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United Kingdom Competition Appeals Tribunal |
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You are here: BAILII >> Databases >> United Kingdom Competition Appeals Tribunal >> Unichem Ltd v Fair Trading Office & Anor [2005] CAT 8 (1 April 2005) URL: http://www.bailii.org/uk/cases/CAT/2005/8.html Cite as: [2005] CAT 8 |
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Neutral citation [2005] CAT 8
Case No: 1049/4/1/05
IN THE COMPETITION
APPEAL TRIBUNAL
Victoria House
Bloomsbury Place
London WC1A 2EB
1 April 2005
Before:
Sir Christopher Bellamy (President)
Professor Paul Stoneman
Mr Graham Mather
Sitting as a Tribunal in England and Wales
BETWEEN:
UNICHEM LIMITED
-v-
THE OFFICE OF FAIR TRADING
supported by
PHOENIX HEALTHCARE DISTRIBUTION LIMITED
Mr Nicholas Green QC and Ms Maya Lester (instructed by Allen & Overy LLP) appeared for the Applicant
Mr Peter Roth QC and Mr Daniel Beard (instructed by the Treasury Solicitor) appeared for the Respondent
Ms Kelyn Bacon (instructed by CMS Cameron McKenna) appeared for the Intervener
Heard at Victoria House on 14 and 18 February 2005
JUDGMENT
TABLE OF CONTENTS
| I | INTRODUCTION |
| II | BACKGROUND |
| III | THE COURSE OF EVENTS BEFORE THE OFT |
| IV | THE CONTESTED DECISION |
| V | THE PROCEEDINGS BEFORE THE TRIBUNAL |
| VI | THE EVIDENCE |
| A.THE OFT'S EVIDENCE | |
| B. PHOENIX/EAP's EVIDENCE | |
| C. UNICHEM'S EVIDENCE | |
| VII | THE PARTIES' SUBMISSIONS |
| A.ORIGINAL GROUND (4) | |
| B.UNICHEM'S SUBMISSIONS | |
| C.THE OFT'S SUBMISSIONS | |
| D.PHOENIX'S SUBMISSIONS | |
| VIII | SECTION 120(4) AND THE IBA CASE |
| IX | THE TRIBUNAL'S ANALYSIS |
| 1.OVERVIEW | |
| 2.THE MARKET CONTEXT | |
| 3. ANALYSIS OF UNICHEM'S SUBMISSIONS |
I INTRODUCTION
"The OFT shall, subject to subsections (2) and (3), make a reference to the Commission 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) Any person aggrieved by a decision of the OFT, the Secretary of State or the Commission 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…"
It is common ground that UniChem is a "person aggrieved" for the purposes of section 120(1).
II BACKGROUND
The parties
The sector concerned
The MMC report of 1996
"Their wholesaling businesses benefit from the fact that they have a captive market, in the form of the pharmacies in common ownership with them, which enables them to spread the fixed costs of their wholesale depots over a larger volume of sales and to achieve more economic van runs. The ownership of pharmacies also brings other benefits to a wholesaler, such as an increase in the stability and predictability of sales (which reduces risk) and in buying power." (paragraph 2.40).
"2.43. There remains the question of the geographical scope of the market. AAH and UniChem provide a full-line service throughout the UK (with the single exception that UniChem does not operate in Northern Ireland). They derive some benefit from doing so, eg in winning the business of retail chains which have branches in many parts of the country and wish to deal with a single wholesaler. Most other full-line wholesalers operate in only one part of the country to another. The main factor influencing the geographical scope of the market is that the frequent (usually twice-daily) delivery service to pharmacies which is characteristic of full-line wholesalers cannot be economically provided more than a certain distance from the depot. This remains true even though some wholesalers extend the reach of their depots by using trunking techniques, whereby lorry loads are dispatched to transshipment points for onward delivery by van."
… (see also paragraphs 4.45 and 4.50)
"2.270. As regards regional full-line wholesalers, we have taken the view that they are not an endangered species whether as a result of vertical integration or for other reasons. We accept, however, that at least some of these wholesalers are vulnerable given their low net margins and that relatively small changes in the market could have a disproportionate effect on them. We would therefore urge the DGFT to keep the position under review. The DGFT will no doubt give due weight to the importance of regional wholesalers to competition in considering whether to refer to the MMC any future merger or proposed merger of either of the two national wholesalers with any other full-line wholesaler."
Confidential guidance given to UniChem in 2000
"2.4 UniChem's interest in the proposed acquisition stems firstly from its desire to enter the wholesale market in East Anglia, where it currently has very low sales penetration, and where both AAH and Philip Harris, a subsidiary of Phoenix, have a substantial presence. UniChem has no warehouse in East Anglia and intends to maintain EAP's distribution depot, as a base from which to combine the complementary efficiencies of the two businesses. Secondly, UniChem wishes to enter the dispensing doctor market, which accounts for 51 per cent of EAP's sales.
2.5 The dispensing doctor market is serviced in the majority of the UK by only two wholesalers – AAH and Philip Harris/ Phoenix. These are the only national full line wholesalers with a credible volume of sales in the market. The proposed acquisition would give UniChem credibility in the dispensing doctor market, which would increase competition on a nationwide basis."
"Further to your request for confidential guidance concerning the above proposal, I am writing to inform you that, based on the information currently available, it seems likely that the Secretary of State would want to refer the proposed transaction to the Competition Commission (CC) for investigation."
The proposed AAH/EAP merger in 2003
"4.4 …Despite having devoted substantial efforts in recent years to growing its share of the dispensing doctors market, UniChem has found it remarkably difficult to make in-roads across the United Kingdom, including in East Anglia, where EAP and AAH have entrenched positions, based on a long history of operating in that region. UniChem has set up a new business unit specifically to target dispensing doctors; it plainly has the expertise and resources to be a credible competitor across the United Kingdom as well as in East Anglia, yet it failed to penetrate the market. As a result its market share in East Anglia is still only 2.8%."
"… UniChem does make a small number of deliveries to customers located more than 90 minutes from its warehouses. However, customers employing distant suppliers are required to place their orders much earlier than are those using a closer supplier. Since the cut-off time for orders is a key determinant of the quality of service that a wholesaler provides to its customers, the inevitably earlier cut-off times for more distant suppliers places them at a significant disadvantage compared to more local competitors. In addition, the higher costs associated with transporting supplies for a longer period mean that more distant suppliers will earn a lower margin on their deliveries than a more local supplier, even if the customer is prepared to pay the same price.
On top of this the more distant supplier may even be required to undercut the more local supplier to compensate the customer for the lower levels of service quality that they are able to provide…"
(2003 briefing paper, Appendix 1)
The AAH Decision
"34. In the supply of Ethicals to dispensing doctors and retail pharmacies, it might be the case that in limited circumstances, Short-liners will be able to provide some constraint on the parties. The evidence suggests, however, that the most likely source of competition to the parties is expected to come from other Full-liners. These may, however, be limited in their ability to provide effective competition given the location of their depots and the ability to serve customers located some distance from those depots. Third party comments tended to suggest this was a limiting factor in certain parts of East Anglia. Further detailed investigation is required to determine how effective such competition is likely to be in constraining the behaviour of the merged business.
35. In the supply of Ethicals to hospitals, direct supply by manufacturers may operate as a constraint on the parties in respect of a limited product range. The evidence, however, indicates that the most likely source of constraint may be expected to come from other Full-liners. It appears that the merger may create a duopoly among Full-liners in some parts of the Relevant Area and lead to a reduction in potential suppliers from four to three in other parts. Hospitals expressed particular concerns about this reduction in choice and potential adverse impact upon service levels.
36. In these circumstances, the OFT believes that it is or may be the case that the creation of the relevant merger situation may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom for goods or services, namely the supply of Pharmaceuticals to retail pharmacies, dispensing doctors and hospitals in the East Anglia region, extending to parts of the East Midlands and the South East of England. The likely adverse effects might be expected to be: a reduction in the level of discounts paid to customers; and/or other less favourable terms of supply; and/or a general reduction in service levels."
III THE COURSE OF EVENTS BEFORE THE OFT
Phoenix's confidential guidance application of 28 April 2004
"The vans which deliver to Lloyds Pharmacies and to Moss Pharmacies are the very same vans which also visit independent pharmacies and dispensing doctors and which seek to increase their business with all outlets – in other words, any other wholesaler delivering anywhere in East Anglia and seeking business in independent outlets faces competition from the two vertically integrated market leaders".
(Confidential Guidance application, paragraph 14)
"5. Why do the parties think the shares of supply for AAH and UniChem to dispensing doctors in East Anglia are so low in comparison to other areas of the country and in comparison to other customer types?
Dispensing doctors by definition are in rural areas, and are more likely to support their local wholesale depot and prefer a more personal service. EAP satisfies these requirements, and if it is successful with the acquisition of EAP, Phoenix intends to maintain the personal level of service, as it has done with previous acquisitions.
AAH has previously closed a local depot in Ipswich and lost local dispensing doctor business as a result.
UniChem is widely regarded as a pharmacy orientated wholesaler, largely due to its roots as a pharmacy co-operative.
The actual sub-market for dispensing doctors is only 5.42% of the market.
Both AAH and UniChem have achieved market domination in all other customer types through national distribution, vertical integration, hospital contracts and traditional origins.
