New Zealand Law Students Journal
Last Updated: 14 January 2013
GAZING INTO THE CRYSTAL BALL: IMPROVING THE EVALUATION OF UNCERTAINTY IN NEW ZEALAND MERGER CLEARANCE APPLICATIONS*
Competition law aspects of New Zealand merger regulation are governed by the
Commerce Act 1986. In 2001 the legal test for merger
amended.1 Part of the reason for this amendment was to allow the
agencies to apply more sophisticated methods of merger analysis.2
However, the opportunity to modernise New Zealand’s merger
analysis test was rejected by the Court of Appeal
in the Warehouse
Case.3 Instead, the Court adopted a test that, this paper will
argue, poorly evaluates the likely consequences of a merger and causes greater
uncertainty for businesses trying to predict whether a potential merger breaches
the statutory prohibition. As an alternative, this
paper suggests an Expected
Value approach for evaluating all numerically quantifiable aspects of a
A. Legislative Framework
The Commerce Act 1986 (the “Act”) is the primary piece of
legislation governing competition law in New Zealand. The Act
is administered by
the Commerce Commission4 (the “Commission”) and its
purpose is to
* This paper is an adaptation of Chapter 2 of my dissertation: Ronen Lazarovitch, An Expected Value Approach to Evaluating Uncertainty in New Zealand Merger Analysis (Honours Research Paper, University of Otago, 2008), available online at
∗ LLB(Hons)/BCom, University of Otago. The author is currently employed by
Chapman Tripp in its Auckland office.
1 Commerce Amendment Act 2001 (2001 No 32).
2 Explanatory Note to the Commerce Amendment Bill 2001 No 2, 111-1.
3 In this paper “Warehouse Case” refers collectively to Commerce Commission v Woolworths
Ltd  NZCA (also “Warehouse Case CA”), Woolworths Ltd v Commerce Commission
29/11/07, Mallon J and Dr King, HC Wellington CIV-2007-485-1255 (also “Warehouse
Case HC”) and Foodstuffs Limited and Woolworths Limited / the Warehouse Group Limited Com
Com Decision Nos 606 & 607 (8 June 2007) (also “Foodstuffs/Warehouse”).
4 New Zealand Commerce Commission, Mergers and Acquisitions
96 The New Zealand Law Students’ Journal (2009) 2
“promote competition in markets for the long-term benefit of consumers in New Zealand.”5 Parts II and III of the Act prohibit certain activities on the grounds that they are anti-competitive.6 If these provisions are breached the person(s) involved are liable to pecuniary penalties.7
Section 47 of the Act prohibits business acquisitions that are likely to substantially lessen competition in a market.8 If a person proposing a business acquisition is concerned that it might breach s 47, that person may apply to the Commission for a merger clearance under s 66 of the Act.9 A clearance allows the applicant twelve months to complete the nominated acquisition, during which time the acquisition will be protected from challenge under the Act.10 The Commission will grant an applicant a merger clearance if it is “satisfied” that the merger is “not likely to have the effect of substantially lessening competition in a market”.11
The Commission publishes the New Zealand Mergers and Acquisitions
Guidelines12 (the “Merger Guidelines”) to assist the
public in determining whether a clearance should be sought and to explain the
Commission’s merger analysis procedure.13 The Merger Guidelines
are not intended as a substitute for the Act and do not bind the
2004), 6. The Commission is also responsible for the regulatory regimes specified in the Dairy Industry Restructuring Act 2001, the Electricity Industry Reform Act 1998, the Telecommunications Act 2001 and the Fair Trading Act 1986.
5 Commerce Act 1986, s 1A.
6 Prohibited activities include entering into contracts, arrangements, understandings and
covenants that substantially lessen competition (Commerce Act 1986, ss 27 and 28), boycotts (s 29), taking advantage of a substantial degree of market power for certain purposes (s 36) and resale price maintenance (s 37).
7 Commerce Act 1986, s 83. The breaching party may also be liable for personal actions
for damages (Commerce Act 1986, 84A), divestiture of assets or shares (Commerce Act
1986, 85) and injunctions (Commerce Act 1986, 84).
8 Commerce Act 1986, s 47(1).
9 Optional merger notification (also referred to as ex post facto control, or the ‘strike-down’
regime) replaced mandatory pre-merger notification in 1990 by virtue of the Commerce Amendment Act 1990. For an analysis of this legislative change see M Berry and A Riley, “Beware the New Business Acquisitions Provisions in the Commerce Amendment Act
1990" (1990) 21 VUWLR 91.
10 Commerce Act 1986, s 69.
11 Commerce Act 1986, s 66(3)(a).
12 Merger Guidelines, above n 4.
13 Ibid, 1.
Gazing into the Crystal Ball 97
Such a publication is in line with most other Western competition law regulatory bodies.15
The general framework used by the Commission to evaluate mergers involves three steps.16 First, the Commission will define the relevant market(s) and estimate the market shares of the participants in the market(s).17 Second, the Commission will establish hypothetical scenarios for each relevant market: what will, or is likely to happen if the acquisition takes place (the “factual”) and what will, or is likely to happen if the acquisition does not take place (the “counterfactual”).18
Third, the Commission will compare the state of competition between the
factual and counterfactual to determine whether any reduction
amounts to a substantial lessening of competition (a “SLC”).
If the Commission determines that
a SLC is not likely then the clearance will be
granted, otherwise the clearance will be refused.
B. The Warehouse Case
New Zealand has only two independent supermarket retailers,
Foodstuffs and Woolworths,19 who between them account for 100%
15 E.g. U.S. Department of Justice and the Federal Trade Commission, Horizontal Merger Guidelines (Washington DC, 1997), Australian Competition and Consumer Commission, Merger Guidelines (Canberra, 1999), UK Competition Commission, Merger references: Competition Commission Guidelines (London, 2003), Canadian Competition Bureau, Merger Enforcement Guidelines (Ottawa, 2004), European Competition Commission, Guidelines on the Assessment of Horizontal Mergers Under the Council Regulation on the Control of Concentrations Between Undertakings (Brussels, 2004).
16 Merger Guidelines, above n 4, 6-7.
17 The Commission uses a broad definition of ‘market’ that includes geographical area(s), goods/services supplied and level(s) of production/distribution. When relevant, the Commission also considers timing elements and customer types. The central inquiry when defining a market is substitutability. That is, products that are good substitutes for
each other will be in the same market. Whether products are good substitutes is measured by customer reaction to price increases; the “SSNIP” test. The SSNIP test measures the smallest geographical area within which a hypothetical localised monopolist could impose a Small yet Significant and Non-transitory Increase in Price without customers
substituting to other goods. Often the SSNIP used to determine customer reaction is a 4-
5% increase in price. (Merger Guidelines, above n 4, 14).
18 See Merger Guidelines, above n 4, 21.
19 Prior to 2002 New Zealand had three independent supermarket retailers: Progressive,
Woolworths (New Zealand) Limited and Foodstuffs. At the time Progressive had
24% of the market-share, Woolworths (New Zealand) Limited
had 18% and Foodstuffs
had 58% (See Foodstuffs/Warehouse, 6). In June 2002, Progressive acquired
Woolworths (New Zealand) Limited from Dairy Farm International Holdings of Hong
acquisition reduced the number of independent supermarket retailers
in New Zealand to
supermarket retail purchases in New Zealand.20 The Warehouse Case involved two separate merger clearance applications to the Commission by both of the supermarkets to acquire the Warehouse Group Limited (the “Warehouse”). The decision to acquire the Warehouse followed the Warehouse becoming a direct competitor of the supermarkets by launching “supercentres”21 that sold general merchandise together with a full range of groceries. The Commission declined both applications on the ground that the acquisitions would result in a substantial lessening of competition.22 On appeal, the High Court overturned the Commission’s decision.23 The High Court’s ruling was itself overturned by the Court of Appeal, which reinstated the Commission’s original determination.24
Both parties accepted in court that the relevant market was the market
for “retailing of grocery items in supermarkets,
local markets not less than 5km in radius from The Warehouse Extra
stores.”25 The central issues were how should uncertainty be
dealt with under s 66 of the Act and how should the SLC be measured.
