If you think it’s bad having to admit at parties that you are a lawyer, try explaining that what you deal with is called the Hart-Scott-Rodino Antitrust Improvements Act of 1976. At least you won’t be stuck talking about work all night. But if there isn’t much glamor in HSR work, there certainly is the devil in it: The Act and the Rules accompanying it are hopelessly complicated and convoluted. Hopelessly? Not quite. There is the new edition of Axinn/Fogg/Stoll/Prager/Pisa. And I am planning a series of posts about HSR, and specifically about questions of reportability, to show some principles, shortcuts, and tricks that I have found helpful. I’ll add the disclaimer now that it will all be eclectic and some of it apocryphal. Probably none of it will be news to those who deal with HSR regularly. Please let me know your comments.

The big question of course is, to what extent does §7 guide the interpretation of HSR? §7 Clayton Act forbids acquisitions of voting securities or assets that will substantially lessen competition or tend to create a monopoly. The HSR Act, as a procedural statute, seeks to aid the enforcement of §7 by requiring the premerger notification of transactions that are likely to run afoul of §7. It is obviously easier to prevent a merger than it is to undo it. But how likely must a transaction be to violate §7 in order to justify premerger notification? There are two opposing interests at work: The interest of the enforcement agencies is to cast the net wide in order not to miss anything. The interest of merger parties is not to incur the costs of the premerger notification process needlessly. But it is also in our general interest not to make the premerger notification process too costly, since inefficiencies in the process by definition will deprive consumers of efficiency-enhancing benefits. The slightly simplified view of antitrust lawyers is that there are only two reasons for a merger or an acquisition: To enhance efficiency or to increase market power (thus potentially lessening competition and harming consumers). If a transaction that doesn’t fall under §7 is subject to premerger notification requirements, the efficiencies flowing from the transaction are delayed, temporarily depriving consumers of the benefit. This trade-off between prevention and efficiency is a necessary feature of a premerger notification program, and the only question is: how can we optimize the selection of mergers that should be notified and subject to a waiting period?

This graph shows the overlap between §7 and HSR reportability. HSR is overinclusive, since it requires the notification of transactions that have little or no potential of substantially lessening competition (that will be theme throughout these posts). But it is also underinclusive, since there are transactions that do (or could) lessen competition but that are not subject to reporting requirements. The primary example are transaction that fall below the minimum threshold of currently $63.1 million. The graph  shows the three tools that HSR gives the antitrust agencies: a waiting period of usually 30 days (15 days for cash tender offers), access to the parties’ relevant documents (specifically those discussing markets, market shares, competition, competitors and so forth), and Requests for Additional Information and Documentary Evidence, known as Second Requests, which function as subpoenas and interrogatories that the agencies may issue without recourse to the courts.

The size of the green circle, for transactions violating §7, is probably too large in the graph, as the following graph suggests. The information comes from the DOJ/FTC Annual Report for Fiscal Year 2007.

The statistics show that about 1.5% of all reportable transactions are ultimately challenged by the agencies. The empirical question raised is whether the competitive harm to consumer welfare of those 1.5% outweighs the cost of premerger notification imposed on the other 98.5% transactions. But phrasing the question that way skews it. It will be hard to quantify the preventive effect of the premerger notification requirement: anti-competitive transactions are restructured or abandoned because it is clear to the parties that the agencies would challenge them after HSR notification has been filed. My hunch is that the preventive effect is significant and significantly higher than it would be if all §7 enforcement occurred post-closing; the HSR Act therefore is not ludicrously broad in its reach.

Rather, the message is that in interpreting HSR’s notification requirement, the ultimate reach of §7 should be kept in mind and the reportability of transactions that cannot even potentially violate §7 avoided.

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I am declaring today HSR Day. After the announcement of the new adjusted thresholds for 2009 came out, the Third Edition of Acquisitions Under the Hart-Scott-Rodino Antitrust Improvements Act: A Practical Analysis of the Statute & Regulations landed on my desk.

