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Coleus Packaging (Pty) Ltd and Rheem Crown Plant (a division of Highveld Steel and Vanadium Corporation Limited) (75/LM/Oct02) [2003] ZACT 7 (11 February 2003)
.RTF of original document
COMPETITION TRIBUNAL
REPUBLIC OF SOUTH AFRICA
Case No: 75/LM/Oct02
In the large merger between:
Coleus Packaging (Pty) Ltd
and
Rheem Crown Plant, a division of Highveld Steel and Vanadium
Corporation Limited
________________________________________________________________
Reasons for Decision: non- confidential
________________________________________________________________
On the 27 January the Competition Tribunal approved, subject to certain conditions, the acquisition by Coleus Packaging (Pty) Ltd,
a wholly owned subsidiary of South African Breweries Limited (‘ SAB’) of the Rheem Crown business, a division of Highveld
Steel and Vanadium Ltd, which is engaged in the manufacture and supply of bottle crowns.
Procedural Background
This merger was notified to the Commission on the 19 August 2002. On the 31 October 2002 the Commission recommended that the merger
be prohibited.
A pre-hearing conference was held on the 9 December 2002. At that stage the Tribunal was advised that there were various firms who
objected to the merger and that one of the objectors, MCG (Pty) Ltd (‘MCG’), a competitor of the target firm, intended
bringing an application to intervene in the proceedings. The Commission indicated that the other objectors, Guinness UDV South Africa
(Pty) Ltd (‘Guiness UDV’) and Distell Limited ( ‘Distell’), competitors of the acquiring firm SAB, had given
statements to the Commission and were to be called as witnesses at the hearing.
The parties and the Commission then prepared for the hearing and exchanged witness statements.
No application for intervention was received from MCG. However, at the commencement of our hearing on 21 January 2003, the parties
advised us that SAB had entered into a procurement agreement with MCG, and that this had alleviated MCG’s concerns about the
merger. (A copy of this agreement, which we analyse more fully later, is annexure ‘A’ to our order.)
The hearing commenced and we heard testimony from Maarten Van Hoven, the Commission’s investigator, Mr John Reilly the Group
Purchasing Manager of Distell, and Mr Grant Wall, his counterpart at Guinness UDV.
During the course of Mr Wall’s cross-examination by Mr Unterhalter, counsel for the merging parties, it became apparent to us
that Guiness UDV was not opposed to the merger, provided certain conditions were imposed, and that SAB for its part was willing to
give certain ‘ comfort’ undertakings to the customers of Rheem. We suggested that the merging parties consider proposing
certain additional conditions to the approval of the merger to meet the concerns of customers of the target firm.
This the merging parties did, and after a series of negotiations with their customers and then the Commission, we were presented with
a draft order for our consideration. The order was acceptable to Mr Wall representing Guinness UDV. It was also largely acceptable
to the Commission who had also consulted with other customers of Rheem on its contents. The Commission and the parties had a fundamental
difference with one term of the proposed conditions. The Commission wanted to impose a condition that SAB be required to sell control
of Rheem within 3 years of the merger. SAB, whilst willing to undertake to sell a minimum of 40 % of the firm’s equity to an
empowerment shareholder within 2 years, was unwilling to commit to a time period to dispose of its controlling interest, although
it insists that this remains its long- term intention.
The Commission and the parties agreed that they would each motivate their respective formulations for our consideration, but were
otherwise in agreement on the remaining content of the order. The Commission indicated that on the basis of the terms of the draft order, with the rider proposed by them requiring a sale of control
within 3 years, it would no longer oppose the merger. The upshot was that on the second day of the hearing both sides had moved from
their initial ‘absolutist’ approach to the merger and agreed to recommend to us that it be approved conditionally on
the terms proposed in the draft order.
After hearing evidence from three further witnesses, Luigi Matteucci of Highveld, Mike Short and Andrew Wolf of SAB, we adjourned
the proceedings to consider our order.
Our proceedings had been slightly truncated as a result and we did not hear the oral testimony of the expert witnesses of either side
nor what we suspect might have been a lengthier examination of witnesses who had testified after the proposed order had been put
to us.
