June 30, 1997, Decided

June 30, 1997, FILED

 DECISION ON MOTION: Plaintiff's motion granted.

JUDGE: Thomas F. Hogan, United States District Judge
 
Defendants are both corporations which sell office products--including office supplies, business

machines, computers and furniture--through retail stores, commonly described as office supply

superstores, as well as through direct mail delivery and contract stationer operations. Staples is the

second largest office superstore chain in the United States with approximately 550 retail stores

lDocated in 28 states and the District of Columbia, primarily in the Northeast and California. In 1996

Staples' revenues from those stores were approximately $ 4 billion through all operations. Office

Depot, the largest office superstore chain, operates over 500 retail office supply superstores that are

located in 38 states and the District of Columbia, primarily in the South and Midwest. Office

Depot's 1996 sales were approximately $ 6.1 billion. OfficeMax. Inc., is the only other office

supply superstore firm in the United States.

On September 4, 1996, defendants Staples and Office Depot, and Marlin Acquisition Corp.

("Marlin"), a wholly-owned subsidiary of Staples, entered into an "Agreement and Plan of Merger"

whereby Marlin would merge with and into Office Depot, and Office Depot would become a

wholly-owned subsidiary of Staples. According to the Agreement and Plan of Merger, the

transaction would be structured as a pooling of interests, in which each share of Office Depot

common stock would be exchanged for 1.14 shares of Staples' common stock. Pursuant to the

Hart-Scott-Rodino Improvements Act of 1976, 15 U.S.C. § 18a, Staples and Office Depot filed a

Premerger Notification and Report Form with the FTC and Department of Justice on October 2,

1996. This was followed by a seven month investigation by the FTC. The FTC issued a Second

Request for Information on November 1, 1996, to both Staples and Office Depot. The Commission

further initiated a second Second Request on January 10, 1997. In addition to the hundreds of

boxes of documents produced to the FTC during this time, the FTC took depositions of 18 Staples

and Office Depot officers and employees. The FTC also undertook extensive ex parte discovery of

third-party documents and, in lieu of subpoenas, obtained at least 36 declarations from third parties.

On March 10, 1997, the Commission voted 4-1 to challenge the merger and authorized

commencement of an action under Section 13(b) of the Federal Trade Commission Act, 15 U.S.C.

§ 53(b), to seek a temporary restraining order and a preliminary injunction barring the merger.

Following this vote, the defendants and the FTC staff negotiated a consent decree that would have

authorized the merger to proceed on the condition that Staples and Office Depot sell 63 stores to

OfficeMax. However, the Commission voted 3-2 to reject the proposed consent decree on April 4,

1997. The FTC then filed this suit on April 9, 1997, seeking a temporary retraining order and

preliminary injunction against the merger pursuant to Section 13(b) of the Federal Trade

Commission Act, 15 U.S.C. § 53(b), pending the completion of an administrative proceeding

pursuant to Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45, and Sections 7 and

11 of the Clayton Act, 15 U.S.C. §§ 12, 21.

II. The Geographic Market

One of the few issue about which the parties to this case do not disagree is that metropolitan areas

are the appropriate geographic markets for analyzing the competitive effects of the proposed

merger. A geographic market is that geographic area "to which consumers can practically turn for

alternative sources of the product and in which the antitrust defendant faces competition."

Morgenstern v. Wilson, 29 F.3d 1291, 1296 (8th Cir. 1994), cert. denied, U.S. , 130 L. Ed. 2d

1068, 115 S. Ct. 1100 (1995). In its first amended complaint, the FTC identified forty-two such

metropolitan areas n5 as well as future areas which could suffer anti-competitive effects from the

proposed merger. n6 Defendants have not challenged the FTC's geographic market definition in this

proceeding. Therefore, the Court will accept the relevant geographic markets identified by the

Commission.

III. The Relevant Product Market

In contrast to the parties' agreement with respect to the relevant geographic market, the

Commission and the defendants sharply disagree with respect to the appropriate definition of the

relevant product market or line of commerce. As with many antitrust cases, the definition of the

relevant product market in this case is crucial. In fact, to a great extent, this case hinges on the

proper definition of the relevant product market.

The Commission defines the relevant product market as "the sale of consumable office supplies

through office superstores," n7 with "consumable" meaning products that consumers buy recurrently,

i.e., items which "get used up" or discarded. For example, under the Commission's definition,

"consumable office supplies" would not include capital goods such as computers, fax machines, and

other business machines, or office furniture, but does include such products as paper, pens, file

folders, post-it notes, computer disks, and toner cartridges. The defendants characterize the FTC's

product market definition as "contrived" with no basis in law or fact, and counter that the

appropriate product market within which to assess the likely competitive consequences of a

Staples-Office Depot combination is simply the overall sale of office products, of which a combined

Staples-Office Depot accounted for 5.5% of total sales in North America in 1996. In addition, the

defendants argue that the challenged combination is not likely "substantially to lessen competition"

however the product market is defined. After considering the arguments on both sides and all of the

evidence in this case and making evaluations of each witness's credibility as well as the weight that

the Court should give certain evidence and testimony, the Court finds that the appropriate relevant

product market definition in this case is, as the Commission has argued, the sale of consumable

office supplies through office supply superstores.

