• THE COMPETITION TRIBUNAL IN THE MATTER of an application by the Director of Investigation and Research for orders pursuant to section 92 of the Competition Act a.s.c. 1985, c. C-34, as amended; ANO IN THE MATTER of the acquisition by Hillsdown Holdin;s (Canada) Limited of 56\ of the ~"""'"""'""~,.._.,...-::;.:;...:.....:.~--...... of Canada Packers Inc • B ET WE E R: THE DIRECTOR OF INVESTIGATION AND RESEAR H I he!eey ce~;:y this to bl a tr.;e cepy c~ the C:fl!;:r:.z! Cx1;m1:-.:. I Je ~r.:!;;r p:r It r;rwst"11e c:i.:e ccei cit u~• c=?~ c.::-.lormo ~;; cx;,;m:r.: c~;;intl. - and - '1 ./ ~~e;,,!~~~Il:.~~~'~:f.~t.s~6 HOLDINGS (CANADA) LIMITED, ~ V · MA LE LEAF MILLS LIMITED, 1 ~.... · ..-.: .· t?. ........ :'I" NADA PACKERS INC. and Fe:· :~:r:~··'"t·. C:>r.-:;:a: ""'' 7:::.:.:J~.z.· 10NTARI RENDERING COMPANY LIMITED Pc;.;: nt.i:::;~:a;·~. T!ibl.!riiJ ca l.i c:on:;.:rrenet AFFIDAVIT OF PROFESSOR D.G. MCFETRIDGE I, Professor D.G. McFetridge, in the City of Ottawa, in the Province of Ontario, MAKE OATH ANO SAY:
l. I have been a professor in the Department of Economics at Carleton University since 1975. I have been ~eaching undergraduate and graduate courses and supervising Ph.D. ~issertations in the field of Canadian industrial organization and public policy at Carleton and at other Canadian universities since 1972. I have written and edited numerous articles and books on industrial organization, industrial policy and competition policy. I have served as an Associate Editor of the Journal of Industrial Economics and I am currently on the Editorial Soard of the Cana~ian Competition Policy Record.
fio. CT-91/l CO.Y.PUITION TRleUNAl TR:!!UNAL DE LA CO~C'.i~:rna • F I ~~ ' ) \ A:~ ? 1991 rt:W ~ D ·---U -G1 -'11A -I -· -· · -·· , ..... T OTTAWA, ONT. I#~ App 1 i cant, COMPETITION TRIBUNAL T"'. · J;NAL DE LA CONCURl\ENU P f f/llloe..+...-... .'. ...i c~ R A~~ ~91 JB61 3 o 1 ReG1::.TRAR - R<G1srnA1Re r OTT AW A, ONT. Respondents
. . - 2 -2. I·have been retained by Maple Leaf Foods Inc. to provide an opinion on whether the efficiency gains offset and are ;reater than the effects cf any lessening cf competition resulting.from the acquisition cf 56\ cf the common shares cf Canada Packers Inc. (now Maple Leaf Foods Inc.) and its subsidiary Ontario Rendering Company Ltd. by Hillsdown Holdings (Canada) Ltd. which, through its subsidiary Maple Leaf Mills (now Maple Leaf Foods Inc.), operated Rothsay Rendering.
3. My ability to comment is based.on my experience and knowledge in the area of industrial organization and policy and competition policy. I have also been provided with and have relied on information from Maple Leaf Foods Inc. about its rendering operations.
~. Attached hereto as Exhibit •A• to this my affidavit is a true copy of the report prepared for Maple Leaf Foods Inc. pursuant to its request.
Sworn before me at the ) City of Ottawa in the ) ProviJlce of Ontarj;o / ) this /.!.:!. .. day of 1:7.,.1> >TI1991.) Professor D.G. McFetridge ..J
A Commissioner, ~tc. (.'. i' l\ ~J.i ( if& .JJ..;,
•
This is Exhibit •A• to the Affieavit of Professor D.G. McFetridge, Sworn before me on the 'L'-vJ day of fl:y4J. 1991 1f /;k tfr8--JJJ_ A Commissioner, etc. t~·~, n·t,:;..(""11.- 6':.:nLi' r-J PROFESSOR D.G. ~CFETRIDGE
REPORT OF D.G.MCFETRIDGE PH.D. l. Sect~on 96 of The Competition Act xecognizes that some mer~ers may be both anticompetitive and efficiency-enhancing. It provides for • balancing of efficiency 9ains against anticompetitive effects in these ·cases. Where this balancing reveals that the efficiency gains outweigh the anticompetitive effects and yield a net benefit to the Canadian economy then the efficie~cy gains are to prevail. 2. The purpose of this report is to explain how the_possible anti-competitive effects of a merger might be estimated and balanced against efficiency gains flowing from that merger and to apply this balancing technique in the case of the acquisition of a controlling ~nterest in Canada Packers Inc. and its subsidiary Ontario Rendering Company Ltd. (Orenco) by Hillsdown Holdings which, through its subsidiary Maple Leaf Mills, also operated a rendering business under the name Rothsay Rendering (Rothsay). Canada Packers and Maple Leaf Mills have since been amalgamated to form Maple Leaf Foods Ltd. Maple Leaf Foods now has a division, Rothsay, and a wholly owned subsidiary, Orenco. 3. The Merger Enforcement Guidelines issued in March 1991 by the Director of Investigation and Research define anticompetitive effects of a mexger as follows: ••. anticompetitive effects refer to the part of the total loss incurred by buyexs and sellers in Canada that is not merely a transfer from one party to another, but represents a loss to the economy as a whole, attributable to the divetsion of resources to lower valued uses. This loss is sometimes xef erred to as. the deadweight loss to the Canadian economy. (p.45) The Merger Enforcement Guidelines further state that: ~here a merger results in a price increase, it brings about both a neutxal xedistribution effect and a negative resource l
allocation effect on the sum of producex and consume? £uxplus < t ota 1 S\lrpl us) within Canada. The efficiency ga i n5 are balanced against the latter effect, i.e., the deadweight loss to the Canadian economy. (p.49) The G~idelines distinguish between Quantitative and gualitative anticompetitive eff~cts. Quantitative anticom~etitive effects are those which result from increases in pr ice relative to cost. Qualitative anticompetitive effects include reductions in service, quality, variety, innovation and other non-pxice dimensions of competition. 4. The Hexger Enforcement Guidelines properly limit the Quantitative anticompetitive effect of a merger to the wealth-reducing misallocation of resources (i.e. restriction of output in the relevant market) resulting from it. The redistribution of surplus be·t~~en .. buyers .r;d 'sellexs xemafning 1n" the market is not
regarded as an anticompetitive effect. The reasons for judging a merger on the basis of its effect on societal wealth rather than on the wealth of any o~e group within society are given at length by Crampton in his exhaustive study of the Competition Act. 1 Crampton correctly concludes that reQuiring that the cost savings resulting from a merger outweigh both the rnisallocative effects (i.e. the deadweight loss) ~the redistributive effects (i.e. the tr~nsfer fxom "consumers" to "producers" ox vice ve;sa) of the mexger would eliminate a substantial class of mex9ers which increase net wealth (i~e. cost savings exceed the deadweight allocative loss) but do so by an amount which is smaller than the wealth transfer involved. In Crampton's view, reguiring that cost savings exceed the sum of
~ Paul s. Crampton, Mergers an~ the Competition Act (Toronto, Carswell, 1990) Ch. 7.
