Staples and Office Depot Again Propose a Merger

On February 4, 2015, Staples and Office Depot announced a definitive agreement between the two companies in which Staples would acquire all of the outstanding shares of Office Depot. Office Depot shareholders would receive cash and Staples stock in return for their shares of Office Depot stock. Based on the cash and stock offering, the deal values Office Depot $6.3 billion.

This was the second proposed merger between the two companies. A 1996 proposed merger between the two companies was challenged by the Federal Trade Commission (FTC) on the grounds that it would create monopoly power in the office supply market. In July 1997, a judge issued an injunction against the merger, and the two companies withdrew their plans. However, much had changed in the retail landscape between 1997 and 2015.

In December, 2015, the FTC filed an administrative complaint alleging that the merger violated antitrust law and would lead to significant harm to consumers. The following is an outline of the case argument presented by the FTC.

NATURE OF THE CASE

Staples and Office Depot areby a wide marginthe two largest vendors of consumable office supplies to large "business-to-business" ("B-to-B") customers (i.e., business customers buying for their own end-use) in the United States. Staples' and Office Depot's own documents state that they are the only participants in a "two player" national market. They are the best options for most large B-to-B customersand the only meaningful options for some large B-to-B customersparticularly those with facilities in multiple regions of the country. And they are each other's closest competitors for such customers. As Staples explained at an internal Leadership Summit, "There are only two real choices for customers," Staples and Office Depot. Office Depot similarly made clear to a customer that "[o]n a national scale, Office Depot's competition is Staples."

Direct head-to-head competition between Staples and Office Depot yields substantial benefits to large B-to-B customers in the form of lower prices and better service. If consummated, the merger of Staples and Office Depot (the "Merger") would eliminate that competition. Office Depot acknowledged this in April 2015two months after the Merger was announcedencouraging a large B-to-B customer to accept its "best and final" offer promptly, stating, "If and when [Staples'] purchase of Office Depot is approved, Staples will have no reason to make this offer."

By eliminating direct competition between Staples and Office Depot, the Merger threatens significant harm to a wide range of large B-to-B customers. Office supplies vendors sell and distribute consumable office supplies (e.g., pens, staplers, notepads, folders, and copy paper) to all manner of businesses across the United States. Employees of these businesses use consumable office supplies in connection with their jobs. As a result, businesses depend on vendors to provide consistent and reliable delivery of consumable office supplies so that their employees have the products they need to work productively and on a cost-effective basis.

Large B-to-B customers typically require an office supplies vendor with experience and a strong reputation for providing consumable office supplies to large B-to-B customers. These requirements are especially important for customers seeking delivery on a multiregional or national basis. Many large B-to-B customers require that their office supplies vendor provide a broad range of national-brand and private-label products, flexible and reliable delivery (including desktop delivery), high levels of customer service, customizable product catalogs, detailed utilization reporting, and sophisticated information technology ("IT") interfaces for procurement and billing. Moreover, large B-to-B customers require those features and services to be part of the transaction, along with consumable office supplies at competitive prices.

Large businesses typically purchase consumable office supplies pursuant to contracts awarded through requests for proposal ("RFPs"), auctions, or bilateral negotiations. Staples and Office Depot generally compete head-to-head in such proceedings. They are often the two finalists in RFPs or other contests because they can obtain the lowest cost of goods from office supplies manufacturers and they possess similar networks of distribution centers, salesforces, and other services and features, such as strong reputations and experience, high levels of customer service, sophisticated IT, and product utilization monitoring and tracking. Large B-to-B customers often use those similar offerings to play one competitor off the other to obtain lower pricing, other financial incentives, better service, and improved contract terms. Indeed, Staples and Office Depot frequently lower prices, increase discounts, and offer other financial incentives to take business away from each other, and to avoid losing business to each other.