The general rule when determining a relevant product market is that "the outer boundaries of a

product market are determined by the reasonable interchangeability of use [by consumers] or the

cross-elasticity of demand between the product itself and substitutes for it." Brown Shoe v. United

States, 370 U.S. 294, 325, 8 L. Ed. 2d 510, 82 S. Ct. 1502 (1962); see also United States v. E.I.

Du Pont de Nemours and Co., 351 U.S. 377, 395, 100 L. Ed. 1264, 76 S. Ct. 994 (1956).

Interchangeability of use and cross-elasticity of demand look to the availability of substitute

commodities, i.e. whether there are other products offered to consumers which are similar in

character or use to the product or products in question, as well as how far buyers will go to

substitute one commodity for another. E.I. Du Pont de Nemours, 351 U.S. at 393. In other words,

the general question is "whether two products can be used for the same purpose, and if so, whether

and to what extent purchasers are willing to substitute one for the other." Hayden Pub. Co. v. Cox

Broadcasting Corp., 730 F.2d 64, 70 n. 8 (2d Cir. 1984).

Whether there are other products available to consumers which are similar in character or use to the

products in question may be termed "functional interchangeability." See e.g., E.I. Du Pont de

Nemours, 351 U.S. at 399 (recognizing "functional interchangeability" between cellophane and

other flexible wrappings); United States v. Archer-Daniels-Midland Co., 866 F.2d 242, 246 (8th

Cir. 1988) (discussing "functional interchangeability" between sugar and high fructose corn syrup),

cert. denied, 493 U.S. 809, 107 L. Ed. 2d 20, 110 S. Ct. 51 (1989). This case, of course, is an

example of perfect "functional interchangeability." The consumable office products at issue here are

identical whether they are sold by Staples or Office Depot or another seller of office supplies. A

legal pad sold by Staples or Office Depot is "functionally interchangeable" with a legal pad sold by

Wal-Mart. A post-it note sold by Staples or Office Deport is "functionally interchangeable" with a

post-it note sold by Viking or Quill. A computer disk sold by Staples-Office Deport is "functionally

interchangeable" with a computer disk sold by CompUSA. No one disputes the functional

interchangeability of consumable office supplies. However, as the government has argued, functional

interchangeability should not end the Court's analysis.

The Supreme Court did not stop after finding a high degree of functional interchangeability between

cellophane and other wrapping materials in the E. L. Du Pont de Nemours case. Instead, the Court

also found that "an element for consideration as to cross- elasticity of demand between products is

the responsiveness of the sales of one product to price changes of the other." Id. at 400. For

example, in that case, the Court explained, "if a slight decrease in the price of cellophane causes a

considerable number of customers of other flexible wrappings to switch to cellophane, it would be

an indication that a high cross-elasticity of demand exists between [cellophane and other flexible

wrappings]; [and therefore] that the products compete in the same market." Id. Following that

reasoning in this case, the Commission has argued that a slight but significant increase in

Staples-Office Depot's prices will not cause a considerable number of Staples-Office Depot's

customers to purchase consumable office supplies from other non-superstore alternatives such as

Wal-Mart, Best Buy, Quill, or Viking. On the other hand, the Commission has argued that an

increase in price by Staples would result in consumers turning to another office superstore,

especially Office Depot, if the consumers had that option. Therefore, the Commission concludes

that the sale of consumable office supplies by office supply superstores is the appropriate relevant

product market in this case, and products sold by competitors such as Wal-Mart, Best Buy, Viking,

Quill, and others should be excluded.

The Court recognizes that it is difficult to overcome the first blush or initial gut reaction of many

people to the definition of the relevant product market as the sale of consumable office supplies

through office supply superstores. The products in question are undeniably the same no matter who

sells them, and no one denies that many different types of retailers sell these products. After all, a

combined Staples-Office Depot would only have a 5.5% share of the overall market in consumable

office supplies. Therefore, it is logical to conclude that, of course, all these retailers compete, and

that if a combined Staples-Office Depot raised prices after the merger, or at least did not lower

them as much as they would have as separate companies, that consumers, with such a plethora of

options, would shop elsewhere.

