Universal Foods Corporation and Pointing Holdings Limited: A report on the merger situation

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Summary

On 17 August 1999 the Secretary of State for Trade and Industry (the Secretary of State) referred to us the acquisition by Universal Foods Corporation (UFC) of Pointing Holdings Limited (Pointing), UFC having acquired control of Pointing on 19 April 1999. See Appendix 1.1 for the terms of reference.

In the UK the companies overlap in the manufacture and distribution of flavours and colours. UFC’s flavours business in the UK is run by Universal Flavors Ltd (UFL). The market shares of UFL and Pointing are approximately 6.5 per cent and 1 per cent respectively. The merger gives rise to a small increment in market share, and other suppliers are present in the market. We consider that no public interest issues arise in the flavours market.

UFC’s European colour business is run by Warner-Jenkinson Europe Limited (WJE), which is based at King’s Lynn. WJE manufactures and distributes synthetic and natural colours for the food, pharmaceuticals and cosmetics industries. It has manufacturing plants in the UK, the Netherlands and Italy. Pointing’s colour business, based at Prudhoe in Northumberland, manufactures and distributes synthetic colours, mainly for the food industry. It purchases natural colours from manufacturers and modifies and blends them for onward sale.

Pointing has a market share of just under 3 per cent of the supply of natural colours in the UK, all of which comprise colours purchased for resale. WJE has a market share of 12.4 per cent. The merger gives rise to a small increment in market share, and there are other manufacturers and distributors, the largest of which has a market share of just over a quarter. We consider that no public interest issues arise in respect of the supply of natural colours in the UK.

WJE is the largest manufacturer and distributor of synthetic food colours to the UK food industry, with a market share of approximately 51 per cent prior to the merger. Pointing had a market share of approximately 23 per cent. WJE and Pointing competed directly in the supply of basic, unblended colours. WJE also specializes in the production of bespoke colour blends to meet the specific needs of end-users. Pointing produces its own range of proprietary blends but not bespoke blends. Nonetheless, its experience in producing blends made it a prospective competitor for WJE in the production of customized blends.

Following the merger, WJE’s main competitors are Neelikon Food Dyes and Chemicals Limited (Neelikon), Fiorio Colori SpA (Fiorio) and Roha Dyechem Limited (Roha), each of which has managed to acquire a relatively small but significant market share. In the case of Neelikon and Roha, their market shares have been acquired in a relatively short period of time.

Neelikon and Roha manufacture in India, which gives them an advantage over WJE in terms of lower manufacturing costs and, because raw materials are mainly sourced in Asia, transport costs, it being considerably more cost effective to import to the UK a kilo of colour (with a high value to weight ratio) than a kilo of raw materials.

Neelikon colours are distributed in the UK by E&E Ltd (Ellis & Everard), which is a well-established and experienced distributor of colours. Ellis & Everard/Neelikon have a market share of approximately 15 per cent. Fiorio has, until recently, sold in the UK to other manufacturers, distributors and co-suppliers of colours, including Pointing. In 1998 it appointed its own UK distributor. Fiorio has a market share of approximately 7 per cent. Roha colours have been distributed in the UK for the past two years by Caleb Technical Products Ltd (Caleb). Roha and Caleb have recently established a joint venture, Roha Caleb (UK) Ltd (Roha Caleb), which is aimed at penetrating the value-added sector of the market. Roha Caleb’s market share is approximately 4 per cent.

The merger would increase WJE’s share of the UK synthetic food colours market to approximately 74 per cent. It would remove WJE’s main competitor in the supply of basic synthetic food colours in the UK and it would remove a competitor with experience in producing blends and the capability of moving further into the value-added sector of the market, which WJE currently dominates.

Dame Helena Shovelton disagrees with some of the following conclusions on competition effects.

We believe that Ellis & Everard/Neelikon, Fiorio and Roha Caleb have been competing vigorously in the basic colours segment of the market, with some success, and we expect that they will continue to compete vigorously with WJE.

We believe that the acquisition of Pointing has not placed WJE in a position where it is able to raise prices for basic colours. There has been a long-term decline in the prices of basic synthetic colours and the market is relatively static. This suggests that customers will tend to be suspicious of any attempt by WJE to raise prices.

Despite the reluctance to switch suppliers on the part of some customers, they can and do switch. They are also prepared to switch to Indian-produced colours, as is evidenced by the success of Ellis & Everard/Neelikon and Roha Caleb. We do not, therefore, regard either the costs of switching or reluctance to switch as significant barriers to entry.

Many purchasers of colours are large food manufacturing companies, with buyer power, which are well able to negotiate with WJE on price. A number of other significant customers are large flavour houses or other food industry intermediates, some of them multinationals, which might be assumed to have buyer power. There are also smaller customers, which do not have buyer power, and would thus be more dependent upon the availability of competitors to WJE. These customers could, if they do not do so already, purchase via distributors, which in turn are large customers with a degree of buying power.

There are two competitors with lower-cost Indian manufacturing bases. Although Indian-based manufacturers still suffer from a reputational hurdle, we believe that this is being overcome in the case of those who meet EC and US standards, such as Neelikon and Roha. We believe that the success of Ellis & Everard/Neelikon and Roha Caleb suggests that similar overseas-based colour manufacturers should be able to enter successfully the UK market.

