JD Group Limited and Profurn Limited in re: JD Group Limited and Profurn Limited (28/CAC/May03) [2004] ZACAC 1; [2004] 1 CPLR 31 (CAC) (13 January 2004)

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[2004] ZACAC 1
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JD Group Limited and Profurn Limited in re: JD Group Limited and Profurn Limited (28/CAC/May03) [2004] ZACAC 1; [2004] 1 CPLR 31 (CAC) (13 January 2004)

IN THE COMPETITION APPEAL COURT
REPUBLIC
OF SOUTH AFRICA
Case
No. 28/CAC/May
In
the appeal of
JD
GROUP LIMITED
and
PROFURN
LIMITED
Appellants
In
re:
COMPETITION
TRIBUNAL
REPUBLIC
OF SOUTH AFRICA
In
the large merger between:
JD
GROUP LIMITED
And
PROFURN
LIMITED
JUDGMENT
DAVIS
JP:
INTRODUCTION
On
12 December 2002 the Competition Tribunal (‘the Tribunal’)
approved a large merger between appellants (‘JD Group’ and
‘Profurn’)
subject to certain conditions. The effect of the
conditions was that the Profurn and JD components of the merged
entity were not
permitted for a period of three years, to purchase a
lower percentage of their stock from independent furniture
manufacturers than
they had so purchased prior to the merger. In the
Tribunal’s order independent manufacturers were defined as any
manufacturer other
than Steinhoff International Holdings Limited
(‘Steinhoff’).
Appellants
appealed to this Court on 28 May 2003 and the matter was heard on 25
September 2003. At the end of argument, the Court
upheld the appeal
and ordered that the order of the Competition Tribunal should be set
aside and be replaced with an order that the
merger be approved
without conditions. The reasons for this order are now set out.
THE
TRIBUNAL’S REASONS FOR ITS DECISION.
The
merger between the appellants can be briefly described thus:
First
Rand Bank was the controlling shareholder of Profurn with 78,8%
shareholding therein. It entered into an agreement with the
Profurn
Group in terms of which the JD Group, or one of its nominees would
acquire all the subsidiaries of Profurn or all the businesses
of the
subsidiaries as going concerns including the assets and liabilities
or a combination of the subsidiaries, assets and liabilities.
At the time that the Tribunal heard argument on
the proposed merger, the exact mechanism for the transaction had not
been finalised.
In return for the sale, First Rand Bank would
acquire shares in the JD Group as consideration and in turn would
sell 5/6ths of these
shares to a foreign investor Daun et Cie. As a
result of this transaction, First Rand and Daun et Cie would hold
approximately 25%
of the shares in the JD Group. Prior to the
transaction, Old Mutual SA was the largest shareholder in the JD
Group with a 27,26%
stake. As part of the transaction, the JD Group
entered into an interim agreement with First Rand Bank and Profurn in
terms of which
the JD Group would provide, what was described as
‘selected retail expertise and services to Profurn’. The
agreement was approved
by the Competition Commission (‘the
Commission’) and came into effect on 28 June 2002. It was intended
to last until the outcome
of the adjudication by the competition
authorities. On 8 October 2002 the Commission recommended that the
merger be unconditionally
approved.
In
its determination, the Tribunal examined the merger from two
perspectives, namely the horizontal effects and the vertical effects
insofar as they affected the merged firms’ buying power on the
market for the purchase of furniture from manufacturers.
Dealing
with the horizontal effects, the Tribunal noted that there were
essentially three types of stores which were all in the business
of
selling furniture. The first type of store was described as ‘the
mass discount’ store trading in higher volumes and are price
competitive because of low margins. Thus ‘for these reasons mass
discounters operate from large stores usually located in urban
areas
where customer volume densities are more assured, sell on a cash
basis only and offer minimum service’.
The
next type of store was described as the furniture retail outlet. This
type of store is in the hands of chains and are organised
in a manner
specifically targeted to a group of consumers. The JD and Profurn
groups usually target a range of consumers who fall
within consumer
Living Standard Measure (LSM) categories, typically LSM 3 to 4. These
stores are smaller than the mass discounters
but there are more of
them in the market. Within the category of furniture chains there
are at least three broad segments namely
a mass market, a middle
market and a mid/upper market. They sell to the consumer on credit
but, according to the Tribunal, spend
vast resources on creating
models of likely risk and use sophisticated information technology to
assess credit policies.
