In a move that could ultimately cost Americans millions of dollars, the U.S. Supreme Court ruled in April that state governments and private parties can challenge mergers that have been approved by the Federal Trade Commission and the Justice Department's Antitrust Division. The decision strengthens the hands of state attorneys general, such as California's John Van de Kamp and New York's Robert Abrams, who aggressively attack corporate mergers.
The Court's ruling came in California v. American Stores. In 1988, Van de Kamp filed an antitrust suit against American to keep it from merging with Lucky Stores Inc., another large California chain. Since the FTC had approved the merger, American urged the court to dismiss the suit, arguing that Van de Kamp didn't have legal standing to prevent the merger. But Van de Kamp argued that state antitrust laws gave him the authority to challenge the merger, and 32 other state attorneys general filed friend-of-the-court briefs agreeing with him.
Van de Kamp's suit alleged that the merger would give American too large a share of the California grocery market, allowing it to charge monopoly prices for food. Van de Kamp ignored an FTC finding that the California market would remain competitive and that the merger would actually allow the firm to lower food prices.
He based his suit on the "market concentration doctrine"—which holds that a large market share by one or a few firms proves that those firms have monopoly power. For much of this century, this doctrine guided antitrust policy. But in the last 30 years, voluminous research has led antitrust economists to reject the doctrine. Today, an economist who believes that market concentration necessitates monopoly power is like a geographer who believes the earth is flat. Unless new companies can't enter the market because of legal barriers, such as licensing requirements, economists now believe, firms can maintain a large market share only by effectively satisfying their customers. Far from ripping off consumers, these businesses demonstrably serve them well.
This implies that antitrust policies that break up firms merely because they are large or "dominant" are grossly misguided. Such policies punish competitive success and stifle productivity.
The Reagan administration's antitrust enforcers took account of these findings. A large market share was usually not a sufficient reason to prosecute a firm. Indeed, unless there was proof that consumers had been harmed, Reagan officials usually assumed that a firm gained a large share of the market by out-hustling its competitors.
Sadly, George Bush's antitrust enforcers seem to see Van de Kamp as a better model than their predecessors in the Reagan administration. Recent FTC actions against the Red Food grocery store chain in Chattanooga, Tennessee, provide an example of the kind of nonsense that passes for antitrust action under the Bush administration.
In early 1989 Kroger decided to shut down its seven unprofitable Chattanooga stores, and Red Food offered to purchase them. The FTC challenged the sale, arguing that because Red Food already had 60 percent of the market, it was a "dominant firm" that monopolized the local market. "Competition and low prices," the FTC charged, "keep new supermarkets out of the city."
The FTC ignored the entry of two large, national grocery chains—Bruno's and Food Max—into the Chattanooga market in the preceding two years. Bruno's and Food Max are, respectively, four and seven times larger than the Red Food chain. The commission also overlooked the fact that such grocery giants as A&P, Winn-Dixie, and Giant Foods, among others, had entered the Chattanooga market during the past 30 years (some have since left). Obviously, there are no significant entry barriers to protect a grocery store monopolist.
In a highly revealing statement, the vice president of a competing grocery chain told a federal district court that he objected to Red Food's "stiff competition and low prices," which have "led to price wars, giving way to such deals as 19-cents-a-gallon milk." Because of Red Food's size (55 stores), he argued, it has "advantages over smaller stores," such as being able to spread the cost of a $5,000 advertisement over a large number of stores. He requested that the government protect him from such competition.
Fierce competition has forced Red Food into a low-margin/high-volume strategy. As Georgia Tech marketing professor David C. Allvine testified, "Red Food's strategy has been one of sacrificing profit to maintain their sales volume and low prices.…That makes them vulnerable because they must maintain high volumes."
The facts supported Allvine's interpretation. Red Food's return on equity was one-third less than that of its two top competitors—Bruno's and Food Lion. While Red Food may have held a large share of the market, it was in no position to gouge consumers.
Indeed, looking at the evidence and not a discredited theory, the Chattanooga grocery market seems quite competitive. In the fourth quarter of 1988—the last before the FTC action—a Chamber of Commerce Researchers Association survey showed that Chattanooga's food prices were 8.8 percent below the U.S. average. Chattanooga had the sixth lowest food prices of the 188 cities surveyed.
U.S. District Judge Orinda Evans saw through the FTC's specious claims and permitted the sale of the Kroger stores in May 1989. "The FTC has not shown a likelihood that Red Food, if it acquires the Kroger stores, will be able to exercise market power," the judge ruled. She also noted that the sale would save 400 jobs. The FTC lost on appeal.
But the FTC wouldn't take no for an answer. In February, Red Food signed a consent agreement with the commission. As the result of what sounds suspiciously like a gun-under-the-table "negotiation," Red Food agreed to sell six of its stores, including four of the ones purchased from Kroger; to sell the stores only to FTC-approved purchasers; to allow the FTC to appoint a trustee to sell the stores if it cannot sell them by December 31; and to get FTC approval before buying any stores in Chattanooga for the next 10 years.
The Chattanooga grocery market will become less competitive because the feds have crippled one of its strongest firms. Red Food's competitors—and other businesses—have learned a lesson that will not serve their customers well: Don't cut prices too much, or the government will drag you into court.
The tough talk by federal antitrust officials and the recent Supreme Court ruling signal a retreat from economic common sense in the antitrust arena. By focusing more on abstract measures of concentration than on competitive realities, the new federal antitrust officials and the newly empowered state attorneys general are about to turn back the antitrust clock, to the detriment of consumers.
Thomas J. DiLorenzo is the Scott L. Probasco, Jr., Professor of Free Enterprise at the University of Tennessee, Chattanooga.