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The Pricing Politburo Slams Shampoo

May 13, 2011

Tags Free MarketsInterventionism

On a late Tuesday evening I walked into the local CVS Pharmacy store and studied the shampoo aisle: two complete rows containing at least 200 different makes of shampoo, conditioner, and related hair products. My attention was on the two cheapest brands available: VO5, produced by Alberto Culver, and Suave Naturals, produced by Unilever. The Suave sold for $1.77. The V05 cost just 77¢, thanks to a store discount bringing it down from the normal 99¢.

Emboldened, I left CVS and went to the grocery store next door. Again I studied the available shampoos. The grocery store had a smaller selection — maybe 50 different items — but the Suave and V05 brands were available. There were noticeable differences. The V05 was consigned to the bottom shelf at the grocery store yet featured prominently on the top shelf at CVS. The prices were also different: The grocery store had the Suave on sale for $1.50, about a quarter less than CVS charged, but charged a full $1 for the V05.

I have no idea why two retailers less than ten feet apart would market the same two products so differently. Managing a store — indeed, a national chain of stores — with tens of thousands of items involves a complex set of market interactions that are invisible to the naked eye. There is no single mathematical formula that will explain why CVS charges 77¢ for something that the neighboring store charges $1 for. The differences are the product of economic calculation.

Government officials don't believe in economic calculation, or if they do believe in it, they don't trust it. Would-be planners are not interested in the interactions of thousands of voluntary decisions (i.e., market exchanges) that go into determining whether to charge 77¢ or $1 for shampoo. The planners want order. They want a price system that reflects their values and desires, and they will use whatever force is necessary to make the rest of us conform to those expectations.

If you think it's strange to talk about the evils of central planning in the context of $1 shampoo, then you'll be surprised to learn the US Department of Justice has just spent several months and thousands of taxpayer dollars pursuing a plan to regulate the price of $1 shampoo.

The trouble started last September when Unilever decided to acquire Alberto Culver for $3.7 billion. The two companies market the aforementioned Suave and VO5 shampoo brands respectively. The Department of Justice's Antitrust Division, led by Assistant Attorney General Christine Varney, said this could not be allowed as a matter of federal antitrust law. Her reasoning was that Unilever would "control" 90 percent of the market for "value shampoo and value conditioner," which in turn might lead to higher prices for VO5 and Suave products.

Notice she defined the market as being for "value shampoo and value conditioner," not shampoo and conditioner generally. In the modern antitrust system, prosecutors strive with all their might to define "relevant markets" as narrowly as possible. Antitrust is ultimately a game of numbers. As a percentage of the overall shampoo and conditioner market, Suave and V05 are relatively insignificant players. But if you define the market as only including those two brands and maybe one other, suddenly you have a budding "monopolist" on your hands!

By the Antitrust Division's own figures, "value shampoo" standing alone amounts to $177 million in annual sales, which is roughly the size of the Antitrust Division's annual budget — and more tellingly, about .0000125 percent of US GDP. It seems remarkable that such a small niche of the larger hair-products industry could justify a rare intervention by the Justice Department. And make no mistake — merger challenges are still uncommon, even in the antitrust-crazy United States. During the government's 2010 fiscal year, the DOJ and Federal Trade Commission combined challenged just 41 mergers out of more than 1,200 reported transactions. The DOJ only brought 19 of these cases, an average of less than two per month.

Like most merger cases, Unilever and Alberto Culver capitulated to the division and paid a ransom — the forced sale of VO5 and a hairspray brand to a yet-to-be-determined buyer — in exchange for allowing the rest of the merger to proceed. This allowed Christine Varney to claim an unqualified victory: "Without the divestitures required by the department," she said, "consumers would have paid higher prices for value shampoo and conditioner and for hairspray sold in retail stores."

This raises two questions: (1) Is Varney right to claim that her intervention thwarted an anticonsumer price increase? and (2) Assuming she is, is it her place to decide what the price of "value shampoo," or any other good, ought to be?

The answer to both questions is a resounding no. While Varney's press release makes a blanket claim that the merger would have raised retail prices for value shampoo, there isn't a shred of actual evidence to support that conclusion. Like all merger cases, Varney and her underlings started with a conclusion and then worked backward, filling in the blanks with speculation and conjecture.

It starts with the market definition. Having declared the market for "value shampoo and value conditioner" as exclusive of all other shampoos and conditioners, the Antitrust Division moved to demonstrate — with math! — that the market is not "competitive" enough. This is done with a magical formula known as the Herfindahl-Hirschman Index (or HHI). The HHI reduces the complexity of market calculation to a single number that can then be used to tell whether a proposed merger is "good" or "bad" for consumers.

In this case, the Antitrust Division said that, according to their calculations, the original Unilever-Alberto Culver merger would have increased the HHI for value shampoo from 4,689 to 8,602. And that's bad. Really, really bad.

"The planners want order. They want a price system that reflects their values and desires, and they will use whatever force is necessary to make the rest of us conform."

