ACCC v Metcash and Pick n Pay

This morning Justice Emmett of the Federal Court ordered that the ACCC's challenge to Metcash's acquisition of Franklins be dismissed.  A summary of the Court's conclusions was released today, with full reasons to follow tomorrow.

Key points

  • The Court has recognised that integrated supermarket operators (such as Coles, Woolworths and Aldi) do competitively constrain grocery wholesalers, contrary to the position pursued by the ACCC for a significant time. This decision may have significant ramifications for other vertically integrated industries where the ACCC has traditionally been reluctant to recognise the competitive constraint imposed across functional levels by integrated suppliers.
  • While the ACCC argued for a lower threshold for adopting a counterfactual, ie that all it has to show is that there is a real chance of it coming to pass, the Court does not appear to have endorsed this lower threshold.  

Fuller consideration of these issues will follow once the Court's detailed reasons are released tomorrow. 

--------------------------------------------------------------------------------

Background

Metcash operates Australia's largest grocery wholesale distribution and marketing company and also provides branding and other support services to independent grocery retailers.  Franklins operates a business in NSW involving both wholesale and retail activities with 80 company owned and 10 franchised supermarkets. 

In July 2010 Metcash entered into an agreement with Franklins' owner, Pick n Pay, to buy Franklins.  Following a review of the proposed acquisition, the ACCC announced in November 2010 that it opposed the acquisition and undertook to commence proceedings to restrain the proposed acquisition. 

Proceedings were duly commenced in December 2010 and the hearing took place in March and April 2011.

--------------------------------------------------------------------------------

The issues at the hearing

Emmett J identified the three key issues he considered in coming to his decision:

  1. the identification of the relevant market;
  1. the likely position and actions of the parties if the acquisition did not proceed (the counterfactual); and
  1. the likely effect of the acquisition on competition in the relevant market.

With regard to market definition, the ACCC argued that the relevant market should be defined as the market for the wholesale supply of packaged groceries to independent supermarkets in NSW and the ACT.  Metcash and Pick n Pay argued for a broader national market for the supply of groceries and related goods to the public that would include the retail operations of integrated supermarket operators such as Coles, Woolworths and Aldi.

The ACCC contended that the appropriate counterfactual was that the 80 company owned Franklins stores would be acquired by a third party or parties who would continue to operate Franklins' wholesale business or would establish their own wholesale business.  Pick n Pay and Metcash argued that if the sale did not proceed then the business would be split up and each store sold off to an integrated supermarket operator, an independent retailer or closed. 

The ACCC's contention regarding the effect on competition was that the acquisition would reduce the number of suppliers and increase barriers to entry, resulting in a substantial lessening of competition.  Metcash and Pick n Pay argued that the proposed acquisition would have little effect on competition. 

--------------------------------------------------------------------------------

The Court's findings

The ACCC was unsuccessful on each of these three issues. 

Relevant market

The ACCC based its whole case on there being a separate market for the wholesale supply of packaged groceries to independent retailers in NSW and the ACT.  This market definition, which necessarily excludes consideration of the retail market, was rejected by the Court because:

  • The IGA banner, which Metcash owns, is a significant element in the rivalry between the independent retailers and the major supermarket chains.  Because Metcash is intimately involved in the retail operations of IGA supermarkets, any attempt to separate Metcash's wholesale activities from its retail activities "involves a significant degree of artificiality".
  • Metcash is not acquiring Franklins for its wholesale assets, but rather for its retail stores.  Eventually Metcash aims to shut down Franklins' wholesale operations and replace them with its own.
  • The grocery industry is characterised by a high degree of vertical integration in the distribution supply chain.  Constraints arising at the retail level are therefore highly relevant to the market definition.
  • In applying the hypothetical monopolist test, it is meaningful only to speak in terms of an increase in the price charged by wholesalers to their customers, the retailers.  The position of the integrated supermarket operators imposes a constraint on the capacity of independent retailers to increase prices which also constrains the capacity of wholesalers, such as Metcash, to increase their prices.  Due to this constraint, the Court found that an increase of between five and ten percent in the price at which goods are supplied by Metcash to independent retailers could not be sustained without a resultant significant loss of business for both the independent retailers and Metcash.

In conclusion, the Court considered that there was vigorous competition at the retail level, and that there may be a market for the supply of grocery products generally by retail as argued by Metcash and Pick n Pay, but that the ACCC never alleged competitive harm in such a broader market. 

Counterfactuals

The Court found the ACCC's argument that a third party would make an acceptable offer to acquire the whole, or a significant majority, of the Franklins assets unpersuasive.  The Court considered it quite unlikely that an offer along the lines foreshadowed by the ACCC would be accepted by Pick n Pay, stating:

The uncertainties surrounding the terms of any potential binding offer from a third party make it a matter of pure speculation as to whether a binding offer might ever be made, let alone whether it would be accepted by Pick n Pay.

The ACCC had argued that it only had to establish that there was a real chance that its counterfactuals would come to pass.  Justice Emmett stated that even if the ACCC was correct in this contention (which is not discussed further in the summary released today), the ACCC did not meet even this test.

If the acquisition of Franklins by Metcash did not proceed, the Court found that it was highly likely that Pick n Pay would dispose of the Franklins assets by means of a store by store sale process.

Effect on competition

The ACCC argued that Metcash is able to engage in sustained and significant differential pricing to the independent supermarket retailers and that this creates and demonstrates an area of freedom that will exist for Metcash to raise prices once competition between Metcash and Franklins was eliminated.  The ACCC argued that this ability is not constrained by the integrated supermarket operators. 

The ACCC also argued that the removal of the Franklins stores would raise barriers to entry in grocery wholesaling. 

To the contrary, the Court found that it was quite likely that that the acquisition of Franklins by Metcash would strengthen the capacity of independent retailers operating under the IGA banner to compete more vigorously with the integrated supermarket operators. 

--------------------------------------------------------------------------------

ACCC response

The ACCC has stated that it will carefully review the detailed reasons when they are released tomorrow, but that it is disappointed by the Federal Court's decision.  It has 21 days in which to decide whether it wishes to appeal the decision.