The
third category of business is the ‘independent’ store which is
neither part of a chain nor a group and is usually managed
by the
owner. Typically, independents constitute single outlet businesses
and the largest type of independent business does not
exceed four
stores. Independent stores vary from being specialist outlets such
as retailers with expensive ‘high tech’ equipment
to general
dealers who sell all forms of furniture.
The
Tribunal had dealt previously with a merger in the furniture market
between the JD Group Limited and Ellerines Holdings Limited
(case No.
78/LM/Jul00). It had then defined the relevant market as: ‘The
relevant market is composed of furniture shops (with a
product mix of
furniture and appliances) directed at credit sales to consumers in
the LSM3-5 category’.
The
merging parties contended in the present dispute that the same market
definition should not be adopted but that the relevant market
was
composed of all furniture and appliance retailers aggregated together
into a national geographic market. The Tribunal did not
make a
definitive finding in relation to the applicable market. It did
suggest that unlike the Ellerines merger, the merging firms
in the
present dispute also had a ‘strong footprint’ in the mass
discount market. The Tribunal found that the independents did
not
act as a counterveiling power to the market behaviour of the chains
and their plurality notwithstanding, they should be excluded
from any
relevant market determination. On this basis and employing the
relevant 3-5 LSM category the Tribunal concluded ‘The
merged firms
have 24,2% of the post merger market. The HHI (Herfindahl –
Hirschman Index of market concentration) is 2113 pre-merger
and 2380
post merger, yielding a change in HHI of 267, suggestive of a
concentrated market’. Viewed accordingly, the Tribunal came
to the
conclusion ‘that it is probable that this concentration would have
occurred even absent the merger’.
The
Tribunal then engaged in an enquiry mandated by section 12 A of the
Competition Act 89 of 1998 (‘the Act’), in terms of which
the
Tribunal is required to determine ‘whether or not the merger is
likely to substantially prevent or lessen competition’.
The
parties had argued that Profurn was a failing firm and hence
contended that the ‘concentration is not the cause of the creation
or strengthening of a dominant position which has a significant
impact on the competitive situation on the relevant market’. See
France v the European Community Commission
[1998] ECR 1-1375.
The
Tribunal held that, although not all the elements of the failing firm
doctrine had been established, ‘we are persuaded by the
evidence
that certain businesses of Profurn would have exited the market if
there had either not been a merger, or if another firm
with a less
competitively adverse profile had been the purchaser’. The
Tribunal concluded that, although the merger would have
increased
concentration and therefore reduced competition in the market
(however so defined), this development would have occurred,
absent
the merger, and accordingly the merger could not be held to be the
cause of the defect of the present state of the market.
Having made
no adverse finding against the parties in respect of the horizontal
aspects of the merger, the Tribunal turned to the
vertical effects
thereof.
The
key issue with regard to vertical effects concerned the role of
Steinhoff, the country’s largest furniture manufacturer. According
to the Tribunal, it was common cause that Steinhoff was the dominant
firm in manufacturing of furniture as well as in the bedding
industry. It cited figures provided by the independent firms to the
effect that Steinhoff enjoyed 54% of this market.
The
Tribunal then engaged in an analysis of the evidence, the key
conclusions of which were:
Steinhoff
was the dominant supplier of bedding and furniture in the South
African retail market.
It
enjoyed particularly close relationships with at least two of the
key chains being the JD Group as well as Relyant.
It
had over the past decade grown dramatically due to a series of
acquisitions while at the same time the role of independent
manufacturers
had declined markedly.
Retailers
had fewer manufacturers to procure core product, thereby inhibiting
their ability to secure best prices and product choices.
Independent
manufacturers were dependent for their survival on preserving the
custom of the chains in order to achieve some economies
of scale and
therefore retain their competitiveness.
The
chains needed to secure high volumes of product and could only so
achieve this at best prices by securing rebates from Steinhoff.
Profurn
was identified by the independents as being one of the chains that
had ‘championed the cause of independent manufacturers’.
Of
all the chains, JD had the closest relationship to Steinhoff.
Within
the merged group it was likely that JD would alter Profurn’s
purchasing powers in favour of Steinhoff and to the detriment
of the
independents. This would lead to a further reduction in the role of
the independents and consequently increase concentration
in the
manufacturing sector.
