appeared to also apply to the office supply superstores, at least it did in the closing statement the FTC issued after reviewing—and electing not to challenge—Office Depot’s merger with the former #3 office supply superstore, OfficeMax in 2013.
Thus, for a previously failed deal to fail a second time, whatever compelling reason the parties had to believe they would be successful must somehow prove to be erroneous or unrealizable in one or more ways. In Staples/Office Depot, several factors contributed to the unusual outcome.
How did the Staples/Office Depot merger fail twice?
The primary reason that Staples/Office Depot failed twice was that the FTC’s two cases against the combination were based on very different narratives. In 1997, the FTC’s narrative was that the merger would reduce competition in the stores, which would increase the price of office supplies to household consumers in the neighboring communities. In 2016, the FTC’s narrative was that the merger would reduce competition for contracts, which would increase the price of office supplies to the largest businesses in America.
The parties should have anticipated this second narrative, because the FTC introduced it in its 2013 Office Depot/OfficeMax closing statement. While there are noticeable discrepancies between how FTC characterized fringe competitors between the 2013 statement and the 2016 Staples/Office Depot, the parties failed to put on evidence showing that the FTC was right the first time. In fact, the parties declined the opportunity to introduce evidence into the record altogether and that might not have even been their biggest mistake. The parties failed to manage their employees who created documents—while the merger was under review—that strongly and unequivocally bolstered the government’s case against the deal.
The evolving narrative of OSS competition in FTC merger review.
In 1997, the FTC’s concerns over the Staples/Office Depot merger were primarily focused on the household consumer. While investigating the merger, the FTC learned the companies engaged in a practice known as “zone pricing.” Effectively, Staples and Office Depot stores would set prices for consumable office supplies such as pens, paper, ink and toner based on whether the other company—and/or OfficeMax—had a store nearby. The data collected by the FTC confirmed this practice: prices for a basket of products was cheapest in markets where all three companies had a presence and most expensive in markets where only one company had a store.
Other businesses that sold office supplies, Target, Walmart, Costco and Amazon, meanwhile, were not well-positioned to take sales away at that time. A customer shopping at Staples in 1997 did not have a smartphone with internet access to compare the in-store price against the online prices. In fact, most customers did not have a cell phone in their pockets to call the local Walmart to see if the same office supplies might be available there for cheaper.
When the FTC elected not to challenge the Office Depot/OfficeMax merger in 2013, the agency issued a closing statement explaining that the market “changed significantly” since it challenged Staples/Office Depot, as increased competition from online retailers brought about new “pricing practices and other strategies.” Namely, office supply superstores have become compelled to match lower prices found online and at other stores that sell office supplies, because most of their in-store customers have the ability and tendency to compare prices at the point of sale.
In the same closing statement, the FTC introduced and dismissed, what at the time seemed to be a seemly innocuous concern—the potential for competitive harm in the sale of consumable office supplies through contracts to large multi-regional or national customers, whose “most demanding purchasing requirements” can typically be met by only a handful of potential suppliers. However, according to the FTC a “substantial body of evidence” indicated that the Office Depot/OfficeMax merger was unlikely to “substantially lessen competition or harm large contract customers.” Namely because the parties faced strong competition for large enterprise customers from Staples, direct selling by manufacturers, a variety of fringe competitors such as W.B. Mason Co., Inc. (that, according to the FTC, were growing in “number” and in “strength”), regional office supply competitors that participated in distribution network cooperatives, and potential competitors in adjacent product categories, such as janitorial and industrial products, who could leverage their existing contractual relationships with large office supply customers to enter the office supply distribution market.
Perhaps because of the rosy outlook of office supply superstore competition that the FTC painted in its November 1, 2013 statement closing the Office Depot/OfficeMax merger without action, Staples and Office Depot waited only 15 months to announce their second attempt at merging. While the FTC—consistent with its findings in Office Depot/OfficeMax—took no issue with the mergers effect on household customers, the FTC’s seemingly innocuous discussion of the large multi-regional and national customers evolved into the FTC’s new narrative of harm, as it challenged the second Staples/Office Depot merger exclusively on those grounds and won decisively at trial.
The FTC’s 2016 complaint conflicts with its Office Depot/OfficeMax closing statement.
