AAI's Bert Foer participated in a Food Policy Retreat sponsored by the Organization for Competitive Markets, April 29-May 1, 2000. The following essay, prepared for the OCM's collection of conference papers, appears in "A Food and Agriculture Policy for the 21st Century," edited by Michael C. Stumo, General Counsel of the Organization for Competitive Markets. Stumo and fellow contributors Peter C. Carstensen, Ronald W. Cotterill, Neil E. Harl, and Jon Lauck all serve on the AAI Food Industries Committee. The collection can be found at http://www.competitivemarkets.com/ or purchased from OCM for $20 plus $3 shipping.
Albert A. Foer1
One is tempted to think of the food industry as a layered cake. At the bottom is the farm layer, at the top is the retail layer, and in between are the various neatly defined levels of processing, manufacturing/packaging, and wholesale distribution. But there is something too static about this representation. Think instead of the overcooked lasagne I recently digested, where the different layers had melted into one another, each dynamically affecting the other. In this brief paper, I want to focus on the interaction between the retail layer and the manufacturing/packaging/distribution layer. My thesis is that the retailing layer has become too concentrated; that largely in response to this development, the manufacturing/packaging layer is about to become too concentrated; that both consumers and smaller businesses will be the losers; and that the federal antitrust laws should be used expansively to preserve as much of the remaining competition as possible.
The Retail Level
The retail level of the food industry is dominated by the supermarket chains. Not that Mom & Pop's, wholesale clubs, and e-commerce grocers don't play a role, but the largest role by far is that of the supermarkets. What is interesting is how rapidly the large supermarket chains have grown larger. It was estimated nearly two years ago that the Safeway, Albertson's, Kroger, Ahold and Wal-Mart control about 33 percent of grocery sales in the U.S.2 I've seen more recent estimates as high as 42%. Only seven years ago, in 1992, the five leading chains controlled just 19 percent of U.S. grocery sales.3 The concentration of many regional markets is often much higher than the national level.4 Various industry observers have predicted that -absent rigorous antitrust enforcement-we will see the near-term emergence of four or five chains with over 60 percent of all supermarket sales in the U.S.5 The CEO of Ahold recently was reported to predict that within a few years there will only be three important chains worldwide, Wall-Mart, Carrefour, and Ahold.
What accounts for this dramatic movement? At least five aspects are noteworthy.
(1) Technological advances and liberalized world trade have made it feasible to manage and operate efficiently in larger sizes than previously, often on a global basis.
(2) The antitrust laws have not presented an obstacle to growth, even to very large size, by merger. Thus, with an important exception we will address in a moment, growth has tended to come in large spurts, by acquisition, rather than by steady internal growth. When growth of one's competitor comes rapidly in large lumps, one tends to counter-punch with a similar strategy, i.e. mergers tend to be contagious.
(3) Very large size brings with it the ability to hammer suppliers. Obtaining or increasing buyer power, therefore, may be a motivation for growing extraordinarily large. With buyer power, one can reduce one's own inventory costs and at the same time gain a comparative advantage over smaller rivals who must pay higher prices. Suppliers who are forced to give massive concessions to their largest customers have to make their profits from their smaller, less powerful customers.
(4) Finally, all of the above may be to some extent a defensive response to the introduction of a dynamic new factor in food retailing, the Wal-Mart phenomenon. Wal-Mart's growth has not come by merger, but rather depends on a new format for doing business, emphasizing very large scale and very low prices.
The four largest chains in England (Tesco, Sainsbury, Safeway and ASDA) now are reported to do nearly 50% of all grocery sales, compared to less than 30% ten years ago. While these chains have enjoyed "massive growth" in profits in the past decade, they are reported to charge higher prices than their counterparts in Western Europe.6 This is not surprising, in that a substantial literature suggests that as supermarket concentration moves toward higher levels, price tends to follow.7
The manufacturing/packaging/distribution level of the food industry, which we will call the "foodmaking" level, has apparently been teetering on a consolidation movement of its own for several years.8 Food giants have not been posting great sales growth. H.J. Heinz Co. had only 3% over the past five years and Campbell Soup Co. has been declining.9 Suddenly in 2000, the dam burst. By mid-2000, $87 billion in food deals had been announced. Unilever Group offered $24 billion for Bestfoods. Philip Morris plans to purchase Nabisco Holding Corp. for $19 billion. Three companies - Switzerland's Nestle SA, Philip Morris (Kraft) and Britain's Unilever PLC-have emerged as the "Big Three" of foodmakers worldwide. The press is full of reports that additional mergers of international magnitude will follow. 10
In many of the discussions of these mergers and the prospect for additional mergers, there are references to suppliers merging in order to better cope with retailers who have already merged.
