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You are here: BAILII >> Databases >> United Kingdom Competition Appeals Tribunal >> Celesio AG v Office Of Fair Trading [2006] CAT 9 (9 May 2006) URL: http://www.bailii.org/uk/cases/CAT/2006/9.html Cite as: [2006] CAT 9 |
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Neutral citation [2006] CAT 9
Case No: 1059/4/1/06
IN THE COMPETITION APPEAL TRIBUNAL
Victoria House
Bloomsbury Place
London WC1A 2EB
9 May 2006
_____________________
Applicant
Respondent
Interveners
_____________________
Mr Mark Hoskins and Miss Kelyn Bacon (instructed by Linklaters) appeared for the Applicant
Mr Peter Roth QC and Mr Daniel Beard and Mr Julian Gregory (instructed by the Solicitor to the Office of Fair Trading) appeared for the Respondent
Mr Nicholas Green QC and Miss Maya Lester (instructed by Slaughter and May and Allen & Overy LLP) appeared for the Interveners
_____________________
| I INTRODUCTION | 1 |
| II LEGISLATIVE FRAMEWORK | 5 |
| III BACKGROUND | 9 |
| The parties | 9 |
| Investigations into the retail pharmaceutical sector | 12 |
| Procedure before the OFT | 17 |
| IV THE CONTESTED DECISION | 34 |
| Proposed Undertakings | 52 |
| V THE PROCEEDINGS BEFORE THE TRIBUNAL | 55 |
| The original ground (a) in the notice of application | 62 |
| VI THE DUTY OF THE OFT TO REFER | 66 |
| VII THE STANDARD AND NATURE OF REVIEW | 75 |
| VIII THE EVIDENCE | 78 |
| A. CELESIO'S EVIDENCE | 78 |
| The LECG evidence | 78 |
| The evidence of Mr Justin Ash | 82 |
| B. THE INTERVENERS' EVIDENCE | 87 |
| C. THE OFT'S EVIDENCE | 89 |
| IX THE PARTIES' SUBMISSIONS ON THE SUBSTANCE | 91 |
| AMENDED GROUND 1 | 91 |
| Celesio's submissions | 91 |
| The OFT's submissions | 104 |
| The interveners' submissions | 111 |
| AMENDED GROUND 2 | 120 |
| Celesio's submissions | 120 |
| The OFT's submissions | 126 |
| The interveners' submissions | 128 |
| AMENDED GROUND 3 | 132 |
| X THE TRIBUNAL'S ANALYSIS | 134 |
| The test for the admissibility of Pritchard | 134 |
| Application of the admissibility test to Pritchard | 144 |
| The Decision in respect of 4 to 3 areas | 172 |
| - SLC in the context of weak competition in the relevant markets | 173 |
| - Share of outlets evidence | 176 |
| 4 to 3 areas | 180 |
| Amended grounds 2 and 3 | 193 |
| XI OTHER MATTERS | 194 |
| Third party material | 194 |
| Submissions by Celesio to the OFT during the investigation stage | 196 |
| Celesio's disclosure of the Lloyds/Cohens & Scholes merger | 198 |
| Evidence on pharmaceutical services regulation | 199 |
| XII CONCLUSION | 200 |
I INTRODUCTION
"(1) Any person aggrieved by a decision of the OFT … under this Part in connection with a reference or possible reference in relation to a relevant merger situation or a special merger situation may apply to the Competition Appeal Tribunal for a review of that decision.
…
(4) In determining such an application the Competition Appeal Tribunal shall apply the same principles as would be applied by a court on an application for judicial review.
(5) The Competition Appeal Tribunal may –
(a) dismiss the application or quash the whole or part of the decision to which it relates; and
(b) where it quashes the whole or part of that decision, refer the matter back to the original decision maker with a direction to reconsider and make a new decision in accordance with the ruling of the Competition Appeal Tribunal."
II LEGISLATIVE FRAMEWORK
"The OFT shall, subject to subsections (2) and (3), make a reference to the [CC] if the OFT believes that it is or may be the case that:
(a) arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation; and
(b) the creation of that situation may be expected to result in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services."
"(1) Subject to subsections (5) and (6) and section 127(3), the [CC] shall, on a reference under section 33, decide the following questions-
(a) whether arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation; and
(b) if so, whether the creation of that situation may be expected to result in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services."
"(1) Subsection (2) applies if the OFT considers that it is under a duty to make a reference under section 22 or 33 …
(2) The OFT may, instead of making such a reference and for the purpose of remedying, mitigating or preventing the substantial lessening of competition concerned or any adverse effect which has or may have resulted from it or may be expected to result from it, accept from such of the parties concerned as it considers appropriate undertakings to take such action as it considers appropriate.
…
(5) An undertaking under this section-
(a) shall come into force when accepted;
…"
III BACKGROUND
The parties
Investigations into the retail pharmaceutical sector
Procedure before the OFT
"We have not yet had the opportunity to carry out a full local analysis across the UK but are concerned that there may be areas where, even if there were 4 or more competitors remaining after the merger, some of these would provide a very weak constraint on [the merged entity]. We also believe that in a number of areas there will be fewer than 4 competitors. Moreover, …we believe that there would be a risk of market exit in a number of cases.
Given the step change that the proposed merger would bring about at the retail level as described above, Celesio submits that it is incumbent upon the OFT to undertake a detailed appraisal of the impact on competition at a local level. We note that issues regarding not only the minimum appropriate number of local competitors but also the nature of the competition between them, as well as questions as to how local market[s] should be defined, have all been important features of the CC's inquiries into supermarkets (the 2004 inquiry into the acquisition of Safeway plc and the 2005 inquiry into the acquisition of certain Morrison stores by Somerfield). These issues also need to be considered very closely in relation to this proposed merger." (Briefing paper, paragraph 3.2.)
IV THE CONTESTED DECISION
| Dispensing | GSL medicines | P medicines |
| Revenue (£m) | Share (%) | Revenue (£m) | Share (%) | Revenue (£m) | Share (%) | |
| Boots | [1,000-1,200][C] | [10-20][C] | [300-500][C] | [15-25][C] | [100-200][C] | [25-35][C] |
| UniChem | [700-900][C] | [0-10][C] | [0-100][C] | [0-10][C] | [0-100] | [0-10] |
| Boots/ UniChem | [1,700-2,100][C] | [15-25][C] | [300-600][C] | [20-30][C] | [100-300][C] | [30-40][C] |
"the extent to which national chains face each other in local areas may well be a factor in determining the extent to which they can influence each other's decision making at the national level, e.g. on pricing policies" (paragraph 14).
On the question of how far local competition influences national policies, the OFT noted (in paragraph 31 of the Decision) that the parties had argued that:
"… on the whole, Boots and UniChem do not tend to be located close to each other; Boots stores tend to be based in high street locations, while UniChem's pharmacy stores fit the "community pharmacy" model and are generally found in residential areas, health centres or smaller shopping centres. … However, both appear with relatively high frequency in rural towns… Overall, the evidence suggests limited competition between the parties in respect of the pricing of P medicines."
"33. One third party submitted that a fascia approach is not appropriate in this case, and that local area analysis based on shares of supply would be more appropriate. This was on the basis that Boots was a significantly different type of retail pharmacy which meant that it should not be treated on the same terms as any other fascia. The OFT considers that this could suggest more that Boots is not a close competitor to other types of pharmacies rather than that a fascia approach would not be appropriate in this case. No other comments were made by third parties to suggest that the fascia test was inappropriate.