The Court acknowledges that there is, in fact, a broad market encompassing the sale of consumable

office supplies by all sellers of such supplies, and that those sellers must, at some level, compete

with one another. However, the mere fact that a firm may be termed a competitor in the overall

marketplace does not necessarily require that it be included in the relevant product market for

antitrust purposes. The Supreme Court has recognized that within a broad market, "well-defined

submarkets may exist which, in themselves, constitute product markets for antitrust purposes."

Brown Shoe Co. v. United States, 370 U.S. 294, 325, 8 L. Ed. 2d 510, 82 S. Ct. 1502 (1962);

see also Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 253 U.S. App. D.C. 142, 792 F.2d

210, 218 (D.C. Cir. 1986)(Bork, J.), cert. denied, 479 U.S. 1033, 93 L. Ed. 2d 834, 107 S. Ct.

880 (1987). With respect to such submarkets, the Court explained "because Section 7 of the

Clayton Act prohibits any merger which may substantially lessen competition 'in any line of

commerce,' it is necessary to examine the effects of a merger in each such economically significant

submarket to determine if there is a reasonable probability that the merger will substantially lessen

competition. If such a probability is found to exist, the merger is proscribed." Id. There is a

possibility, therefore, that the sale of consumable office supplies by office superstores may qualify as

a submarket within a larger market of retailers of office supplies in general.

The Court in Brown Shoe provided a series of factors or "practical indicia" for determining whether

a submarket exists including "industry or public recognition of the submarket as a separate economic

entity, the product's peculiar characteristics and uses, unique production facilities, distinct customers,

distinct prices, sensitivity to price changes, and specialized vendors." Id. Since the Court described

these factors as "practical indicia" rather than requirements, subsequent cases have found that

submarkets can exist even if only some of these factors are present. See, e.g., Beatrice Foods Co.

v. FTC, 540 F.2d 303 (7th Cir. 1976) (finding submarket based on industry recognition, peculiar

characteristics of the product, and differences in production methods and prices); International

Telephone and Telegraph Corp. v. General Telephone & Electronics Corp., 518 F.2d 913, 932

(9th Cir. 1975) (explaining that Brown Shoe's practical indicia were meant as "practical aids . . .

rather than with the view that their presence or absence would dispose, in talismanic fashion, of the

submarket issue").

The Commission discussed several of the Brown Shoe "practical indicia" in its case, such as industry

recognition, and the special characteristics of superstores which make them different from other

sellers of office supplies, including distinct formats, customers, and prices. Primarily, however, the

FTC focused on what it termed the "pricing evidence," which the Court finds corresponds with

Brown Shoe's "sensitivity to price changes" factor. First, the FTC presented evidence comparing

Staples' prices in geographic markets where Staples is the only office superstore, to markets where

Staples competes with Office Deport or OfficeMax, or both. Based on the FTC's calculations, in

markets where Staples faces no office superstore competition at all, something which was termed a

one firm market during the hearing, prices are 13% higher than in three firm markets where it

competes with both Office Depot and OfficeMax. The data which underly this conclusion make it

compelling evidence. Prices were compared as of January 1997, which, admittedly, only provides

data for one specific point in time. However, rather than comparing prices from only a small

sampling or "basket" of goods, the FTC used an office supply sample accounting for 90% of

Staples' sales and comprised of both price sensitive and non-price sensitive items. The FTC

presented similar evidence based on Office Depot's prices of a sample of 500 items, also as of

January 1997. Similarly, the evidence showed that Office Depot's prices are significantly higher, well

over 5% higher, n8 in Depot-only markets than they are in three firm markets.

______________________________________________________________________________________

Footnote

n8. The analytical framework set forth in the Merger Guidelines approaches the inquiry regarding

the reasonable interchangeability of use or cross-elasticity of demand by asking whether a

"hypothetical monopolist . . . would profitably impose at least a 'small but significant and

nontransitory' [price] increase." Merger Guidelines at § 1.11. The Merger Guidelines use 5% as the

usual approximation of a "small but significant and nontransatory price increase." Id. For this reason,

the Court's analysis will often refer to this 5% number.

______________________________________________________________________________________

End Footnote

Other pricing evidence presented by the FTC is less convincing on its own, due to limitations in the

underlying data. For example, relatively small samplings or "baskets" of goods may have been used

or it may not be clear how many stock keeping units ("SKUs") of supplies were included. For

example, the FTC also presented evidence comparing Staples' prices in Staples-only markets with

Staples' prices in three-firm markets for four different time periods, August 1994, January 1995,

August 1995, and May 1996. The result is startlingly similar to that found in the first two examples.

