I have been working on some operations research issues related to antitrust and monopolies. A discussion of related research will be coming up on the blog soon, but I wanted to talk about monopoly issues recently in the news.
This is not a post on Facebook and Instagram, or another commonly directed invective at Amazon, YouTube, and other platform monopolies that are pervading our lives. After a long lull, FTC has decided that they need to step in and prevent the most pernicious monopoly that has cut many people: Razor Blades. Also, not in the way you think.
Everyone knows that P&G’s Gillette (and its brand for women – Venus) has been the dominant player in the US market, with 52.8% market share of men’s razors (according to Euromonitor). Last year, Gillette sold $6.22B worth men’s razors and $1.28B of women’s razors. Despite this dominant market share, 52.8% market share is a far cry from its heyday of 70%+ market share that Gillette saw as late as 2010. (Gillette was acquired by P&G in 2005).
Even more recently, razor demand has depleted due to cultural headwinds, as growing beards have become more popular. Of course, every fad has a peak. Now that many US senators like Ted Cruz have started growing a beard, I fully expect the coolness of beards to disappear into thin hair.
Economically speaking, Gillette has faced stiffening competition from new startups such as Dollar Shave Club and Harry’s that sell directly to consumers, instead of using traditional retail channels.
Truly in the disruptive fashion described by Clayton Christensen (in his book Innovator’s Dilemma), an upstart brand Harry’s that started as a Direct to Consumer internet brand, thrived by undercutting Gillette in prices. Harry’s exemplifies the nature of disruption clearly: A cheaper product with not as much tech (No fusion gels or 15 blades), and sold in a channel (i.e., internet) where product tactile verification is reduced. Harry’s sells a set of four blades, shaving cream, and a holding case — all for $15.
So, how did the behemoths react? Of course, by cutting prices and by marketing their brands harder (including somewhat cynically designed woke campaigns from P&G to attract millennial customers). Finally, when all else failed they acquired.
- Gillette undertook a massive price cut (25% price cut for leading SKUs such as Gillette Fusion).
- Unilever bought Dollar Shave Club for $1 billion cash in 2016.
- In the summer of 2019, Edgewell, the parent company of Schick brands which owns a 15% market share spent $1.37 billion (79% cash deal) on Harry’s.
What happened?
Step in FTC, (not) in the nick of time, but after a significant delay during which Edgewell and Harry’s integrated their “operations know-how”. FTC spent months considering the case and reached a rare unanimous decision (Note: the commission has 3 Republicans and 2 Democrats) earlier in February to block Edgewell from acquiring Harry’s.
Both firms were disappointed but have reacted differently to the decision. From WSJ:
“We are disappointed by the FTC’s decision and continue to disagree with its position,” said Rod Little, Edgewell’s chief executive. He said the company decided not to fight the FTC in court given the uncertain outcome and potential resulting distraction. There is no cash breakup fee from the scuttled deal, he said.
Edgewell said Harry’s has informed it that it intends to pursue litigation against its former merger partner. Edgewell said it believes that such litigation has no merit.
“We continue to be perplexed by the FTC’s process and disregard of the facts,” Harry’s said. The company said it was “disappointed by the decision by Edgewell’s board not to see this process to its conclusion.”
I am not an M&A expert, but I am surprised that there was not a breakup clause that would have protected Harry’s interests. The stark difference in their reactions also reflects the possibility of Edgewell’s buyer remorse, — a realization that it overpaid for Harry’s. It is also very likely their post-acquisition diligence gave Edgewell a significant view of Harry’s operations. Perhaps, Edgewell has learned all they wanted to. I will return to this point in the end.
Viewing FTC Lens: DTC vs. Brick and Mortar
The FTC decision is particularly interesting in the light of the unanimous nature of the decision, and given how it has (so far) allowed Charles Schwab to acquire TD Ameritrade (Dec 2019) and TurboTax acquire Credit Karma (Feb 2020).
I think this schism in responses boils down to FTC (and many others) viewing e-commerce channels as quite different from the brick and mortar channels. Also, they view physical supply chains as distinct from internet businesses. The key section is in paragraph 22 of the FTC decision.
It is also appropriate to analyze the effects of the Proposed Acquisition in narrower relevant markets within the wet shave razor market. The razor industry recognizes several distinct segments within the wet shave razor market. The relevant market may be divided by gender lines into markets of men’s and women’s products. Additionally, the relevant market may be separated into markets for system razors and disposable razors. Finally, the relevant market may be divided by channel of sale, resulting in separate markets for brick-and- mortar sales and online sales.
