The Monopolies and Mergers Commission (MMC) report into the acquisition by FirstGoup (formerly FirstBus) plc (FirstGroup) of S B Holdings Limited (SBH)

No. ME/0154-96

A report under section 125(4) Fair Trading Act 1973 on the advice of the Director General of Fair Trading, given on 21 December 2001, to the Secretary of State for Trade and Industry under section 88(2) of the Act

The MMC's report into this merger was published on 24 January 1997. This is my report under section 88(2) of the Fair Trading Act 1973 (the Act) on the outcome of the negotiations with FirstGroup on the terms of the undertakings arising from the MMC's report.

Recommendation

I believe that the undertakings attached to this submission satisfy the requirements set out by your predecessor in 1998 and, on that basis, can be accepted. If you decide to do so, the signed undertakings should be published in accordance with section 88(2A) of the Act.

Timing

Urgent. These undertakings, while already being applied to some extent, should be applied in full as soon as possible.

Background

The reference and MMC report

This merger was completed in June 1996 and brought together the two major bus operating companies in central and south east Scotland. The merger was referred to the MMC on 23 September and the MMC reported in January 1997 that the merger operated against the public interest. The MMC recommended that FirstGroup (FirstBus as it was at the time) should be required to divest one of its three operating companies in the area, Midland Bluebird, together with one of the four Glasgow depots of SBH. The Glasgow depot would have to include a network of routes (and buses) representing at least 20% of SBH's turnover in Glasgow.

The then Director General (John Bridgeman) recommended acceptance of the MMC's findings and recommendation as to remedy subject to some marginal changes. The then Minister for Corporate and Consumer Affairs announced on 24 January 1997 that he accepted Mr Bridgeman's advice and requested that he obtain undertakings to this effect.

FirstGroup's initial response to this announcement was that it was considering a judicial review of the MMC's findings and recommendation. In particular, FirstGroup was concerned about the reliance that the MMC had placed upon statements from Stagecoach that, because of FirstGroup's now dominant position, it would not enter the Glasgow bus market. FirstGroup's concern was given some force when Stagecoach did then enter the Glasgow bus market in March 1997, albeit in a limited way. Following the General Election and change of government in May 1997, FirstGroup made a formal approach to the (new) Minister for Competition and Consumer Affairs, Nigel Griffiths MP, requesting that he reconsider his predecessor's decision to accept the MMC's report and my predecessor's advice

The Minister then asked John Bridgeman to consider and advise on FirstGroup's request that the remedy be reconsidered in the light of the alleged changes to the bus market in Glasgow since the MMC had reported.

Review of the Scottish bus market and MMC's findings

The OFT carried out an extensive review of the Scottish bus market and John Bridgeman advised, on 13 November 1997, that while the divestment of the Glasgow depot (and routes) was no longer required, FirstGroup should be required to dispose of Midland Bluebird. The Secretary of State replied on 10 March 1998, indicating that she was minded to seek behavioural undertakings from FirstGroup, rather than making the recommended divestment and asked for advice on the composition that such undertakings might take. John Bridgeman responded on 6 April with an outline of the offer of undertakings made by FirstGroup but re-iterating his preference for a structural remedy. The point was made that the undertakings would be seeking to regulate the bus fares for a substantial proportion of the total population of Scotland and would entail significant monitoring costs for the OFT.

This did not change the Secretary of State's mind and on 31 July 1998 she announced that she had decided to seek a package of behavioural undertakings from FirstGroup, rather than divestment of Midland Bluebird. The undertakings were intended to regulate prices and minimum service levels, and included restrictions on fare and frequency changes, journey intervals and competition against tendered services. The Director General was asked to negotiate undertakings to this effect.

The undertakings

One of the main difficulties in seeking to negotiate these undertakings has been that such a behavioural remedy was substantially different from the structural remedy that the MMC had recommended. As a consequence, the MMC report itself, in considering remedies intended to address the adverse effects which it had identified, did not address behavioural remedies to any great extent. The OFT, therefore, lacked significant information about the behavioural issues which the undertakings were intended to address. To some extent, therefore, my officials have been negotiating from a position of weakness- with some knowledge and experience of the operation of bus markets generally, but little specific information about behaviour in the specific market. This has required rather more discussion of the detail of the undertakings than might otherwise have been the case.

The two main elements of the undertakings are: a fare cap covering most of FirstGroup's First Glasgow (formerly SBH), Midland Bluebird and Lowland operating areas; supported by a package of essentially anti-predation undertakings covering the Midland Bluebird and Lowland area. The fare cap undertakings are themselves supported by necessary undertakings not to change, without consent, a range of matters including fare types, fare stages and zones, and peak fare periods.

The fare cap undertaking operates in two parts: first, a fare freeze for a period of 12 months and then a requirement that the increase in the basket of fares in any Fare Year will, effectively, not exceed the change in the RPI index in the preceding year. Because of differences in the way in which fares are set and applied, it has been necessary to allow for separate fare 'baskets' for each of the First Glasgow area and the Midland Bluebird/Lowland area. The latter has, moreover, been slightly refined to allow for a dispensation where Midland Bluebird and Lowland fares are of the same type and value. This is because, due to the different nature of the journey (Midland Bluebird being a largely urban area and Lowland much more rural), FirstGroup may not be able to increase the same fares at the same rate (or at all).