Where Staples does not compete with other office superstores, it charges prices well over 5%

higher than where it does so compete. While having the advantage of showing a trend over time, the

Court recognizes that this evidence has some problems. These particular calculations were made

based on a "basket" or sample of supplies comprised of supplies used by Staples to price check

against Office Depot. The number of SKUs in the sample was not provided to the Court, and it

appears that the components of the baskets may have changed over time. Therefore, the Court

would not give much weight to this evidence standing alone. However, since additional evidence

supports the same conclusion, the Court credits this evidence as confirmation of the general pricing

trend.

The FTC also pointed to internal Staples documents which present price comparisons between

Staples' prices and Office Depot's prices and Staples' prices and OfficeMax's prices within different

price zones. n9 The comparisons between Staples and Office Depot were made in August 1994,

January 1995, August 1995, and May 1996. Staples' prices were compared with OfficeMax's

prices in August 1994, July 1995, and January 1996. For each comparison, Staples' calculations

were based on a fairly large "basket" or sample of goods, approximately 2000 SKUs containing

both price sensitive and non-price sensitive items. Using Staples' data, but organizing it differently to

show which of those zones were one, two, or three firm markets, the FTC showed once again that

Staples charges significantly higher prices, more than 5% higher, where it has no office superstore

competition than where it competes with the two other superstores.

The FTC offered similar price comparison evidence for Office Depot, comparing Office Depot's

prices across Staples' zones. The comparisons were made in August 1994, January 1995, August

1995, and May 1996. Again, a large sample, approximately 2000 SKUs, was considered. The

results of this analysis are slightly less favorable to the FTC's position. Price differentials are

significantly smaller and there are even a few instances where Office Depot's prices appear to be

higher in one of its three firm markets than prices in its two firm markets and at least one point

where prices in one of the Depot-only zones were lower than prices in one of the three firm

markets. On average, however, this evidence shows that Office Depot's prices are highest in its one

firm markets, and lowest in its three firm markets.

This evidence all suggests that office superstore prices are affected primarily by other office

superstores and not by non-superstore competitors such as mass merchandisers like Wal- Mart,

Kmart, or Target, wholesale clubs such as BJ's, Sam's, and Price Costco, computer or electronic

stores such as Computer City and Best Buy, independent retail office supply stores, mail orders

firms like Qill and Viking, and contract stationers. Though the FTC did not present the Court with

evidence regarding the precise amount of non-superstore competition in each of Staples' and Office

Depot's one, two, and three firm markets, it is clear to the Court that these competitors, albeit in

different combinations and concentrations, are present in every one of these markets. For example,

it is a certainty that the mail order competitors compete in all of the geographic markets at issue in

this case. Office products are available through the mail in all 50 states, and have been for

approximately 30 years. Despite this mail order competition, however, Staples and Office Depot

are still able to charge higher prices in their one firm markets than they do in the two firm markets

and the three firm markets without losing a significant number of customers to the mail order firms.

The same appears to be true with respect to Wal-Mart. Bill Long, Vice President for

Merchandizing at Wal-Mart Stores, testifying through declaration; explained that price-checking by

Wal-Mart of Staples' prices in areas where both Staples and Wal-Mart exist showed that, on

average, Staples' prices were higher where there was a Staples and a Wal-Mart but no other

superstore than where there was a Staples, a Wal-Mart, and another superstore. n10

The evidence with respect to the wholesale club stores is consistent. Mike Atkinson, Vice

President, Division Merchandise Manager of BJ's Wholesale Club, testified at the hearing regarding

BJ's price checking of Staples and Office Depot in areas where BJ's competes with one or both of

those superstores. Though his sample was small--he testified that less than 10% of BJ's 80 stores

are located in the same area as a Staples and/or Office Depot--BJ's price checking found that, in

general, office supply superstore prices were lowest where there was both a Staples and an Office

Depot. In addition, Staples' own pricing information shows that warehouse clubs have very little

effect on Staples' prices. For example, Staples' maintains a "warehouse club only" price zone, which

indicates a zone where Staples exists with a warehouse club but without another office superstore.

The data presented by the Commission on Staples' pricing shows only a slight variation in prices

(1%-2%) between "warehouse club only" zones and one superstore markets without a warehouse

club. Additionally, in May 1996, two price comparison studies done by Staples, first using 2,084

SKUs including both price sensitive and non-price sensitive items and then using only 244 SKUs of

price sensitive items, showed that prices in the "club only" zones, on average, were over 10% higher

than in zones where Staples competes with Office Depot and/or OfficeMax.

There is also consistent evidence with respect to computer and/or consumer electronics stores such

as Best Buy. For example, Office Depot maintains a separate price zone, which it calls "zone 30,"

for areas with Best Buy locations but no other office supply superstores. However, the FTC

introduced evidence, based on a January 1997 market basket of "top 500 items by velocity," that

prices in Office Depot's "zone 30" price zone are almost as high as in its "non-competitive" price

zone, the zone where it does not compete with another office superstore.

