Anticipated acquisition by LOVEFiLM International Limited of the online DVD rental subscription business of Amazon, Inc.

Affected market: Video content delivery services

No. ME/3534/08

Please note that the full text of the decision can be downloaded by using the link on the right. What follows are extracts regarding the parties, the transaction, jurisdiction, third party views, assessment and decision.

The OFT's decision on reference under Section 22(1) given on 15 April 2008. Full text of the decision published on 8 May 2008.

Please note that square brackets indicate figures or text that have been deleted or replaced with a range at the request of the parties for reasons of commercial confidentiality.

PARTIES

LOVEFiLM International Limited (LF) is a European online DVD and games rental subscription service with operations in the UK, Germany, Sweden, Norway and Denmark. In the UK, LF offers its services through its website www.lovefilm.com and through a number of 'white label' contractual arrangements with other companies. Under these arrangements, LF fulfils its white label customers' online DVD rental orders using its DVD library and back-office systems and re-brands the LF DVD packaging with the company's brand (although the white label customer's website and/or the DVD packaging may still say 'Powered by LOVEFiLM'). In addition to DVD rental, LF also offers its members downloading to rent (DTR) and downloading to own services (DTO) via its website. LF started to offer DTR services in December 2005 and DTO services in April 2006. In the year ending 31 December 2007, LF achieved sales of £49 million, of which £41 million was in the UK.

Amazon Inc. (Amazon) is an online retailer of a wide range of products including books, toys and DVDs. Amazon operates a global business with websites in the US, Canada, Japan, China, France, Germany and the UK, and is listed on the US NASDAQ stock exchange. For the purpose of the anticipated transaction (the transaction), LF will acquire Amazon's online DVD rental (ODR) subscription service which operates in the UK and Germany (the Target Business). Amazon operates the UK part of the Target Business via its UK website www.amazon.co.uk. In the year ending 31 December 2007, the Target Business achieved UK sales of US$17.5 million (approximately £9 million).

TRANSACTION

LF will acquire from Amazon the Target Business, together with £ […] million in cash (plus pre-paid subscriptions) and certain marketing commitments by Amazon in return for granting to Amazon a […] per cent fully-diluted shareholding in LF.

The parties submitted an informal merger notification on 18 February 2008. The OFT's administrative deadline expired on 15 April 2008.

JURISDICTION

The transaction qualifies as a relevant merger situation on the share of supply test under Section 23(3) of the Enterprise Act 2002 (the Act) as the parties' combined share of supply in the UK for online DVD rental services exceeds the 25 per cent threshold.

The OFT therefore believes that it is or may be the case that arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation.

THIRD PARTY VIEWS

In the course of its investigation, the OFT contacted numerous companies active in the provision of video content delivery services. None of them raised any concern in relation to the anticipated transaction.

However, the OFT received four unsolicited complaints from customers. All four identified concerns regarding the lack of consumer choice that could arise as a result of the merger, as well as potential service quality reductions for Amazon customers. One noted that other channels of video content do not offer viable alternatives for consumers.

ASSESSMENT

As a result of the transaction, the parties' main overlap in the UK relates to the provision of ODR services. According to a critical loss analysis, the relevant frame of reference may be wider than only ODR. However, given the various alternative means of accessing video content and in the absence of a clear second choice of content-delivery channel suggested by the analysis, the OFT does not conclude on a precise definition of how much wider than only ODR the relevant product market may be. The geographic market is UK-wide.

The parties' share of supply varies significantly according to which candidate product market is considered: from 92 per cent with a 13 per cent increment on the narrowest plausible candidate market (ODR only), to 8.9 per cent with a 1.2 per cent increment on the widest plausible candidate market (all DVD rental, PPV and DVD retail). The OFT therefore focuses on assessing the closeness of competition (i) between LF and Amazon directly, and (ii) between the parties and alternative delivery channels. To that end, the OFT relies in the first instance on quantitative analysis of customer survey evidence provided by the parties and then subsequently on a large volume of internal business documents provided by the parties.

The quantitative analysis gives an estimate of the loss of competitive rivalry likely to arise as a result of the merger on the basis of (i) the parties' gross margins and (ii) diversion ratios between them. The OFT's estimate of the loss of competitive rivalry in this instance suggests a rebuttable presumption that the merger causes a realistic prospect of a substantial lessening of competition, giving rise to adverse unilateral effects.

In rebutting this presumption, the parties have provided documentary evidence of a sufficiently high evidentiary standard, given its volume and consistency, to suggest that Amazon is just one of many competitors-both ODR and non-ODR- which LF consistently and substantially monitors and responds to. The documentary evidence suggests that Amazon is not a principal constraint upon LF among those many competitors.

Additionally, considering the nature of demand for ODR services and LF's high customer churn rate, the OFT appreciates the importance of price and value propositions in the provision of ODR services. Furthermore, the OFT takes into account the relative immaturity of the ODR segment. Finally, the OFT also gives credence to the argument that ODR is a way for LF to develop its brand, widen its customer base and improve its reputation, in order to become a large-scale platform for online video content delivery. For these different reasons, the OFT acknowledges that the merged entity is unlikely to have an interest in worsening consumer propositions post-merger.

Lastly, the OFT also finds as a result of its investigation that the merged entity is likely to face various types of countervailing constraints post-merger in the form of the negotiating strength of powerful commercial partners and the potential expansion of existing ODR providers. The OFT also considers to be credible the possibility of entry by non-ODR video content providers, with substantial existing customer website traffic and a strong brand-potentially in partnership with smaller existing ODR or other players.

Consequently, the OFT does not believe that it is or may be the case that the merger may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom.

DECISION

This merger will therefore not be referred to the Competition Commission under section 33(1) of the Act.

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