2
the deadweight loss and the amount of wealth redistributed: " ••• would seriously compromise, if not completely frustrate, the efficiency objective, which is explicitly paramount in the merger provisions lof the Competition Act), and arguably paramount in section 1.1" 2 s. Although the Guidelines do not explicitly exclude transfers.of surplus from Canadians to citizens or residents of other countries from the anticompetitive effects of a 111er9er, there are some compelling reasons for doing so. These are: (a) As the analysis in Section 2 of the Appendix attempts to demonstrate, the determination of the identity of firms or industries wtiich lose surplus as a result of a restriction of activity at one stage of production is not straightforward. (b) \Jhen a Canadian firm merges with a foreign firm it. is ~ifficult to determin~ how much of th~ ~nti~ipate~ future.pr~fit of the merged entity is realized by Canadian shareholders in the form of capital gains. Studies of this issue find that most~ if not all of the anticipated. benefits of a merger are captured by the shareholders of the acquired firm.a This would imply that in the present case the anticipated benefits of the Acquisition were captured by the (Canadian) shareholders and former shareholders of Canada Packe:rs • If, however, a Canadian firm were to acQuire a . oreign-owned firm operating in Canada, the anticipated !ncrease in prof it would, on the basis of existing empirical evidence, likely 90 abroad. As a practical matter lt will be very difficult to determine how much of a transfer stays in Canada and is, therefore,
=-Ibid. p. 524 a B.E.Eckbo "Mergers and the Market for Corporate Control: The Canadian Evi~ence" (1986) 19 Canadian Journal of Economics 236 3
neutral and how much 9oes abroad and is, therefore, potentially part of the anticompetitive effect of a merger. On the basis of existing empirical evidence, foreigners buying Canadinn firms would be treated more favorably than Canadians buying foreign-owned firms ~aking the measurement of anticompetitive effects not only cumbersome but discriminatory. (cl Giving surplus accruing to foreigners a zero weight in the market power-efficiency trade-off (which ls the same as including transfers to foreigners in the anticompetitive effect) change~ the application of the Competition Act in a profound way. Under this approach, the efficiency gains resulting from the merger of two foreign firms are not benefits .to the Canadian economy. All the ·1ings accrue to foreigner-shareholders in the form of increased. prof its. Thus, these firms would be deprived of an efficiency defence of any kind. The extent to which efficiencies would count in favour of a merger would depend on the composition of ownership - counting fully only with full Canadian ownership on both sides. It is difficult to believe that this type of discrimination was intended or that this approach encourages efficiency and adaptability. ~ The method of balancing the cost savings flowing from a merger against the deadwelght loss in surplus which also flows from it is illustrated in a number of Canadian law and industrial organization texts including Crampton•, Green• and Perrakis•. The concept of • Ibid. pp. 499-532. • c. Green, Canadian Industrial Orcanization and Policy Second ~dition (Toronto, McGraw Hill, 1985) pp.145-7.
. . evaluating mergers on the basis of their net effect on aggregate economic surplus ot wealth or welfare was popularized by Professor Oliver TJilliamson"'. In his advocacy of an aggregate economic surplus standard for merger evaluation Williamson can ·be interpr~ted as arguing that the principles of benefit: cost analysis which guide- other public sector resource allocation decisions should also guide antitrust or competition policy. I agree with this argument. In the case of merger evaluation, the benefit is the reduction in the value of the resources required to produce a 9 i ven level of output and the cost is the surplus foregone due to the monopolistic or oligopolistic restriction of output made possible by the merger. Both are potentially ~asureable as annual dollar flows. i. The Director of Investigation and Research has alleged in his Notice of Application that the Acquisition, as defined in the Notice of Applicatio~, will result in a substantial prevention or lessening of competition in the rendering of noncaptive red meat by-products in Ontario and that the Acquisition has not resulted in gains in efficiency that will be greater than and will offset the effects of this prevention or lessenin~ and is unlikely to do so. ·1ewed in the context of the Merger Enforcement Guidelines and the economic literature referred to previously, the Director of Investigation and ~esearch is alleging that the deadweight loss in surplus resulting fxom the Acquisition is as 9reat as ox greater
• s. Perrakis, Canadian Industrial Organization (Scarborough, Pzentice Hall, 1990) pp. 253-6 • ., O.E.~illiamson, "Economies as an Antitrust Defense: The ~elfare Tradeoffs" (1968) SS American Economic Review 18 5
than any cost savings that flow from the AcQuisition. e. The potential deadwelght loss resulting frcm the Acquisition can be viewed either as resulting from the excercise of monopsony power in the market for renderable material (raw material) or from the . excercise of monopoly power in the market for rendering services. The two approaches should yield the same conclusions (Appendix Section l). 9. Renderable or raw material consists of trim fat, trim bones, beef and pork heads, feet, offals, bones, fat and blood and is obtained by rende:rers from slaughte:rhouses, abattoirs, restaurants, grocery stores and ·butcher shops. Raw.material is picked up by •enderers and taken to a rendeting plant whexe it is setted, gxaded and ultimately cooked and pressed to produce tallow arid meal (animal meal). Tallow is used in the production of soaps, animal feeds, cosmetics, paints, rubbers and other products. Animal meal is used in animal feed, iertilizex and pet food. 10. Renderers pay fox the raw materials they collect. They may also chaxge a pick-up or collection fee. Tallow and meal are sold to both domestic and international buyers. Renderers are generally regarded as price takers in the markets for tallow and meal.• The _mount renderers are willing to pay for raw materials depends on tallow and meal prices and on the renderers' trucking and processing costs. This relationship can be expressed as Pa • V - H where P~ • price, net of pick~up charges, paid by the tenderer for raw material (per raw HT.)