There is similar evidence with respect to the defendants' behavior when faced with entry of another

"competitor." The evidence shows that the defendants change their price zones when faced with

entry of another superstore, but do not do so for other retailers. For example, Staples-changed its

price zone for Cincinnati to a lower priced zone when Office Depot and OfficeMax entered that

area. New entry by Staples and OfficeMax caused a decline in prices at Office Depot's Greensboro

stores. In July 1996, after OfficeMax entered Jackson, Michigan, Staples moved its Jackson store

to a new zone, cutting prices by 6%. There are numerous additional examples of zones being

changed and prices falling as a result of superstore entry. There is no evidence that zones change

and prices fall when another non-superstore retailer enters a geographic market.

Though individually the FTC's evidence can be criticized for looking at only brief snapshots in time

or for considering only a limited number of SKUs, taken together, however, the Court finds this

evidence a compelling showing that a small but significant increase in Staples' prices will not cause a

significant number of consumers to turn to non-superstore alternatives for purchasing their

consumable office supplies. Despite the high degree of functional interchangeability between

consumable office supplies sold by the office superstores and other retailers of office supplies, the

evidence presented by the Commission shows that even where Staples and Office Depot charge

higher prices, certain consumers do not go elsewhere for their supplies. This further demonstrates

that the sales of office supplies by non-superstore retailers are not responsive to the higher prices

charged by Staples and Office Depot in the one firm markets. This indicates a low cross-elasticity of

demand between the consumable office supplies sold by the superstores and those sold by other

sellers.

Turning back to the other Brown Shoe "practical indicia" of submarkets that the Commission

offered in this case, the Commission presented and the Court heard a great deal of testimony at the

hearing and through declarations about the uniqueness of office superstores, and the differences

between the office superstores and other sellers of office supplies such as mass merchandisers,

wholesale clubs, and mail order firms as well as the special characteristics of office superstore

customers. In addition, the Court was asked to go and view many of the different types of retail

formats. That evidence shows that office superstores are, in fact, very different in appearance,

physical size, format, the number and variety of SKU's offered, and the type of customers targeted

and served than other sellers of office supplies.

The Court has observed that office supply superstores look far different from other sellers of office

supplies. Office supply superstores are high volume, discount office supply chain stores averaging in

excess of 20,000 square feet, with over 11,000 of those square feet devoted to traditional office

supplies, and carrying over 5,000 SKUs of consumable office supplies in addition to computers,

office furniture, and other non-consumables. In contrast, stores such as Kmart devote

approximately 210 square feet to the sale of approximately 250 SKUs of consumable office

supplies. Kinko's devotes approximately 50 square feet to the sale of 150 SKUs. Target sells only

400 SKUs. Both Sam's Club and Computer City each sell approximately 200 SKUs. Even if these

SKU totals are low estimates as the defendants have argued, there is still a huge difference between

the superstores and the rest of the office supply sellers.

In addition to the differences in SKU numbers and variety, the superstores are different from many

other sellers of office supplies due to the type of customer they target and attract. The superstores'

customer base overwhelmingly consists of small businesses with fewer than 20 employees and

consumers with home offices. In contrast, mail order customers are typically mid-sized companies

with more than 20 employees. Another example is contract stationers who focus on serving

customers with more than 100 employees. While the Court accepts that some small business with

fewer than 20 employees as well as home office customers do choose other sellers of office

supplies, the superstores' customers are different from those of many of the purported competitors.

It is difficult to fully articulate and explain all of the ways in which superstores are unique. As the

plaintiff and defendant requested, the Court viewed some of the various sellers of office supplies

located in the Rockville, Maryland area, including Staples, Office Depot, CompUSA, Best Buy,

CVS, Kmart, Giant Food, and Wal-Mart. Based on the Court's observations, the Court finds that

the unique combination of size, selection, depth and breadth of inventory offered by the superstores

distinguishes them from other retailers. Other retailers devote only a fraction of their square footage

to office supplies as opposed to Staples or Office Depot. The evidence shows that the typical club,

mass merchant, or computer store offers only 210 to 2000 square feet of office supplies, compared

to over 11, 182 square feet at a typical Staples. This was evident to the Court when visiting the

various stores. Superstores are simply different in scale and appearance from the other retailers. No

one entering a Wal-Mart would mistake it for an office superstore. No one entering Staples or

Office Depot would mistakenly think he or she was in Best Buy or CompUSA. You certainly know

an office superstore when you see one. Cf. Bon-Ton Stores, Inc. v. May Department Stores, 881