Because of the reasons stated above, it is logical that AAH and UniChem should have concentrated on the much larger market segments of the other customer types.
6. What impediments would AAH or UniChem face in increasing their share of supply to dispensing doctors in East Anglia?
There are no impediments that either AAH or UniChem face in increasing their share of supply to dispensing doctors in East Anglia. AAH and UniChem are both very active in trying to win business in East Anglia, as indeed they are all over the country. The parties would refer back to Table 6 of Annex A of the Submission relating to AAH and UniChem growth in dispensing doctors within East Anglia. Annex C of the Submission provides evidence of switching by dispensing doctors including from both Phoenix and EAP to AAH."
The First Issues Letter of 29 June 2004
"Our assessment so far indicates that the proposed merger may raise competition concerns which warrant discussion at a Case Review Meeting (CRM). At this stage, it is anticipated that the CRM will take place on Wednesday 7 July. Therefore, you should consider our meeting as your client's last opportunity to make representations to the case team prior to the CRM.
The Issues Paper is based on the case team's analysis so far. The analysis is based upon facts and opinions provided by your client over the past few weeks. It is important to note that the case team has not reached a firm conclusion on any of the issues contained in the Issues Paper…"
"The following are hypotheses at this stage, which we are still evaluating in the light of the evidence put to us by the parties. They do not necessarily represent the OFT's final view on these issues:
1. Data provided by the parties suggests that the merger will reduce from four to three the number of Full-liners in the East Anglia Region. This change in market structure will not only result in loss of competition between the parties, but will also contribute to reduced incentives for the remaining players to compete as strongly as before. There is therefore the risk that the merger will lead to a lessening of competition in which all firms find it profitable individually to offer less favourable terms or lower their level of service.
2. The data also shows that the parties are the strongest competitive constraint on each other because they are each other's closest competitor both in terms of geographic location and their respective customer bases.
In terms of depot location, the closest depot to EAP's Norwich depot is the Phoenix depot in Cambridge. Therefore in terms of the level of service offered (particularly cut-off times for twice daily deliveries) the offering provided by EAP is likely to be the next best alternative for a Phoenix customer and vice versa.
In terms of customer base, both parties tend to mainly supply Independent Pharmacies and Dispensing Doctors and so compete for the same customers. In the East Anglia Region, the parties will have a combined share of supply of 21% to Independent Pharmacies and 83% to Dispensing Doctors. AAH and UniChem by contrast compete more actively in the supply to multiple pharmacies and supermarkets. Therefore for Independent Pharmacies and Dispensing Doctors, the parties represent each other's next best alternative.
AAH and UniChem are at a disadvantage geographically and have a different customer focus. They therefore do not provide as strong a competitive constraint on the parties as do the parties on each other.
3. Of the depots currently supplying the East Anglia Region, the parties' depots are located further east than AAH's depot (Romford) and UniChem's depot (Letchworth). It is therefore difficult for AAH and UniChem to offer competitive service levels to Independent Pharmacies and Dispensing Doctors located in the far east of the East Anglia Region. For these customers, the transaction will therefore reduce their choice to one effective Full-liner.
Given the above concerns, barriers to entry may not be low enough to allay the prospect of a substantial lessening of competition, namely lowering or removal of discounts, lower service levels, or offering less favourable terms, in the supply of Ethicals to Customers in the East Anglia Region.
4. Post merger, the remaining three Full-liners in the East Anglia Region may be able to tacitly or explicitly coordinate their behaviour. This might occur either through geographic market sharing or through coordination on the level of discounts or service. Prices of Ethicals are set and fixed by the drug manufacturers and the NHS through the 1999 Pharmaceutical Price Regulation Scheme (PPRS), therefore, Full-liners do not compete on the price of individual products. Nevertheless, they do compete on price via the level of discounts offered to customers. Further, the service offered by Full-liners is to all intents and purposes homogenous. Full-liners would therefore be able to align their behaviour in the market. In addition, because customers generally do not often switch between Full-liners, there would be no short term incentive for any one firm to cheat and because of high barriers to entry coordination is likely to be sustainable.
5. The parties are invited to consider whether they might be able to offer appropriate undertakings to remedy the potential competition concerns outlined above in lieu of a reference to the Competition Commission."
(a) the independent pharmacy or independent pharmacy chain is a model "on the wane" because of increased vertical integration by AAH and UniChem and pressure from supermarkets. Phoenix and EAP were excluded from supplying to national accounts and to the national chains of AAH and UniChem, which accounted for about half the national market;
(b) taking full-line and short-line supply together, AAH would still have a 50% share of the wholesaling market in East Anglia (excluding hospitals), UniChem would have a 19% share and EAP/Phoenix would have a 20% share;
(c) Within the independent sector the maps of East Anglia provided by Phoenix on 2 June 2004 demonstrated that:
(i) there are a large number of customers in East Anglia who are not supplied by either EAP or Phoenix;
(ii) AAH and UniChem have customers throughout the East Anglian region;
(iii) existing EAP or Phoenix customers have the real choice of switching to AAH, UniChem or another wholesaler;
(iv) AAH and UniChem are able to service the remotest parts of the East Anglian region from depots in Romford and Letchworth respectively;
(v) there are many pharmacists or dispensing doctors in the immediate vicinity of Norwich and Cambridge (where, respectively, the EAP and Phoenix depots are based) who choose to use alternative sources of supply; and
(vi) in East Anglia AAH has a share of 53% of the supply to independent pharmacies by full-liners and UniChem 23%. AAH has a share of 14% to dispensing doctors by full-liners and UniChem 1%.
The OFT's confidential guidance assessment of 14 July 2004
"34. On a national level, the merger is not expected to lessen competition. Indeed, the merger may create efficiencies that enhance competition in the supply of Ethicals to hospitals by enabling Phoenix to become a rival supplier to AAH and UniChem.
35. In the East Anglia Region, the merged entity will be the second largest Full-line wholesaler of Ethicals to pharmacies and dispensing doctors. However, this does not reflect the fact that many of these pharmacies are tied to their vertically-integrated supplier so that there is no competition for their business. In the supply of Ethicals to independent customers, the parties will be the largest Full-liner. In either case, the merger will reduce the number of Full-liners from four to three.
36. It might be the case that, in limited circumstances, Short-liners will be able to provide some constraint on the parties. However, the mostly likely source of competition to the parties is expected to come from other Full-liners. The OFT's recent investigation in the AAH/EAP merger indicated that Full-liners in the East Anglia Region may be limited in their ability to provide effective competition given the location of their depots and the ability to serve customers located some distance from those depots. On the basis of the available evidence, it is unclear at this stage whether other Full-liners in the region, namely AAH and UniChem, could be expected to meet the delivery and service standards required by the parties' customers should these customers wish to switch to alternative suppliers post merger.
37. In these circumstances, the OFT believes that it is or may be the case that the creation of the relevant merger situation may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom for goods or services, namely the supply of Ethicals to dispensing doctors and pharmacies in East Anglia extending to parts of the East Midlands and the south east of England. The adverse effects might be expected to be: a reduction in the level of discounts paid to customers; and/or other less favourable terms of supply; and/or a general reduction in service levels."
"40. On these grounds, guidance should be given that on the evidence presently available it is likely that this merger would be referred to the Competition Commission. However, at the public stage, we may come to a different view:
• if there is sufficient evidence that other full-line pharmaceutical wholesalers provide an effective competitive constraint within the regional market in which the parties operate, suggesting that no substantial lessening of competition arises; or
• in the event that we do believe that there is a realistic prospect that the merger will lessen competition, if there is clear and compelling evidence that the merger will result in sufficiently certain merger-specific customer benefits in the hospital sector which outweigh the competition detriments which may be caused by the merger."
"…On the evidence presently available it is likely that this merger would be referred to the Competition Commission. However, at the public stage we may come to a different view:
if there is sufficient evidence that other full-line pharmaceutical wholesalers provide an effective constraint within the regional market in which the parties operate, suggesting that no substantial lessening of competition arises; or
in the event that we do believe that there is a realistic prospect that the merger will lessen competition, if there is clear and compelling evidence that the merger will result in sufficiently certain merger-specific customer benefits in the hospital sector which outweigh the competition detriments which may be caused by the merger."
Contacts between Phoenix and OFT between 14 July 2004 and 22 October 2004
The "public stage" of the OFT's investigation from 22 October 2004
"The location of independent sector customers served by AAH or UniChem
18. The Office seems to be mainly concerned about the north of East Anglia and the options available to customers within this area.
19. Therefore, in addition to the maps previously provided showing the location of Phoenix, EAP and competitors' customers throughout the whole of East Anglia (Annex 6), the parties also provide at Annex 7 maps showing only the area north of the A14 with which the Office is chiefly concerned. The maps show that both AAH and UniChem now supply independent sector customers throughout the entire East Anglian region, for example in Burnham Market on the Norfolk coast (UniChem) and Lowestoft and Gorleston on the north east (AAH).
20. The maps also show that Phoenix has very few customers in the north of East Anglia, certainly fewer than either UniChem or AAH, despite the fact that Phoenix's depot in Cambridge is closer to the north of East Anglia than the AAH depots in Essex (Romford) and Northamptonshire (Weedon) and the UniChem depot in Hertfordshire (Letchworth). This indicates that location of the depot is not the determining factor for customers in deciding which supplier to use.