This trusted and indispensible resource for anyone who deals with premerger notification issues under HSR is now in three volumes, which I hope will make it a bit handier—the most relevant discussions are in Volume 1, and Volumes 2 & 3 are for occasional reference. (Volume 2, for example, contains the Statement of Basis and Purpose—or SBP, as it is known to HSR junkies.) The Third Edition adds Joe Nisa as an author, who is acknowledged in the Introduction as a primary contributor to the revised work. The treatise is published by the Law Journal Press, and more information can be found here. Congratulations to the authors! I’ll blog about my impressions as I’ll work my way through the Third Edition.

The final reason this is HSR Day on the Antitrust Review is that I will be kicking off a series of posts about HSR and the U.S. premerger notification process. The posts will be geared toward those who want a quick understanding of HSR filing requirements; I also hope to share some shortcuts and tricks for getting the question “Do we have to file?” right.

Happy HSR Day!

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The FTC has announced the new adjusted HSR thresholds. Every year the thresholds are adjusted, up from the original amounts in §7A Clayton Act. Adjustments will be effective 30 days after publication. The FTC’s press release is here.

HSR ORIGINAL THRESHOLD AND ADJUSTED THRESHOLD

• $10 million adjusted to $13.0 million
• $50 million adjusted to $65.2 million
• $100 million adjusted to $130.3 million
• $110 million adjusted to $143.4 million
• $200 million adjusted to $260.7 million
• $500 million adjusted to $651.7 million
• $1 billion adjusted to $1,303.4 million

The thresholds for §8 Clayton Act (Interlocking Directorates) will also be adjusted, as follows:

CLAYTON ORIGINAL THRESHOLD AND ADJUSTED THRESHOLD

• $1 million  adjusted to $2,616,100
• $10 million  adjusted to $26,161,000

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The D.C. Circuit Court of Appeals issued an order today denying Whole Food’s petition for a rehearing en banc. We have posted about the case here, here, here, and here. It will be no comfort to the defendant that the Circuit granted the unusual motion for leave to file a reply (which was written by Ted Olson). The denial of a rehearing means that the panel’s decision remanding the FTC’s petition for a preliminary injunction to the district court stands, and that we can expect further insight into whether the FTC met the newly-confused standard for a preliminary injunction that will guide the district court (in this particular case).

Meanwhile, the FTC is pursuing administrative proceedings on the substance of the alleged §7 violation before Administrative Law Judge Michael Chappell.

Here is the text of the order denying rehearing:

The petition of appellee Whole Foods Market, Inc. (”Whole Foods”) for rehearing en banc was circulated to the full court, and a vote was requested. Thereafter, a majority of the judges eligible to participate did not vote in favor of the petition. Upon consideration of the foregoing and the motion of Whole Foods for leave to file a reply, the opposition thereto, and the lodged reply, it is ORDERED that the motion for leave to file a reply be granted. The Clerk is directed to file the lodged reply. It is FURTHER ORDERED that the petition be denied.

Judge Ginsburg along with Judge Sentelle issued a concurrence to the denial of rehearing which stated:I concur in the denial of rehearing en banc because, there being no opinion for the Court, that judgment sets no precedent beyond the precise facts of this case. See King v. Palmer, 950 F.2d 771, 783 (D.C. Cir. 1991) (en banc) (”without implicit agreement” among a majority of the judges “we are left without a controlling opinion”).

An amended version of the panel decision, also issued today, is here. HT to AT-CONVERSATION listserve.

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Here is a youtube clip describing the sadly imperfect market conditions prevailing in the Death Star… cantine. It is a useful, if somewhat technical, illustration of asymmetrical information barriers to concluding a transaction.

HT to Olivier. And TGIF.

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The Supreme Court will hear oral arguments in the case of Pacific Bell Telephone Company v. LinkLine Communications, Inc. on December 8th. (Briefs can be found here.) The court rushed to grant cert on a case that is on interlocutory appeal from a 12(b)(6) motion; the facts haven’t been fully developed, leaving (for example) the question of market definition open—do DSL services compete with satellite and cable? I predict that the Supreme Court will regard the case as an opportunity to extend the reach of Brooke Group, thereby further limiting Section 2 liability and abolishing price squeezes as a theory of liability, and to reinforce the message in Trinko that antitrust law takes a backseat to regulation, even imperfect regulation.