As explained above, in the 2013 closing statement for Office Depot/Office Max, the FTC indicated that non-office supply superstores such as W.B. Mason Co., Inc., regional office supply competitors working with office supply wholesalers and participating in distribution network cooperatives; and potential competitors in adjacent product categories, such as janitorial and industrial products, were all well-positioned to meet the needs of large multi-regional and national customers.
But in its 2016 complaint against Staples/Office Depot, the FTC explains that these competitors, could not “meaningfully constrain a post-Merger Staples” due to “some combination of higher costs and thus higher prices, limited geographic footprints, and/or logistical and coordination challenges” as well as limitations in “scale and capabilities.”
At the very least, this begs the question of why the FTC found these other competitors sufficient to permit a 3-to-2 merger in 2013, but not a 2-to-1 merger in 2016. The answer may very well be that Staples and OfficeMax were very different competitors in the enterprise market, though the Office Depot/OfficeMax closing statement does not make that clear. The answer may also be that the agency was less enforcement-minded when it reviewed Office Depot/OfficeMax and became very enforcement-minded by Staples and Office Depot’s brazen re-attempt at combining on the heels of the previous mega-merger in the same industry.
The parties were not adequately prepared to respond to the government’s reversed position.
Regardless of why the government shifted at least some of its thinking about fringe competitors to office supply superstores, the parties were not adequately prepared to respond to the case. This is apparent by two mistakes, and the responsibility for both ultimately lies with party counsel.
The parties’ first mistake was declining to advance testimony or evidence at the hearing. In briefs, the parties advanced several arguments, any of which if proven true could have won the case: the set of products the government included in calculating market was incorrect; the parties faced steep competition from Amazon for large multi-regional and national customers; the merger produced benefits for 99% of the customers that would outweigh any harm caused to the 1% of customers that were the large multi-regional and national customers.
However, the parties could not have possibly expected the court to rule with them on any of these points once they opted not to introduce any evidence or witnesses to testify to these facts. One of the fundamental rules of antitrust merger law is that if the government can show that the merging parties are the two primary competitors for an identifiable set of customers, then the government is essentially legally entitled to a presumption that a merger is anticompetitive and the burden is on the parties to prove otherwise. One of the unspoken rules of antitrust law is that the court is going to believe almost anything it hears from a respectable economist unless another respectable economist testifies that the opposite is true. If the parties believed that the FTC’s case against the deal produced all of the evidence that favored the deal, this raises serious questions about their assessment of the merits of the deal or their assessment of the FTC.
The parties’ second–and perhaps biggest–mistake was failing to adequately manage the employees’ creation of emails that supported the government’s case. Invariably, when close competitors attempt to merge, their lawyers have the task of explaining away “hot docs,” which are emails created by employees for the companies in the normal course of business—typically before there is any merger on the table—that show the intensity of competition between the parties. Once the parties agree to merge, however, antitrust counsel has an important job of stepping in and training employees to avoid creating any more “hot docs” than what already exists and making things that much harder.
Here, that was not done—at least it was not done effectively. In fact, the employee training was so poor, that the employees actually thought it was wise to use the proposed merger–according to the decision–“to pressure B-to-B customers to lock in prices based on the expectation that they would lose negotiating leverage if the merger were approved.” Examples of troubling and entirely avoidable “hot docs” created in this case included language such as:
- “This offer is time sensitive. If and when the purchase of Office Depot is approved, Staples will have no reason to make this offer.”
- “[The merger] will remove your ability to evaluate your program with two competitors. There will only be one”
- “Today, the FTC announced 45 days for its final decision. You still have time! You would be able to leverage the competition, gain an agreement that is grandfathered in and drive down expenses!”
There are a few interesting lessons to be learned from FTC v. Staples/Office Depot II. First, it illustrates how the largest players and closest competitors in certain markets often compete for several different customers in various ways, and how they may react to innovation and other market changes in parallel fashion. Thus, even if competition between those firms changes drastically in form over time, it can still remain constant in magnitude.
Second, the decision should remind lawyers of the importance of introducing evidence at hearings and of adequately training clients on internal emailing best practices while a merger is undergoing an antitrust review.
Third, it reminds us that antitrust enforcement remains an imperfect science that will often leave some important questions unanswered. In this case, if the parties could not prove to the court or the FTC that fringe competitors play a significant role today. So why did the FTC think they played enough of a role in 2013 to justify closing the Office Depot/OfficeMax merger review without action?