ECON 2200 Lecture 5: ECON 2200 lecture 5

Proposed Merger Between Heinz and Beech-Nut Scrutinized

Michael Baye and Patrick Scholten prepared this case to serve as the basis for classroom discussion rather than to represent economic or legal fact. The case is a condensed and slightly modified version of the public copy of the decision in FTC (Appellant) v. H.J. Heinz Co. and Milnot Holding Corporation that was argued on February 12, 2001 and decided April 27, 2001. No. 00-5362.

OVERVIEW OF THE BABY FOOD MARKET

Four million infants in the United States consume 80 million cases of jarred baby food annually, representing a domestic market of $865 million to $1 billion. The baby food market is dominated by three firms, Gerber Products Company (Gerber), Heinz and Beech-Nut. Gerber, the industry leader, enjoys a 65 percent market share while Heinz and Beech-Nut come in second and third, with a 17.4 percent and a 15.4 percent share respectively. Gerber enjoys unparalleled brand recognition with a brand loyalty greater than any other product sold in the United States. Gerber's products are found in over 90 percent of all American supermarkets.

By contrast, Heinz is sold in approximately 40 percent of all supermarkets. Its sales are nationwide but concentrated in northern New England, the Southeast and Deep South and the Midwest. Despite its second-place domestic market share, Heinz is the largest producer of baby food in the world with $1 billion in sales worldwide. Its domestic baby food products with annual net sales of $103 million are manufactured at its Pittsburgh, Pennsylvania plant, which was updated in 1991 at a cost of $120 million. The plant operates at 40 percent of its production capacity and produces 12 million cases of baby food annually. Its baby food line includes about 130 SKUs (stock keeping units), that is, product varieties (e.g., strained carrots, apple sauce, etc.). Heinz lacks Gerber's brand recognition; it markets itself as a “value brand” with a shelf price several cents below Gerber's.

Beech-Nut has a market share (15.4%) comparable to that of Heinz (17.4%), with $138.7 million in annual sales of baby food, of which 72 percent is jarred baby food. Its jarred baby food line consists of 128 SKUs. Beech-Nut manufactures all of its baby food in Canajoharie, New York at a manufacturing plant that was built in 1907 and began manufacturing baby food in 1931. Beech-Nut maintains price parity with Gerber, selling at about one penny less. It markets its product as a premium brand. Consumers generally view its product as comparable in quality to Gerber's. Beech-Nut is carried in approximately 45 percent of all grocery stores. Although its sales are nationwide, they are concentrated in New York, New Jersey, California and Florida.

At the wholesale level Heinz and Beech-Nut both make lump-sum payments called “fixed trade spending” (also known as “slotting fees” or “pay-to-stay” arrangements) to grocery stores to obtain shelf placement. Gerber, with its strong name recognition and brand loyalty, does not make such pay-to-stay payments. The other type of wholesale trade Page 2spending is “variable trade spending,” which typically consists of manufacturers' discounts and allowances to supermarkets to create retail price differentials that entice the consumer to purchase their product instead of a competitor's.

On February 28, 2000 H.J. Heinz Company (Heinz) and Milnot Holding Corporation (Beech-Nut) entered into a merger agreement. Under the terms of their merger agreement, Heinz would acquire 100 percent of Beech-Nut's voting securities for $185 million.

Arguments Supporting Anti-Competitiveness of Merger

The relevant product market was defined as jarred baby food and the geographic market as the United States. Sufficiently large HHI figures indicate that a merger is anti-competitive. The pre-merger HHI score for the baby food industry is 4775 -- indicative of a highly concentrated industry. The merger of Heinz and Beech-Nut will increase the HHI by 510 points. This creates, by a wide margin, a presumption that the merger will lessen competition in the domestic jarred baby food market.