The facts. LinkLine is an internet service provider (ISP) that sells its customers DSL access. It purchases wholesale DSL services from AT&T California (formerly SBC, formerly Pacific Bell), which is the incumbent local exchange carrier (or ILEC) and required under the Telecommunications Act to provide wholesale DSL services to ISPs. AT&T is vertically integrated and also sells DSL access and ISP services at retail. LinkLine claims that the difference between the price at which AT&T sells wholesale DSL services and the price of AT&T’s retail DSL/ISP is such that LinkLine cannot compete at retail with AT&T. It is the classic price squeeze allegation first formulated in Alcoa. The (so far uncontested) allegation is that at times AT&T’s retail price was below the wholesale price for DSL access charged to LinkLine. (Here is another point that is not developed factually because of the early grant of cert: to what extent are prices for whole sale DSL services and retail DSL access + ISP services comparable?)

Depending on how you look at it, the problem is either that AT&T’s wholesale rate is too high, or that its retail price is too low. The wholesale price is subject to regulation and regulatory oversight. The retail price isn’t; but a retail DSL price that is too low points to a Brooke Group-style predatory-pricing claim. The district court, granting leave to file an interlocutory appeal from its denial of AT&T’s 12(b)(6) motion, certified the following question to the Ninth Circuit:

“The issue before the Ninth Circuit will not be whether Trinko bars price-squeeze claims generally but, more specifically, whether it bars predatory price-squeeze claims (i.e., price-squeeze claims which comply with the Brooke Group requirements).”

The Ninth Circuit affirmed. By the time the Supreme Court granted cert (the Solicitor General was in favor, the FTC opposed), the issue had become broader:

Whether a plaintiff states a claim under § 2 of the Sherman Act by alleging that the defendant—a vertically integrated retail competitor with an alleged monopoly at the wholesale level but no antitrust duty to provide the wholesale input to competitors—engaged in a “price squeeze” by leaving insufficient margin between wholesale and retail prices to allow the plaintiff to compete.

The case raise two issues: Should there be a price squeeze theory of liability under §2? And does Trinko preclude liability in this case because there is regulation in place that controls the wholesale price AT&T can charge as the ILEC?

The Reach of Trinko. The Ninth Circuit, in an elegantly reasoned opinion (pdf), argued that Trinko does not preclude liability. The Trinko decision of course is a bit schizophrenic in its treatment of antitrust in regulated industries. Trinko first acknowledges that the Telecommunications Act explicitly does not replace antitrust liability: “[N]othing in this Act … shall be construed to modify, impair, or supersede the applicability of any of the antitrust laws.” By the end of the Trinko decision, however, the Supreme Court holds that antitrust liability is precluded by the existence of regulation, for two reasons: (1) The claim in Trinko was novel while the TelCo Act did not contemplate an expansion of antitrust liability, and (2) the presence of a regulatory structure designed to deter and remedy anti-competitive harm and the cost of false positives flowing from enforcing §2 counsel against expanding the reach of §2. Applying this test, the Ninth Circuit found that a price-squeeze claim is a traditional antitrust theory of liability going back to Alcoa (thus does not require an expansion of antitrust liability), and that the regulatory structure at work in the LinkLine case is not “designed to deter and remedy anti-competitive harm” of the price-squeeze kind, because the regulation operates only on wholesale level but not on the retail level. Here is a graphic summary of the argument:

While I am sympathetic to the Ninth Circuit’s argument, I doubt that the Supreme Court will buy it. It’s an antitrust commonplace these days that putting courts in the position of setting or approving prices is a bad idea. This will be grounds enough for the Supreme Court to further tighten the Trinko holding, I believe. The Court will hold that even incomplete regulation precludes antitrust liability and that it is the regulator’s duty to make sure that regulated wholesale price is low enough not to enable the vertically-integrated monopolist to use a price squeeze. This approach is problematic: The LinkLine case shows that price regulation at only the wholesale level provides an opportunity for the vertically-integrated monopolist to distort competition to the detriment of its competitors, whose costs it at least partially controls. That is not to say that I am entirely comfortable with a court imposing §2 liability here. I also would rather avoid thrusting the courts in a position of approving prices. But wouldn’t the threat of §2 liability, even imperfectly administered, have a salutary effect on the behavior of vertically-integrated monopolists?