The
demise of the independent manufacturing sector was likely to raise
barriers to entry to the increasingly concentrated retail
sector.
On
the basis of this reading of the evidence, the Tribunal concluded
that the adverse effect ‘can be remedied by placing conditions
on
the merger – outright prohibition is not warranted’. Pursuant to
this finding, the conditions which had been summarised above
were
imposed by the Tribunal as a condition of its approval of the merger.
APPELLANTS
CASE
Mr
Subel, who appeared together with Mr Blou on behalf of the JD Group,
began his argument by summarising the steps taken by the Tribunal
in
arriving at its decision to impose conditions on the merger:
Steinhoff
dominated the market as defined in that it enjoyed some 54% market
share.
Steinhoff
enjoyed an extremely close business relationship with the JD Group.
Because
of the merger, business would be diverted by Profurn to Steinhoff
from the independent manufacturers which would only increase
the
market share of Steinhoff. This would result in increased prices
charged to competitors, a reduction in the choice of goods
available
on the market and hence an increase in the barrier for entry in both
vertical and horizontal markets.
According
to Mr Subel, all of these steps were flawed. He contended that
Steinhoff’s market share was nowhere near the figure of
54% claimed
by the independent manufacturers and seemingly accepted by the
Tribunal. He referred to a document of 14 November 2002
from the
Competition Commission in which it was calculated that the share of
Steinhoff was in the region of 24.4% for the market
for local
furniture comprising case goods, bedding and upholstery.
Mr
Subel also referred to the cross-examination of Mr Pritchard, and in
particular the latter’s evidence regarding Steinhoff’s
54%
market share. When cross-examined by Mr Pretorius on behalf of
Profurn, Mr Pritchard had no satisfactory answer to the proposition
that Steinhoff’s market share was closer to 20% than the 54% which
he had informed the Tribunal. Mr Subel submitted that, as there
was
no satisfactory explanation from Mr Pritchard or any of the other
witnesses, the Tribunal’s conclusion that ‘Steinhoff is
a
dominant supplier of bedding and furniture to the South African
retail industry’ based upon the figure of 54%, market share had
to
be treated with a considerable measure of qualification.
Turning
to the conclusion reached by the Tribunal that, after the merger, JD
was likely ‘to alter Profurn’s purchasing power
policies away
from independents in favour of Steinhoff', Mr Subel referred to the
only express evidence tendered in relation to the
future purchasing
policy of the merged entity in relation to Profurn Group. This
testimony was given by Mr Strauss of the JD Group,
the relevant
passage of which reads thus:
“
MR
STRAUSS: Sir there is certainly no reason for any one of the
intervenors to feel that we are not going to do business with them.

It is common practice in any industry that you have relationships
with certain suppliers. It is true that JD, on an annual basis,
go
to the major suppliers within a group where we actually sit down and
we plan our projections for the year ahead. In order for
them to be
able to meet our requirements one has to do those things.
And
I’ve stated that before, in terms of the way we run our businesses
and the way we see it going forward, if we take two more
chains,
which is certainly the plan right now and that is Morkels and
Protea/Barnetts as a combined unit, we are going to need
differentiation.
Now we’ve stated that before and there is
certainly no intention that we want to go wholesale and close
accounts. We have not
that intention. It is not our strategy. The
only strategy that we have stated before that we have is that we sell
branded bedding,
and that is the only reason why my friend on my
right, we are no longer doing business with him.”
Mr
Subel suggested that, by contrast to the evidence, the reasoning
employed by the Tribunal to the effect that the JD Group would
shift
Profurn’s purchases away from independents and to Steinhoff, was
based on nothing more than speculation. The key passage
in the
Tribunal’s decision reads thus: ‘Almost all of the intervenors
testified that they had lost the custom of the JD Group
presumably to
Steinhoff. Profurn, in contrast to JD, was a chain that purchased
overwhelmingly from the independents. Their underlying
fear was
therefore that post merger, the merged entity would favour Steinhoff
at their expense given JD’s current purchasing policies.
Despite
the party’s insistence that in order to maintain the Profurn stores
brand awareness they would be compelled to continue
sourcing supplies
from the independents, we are not convinced that the intervenors
fears are unfounded’.