F. Supp. 860, 870 (W.D. NY 1994) ("Customers know a department store when they see it.").

Another of the "practical indicia" for determining the presence of a submarket suggested by Brown

Shoe is "industry or public recognition of the submarket as a separate economic entity." See also

Rothery Storage & Van Co. v. Atlas Van Lines, 253 U.S. App. D.C. 142, 792 F.2d 210, 219

(D.C. Cir. 1986) (Bork, J.) ("The industry or public recognition of the submarket as a separate

economic unit matters because we assume that economic actors usually have accurate perceptions

of economic realities."), cert. denied, 479 U.S. 1033, 93 L. Ed. 2d 834, 107 S. Ct. 880 (1987);

FTC v. Coca-Cola Co., 641 F. Supp. 1128, 1132 (D.D.C. 1986) ("Analysis of the market is a

matter of business reality-a matter of how the market is perceived by those who strive for profit in

it."), vacated as moot, 264 U.S. App. D.C. 406, 829 F.2d 191 (D.C. Cir. 1987). The Commission

offered abundant evidence on this factor from Staples' and Office Depot's documents which shows

that both Staples and Office Depot focus primarily on competition from other superstores. The

documents reviewed by the Court show that the merging parties evaluate their "competition" as the

other office superstore firms, without reference to other retailers, mail order firms, or independent

stationers. In document after document, the parties refer to, discuss, and make business decisions

based upon the assumption that "competition" refers to other office superstores only. For example,

Staples uses the phrase "office superstore industry" in strategic planning documents. PX 15 at 3186.

Staples' 1996 Strategy Update refers to the "Big Three" and "improved relative competitive

position" since 1993 and states that Staples is "increasingly recognized as [the] industry leader." PX

15 at 3153. A document analyzing a possible acquisition of OfficeMax referenced the "benefits from

pricing in [newly] noncompetitive markets," and also the fact that there was "a potential margin lift

overall as the industry moves to 2 players." PX 33 at 8393, 8399.

When assessing key trends and making long range plans, Staples and Office Depot focus on the

plans of other superstores. In addition, when determining whether to enter a new metropolitan area,

both Staples and Office Depot evaluate the extent of office superstore competition in the market

and the number of office superstores the market can support. When selecting sites and markets for

new store openings, defendants repeatedly refer to markets without office superstores as

"non-competitive," even when the new store is adjacent to or near a warehouse club, consumer

electronics store, or a mass merchandiser such as Wal-Mart. In a monthly report entitled

"Competitor Store Opening/Closing Report" which Office Depot circulates to its Executive

Committee, Office Depot notes all competitor store closings and openings, but the only competitors

referred to for its United States stores are Staples and OfficeMax. PX 75 at 1309.

While it is clear to the Court that Staples and Office Depot do not ignore sellers such as warehouse

clubs, Best Buy, or Wal-Mart, the evidence clearly shows that Staples and Office Depot each

consider the other superstores as the primary competition. For example, Office Depot has a Best

Buy zone and Staples has a warehouse club zone. However, each still refers to its one firm markets

with no other office superstore as "non-competitive" zones or markets. In addition, it is clear from

the evidence that Staples and Office Depot price check the other office superstores much more

frequently and extensively than they price check other retailers such as BJ's or Best Buy, and that

Staples and Office Depot are more concerned with keeping their prices in parity with the other

office superstores in their geographic areas than in undercutting Best Buy or a warehouse club.

For the reasons set forth in the above analysis, the Court finds that the sale of consumable office

supplies through office supply superstores is the appropriate relevant product market for purposes

of considering the possible anti-competitive effects of the proposed merger between Staples and

Office Depot. The pricing evidence indicates a low cross-elasticity of demand between consumable

office products sold by Staples or Office Depot and those same products sold by other sellers of

office supplies. This same evidence indicates that non-superstore sellers of office supplies are not

able to effectively constrain the superstores' prices, because a significant number of superstore

customers do not turn to a non-superstore alternative when faced with higher prices in the one firm

markets. In addition, the factors or "practical indicia" of Brown Shoe support a finding of a

"submarket" under the facts of this case, and "submarkets," as Brown shoe established, may

themselves be appropriate product markets for antitrust purposes. 370 U.S. at 325. n11

IV. Probable Effect on Competition

After accepting the Commission's definition of the relevant product market, the Court next must

consider the probable effect of a merger between Staples and Office Depot in the geographic

markets previously identified One way to do this is to examine the concentration statistics and HHIs

within the geographic markets. n12 If the relevant product market is defined as the sale of

consumable office supplies through office supply superstores, the HHIs in many of the geographic

markets are at problematic levels even before the merger. Currently, the least concentrated market

is that of Grand Rapids-Muskegon-Holland, Michigan, with an HHI of 3,597, while the most

concentrated is Washington, D.C. with an HHI of 6,944. In contrast, after a merger of Staples and

