1)
Ndicore core board
This is a core board, manufactured from recycled paper, with a maximum strength of 300-330 scott ply. It is not a strong paper for “scott ply bond” purposes, as it does not have individual ply adhesion strengths and tears
easily. It does however create bulk to build up the wall thickness, and, hence, the ‘crush strength’, of cores. Mondi
specifically developed Ndicore approximately 6 years ago specifically for use in the cores and tubes industry. The price per ton
is approximately R3 723. The witness from Mondi averred that at approximately 12 000 tons per annum, the production of Ndicore represents a relatively small part of Mondi Cartonboard’s total output, and that it is a relatively
low return part of the carton board business.
2)
Kraft Paper
Kraft paper is manufactured for use in the corrugated box industry, although, to a limited extent it is also used in the manufacture
of cores and tubes. Kraft paper (“kraft”) is manufactured from virgin paper and is stronger and gives a smoother finish
than Ndicore. Kraft prices are currently lower than the price of Ndicore. Mondi Kraft is manufactured at the company’s Richard’s
Bay mill.
12.
Sappi – the other South African producer of paper products – also produces kraft paper at its Ngodwana and Tugela mills.
However, the Sappi product specifically directed at the manufacture of cores and tubes is Spiralwind. This is the trade name given to the kraft liner board which Sappi supplies to the cores and tubes industry. Spiralwind then is a
kraft paper manufactured from off-cuts with an approximate maximum strength of 200 scott ply. It is manufactured from virgin paper. As with the kraft paper produced by
Mondi, it is stronger and gives a smoother finish than Mondi Ndicore. Price per ton for both Mondi and Sappi kraft paper is between
R3 247 – R3 555. Note that although Ndicore currently costs approximately 15% more than Spiralwind, it does give a 7% better yield leaving an effective
price differential of approximately 8%.
13.
Core board can also be imported from Indonesia, Finland, France, Spain and the UK. Imported core board is generally of a higher quality than that available locally and is used where exceptional crush strength or
very large internal diameters of the core are required. Some of these papers are also made from recycled waste. The import duty on
imported paper used in the manufacturing of cores and tubes is 8% and will be lowered over the next 2 years to 2%.
14.
Mondi supplies Ndicore to KC&T, Qualicores and Triumph in Kwazulu Natal and to Framen (the second largest producer of cores and tubes in South Africa) and Tube Products in Gauteng. It also supplies Ndicore to KC&T
in the Western Cape.
The downstream market
15.
KC&T manufactures cores and tubes, angle board, dufaylite (honeycell) and textile cones. Kohler operates from 3 factories located
in Johannesburg, Pinetown in Natal (known as Texac) and Cape Town.
16.
Cores and tubes are spirally wound paper tubes. They are utilized as an inner core in various applications – for example, products
such as paper, board, textiles, steel and plastic are wound on to an inner core or tube. Note that when these products – for
example, newsprint, - are used by their downstream purchasers, the core is inserted into the printing press and the product is wound
off. This means – and the significance of this point will become apparent – that if the core collapses or crushes it
is not possible to use the surrounding material because it cannot then be easily and smoothly wound off the core. Hence, although
the value of the core is a fraction of the value of material surrounding it, a malfunctioning core may nevertheless render useless
the material that it supports.
17.
KC&T’s largest customers for its cores and tubes are Sappi Paper, Hulett’s Aluminium, Columbus Steel and S.A. Nylon
Spinners. These high-end industrial customers represent 65% of KC&T’s core and tube turnover per annum. Mondi Cartonboard,
Mondi Paper, and Mondi Kraft currently purchase 25%, 57% and 50% respectively of their cores and tubes requirements from KC&T.
18.
Framen, KC&T’s largest rival, supplies most of Mondi’s core and tubes requirements. According to the parties Framen supplies 100% of Mondi’s requirements in the Gauteng province while KC& T supplies 100%
of Sappi’s requirements in the same region.
19.