"Because of consolidation in the retail industry, [companies] need to have a portfolio of brands with power," says Tom Palombo, president of Merchandising Corp. of America, which handles displays for packaged-goods for companies. "Years ago, if you didn't buy my brand, I'd sell to someone else." With fewer retailers in the game, companies such as Nabisco have been hard-pressed to push around the likes of a Wal-Mart Stores Inc. or Kroger Co.11
Antitrust has traditionally spent most of its energy on dealing with problems raised by sellers having too much market power. These are the "-poly" twins of monopoly and oligopoly. But there is increasing awareness that competition can be harmed when buyers have too much market power, the "-sony" twins of monopsony and oligopsony. In what is considered an important indication that the federal enforcement agencies are paying more attention to buyer power, Marius Schwartz, a Justice Department economist, drew attention to the fact that "Concerns with increased monopsony power featured heavily in the Antitrust Division's challenges of two prominent recent mergers: Aetna's acquisition of Prudential's health insurance assets, and Cargill's acquisition of Continental's grain trading division."12
Schwartz addressed a common error, the claim that a merger that depresses prices to suppliers must benefit consumers and increase overall welfare. It is true, he said, that a merger may generate efficiencies for the merged firm and lower the cost to suppliers of dealing with it, e.g. by reducing contracting costs and transport costs by ordering in larger volume, or relieving suppliers of certain functions that it can now perform more efficiently than they can. However, suppose instead that the merger generates no efficiencies, but generates supplier reductions driven by the merged firm's willingness to decrease the input quantity it buys in order to force down price. This is just the opposite of the monopolist who drives prices higher by reducing the quantity it sells. In the monopsony model, sellers are willing to accept lower prices for supplying less, because their marginal costs increase with the quantity they supply. The monopsonist depresses the input price it pays below the competitive level by reducing the input quantity it purchases.
Does this harm consumers? If input price falls because of efficiencies, this may help consumers...provided the retailer is in a competitive market. "If," says Schwartz, "input price falls because of the exercise of increased monopsony power by the merged firm, the input quantity will typically fall, inducing the firm to cut its sales to consumers and raise its price." It is the combination of market power at the retail level and buyer power at the retail level that results in harm to both the consumer and the supplier.13
Buyer power has surfaced in several other recent antitrust cases, most notably in the Staples/Office Depot merger and the FTC's case against Toys R Us. It has not yet been recognized as a factor in a supermarket merger, although in opposing the acquisition of Pathmark by Royal Ahold, the American Antitrust Institute argued that the merger could not be "fixed" by divestitures, because this would not deal with the problem of enhanced market power for Ahold.14 The FTC turned down several substantial divestiture proposals by Ahold and the deal eventually fell through, but the FTC's reasons for objecting to the merger were never formalized and staff has informally suggested that the buyer power argument, while of interest, was not influential on the outcome.