Now, I could explain how the HHI was calculated and what the "ideal" ranges are, but that's completely irrelevant. The formula and the scale are simply DOJ inventions. They have no actual meaning. When you say the HHI is 8,602, it's not 8,602 of anything. This is nothing more than a lazy attempt by the division to find some sort of substitute for economic (i.e., monetary) calculation in the marketplace.

The division claims the HHI — my God, it's up to 8,602! — "proves" the market would be too highly concentrated to ensure adequate competition. From there the division races through a series of conclusory statements with no logical or empirical basis. First,

The significant increase in market concentration … is likely to substantially lessen competition … resulting in higher prices for consumers of value shampoo and conditioner.

The division assumes that the merger is the only factor in ascertaining the likelihood of future price increases. From there, the division claims that customers are either unwilling or unable to respond to this hypothetical threat:

Purchasers of value shampoo and conditioner are unlikely to reduce their purchases of value shampoo and conditioner in response to a small but significant and non-transitory price increase to an extent that would make such a price increase unprofitable.

What constitutes a "small but significant and non-transitory price increase"? The Antitrust Division's internal guidelines state that,

in most contexts, [the Division] will use a price increase of five percent lasting for the foreseeable future. However, what constitutes a "small but significant and nontransitory" increase in price will depend on the nature of the industry, and the [Division] at times may use a price increase that is larger or smaller than five percent.

So just like the HHI, the threshold for a price increase is an arbitrary metric that depends entirely on the whims of the division's lawyers and political leadership. The concentration of "value-shampoo" brands in one company's hands might lead to a price increase — it may be 5 percent, or higher, or lower — which will last for some "foreseeable" future. (And how does one know how far the Antitrust Division's lawyers can see into the future?) In any case, the division never discloses its precise calculations or estimates, so it's impossible for anyone to check their work.

In reality, there's no way to know what market prices will be two days or two years from now. Certainly it doesn't come down to the single factor of "market concentration," which is by design a static snapshot. As I noted above, the price of V05 on one Tuesday night differed by 25 percent between two retailers located right next to one another.

As for customers, the Division assumes they must all think and act alike, and that they won't respond en masse to a hypothetical price increase by switching to nonvalue shampoos or simply purchasing less shampoo. But why should they? In reality, every consumer responds differently to prices — and they don't always go out of their way to find the lowest prices. Suppose I was grocery shopping on Tuesday and decided to pickup a $1 bottle of VO5 as part of my purchase. I wouldn't have even known the same item was on sale for 77¢ next door — and even if I did, I wouldn't have made a second trip just to save 23¢ on one item.

Of course, the dirty little secret here is that the Antitrust Division really doesn't care about retail customers. These cases involving niche markets like "value shampoo and value conditioner" reflect the antitrust establishment's obsession with distribution channels. Consider the Division's explanation of why it doesn't believe other firms, absent government intervention, could address Unilever's higher market share or hypothetical price increases:

Responses from competitors and new entry likely will not prevent the proposed acquisition's likely anticompetitive effects. Barriers to entering these markets include: (i) the substantial time and expense required to build a brand reputation to overcome existing consumer preferences; (ii) the substantial sunk costs for promotional and advertising activity needed to secure the distribution and placement of a new entrant's product in retail outlets; and (iii) the difficulty of securing shelf-space in retail outlets.

Because of these entry barriers even sophisticated, well-funded entrants have not been able to enter the value shampoo and conditioner markets. For example, one major US manufacturer repositioned an existing brand into the value shampoo and conditioner markets in 2003, but discontinued it in 2004 because of low sales. Similarly, a major US retailer introduced a private label value shampoo and conditioner in 2009, but also discontinued the product because of low sales.

In other words, other competitors failed to gain market share because customers were perfectly satisfied with existing providers. From this the Antitrust Division infers "market failure." Specifically, it believes that established brands like Suave and VO5 have an unfair chokehold over scarce shelf space in major retailers. By forcing the sale of the V05 brand to a firm other than Alberto Culver and Unilever, the Division is in effect micromanaging the allocation of retail shelf space. The antitrust lawyers in Washington simply don't trust retailers — sophisticated firms like CVS and Walmart — to act in the best economic interest of themselves and their customers.

In the end, even if you believe every spurious Antitrust Division argument about the "anticompetitive" effects of the Unilever–Alberto Culver deal, you still have to justify the significant expenditure of state resources to, in effect, prevent the price of V05 from rising from $1.00 to $1.05. Antitrust cases, even settled ones, don't just happen. The Antitrust Division's court papers listed 12 lawyers, in addition to division chief Varney, as participants in the case.

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On the private side, Alberto Culver's lead counsel, J. Robert Robertson, was a former chief trial counsel at the FTC, who parlayed a successful record of merger challenges into a lucrative private-sector partnership. And all that expensive expertise got Alberto Culver was an unconditional surrender that any first-year law student could have negotiated.

But that's the cost of doing business, or so the antitrust establishment would have us believe. We have to tolerate these ridiculous interventions in order to justify the continued diversion of hundreds of millions in capital away from productive uses — like producing $1 shampoo available at thousands of retail outlets — toward the maintenance of thousands of lawyers who spend their days arguing over how to "define" the market for $1 shampoo.

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