The cores and tubes market accounts for 65% of KC&T’s turnover and is the focus of this decision. Note however that KC&T
is also active – indeed is the dominant force – in the production of angle board, dufaylite and textile cones. KC&T’s
market share for Angle Board, which is used as a stabilizing strut for pallet loads for transport of fruit is 65%. Its market share for Dufaylite, which is used as a lightweight filler for door panels is 33%. Its market share for Textile Cones, on to which yarn is wound is 75%. It was common cause between the Commission and the parties that the merger raised no competition
concerns in respect of these three markets. We concurred with this assessment and accordingly we confine ourselves to the cores and
tubes market.
The hearing
20.
A pre-hearing conference was held on 4 April 2002 at which the Tribunal instructed the merging parties and the Commission to furnish
additional information. The parties indicated that they intended calling only Mr. Peter Davies, Divisional Manager of Kohler Cores
and Tubes, for the plants in Natal, Gauteng and the Cape as a witness. The Commission informed the pre-hearing conference that it
would be calling only Mr. Bino Silva, Managing Director and sole shareholder of Diversified Paper Cores & Tubes (Pty) Ltd. Mr.
Silva’s opposition to the transaction was on record.
21.
The Tribunal member presiding at the pre-hearing conference instructed the Commission to secure the presence at the hearing of representatives
of Framen Paper Products, the target company’s largest competitor, from International Tube Technology, another producer of
cores and tubes, and from Sappi, another major supplier of board to the cores and tubes manufacturers and a significant purchaser of cores and tubes. We also requested that representatives of Mondi and KC&T be available for questioning at the hearing.
22.
The following witnesses then gave evidence at the hearing:
•
Mr. Bino Silva, Managing Director and sole shareholder of Diversified Paper Cores & Tubes (Pty) Ltd.
•
Mr. Peter Davies, Divisional Manager of Kohler Cores and Tubes, for the plants in Natal, Gauteng and the Cape.
•
Mr. Peter Jooste, Manufacturing Director of International Tube Technology.
•
Mr Theo van Breda, General Manager of Mondi Carton Board.
•
Mr. Shalom Bouzaglou, Managing Director of Transpaco Cores (Trading as Framen Paper Products)
•
Mr. Koos Janse van Vuuren, Purchasing Manager of Sappi Enstra Mill.
•
Mr. Antonio de Sousa, Business Manager for Container Board, Sappi.
Competition Evaluation
Introduction
23.
In his closing statement counsel for the merging parties cautioned us against being ‘… seduced by speculative arguments,
which are easy to conjure up but altogether more difficult to prove…’. As a statement of general principle this caution
is, of course, unimpeachable, even trite. But in the context of merger adjudication it invites comment. Judge Richard Posner, the
highly regarded anti-trust scholar and US Appeals Court Judge expresses it thus:
‘Section 7 (of the Clayton Act) does not require proof that a merger or other acquisition has caused higher prices in the affected
market. All that is necessary is that the merger create an appreciable danger of such consequences in the future. A predictive judgment,
necessarily probabilistic and judgmental rather than demonstrable, is called for. Considering the concentration of the market, the
absence of competitive alternatives, the regulatory barriers to entry (the certificate of need law), the low elasticity of demand, the exceptionally severe cost pressures under which American hospitals labour today, the history of
collusion in the industry, and the sharp reduction in the number of substantial competitors in this market brought about by the acquisition
of four hospitals in a city with only eleven (one already owned by Hospital Corporation), we cannot say that the Commission’s
prediction is not supported by substantial evidence.’
24.
