National Law Journal

'Core' approach is incorrect

Jane E. Willis & Matthew P. Garvey / Special to The National Law Journal
August 18, 2008

Defining markets is a difficult but crucial aspect of antitrust cases. In its decision in FTC v. Whole Foods Markets on July 29, the U.S. Circuit Court of Appeals for the District of Columbia has made the process of defining the relevant market more difficult.

In its decision, the court departed from well-settled principles by emphasizing "core," rather than marginal, customers in determining market definition. The court reversed the district court's refusal to enjoin the merger of Whole Foods Market Inc. and Wild Oats Markets Inc., the two leading premium, natural and organic supermarket chains. Over vigorous dissent, Judge Janice Rogers Brown wrote: "The district court assumed 'the 'marginal' consumer, not the so-called 'core' or 'committed' consumer, must be the focus of any antitrust analysis . . . .To the contrary, core consumers can, in appropriate circumstances, be worthy of antitrust protection . . . .The district court's error of law led it to ignore [Federal Trade Commission] evidence that strongly suggested Whole Foods and Wild Oats compete for core consumers within a [premium, natural foods] market, even if they also compete on individual products for marginal consumers in the broader market."

Brown is no doubt correct that core consumers are worthy of antitrust protection — indeed, all consumers are. But she incorrectly viewed focusing on the "marginal" customers as inimical to protecting the interests of the "core" customers. The key question in defining the relevant market is whether certain products are reasonable substitutes for one another.

Focus on marginal customers

According to the FTC's Merger Guidelines, the relevant market is generally the smallest market in which a hypothetical monopolist could profitably impose a "small but significant non-transitory increase in price." — a SSNIP. If the combined company could profitably impose a 5% price increase (because the increase would not cause a significant number of marginal customers to switch to substitutes outside the proposed market definition), then the proposed merger would likely lessen competition. In determining whether a combined Whole Foods/Wild Oats could profitably increase prices, the focus is on the marginal customers — those who would take their business to other stores in response to a price increase. If the evidence shows that the combined entity would be able to increase prices enough to offset lost business, then the merger should not survive scrutiny.

The district court had concluded that the FTC could not prevail because the evidence did not show that a combined Whole Foods/Wild Oats could profitably impose a SSNIP. Brown's focus on "core" customers does not cure the FTC's lack of evidence. Indeed, focusing only on "core" or "committed" customers is a poor way to determine the effect of a price increase on a company's bottom line: If enough customers turn to alternative sources, the company will not be able to sustain a significant price increase. Hence the traditional focus on the marginal customer.

Although not expressly stated, Brown's concern about the "core" customers suggests that there may be a submarket within the premium grocery industry for natural or organic perishable products, and that this submarket could be adversely affected by the merger. She pointed out that Whole Foods internal documents revealed that it monitored conventional grocery store prices for dry goods, but not prices for perishables. While perishables could form such a submarket, the FTC proposed no such submarket in the district court. Conceivably, the FTC could have developed evidence suggesting that the combined company would be able to profitably increase prices for perishables to the detriment of consumers; that case would have focused on whether sufficient numbers of marginal customers would turn to other sources to buy perishables.

Brown's emphasis on core customers will cause further confusion in this difficult area of the law. Indeed, all companies that successfully differentiate themselves from the bulk of their competitors will attract "core" or "committed" customers who will not readily seek substitutes. If courts focus solely on these most committed customers, injunctions may become a fait accompli. Neither core nor marginal consumers will benefit from having mergers blocked when the combined company would not have been able to sustain price increases. In addition, all consumers will lose if firms are discouraged from initiating pro-competitive efforts to separate themselves from the pack.

Whole Foods may seek rehearing en banc by the full D.C. Circuit. The court would serve competition law well by rejecting an emphasis on "core" customers and reaffirming the use of settled antitrust principles, including whether the merged company can profitably impose a significant price increase, in determining whether a merger violates the antitrust laws.

Jane E. Willis, a partner at Boston-based Ropes & Gray, focuses her practice on antitrust and complex business litigation. Matthew P. Garvey is a litigation associate at the firm.