A significant manifestation of buyer power is the "slotting fee".15 This is a payment, in one form or another, that a powerful retailer imposes on a foodmaker as a condition of placing certain products on the shelf. The Senate Small Business Committee16 and the House Judiciary Committee17 held hearings on this phenomenon, leading to a two-day workshop at the FTC earlier this year. The FTC is now pondering its next step. The American Antitrust Institute wrote to the FTC following the workshop,18 offering the following conclusions from the information and views explored at the workshop: (a) slotting allowances have become widespread in the grocery industry; (b) there are instances, perhaps many instances, in which their effect is exclusionary from the standpoint of smaller suppliers and discriminatory from the standpoint of smaller retailers; (c) there is reason to believe that their cumulative industrywide effect may be anticompetitive and anti-consumer; (d) there is considerable need for further research into this phenomenon; and, most clearly, (e) there is deep disagreement over the appropriate legal and enforcement agency response to these practices and concomitant widespread interest in some Commission guidance in this area. The AAI urged that a public report be written, reflecting the workshop record and current levels of staff understanding, including recommendations. Hopefully, such a report could itself provide guidance to the industry on how to distinguish between lawful versus unlawful or at least problematic uses of slotting allowances and related conduct. In addition, the AAI proposed that the FTC utilize its powers under Section 6(b) of the FTC Act to issue orders to file "special reports"-in effect, using compulsory process directed at the largest suppliers and supermarket chains in order to learn more about the subject.
The power buyer problem could be addressed to some degree under the Robinson-Patman Act. This law, which was enacted in part to protect small retailers from price discrimination and other practices that power buyers could use to disadvantage their smaller competitors, has been a dead letter for many years. There was some hope that it would be given new life in the FTC's recent investigation of McCormick Spice Co.19 This involved allegations that a large food company had paid fees to retailers to assure that it would have exclusive positioning in their stores. By the time the case was settled, only a small number of technical R-P violations were identified. If the FTC is concerned about abuses of buyer power, it will probably have to develop a stronger Robinson-Patman presence.
An excellent overview of supermarket merger enforcement is available in an article by David A. Balto of the FTC.20 He points out that five mergers reviewed by the FTC in just the twelve months before he wrote involved firms with total sales of over $110 billion, including Albertson's acquisition of American Stores (the second and fourth largest chains in the U.S.) and Kroger's acquisition of Fred Meyer, which created the largest US supermarket chain.21 "The vast majority of supermarket mergers do not raise competitive concerns," says Balto. "Yet in the last four years, the FTC has brought more than ten enforcement actions involving supermarket mergers, more than in any other industry except pharmaceuticals...Most of these enforcement actions have been efficiently resolved through divestitures in those areas in which there were competitive overlaps."
This is true. But the question is whether it is enough to focus on overlaps.22 If company A on the west coast merges with company B on the east coast, there are no overlaps, and consumers in the areas served by either company are not likely to face a price increase as an immediate result of the merger. But, if the merger (and similar mergers) results in a small number of extremely large companies, each of which has buyer power, there are several reasons to worry. First, as buyer power is exercised, the supplier level of the industry feels it has to respond by consolidating. It takes big to fight big, power against power. Second, as the supplier level consolidates, there will be less competition at the supplier level. At some point, this will probably lead to higher prices and perhaps less innovation. Fewer suppliers could mean fewer choices for consumers. Third, as suppliers make their deals with power buyers at the retail level, they will have to earn their profits by (in effect) charging more to smaller retailers. Thus, the vicious cycle places smaller retailers at a competitive disadvantage and assures that their market share will sink as that of the large retailers grows. This will lead to further retail concentration, higher prices and fewer choices for consumers. And fourth, in the new arena of big vs. big, the issue is not how to create new efficiencies that will yield a competitive advantage, but how two giants (a retailer and a supplier) can sit at the table and most lucratively split the consumer's food dollar between them. There is no assurance that this negotiation will lead to any benefits for consumers. Without substantial competition at the retail level, cost efficiencies, however real, do not need to be passed on, and gains from hammering suppliers can be retained within the company. Without substantial competition at the supplier level, even the largest retailers will pay more, and this will be passed on to consumers.
In effect, we are moving into the economy that was pre-described in John Kenneth Galbraith's 1952 book, American Capitalism. Galbraith said, "[P]ower on one side of a market creates both the need for, and the prospect of reward to, the exercise of countervailing power from the other side." He thought of the great retail chains as representing countervailing power on behalf of consumers against the market power of the producers and processors of consumers' goods. He argued that an important role of the government should be to foster the development of countervailing power wherever it was needed, since he had little confidence in competition doing the job by itself. I doubt that Galbraith would be happy to see the latest manifestation of countervailing power at the supplier level, because he did not see the government's role as limited to helping create countervailing power, but rather as the people's agent for serving a larger public interest.