34. In 1996 when it looked at UniChem/GEHE/Lloyds, the MMC only examined two-to-one overlaps on a one mile basis – and even in these areas concluded that the customer benefits of the mergers would in each case outweigh any reduction in competition. However, at the time of the MMC inquiry, resale price maintenance was still in place in OTC (GSL and P) medicines such that scope for competition, especially on price, might be expected to have been more limited than it is today.
35. The OFT report on control of entry regulations (see footnote 4) – published after the removal of RPM – found that competition, particularly price competition, between pharmacies and between pharmacies and other retailers was still muted. It did however find some correlation between local concentration and quality of service on matters such as extended opening times, provision of consultation areas and home delivery.
36. There is no price competition between retail pharmacies in the supply of ethicals, which account for [80-90] [C] per cent of UniChem's turnover ([20-30] [C] per cent of Boots turnover) and a number of retail outlets other than pharmacies supply GSL medicines and non-pharmaceutical products. Price competition between retail pharmacies in the product categories we are considering is therefore mainly limited to P medicines. A number of third parties suggested that competition between pharmacies on service levels was also limited because NHS service contracts specify national minimum standards for pharmacies. The NHS contract is restrictive in terms of its imposition of service standards and required opening times for instance. Such restrictions serve to limit the parameters of competition. In fact, third parties suggested that the main form of competition takes place on initial choice of location – a factor of competition which, on the basis of third party comments, still appears to be highly regulated by PCTs.
37. However, the parties' internal documents clearly show that there is some competitive interaction between different retail pharmacies. Both Boots and UniChem monitor a number of different price and service quality variables and compare themselves to competitors. Possible aspects of competition mentioned in Boots' consumer research documents include product availability, store layout, ease of shopping and shopping environment. At a local level, waiting times for obtaining a prescription and the provision of deliveries seem to be key measure of competition too. For instance, a Boots' internal document […][C].
38. Even though locality appears to be the main factor determining customers' choice of pharmacy, there is nonetheless some evidence to suggest that a reduction in pharmacy fascia numbers could bring about a reduction in competition, whether by lowering service/ quality levels, by reducing choice (on a quality level) or, less so, affecting prices, particularly for P medicines.
39. On the question of what is the appropriate level of competition in a locality, differing views have been provided to the OFT. One third party told us that it would expect to face at least two competitors within a one-mile radius. The parties, on the other hand, state that there is no realistic prospect of a substantial lessening of competition arising in any local area due to the limited nature of competition in the sector. This is particularly true in this case, they submit, because Boots and UniChem have different business models and therefore should not be considered to be particularly close competitors."
"Conclusion on local overlap analysis
43. In looking at local area overlaps the starting point of our analysis has been the 1996 MMC report which found that a reduction in pharmacy fascia from two to one in a one mile radius would [not][7] be against the public interest. The OFT notes, however, that this was before RPM on OTC medicines was removed, suggesting that the scope for competition in 1995 might have been more limited than it is currently. On the other hand, UniChem is a relatively small player in the OTC sector and this could suggest a similar approach being taken here. Additionally, the fact that there has been further deregulation in the form of the relaxation of entry rules could militate in favour of a less intrusive approach, although it is noted that the evidence on this issue provides far from conclusive backing to such an approach. The parties' internal documents do, however, show that a level of competitive interaction between retail pharmacies does exist and that new entry will usually prompt some competitive response. Such evidence would clearly suggest that a reduction in pharmacy fascias from two to one within a one mile radius could lead to a reduction in the incentives to compete and have a detrimental effect on matters such as the standard and quality of the services provided by the pharmacies concerned (over and above the levels stipulated by the NHS contract).
44. In many respects the pharmacy sector is unique in terms of being a highly regulated retail sector where matters such as entry and even opening hours are, to a large extent, controlled by the local PCTs. However, a level of competition does exist and the OFT has sought to ascertain whether it is possible to establish, to a reasonably conclusive degree, the number of fascia required to maintain adequate competition in a local area. To this end, in addition to the two to one analysis referred to above, the OFT looked in detail at those local areas where the merger will result in a reduction in competitor fascias from three to two. Even in these areas, switching of customers between Boots and Unichem stores may be high, and for a large proportion of customers, Boots and Unichem would be the closest competitors. This may arise particularly in those localities where the merging parties' pharmacies are located close together. In such a situation the competitive scenario post merger does not significantly differ from that in the two to one areas.
45. This has to be considered alongside the high barriers to entry in this sector combined with what the parties' internal documents say on the issue of competition – see, for instance, the references at paragraph 37 above to the monitoring of various competitor price and service quality variables. On balance, the OFT believes that a substantial lessening of competition may go beyond those areas outlined at paragraph 43 and may also arise where fascia are reduced from three to two within a one mile radius.
46. Any higher reduction in fascia number than this (e.g. four to three or higher) could also give rise to a lessening of competition but on the basis of the evidence before the OFT, it believes that this cannot be expected to be substantial. One major competitor suggested that it would be usual to face two other competitors within a local area. Moreover, the CC's 1995 report considered only two to one fascia reductions. While there have been small changes to the market since then (primarily the removal of resale price maintenance on OTC medicines) which might suggest some small increase in the scope for potential competition, these changes do not support an argument that reductions from four to three fascias might give rise to competition concerns."
"80. A large exercise to consult third parties was undertaken in this case and, as can be seen above, a number of concerns were raised. Some PCTs were concerned about local competition in their particular areas and about the parties' willingness to engage in, and negotiating strength in respect of, PCT initiatives.
81. A number of competitors also expressed concerns about the merger, however, some of these appeared directed at the fear that a combined Boots / UniChem would be a stronger competitor, which may indeed have a positive effect on competition, and it is noted that not all competitors were concerned by the merger. A suggestion was also made that the complexity of the issues raised meant that they were not capable of being resolved by a first stage investigation."
"82. The parties overlap in the provision of retail pharmacy services. In terms of national competition, no concerns arise. However, on a local level on the basis of a one mile radius around both Boots and UniChem pharmacies there are 38 areas where the merger would result in a two to one reduction in the number of competing pharmacies ('fascias') and a further 61 areas where it would result in a reduction in the number of fascias from three to two. The evidence considered during this assessment clearly shows that a reduction in pharmacy fascias from two to one in a local area is, despite the restrictive terms of the NHS contract, expected to result in a substantial lessening of competition (SLC). Such an SLC could take the form or reductions in quality or the level of service provided (over and above the levels stipulated in the contract). There may also be an impact on pricing, particularly of P medicines. The evidence on whether an SLC would arise in the case of three to two overlaps is less conclusive but, on balance, the OFT takes the view that it may be the case that the merger may be expected to result in an SLC within these three to two overlap areas given the high barriers to entry present in this market as a result of the control of entry regulations. …
…
85. Given the conclusions at paragraph 82 above, the OFT believes that it is or may be the case that the merger may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom."
"91. The merger will therefore be referred to the Competition Commission under section 33(1) of the Act, unless Boots gives suitable undertakings pursuant to section 73 of the Act to address the potential competition concerns outlined above."
Proposed Undertakings
V THE PROCEEDINGS BEFORE THE TRIBUNAL
(a) The OFT incorrectly based its assessment of competitive concerns on the local retail market solely on a "fascia test". The OFT thereby erred in its reasoning, and failed to consider material factors relevant to the identification of the competitive concerns arising from the merger.
(b) Even if the fascia test was sufficient to identify the competitive concerns arising from the merger on the local retail market, the OFT's conclusion in this case that a reduction from 4 to 3 fascias would not give rise to a SLC was incorrect in fact and law, and in adequately reasoned.
