Ryan Hawthorne and Genna Robb, March 2019

A recent merger decision by the Competition Tribunal provides a useful clarification of the importance of economic evidence in an assessment of information exchange. Following a series of Competition Tribunal merger decisions which imposed limitations on cross-directorships post-merger due to coordination concerns [1], the Competition Commission recommended the imposition of a similar condition in a merger in the property sector. After consideration of the economic evidence led, the Competition Tribunal determined that cross-directorships were unlikely to lead to collusive effects in the market in question and approved the transaction without conditions. This reversed a trend of almost blanket application of restrictive conditions relating to cross-directorships in mergers, which often had no basis in the economics of information exchange and coordination.

The transaction in question was part of a series of transactions concerning the establishment of DiverCity, an urban property investment fund focused on investing and developing inner-city precincts and renewing dense urban precincts.[2] The merger resulted in the acquisition of an 18% stake in DiverCity by Nedbank and by RMH Property Holdco 5 which is controlled by entities ultimately controlled by RMB Holdings Limited (collectively referred to as the RMH Group).

The RMH Group had various property investment holdings through stakes in Propertuity, Atterbury and Genesis Capital Three. Nedbank, together with its shareholder, Old Mutual group Holdings (SA), held various commercial, residential and industrial properties, including through a stake in Vestfund. Pre-merger, Propertuity, Atterbury, Genesis Capital Three and Vestfund were the shareholders in DiverCity, with the result that pre-merger, the RMH Group already had an indirect interest in DiverCity. The transaction would result in both Nedbank and RMH Property Holdco 5 acquiring a direct stake in DiverCity and gaining the ability to appoint directors to the board. DiverCity’s property portfolio included two small shopping centres and office and residential property in Johannesburg, Durban and Pretoria.

The Competition Commission found that the merger would not give rise to any unilateral effects in any of the markets in which the merging parties’ activities overlapped. However, it raised a concern with respect to the exchange of competitively sensitive information between the parties to the transaction. It therefore approved the transaction subject to conditions on cross directorships to prevent information exchange between DiverCity and Nedbank and RMH’s other property investments. The Commission did not, however, provide a theory of harm explaining how information exchange would be likely to lead to anti-competitive harm in this case, particularly given its conclusion that the merging parties’ market shares in the various markets were low and in the light of the large number of competitors in the South African property market.

From an economic perspective, the impact of information exchange on competition is ambiguous and depends on market structure and dynamics. In some circumstances, information exchange is pro-competitive, as recognised by the Competition Commission in its draft guidelines on information exchange, including where it leads to: “improvement of investment decisions; improvement of product positioning; provision of organisational learning; facilitation of entering an industry; lower search costs; benchmarking best practices; and more precise knowledge of market demand”. [3] On the other hand, information exchange can also facilitate coordination between competitors, where the market characteristics are conducive to such conduct.

Economic analysis of coordination shows that for a cartel to be sustained it must be in the best interests of each cartel member because each member of a cartel always has some incentive to cheat on the cartel. Each member of a cartel thus weighs (1) the profits from maintaining the cartel arrangement over a period of time against (2) the profits from cheating (deviating from the agreement by undercutting its competitors in order to win a greater share of the market) now and reduced profits in later periods when they are punished.[4] In economics, these are known as the incentive constraints to cartel participation. If these incentive constraints are not met, cartel membership is not in the best interests of each firm concerned. The factors typically considered in an assessment of coordinated effects are linked to these incentive constraints and include the likelihood of reaching agreement, monitoring that agreement and enforcing the agreement. At the most basic level, where there are many outside, non-participants to a potential cartel as is the case in the property sector (and there are many property developers, listed and unlisted property funds, financiers, and other participants in the property sector outside of DiverCity and its shareholders) then coordination will be difficult to reach and sustain. Where products are homogenous and prices are transparent, it is easier for market participants to reach an agreement and monitor it. There is significant product differentiation in property markets, even within particular segments such as retail or commercial property. There are also a range of different types of market participants with different roles and objectives. These factors suggest that the incentives of market participants may not be easy to align.