1. Evaluating uncertainty under Section 66
The relevant part of s 66 reads:
s66: Commission may give clearances for business acquisitions (1) A person who proposes to acquire assets of a business or shares may give the Commission a notice seeking clearance for the acquisition.
two. In December 2005, Progressive was sold by Foodland Association Limited of
Australia to Woolworths Limited of Australia.
20 Woolworths holds a market share of approximately 44% while Foodstuffs accounts for
the remaining 56% (Foodstuffs/Warehouse, 10).
21 Supercentre is a generic term for exceptionally large stores that offer both a wide range
of general merchandise and a full range supermarket, all under one roof. The Warehouse called its supercentre stores “Warehouse Extra”.
22 Foodstuffs/Warehouse, 71.
23 Warehouse Case HC, .
24 Warehouse Case CA, .
25 Foodstuffs/Warehouse, 30. At the High Court the supermarkets contested that the
Commission’s 5 km radius was arbitrary, but the High Court found that
extending the boundary made no difference to the final
result (Warehouse Case
HC, -). See also Warehouse Case CA, .
(3) Within 10 working days after the date of registration of the notice, or such longer period as the Commission and the person who gave the notice agree, the Commission shall either—
(a) If it is satisfied that the acquisition will not have, or would not be
likely to have, the effect of substantially lessening competition in a
market, by notice in writing to the person by or on whose behalf the
notice was given, give a clearance for the acquisition; or
(b) If it is not satisfied that the acquisition will not have, or would not
be likely to have, the effect of substantially lessening competition in a
market, by notice in writing to the person by or on whose behalf the
notice was given, decline to give a clearance for the
The Court of Appeal found that s 66 requires the Commission to engage in an inquisitorial rather than adversarial process.26 As part of this process, the Commission should make its own “reasonable inquiry” into the merits of the clearance sought27 and grant a clearance “only if satisfied that a substantial lessening of competition is not likely.”28 If the Commission is left in “doubt” as to whether a SLC is likely or not, it should refuse the clearance.29 The standard of proof to which the Commission should be satisfied that a SLC is unlikely is the civil “more probable than not” standard.
The Court of Appeal did not directly discuss the meaning of the word “likely” in s 66. The High Court expressed the meaning of
What is clear from the case law is it must be more than
‘possible’ that the proposed acquisition will have the prescribed
effect but it need not be ‘more probable than not’ that it will. To
be above merely what is ‘possible’,
the case law has referred to
‘a real chance’ and a ‘real and substantial
26 Warehouse Case CA, .
27 Warehouse Case CA, .
28 Warehouse Case CA, . The Court considered that s 66(3)(b) should be read as “In any other case ... decline to give a clearance for the acquisition.” instead of “If it is not satisfied that the acquisition will not have, or would not be likely to have, the effect of substantially lessening competition .. decline to give a clearance.” (Warehouse Case CA ). This interpretation is intended to simplify the reading if the double negative in the subsection.
29 The Court of Appeal defined doubt in this context as “a failure to exclude a real chance of a substantial lessening of competition.” (Warehouse Case CA, ).
30 Warehouse Case HC, .
The High Court held that this formulation supported the following
• ‘Likely’ contemplated a 30% probability of occurrence;31
• There can be more than one ‘likely’ effect or outcome;32
• Where a certain outcome is dependent on more than one probability,
both probabilities must be independently likely for the effect or
outcome to be likely;33 and
• The likelihood of an outcome must not be assessed in relation to the
The Court of Appeal rejected this approach and stated that:
We regard the key question on this aspect of the case as being whether
there is a real and substantial prospect that
the Extra concept will
succeed to the extent that the Warehouse is prepared to roll out more stores.
This question can, in the
end, only be answered as a matter of
This passage dictates an approach whereby ‘likely’ is to be
assessed on impressionistic grounds. Under this approach it
is unclear when the
Commission would be required to resort to economic evidence. Even where the
Commission decides to resort to economic
evidence, the impressionistic approach
seems to allow a reasonable degree of discretion in weighting the evidence.
Moreover, if the
Commission is not confident of its own impressionistic
evaluation, the Court of
31 Warehouse Case HC, . Note that the Court adopted this threshold simply because the parties agreed to it. Subsequently, however, the Court placed little weight on the actual figure. For the purposes of this paper it is of little importance whether the probability threshold is 20%, 30% or 49% since they all carry the same degree of predictability for merger clearance applicants and they all treat uncertainty in the same manner. For reasons of simplicity this paper will use the Court’s 30% threshold for illustrations.
32 Warehouse Case HC, . The Commission and the Court are not entitled to choose
the one likely outcome that has the greatest prospect of occurring and evaluate only that outcome. Rather, if any one of these ‘likely’ outcomes will result in a SLC, the merger clearance will not be granted.
33 Warehouse Case HC, .
34 Warehouse Case HC, . In other words the court must limit itself to the probability of an event occurring, while ignoring the consequences of that event: “The question is what is likely to happen, not what benefit to customers potentially could be gained if the acquisition is locked unrelated to the chance of that gain materialising.”
35 Warehouse Case CA, .
Appeal’s approach means that the Commission should err on the side of declining the clearance.
This approach creates a gap between s 47, where the onus of proof is on the
Commission to prove that a SLC is likely, and s 66 where
the Commission must be
satisfied that a SLC is unlikely. Thus, an applicant whose clearance application
is declined because the Commission
is uncertain whether a prescribed effect
is likely, may decide to proceed with the acquisition without a clearance. The
of then proving that the acquisition is likely to result in a SLC, as per s
47, will rest on the Commission. Given the Commission’s
to be satisfied one way or the other, the Commission is unlikely to successfully
discharge its onus of proof.
2. The factual and counterfactual
There was little disagreement between the Commission, the High Court and the Court of Appeal as to the formulation of the factual. All three agreed that the supermarkets currently competed with each other, but that the competition could potentially be more vigorous.36 They also agreed that the supermarkets had no incentive to develop a successful Warehouse Extra once they purchased the Warehouse.
When assessing the counterfactual both the Commission and the High Court
found it was not their role to evaluate Extra’s business
model and its
likelihood of success.37 However, both proceeded to evaluate the
business model. The Commission found that the Warehouse Extra was
succeed because, by and large, the supercentre concept was
successful overseas.38 The High Court found three possible
counterfactuals,39 two in which the Warehouse Extra concept would
fail and one in which it would succeed. The High Court held that the third
was not likely because the Warehouse Extra’s chances of
success were “remote”.40
36 Foodstuffs/Warehouse, 33, Warehouse Case HC,  and Warehouse Case CA, . The disincentive arose from the fact that a successful Warehouse Extra would cannibalise the traditional supermarkets’ sales.
37 Foodstuffs/Warehouse, 34 and Warehouse Case HC, .
38 Foodstuffs/Warehouse, 35.
39 Warehouse Case HC, .
40 Warehouse Case HC, . Note, however, that the Court
only evaluated the limited empirical data available on Extra’s performance
launch to decide this (Warehouse Case CA, ).
The Court of Appeal examined Extra’s business plan and found
that it was both viable and showing signs of success.41 Rather than
leaving the business model assessment at that, however, the Court of Appeal went
further and held that:
While it is true that the [supercentre] concept has not been universally
successful, it has had considerable success elsewhere. It
is difficult to see
why it cannot be developed to operate successfully in New Zealand, at
least in some form. In this respect
we are not prepared to second-guess the
business judgment of the senior management and directors of the Warehouse.
