The Treatment of Efficiencies in Merger Review: An International Comparison

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4 United Kingdom

4.1 General Background

Merger control came to UK competition policy in the Monopolies and Mergers Act of 1965 but the merger review system continues to go through a period of change at the present time. With the Competition Act 1998, the UK is supposedly bound to the EU competition principles, although the 1998 Act does not include provisions for mergers, which are therefore still covered by the Fair Trading Act 1973.¹³⁶ The White Paper published in July 2001 indicated that the UK is headed toward the enactment of a new competition law, which is going to thoroughly change the system that is now in place.¹³⁷ Among the proposed changes, the most significant involve removing Ministers from decision making except in the exceptional cases of public interest; changing the merger test from the current public interest test to the substantial lessening of competition test; allowing anti-competitive mergers to proceed when they bring overall consumer benefits, and improving transparency in the merger process.

4.2 Merger Review Process

The relevant provision in the Fair Trading Act (the Act) in determining whether or not to allow a merger is Section 73, which states that the Secretary of State for Trade and Industry (the Secretary of State) is empowered to take action to remedy or prevent any adverse effects of a merger if "it is found that it operates or may be expected to operate against the public interest." In determining whether the merger operates, or may be expected to operate, against the public interest, Section 84 states that "the Commission shall take into account all matters which appear to them in the particular circumstances to be relevant", and gives a non-exclusive list of matters which must be considered - a list which includes competition issues as well as social considerations. In general, 'public interest' is a very wide concept.

Section 84(1) of the Act provides some guidance regarding how "public interest" is to be interpreted. It indicates that the CC shall take into account "all matters which appear to them in the particular circumstances to be relevant" having regard, among other things, to the desirability of:

(a) maintaining and promoting effective competition in the United Kingdom;

(b) promoting the interests of consumers, purchasers and other users in the United Kingdom;

(c) promoting, through competition, the reduction of costs and the development and use of new techniques and new products, and of facilitating the entry of new competitors into existing markets;

(d) maintaining and promoting the balanced distribution of industry and employment in the United Kingdom; and

(e) maintaining and promoting competitive activity in markets outside the United Kingdom, on the part of producers and suppliers of goods and services in the United Kingdom.

While these goals go well beyond simply the protection of competition, recent governments have tended to consider most seriously the factors that do involve the enhancement of competition and less seriously the other factors. And this is definitely the direction the government indicates it intends to take with the upcoming reforms.¹³⁸

It is important to note the different role played by this "public interest" test and that played by the "public benefits" test in Australia. In the U.K. system, the public interest test in the entire test of the desirability of a merger - there is no other SLC or dominance test, save the rather limited conditions imposed by the assets or market share thresholds described below. The Australian public benefits test, in contrast, is part of the authorization process which would - in principle at least - only come into play if there was concern that the merger would substantially lessen competition in a market. The implication of this difference is that a merger in the U.K. could be blocked (again, in principle) when it had no effect on competition, if it was found to offend other aspects of the public interest.

The investigation of mergers and acquisitions in the UK is currently a process involving three separate entities. The Office of Fair Trading (OFT) (headed by a Director General), The Competition Commission (CC) (formerly the Monopolies and Mergers Commission,), and the Secretary of State for the Department of Trade and Industry. The CC is a department under the Secretary of State, and must follow the policies laid out by the Secretary. The process is by nature almost completely administrative, with essentially no role for courts.

The OFT is responsible for monitoring the UK market for mergers and acquisitions, for which notification is not required. When the OFT finds that a merger might operate against the public interest it will advise the Secretary of State. If the merger qualifies, the Secretary of State has discretion in deciding whether or not to make a reference of the case to the CC for investigation, although in October 2000 the Secretary of State announced that he will follow the advice of the OFT except in exceptional cases of national security.¹³⁹ The Secretary of State may also refer cases on his own, without the recommendation of the OFT.

In order to be a qualifying merger, two or more enterprises must "cease to be distinct" and the merger must satisfy either the "assets" tests or the "market share" test. To satisfy the assets test, the value of the gross assets acquired must exceed £70 million. To satisfy the market share test, the combined firm must "together supply or receive at least one-quarter of the goods or services of a particular description supplied in the United Kingdom or a substantial part of it". We do not think it is appropriate to consider these as anything like an SLC test, rather they are simply screens that allow for the exclusion of many small mergers that can have little or no effect on the public interest.