The Price Squeeze. The second issue is the price squeeze. The theory flows from United States v. Aluminum Co. of America [Alcoa] (1945) and Town of Concord v. Boston Edison Co. (1990). Judge Learned Hand in Alcoa identified four elements of a price squeeze claim: (1) monopoly power; (2) the monopolist charges a wholesale price that is higher than a “fair price;” (3) the monopolist competes downstream (that is, is vertically-integrated); and (4) the monopolist’s downstream or retail price is so low that competitors cannot match it and still earn “a living profit.” Two things about this test are problematic. First, the thought that courts will need to adjudicate what a “fair” wholesale price is, and second that the Alcoa test is not connected to the question whether the monopolist has a duty to deal with its competitors. It seems obvious that, if the monopolist has no duty to deal at all with a (downstream) competitor, it cannot have a duty to deal at a particular price if it chooses to sell to the downstream competition. Charging “high” wholesale prices is economically equivalent to an outright refusal to deal, and it should not lead to liability absent a duty to deal at the wholesale level.

The duty to deal is also the point of departure for the DoJ in its brief favoring reversal of the Ninth Circuit: AT&T had no antitrust duty to deal with LinkLine. True, there was a regulatory duty to deal under the TelCo Act, but since that wasn’t an antitrust duty to deal, it should be ignored and the case decided as if there were no duty to deal at all, according to the DoJ. This line of reasoning has a certain logical elegance, and it builds on some previous cases (like Covad), but it isn’t satisfying. The TelCo Act, after all, created the system of ILECs and CLECs and duties to deal in order to create competition with the ILECs. If antitrust law (which the TelCo Act by its own terms did not impair or supersede) ignores the regulatory duty to deal, and the TelCo Act regulation doesn’t address the price squeeze because it reaches only the wholesale level, the public policy underlying the TelCo Act is undermined. The mandate that there be competition with the ILECs has lost its teeth.

The conclusion reached by the DoJ is that price squeezes, absent (antitrust) duty to deal at the wholesale level, can’t state a claim. (And it doesn’t help that the Ninth Circuit was unable to formulate a really practicable test for a price-squeeze claim, withdrawing instead to an intent requirement “so serve monopolistic purposes” drawn from the Ninth Circuit’s City of Anaheim decision.) According to the DoJ, price-squeeze theories boil down to a claim that retail pricing is so low as to harm competition. Antitrust liability for price squeezes is therefore justified only, according to the DoJ, if the Brooke Group standard for predatory pricing is met. This in effect abolishes the price squeeze as a theory of antitrust liability, because no additional elements of the squeeze are necessary if prices are below cost and there is a prospect of recoupment.

But I have my doubts that Brooke Group fits in these situations: on the one hand, the predatory-pricing test ignores the existence of a regulatory duty to deal (as I’ve discussed), since it only compares retail prices with some measure of cost of the monopolist—it is blind to the wholesale level. On the other, the Brooke Group standard, with its recoupment test, is particularly tough to meet. This toughness is generally justified because antitrust law should be wary of enforcing higher prices; low prices prima facie enhance consumer welfare. In other words, the risk of false positives is particularly high where liability is based on prices that are allegedly too low. The tough standard is much less justified if, as in the price-squeeze cases, the defendant monopolist controls the cost of a significant input of its competitors. In LinkLine, AT&T controls the price of DSL wholesale services, which we can assume will make up the largest item in LinkLine’s cost of delivering DSL retail services. This fact diminishes significantly the concern of false positives. A tough standard for predatory pricing is justified where there is a danger of protecting the less-efficient competitor. It is much less justified where it is in the power of the low-price vertically-integrated monopolist to raise the cost of its retail competitors.

Update: The American Antitrust Institute, a private think tank that filed an amicus brief in LinkLine,  has been given time at oral argument. It is highly unusual or even unprecedented for public-interest organizations to be given oral argument time in antitrust cases, although the state AGs have appeared in oral argument before (for example in State Oil v. Khan and Leegin). HT to the AT-CONVERSATION listserve.

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The FTC yesterday granted Early Termination (.pdf) for the $34.9 billion transaction in which Bank of America will buy Merrill Lynch, a deal that was announced just after Lehman Brothers folded.