• United Kingdom, Monopolies and Mergers Commission, Animal ~oste (London, HMSO, 1985) pp.12-16 6
V s value of .tallow and meal derived fzom a metzic tonne of raw material H& %enderer's processing and transportation cost plus profit per metric tonne of raw material 11. The variable H might be termed the ~endering margin or spread. The Director of Investigation and Research alleges in his Notice of Application that, as a result of the AcQuisition, Rothsay-Orenco could sustain a material reduct~on in Pa for two years or more in a substantial part of the market. This may involve:higher pick-up charges or lower payments for raw material or both. For a given V (which the renderers do not control) a lower Pa implies a higher rendering maJgin o. . r.. .. spr. ead. . , . H. ... .......... . 12. A reduction in the net payments by renderers for raw material results in a transfer of economic surplus. The renderers gain surplus or profit. The raw materials suppliers and their customers and suppliers lose s~rplus. The excess of these losses in surplus over the renderers' gains is the deadweight loss. A deadweight loss occurs if the volume of raw materials supplied to renderers declines as a conseQuence of the reduction in the net price paid for them. If the volume of raw materials supplied to renderers is insensitive to the price paid for them, a reduction in this price results in a transfer of surplus but no deadweight loss. Under these circumstances the volume of material rendered is roughly the same as it was prior to the price reduction so that there has be~n no distortion of economic activity. 13. A measure of the responsiveness of raw material S\.lpply to changes in the net price paid for raw materials is the elasticity of raw material supply. If this elasticity is zero, supply is 7
unresponsive to price changes and there is no deadweight loss. lf this elasticity is infinite renderers have no control over the price t"hey pay for xaw materials and cannot,· by definition, profitably reduce it. For supply elasticities lying between these two extremes a hypothetical monopsony renderer may fina it profitable to reduce his buying price below that which currently prevails and this would result in a deadweight loss. 14. Thf: magnitude of the deadweight loss resulting fi:om a reduction in the net price paid by renderers for raw materials depends on four factors. These factors are: (a) the per centage reduction in the net price, P~, paid by enderers.for raw material; ....... . (b) the elasticity of raw material supply; (c) the value of payments for raw materials in the absence of the excercise of monopsony power; (d) the proportion of the renderers' spread that is accounted for by fixed costs and profit. The first three of these factors are relevant to the determination of the conventional deadweight loss (Harberger) triangle employed in Williamson's initial analysis of the welfare trade-off between market power and 9ains in productive efficiency.• The Harberger triangle ls the deadweight loss in consumers surplus (although Section 2 of the Appendix shows that moxe than consumers may be involved) and is represented by area A in Appendix Figures 1, 2 and 3. The fourth factor is relevant to • See o.E.Wiliamson, "Economies as an Antitrust Defense: The i.Jelfare Tradeoffs" (1968) SS .American Economic: ~eview 18 and A.C.Harberger, "Monopoly and Resource Allocation" (1954) 44 American Economic Review i7. . 8
the determination ~f losses in any economic profit and contribution to fixed overhead suffered by renderers as a consequence of any decrease in the volume of %aw materials they process.ao This loss is represented by area B in Appendix Figures l, 2 and 3 and is referred to on page SO of the Herger Enforcement Guidelines. ~here is no loss in £urplus from this source 1£ all costs are variable over the relevant time horizon ana normal profits are being earned. 15. The magnitude of the reduction in the net· price of raw materials which might result from this acquisition depends on the post-acquisition state of competition anC! potential competition and m -the elasticity of- raw material .supply •. The position .~f .. Ma.pl_e Leaf Foods is, int~r alia. that competition from Daxling, Banner, Schneider and Couture as well as the threat by some suppliers to int~grate into rendering is, in the context of a stead1ly declining supply of :raw material, sufficient to ensure that Rothsay and Orenco would not find it profitable to reduce the price they pay for :raw material by a significant and nontransitory amount. The position of the Director of Investigation and Research is that the lcquisition may result in raw material price decreases of twenty per cent or more~~. The purpose of this report is to determine whether the deadweight loss in surplus that would occur if :raw material prices were to be reduced by twenty per cent or rnore, as the Director alleges they will be, woulc5 be less than the value of
~a 0.£.~illiamson "Economies as an Antitrust Defense: Reply" (1969) 59 American Economic Review 954 anO P.Crampton, Heroers an~ the Competition Act S3l · ~ 2 Statement of Hr. Steve Peters in examinaton for discovery June 1"7,1991. 9
• the efficiency 9ains !lowing from the AcQuisit~on. 16. The elasticity of raw material supply depends on the elasticities of demand for beef and pork, the elasticities of supply of cattle and hogs and the respective ra~ios Qf the value of renderable material to the value of a beef or pork carcass or animal (see Appendix Section 2). Jn the simple case where the elasticities of supply of cattle and hogs (as well as all other slaughterhouse inputs) are infinite and the elasticities of demand , for all by-products (i.e. hides, edible and inedible rendering) are
infinite the (weighted average pork-beef) elasticity of raw material supply collapses to:
liere. e•"' 's ·e'lasticit"y of" aemana •foi: pork and "beef "{-weighted average) P~ s net price paid by renderers for inedible by-products P~ s value of .a carcass as meat The ratio of the value of renderable material to the value of a carcass is very low. According tn calculations made by Maple Leaf Foods Agribusiness Group, P~/P- is presently~for beef cattle and .,for hogs.~=- Estimated long-run elasticities of demand or beef and pork in Canada arel!llllandlllfrespectively.~' The implied elasticity of raw material supply is under .01 for both beef and pork by-products. If the elasticities of supply of other
~~ J.R. Coleman and ~arl D. Meilke, ~The Influence of Exchange ~ates on Red Meat Trade between Canada and the United States" (1988) 36 Canadian Journal of Agricultural Economics 401, Tables 1 and 2. ·10
