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Davids Holdings v Attorney-General and QIW

[1994] FCA 1039; (1994) 49 FCR 211; (1994) ATPR 41-304

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Facts

QIW Retailers Ltd (QIW) and the Attorney General of the Commonwealth, each brought proceedings against Davids and its subsidiaries in respect of a proposed acquisition. At trial, Justice Spender granted the applications, declaring that an acquisition by Davids of the issued shares in QIW would contravene s 50 of the TPA. Davids Holdings Pty Ltd (Davids) and the second to tenth appellants (subsidiaries of Davids) appealed against these orders.

Justice von Doussa described the companies and their activities as follows (my emphasis):

  • 'Davids is the holding company of a group of companies whose principal activities are the wholesaling and distribution of a range of grocery products and liquor in Victoria, New South Wales and Queensland.' (para 2)
  • QIW is the holding company of a group of companies whose principal activities are the wholesaling and distribution of a similar range of grocery products in Queensland and northern New South Wales' (para 2)
    • 'The main operating subsidiary is Queensland Independent Wholesalers Limited.' (para 9)
    • 'QIW has cooperative attributes in that approximately 25% of its shares are held by independent retailers.' (para 9)
  • 'Davids and QIW compete fiercely for the business of independent retailers in Queensland and northern New South Wales.' ' (para 2)
  • 'Independent retailers are those retailers of grocery products other than the three national chains of stores carrying on business in Queensland and northern New South Wales, namely Coles, Franklins and Woolworths.' (para 2)

The proposed takeover was described as follows (para 3 von Doussa):

"Following completion of the takeover scheme and subject to requisite shareholder approval, Davids proposes to procure the merger of QIW and Davids group's existing Queensland grocery and liquor distribution and cash and carry operations (Davids Queensland). The merger would be effected by QIW purchasing the business operations of Davids Queensland. Davids does not propose to redeploy QIW's fixed assets.

Davids will thus continue QIW's business and will seek to enhance its capacity to service both QIW's existing customers and an expanded customer base. The merger of the business of Davids Queensland with the business of QIW is expected to result in improved service to QIW's customers as a result of access to the Davids Queensland general merchandise range and the inclusion of liquor in QIW's cash and carry range."

Note: Davids was the forerunner to Metcash. The takeover of QIW and CBL was completed in 1996. The company name changed from Davids Limited to Metcash Trading Limited in September 2000. In 2011 the Federal Court once again considered the appropriate market definition for a merger involving Metcash - in this case it related to a proposed acquisition of Franklins stores. In assessing the market in that case the court rejected the claim that there was a separate market for the wholesale supply of packaged groceries to independent supermarket retailers. See Metcash.

 

The law

At the relevant time the dominance test still applied to the consideration of mergers in Australia (this was the case notwithstanding that after the takeover proposal was made changes to the law resulted in Australia converting to a lessening of competition test):

50(1) "A corporation shall not acquire, directly or indirectly, any shares in the capital, or any assets, of a body corporate if:

(a) as a result of the acquisition, the corporation would be, or be likely to be, in a position to dominate a market for goods or services..."

 

Held (Trial Judge)

Justice Spender

At trial, Justice Spender granted applications by QIW and the Attorney General, declaring that the proposed acquisition by Davids of the issued shares in QIW would contravene s 50 of the Trade Practices Act (TPA). His Honour also restrained Davids from acquiring a majority of the issued shares of QIW.

In the course of his judgment he held that 'the relevant market for the purpose of s50 was the market for the supply of grocery products by independent wholesalers to independent retailers in Queensland and northern New South Wales, that the market was a substantial one, and that if the takeover proceeded the merged Davids - QIW entity would, or would be likely to, dominate the market. ' (para 6, von Doussa)

See trial judgment page

 

Held (Full Court)

Justice von Doussa

On the issue of market definition

The trial judge defined the market as 'the market for the supply of grocery products by independent wholesalers to independent retailers in Queensland and northern New South Wales' (para 6).

Davids challenged the trial judge's market definition as too narrow, contending that it 'should have been defined as the market for the supply and distribution of grocery products to consumers in Australia, or alternatively in the geographic area consisting of the eastern mainland States of Australia.' (para 7). This would include wholesale and retail levels of activity.

Justice von Doussa noted that, for the most part, the trial judge's findings of fact were not challenged on appeal, but rather counsel challenged the weight given to some of the facts and inferences drawn from them.