It is probable that this merger will eliminate competition between the two merging parties at the wholesale level, where they are currently the only competitors for the second position on the supermarket shelves. Although Heinz and Beech-Nut claim that in areas that account for 80% of Beech-Nut sales, Heinz has a market share of about 2% and in areas that account for about 72% of Heinz sales, Beech-Nut's share is about 4%, there is evidence that Heinz and Beech-Nut are locked in an intense battle at the wholesale level to gain (and maintain) position as the second brand on retail shelves. Heinz's own documents recognize the wholesale competition and anticipate that the merger will end it. Indeed, those documents disclose that Heinz considered three options to end the vigorous wholesale competition with Beech-Nut: two involved innovative measures, while the third entailed the acquisition of Beech-Nut. Heinz chose the third and least pro-competitive of the options.

Finally, the anticompetitive effect of the merger is further enhanced by high barriers to market entry. Barriers to entry are important in evaluating whether market concentration statistics accurately reflect the pre- and likely post-merger competitive picture. If entry barriers are low, the threat of outside entry can significantly alter the anticompetitive effects of the merger by deterring the remaining entities from colluding or exercising market power. Low barriers to entry enable a potential competitor to deter anticompetitive behavior by firms within the market simply by its ability to enter the market. Existing firms know that if they collude or exercise market power to charge supra-competitive prices, entry by firms currently not competing in the market becomes likely, thereby increasing the pressure on them to act competitively. In this case, there had been no significant entries in the baby food market in decades and new entry was “difficult and improbable.” This finding seems to eliminate the possibility that the reduced competition caused by the merger will be ameliorated by new competition from outsiders.

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Arguments Supporting the Merger

Extent of Pre-Merger Competition

Heinz and Beech-Nut claim that they do not really compete against each other at the retail level. They also contend that consumers do not regard the products of the two companies as substitutes and generally only one of the two brands is available on any given store's shelves. Hence, there seems to be little competitive loss from the merger.

This argument has a number of flaws. First, there is evidence that Heinz and Beech-Nut do in fact price against each other and that, where both are present in the same areas. There are at least ten metropolitan areas in which Heinz and Beech-Nut both have more than a 10 percent market share and their combined share exceeds 35 percent. They depress each other's prices as well as those of Gerber even though they are virtually never all found in the same store. By defining the relevant product market generically as jarred baby food, it was found that in areas where Heinz's and Beech-Nut's products are both sold, consumers will switch between them in response to a “small but significant and non-transitory increase in price.”

Perhaps most important is the indisputable fact that the merger will eliminate competition at the wholesale level between the only two competitors for the “second shelf” position. Competition between Heinz and Beech-Nut to gain accounts at the wholesale level is fierce with each contest concluding in a winner-take-all result. Fixed trade spending, which consists of “slotting fees,” “pay-to-stay” arrangements, new store allowances and other payments to retailers in exchange for shelf space and desired product display, does not affect consumer prices. It is impossible to conclude with any certainty that the consumer benefit from couponing initiatives would be lost in the merger.

Post-Merger Efficiencies

Heinz and Beech-Nut's second argument is their contention that the anticompetitive effects of the merger will be offset by efficiencies resulting from the union of the two companies, efficiencies which they assert will be used to compete more effectively against Gerber. It is true that a merger's primary benefit to the economy is its potential to generate efficiencies. As the Merger Guidelines now recognize, efficiencies “can enhance the merged firm's ability and incentive to compete, which may result in lower prices, improved quality, or new products.”

Nevertheless, the high market concentration levels present in this case require proof of extraordinary efficiencies. Moreover, given the high concentration levels, a rigorous analysis must be undertaken of the kinds of efficiencies being urged by the parties in order to ensure that those “efficiencies” represent more than mere speculation and promises about post-merger behavior.