Office Depot, the least concentrated area would be Kalamazoo-Battle Creek Michigan, with an

HHI of 5,003, and many areas would have HHIs of 10,000. The average increase in HHI caused

by the merger would be 2,715 points. The concentration statistics show that a merged

Staples-Office Depot would have a dominant market share in 42 geographic markets across the

country. The combined shares of Staples and Office Depot in the office superstore market would be

100% in 15 metropolitan areas. It is in these markets the post-merger HHI would be 10,000. In 27

other metropolitan areas, where the number of office superstore competitors would drop from three

to two, the post-merger market shares would range from 45% to 94% with post-merger HHIs

ranging from 5,003 to 9,049. Even the lowest of these HHIs indicates a "highly concentrated"

market.

The HHI calculations and market concentration evidence, however, are not the only indications that

a merger between Staples and Office Depot may substantially lessen competition. Much of the

evidence already discussed with respect to defining the relevant product market also indicates that

the merger would likely have an anti-competitive effect. The evidence of the defendants' own

current pricing practices, for example, shows that an office superstore chain facing no competition

from other superstores has the ability to profitably raise prices for consumable office supplies above

competitive levels. The fact that Staples and Office Depot both charge higher prices where they face

no superstore competition demonstrates that an office superstore can raise prices above competitive

levels. The evidence also shows that defendants also change their price zones when faced with entry

of another office superstore, but do not do so for other retailers. Since prices are significantly lower

in markets where Staples and Office Depot compete, eliminating this competition with one another

would free the parties to charge higher prices in those markets, especially those in which the

combined entity would be the sole office superstore. In addition, allowing the defendants to merge

would eliminate significant future competition. Absent the merger, the firms are likely, and in fact

have planned, to enter more of each other's markets, leading to a deconcentration of the market

and, therefore, increased competition between the superstores.

In addition, direct evidence shows that by eliminating Staples' most significant, and in many markets

only, rival, this merger would allow Staples to increase prices or otherwise maintain prices at an

anti-competitive level. n14 The merger would eliminate significant head-to-head competition

between the two lowest cost and lowest priced firms in the superstore market. Thus, the merger

would result in the elimination of a particularly aggressive competitor in a highly concentrated

market, a factor which is certainly an important consideration when analyzing possible

anti-competitive effects. See e.g., FTC v. Food Town Stores, Inc., 539 F.2d 1339, 1345 (4th Cir.

1976) (enjoining merger when merging firms had been "aggressive competitors in the past," by

opening stores in each other's markets and increasing sales by greater than the industry's sales

average). It is based on all of this evidence as well that the Court finds that the Commission has

shown a likelihood of success on the merits and a "reasonable probability" that the proposed

transaction will have an anti-competitive effect.

V. Entry Into the Market

"The existence and significance of barriers to entry are frequently, of course, crucial considerations

in a rebuttal analysis . . . [because] in the absence of significant barriers, a company probably cannot

maintain supra-competitive pricing for any length of time." Baker Hughes, Inc., 908 F.2d at 987.

Thus, the Court must consider whether, in this case, "entry into the . . . market would likely avert

anticompetitive effects from [Staples'] acquisition of [Office Depot]" Id. at 989. If the defendants'

evidence regarding entry showed that the Commission's market-share statistics give an incorrect

prediction of the proposed acquisition's probable effect on competition because entry into the

market would likely avert any anti-competitive effect by acting as a constraint on Staples-Office

Depot's prices, the Court would deny the FTC's motion. The Court, however, cannot make such a

finding in this case.

The defendants argued the hearing and in their briefs that the rapid growth in overall office supply

sales has encouraged and will continue to encourage expansion and entry. One reason for this,

according to Dr. Hausman's declaration, is that entry is more attractive when an industry is growing,

because new entrants can establish themselves without having to take all of their sales away from

existing competitors. In addition, the defendants' impressive retailing expert, Professor Maurice

Segall, testified at the hearing that there are "no barriers to entry in retailing," and defendants pointed

to the fact that all office superstore entrants have entered within the last 11 years.

There are problems with the defendants' evidence, however, that prevent the Court from finding in

this case that entry into the market by new competitors or expansion into the market by existing

firms would likely avert the anti-competitive effects from Staples' acquisition of Office Depot. For

example, while it is true that all office superstore entrants have entered within the last 11 years, the

recent trend for office superstores has actually been toward exiting the market rather than entering.

Over the past few years, the number of office superstore chains has dramatically dropped from

twenty-three to three.