.. .slaughtex:house inputs axe less than infinite an~/ ox the elasticities of deman~ for othex by-products are less than infinite the ela~~icity of xaw matexial supply, e., would be lowex: yet (see Appendix Section 2 for details).a• According to the .report· of Deloit~e ~ Touche, the elasticity of '?aw material supply is effectively zero. 17. A consequence of this low elasticity of xaw material supply is that even a relatively large reduction ln the price paid for xaw material will not evoke much in the way of a supply reduction so that both the distortion in the allocation of resources and the deadweight loss must be relatively small. The Monopolies and Mergers Commission in the U.K. comes to the same conclusion in •• • ,.. •. ·. . .. • •• :~ ••. . •. • . . . r.. • . • .. ~ir l9SS report. On p.10 the Commission concludes that: The income received by abattoixs from animal waste, while a small part of their eaxnings, is perceived as important by abattoir owners .•• The total supply of animal waste is outside the control of r~nderers ••• It is determined by the level of activity of abattoix:s and the demand from other users of by-products, who have priority by virtue of their ability to offer hlghex px:ices. On pp.99-100 the Commission concludes that: ••. since abattoirs' eaxnings fxom the sale of material to renderers constitute on average a very small proportion of their total earnings and that the effect of exploitation by a renderer would be slight, it might be that lt would not be sufficient to induce abattoirs to take.defensive action. In these cixcurnstances would be possible for ••• any efficient renderer to Jnake high ~~ofits ••• Moreover, if the adverse effect on abattoirs of exploitation by renderers would be so slight that 1t produced no countervailing action, it is difficult to see how any adverse a• This elasticity discussion does not explicitly consider deadstock. Deadstock supply 1s assumed to be governed by the same conditions that govern the supply of red meat by-products. A reduction in the price paid for deadstock reduces the farmer's expected return pex animal and ultimately reduces the number of animals available fox slaughter implying a higher price to consumers. The effect of a change in the deadstock price depends ~n the portion of the farmer's income accounted fox by deadstock zeceipts. This is likely to be small. 11
effect on the public interest could be other than minimal. 18. The.~bsolute (dollar) value of any deadweight loss ~esulting from a given per centage reduction ln the price pai~ by renderers for raw materials depends on the value of raw materials purchases prior to the price reduction. The value of raw materials puxchases depends on the number of tonnes of raw material puxchased and on the net purchase price per tonne. The weekly volume of noncaptive red meat by-products and deadstock purchased by Ontario renderers is estimated by Maple Leaf Foods to be This implies annual purchases of According to Pxofessor Van Duren's affidavit, the Ontario supply of renderable ····· , .......... ~c~erial from cattle is likely to decline by 4\ annually and the supply of renderable material from hogs by .3% annually ovex the period 1991-95. This implies a weighted average annual rate of decline in the supply of.non-captive raw material of 3.1\.~• 19. The net price paid for raw materials in 1990 is assumed to be the same as the raw materials cost of Rothsay's Toronto plant after deducting pick-up charges. According to Maple Leaf Foods, the raw material, trucking and processing costs of the Toronto plant are
~· According to Deloitte ~ Touche, hogs account for S2\ of red meat raw material with cattle accounting - ... ..,,. • -..'>.". ~ v • - • • •• ,,... • ' •• : . 12
for the balance. • ~ • ... • • ' : ... ' - '
fairly representative of noncaptive Ontario reO meat renOering as a whole in the sense that the Toronto plant did not process poultry by-proOucts and had no t:apti ve business.. 9l'he 199 0 raw material cost of the Rothsay Toronto plant is-per %AW tonne 9ross of pick-up charges and per %aw tonne net of pick-up charges (see Attachment 1). 9l'h1s includes grease. When grease ls excluded zaw mate% ial cost is 9J:oss of pick-up charges and 20. The raw material supply foJ:ecast described in paragra_ph 18 and the estimated net raw material price per tonne given in paragraph 19 together imply that net payments by Ontario renOereJ:s for raw material <excluding grease) amounted to in 1990. · ... ·Accoxding to Maple.Leaf Foods'~- the 1990 avezage raw mate-rial ·price· per tonne is as good an estimate as any of the pr ice which is likely to prevail ove~ the next few years. If the raw material price were to remain at its 1990 level in real terms, net payments fur raw material would fall by 3.1\ annually which is the forecast rate of decline in tonnage available. 'l'his would imply the following annual net payments to nonintegrated raw materials suppliers in the absence of the excercise of any monopsony power: Net payment for Raw Materials
s• The source of this supply estimate is Maple Leaf Foods (tonnage, noncaptlve pork share); Professor Van Ouren's affidavit (rates of decline in cattle and hog material) and; Deloitte & 13
•ooo M.T. 1990 1991 1992
1993 .1994 1995
21. If some rendering costs are fixed, a restriction in the volume of rendering activity due to the excercise of monopsony power ln the market for raw materials results in a loss in contribution to overhead or, as economists call 1t, quasi-rent. This 1s also a deadweight loss. While the existence of fixed costs increases the deadweight loss resulting from a given reduction in raw material pr ices, 1 t also reduces the renderer's incentive to lower his ~uying pr i_~e. The reason is that, while the renderer pays less for the volume of raw material he continues to process, he foregoes a contribution to overhead (and perhaps economic prof its) on the volume which ls no longer supplied and processed. 22. A renderer's costs ·of collection and processing are generally regarded as fixed, to a considerable degree, with respect to a small per centage decrease in volume. According to the affidavit of Dr. Bisplinghoff (p.28): If a plant ls running at 80\ of capacity and the throughput is ~educed by 6~ per year (assuming average yields) costs are normally reduced by only 2-4\. If a 6\ throughput reduction results, on average, in a 3\ reduction in plant costs, this implies that SO\ of plant costs are variable. The Monopolies and Mergers Commission states in its report (p.36) that:
Touche (hog:cattle ratios, noncaptive share). 14
