SUMMARY OF NV VERENIGDE BEDRIJVEN NUTRICIA AND ENTERPRISES BELONGING TO MILUPA AG: A REPORT ON THE MERGER SITUATION

On 28 March 1996 the Secretary of State for Trade and Industry required us (see Appendix 1.1) to investigate and report on the question whether the acquisition by NV Verenigde Bedrijven Nutricia (NV Nutricia) of the assets of Milupa AG's German business, and Milupa AG's subsidiary companies elsewhere including Milupa Ltd (Milupa), is a merger situation qualifying for investigation and if so whether that situation may be expected to operate against the public interest. We have concluded that the acquisition has created a merger situation qualifying for investigation.

NV Nutricia is the parent company of Nutricia Holdings Ltd (Nutricia), the UK holding company of Cow & Gate Nutricia Ltd (CGN) and SHS Holdings Ltd (SHS). The activities of CGN and SHS (through its operating company SHS International Ltd) include the supply of enteral clinical nutrition (ECN) products. CGN also supplies baby drinks, baby meals and baby milk products. Milupa's activities in the UK overlap with Nutricia's in the supply of all these products.

ECN products

The overlap of ECN products which both CGN/SHS and Milupa supply is very limited. The MMC in their recent report on the Nutricia/Valio (1) merger found that the market was competitive even after the merger between NV Nutricia and Milupa AG. The Group of members responsible for this present inquiry reviewed that finding and agreed that the market is competitive. We do not consider that the merger may be expected to have effects adverse to the public interest in the market for ECN products.

Baby drinks

Nor do we consider that the merger may be expected to have effects adverse to the public interest in the market for baby drinks, given the competition faced by CGN/Milupa from other large manufacturers and strong own-label suppliers, the ready availability of substitutes for baby drinks and the ease of entry for existing soft drink manufacturers.

Baby meals

We have treated manufactured baby meals, which may be wet or dry, as one market worth ,84 million at trade level. CGN (15 per cent) and Milupa (13 per cent) together supplied about 28 per cent of baby meals in the UK in 1995. Heinz/Farley was the market leader with some 53 per cent. The own-label sector, led by Boots The Chemists Ltd (Boots), had a 13 per cent share.

There have been changes in the structure of the market in recent years. In 1994 H J Heinz Company Limited (Heinz) acquired Farley Health Products Limited (Farley) and CGN acquired Robinsons. In addition several new branded and own-label suppliers have entered, indicating that this growing market is attractive to newcomers. The technology and equipment for wet and dry meals are different, but in both cases they are similar to those used to produce other food products, suggesting that for some food manufacturers entry costs would be relatively low.

We take the view that there are virtually no constraints on entry to the market for baby meals by established food manufacturers. There is a strong own-label sector led by Boots, and some branded entry, albeit in niche sectors. The principal retailers of baby meals, ie Boots and the major supermarkets, are powerful purchasers. Parents can switch to home-prepared meals if manufactured products become unduly expensive. We do not consider that the merger may be expected to have effects adverse to the public interest in the market for baby meals.

Baby milks

Baby milks are manufactured alternatives to breast-milk, and are used to supplement or replace breast-feeding for babies up to about two years old. There are two main types of baby milk: infant milk formula (IMF) and follow-on milk (FoM). Most manufacturers also supply baby soya milk. IMF products account for 82 per cent of trade sales and FoM for 12 per cent.

The composition, labelling, promotion and advertising of IMF and the composition and labelling of FoM are regulated. There is no advertising of IMF direct to the consumer. Promotion of IMF to the general public through special displays or free or reduced price samples is prohibited. Parents' decisions about which brand to use tend to be based on perceptions about product quality rather than price, and they are usually advised not to switch brands unless there is a feeding problem, reinforcing strong brand loyalty. Thus there is limited price sensitivity at consumer level.

The market for baby milks, with trade sales of 131 million in 1995, has two sectors-the supply to retailers amounting to two-thirds of total supply, and the supply to the Welfare Food Scheme (WFS) and the National Health Service (NHS) taking the remaining one-third of total supply.

Baby milks are sold through a wide range of retail outlets, including large supermarket chains and other grocers, chemist chains and independent chemists. CGN's five largest retail customers, Boots, Tesco PLC (Tesco), J Sainsbury plc (Sainsbury), ASDA Stores Ltd (ASDA) and Safeway Stores plc (Safeway) accounted for half its sales to the retail sector in 1995.

The National Health Service Supplies Agency (NHSSA) negotiates with each supplier a contract price for supplies to the WFS/NHS, making it by far the largest purchaser of baby milks. Most of these supplies are distributed through the WFS, the great majority in exchange for tokens which are supplied free of charge to families on Income Support. There are also some sales, commonly at half the normal retail price, to families receiving Family Credit (less than 6 per cent of WFS supplies in England). In addition there are some retail sales (with a modest mark-up) through NHS clinics and other welfare food distribution centres (WFDCs) estimated at up to 11 million in 1995.

