Foodstuffs North Island CEO Chris Quin would head the new entity if the regulator approves the merger with the South Island entity. Photo / Michael Craig
ANALYSIS
All interested parties’ cards are now on the table as the Commerce Commission prepares to make a final decision on the proposed Foodstuffs merger, but an independent expert is sceptical that approval will be given.
The market for groceries in New Zealand is already highly concentrated – dominated by Woolworths NZ on one hand and Foodstuffs, divided into North Island and South Island entities on the other.
Foodstuffs, which operates many of the same supermarket banners across both islands, already co-operates across various business areas, including marketing and some purchasing.
But it would like to properly merge its two co-operatives, owned by retailer members, which include many of the country’s best-known supermarket banners (New World, Pak’nSave and Four Square).
(It’s notable that Foodstuffs North Island is listed with the Companies Office as a public limited company, and several academics have raised the matter of the entity’s corporate structure as a concern for the commission.)
Last December, Foodstuffs applied for merger clearance from the Commerce Commission and, after several delays, the regulator is now due to give its decision on October 1.
The commission is responsible for enforcing New Zealand’s competition laws and regulating the grocery market.
In order to grant clearance for the merger, the commission must be satisfied that it will bring about no substantial lessening of competition in the market.
The current political climate – marked by concern over concentrated market power – and matched by a public mood embittered by diminishing household buying power is an odd one in which to seek consolidation.
Edward Willis, an associate professor of law with expertise in competition law, at the University of Otago told the Herald he doesn’t think the merger will receive clearance from the regulator, though perhaps not for the reasons of retail power that shoppers think about.
”While it [the commission] says it has not made up its mind (it has to say this so it doesn’t face allegations of pre-determination) it has set out a range of reasons that this proposed merger is a real problem. I can’t see the merging parties addressing all of these issues satisfactorily,” Willis said.
The key reason, according to Willis, is likely to hinge on competition for the wholesale purchase of groceries from supplier companies: what the commission calls the “upstream market”.
The problem, as Willis described it, is “3-to-2 consolidation in the market for wholesale acquisition of grocery products.”
Essentially, he said, “the commission sees Foodstuffs North Island, Foodstuffs South Island and Woolworths as three competitors buying wholesale goods from suppliers. A merger would reduce the number of competitors for grocery supply to two.
“The commission is really clear in the Statement of Unresolved Issues that it sees this as a structural issue. That’s not really something that can be addressed in submissions [by interested parties] – the structural change is going to happen if the merger goes ahead and that must have a negative impact on competition. There are no behavioural dynamics or incentives in the market that affect this.
”The commission is going to be quite strict on structural issues. Once a merger changes market structure, it can’t really be undone,” Willis said.
The commission could approve the merger with conditions. The agreed sale of assets (divestment), for example, can be an effective way to remedy competition law problems.
Simon “Tex” Edwards, co-founder of the mobile upstart 2degress who has been an outspoken proponent of breaking up the supermarkets, has suggested to the commission in submissions that it use the merger approval process to create some structural separation of Foodstuffs’ businesses.
Willis, however, thought that meaningful divestment would not likely result as part of this commission process.
”The way it would work in practice is for the commission to determine that there is the prospect of a substantial lessening of competition, Foodstuffs would propose a divestment that addresses the specific issues identified, and the commission would approve the merger subject to the divestment taking place.“
”If divestment was realistically on the table, I think this would happen outside of the commission’s merger process to ensure that the deal proceeded on commercial terms,” Willis said.
The Grocery Industry Competition Act of 2022 made a series of new rules aimed at improving industry competition; among them, it established a new wholesale grocery supply regime that obliges both Woolworths and Foodstuffs to wholesale groceries to other grocery retailers, including to direct competitors.
The bill also established an enforceable code to regulate conduct between supermarkets and their often relatively smaller suppliers.
The commission has rebuffed arguments that the GICA improves market competition, such that a change to market structure would no longer be a concern.
On Wednesday, Grocery Commissioner Pierre van Heerden released a damning report on the sector, which found that all three major supermarket groups have increased their margins over the past year, and that profitability has either been maintained or increased.
Willis said that the GICA, “clearly won’t compensate for a loss of competition at a structural level”.
Most submissions to the commission on the merger proposal dealt directly with matters of competition, however, two newly published views warn that a merger could be a precursor to a sale of the entity.
Submissions by three academics called on the commission to both request from Foodstuffs and release to the public key documents related to the ownership and control of Foodstuffs North Island (FSNI).
Lisa Asher, a PhD candidate and sessional academic, and Associate Professor Catherine Sutton-Brady, both of the University of Sydney, raised the issue in a submission that provided a close examination of Foodstuffs’ corporate structure, ownership and control.
The matter was also well canvassed by Robert Hamlin of the Department of Marketing at the University of Otago – the parties filed new submissions late last month.
The academics pointed out that, despite the description of “co-operative” that Foodstuffs’ communications favour, FSNI is identified in the New Zealand Companies Office register as a New Zealand Limited Company.
According to the publicly available documents the academics relied on, FSNI has two kinds of common shares (A, which are voting, and B, which are non-voting), 92% of these are held by the private limited company, Strategic Interchange Ltd.
The balance of these shares is held by store owners.
Less than 1% of FSNI shares are owned by another limited public company, Tetrad Ltd. This company holds a further class, C shares.
As Hamlin put it, C-class shares can carry either “considerable” or “overwhelming” control of FSNI in instances where specific triggering events occur, such as a takeover offer.
Beneficial ownership and control of Strategic Interchange Ltd and Tetrad Ltd isn’t made clear through the publicly available documents.