Upon receiving the case, the CC conducts a thorough investigation of the merger, and sends its advice on the matter to the Secretary of State, who again has discretion on whether or not to allow the merger. The Secretary of State has to power to block the merger, to require divestiture if it has already been completed, or to permit the merger to proceed subject to appropriate safeguards. The Secretary of State cannot block the merger if the CC has not objected to it.¹⁴⁰

Although there are no statutory notification requirements, parties to mergers will often notify the OFT. There are two different ways of notifying a merger. The first notification process is the 'statutory voluntary' notification.¹⁴¹ The Statutory process provides for strict timelines within which the OFT and the Secretary of State have to render a decision of whether or not to refer the merger to the CC. If a decision has not been rendered with 35 days, the merger is automatically cleared. The statutory voluntary notification is only available when the proposed merger has been made public, and the prescribed Merger Notice form must be used.

The second notification process, and the most popular with merging firms, is the 'informal voluntary' notification, which the OFT considers equally acceptable as the statutory process. A decision on whether or not to make a reference to the CC is usually given within 45 days, and the parties need not follow a prescribed form.

The OFT also makes available confidential guidance, as long as the proposed merger has not been made public, but does not make binding decisions on whether or not to recommend a proposed merger be referred to the CC. If new information becomes available when the merger is made public, the OFT and the Secretary of State may change their decisions.¹⁴²

If a merger is made public without prior notification to the OFT, the OFT has four months from the date of publication to decide whether or not to launch an investigation. There are no ramifications for the parties involved for not notifying the merger if the CC ultimately decides that the merger operates against public interest, but the parties to the merger can potentially be ordered to reverse an already executed transaction.¹⁴³

This indicates a very administrative and potentially political process since the Secretary of State has the last word in all cases. Furthermore, the access to appeals on decisions is very limited. It would appear that appeals must be based purely on the point of law as the House of Lords instructed in Lonrho¹⁴⁴:

"the courts must be careful not to invade the political field and substitute their own judgement for that of the Minister"¹⁴⁵

and that action taken under the Act: "could be very much a political question. All decisions were to be made by the Secretary of State. That was what would be expected in a field as politically charged and as important to the economy as competition policy."¹⁴⁶

Commentators state that it can be very difficult to derive the policy and reasoning behind decisions because of this administrative - and, at times, political -- process. Over the past few years the process has become more open, and the CC now publishes all recommendations made to the Secretary of State. But concerns about the politicization of competition policy remain. As Wilks (1999) reports, the UK "approach has rested ultimately on the operation of ministerial discretion, a phenomenon that cannot be analysed other than with political tools."¹⁴⁷

The OFT has published a Merger Guide that explains its approach to investigating mergers. It defines its role as:

"The judgment that has to be made is whether the merger would give rise to a degree of market power that would allow the merged company to raise prices or reduce quality to the detriment of its customers or to operate in some other way that could be against the public interest."¹⁴⁸

The OFT categorizes efficiencies as part of the public interest issues that can be evaluated, and states that although it encourages claims of efficiencies, the OFT will "not closely involve itself in evaluating claims for gains in efficiency".¹⁴⁹ Rather, "any judgment that needs to be made about the trade-off between efficiency claims and the potential detriment to competition is usually better left until after a more detailed investigation by the Competition Commission." The OFT also considers a mergers effect on employment and regional development as part of the public interest considerations.

The CC has not published any guidelines expressing its views on the definition of efficiencies.