They would not have developed the Extra concept unless they saw it as
viable.42 (Emphasis added)
The Court of Appeal appears to make its final assessment of what is likely to
happen by reference to management rather than the plan’s
success. The Court is presuming that Extra is likely to succeed because the
Warehouse executives chose to invest in
it. Such a “Presumptions
Approach”, which is discussed in detail below, in section C 2 (b),
is appealing because
it allows the Court to avoid an evaluation of the empirical
data. However, it sets a difficult precedent for future cases where
Commission and the courts might be required to presume that every business
plan is likely to succeed merely because someone
chose to invest in it. Such an
approach risks substituting the judgment of business persons for that of the
3. Likely competitive impact
When evaluating Extra’s likely competitive impact on the market, the
Commission considered several theoretical concerns. Most
Commission evaluated the general undesirability of three-to-two mergers43
and the high barriers of entry to the supermarket industry to conclude
that a SLC was likely.44 The High Court, on the other hand, was not
required to evaluate the competitive impact since it concluded that Extra was
to continue operating. The High Court nonetheless proceeded to assess
the competitive impact of Extra if it
41 Warehouse Case CA, .
42 Warehouse Case CA, .
43 “Three-to-two mergers” are mergers that reduce market competition from three independent competitors to two independent competitors.
44 Foodstuffs/Warehouse, 64.
continued in operation.45 The Court focused on the available quantitative and empirical data on Extra’s performance. It determined that the threshold for a SLC is generally a 4-5% price increase for consumers46 but decided to reduce the threshold to 3% in this case because of the small profit margins characteristic of the supermarket retailing industry.47 This approach is in line with the most recent Australian Competition and Consumer Commission’s 2008 Draft Merger Guidelines, which state that a 5-10% increase in price for consumers will generally amount to a SLC under the Australian legislation.48 The High Court then evaluated Extra’s financial impact to date and concluded that a SLC was unlikely, even if Extra was continued, because Extra did not compete on price.49
The Court of Appeal criticised both approaches. The Commission, it found,
focused too much on theory50 while the High Court focused too much
on available empirical data.51 The Court of Appeal also rejected the
idea of a general threshold for assessing a SLC.52 The Court
[W]hat constitutes a substantial lessening of competition must in the end be
a matter of judgment, although we accept, of course,
that such a judgment must
be informed by as much practical evidence as possible.53
This approach is in line with the recent Court of Appeal authority in New
Zealand Bus Ltd v Commerce Commission.54 There the
Court considered that the s 47 SLC assessment is one of “fundamental
judgment”, not to be obscured by “false
45 Warehouse Case HC, .
46 Warehouse Case HC, .
47 Warehouse Case HC, .
48 See Australian Competition and Consumer Commission, Merger Guidelines Draft 2008
(Canberra, 2008), 7. New Zealand adopted the current SLC test for merger analysis from the Australian legislation (G Goddard and E Curry, “New Zealand's New Mergers Test: A Comparison of Dominance and Substantial Lessening of Competition in the Supermarket Industry" (2003) 24 European Competition Law Review 300).
49 Warehouse Case HC, .
50 Warehouse Case CA, .
51 Warehouse Case CA, .
52 Warehouse Case CA, .
53 Warehouse Case CA, .
54  NZCA 502.
55 New Zealand Bus Ltd v Commerce Commission  NZCA
The Court of Appeal’s approach to evaluating Extra’s likely competitive impact was to consider both the available empirical evidence and the theoretical concerns of a three-to-two merger in a market with high barriers to entry. In its conclusion the Court favoured a theoretical evaluation of the evidence over an empirical evaluation.56
It concluded that there is “no reason why [a successful Extra] would
not have a significant effect” on Woolworths’
pricing, quality, range and service.57 Woolworths and Foodstuffs
would not be able to ignore Extra because neither could replicate Extra’s
offering involving general
merchandise.58 As a result the merger had
a likely effect of substantially lessening competition in a market, and
clearance was declined.
C. The Treatment of Uncertainty
That business and commerce are inherently uncertain has been recognised at least as far back as biblical times.59 Businesses throughout history have nonetheless managed to deal with uncertainty with relative success.60 Business best practice today employs various statistical methods to reach the best decision given the available information.61
Statistics can in no way eliminate uncertainty (and the current economic turmoil is testament to that fact), but in practice statistics can help the decision-maker reach the best decision given the available information. It is, of course, essential that the decision-maker understand the statistic in order for him or her to utilise it effectively.
The Commerce Commission is also required to make business-like
decisions in conditions of uncertainty. This is especially
true when the
Commission attempts to determine what is likely to happen in a given market when
assessing a merger clearance under
s 66 of the Act. Given the wide raft of
factors that influence the behaviour
56 Warehouse Case CA, : “This question can, in the end, only be answered as a matter of impression”.
57 Warehouse Case CA, .
58 Warehouse Case CA, .
59 James 4:13, “Come now, you who say, 'Today or tomorrow we will go to such and such a city, and spend a year there and engage in business and make a profit.' Yet you do not know what your life will be like tomorrow.”
60 Peter L Bernstein, Against the Gods: The Remarkable Story of Risk (John Wiley & Sons,
New York, 1996), 1.
61 See generally Robert Kast and André Lapied, Economics and Finance of Risk and of the
Future (John Wiley & Sons, Chichester, England, 2006).
of a market and its participants,62 this is a very difficult task. Yet the decision must be good, since the wrong decision may have negative long-term consequences for consumers in New Zealand.
This part of the paper will argue that the Court of Appeal’s approach
to evaluating uncertainty, as expressed in the Warehouse Case, is
inadequate. Rather, the Commission and the courts should use a simple
statistical method called “Expected Value”,63 which is
discussed in detail below, in section C 2 (c), to improve their analysis of
uncertainty. This paper will only discuss how
to improve the analysis of effects
that the Commission and the courts are able to quantify, and which they do
quantify on a regular
basis. The paper does not advocate a wholly scientific
approach to merger analysis, nor does the majority of literature on the use
Expected Value in business decision- making.64 Moreover, economics
alone cannot provide objective or scientific solutions to merger analysis. As
John Maynard Keynes once observed:
The Theory of Economics does not furnish a body of settled conclusions
immediately applicable to policy. It is a method rather than
a doctrine, an
apparatus of the mind, a technique of thinking, which helps its possessor to
draw correct conclusions.65
The evaluation of qualitative effects, their relationship to quantitative
effects and the final measurement of a SLC are beyond the
scope of this
62 These would include changing customer preferences, the availability and costs of capital and labour, the behaviour of other firms in the relevant market, changes in the legislative framework, etc.
63 Expected Value is also referred to in the literature as “Expected Utility”, “Decision- Theory”, “Prospect Theory” and sometimes simply as “Risk Assessment”.
64 Eg, Sean Cleary and Thierry Malleret, Global Risk: Business Success in Turbulent Times (Palgrave Macmillan, New York, 2007), 48: “In risk assessment, different forms of quantitative and qualitative techniques are used. More often than not, quantitative modelling is complemented by qualitative analysis for risks that are less suited to formal modelling.”
65 This observation is contained in an introduction written by Keynes to a series known
as "The Cambridge Economic Handbooks", cited by C. W. Guillebaud and Milton Friedman in the introduction to Sir Dennis Robertson and Stanley Dennison, The Control of Industry (Cambridge University Press, Cambridge, 1960), vii.
66 However, they are discussed in my dissertation: Ronen Lazarovitch, An Expected Value
Approach to Evaluating Uncertainty in New Zealand Merger Analysis (Honours Research Paper, University of Otago, 2008), available online at
1. Econometric analysis in merger clearance evaluation
When assessing the likely effects of a merger, the Commission evaluates changes in a number of market competition indicators. The Commission often focuses on changes in coordinated67 and non- coordinated68 market power.69 An increase in coordinated market power means that firms find it easier to tacitly coordinate their pricing, output or related commercial decisions, usually due to a decrease in the number of participants in the market.70 An increase in non- coordinated, or unilateral market power means that competitive restraints on a firm have been removed or weakened such that the firm finds it profitable to raise prices, reduce output or otherwise exercise market power.71
The economic measures used to estimate the potential changes in coordinated and non-coordinated market power include market concentration, market barriers to entry, elimination of a vigorous competitor, scope for collusion, etc.72 These measures can be utilised in two ways. They can either be used as isolated measures to gain a general impression of the competitive effect of the merger or they can be integrated into an econometric model that estimates the quantitative effect of the merger. The quantitative measurement is often expressed as a percentage price increase or decrease for consumers.73
The Commission often assesses merger clearances using a number of
relevant individual measures rather than a full econometric
This is appropriate when the merger clearance is relatively
uncontroversial, either because one or more of the economic measures
67 For a discussion on coordinated effects and their econometric simulation see K U Kühn, “The Coordinated Effects of Mergers" in P Buccirossi (ed.), Handbook of Antitrust Economics (MIT Press, London, 2008), 105.
