An Act with Taste and Teeth

Cliona McNally - Senior Sophister

The Irish whiskey market has been dominated by Irish Distillers for many years. Cliona McNally's case study discusses the IDG/Cooley case from both an economic and legal perspective. Her anlaysis sheds some light on the broader aspects of competition policy.

'The Authority has shown that the Act has teeth as well as a taste for blended whiskey'. remarked Ken Murphy in response to the ruling on Notification No. CA/62/93 - Irish Distillers Group (IDG) plc./Cooley Distillery plc. This is the case, which has the dubious distinction of being the first merger to be found offensive by the Competition Authority. In this paper, I intend to examine and assess the economic and legal arguments presented by the IDG/Cooley and contested by the Competition Authority. I will, then, follow the repercussions the decision has had on the firms, in particular Cooley Distillery, and on the market.

An accurate definition of the market is crucial in any merger case. However, as the companies invariably have different definitions than the regulatory authority this can be problematic. Strangely, Cooley and IDG differed in their interpretations to each other as well. At the oral hearing, Dr. Teeling, of Cooley Distillery, declared that the relevant market was the world spirit market while Mr. Burrows, on behalf of IDG, claimed that they regarded the market as being the world whiskey market. However, they concurred that it was the perception of the companies themselves, which was the significant factor in determining the definition of the market.

IDG submitted a report compiled by the Henley Centre to support their claim that Irish whiskey was not the relevant market. The report argued that Irish whiskey drinkers consumed a wide range of drinks and that all alcoholic drinks should be considered part of the same market. This assertion was based on research of beer right through to fruit juice, and mineral water consumption during the past month. Anyone surveyed as having drunk various drinks from wine, whiskey and consumed the product in the past month, fell under the general category of Irish whiskey drinker. To me this is a rather spurious argument as there is no indication that when a person enters an off-licence or bar, wine competes head on with whiskey. The figures seem to show merely that during a month people consume many different things. Common sense would have suggested this to be the case. Firstly, it is clear that all alcoholic drinks are not substitutes, as personal tastes and preferences vary considerably - for example, beer and spirits are not as substitutable as are two types of lager. Also, it does not clarify what a true lover of whiskey would regularly substitute to when whiskey prices increase in a non-transitory manner beyond their budget constraint. Thus, the Competition Authority did not accept this argument as valid, especially as the report showed that since 1991 Irish whiskey prices rose in comparison to Scotch but without loss of market share. In addition and somewhat conversely, the report showed that of all the 'individuals in the survey who cited Irish Whiskey as the drink consumed most often, less than 2% had drunk Scotch once a month or more frequently.' A third party submission supported this, arguing that there was almost no cross price elasticity between Scotch and Irish whiskey.

The Irish Whiskey Act of 1980 requires whiskey to be distilled in Northern Ireland or the Republic of Ireland and matured in wooden casks in the state (or NI) for a minimum of three years. Thus to a certain extent Irish whiskey is a unique and rare product. Cooley Distillery whiskey is even rarer due to the fact that it is the only other whiskey that may be called 'Irish' apart from IDG's brands. For this reason the Authority found that drinkers would be more likely to substitute between Cooley and IDG. The brand would therefore 'have a far greater impact on the price and level of sales of IDG's products than would the entry of a new brand of imported whiskey.' Therefore the Competition Authority concluded that the relevant market definition was Irish whiskey within the state.

IDG claimed that one of its main motivations for buying Cooley was to protect its own quality brand image; the purchase was a form of damage control. Cooley distillery produces a product which is double distilled, like a scotch, and all of IDG's whiskeys are triple distilled. IDG feared that Cooley's financial difficulties would lead to this whiskey being sold at cheap prices which have negative repercussions upon their own brands as Cooley's brands were inferior. They claimed that the market was saturated and there was no market for Cooley's products. The Competition Authority found that Cooley's brands were not inferior, merely different, and this variety benefits the consumer.

