Pricing Pencils

The FTC's creative market definitions


When my ink-jet cartridge starts to sputter or I run out of once-used paper to cycle back through my printer, I, like many small office managers, am faced with a choice. If the day is nice, I can walk four blocks to the west and restock my garrison with provisions from Office Depot. Or, if I feel like walking past the White House, I may visit Staples. When my ink runs dry on deadline, I stop short of the Depot and buy a cartridge at Time Office Products, a small office supplies store that promises to "provide any of 30,000 urgent supply items" the day you call, if you are willing to pay a slightly higher price. Given enough foresight, I need not even leave my office. With just a half-day's notice, I fax an order form into the 800-number ether, and the next day a delivery man (yes, he is always a man) brings my supplies at prices competitive with the two superstores.

This story is not remarkable. Similar scenarios are played out across America. What is remarkable is that the federal government contends that these choices don't exist. In its efforts to block a merger between Staples and Office Depot, the Federal Trade Commission, which itself purchases office supplies from 105 vendors, has objected to this marriage on the grounds that it would result in a manila envelope monopoly.

Never mind, say the regulators, that Staples and Office Depot once combined would account for roughly 6 percent of the office supply market nationwide. Never mind, they say, that both stores lower the cost of office supplies by at least 20 percent in markets in which only one enters. Never mind, they say, that the two stores spent millions of dollars crafting a plan to sell 63 stores to rival OfficeMax, in a good faith attempt to appease FTC staffers. Never mind, they say, that the business strategy to which both stores owe their success is relentless price cutting, which has saved Americans hundreds of millions of dollars since superstores first revolutionized the office supply business in the mid-1980s.

The FTC likes the world as it is–with three office supply superstores. To keep it that way, it is victimizing the very companies responsible for this world of low-priced office suppliers. It claims the superstores compete only against each other in markets where all three exist. In fact, the three stores–Office Depot, Staples, and OfficeMax–account for less than 10 percent of the office supply market, although there is regional variation. The FTC paid for an econometric model which showed superstore prices to be up to 15 percent higher in markets with just one superstore than in markets with two, although prices are higher still in markets that lack a superstore. And it marched into federal court in late May and argued that this merger should be blocked, lest America's budding entrepreneurs and home office enthusiasts face higher stationery prices.

U.S. District Judge Thomas F. Hogan is expected to deliver a decision in late June. But no matter what he decides, this case's existence says much about the bureaucratic impulse to define, categorize, manage, and control. It may also provide a preview of where Clinton's Scotch-tape trust busters may be headed in the coming years.

It is not surprising that the government and the two superstores don't completely agree on the relevant market. Under the merger guidelines, determination of monopoly power requires a two-step process: The market is defined and then a formula which uses market-share data, the Herfindahl-Hirschman Index, is used to determine market concentration. As a result, the biggest battle in antitrust merger cases is always over market definition, with the government arguing for a restrictive definition and the firms arguing for a broader definition.

The absurdity in this case–which promises to be replicated if successful–is the FTC's contention that no other stores compete vigorously enough with Office Depot and Staples to discipline their price-increasing urges. Forget the small mom-and-pop corner grocery that carries cards. The FTC claims that Wal-Mart, which already sells more office supplies than Staples and Office Depot combined, isn't a threat to the single-subject superstores. Nor are the fax order houses that deliver to anyone, even a one-person operation like mine. Worse yet, the FTC claims there is no possibility for entry into the market in the event that a monopolist does increase prices. Rick Warren-Boulton, the FTC-retained economist who served as chief economist in the antitrust division at the Department of Justice under Reagan, calls the notion that other people would start new superstores "bunk."

Such an ossified view of the world is equivalent to defining the book market as a battle between Borders and Barnes & Noble, neglecting the complex ecology of smaller bookstores and even coffee shops, which drives these two giants to excellence and forces them to keep their book and latte prices low. According to the FTC's logic, Circuit City and The Good Guys would be considered a market insulated from the electronics sections of the department stores and office supply superstores that are often found right across the street.

All of us, and most institutions, occupy multiple niches, play a variety of roles, and compete and cooperate in a plethora of settings that belie simple government box checking. Just because the government must identify people and institutions doesn't mean that they will always fit easily into the government's categories, as Tiger Woods's self-identification illustrates. (See "Blurred Vision," July 1997.)

Broadly defined, Office Depot and Staples are retailers; narrowly defined, they are office supply retailers; and absurdly defined, they are specialty office supply superstores. But office supplies account for just over a third of these two stores' sales, the other two-thirds being such things as computers, cellular phones, and furniture. And while traditional furniture stores may not sell office paper, many computer stores do. The markets for all of these products are deep, complex, and interwoven. Just as Circuit City can't increase the price of its computers, lest its customers defect to Office Depot, even a lone Office Depot store faces price constraints because of Wal-Mart's, Kmart's and other stores' ability to expand into their markets.

Noting that for the last 20 years leading-edge thinking in antitrust–which focuses on barriers to entry rather than market share–has found less and less for government to do, economist Thomas DiLorenzo charges the FTC with going back to a 1950s way of thinking in an attempt to build its bureaucracy. "The problem with the FTC is that the real capital today is knowledge," says DiLorenzo, who teaches at Loyola College in Maryland. "Their old argument about physical capital being the barrier has been stripped from them." However, this hasn't dampened the FTC's desire to manage markets.

We can expect to see more ill-founded antitrust intervention during the remainder of the Clinton presidency. In Washington, rewards come to those who amass and exercise power. And antitrust activism is particularly appealing because it provides a way of promoting big government while pretending to champion business competition. Warren-Boulton offers the classic dichotomy. "[There are] two kinds of worlds to operate in," he says. "A world in which firms face competitors and fight it out for the consumers or one of monopoly in which the government regulates you."

I don't doubt Warren-Boulton's sincerity. But it's hard to take seriously the contention that government needs to regulate the price of pencils. Somehow I think Wal-Mart, the local bookstore, some yet-unproven entrepreneur, or even OfficeMax would seize the opportunity to drive the newly merged company out of business, should it decide to increase prices in the 6 percent of the market it would occupy. In the FTC's world, such thinking is derided as mere "speculation."