The NHSSA has over the last three years refused price increases by suppliers of baby milks in the absence of a full cost breakdown for IMF. Thus the price discount for the WFS/NHS compared with prices paid by wholesalers and retailers has been increasing.

The market for baby milks was already highly concentrated before the merger with the two market leaders, SMA Nutrition (SMA) with 44.4 per cent and CGN with 37.5 per cent, holding a combined share of 81.9 per cent. Other suppliers are Heinz/Farley (8.9 per cent), Milupa (7.6 per cent) and Boots and Sainsbury's with own-label products (1.7 per cent). The merger will have the effect of increasing the combined market share of SMA and CGN/Milupa to 89.5 per cent. While there has been market entry by Heinz, Boots and Sainsbury in the past four years, we consider that further significant entry into the market for baby milks is unlikely over the next few years, but that entry conditions have not been changed very much by the merger.

In our view, the possible effects of the merger in the market for baby milks are likely to fall under three categories:

As to (a) above, without the merger the continuation of the Milupa brand in the UK would have been in doubt over the longer term because of Milupa's continuing losses despite a subsidy from its parent company. The vulnerability of the brand in the UK derived from two principal sources: Milupa AG's excessive manufacturing costs in Germany (made worse by unfavourable exchange rates), and relatively high marketing and sales costs associated with its UK baby milk and baby meal operations. Nutricia plans to deal with both problems, the first by transferring the manufacture of Milupa's baby milks to an enhanced manufacturing facility in Ireland, and the second by integrating CGN's and Milupa's marketing and sales operations in the UK. Given the synergies, the merger appears to provide a way of overcoming Milupa's cost disadvantages and thus reducing the vulnerability of the brand.

Nutricia's expressed intentions are to support the Milupa brand and we believe there are strong commercial arguments for Nutricia doing so. We therefore expect the merger to provide a benefit to the public interest by helping to secure the viability of the Milupa brand of baby milks in the UK, a brand valued by parents.

Regarding (b) above, the risk of a reduction in the diversity of research, leading to less innovation, is balanced by the likelihood of more effective research. We do not expect effects adverse to the public interest in this area.

As regards (c) above, we consider that in the retail sector the underlying weakness of Milupa prior to the merger because of its excessive cost structure was likely, without the merger, to require price increases if viability and continuity of the brand were to be ensured. The merger, which overcomes the excessive cost problems, reduces these pressures for price increases. Nutricia will be attempting to build Milupa's reputation as a premium brand, and increases in Milupa prices at a rate faster than appears justifiable to the trade (which consists primarily of large, powerful purchasers) risks being counter-productive. Nutricia's ability to extract price increases for the CGN products is unlikely to be enhanced by the merger, with SMA continuing as market leader and Heinz (number 3 in the market) apparently adopting an aggressive marketing stance. Boots' and Sainsbury's own-label products will continue to put competitive price and shelf-space pressures on Nutricia's products in their stores. Comparatively low prices in WFS/NHS clinics, particularly for Milupa's premium brand, will also exert some downward pressure on retail prices.

Turning to the WFS/NHS sector, we note that the NHSSA is the largest and most powerful purchaser of baby milks. While the Department of Health (DoH) has expressed concern at Milupa falling under the control of Nutricia, we do not feel that the merger is likely to lead to faster increases in prices. Nutricia is unlikely to risk lasting damage to either the CGN or the Milupa brand by withdrawing from the WFS/NHS sector. The substantial bargaining power of the NHSSA in its relations with the baby milk suppliers has been demonstrated by its holding baby milk prices constant over the last three years. This bargaining power is not reduced by the merger. Although it may be reluctant to weaken its policy of providing choice to welfare customers, the NHSSA has the sanction of dropping any particular supplier whose price demands seem unreasonable. Anticipated problems of supplies of a particular brand could be offset by building up temporary stocks from other suppliers, admittedly at some cost. The NHSSA also has the ultimate sanction of purchasing its own generic supplies from international suppliers on tender. This position is not changed by the merger. As in the retail sector, Milupa's underlying weakness prior to the merger because of its excessive cost structure was likely, without the merger, to require price increases in the WFS/NHS sector if viability and continuity of the brand were to be ensured. The merger should not lead to any more rapid increase in Milupa prices to the NHSSA than under an alternative scenario.

We take the view that in both the retail and WFS/NHS sectors of the market for baby milks the merger will be unlikely to have adverse effects on prices.

We conclude that the merger may be expected not to operate against the public interest. One member of the Group, Professor Sam Eilon, disagrees; his views are set out in a note of dissent following Chapter 2.

This report concerns the effects of the merger between NV Nutricia and Milupa AG. The UK market for baby milks was already highly concentrated before the merger and had attracted the attention of the Director General of Fair Trading (DGFT). He decided in 1995 not to make a monopoly reference to the MMC at that time, but informed the principal companies that he would be keeping the matter under review. It is therefore likely that any action by the market leaders (SMA and Nutricia) to raise prices unjustifiably will quickly be brought to his attention.

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