In relation to the operations of QIW, Justice von Doussa noted

(para 10) 'Although the major activity of QIW is the wholesaling of groceries to independent retailers in Queensland and northern New South Wales, it also has not insignificant retailing activities. The groceries which are supplied by wholesale comprise an extensive range of staple household and domestic stores and merchandise. ... QIW also provides independent retailers who own and operate their own retail businesses with a range of services and support intended to assist in developing the businesses, business skills, market share and profitability.

(para 11) 'QIW carries on its operation through seven operating divisions: a Central Distribution Warehouse Division; a Variety Division; a Food Services Division; a Cash and Carry Division; a Refrigerated Food Division; a Fruit and Vegetable Division and a Retail Operations Division. Each of these Divisions operates as a separate profit centre. ...'

(para 14) 'QIW has close to 800 customers who are independent retailers. Those customers comply, generally, with warehouse minimum quantity order requirements. In addition the warehouse supplies QIW Cash and Carry warehouses and QIW operated retail outlets operated by the Retail Operations Division. The average order size is 3 to 4 pallets. There are usually about 70 cartons to a pallet, and palleted orders have an average wholesale value of $1,000 per pallet. ...

(para 15) 'The great majority of orders from independent retailers are received by an electronic ordering system known as TEOS (Tickle's Electronic Ordering System) which operates 24 hours a day by means of a coded telephone message. ...

(para 16) Approximately 200 carriers are loaded each day at the Rocklea Warehouse. By volume approximately 25% of the orders are for the Queensland metropolitan area, 60% for the Queensland country area, 10 to 12% for northern New South Wales and 2 to 3% for the Northern Territory and Thursday Island. The stores in New South Wales are predominantly north of a line through Port Macquarie, although there are some stores south of that line and as far west as Bourke supplied from Rocklea.

His Honour went on to describe, in more detail, the operations of the relevant divisions and then observed (at para 36):

Davids is the only other wholesale supplier to independent retailers in Queensland and northern New South Wales of a range of grocery products comparable to the range supplied by QIW to its customers.

His Honour noted (para 38) that Davids' initial operations in Queensland market ran at a loss for approximately 18 months before becoming consistently profitable. The trial judge considered this highly relevant to a consideration of barriers to entry in the event of a Davids/QIW merger. His Honour went on to describe the operations of Davids in some detail.

His Honour continued (at para 50)

It is apparent from the foregoing description of the businesses of Davids and QIW in Queensland and northern New South Wales that each is conducting a broadly similar operation. It is common ground that both Davids and QIW offer incentives to independent retailers in that area in an endeavour to have them change the wholesale source of supply. The incentives include such things as store paint-ups, changeover of banner signage, staff uniforms and changeover costs for internal computer labels. In the period from June 1990 to June 1992 the QIW Rocklea warehouse gained 19 independent retailers from Davids, and Davids gained 16 independent retailers from QIW. As the trial judge observed, there is clearly substitution by independent retailers between Davids and QIW as their source of supply.

...

(para 52) It was common ground at trial that grocery products reach the shelves of Australian retail stores in three main ways: (1) by direct delivery by the manufacturer or processor; (2) by delivery by the manufacturer or processor to the distribution centre of a major retail chain which then delivers the goods to its own stores; and (3) by delivery by the manufacturer or processor to the warehouse of a grocery wholesaler who then sells and delivers the goods to retail outlets which are predominantly independently owned. The route trade falls within the first of these categories. Davids and QIW compete in the third category, and in Queensland and northern New Wales do so fiercely as the two participants in that geographical area. The national chain stores fall in the second category.

(para 53) In Queensland and northern New South Wales the national chain stores are Woolworths, Coles and Franklins. Woolworths and Coles each have 76 retail stores in Queensland with distribution centres in Brisbane, and Franklins has 52 retail stores. The retail chains do not wholesale groceries. From the time goods are purchased by the chains from manufacturers until sold at retail to consumers, the products remain in the possession and ownership of the chains. The administrative, accounting and reporting systems operated by the chains for buying, warehousing and distribution are designed for handling large quantities of products in supermarkets and could not handle wholesale transactions of the kind conducted by QIW and Davids with independent retailers. The average distribution from a chain warehouse to a retail supermarket is around 70 pallets compared with the average order of an independent retailer which is around 3-4 pallets.