All but Staples, Office Depot, and OfficeMax have either closed or been acquired. The failed office

superstore entrants include very large, well-known retail establishments such as Kmart,

Montgomery Ward, Ames, and Zayres. A new office superstore would need to open a large

number of stores nationally in order to achieve the purchasing and distribution economies of scale

enjoyed by the three existing firms. Sunk costs would be extremely high. Economies of scale at the

local level, such as in the costs of advertising and distribution, would also be difficult for a new

superstore entrant to achieve since the three existing firms have saturated many important local

markets. For example, according to the defendants' own saturation analyses, Staples estimates that

there is room for less than two additional superstores in the Washington, D.C. area and Office

Depot estimates that there is room for only two more superstores in Tampa, Florida.

The Commission offered Office 1 as a specific example of the difficulty of entering the office

superstore arena. Office 1 opened its first two stores in 1991. By the end of 1994, Office 1 had 17

stores, and grew to 35 stores operating in 11 Midwestern states as of October 11, 1996. As of that

date, Office 1 was the fourth largest office supply superstore chain in the United States.

Unfortunately, also as of that date, Office 1 filed for Chapter 11 bankruptcy protection. Brad

Zenner, President of Office 1, testified through declaration, that Office 1 failed because it was

severely undercapitalized in comparison with the industry leaders, Staples, Office Depot, and

OfficeMax. In addition, Mr. Zenner testified that when the three leaders ultimately expanded into the

smaller markets where Office 1 stores were located, they seriously undercut Office 1's retail prices

and profit margins. Because Office 1 lacked the capitalization of the three leaders and lacked the

economies of scale enjoyed by those competitors, Office 1 could not remain profitable.

For the reasons discussed above, the Court finds it extremely unlikely that a new office superstore

will enter the market and thereby avert the anti-competitive effects from Staples' acquisition of

Office Depot. The defendants, of course, focused their entry argument on more than just the entry

of additional superstores, pointing also to the expansion of existing companies such as U.S. Office

Products and Wal-Mart. The Court also finds it unlikely that the expansions by U.S. Office

Products and Wal-Mart would avert the anti-competitive effects which would result from the

merger.

Thomas Stemberg pioneered the office supply superstore concept in 1985. He created a deep

discount chain selling a broad array of office supplies primarily to small businesses which theretofore

were undeniably "paying through the nose" for office supplies. Staples was to be a high volume chain

operating at low gross margins, with higher volume leading to still lower costs for consumers.

Staples' pricing as well as the pricing of other office supply superstores which soon followed

Staples' lead, revolutionized the office products industry, impacting all channels of office products

retailing. By selling office products at 30 to 60% off list price, Staples and the other superstores

worked as a catalyst that forced everyone else in the industry to focus on cutting their prices. In a

relatively short period of time, the office supply superstores caused a general decrease in the price

of office products across the board. That decrease continued as the superstores have increased

their buying power, forcing manufacturers and suppliers to implement efficiencies in their own

businesses in order to compete in the sale of their products.

In light of the undeniable benefits that Staples and Office Depot have brought to consumers, it is

with regret that the Court reaches the decision that it must in this case. This decision will most likely

kill the merger. The Court feels, to some extent, that the defendants are being punished for their own

successes and for the benefits that they have brought to consumers. In effect, they have been

hoisted with their own petards. See William Shakespeare, Hamlet act 3, sc. 4. In addition, the

Court is concened with the broader ramifications of this case. The superstore or "category killer"

like office supply superstores are a fairly recent phenomenon and certainly not restricted to office

supplies. There are a host of superstores or "category killers" in the United States today, covering

such areas as pet supplies, home and garden products, bed, bath, and kitchen products, toys,

music, books, and electronics. Indeed, such "category killer" stores may be the way of retailing for

the future. It remains to be seen if this case is sui generis or is the beginning of a new wave of FTC

activism. For these reasons, the Court must emphasize that the ruling in this case is based strictly on

the facts of this particular case, and should not be construed as this Court's recognition of general

superstore relevant product markets.

Despite the Court's sympathy toward the plight of the defendants in this case, the Court finds that

the Commission has shown a "reasonable probability" that the proposed merger between Staples

and Office Depot may substantially impair competition and likewise has "raised questions going to

the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough

investigation, study, deliberation and determination by the FTC in the first instances and ultimately

by the Court of Appeals." Therefore, the Court finds that the Commission has shown a likelihood

that it will succeed in proving, after a full administrative trial on the merits, that the effect of the

proposed merger between Staples and Office Depot "may be substantially to lessen competition" in

violation of Section 7 of the Clayton Act. In addition, the Court has weighed the equities and finds

that they tip in favor of granting a preliminary injunction. A preliminary injunction is, therefore, found

to be in the public interest. The FTC's motion for a preliminary injunction shall be granted.