4.3 Reform Forthcoming

As mentioned above, in July 2001, the Secretary of State for Trade and Industry published a White Paper, which promises to lead to significant changes to the merger regime.¹⁵⁰ As of this writing, no new legislation has yet been passed, but since the beginning of the discussions on reform in 1999 the Minister has begun to operate by some of the principles of the new system. Most notably, abiding the recommendations of the Commission and the OFT, so as to remove any political overtones from decisions.¹⁵¹ It is expected that the new merger regime will work as follows:

• Final decisions on most mergers will be taken by independent competition authorities rather than Ministers.
• The test they will apply will be to determine whether the merger results in a substantial lessening of competition rather than the current public interest test.
• Exceptionally, where competition considerations point the other way, it will be possible for the authorities to clear a merger or allow it to proceed with less stringent competition remedies where they believe it will bring overall consumer benefits.
• The Secretary of State for Trade and Industry will continue to decide the small minority of mergers which raise defined exceptional public interest issues.
• National security will be defined at the outset as an exceptional public interest issue. It will be possible to define further exceptional public interest issues by statutory instruments.
• The new regime will retain a two-stage approach to merger investigations. The OFT will carry out first stage investigations which will be sufficient to decide most cases. The Competition Commission will continue to carry out second stage, in-depth investigations where necessary.
• There will be statutory maximum timetables for both first and second stage investigations by the competition authorities. There will also continue to be the option of an administrative timetable at stage one.
• The criteria used to determine which mergers qualify for investigation will be modernized to focus more efficiently on cases that may raise concerns.
• The UK's system of voluntary rather than compulsory pre-notification of mergers will be retained.¹⁵²

The White Paper lays describes a substantial lessening of competition test that encompasses those situations where, although competition has been lessened as a result of the merger, it may nonetheless produce overall benefits to the consumers and therefore be permissible. Consumer benefits are lower prices, or greater innovation, choice, quality of products or services. The benefits must be expected to materialize within reasonable time, and be unlikely to be realized without the merger. Consumers are typically end-consumers, but can also encompass consumers in upstream markets, where the immediate beneficiaries of a merger are other businesses.¹⁵³

4.4 Historical Context and Evolution of the Role of Efficiencies

Historical information on the treatment of efficiencies in mergers is scarce. As seen from the description of the merger review process above, the process has, until recently, been highly political. The wide definition of public interest, under which efficiencies belong, makes deriving a definite conclusions on the treatment of efficiencies very difficult. A few points will be made here.

Wilks (1999) lists six principles that have been paramount since the first Fair Trade Act was enacted in 1965 containing merger legislation:

• Mergers are regarded with favor
  
• Merger control is administrative, not judicial
  
• The American model of prohibition is rejected
  
• The economic impact of mergers is subject to a 'monopoly' test
  
• The procedures and the ultimate criteria are politically controlled
  
• The main discipline is business self-regulation¹⁵⁴

In a 1988 White Paper, the laissez-faire policy of the competition authorities was reinforced, by stating that 'the market will be a better arbiter than Government of the prospects for the proposed transaction, and will ensure better use of assets, for the benefit of their owners and the economy as a whole.'

According to Gardner (2000), UK practice is "to permit a merger to proceed, even if it leads to a substantial increase in market power, unless there is convincing evidence that it will be against the public interest."¹⁵⁵ He also states that efficiency must be sought through competition, but that objective of public interest must be balanced against a number of others.

It appears as though the policy starts to turn more consumer-oriented in the 1990's, and a clearer picture of the principles used arise. The impact on competition is more important today than other policy objectives that the sitting Government might have. The current Secretary of State has already, before legislation is in place releasing her from the final say in mergers, kept out of such decisions for the most part. In the following chapters decisions by the CC will illustrate the treatment of efficiencies in the public interest test as far as it is possible.

4.5 Definition and Treatment of Efficiencies

Mergers in the UK are assessed under the public interest criteria, which involves "all matters which appear to them in the particular circumstances to be relevant", pursuant to s. 84 of the Act,¹⁵⁶ which also specifies the five areas that must be considered in this regard. S. 84 leaves, as noted above, the assessment of mergers open to a wide range of factors that can be considered. Since it is the Secretary of State that has the ultimate power to allow or prohibit a merger, with no requirements to explain his decision, it is essentially the policy of the particular Secretary of State that matters in the current review system.

Nevertheless, cases are referenced and summarized by the CC with explanation of the conclusions made, and some general rules on the consideration of efficiencies can be derived. Röller et al. (2000) upon reviewing the cases, indicate that for efficiencies to be decisive in the UK, they have to be significantly large, merger-specific and passed on to consumers.¹⁵⁷ The OFT Merger Guide does not give any definitions or guidance as to which types of efficiencies could be accepted, how to calculate them, or how to weigh them against anti-competitive effects. Correspondingly, the CC has not published guidelines that would clarify its view of efficiencies.