Never
were any of these difficulties put expressly to Mr Strauss nor was Mr
Strauss asked about the consequences of conditions to
be imposed and
which the Tribunal ultimately did impose nor did the Tribunal in any
way deal with the fact that JD was in no contractual
relationship
with Steinhoff and hence that a ‘close business relationship’
could not be equated with a series of contractual
obligations which
would have imposed a duty upon the JD Group to ensure that Profurn
secured its product from Steinhoff.
Mr
Subel also referred in the finding of the Tribunal that: ‘We are
persuaded by the evidence that certain businesses of Profurn
would
have exited the market if there had either not been a merger or if
another firm with a less competitively adverse profile had
been the
purchaser’. Without the merger, it appeared that at least three of
the four Profurn chains would have ceased operations
which would have
placed the independent manufacturers in precisely the same position
as they would have been, absent the merger.
There was no evidence
provided by the independent manufacturers which gainsaid the
contention that, absent the merger, the independent
manufacturers
would have suffered serious consequences in their ability to sell
their products.
EVALUATION
In
my view, there are significant further defects in the reasoning
employed by the Tribunal in addition to those set out by appellants.

Although the Tribunal engaged in some detail with the definition of
the appropriate market, it ultimately desisted from providing
a clear
finding, concluding that ‘Because we make no adverse finding
against the parties in respect of the horizontal aspects of
the
merger, it is unnecessary for us to come to some definitive
conclusion on the boundaries of the relevant market’.
That
may well have been a satisfactory side step if the dispute had
turned exclusively on the horizontal aspects of the merger. Once
the
Tribunal was required to engage with the significant vertical
implications of the merger, clarity in respect of the definition
of
the market was clearly required.
This
problem of market definition is not only common to South Africa. In
France v The Commission
(case No.68 – 94, C –34/35, a
judgment of the European Court of Justice given on 31 March 1998) the
court states ‘A proper definition
of the relevant market is a
necessary precondition for any assessment of the effect of
concentration on competition’. Similarly,
in a case which has been
cited often by this Court and the Tribunal,
Brown Shoe Company v
United States
[1962] USSC 112
;
(1962) 370 US 294
, the court held ‘Thus as we
have previously noted: ‘determination of the relevant market is a
necessary predicate to a finding
of a violation of the Clayton Act
because the threatened monopoly must be one, which will substantially
lessen competition within
the area of effective competition.
‘Substantiality’ can be determined only in terms of the market
affected’. See also
Lantec Inc v Novell
(146) F.Supp 2d
1140.
The
absence of clarity in respect of the appropriate market then leads to
the further difficulty with the reasoning employed by the
Tribunal.
The Tribunal acted in terms of section 12 A(1)(a) which provides:
Whenever
required to consider a merger, the Competition Commission or
Competition Tribunal must initially determine whether or not
the
merger is likely to substantially prevent or lessen competition, by
assessing the factors set out in subsection (2), and –
(a) if it appears that the merger is likely to
substantially prevent or lessen competition, then determine –
(i) whether or not the merger is likely to result in any
technological, efficiency or other pro-competitive gain which will
be greater
than, and offset, the effects of any prevention or
lessening of competition, that may result or is likely to result from
the merger,
and would not likely be obtained if the merger is
prevented.
From
the wording of this section it appears that the Tribunal, prior to
having imposed any condition on an approved merger (or in
the case of
the prohibition of a merger) should have considered whether, having
found a substantial lessening of competition, there
were efficiencies
that offset the substantial lessening of the competition. This
approach was accepted in the judgment of this Court
in
Schumann
Sasol S.A.(Pty) Ltd Price Daelite (Pty) Ltd
(case No.
10/CAC/Aug01) which cautioned against speculation unconnected with
the record of evidence and where the judgment referred
with approval
to the case of
Alberta Gas Chemicals EI du Pont de Nemours
F
3d 1235 (3
rd
Circuit)(1987) at 1244.
There
is also very little in the way of justification provided by the
Tribunal with regard to the specific nature of the conditions
imposed
by it. The manner in which the conditions were framed appears to
prevent the JD Group from making buying decisions in accordance
with
its best commercial interests and would seem to have been imposed not
to protect other retailers from undesirable consequences
of the
merger but to protect a group of suppliers against competition from
Steinhoff.
