Why Deans/Stonegate merger enquiry was ordered

UK - The Office of Fair Trading has revealed why it ordered an inquiry into the merger of Deans and Stonegate.
calendar icon 16 October 2006
clock icon 6 minute read

The OFT reached a conclusion that the deal to create Noble Foods will or might result in a “substantial lessening of competition” within the egg market for three key reasons. They were that:

• Noble’s existing competitors are so small that if a major customer wanted to switch significant business no other company would be capable of coping with it.

• These small competitors are unlikely to expand rapidly.

• New entry to the egg industry is so difficult that a new competitor could not get into the market in time to remedy any ill effects caused by the merger.

The OFT dismisses the need to even consider the production of eggs. It says the combined share of production of Deans and Stonegate has been consistently below 25 per cent of the UK total in the past three years. And since it received no third party comment on the issue during investigations “the merger does not give rise to any significant concerns in this segment”. In fact in the whole 11-page document egg producers do not receive a single mention.

It comes to the same conclusion about egg packing since neither company packs eggs for third parties. In fact it had been given evidence that there are 1,000 alternative egg packers in the UK. It also found no reason to probe the supply of shell eggs to processors or customers other than retailers.

Its concerns centred on the supply of shell eggs and liquid egg. “A significant number of customers across all shell egg market segments were concerned about the competitive effects of the merger,” says the report. And all those who responded from the liquid egg sector expressed concern about the impact of the deal on their business.

“The merger therefore raises significant horizontal concerns in the supply of all shell eggs, shell eggs to retailers and liquid egg to all types of customer,” says the report.

The dominance of Noble in the retailer sector was underlined by the fact that it had around 70 per cent of the market and its closest competitor had between 5-10 per cent.

Noble argued that imports from Europe could prove effective competition. But the OFT dismissed this because of the emphasis placed in the UK on the Lion brand and because of transport costs.

The report stresses that in the past Deans and Stonegate have been each other’s strongest competitors. It says that when one firm increased its share of supply to a retailer the other one lost almost—and in some cases exactly—the equivalent share. Over the past six years the shares of supply to some major supermarkets have switched between the two by as much as 40 per cent.

The companies argued that the major supermarkets were able to employ substantial buyer power in the market. They told the OFT that between 55-65 per cent of all shell egg purchases were accounted for by just three customers, Tesco, Asda and Sainsbury. And that the big five retailers (including Morrisons and Somerfield) accounted for 85 per cent of purchases.

“The OFT does not discount the possibility of the major retailers having buyer power,” says the report. “Although possibly constrained by a need to source the bulk of their total requirement from one supplier, such larger retailers may still have the ability to discipline the merged entity by switching a sufficient proportion of that total requirement to an alternative supplier, by threatening to source from outside the UK or by threatening to build up a smaller supplier in the UK. However, the scale of past switching between Stonegate and Deans by major supermarkets has been considerable and it is not clear that shell egg suppliers other than the parties currently have the capacity to fulfil requirements on this scale. Therefore, it seems reasonable that some countervailing buyer power has been lost as a result of the merger.”

Some large customers told the OFT that they did not possess sufficient buyer power to offset the effects of the merger given that all the remaining alternative competitors operated on such a significantly smaller scale.

“The OFT considers that some customers will retain buyer power,” says the report. “However, these customers are not representative of the entire customer base.“
And the officials brushed aside the idea that a newcomer could enter the market and offer competition to Noble Foods.

“A body of third party comment indicates,” says the report, “that a new entry into an industry characterised by declining profitability would be difficult and would not be achievable at a scale and within a short enough period of time to remedy any adverse effects that may arise from the merged entity’s increased market power.”

They also did not accept that any of Noble’s existing competitors were likely to expand rapidly.

“There is some evidence of expansion in recent years,” says the report, “but none to indicate that this has been of significant scale relative to the size of the parties.”

It cites the example of the Scottish-based Glenrath Farms which won its first contract to supply Tesco in 1983 and after twenty years of growth has achieved less than ten per cent of the retailer market.

It also points out that much of the expansion of Deans and Stonegate has been through acquisitions.

The report confirms that Noble Foods offered undertakings about its business in order to avoid the issue being referred to the Competition Commission. While it does not disclose what these offers were it describes them as “essentially behavioural undertakings”. They were rejected because officials decided they were not capable “of maintaining the competitive dynamic” in the supply of shell and liquid egg.

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