Until the undertakings have been formally accepted, as a gesture of good faith FirstGroup has sought to apply the principles of the fare cap undertakings since September 1997 in the case of First Glasgow, and since February 1998 for Midland Bluebird and Lowland. There have been some fare increase for FirstGroup companies, limited by the fare cap undertakings, since then.

Unfortunately, there was an information breakdown within the local management at Midland Bluebird/Lowland, who calculated and applied a fare increase in September 2000. Technically, FirstGroup would not have been permitted, under the terms of the undertakings as drafted, to make a fare increase at this time since the full increase allowable in that Fare Year had already been applied in February 2000.

While there might be a case for arguing that, following this error, the price cap undertakings should start again- at least for Midland Bluebird/Lowland- this would, in my view, have been unfair on FirstGroup. The company had already foregone any fare increase in the fare freeze period and limited one subsequent fare increase in accordance with the undertakings. We therefore sought to reword the undertakings to allow FirstGroup to bring its operating companies to a common fare increase date by acknowledging but limiting the "interim permitted increase" applied in February and September 2000.

My officials have reviewed the fare increases calculated and applied by FirstGroup to date and are satisfied, subject to the points mentioned above, that these have been made correctly and within the terms and spirit of the draft undertakings.

The package of anti-predation undertakings apply only within the Midland Bluebird/Lowland area. These include the requirement that FirstGroup shall not reduce its fares and frequencies on routes where a competitor ceases to operate a bus service as a result of action on the part of FirstGroup. The undertakings also provide that FirstGroup shall ensure that any new commercial bus services are evenly spaced between those of a competitor and that it will not provide or operate a new commercial service in competition with a tendered service which it had applied unsuccessfully to run. The undertakings also require that FirstGroup shall not reduce its commercial mileage within the Midland Bluebird/Lowland area to below 95% of that at the date of the undertakings.

Assessment

Clearly these undertakings are both broad and complex. They seek to remedy a loss of competition with a regulatory framework of controls- the fare cap applying to a combined area containing some 45% of the population of Scotland. In his letter of 6 April 1998 John Bridgeman outlined his concerns about this approach and so I do not need to repeat them here. Suffice to say that I share those concerns, which have, to some extent, been borne out by the time it has taken to finalise the terms of these undertakings.

During the course of these negotiations FirstGroup sought to have the price cap increased after year 3 to the change in RPI+1%. It subsequently withdrew this request when it was suggested that this might delay the consideration of the undertakings. As my predecessor recognised, it is a general feature of such price caps that they tend to be inflexible and unable to respond to exogenous increases in specific costs, such as changes in fuel and duty rates. The price cap, if set too low, might also inhibit investment, for example in new vehicles or in higher quality services or infrastructure. More recently FirstGroup has again mentioned the possibility of reviewing the level of increase permitted by the undertakings at some point in the near future. A review strictly in line with the Secretary of State's views in 1998 could mean that the undertakings might not be reviewed until late 2006 (i.e. not later than five years after they are dated). However, FirstGroup has been applying the principles of the fare cap in Glasgow since September 1997 and, by the time of the next fare increase in September 2002, will have been operating the fare cap in Glasgow for five years. In view of this, rather than including a sunset clause in the undertakings, we propose to write to FirstGroup once the undertakings have been signed setting out our intention, subject to your agreement, to review the operation of the fare cap in Glasgow by September 2002. This may suggest there will be an on-going need to reconsider the level of the price cap, which would significantly add to the monitoring costs to be incurred by the OFT, and the cost to business, but it is an inevitable consequence of this type of undertaking.

In drafting the undertakings we have sought to reduce the level of monitoring required- for example, by placing a positive obligation on FirstGroup regarding the spacing of bus services (clause 7 of the undertakings) - but there are still a significant number of 'consent' provisions. I am advised by FirstGroup that most of the rationalisation of the former SBH operations has been completed.

You should also be aware that the OFT has recently received a complaint from Lothian Regional Transport (LRT) - the municipal-owned operator of buses in and around Edinburgh - alleging predatory behaviour on the part of FirstGroup in the supply of bus services in Edinburgh. The complaint is still under consideration and we have, as yet, taken no view on the matter. These undertakings do not, however, apply to bus services within the City of Edinburgh. The price cap element of the undertakings may, however, restrict FirstGroup's ability to cross-subsidise loss making services in Edinburgh with higher fares for the rest of its services in central and south east Scotland. To that extent, therefore, these undertakings may be relevant to the consideration of the complaint from LRT.

Conclusion

I believe that the attached undertakings meet the requirements for the behavioural undertakings set out by the Secretary of State in 1998 and which my predecessor was requested to obtain. The parties have indicated they are content with the terms of the undertakings and have signed them in advance to indicate commitment to them.

If you agree that these undertakings are satisfactory, I recommend that you accept and date them and that they be published in accordance with section 88(2A) of the Act, in due course.

Back to top