Today the government can still use its resources to make competition in the food industry work. This would require a program aimed at stopping the enhancement of buyer power at the retail level through merger enforcement that takes this issue seriously, supplemented by use of the Robinson-Patman Act directed at abuses of buyer power. With respect to the supplier level, it will be necessary to have a merger enforcement vision that goes beyond identifying overlapping brands. The dynamic between the two levels of retail and supply must be understood and viewed as a whole. We need antitrust enforcers to ask, "Where are we going? What are the dangers? What kind of industry structure will be acceptable? What do we need to do now in order to keep an unacceptable reality from coming into existence?" The primary tool is Section 7 of the Clayton Act, authorizing antitrust to apply an incipiency standard to deal with the diminution of competition at a point where it "may" occur. In the food industry, we are already at the danger point.
1 Foer is President of the American Antitrust Institute, www.antitrustinstitute.org
2 Robert Goch, "Merger and Acquisition Activity in the US Supermarket Industry 1991-1998," Special Report, Information Clearinghouse, Inc. (Great Neck, NY, December 21, 1998); Ronald W. Cotterill, "Policy Editorial: Food Industry Concentration: The Uncharted Global Venue," 6 Food Marketing Policy Center Newsletter (April 1999).
3 Goch, op. cit.
4 E.g., the four-firm concentration is over 66% in Boston-Worcester-Lawrence; 90% in Buffalo-Niagara Falls; 68% in Cleveland-Akron; and 73% in Hartford. Information ClearingHouse, Inc., Customer & Market Insights, June 19, 1998 report on Royal Ahold, N.V.
5 Cotterill, op. cit. Note 5 supra; also see R. Matthews," Consolidation: Out of Our Hands," 65 Grocery Headquarters 21 (1999); Arthur Andersen Inc., "SuperShakeout," 5 Senn-Delaney's Food for Thought (February, 1999); R. Goch, op. cit.
6 Gene Hoffman, "Sounding a Warning: The Consolidation of the Supermarket Industry in England Poses Vital Questions for U.S. Grocery Retailers," Progressive Grocer 104 (March, 1999).
7 Marion, Heinforth and Bailey, for example, conducted a study in which they concluded, "[O]ur results find a positive linkage between concentration and prices even after holding costs and quality/service constant. The results of this study are consistent with six other studies that found a significant positive relationship between grocery store prices and the concentration of sales in local markets." "Strategic Groups, Competition and Retail Food Prices," in Ronald Cotterill (ed.), Competitive Strategy Analysis in the Food System (Boulder, CO, 1993) at 197. The same results are reported using updated information in Marion, "Competition in Grocery Retailing: The Impact of a New Strategic Group on BLS Price Increases," 13 Review of Industrial Organization, 381,398 (1998). Also see Cotterill, "Measuring Market Power in the Demsetz Quality Critique in the Retail Food Industry," 15 Agribusiness 101 (1999); Cotterill, Dhar and Putsis, "On the Competitive Interaction Between Private Label and Branded Grocery Products," (forthcoming, Journal of Business, 1999); Lamm, "Prices and Concentration in the Food Retailing Industry," 30 Journal of Industrial Economics 67 (1981); Geithman, Marvel and Weiss, "Concentration, Prices and Critical Concentration Ratios,"63 Rev. of Economics and Statistics 346 (1981); Hall, Schmitz and Cothern, "Beef Wholesale-Retail Marketing Margins," 46 Economica 295 (1979); Marion, Mueller, Cotterill, Geithman & Smelzer, "Price and Profit Performance of Leading Food Chains," 61 American Journal of Agricultural Economics 420 (1979); Cotterill, "Market Power in the Retail Food Industry: Evidence from Vermont," Review of Economics and Statistics 379 (Aug. 1986).
8 "For years, investment bankers have salivated as they eyed the struggling food industry. Its inability to raise prices and its mature, slow-growth product lines put pressure on earnings growth, making the business ripe for a merger wave. But a variety of obstacles, chief among them CEOs not ready to give up power, kept the consolidation engine idling." "Coming Soon: A Feast of Mergers," Business Week, May 22, 2000 at 56.