Both companies have the same four directors (who are also the shareholders): Peter Anderson and John Street, former North Island store owners; Murray Jordan, former CEO of FSNI; and lawyer Martin Wiseman.
The four directors are also listed as the four “Protection and Perpetuation Trustees” in FSNI documents. However, the purpose of the Protection and Perpetuation Trust is unclear as its deed is not public.
Hamlin’s submission notes that the C shares are “clearly designed” to prevent any takeover of FSNI, however, he could see no document that compels the directors to vote against such a move. Without such a safeguard, he said the C shares, “far from blocking any takeover attempt, might actually serve to guarantee its success”.
Foodstuffs South Island, on the other hand, is listed on the Companies Register as a NZ Co-operative company, and its shares appear relatively evenly distributed among a large body of shareholders.
Hamlin, like Asher and Sutton-Brady, expressed concern that the ownership structure of FSNI is opaque to the public.
The Herald asked Foodstuffs to respond to the Asher and Sutton-Brady submission.
A spokeswoman said that FSNI is: “a company registered under the Companies Act, which operates according to co-operative principles enshrined in its constitution and capital structure. Foodstuffs South Island is structured as a co-operative company under the Co-operative Companies Act and operates according to co-operative principles enshrined in its constitution and capital structure.”
She said that both the North and South Island entities are fully New Zealand-owned and that the structure of both is: “built on the principles of shared resources, collective buying and mutual support … as a member-owned and controlled organisation, members (who are also owners) have an important role in the decision-making process”.
The spokeswoman said the members of both the Foodstuffs entities have franchise rights, but they are also co-operative members with “significant influence”.
”Under a franchise model, the franchisor (the original business owner) grants the franchisee (an independent operator) the licence or right to operate a business using the franchisor’s brand, systems, and support,” she said.
The commission has published three successive statements on Foodstuffs’ proposal: a Statement of Preliminary Issues, made in January, a Statement of Issues, made in April, and a Statement of Unresolved Issues made in July.
The statements raise matters related to the merger application where the regulator has yet to be satisfied that it would not substantially lessen competition. In each instance interested parties can both respond to the commission’s statement, and make so-called “cross submissions” on the submissions of other parties (many of the documents were released to the public with redactions).
In general, Foodstuffs and related parties have consistently argued that a merged entity would be more efficient – for example, one head office instead of two, streamlined dealings for suppliers – and that the result of improved efficiency would be better value for customers, including better more innovative products and services, and prices lower than they otherwise would have been.
In its most recent submissions, Foodstuffs focused on its relationship with its suppliers, and emphasised that a merged company would have no incentive to abuse its buying power, since this would reduce competition among suppliers to the supermarkets, and this, in turn, would make it harder for Foodstuffs to buy high-quality goods at a good price.
Foodstuffs has used the Australian economics consultancy HoustonKemp and law firm Chapman Tripp to help it hone its submissions and provide information and views to the commission.
Those backing Foodstuffs include winemaker and distributor Pernod Ricard New Zealand, which said that it expected a merger would provide for more effective operations and greater efficiency, including the benefit of dealing with just one head office.
A submission by Foodstuffs customer service centre employee, Beverley Moore, argued that it would be unfair if New Zealand-owned Foodstuffs was prevented from consolidating to gain efficiencies, especially since foreign-owned Woolworths already enjoys this advantage.
Murray Edridge of the Wellington City Mission also wrote in favour of the merger; he cited Foodstuffs’ extensive help with a “social supermarket”, and noted that another is planned to open soon.
Parties aligned against the proposed merger include: suppliers such as the New Zealand Specialist Cheesemakers Association and the broader supplier group, the New Zealand Food and Grocery Council; the recently formed consumer advocacy group Grocery Action Group and Consumer NZ; the academics Asher, Sutton-Brady and Hamlin, the competition campaigner Tex Edwards and a scattering of others.
A commission spokeswoman said the regulator received 50 submissions on the merger application (these are published on its website). In addition, it conducted 93 interviews to help assess the competition effects of the proposed transaction, she said. These interviewees and their information has not been made public.
The NZFGC noted that, while there is a mix of views among its members, “the overwhelming majority” of those who communicated with the organisation on the matter, feared that the merger would reduce competition for their supplies.
Consumer advocacy group Consumer NZ also focused on the likely loss of competition between supermarkets for the supply of groceries. CEO Jon Duffy told the Herald that his group presented views to the commission in an oral submission, and emphasised that a reduction for buying groups from three to two, would ultimately harm consumers because it would result in fewer grocery suppliers over time.
Consultant Ernie Newman told the commission that merger approval would make what he called “tacit coordination” between Foodstuffs and Woolworths more efficient, and furthermore that the commission would be seen as “toothless” for allowing it.
He also took aim at the co-op’s status quo, whereby the North Island and South Island entities stick to their respective islands and don’t compete in the retail market.
Newman called this “cartel-like conduct”, a point that was echoed by other submitters including Asher and Sutton-Brady and Edwards.
Foodstuffs refutes any such behaviour; a spokesman recently pointed the Herald to a paragraph in the commission’s Statement of Unresolved Issues.
It reads: “We are satisfied based on the evidence before us that there is not a real chance of a counterfactual scenario where the Parties enter each others’ island and compete in any grocery markets. However, based on the evidence before us, we do not consider that there are any arrangements between the parties to not compete, or that prevent them from competing, in any retail grocery markets.”
The commission has also noted that its role in assessing the Foodstuffs merger application is limited to determining whether or not the proposed merger would substantially lessen competition. It has also pointed out that only a court can determine whether a breach of cartel laws has occurred.
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