Restricting vertical arrangements in the Kenyan vehicle industry
Grace Nsomba
On 29 August 2017, the Competition Authority of Kenya (CAK) approved with conditions the proposed acquisition of Associated Vehicle Assemblers Limited (AVA) by Simba Corporation Limited (Simba Corp). The approved merger sees the acquisition of an additional 50% of the shares in AVA which were previously controlled by Marshalls East Africa Limited (Marshalls).
The case appears to be fairly straight forward. However, the issues raised by the merger pertaining to vertical foreclosure and the setting of access conditions are relevant for similar cases being considered by authorities, particularly in a developing country context where there is likely to be high concentration at the downstream or upstream level. Simba Corp, an integrated multi-sector business group with diversified interests in automotive and generator distribution, real estate and hospitality; set out to acquire full control of a company it already had business interests in on a going concern basis. The entity expressed that the key driver of the transaction was Marshalls’ lack of capacity and its unwillingness, as a partner, to make investments within the AVA business. However, there were foreclosure concerns as the AVA business serves as an assembly plant for third party vehicle assemblers other than Simba Corp.
Simba Corp distributes, services and sells parts of vehicles, while AVA engages in the assembly of commercial motor vehicles including trucks, buses and pickups. There is an existing vertical relationship between Simba Corp and AVA, particularly because AVA assembles two brands of vehicles for Simba Corp. The AVA assembly plant prior to the acquisition was open to third party vehicle assemblers such as Tata and Scania. The acquisition therefore raised concerns over third party market foreclosure over the use of the plant and barriers to entry following the approved acquisition.
Vertical mergers are generally less likely to significantly impede effective competition than horizontal mergers. This is because there is no change in concentration in the markets involved in the merger, whereas horizontal mergers involve a direct loss in competition as a result of the change in the level of concentration in the relevant market. However, there are circumstances in which vertical mergers can affect healthy competition, particularly in instances where a dominant position is created or strengthened in at least one level of the market.
In the current transaction, the vertically integrated entity will have sole control of the only assembly plant in Mombasa. The CAK did impose conditions on the merged entity so as to ‘cushion’ third party brands and any other competing brand from foreclosure. The conditions imposed were that the merged entity:
· Shall keep the plant open to existing third party brands and any other competing brands that may wish to use the AVA plant for assembly, for as long as there exists excess capacity at the plant; and,
· Honour all existing assembly contracts with third party brand assemblers at the AVA plant.
As highlighted above, a merging entity can foreclose rivals not only through refusing access, but also by affecting the price, quality, timeliness and terms of access. Although the CAK imposed conditions on the merged entity so as to allow third party assemblers access to the plant, the conditions do not directly address these other strategies that can be used to foreclose existing and future third party assemblers. In this case, this includes the ability of the merged entity to claim that plants are operating at full capacity or that the plant is committed for future projects even if this is not the case. It may, of course, be a challenge to explicitly address these issues as they are not straightforward to monitor.
However, it is important that consideration be given to other possible foreclosure strategies and that the conditions at least specify explicitly that access will be granted on fair and reasonable terms that are not less favourable than those granted to the integrated entity, and/or those currently available. This consideration may be implicitly accounted for in the requirement that existing contracts be honoured, although this does not appear to relate to future contracts as well.
In light of Kenya being a potential hub for automotive assembly and production in the East African region, coupled with the strong geographic advantage Mombasa port holds in terms of access to international and regional markets, a vertical merger such as this can work to the detriment of market participants and competition. The automotive assembly market in Kenya is still in its infancy, but holds great prospects with vehicle assembly figures expected to double by the year 2019. Access conditions to facilities such as the AVA assembly plant are important to the extent that rivals require access to compete effectively in the market; especially in the developing country context where markets are particularly concentrated in key industries.
Conditions that are imposed in mergers are an important way in which competition law links with industrial policy objectives. By ensuring access for rivals, they are better positioned to compete and grow their businesses. Vertical foreclosure can raise rivals’ costs rendering them less efficient and effective as rivals which in turn can have negative effects on the economy or sector as a whole.
In 2016 the Comesa Competition Commission (CCC) also dealt with a vertical merger case involving input foreclosure in the copper industry, in which access conditions were imposed. Reunert Limited, a downstream producer of copper products proposed to acquire Zamefa, a Zambia based upstream supplier of copper rods with a significant share of the market. The CCC raised concerns over potential input foreclosure. With the acquisition of Zamefa’s copper rod supply and existing business in the downstream cables market, the merged entity had an incentive to limit the supply of copper rods to Reunert’s competitors in the Common Market. The conditions imposed in this case were that:
· The merged entity should continue to supply copper rods on the same conditions to customers in the Common Market;
· The above condition shall cease to apply should there be presence of new competitors with the ability to supply copper rods of sufficient quality and quantity to satisfy the requirements and demand in the Common Market; and
· The merging parties should submit to the CCC an affidavit of complying with imposed conditions.
The CCC addresses the terms on which copper rods should be supplied. However, the conditions do not cover new contracts that may arise post-merger, in the absence of new competing suppliers. The merged entity is therefore free to assign new contracts that may have significantly less favourable terms to those enjoyed by Zamefa, such as to undermine competition. This leaves room for foreclosure strategies involving manipulation of price, quality and access in future contracts.
The copper industry is one of the cornerstones of the Zambian economy. Kenya, Malawi and Uganda are also heavily reliant on the supply of copper from Zambia, with Zambia having an estimated copper rod supply market share of at least 50% in these markets. In this particular case there needs to be evidence that customers could not access alternative sources or available alternatives such as imports were imperfect substitutes perhaps due to prohibitive transport costs. There also needs to be consideration of whether the vertically integrated firm has the ability and incentive to foreclose – this includes considering whether it would be profitable.