••• over a fairly wide xange of capacity utilisation of continuou~ plants energy costs rise or fall in line with amount of material rendered. but that below 30 to 40 pex cent capac:i ty utilisation energy costs per tonne of material processed begin to rise. Labour costs are relatively fixed in the short term and labour costs per tonne of material processed rise or fall in inverse proportion to throughput as does any fixed proportion-of other costs. With respect to trucking costs Dr. Eisplinghoff concludes on p . . 30 of his affidavit that: When tonnage drops 6\ per annum there are very few realignments that can be made. With continued significant drops, some routes can be combined, but there ls a limit since you must service customers in all directions and lockers on their ~ill ~ays. Another step could be cutting back on service: and realigning %outes. This means some raw material will be left in territory for longer periods of time and begins to deteriorate. There is a limit to cutting service to locker plants and custom slaughtering operations or even medium sized slaughtering facilities. State and federal inspection laws dictate that these plants must be picked up on their kill day. Many routes are designed around these large volume accounts". ~ their k"ill" ··dr-ops, . the ·rend~rer t:ont1nues servicing the same area for 25 to SO\ fewer pounds. Costs accelerate and the route loses money. According to Maple Leaf Foods, no more tha711111f 0£ trucking cost would be variable with respect to a small per centage change in volume. 23. ~he unit processing and.trucking costs of Rothsay's Toronto plant are assumed to be representative of noncaptive red meat rendering in Ontario in 1990. Maple Leaf Foods is of the opinion that unit costs for the Moorefield (Rothsay) and Dundas (Orenco) plants would be less representative 1n that _.. ... ,,.., .. The • -~ .,, ·-~ ..... ~~.Z- .. """'" ..... Rothsay Toronto unit costs are (in dollaxs per raw metric ton) as
follows:~• 1 • These unit costs include grease transportation and processing. I have been unable to separate the costs of trarJsporting and processing grease from the costs of transporting and processing other raw mater 1 als. l am, as a conseQ\lence, 15
..... Manufacturing Costs Trucking 20 -_. Administration Prof it Margin -Renderer's Spread (H) -24. In accordance with the evidence presented in paragraph 22, one-half the cost of manufacturing and ·one-fifth of the cost of trucking are assumed to be variable with xespect to a small change in volume. This implies that variable costs per raw tonne are while fixed costs plus profit ar
affidavit, Profe~sor Trebilcock correctly argues that the lessening of competition resulting from the Acquisition should be evaluated relative to the lessening that would otherwise have occurred.
The essence of Pxofessor Txebilcock's argument is that the AcQuisition advances the timing of the increase in concentration and any associated "essening of competition in this market. The implication of Professor Trebilcock's reasoning is that the deadweight loss which is incremental to the Ac;uisition ls confined to the period 1992
obliged to assume that the unit costs of a non-grease operation would be the same as Rothsay Toronto's 1990 unit costs. 20 Trucking costs on the Rothsay Toronto cost statement are net of pic~-up charges. Estimated pick-up charges are ~e. The transportation cost estimate in the text is the sum of -16
. .. . . .. .
'or the year of_ disposition of the case) to 1995. 26. The deaOweight losses for the years 1992-1995 resulting from a hypothetical 20\ decrease in the price paid by all Ontario . . zenderers to all non-captive suppliers of zaw materials at the beginning of 1992 •nd assuming: - a linear zaw m&terial supply schedule; - an elasticity of raw m~terial supply of 0.1 (which, qiven the discussion in paragraph 16, ls on the high side); - raw materials payments as given in paragraph 20 and; - unit variable costs as given in paragraph 24 are as follows (in thousands of 1990 dollars): 21 fill iost"Consumer~" ~Ur:QlU~ Lost Qverh~a~ IQ~al 1992 1993 1994 1995 I I Present Value @ 8\ 22 •• - -27. The deadweight loss in "consumers" surplus (the Harberger
triangle) resulting from a 20 per cent reduction in raw material prices is trivial amounting to roughly annually. The 21 The deadweight loss in "consumers" surplus (Harberger triangle) is calculated as: .S x e. x payments for raw materials x ., price change squared where e. is .1, \ price chan~e is .2 and payments for raw materials are as given in paragraph 18. The deadweight loss in contribution to fixed costs and profit is calculated as: e. x \ price change x fixed cost and profit where fixed cost and prof it per tonne is given in paragraph 22 and tonnage is given in patagraph 18. Futther detail is provided in the Appendix. 22 The 8\ discount rate is as specified in the Merger Enforcement Guidelines ~.Sl 17
. . reason is that the elasticity of supply of raw material is very low so that the output restriction resulting frpm the assumed price decrease. is also very low. The bulk of the deadweight loss takes the form of lost contribution to rendezer overhead. ~his 1£ a consequence of the assumption that a large fraction of the costs of rendering is fixed. If some costs which are deemed fixed in the short-run could in fact be avoided over longer periods of time the loss in surplus from this source could be cut significantly~ 28. The same results are obtained if the problem is analyzed as the hypothetical monopolization of the market for rendering services. As is demonstrated in Section 1 of the Appendix, a 20% reduction in the price of raw material is equivalent to an 8.9\ increase in the nderers' spread. An elasticity of raw material supply of .1 is equivalent to an elasticity of demand for rendering services of .23. The Appendix (Sectlon 5) also demonstrates that if the demand for rendering services is isoelastic with all other assumptions remaining the same the deadweight loss is somewhat smaller. • ; 29. The joint ownership of Rothsay and Orenco has already yielded savings in administration, transportation and processing costs. That is, operating under common ownership, Rothsay and Orenco ca ..n ocess a given volume of material at lower cost than·they could
~nder separate ownership. According to Dr. Bisplinghoff 'f affidavit, savings of the sort xealized by Rothsay and Orenco have also been experienced by multiplant rendering firms in the United States. This may be why noncaptive xendering in the United States appears to be dominated by multiplant firms. According to the affidavit of DI. Bispl1nghoff (p.36), Daxling has 40 plants, N&tional By-Products has 11, Griffin Industries has 16 and Baker lC
Commodities has 9 plants. 30. According to Maple Leaf Food-amir.iistrative positions have .been el.1minated at O_renco since the acquisi ti~n •. - more positions are scheduled to be •liminated upon the approval of the AcQuisition.
