Efficiency Presentation FTC v. Heinz

Efficiencies in the U.S. Merger Guidelines “[A] primary benefit of mergers to the economy is their potential to generate significant efficiencies and thus enhance the merged firm’s ability and incentive to compete, which may result in lower prices, improved quality, enhanced service, or new products.” “[M]erger-generated efficiencies may enhance competition by permitting two ineffective competitors to form a more effective competitor, e.g., by combining complementary assets.” “In a unilateral effects context, incremental cost reductions may reduce or reverse any increases in the merged firm’s incentive to elevate price.” “In a coordinated effects context, incremental cost reductions may make coordination less likely or effective by enhancing the incentive of a maverick to lower price or by creating a new maverick firm.”

Efficiencies Must Be Merger Specific “The Agencies credit only those efficiencies likely to be accomplished with the proposed merger and unlikely to be accomplished in the absence of either the proposed merger or another means having comparable anticompetitive effects.” “Only alternatives that are practical in the business situation faced by the merging firms are considered in making this determination.”

Efficiencies Must Be Verifiable “[I]t is incumbent upon the merging firms to substantiate efficiency claims so that the Agencies can verify by reasonable means the likelihood and magnitude of each asserted efficiency.”

Cognizable Efficiencies “Cognizable efficiencies are merger-specific efficiencies that have been verified and do not arise from anticompetitive reductions in output or service.”

Efficiencies vs. Competitive Effects “The Agencies will not challenge a merger if cognizable efficiencies are of a character and magnitude such that the merger is not likely to be anticompetitive in any relevant market.” “To make the requisite determination, the Agencies consider whether cognizable efficiencies likely would be sufficient to reverse the merger’s potential to harm customers in the relevant market, e.g., by preventing price increases in that market.” “[E]fficiencies are most likely to make a difference in merger analysis when the likely adverse competitive effects, absent the efficiencies, are not great.”

First Consider the Competitive Effects Without Efficiencies How did Heinz argue that competitive effects were small?

Heinz and Beech-Nut do not Constrain Consumer Prices FTC assertion: “ ... retail pricing is affected by competition at the wholesale level.” Heinz and Beech-Nut: “ ... wholesale competition between Beech-Nut and Heinz does little to affect retail prices, so the loss of that competition would not make much difference to the price charged at retail by the merged firm.”

HHI Calculations Overstate Merger’s Impact Ignore historic Gerber dominance and price leadership Ignore Heinz and Beech-Nut’s lack of national distribution and geographic overlap Ignore market realities – lack of store shelf overlap Ignore decline in category Ignore lack of consumer substitution at retail

Pricing and Competition Limited consumer substitution at retail Distribution (get on-the-shelf) competition between Heinz and Beech-Nut has little effect on consumer prices Heinz and Beech-Nut target Gerber, not each other Trade spending occurs in all accounts Bidding involves “fixed” up front payments, depletes consumer funds Incremental “fixed” payments do not affect retail prices DX 1605

Limited Consumer Substitution at Retail Lack of national distribution, geographic overlap Lack of in-store competition, shelf space overlap Different brand appeal, product niches Low cross elasticities DX 1606

Heinz and Beech-Nut Pricing Core versus Mixed Markets

Heinz and Beech-Nut Pricing Core versus Mixed Markets Source: DX 612

Economic Expert Testimony Professor Baker: “[C]onsumer substitution between Heinz and Beech-Nut is very small and, therefore, … these two firms are not constraining each other’s pricing at the retail level very much.”

FTC Expert Testimony: Heinz and Beech-Nut Price Against Gerber, Not Each Other Q: “There’s nothing in [DX 48] about a targeted differential versus Beech-Nut, is there? A: “No. Generally Heinz targets off of Gerber.” Q: “... The objective is solidify Heinz baby food’s position as an every day brand alternative to Gerber. Not to Beech-Nut; is that right?” A: “That’s right.”

Incremental “Fixed” Up Front Payments Deplete Consumer Funds “Bid situations generally result in higher fixed spending . . . .” Meader Tr. at 816

Incremental Payments do not Change Retail - Consumer Prices Retailer’s View Supermarket Executive: Q: “So to the extent that you can use funds that you receive from manufacturers to keep the prices low, you have a rational incentive to do that, don’t you?” A: “Yes. We also want some of it to stick to our fingers so we can show a profit for our investors.” “[Supermarket] was from the beginning focused on up-front dollars to be used to pay down their acquisition debt.”

Incremental Payments do not Change Retail - Consumer Prices Retailer’s View Supermarket Executive Q: “... [W]hat did [Supermarket] do with that money provided by Beech-Nut?” A: “We took that money as income.” Q: “Did [Supermarket] use any of the money ... to lower its prices on baby food?” A: “No.”

Gerber U.S. Strategy As category volume has declined, Gerber dollar sales have steadily increased

Declining ACV Bill Johnson “We have not been able to build distribution. Our distribution has actually declined over the years.” * * * * “[T]he reality at this is that our distribution has eroded over the years.” Tracy Quinn “[Heinz’s] business has declined in distribution. … As has Beech-Nut’s. My ACV is down as far as theirs.”

Heinz Post Merger Plan Heinz committed to baby food, with the number one position in several markets around the world Shut down the Beech Nut facility and increase utilization at the Heinz manufacturing facility Results in substantial reduction in the cost of manufacturing Beech Nut baby food Heinz would pick the best recipes Label its baby food Beech Nut everywhere Charge the lower Heinz value price everywhere Combination results in a strong national brand Can launch new products as a result of national presence

Source: DX 2 DX 1656

DX 1657

Efficiencies- Expert Analysis Q: “As a result of all the work you have done, what is your opinion regarding the manufacturing cost savings that may be achieved by this merger?” A: “I believe the variable manufacturing cost savings that will be achieved as a result of this merger under the assumptions that are incorporated in Mr. Campbell’s analysis, that is, that they would move the production over to the Pittsburgh facility primarily, that’s what gives rise to most of it, are substantial, significant. And they are among the largest that I have ever seen certainly in a manufacturing segment.” DX 1669

Cost Reduction Resulted in a cost reduction of 22.3% of Beech Nut variable manufacturing cost

Unilateral Effects Determining Efficiencies Model project price increase without efficiencies Consider UPP model in the Merger Guidelines Model the downward pressure on price Even a monopolist will lower price if its costs fall Does the reduction in costs reverse the price increase?

Coordinated Effects: Determining Efficiencies Model the price increase without efficiencies Monopoly pricing? Cournot pricing? Bertrand pricing? Model the downward pressure on price

Production efficiency gain Welfare Effects of a Merger That Reduces Cost and Increases Price Production efficiency gain Wealth transfer from buyers to sellers Allocative efficiency loss P1 P0 MC0 Industry Demand MC1 Q1 Q0

The Court of Appeals on Heinz Efficiencies Cost reduction not merger specific: “[T]he question is how much Heinz would have to spend to make its product equivalent to the Beech-Nut product and hence whether Heinz could achieve the efficiencies of merger without eliminating Beech-Nut as a competitor. The district court, however, undertook no inquiry in this regard.”