SUMMARY OF UNICHEM PLC AND LLOYDS CHEMISTS PLC AND GEHE AG AND LLOYDS CHEMISTS PLC: A REPORT ON THE PROPOSED MERGERS

In January 1996 UniChem PLC (UniChem), one of the two largest wholesalers of pharmaceutical products in the UK and the owner of a chain of retail pharmacies, made an offer for Lloyds Chemists plc (Lloyds), which owns the second largest chain of retail pharmacies in the UK and has in recent years entered the business of pharmaceutical wholesaling. In February 1996 GEHE AG (GEHE) also made an offer for Lloyds. GEHE is the second largest wholesaler of pharmaceutical products in Germany and its wholly-owned subsidiary AAH plc (AAH) is the other large UK pharmaceutical wholesaler. Under two references (see Appendix 1.1) we have to investigate and report on the merger situations arising from these two proposed acquisitions respectively. The proposed GEHE/Lloyds merger fell for consideration under the EC Merger Regulation. The EC Commission agreed to a request by the UK Government to refer back the case for consideration by the UK competition authorities.

UK sales of pharmaceuticals amounted to some 6,400 million in 1995. Of these, around 80 per cent were prescription medicines (known as ethicals) and 20 per cent were over-the-counter (OTC) medicines. Most ethicals are dispensed by retail pharmacies, the rest by hospitals or doctors. There are about 12,000 retail pharmacies with contracts to dispense National Health Service (NHS) prescriptions. They typically also sell a range of other products including OTC medicines, toiletries, baby foods and health foods. The largest retail pharmacy chain is Boots The Chemists Ltd (Boots), with a share of retail ethical sales of 12.6 per cent. Lloyds has 7.8 per cent, UniChem 3.4 per cent and AAH 2.8 per cent.

Retail pharmacies and dispensing doctors are supplied with most of their requirements of ethicals by 19 full-line wholesalers. Most pharmacies use one full-line wholesaler as their preferred or `first-line' supplier and a second to provide a back-up service. The full-line wholesalers comprise two national wholesalers, UniChem and AAH, with 37 per cent and 32 per cent shares of supply respectively, Lloyds with 14 per cent and regional wholesalers which together have 17 per cent. The three leading wholesalers and some of the regionals also own retail pharmacies; in particular two-thirds of Lloyds' wholesale sales are to its own retail chain. Shares of supply to external customers only are 39 per cent for UniChem, 34 per cent for AAH, 7 per cent for Lloyds and 20 per cent for the regionals. (These figures exclude Boots, which obtains nearly all its requirements direct from manufacturers.)

The pharmaceutical market is subject to a great deal of regulation. Demand for ethicals is dependent on what the doctor prescribes rather than price. The pricing of branded ethicals at both wholesale and retail levels is constrained by a voluntary scheme agreed by the manufacturers with the Department of Health (DoH). OTC medicines are subject to resale price maintenance (RPM). Entry into pharmaceutical retailing is subject to control. The DoH determines the payment to retail pharmacies for dispensing NHS prescriptions. In short, normal competitive pressures in many respects do not apply.

There has been a trend in recent years towards concentration in both the wholesale and retail sectors. UniChem and AAH have increased their shares of the wholesale market, while the regionals taken together have declined in number and market share, mainly as a result of acquisition by Lloyds and, to a lesser extent, UniChem. Nevertheless there is evidence that the regionals which remain have on average been increasing their sales and profits more quickly than the nationals. In retailing, the proportion of outlets owned by chains of over 50 stores has risen from 20 per cent in 1991 to 28 per cent in 1995.

The wholesale market is sub-national, a key factor being that the twice-daily delivery service to pharmacies which full-line wholesalers provide cannot be economically provided at more than a certain distance from the depot.

Vertical integration has existed in the industry for many years, Boots in particular having always self-supplied its retail outlets. A more recent trend is the rapid increase in the number of pharmacies owned by full-line wholesalers and therefore supplied largely from within the group. This has risen from 419 in 1991 to some 1,820 (including Lloyds) today.

