Wessex Water Plc and South West Water Plc: A report on the proposed merger

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On 6 March 1996 Wessex Water Plc (WW) announced its intention to acquire South West Water Plc (SWW). WW and SWW own regulated water and sewerage businesses in the south-west of England, respectively Wessex Water Services Ltd (WWS) and South West Water Services Ltd (SWWS).

WWS is the smallest of the ten water and sewerage companies (WaSCs) in terms of turnover. It supplies sewerage services to around 2.4 million customers in an area of south-west England centred on Bristol, and water services to around 1.1 million customers. The conur-bations of Bristol and Bournemouth obtain their water supplies from two water-only companies (WoCs) in WWS's area of supply. SWWS, whose area of supply is contiguous with that of WWS, supplies water and sewerage services to around 1.5 million customers, principally in Devon and Cornwall.

Under the reference made to us on 21 May 1996 (Appendix 1.1), we are required to decide whether arrangements are in progress which if carried into effect would result in the creation of a merger of two or more water enterprises which is required by section 32 of the Water Industry Act 1991 (WIA) to be the subject of a reference. We are satisfied that arrange-ments for such a merger are in progress.

Sections 32 to 34 of the WIA (Appendix 1.2) make special provisions for references to the MMC of such mergers. Section 34(3)(a) provides that in determining whether such a merger operates against the public interest the MMC `shall have regard to the desirability of giving effect to the principle that the Director's [Director General of Water Services-DGWS's] ability, in carrying out his functions ..., to make comparisons between different water enter-prises should not be prejudiced'. The system of comparative competition by which the water industry is regulated depends upon the DGWS's ability to make such comparisons.

The availability of a wide range of comparative informa-tion about companies' costs and levels of service is important to the DGWS in enabling him both to set prices at each Periodic Review and, between Reviews, to secure higher standards of performance and customer service. The uses which the DGWS makes of comparisons between companies has been devel-oping as the industry has evolved since privatization.

WW emphasized that it would seek to integrate WWS and SWWS under a single appointment as soon as possible. It accepted that, as a result, SWWS would be lost as a com-parator, but argued that this loss would be more than offset by the emergence of an `exemplary comparator' and a comparator more representative of the industry as a whole in terms of size and other characteristics than SWWS. We do not accept this argument. Following the merger, the DGWS would have a comparator at best only as efficient as is WWS now. So far as representativeness is con-cerned, a diversity of size and other characteristics exists among the WaSCs and WoCs, so that the merged company would be no more useful than are SWWS and WWS individually at present.

We consider that this proposed merger, involving as it would for the first time the loss to the comparator system of one of the ten WaSCs, is of a different order to any that have previously taken place in the industry. We consider that SWWS is of substantial value to the DGWS for comparative purposes. This is particularly the case on the sewerage side, where the DGWS already has difficulties in making robust comparisons of operating efficiency with only ten comparators. The loss of SWWS as a comparator would weaken the comparative system across the range of uses to which comparisons are put. We do not, however, think that this loss can be reliably quantified.

Our conclusion under section 34(3)(a) of the WIA is that the loss of SWWS as a comparator would seriously prejudice the DGWS's ability to make compar-isons between different water enterprises.

We considered the cost savings, namely £38 million a year by the year 2002, and other benefits that WW claimed for the merger. A substantial proportion of these savings were unidentified; moreover, SWW claimed that it could make some savings without a merger. It con-sidered that annual cost savings of at most £10 mill-ion a year were possible from the merger, all from head office savings. We conclude in the terms of section 34(3)(b)(ii) of the WIA that the prospec-tive savings and other benefits to be expected from the merger are insufficient to be of `substantially greater signifi-cance in relation to the public interest' than the principle that the DGWS's ability to make comparisons between different water enter-prises should not be prejudiced.

We also considered possible detriments from the merger, apart from that referred to in paragraph 1.8 above, and found that the disappearance of the border between WWS and SWWS which would be a consequence of the merger would reduce the scope for future cross-border competition between water enterprises.

We conclude that the acquisition of SWW by WW may be expected to operate against the public interest, with the particular adverse effects of prejudice to the DGWS's ability to make comparisons between different water enterprises and that future opportunities for cross-border competition between water enter-prises would be reduced.

We are required under section 72(2) of the Fair Trading Act 1973 (FTA), which applies to this reference, to consider what action should be taken to remedy or prevent those adverse effects.

The DGWS submitted that the loss of a comparator could in principle be remedied by a package of measures, which in relation to this case should include an undertaking by WW to make such a substantial reduction in charges to customers across the merged enterprise that it would be forced to move beyond the `efficiency frontier' for the industry and become an exemplary comparator. WW itself did not consider that the level of price reductions suggested by the DGWS was feasible and we are not convinced that WW would be able to make efficiency savings sufficient to enable such reductions to be made.

We take the view that in respect of this proposed merger no remedy, even in the shape of significant price reductions aimed at forcing the merged enter-prise beyond the current effi-ciency frontier, would be sufficient to compen-sate for the loss of SWWS as a comparator. The loss of SWWS as an independent WaSC, providing sewerage as well as water comparisons to the DGWS, would be substantial and would weaken the comparative system permanently. Benefits to customers in the shape of lower prices and better service which might be secured as a condition of the merger would, however, be transi-tory, as the dynamics of the comparative system caused other companies to equal and exceed them over time. We accordingly take the view that no remedy is adequate in this case.

We therefore recommend that the merger be prohibited.

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