In the early days of merger review, competition authorities were generally less concerned with the vertical impact of mergers than with the consolidation of market power on a horizontal level. More recently, the tendency has been to apply a more cautious approach in assessing the economic impact of vertical integration – a case in point being the Competition Commission's recent prohibition of the proposed acquisition of Komatiland Forests by Bonheur.
The proposed transaction would have seen the merger of two firms active at various levels of the forestry industry. Although the Commission identified a number of overlapping timber and forestry-related product offerings, it ultimately concluded that none of the overlapping products gave rise to concerns on a horizontal level. Rather, the Commission was concerned with how the merged entity's position in one market might influence its position at a different stage of the value chain. In particular, the Commission was concerned about how the parties' combined presence in the upstream market for the production of saw logs might affect their strength in the downstream market for sawn timber.
If these two markets are viewed in isolation, there would appear to be little cause for concern. In the market for saw logs, the Commission accepted that the parties were not direct competitors, while in the market for sawn timber, investigation indicated a combined post-merger market share of only 15.4%.
According to the Commission, the competitive threat lay in the fact that both Komatiland and controlling members of the Bonheur consortium were vertically integrated operations; that is, they each had the capacity to consume saw logs in-house in the production of sawn timber.
The Commission's economic argument assumes that the merged entity's control of approximately 51% of the total amount of saw logs available in South Africa, translates into the ability and incentive to manipulate competition in the sawn timber market.
According to the Commission, the merged entity could foreclose against other producers of sawn timber, such as independent saw mills, through self-dealing. To the extent that the merged entity remained prepared to supply independent mills, it would be able to raise rivals' costs by increasing the prices for saw log inputs. The Commission concluded that the merged entity would be able to leverage its upstream dominance into a concomitant dominance in the downstream market. This would allow it to increase prices to end users of sawn timber, without fear of competition from rival producers, who would be unable to obtain sufficient inputs to contest the market. This was worsened by the Commission's findings that the local production of saw logs is subject to high barriers to entry while offshore supply is not viable.
The Commission took the analysis a step further in finding that the potential threat to independent millers would negatively affect the public interest, in particular regarding employment, small businesses and local communities. Although the parties alleged a number of efficiency gains, the Commission felt that they were not likely to offset the perceived anti-competitive effects.
The decision serves to highlight the growing importance in merger analysis of an understanding of possible vertical effects. Where a merger includes a vertical component, parties and their advisors should be alive to the potential competitive concerns associated with vertical integration, such as market foreclosure and raising rivals' costs, together with other concerns not highlighted in the Komatiland case (including access to competitors' commercially sensitive information and the facilitation of collusion).
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