(c) The defects in the OFT's assessment of the local retail market vitiate the OFT's conclusions that no competitive concerns arise at a national level. The OFT's conclusions on this issue are also not substantiated by the evidence.
(d) If any of points (a) to (c) above are correct, the undertakings proposed by the parties are insufficient and inappropriate to remedy the competitive concerns arising from the merger.
The original ground (a) in the notice of application
"(a) the reasons given in the Decision are not capable of sustaining the OFT's conclusion that a reduction from 4 to 3 fascia in local retail markets would not give rise to a SLC;
(b) this error of assessment in relation to local retail markets necessarily vitiates the OFT's conclusion relating to the national retail market; and
(c) it further follows that the OFT is not entitled to accept undertakings in lieu of a reference pursuant to s.73(2) of the Enterprise Act 2002."
In this judgment we refer to these issues as amended ground 1, amended ground 2 and amended ground 3 respectively.
VI THE DUTY OF THE OFT TO REFER
(a) The OFT must refer the proposed merger to the CC where it believes that it "is or may be the case that" the merger may be expected to result in a SLC. The words "may be the case" denote a lower degree of likelihood than an expectation, but exclude the purely fanciful. The threshold for the making of a reference to the CC is therefore a low one.
(b) The OFT has a margin of judgment "between the fanciful and a degree of likelihood less than 50 per cent". However that margin of judgment does not imply that the OFT has a wide discretion; rather, that the degree of likelihood of a SLC will vary according to the circumstances.
At the hearing Celsio submitted that if the prospects of there being a SLC are between fanciful and 50 per cent or above, then there is an obligation on the OFT to refer the proposed merger to the CC.
"The OFT shall, subject to subsections (2) and (3), make a reference to the [CC] if the OFT believes that it is or may be the case that –
(a) arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation; and
(b) the creation of that situation may be expected to result in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services."
"(a) whether arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation; and
(b) if so, whether the creation of that situation may be expected to result in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services."
i. Section 33 imposes a duty on the OFT to refer if the requirements set out in the section are met.
ii. The OFT's investigation is a first-stage investigation to consider whether a reference is necessary.
iii. The belief must be reasonably held by the OFT: it must be reasonable and objectively justified by relevant facts.
iv. The phrase "believes that it may be the case" imports a lower degree of likelihood than paragraph (b) in sections 33(1) or 36(1) would by itself involve. As Sir Andrew Morritt V-C said in IBA Health at paragraphs 47 and 48:
"47. That lower degree of likelihood might, for example, exist in circumstances where the work done by the OFT did not justify any positive view, but left some uncertainty, and where OFT therefore believe that a substantial lessening of competition might prove to be likely on further and fuller examination of the position (which could be undertaken by the Competition Commission).
48. At the other end of the scale it is clear that the words "may be the case" exclude the purely fanciful because OFT acting reasonably is not going to believe that the fanciful may be the case. In between the fanciful and a degree of likelihood less than 50 per cent there is a wide margin in which OFT is required to exercise its judgment. I do not consider that it is possible or appropriate to attempt any more exact mathematical formulation of the degree of likelihood which OFT acting reasonably must require."
VII THE STANDARD AND NATURE OF REVIEW
VIII THE EVIDENCE
A. CELESIO'S EVIDENCE
The LECG evidence
The evidence of Mr Justin Ash
"The parties' submission that consultation areas are mandatory under the new pharmacy contract is incorrect.
… there is no obligation upon a pharmacy to provide Advanced Services under its pharmacy contract. Therefore, while it is true that consultation rooms to a certain standard are required for the provision of Advanced Services by those pharmacies which wish to provide such services, it is not the case that consultation rooms are mandatory for all pharmacies.
With regard to the regulation of opening hours, these have always been regulated. Under the new regulations core hours must be declared to the PCT but discretion remains as to when these hours of opening occur and as to whether a pharmacy contractor wishes to open for hours additional to the core hours. These are classified as supplementary hours…"
"Celesio felt that it was important to identify and correct these errors, both by way of background to the hearing before the Tribunal, and in case the matter is to go any further (e.g. upon remittal to the OFT).
However, …Celesio does not intend to make any free-standing submissions in reliance on Mr Ash's witness statement".
"We have made the point that we actually think that there is an error of fact, but if I lose on all my submissions today and that is the only thing left, I will not be submitting that we nonetheless win on that point."
(transcript, p 7)
B. THE INTERVENERS' EVIDENCE
C. THE OFT'S EVIDENCE
"Relevance of local overlaps to national issues
37. The OFT is well aware of the significance of local issues in retail markets in which there are national policies on pricing or non-pricing aspects of competition (such as service standards). As noted at paragraph 14 of the Decision, national policies may be affected by the extent to which chains face each other locally across the country. Two issues are relevant in this regard: first, the degree of overlap as a proportion of each parties' national estate; second, the degree of competition concerns in those overlap areas.
38. In the case of Boots and UniChem, the degree of overlap of estates in areas where local concerns arise is particularly low. As noted, UniChem and Boots have 958 and 1,350 pharmacy outlets respectively, and they are each other's only local rivals (on a 1-mile radius) in only 38 areas, and two of three in only 61 areas. The sum total of 2:1 and 3:2 overlap areas is around 10% of either party's estate, i.e. each party faces close geographic competition from the other in such areas only a fraction of the time. In such circumstances, it could not be said that the low national shares were masking a potential unilateral effect at national level deriving from local-level competition between the parties.
39. This is in line with evidence from Boots' internal documents which indicate that, on the whole, Boots and UniChem stores tend not to be located close to each other: Boots stores tend to be in high street locations, whereas UniChem's pharmacy stores fit the "community pharmacy" model and are generally found in residential areas, health centres or small shopping centres. Boots' own analysis of catchment areas breaks down pharmacy coverage across classes of shopping centre area. Boots appears most frequently ([…][C] % of stores) in "major regional centres" with an average catchment population of […][C]; a category which accounts for only […][C]% of "Moss" (the brand of most of Alliance Pharmacy stores) portfolio. Moss' most frequent location is "small district centres", with an average catchment population of […][C]; whereas only […][C]% of Boots' stores fit this profile. While both appear with relatively high frequency in rural towns, on balance the OFT took the view that the evidence did not support the proposition that the parties were particularly similar as concerned the geographic scope of their store portfolio.
40. As to the degree of competition concern in local areas, this goes to the heart of the local analysis conducted in this case; the OFT decided that local divestment in 2:1 and 3:2 areas addresses concerns at the local level, and in turn those that may arise at the national level, though increased incidence of problematic overlaps within the merging parties' national store portfolio.
IV THE OFT'S CONTESTED ASSESSMENT OF LOCAL ISSUES
41. The Decision's assessment of local competition issues is the focus of two grounds of Celesio's application. The OFT's analysis of local competition issues is set out in the Decision at paragraphs 33 to 49, which draws on and should be read in the light of its more general analysis of the retail pharmacy sector in paragraphs 8 to 16 and 26 to 32.
42. As noted above, in accordance with OFT guidelines, the OFT takes an assessment of market concentration as an initial starting point before a full assessment of competitive effects. Typically, therefore, the OFT proceeds as follows. First, it identifies the measure(s) of concentration most appropriate in the circumstances of the case. Second, it carries out a full assessment of competitive effects within a framework set by the concentration measure adopted. In this case, the OFT concluded that a fascia test was the most appropriate measure of concentration on the facts, and its assessment of competitive effects was carried out within a framework set by the fascia test, i.e. the OFT first analysed competitive effects in local areas with a 2:1 fascia reduction, and then moved on to consider 3:2 and 4:3 areas.