21. The parties have also produced spreadsheets (at Annex 8) showing the customer bases of each of the parties. Each customer is matched against the service that the closest other independent pharmacy is receiving. (Lloyds, Moss and the Co-op have been excluded on the basis that they are tied pharmacies and can only accept the service given by their affiliated or contracted wholesaler, respectively AAH/ UniChem/AAH).
22. The resulting analysis shows that in the area to the north of the A14:
- EAP's 114 first line customers (ie. Customers for whom EAP is the primary wholesaler) lie on average just 5.2 miles from another independent sector customer currently supplied on a first line basis by UniChem, AAH or Maltbys.
- Phoenix's 33 first line customers lie on average just 3.7 miles from another independent sector customer currently supplied on a first line basis by UniChem, AAH or Maltbys.
- Within the Norwich (NR) postcode region the average distances fall still further to 4.6 miles for EAP and 1.2 miles for Phoenix.
23. To put these statistics into context, the average van run for all wholesalers is over 100 miles and involves many diversions involving the distances specified above or greater distances.
24. Therefore it is clear that the opportunity exists for both EAP and Phoenix customers to switch to one of (including Maltbys) three alternative suppliers as such a change would require only minor adjustments to the new supplier's existing van routes.
The location of other customers of AAH and UniChem
25. The maps at Annex 6 show the location of all customers now served by AAH or UniChem in East Anglia. In the East Anglian region 109 pharmacies are now served by AAH and UniChem. AAH and UniChem vehicles visit those sites twice a day. The same vehicles can, and do, deliver to independent sector customers on the same route as they deliver to their wholly-owned pharmacies.
26. They are carrying the same products to customers with substantially the same requirements. Whether a pharmacy is wholly-owned or independent does not matter; many of the products required are the same and there is nothing to stop AAH or UniChem competing for the business of independent sector customers along the route to, or in the area of, a wholly-owned customer. Both AAH and UniChem already compete in this way, throughout the entire East Anglian region.
27. It is important to note that AAH and UniChem are currently the only wholesalers that are able to exploit such economics of scale…
Cut-off Times
28. It has been suggested that the location of the AAH and UniChem depots places them at a disadvantage in the north of East Anglia, since the cut-off time (i.e. the latest time at which a customer can order items for the next delivery) has to be earlier than the cut-off times offered by EAP or Phoenix, whose depots are nearer to the customer.
29. The importance of this factor has been overstated. The parties estimate that some 70% of all items purchased by independent pharmacies are purchased overnight. Cut-off times for overnight deliveries are typically after the pharmacy staff have left work and are therefore not relevant as all afternoon orders are covered.
30. The spreadsheets at Annex 8 show cut-off times and delivery times for same day deliveries (30% of the requirement) for independent pharmacy customers of AAH, UniChem, Phoenix and EAP.
31. The cut-off times are not that different. For example, within the Cambridge (CB), Peterborough (PE) and Ipswich (IP) postcode areas the average cut-off times offered by a credible alternative wholesaler are actually later than or within 5 minutes of the times offered by the earlier of EAP and Phoenix and within 45 minutes of the later of EAP and Phoenix. The Office will also note that some customers do not require an afternoon delivery at all.
32. The cut-off times currently offered by EAP in the Norwich (NR) postcode area are on average 2 hours later than those offered by UniChem and AAH. Therefore Phoenix, which offers average cut-off times 30 minutes earlier than EAP, appears prima facie to be the most credible alternative supplier. However the Phoenix market penetration in this area is smaller than that of either UniChem or AAH.
33. In considering cut-off times, the Office should also bear in mind that all full-line wholesalers operate an "emergency" service, so any patient with a critical need will always have that need met, whatever the cut-off time.
34. If cut-off times were a real problem for AAH and UniChem, their market shares would reflect that. However, they have a combined full-line wholesaling market share of 50.5% of independent customers in East Anglia, including customers in the Norwich (NR) postcode (where their cut-off times are most different from those offered by Phoenix and EAP). These customers appear to have no problem with the cut-off times offered by AAH and UniChem, and source their requirements from them. A further 2.3% accept cut-off times from other wholesalers, indicating that 53% of independent customers in East Anglia are willing to accept cut-off times offered by suppliers other than Phoenix and EAP."
The OFT's invitation to comment
The questionnaire to customers
"7. Are cut-off times important? For example would a difference in cut-off/delivery times of the following make a difference?
a) 10 minutes
b) 30 minutes
c) 1 hour
d) 2 hours
8. If so what difference would this make to your business?
9. If another full liner were to offer you a better service and/or a better discount, would you switch supplier? If you would not switch please give your reasons.
10. Are there any particular barriers to switching supplier?
11. If you decided to switch to another full liner (for whatever reason) which firm would you be most likely to switch to?
…
14. Do you have any competition concerns regarding the proposed transaction? If so, please explain your reasoning?"
OFT contacts with UniChem
"1. Please describe the nature of your business and the extent of your relationship with the merging parties.
2. Do you have any customers in the Northern and Eastern parts of East Anglia (for example, north of the A14)? If so, please list them stating whether they are a) your own tied chains or b) independent pharmacies and dispensing doctors.
3. What cut-off and delivery times are you able to offer these customers? How many deliveries a day do they receive? Does this differ between tied and independent customers?
4. Do discounts offered vary with the distance from your depot? For example, do customers located further away receive in general larger or smaller discounts to those who are located nearby?
5. How far away from your depot are your furthest independent customers?
6. Do you have any competition concerns in relation to the proposed transaction? Specifically; what do you expect the impact of this merger to be on:
a) Prices/discounts
b) Levels of service
c) Your ability to compete with the merged entity
Please explain your reasoning."
"Although a 1.5 hour one-way drive time is not a maximum distance, UniChem is unable to provide more distant customers with the same quality of service as those located closer to its warehouse. It also endures narrower margins on such custom due to higher transport costs. As a result, UniChem does not believe that it can provide full and effective competition for customers located further than 90 minutes drive time from its warehouse. This limitation is most likely to be very similar for its principal competitors."
That contention was supported by an isochrone analysis, prepared by RBB Economics, very similar to the isochrone analysis submitted by UniChem in 2003. That analysis identified areas of overlap between delivery areas of the main wholesalers, broken down into six "zones". In particular a "Zone A" in the North of East Anglia in which, it was said, competition would be eliminated altogether by the proposed merger. That area encompassed "large swathes of Norfolk, including both Kings Lynn and Norwich, and a substantial part of rural Suffolk". Similarly it was alleged that competition would also be reduced in Zones B, C, D and E marked on the isochrone. The customers in each zone said to be affected by the reduction in competition were listed in annexes to the RBB report.
"Despite having devoted substantial efforts over recent years to growing its share of the dispensing doctors market, UniChem has found it remarkably difficult to make in-roads across the UK, including in East Anglia, where EAP and AAH have entrenched positions, based on a long history of operating in that region. UniChem has set up a new business unit specifically to target dispensing doctors; it plainly has the expertise and resources to be a credible competitor across the UK as well as in East Anglia, yet it failed to penetrate the market. As a result, its market share in East Anglia is still only 1.5%."
"I called Ingrid Nitsche (OFT case officer) this afternoon to discuss the case.
She said she had reviewed the submission and thought it was 'very helpful and comprehensive'.
She did not envisage that the OFT would be sending UniChem any further information requests.
I raised the question of a possible meeting. She said the OFT was running to a "tight timetable" and from their perspective didn't think a meeting would be necessary. She reiterated that the submission was comprehensive and didn't require clarification. However she said the OFT would consider a meeting if UniChem had any additional issues or concerns it wished to raise. Does anyone have views on whether there are additional issues that we have not yet raised? If not, perhaps the best course of action is to wait for the OFT's decision."
The Second Issues Letter of 30 November 2004
"5.17 In cases that raise more complex or material competition issues, a different process will be followed. Once a case has been so identified, the parties will be advised and invited to attend an issues meeting with the Branch. To help the parties prepare for this meeting, the case officer will send an 'issues' letter to the parties. This will set out the core arguments and evidence in the case. It is intended that 'issues' letters will set out the arguments in favour of a reference so that parties have an opportunity to respond to the reasons why a reference, if it follows, has been made. That is not to say that a reference will follow in all cases in which an 'issues' letter is sent."
"Issues Paper
Note – the following are hypotheses at this stage, which we are still evaluating in the light of the evidence put to us by the parties and third parties. They do not necessarily represent the provisional or final view of the OFT on these issues.
…
Key potential competition concerns:
1. The merger will reduce from four to three the number of Full-liners serving the East Anglia Region. This change in market structure may result in a loss of competition between the parties and may also contribute to reduced incentives for the remaining players to compete as strongly as before. There is therefore the risk that the merger may lead to a lessening in competition in which all firms find it profitable individually to offer less favourable terms or lower their level of service.
2. In terms of customer base, both parties tend to mainly supply Independent Pharmacies and Dispensing Doctors and so compete for the same customers. In the East Anglia Region, the parties will have a combined share of supply of 21% to Independent Pharmacies and 83% to Dispensing Doctors. AAH and UniChem by contrast compete more actively in the supply to multiple pharmacies and supermarkets. Therefore for Dispensing Doctors, at least, the parties may represent each other's next best alternative.