68 For a discussion on non-coordinated effects and their econometric simulation see G J
Werden and L M Froeb, “Unilateral Competitive Effects of Horizontal Mergers" in P Buccirossi (ed.), Handbook of Antitrust Economics (MIT Press, London, 2008), 43.
68 Merger Guidelines, above n 4, 12.
69 Merger Guidelines, above n 4, 12.
70 Australian Competition and Consumer Commission, Merger Guidelines Draft 2008
(Canberra, 2008), 28.
71 Ibid, 20.
72 See generally Merger Guidelines, above n 4.
73 James Michael Mellsop and James Palmer, Economics and Competition Law (New Zealand
Law Society, Wellington, 2004), 60-61.
74 Merger Guidelines, above n 4, 22-31.
is so high that the merger is likely to cause a SLC or because the relevant measures are so small that the merger is unlikely to cause a SLC. In controversial or difficult mergers where the market is appropriate for modelling,75 however, the Commission may undertake full econometric modelling. For example, econometric modelling was used for the Progressive/Woolworths,76 Cendant/Budget77 and Contact Energy/NGC78 clearance applications and the Qantas/Air New Zealand79 authorisation application.80 All these applications involved oligopolistic markets and conflicting individual economic indicators. Econometric modelling is necessary in such cases because the Merger Guidelines require that merger effects on price or quantity must be sustainable for a period of two years or more.81 In borderline cases this can only be gauged from full econometric modelling, as opposed to an assessment of individual economic indicators.
The Commission uses one of two broad economic models to evaluate mergers in
oligopolistic markets: the Cournot model and the Bertrand
These are both well-established economic models that differ on the
assumptions that they make. The Cournot model assumes that oligopolies
single homogenous product.83 It is therefore most appropriate for
modelling industries where firms make decisions based on quantity, as opposed to
price. An example
of such an industry would be the electricity market.
The Bertrand model assumes firms largely compete on price with similar
differentiated products.84 It would therefore be appropriate
for modelling, for example, the personal computer hardware market. The
Commission will sometimes
use modifications of these models to better
75 Most oligopolistic markets are appropriate for econometric modelling, see I Kokkoris, “Merger Simulation: A Crystal Ball for Assessing Mergers" (2005) 28 World Competition
327, 332 (henceforth “Kokkoris I”).
76 Progressive Enterprises Ltd / Woolworths NZ Ltd, Com Com Decision No 448 (14
77 Cendant Corporation / Budget Group Incorporated, Com Com Decision No 482 (6
78 Contact Energy Ltd / Natural Gas Corporation Holdings Ltd, Com Com Decision No 491 (4
79 Qantas Airways Ltd / Air New Zealand Ltd, Com Com Decision No 511 (23 October
80 Mellsop and Palmer, above n 73, 60-61.
81 Merger Guidelines, above n 4, 13.
82 Mellsop and Palmer, above n 73, 58.
84 Ibid, 59.
the market analysed. However, the fact that the Commission uses one of two broad models means there is relatively little scope for disagreement over the general economic framework.
Under the current approach the Commission uses econometric modelling
for a single factual or counterfactual that is considered
and causes the most serious reduction in competition. Factuals and
counterfactuals that do not
reach the ‘likely’ threshold or whose
effects are not as serious as the factual or counterfactual being assessed
ignored from this early stage. However, once econometric modelling is
created for a given merger, it is relatively simple
to run the simulation
several times with small changes that take account of the different possible
factuals and counterfactuals.
For example, if there is a 25% chance of new entry
into the market and that possibility was not evaluated in the
counterfactual, then the exact same model could be run
again, only with the added information of the new entry, resulting in two
of possible price increases. Moreover, the information used to create the
econometric model can be used to help quantify the
likelihood of each potential
2. Three approaches for evaluating uncertainty
(a) The “Real Risk” Approach
This paper identifies three separate approaches for evaluating
uncertainty in the context of merger analysis. The first
is the Real Risk
approach. This approach refers to the use of either a verbal or
numerical probability threshold for
the assessment of likely events. This
is the current approach in New Zealand for evaluating uncertainty in merger
The Merger Guidelines express the evaluation of uncertainty
under ‘likely’ in s 66 as:
Likely does not mean more likely than not. It means more than a mere
possibility, but it can mean less than a probability of 50 percent.
a real risk, a substantial risk or something that might well
85 See Kast and Lapied, above n 61, Chapter 6: Risk Economics. See also Kokkoris I, above n 75.
86 Merger Guidelines, above n 4, 10.
This interpretation accords largely with the pronouncements of the
High Court and Court of Appeal in the Warehouse Case.
The advantage of the verbal formulation is that judges are familiar with it from their experience with other areas of the law. However, the formulation is vague and unpredictable in application. While it may be appropriate in criminal cases where the actions or beliefs of a person are at issue, it is not necessarily appropriate for the evaluation of the likely behaviour of a market and its participants. Moreover, an attempt to determine what the formulation means in practice may cause some frustration. Clearly any event with a 50% chance of occurring or more will be ‘likely’. But, when the probability is lower one must try and determine, using an “impressionistic approach”,87 whether the chance of occurrence is “more than merely possible” and a “real risk”.
The High Court’s adoption of a 30% threshold for likelihood in the Warehouse Case, while arbitrary, could have injected a significantly higher degree of certainty into the Real Risk formulation. However, the
30% threshold shares two central deficiencies with the verbal formulation.
The first deficiency is that the Real Risk formulation
amounts to an
“all-or-nothing” approach. That is, if a counterfactual reaches the
‘likely’ threshold it is
treated as an absolute certainty and if it
does not, the counterfactual is treated as if it does not exist. In the American
Katz and Shelanski express this deficiency as:
Under this approach, events found to be of low probability or supported by
uncertain evidence receive no weight in the decision calculus.
with probabilities above the threshold are sometimes treated as if they
were certain to occur. In short,
uncertainty is treated as if it did not
exist. This treatment can generate seriously inaccurate predictions regarding
welfare when low-probability events would have significant
effects if they occurred.88
In the Warehouse Case the High Court considered that the
counterfactual where Extra succeeded did not reach the ‘likely’
threshold.89 As a result the Court ignored that
counterfactual completely. Ignoring
87 Warehouse Case CA, .
88 M L Katz and H A Shelanski, “Merger Analysis and the Treatment of Uncertainty: Should We Expect Better?" (2007) 74 Antitrust Law Journal 537, 538-539.
89 Warehouse Case HC, .
counterfactuals reduces the information on which the decision is founded and the quality of the decision is reduced. Innovation, for example, is a major casualty of such an approach. Innovation is often considered more important to a competitive market than price competition,90 but it frequently takes several years to make its full impact on a market.91 Effects due to take place several years into the future are more difficult to predict with accuracy than events in the near future and will therefore have lower likelihoods of occurrence. As a result detriments to consumers from losing this innovation will rarely be assessed by the Commission and the courts under the Real Risk approach, no matter how significant.
The second deficiency, closely related to the first, is that the Real Risk approach disregards likelihood when assessing the effects of a merger. That is, once a counterfactual passes the ‘likely’ threshold, the probability of it occurring is disregarded in the later assessment of the merger’s effect. Consider, for example, two counterfactuals in two separate mergers. The counterfactual in the first merger is ‘likely’ and has a 90% chance of causing a 5% increase in prices for consumers. The counterfactual in the second merger is also ‘likely’ but has only a
40% chance of causing a 5% increase in prices for consumers. Under the Real
Risk approach both counterfactuals would be evaluated
as having an equal effect
on the relevant markets. However, consumers should worry about the first merger
more than the second, because
the price increase in the first merger is almost
certain to occur whereas the price increase in the second merger has a much
chance of occurring. Katz and Shelanski note that:
The fundamental point for policy is that the magnitude of each
possible outcome... and not just whether it is likely ...
must be taken into
account if the welfare implications of the merger are to be fully
To properly assess a merger, then, the probability of a counterfactual
occurring must be linked to that counterfactual’s effect.