sal~ries, ·expenses and benefits resulting from the elimination of the administrative positions at Orenco is annually. The saving resulting from the proposed elimination of the additional ( -positions is annually. The total saving in administrative salaries, benefits and expenses will be (with rounding) annually. According to Maple Leaf Foods, the staff reduction at Orenco has not resulted in additional contracting-out and will not result in any reduction in service. Moreover, according to Maple Leaf Foods, these administrative savings would not have been realized the absence of the Acquisition. To the best of my knowledge, no specific alternative merger exists and the •·,rger Enforcement Guidelines state: Efficiencies generally will not be excluded from the balancing process on the speculative basis that they could be attained by a merger with an unidentified third party. (p.47) :n. The Acquisition has also resulted in the rationalization of ~h~ overlapping raw materials collection routes of Rothsay and Or~nco in western Ontario. According to Maple Leaf Food~, this route ration al i :zat ion ls currently yl eld ing savings in the amount of annually. ThiE saving is comprised of: the wages and 19
benefits of- employees operating cost savings of the annualized capital cost·. of 919 trucks It ls diff lcult to see how Rothsay and Orenco could have combined the ix western Ontar lo routes had they remained competitors. While one firm's trucks might Dake collections on behalf of the other, Maple Leaf Foods ~oes not regard this as a long term solution in that neither firm would want its customers being picked up by the other's trucks for an extended period. Dr. Bisplinghoff is of the same opinion. It might be possible for an incependent hauler to service both plants • Dr. Bisplinghoff's ., f idavi t ( p. 33) notes that contrac:t haulers are common in the United States. The relevant question is whether contrac:t haulers commonly serve two competing plants. According to Maple Leaf Foods, contract haulers generally serve a single plant. Deloitte & Touche express the same ~pinion in their report. 32. The Acquisition has also allowed the rationalization of at least some of the Toronto routes formerly served by the Rothsay Toronto plant and Orenco•s Toronto routes. According to Maple Leaf ~oods, the consolidation of the routes formerly served by Rothsay's expropriated Toronto plant with Orenco•a Toronto routes has resulted in a saving o This saving is composed of a> The trucks c apiece and are sold aftertlllyears for an average of · .ap e Leaf Food's calculation assumes straight-line depiec1a ion over.years plus ••cost of capital. The economic decay rate implied y the purchase and ~isposal prices quoted ve is just unC!ei: .. annually. Using this decay rate plus an f capital yie'Tds an implicit rental price on these truc:ks of ually. This implies that the annual cost higher than Maple Leaf Foods has claimed. ·20
• labour savings of 111111 drivers 1 operating cost savings and savings· in the annualized capital cost o~ 1i19 trucks -· . . _. . .. ~ . . ~ -> • .. ~ • • -~ ............. . - . , ' ...... ' _,. '!"-.,.-::;" -~ - • • - • ...... • '~~ ~The saving involved would, according to Maple Leaf Foods, have been approximatel~of the which actually has been saved or 33.
34. The total cost savings made possible by the AcQuisition amount •- The implicit annual tental price o~trucks ~·vae n. annual economic decay rate and an 9:ost of capital is or more than the amount cla1~ed by Maple Leaf Foo s. . 21
to~nnually on the basis of 1990 .volume (Administi:ation Transportation Manufac:turin This saving ~eclines 1£ throughput decreases but only slightly. The saving in administrative cost is a fixed cost saving. so that any reduction in throughput would affect only this portion of the transport~tion cost saving. 2y similar reasoning a reduction in throughput would af feet about half the manufacturing cost saving. It has been estimated that throughput will decline at the rate of 3.1\ annually over the period 1990-1995 in the absence of the excercise of any monopsony power (see paragraph 18). A hypothetical 20\ reduction in the raw material price would result in a further once-for-all xeduction in volume of 2\ if the elasticit~ of raw material " s upply were .l.
. . . ... - . . . ... • "<I". • • - --.T-'" · ... ...... .. the Acquisition thus serves to advance the date at which the cost savings resulting from these forms of rationalization occur. It was· argued in paragraph 21 that the AcQuisition similarly advances the date at which increased rendei:er concentration and any associated deadwelght losses· oceui:s. incremer1tal deadweight loss and ~ of the inci:emental cost savings are zero after 1995. The administrative cost savings would not be realized after 1995 in the absence of the ·22
. , ~ - .,_ '- ' . - . ..._ - ~. " - . ' .._.-=. ..._ ·~ -. .. ,/ ,,. .. .. ·- ~~ - ... . . - .. . , Thus, the pos5ible
• Acquisition. These savings can be zegazded as continuing indefinitely. 36. Gi"en a 3.1, annual rate of decline in throughput and a hypothetical once-fo::-all 2' decrease in raw material supply at the beginning of 1992 and the realization of the remaining administrative economies at the beginning of 1992, the time pattern of cost savings (in thousands of 1990 ~ollars) resulting from the Acquisition ls as follows: Xea; 1991 1992
1993 1994 1995
P.V. @ S\. 1992-1995 '2-2111 -Ji. Four aspects of the results reported in paragraph 36 merit
further emphasis. First, although they will not be included in the trade-off calculation,· ct>st savings are currently (as of 1991) being realized as a result of the Acquisition. These savings are _not hypothetical. Second, cost savings are not sensitive to volume ~ecreases resulting from the hypothetical excercise of monopsony power. Third, while the transportation and processing cost savings ~ ~ributable to the Acquisition may be regarded as ceasing (along with any deadwelght loss) after l99S; the administrative savings attributable to the Acquisition continue. Their present value over a twenty year time horizon ls Fourth, if deadweight losses and cost savings were both assumed to continue for twenty yeai:s, the pzesent value of the cost savings would inczease relative to to the present value of the deadwelght loss. This is 23
