First published in NZ Lawyer 1 July 2011.

The Commerce Commission recently granted the first business acquisition authorisation for over a decade in a decision which confirmed the relevance of global competition dynamics in authorisation assessments.

Competition a proxy for economic efficiency

The Commerce Act is an enactment which, as part of New Zealand's economic legislation, has the ultimate purpose of making New Zealand's economic "cake" bigger. While there will always be debate about whether specific policies achieve that objective, it remains (or at least should remain) an important touchstone.

The Commerce Act seeks to achieve this purpose by promoting workable or effective competition. The unstated premise being that workable or effective competition is a good proxy for efficiency, such that greater competition and therefore greater efficiency will, in general, deliver greater economic well being for NZ Inc.

Interests of NZ Inc are paramount

Nevertheless, the role of competition can sometimes be elevated to become the objective.

It may not always be the case that promoting competition in New Zealand will deliver greater benefits for New Zealand Inc; this is particularly so in industries where the "New Zealand market" and hence competition in New Zealand reflects, or is a part of, a global market environment in which New Zealand firms compete more broadly with overseas suppliers.

In such circumstances, NZ Inc may be considered better off by concentrating domestic resources in an attempt to compete more effectively in the global economy. As explained below, such an argument was raised, and was successful, in the Cavalier Wool Holdings authorisation.

Such a move is, of course, a judgement call and must be based on the individual circumstances of each industry and each case. However, there are many examples of such judgements being made with the Government's support for the formation of Fonterra and the continued existence of the single export desk for kiwifruit being but two examples (regardless of one's view of the efficacy of those judgements).

While those judgements reflect policy decisions, the Commerce Act also enables the Commerce Commission to authorise business acquisitions, or business arrangements, that result in net benefits to New Zealand, even if they lessen competition in New Zealand.

Authorisation for Cavalier Wool Holdings

While examples of applications for authorisation are reasonably rare – the last authorisation for a business acquisition was filed in 2002 (Qantas/Air New Zealand) and the last successful application was granted in 2000 (when Whakapapa ski field took over the Turoa ski field) – the Commerce Commission's recent decision authorising Cavalier Wool Holdings (CWH) to acquire the wool scouring assets of Wool Services International (WSI) is a contemporary and significant example of the considerations that apply.

CWH's application followed its 2009 acquisition of Godfrey Hirst's wool scouring business, an acquisition which left CWH and WSI as the only domestic wool scour operators. In contrast, in 1994 there were 20 scour sites in New Zealand.

The competition arguments

The key driver of a wool scourer's profitability is volume, with greater volumes leading to material economies of scale benefits and reductions in unit costs. The massive decline in New Zealand's sheep flock from its peak of 70 million in 1982 to around 33 million today, reduced demand and hence created diseconomies of scale which in turn drove consolidation in the industry.

This reduction in demand caused by falling sheep numbers has been exacerbated by the movement of wool processing from traditional markets towards low cost textile and apparel manufacturing in developing countries, most notably China and India, and the rise of domestic scouring industries in those markets. China, for example, is the world's second-largest grower of wool- it accounts for 49% of the world's wool imports and it is the world's largest manufacturer of textiles and clothing, accounting for nearly one third of the world's raw wool used for processing and manufacturing.

In its application, CWH argued that these same trends have already seen the Australian, French, Italian and British wool scouring industries retrench to a point where they are competitively marginalised. In its decision, the Commission confirmed historical global competitive dynamics can be relevant when considering New Zealand's likely post-acquisition competitive position and cited the decline of the Australian scouring industry whose capacity had fallen from 600,000 tonnes per year in 1995 (about 90% of wool grown) to 54,000 tonnes per year in 2009 (about 13.5% of wool grown).

In these circumstances, CWH argued that it would remain constrained by the long term threat provided by these overseas markets, plus the potential for domestic new entry. The Commission undertook substantial analysis of the Chinese scouring industry but overall was not satisfied there would be no substantial lessening of competition in New Zealand and so went on to examine the public benefits. However, the Commission did give weight to the threat of greasy wool being scoured in China as setting a cap on the size of any potential price increases in New Zealand which might flow from having only one domestic wool scourer.

The public benefits

In its decision the Commission adopted the accepted approach in explaining that "a public benefit is any gain, and a detriment is any loss, to the public of New Zealand, with an emphasis on gains and losses being measured in terms of economic efficiency".

Consistent with an approach focussed on NZ Inc, changes in the distribution of income (i.e., transfers between groups within New Zealand) were disregarded "because a change in efficiency is not involved".

CWH identified a number of public benefits, which included:

  • consolidation of New Zealand's existing scouring capacity upon CWH acquiring control of WSI, thereby generating decreased costs and promoting economies of scale and enabling CWH to offer a lower cost, higher quality scouring service and improving CWH's ability to compete more effectively in the global market place;
  • enabling the existing WSI sites to be released for other purposes; and
  • facilitating the implementation of a wool superstore development, which would reduce the cost of wool storage and transport in New Zealand for the benefit of the entire New Zealand wool industry, and which the Commission regarded as being likely to "deliver real commercial gains and significant public benefit".

On the detriments side, while CWH adopted the categories traditionally used to assess detriments (allocative, productive and dynamic), CWH argued that there would be limited competitive detriment given the primary constraints on CWH – being the permanent reduction in the wool clip and the increasing constraint imposed by Chinese wool scourers – and the potential for new entry would remain unaffected.

Considerations of global competition dynamics were perhaps most determinative in the Commission's analysis of detriments, with the Commission concluding that CWH would be constrained by the potential for wool merchants to export wool greasy (i.e. unscoured) in the face of a price increase.

While interested parties had identified the potential for production disruptions and disruptions to wool prices if CWH acquired WSI, the Commission agreed with CWH that such disruptions were unlikely.

Overall, despite substantial opposition from some other parties, the Commission agreed with CWH's view that the public benefits are likely to significantly outweigh the public detriments and so granted authorisation.

In assessing the net benefits the Commission sought to quantify the benefits and detriments, although noted that "quantification is only one tool to be used in its judgements in such a case". This is a pragmatic and commercially realistic approach to the Commission's task. Quantification does assist in framing the analysis and in ensuring that decisions are not based on intuition. As the Commission has previously said, the value of quantification and of economic models more generally is that they serve to identify and isolate those assumptions which really matter.

Significance of the decision

The decision is of significance given it is the first successful business acquisition authorisation for over a decade, and that it is the first authorisation considered by the Commission under Chair Mark Berry.

While a decision timeframe of four months may on its face appear lengthy, it compares favourably to the Air NZ/Qantas timeframe (10 months), the timeframe for complex clearance application (it was shorter than the Woolworths/Warehouse decision time period) and the timeframes in other jurisdictions. In our view this reflects a recognition of the Commission's role as being to facilitate commerce and commercial transactions and a recognition that business acquisitions reflect one aspect of a functioning economy.

In terms of substance, the Commission's analysis reflects a reasoned and commercially pragmatic approach which fully takes account of the impacts of global competitive constraints on New Zealand firms and practical acceptance of the role of the Commerce Act as being to promote the interests of NZ Inc.