Proposed acquisition by Duralay International Holdings Ltd of Gates Consumer and Industrial

No. ME/1111/01

A report under section 125(4) Fair Trading Act 1973 on the advice of the Director General of Fair Trading, dated 24 May 2001, to the Secretary of State for Trade and Industry under section 76 of the Act

Jurisdiction

The merger satisfies the share of supply test of the Fair Trading Act in respect of the supply of carpet underlay and gripper in the UK. The ECMR does not apply.

The parties

Duralay International Holdings Ltd (Duralay) was formed in 1996 following a management buyout of the underlay and related accessories business of the BBA Group. Duralay acquired the Airstep brand in 1997. In the year ended May 2000 Duralay reported turnover of £69.6m (see note 1), pre-tax profit of £4.6m, and gross assets of £30.17m.

Gates Consumer and Industrial (Gates) is a division of Gates (UK) Ltd, a wholly owned subsidiary of Tomkins plc. Gates is a UK manufacturer of rubber products including carpet underlay, and related carpet fitting accessories, specialised rubber flooring and footwear. It owns the Tredaire and Gripperrods brands. In the year to May 1999 the Division reported sales worth [detail omitted], pre-tax profit of [detail omitted] and gross assets of [detail omitted].

ASSESSMENT

Relevant markets

The parties overlap in the manufacture and supply of carpet underlay and related accessories. There are three relevant markets: the manufacture and supply of carpet underlay, the manufacture and supply of gripper, and the manufacture and supply of metal edgings.

The parties' combined market shares in metal edgings (which are used in joining carpets) will be below 25 per cent, and barriers to entry are low. In the manufacture and supply of gripper (used to stretch and fit carpet), the combined market share of new gripper will be in the range of 65-85 per cent (see note 2). However, barriers to entry are very low and market shares have fluctuated considerably in the past ten years. There is also evidence of countervailing buyer power. These two markets are not considered to raise significant competition concerns, despite the high market shares for gripper.

Carpet underlay is used to provide sound and heat insulation. It is generally made using one or more of the following materials: rubber sponge, polyurethane (PU), latex foam, crumb and felt, and expanded polyurethane foam. Underlay is produced in a variety of weights and thicknesses with heavier and thicker underlays being more hardwearing and giving a more luxurious feel to a carpet. Both parties are active in the production of rubber sponge underlay (referred to as 'sponge underlay'). The majority [see note 3] (55-75 per cent) of carpet underlay sold in the UK is sponge underlay.

All types of underlay perform the same function, with performance tending to improve as weight and thickness increases. While it is possible to switch between the manufacturing processes for foam and crumb rubber underlay, switching between producing sponge underlay and foam would not be possible using identical equipment. However, on the basis of the high degree of demand side substitution it seems reasonable to conclude that the relevant market includes all types of carpet underlay regardless of their composite material, weight or thickness.

The parties argue that the continued threat of new entry from imports acts as a constraint on their ability to increase prices post merger. Although they were able to supply competitive quotes from a manufacturer in the USA and one in Malaysia, imports are currently very low, accounting for a very small percentage of UK sales. Third parties have mixed views on the geographic market and the feasibility of imports. Underlay is a low value, bulky product that is relatively costly to transport. Imports therefore seem unlikely unless exchange rates are particularly favourable (which arguably they have been in recent years on account of the strength of sterling). Since there has been no firm evidence that customers regularly consider the possibility of imports, I have concluded that the geographic market is likely to be no wider than the UK.

Horizontal issues

The parties estimate that total sales of underlay in 2000 in the UK were [see note 4] in excess of £90 million. The merging parties are the two largest players in the carpet underlay market and will have a post-merger market share of nearly [see note 5] 55-75 per cent. Certain third parties have estimated the parties' market share to be closer to 80 per cent [see note 6] and there is only one other competitor of any size. This is a mature market and market shares have not fluctuated significantly in the past five years, although the parties contend that the stability of market share understates the strength of competition in this market.

Barriers to entry are hard to judge. While start up costs appear to be low, excess capacity, the presence of established firms with distribution networks and the existence of a mature market may act as deterrents to new entry.

The parties' sales tend to be concentrated on a small number of large retail players. Both the parties and these customers consider that they have a degree of buyer power. However, it is not clear that these customers would so easily exert their power to keep prices competitive post-merger. Since underlay is considered a secondary sale to the sale of carpet, and final consumer demand may not be very sensitive to the price of underlay, retailers might simply be able to pass any price increases on to consumers.

Vertical issues

There are no vertical issues arising from this merger.

Undertaking in lieu

The parties did not offer undertakings in lieu of a reference should the transaction raise concerns. However, since neither of the target's plants produce solely underlay products, I do not consider that this proposed transaction would easily lend itself to a divestment remedy.

Third party views

I have received a number of representations from customers and competitors. Third party views were mixed, but some expressed concerns over the high market shares that would result from the proposed transaction.

CONCLUSION

This case is finely balanced. The proposed transaction will create a strong firm with high market shares. The parties have suggested that there are countervailing factors - buyer power, low barriers to entry, and the threat of imports - that would negate any competition concerns that may arise as a result of the high market shares. As I have indicated, the strength of these factors is unclear in relation to carpet underlay and there were some concerns raised by third parties.

On balance, therefore, I consider that it is appropriate to refer this proposed transaction to the Competition Commission for further investigation, so that the strength of possible countervailing factors may be more fully assessed.

NOTES

1. Corrected by the parties to read £69.0m.
2. Detail omitted and replaced at parties' request with the range of 65-85 per cent.
3. Detail omitted and replaced at parties' request with the range of 55-75 per cent.
4. Detail omitted and replaced at parties' request with: in excess of £90m.
5. Detail omitted and replaced at parties' request with the range of 55-75 per cent.
6. The parties do not agree with this view.

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