OUR APPROACH
In this case, as we have mentioned above, the parties and the Commission had with the exception of one clause, reached agreement on
the conditions that should be attached to the approval of the merger. If this was a restrictive practice case, not a merger, all
the Act would then require of us would be to approve the terms of the order. We would not be required to come to our own conclusion on the evidence. No such mechanism exists in merger cases, as the Tribunal
is obliged in terms of section 16 to:
“..consider the merger in terms of section 12A, and the recommendation and the request, as the case may be, and within the prescribed
time…”
Nevertheless, for the same reason that consent orders are seen as desirable in restrictive practice cases – inter alia, that
they curtail proceedings and encourage settlement of disputes – we should try and encourage this practice in mergers without
abdicating our adjudicative function.
For this reason we have taken the approach in this case that although the hearing of oral evidence was not concluded as originally
contemplated, we nevertheless had sufficient evidence of the anticompetitive effects, that had been alleged. Further hearing would
have only served to test whether these allegations were sustainable, as the parties challenged some of these conclusions in their
filings. Nevertheless we take the parties willingness to agree to propose conditions as a concession not to challenge the correctness
of the allegations.
Given this development our approach in this decision is to assume that the allegations of anticompetitive effects have been established
and then to assess whether the proposed remedy adequately addresses the harm alleged. In this way we give effect to the efficiency
of the proposed order without abandoning our discretion to one of simply approving a consent order.
It was for this reason that the Tribunal advised the parties and the Commission on adjourning, that if we did not feel satisfied with
either of the proposals concerning the consent order, we would advise them and continue the hearing.
We are satisfied that the consent order as proposed by the parties is adequate to ameliorate any anticompetitive effects brought about
by the merger. We explain below why we have come to this conclusion, and in particular why we have preferred the parties’ formulation
of clause 2 to that of the Commission.
Background
Rheem’s business is very simple. It takes sheets of tin plate and transforms them into crowns. The crowns serve as closures on glass bottles, which contain either soft drinks or alcohol. The crowns are either of a twist-off
or pry-off variety. The physical dimensions and decorations on crowns vary, depending on the specifications of a particular customer.
The crowns are then packed and delivered in large volumes to the customer, typically a beverage manufacturer. The customer is responsible
for inserting the crowns on the bottles, a process known as crimping.
The cost of a crown is negligible in relation to the total cost of the beverage. The manufacturing process whilst requiring expensive machinery is not unusually complex. So why are beverage manufacturers so exercised
by this merger?
The answer is that the mundane aspect of the crown belies its importance to the product it covers.
A poorly made crown may inhibit the high speed crimping process and thus delay a production line at great cost. It can also detract from the quality of the finished product if it releases pressure from the bottle leading to premature decay of
the product. Furthermore, as crowns are also often part of the get-up of the product, their physical appearance must conform to the
specifications given by the customer.
The crown manufacturer needs to be capable not only of conforming to the technical and decorative requirements of the customer, but
also of delivering in time, particularly for product promotions, where deadlines are short.
Given that their strategic value exceeds their cost, beverage manufacturers pre-occupation with the source of supply is then not surprising.
Beverage manufacturers are as vigilant about their other sources of supply .In 1998 our predecessor, the Competition Board, considered
a merger between Nampak Ltd and Crown Cork SA (Pty)(Ltd) a manufacturer of cans and crowns. The merger was opposed by Coca Cola SA,
but not by SAB.
Although the overlap in that merger involved metal cans, and not crowns, the following observation of the Board is at least indicative
of the buying power of the beverage manufacturers, that as we discuss later may be a feature of the market for crowns as well.
“ The applicants [i.e. Nampak and Crown Cork SA] aver that the beverage can industry has two dominant customers, namely Coca Cola and
SAB, who between them control the purchase of eighty- five percent of cans provided and both require competitive pricing. Nampak’s
prices to both have been below CPI and well below the customer’s own price increases for filled products.”