90 M E Porter, “Competition and Antitrust: Toward a Productivity-Based Approach to
Evaluating Mergers and Joint Ventures." (2001) 46 Antitrust Bulletin 919.
91 Ministry of Economic Development, Discussion Document: Review of the Clearance and
Authorisation Provisions under the Commerce Act 1986 (Wellington, 2007), 13.
92 Katz and Shelanski, above n 88, 550-551.
(b) The “Presumptions” Approach
The Presumptions approach is a modification of the Real Risk approach. It attempts to address some of the deficiencies in the way the Real Risk approach deals with events that have a low probability of occurrence by assuming that an event is likely, regardless of its actual probability, if a certain set of facts exists.
The Court of Appeal in the Warehouse Case tends towards this approach. This is particularly evident when the Court stated its unwillingness to “second-guess” the business judgment of the Warehouse’s executives.93 While a credible, well resourced management team with continuing faith in a business plan is relevant to the assessment of the plan’s likelihood of success, the Court’s comments can be interpreted as going further than this and creating a presumption that the Warehouse Extra is likely to succeed because: (a) the business plan envisages its success, and (b) the Warehouse executives chose to invest in it. Such an approach could be transferable to other cases where the Commission would be required to assume that a given business plan is likely to succeed because a competent investor thought that it was a good investment. While the matter was not explored in the Court of Appeal’s judgment, it is possible that these presumptions are rebuttable. For example it may be possible to rebut the likelihood of Extra’s success by showing that the business plan is wholly illusory or that it was negligently prepared.
The attraction of the Presumptions approach is the
foreseeability and objectivity it injects into the analysis of certain kinds of mergers. Once a presumption is articulated by the Commission or the courts, legal advisors can forecast with reasonable accuracy whether a similar merger is likely to receive clearance or not. As things presently stand, however, businesses may be required to wait a long time until a sizable case law builds up articulating the various presumptions and their rebuttals.
Moreover, the Presumptions approach does not remedy the
structural deficiencies of the Real Risk approach. By creating a list of
presumptions it merely attempts to remedy specific situations
presumptions may provide for the best outcome in most, but not
93 Warehouse Case CA, : “In this respect we are
not prepared to second-guess the business judgment of the senior management and
the Warehouse. They would not have developed the Extra concept
unless they saw it as viable”.
all, cases. Indeed, once the factual patterns that are required for a
presumption become known, companies may attempt to artificially
their affairs to fit into a presumption’s requirements if it will benefit
them. Such a development would reduce
the number of instances where the
presumption provides for the best outcome and creates a whole new set of
problems without solving
the old ones. It is submitted, therefore, that a
framework that arrives at the best decision without creating a list of
to the rule would be preferable.
(c) The “Expected Value” Approach
Expected Value is a summary statistic.94 It quantifies a
decision’s various possible outcomes, weighs each of them by the
probability that they will occur, and sums
these estimates together.95
The Expected Value result can then be employed to help guide
decision-makers, such as the Commerce Commission, in cost-benefit
analysis.96 Richard Posner argued as early as 1972 that the law in
general should utilise an Expected Value-like approach to appraise legal
disputes.97 Today Expected Value is advocated by academics for use
in various aspects of competition law.98 Michael Katz and
Howard Shelanski of the University of California at Berkley advocate an
Expected Value approach for
use in US merger analysis.99 Ken Heyer,
the Economics Director at the Antitrust Division of the United States Department
of Justice, advocates a similar approach,
which he would apply generally to most
antitrust assessments of uncertainty.100 The approach advocated in
this paper differs from these US writers by tailoring the approach
94 Summary statistics are a type of descriptive statistics that are used to summarise a set of observations in order to communicate them as simply as possible (“Summary Statistics”
in Graham Upton and Ian Cook, A Dictionary of Statistics (2nd ed, Oxford University Press,
95 K Heyer, “A World of Uncertainty: Economics and the Globalization of Antitrust"
(2005) 72 Antitrust Law Journal 375, 376.
96 Christian Gollier, The Economics of Risk and Time (MIT Press, Cambridge, Mass, 2001), 3.
97 R A Posner, “An Economic Approach to Legal Procedure and Judicial Administration" (1973) 2 JLS 399.
98 See eg, D S Evans and A J Padilla, “Designing Antitrust Rules for Assessing Unilateral Practices: A Neo-Chicago Approach" (2005) 72 University of Chicago Law Review 73, C Frederick-Beckner and S C Salop, “Decision Theory and Antitrust Rules" (1999) 67
Antitrust Law Journal 41 and K Hylton and M Salinger, “Tying Law and Policy: A
Decision Theoretic Approach" (2001) 69 Antitrust Law Journal 469.
99 Katz and Shelanski, above n 88.
100 Heyer, above n 95.
fit the unique characteristics of New Zealand competition law. It also differs by combining Expected Value with qualitative assessments rather than relying on the Expected Value alone.101 Expected Value is a suggested tool to improve merger analysis that has yet to be used judicially in New Zealand or overseas.
In order to calculate an Expected Value for a given merger the Commission
would require three sets of figures: the number
counterfactuals (n), the probability of each counterfactual occurring (PR)
and the percentage price impact102 of each
counterfactual, when compared to the factual (PI).103 These figures
would be assessed through econometric analysis currently undertaken by the
Commission. Once these figures are obtained
the Expected Value of the merger is
calculated using the following formula:
Equation 1: Expected Value Formula
EV = PRi × PIi
EV = Expected value.
PR = Probability of counterfactual occurring.
PI = Price impact of each counterfactual, compared to the factual.
n = Number of possible counterfactuals.
This formula multiplies each counterfactual probability by the price impact
of the counterfactual when compared to the factual,104 and adds all
the outcomes together.
101 Katz and Shelanski, above n 88, 571-574.
102 Percentage price increases are used because it is a figure the Commission often calculates and that the courts often deal with (as was the case in the Warehouse Case). This approach can easily be modified to take account of any other quantifiable impact that the Commission may determine is relevant to the assessment of a particular merger (see Charles M Grinstead and J. Laurie Snell, Introduction to Probability (2nd ed, American Mathematical Society, Providence, RI, 1997), chapter 6: Expected Value and Variance).
103 The comparison to the factual is used, so as to represent the fact that the counterfactual cannot occur if the merger takes place (see below n 104).
104 In other words, the effect of each counterfactual is first
deducted from the factual in
To illustrate, consider the three counterfactuals identified by the High Court in the Warehouse Case. For the purposes of illustration I will use probability percentages that are either above or below the 30% threshold expressed by the High Court, since the High Court did not assign percentage probabilities to each counterfactual.105 The first counterfactual was that the Extra concept would fail. I will assign it a probability of 40% with a price impact of 0%. The second was that Extra would continue to be trialled for a while and then fail. I will assign that a probability of 35% and a price impact of 0%. The third was where Extra would succeed. This counterfactual was held not
‘likely’ and therefore I will assign it a probability of 25% and
an impact of a 2.5%106 price increase for consumers, when
compared to the factual.107 Putting the numbers into the equation we
Equation 2: Expected Value Example 1
(0.4 × 0) +(0.35 × 0) +(0.25 × 0.025) = 0.00625
Under the High Court’s assessment the price effect on consumers was
zero because the third counterfactual did not reach the
order to receive a net price impact for that scenario if the merger takes place. This is done so that the expected impact under Expected Value is calculated for the merger as a whole, rather than calculating Expected Value twice, once for all the factuals and again for all the counterfactuals, and then deducting one from the other. Thus, where a counterfactual would result in a price decrease for consumers, but that price decrease would be lost in the factual (ie, if the merger took place) then that price decrease would be calculated as a price increase to represent the fact that consumers could not benefit from it if the merger took place.
105 Note that the High Court did not place significant weight on the 30% threshold, nor
did it calculate the precise percentage probability of each counterfactual. However, the
30% threshold is useful for illustration purposes to demonstrate the difficulties associated
with the Real Risk approach, which always uses an arbitrary cut-off point (expressed as either a verbal cut-off point or a percentage cut-off point). The percentage probability used here is either above or below the 30% threshold depending on whether the High Court considered the counterfactual was ‘likely’ or not.
