English Welsh & Scottish Railway Holdings Ltd (“EWS”)/ Marcroft Holdings Ltd

Adam LandDirector of Remedies and Business Analysis

Usual disclaimer: Personal views, not to be taken to indicate Competition Commission endorsement

The acquirer

EWS

• Largest provider of rail freight haulage in Great Britain (market share ~ 70%).

• Turnover 2005: £497.5m, profit before tax £35m

• Carries out own in-house freight wagon maintenance

The acquired

Marcroft Engineering Limited

• Largest provider of wagon maintenance services to third parties in Great Britain.

• Turnover 2004 £12.7 million, loss before tax £1.5 million

• Specialist maintainer of wagons: no haulage business, no passenger coach maintenance

A customer ofMarcroft

Freightliner

• Second largest rail haulage company after EWS

• Created by privatisation of BR container business, entered heavy haul market in 2005

• Carried out some of its own maintenance, but all heavy haul maintenance contracted to Marcroft.

The maintenance market – workshop services

The maintenance market – workshop services

The maintenance market – outstation work

The merger

• Agreement for EWS to acquire Marcroft announced 4 November 2005, merger completed on 1 February 2006

• OFT referred the merger to the CC on 6 February 2006;

• Interim undertakings accepted by CC on 13 March 2006 to prevent further integration.

Marcroft

Other3rd

party

Maintenance services

Haulage services

Market structure, including self-supply

End-customers

Market definition

• Product market: Wagon maintenance services

• Geographic market: Great Britain

• Is self-supply in the same market as third-party?

The significance of self-supply for market shares

Post-merger

Including self-supply

56.7% 18.9% 75.6%

3rd-party only 2.5% 55.8% 58.3%

Source: EWS figures for light in-field maintenance quoted in CC Report page 10

Should self-supply be in the market?

Yes:– EWS already supplies some 3rd party maintenance. Could it do more?

– In-house represents capacity available for potential competition acting as a constraint, even if limited presence in 3rd-party

– Conceptual argument that ‘bundle’ of maintenance and freight services provides an indirect competitive constraint between EWS self-supply maintenance and 3rd-party maintenance (eg Inderst and Valetti).

No:– Detailed examination of the activities and future plans for EWS

maintenance business

– Uncompetitive EWS cost structure

– No evidence of historical effect of EWS in limited number of bids

– Capacity and indirect arguments regarded as “speculative”

CC concluded that self-supply was not in the market

Marcroft

Other 3rd party maintenance

Pre-merger

Little horizontal effect in 3rd party maintenance

Other 3rd partymaintenance

Post-merger

Marcroft

Othermaint

…but possible vertical effect arises

3rd-party maintenance services

Other 3rd partymaintenance

Haulage services

Theory of harm: raising rivals’ costs

From Church report. A vertical merger:

• Eliminates double marginalisation

• But creates an incentive to supply less upstream

• Complete foreclosure possible (if commitment credible) if gains downstream exceed losses upstream

• Downstream rivals have incentive to counter-merge

• Welfare effects depend on credibility of foreclosure, and the impact of double marginalisation

Application of RRC theory to this case EWS ~70% market share in downstream haulage market, vertically integrates with Marcroft ~60% market share in upstream 3rd-party maintenance market

• No elimination of double marginalisation. 3rd-party maintenance market is solely used by EWS’s competitors, and EWS is already vertically integrated pre-merger

• Incentive for EWS/Marcroft to reduce service quality or increases price to rivals. This would strengthen EWS position in downstream haulage markets.

• Alternative supply available to downstream competitors only at higher prices or lower quality. Also risk of alternative supplier acquiring market power as ‘residual monopolist’

• Benefits of softer competition in £800m haulage market seem likely to exceed losses in smaller maintenance market. But no formal modeling.

Conclusions on vertical theory of harm

• EWS already had market power in rail haulage (supported after report by finding of abuse of dominant position)

• Merged entity would have market power in 3rd party maintenance

• Cost/benefit trade-off of foreclosure was good for EWS/Marcroft: reduced quality significantly diminishes competition downstream for little financial loss upstream

• No benefit from elimination of double-marginalisation

• CC considered that competition law (eg Article 82 EC) would make it less likely that EWS/Marcroft would foreclose, but not so much as to overcome incentive and ability

Substantial Lessening of Competition finding, leading to remedies

Remedies

Behavioural remedies

– Offered but not considered effective

– How could you prevent a fall in service quality?

Structural remedies

– No need to divest workshop

– Full divestment of outstation business would be effective;

– Partial divestment of outstation business could also be effective.

Challenges for partial divestment

– Purchaser risks (eg competition problems, capability)

– Composition risk (is a viable business being sold?)

A partial divestment was (eventually) made to Davis, a small competitor in 3rd party maintenance

Reflections• Role of market definition in framing theories of harm:

– If narrow 3rd party maintenance market, concerns about vertical Raising Rivals Costs theory

– If wider maintenance market, potential concerns about horizontal concentration

• Indirect constraint argument – when should it apply?

• Vertical theories difficult for non-economist decision-makers and advisors (Church report = 382 pages)

• Vertical theories of harm can create requirements for assessment of other markets (eg haulage)

• Challenges of remedying completed mergers