The strong start to 2013′s M&A market continued yesterday, with Office Depot announcing it would acquire its rival OfficeMax in a $1.17 billion deal. Despite the heavy press coverage, investors greeted the announcement with a collective “meh,” as Office Depot shares fell 16.73% in trading yesterday, while OfficeMax’s shares fell 7%. (Although OfficeMax shares did rise when rumors of the merger leaked earlier in the week).
This indifference should tell us a number of things. The first is that Office Depot and OfficeMax are far less efficient enterprises than their larger office-superstore rival, Staples. As Morningstar analyst Joscelyn MacKay wrote in a research note, the merger between Office Depot and OfficeMax will make the company the largest office superstore by store count with roughly 2,000 domestic locations compared with Staples’ 1,900. But even with that store advantage, the combined company’s revenue is just 70% of Staples top line. In other words, the combined company will have a lot of catching up to do.
But it’s not like Staples has been knocking the cover off the ball the past few years, either. Office supply superstores have been struggling to stave off competition from online retailers, while also dealing with the slow decline of paper products as offices become increasingly digitized.
There is irony, however, in the fact that as recently as 1997 the Federal Trade Commission and a Federal District Court — in awe of the power of the big-box business model — refused to sanction a merger between Office Depot and Staples. The FTC argued then that despite the fact that office supplies were sold by a diverse group of vendors like grocery stores, drug stores and other retailers like Target or Kmart, the sale of office supplies by a superstore constituted a distinct market with only three competitors. The FTC claimed that superstores offer a unique set of products and services — specifically the ability to do all your office-supply shopping in one place — and that this made superstores immune to the competitive actions that other sellers of office suppliers might take. The FTC backed this up with a bunch of evidence from Staples own internal documents, which showed that Staples pretty much took this view itself, and with empirical analysis that predicted price increases if the merger were to go through.
Fast forward just 15 years, and the retail market has completely changed. Granted, Office Depot and OfficeMax are much smaller than Staples, so a merger between these two will result in less concentration than a merger between Staples and either Office Depot or OfficeMax would. But viewing even this smaller merger through the FTC’s 1997 logic would cause you to see a market that is far too concentrated. The FTC isn’t in the habit of allowing markets with only three competitors to consolidate into a market with just two.
Now, there’s no way to know how the FTC will react to the proposed merger at this point in time. It may still place roadblocks in front of the deal. But the two firms surely studied the 1997 case closely and conclude that the feds would view the late 90s market for office supplies and the early 2010s market as two completely different animals.
And reading original 1997 opinion gives you an idea of how different the retail industry was a decade and a half ago. The core of the case was that the superstore model was such a unique innovation as to constitute a market in and of itself. Judge Thomas Hogan’s opinion only reluctantly granted a preliminary injunction against the merger, out of fear that he was punishing the success of two firms that had devised a better business model for distributing office supplies to consumers. He writes glowingly of Staples, noting that “category killers” were a model that was sweeping the industry and may indeed be “the way of retailing for the future.”
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Just 15 years later, we see that the FTCs action against Staples was probably unnecessary, even if the merger would have raised prices in some locations for a short period of time. As retail entered the new millennium, internet retailers like Amazon started to chip away at the would-be category killers by neutralizing their biggest advantage: selection. Business-to-business firms like the privately-held W.B. Mason began to leverage the internet to reach a larger number of customers. And all-around discount firms like Costco and Walmart proved that they could draw customers away from the specialized big-box stores.
This is not to criticize the FTC’s decision to challenge the merger 15 years ago. It’s the role of the federal government to police monopoly power, and for more than a century our federal court system has successfully mediated between the need to reward innovation and the need to guard against monopolistic behavior. It’s simply evidence that creative destruction in capitalist economies can be swift and impressive. The big-box “category killer” model was very recently as dominant in retail as Amazon now appears to be. But the Office Depot/OfficeMax merger is just one more piece of evidence that its glory days are far in the past. Of course, Amazon may too be at the zenith of its influence, while all of us who are currently marveling at its dominance could look pretty naive 15 years down the road.