106 The price increase figures were omitted from the public version of the High Court judgment in the Warehouse Case. Since the SLC threshold in that case was held to be 3%, the price increase must be lower. Hence the use of a 2.5% price increase in this example.
107 If the merger was declined and the counterfactual occurred then there would be a
2.5% price decrease for consumers. However, this price decrease would be lost
in the factual (ie, if the merger took place). Therefore
when comparing the
counterfactual to factual we represent the loss of this price decrease as
a price increase for consumers.
‘likely’ threshold and was therefore ignored. Under the Expected Value calculation the average expected price increase is small, 0.625%,108 but it is not zero.
As a second example, consider a fictional merger with two possible
counterfactuals: an 80% chance of a 1% price increase for consumers
and a 20%
chance of a 15% price increase for consumers. Under the Real Risk approach this
merger would be allowed,109 since the 20% probability counterfactual
would be ignored and a 1% price increase may not be sufficient to constitute a
Value would measure the merger in this way:
Equation 3: Expected Value Example 2
(0.8 × 0.01) + (0.2 × 0.15) = 0.038
The average expected price increase of allowing this merger is 3.8%. The use of this statistic allows the lower probability counterfactual to be considered together with all other counterfactuals. As a result the decision-maker can come to an informed decision on whether to grant or decline the merger application.110
Before proceeding it is important to explain what the Expected Value
result actually means. Expected Value is a descriptive
quantity, akin to an
average or a mean, of all the counterfactuals and their effects.111
It is not equivalent to a price increase in a given counterfactual. The
Expected Value may be, and often is, a result that we would
not expect to
observe in practice after making the decision a single time. In this respect it
is similar to a class with an average
grade of 72.3 despite no individual
student receiving this mark. A useful way to conceptualise Expected Value, then,
is as an average
result for the proposed merger. What the Expected
Value “average” actually measures is the price increase
would occur if we allowed a large
108 The Expected Value of 0.625% is reached by multiplying the Expected Value result of
0.00625 by 100. This is because the Expected Value calculation expresses the percentage
outcome out of a maximum of 1 (ie, a result of 1 = 100% and a result 0.5 = 50%). To express the Expected Value result as a percentage out of 100% we simply multiply the Expected Value result by 100.
109 Assuming all other facts are equal.
110 See Katz and Shelanski, above n 88 for numerous examples of how such an approach would work in different types of mergers with varying probabilities and outcomes.
111 Grinstead and Snell, above n 102, 225.
number of mergers with the same facts and averaged the price increases that resulted in all of them.112
By combining all the possibilities and outcomes of a particular decision together, Expected Value allows us to assess a summary of all aspects of the decision instead of focusing on individual parts of it. To illustrate, consider an attempt to assess whether a given school class performed well in an exam. Adapting the Real Risk approach, we would measure how well a class did by determining whether a certain proportion received a mark higher than 80% and ignore the rest of the class, which would be misleading and unhelpful. The Expected Value approach would be akin to using an average mark for the class to determine how well it performed, thus taking into account more information than the Real Risk approach and condensing it into a single figure.
To further explain Expected Value, we can use a more complicated example. Consider being faced with an American roulette and the question whether it would be profitable to place a bet on one of the numbers? An American roulette has 38 numbers on it.113 If you place a $1 bet on the winning number you will get your $1 back plus
$35,114 otherwise you will lose your $1. You thus have a 1/38
chance of winning 35 times your original bet and a 37/38 chance of losing your
original bet. Using Expected Value we can calculate that you should expect to
lose 5.26% of your money.115 Obviously you could not lose this
percentage of money on an individual bet. The Expected Value is the loss that
you would expect if
you repeatedly placed bets on the roulette. Note that if you
bet $1 on all 38 numbers in a single roulette spin, then one of your
would inevitably come up and you end up with $36. This $36 represents a 5.26%
loss from the $38 that you bet on the round,116 which is equal
to the loss as calculated by
112 Note that an ordinary average calculation can be accompanied by a variance, so that the average of 50 and 100 (ie, 75) can be distinguished from the average of 70 and 80 (which is also 75). Similarly Expected Value can be accompanied by a variance measure so that a merger with potential outcomes of -100% and +100% price change for
consumers and a merger with -2% and +2% price changes can be distinguished from one another (see , Chapter 6 for a full explanation of the Expected Value variance).
113 American roulettes have numbered slots 1-36 as well as “0” and “00” slots (38 slots in total). Non-American roulettes only one “0” (and therefore 37 slots in total).
114 This is the standard ‘win’ when playing American roulette.
115 The Expected Value calculation is 1 × 35 − 37 × 1 = −0.0526 .
116 The calculation is 36 − 1 = −0.0526
Expected Value. Expected Value can thus help us reach the logical conclusion that gambling on roulette is a loss making exercise. When applied to merger analysis, Expected Value can give the decision-maker the same level of insight into the risks of granting clearance to a merger.
Since Expected Value represents an average outcome for a decision, it is especially useful in merger analysis. The Commission is required to analyse numerous merger clearance applications every year.117 Most of these applications represent borderline cases where the advising solicitor is unsure whether the merger will or will not breach s
47 of the Act. Therefore the applications will often have similar probabilities and outcomes, despite existing in different markets and at different times. An Expected Value approach would allow the Commission to both make a long-term assessment of the benefit to consumers in New Zealand and enhance its ability to compare different mergers. Moreover, since Expected Value calculates the likely effect of the merger as a whole, it avoids the ‘gap’ between ss 66 and 47 caused by the current approach by the Court of Appeal.118
Further, the Court of Appeal in the Warehouse Case noted that:
[T]he Commission can be expected to engage in an inquisitorial
process in which it would make a reasonable inquiry into the
merits or otherwise
of the clearance that is sought. The decision to grant or refuse a clearance
is necessarily to be made on the
basis of all the
It is difficult to see how the Court of Appeal’s Real Risk approach complies with its own pronouncement. An approach that omits potentially important evidence from the final determination does not result in a decision made “on the basis of all the evidence”. Expected Value, on the other hand, evaluates all the possible counterfactuals to allow a decision to be truly made on the basis of all the evidence.
In summary, Expected Value provides a single numerical summary of the entire
quantitative aspects of the proposed merger, with which
the Commission can
begin to assess its likely impact.
117 On average the Commission evaluates approximately 20 clearance applications per year (Ministry of Economic Development, Discussion Document: Review of the Clearance and Authorisation Provisions under the Commerce Act 1986 (Wellington, 2007), 23).
118 See section B 1.
119 Warehouse Case CA, .
Expected Value provides several additional benefits over the Real Risk and
Presumptions approaches. The formalistic and well-established
Expected Value promotes transparency in the merger clearance process; many
applicants will easily understand the Expected
Value techniques since they
regularly use it in their business dealings; Expected Value takes into account
future events with a low
probability, ensuring that serious detriments to
consumers will not be ignored; Expected Value links the probability of a
occurring to its effect; and, Expected Value allows the
Commission and the courts to make their own assessment of the likely effect
the merger, rather than relying on the opinions of the parties involved in the
merger. This quantitative assessment must,
however, be supplemented
by a qualitative assessment.120
3. The potential prevalence of Expected Value in merger analysis
Under the current Real Risk approach the Commission focuses on a single
factual or counterfactual that is ‘likely’. Therefore
most of the
reported cases and decisions do not discuss alternative possible
counterfactuals. For example, in Brambles New Zealand Ltd v Commerce
Commission121 the Commission identified the relevant
counterfactual as being a continuation of the status quo. The Commission
an alternative counterfactual from its analysis because the
probability of that counterfactual occurring did not reach the statutory
threshold of ‘likely’.122 Since ignored counterfactuals
are often not reported it is difficult to estimate precisely how much
information is currently being
discarded. The scarcity of discussion over
alternative counterfactuals does not, however, mean that they do not exist. Nor
mean that the alternative counterfactuals can be safely ignored:
“low probability events can matter, and for that reason they
should not be
casually or easily discarded.”123
120 The link between quantitative and qualitative assessment is outside the scope of this paper. However, it is discussed in my dissertation, above n 66.