Assuming that post-merger efficiencies will outweigh the merger's anticompetitive effects, the consolidation of baby food production in Heinz's under-utilized Pittsburgh plant “will achieve substantial cost savings in salaries and operating costs.” Heinz and Beech-Nut promise to improve product quality as a result of recipe consolidation. Heinz's distribution network is much more efficient than Beech-Nut's. Although Beech-Nut has an inefficient distribution system, it can make that system more efficient without merger. Heinz's own

Pleasee help me answer

I. Research: In this section, you will apply economic theory and quantitative analysis to your research topic.

A. Describe the relationship between the economic factors you identified and the presented issue.

B. Using mathematical concepts, illustrate the relationships between economic factors and the issue.

C. Describe the market structure of your organization’s industry.

D. Determine how the market structure of the industry influences the issue. Support your response with relevant examples from the case.

QUESTION 1

_____ refer to the forces of change whose direction and sometimes timing can be predicted.

2 points

QUESTION 2

Management institutes, certification agencies, and headhunting firms are examples of specialized intermediaries for:

2 points

QUESTION 3

_____ involves analyzing markets for their potential size, accessibility, cost of operations, and buyer needs and practices to aid the company in deciding whether to invest in entering that market.

2 points

QUESTION 4

Consumer safari refers to the initiatives taken by Unilever executives to spend a day with consumers in their homes to:

2 points

QUESTION 5

_____ refer to the forces of change whose direction and pace is largely unknown.

2 points

QUESTION 6

_____ are straight-line, one-factor projections from present to future.

2 points

QUESTION 7

The United States is separated from Nigeria by 5,840 miles and the Atlantic Ocean. According to the CAGE framework this is a case of:

2 points

QUESTION 8

The GDP of France is 2.113 trillion USD whereas Sierra Leone's GDP is approximately 4.812 billion USD. According to the CAGE framework, this is a case of:

2 points

QUESTION 9

_____ occurs when a function is taken out of one's country of residence to be performed in another country, generally at a lower cost.

2 points

QUESTION 10

Which of the following is true of acquisitions?

2 points

QUESTION 11

Which of the following statements holds true for the ISO 9001:2008 certification?

2 points

QUESTION 12

_____ refers to buying goods and services from foreign sources and bringing them back into the home country.

2 points

QUESTION 13

The _____ is the contract between the exporter and the carrier, authorizing the carrier to transport the goods to the buyer's destination.

2 points

QUESTION 14

_____ is the document by which the exporter tells the importer to pay a specified amount at a specified time.

2 points

QUESTION 15

Which of the following can also function as collateral against loans?

2 points

QUESTION 16

_____ refers to the financing granted against collateral, which can be the imported/exported goods.

2 points

QUESTION 17

Which of the following is a contractual mode of entry into a foreign market?

2 points

QUESTION 18

_____ refers to an organization that assists foreign companies in exporting their products to Japan by providing free-market entry information and business-partner matching as well as some subsidies.

2 points

QUESTION 19

Which of the following statements holds true for a nonentity joint venture?

2 points

QUESTION 20

The _____ is a legal document issued by a bank at the importer's (or buyer's) request wherein the importer promises to pay a specified amount of money when the bank receives documents about the shipment.

2 points

QUESTION 21

_____ refers to the constellation of business, corporate, and international strategy elements, which managers must consider when making decisions.

2 points

QUESTION 22

Strategy implementation is the process of:

2 points

QUESTION 23

The _____ function requires monitoring performance so that it meets the performance standards established by the organization.

2 points

QUESTION 24

_____ refers to the sequence of activities that include the various steps of the supply chain as well as additional activities, such as marketing, sales, and service.

2 points

QUESTION 25

Outsourcing involves:

2 points

QUESTION 26

The U.S. fast-food chain Sonic will only open new outlets in states that are adjacent to states where it already has stores. This is an example of:

2 points

QUESTION 27

_____, which are a part of the SWOT analysis, assess the external attractive factors that represent the reason for a business to exist and prosper.