3. The merger may create a monopoly in certain parts of East Anglia where neither AAH nor UniChem can provide an effective service. AAH and UniChem are at a disadvantage geographically and, as noted above, have a different customer focus. They therefore may not provide as strong a competitive constraint on the parties as do the parties on each other. In terms of the level of service offered (particularly cut-off times for twice daily deliveries) the offering provided by EAP may be likely to be the next best alternative for a Phoenix customer and vice versa.
4. EAP is a very efficient and flexible operator with very good levels of customer service. Large, national wholesalers do not tend to have the customer focus on small Independent pharmacies that a regional wholesaler offers. Some customers are concerned that the service offered by EAP will be of lower quality once Phoenix takes over.
5. The merger may increase the prospect of the remaining three Full-liners in the East Anglia Region tacitly or explicitly coordinating their behaviour. This might occur either through geographic market sharing or through coordination on the level of discounts or service.
6. In summary, concerns arise that the merger may create a substantial lessening of competition in the supply of Ethicals to Customers in the East Anglia Region resulting in the lowering or removal of discounts, lower service levels, and the offering of less favourable terms."
Events between 30 November and 9 December 2004
"It is misleading to suggest the 5-6 new customers make a new route viable. When a wholesaler establishes a new customer, existing van routes are adjusted to accommodate that customer. Full-liners use computerized systems to re-configure van routes on a regular basis. It is not a question of waiting to recruit 5-6 new customers and then putting on a new van route."
IV THE CONTESTED DECISION
"Shares of supply
National issues
24. The transaction raises no concerns at a national level. The merger will give Phoenix and EAP a combined share of full-line supply to pharmacies and dispensing doctors of 10 per cent with an increment of 1 per cent.
Regional issues
25. As mentioned above, EAP's depot is located in Norwich and Phoenix's nearest depot is located in Cambridge. The parties' closest rivals are situated in Romford (AAH) and Letchworth (UniChem). The East Anglia region is also served to a limited extent by two other independent full-liners, Mawdsley Brooks, based in Milton Keynes and, to a lesser extent, Maltbys based in Lincoln.
26. According to the parties' data on the wholesale supply of Ethicals by full-liners to pharmacies and dispensing doctors, post merger, they would have a combined share of [25-35] per cent (increment [15-25] per cent) in the East Anglia region. The merger would make them the second largest full-liner, after AAH with [40-50] per cent, with UniChem accounting for [20-30]. The total number of full-liners serving this area to any substantial extent would reduce from four to three.
27. In terms of their respective customer bases, the parties may be considered each other's closest competitors. Both EAP and Phoenix specialise in supply to dispensing doctors and smaller independent pharmacies. They cannot effectively supply chains of pharmacies (referred to as multiples – such as Superdrug, Boots and the supermarket chains) due to their lack of national coverage and they cannot supply 'tied' chains such as Moss or Lloyds since these chains are vertically integrated with UniChem and AAH respectively. Similarly supermarkets look to source from a single national supplier and so currently can only source from the two national full-liners.
28. Looking at shares of supply based upon independent pharmacies and dispensing doctors only (i.e. excluding those customers who are not free to choose Phoenix or EAP as their supplier), the parties have a combined share of supply for independent pharmacies in East Anglia of [15-25] per cent (increment [10-20] per cent) with AAH having [45-55] per cent, UniChem [15-25] per cent and Mawdsley Brooks [<5] per cent. For dispensing doctors in the same area the parties have a combined share of supply of [75-85] per cent (increment [55-65] per cent) with AAH with [10-20] per cent and UniChem with [<5] per cent and minimal sales from Mawdsley Brooks. In the decision on the anticipated acquisition by AAH of EAP (see paragraph 5 above), the OFT found that there was insufficient evidence to suggest that supply to dispensing doctors exhibits sufficiently different characteristics from supply to retail pharmacies to justify separate analysis. The OFT has not received any evidence as a result of this investigation to contradict that view. The high combined share figure is, however, indicative of the similarity in the types of customer that the parties supply. EAP contends that it has always had a strong presence in the dispensing doctors sector and Phoenix contends that the lack of a full range twice-daily delivery service from its Cambridge depot (see paragraph 32 below) means that its service is more suited to dispensing doctors in the area.
29. The price of branded Ethicals is subject to price regulation under the PPRS. Under this scheme, the Department of Health (DoH) sets a 'list price' at which manufacturers supply these products to wholesalers. The parties claim that wholesalers can offer their customers a discount, equivalent to a maximum of 12.5 per cent off the list price. The DoH then claws back most of the discount from the pharmacists (the rate of the clawback is currently around 10.5 per cent). The result of this is that the margin within which full-liners can offer differential discounts is small and as a result there tends to be very little difference in the level of discounts offered by wholesalers to pharmacies. This has been backed up by third party comment which tends to focus on levels of service as being the deciding factor in the choice of wholesale supplier.
30. In assessing whether this merger may substantially lessen competition, the OFT considers that the following considerations are relevant:
a. What level of constraint does Phoenix confer upon EAP pre merger?
b. Are AAH and UniChem effective competitors in the outlying North and Eastern areas of East Anglia?
c. Are AAH and UniChem effective competitors in the supply of Ethicals to dispensing doctors?
31. On the basis of the evidence available, the constraint that Phoenix currently offers to EAP in East Anglia is considered to be low. Phoenix has what could be considered a surprisingly low share of supply ([<10] per cent) in East Anglia, given its apparently advantageous geographic location in the region. There are a number of reasons for this.
32. First, the Phoenix depot at Cambridge is a 'link' depot rather than a full-line depot. This means that the site at Cambridge only carries a limited range of [2,000-4,000] lines, which can be dispatched the same day. The remaining 7-10,000 product lines need to be ordered from a feeder depot in Birmingham and can only be delivered on a next day basis. The service that Phoenix can offer from Cambridge could be considered therefore more like a quick delivery short-line service than a full-line offering.
33. In addition, although Phoenix has its own chain of tied pharmacies (Rowlands), it has no outlets in East Anglia. This puts Phoenix at a competitive disadvantage to the other players because it cannot build up the requisite network densities to operate efficiently. AAH, UniChem and EAP have hospital contracts, and AAH and UniChem have business with their own tied chains and supermarkets. This allows them to build up customer clusters which make a stand alone van route viable. For example, the OFT considers that these parties should indeed be able to offer a pharmacy near to an existing route a service at negligible marginal cost since they already make drops in the area. EAP is very successful in relatively distant geographic areas, because it can offer a drop to a customer in the same van that is going to a hospital contract. Phoenix by contrast has no volume in many areas of East Anglia. Therefore its marginal cost of servicing customers, in a new area, is by contrast relatively high since adding a new van route rather than altering an existing route is relatively expensive.
34. Regarding the question of whether AAH and UniChem are effective competitors in the outlying North and Eastern areas of East Anglia, both competitors deliver to tied chains and supermarkets in these areas already. It should therefore be relatively easy and cost effective to add one or more drops to an existing 'round'. The parties have shown that both AAH and UniChem are serving independent customers in these areas. AAH and UniChem maintain that they are unable to offer a good enough service in these areas; however, the level of service that they provide is evidently good enough for some independent customers and for the national supermarkets.
35. Phoenix and EAP have provided detailed spreadsheets setting out the distances between and cut-off times for independent sector customers supplied by all full-liners operating in the region. The spreadsheets suggest that the service levels of all suppliers (including AAH, UniChem and Mawdsley Brookes)[2] do not necessarily deteriorate significantly in response to distance and undermine the suggestion that AAH, UniChem or Mawdsley Brooks cannot effectively compete in parts of East Anglia, since they clearly do provide services for all types of customers in this area.
36. AAH and UniChem are relatively well placed to compete for business throughout East Anglia by virtue of their full size depots and the network benefits they gain from existing customer density, and from customer clusters over longer distances. It therefore seems that any customer of the merged entity could switch to AAH or UniChem (or in the West of the region, Mawdsley Brookes). Furthermore, a number of third parties have indicated that they would switch in the event of poor service from EAP, and none has identified any significant barriers to switching to an alternative supplier.
37. Customer responses in relation to this case indicate that cut-off and delivery times are one of a number of aspects to service quality which customers value highly. Other important factors cited by customers, that do not vary with geography include: customer service levels, order accuracy, flexibility, discounts and friendliness of staff.
38. In terms of the supply of Ethicals to dispensing doctors, there are no particular barriers on either the demand or supply side between pharmacies and dispensing doctors. A dispensing doctor is essentially another drop on the route, so if AAH and UniChem are supplying pharmacists in the region, there appears to be no reason why they should not be able to add dispensing doctors to their existing route network. Furthermore, responses from dispensing doctors indicate that they are less demanding in their requirements, many preferring only one daily drop. Third parties have indicated that dispensing doctors are reluctant to switch unless service levels fall, and are relatively insensitive to price as they are reimbursed at cost for the Ethicals that they prescribe to patients. This implies that they have less incentive to shop around in search of cheaper drugs. For them, service quality is a key consideration in choosing their full-liner. However the dispensing doctors contacted by the OFT indicated that there were no barriers to switching supplier and a number stated that in principle there is no reason not to use AAH or UniChem. They are reluctant to switch because they are happy with their current supplier and because there is little difference in the offers from full-line competitors.
39. On the basis of the above, the OFT does not expect that there will be an adverse impact from the reduction of choice among full-liners in East Anglia. In the OFT's view there will not be an appreciable impact on discounts or on service levels.
