FTC:WATCH® No. 577
November 19, 2001
DIVESTITURE AND THE CATEGORY CAPTAIN: NEW CONSIDERATIONS IN MERGER REMEDIES
Albert A. Foer
Two projects of the American Antitrust Institute come together in this essay. First, we have been calling attention to the anticompetitive potential of the new category captain relationship that has blossomed in consumer goods industries. Second, we have been urging the enforcement agencies to consider the adoption of guidelines for merger remedies, in order both to expedite the process and to better assure that settlements do not result in reduced competition. Here we will argue that the role of category captains in an industry may be highly relevant to the qualification of the buyer of assets to be divested under a settlement. This is not hypothetical, in that the current Nestle-Ralston merger directly raises the issue.
The idea of category captains was presented to the food industry in 1995 as part of the concept of category management. It has quickly spread beyond food and beyond the U.S. to become a common feature of distribution channels for consumer goods. Before there were category captains, companies focused on the profitability of brands. This developed into the concept of channel partnerships, in which retailers and their suppliers engaged in various forms of strategic partnerships, bringing new efficiencies to vertical channels of distribution. Category management, focusing on whole categories rather than brands, and the introduction of category captaincy, was the next step. Instead of the retailer having separate relationships with each supplier in a category, the retailer would appoint a single supplier (almost always, the leading supplier) to be the category captain. This would entail substantial work and expense for the captain, but it was an investment the captain's firm has been only too willing to undertake.
The captain receives from the retailer all information pertinent to the category. For example, if the category were wet dog food, the captain would learn all about the sales, pricing, turnover, shelf-placements and promotions of the wet dog food brands carried by the retailer. The captain on an annual basis conducts a thorough analysis of this information, which of course includes not only his own brand but all of his competitors' brands, and, using this analysis and his own expertise in consumer behavior, provides to the retailer both a report and a plan. The plan includes a plan-o-gram for each of the retailer's stores, setting out which brands should be located where (eye-level, foot-level, etc.), linear feet to be allocated to each brand, what new brands to include, what old brands to cut back or exclude, pricing, and promotional schedules.
Of course the retailer has ultimate decision-making authority, but the high degree of information asymmetry accounts for the fact that retailers almost always accept the proposals of the category captains. Even major retailers have thin staffs so that the retailer's category manager who interfaces with the manufacturer's category captain generally must handle a dozen or so categories to the captain's one. Information asymmetry renders the retailer dependent on the manufacturer.
In many industries, the leading manufacturer ends up operating category captaincies for almost all competing retailers.
This arrangement has two obvious types of anticompetitive potential. First, the hub and spoke arrangement that brings all relevant information to the category captain, who then plans how its various retailer clients can maximize profits, is a structure that can facilitate tacit collusion. The retailers do not need to communicate with one another to discuss prices or market shares; they merely have to accept that the category captain is working in the whole industry's interest.
The category captain system also facilitates exclusionary practices. The category captain serves as a gatekeeper to the retailer. While the category captain is generally too sophisticated to urge the retailer to drop the Number Two supplier, there are many more subtle suggestions that can not only serve to improve the category captain's own positioning, but can raise rivals' costs or entirely exclude rivals from the retailer's (or retailers') shelves. A brand that is represented by a category captain therefore has a large advantage over the other brands in the category. (Exactly how much of an advantage is likely to vary by company and by category.)
When the category captain's company operates a portfolio of brands in various categories (as in the case of Nestle), the captain's power is even greater because of what marketers refer to as "multi-category clout." The so-called "market development fund" is a major device by which multi-category manufacturers leverage their clout from one category to the next. Such funds provide additional discounts and rebates to retailers who support the manufacturer's brands across all the categories in which the manufacturer is presently active and those he aspires to enter.
Schematically, assume that a food manufacturer has branded products in four categories and that for a particular retailer, Category A is strategically very important. Let's say that the manufacturer is category captain in both Category A and also in Category D. The manufacturer can use its leverage in Category A to bolster its bargaining power in Category D. (It is also possible that the multi-category clout could come to the assistance of a portfolio member in Category C who is not the category captain there.) We are not denying the possibility of efficiencies arising from category captaincy or from multi-category clout. How large they might be, however, and whether they would in some sense outweigh the anticompetitive potential is a public policy decision that awaits more knowledge.
For present purposes, suppose a category captain's company wants to merge, that there are horizontal overlaps, that the merging parties agree to divest a brand as a condition for the merger, and that, despite the divestiture, the post-merger company will continue as the category captain. We believe this describes the current Nestle-Ralston situation. Two questions arise.
First, a knowledgeable putative buyer must take into account that (a) the divested brand was once owned by the category captain and (b) the buyer will have to compete in a market where the category captain is the gatekeeper to the leading retailers. By how much will the putative buyer discount the purchase price to reflect the disadvantage facing the brand once it is stripped of the category captain's support? Will the disadvantage be so large as to reduce the number of putative buyers?
Second, must not the enforcement agency, in evaluating the putative buyer, take into account the difference between the category captain's ownership of a brand and the buyer's ownership of the same brand? To preserve the level of competition that existed before the merger, it might be necessary to take extraordinary remedial action. Some examples of what this could include: requiring that the merging firm not serve as category captain for a number of years; or that the divestiture be of additional assets (in effect, a "negative delta"); or that the category captain operate in a transparent way, sharing with all rivals any data it receives and any proposals it offers to the retailer; or that the merger be disallowed altogether for lack of a qualified buyer.
It is troubling to recognize that in these situations, only a buyer of some magnitude, one that either has realistic prospect of becoming a category captain or has multi-category clout, is likely to be a buyer capable of providing a comparable level of competition for the divested asset. This can only contribute to sectoral consolidation, a twilight zone danger located somewhere between market concentration, which is recognized by our antitrust policies, and aggregate concentration, which is not. Nevertheless, in mergers that involve a category captaincy, we do not believe that the enforcement agencies can conduct an adequate analysis if they do not take into account the current and future role of the category captain and the implications of multi-category clout.