Big merger to be sent packing?

The big egg industry merger is set to be blocked by the Competition Commission.

The CC inquiry team has concluded that the coming together of Deans and Stonegate to form Noble Foods is likely to drive up prices in the shops and damage the interests of egg producers.

Now after a three month inquiry into the deal the company has one last chance to change the Commission's view which at this stage remains provisional. The inquiry team will then arrive at a final decision and declare a remedy. It is already suggesting that either the Deans or Stonegate part of the business will have to be sold.

In its official statement the CC said "the merger, which brings together the two largest suppliers of shell eggs and processed eggs in the UK, is likely to lead to a substantial lessening of competition in markets for the supply of shell eggs to retailers, for the supply of liquid egg to some customers and for the procurement of eggs from producers."

Inquiry chairman, Dame Barbara Mills, said: "The merged companies would be in a notably strong position. Customers' ability to switch to alternative suppliers would be much reduced with potential competitors unable to provide the required volumes due to their small scale compared with Deans and Stonegate. There would also be difficulties with production capacity within a reasonable time."

"Given these factors" she said, "we think it is likely that the merged company would be able to increase prices to its customers, knowing that many would be unable to respond by buying from another supplier. Ultimately these prices could feed through to the consumer.

"We also considered that the merged company's size could have an effect on egg producers, giving it the ability and incentive to use its buying power to reduce prices and the quantity of eggs produced. This would have a further damaging effect on competition in the supply of eggs to customers."

In a summary of its deliberations the inquiry team has listed the key considerations that led it to its provisional decision. These include:

Effect on producers

Many farmers, said the CC, had raised concerns about the bargaining power of Noble Foods and feared that it would result in lower prices being paid to producers and/or a reduction in the number of eggs produced. The inquiry team was concerned about the "monopsony buying power" of the new company—if it became effectively the only buyer in the market. This would "give it the ability as well as the incentive to buy from producers on less favourable terms in a number of ways". These could include cutting back prices to producers, failing to pass on any increases in price it may receive from retailers or to bundle its purchases with sales of inputs such as animal feed, pullets or spent hen facilities. It could also offer less favourable contracts in non-price terms such as payment arrangements.

"Lower prices to producers could benefit consumers if passed on to them," said the inquiry team, "but ultimately reduction in the quantity of eggs produced would raise prices to retailers and finally to consumers." Consequently the merger could be expected to result in a substantial lessening of competition in the procurement of shell eggs from producers.

Switching

The CC noted that Noble controls over 60 per cent of sales of shell eggs to retailers and that the next largest supplier is "significantly smaller". As a result of the merger the potential for customers to be able to switch business from one supplier to another appears likely to be "much reduced" the team decided.

Although Noble executives argued that all their customers also use smaller suppliers and could easily switch volumes to these if they were faced with a price rise the inquiry team rejected this. "Most of the switching by the largest multiples has been to or from and often between Deans and Stonegate," they concluded. "In our view the loss of business likely to be incurred by the merged company in response to any price rise is likely to be low; that is price rises would be profitable."

In any case competitors told the inquiry that they currently faced a shortage of eggs and could not compete for new business on the basis that supplies might become available.

Entry and expansion

To replace the rivalry between Deans and Stonegate other suppliers would need to expand "significantly and rapidly" the team said. But the expansion of existing competitors and the entry into the market of new ones appeared to be constrained primarily by the availability of eggs to pack. "Also, entry or expansion of free range production is likely to be a lengthy process," the team decided, "given the need for planning permission, possible construction of facilities, the time required for a flock to come into production and the need to have the facilities approved against regulatory and quality standards.

"Sufficient rapid expansion in a timescale to prevent the merged company increasing prices or worsening quality is, in our view, on balance unlikely."

Bargaining Power

Although Noble had argued strongly that it would not have the power to dictate terms to the big retailers the inquiry team did not agree. "Given the difficulty in switching supplier, the limited prospects for entry and expansion and the reluctance to import," the team concluded, "the effects of the merger would appear likely materially to reduce retailers' bargaining power which may be expected in this particular instance adversely to affect consumers."

When it came to considering possible remedies to the substantial lessening of competition (SLC) the inquiry team has decided there is only one option. "The divestment of the Deans business or of the Stonegate business, provided that constitutes a business capable of competing on a stand-alone business, should be sufficient to address the SLC," it concluded.

But it also added that if the Stonegate business were to be sold then additional assets or contracts may need to be added to the business. In any event in order for a divestment to be an effective remedy it would need to involve a purchaser "who would operate as an effective competitor in the market".

Michael Kent, formerly chairman of Stonegate and now chief executive of Deans, commented: "These findings are only provisional. Even if they were correct we do not accept that divestment is an appropriate remedy. We will be challenging the findings and working towards a more satisfactory outcome."