…
Barriers to entry and expansion
42. Barriers to entry in full-line wholesaling are considered to be high. This is because of the high cost of establishing and stocking a depot, the low returns that would be expected and the difficulty in achieving a critical mass of customers to make a depot viable. As a result all of the new entry observed in the past five years has been by acquisition rather than organic growth.
43. Further barriers exist at the route level, where the parties estimate that in order to make a new route in a new geographic area viable, the route needs to carry a turnover of approximately £150k per month (equivalent to 5-6 customers) in order to break even. However, the parties maintain that all full-liners use sophisticated routeing software to optimize their networks. As a result, the addition of a new customer to the network will typically be followed by a re-organization of the entire route network. The marginal cost of supplying a new customer, where existing customer drops are nearby, should therefore be very low. However opening a route in an area where the full-liner has no pre-existing drops (even within the 2-hour drive time radius) is likely to carry a higher incremental cost.
Buyer power
44. Whilst there are a number of large national buyers of Ethicals in the UK (for example supermarkets and large chains like the Co-op) their choice of supplier is extremely limited since only AAH and UniChem are able to supply on a national basis.
45. For smaller customers in the East Anglia area the choice is more varied as they can source from AAH, UniChem and Phoenix and regional full-liners. However due to their small size their buying power is not significant. The parties submit that buying groups confer buyer power upon smaller customers. However buying groups tend to supply generics under the group brand, for which short-line alternatives are already available. Buying groups do not therefore have a significant impact on the competitive assessment. There is therefore little prospect of customers being able to exercise any buyer power.
…
Third Party Views
47. Competitors to the parties raised concerns about the acquisition, suggesting that for certain customers in certain areas, the merger would severely reduce customer choice. A number of customers who were contacted currently use EAP and Phoenix as main and back up full-liners. While a number of these customers were concerned over their potential reduction in choice, many were not and expressed the view that adequate competition would remain in the area post-merger.
Assessment
48. In the East Anglia region, the merged entity will be the second largest full-line wholesale supplier of Ethicals pharmaceuticals. At this regional level, the merger will effectively reduce the number of competing full liners from four to three. In addition, in terms of their geographic coverage and respective customer bases (namely, a focus on dispensing doctors) the parties could be considered close alternatives.
49. It might be the case that, in certain circumstances, short-liners will be able to provide some constraint on the parties. However, competition to the parties is expected to come from other full-liners operating in the region, namely AAH and UniChem. In assessing the extent of this constraint, the OFT notes that both AAH and UniChem currently offer a service to tied chains and supermarkets (and independent customers) throughout the East Anglia region and can be considered well placed to compete for additional custom in the region. The OFT also considers there is nothing specific about dispensing doctors as customers, which would prevent these competitors from servicing their needs. Added to this is the fact that overall Phoenix currently offers a limited constraint on the activities of EAP.
50. Consequently, the OFT does not believe 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."
V THE PROCEEDINGS BEFORE THE TRIBUNAL
The notice of application
Ground 1: The OFT's decision that it was not under a duty to refer the proposed merger to the CC was irrational and unjustified and/or a misconstruction or mis-application of its duty under section 33.
Ground 2: The OFT's reasons for not referring the merger to the CC were insufficient to justify the Decision, and did not dispel the serious likelihood of a substantial lessening of competition.
Ground 3: There are a number of unresolved issues of material fact outstanding. In those circumstances the OFT erred in deciding not to refer to the CC. Further, the OFT acted irrationally or unreasonably in purporting to resolve those issues in the way it did.
Ground 4: The OFT failed to take adequate account of its previous decisions, and in doing so breached its duties to act consistently, to take into account relevant considerations, to uphold legitimate expectations, and to give adequate reasons for its decisions.
VI THE EVIDENCE
A. THE OFT'S EVIDENCE
Market definition
Geographic market
Concentration data
(a) the difficulties of arriving at a precise definition of the relevant product market and the relevant geographic market;
(b) since it was certainly not the case that each wholesaler could provide a consistent service across the whole of East Anglia, given the geographic spread of their depots, concentration data would not provide the OFT with a good guide to the "dynamics of competition" among pharmaceutical wholesalers in the East Anglia region;
(c) there were evidential disputes between the relevant wholesalers as to their respective sales in East Anglia and the OFT considered that it should be circumspect in relying on such information; and
(d) although the OFT had calculated the "relevant" HHIs and concentration ratios they were not included in the Decision as the OFT did not consider that such information added anything to its analysis, given that it had already concluded that market shares provided only a limited guide to current competitive conditions in this market.
(Priddis, paragraph 64)
Non – coordinated effects
The level of constraint imposed by the merging parties on each other before the merger
(a) Phoenix offers only a limited service from its depot in East Anglia, more akin to a short-line wholesaler than a full-line wholesaler. The Phoenix depot in Cambridge is a "link" depot rather than a full-line depot and carries only a limited range of 3,000 lines which can be dispatched on the same day. The remaining 7,000 to 10,000 product lines must be ordered from a "feeder depot" in Birmingham and can only be delivered on a "next day" basis.
(b) Despite the apparent competitive advantage arising from the geographic location of its depot, Phoenix faces disadvantages in competing with UniChem, AAH and EAP because of its low customer density in East Anglia and consequent lack of network efficiencies.
(Priddis, paragraphs 85-88)
Whether, following the merger, AAH and UniChem would offer effective competition in the outlying North and Eastern areas of East Anglia
"•…confirmation that planning of delivery routes by wholesalers changes often to take account of new accounts. For example, EAP said that even the gain or loss of one customer may result in the re-mapping of the entire delivery network.
- It was not therefore the case that the economics of the delivery routes were such that routes were fixed and could not readily be altered to include or exclude customer drops.
- The costs of running a van route are largely fixed, until the point that the allocated van becomes full so if the van is driving nearby, the only additional costs that would be incurred in making a small detour for an additional customer drop would be fuel, invoicing costs etc
- UniChem's website claims that it offers the most efficient and lowest cost pharmaceutical wholesale logistics system
- UniChem and AAH have, in the past, expanded their vehicle routes to add additional customer drops. There is no reason why they would not be able to do so in the future.
- There do not appear to be any areas where AAH and UniChem do not have existing routes which can be used as the basis for expansion
- The OFT received no evidence to suggest that the marginal costs of serving an additional customer would be high."
(Priddis, paragraph 95(g))
(a) UniChem's submission concerning cut-off and delivery times did not apply to overnight orders for delivery the following morning which account for 70% of product deliveries to pharmacies.
(b) If UniChem's submissions concerning a 90 minute drive-time were correct then UniChem would, by definition, have had little commercial success in the area north and east of the A14. However, information before the OFT demonstrated that UniChem had won a number of independent pharmacy and dispensing doctor accounts in that area.
(c) UniChem's information also showed that UniChem provided twice-daily deliveries to customers north of the A14. The cut-off times provided by UniChem to these customers was not indicative of a poor service level. The OFT considered that, for many customers, UniChem's "cut-off times were within the margin of comfort that pharmacy customers told us was acceptable to them".
(d) The detailed spreadsheets provided to the OFT by Phoenix and EAP showed that there was not necessarily any significant deterioration in order cut-off times as the distance of the customer from the depot increases. The evidence of Phoenix and EAP showed that many independent pharmacies or doctors north of the A14 had later cut-off times than pharmacies or doctors closer to the depot. Even where the cut-off time was later in the day, customer evidence suggested to the OFT that AAH and UniChem still provided an adequate service.
(e) The spreadsheets provided by Phoenix and EAP showed that AAH and UniChem served customers in the outlying areas of East Anglia with a twice-daily service that was competitive with the service provided by EAP. While the afternoon delivery service provided by UniChem and AAH was generally later in the day than that provided by EAP, the deliveries arrived in sufficient time to allow for delivery acceptance and prescription dispensing on the same day. Therefore, the OFT took the view that the spreadsheets supported the notion that service levels did not deteriorate significantly as distance from the depot increases.
(f) The detailed maps and customer lists received by the OFT confirmed that UniChem's customer spread is considerably wider than that suggested by the RBB isochrone analysis. Furthermore, the evidence showed that the customer spreads of each wholesaler were quite different. AAH's customer spread did not fit a 90-minute delivery drive time. Phoenix, on the other hand, had a very limited customer spread narrowly focused around Cambridge.
Whether AAH and UniChem are effective competitors in the supply of Ethicals to dispensing doctors
The OFT's assessment of the scope of competitive constraint from new entrants
B. PHOENIX/EAP'S EVIDENCE
(a) Since the merger was announced, UniChem has been approaching Phoenix and EAP customers in all parts of East Anglia offering them advantageous commercial terms, which negates any suggestion that UniChem cannot compete in East Anglia (Cole at paragraphs 36 to 39; Briggs at paragraphs 7 to 13).
(b) The spreadsheets submitted by Phoenix/EAP show:
(i) that in the area to the north of the A14, Phoenix's "first-line customers" lie an average of 3.7 miles, and EAP's "first-line customers" lie an average of 5.2 miles from an independent sector customer of UniChem, AAH or Maltbys. Within the Norwich (NR) postcode region the average distances fall still further to 4.6 miles for EAP and 1.2 miles for Phoenix.
(ii) that the service levels of AAH, UniChem and Maltbys largely do not deteriorate the further the supplier travels from the depot to make a delivery.