Many large B-to-B customers contract with a single office supplies vendor for consumable office supplies. Doing so allows these customers to consolidate their purchases and leverage the bigger purchasing volume to negotiate lower prices and higher discounts, rebates, or other pricing concessions. In addition, contracting with a single office supplies vendor allows large businesses to track and monitor usage of office supplies through one vendor, rather than several different vendors, thereby lowering their costs and improving operational efficiency. Using a single office supplies vendor also provides large B-to-B customers with a single point of contact for problems or concerns, a single IT interface for ordering, and a single payee for administrative purposes. These features are important to many large B-to-B customers because they enhance efficiency, ease of use, and administration, thereby lowering their costs of doing business.

For large B-to-B customers with locations across the United States or in multiple regions of the country, using a single office supplies vendor generally means choosing an office supplies vendor with national or multi-regional distribution capabilities. Staples and Office Depot are the only two office supplies vendors that can provide on their own the low prices, nationwide distribution, and combination of services and features that many large B-to-B customers require.

Once a large B-to-B customer contracts with an office supplies vendor, it attempts to ensure that the employees responsible for purchasing consumable office supplies purchase under the contract with its chosen office supplies vendor. Maximizing spend with its contracted office supplies vendor often allows a large B-to-B customer to earn the highest volume-based discounts, rebates, or other pricing incentives. It also minimizes the inefficiency of having to pay invoices from multiple vendors and accommodate multiple deliveries.

Other supply options have significant disadvantages for large B-to-B customers. Local or regional vendors (including but not limited to W.B. Mason), local or regional consortia, and ad hoc region-by-region networks of suppliers have higher costs and thus higher prices, limited geographic footprints, and/or logistical and coordination challenges for large B-to-B customers. Because of these disadvantages, these other supply options have relatively small shares of sales to large B-to-B customers.

The Merger would combine the office supplies vendors that areby farthe two top choices for a significant number of large B-to-B customers. It would eliminate beneficial competition between the two largest, most significant, and most attractive alternatives for many large B-to-B customers.

The Merger also would create firm with a dominant share of the relevant market and significantly increase market concentration. Post-Merger, Staples would control more than 70% of the relevant market. The next-largest competitor would possess less than 5% of the relevant market. Under the 2010 U.S. Department of Justice and Federal Trade Commission Horizontal Merger Guidelines ("Merger Guidelines"), a post-merger market-concentration level above 2,500 points, as measured by the Herfindahl- Hirschman Index ("HHI"), and an increase in market concentration of more than 200 points renders a merger presumptively unlawful. Post-Merger market concentration would be more than 4900, and would increase HHIs in an already concentrated market by well over 200 points. Thus, the Merger is presumptively unlawful.

Other office supplies vendors, including but not limited to Amazon Business, regional vendors such as W.B. Mason, distribution consortia, and vendors of adjacent products, such as janitorial/sanitation products or breakroom supplies, cannot meaningfully constrain a post-Merger Staples. As a result, Staples could charge higher prices and would have a diminished incentive to maintain or improve quality for large B-to-B customers if it were allowed to acquire Office Depot.

Similarly, manufacturers of "core" consumable office products, such as pens, folders, and notepads, generally do not sell core office supplies directly to large B-to-B customers, particularly in the quantities that such customers would want. They generally sell to wholesalers or vendors such as Staples and Office Depot. Nor would it be practicable for large B-to-B customers to buy office supplies from a large number of manufacturers. Wholesalers do not generally sell consumable office supplies directly to large B-to-B customers. Rather, they generally sell to office supplies vendors, which then resell those products to large B-to-B customers.

Finally, buying at retail, whether from brick-and-mortar or online retailers, including Amazon Business, generally would be more expensive for large B-to-B customers than purchasing from an office supplies vendor, and generally would not provide the full combination of other benefits important to large B-to-B customers, such as desktop delivery, order tracking, electronic ordering, flexible payment terms, negotiated pricing, and consistency of product selection and availability.

The companies cannot show that new entry or expansion by existing vendors would be timely, likely, or sufficient to counteract the anticompetitive effects of the Merger. Significant barriers to entry into office supplies distribution to large B-to-B customersparticularly national and multi-regional customersexist, making entry or expansion difficult and incapable of constraining the merged entity.

