FTC:WATCH® NO. 550
September 11, 2000
The aai Column
Short leap from Toys-R-Us to Heinz-Beechnut
By Robert A. Skitol
Sixty-four years after Huey Long declared that he "would rather have thieves and gangsters than chain stores in Louisiana," our antitrust policymakers should be newly energized to address abuses of retail chain buying power as a result of the Seventh Circuit's affirmance of the Commission's decision in the Toys-R-Us case. There is no dearth of candidates for scrutiny, but none more inviting than today's dominant supermarket chains, particularly in the wake of last June's FTC workshop on slotting fee practices and the latest round of merger activity in the food industry.
In 1998, the Commission found that Toys-R-Us ("TRU") had induced 10 major toy manufacturers to join in a boycott of warehouse club, depriving consumers of lower prices that these clubs otherwise would have brought to the toy market generally. As characterized in the Seventh Circuit's affirmance in August, TRU coerced the manufacturers into an illegal "horizontal" agreement whereby each firm "promised to restrict the distribution of its products to low-priced warehouse club stores," the only condition being "that other manufacturers would do the same."
As the Seventh Circuit observed, the manufacturers "were in effect being asked by TRU to reduce their output . . . and, as is classically true in such cartels, they were willing to do so only if TRU could protect them against cheaters." In essence, TRU embarked on a plan "to disadvantage" its warehouse rivals by getting suppliers "to deny the clubs the products they needed"; it "accomplished this goal by inducing the suppliers to collude, rather than to compete independently for shelf space in the different toy retail stores."
One notable aspect of the affirmance is the court's resurrection of two hoary Supreme Court precedents as support for the holding that TRU's conduct created an illegal horizontal restraint: Interstate Circuit v. United States, 306 U.S. 208 (1939); and Klor's v. Broadway-Hale Stores, 359 U.S. 207 (1959). Both cases involved powerful buyers bending suppliers to their will in ways that suppressed downstream competition. Long disparaged in many quarters as "outmoded" law, these cases now warrant the fresh respect and attention of counselors to today's retail titans.
One of TRU's principal defenses was that it lacked sufficient market power to support finding an antitrust violation since its share of toy sales nationally was "only" 20%. The Seventh Circuit initially observed that a finding of market power was unnecessary in light of the horizontal nature of the agreement that TRU constructed. It then effectively sidestepped the issue by upholding the Commission's finding of actual anticompetitive impact: "however TRU's market power as a toy retailer was measured, it was clear that its boycott was having an effect in the market"; it caused "10 toy manufacturers to reduce output of toys to the warehouse clubs, and that reduction in output protected TRU from having to lower its prices to meet the clubs' price levels."
The Commission's own decision was more robust in its treatment of the market power issue. The Commission found that (a) while TRU's share of national toy sales and of national toy purchases at wholesale was 20%, its share of sales within major metropolitan areas ranged between 35 and 49%; and (b) it buys about 30% of the largest toy companies' total output. These shares, however, were also found to understate significantly TRU's actual market power: "While not a monopolist or a monopsonist, TRU enjoys a dominant position" on both the buying and selling side.
As the Commission explained, several considerations supported a conclusion that TRU's power as a toy buyer exceeded that inferable from market shares alone: it purchased so much of each manufacturer's output "that no other retailer could make up for lost sales should [it] decide to terminate" the relationship; for many suppliers it was the only buyer of older or low volume toy products, the sale of which was important to their profitability; and without its support, suppliers could not cost-justify marketing campaigns. Most importantly, as a "very large multi-brand retailer," it was adept at "playing favorites" and "threatening" to do so, a "source of market power that is not available to single-brand retailers." A "rejected or disfavored product's shelf space [can] be given to that product's closest substitute" without dealer loss. TRU "can also exercise subtle forms of discrimination short of termination" such as denying "highly valued shelf space positions at the end of an aisle or at the front of a store."
The bottom line from the record as a whole was "that TRU had sufficient market power to induce the toy manufacturers to bend to its will with regard to their sales to the clubs. That such a wide range of toy manufacturers, all with serious reservations about the wisdom of discriminating against the clubs on toy sales, fell in line when TRU asserted its demands is proof by itself of TRU's extraordinary power to coerce its suppliers."
The antitrust world has come a long way from Huey Long's populist crusade against buying power generally, with its focus on protecting small merchants, to today's post-Chicago scrutiny of more particularized buying power abuses and their consumer welfare ramifications. We now know that buying power can either enhance efficiency and ultimately lower consumer prices or, alternatively, facilitate collusive and exclusionary practices that suppress both upstream and downstream competition generally. Two important insights from the Toys-R-Us decision are that (a) even buying power falling short of economists' technical definitions of "monopsony" can threaten serious anticompetitive effects and (b) buyer power can be particularly anticompetitive under market conditions where it partners with and facilitates the exercise of seller market power, suppressing competition at both levels of the distribution chain.
These insights can now be applied to outstanding issues confronting the food industry. As elucidated by thoughtful participants throughout last June's slotting allowance workshop, supermarkets' "gatekeeper" power over shelf space essential to their suppliers enables them to extract exorbitant and discriminatory fees that both undercut the competitive viability of smaller retailers and raise entry barriers for smaller suppliers. These fees, moreover, have become tools for the sale of "exclusionary rights" that enable dominant suppliers to foreclose smaller rivals from retail access, exemplified by the Commission's allegations against McCormick & Co. earlier this year. In short, just as Toys-R-Us used its power to effectuate cartel conduct among its suppliers, supermarket chains use their power to facilitate exclusionary conduct by their suppliers. The result is suppressed competition at both levels of food distribution and ultimately both higher consumer prices and less consumer choice.
AAI President Bert Foer has on several occasions over the past year forcefully called upon the Commission to address this situation, both by developing enforcement guidelines for slotting fee practices and by implementing a new focus on buying power effects of supermarket mergers. Disregard of the latter concern has now burdened the Commission's enforcement mission as applied to mergers among food manufacturers, illustrated by competing arguments presented in the pending challenge to the Heinz-Beechnut baby food merger. The Commission is arguing that competition between the merging firms for supermarket shelf space is a desirable dimension of rivalry; the parties are arguing that the elimination of that competition is an "efficiency" that will enhance the merged firm's ability to compete with Gerber, the dominant and only other significant supplier in this market.
Both arguments miss the mark and ignore a far broader unsatisfactory state of affairs in the food industry generally. There is too much buyer concentration at the retail level as a result of myopic focus on seller power alone in past decisions on supermarket mergers. This situation, however, cannot now justify the accumulation of "countervailing" upstream power as many promoters of more consolidation in food manufacturing now suggest. The fact that numerous supermarket chains have given Heinz and Beechnut declarations for use in support of their merger should be telling evidence against that defense. When retail market power begets supplier market power, the consuming public loses big-time.