Of course a prediction must be supported by evidence, but no amount of reliable evidence will remove the predictive or ‘probabilistic’
element in merger adjudication. This is explicitly recognized in the Act, which enjoins us to determine the ‘likely’ consequences of a transaction before us. The Act provides explicitly for a regime where the effect of a merger is assessed prior to
its implementation. The necessary implication of this regime is that adjudication is a priori, not post hoc. Since the merger has not taken place at the time of adjudication and indeed may not take place at all, an element of prediction
regarding what may happen after implementation is inherent in the statutory design. Fortunately significant advances in economic theory, particularly in game theory, have eased the task of prediction – based
on observations of past behaviour and on the rational responses of profit maximizing firms to a given set of incentives we are able
to make predictions from a strong scientific basis, one far from the act of ‘conjuring’ which counsel for the merging
parties so rightly disparages. It is instructive that game theory has its earliest origins in observations of the behaviour of participants
in oligopolistic markets.
25.
We are dealing here with a vertical transaction. We have elsewhere observed that vertical transactions seldom attract adverse attention
from the competition authorities. This is not surprising given that these transactions, unlike their horizontal counterparts, do not imply greater concentration in
either of the markets implicated in the transaction. Indeed contemporary anti-trust scholarship and jurisprudence is careful to acknowledge
the pro-competitive, efficiency promoting features that frequently attach to vertical arrangements generally.
26.
However, there was a time when the US Courts treated vertical mergers as almost per se illegal and several landmark Supreme Court
decisions perceived a danger of foreclosure arising from what would now be considered very low upstream and downstream market shares
indeed. The Brown Shoe judgment in which a manufacturer with a 4% share of the upstream market was prevented from acquiring a retailer with a market share
of less than 2% is the best known of these Supreme Court judgments. The Chicago School attacked this view – which it disparaged as protecting competitors rather than competition - with a significant
degree of success although judicial and scholarly opinion clearly never embraced Robert Bork’s argument in support of treating
vertical transactions as per se legal. Now the pendulum has swung back some considerable distance since the halcyon days of the Chicago School and, while contemporary
anti-trust would distance itself from the approach taken in Brown Shoe, the prevailing wisdom strongly accepts that vertical transactions require close anti-trust scrutiny, and, in certain circumstances,
outright prohibition. Certain features of the transaction currently under examination would unquestionably attract contemporary anti-trust attention.
27.
Firstly, that the target firm, KC&T, is overwhelmingly the most powerful firm in its market is bound to attract the attention
of any competition authority – Mr. Davies, the KC&T official who testified at the hearing, describes it ‘a very dominant
player in the industry’. Secondly, the acquiring firm, Mondi, does not only enjoy a powerful presence in the upstream core board market, but is also one element
of a long-standing duopoly spanning a significant number of markets within the broadly defined paper products market. The other member
of this duopoly, Sappi, is also an important supplier of input to the cores and tubes manufacturers (including to the target firm)
and is also a significant customer of the target firm – indeed Sappi is a more significant customer of KC&T, the target
firm, than is the acquiring firm, Mondi. And then there are several highly unusual features of this transaction. For example, it
is unusual, to say the least, that the acquiring firm, Mondi (as well as its fellow duopolist Sappi) is both a key input supplier
to the target firm and a key purchaser of its output. Moreover, the fact that KC&T’s competitor, [acquiring firm –
confidential], is simultaneously in the process of concluding a deal with the acquiring firm, Mondi, to purchase, post-merger, the
Cape Town plant of KC&T also demands consideration by the competition authorities.
28.
There are three broad theories or sets of concerns that inform anti-trust evaluation of vertical mergers. The first is best characterised
as ‘raising rivals costs’ pursued by means of ‘foreclosure’ – either by foreclosing access on the part
of downstream customers to key inputs (‘input foreclosure’) or else through foreclosing access on the part of upstream
competitors to key customers (‘customer foreclosure’). The second set of concerns centers on the vertical transaction’s
ability to promote coordinated conduct between competitors (horizontal coordination) through facilitating an exchange of competition
sensitive information. The third – not relevant to this transaction – is concerned with the ability of a vertically integrated
firm to evade price regulation. The parties have also identified these as the major concerns arising from vertical mergers.
Foreclosure
29.