2 points

QUESTION 28

_____ refers to the number of different topographical markets in which an organization participates.

2 points

QUESTION 29

The first step in the planning process is:

2 points

QUESTION 30

In Holland, KFC makes a potato-and-onion croquette, while in France it sells pastries alongside chicken. KFC:

2 points

QUESTION 31

An automobile giant headquartered in the United States sells high-end bikes across the world. It wants to enter an emerging market. Customers in the market cannot afford the types of accessories used in the bikes. Thus the regional branch of the organization makes an autonomous decision to remove the accessories and to offer a toned-down version of the bikes to compete in the emerging market. This decision is accepted by the headquarters on the principle that the man on the ground is the best judge of local conditions. The above serves as an example of a(n):

2 points

QUESTION 32

Nike products are manufactured in factories in countries such as China, Vietnam, Indonesia, and Mexico. Wholesalers, retailers, agents, and brokers are intermediaries who help in bringing the products to the consumer. These intermediaries bring the products from the factories to the consumers. They serve as an example of:

2 points

QUESTION 33

Which of the following statements holds true for a global brand?

2 points

QUESTION 34

An organization that manufactures readymade cotton shirts sources the raw material from all over the world. It does this as a precaution against the failure of one or more companies to deliver the raw materials. The above serves as an example of:

2 points

QUESTION 35

Which of the following holds true for product adaptation?

2 points

QUESTION 36

In marketing, market segmentation refers to the:

2 points

QUESTION 37

In marketing, which of the following holds true for counterfeit markets?

2 points

QUESTION 38

_____ refers to buying raw materials, components, or services from one supplier exclusively, rather than buying from two or more suppliers.

2 points

QUESTION 39

_____ refers to a situation which means that there is no more stock of the company's product.

2 points

QUESTION 40

Which of the following statements holds true for the indirect channel of distribution?

This discussion involves a business ethics case that companies and boards of directors regularly face in conduction business.:

1. Identify the most important and ethical issues arising from the situation.

2. Identify the viable options for addressing these issues and the ethical implication of the identified options.

3. Reach a definite resolution of the ethical issues by choosing what you think is the best option.

4. Develop a strategy for implementing your resolution. Please cite your references.

Background

Paul Oliver, Sr., immigrated to the United States from Greece. After working for several wineries, he started Oliver Winery, Inc., which eventually found a market niche in non-varietal jug wines. Through mass-marketing techniques, the company established a substantial presence in this segment of the market. Ten years ago, Paul, Jr., joined the firm after receiving a degree in enology (the study of winemaking). He convinced his father of the desirability of entering a different segment of the wine market: premium varietals. To do this, the company needed a large infusion of capital to purchase appropriate vineyards. Reluctantly, Paul, Sr., agreed to take the company public. The initial public offering succeeded, and 40 percent of the company's stock went into outsiders' hands. Also, for the first time, outsiders served on the board of directors. Although Paul, Jr., wanted to use a new name for the premium varietal to appeal to a more upscale market, his father insisted on using the name, Oliver.

Board Meeting

The board of directors met, along with Janet Stabler, the director of marketing of Oliver Winery, Inc. The following directors were in attendance:

Paul Oliver, Sr., chairman of the board and founder of the company

Paul Oliver, Jr., CEO, has an advanced degree in enology

Cyrus Abbott, CFO, has an MBA

Arlene Dale, the comptroller, has a CPA with a master's degree in accounting

Raj Ray, COO, has a master's degree in industrial engineering

LaTasha Lane, vice president legal, has a J.D. degree

Elisabeth Constable, the union representative to the board, has a GED degree

Rev. John W. Calvin, the outside director, has a Doctor of Divinity degree

Carlos Menendez, the outside director, has an MFA degree

Oliver, Sr.:

The next item on the agenda is a proposal to develop a new line of wines. Janet Stabler will briefly present the proposal.

Stabler:

Thank you. The proposal is to enter the fortified wine market. It's the only type of wine in which unit sales are increasing. We'll make the wines cheaply and package them in pint bottles with screw-on caps. Our chief competitors are Canandaigua with Richard's Wild Irish Rose, Gallo with Thunderbird and Night Train Express, and Mogen David with MD 20/20. We'll market the wine with little or no media advertising by strategically sampling the product to targeted consumers. That's it in a nutshell.