We have considered whether the merger would alter WJE’s ability to discriminate between customers by charging different prices for the same colours. The merger would remove an alternative source of colour for customers. Nevertheless, we believe that it would not affect WJE’s ability to discriminate between customers. Those customers with buyer power could rely on their negotiating strength to secure the best price; all customers would be able to obtain quotes from alternative sources, in particular Ellis & Everard/Neelikon, Fiorio and Roha Caleb.

We also considered whether WJE would be able to refuse to supply actual and potential distributors, thereby making it more difficult for them to compete in the supply of basic or blended colours. The merger would remove an alternative source of supply for distributors. Nevertheless, we believe that they would be able to source colours from other lower-cost manufacturers in India and possibly China.

We therefore do not believe that WJE could raise prices, discriminate between customers, or refuse to supply distributors without a sizeable proportion of those customers or distributors switching to other lower-cost suppliers.

We have considered whether, as a result of its enhanced market share, WJE might be able to price aggressively in the short term in order to damage its smaller competitors. We believe that given the price advantages enjoyed by companies such as Neelikon and Roha, and their ability as importers to enter and exit the market with relative ease, such a strategy is implausible. WJE could not hope to pursue such a strategy to a successful conclusion, ie the permanent exclusion from the market of its competitors.

We believe the merger would not place WJE in a position to price aggressively in the short term in order to damage its competitors and to raise prices for basic colours in the long term.

We considered whether the merger would make a difference in the value-added segment of the market. In this sector Pointing was more a potential competitor rather than an actual competitor. WJE already has a very large share of supply in the sector and this is likely to continue for some time, even though Ellis & Everard/Neelikon already compete and Roha Caleb is beginning to do so.

Some food manufacturers purchase basic colours which they then blend themselves. Flavour houses have blending facilities. WJE would be unable to exploit its position in the value-added segment without some significant customers switching to the purchase of basic colours, to blend themselves, or getting blends from flavour houses.

Roha Caleb was concerned that the merger would make it more difficult to build key accounts; it said that WJE was now trying to tie up key customers for longer periods. Basic synthetic colours are essentially commodities which are not sold on the basis of long-term contracts. We do not believe that WJE would be able to tie up a sufficient number of key accounts to make the strategy successful. Given the potential for lower-priced supply from Indian-based manufacturers, and the fact that some companies regard dual sourcing as important, we think it implausible that many customers would agree to long-term contracts with a single supplier.

We accept WJE’s argument that, by increasing the volume of business at King’s Lynn, costs would be reduced and the profitability of the business improved. We conclude that the merger may be expected not to operate against the public interest on the grounds of its effect on employment.

Summary of views of Dame Helena Shovelton

As a result of the merger, WJE could reduce prices to a low enough level, and sustain them at that level for long enough, to cause significant damage to its competitors and permanently damage their ability to compete effectively in the UK market. In the longer term, WJE could raise prices to levels higher than would have been the case if the merger had not taken place. I expect this to be the long-term result of the merger. WJE is part of a large, global company with considerable capital resources. It has the financial ability to act in such a way that, in the short term, it may create a further constriction of competition. I believe this to be probable.

Despite the considerable differences in price between WJE and lower-cost suppliers, companies which purchase colours are reluctant to switch suppliers. In my view, switching both constrains existing competitors and acts as a significant barrier to entry due to: the inertia of customers; and the extreme care needed in today’s sensitive market to ensure that customers remain confident in the contents of the food they purchase. Either of these reasons acts to deter customers from switching.

The UK market for synthetic colours is static. The number of firms competing is diminishing and WJE has, following the merger, a market share of 74 per cent. There is existing overcapacity which will act as a barrier to entry. There has been no European manufacturer enter the market in the last ten years. Indeed some companies have ceased manufacture. Tariffs discourage US companies from entering the UK market.

The combination of price differential and a well-known UK distributor have assisted Neelikon to compete with WJE. Despite its market share, Fiorio is not seen as a major supplier in the market. Fiorio will have to establish its own name and reputation if it is to succeed. This should be possible but it will take a considerable time. Roha Caleb is seeking market share, but told us that it would be happy to be a price follower in the event that prices increased. Its competitive advantage, which is based mainly on lower prices, would be removed in the event that WJE either: operated at a similar level of prices for a sufficiently long period to preclude Roha’s growth; or bought an Indian-based manufacturer and so could operate at a similar level of prices permanently. Roha is seeking to expand its market share and as a global company would be likely to succeed over time, if the playing field was level. It is not.

All other companies mentioned as likely future competitors are Indian or Chinese in origin, have no established UK distribution channel, and are not global companies. Competitors from India and China face reputational hurdles and will have to offer evidence of product quality and conquer the natural inertia among customers.

WJE’s global backing, its reputation for quality, its extensive range of colours, and its value-added approach, provide competitors with a formidable challenge, despite the price differential. With the removal of Pointing as WJE’s biggest competitor the task is even harder.

These competitive hurdles will limit the ability of Neelikon/Ellis & Everard, Roha Caleb and Fiorio to provide sufficient competitive pressure on WJE to avoid a public interest detriment. The number of competitors would be diminished by the merger, which is likely therefore to act against the public interest.

Public interest conclusion

For the reasons given in paragraphs 1.11 to 1.24 we conclude that the acquisition by UFC of Pointing may be expected not to operate against the public interest.

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