aai The American Antitrust Institute Whole Foods Proposed Acquisition of Wild Oats: The FTC Has Earned Its Day in Court July 7, 2007 Diana Moss 1 I. INTRODUCTION The American Antitrust Institute (AAI) has conducted an independent review of the proposed acquisition of Wild Oats Markets, Inc. (Wild Oats) by Whole Foods Market, Inc. (Whole Foods). Whole Foods and Wild Oats are the two largest retailers of natural and organic products, including food, vitamins, health and body care, and household items. The two companies operate (or potentially operate through plans to enter) in 28 geographic markets in the U.S. After three months of preliminary investigation, the Federal Trade Commission (FTC or the Commission) filed on June 6, 2007 a complaint in the U.S. District Court for the District of Columbia for a temporary restraining order and preliminary injunction to block the proposed merger. A hearing is scheduled for July 31, 2007 to decide whether the FTC’s application will be approved. If it is approved, in the normal course of events, 1 Vice President and Senior Fellow, American Antitrust Institute (AAI). The American Antitrust Institute is an independent Washington-based non-profit education, research, and advocacy organization. Our mission is to increase the role of competition, assure that competition works in the interests of consumers, and challenge abuses of concentrated economic power in the American and world economy. For more information, please see www.antitrustinstitute.org. This briefing paper has been reviewed by individuals inside and outside the AAI and has been approved by the AAI Board of Directors. It should not be taken necessarily to reflect the views of any member of the Advisory Board. A list of our contributors of $1,000 or more is available on request. 1 the merging parties will walk away from the merger. If the preliminary injunction is denied, the parties may go through with their transaction, but the Commission may nonetheless subsequently challenge it in an administrative trial. The AAI’s review of the proposed merger has been informed by publicly available information. We believe this background provides an adequate understanding to frame the major competitive questions that are likely to be addressed at hearing in order to determine if the merger may tend substantially to lessen competition, thereby violating Section 7 of the Clayton Act and Section 5 of the Federal Trade Commission Act. There has been a good deal of public criticism of the Commission for bringing this case, both by the parties themselves through an unusual website-based public relations initiative, and by such critics of antitrust as the Wall Street Journal. 2 The FTC cites to numerous factors and questions that make a highly compelling case for looking closely at whether a Whole Foods/Wild Oats combination will tend substantially to lessen competition. In our opinion, therefore, there is enough “smoke to suspect a fire.” And rather than condemning the FTC--as some pundits have already done--the public should await the results of the hearing. The AAI believes that there are at least three major issues that are worthy of investigation at a hearing on the preliminary injunction: ● The legality of the proposed merger turns on product market definition. The Commission defines a relevant product market centered on the category of “premium natural and organic supermarkets.” In such a highly concentrated market in 28 geographic regions across the U.S., the merger would eliminate the second largest competitor or a potential competitor. The merging parties make statements that support this market definition. But they also make statements that the relevant market is centered on full-line supermarkets and mass merchandisers selling natural and organic products, in which case the effect of the merger is de 2 See, e.g., Holman W. Jenkins, Jr., “Whole Food Fight,” Wall Street Journal , June 27, 2007. 2 minimis . Given this controversy, the appropriate scope of the relevant market will undoubtedly attract significant attention. ● An analysis of the merging parties’ pricing data in relevant markets should be viewed as complementary to the parties’ statements that the purpose of their merger is to avoid competition. Whole Foods’ John Mackey has made a number of public statements regarding the motives for the merger. Some of these statements reflect legitimate objectives such as cost savings, but others reflect a clear desire to stifle competition. In light of this, “natural experiments” using price data to determine if existing or potential competition discipline pricing by the merging parties should be viewed as a complement to anticompetitive motives in developing evidence that the merger would tend substantially to lessen