(para 54) There are significant differences in the purchasing, warehousing and pricing practices between the independent wholesalers and the chains. The chains have a restricted product range determined by the head or State office. Independent wholesalers carry a wider range to meet the requirements of a more diverse customer base. Orders from independent retailers may require a product mix and lines which the chain warehouses could not supply. The chains supply company owned stores only and derive their profitability from retail operations. This contrasts with the operations of independent wholesalers and retail stores supplied by them where each makes separate profits. The locations serviced by chains are limited to the larger population centres. The average store order for retail chains involves larger warehouse picking runs resulting in economies. Because the product range of chains is more tightly controlled, and demand can be more accurately forecast, stock levels can be minimised whereas independent wholesalers must carry not only a wider range but more low volume lines. Stock levels therefore tend to be higher and stock turnover is lower than with the chains.

His Honour went on to discuss some of the other differences in operation between the chains and independent wholesalers

His Honour then considered the testimony of the economists, noting various differences of opinion:

(para 63): Professor Parry and Ms Smith considered that the relevant product and functional dimensions of the market involved the supply of groceries acquired from manufacturers and sold by various means to the public. They considered there should be no market distinction between the wholesale and retail levels of distribution. They included the independent retailers in the same market as Davids and QIW because those companies' dependence on the continued viability of the independent retailers acted as a restraint on the prices which Davids and QIW could charge. They included the chains and the independent retailers in the same market as the pricing and related decisions of each group influenced the other group. This was so, in the view of Ms Smith, even though the small retailers did not compete directly on price but competed indirectly on matters of convenience. They considered Davids and QIW should be treated as if they were vertically integrated with the retailers they supplied; but even if this were not so, Professor Parry considered that the nature of competition at the retail level would flow to the upstream functional level of wholesale distribution, and would have to be considered as part of the competitive pressures affecting participants operating at the wholesale level. They considered the market extended beyond Queensland, but that the exact geographical scope was unnecessary to decide.

(para 64) Dr Williams and Professor Hay considered that the relevant product market is the market for distribution of groceries to retail stores. They considered that as the range of activities undertaken by QIW and Davids is principally wholesaling and distribution, it seems appropriate to confine the functional level of the market to wholesaling and distribution to retailers. However they both considered that the market should include the wholesaling services provided by the chains to their retail outlets. In that market a merged Davids-QIW entity would not be dominant. They considered there should be no division between the wholesaling activities of the independent wholesalers and the chains because markets are to be defined to include all those participants who influence the price and product policies of the enterprise being considered (in this case the proposed merged Davids-QIW entity). Professor Hay stressed that the pricing discretion of the merged entity would be constrained by the fact that the independent retailers are in competition with the chains. He said:

"I am perfectly prepared to accept the wholesale market, but I would include, as players in that market, as participants in that market, the wholesaling operations of the integrated chains. They constrain the ability of the Davids/QIW wholesaler to charge monopoly prices. So there is a market. The only question is whether the wholesale activities of the chains are part of that market, and in my opinion they are...

There will be substitutes at the wholesaling level, but the mechanism by which the substitution occurs will be at the
downstream level. That is it is because the integrated chains will pick up business at retail, that their wholesaling function will increase and take away business from the Davids/QIW wholesaling function. So the substitution is wholesaling for wholesaling. But that substitution takes place because it is driven by the competition downstream..."

Dr Williams considered the geographical scope of the market extended beyond Queensland and was very probably considerably wider.

(para 65) As between themselves, Dr Fallon, Professor Kolsen and Mr Copp reached similar conclusions. They disagreed with the opinions of the other four economists. They considered the relevant market to be the supply by independent wholesalers of a wide range of grocery items to independent retailers in Queensland and northern New South Wales.

His Honour then referred to the judgment of Spender J, who described the relevant principles for determining market and market dominance as described by the Tribunal in the QCMA decision (We take the concept of a market to be basically a very simple idea ...) and observed, at para 66, that Spender J

'was critical of the application of the concepts of close competition and strong substitution by the witnesses called by the appellants as they gave no or insufficient consideration to matters of degree: the degree to which the activities of the chains exerted a restraining influence on the pricing policies of the independent retailers, the degree to which the activities of the chains would exert a restraining effect upstream on the pricing policies of the merged entity, and the degree of pricing freedom or opportunity for reducing services to independent retailers which the merged entity would retain. The same criticisms had been made by Dr Fallon, Professor Kolsen, and Mr Copp whose opinions the trial judge accepted about market identification. Referring to the market which he identified, his Honour said:

"Only within the market so defined is there an area of close competition between firms and significant cross-elasticity of demand and supply. Collectively, Davids and QIW possess a relatively small but nevertheless significant margin within which they may exercise monopoly power to substantially increase
profits. This could be achieved not only by increasing prices, but also ...by not passing on all promotional advantages, increasing minimum quantities from warehouse and thus forcing demand to cash and carry, reducing levels of support facilities, imposing stricter trading terms, and varying service levels and conditions. ... because wholesalers operate on a large turnover but small margin, small increases in prices or decreases in costs translate into substantial profit increases.