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As I posted earlier, Whole Foods filed a petition for a rehearing en banc after losing its appeal in the D.C. Circuit. Last month, the FTC responded by filing a brief in opposition (pdf), stating that the D.C. Circuit Court panel “applied established standards to the specific factual setting of this case, and rendered a ruling that focused on the evidenced adduced by the FTC.” Whole Foods is now responding with a reply brief (pdf) written by Ted Olson of Dechert: “As if in a time warp, the [D.C. Circuit Court] Panel eclipsed decades of leading cases — including this court’s decision in Heinz and Baker Hughes, which require an analysis of the competitive effects of a merger under modern economic principles — and dusted off a series of cases dating back to the 1960s that have long been discarded by modern antitrust decisions.” (Here is Whole Foods’ petition for leave to file a reply, since replies are not typically provided for in en banc petitions.)

I’ll have some commentary on the back and forth a little later.

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Perhaps you need a little relief from watching the distressing news from Wall Street. Here is an article by Jonathan Baker in the New Republic: Turning on Itself: How Dueling Agencies in the Bush Administration Made Mincemeat of Antitrust Regulation Policy. I daresay much will be written about the antitrust legacy of the Bush administration, and the recent Single-Firm Conduct report will be regarded as an effort to leave a tangible legacy of the administration’s impact on antitrust doctrine. Here is a taste from Baker’s article:

There’s no doubt that the non-interventionists at Justice are thoughtful and principled, but in cutting back on antitrust enforcement, they have taken antitrust policy in a dangerous direction. Even the FTC’s counterweight won’t undo the damage because the FTC specializes in different industries. It will take time, of course, to see how the non-interventionist antitrust stance at Justice affects people’s everyday lives–if the small Korean appliance importers can challenge Whirlpool’s dominance, for example. But, with luck, the damage will be minimal, and we can rid the Justice Department of the deregulatory radicalism that allows monopolies to spin out of control if a new administration rolls into town in January.

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On the heels of the DoJ Report on Single Firm Conduct, the FTC Commissioners have issued two statements, one by Chairman Kovacic and another by the other three Commissioners.

Here is what Commissioners Harbour, Rosch, and Leibowitz have to say:

We have two overarching concerns with the Department’s Report. First, the U.S. Supreme Court has declared that the welfare of consumers is the primary goal of the antitrust laws. However, the Department’s Report is chiefly concerned with firms that enjoy monopoly or near- monopoly power, and prescribes a legal regime that places these firms’ interests ahead of the interests of consumers. At almost every turn, the Department would place a thumb on the scales in favor of firms with monopoly or near-monopoly power and against other equally significant stakeholders.

Second, the Report seriously overstates the level of legal, economic, and academic consensus regarding Section 2.

The full statement is here (pdf).

Chairman Kovacic offers substantive observations on the historical perspective, intellectual influences, and the “double-helix” of Harvard and Chicago school. His introduction hints at the fact that the report reflects the surface of an apparently deepening rift between FTC and DoJ:

To advance the analysis of dominant firm conduct, the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC) in 2006 undertook an ambitious program of public consultations. When these proceedings began, I hoped that if the agencies were to publish something based on the deliberations, they would prepare one document that reflected their common views. That did not come to pass. Today the DOJ has issued its policy prescriptions based on the proceedings and related research.

Robust public debate – even between the two federal antitrust agencies – can serve the valuable end of pressing the U.S. antitrust system toward the acceptance of better practices. If one fears one’s ideas cannot survive an open intellectual contest, it is time to get new ideas. I do not expect today’s events to diminish the efforts of the DOJ and the FTC to cooperate in addressing key issues and in performing the valuable function of giving guidance about their views of doctrine and about their enforcement intentions.

Kovacic’s statement is here (pdf).

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As we have reported here before, the D.C. Circuit recently overturned the district court’s ruling in FTC v. Whole Foods, holding that it was legal error to consider only marginal customers in assessing whether the FTC had met its burden for a preliminary injunction, since “core customers,” under the Brown Shoe practical indicia, could form a submarket for purposes of Section 7 Clayton Act.

