FTC sues Whole Foods over Wild Oats deal

AUSTIN, TEXAS —A definition can mean a lot. In filing a suit to block the merger of Whole Foods Market and Wild Oats, the Federal Trade Commission developed a narrow definition of the competitive circumstances in which the retailers compete, one it refers to as the premium natural and organic supermarket sector.

Whole Foods says the definition is a flawed one.

Many retailing observers reacted with genuine surprise to the June 6 FTC announcement about the suit, but the agency informed Whole Foods about its decision a day earlier.

Whole Foods reacted immediately, issuing a statement that declared its intention to take on the FTC in federal court. In essence, Whole Foods asserted that the FTC had developed a flawed definition and applied it to a marketplace that is more diverse than the agency assumes.

“We are very disappointed by this decision and we intend to vigorously challenge the FTC in court,” Whole Foods chairman and ceo John Mackey stated. “The FTC has failed to recognize the robust competition in the supermarket industry, which has grown more intense as competitors increase their offerings of natural, organic and fresh products; renovate their stores; and open stores with new banners and formats resembling Whole Foods Market. Evidently the FTC does not appreciate the many benefits for consumers of the proposed merger, including our plan to invest capital in and improve many of the stores currently owned by Wild Oats.”

A Whole Foods spokeswoman said the company would not comment beyond the statement on the FTC decision.

An FTC spokesman said a point of view about the supermarket industry and the place of natural food retailers had prompted the FTC’s decision. “The market—that’s what people find interesting here,” said agency spokesman Mitchell Katz.

In defining the market to determine if the merger might constitute a restraint on trade, the FTC concluded that the premium natural and organic supermarket sector functions separately from the conventional supermarket industry.

According to the FTC complaint, completion of the Whole Foods acquisition of Wild Oats would violate federal antitrust laws by eliminating the substantial competition between two uniquely close competitors in multiple markets. If the transaction continues unopposed, the FTC stated, Whole Foods would likely raise prices and reduce quality and services unilaterally.

In announcing the agency’s decision, Jeffrey Schmidt, director of the FTC’s bureau of competition, said, “Whole Foods and Wild Oats are each other’s closest competitors in premium natural and organic supermarkets and are engaged in intense head-to-head competition in markets across the country. If Whole Foods is allowed to devour Wild Oats, it will mean higher prices, reduced quality and fewer choices for consumers.”

The FTC’s contention that the Whole Foods move to “devour” Wild Oats would result in such a loss of competition in so many markets as to make the entire transaction untenable is an ironic contrast with Whole Foods’ determination that a major benefit of the Wild Oats acquisition would be the introduction of its banners into markets that it has not, or at least not significantly, penetrated.

Even more ironically, Mackey asserted when the merger was announced that the pressure of competition from conventional food retailers, who have been expanding their organic and natural food assortments, had been a factor in prompting Whole Foods to bid for Wild Oats.

Of course, the FTC routinely reviews supermarket mergers, and supermarket operators often divest properties during the course of an acquisition to satisfy monopoly concerns in local markets. Supervalu, for example, divested its Cub supermarkets in Chicago when it acquired Jewel so it wouldn’t tempt FTC consideration.

The FTC rarely blocks a full-blown retail merger, but it does sometimes step in. “The agency considers a transaction blocked if it is abandoned due to an action,” Katz said. He noted he could only recall two recent incidents when the FTC action foiled a comprehensive retailer merger: Office Depot and Staples in 1998 and, more recently, Block-buster and Hollywood Video.

Given the consolidation in retailing, the fact that the FTC launched just two actions suggests how rarely it steps in. Rare or not, all five FTC commissioners voted to instruct agency staff to file suit against Whole Foods.

The vote is in contrast to the view of many retailer observers who see competition within and between trade channels as becoming more intense and comprehensive. After the FTC announcement, JP Morgan analyst Stephen Chick deemed the agency’s action “irrational.”

Mitchell Corwin, a Morningstar analyst, in a research note, asserted, “We do not believe the FTC’s arguments hold water.” He added, “The FTC believes that combining Whole Foods and Wild Oats would give them a lock on the consumer seeking higher-quality natural and organic products and the extra amenities that lead to a unique shopping experience, enabling the combined companies to raise prices. Defining the market this way ignores the headway conventional grocers have been making in natural and organics and how they are weaving those products into their merchandising strategies and remodeling efforts.”

Yet, Corwin cautioned that legal proceedings could have a negative impact on both Wild Oats and Whole Foods and that, ultimately, a court could side with the agency and block the merger.

So, it’s not something investors, including Ron Burkle and his Yucaipa Cos., which effectively controls Wild Oats and owns a large chunk of its stock, are bound to appreciate.

Bruce Hoffman, a former deputy director for the FTC’s competition bureau and a partner in the global competition practice Group at Hunton & Williams LLP in Washington, said the agency’s ability to block the acquisition boils down to whether the chains are classified as natural-food stores or grocery stores. He added that the FTC lawsuit raises tough issues in market definition that may reach beyond the food channel to the broader retail industry.

“While the FTC frequently imposes divestitures in supermarket mergers and, somewhat less frequently in other retail mergers, the underlying issues have rarely been litigated,” Hoffman said. “Retail mergers present challenging market definition and competitive-effects issues. Even assuming that most of the customers would not switch to traditional supermarkets if faced with aprice increase, it is hard to imagine that there would not be some customers who would. Would those marginal customers be enough to make a post-merger price increase unprofitable? If so, is there some way the merged firm could avoid raising prices to those customers? If this litigation proceeds, it will likely shed light on these issues and many more that are at the core of retail merger enforcement.”