9 Business Week, July 10, 2000 at 178.
10 E.g., "Both Nestle and a group of second-tier food companies, including Groupe Danane of France and Cadbury Schweppes PLC of Britain, are now expected to aggressively seek out other acquisitions in an effort to compensate for the clout of Philip Morris. Two of their likeliest targets: Elmhurst-based Keebler Foods Co. and Chicago-based Quaker Oats Co." Janet Kidd Stewart, "Combination Could Prove Hard for Shoppers to Digest," Chicago Tribune, June 27, 2000. The mammoth deals of the past few weeks "are going to cause other companies to take a second look at their peers," says an analyst at J.P. Morgan. Once they start examining one another, "they may be a little more attracted to them than before." Heinz, Campbell, and Ralston Purina Group are also among those being mentioned as merger candidates. Shelly Branch, "Mammoth Deals Are Expected to Spur More Consolidation in the Food Industry," Wall Street Journal, June 27, 2000. On July 7, 2000, the FTC voted to seek an injunction against the acquisition of Beech-Nut Nutrition Corporation by H.J. Heinz Co., which, if consummated, would combine the number two and number three companies in the baby food, leaving a duopoly with 98 percent of the U.S. baby food market. http://www.ftc.gov/opa/2000/07/heinz.htm.
11 ." Shelly Branch, "Mammoth Deals Are Expected to Spur More Consolidation in the Food Industry," Wall Street Journal, June 27, 2000.
12 Marius Schwartz, Economics Director of Enforcement, Antitrust Division, U.S. Department of Justice, "Buyer Power Concerns and the Aetna-Prudential Merger," October 20, 1999, available at http://www.usdoj.gov/atr/public/speeches/3924.htm.
13 See also Julian Maitland-Walker, "Buyer Power,"  E.C.L.R., Issue 3 at 170 (arguing that buyer power has become a problem in U.K. food retailing).
14 See letter of Albert A. Foer to Chairman Robert Pitofsky of the FTC, available at www.antitrustinstitute.org, June 18, 1999.
15 See Paul N. Bloom, Gregory T. Gundlach, & Joseph P. Cannon, "Slotting Allowances and Fees:Schools of Thought and the Views of Practicing Managers," 64 J. of Marketing 1 (April 2000).
16 See testimony of Robert A. Skitol on behalf of the American Antitrust Institute before the Committee on Small Business, U.S. Senate, Sept. 14, 1999, available at www.antitrustinstitute.org.
17 See testimony of Willard K. Tom, Bureau of Competition, FTC, before the Committee on the Judiciary, U.S. House of Representatives, Oct. 20, 1999.
18 Letter of Albert A. Foer to Chairman Robert Pitofsky of the FTC, June 27, 2000, available at www.antitrustinstitute.org.
19 See, Robert A. Skitol, "FTC SPICES UP DEBATE OVER SLOTTING FEES AND THE ROBINSON-PATMAN ACT WITH ITS MCCORMICK ACTION," FTC:WATCH, March 13, 2000, available at www.antitrustinstitute.org.
20 David A. Balto, "Supermarket Merger Enforcement," Antitrust Report 2 (August 1999). As of this writing, the most recent supermarket merger to be stopped by the FTC is FTC v. Kroger et al., Civil Action No. 3-00CV1196-R (N.D. Texas). This case, which was voted out by the Commission on June 2, 2000 and filed in court in Dallas on June 6, 2000, alleged that Kroger's acquisition of Winn-Dixie's Texas Division was anticompetitive in the Fort Worth metropolitan area and several smaller markets in Texas. See the FTC June 2, 2000 press release. Kroger and Winn-Dixie terminated their deal on June 22, 2000 rather than pursuing litigation.
21 Kroger has now moved past Sears Roebuck to become the nation's second largest retailer, after Wal-Mart. Washington Post, July 7, 2000.
22 See Albert A. Foer, "Are Divestitures an Adequate Remedy for Supermarket Mergers?" available at www.antitrustinstitute.org for July 12, 1999.