competition. ● The merger’s effect on eliminating a potential competitor deserves equal attention to the elimination of an existing rival in the relevant market. Whole Foods’ John Mackey clearly acknowledges that one motive for the merger is to eliminate the single competitor which has the scale and brand identity that could serve as a “toe hold” for entry or expansion by a Whole Foods’ rival. This possible effect of the merger deserves significant scrutiny. II. BACKGROUND On February 21, 2007, Whole Foods and Wild Oats entered into an agreement in which Whole Foods proposed to acquire all of the voting securities of Wild Oats for $671 billion in cash and assumed debt. Whole Foods has acquired 18 other natural and organic retailers since its founding in 1980, including Fresh Fields, Harry's Farmer's Market, and Nature's Heartland. None of these transactions were opposed by the Commission. Whole Foods estimates that 25 percent of Whole Foods’ growth has come from acquisitions and 75 percent from opening new stores. 3 In 2006, Whole Foods had estimated revenues of about $5.6 billion across 191 stores in the U.S., Canada, and the United Kingdom. Wild Oats has about $1.2 billion in revenue with 110 stores in the U.S. and Canada. 3 “Whole Foods Market, Wild Oats, and the Federal Trade Commission.” June 19, 2007. Online. Available http://www.wholefoods.com/blogs/jm/archives/2007/06/whole_foods_mar_1.html#2. (wholefoods.com). 3 III. ISSUES LIKELY TO BE RAISED IN A HEARING ON THE PRELIMINARY INJUCNTION The three issues likely to be raised at the hearing on the preliminary injunction outlined in the previous section appear frequently in publicly available information regarding the proposed merger. They have generated significant controversy and, in some cases, contradictory statements by the merging parties, as discussed in the following sections. A. The Legality of the Proposed Merger Turns on Product Market Definition In a website posting dated June 19, 2007, 13 days after the FTC filed their complaint in federal district court, Whole Foods Chairman and CEO John Mackey reveals a number of reasons for acquiring Wild Oats. He states that these reasons were provided to his Board of Directors prior to the first Board Meeting to discuss the deal. They include, among others: “Elimination of a competitor--they compete with us for sites, customers and Team Members.”4 This statement clearly recognizes a relevant market that includes both Whole Foods and Wild Oats. The FTC argues in its complaint for a separate category of “premium natural and organic supermarkets” as the relevant product market. It notes, for example, a supporting statement in Whole Foods’ 2006 annual report: “’We believe our heavy emphasis on perishable products differentiates us from conventional supermarkets. .’”6 4 wholefoods.com. 6 Federal Trade Commission, v. Whole Foods Market, Inc. and Wild Oats Markets, Inc. , Complaint for Temporary Restraining Order and Preliminary Injunction Pursuant to Section 13(b) of the Federal Trade Commission Act, Case No. 1:07-cv-01021 (Complaint), June 6, 2007, at 8. 4 The Commission quotes Wild Oats most recent 10K to similar effect: “’. .[Wild Oats] believe[s] that conventional supermarkets still lack the concentration on a wide variety of natural and organic products, and emphasis on service and consumer education that our stores offer.’” 7 The FTC complaint goes on to allege that Whole Foods believes that customers do not view other channels that sell natural and organic foods as alternatives. For example, Mr. Mackey states that: “’Wal-Mart doesn’t sell high quality perishable and neither does Trader Joe’s. .[t]hat is why Whole Foods coexists so well with [Trader Joe’s] and it is also why Wal-Mart isn’t going to hurt Whole Foods.’” 8 “’Safeway and other conventional retailers will keep doing their thing – trying to be all things to all people . .they can’t really effectively focus on Whole Foods Core Customers without abandoning 90% of their own customers.’” 9 “’Whole Foods is “a company that is authentically committed to its mission of natural/organic/healthy foods. Its core customers recognize this authenticity and it creates a customer loyalty that will not be stolen away by conventional markets who sell the same products. Whole Foods has created a “brand” that has real value for millions of people.’” 10 However, in a June 19 website posting (after the FTC Complaint was issued), Mr. Mackey argues for a broader all-supermarket market definition. He acknowledges the existence of a “premium natural and organic supermarket” but states that Whole Foods is the only company in that market. 11 At the same time, he asserts that Whole Foods 7 Ibid, at 10. 8 Ibid, at 8. 9 Ibid, at 9. 10 Ibid, at 9. 11 wholefoods.com. Mr. Mackey states