Is Amazon’s takeover of Whole Foods anti-competitive? Probably not.

This originally appeared as a guest post on the Adam Smith Institute’s blog last week.

A few days ago, Amazon announced its plans to purchase the predominantly USA-based grocery retail chain Whole Foods for almost $14bn. Although both companies operate in many countries, the main competition issues (if any) are likely to arise in the US, were both companies have a non-negligible presence.

Indeed, this announcement has resulted in a number of people claiming that the proposed merger will be anti-competitive. Specifically, there are some claims that the merger would result in 1) bundling and foreclosure of rivals; and/or 2) predatory pricing. In short, the first theory of harm posits that Amazon would force customers that wanted to purchase its distribution (or other) services to also purchase from Whole Foods (or vice versa), while the second theory of harm suggests that the merged entity would price below cost in order to drive out rival grocery firms before increasing prices once those rivals exited.

Importantly, both of these theories of harm require that the merged entity have some form of “market power” (i.e. the ability to charge a price above the competitive level and to act independently of its rivals). Typically, this is most likely to occur when a firm has a share of sales in a particular market of over 40%. However, as a general point, these theories of harm gloss over the fact that Amazon and Whole Foods’ shares in grocery sales are tiny – less than 5% combined in the US. As such, it is difficult to see how the combined entity can have any market power.  Clearly, the merged entity would not satisfy this for sales of groceries at the moment of the merger.

Bundling

However, others might argue that Amazon does have a sufficiently high share of sales of “online retail” to be classed as dominant. As such, they argue that Amazon could “leverage” its power in that area to grocery retail by bundling some of its services with those of its groceries. However, as the merged entity will be active at the retail level of groceries, it is not obvious exactly what other services offered by Amazon could be bundled with them – for the bundling strategy to work, consumers would still have to want at least one of the items in the bundle, and could continue to purchase them separately from Amazon or elsewhere anyway. Hence, there does not appear to be a viable mechanism through which this bundling theory of harm could occur.

Predatory Pricing

Moreover, for the predatory pricing theory of harm to be valid, there must be strong evidence that 1) the merged entity would price its groceries below some measure of cost that represents the extra cost that would be incurred by supplying one extra unit of output (usually measured as average variable cost of long-run average incremental cost); and 2) it would have an incentive to do so.

The first condition is notoriously difficult to prove – one first has to decide which costs should be included / excluded in the measure (which really isn’t as easy as one would think – e.g. should advertising spend that applies to brand-related marketing, but isn’t specifically related to groceries, be included), as well as deciding the relevant time-frame over which costs are assessed.

The second condition requires proving that the merged entity would become dominant (and therefore be able to recoup the losses it had made in pricing below cost) in the future. This is where the theory of harm becomes incredibly speculative – it assumes that sufficient sales would switch to the merged entity from rival grocery firms that the merged entity would be dominant. In other words, it assumes that pricing below cost would be sufficient in and of itself to persuade consumers to switch (regardless of e.g. quality of service provided) and that rival grocery firms would not respond in any way to the merged entity’s actions. Clearly both of these assumptions are likely to be violated in practice and, as such, the predatory pricing theory of harm seems unlikely.

Summary

Given that the merged entity is unlikely to have the incentive or ability either to bundle its products together or recoup any losses made from pricing below costs, both of the theories of harm currently being bandied about are unlikely to be valid. As such, it is difficult to see how the cries that the proposed merger is anti-competitive are anything more than “a big firm is buying someone so they have to be stopped”. That should not be a basis on which a merger can be prevented.