121 (2003) 10 TCLR 868.
122 Ibid, 873. The details of that counterfactual were censored from the public version of
the judgment: “[The Commission] then considered the counterfactual and concluded that the status quo was the counterfactual. In particular, it rejected the possibility that [...].”
123 Katz and Shelanski, above n 88, 554.
It is feasible to estimate what counterfactuals may have been ignored in a decision by reading the case and contemplating what alternative scenarios may have been possible. For example, in New Zealand Bus Ltd v Commerce Commission124 the largest bus company in Wellington, New Zealand Bus Limited, wanted to purchase the second largest bus company in Wellington, Mana Coach Services Limited.125
The factual, that Mana and NZ Bus would no longer compete with each other after the merger was virtually certain and was not controversial.126 The counterfactual, however, was not as obvious.127
The High Court nonetheless considered that the only relevant counterfactual was that Mana would be sold to a different bus company who wished to enter the Wellington market, and that under new ownership Mana would compete with NZ Bus.128 The High Court did not evaluate other counterfactuals, but that does not mean that there were none. One possibility would be for Mana to go bankrupt and not be purchased at all. Moreover, if Mana would have been purchased then there would still be at least two possibilities: that Mana remain a meek competitor, or, if Mana would have been purchased by a bus company that wanted to usurp NZ Bus, it may have become a very aggressive competitor. It would have been preferable for the High Court to have evaluated all the possible counterfactuals rather than a single one.
Notwithstanding this estimation exercise, without the information held at the time by the parties and the court we cannot know what scenarios were possible, or how possible they were. This exercise shows that, since the Commission and the courts can rarely determine with absolute certainty what will happen in the future, alternative possible counterfactuals should not be ignored.
The discussion in this paper has focused on the benefits of using Expected
Value to calculate price increases as measured by econometric
However, Expected Value can also be used to evaluate the likely effect of
individual economic indicators that are expressed
in numerical terms. For
example, an economic indicator used to estimate increases or decreases in a
firm’s unilateral power
124  NZCA 502.
125 Ibid, .
126 Ibid, - and Commerce Commission v New Zealand Bus Ltd  NZHC 736; (2006) 11 TCLR 679,
127 Commerce Commission v New Zealand Bus Ltd  NZHC 736; (2006) 11 TCLR 679, 720.
128 Ibid, 721.
firm’s market share. Under the Real Risk approach the Commission would only evaluate the change in a firm’s market share in a single
‘likely’ counterfactual and ignore market share changes in scenarios that do not reach the ‘likely’ threshold. Under the Expected Value approach the Commission would estimate the change in market share under all possible counterfactuals and use Expected Value to gain a complete understanding of the merger’s effect on the firm’s market share.
Thus, the Commission’s and the court’s use of the Real Risk
approach masks the true risks that a merger gives rise to
counterfactuals early on in the investigation. These counterfactuals are often
not mentioned in the final decision
or judgment, but they nonetheless exist. As
a result the potential prevalence of Expected Value in merger analysis is
Expected Value approach could be employed in every merger analysis
where the assessment involves deciding what is ‘likely’
and where that evaluation involves quantitative indicators of
4. Potential Criticism of the Expected Value Approach
The Expected Value approach, and indeed any mathematical or
statistical usage can seem foreign within the law. In this part
of the paper I
would like to anticipate and address a number of potential criticisms that the
Expected Value approach may give rise
to. The first potential criticism that
will be addressed is that judges and the Commission will not understand the
concept or be
able to apply it in practice. Katz and Shelanski also identify
this potential criticism129 and pose a simple, yet effective response
to it – observing that “the difficulties of the expected-value
arise not because the method of analysis is hard, but because the
problem to be addressed is hard.”130 Merger analysis
necessarily involves complicated econometric and statistical data.131
The Expected Value approach helps synthesise this information in a more
effective manner. It does not introduce foreign statistical
calculations in an
area of law where they do not currently exist.132 Nor does it create
an additional burden by including
129 Katz and Shelanski, above n 88, 554.
131 See Mellsop and Palmer, above n 73, Chapter 3.
132 Telecom Corporation of New Zealand Ltd v Commerce
Commission  3 NZLR 429, 441.
quantitative data that could be safely ignored, since ignoring low probability events does not eliminate their impact.133
Moreover, the Commission and the courts are equipped to effectively implement such an approach. The Commission is a specialist tribunal that deals with significantly more complex mathematical, statistical and econometric data than Expected Value. A significant portion of the Commission’s staff are trained in economics and related disciplines, and specialist economist assistance is regularly sought for merger clearance review.134 Judges on appeals from the Commission are naturally privy to all the reports prepared by and presented to the Commission, and High Court Judges sitting on Commerce Act cases are in the unique position of sitting alongside a lay-member advisor who is literate in economics.135 A central purpose of this arrangement is cross-pollination of expertise. One would expect the lay-member to explain the meaning of the Expected Value statistic to the judge in order for them to reach a conclusion on it together.
A second potential criticism that I would anticipate is that the
Expected Value approach is one of “false scientism”136
whereby the work of the law is replaced by an imprecise mathematical
calculation. Such criticism, however, misunderstands the approach
First, it is vital that the Commission and the courts understand the figures,
the econometric modelling and the assumptions
that make up the Expected Value.
Since the Commission currently analyses this data itself there is no reason to
assume that the
Commission will not be able to continue to do so in the future.
Second, Expected Value will rarely be the sole determining factor
outcome of a clearance application. The use of Expected Value in merger
analysis, like in business decision-making,
requires an additional
consideration of qualitative factors before a decision is made.137 It
should be noted that,
133 Katz and Shelanski, above n 88, 555.
134 Alan Lear, Report to the NZ Commerce Commission: A Best Practice Review of the New Zealand
Merger Clearance Regime (Auckland, 2007), 25.
135 In competition law cases a “lay-member” ordinarily sits alongside the judge in High
Court proceedings (Commerce Act 1986, ss 77 & 78). The lay-member is selected from a panel of persons with “knowledge or experience in industry, commerce, economics, law or accounting” (Commerce Act 1986 s 77(2)) and may issue his or her own opinion. In cases where there are two or more lay-members, they may constitute a majority opinion that decides the outcome of the case, notwithstanding the judge’s opposing view (, 259).
136 New Zealand Bus Ltd v Commerce Commission  NZCA 502,  per Hammond J.
137 Cleary and Malleret, above n 64, 48-49.
A further potential criticism, also mentioned by Katz and Shelanski,138 is that the figures used to calculate the Expected Value are sometimes controversial and could lead to disagreement between the Commission and the applicants. A subsequent appeal to the High Court would be very expensive, long and complicated, involving significant economic data and analysis. Such a criticism is well placed. However, it could equally be directed at the Real Risk approach. There too the Commission is required to undertake economic analysis of the proposed acquisition and, if the parties disagree over the Commission’s modelling, the ensuing litigation is likely to be long, expensive and complicated. Thus, if there is no reliable economic data available the implication and solution in the Real Risk approach and the Expected Value approach is the same: to skip the quantitative assessment and focus on theoretical and qualitative concerns.
Moreover, it is submitted that where the data is reliable but the Commission
misapplies the economic modelling, then the applicant
is entitled to, and should
challenge the modelling. In such a case the area requiring improvement is not
the theoretical treatment
of complicated economic data, but the quality of
modelling undertaken by the Commission. Further, an Expected Value approach
be preferable to the Real Risk approach in such circumstances by reducing
disagreements over small inaccuracies in the economic modelling.
under a 30% probability threshold it may be extremely important for an applicant
to establish whether the likelihood
of a potential event is estimated at 28% or
32%.139 As a result significant resources may be expended in
debunking the Commission’s accuracy when assessing the event’s
Expected Value, on the other hand, combines all the merger’s
figures together instead of focusing on one single figure. Therefore
small variation would be virtually immaterial when using Expected Value,
especially once qualitative factors are taken
138 Katz and Shelanski, above n 88, 553. Note, however, that Katz and Shelanski address this criticism from the context of evidence in American antitrust cases.
