In April the Commerce Commission released its full decision in relation to the application by National Foods Limited to acquire New Zealand Dairy Foods. The decision is important because it is only the second decision of the Commerce Commission in which the Commission has declined an application for clearance made under the new substantial lessening of competition test.

The Commerce Commission found against National Foods on the basis that the proposed merger would be likely to have the effect of substantially lessening competition in the yogurt and dairy desserts market. The Commerce Commission indicated that it would also have been prepared to decline the transaction on the basis that Fonterra was not able to divest New Zealand Dairy Foods to National Foods under section 9 of the Dairy Industry Restructuring Act as Fonterra and National Foods were associated parties.

The Commerce Commission's key conclusions in finding a substantial lessening of competition in the yogurt and dairy desserts market were as follows:

In deciding whether the transaction was likely to substantially lessen competition the Commerce Commission had to compare the likely state of competition if the proposed acquisition took place against a counterfactual of what the Commission considered would be likely to happen in the absence of the acquisition. The Commission held that the counterfactual was a situation in which New Zealand Dairy Foods was bought by another party and International Fine Foods Limited (owned by National Foods) remained as a third player in the New Zealand market. Fonterra was required by the Dairy Industry Restructuring Act to divest its interest in New Zealand Dairy Foods so the current situation of ownership of New Zealand Dairy Foods by Fonterra could not continue.

The Commission held that the proposed acquisition would cause a significant increase in concentration in the yogurt and dairy desserts market. The number of major participants in the market would fall from 3 to 2 and the merged entity would have a substantial market share (the actual likely market shares are not disclosed in the Commerce Commission decision due to confidentiality). The application of an economic model by the Commission suggested that the merger could lead to significant price increases - possibly in the range of 5% to 8%. The Commission concluded that the scope for the exercise of market power would be enhanced by the acquisition.

The Commission also concluded that barriers to entry to the market were high. Accordingly in its view the merged entity was not likely to face effective competition from new entrants. Among other barriers to entry the Commission referred particularly to the difficulty of establishing a new brand, access to shelf space (as there is limited chilled space in supermarkets), the cost of new plant (on a scale big enough to achieve 10-12% market share - between $10m and $15m), the necessity of establishing an efficient and nationwide distribution network, the small size of the market compared with the investment required, and potential difficulties in obtaining milk supply.

The Commission also concluded that supermarkets may be able to exert some countervailing power against the ability of the merged entity to raise prices, but that this power may be limited. The Commission held that the countervailing power was likely to be more muted when the supermarkets had only 2, rather than 3, suppliers to play off against each other, and when one of those suppliers had the lion's share of the market. The Commission also concluded that supermarkets were not likely to introduce house brand yogurt and dairy desserts.

The Commission concluded that there would be insufficient constraint on the merged entity from existing competition, potential competition from new entry, or from its customers. The Commission therefore held that the merger would be likely to have the effect of substantially lessening competition, and declined the application for clearance.

The contents of this document are for information purposes only and should not be acted upon without specific legal advice. KPMG Legal does not accept any liability other than to its clients and only then in relation to specific requests for advice. KPMG Legal is an independent law firm.

If you would like more information please contact a member of our competition law team in Auckland or Wellington:
John Land: jland@kpmg.co.nz
Rob Noakes: rnoakes@kpmg.co.nz
David Moorman: dmoorman@kpmg.co.nz
Sean Garelli: sgarelli@kpmg.co.nz

Bryan Gundersen: bgundersen@kpmg.co.nz
Tim Clarke: tdclarke@kpmg.co.nz
Lyn Lim: lhlim@kpmg.co.nz

Web site: KPMG Legal: Competition Law