Whole Foods has now filed a motion for rehearing en banc. In its motion, Whole Foods argues that the D.C. Circuit panel, particularly the majority of Judges Brown and Tatel, erred in three respects:

• The standard that an injunction should be granted unless the FTC “entirely failed” to show a likelihood of success on the merits conflicts with D.C. Circuit precedents, as well as with other decisions of other circuits;
• The analysis of the standard for product markets was wrong; and
• The D.C. Circuit should have considered Whole Food’s arguments regarding the transaction’s likely effect on competition.

Whole Foods earlier this week filed another motion, “to disqualify the Commission as administrative law judge and to appoint a presiding official other than a Commissioner.”

The motion for rehearing en banc is here, and the motion for another administrative law judge is here.

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Jeff Schmidt, the current Director of the Bureau of Competition, will leave the FTC. He will be replaced by David P. Wales as Acting Director.

The FTC’s press release states:

Schmidt joined the Commission in February 2005 as Deputy Director of the Bureau of Competition. As Director, he supervised the Bureau’s merger and non-merger enforcement divisions, played a key role in developing antitrust policy, secured important changes in the Bureau’s infrastructure and merger review processes, and managed Bureau resources during a time when the FTC’s federal court case docket was greatly expanded.

In the merger area, Schmidt directed enforcement efforts against several proposed transactions, including district court challenges in the Whole Foods/Wild Oats, Inova/Prince William Hospital, and Equitable/Dominion matters. He also helped lead the FTC in gaining favorable enforcement results in Allegan/Inamed, Fresenius/Renal Care Group, Boston Scientific/Guidant, Linde/BOC, Compagnie de Saint-Gobain/Owens Corning, Schering Plough/AkzoNobel, Johnson & Johnson/Pfizer, and Carlyle Partners/INEOS Group, Ltd.

In the non-merger area, Schmidt was responsible for supervising challenges in several matters, including Cephalon and Warner-Chilcott in the pharmaceutical industry and MiRealSource and RealComp in the real estate industry.

After leaving the Commission, Schmidt will join the Linklaters law firm as a partner in their New York office.

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Dan Sokol is conducting a “survey of non-government antitrust practitioners (including practitioners with law firms and in-house) who undertake antitrust work in the United States to better understand how antitrust law shapes compliance.” You can take 8-12 minutes to fill it out here.

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After mulling it over for a couple of days, here are some first thoughts on FTC vs. Whole Foods. Litigated cases, and especially appellate court decisions, are so rare in Section 7 matters that each decision carries enormous weight in shaping the advice counsel will give their M&A clients and the agencies’ attitude when deciding whether to undertake the cost and uncertainty of litigating merger challenges. It is unfortunate, therefore, that the Whole Foods opinion from the disproportionately influential DC Circuit seems a step backward in Section 7 jurisprudence.

Brown Shoe Retooled. The majority opinion and concurrence cite to Brown Shoe ten times, but only once to Baker Hughes. There are 18 cites to H.J. Heinz, but only for the question what standard a district court must apply in deciding whether to grant the FTC’s motion for a preliminary injunction blocking the merger. There is no cite to Heinz’s discussion of the test for market definition and anticompetitive effects. In Whole Foods, it’s a straight diet of Brown Shoe. One doesn’t like to speak poorly of venerable precedent, but Brown Shoe is a decision that condemned a merger that would have lead to the four largest manufacturers accounting for 23% of the domestic production of shoes. The opinion shows more than a little ambivalence about protecting competition, not competitors, even though Brown Shoe is often cited for that maxim (which the Supreme Court in its recent spade of antitrust decisions has gone out of its way to endorse and enforce). Here is a that passage from Brown Shoe:

It is competition, not competitors, which the Act protects. But we cannot fail to recognize Congress’ desire to promote competition through the protection of viable, small, locally owned business. Congress appreciated that occasional higher costs and prices might result from the maintenance of fragmented industries and markets. It resolved these competing considerations in favor of decentralization. We must give effect to that decision. 370 U.S. 294, 344.

Brown Shoe also shows some ambivalence about how markets can be defined. There is, one the one hand, a very modern sounding reference to cross-elasticity of demand between the product and its substitutes for defining markets. But it is followed in Brown Shoe by an endorsement of the concept of submarkets that are not defined by rigorous economic principles, but rather by the dreaded “practical indicia”:

However, within this broad market [defined by cross-elasticity of demand], well defined submarkets may exist which, in themselves, constitute product markets for antitrust purposes. United States v. E.I. du Pont de Nemours & Co., 353 U. S. 586, 353 U. S. 593-595. The boundaries of such a submarket may be determined by examining such practical indicia as 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. Because § 7 of the Clayton Act prohibits any merger which may substantially lessen competition “in any line of commerce” (emphasis supplied), 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. 370 U.S. at 326.