The Commission’s recommendation that the transaction be prohibited rests primarily upon the ability of the merged, vertically
integrated firm to foreclose the downstream market by denying to its non-integrated competitors the supply of the board essential
in the manufacture of cores and tubes (input foreclosure). The parties, however, take issue with the factual basis of this concern:
they contend that, should the integrated firm attempt to ‘self-deal’ only, that is, should it decide to deny Ndicore
to its downstream competitors, then the foreclosed cores and tubes manufacturers will simply turn to alternative inputs readily available
in the market. It appears then that the identification of the relevant market will determine whether or not foreclosure will result from this transaction.
30.
However, as will be elaborated below, while our analysis of the relevant market does, on balance, persuade us of the likely existence
of substitutes for Ndicore, those substitutes are only available from Sappi, the other member of the paper products duopoly. We will
demonstrate that by withholding Ndicore from non-integrated rivals downstream, Mondi will enable Sappi to increase the price of its
core board thus raising the costs of Mondi’s rivals in the downstream cores and tubes market. In other words, foreclosure will
not be affected by Mondi unilaterally withdrawing supplies of Ndicore from non-integrated cores and tubes producers. Rather, foreclosure
will be affected through coordination between Mondi and Sappi. This coordination need not be explicit. It may be tacit, driven by
the respective interests of the members of the paper products duopoly which point them in the direction of cooperation. We have also
determined that the foreclosure will not only be directed at Mondi’s rivals in the downstream market. We will also show that
it will be directed against prospective imports of paper products or new entrants into the upstream market where, trite to say, Mondi
and Sappi’s interests are closely aligned.
Facilitating Coordinated Conduct
31.
In addition, we are persuaded that the transaction will facilitate coordinated conduct between Mondi and Sappi in the input market
as well as in other related markets in which the duopolists are present. The transaction will facilitate this conduct by easing the
exchange of information in both the upstream and downstream markets. The prospect that a vertical agreement may be an instrument
for strengthening a horizontal arrangement is widely accepted in anti-trust scholarship and jurisprudence. In the words of Areeda,
Hovenkamp and Solow:
‘..under fairly conventionally accepted theories vertical mergers might facilitate horizontal collusion, principally by changing the
nature of output pricing and thus making cartel ‘cheating’ easier to detect and discipline.’
32.
We are enjoined by Section 12A of the Act to determine whether the transaction ‘is likely to substantially prevent or lessen
competition’. In summary, we find that the transaction will likely
¬
Raise the cost of doing business by rivals of Mondi and Sappi in the upstream market,
¬
Raise the cost of doing business by rivals of KC&T in the downstream market;
¬
Facilitate the exchange of pricing and other sensitive information and, hence, facilitate coordinated conduct between Sappi and Mondi
in the upstream market and in a number of other markets in which both are engaged,
and, thus, ‘substantially prevent or lessen competition’.
33.
The reasons for these findings follow.
The Relevant Markets
34.
This being a vertical transaction there are, per definition, two relevant markets to be determined. The upstream market is that market
in which board is supplied to manufacturers of cores and tubes. The downstream market is the market in which cores and tubes are
supplied to a variety of end-users. As already noted the characteristically neat distinction between these markets is somewhat muddied
by the dual role of the input suppliers who are simultaneously amongst the most important purchasers of cores and tubes.
The Downstream Product Market
35.
It is, for ease of exposition, preferable to begin with identifying the relevant downstream market. The Commission argues that there
is not a single market for cores and tubes. It insists that there are two markets, a top-end and bottom-end market. The parties make
much of the Commission’s failure to delineate clearly the two markets for which they contend. This shortcoming notwithstanding
it is clear that all the participants in the market share the Commission’s view to the extent that they recognize a distinction
between, on the one hand, the market segment for heavy industrial cores in which the quality of the core and particularly its ‘crush
strength’, that is its ability to withstand considerable pressure, is paramount, and, on the other hand, the market segment
for light industrial and consumer product cores. The various witnesses all distinguished their firms’ activities by reference
to the segment of the market in which they competed – certainly while KC&T, Framen and Diversified Cores and Tubes were
somewhat active in the production of lighter cores and tubes, all clearly identified the production of heavy cores and tubes as their
principal market. ITT, on the other hand, clearly operated at the lighter end of the market and while it was not confined to the
production of mere cores for toilet rolls – the core consistently caricatured as typifying the lower end of the market - nor,
it appears, was it active in the production of heavy industrial cores and tubes.