'Cooley has a number of things in its favour. Its single malt is a delicate distillate of some finesse ... The grain whiskey - to go into the John Locke blend which is on the way - is among the most flavoursome and beautifully textured I have tasted. But Cooley's greatest coup is its peated Irish malt, the only one in living memory, which is a masterpiece.'

As they fulfilled the terms of the Irish Whiskey Act (1980) they were entitled to sell as such. In addition, there was evidence of a domestic and international market for the products contrary to what had been claimed, as submissions from the domestic Molloy group (liquor outlets), US, and German companies asserted. The third party submissions highlighted the salient point that if Cooley had gone into receivership then IDG could have acquired the whiskey stocks, presuming that they would be willing to pay more than any other party, at a much lower price. This suggests that their motivation was not acquiring Cooley as a means of quality control but as a form of competition control.

Another economic argument, which has found use in the courts, is that of the degree of concentration in a market and how a merger would affect this. Clearly this relies heavily on how the market is defined. IDG and Cooley argued that the degree of market concentration would not be affected in any significant manner and their justification for this was that IDG already had 47% percent of the total sales of spirits compared with less than a paltry 1% which was Cooley's. The Competition Authority's response was that in light of its definition of the market, being that for Irish whiskey, the takeover of all Cooley assets by IDG would result in a return to a monopoly situation, as Cooley Distillery is the only distillery which manufactures Irish whiskey that is not owned by IDG. Also the inflated price that IDG was willing to pay for Cooley and all its assets, indicates their willingness to pay for the cost of maintaining their monopoly (£24.5 million being the total cost to IDG after all obligations have been discharged) - in other words, it seems a prime example of rent-seeking. Both a dominant position in the market and also a monopoly position would have resulted. The removal of Cooley would be the end of the meagre amount of competition which was present and would hail the elimination of 'potential competition'. This area was addressed by the Authority in the case of Nallen O'Toole where it was indicated that competition shows the potential for competition also. Given Cooley's production capacity it is clearly a potential competitor. Dr. Teeling informed the Authority that Cooley had hoped to achieve sales on the domestic market, after four years, of 8% of the 1992 sales. The Authority decided that allowing the arrangement to proceed would eliminate any possibility of this potential being fulfilled, (e.g. by investment by an overseas drinks producer) and thus inhibiting competition.

Another important issue at stake was the fact that IDG intended to buy all of Cooley's distilling equipment, plant, and sister companies' whiskey stocks, mature or not, and thus in one fell swoop create a significant barrier to entry by any other prospective producer. Third parties submitted that 'the time taken to build a new distillery, coupled with the requirement that the plant would have to operate for a number of years before any product would be ready for sale, meant that it would take at least five years before any new competitor could enter the market'. Due to the high entry costs and the long run sunk costs, before sales could reach break-even, the finance required presents a significant barrier to entry. Coupled with the blatantly anti-competitive statement by Mr. Richard Burrows (IDG), that IDG had no use for the distillery and were buying it so that no one else could, this could be construed as a possible abuse of a dominant position to prevent or at least deter future entry. In the Sculley Tyrrell decision an important consideration in the issuing of that licence was the fact that it 'would be unlikely to prevent, restrict or distort competition where there were no significant impediments preventing new competitors from entering the market.' This is clearly a different scenario.

The Competition Authority has expressed various pertinent views in other cases which are relevant to the Cooley/IDG case. In Sculley Tyrrell, the Authority stated that 'the Authority believes that in a highly concentrated market a merger which results in even a relatively small increase in the market share of one of the larger firms merits closer examination.' IDG accounts for 46% of the Irish spirits market, 72% of the gin market, and crucially 76% of the whiskey market and almost 100% of the Irish whiskey market. Mergers below this margin were per se not anti-competitive yet the Competition Authority decided that the notification, however, did fall foul of the Competition Act.