(iii) that in the majority of East Anglia, apart from the Norwich (NR) postcode, the average cut-off times offered by a credible alternative wholesaler are very similar to, and in many cases actually later than, those offered by Phoenix and EAP. In the Norwich (NR) postcode, Phoenix and EAP offer later average cut-off times than UniChem or AAH. However, Phoenix's general market penetration in this area is smaller than that of either UniChem or AAH. It is therefore clear that cut-off times are in fact only one of the aspects of service about which customers are concerned (Cole at paragraphs 8 to 12).
(c) UniChem's briefing paper of 10 November 2004 was incomplete and erroneous, not only because it is contradicted by the evidence in the spreadsheets, and the evidence of UniChem's approaches to Phoenix/EAP customers, but also because UniChem and AAH have numerous customers in "Zone A" shown on UniChem's isochrone where, according to UniChem, EAP/Phoenix would have a monopoly because UniChem and AAH could not supply customers in that zone. In addition, UniChem has customers even beyond Zone A (Cole at paragraphs 34 to 35, Briggs at paragraph 16).
(d) UniChem failed to disclose to the OFT that it operated a system of trunking from Letchworth to Thetford, and thus gave a misleading account of its delivery capability (Briggs, paragraph 14).
(e) It is not necessarily the case that customers furthest from the depot have later cut-off or delivery times, since the van may go to the furthest customer first, and then work back (Briggs, paragraphs 17-18).
(f) UniChem delivers to a number of customers at a greater distance from Letchworth than North Walsham which UniChem stated to the OFT was its furthest customer (Briggs, paragraphs 20 to 21).
(g) UniChem has continued to buy pharmacies in the area, including in "Zone A" shown on the RBB isochrone analysis.
C. UNICHEM'S EVIDENCE
(a) UniChem finds it very difficult to compete for the business of independent pharmacies in the area north of the A14 (paragraph 5);
(b) UniChem's independent pharmacy customers in those areas are, in many instances, a legacy from the days prior to 1990 when UniChem was a pharmacists' co-operative. Such customers accept early cut-off times for reasons of historical loyalty (paragraph 6);
(c) UniChem has 13 such outlets (9 customers), north of the A14, excluding pharmacies that are parts of chains of 5 or more outlets. 6 of those customers have been with UniChem since at least 1988 (paragraphs 6 and 22);
(d) in the last five years UniChem has won only 3 independent pharmacy customers in that area, and since 1990 only 7 independent pharmacies, 3 of which belong to the same chain (paragraph 7);
(e) UniChem faces substantial practical and logistical difficulties in adding drops to existing routes, since UniChem is capacity constrained. It would be extremely difficult to reorganise the system to accommodate more than a handful of Phoenix/EAP customers (paragraph 8);
(f) UniChem has 9 routes covering the relevant parts of Norfolk and Suffolk, based on a system of trunking to Thetford, from which vans deliver along the routes in question. In the morning the vans leave Thetford at 8.00am and return by 12.45pm. The afternoon delivery commences at 2.30pm and must be completed by 5.30pm. There is very little time for unforeseen delays. In addition, there is very little capacity to add an extra drop while ensuring that the last customer receives the order by 5.30pm (paragraphs 12 and 38).
(g) The OFT never checked with UniChem whether it had spare capacity on the routes, which is the underlying assumption in paragraph 34 of the Decision and paragraph 95(g) of Priddis (paragraphs 13 to 15).
(h) If UniChem were to succeed in winning more than a handful of new customers it would need to set up a new route, which would, according to paragraph 42 of the Decision, require a turnover of around £150,000 per month (paragraph 15).
(i) The OFT did not check with UniChem the inferences to be drawn from the Phoenix spreadsheets. Average distances do not tell one whether a new customer could be accommodated within an existing route, which is the crucial question (paragraph 16).
(j) The average distances between EAP customers and UniChem's independent customers are in any event 16.54 miles in the NR postcode area and 25.26 miles in the IP postcode area. For Phoenix customers the distances are 17.71 miles in the NR postcode area and 20.29 miles in the IP postcode area (paragraph 16).
(k) UniChem's lack of success, despite having a full time salesman prospecting in the region, is due to the poor cut-off time (11.10 am) that UniChem is able to offer in these areas. Local cut-off time is less crucial for national or regional chains, who negotiate centrally, or for tied outlets. The tied pharmacies are less demanding in their cut-off times, having no choice in the matter (paragraphs 17 to 19).
(l) Contrary to paragraph 103(b) of Priddis, UniChem has been able to win very few new customers on the far Norfolk coast (paragraph 20).
(m) Recent contacts by UniChem with EAP and Phoenix customers were "to gauge their reaction" to the Phoenix/ EAP merger and to see if customers would support UniChem's case to the OFT (paragraphs 24 to 26).
(n) UniChem is not an effective competitor in supplies to dispensing doctors, and in fact has no such customers north of the A14. Sales to dispensing doctors in East Anglia account for £107 million, about 40 per cent of the "contestable" market (paragraphs 27 to 31).
(o) One obstacle to supplying dispensing doctors is manufacturers' discount schemes administered by Phoenix, 21 of which are exclusive to Phoenix (paragraphs 32 – 34).
(p) The OFT's arguments that Phoenix is not a significant constraint on EAP are not soundly based (paragraphs 35 to 38).
(q) At no stage did the OFT express any doubts about UniChem's evidence or put back to UniChem the points about UniChem's capabilities which were put to the OFT by Phoenix (paragraph 39 to 40).
"• the parties' calculation of average distances between EAP/Phoenix independent customers and the independent customers of their competitors relies on the use of the minimum of the distances identified for each EAP/Phoenix customer (i.e. one for each of UniChem, AAH, Maltby and the closest dispensing doctor);
- the average distances between EAP/Phoenix independent customers and the independent customers of their competitors conceals a wide distribution of distances, such that many outlets are substantially further from a competitor's customer than is suggested by the average;
- although 114 EAP customers and 33 Phoenix customers are analysed in the spreadsheets, just 12 UniChem customers appear on it, indicating that any one UniChem customer is the closest UniChem customer to several EAP and Phoenix customers (one UniChem customer is treated as the nearest outlet 44 times);
- the data in the spreadsheets, as it relates to the UniChem customers, contains a number of errors when compared to UniChem's own customer list;
- the spreadsheets indicate that, of the three named competitors (UniChem, AAH and Maltby) AAH and, in particular, wholesalers to dispensing doctors, are the closest competitors to EAP and Phoenix far more of the time than UniChem and that the presence of UniChem only minimally impacts the outcome of this analysis; and
- the last drop on the delivery routes on which several of the relevant UniChem outlets are located is already close to the close of the business day and therefore extending the route to cover even one more drop may prejudice the ability of that van to reach its last customer before it closes."
VII THE PARTIES' SUBMISSIONS
A. ORIGINAL GROUND (4)
B. UNICHEM'S SUBMISSIONS
(a) On the basis of the two Issues Letters, and the facts and matters set out in the Decision, the OFT had no option but to refer under section 33(1), on the basis that it cannot reasonably be said that the material set out in the Decision is adequate to dispel or remove the possibility that it "may be the case" that the proposed merger would result in a substantial lessening of competition ("SLC"), or give proper reasons for that conclusion, as indicated by the Court of Appeal in OFT and others v. IBA Healthcare Ltd [2004] 4 All ER 1103 (hereafter the "IBA case") at [57], [71] to [73] (Morritt VC) and [100] (Carnwath LJ).
(b) The OFT failed adequately to investigate the underlying facts upon which it based its conclusion that there would not be SLC, in particular by not seeking UniChem's views on matters directly concerning UniChem. Alternatively, the OFT omitted relevant factual considerations which it ought to have taken into account, or made material errors of its assessment of the facts: see notably the IBA case at [57], [86], [87], [93], [100], [106] and Secretary of State for Education and Science v. Metropolitan Borough of Tameside [1977] AC 1014, at 1047.
(c) The OFT failed to follow a proper procedure and/or exceeded its jurisdiction: (i) in failing to enable UniChem to see or comment on the Second Issues Letter, or on the evidence provided by Phoenix/EAP; (ii) in failing to seek UniChem's views on factual issues concerning UniChem's capability to compete with the merged concern; and (iii) in relying almost entirely on the evidence of the merging parties in seeking to resolve key and disputed issues of fact.
(a) The OFT never examined capacity constraints nor asked UniChem for any evidence on this point. The OFT never asked UniChem for any details of its distribution system, whether it was capacity constrained, or its ability to add new customers. The Decision depends on the idea that the existing network can be easily expanded. But, to be a credible competitor to Phoenix/EAP, UniChem would have to add many new customers to existing routes, which would not be feasible. It is not logical "to jump from dots on a map" to the conclusion that UniChem can easily expand its existing network structure. UniChem would have to add new routes, the incremental cost of which is high, as the Decision accepts.
(b) The Decision is based incorrectly on the assumption that, since the marginal cost of adding a new customer to an existing network is small, it is easy to extend networks. That ignores the logistical constraints and time constraints explained by Mr Johnson. UniChem had no idea that this was a key issue until it saw the Decision.
(c)UniChem has a market share of about 5-7 per cent of contestable sales north of the A14, compared with the merged Phoenix/EAP of between 57 and 61 per cent and AAH with 32 to 34 per cent, according to the map disclosed by Phoenix/EAP, despite the network advantages which the OFT claims that UniChem has.