Analyzing the Proposed Acquisition in these segments individually would focus attention on specific narrower markets where the harm is most acute— for example, a market for men’s system razors sold in brick-and-mortar retailers. Given consumer preferences for particular retailers or retail categories, relevant markets may even be defined as narrowly as a single retailer or a cluster of retailers in which competitive conditions are similar, such as brick-and-mortar retailers where Harry’s currently available.
(Note: Emphasis in the quotes are mine).
FTC’s analysis to narrow the market to only Brick-and-Mortar channel (B&M) is somewhat of a simplistic view.
In a product line that has minimal shipping costs (small size & low weight), and significant physical similarity (different razors can be efficiently packed for B2B or B2C shipments), the operations of internet e-commerce and B&M channels can look very much alike. This is because shipping costs + marketing costs in DTC channels become increasingly comparable to overall SG&A costs in Brick and mortar channels. I make this comparison in my Operations strategy class, using firm-level data. In essence, e-commerce becomes a contiguous arm in the channel strategy.
Of course, consumers may still view the internet and stores as completely different channels. This difference might explain why customer segments are quite different between DTC and retail chains. But, much of back-end fulfillment issues are integrated. One could argue that there is a more fundamental market difference between system razors and disposable razors than between DTC and B&M channels.
This “what’s the right market?” argument is extended into FTC’s analysis of the competitive landscape.
63. On the heels of its men’s system razor’s growing success, Harry’s launched a women’s system razor under the Flamingo brand in late 2018. This time, Edgewell acted aggressively before Flamingo razors hit brick-and-mortar retail shelves, implementing preemptive price cuts on its women’s system razors as part of the 2018•price reduction.
Edgewell also developed a [redacted] Flamingo’s impending entry. Despite Edgewell’s efforts, Harry’s gained at Edgewell’s expense: Flamingo established a significant competitive foothold, and took [redacted] shelf space from Edgewell products.
This head-to-head competition continues to the present day. Harry’s, with its men’s and women’s products at value price points, continues to be a fierce competitor. Harry’s recently expanded its brick-and-mortar footprint again, selling its products in Hy-Vee, Meijer, and Kroger. And Harry’s products are likely to expand into additional retailers in the near term regardless of whether Harry’s is acquired by Edgewell.
I am not sure about the argument that only Harry’s entering B&M retail such as Target is what finally pressured Edgewell to reduce its prices, and that Edgewell had held steady without any price cuts when Harry’s was just a DTC firm. (After all, we have seen P&G and Edgewell both lose market share over the years).
I have not looked at the price-history data of Gillette and Schick products, but it strikes me as not very compelling that P&G decreased prices but Edgewell stuck to their prices. It is possible that Edgewell might have reduced prices, but not as steeply as P&G. This difference only indicates the likelihood that Gillette blades were being priced much higher compared to their marginal costs, whereas Edgewell’s Schick had a much tighter margin to play with prices.
Competitive Index
The FTC decision used the famous Herfindahl Hirschman Index (HHI) to measure the competitive landscape in making its decision. FTC report cites that,
65. The Proposed Acquisition is anticompetitive because it will eliminate the growing competition between Harry’s and Edgewell that has been highly beneficial to consumers. As a result of that competition, consumers today enjoy lower prices on many different types of wet shave razors, and they have a broader selection of razors at value price points.
Of course, the presence of Harry’s as a separate brand in the market would likely increase consumer welfare and provide a wider selection of products. FTC is also right that there are significant barriers to entry. Competing in the razor market requires a vertical integration with the production supply chain, just as Harry’s had done by building their factory in Germany and making a big financial commitment.
I would just expand the market to include the internet market as well, not just the B&M market. But, it is not clear the head-to-head competition is only between Harry’s and Edgewell (and NOT between P&G and Edgewell and with Harry’s playing a third wheel).
What does this mean for Harry’s?
It just seems to me that Harry’s cannot sustain in the long term on their own unless they break into B&M retail and grow significantly fast. Not only e-commerce is too small to subsist on, in future customers will increasingly use both internet and B&M retail channels. By all accounts, Harry’s just turned to profitability, which means their marginal net profits are thinner and in a more precarious compared to that of Gillette and even Edgewell (Schick). In the short-to-medium run, we will see Gillette and P&G slashing prices (which is of course great for consumers as FTC has correctly argued), and preventing Harry’s growth into B&M.
What is the long-term game? P&G will build a DTC brand (separate from their Gillette brand to prevent cannibalization and maintain retail channels happily). These brands will soon give new DTC brands run for their money in e-commerce channels.
In fact, on January 8, 2020, P&G acquired Billie’s a subscription-based startup that sells women’s razors. I am waiting for FTC to step in because I do not see how this acquisition is any different.
Footnotes:
- US FTC Docket No. 9390. Edgewell Personal Care Company and Harry’s Inc.