Section 3(1) of the Competition Act defines an undertaking as:

'a person being an individual, a body corporate or an unincorporated body of persons engaged for gain in the production, supply or distribution of goods or the provision of a service.'

Thus, it is clear that IDG and Cooley both being corporate bodies engaged in production for gain are considered undertakings covered by the Act. However, the issue of defining an undertaking can often be as difficult and contentious a definition as that for the relevant market.

Section 4(1) of the Competition Act states that:

'all agreements between undertakings, decisions by associations of undertakings and concerted practices which have as their object or effect the prevention, restriction or distortion of competition in trade in any goods or services in the State or in any part of the State are prohibited and void.'

IDG submitted that the agreement about which they notified the Authority was not a merger or takeover and therefore should be certified. The reasoning presented to the court was that the actual takeover would be effected by individual agreements between IDG and individual shareholders and, as they were not 'undertakings' these agreements were not notifiable. The Authority was not impressed with this piece of verbal quick-step, stating that if IDG had actually done what they asserted, that is 'isolated arrangements peripheral to their merger with no anti-competitive effect' and had chosen to notify only these, then the Authority would consider that 'a waste of time, and if deliberate an abuse of its procedure'. In fact what the notification contained was an agreement which bound IDG to making a takeover bid, and to the terms under which the offer would proceed. Thus it was judged to be an agreement between undertakings. The requirements of the Letter of Agreement were stringent, providing an exclusive dealing arrangement between Cooley and IDG during the offer period which naturally did not help Cooley's ailing condition (although IDG did buy some whiskey stocks to tide them over). In addition, an addendum to the offer document was that 'the directors of Cooley will enter into a covenant with IDG not to compete in whiskey manufacturing to the extent permitted by law'. This appears to be a very definite restriction on future and potential competition, as the directors in question, especially Dr. Teeling, would have learnt a lot from their foray into the industry and could quite conceivably have returned in future years to set up, or aid, a viable competitor. However, the Authority did not take to task this aspect of the document.

The proposed buyout did not meet the requirements specified in section 4(2) for a licence. This section allows for a licence to be granted even if the proposed agreement is found to offend section 4(1). It allows for the consideration of other mitigating factors which may show that the agreement is in the interests of aggregate social welfare. In particular those which

'contribute to improving the production of goods or provision of services or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit and which does not: ...(ii) Afford undertaking the possibility of eliminating competition in respect of a substantial part of the products or services in question.'

It is evident that IDG's proposed shutdown of the plant does not improve any of the requisite categories and indeed, offends against (ii) as it removes all of Cooley's products from the market.

Cooley and IDG contested that Cooley would go into receivership in the near future and with reference to the 'failing firm' defence from the US it was argued that the merger should be allowed to proceed. The key areas of note are that the firm would be unable to meet its financial obligations in the near future, and that it had made 'unsuccessful good faith efforts to elicit reasonable alternative offers of acquisition that would keep it in the market and pose less severe danger to competition than does the proposed merger' (Department of Justice Merger Guidelines 1984). This proposed merger ensured that Cooley products and assets would exit the market. Changes in Business Expansion Scheme (BES) legislation forced Cooley into substantial borrowing. With the result, it found additional resourcing, which was needed to reach new markets, very difficult to obtain. Dr. Teeling declared that £9 million would be required. The fact that Cooley was for sale at various stages since 1991 was cited, and articles in newspapers were produced as further evidence that the firm was indeed on the verge of collapse. However, third party submissions contested that sufficient 'good faith efforts' had not been used to source another buyer as parties in the US had expressed interest in acquiring Cooley in 1993 and the directors had not been interested. A cynical mind might suggest they were aware they could hold out for a better offer. A German distributor along with others expressed its interest in Cooley and its willingness to invest in inventory and advance promotion of the products. This casts further doubt on the viability of the failing firm defence but it is true that there was no proof at the time that this would be sufficient to see Cooley back on track.

