Are the High Court and the Commerce Commission in the business of picking winners?

The High Court's judgment in NZ Bus is also important for the evolution of substantive merger analysis in New Zealand. The court's decision:

• highlights how critical it is to define the correct alternative to the deal in question (the so-called "counterfactual"); and
  
  
• marks a further departure from a strict "barriers to entry" analysis in assessing the level of constraint imposed by potential competition by reinforcing that the LET test is the appropriate test for assessing the constraint from potential competitors.

Background

The case centred on the provision of subsidised bus services in the Wellington region. The Greater Wellington Regional Council operates a tender for the operation of subsidised bus services, with those tenders subject to strict rules. 1NZ Bus and Mana Coach Services Ltd (Mana) were the only major operators of subsidised bus services in the Wellington region but with each operating in distinct geographic parts of it.

The counterfactual

In bringing proceedings to stop the acquisition, the Commission argued that competition was only likely to emerge in the geographic parts of the region that NZ Bus operated in if a major overseas or other New Zealand bus company acquired Mana and then used it as a springboard to compete with NZ Bus. In contrast, NZ Bus claimed that competition from Mana would be unlikely to emerge in its part of the region whether the acquisition proceeded or not.

After hearing evidence from industry players, including those identified as potential entrants into the market, Justice Miller accepted the Commission's characterisation of the counterfactual:

"I prefer the view that the counterfactual involves acquisition of the 74% [of Mana Coach Services Ltd] by a substantial entrant that would use it as a springboard to compete in the Wellington regional market, notwithstanding that such a strategy would result in NZ Bus retaliating".2

Barriers to entry and the LET test

It was not enough for the court to simply conclude that a new entrant would acquire Mana in the counterfactual. It was also necessary to conclude that the new entrant would be unlikely to enter in a constraining fashion by an alternative method.

In assessing whether a new entrant could enter de novo, Justice Miller downplayed the importance of defining barriers to entry and establishing that those defined barriers to entry were low. The court preferred to focus on conditions of entry through the lens of the "LET" test.

The LET test asks whether entry:

• is likely;
  
  
• will be of sufficient extent to constrain the merged firm; and
  
  
• will be timely.

The court's judgment reinforces the approach taken by the High Court in Air New Zealand v Commerce Commission 3 and suggests that purchasers cannot simply rely on a dogma of low barriers to entry as an answer to any competition problem. While a lack of barriers to entry is a necessary condition for a finding that the LET test is satisfied, it is not sufficient. All factors that would prevent entry in the next three years must be examined, and a purchaser will need to demonstrate either a history of entry into the market or provide a compelling explanation why entry has not previously occurred but would be likely to occur in the future (i.e. incumbents have been achieving normal returns or conditions of entry that formerly existed have been removed).

When must entry be likely?

The judge rejected NZ Bus's argument the court need not be satisfied that entry was presently likely but only that entry would be likely in response to a price increase or other future change in NZ Bus's behaviour. However, that begs the question: a price increase or change in behaviour relative to what price and what behaviour? Justice Miller held that the starting price and behaviour for that comparison was not today's market price and behaviour. Rather, it will be the price and behaviour that would have occurred in the market if the acquisition did not proceed because:

• he was not satisfied that the current market price was the competitive price there was evidence that Mana and NZ Bus typically did not tender against each other and that there was a correlation between the number of tenders submitted and the winning subsidy price; and



• in the counterfactual new entry would be likely and that would reduce prices compared to current market levels.

Accordingly, Justice Miller stated:

"In this case, in which there is evidence that NZ Bus and Mana already possess market power and the counterfactual involves acquisition by another competitor, the question posed by the LET test is whether and how far prices will fall in the counterfactual relative to the factual. " (emphasis added) 4

Are the court and the Commission in the business of picking winners?

The court's decision reiterates the approach previously taken by the Commission in Decision 558: Fletcher Concrete and Infrastructure Limited/W Stevenson and Sons Limited, where the Commission has declined clearance on the basis that an asset for sale will be used as a staging post to enter an adjacent market. 5

While neither the Commission nor the court should be in the job of "picking winners" where an asset is up for sale, the approach taken by the court and the Commission does place a great deal of emphasis on defining the correct counterfactual in a situation where an asset is up for sale and potential purchasers include an existing player and a new entrant. In this case, the court's conclusion was based on evidence received under oath and tested under cross-examination. We would be concerned if this recent predilection towards "picking winners" was to pervade merger analysis in situations where there was not very clear and corroborated evidentiary support for that approach.

Having said that, neither the court nor the Commission have abandoned an analysis of constraints on market players. It is highly unlikely that the Commission would simply decline to grant clearance on the basis that there is an alternative purchaser not currently present in the market. Nor would we expect the Commission to decline clearance on the basis of a bid by a new entrant where a competitive market already exists and will continue to exist following an acquisition involving incumbents. The additional finding that the alternative purchaser would be unlikely to enter the market absent acquiring the asset for sale would be needed. Of course, following this judgment, an alternative and competing purchaser would be likely to tell the Commission that it required the asset in question to enter the market (or an adjacent market) in which competition was limited.

 

1 For example, the maximum size of any one tender is limited to 22 buses and the maximum time allowed between the tender and the commencement of service is limited to eight months.

2 Paragraph 190.

3 (2004) 11 TCLR 347.

4 This approach accords with that suggested by Professor Steven C Salop who has commented that where the alleged anti-competitive effects include the deterrence of a new efficient competitor: "the proper competitive benchmark should be the price that would prevail after the price reduction caused by the entryIf instead the current price is used as the competitive benchmark, the result might be an erroneous finding of no market power". Salop S "The First Principles Approach to Antitrust, Kodak, and Antitrust at the Millennium" Antitrust Law Journal (2000) Vol 68, pg 187 at 197.

5 In Decision 558 (Fletcher Concrete and Infrastructure Limited/W Stevenson and Sons Limited) the Commission declined clearance for Fletcher Concrete to acquire Stevensons' masonry, precast and readymix concrete businesses. The Commission was concerned with the effect of the acquisition on competition in the upstream duopoly cement market in which Stevensons did not compete and in which Fletcher's was not acquiring any assets. The Commission defined the counterfactual in that case as being a third party acquiring Stevensons and using that downstream business as a method for entering the cement market.

Enquiries and information

For more information on any of the cases, articles and features in Competition Update, please contact one of our team:

Phil Taylor, Partner; Jenny Stevens, Senior Associate; Torrin Crowther, Senior Associate; David Blacktop, Senior Associate