Staples and Office Depot cannot show cognizable efficiencies that would offset the likely and substantial competitive harm from the Merger.

BACKGROUND

Jurisdiction

Staples Inc. and Office Depot, Inc., and each of their relevant operating entities and parent entities are, and at all relevant times have been, engaged in commerce or in activities affecting "commerce" as defined in Section 4 of the FTC Act, 15 U.S.C. 44, and Section 1 of the Clayton Act, 15 U.S.C. 12. The Merger constitutes an acquisition subject to Section 7 of the Clayton Act, 15 U.S.C. 18.

Companies

Staples is a publicly traded corporation organized under the laws of Delaware with headquarters in Framingham, Massachusetts. In fiscal year 2014, Staples generated $22.5 billion in sales, with 54.8% of that coming from office supplies. Staples operates three business segments: North American Stores & Online, North American Commercial, and International Operations. In fiscal year 2014, 36.8% of Staples' total sales came from the North American Commercial segment. Staples is the country's largest vendor of consumable office supplies to B-to-B customers.

Office Depot is a publicly traded corporation organized under the laws of Delaware with headquarters in Boca Raton, Florida. In fiscal year 2014, Office Depot had $16.1 billion in revenue, with 47.2% of that coming from sales of office supplies. Office Depot operates through three divisions: North American Retail Division, North American Business Solutions Division, and International Division. In fiscal year 2014, 37.4% of Office Depot's sales came from the North American Business Solutions Division. Office Depot is the country's second-largest vendor of consumable office supplies to B-to-B customers.

The Merger

On February 4, 2015, Staples and Office Depot entered into an Agreement and Plan of

Merger ("Merger Agreement"), pursuant to which each share of Office Depot stock would be converted into the right to receive $7.25 in cash, plus approximately 0.2 shares of Staples' common stock. As of the market's close on February 3, 2015, these terms of the Merger Agreement equated to a value of Office Depot of $6.3 billion. Either party may terminate the Merger Agreement if it is not consummated by February 4, 2016.

RELEVANT MARKET

The relevant market is the sale and distribution of consumable office supplies to large business-to business customers in the United States. Large B-to-B customers are particularly vulnerable to the proposed Merger because many have nationwide or multiregional operations and require an office supplies vendor that can provide low pricing, high levels of service, and delivery across all of their operations. For such customers, Staples and Office Depot are the two best options.

Relevant Product Market

Consumable office supplies consist of an assortment of office supplies, such as pens, paper clips, notepads, and copy paper, which are used and replenished frequently. It is appropriate to evaluate the Merger's likely effects through an analysis of the assortment of consumable office supplies because each of the products in the assortment is offered under similar competitive conditions. Thus, grouping the hundreds of individual consumable office supplies into an assortment for analytical convenience enables the efficient evaluation of competitive effects with no loss of analytic power.

B-to-B customers buy consumable office supplies for their own end-use (i.e., for their employees to use in the course of performing their job duties), rather than for resale. Consumable office supplies do not include ink and toner for printers and copiers. Many B-to-B customers, particularly large B-to-B customers, buy ink and toner directly from ink and toner manufacturers, or as part of a package of "managed print services," in which vendors bundle ink and toner sales with leases of copier and printers, repair services, and/or copy and printer maintenance services. As a result, large B-to-B customers often purchase ink and toner from different vendors, under different contracts, than those from which they purchase consumable office supplies.

Consumable office supplies do not include other office-related products, such as janitorial or break-room products. Janitorial or break-room products are sold under substantially different competitive conditions than consumable offices supplies.

Large B-to-B customers include, but are not limited to, those that buy $1 million annually of consumable office supplies for their own end-use. The sale and distribution of consumable office supplies to large B-to-B customers, many of whom have multi-regional or national operations, entails the warehousing, sale, and distribution of a wide range of such office supplies, along with high levels of customer service and value-added services.