The Board report notes that at that time (1998) there were only two crown producers in the country, Crown Cork SA having 65 % of the
market and Rheem SA having 35 %. The report further notes that the dominant customer is SAB. Just how dominant we later see.
Nampak, we are advised, found the crown business unsustainable, apparently because they were unable to agree on the terms of an acceptable supply agreement
with SAB. This led SAB to enter into a five- year supply agreement with Rheem SA in 1999. The power of SAB becomes clear when we note that
according to Rheem, for the year ending 2000 its share of the market was now 74 %, whilst Crown Cork’s had declined to 24%.
Not surprisingly Crown Cork exited the market in April 2000 and for a short period Rheem was the only local manufacturer.
Rheem also has an ad hoc supply arrangement with Coca Cola South Africa. Coca Cola South Africa (‘CCSA’) is a subsidiary
of the Coca Cola Company based in Atlanta Georgia. However, it negotiates supply arrangements centrally on behalf of other firms
in South Africa who are its bottlers. There are several Coca Cola bottlers in South Africa, but by far the largest is ABI a wholly
owned subsidiary of SAB.
We described the arrangement as ad hoc, as although CCSA and Rheem have been attempting to negotiate a supply agreement, negotiations
were inconclusive and they entered into an arrangement based on an exchange of letters in 2002, in terms of which CCSA has awarded
Rheem the supply of 400 to 500 million crowns to Coca Cola bottlers at an agreed price. The arrangement is for the period April 2002
to March 2003. Although this arrangement was subject to the firms entering into a mutually acceptable service level agreement by
June 2002, no such agreement was entered into and the ad hoc arrangement effectively continues.
Exactly how influential ABI is in these negotiations is unclear. The Commission and MCG believe that they are, whilst the parties,
avoiding the substance of ABI’s relationship with CCSA, rely on the fact that formally CCSA, not ABI, negotiates with suppliers
on behalf of all its bottlers.
In February 2001, a new player, MCG Industries (Pty)(Ltd) (‘MCG’), entered the market. MCG has been in business in South
Africa since 1957 as a packaging company but was not involved in the production of crowns. It had however supplied printed tin plate
sheet to Crown Cork.
MCG had undergone some changes at this time. In December 2001, its controlling shareholder Zumtobel AG, had sold the business to a
consortium that included empowerment firm Wiphold. Previously disadvantaged persons now hold 44,5% of the equity in the company.
According to SAB, MCG entered into the crown market at the behest of Distell, who, concerned that it would be left with one supplier
after the exit of Crown Cork SA, guaranteed it’ s business to MCG.
Distell entered into a three-year contract with MCG. Since entering the market MCG has acquired a few other customers mostly soft
drink manufacturers. It does a small amount of production for CCSA although it says that more business may become available from
this source when CCSA’s contract with Rheem ends in March this year. At our hearing Mr Wall from Guinness UDV indicated that
they have started using MCG to a small extent to try them out.
Nevertheless MCG’s production figures show that Distell is overwhelmingly its major client.
Relative to Rheem, MCG is however a minor player. If we disregard SAB’s purchases, MCG has 41% of the market and Rheem 59 %.
However once SAB is included, the picture changes dramatically – Rheem has 90% to MCG’s 10%.
MCG is currently utilising only [confidential %] of its production capacity. KPMG, in a report prepared for MCG in October last year,
forecasts that it will produce [confidential figure] units by the end of its next budget year, April 2003.Yet we are advised that
its break even point is [confidential figure] units. This volume is only obtainable according to the Commission, assuming SAB and ABI remain with Rheem, if MCG secures all the remaining
domestic production. The Commission argues that this break-even figure does not ensure the minimum level of profitability that a
firm would require in order for it to be worth its while to stay in the industry. If the Commission is correct, then given the size
of the domestic market this will only be achieved if they win some volume from Coke and or SAB, the two largest customers for crowns
in the market.
With this background we turn now to the concerns that have been raised about the mergers effect on competition.
Analysis of Competition Concerns
There is no dispute among any of the participants about the relevant market in which Rheem operates. This is defined as the market
for the supply of crowns for glass bottles. The market is defined as national. Although technically other products can be used as
substitutes for bottle closures instead of crowns, plastic being an obvious example, these are not considered to be substitutes for
the purpose of competition analysis due to pricing and other technical reasons.