And here is Judge Brown in 2008:

In short, a core group of particularly dedicated, “distinct customers,” paying “distinct prices,” may constitute a recognizable submarket, Brown Shoe, 370 U.S. at 325, whether they are dedicated because they need a complete “cluster of products,” Phila. Nat’l Bank, 374 U.S. at 356, because their particular circumstances dictate that a product “is the only realistic choice,” SuperTurf, Inc. v. Monsanto Co., 660 F.2d 1275, 1278 (8th Cir. 1981), or because they find a particular product “uniquely attractive,” Nat’l Collegiate Athletic Ass’n v. Bd. of Regents of the Univ. of Okla., 468 U.S. 85, 112 (1984). For example, the existence of core customers dedicated to office supply superstores, with their “unique combination of size, selection, depth[,] and breadth of inventory,” was an important factor distinguishing that submarket. FTC v. Staples, Inc., 970 F. Supp. 1066, 1078–79 (D.D.C. 1997). As always in defining a market, we must “take into account the realities of competition.” Weiss v. York Hosp., 745 F.2d 786, 826 (3d Cir. 1984). We look to the Brown Shoe indicia, among which the economic criteria are primary, see Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 792 F.2d 210, 219 n.4 (D.C. Cir. 1986).

Maybe I shouldn’t be surprised by this. But the passage does more than accept that, given the difficulties of economic analysis, we can supplement it with some common-sense heuristic insights to come up with markets. This approach seems to undermine the acceptance of the theoretical foundations of economic analysis. In Whole Foods, the majority goes on to say that, based on the “unique environment” of the stores and the “core values” of the customers, there is a “submarket” of core customers of Premium, Natural and Organic Supermarkets. The court cites favorably the FTC’s efforts to connect the intangible properties with facts: PNOS carry a much larger selection of natural and organic products and have a much greater concentration of perishables than conventional supermarkets. The court also points out, at another point, that it doesn’t change the analysis that customers cross-shop at conventional supermarkets, and that PNOS check their prices. This, the court reasons, is because “cross-shopping is entirely consistent with the existence of a core group of PNOS customers.”

I read this to mean that the “practical indicia” have become the trump card to beat economic analysis. At this point I should admit that I don’t believe in submarkets. If there is a product bundle that some customers value to such an extent that they will pay the hypothetical monopolist’s SSNIP, then that product bundle may certainly be a market. But such an approach just highlights the maddening absence of any product market definition at all in the FTC’s case. In its complaint, the FTC stated under the heading Relevant Markets: “The operation of premium natural and organic supermarkets is a distinct ‘line of commmerce’ within the meaning of Seciton 7…” That’s not a market, unless you buy and sell supermarkets for a living. In defining a product market, the products sold in PNOS could be a market, and this brings out the possibility that only certain products sold in PNOS could form a market, to the exclusion of others also sold there. Starting with a bundle of products sold in PNOS makes the distinction between core and marginal customers clearer, because market definition then depends not on Brown Shoe’s practical indicia, but on the customers’ preferences or demand curves, as it should. Core (or inframarginal) and marginal customers, by definition, are terms that reference the same market (substitutable products), and are distinguished only on the basis of the projected reaction of consumers to a hypothetical increase in price. Every customer is a marginal customer if you only raise price high enough.

