Proposed acquistion by Daimlerchrysler Rail Systems (UK) Limited (Adtranz) of Railcare Limited

No. 00234/C

Report under Section 125(4) of the Fair Trading Act 1973 of the Director General's advice, dated 14 November 2000, to the Secretary of State for Trade and Industry under Section 76 of the Act

The Parties

Adtranz is a wholly owned subsidiary of DaimlerChrysler AG. The group is involved in the design and manufacture of railway rolling stock and signalling equipment, and the maintenance and repair of railway rolling stock and associated equipment. Its main operating premises are at Crewe, Derby, Doncaster, Ilford and Chart Leacon. In the year to 31 December 1998, Adtranz had a turnover of £285.6 million.

Railcare Ltd is involved in the heavy maintenance, repair and refurbishment of railway rolling stock and equipment and also designs and supplies carriage interiors. It has premises at Wolverton (Milton Keynes), Glasgow and Coventry (used only for carriage interiors). In the year to 31 March 2000, its turnover was £55.8 million and the gross assets were £32 million.

Jurisdiction

The merger qualifies for investigation by satisfying the share of supply test in section 64(1)(a) and (3) of the Fair Trading Act 1973 (FTA) in the supply of heavy maintenance services for railway rolling stock, and the supply of associated spare parts, within the UK. The ECMR does not apply.

Assessment

Relevant Markets

The parties are involved in the supply of maintenance services for railway rolling stock – Adtranz provides both light and heavy maintenance services, Railcare supplies only heavy maintenance services. The parties also overlap in the repair of spare parts, but this sector does not raise competition concerns given the alternative sources and it will not be considered further. No concerns arise from the acquisition of Railcare's carriage interior business, as there is no overlap. Adtranz currently sources its requirements for carriage interiors from external suppliers, including Railcare.

Since privatisation the market has been split between light and heavy maintenance sectors with light maintenance carried out at local depots managed by the train operating companies (TOCs) and heavy maintenance carried out at more remote "workshops" generally owned by specialist contractors. Workshops require more specialist equipment to perform this type of work, in particular lifting gear to remove bogies, wheelsets and other major components.

Since privatisation of the rail network in 1995 and the expiry of the initial heavy maintenance contracts, the market has been subject to change and there has been a degree of convergence between light and heavy maintenance. This is partly a result of TOCs' desire to undertake more maintenance work at local depots to minimise the time a train is out of service. The parties claim that the market can no longer be segmented into separate light and heavy maintenance. They consider that, in future, the pattern will be for a single company to provide all maintenance work. A further significant development has been the introduction of integrated maintenance packages for new build trains by the train manufacturers, which cover the life of the train and provide TOCs with greater certainty over maintenance costs and reduce technical risk. The parties claim that, as a result of these two changes, the fact that modern rolling stock requires less maintenance with a greater emphasis on light work, together with buyer power of rolling stock operating companies (ROSCOs) and TOCs to secure lower prices, means that the heavy maintenance is declining.

The market for heavy maintenance has declined from £300 million in 1995 to about £200 million currently and there appears to be significant over-capacity in the industry at present. This trend is likely to continue with the introduction of an increasing volume of new rolling stock during the next few years, which s. requires less heavy maintenance. However, I have been advised that a significant proportion of old rolling stock is likely to remain in use for a considerable time, possibly until 2020 or so.

While I recognise that changes are taking place in the provision of maintenance services, I am not convinced that these are sufficient to conclude that heavy and light maintenance services have converged to form a single market. I have concluded, therefore, that it is appropriate to regard heavy maintenance as a separate market and that this is the relevant market to assess the effects of this merger proposal.

Horizontal Issues

The parties calculated a national market share figure for heavy maintenance [greater than 30%] (see note) based on the assumption that in-house maintenance performed by certain TOCs was in the same market. Market shares are significantly higher - [greater than 50%] (see note) - in certain sub-markets such as the overhaul of wheelsets and bogies. I also note that some of the TOCs supply their own heavy maintenance services in-house but do not offer these services to other companies. It is debatable whether their services should count as part of the market. These reasons lead me to believe that the parties' overall figure may understate their share of the competitive market for heavy maintenance. I also note that the parties would become by far the largest player in the market following the merger. In terms of size, the next two competitors active in the open market for heavy maintenance services for existing rolling stock are much smaller,There are only two smaller independent competitors active in heavy maintenance of old rolling stock and their combined market share is [greater than 20%] (see note). The merger would thus give rise to a significant structural change in the market.

It is clear that transport costs and the associated time out of service can be significant factors in the choice of location for heavy maintenance. However, it is also clear that some of the depots that are the subject of this merger have undertaken work at some distance from the TOC depots. It seems to me that there is likely to be a chain of substitution geographically between depots and I therefore conclude that the appropriate geographic market is likely to be national.

Barriers to entry appear to be significant given that the flow of heavy maintenance work is uneven, there is excess capacity, it is difficult to find sites to establish facilities and the market itself is declining. Overall, I consider the prospect of new entry to be unlikely.

The parties' main customers are the ROSCOs. A typical heavy maintenance contract for existing trains would be for three or four years. Where maintenance contracts are negotiated as part of an integrated contract for the supply and maintenance of new rolling stock, the contract is likely to be for a longer period and may run until expiry of the associated rail franchise. I have received varying views on the question of whether ROSCOs are likely to place contracts for maintenance of existing stock with the same company that supplies them with new trains. I consider it unlikely that existing contracts would readily be replaced but I note the work would be re-tendered when the contract expired.

The ROSCOs may now have a degree of buyer power. However, I am less certain that the ROSCOs would be able to continue to exercise buyer power following the merger. I would expect the parties to reduce capacity and there would be less competition in the market for heavy maintenance (effectively four independent companies would be reducing to three).

Vertical issues

There There are no significant vertical issues arising from the merger. Adtranz is active in the supply of parts for maintenance, but there is no increment in their market position as a result of the merger. I have considered Adtranz's position as a supplier of new trains and that of Railcare as a supplier of carriage interiors but do not regard its position in either market as being strengthened to such an extent as to give rise to competition concerns.

Third Party Views

I have consulted interested parties during my investigation. Customers and competitors expressed serious concerns about the increased market power of the merged company.

Undertakings in lieu of a reference

With substantial spare capacity now in the market, it is not clear that divestment of one or more maintenance depots would provide a workable remedy. With prices and specifications likely to vary from contract to contract, undertakings capping prices or maintaining quality would be excessively difficult to describe and enforce efficiently. Some respondents suggested that prospective competitive problems might be addressed in the form of an industry Code of Practice for heavy maintenance work. They did not provide details of how this would work and, in any case, you would have the power to impose a remedy only on the parties to this merger, rather than the whole industry. The industry regulators did not consider that a Code of Practice would be an effective solution. There are, therefore, no obvious remedies that could address the potential problems related to market power in the supply of heavy maintenance services in such a way as to make unnecessary a fuller examination by the Competition Commission of the proposed merger situation.

Conclusion

I accept the parties' contention that the markets for light and heavy maintenance are converging to some degree, but I have concluded that, at the present time, the markets remain distinct. The merger would result in a substantial increase in concentration in the market for heavy maintenance services. Even including the TOCs' self-provision of such services, the merged entity would have [a share greater than 30%] (See note 1) of the market.

I have also concluded that barriers to entry are substantial, and that new entry is unlikely. I am therefore concerned that this merger, if it were to proceed, might lead to increases in prices or a reduction in the quality of services.

I therefore conclude and recommend that you should refer this completed proposed merger to the Competition Commission.

NOTES

1. The precise figure has been excised at the request of the parties

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