The merger is a vertical merger – a customer, SAB is buying one of its suppliers.
We have previously held in the case of Mondi Limited and Kohler Cores and Tubes, a division of Kohler Packaging Limited, following the seminal work of Riordan and Salop – that vertical mergers can raise three possible concerns:
i.
raising rivals costs by means of either input or customer foreclosure,
ii.
ability to promote co-ordinated conduct between competitors, and
iii.
ability of a vertically integrated firm to evade price regulation
In this particular merger the evasion of price regulation is not relevant so we need take that no further. The possibility of co-ordination
is something that we will examine, although neither the Commission nor the objectors raise this as a concern, correctly in our view.
The real concern then is the incentive the merged firm would have to foreclose.
Customer Foreclosure
Both Rheem and MCG, its only domestic rival, produce crowns. Given that SAB is overwhelmingly the dominant purchaser of crowns and
further the fact that its ownership of ABI, the key Coca Cola bottler, gives it enormous leverage as to where CCSA awards it supply
contract, the acquiring firm exercises considerable market power as a buyer in the market for the production of crowns. The recent history of the industry, which we set out above, is consistent with this observation.
SAB’s acquisition of Rheem makes MCG’s concerns that the merger may lead to it being foreclosed as a supplier because
its competitor is controlled by the same firm that accounts for 78.2% of the current purchases in the market, entirely reasonable.
If MCG has no prospect of being awarded a contract from SAB and/or CCSA then it is unlikely to be viable on its present volumes according
to the KPMG report. Nor is it likely to embark on investment that might lead it to lower costs of production and hence make it a
more formidable rival to the merged firm.
MCG states that a nominal investment in production would enable it to expand its production capacity to meet all of CCSA’s demand.
MCG is unlikely to be able to enter the export market, where there are a number of firms considerably larger than it, unless it obtained
sufficient domestic custom to enable it to invest in the necessary plant to lower its costs. Another disadvantage for any SA firm
wanting to enter the export market is that they are unable to produce the considerably cheaper tin free crowns. This is because ISCOR,
the only local supplier does not produce tin free steel.
The merger could lead to the foreclosure of MCG and hence its exit from the market leaving customers some of whom are SAB and /or
ABI ‘s rivals with only one source of supply, Rheem.
Apprehension about customer foreclosure is justified.
Input foreclosure
Guinness UDV and Distell are two major players in the alcoholic beverage market who source their crowns locally for the most part.
Both firms sell products that require crowns which compete with similar offerings from SAB, by way of example fruit flavoured alcoholic
beverages or as they are commonly referred to in the industry, FAB’s. Distell currently does not make use of Rheem as a supplier
but has in the past. Guinness UDV currently uses Rheem but has recently placed some business on a trial basis with MCG.
Both firms expressed a similar set of concerns.
If they relied on Rheem as a source of supply they feared –
•
Price discrimination, with SAB being treated more favourably;
•
Supply might be refused or restricted. For instance if the Rheem plant experiences production constraints it is probable that it will
favour the customer who owns it at the expense of its other customers;
•
Confidential business information about their production requirements might be made known to SAB who would then be able to respond
accordingly. The production information would relate to inter- alia size of product runs and seasonal fluctuations. In particular
they felt that this put them at a disadvantage in respect of new product launches as the crown manufacturer would have to have access
to information where reaction time to ones rivals efforts is crucial. A firm innovating wants its rivals to have the shortest possible
time to react, as it maximizes it gains during the period before its rivals have reacted. If SAB has access to this type of information
prematurely, it means that they can respond more quickly than they might otherwise have.
•
The FAB market in which they compete with SAB is a crucial growth area where new marketing initiatives are typical and response times
to market changes crucial.
•
Concerns that SAB may not have the same interest as they do in introducing innovation to Rheem’s technology particularly as
this is not part of SAB's core business.