• aiOf!tiEfHilfla b~cause the cost s&vings are less sensitive than the magnitude of the deadweight loss to the decrease in raw material supply which is expecte~ to occur in the future. 38. The excess of cost savings over the deadweight loss resulting fxom a 20\ reduction in %BW ~aterial prices with a raw material supply elasticity of .1 has a present value value over four years of If administrative cost savings are allowed to run for twenty years (and there is no reason for terminating these savings after four years), the present value of the excess of the .· cost saving over the deadweight loss is The cost savings .clearly outweigh the deadweight loss under these circumstances and would also do so for lower hypothetical rates of tduction in raw material prices and for lower elasticities of raw material supply. It ls important to note in this regard that the cost savings outweigh the deadweight loss in "consumers" surplus (the Harberger deadweight loss triangle) thus satisfying what is known as the "naive trade-off" for even extreme raw material price reduction and supply elasticity assumptions. Most of the deaOweight loss takes the form of reduced coverage of i:endere:r fixed costs. It is difficult to believe more of these costs would ::>t be avoidable given a permanent, albeit small, decrease in volume. 39. The Merger Enforcement Guidelines (p. SO) suggest that the sensitivity of the trade-off analysis to alternative assumptions about the elasticity of raw ~aterial supply and the rate of raw material price decrease be investigated. Two alternative ~lasticity assumptions Ce. c.05 and .2) and one alternative price %eduction a~sumption (30\) are investigated. The res\Jlts for a
four year time horizon are as follows: Net Change ln Surplus ($'000) Elasticity of Raw Material Supply .OS .l .2 Price Reduction 20\ JO\ The results for a twenty year time horizon on administrative cost savings are as follows: Net Change in Surplus($'000) Elasticity of Raw Material Supply .OS .l .2 Price Reduction 20\ 30\ -.to. The Merger Enforcement Guidelines also specify (p • .(9) that qualitative manifestations of reduced competition such as reduced ciety, quality or service be considered. According to Maple Leaf Foods, service reductions are ~nlikely because pick-ups are in many cases requir~d by law and because lt is in the renderer's interest to have fresh raw material for processing. According ~o Dr. ~isplinghoff's affidavit, service problems in the United States have been the r~sult of declining amounts of raw material available from suppliexs. Thus, what suppliexs may perceive as Quality problems appear to be inevitable in any event.
41. The Qualitative aspects do not appeax to be impoxtant. Insofar as the Quantitative aspects are concerned, t'he cost savings which have already been realized as a ·result of the acQuisition exceed the deadweight loss resulting from a broad xanqe of hypothetical raw material price reductions. 42. The analysis in this report differs in a number of respects with the trade-off analysis, prepared with my assistance, submitted to Mr. R.T. Hughes, counsel to the Director of Investigation and Research, in a letter dated December 14, 199~ •.· The pr iricipal dif!erences and the reasons for them are as follows: (a) The two analyses differ in their respective formats. The December 14 letter calculated the pex centage cost reduction 1-~uired to offset the welfare effects of a variety of hypothetical incxeases in the pr ice of rendering services. This xepoxt calculates the dollar value of the welfare effects of a variety of hypothetical decreases in the pxice of raw material (and equivalent increases in the renderexs' spread) and compares them with the dollar value of the cost savings attributable to the Acquisition. While these approaches are fundamentally the same, the approach ysed in this report is more flexible. It can deal more readily ;h different time patterns in cost savings and deadweight losses and with cost savings that axe paxtly in fixed c.osts and paxtly in var.iable costs. (b) The xeports diffex with xespect to the time horizon aaoptea. The December 14 letter assumed implicitly that deadweight losses and cost savings continue indefinitely. This report recognizes that the deadweight losses ana some of the cost savings resulting from the Acquisition would ultimately have been incurred in any .26
•I I event as noncaptjve xendering becomes more concentxated. (c) The reports differ with xespect to the elasticities of raw material supply (or demand for rendering services) assumed. The December 14 letter assumed the range of elasticities usually found in trade-off calculations published in scholarly ~ournals. -~his repoxt has the benefit of both a mor~ detailed analysis of the factors undexlying these elasticities and moxe evidence regarding the empirical magnitudes of these factors. (d) The xeports differ with respect to the magnitude of the cost ~avings they attribute to the Acquisition.
~- ---.... ,. ... _ The savings realized by consolidating these routes with those of Orenco are attributable to the Acquisition.
2'7
APPENDIX l. Relationship Between the Raw Materials and Rendering Services Approaches / The raw materials approach see& the problem as a monopsonistic reduction in the price paid by renderers for their i:aw materials. The al ternatlve ls to view the renderers as disposal agents who charge a fee for their services. This fee is the difference between the amount the renderer receives for meal and tallow and what the renderer pays for raw material. This might be termed the renderer's spread and is formally defined as: H • V - P" where H = processing costs plus profit per raw tonne V = value of rendered material per raw tonne P" = net payment for raw materials per raw tonne The rendering services approach sees the problem as a monopolistic increase in H, the renderers' spread. The weal th transfer and wealth loss resulting from an increase in H must be identical to that which occurs when Pa is reduced. There are two offsetting differences between the two calculations. The ~irst difference ls that a given per centage :reduction in P" implies a smaller per centage increase in H. Specifically: dH/H • -(dra/Pa)(Pa/H) where d stands for "change in". According to the paragraphs 17 and 21 of the text, processing and collection cost and profit per raw tonne, H, amount to and raw matetial cost, P~, is A 20\ decrease in r~ therefore implies an B.9\ ir1cr~a~c in P.. 2£
. .
The second difference is that the elasticity of demand for rendering services is 9reater than the elasticity of supply of raw material material fox rendering. Specifically: . e.•(Pa/Q)dQ/dPa•(Pa/H)(H/Q)dQ/dH•(Pa/H)e• or e. • e.(H/Pa) where e. is the elasticity of supply of raw material and ea is the elasticity of demand for rendering services. Using the data from patagiaphs 17 and 21 of the the text for H and Pa and an assumed raw n~terial supply elasticity of .1 we 9et an elasticity of demand for rendering services, e., of .23.
It is apparent that the higher elasticity of demand just offsets the smaller per centage price change so that we 9et the same reduction in tonnage xegardless of whether we view the problem as an increase in H or a decrease in P~.