Oliver, Sr.:

Any questions before we vote?

Menendez:

Who'll buy this wine?

Calvin:

From what I know about the consumers of your competitors, it appears to me that it's bought by homeless winos.

Stabler:

Not entirely. For example, pensioners on a fixed income would find the price of the wine appealing. Thunderbird has been recently introduced into England and has become very popular with the yuppie crowd.

Calvin:

Then why put it in pint bottles?

Stabler:

For the convenience of consumers.

Menendez:

Why would pensioners want a small bottle?

Calvin:

Homeless people want it in pints so they can fit it in their hip pockets. They obviously don't have a wine cellar to lay away their favorite bottles of Mad Dog.

Stabler:

The pint-size also keeps the price as low as possible.

Calvin:

Translation: The homeless don't have to panhandle as long before they can make a purchase. Also, why would you increase the alcoholic content to 18 percent and make it so sweet if it weren't for the wino market?

Stabler:

Many people like sweet dessert wines and 18 percent are not that much more than other types of wines that have 12 percent alcohol.

Menendez:

Is it legal?

Lane:

Sure. We sell to the retailers. It may be against the law to sell to intoxicated persons, but that's the retailers' business. We cannot control what they do.

Calvin:

Isn't this product intended for a perpetually intoxicated audience that many people consider to be ill? Wouldn't we be taking advantage of their illness by selling highly sugared alcohol that suppresses their appetite? I've spoken to drinkers who claim to live on a gallon of this type of product a day.

Oliver, Jr.:

What will this do to our image? We're still trying to get our premium wines accepted.

Stabler:

Of course, we won't use Oliver's name on these wines. We will use another name.

Menendez:

Is it okay to do that?

Stabler:

Why not? Canandaigua, Gallo, and Mogen David all do the same thing. None of them put their corporate name on this low-end product.

Abbott:

We're getting away from the crux of the matter. Profit margins would be at least 10 percent higher on this line than our others. Moreover, unit sales might increase over time. Our other lines are stagnant or decreasing. The public shareholders are grousing.

Dale:

Not to mention that our stock options have become almost worthless. I'm only a few years from retirement. We need to increase the profitability of the company.

Ray:

Operationally, this proposal is a great fit. We can use the grapes we reject from the premium line. It will also insulate us from bad grape years because any grape will do for this wine. We can fill a lot of our unused capacity.

Constable:

And hire back some of the workers who were laid off!

Stabler:

It's a marketing dream. Just give out some samples to "bell cows."

Menendez:

What are bell cows?

Stabler:

Opinion leaders who will induce other consumers to switch to our brand.

Calvin:

Do you mean wino gurus?

Oliver, Sr.:

Look, if we don't do it, others will. In fact, they already have.

Abbott:

And they'll get richer, and we'll get poorer.

Lane:

Gallo pulled out of several of these skid-row markets as did Canandaigua. Little good it did. The alcoholics just switched to malt liquor, vodka, or anything they could get their hands on.

Dale:

I think our concern is misplaced. These people are the dregs of society. They contribute nothing.

Calvin:

They're human beings who need help. We're profiting off their misfortune and misery.

Oliver, Sr.:

We can take that up when we decide on what charities to support. Is anyone opposed to the proposal?

Calvin:

Is this a done deal? I believe we should contribute half of our profits from this product to support homeless shelters and other programs that benefit indigent and homeless people. If not, I must resign from this board.

Sources

Carrie Dolan, Gallo Conducts Test to Placate Critics of Its Cheap Wine, The Wall Street Journal, June 16, 1989, p. B3.

Frank J. Prial, Experiments by a Wine Maker Fails to Thwart Street Drunks, The New York Times, February 11, 1990, p. A29.

Alix M. Freedman, "Winos, and Thunderbird Are a Subject Gallo Doesn't Like to Discuss," Wall Street Journal, February 25, 1988, p. 1.