If they relied on MCG as their only source of supply they would be faced with a single supplier who could raise prices above the competitive
level knowing that the firms’ had no domestic alternative. Furthermore MCG has only recently commenced the production of twist
off crowns and, at least in the opinion of Mr Wall from UDV, have no track record yet. He also does not consider pry–off crowns
as a substitute for twist-off crowns. Hence vulnerability to MCG as the only source for domestic supply is not merely a price issue.
Both firms explained that whilst they had had some experience of importing crowns this was not an attractive alternative. Firstly,
unlike SAB, their volumes were too low to secure them attractive contractual terms from an offshore manufacturer. Secondly, on their
volumes, imports were more expensive, and thirdly, due to the need to ship these goods, they are vulnerable to the vicissitudes of
transport logistics. All this impacts on their ability to launch new product, where lead times need to be reduced if a product needs
to come to market before rivals can respond.
ABI, not surprisingly did not oppose the transaction. Yet its reason for doing so justifies the concern expressed by the other firms.
In a letter to the Commission ABI states:
“ As major customer, ABI has no concerns that it would hamper its own ability to compete. Neither Coleus packaging nor SAB compete with Coca-Cola or its bottlers in the market place, nor can we foresee a situation where we might be denied access to limited supply. (Our emphasis)
Again, we are satisfied that apprehension by SAB’s rivals about the possibility of input foreclosure is justified.
Collusion
As mentioned earlier this is sometimes one of the concerns in relation to vertical mergers although neither the Commission nor any
of the other competitors thought it relevant here. We would agree with this. Given the vast difference in size between the firms,
the fact that the business is non-core to SAB’s activities, we see no reason why Rheem would have any incentive to collude
with MCG and much to risk to both it and its parent, if it did.
Market analysis
When a merger is likely to substantially lessen competition we have two possible remedies. We may prevent a merger or where appropriate
approve it subject to conditions that serve to ameliorate the anticompetitive effects.
Initially, as we noted the Commission had recommended that we prohibit the merger. The parties response to this was that if the merger
was prohibited Highveld would exit the market and sell the plant to an overseas buyer. Since SAB was not prepared to be dependant
on one local supplier, which in any event could not meet its needs at present, it would in all likelihood have sourced plant from
overseas and set up an in-house crown division to meet its needs. It is not difficult to see why this would be the most perverse
of outcomes.
Although the Commission challenged whether Highveld had tried sufficiently hard to find a local buyer we have no reason to believe
it did not.
It is not hard to see why. The structure of the market is such that any firm that hopes to remain viable needs to source work from
SAB. With SAB currently requiring a sole supplier it is powerful enough to impose a sub-optimal contract on its supplier. This was precisely the case with the Highveld contract where Rheem’ s margins were under continual pressure so that it had no
incentive to invest. Accordingly it was never able to lower its production costs and as the contract progressed, it experienced ever-declining
returns. Highveld also never saw Rheem as part of its core business so its enthusiasm for the division diminished with its returns. Staff
morale suffered and key personnel were lost. The decision to exit became inevitable.
We are satisfied that prohibition is not a viable option given the current market structure as it is likely to lead to the exit of
Rheem.
Conversely approving the merger will allow SAB the opportunity to introduce the efficiencies into the Rheem business, which it could
not achieve in terms of its contract. As owner it will have incentives to allow Rheem to invest, which it never had as a customer,
and it is probably, at the moment, the only owner to have this incentive.
The proposed conditions
The proposed conditions have been designed to deal with all the foreclosure concerns raised by MCG, Guinness and Distell. All parties
were consulted and were part of the negotiations.
The details of the conditions are contained in our order and need not be repeated here.
The supply contract that SAB has entered into with MCG will ensure that that firm has the minimum scale that it requires to invest
in its’ plant and become competitive, provided that it retains its other business. The agreement lasts for three years and
although MCG is vulnerable to losing this business to Rheem thereafter, it would be inappropriate to make this condition for any
longer period.
The conditions inserted for the benefit of Rheem’s customers all address the concerns raised by Guinness UDV and Distell and
in our view are sufficient. They provide for a mechanism to protect confidentiality, inhibit price discrimination and ensure supply.