43. This section elucidates the OFT's reasoning in relation to local issues in the light of the arguments advanced by Celesio in its application, and is structured as follows.
- First, I discuss the evidence which suggested that there existed only a limited scope for local competition among retail pharmacies in the UK. This conclusion served as a point of departure for the OFT's local area analysis, including contested elements of it.
- Second, in response to Celesio's first ground of application, I explain why Celesio mischaracterises the role played by the fascia test, and why, contrary to Celesio's submissions, it was the most appropriate measure of concentration in the circumstances of the case.
- Third, in response to Celesio's second ground of application, I discuss the OFT's reasons for its conclusions in respect of local areas featuring various reduction in fascia, i.e., in respect of 2:1, 3:2, and 4:3 areas, and why the OFT committed no error of assessment in concluding that the statutory reference test was not met in respect of 4:3 areas.
LIMITED SCOPE FOR LOCAL PHARMACY COMPETITION
44. In its application, Celesio argues, among other things, that the OFT should have concluded that the statutory reference test was satisfied in relation to 4:3 areas in the light of its approach in other cases relating to other sectors. It is important to remember that the retail pharmacy market is in many respects unusual and, although some limited competition appears to exist within it, the extent and intensity of that competition is considerably less than in many other markets. For example, paragraph 44 of the Decision notes that:
"In many respects the pharmacy sector is unique in terms of being a highly regulated retail sector where matters such as entry and even opening hours are, to a large extent, controlled by the local PCTs".
Previous cases relating to the local retail pharmacy market
45. The OFT was already aware of the limited nature of competition within the retail pharmacy market when it came to carry out its local area analysis in this case, and this awareness informed its analysis and conclusions. As described at paragraphs 34 to 36 and following of the Decision, the OFT considered the evidence from the MMC's 1996 report and the OFT's MPI report on Control of Entry Regulations ("the MPI report"). Also relevant in the context of this challenge by Celesio is the evidence gathered during, and Celesio's submissions in Lloyds/ C&S, its own recent merger case. Finally aspects of the OFT's analysis of national issues are relevant also at the local level.
The MMC Report
46. As noted in paragraph 34 of the Decision, in UniChem/ GEHE/ Lloyds, the MMC restricted its examination of potential merger concerns to 2:1 areas. It noted that competition between retail pharmacies was muted and concluded that even in 2:1 areas any detrimental competitive effects would be small and outweighed by the beneficial effects of the merger. However, at the time of the MMC inquiry, resale price maintenance ("RPM") was still in place in P medicines.
The OFT's pharmacy report
47. Following the lifting of RPM for P medicines in 2001, the OFT examined the retail pharmacy sector in the MPI report. The OFT found only muted competition between pharmacies. The econometric analysis commissioned by the OFT and carried out by Frontier Economics ("Frontier") as part of this study revealed no statistically observable relationship between the prices, in 2001, charged by a pharmacy on P medicines, and any (tested for) measure of local concentration. In other words, the number of pharmacies in an area did not, as one might expect, affect discounting (or lack thereof) on P medicines.
48. The analysis performed by Frontier on behalf of the OFT did find a degree of correlation between local concentration and quality of service (Decision, para 35):
- pharmacies are more likely to be open before 9 am if they face a higher number of community pharmacies (CPs) per GP in their locality, or if they are a closest pharmacy to a GP;
- pharmacies are more likely to offer a consultation area if there are more supermarket pharmacies in their locality; and
- when a pharmacy faces no other pharmacy within 5 km, it was less likely to offer home delivery.
49. In relation to this analysis, in Boots/UniChem the merging parties pointed out that these relationships are open to a number of interpretations, and did not necessarily indicate the existence of significant competition. This is acknowledged by Frontier itself. Further, the parties noted that, since the Frontier report, two out of three of these aspects of quality of service had now become regulated under the new pharmacy contract (see paragraph 57 below). However, notwithstanding these uncertainties and limitations, the OFT was unable to rule out the possibility that there was some degree of competition in local markets and we proceeded on that cautious basis.
Lloyds/ C&S
50. In Lloyds/ C&S, Celesio and the target argued that competition was limited. Their briefing paper to the OFT […][C] states that, in analysing local overlaps, the "nature" of pharmacy competition should be noted. Celesio argued as follows:
"(a) The bulk of a pharmacy's sales relate to POM Medicines. NHS dispensing contracts are regulated and so there is no price competition between local pharmacies in relation to the supply of POM medicines.
(b) Other P Medicines can be sold only under the supervision of a pharmacist and may be subject to price competition. In relation to these medicines, however, local pharmacies (i.e., within the 1 mile radius) are not the only other alternative suppliers. As these are not prescription medicines, Lloyds finds that pharmacies outside the immediate neighbourhood location could exert price pressure on a local pharmacy. In any event, P medicines account for only a small proportion of a typical local pharmacy's sales.
(c) For GSL medicines (or OTCs) and non-pharmaceutical products, competition also comes from non-pharmacy outlets including supermarkets, newsagents, petrol station forecourts, etc.
(d) The provision of other pharmacy services (such as diagnostic services) is complementary to that provided by GPs. The quality of such services is in many cases subject to control by the local Primary Care Trust (PCT) under the pharmacy contract.
(e) Regulatory safeguards exist in relation to the maintenance of standards by pharmacists."
51. Celesio (Lloyds) thus characterised the UK pharmacy sector as one where limited competition occurs and where such competition that does occur is limited to non-price factors such as the availability and quality of consulting rooms (as stated at para. 1.4 of the Lloyds/ C&S Merger Notice). […][C], Celesio (Lloyds) submitted that the highest degree of concentration by a fascia count was a 4:3 overlap. The briefing paper states that Lloyds does not consider that the acquisition of C&S will lead to any lessening of competition in the supply of retail pharmacy products or services in any of the locations where the parties overlap in part because the merging parties would be constrained by "regulatory incentives to maintain service quality, so as to ensure competition in all affected local markets".
52. Third party inquiries in Lloyds/ C&S corroborated Celesio's position, indicating that competition between retail pharmacies is limited.
Evidence in Boots/UniChem considered above in relation to national competition
53. Finally, the OFT's findings in Boots/UniChem discussed above in relation to national competition were of relevance to its analysis of effects on local competition. As noted above, Boots and UniChem each has a national commercial strategy which determines the nature of its competitive offering, i.e. Boots positions itself and competes as a general health and beauty retailer, whereas UniChem is more of a local pharmacy. To a large extent, at least in relation to price competition on P medicines and service offerings, all pharmacies exert similar levels of competitive constraint, subject to their precise geographic position. However, to the extent that Boots and UniChem have distinct competitive offerings, they are not close competitors. This is true at a national level, but is also relevant when carrying out a full assessment of the degree of competitive constraint imposed by the parties on each other in local markets.
54. For all of these reasons, the OFT's point of departure when it came to analyse local competitive effects in the Boots/UniChem case was that the scope for local competition among pharmacies was relatively limited.
Local evidence in the instant case
55. As part of its detailed effects analysis in this case, the OFT sought further evidence as to the extent of competition in local areas.
Evidence suggesting no material non-price competition
56. Consistent with Celesio's position in Lloyds/C&S, the merging parties and third parties submitted and provided evidence to support the conclusion that non-price competition between retail pharmacies was limited, because national minimum standards reduce the scope for competition (Decision; para 36.
57. In particular, the merging parties submitted that national minimum standards had increased over time. They noted that, since the OFT's MPI report opening hours have become regulated and consultation areas mandatory under the new pharmacy contract. These parameters were notable as being two of only three aspects of pharmacy service in respect of which Frontier, on behalf of the OFT, had found possible evidence of local competition.