It is against this background that we address the effects on the public interest of the two proposed mergers in turn.

UniChem/Lloyds

This proposed merger would involve UniChem, one of the two leading full-line pharmaceutical wholesalers, with over a third of the market, acquiring the third-largest wholesaler. It would also bring together the second- and third-largest chains of retail pharmacies.

As regards wholesaling, since this market is sub-national we examine the situation in the areas where Lloyds' depots are based case by case. We believe the proposed merger would result in a significant loss of competition in six cases, leading to higher prices and lower standards of service.

As regards retailing, UniChem's national share of the market if this merger were to proceed would be 11 per cent and is not a matter for concern. Competition between retail pharmacies is muted, largely local and confined primarily to service rather than price. We identify a few locations where there is a UniChem outlet and a Lloyds outlet and no other pharmacy, but we believe that any small loss of competition in these cases would be outweighed by some improvement in standards of service resulting from the merger.

We considered whether the enlargement of UniChem's retailing activities by the acquisition of Lloyds' chain of retail pharmacies would enhance UniChem's position as a wholesaler, to the detriment of competition in the wholesaling market. We believe it would not: the merger would not increase the number of retail outlets foreclosed to competition from other wholesalers, nor materially strengthen UniChem's buying power.

We unanimously conclude that the merger would be against the public interest because of the expected adverse effects arising from the loss of competition in wholesaling in the areas around six of the Lloyds depots. The majority of us recommend by way of remedy divestment of the six depots concerned and the full-line wholesaling businesses operated therefrom.

GEHE/Lloyds

This proposed merger would involve GEHE, owner of one of the two leading full-line pharmaceutical wholesalers, with about a third of the market, acquiring the third-largest wholesaler. It would also bring together the second- and fourth-largest chains of retail pharmacies.

As regards wholesaling, again since this market is sub-national we examine the situation in the areas where Lloyds' depots are based case by case. We believe the proposed merger would result in a significant loss of competition in seven cases, leading to higher prices and lower standards of service.

As regards retailing, GEHE's national share of the market if this merger were to proceed would be 10.5 per cent and is not a matter for concern. As noted above, competition between retail pharmacies is muted, largely local and confined primarily to service rather than price. We identify a few locations where there is an AAH outlet and a Lloyds outlet and no other pharmacy, but we believe any small loss of competition in these cases would be outweighed by some improvement in standards of service resulting from the merger.

We considered whether the enlargement of AAH's retailing activities by the acquisition of Lloyds' chain of retail pharmacies would enhance AAH's position as a wholesaler, to the detriment of competition in the wholesaling market. We believe it would not: the merger would not increase the number of retail outlets foreclosed to competition from other wholesalers, nor materially strengthen AAH's buying power.

We unanimously conclude that the merger would be against the public interest because of the expected adverse effects arising from the loss of competition in wholesaling in the areas around seven of the Lloyds depots. The majority of us recommend by way of remedy divestment of the seven depots concerned and the full-line wholesaling businesses operated therefrom.

Concluding remarks

Finally, we draw attention to some important features of the industry which go beyond the scope of the current inquiry. This is a highly regulated industry, characterized by trends towards horizontal concentration and vertical integration. Given the limitations on price competition in the supply of branded ethicals at both manufacturing and retailing levels, competition among full-line wholesalers has a special significance and should be kept under review. The Director General of Fair Trading (DGFT) will no doubt give due weight to the importance of regional wholesalers to competition in considering whether to refer to the MMC any future merger or proposed merger of either of the two national wholesalers with any other full-line wholesaler.

Supplementary notes

Two members, while agreeing with the conclusions summarized in paragraphs 1.13 and 1.18, identify further adverse effects and believe both mergers should be prohibited. Their views are set out in supplementary notes following Chapter 2.

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