36.
These two markets are distinguished by a variety of factors. As already noted, the quality of the core, and, in particular, its crush
strength is paramount. Predictably, it appears that those manufacturers focused on the production of lighter cores are not easily able to compete in the
production of heavier cores without investment in particular equipment and skills. Mr. Bouzaglou, the witness from Framen, even held
that a producer would not want to use the same machine in producing for the top and lower ends of the market, nor, he averred, would
it be commercially sensible to switch from one paper input to another on the same machine. Mr. Silva also testified – and this part of his testimony was not contested - that returns in the upper segment of the market
are notably larger than those at the lower, easier-to-enter end of the market.
37.
This having been said, it is indeed not easy to specify a precise point of delineation between these market segments. Counsel for
the parties insists that because a specific delineation proves elusive, we are then left with a single market for cores and tubes
with the various categories simply falling along a single, seamless spectrum. It is somewhat akin to defining an elephant –
while this may be a difficult task, it is nevertheless easy to recognize an elephant when one happens upon one. A failure to accurately
define an elephant does not simply place it along a continuum of four-legged beasts, the one substantively indistinguishable from
the other. So with cores and tubes – every witness who testified before the Tribunal (including those representing the merging
parties) constantly referred to two distinct market segments. We accept this delineation and simply identify the downstream market
relevant to this transaction as the market for heavy industrial cores and tubes. Its principal customers are in the metal, paper
and textile industries although certain textile cores and tubes do belong at the heavier end of a second market segment, namely,
the market segment for light industrial and consumer product cores and tubes which is not relevant to this transaction.
38.
KC&T’s national market share of all cores and tubes is 45%. Its main competitors are Framen Paper Products (11%), International
Tube Technologies (ITT) (6%), Tube Products (1%) and Raybro (1%). If the other products produced by KC&T are included –
that is, the textile cones, dufaylite and angle board – KC&T’s share rises to 59% and Framen’s to 15%. The
Commission calculated the concentration level (HHI) in the downstream market at approximately 2502 points – the 1984 US Vertical
Guidelines, par. 4.131, states “that the Department is unlikely to challenge a potential competition merger unless overall concentration of the acquired firm’s
market is above 1800 HHI.”
The Upstream Product Market
39.
As already noted, the upstream market may be generally characterized as that in which core board is supplied to manufacturers of cores
and tubes. Indeed the merging parties are content to leave the definition there. On this version the market is characterized by a
range of competing products, a variety of types of board, each of which may be used interchangeably in the production of both heavy
and light cores. This includes the specialty core boards – namely Mondi’s Ndicore and Sappi’s Spiralwind –
as well as kraft paper produced by Mondi. In support of this contention, the parties have submitted evidence purporting to show that
cores and tubes are indeed manufactured using both of the locally produced specialty core board varieties, Mondi-produced kraft and
specialty imported core board.
40.
However, the Commission holds otherwise. It holds that the relevant market is that for the supply of Ndicore, the specialty core board
produced exclusively by Mondi, the acquiring firm. The Commission provides evidence purporting to show that there is no efficient,
commercially viable substitute for Ndicore in the manufacture of ‘top-end’ or, what we have described as ‘heavy
industrial’ cores and tubes. This naturally implies that the acquiring firm is a monopolist in the relevant market. By foreclosing
the supply of Ndicore to all but its vertically integrated producer of cores and tubes – itself a dominant producer in its
market – it would effectively l
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