The sale and distribution of consumable office supplies to large B-to-B customers is distinct from the sale and distribution of consumable office supplies to other customers, including individual consumers or small- and medium-sized businesses. Large B-to-B customers generally require, and the sale and distribution of consumable office supplies to large B-to-B customers is distinguished by, a number of key attributes, including but not limited to:

Procurement Processes: Large B-to-B customers generally procure consumable office supplies on contracts awarded through formal RFPs, auctions, or direct negotiations, often obtaining lower prices than other customers.

National or Multi-Regional Distribution: Many large B-to-B customers have operations in multiple regions of the United States. As a result, to increase efficiency and reduce transaction costs, large B-to-B customers often require a single vendor with a broad geographic footprint that can distribute consumable office supplies to all their locations in multiple regions of the country.

Next-Day Desktop Delivery: Many large B-to-B customers require next-day and desktop deliverythat is, delivery to one or more desks or drop-off points within an office buildingto reduce storage costs.

High Levels of Service: Large B-to-B customers require that their office supplies vendors provide high levels of customer service, including dedicated account representatives and/or customer service representatives to address any customer concerns or issues in a timely manner.

Valued-Added Services: Large B-to-B customers often require detailed utilization reporting to allow them to track and monitor on a regular basis their employees' uses of and needs for office products. They also often require the creation of customizable product catalogs to encourage their employees to order and use products for which they have already negotiated the lowest prices.

Sophisticated IT Systems: Large B-to-B customers generally require their office supplies vendor to have sophisticated IT capabilities that interface directly with their e-procurement and billing systems.

Reputation and Financial Stability: Large B-to-B customers generally require an office supplies vendor with experience and a strong reputation for supplying large B-to-B customers with office supplies, as well as financial stability.

Staples and Office Depot recognize the particular needs of large B-to-B customers and tailor their products and services to meet those needs. Both companies categorize B-to-B customers by size, with groups of employees dedicated to serving different groups of customers.

Thus, the sale and distribution of consumable office supplies to large B-to-B customers is the relevant product market in which to analyze the Merger's likely effects.

Relevant Geographic Market

Staples and Office Depot compete for the sale and distribution of consumable office supplies across the United States. Many large B-to-B customers operate nationally or in multiple regions of the country. Accordingly, it is appropriate to analyze the competitive effects of the Merger in the United States.

Internal company documents acknowledge the existence of a national market for the sale and distribution of consumable office supplies to large B-to-B customers, referring to themselves as the only two players in a "national market." They compete to provide the sale and distribution of consumable office supplies to large B-to-B customers through their respective networks of warehouses and distribution centers located around United States.

Many large businesses have a number of locations dispersed nationwide or across multiple regions of the United States. A substantial number of large B-to-B customers choose a single office supplies vendor with a geographically dispersed network of distribution centers to serve their facilities. These customers do so because consolidating their purchases with a single vendor gives them the ability to get lower prices, or increased discounts, rebates or other pricing incentives, from that vendor. In addition, choosing a single nationwide office supplies vendor provides large B-to-B customers with centralized and consistent services and terms across their facilities, including: (1) centralized contracting, (2) a single point of contact, (3) a single reporting/auditing function, (4) a single IT interface for users, and (5) ease of administration of the distribution contract.

Additionally, many large B-to-B customers enter into contracts for nationwide distribution, with nationwide pricing terms, and consider the vendor's ability to provide nationwide distribution and service in the selection process. Many large B-to-B customers with operations in multiple regions of the country, as opposed to nationwide, similarly want one vendor that can provide consistent pricing, service, and delivery across all their locations, and therefore often require a vendor with national capabilities. Therefore, for consumable office supplies sold and distributed to large B-to-B customers, the United States is the relevant geographic market.

MARKET STRUCTURE AND THE MERGER'S PRESUMPTIVE ILLEGALITY

Staples and Office Depot are by far the two largest vendors of consumable office supplies to large B-to-B customers. When large B-to-B customers issue RFPs for the sale and distribution of office supplies, Staples and Office Depot (including OfficeMax, which was acquired by Office Depot in 2013) are usually the two finalists for the business. In fact, Staples and Office Depot are often the only two companies that submit a proposal to supply a broad range of consumable office supplies on a nationwide basis.