It is true that some restraints exist on the ability of Davids and QIW to exercise their market power. In particular, they could not act so as to erode the profitability of the independent retailers to such an extent that they would be forced out of business, as this would have a similarly disastrous impact on Davids and QIW. Indirectly, the retail pricing and product policies of the major chainstores, because they act as an ultimate constraint on the pricing policy of independent retailers, also act as a constraint on the prices Davids and QIW can charge independent retailers without threatening their continued viability. However, the relevant inquiry is whether the existence of these restraints acts as such a significant check on the power of Davids and QIW that it is correct to say that they are in close competition with the independent retailers and the chainstores' retail outlets. In my view, this is not the case. The restraints operating here are of an ultimate nature only, and in this sense restraints exist on the power of all monopolies."

Following from this Spender J held that (para 67)

'after the proposed takeover the merged entity would control the only competitors in the market; transport costs, and State by State distribution systems, would render it impracticable for the independent retailers to obtain their source of supply from interstate; and there is no likelihood that one of the other major wholesalers (IHL, FAL or CBL) would enter the market, at least in the next three to five years. A new entrant would face substantial barriers. There would be high capital costs. A new entrant would need a generic brand and an annual sales turnover in excess of $150 million to be viable. His Honour observed "such a market share would not come easily and the merged entity would have long pockets for a retaliatory price war". The chains do not participate in the wholesale market and his Honour found that it is unlikely that they would do so for several reasons. The warehousing procedures of the chains, and their accounting and distribution systems are incompatible with the procedures and requirements necessary to supply the independent retailers. The evidence is to the effect that the chains would not supply their generic brands, and that they have no intention of wholesaling groceries to the independent retailers with whom they compete for retail custom. The position of the chains has been realistically summarised by senior counsel for the appellants in the course of his submissions:

"The very reason why chains will not supply independents is that they want to drive them out of business and appropriate the market share at retail from them."

Justice von Doussa accepted the market definition identified by the trial judge (para 70) and observed that that market was a substantial one (para 68). His Honour noted, at para 70:

In the present case the process of defining the market involves including participants which compete in the field of actual or potential transactions in which the merged Davids - QIW entity would operate and excluding those which do not. On the above findings there simply are no other competitors besides Davids and QIW in that field, and are not likely to be, at least for some years.

His Honour then considered arguments made by counsel for the appellants, including (at para 71), the submission that

'the trial judge has made a fundamental error in failing to find that independent retailers are in competition in the same market with the chain stores, and in concluding that it is unnecessary for the purposes of the case to decide whether the independent retailers and the major chains participate in a single retail market or in separate markets. It is contended that it should have been held that both groups compete in a single market for groceries at the retail level; and that it would follow necessarily from the finding that the independent wholesalers are constrained by the activities of the chain stores because in a single market at retail if the independent retailers are forced to raise their prices they will lose sales to a corresponding extent to the chain stores. Thus, it is said, there is "perfect cross-price elasticity", and the merged entity will thereby be restrained upstream from exercising monopoly power. It is submitted that if the trial judge had found that the independent retailers and the chains are in the same market at retail, inevitably the proceedings against Davids must fail.'

His Honour concluded (at para 72) that the trial judge did not make the fundamental error alleged and accepted (at para 73) that the conclusion that 'the independent wholesalers and the chain stores are not in close competition at the wholesale level' should be 'upheld as an inference fairly open on the primary facts' and one which is 'strongly supported by the evidence'.

His Honour went on to considered and rejected the other fourteen points argued for the appellant:

  • Failure to appreciate the nature of price competition (para's 75-81)
  • The 'Mason perspective' (para's 82-90) (argument that the TJ 'mistook the significance and place in economic reasoning of the analysis [of Prof Mason] and misunderstood the difference between the theoretical model of perfect competition and practically attainable or workable competition')
  • Cross elasticities between the chain's distribution functions and independent wholesalers (para 91)
  • Application of a wrong test (para 92)
  • A firm exercising a strong constraint might not be a competitor (para 93)
  • Barriers to entry (para's 94-99)
  • The spread of business of Davids and QIW (argument that TJ failed to properly consider this spread) (para's 100-106)
  • Incorrect focus on points of distinction in organisational attributes (para 107)
  • The route trade (failure to consider its significance) (para 108)
  • The perception of business people as to market ambit (argued evidence that QIW considered itself in competition with retail chains) (para 109)
  • There is a functionally over-reaching effect from wholesaler to independent retailer (para 110)
  • Geographic ambit of the market (para 111)
  • The economists' evidence (argument that TJ failed to properly analyse and construe evidence of economic witnesses) (para 112-113)

His Honour dismissed the appeal.