Evidence suggesting material non-price competition
58. Notwithstanding the above the OFT requested a substantial body of internal documents from the merging parties likely to be relevant to the scope for non-price competition. In the event, such documentary evidence proved to be key in providing evidentiary support for the OFT's ultimate conclusion that there was some, albeit limited, competitive interaction among pharmacies and thus between the parties pre-merger. The following points emerged from the evidence.
- Both Boots and Alliance Pharmacy monitor and benchmark themselves against rivals on a number of price and non-price variables. Possible parameters of competition, not considered by the OFT's MPI report, but mentioned in Boots' consumer research documents, included:
- product availability;
- store layout;
- "ease of shopping";
- "shopping environment".
- Boots' internal guidance […][C]:
- […][C]
- […][C].
59. On balance, the documentary evidence did not suggest substantial competitive interaction between retail pharmacies, certainly relative to the majority of local (or national) markets that the OFT has occasion to consider in merger review. Indeed, the competitive conditions in the retail pharmacy sector in particular because of the high level of regulation are obviously very different from (i.e. less lively than) those in other markets, including some of those Celesio urges by way of comparison in its N[otice] o[f] A[pplication]. However, this evidence from the internal documents of the merging parties was considered sufficient to eliminate the hypothesis that there was no or so little competition at local level such that, per se, no retail pharmacy merger in the UK could give rise to a substantial lessening of competition.
Evidence on scope for price competition
60. Finally, the parties and other market participants in this case affirmed the previous conclusion on scope for price competition, as being limited to discounting in P medicines only (aside from GSL, where no issue arises).
…
THE OFT'S DUTY TO REFER IN RESPECT OF PARTICULAR LOCAL MARKETS
The OFT's fascia reduction analysis
99. Once a fascia analysis is adopted, the next step is to class areas according to the relevant reduction of fascia: 2:1, 3:2, 4:3, 5:4 areas and so on. Each step in concentration reflects the loss of one independent consumer choice in an area. The basic intuition is that the lower the number of choices to begin with, the more significant the loss of any single choice is likely to be.
100. In the Boots/UniChem case, the OFT considered it appropriate to use an iterative approach beginning with the most concentrated markets: the 2:1 or post-merger monopoly areas, where consumer choice is effectively eliminated. If further competitive effects analysis reveals ongoing concerns for 2:1 areas, the OFT next considers 3:2 areas, and the iterative process continues until no concerns arise at a given fascia reduction. The rationale is relatively simple: if effects analysis for an area of a higher degree of concentration fails to raise concerns (say 2:1), this will tend to obviate the need for further iterative effects analysis at lesser degrees of concentration (3:2 and beyond). In this case, beginning with the most highly concentrated areas is particularly appropriate given the peculiarly limited scope for competitive interaction over and above regulated price and service levels in local pharmacy markets.
101. There was no evidence to suggest any particular level of concentration above 2:1 where a "step change" to observable competitive (price or non-price) variables occurred when comparing one degree of fascia concentration to another. For example, there was no statistical support for a proposition that prices were higher or service levels lower in an area with three pharmacy fascia than in areas with four. This was the conclusion of the OFT study, which tended to be supported by UniChem's internal econometric analysis provided in this case.
102. That the OFT's analysis developed incrementally in this way is evident from paragraphs 43 to 46 of the Decision. However, this development is not recognised by Celesio in paragraph 81 of its application, where it states that the OFT's "reasons for excluding 4:3 areas are set out in a single paragraph of the Decision, paragraph 46". That is not the case. Rather, the OFT's conclusion on 4:3 areas was reached in the light of its overall assessment of the level of competition in the market, informed by evidence referred to throughout the Decision. A better summary of this aspect of the Decision is set out in paragraph 43(g) of the application, where Celesio states that the OFT concluded that a reduction in fascia numbers of 4:3 or higher could not be expected to give rise to a substantial lessening of competition "on the basis of the evidence before the OFT" (Celesio there using the language of paragraph 46 of the Decision).
The OFT's assessment of competitive effects in respect of 2:1 areas
103. The OFT assessment of the potential for a substantial lessening of competition ("SLC") therefore began in respect of 2:1 local areas. While the OFT had regard to all the evidence in making its assessment of 2:1 local areas, its reasoning was fairly straightforward.
104. By way of summary, it is common ground among all affected parties that for many years competition in the local retail pharmacy sector has been modest, in particular since 1996 when the MMC had described such competition as being "muted". Notwithstanding the subsequent ending of RPM on OTC medicines and some relaxation of entry barriers, this background remained relevant as a great deal of evidence in the case supported the conclusion that price competition on P medicines and non-price competition (retail proposition, including service levels) remained limited, in large part as a result of regulatory controls [Decision paragraph 35 to 36].
105. However, although the evidence was not entirely conclusive, the internal documents of the merging parties supported the conclusion that there existed some, albeit limited, competition. A 2:1 merger would, by definition, eliminate all such existing competition. As for the threat of competition from entrants, there was insufficient evidence to conclude that the relaxation of the entry requirements had been effective in reducing barriers to entry. Accordingly, the OFT decided that it is the case that the merger may be expected to result in a substantial lessening of competition in 2:1 areas.
106. It may be noted that this conclusion was consistent with the OFT's view in Lloyds/ C&S that a 2:1 in Mexborough warranted the sending of an Issues Letter. The matter was never resolved in the Decision because the parties removed this overlap from their transaction in lieu of proceeding with the CRM process. Celesio had, however, argued that the 2:1 overlap did not give rise to a substantial lessening of competition.
The OFT's assessment of competitive effects in respect of 3:2 areas
107. In contrast, the OFT's assessment of whether the statutory reference test was satisfied in respect of 3:2 areas was much more finely balanced. As stated in paragraph 44 of the Decision, the OFT "looked in detail" at 3:2 areas, considering all the evidence available to it.
108. Obviously, 3:2 areas are very significantly different from 2:1 areas in that competition, creating consumer choice, is not eliminated within the area, and the merger does not create a local monopolist. If, as the evidence suggested, demand for pharmacies is driven primarily by convenience and customers were willing to travel up to 1 mile for a pharmacist, the remaining competitor in the isochrone represents an effective consumer choice which the merged company must necessarily take into account.
109. The OFT developed concerns in relation to 3:2 areas only because, following our scrutiny of the relevant maps, we could identify a minority of 3:2 areas that closely resembled 2:1 areas (i.e. where the third competitor was within 1 mile, but significantly further away from the two parties than they were to each other).
110. However, such concerns as existed in relation to this minority of 3:2 areas were marginal for two reasons:
- First, because the basis for the concern, namely that these areas were similar in some respects to 2:1 areas, ran contrary to the proposition underpinning the OFT's geographic market definition, namely that consumers would travel up to 1 mile to visit a pharmacy, which was supported by considerable evidence and numerous parties within the industry;
- Second, given the very limited nature of competition in the market, there was a serious question as to whether the presence of both merging parties as two fascia in that market, along with a third fascia, were really making conditions substantially more competitive than with two fascia.