2. The Determinants of the Elasticities of Supply of Raw Materials and Demand for Rendering Services The elasticity of supply of raw material, e., and the ... lasticity of demand for rendering services, ea, depend on the underlying elasticities of demand for beef and pork and elasticities of supply of cattle and hogs. The relationships are: e. • l/((P.../Pa)/e. + (P./Pa)/e.]· ea• l/l(P..JH)/em + (P./H)/e.] where em • elasticity of demand for meat (pork, beef) e. = elasticity of ~upply of livestock (hogs, cattle) Pm/P~ : receipts per animal from sale of meat/receipts per animal
29
;.,
. . . from the renderer P./Pll:. price per animal as livestock/:receipts per animal from the :renderer P..IH • receipts pe:r animal f:rom the sale of ~eat/renderer cost plus prof it per animal P./H • price per animal as livestock/rendere:r cost plus p:rofit per animal. These :relationships are derived under the assumption that packers, ab~ttoirs and butchers which supply :raw materials are in competitive equilibrium so that P~(Q) + Pll • c + P.(Q) where P~(Q) • the inverse demand function for meat (pork, beef) c • the marginal cost of slaughtering etc. P.(Q) • the supply function of livestock (hogs, cattle) and dP..JdQ < 0, dP./dQ. > 0, dPll/dQ • 0 and dc/dQ • 0. This derivation assumes that the respective proportions of cattle and hogs going to various uses (i.e. meat, hides, edible :rendering, inedible rendering etc.) ~re constant. lt also assumes +hat the demands for by-products and the supplies of inputs other than livestock to packers and abattoirs are infinitely elastic. The relaxation of the latter assumption :results in the appearance of more underlying elasticities in the e. and e. expressions. It al~o results in the supply of :raw materials and the demand for rendering services becoming ~elastic. If the elasticity of livestock supply is infinite the expreEsions for e. and e. collapse to
30
e. • e..Pa/P-and ea • e ..H /P. . According to Coleman and Hellke, the elasticities of Canadian demand fo:r b'eef and pork respectively are .46 ana .18. The elasticity of Canadian steer and heifer slaughter is .24 and the elasticity of eastern Canadian hog slaughter ls .2e. 2 • According to Maple Leaf Foods, the xatios P-/Pa ana P./Pa are currently~andllllllrespectively for beef anctilllll~n~ respectively fo:r pork. Plugging these values into the expression fo:r e. given above yields an elasticity of raw material supply from beef cattle slaughter of .0019 and an elasticity of raw material supply from hog slaughter of .00076. These elasticities are very low implying, for example, that the reduction in Pa to zero would reduce beef raw material supply by ;2\ and pork raw material supply by .08\. !f cattle and hog supply were infinitely elastic the elasticities of beef and pork raw material supply would be .OOS and .003 respectively. These results imply that the composite elasticities of raw material supply of .OS, .1 and .2 assumed in the text are very much on the high side. 'The txansfer of surplus resulting from a decrease in Pa is to renderers and from any participant in the vertical chain from farmer to consumer who has a f inlte elasticity of supply (of an input) or a finite elasticity of demand (for an output). In the 2 • J.R.Coleman and X.D.Meilke "The Influence of Exchange Rates on Red Meat Trade between Canada and the UniteO States" (1988) Cana~ian Journal of ~gricultu:ral Economics 36, 401, Tables l and 2. 31
• • model used above only meat consumers anO farmers have this characte.r istic. The ratio of meat consumer to farmer surplus losses can be ahown to be~ <e.te.> CP..J'P.) It ls because the loss in surplus is share~ along the vertical chain that the discussion in the text refers to deadweight losses in consumers surplus in quotation marks. ,.his analysis also illustrates the difficulty of determining the redistributive effects of monopoly power in a vertical chain.
3.The Deadweight Loss and Surplus Transfer Resulting from a ... ecrease in Pa The wealth transfers and deadweight loss resulting from a decrease in Pa are calculated as follows: (a) The annual ~upplier loss is areas A + c in Figure l or: PaQdPa/Pa(l - .Se.dPa/Pa) where P~Q ls the total payment by all renderers· for relevant raw materials in the absence of the excereise of monopsony power and dPa/Pa is the .hypothesized rate of price decrease. (b) The annual renderer gain from lower raw material prices is areas c - B in Figure 1 or: PaQdPa/Pa(l-e.dPa/Pa) - FQe.dPa/Pa where FQ is renderer fixed cost anO prof it. (c) The deadwelght loss ls the difference between renderer gains and supplier losses which areas A+ B in Figure 1 or: .Se.PaQ(dPa/Pa) 2 + e.FQdPa/Pa 32
.. .
The deadweight loss is composed of two terms. The first is the Harberger triangle which ls the deadweight loss in "consumers" surplus (area A). The second term ls ·the lost contribution to renderer overhead and.profit (area 8).
4.The Deadweight Loss and Wealth Transfer Resulting from an Increase in H The calculation for the annual deadwe ight loss and weal th transfer resulting from an increase in H is as follows: (a) Suppliers and their customers and suppliers lose areas A C in Figure 2 or: HQdH/H(l - .se.dH/H) (b) Renderers 9ain ar~as C - B in Figure 2 or: HQdH/H(l - eadH/H) - FOeedH/H (c) The deadweight loss is areas A+ B or: .SHOea(dH/H) 2 +FOeadH/H Ji= A s ample calculation of areas A, B and C with 0=261, 000, F=- e.•.23 and dH/H•.089 yields: A•
c • S. Deadweight Loss with an I~oelastic Demand for Rendeiing Ser~ices The deadweight loss with an isoelastic demand (areas A+ B in Figure 3) is: HQ{{(l+dH/H)c 1 -•>-l]/(l-e)-(l+dH/H)-•dH/Hl+FQll-(l+dH/H)-•)
• •• • wh~re e is the elasticity of demand for xendering services, xepresented as e. ln previouE aectlons. The deadweight loss with an elasticity of .23 and an 8.9\ increase 1n M is comparea with in the linear case above. 34
. •· .
Figure 1
$/tonne s v
a a fl)rne$ /year SUPPLY OF RENDERABLE MATERIAL
35
• • • Figure 2
a a LINEAR ~O FOR RENDERIN~ SERVICES
Fiqure l .,.,. '' '' Hw ············-··· a a b"lnN/,.. ISOEJ..ASTIC DEMAND FOR RENDERING SERVICES
36
D tonwl/,..
• • •I • ATTACHMENT l DELETED FROM NON-CONFIDENTIAL VERSION
37