In General Utilities,¹⁵⁸ the benefits arising from the merger (which concerned General Utilities' ability to materially influence the policy of Mid Kent Water with a 30% share of the capital) were not considered 'of substantially greater significance in relation to the public interest...', and would not outweigh any detriment. Among the benefits was the development of complementary business activities. The merger concerned water companies, which are also regulated by the Water Act. The merger was eventually approved on the condition of certain undertakings.

It would appear that gains in efficiencies must be passed on to consumers if competition has been lessened substantially. In Rockwool, ¹⁵⁹ the Commission accepted that there would be significant efficiency gains flowing from the merger as well as a bettering of the environment, but the efficiency gains, although significant, were not considered to be large enough to outweigh the damage to competition and the merger was rejected. Rockwool, with a market share of 78%, was to buy Owens, with a market share of 18%, a rockwool manufacturing plant. It was clear that if the merger was blocked, the plant would be sold to another buyer (if one could be found), or alternatively closed, and in both alternatives the likely efficiency gains would be less than if Rockwool acquired the plant. The employment effects of all alternatives were considered alongside efficiencies, environmental issues and public benefits in general. With regards to consumers the Commission said:
2.152. We have no doubt that Rockwool would raise the efficiency of the Queensferry plant if the merger proceeded. We do not expect the benefits to be passed on to customers in lower prices: Rockwool's business plan indicates that it expected to retain the benefits of the cost savings, as well as the price increases.

An older case had suggested somewhat less concern about seeing consumers derive positive benefits from the merger. In Scottish & Newcastle/Matthew Brown (1985)¹⁶⁰ it was concluded that:

"we discern no material advantages to the public interest arising from the proposed merger; but the question before us is whether the merger may be expected to operate against the public interest, and in our view there are not sufficient grounds for such an expectation."

It appears that efficiencies claimed must not be attainable in a less anticompetitive manner. In Capital Radio¹⁶¹, which concerned a merger between commercial radio stations, the claimed efficiencies stemming from better management and financial strength were considered attainable in the absence of the merger. Certain cost savings stemming from moving Virgin Radio to Capitol's studios were insignificant. Also, prices were expected to rise higher than in the absence of the merger. The merger was subsequently abandoned by the parties.

We expect that the new merger regime will require that efficiencies must be merger specific. Also, as mentioned above the new merger regime states that, in order for to efficiencies to apply in a defense of a merger that substantially lessens competition, they must be unlikely to occur in absence of the merger.

In the past, some mergers have been cleared based on efficiencies despite evidence that there could be a substantial effect on competition. This may become more difficult, as it appears that the new merger system will allow some lessening of competition, but only if there is proof that benefits to the consumers are expected to materialize within a reasonable timeframe. Whish (2001) states that although efficiency claims are heard, the CC most likely will be reluctant to allow a merger that is otherwise detrimental to competition.

Earlier cases suggested a greater tolerance of mergers in concentrated markets. In Stagecoach,¹⁶² the Commission accepted 'several benefits' including increased efficiency in operations, improved fleet and quality of service and a more innovative approach in developing the market. Stagecoach acquired Chesterfield, another bus operator bringing the combined market share to 63%. It was considered unlikely that Chesterfield, or any other potential acquirer, could achieve the expected gains in efficiency in absence of the merger. Also important perhaps too, however, was the fact that there were concerns that Chesterfield could not continue as an independent operator.

In Swedish Match/Alleghany¹⁶³ the merger was allowed despite an already highly concentrated market, in part because of a declining market, stating:

"this is a merger which would lead to a substantial degree of additional concentration in an already highly concentrated market. We believe, however that, in the exceptional circumstances of the declining market which we have described, it is unlikely that a merged Bryant & May/Masters would raise prices unreasonably, or materially reduce the number of brands available, or the standards of service to customers."

It later turned out that the Competition Commission (then the Mergers and Monopolies Commission) was mistaken -- prices rose dramatically, and price controls were recommended to control profits.¹⁶⁴ The case exemplifies that mergers in highly concentrated markets have been allowed in the past, based upon efficiencies or public interest claims.