(d) That "deplorable result" is because UniChem focuses on the pharmacy chains and tied outlets, and is capacity constrained, as Mr Johnson explains.
(e) UniChem has won only three new independent pharmacy customers in the relevant area of East Anglia the last three years, and seven since 1990.
(f) The switching material relied on by Phoenix/EAP (but not previously disclosed to UniChem) shows no customers switching from EAP to UniChem, with 77 per cent of switches being from EAP to Phoenix. UniChem has acquired customers only by the more expensive process of acquiring pharmacies for the Moss chain.
(g) UniChem has no sales to dispensing doctors in that area, and only 1.5 per cent of sales in East Anglia, in circumstances where dispensing doctors account for 40 per cent of total sales.
(h) The spreadsheets were never put to UniChem, although it is clear from paragraph 35 of the Decision that the OFT viewed the spreadsheets as pivotal, in particular as regards distances and cut-off times, and for the proposition that service levels do not necessarily decline in response to distance.
(i) The spreadsheets are flawed for the reasons given by Mr Baker.
(j) If the spreadsheets show anything, they show that UniChem is not an effective competitor North of the A14.
(k) Mr Priddis' evidence is that a majority of customers stated that they would not be concerned with an earlier cut-off time of up to one hour. According to UniChem, the spreadsheets show that in the IP post code, UniChem's cut-off time is about one hour earlier than EAP or Phoenix, but in the NR (Norwich) post code the cut-off times for UniChem are in fact two hours, or one and a half hours earlier, than for EAP and Phoenix respectively.
(l) The OFT's proposition in the Decision that service levels do not deteriorate in response to distance is based on inadequate evidence and overlooks the fact that the nearer the customer is to the depot the better the service the wholesaler can offer, as was recognised by the MMC in 1996, and in both the First and Second Issues letters.
(m) The issue of co-ordinated effects is not dealt with in the Decision.
(n) The OFT failed to put any time frame on the period within which, according to the OFT, UniChem would be able to exercise a competitive constraint on Phoenix/EAP.
(o) Given the facts of the case, and the Issues Letters, the OFT has not discharged the burden of dispelling the concerns set out in the letter: IBA at [57] and [100]. Even assuming that the OFT has correctly assessed the position of AAH, the evidence is that the proposed merger would give rise, at the least, to a duopoly north of the A14, and hence a serious risk of SLC.
C. THE OFT'S SUBMISSIONS
"(i) both AAH and UniChem already supply to all types of customer in the outlying areas where they say that they cannot compete, including to independent pharmacies and dispensing doctors; (ii) service levels do not necessarily fall significantly as the distance from depot to customer increases; (iii) customers have said that AAH and UniChem are alternative suppliers for them; and (iv) it would be incorrect to focus only on the cut-off time for placing an order as the key parameter of "service levels" to customers.
D. PHOENIX'S SUBMISSIONS
"It is unlikely that UniChem would consider it worthwhile to target supply to dispensing doctors, faced with the significant cost of introducing new, long van routes to sparsely populated rural areas with little likelihood of being able to generate meaningful market share growth."
VIII SECTION 120(4) AND THE IBA CASE
The IBA case
"44. First, it is apparent from s 33(1) and the contrast between belief and suspicion demonstrated in ss 42 and 131 that it is necessary for the OFT to form the relevant belief. Thus some form of mental assent is required as opposed to the less positive frame of mind connoted by a suspicion…
"45. Second, the belief must be reasonable and objectively justified by relevant facts. In Secretary of State for Education and Science v Metropolitan Borough of Tameside [1977] AC 1014 the question was whether the Secretary of State 'is satisfied'. Lord Wilberforce pointed out [1977] AC 1014 at 1047) that -
'This form of section is quite well known, and at first sight might seem to exclude judicial review. Sections in this form may, no doubt, exclude judicial review on what is or has become a matter of pure judgment. But I do not think that they go further than that. If a judgment requires, before it can be made, the existence of some facts, then although the evaluation of those facts is for the Secretary of State alone, the court must enquire whether those facts exist, and have been taken into account, whether the judgment has been made on a proper self direction as to those facts, whether the judgment has not been made on other facts which ought not to have been taken into account.'
It was not disputed that the belief must be reasonably held as accepted in para 3.2 of the OFT guidance…
"46. Third, by themselves, the words 'may be expected to result' in para (b) of both ss 33(1) and 36(1) involve a degree of likelihood amounting to an expectation. In para 182 of its judgment the CAT expressed the view that these words connoted more than a possibility and adopted what they described as a crude way of expressing the idea of an expectation as a more than 50% chance. No doubt this is right when applied to the single question which the Commission is required to answer under s 36(1)(b).
"47. Fourth, however, the belief that must be held by the OFT under s 33(1) is 'that it is or may be the case that'… The test for the OFT is only whether the anticipated merger 'may result in a relevant merger situation' or not. This is consistent with the respective functions of the OFT and the Commission. The former is a first screen, the latter decides the matter. Accordingly, although the word 'may' appears in the opening phrase of s 33(1) and in para (b) of both ss 33(1) and 36(1) it is clear that the opening phrase 'believes that it…may be the case' imports a lower degree of likelihood than para (b) in ss 33(1) or 36(1) would itself involve. 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 the OFT therefore believed that a substantial lessening of competition might prove likely on further and fuller examination of the position (which could only by 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 the 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% there is a wide margin in which the OFT is required to exercise its judgment. I do not consider it possible or appropriate to attempt any more exact mathematical formulation of the degree of likelihood which the OFT acting reasonably must require."
"…Their comments are readily understandable in the light of the OFT's apparent change of view in the course of a few days. If the hypotheses set out in the issues letter were well founded then the OFT was bound to refer. The CAT was entitled and bound to examine with care why such hypotheses were rejected in so short a time and whether their rejection was justified, particularly in view of the statutory duty to give reasons imposed by s 107."
"82. The difference between sections 33 and 36 lies in the nature of the conclusion to be arrived at. The question for the OFT is whether it 'believes that SLC is or may be the case'; the Commission is required to 'decide' whether there will be SLC. Thus for the OFT, unlike the Commission, belief in the possibility of SLC is enough to trigger the next stage."
"(1) that the OFT believed that there would be SLC; (2) that the OFT believed that there might be SLC; and (3) that the risk of SLC was sufficiently low for the OFT to believe there neither was nor might be a SLC. (1) and (2) follow from the words "is or may." (3) is their implicit obverse."
"87. …The material placed before the Tribunal represented the results of the first-stage investigation. The issue for the Tribunal was whether on that material the OFT could reasonably take the view that the issues (so clearly defined by the 'issues letter') had been sufficiently resolved for it to be satisfied that there would not be SLC. If not, it was its duty to refer the matter for 'in-depth' investigation by the Commission."
"On the other hand where the question is the fairness of a procedure adopted by a decision-maker, the court has been more willing to intervene: 'such questions are to be answered not by reference to Wednesbury unreasonableness, but in accordance with the principles of fair procedure which have been developed over the years, and of which the courts are the author and sole judge' (see R v Panel on Take-overs and Mergers, ex p Guinness plc [1989] 1 All ER 509 at 531, [1990] 1 QB 146 at 184 per Lloyd LJ)."
"The present case, as the Tribunal observed (para 223), is not concerned with questions of policy or discretion, which are the normal subject matter of the Wednesbury test. Under the present regime (unlike the 1973 Act), the issue for the OFT is one of factual judgment. Although the question is expressed as depending on the subjective belief of the OFT there is no doubt that the court is entitled to enquire whether there was adequate material to support that conclusion."
"…Those principles, whether applied by a court or a specialised tribunal, are flexible enough to be adapted to the particular statutory context. No doubt the existence of such a special jurisdiction will help to ensure consistency from case to case; and the expertise of the tribunal will better fit it to deal with such cases expeditiously and with a full understanding of the technical background. However, the essential question was no different from that which would have faced a court dealing with the same subject matter. That question was whether the material relied on by the OFT could reasonably be regarded as dispelling the uncertainties highlighted by the issues letter. That question was wholly suitable for evaluation by a court. It involved no policy or political judgment, such as would be regarded as inappropriate for review by the Administrative Court."
Tetra Laval
"Whilst the Court recognises that the Commission has a margin of discretion with regard to economic matters, that does not mean that the Community Courts must refrain from reviewing the Commission's interpretation of information of an economic nature. Not only must the Community Courts, inter alia, establish whether the evidence relied on is factually accurate, reliable and consistent but also whether that evidence contains all the information which must be taken into account in order to assess a complex situation and whether it is capable of substantiating the conclusions drawn from it. Such a review is all the more necessary in the case of a prospective analysis required when examining a planned merger with conglomerate effect."
The Tribunal's approach
"If a judgment requires, before it can be made, the existence of some facts, then, although the evaluation of those facts is for the Secretary of State alone, the court must enquire whether those facts exist, and have been taken into account, whether the judgment has been made on a proper self direction as to those facts, whether the judgment has not been made on other facts which ought not to have been taken into account."