111. In considering whether the merger reference test was met in relation to this problematic minority of 3:2 areas, the OFT took into account all the evidence before it in the case, summarised throughout the Decision. The Decision required careful judgement. On balance, the OFT did not believe that it was likely – that it "is the case" under s 33 of the Act – that the merger may be expected to result in a substantial lessening of competition, even in the 3:2 areas that, on closer examination of the relevant maps, resembled a 2:1 area. In other words, even in respect of these areas, the OFT considered that it was unlikely to result in an SLC. In effect, this was because there was an effective competitive choice for consumers within a 1-mile radius of the merged firm, acting as a disincentive and constraint on it to raise price or reduce service. However, the OFT believed that it "may be the case" that the merger may be expected to result in an SLC within the meaning of s 33 of the Act. The OFT did not feel able to conclude that the prospect of a SLC in these areas was merely fanciful. Rather, it considered the statutory reference test to be satisfied in respect of these problematic areas.
112. Given this position, the OFT then considered whether it was possible to segregate the vast majority of 3:2 areas that were not marginally problematic from the minority that were. The OFT therefore devoted considerable time, including ultimately at the CRM meeting, to the question of whether it could reasonably apply a "secondary filter" to the 3:2 areas to discriminate in a robust manner between those few "may be the case" 3:2 areas from the remainder.
113. After considering whether we could develop a principle sufficiently robust to account for classifying all 3:2 areas into "reference" and "no reference" categories, we determined that it was not possible to do so within the statutory timetable. Moreover, such an approach would tend, again, to question the fundamental premise of geographic market definition, which had substantial evidentiary support in this case (and had been used, for example, by the MMC).
114. The OFT was therefore obliged to conclude, reluctantly, as a result of the limited number of 3:2 areas that were marginally problematic, its duty to refer applied "across the board" to every 3:2 area. I say reluctantly because we were aware that, depending on the undertakings in lieu proposals, that this might compel a reference in respect of areas where none was necessary, or result in divestments where none was really necessary. Nevertheless, this issue is consistent with our first-phase role in UK merger control, despite the extensive investigation and experience applied to this particular case.
The OFT's assessment in respect of areas of lesser concentration (4:3 and beyond)
115. In was against this background of a detailed analysis in respect of 3:2 local areas that the OFT came to assess 4:3 local areas. The Decision at paragraph 46 opens with the decisive point as to the OFT's positive belief:
"Any higher reduction in fascia number than [3:2] (e.g. four to three or higher) could also give rise to a lessening of competition but on the basis of the evidence before the OFT, it believes that this cannot be expected to be substantial."
116. This statement identifies the critical question for the OFT, namely whether any lessening of competition is substantial. As mentioned, our test is whether a merger "is expected to weaken rivalry to such an extent that customers would be harmed." We could not expect such harm in a 4:3 area.
117. The OFT's conclusion in respect of 4:3 areas was, as in the case of other areas, reached after a detailed consideration of all the evidence in the case. In short, the OFT was already concerned that a finding of SLC, even on the lower "may be the case" standard, was marginal in respect of those limited number of 3:2 areas that arguably resembled 2:1 areas, but felt obliged to extend this lower level of belief across the entirety of the 61 3:2 overlaps. Once an additional effective competitor and choice for consumers within 1 mile of the merged firm was "added" to the competitive assessment, the merged firm would be disciplined by two effective competitors within 1-mile of its operations. Any prediction that harm would occur in the circumstances of local competition among pharmacies, became, in our judgment, plainly speculative and fanciful because it was unsupportable on the evidence. Hence the OFT's reference to its positive belief "on the basis of the evidence before the OFT" (Decision; paragraph 46). Having established a lack of concern in respect of 4:3 areas, there was no need to proceed further with the iterative approach.
118. At the drafting stage, two supplemental observations were added to the key conclusion set out in the first sentence of paragraph 46 of the Decision.
119. One relates to the MMC report, and was intended to add some historical context to the OFT's conclusions. This was merely that the MMC considered only 2:1 areas and concluded (as mentioned at paragraph 34 of the Decision), that the detriment to competition in a 2:1 area was sufficiently small that it was outweighed by the customer benefits. Given this analysis, and the fact that 4:3 areas are two fascia steps removed from 2:1 reductions, one might reasonably expect there to be evidence of a relatively large-scale increase in the degree of local pharmacy competition in the UK in order to justify a conclusion that a 4:3 area might raise concerns.
120. As to the sentence recounting the observation of a competitor that it would be usual to face two other competitors within a local area, this is correct, but in fact did not form part of the OFT's reasoning on any aspect of the case, including as to our evaluation of 4:3 areas prior to the CRM, at the CRM, or at the Decision Meeting. Since it did not form part of the Decision, I recognise that this sentence should not have been included in the Decision."
IX THE PARTIES' SUBMISSIONS ON THE SUBSTANCE
AMENDED GROUND 1
Celesio's submissions
"the OFT considered it appropriate to use an iterative approach beginning with the most concentrated markets: the 2:1 or post-merger monopoly areas, where consumer choice is effectively eliminated. If further competitive effects analysis reveals ongoing concerns for 2:1 areas, the OFT next considers 3:2 areas, and the iterative process continues until no concerns arise at a given fascia reduction."
The OFT's submissions
(a) The report of the view of a major competitor is set out but did not form any part of the OFT's reasons. The OFT accepts that this sentence therefore should not have been in the Decision: Pritchard, paragraph 120.
(b) The 1996 MMC Report was relied on to the extent that the MMC had found that even in localities with a 2 to 1 reduction, it expected any detriment to competition to be small. The OFT noted, however, that this was before the removal of RPM on OTC medicines, but found no evidence that this change alone meant that a 4 to 3 reduction may give rise to competition concerns.
The interveners' submissions
(a) regulation governs a very large number of facets of competition;
(b) there is no suggestion that P medicines are substantially, or at all, problematic;
(c) there is no material problem at the local level: local retail competition is sufficiently strong that even 2 to 1 reductions are unproblematic in respect of both price and non-price competition.
AMENDED GROUND 2
Celesio's submissions
"…the OFT notes that the extent to which national chains face each other in local areas may well be a factor in determining the extent to which they can influence each other's decision making at the national level, e.g. on pricing policies."
The OFT's submissions
The interveners' submissions
AMENDED GROUND 3
X THE TRIBUNAL'S ANALYSIS
The test for the admissibility of Pritchard
"64. The application of this approach is a matter of fact and degree in each case. The general principle in [R v Westminster City Council, ex p Ermakov [1996] 2 All ER 302] was expressed by Hutchison LJ in these terms at 315h:
'The court can and, in appropriate cases, should admit evidence to elucidate or, exceptionally, correct or add to the reasons; but should, consistently with Steyn LJ's observations in Ex p Graham, be very cautious about doing so.'
…
67. Accordingly, we would anticipate that in most cases such as this supplementary witness evidence from the CC should be kept to a minimum. As with judicial review generally, any witness statements that are necessary should be closely cross-referred to the report under consideration, with any appropriate explanation of the relevance of the additional evidence, bearing in mind that it is the report, not the witness statement, that is the subject of the review. While it may well be helpful for a witness statement to elucidate technical matters contained in the report or respond to evidence submitted by the applicant, witness statements are not submissions and should not need to repeat or place any particular "gloss" on the report in question. …"
"ADEQUACY OF REASONS
[102] Finally, although inadequacy of reasons is not a ground of challenge as such, it may be helpful to comment briefly on the tribunal's observations on this aspect.
[103] The tribunal expressed concern at having to consider material outside the decision letter. It noted that the OFT was under a statutory duty to give its reasons, and referred to what it called the 'well-known principle' that 'the court should, at the very least, be circumspect about allowing material gaps to be filled by affidavit evidence or otherwise' (see para 257, citing R v Westminster City Council, ex p Ermakov [1996] 2 All ER 302 at 312 per Hutchison LJ). It commented (at para 258):
'If a material element is not set out in the decision, it is very difficult for the reviewing court or tribunal to be satisfied that the matter was properly investigated or that the supplementary reasons did in fact form part of the decision-making process.'