The
difficulty with the conditions imposed can be illustrated thus:
If
the independent manufacturers are unable to deliver sufficient
products to the JD Group during the so-called ‘Christmas rush’
(October to December) the JD Group may well be precluded from making
up the shortfall by purchasing from Steinhoff. If the JD Group
does
seek to increase its purchases of a Steinhoff line of products that
is selling particularly well, it would be required to cut
back on
other Steinhoff products so as not to exceed the permitted Steinhoff
ratio. If a Profurn chain closes, which the Tribunal
found would
have been likely to have occurred in respect of at least three of the
Profurn chains but for the merger, the proportion
of stock that the
other chains must purchase from independent manufacturers would
escalate dramatically because they would be required,
in terms of the
imposed conditions to assume the obligations of the closed stores
purchases from the independent manufacturers.
This could have the
effect of reducing the purchases from Steinhoff to nothing, with
serious consequences both for Steinhoff and
for the remaining chains
which would be obliged to buy uncompetitively priced products,
thereby placing their business at risk.
A
further concern pertains to the position of Steinhoff which was not
placed in a position whereby it could respond to the possibility
of
conditions being imposed by the Tribunal. Whatever indication may
have been given to the Tribunal by Steinhoff’s representative,
Steinhoff were never notified of the proceedings regarding the order
being made which affected their interest regarding the possibility
of
conditions being imposed. The very nature of the conditions so
imposed necessitated Steinhoff being afforded an opportunity of
making duly considered representations prior to the final decision by
the Tribunal.
CONCLUSION
The imposition of a series of conditions as
occurred in the present case, requires at the, very least, a rational
justification based
on the evidence presented to the Tribunal. In
the present case, the Tribunal was not able to point to any clear
evidence which justified
the imposition of the conditions so imposed.
The best that was offered by the Tribunal in the form of an
explanation was the speculation
that, given a previous buying pattern
by the JD Group in respect of Steinhoff products, and the close
relationship between these
two groups (which was not contractual in
nature) it was reasonable to infer, the evidence of JD Group’s Mr
Strauss and Mr Sussman
notwithstanding, that significant changes in
purchases, away from the independents and towards Steinhoff, would
inextricably take
place.
The
Tribunal appears to have had an anxiety that some deleterious set of
consequences could follow the merger. It behoved it, on
the basis
of this anxiety, to have considered the record and if necessary to
call for further evidence in order to test whether this
‘anxiety’
of the consequences was justified in terms of sound evidence which,
arguably, could have been obtained by way of questions
to directors
of Steinhoff.
Even
if this evidence had been found and the Tribunal was able to lay a
clearly ascertained foundation for its conclusions, far greater
attention would have had to be given to the formulation of the
conditions so as to ensure that they were designed to restore
effective
competition in the particular market as a result of the
consequences of the merger.
REVIEW
APPLICATION.
Following the decision of the
Tribunal, Steinhoff brought a review application for the setting
aside of the conditions laid down by
the Tribunal, pursuant to its
decision to approve the merger between the JD Group and Profurn.
Mr Rogers, who appeared together with Mr Campbell
on behalf of Steinhoff, contended that the proper approach to be
adopted by this
Court was to hear the appeal first in that, were the
substantive objections to the decision of the Tribunal to be upheld
on the broader
grounds permissible in terms of an appeal, the review
application would be rendered redundant. In support of this
proposition, Mr
Rogers referred to
section 7
(2)(a) of the
Promotion
of Administrative Justice Act 3 of 2000
which requires the exhaustion
of any internal remedy provided for in any other law before judicial
review proceedings may be brought,
the Act provided for an appeal to
this court. The appeal had properly been prosecuted by the appellants
and for this reason it was
proper for the Court to deal first with
the appeal and then only, if necessary, canvass the issues raised in
the review.
After
oral argument, this Court agreed with these contentions advanced by
Mr Rogers and accordingly decided to hear the appeal first.
In the
light of the decision to which the Court arrived, there was no need
to deal any further with the review application.
In
arriving at its decision and in the formulation of the reasons
therefore, this Court derived considerable benefit both from the
heads of argument and oral argument which was advanced by Mr Arendse,
who appeared together with Mr Maenetje on behalf of the
amicus
curiae
the request of the Court. To them this Court owes a
significant debt of gratitude.
Jali
JA & Malan AJA agreed.