The Result

It is said that the proof is in the pudding. Similarly the truth of Cooley's 'inevitable downfall' is to be found in its present state, which I hasten to add is not liquidation. The following is an assessment of the short and long term effects of the Competition Authority's decision on the firm, industry and market.

Cooley announced a £1.9 million rescue package when the Authority's judgement was made. Cooley was also due a £600,000 termination payment from IDG if the deal did not go ahead but as Cooley had to buy back the £615,000 of whiskey purchased by IDG it found itself owing £15,000 instead. Changes in the 1993 Finance Act increased the ceiling for the amount of money that can be invested in any one company from £500,000 to £1 million which gave the Cooley group the opportunity to raise another £3 million in the BES. 'They are a string of pearls' commented a Cooley spokesman. In March 1994, Cooley Distillery signed a contract worth $7 million (£4.86 million) to supply the Kilbeggan brand of blended whiskey to Heaven Hill Distilleries. Cooley received £1.18 million of that sum up front, in addition Heaven Hill agreed to finance the promotional end for Kilbeggan in the US. Heaven Hill, being the largest independent distiller and the eighth largest supplier in the States is a significant partner to gain. In August of the same year, Cooley signed a joint venture company (Moet Hennessy Distribution and United Distillers) for its brands Kilbeggan and Tyrconnell and within five years they hoped to take 20% to 25% of the French market. This will take Cooley's products into head-to-head competition with IDGs' who in conjunction with their owners, Pernod Ricard, had almost exclusive supply of the market. A month later in September 1994, Cooley signed a distribution agreement with Tobacco Distributors Ltd. for the sale of all its products on the domestic market. This distributor had 4,000 accounts and supplied 12,000 licensed premises at the time of the agreement. John Teeling commented that the organisation had 'integrity, resources and competence', the three things Cooley needed, and that he hoped to capture 10% of the domestic market annually. In June of 1995, Cooley joined forces in a ten-year agreement with Invergordon Distillers to supply bulk whiskey for the company to blend and bottle for British retailers to sell as an own brand. This good news goes on in a similar manner with an own label deal with Tesco's, and distribution in the UK of Kilbeggan and Tyrconnell with Waverly Vintners (March 1996).

So with the benefit of hindsight it seems that the Authority was perfectly correct in its assertion that Cooley was a potential competitor. How does face value measure up to the experiences of Dr. John Teeling, a founding director? The short-term result was catastrophic with a share price reduction from £1.80 to 35p. The long-term financial damage was very serious. The workers are on part-time work with no hope of full-time in the near future and he remarks that they might have been better off as well. However, he believes the decision was an excellent one for the consumer, industry and nation.

'Prices have fallen, there is a far greater variety of products, quality employment is growing as greater emphasis is placed on marketing, exports are up and there are more whiskey based products, e.g. cakes, sweets and jam.'

In the short run, the UK and France benefited with a great increase in competition resulting from the introduction of Cooley's own brand label. In the long run Cooley have established themselves in many markets and significantly Dr. Teeling comments that 'IDG have to compete very hard with us.'

The policy implications are clear from a social planner's point of view, especially with the benefit of hindsight: jobs were saved and more variety resulted in the whiskey and spirits markets and spin-off product markets. Most importantly, given the brief of the Authority, the decision ensured more competition on domestic and international markets.

Bibliography

Competition Authority (25 February 1994) Decision No. 285.

Competition Authority (1993) Decision No. 12.

Massey, P. and O'Hare, P. (1996) Competition Law and Policy in Ireland, Oak Tree Press: Dublin.

McCarthy 'The CD Rom McCarthy files', in The Irish Times and The Irish Independent.

Murray, Jim (14/3/1993) Sunday Telegraph.

Notification No. CA/62/93 Irish Distillers Group plc/Cooley Distillery plc.

Whitaker, A. (ed.) Competition. Competition Press.