In a merger transaction, a key question is whether the merger changes any of the market characteristics such that coordination is more likely and therefore a substantial lessening of competition. All of this requires an analysis of economic evidence on a case by case basis.

The Competition Tribunal and Competition Appeal Court debated the economic effects of joint ventures and coordinated effects at some length in the Primedia / NAIL transaction.[5] The transaction resulted in Primedia, the owner of the Highveld radio station, having the right to appoint a director onto the board of NAIL, which partially owned a rival radio station, Kaya FM. After the Competition Appeal Court referred the matter back to the Competition Tribunal, the Competition Tribunal found that a range of factors mitigated against the possibility of coordination in this case. In particular, the Tribunal recognized that in a differentiated market, the different entities involved in a joint venture are likely to face divergent incentives in terms of setting prices which would make a coordinated agreement difficult to achieve and sustain. The Tribunal further explained that “In order to make the case for co-ordinated effects the evidence needed to be stronger than the mere holding of an interest in a rival and the right to appoint a director to its board.”

In a similar vein, according to the ICN merger guidelines, the correct manner in which to conduct an analysis of coordinated effects is first to consider whether the market has conditions which are conducive to coordination, and then to assess whether “the merger will make coordination easier or more likely, considering the specific features of the market that affect the merged firm’s ability and incentives to exercise market power in coordination with rivals.”[6] They explain that “Agencies should focus on whether the merger will materially alter firms’ ability or incentives to achieve and sustain coordination.” Both the ICN and the EC merger guidelines correctly treat information exchange as one factor to be considered as part of a wider coordinated effects assessment, where the characteristics of the market and the ability of firms to reach, monitor and sustain a collusive agreement are to be interrogated in detail as well as the likely impact of the merger on each of these factors.[7]

In the case of the DiverCity merger, the available evidence did not suggest that the market was one in which coordination was likely or that the merger made this substantially more likely. The Tribunal assessed “whether the Commission showed that the acquiring firms each have other property investments that are rivals of DiverCity to the extent that an exchange of confidential information might lead to a collusive outcome.” It concluded that the Commission had not provided evidence that this was the case and approved the merger without conditions. In particular, it found that the exchange of information was unlikely to have a collusive effect as the merging parties’ property assets were differentiated and catered for different market segments.

This case therefore provides a useful reminder that, contrary to some of the recent practice by the competition authorities, information exchange resulting from merger transactions needs to be assessed with regard to economic evidence and cannot be assumed to lead to a substantial lessening of competition absent consideration of the competitive dynamics of the relevant market.

Acacia Economists Ryan Hawthorne and Genna Robb provided expert economic advice to the merging parties in relation to the transaction.

[1] See for example Investec/Assupol, case number LM042May18; ARC/Ooba, case number LM257Mar16; Arrowhead/Synergy, case number LM076Aug16; and, Pembani/Shanduka, case number LM041Jun15.

[2] Case number LM083Jun18.

[3] See ‘Draft Guidelines on the Exchange of Information between Competitors under the Competition Act’, available here.

[4] See, for example: Motta, M. (2004). Competition policy: theory and practice. Cambridge University Press.

[5] See the Competition Appeal Court decision in case number 68/CAC/MAR/07 and Competition Tribunal decisions in case number 39/AM/MAY06.

[6] ‘ICN Recommended Practices for Merger Analysis’ p.23.

[7] ‘ICN Recommended Practices for Merger Analysis’ p.24; EC (2004) ‘Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings’ paragraphs 47 and 51.

 

Sha’ista Goga, November 2018

The rise of online retail internationally has raised an apocalyptic spectre of empty malls, dying city centres, local factory closures and rising unemployment.

It also evokes images of a de-personalised landscape in which electronic orders are processed at automated warehouses and boxes of goods on conveyor belts in China are shipped directly to mailboxes around the world. This, while the international tech giants that facilitate transactions, profit without paying income tax.

But the reality is that while e-commerce is changing the face of retail internationally, it has the potential to enhance consumer experiences and create organic opportunities if we correctly harness it. Appropriate policies for the digitalisation of business are urgently required to make sure the playing field is level and to ensure technological changes open up markets to entrepreneurs.

