Approximately eight months after the announcement of Loblaw Companies Limited's proposed acquisition of Shoppers Drug Mart Corporation, the Competition Bureau (Bureau) concluded its review and reached a consent agreement with Loblaw to resolve certain concerns over the potential anti-competitive effect of the transaction.
According to the Bureau, the consent agreement will "preserve competition in the retail sale of pharmacy products and drugstore-type merchandise in Canada by requiring divestitures in 27 local markets and prohibiting Loblaw from engaging in specific conduct with suppliers." While store divestitures are not uncommon in retail mergers, it is noteworthy the Bureau imposed restrictions on the parties' contracting practices going forward in an effort to address the transaction's impact on suppliers.
On July 14, 2013, Loblaw and Shoppers entered into an agreement pursuant to which Loblaw proposed to acquire all of the outstanding common shares of Shoppers for a total purchase price of $12.4 billion. The combination of Loblaw (the country's largest food retailer) with Shoppers (the country's largest drugstore retailer) would have resulted in a retailer with approximately 2,738 stores and 1,824 pharmacies across Canada.
The Bureau's analysis
In its review of the transaction, the Bureau focused on assessing (1) the potential for Loblaw to exercise market power in its retail operations that could lead to substantially higher prices for consumers; and (2) the impact of Loblaw's market power with suppliers on competition and consumers.
Effects of the merger on consumers
In what the Bureau referred to as its "downstream investigation," it analyzed whether the acquisition of Shoppers would likely create, maintain or enhance Loblaw's market power by enabling it to sustain materially higher prices than those that would exist without the merger.
The first step in this analysis involved identifying the overlapping product categories of the two companies. The Bureau noted that both Loblaw and Shoppers sell prescription drugs, over-the-counter medications and behind-the-counter medications (collectively, the Pharmacy Products), as well as health and beauty aids and drugstore-type foods and cosmetics (collectively, the Drugstore-Type Merchandise).
The second stage of the downstream investigation involved defining the market in which Loblaw and Shoppers compete.
Based on extensive analysis, which included using geomatics software, interviewing market participants, consulting industry experts and examining the parties' internal documents, the Bureau concluded that consumers choose to fill their prescriptions or shop for Drugstore-Type Merchandise based on a number of factors, including convenience, the proximity of a store to their home, and the location of doctors and medical services. Accordingly, the Bureau held that the relevant geographic market for the retail sale of Pharmacy Products and Drugstore-Type Merchandise (collectively, the Overlapping Products) is local.
Local markets—a key consideration
Next, for each local market where the Overlapping Products are sold, the Bureau examined concentration levels using sales data from the parties and many of their major competitors. In addition, the Bureau looked at the extent and nature of effective remaining competition in each local market of concern, which was a key consideration in its analysis.
Based on the above analysis, the Bureau estimated the potential competitive effects resulting from the merger in each local market where the Overlapping Products are sold and, consequently, identified those markets of greatest concern. The Bureau concluded the proposed merger would result in a substantial lessening of competition in 27 local markets for the retail sale of the Overlapping Products. The Bureau also found that entry into these markets by new competitors would not be likely, timely or sufficient to counteract the merger's anti-competitive effects.
As a result, the Bureau entered into a consent agreement with Loblaw pursuant to which Loblaw agreed to sell nine of the pharmacies within its stores to independent operators and 18 of its stand-alone stores to third parties.
Effects of the merger on suppliers
Following the merger, Loblaw will be the largest purchaser in Canada for many of the Overlapping Products. Accordingly, the Bureau's review in this respect focused on the market power held by Loblaw with its suppliers post-merger and the resulting impact on competition.
In analyzing the competitive effects of the merger on suppliers, the Bureau interviewed numerous Loblaw and Shoppers suppliers, competing retailers, buying groups and industry associations. It also reviewed Loblaw's internal documentation with respect to its relationship and interactions with suppliers and obtained advice from economic and industry experts. In the end, the Bureau concluded that Loblaw could exercise market power, and in certain cases would have increased market power, in its dealings with suppliers after the merger.
Compensation for pre-determined profit margins
In its review, the Bureau identified certain agreements Loblaw has in place with suppliers that caused competition concerns in the context of the merger. In particular, the Bureau noted that certain agreements require suppliers to compensate Loblaw for a pre-determined profit margin, where the compensation is calculated using a prescribed method and referenced the advertised prices of competing retailers. The Bureau concluded that if these agreements were extended to product purchases for Shoppers' stores, a substantial lessening or prevention of competition would likely result that would lead to higher wholesale prices charged to the suppliers' other retailers and, in some circumstances, higher retail prices for consumers.
Based on the above conclusion, the Bureau required Loblaw to agree to certain behavioural restrictions in the consent agreement.
Specifically, the Bureau prohibited Loblaw from entering into agreements similar to the above with suppliers for Shoppers' stores for a period of five years from the closing of the proposed transaction. The consent agreement further restricted Loblaw, for five years, from seeking financial compensation from suppliers if the retail price of a product advertised in a competing retailer's flyer is lower than the price of the same product in a Loblaw flyer at the same time. Finally, Loblaw committed, for two years from closing, not to charge penalties related to short deliveries, not to charge new supply chain penalties and fees to suppliers that supply less than $4 million of products to Loblaw and not to require a reduction in the current cost of products from such small suppliers.
Recent press reports have noted the intensified competitive landscape in Canada's grocery industry, and the pressure being felt by suppliers as retailers seek to maintain margins despite offering lower retail prices. Certain grocery suppliers have turned to using minimum advertised pricing programs as a means to preserve their brand equity when faced with retailer discounting (additional details can be found in our recent article, Canadian food fight: producers combatting grocery discounts with minimum advertised pricing plans).
It is against this backdrop that the Bureau recently issued draft Price Maintenance Guidelines that explore when companies can engage in price maintenance behaviour, such as instituting a minimum advertised pricing program. It also explains why the Bureau stated in its press release announcing the Loblaw settlement that its Civil Matters Branch will continue to investigate Loblaw policies, agreements and conduct related to pricing programs with suppliers that reference rivals' prices.
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