In Alanod Aluminium¹⁶⁵ the CC accepted that the merger had created opportunities for cost savings and that it had contributed to the security of production and employment in the town of Milton Keynes, but did not believe that these benefits were sufficient to balance the detriments to competition. The merger resulted in Alanod having a 75% market share in the market for anodised aluminium coil, and CC concluded that the firm would have substantial market power. However because the merger had already been completed, it was permitted subject to remedies, including a price cap.

If there are concerns that a merger will reduce efficiency, this can be seen to operate against the public interest. A reduction in efficiency was one of the reasons for concluding that the merger between two pharmaceutical information businesses was considered to operate against public interest in IMS Health.¹⁶⁶ IMS was already dominant in the market, but the merger was nevertheless allowed subject to behavioral and structural remedies.

4.6 Efficiencies in other Competitive Restraints

With the enactment of the Competition Law of 1998 the UK has adopted the EU's Articles 81 and 82, and will treat all cases pertaining to agreements that restrict competition and cases on abuse of dominance according to the principles of the EC Treaty and the Court of Justice decisions.

In chapter 3 on the EU, the treatment of efficiency claims in Article 81 (3) cases was described, and we will not repeat all of that discussion here. Significantly, the test is not a public interest test. Article 81 of the EC Treaty prohibits agreements between firms that might prevent, restrict or distort competition, these agreements being possibly horizontal (but not mergers) or vertical. Article 81(3), provides an exemption if the agreement "contributes to improving the production or distribution of goods, or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit."

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¹³⁶ See appendix C for relevant provisions of the Act.

¹³⁷ Department of Trade and Industry: "A world Class Competition Regime", July 2001.

¹³⁸ See, e.g. Rowley and Baker (2001, p. 63-9).

¹³⁹ Whish (2001), p. 813.

¹⁴⁰ Gardner (2000), White Paper (2001), Rowley & Baker (2001)

¹⁴¹ Merger Guide, OFT, para. 5.5. and Whish (2001), p. 811.

¹⁴² Merger Guide, OFT, para. 5.10.

¹⁴³ Whish (2001), p.809.

¹⁴⁴ R. v. Secretary of State for Trade and Industry, ex p. Lonrho (1989) 1 W.L.R. 525, regarding Lonrho's complaint that the Secretary of State had not referred Fayed's acquisition of House of Fraser to the Commission for review. Lonrho had also wanted to acquire House of Fraser.

¹⁴⁵ Rowley and Baker (2001) p.63-5.

¹⁴⁶ Rowley and Baker (2001), p. 64-34.

¹⁴⁷ Wilks (1999), p. 156.

¹⁴⁸ Merger Guide, OFT, para. 4.6.

¹⁴⁹ Merger Guide, OFT, para. 6.17.

¹⁵⁰ White Paper (2001).

¹⁵¹ Rowley & Baker (2001).

¹⁵² White Paper (2001), p. 24, box 5.1.

¹⁵³ White Paper (2001), p. 25.

¹⁵⁴ Wilks (1999), p. 205.

¹⁵⁵ Gardner (2000), p. 76.

¹⁵⁶ See Appendix C for the full text of s. 84.

¹⁵⁷ Röller et al. (2000), p. 80.

¹⁵⁸ General Utilities plc/The Mid Kent Water Company, 4.7.1990.

¹⁵⁹ Rockwool Limited and Owens-Corning Building Products (UK) Limited: A report on the proposed merger, 07.05.99

¹⁶⁰ Scottish & Newcastle/Matthew Brown (1985), para. 7.13. See Gardner (2000) p. 76

¹⁶¹ Capital Radio Plc and Virgin Radio Holdings Limited: A report on the proposed acquisition, para. 2.123.

¹⁶² Stagecoach Holdings plc/Chesterfield Transport (1989) Limited, 18.1.96. Summary account from Competition Commisson, full text not available.

¹⁶³ Swedish Match/Alleghany, Cm 227, 21.10.87

¹⁶⁴ Gardner (2000).

¹⁶⁵ Alanod Aluminium-Veredlung GmbH & Co/Metalloxyd Ano-Coil Ltd, Cm 4545 (2000)

¹⁶⁶ IMS Health Inc./Pharmaceutical Marketing Inc Cm 4261, 2001.