The Merger Guidelines measure concentration using the Herfindahl-Hirschman Index ("HHI"). The HHI is calculated by totaling the squares of the market shares of every firm in the relevant market. Under the Merger Guidelines, a merger is presumed likely to create or enhance market powerand is presumptively illegalwhen the post-merger HHI exceeds 2,500 and the merger increases the HHI by more than 200 points.

The market for the sale and distribution of consumable office supplies to large B-to-B customers is highly concentrated, and the parties control the majority of sales. Post-Merger, the market would be substantially more highly concentrated than it is today. Post-Merger, Staples would control more than 70% of this relevant market. The next largest competitor would possess less than 5% of the relevant market. The Merger would result in a post-Merger HHI of well over 2500, and an increase in concentration of well over 200 points. Post-Merger market concentration would be more than 4900, and would increase HHIs in an already concentrated market by well over 200 points. Thus, the Merger would result in concentration above the amount necessary to establish a presumption of competitive harm.

ANTICOMPETITIVE EFFECTS:

The Merger Would Eliminate Vital Head-To-Head Competition between Staples And Office Depot

The two companies are each other's closest competitors. They are the two largest vendors of consumable office supplies to large B-to-B customers in the United States. The scale and capabilities of Staples and Office Depot are similarly matched, and are much larger and more robust than those of the next-largest vendor of consumable office supplies to large B-to-B customers (a regional office supplies vendor, W.B. Mason).

Staples' and Office Depot's size allows them to obtain products from manufacturers at lower prices than other vendors generally can. Both also offer a collection of distribution services that no other vendor of consumable office supplies can match: a national footprint with an extensive array of warehouses and distribution centers located across the country; correspondingly large salesforces; product breadth and depth, including private-label products; a single point of contact across all of a customer's locations; a single user interface that connects to a customer's procurement and billing systems; and other significant value-added offerings, such as order tracking, utilization reporting, and customizable catalogs.

The companies acknowledge that they are each other's closest competitors. One of Office Depot's own documents indicates that "[o]n a national scale, Office Depot's competition is Staples." Staples refers to itself as operating in a "2 player national market" and notes that "[t]here are only two real choices for customers."

They are often the first and second choices for large B-to-B customers of consumable office supplies, and predominantly win large B-to-B customers from, and lose large B-to-B customers to, each other.

Staples and Office Depot compete aggressively with each other on price and non-price terms to win and retain the business of large B-to-B customers. Staples and Office Depot frequently must compete with each other by lowering prices, increasing discounts or rebates, and providing significant cash incentives to win or keep large B-to-B customer accounts.

Large B-to-B customers benefit from the competition between the two firms. Among other things, that competition enables customers to pit Staples and Office Depot against each other to obtain lower prices and better contract terms. Large B-to-B customers switch, or threaten to switch, their business from Staples to Office Depot, and vice versa, to obtain better prices, discounts, cash incentives, and other beneficial terms. There are many of examples of direct price competition between Staples and Office Depot for large B-to-B customers. The Merger would eliminate this intense head-to-head price competition for large B-to-B customers.

Staples and Office Depot also compete aggressively on non-price terms to win large B-to-B customers by offering high-quality services. They currently risk losing business to each other if large B-to-B customers perceive one company's service as inferior or lacking. After the Merger, Staples would face substantially less competition for large B-to-B customers, and would have less incentive to improve, or even maintain, its current level of service to win or keep business.

Retail stores and internet websites directed at retail consumers are not viable alternatives for most large B-to-B customers. Such retailers cannot provide the level of pricing or service that office supplies vendors such as Staples and Office Depot provide and that large B-to-B customers require.

Wholesale suppliers of office supplies are not meaningful alternatives for most large B-to-B customers because wholesalers generally sell only for resale, not to businesses for their own use. Even when wholesalers work with independent vendors to distribute to customers, those wholesaler-vendor partnerships cannot provide the level of pricing or service that large office supplies vendors provide and that large B-to-B customers require.