They even go further to deal with plant innovation.
The other benefit of these conditions is that they make Rheem a real alternative for SAB’s beverage rivals, so they are not
faced by MCG as a sole supplier. If MCG is aware that its customers have a viable alternative it will ensure that it will be more
competitive in tendering for their business.
The one area of dispute between the Commission and the merging parties was whether, as part of the conditions, SAB should be required
to sell its control of Rheem rather than a minimum stake that falls short of control.
The Commission argued that if SAB’s rationale for the merger was to turn the company around for the purpose of selling it on
to an empowerment group then they had ample time to do so, within the three- year period the Commission was proposing. SAB protested
vehemently that they could not be certain how long they would need, and should not be stampeded into a fire sale to meet an arbitrarily
imposed deadline.
To some extent the Commission has succeeded in calling SAB’s bluff. Clever public relations by SAB had suggested that the rationale
for the deal was just that – to quote a letter addressed to Mr Wall from Mr Short of SAB
“In short therefore, we feel that the purchase of Rheem by SAB will allow:..Significant progress in terms of further black advancement
in South Africa through selling the company on to black ownership after turn around.”
In his line of questions to witnesses counsel for the merging parties put forward the same proposition:
“ADV UNTERHALTER: There’s one other feature of this merger, which you may know of, but perhaps you don’t, which is that
SAB is acquiring control of Rheem in order to undertake investments and bring it up to spec as far as its own requirements for crowns
are concerned. But it wishes to do so in order then to on-sell it to a black economic empowerment company. So it means only to hold
the company for a period of time. Were you aware of that? “
The Commission could be forgiven for holding SAB to what appeared to be its stated position.
Be that as it may, we must decide whether the condition suggested by the Commission is necessary or viable to cure the anticompetitive
effects.
In our view forcing SAB to sell prematurely would not cure the problem. It would mean that the new owner would be forced to accept
an unfavourable contract from SAB, likely to be as onerous as the one Rheem had under Highveld’s stewardship, and we would
soon be back where we are today with another controlling shareholder wanting to sell.
It would be better to have the company under SAB’s control, but still subject to the conditions imposed by this order, than
for it to de facto control the company by contract without having to be subject to these conditions.
It must be remembered that except for the contract with MCG, which is of a 3-year duration, the remaining conditions remain in force
for so long as SAB has control.
These conditions, together with the obligation to sell at least 40 % to an empowerment partner in 2 years, are sufficient incentive
for SAB to dispose of its control sooner rather than later, but at least when it does so, it will be in terms of market driven, as
opposed to regulatory driven, forces and for this reason the outcome is more likely to favour the formation of a genuinely independent
firm rather than one that has to be constructed to meet an imposed deadline.
For this reason we have opted for the parties version of this clause in our order.
With the exception of this clause the conditions imposed are behavioural remedies. There is some scepticism amongst competition law
commentators about whether this type of remedy works. Often it is suggested they are too difficult or too costly to monitor or that
they involve the diversion of resources by the regulator from other areas where they could be more productively spent. In this case
there is no ongoing burden placed on the Commission. The competitors of Rheem and SAB, who benefit from the conditions, are all large
and sophisticated concerns, and will for this reason be well placed to police compliance. The Commission is not obliged to perform
any ongoing monitoring of market behaviour. Its only function post merger is to receive reports from SAB detailing the progress of
the intended rehabilitation of Rheem, a condition that it had requested.
A powerful incentive for the merged firm to comply with the merger conditions, is that amongst the remedies for non-compliance, is
revocation of the merger or divestiture. For this reason we also required that that a breach by SAB of its contract with MCG, in
respect of certain material clauses, would also constitute a breach of the merger conditions, and not just be enforceable at civil
law.
We are satisfied that although the merger will lead to a substantial lessening of competition in the market for the manufacture of
crown closures, the conditions imposed in the order will adequately ameliorate the anticompetitive effects.
Order
The merger is approved subject to conditions contained in the annexed order. A non-confidential version of our order is annexed to
the public version.
__________
11 February 2003