Justice O'Loughlin

Justice O'Loughlin agreed with the reasons given by Justice von Doussa.

Justice Drummond

His Honour agreed with the reasons given by Justice von Doussa and made some additional comments. His Honour noted:

(para 2) The central issue in this appeal is whether the learned trial judge was correct in finding that there was a market for the supply of grocery products by independent wholesalers to independent retailers in Queensland and northern New South Wales. If he was correct in so finding, it necessarily follows that the merged firm would dominate that market, since the only actual or potential wholesalers in it are Davids and QIW.

(para 3) The merged firm would undoubtedly be constrained ... by the existence of the national chains, but only in the sense that there is a limit beyond which the merged firm could not raise its prices to the independent retailers without bringing those retailers into price competition with the retail chains to such an extent that the merged firm would not be able to maintain its own raised prices to the retailers. However, the fact that there are identified constraints upon the pricing activities of the merged firm and of the firms whose merger is under investigation does not mean that the organisations who have that constraining influence must of necessity be included in the market of which those firms themselves form part. ...

(para 4) The evidence, accepted by the trial judge, shows that there is an area of freedom which neither Davids nor QIW now enjoy, but which the merged firm would be likely to enjoy, to raise prices to the independent retailers, before there would be any price competition between those retailers and the chains and a resultant impact on the merged firm itself. ... That QIW had to drop its prices to the independent retailers by from 2%-3% following upon the entry of Davids into direct competition with QIW in 1986 is an indication of the measure of the discretion that the merged firm would be likely to have to charge prices to the independent retailers higher than those that either Davids or QIW can charge them, without itself encountering the effects of price competition between the retailers and the chains. ...

...

(para 9) Whether price rises that are likely to result from a proposed merger are significant to the exercise of identifying the relevant market for the purposes of s. 50 depends in my view on whether the merger will produce detriments to consumers, rather than whether the merger will produce detriments to competitors of the merged firm or benefits to the merged firm that are not available to the merging organisations individually or a net benefit to the community as a whole. Even though attention in this case was properly focused on whether there was a market for the sale of groceries by independent wholesalers to independent retailers in the area in question, and even though the price rises the merged firm could be expected to impose on the retailers with whom it would deal are likely to be small, the fact that such price rises would in all probability be passed on to consumers is a key fact in identifying whether those price rises are sufficiently significant to justify a conclusion that the merger would infringe s. 50.

(para 10) If the price rises identified as likely to flow through to consumers as the result of a merger, being rises which the merging firms could not otherwise sustain individually can be seen to constitute a real or noticeable, as opposed to a trivial detriment to consumers, that will, in my opinion, be sufficient to bring the proposed merger into conflict with s. 50. Whether or not the rises are trivial in the context of this case will require consideration to be given to the magnitude of the rises, the kind and range of goods to which they will apply and the size of the consumer group likely to be affected by them.

(para 11) In my opinion, if the large number of consumers of groceries who buy from the independent retailers can be taxed with a price rise of the order of 2% or so, over the entire range of groceries sold by those retailers which they would not be exposed to but for the merger, that is a sufficient detriment to justify the conclusion reached by the learned trial judge that there is a discrete market whose boundaries comprise sales of groceries by independent wholesalers to independent retailers within the geographic area identified by him.

 

Commentary

  • Rhonda L Smith, 'Merger Policy in Close-Up: QIW and Davids Holdings' (1994) The Australian Economic Review 101-107
    Observing that 'the QIW case shows continued difficulty in dealing with functional aspects of markets, especially where some companies are vertically integrated, while others are not' (p 102, footnotes omitted)
  • Maureen Brunt, 'Issues from the Davids/QIW merger case — a comment' (1995) 3 Competition & Consumer Law Journal 16
    (observing that the courts 'took a narrow, technical view of market definition' and expressing concern that 'the very litigation process may have given rise to a view of the economic processes at work that was both distorted and unduly narrow')
  • J Blunt, R Shafron and B Keneally, 'From Arnotts to QIW - a study of expert evidence in trade practices cases' (1994) 1 Competition & Consumer Law Journal 181
  • George Hay, 'Market definition and market dominance: issues from the Davids/QIW case' (1995) 3 Competition & Consumer Law Journal 1.

 

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