In other parts of the judgment, the tribunal criticised the failure of the OFT to set out all the underlying material (see paras 211, 252).
[104] With respect, I think this concern, and the associated criticisms, were misplaced. The statutory duty to give reasons is an important one, but it is not the same as a duty to give a 'judgment' (such as that of a court) or a duty to make a 'report' (such as that of an inquiry inspector). Again reference to the textbooks might have assisted. The numerous cases on the subject lay down no general test, other than the requirement that reasons must be 'intelligible and must adequately meet the substance of the arguments advanced' (see Re Poyser and Mills' Arbitration [1963] 1 All ER 612 at 616, [1964] 2 QB 467 at 477-478, cited in De Smith, Woolf and Jowell p 465 (para 9-049, n 8) as 'the most frequently cited judicial articulation of the test'; see also Wade and Forsyth pp 916–919).
[105] In a case such as the present, where the subject matter is complex and the supporting material voluminous, there is no statutory requirement for all the evidence to be set out in the decision letter. However when a challenge is made, there is, as the tribunal noted, an obligation on a respondent public authority to put before the court the material necessary to deal with the relevant issues; 'all the cards' should be 'face upwards on the table' (see R v Lancashire CC, ex p Huddleston [1986] 2 All ER 941 at 945).
[106] There is certainly nothing unusual, particularly in a case which has to be dealt with in a relatively short timescale, for the stated reasons to be amplified by evidence before the court. While in some areas of the law, the court may need to be 'circumspect' to ensure that this is not used as means of concealing or altering the true grounds of the decision, that does not arise in this case. As I understand it, no objection had been taken to any of the evidence being put before the tribunal (or to the additional evidence adduced in the Court of Appeal). The question for the tribunal was not whether the reasoning was adequately expressed in the decision, but whether the material ultimately before it, taken as a whole, disclosed grounds on which the [OFT] could reasonably have reached the decision it did."
"In our respectful view the remarks of Carnwath LJ in IBA Health, cited above, arise in the different context of the "short-form" clearance decisions given by the OFT under sections 22 and 33 of the Act, where the duty to give reasons arises not under section 38 but under the more general provisions of section 107 (in particular section 107(1), (4) and (5)). In our view the details and reasoning of the OFT's decision on preliminary investigations under sections 22 or 33 cannot be expected to be set out to the same extent as those of the CC's report following a formal in-depth inquiry."
Application of the admissibility test to Pritchard
"First, it identifies the measure(s) of concentration most appropriate in the circumstances of the case. Second, it carries out a full assessment of competitive effects within a framework set by the concentration measure adopted. In this case, the OFT concluded that a fascia test was the most appropriate measure of concentration on the facts, and its assessment of competitive effects was carried out within a framework set by the fascia test, i.e. the OFT first analysed competitive effects in local areas with a 2:1 fascia reduction, and then moved on to consider 3:2 and 4:3 areas."
and in paragraph 62 that:
"the OFT uses concentration tests to provide an initial indicator of potential concerns before carrying out further and a more detailed investigation for the likely competition effects of a merger. In this case, the OFT adopted the fascia test as its initial concentration test. As well as providing an initial and rough guide to the level of likely concern in different local markets, the fascia test here also provided the OFT with a framework or structure in which it carried out its more detailed analysis, as the OFT analysed the different markets in "fascia-reduction groups", beginning with 2:1 local areas, and progressing to 3:2 and 4:3 areas."
"…. the OFT carried out a full assessment of competition in local areas, and did not limit itself to fascia considerations. Rather, the OFT expressed the conclusions of its full competitive assessment in terms of different fascia reduction areas, and used the fascia test to provide a structure for its analysis, progressing from 2:1, to 3:2 and finally to 4:3 areas, as is evident from paragraphs 43 to 46 of the Decision."
and in paragraph 99:
"Once a fascia test is adopted, the next step is to class areas according to the relevant reduction of fascia: 2:1, 3:2, 4:3, 5:4 area and so on. Each step in concentration reflects the loss of one independent consumer choice in an area. The basic intuition is that the lower the number of choices to begin with, the more significant the loss of any single choice is likely to be."
and in paragraph 100:
"…, the OFT considered it appropriate to use an iterative approach beginning with the most concentrated markets: the 2:1 or post–merger monopoly areas, where consumer choice is effectively eliminated. If further competitive effects analysis reveals ongoing concerns for 2:1 areas, the OFT next considers 3:2 areas, and the iterative process continues until no concerns arise at a given fascia reduction. The rationale is relatively simple: if effects analysis for an area of a higher degree of concentration fails to raise concerns (say 2:1), this will tend to obviate the need for further iterative effects analysis at lesser degrees of concentration (3:2 and beyond). In this case, beginning with the most highly concentrated areas is particularly appropriate given the peculiarly limited scope for competition interaction over and above regulated price and service levels in local pharmacy markets."
and in paragraph 102:
"That the OFT's analysis developed incrementally in this way is evident from paragraphs 43 to 46 of the Decision… [T]he OFT's conclusion on 4:3 areas was reached in the light of the overall assessment of the level of competition in the market, informed by evidence referred to throughout the Decision."
and in paragraph 103:
"The OFT assessment of the potential for a substantial lessening of competition ("SLC") therefore began in respect of 2:1 local areas. While the OFT had regard to all the evidence in making its assessment of 2:1 local areas, its reasoning was fairly straightforward."
and in paragraph 105:
"However, although the evidence was not entirely conclusive, the internal documents of the merging parties supported the conclusion that there existed some, albeit limited, competition. A 2:1 merger would, by definition, eliminate all such existing competition. As for the threat of competition from entrants, there was insufficient evidence to conclude that the relaxation of the entry requirements had been effective in reducing barriers to entry. Accordingly, the OFT decided that it is the case that the merger may be expected to result in a substantial lessening of competition in 2:1 areas."
"111. In considering whether the merger reference test was met in relation to this problematic minority of 3:2 areas, the OFT took into account all the evidence before it in the case, summarised throughout the Decision. The Decision required careful judgement. On balance, the OFT did not believe that it was likely – that it "is the case" under s 33 of the Act – that the merger may be expected to result in a substantial lessening of competition, even in the 3:2 areas that, on closer examination of the relevant maps, resembled a 2:1 area. In other words, even in respect of these areas, the OFT considered that it was unlikely to result in an SLC. In effect, this was because there was an effective competitive choice for consumers within a 1-mile radius of the merged firm, acting as a disincentive and constraint on it to raise price or reduce service. However, the OFT believed that it "may be the case" that the merger may be expected to result in an SLC within the meaning of s 33 of the Act. The OFT did not feel able to conclude that the prospect of a SLC in these areas was merely fanciful. Rather, it considered the statutory reference test to be satisfied in respect of these problematic areas.
112. Given this position, the OFT then considered whether it was possible to segregate the vast majority of 3:2 areas that were not marginally problematic from the minority that were. The OFT therefore devoted considerable time, including ultimately at the [case review] meeting, to the question of whether it could reasonably apply a "secondary filter" to the 3:2 areas to discriminate in a robust manner between those few "may be the case" 3:2 areas from the remainder.
113. After considering whether we could develop a principle sufficiently robust to account for classifying all 3:2 areas into "reference" and "no reference" categories, we determined that it was not possible to do so within the statutory timetable. Moreover, such an approach would tend, again, to question the fundamental premise of geographic market definition, which had substantial evidentiary support in this case (and had been used, for example, by the MMC).