IX THE TRIBUNAL'S ANALYSIS
1. OVERVIEW
2. THE MARKET CONTEXT
| Table 1 – Market Shares in the contestable sector | Table 1 – Market Shares in the contestable sector | Table 1 – Market Shares in the contestable sector | Table 1 – Market Shares in the contestable sector | Table 1 – Market Shares in the contestable sector |
| 1.1 Independent pharmacies and dispensing doctors in East Anglia | 1.1 Independent pharmacies and dispensing doctors in East Anglia | 1.1 Independent pharmacies and dispensing doctors in East Anglia | 1.1 Independent pharmacies and dispensing doctors in East Anglia | 1.1 Independent pharmacies and dispensing doctors in East Anglia |
| Pre-merger | Post-merger | Post-merger | Post-merger | |
| AAH | 36.6% | Phoenix/EAP | 47.2% | |
| EAP | 33.1% | AAH | 36.6% | |
| Phoenix | 14.1% | UniChem | 13.9% | |
| UniChem | 13.9% | Others | 2.3% | |
| Others | 2.3% | 100% | ||
| 100% | ||||
| 1.2 Independent pharmacies in East Anglia | 1.2 Independent pharmacies in East Anglia | 1.2 Independent pharmacies in East Anglia | 1.2 Independent pharmacies in East Anglia | 1.2 Independent pharmacies in East Anglia |
| Pre-merger | Post-merger | Post-merger | Post-merger | |
| AAH | 52.8% | AAH | 52.8% | |
| UniChem | 22.9% | UniChem | 22.9% | |
| EAP | 14.2% | Phoenix/EAP | 21.3% | |
| Phoenix | 7.1% | Others | 3.0% | |
| Others | 3.0% | 100% | ||
| 100% | ||||
| 1.3 Dispensing doctors in East Anglia | 1.3 Dispensing doctors in East Anglia | 1.3 Dispensing doctors in East Anglia | 1.3 Dispensing doctors in East Anglia | 1.3 Dispensing doctors in East Anglia |
| Pre-merger | Post-merger | Post-merger | Post-merger | |
| EAP | 59.4% | Phoenix/EAP | 83.1% | |
| Phoenix | 23.7% | AAH | 14.2% | |
| AAH | 14.2% | UniChem | 1.5% | |
| UniChem | 1.5% | Others | 1.0% | |
| Others | 1.0% | 100% | ||
| 100% | ||||
| Table 2 – Market Shares: All pharmacies and dispensing doctors in East Anglia | Table 2 – Market Shares: All pharmacies and dispensing doctors in East Anglia | Table 2 – Market Shares: All pharmacies and dispensing doctors in East Anglia | Table 2 – Market Shares: All pharmacies and dispensing doctors in East Anglia | Table 2 – Market Shares: All pharmacies and dispensing doctors in East Anglia |
| Pre-merger | Post-merger | Post-merger | Post-merger | |
| AAH | 44.8% | AAH | 44.8% | |
| UniChem | 25.9% | Phoenix/EAP | 28.0% | |
| EAP | 19.5% | UniChem | 25.9% | |
| Phoenix | 8.5% | Others | 1.3% | |
| Others | 1.3% | 100% | ||
| 100% |
| £ million | |
| Independent Pharmacy | 147 |
| Multiple Pharmacy (Lloyds, Moss, Rowlands, Boots) |
151 |
| Dispensing Doctors | 105 |
| Supermarkets | 26 |
| 451 |
That gives a total value for the 'independent' sector of some £252 million, of which £147 million is independent pharmacies and £105 million dispensing doctors.
3. ANALYSIS OF UNICHEM'S SUBMISSIONS
A. GENERAL
"1. The merger will reduce from four to three the number of Full-liners serving the East Anglia Region. This change in market structure may result in a loss of competition between the parties and may also contribute to reduced incentives for the remaining players to compete as strongly as before. There is therefore the risk that the merger may lead to a lessening in competition in which all firms find it profitable individually to offer less favourable terms or lower their level of service.
2. In terms of customer base, both parties tend to mainly supply Independent Pharmacies and Dispensing Doctors and so compete for the same customers. In the East Anglia Region, the parties will have a combined share of supply of 21% to Independent Pharmacies and 83% to Dispensing Doctors. AAH and UniChem by contrast compete more actively in the supply to multiple pharmacies and supermarkets. Therefore for Dispensing Doctors, at least, the parties may represent each other's next best alternative.
3. The merger may create a monopoly in certain parts of East Anglia where neither AAH nor UniChem can provide an effective service. AAH and UniChem are at a disadvantage geographically and, as noted above, have a different customer focus. They therefore may not provide as strong a competitive constraint on the parties as do the parties on each other. In terms of the level of service offered (particularly cut-off times for twice daily deliveries) the offering provided by EAP may be likely to be the next best alternative for a Phoenix customer and vice versa.
5. The merger may increase the prospect of the remaining three Full-liners in the East Anglia Region tacitly or explicitly coordinating their behaviour. This might occur either through geographic market sharing or through coordination on the level of discounts or service.
6. In summary, concerns arise that the merger may create a substantial lessening of competition in the supply of Ethicals to Customers in the East Anglia Region resulting in the lowering or removal of discounts, lower service levels, and the offering of less favourable terms."
(1) That the change in market structure resulting from the merger will not only lead to a loss of competition but may contribute to a reduced incentive for the remaining players to compete as strongly as before. There is a risk that all firms would find it profitable individually to offer less favourable terms or lower their level of supply.
(2) AAH and UniChem compete almost entirely in the supply to multiple pharmacies and supermarkets, and that the merging parties are each other's closest competitors for dispensing doctors.
(3) There may be a monopoly in parts of East Anglia where UniChem and AAH cannot provide an effective service. AAH and UniChem are at a disadvantage geographically and have a different customer focus. In terms of the level of service (particularly cut-off times) EAP and Phoenix are each other's closest alternative.
(4) There may be a risk of AAH, UniChem and Phoenix/EAP tacitly coordinating their behaviour.
B THE MAIN FACTUAL ISSUES
(a) whether UniChem is or would be capacity-constrained in adding new customers to existing routes, and the difficulties allegedly involved in adding extra drops to existing routes or adding new routes;
(b) whether UniChem's existing pattern of success shows that UniChem is or is likely to be a credible competitor in the parts of East Anglia north of the A14;
(c) whether any conclusions can properly be drawn from the spreadsheets supplied by Phoenix/EAP to the OFT, in particular as to cut-off times and whether service levels deteriorate with distance from the depot; and
(d) the correctness of the OFT's conclusions as regards dispensing doctors.
(a) The issue of capacity constraints
"the OFT considers that [AAH and Unichem] should indeed be able to offer a pharmacy near an existing route a service at negligible marginal cost since they already make drops in the area" (paragraph 33)
"in the outlying North and Eastern areas of East Anglia, both competitors deliver to tied chains and supermarkets in these areas already. It should therefore be relatively easy and cost effective to add one or more drops to an existing 'round'." (paragraph 34)
"AAH and Unichem are relatively well placed to compete for business throughout East Anglia by virtue of their full size depots and the network benefits they gain from existing customer density, and from customer clusters over longer distances. It therefore seems that any customer of the merged entity could switch to AAH or Unichem (or in the West of the region, Mawdsley Brookes)" (paragraph 36)
"A dispensing doctor is essentially another drop on the route, so if AAH and Unichem are supplying pharmacists in the region, there appears to be no reason why they should not be able to add dispensing doctors to their existing route network." (paragraph 38)
"Further barriers exist at the route level, where the parties estimate that in order to make a new route in a new geographic are viable, the route needs to carry a turnover of approximately £150k per month (equivalent to 5-6 customers) in order to break even. However, the parties maintain that all full-liners use sophisticated routing software to optimize their networks. As a result, the addition of a new customer to the network will typically be followed by a re-organization of the entire route network. The marginal cost of supplying a new customer, where existing customer drops are nearby, should therefore be very low. However opening a route in an area where the full-liner has no pre-existing drops (even within the 2-hour drive time radius) is likely to carry a higher incremental cost." (paragraph 43)
(b) UniChem's existing pattern of success
(c) The spreadsheets
(a) the spreadsheets showed that "there was not necessarily any significant deterioration in order cut-off times as the distance of the customer from the depot increases"; and
(b) the spreadsheets showed that "UniChem served customers in the outlying areas of East Anglia with a twice-daily service that was competitive with the service provided by EAP" (Priddis, 103(d) and (e)).
"37. Customer responses in relation to this case indicate cut-off and delivery times are one of a number of aspects to service quality customers value highly. Other important factors cited by customers, that do not vary with geography include; customer service levels, order accuracy, flexibility, discounts and friendliness of staff."
(d) Dispensing Doctors
"It is unlikely that UniChem would consider it worthwhile to target supply to dispensing doctors, faced with significant cost of introducing new, long van routes to sparsely populated rural areas with little likelihood of being able to generate meaningful market share growth." (paragraph 5.8)
C. UNICHEM'S SUBMISSION AS TO A FAILURE OF PROCEDURE
D. OVERALL ASSESSMENT
Christopher Bellamy Graham Mather Paul Stoneman
1 April 2005
Registrar
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Note 1 Most recent financial information available to the Tribunal. [Back] Note 2 It appears, from the spreadsheets submitted to the Tribunal, that the references to “Mawdsley Brookes” in this paragraph may be an error and that the reference should have been to “Maltbys”. [Back] Note 3 EAP is referred to as “Hawk” in the key to the map at Appendix 1. [Back]