At present, online retail in SA is small, making up a mere 1% of total retail, while the most developed online markets such as the UK approach 20% of retail spend. This has been attributed to having densely populated markets of customers with fast internet access, credit cards and a willingness to pay extra for delivery.

By comparison, in SA we have a shopping mall culture, concerns over sharing card details online and delivery by an inefficient postal service.

However, local industry is innovating to expand the pool of potential customers. In response to low broadband penetration, companies are investing in mobile shopping apps. Small entrepreneurs are using social media platforms to build their brands and reach consumers. Retailers are integrating store payment cards into online shopping to expand the customer pool. Innovation in the payment space includes instant electronic fund transfers (EFTs) and options including cryptocurrency. Investment in data analytics is increasing.

Many local larger retail groups see omni-retailing or seamless integration of in-store and online experiences as core to their growth plans. Developments in websites are being combined with the digital transformation of other aspects of retail businesses (such as integrated inventory systems). For example, a store may allow customers to check stock of their size at their local store online before going in to try it on.

Online-only retailers are investing substantially and creating new employment. Entrepreneurs have created a plethora of companies that support payment, logistics and software, particularly in segments that service small, medium and micro-sized enterprises (SMMEs). Small businesses have also benefited as barriers to creating websites fall, while the potential to outsource specialised aspects such as payment systems and logistics have risen.

SA has been shielded from international competition by a combination of factors. From a customer perspective there is a disincentive to order from international firms due to weak local postal services, delays due to customs processes and duties that are variable and opaque at point of purchase.

From an international provider perspective, the cost of shipping, small market size, volatile exchange rate and high levels of theft make SA unattractive for direct entry thus far. However, that can and will change as other markets mature.

Entry by companies such as Amazon or Alibaba, which have immense scale, brand, supplier networks and data capabilities could change this balance and move the location of head office employment, taxation and manufacture offshore with repercussions for our tax, employment and local industry. In the absence of steps to inoculate us, these changes could decimate local industry.

SA has not developed into an e-commerce hub for supply to other countries in Africa. This is despite us having infrastructural advantages — ports, rail, and internationally competitive logistics. As such, it is important that the country focuses on smart proactive regulation to support the industry as has been done by countries such as China and Malaysia.

First, we need to protect local companies from unfair international competition. Ensuring that tax policy is set to ensure a level playing field is important, particularly in the face of income tax avoidance by large tech companies, and consumer tax avoidance by suppliers who try to avoid duties by under-invoicing.

The Treasury has led the way internationally in taxing intangible goods, but this needs to be extended. The UK has recently announced a 2% turnover tax on the largest tech companies to address income tax avoidance. It is also important to make tax collection more efficient, especially on large volumes of small value purchases, through digitalisation of tax collection.

Second, public infrastructure that impacts on e-commerce needs to be improved. While payment systems are working well, the Post Office and ineffective telecoms regulation are letting down the team. SA urgently needs cheaper, faster and more reliable data.

Third, policies need to be to put in place to promote use of e-commerce by SMMEs. Practical skills development in e-commerce entrepreneurship and simple information on the required processes and providers is essential to better equip SMMEs to access online opportunities. Investment in coding and science, technology, engineering and mathematics (STEM) skills is integral to the broader industry.

Fourth, proactive policies are needed to enhance outward-facing commerce. This can include incentives for e-commerce investment, and strategic investments in the value chain (as in China and Malaysia). OR Tambo International Airport or the Durban harbour can be developed to create hubs for African e-commerce, providing local industry with a platform for outward expansion. Warehouses for exports could be built, goods that are not entering the country could be expedited for onward travel and we would benefit from employment and investment effects of an e-commerce hub.

Fifth, a united regulatory and policy approach to e-commerce is required with the relevant government departments working in a unified manner to harness the benefits.

Change in retail is coming, and it is still early enough in the game that we can leapfrog rather than being left behind if we move quickly now.

This article was first published in the Business Day on 19 November 2019.