114. The OFT was therefore obliged to conclude, reluctantly, as a result of the limited number of 3:2 areas that were marginally problematic, its duty to refer applied "across the board" to every 3:2 area. I say reluctantly because we were aware that, depending on the undertakings in lieu proposals, that this might compel a reference in respect of areas where none was necessary, or result in divestments where none was really necessary. Nevertheless, this issue is consistent with our first-phase role in UK merger control, despite the extensive investigation and experience applied to this particular case."
"Even in these areas, switching of customers between Boots and Unichem stores may be high, and for a large proportion of customers, Boots and UniChem stores would be the closest competitors. This may arise particularly in those localities where the merging parties pharmacies are located close together. In such a situation the competitive scenario post merger does not significantly differ from that in the two to one area." (paragraph 44)
"This has to be considered alongside the high barriers to entry in this sector combined with what the parties' internal documents say on the issue of competition – see, for instance, the references at paragraph 37 above to the monitoring of various competitor price and service quality variables. On balance, the OFT believes that a substantial lessening of competition may go beyond those areas outlined at paragraph 43 and may also arise where fascia are reduced from three to two within a one mile radius." (paragraph 45)
"Any higher reduction in fascia number than this (e.g. four to three or higher) could also give rise to a lessening of competition but on the basis of the evidence before the OFT, it believes that this cannot be expected to be substantial. One major competitor suggested that it would be usual to face two other competitors within a local area. Moreover, the CC's 1995 report considered only two to one fascia reductions. While there have been small changes to the market since then (primarily the removal of resale price maintenance on OTC medicines) which might suggest some small increase in the scope for potential competition, these changes do not support an argument that reductions from four to three fascias might give rise to competition concerns."
"The OFT's conclusion in respect of 4:3 areas was, as in the case of other areas, reached after a detailed consideration of all the evidence in the case. In short, the OFT was already concerned that a finding of SLC, even on the lower "may be the case" standard, was marginal in respect of those limited number of 3:2 areas that arguably resembled 2:1 areas, but felt obliged to extend this lower level of belief across the entirety of the 61 3:2 overlaps. Once an additional effective competitor and choice for consumers within 1 mile of the merged firm was "added" to the competitive assessment, the merged firm would be disciplined by two effective competitors within 1-mile of its operations. Any prediction that harm would occur in the circumstances of local competition among pharmacies, became, in our judgment, plainly speculative and fanciful because it was unsupportable on the evidence. Hence the OFT's reference to its positive belief "on the basis of the evidence before the OFT" (Decision; paragraph 46). Having established a lack of concern in respect of 4:3 areas, there was no need to proceed further with the iterative approach."
(a) its content is not inconsistent with the Decision; and
(b) it contains elucidation of the Decision.
The Decision in respect of 4 to 3 areas
(i) SLC in the context of weak competition in the relevant markets; and
(ii) Share of outlets evidence.
- SLC in the context of weak competition in the relevant markets
- Share of outlets evidence
4 to 3 areas
(a) In terms of national competition no concerns arise.
(b) On a local level on the basis of a one-mile radius around both Boots and UniChem pharmacies there are 38 areas where the merger would result in a 2 to 1 reduction in the number of competing pharmacies and a further 61 areas where it would result in a reduction in the number of fascias from 3 to 2.
(c) The evidence clearly shows that a reduction in pharmacy fascias from 2 to 1 in a local area, despite the restrictive terms of the NHS contract, is expected to result in a substantial lessening of competition. Such SLC could take the form of reductions in quality or the level of service provided (over and above the levels stipulated in the contract). There may also be an impact on pricing, particularly of P medicines.
(d) The evidence on whether a SLC would arise in the case of 3 to 2 areas is less conclusive but, on balance, it may be the case that the merger may be expected to result in a SLC within these 3 to 2 overlap areas.
(e) Any higher reduction in fascia number than 3 to 2 (i.e. 4 to 3 or higher) could also give rise to a lessening of competition but the OFT believes that this cannot be expected to be substantial.
(a) The reasons given in the Decision are not capable of sustaining the OFT's conclusion that a reduction from 4 to 3 fascias in local retail markets would not give rise to a SLC;
(b) This error of assessment in relation to local retail markets necessarily vitiates the OFT's conclusion relating to the national retail market;
(c) It further follows that the OFT is not entitled to accept undertakings in lieu of a reference pursuant to section 73(2) of the Act.
(a) The 1996 MMC Report, which found that a reduction in pharmacy fascias from 2 to 1 in a one mile radius would not be against the public interest.
(b) The fact that since that report RPM on OTC medicines has been removed.
(c) UniChem is a relatively small player in the OTC sector.
(d) Entry rules into the pharmacy sector have been relaxed (although the evidence as to the impact of this is inconclusive).
(e) The merging parties' internal documents showed that:
i. a level of competitive inter-action between retail pharmacies does exist; and
ii. new entry will usually prompt some competitive response.
(a) The pharmacy sector is unique in terms of being highly regulated.
(b) A level of competition does exist in this area.
(c) Switching between Boots and UniChem may be high for a large proportion of customers, particularly in those localities where the merging parties' pharmacies are close together.
(d) There are high barriers to entry in this sector.
(e) That there is some competitive interaction between different retail pharmacies. The OFT referred to the parties monitoring a number of different price and service quality variables and comparing themselves to competitors; to Boots' consumer research documents which mention product availability, store layout, ease of shopping and shopping environment as possible aspects of competition and, at a local level, waiting times for obtaining a prescription and the provision of deliveries as key measures of competition too (see Decision, paragraph 37 as elucidated by Pritchard, paragraphs 49 and 58).
(a) That the vast majority of the parties' pricing policies are set nationally (paragraph 14); and that following the lifting of RPM, price competition was still limited (paragraphs 31 and 35);
(b) That in the P medicines sector, UniChem was not a particularly aggressive competitor to Boots (paragraph 29); that the parties consider that supermarkets are their most significant individual competitors in P medicines and GSL medicines (paragraph 29); and that, by numbers of stores, the supermarkets are gaining significant shares of supply (paragraph 32);
(c) P medicines account for less than 5 per cent of UniChem's revenues (paragraph 29).
(a) the competitive scenario post-merger does not significantly differ from that in the 2 to 1 areas; and
(b) on balance, a SLC may arise where fascias are reduced from 3 to 2 within a one-mile radius.
(a) could also give rise to a lessening of competition; but
(b) on the basis of the evidence before the OFT it did not believe that such a reduction could be expected to be substantial.
Amended grounds 2 and 3
XI OTHER MATTERS
Third party material
Submissions by Celesio to the OFT during the investigation stage
Celesio's disclosure of the Lloyds/Cohens & Scholes merger
Evidence on pharmaceutical services regulation
XII CONCLUSION
Marion Simmons Andrew Bain Vivien Rose
Registrar 9 May 2006
Note 1 Information requests were issued on 7 December 2005, 21 December 2005, 6 January 2006, 10 January 2006, 11 January 2006 and 17 January 2006. [Back] Note 2 Annex 6 to the merging parties’ main submissions to the OFT on 30 November 2005. [Back] Note 3 Attachment G to the merging parties’ main submissions to the OFT on 30 November 2005. [Back] Note 4 Annex 1 to the merging parties’ main submissions to the OFT on 30 November 2005. [Back] Note 5 Annex 4 to the merging parties’ main submissions to the OFT on 30 November 2005. [Back] Note 6 Annex 5 to the merging parties’ main submissions to the OFT on 30 November 2005. [Back] Note 7 During the course of these proceedings the OFT clarified that the word “not” was inadvertently omitted from the Decision. [Back]