But the majority opinion in Whole Foods is difficult to follow when it comes to core vs. marginal customers: Judge Brown states that “the district court committed legal error in assuming market definition must depend on marginal consumers,” and that “the district court’s error of law led it to ignore FTC evidence that strongly suggested Whole Foods and Wild Oats compete for core consumers within a PNOS market, even if they also compete on individual products for marginal consumers in the broader market.” The court takes Sheffman’s economic analysis to task for depending “only on the marginal loss of sales.” But it seems clear that in gauging incipient competitive harm, the question to ask is whether the presence of marginal consumers, whose sales would be diverted to traditional supermarkets if the merged parties raised prices, protects the core customers, whose demand is less elastic. And under the Guideline’s SSNIP test, market definition also turns on marginal customers, since diversion in the case of the hypothetical monopolist’s SSNIP determines substitutability. Whether Section 7 acts to protect core customers depends not on whether core customers can be distinguished by intangibles or “practical indicia” but rather on how many marginal costumers there are: if there there are enough marginal customers to make raising prices unprofitable, and price discrimination between core and marginal customers isn’t feasible, the merger is unlikely substantially to lessen competition. The majority states:

In sum, the district court believed the antitrust laws are addressed only to marginal customers. This was an error of law, because in some situations core consumers, demanding exclusively a particular product or package of products, distinguish a submarket. The FTC described the core PNOS customers, explained how PNOS cater to these customers, and showed these customers provided the bulk of PNOS’s business. The FTC put forward economic evidence—which the district court ignored—showing directly how PNOS discriminate on price between their core and marginal customers, thus treating the former as a distinct market.

Price discrimination between core and marginal customers is of course highly relevant, but the concept appears here surrounded by a penumbra of heuristics that makes hard if not impossible to distill guidance on market definition. The only economic evidence of price discrimination between core and marginal customers cited in the opinion is the fact that Whole Foods stores enjoyed lower margins (not prices!) in cities where they competed with Wild Oats stores. One would have hoped for a discussion of how Whole Foods identifies core customers (the ones in Birkenstocks, perhaps?) and manages to charge them higher prices than the marginal customers (in wingtips and high heels, or flip-flops).

So, does the FTC have to define a market? There is another potential source of confusion in the opinion. Judge Brown criticizes the FTC:  “inexplicably, the FTC now asserts a market definition is not necessary in a §7 case.” The FTC suggested in its brief that “market definition is a means to an end—to enable some measurement of market power—not an end in itself.” That seems obvious enough, particularly in unilateral-effects cases where it is often easier to go directly to competitive effects. The Circuit court’s argument for why a market definition is indispensable is to go back 46 years: “only ‘examination of the particular market—its structure, history[,] and probable future—can provide the appropriate setting for judging the probably anticompetitive effects of the merger.’ Brown Shoe, 370 U.S. at 32 n.38.” Again, this reference to Brown Shoe seems to muddy the waters. And the court immediately backpedals from its insistence of a market definition:

‘That is not to say market definition will always be crucial to the FTC’s likelihood of success on the merits. Nor does the FTC necessarily need to settle on a market definition at this preliminary stage…. For example, the FTC may have alternate theories of the merger’s anticompetitive harm [sic], depending on inconsistent market definitions.”

There may be a substantial cost to this ambiguous approach. Litigation to enjoin a merger is preceded by an intense investigation during which the parties on the one hand seek to respond to the agency’s broad document and interrogatory requests, while on the other hand hope to substantively address the agency’s concerns about competitive effects. If the FTC need not settle on some specific theory of competitive harm or a market definition during the investigation, the parties may be at a distinct disadvantage to respond to the FTC’s concern. This effect will be exacerbated by the absence of clear guidance in the DC Circuit’s opinion: it opens the door to vague and impressionistic market definitions. The Whole Foods opinion is a step backward and it runs counter to the strong trend in recent Supreme Court jurisprudence for economic rigor and clear standards to guide businesses and the agencies.

Update: Geoff Manne has an very interesting post in a similar vein on Truth on the Market:

“But wait!,” you say.  Some people have idiosyncratic preferences.  They preferer buying organic tomatoes, zucchini and grapes from premium natural stores–it’s a combination, you see, not only of the food being consumed but also the channel of distribution.  These poor sots will be gouged without competition between Whole Foods and Wild Oats, because they don’t want to shop for produce at Safeway.  And Whole Foods without Wild Oats would easily overcharge these 17 or 18 people in any given market. Yes, indeed.  One can always define a market by focusing on idiosyncratic preferences or product variations.

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See our very own Hanno Kaiser in the news today: the Recorder is running a story on “Bracing for China Monopoly Law.” Free registration required. Despite concerns, Hanno says, the new Chinese antitrust law is a step in the right direction.

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