Manufacturers of consumable office supplies are not a viable distribution option for most large B-to-B customers' consumable office supplies needs. Given the breadth of office supplies large B-to-B customers buy, such customers would have to purchase from a large number of different manufacturers to cover their employees' needs. Such purchasing would be highly inefficient, costly, and not practicable for most large customers. Moreover, manufacturers of consumable office supplies generally sell only in very large quantities, generally far larger than a B-to-B customer would purchase for its own use. As a result, manufacturers of consumable office supplies generally do not sell their products directly to customers buying for their own end-use and not for resale.

Other office supplies vendors, such as Amazon Business, regional vendors such as W.B. Mason, distribution consortia, and vendors of adjacent products, such as janitorial/sanitation products or breakroom supplies, generally have some combination of higher costs and thus higher prices, limited geographic footprints, and/or logistical and coordination challenges for large B-to-B customers. As a result, they would not meaningfully constrain Staples' exercise of market power post-Merger.

LACK OF COUNTERVAILING FACTORS

Barriers to Entry and Expansion

It is not likely that new entry or expansion by existing firms would be timely, likely, or sufficient to offset the anticompetitive effects of the Merger. A firm seeking to enter or expand in the market for the sale and distribution of consumable office supplies to large B-to-B customers, many of whom operate nationally or in multiple regions of the country, would face significant barriers to success.

One key obstacle to expansion by regional firms or consortia is having the geographic footprint to serve large B-to-B customers, many of which operate nationally or in multiple regions of the country. Creating a national distribution network anywhere close to that offered by Staples or Office Depot would be time and resource intensive.

Other vendors of consumable office supplies are many years and significant capital investments away from being in a position to replace the competition that Office Depot currently provides to Staples, even assuming those other vendors were likely to expand their geographic footprints.

Additionally, entrants must develop sophisticated IT systems that large B-to-B customers expect, to allow customized ordering systems that interface with the customer's procurement, billing, and utilization tracking systems. Such systems are costly to develop and maintain.

Large B-to-B customers also value having a relationship with an experienced sales representative that understands their particular needs. Thus, vendors seeking to enter or expand must recruit and hire a competent and experienced salesforce that can serve customers in multiple regions of the country. To hire enough sales representative to enter or expand on a sufficient scale to constrain the merged firm in multiple regions or nationally would take a significant amount of time and effort, particularly in light of noncompetition and non-solicitation agreements that incumbent vendors have with their employees.

Entrants also must overcome reputational barriers to entry and the companies' strong incumbency advantage. A significant percentage of RFPs are won by incumbent vendors-and often by Staples or Office Depot.

Efficiencies

Staples and Office Depot have not demonstrated cognizable efficiencies that would be sufficient to rebut the strong presumption and evidence that the Merger likely would substantially lessen competition in the relevant market.

CONCLUSION

For the reasons outlined above, the Staples and Office Depot merger should not go through as proposed by the two companies. The merged entity would have the ability to significantly raise price, and due to diminished competition would have less incentive to increase service to this segment of customers.

Questions

1. How would you classify the office superstore industry? Who are the competitors? What are the characteristics of this industry that lead to this conclusion?

2. How has the office superstore market changed in the 18 years since Staples and Office Depot originally attempted to merge?

3. What barriers to entry help maintain the industry structure?

4. If the merger were to be allowed, how would you characterize the merged firm's own price elasticity in a geographic market that contained only that firm? How would this change over time?

5. What is the relevant market for this case? Who are the customers? Should retailers that sell, but do not specialize in office products, be considered as part of the market? What evidence supports this conclusion?

6. How is the Herfindahl-Hirschman Index (HHI) affected by the merger? Are the HHI levels in the case indicative of high industry concentration?

7. How might the merger lead to cost reductions for Staples? Could this be beneficial for Staples' customers?

8. What arguments could Staples and Office Depot make in defense of their merger?