139 Similarly, under an impressionistic approach, where it is controversial whether a
counterfactual is ‘likely’ or not, the parties will conduct the same expensive exercise. The central difference between a percentage probability threshold and an impressionistic threshold is that the decision-maker has more discretion when using an impressionistic threshold. While the use of that discretion may in some cases resolve the disagreement, in other cases it may simply form the grounds for an expensive and drawn out appeal process.
140 For example two calculations of expected value with such a
variation could be
Some could build on the above potential criticism and claim that parties to litigation would engage in expensive ‘arms races’ or that judges could manipulate Expected Value and use it as a cover for intuitive judgments rather than a way of forcing transparency. Such criticism misses the purpose of Expected Value. Expected Value cannot, and is not designed to provide a foolproof mechanism for foreseeing the future. Expected Value is merely designed to improve the Commission’s merger evaluation from its current state and provide a comprehensive summary of the quantitative information already at the Commission’s disposal. It is possible that some people may attempt to manipulate Expected Value. However, Expected Value would be harder to manipulate than the Real Risk approach because Expected Value mandates deference to more objective criteria and, unlike the Real Risk approach, does not condone judges using their own intuitive impression to determine the outcome of complicated legal proceedings. The final potential criticism that this paper will address is that the Expected Value approach takes into account price decreases as well as price increases for consumers. This appears, on first inspection, similar to merger authorisation under s 67 of the Act where the Commission is required to look at the net benefit to the public.141 Therefore, the argument would run, the Expected Value approach wrongly encroaches on territory reserved for merger authorisations.
The response to this criticism is twofold. First, it is true that the
Expected Value approach increases the level of overlap between
the clearance and
authorisation provisions. However, the authorisation process takes into account
significantly more information
on the benefits to the public than the Expected
Value approach. This ‘Public Benefit’ test under s 67 has been given
a wide interpretation that includes matters such as greater international
competitiveness for New Zealand, increased utilisation
of New Zealand resources,
preserving local economic activity and employment, better consumer
(0.28 × 0.05 + 0.72 × 0.01) = 2.12% and
(0.32 × 0.05 + 0.68 × 0.01) = 2.28%.
The difference between the two figures is a fraction of percentage point (0.16%).
141 Section 67(3)(b) requires the Commission to authorise a merger
“if it is satisfied that the acquisition will result, or will
be likely to
result, in such a benefit to the public that it should be permitted.” For
an explanation of the net benefit test
and some of its shortcomings see G
Bertram, “What’s Wrong With New Zealand’s Public Benefit
Test?" (2004) 38 New
Zealand Economic Papers 265.
and preventing “free riding”,142 to name a few. Moreover, there is a difference between the authorisation procedure and the clearance procedure in the way the information is used.143 The authorisation process uses this information to assess whether there is a net benefit to the public, while the clearance procedure uses this information to
assess whether there is likely to be a change in the competitive pressures in a market.144
Second, the clearance process is a complex process. The Court of
Appeal in the Warehouse Case noted that the 10 working day timeframe for
clearances145 is not an indication that the clearance process
should be used only for obvious cases.146 In practice it takes the
Commission over two months on average to assess and publish a clearance
decision.147 In making this decision all relevant and available
information that affects competition in the market should be taken into account
to evaluate the likely effect of the merger.148 This should
include potential increases in competition as well as decreases in
142 R Ahdar, “The Authorisation Process and the ‘Public Benefit’ Test" in R Ahdar (ed.),
Competition Law & Policy in New Zealand (The Law Book Company, Sydney, 1991), 217,
239. See also Jill Caughey, A Tangible Distinction? Intangibles and the Public Benefit Test in the
Commerce Act 1986 (Honours Research Paper, University of Otago, 2006).
143 See R Ahdar, “A Tale of Two Airlines (Still)" (2005) 33 Australian Business Law
Review 64 for an analysis of Air New Zealand Ltd v Commerce Commission (No 6) (2004) 11
TCLR 374 where the Commission was required to analyse both a SLC and the public
benefit tests under a merger authorisation request.
144 For alternative views on analysing what constitutes a “Public Benefit” and the
different factors that could be considered in the test see J S Gans, “Reconsidering the Public Benefit Test in Merger Analysis: The Role of 'Pass Through'" (2006) 34 Australian Business Law Review 28, P Hughes, “Comments on Professor Joshua Gans's Presentation 'Reconsidering the Public Benefit Test'" (2006) 34 Australian Business Law Review 49 and S P King, “The Public Benefit Standard for Merger Authorisations"
(2006) 34 Australian Business Law Review 38.
145 Section 66(3) of the Commerce Act 1986 requires the Commission to issue a decision over a clearance application within 10 working days unless the applicant agrees to extend that period.
146 Warehouse Case CA, .
147 Ministry of Economic Development, Discussion Document: Review of the Clearance and
Authorisation Provisions under the Commerce Act 1986 (Wellington, 2007), 25.
148 Warehouse Case CA, .
5. Does the Commerce Act 1986 prohibit an Expected Value approach?
It is well established that merger analysis in New Zealand requires a comparison of the factual with the counterfactual.149 The word ‘likely’ in s 66 dictates how the Commission and the courts are to treat uncertainty in merger analysis. ‘Likely’ is not defined in the Commerce Act 1986. Nonetheless, ‘likely’ has been interpreted as providing for a Real Risk approach in Port Nelson Ltd v Commerce Commission150 case, which interpreted ‘likely’ in the context of s 27 and restrictive trade practices, and has since been expanded to all usage of the term ‘likely’ in the Commerce Act, regardless of the differences in context.151
Clearly, Parliament could mandate the use of an Expected Value approach through specific legislation. However, this paper contends that the Supreme Court could reverse Port Nelson in the context of s 66 clearance applications, and adopt an Expected Value approach. The question that arises is whether, in this context, an interpretation of
‘likely’ necessarily dictates a Real Risk approach and prohibits an
Expected Value approach.152
The interpretation of ‘likely’ depends on the statutory context
in which it exists.153 In Telecom Corporation of New Zealand Ltd v
Commerce Commission154 the Court of Appeal held that the
essential notions and objectives of the Commerce Act 1986 were economic
ones.155 Words such as “market” and
“competition” should be interpreted with reference to their economic
equivalent.156 Maureen Brunt, for example, who has sat as lay-member
on many competition law cases in New Zealand and Australia, considers that
antitrust is to be relevant and socially useful, the very fabric of
the law must have mixed economic-
149 See Tru Tone Ltd v Festival Records  2 NZLR 352 (CA) and New Zealand Bus Ltd v
Commerce Commission  NZCA 502, .
150 Port Nelson Ltd v Commerce Commission  NZCA 230;  3 NZLR 554, 563.
151 For an in depth discussion on the evolution of the interpretation of ‘likely’ under the
Commerce Act 1986 see above n 66.
152 Note that Katz and Shelanski consider that Expected Value is not barred by the US statutory language which bars mergers where “the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly” (emphasis added, Katz and Shelanski, above n 88, 562-564).
153 Commissioner of Police v Ombudsman  NZCA 211;  1 NZLR 385, 404.
154  3 NZLR 429.
155 Ibid, 441.
156 See Miriam Dean and Tom Weston, New Zealand Law Society Seminar: Competition Law
Update (New Zealand Law Society, 2001), part 3.
legal content, with due attention given to both.”157 Thus, interpretation of ‘likely’ within the Commerce Act 1986 could be performed with reference to its economic equivalents of risk assessment, which would include Expected Value.158
Moreover, the current interpretation of s 66 assesses the likelihood of individual counterfactuals without linking them to the outcome or effect.159 This interpretation appears incompatible with s
66, which requires an assessment of the merger’s “likely effect of substantially lessening competition”.160 Read literally, the likely effect is for the merger as a whole where the likelihood and effect are linked to each other. This is precisely what Expected Value calculates. The current interpretation reads s 66 as if it read “a likely factual or counterfactual that has an effect of substantially lessening competition”, despite no indication in the section that it should be read this way.
Finally, the Court of Appeal in Benton v Miller & Poulgrain (a
firm)161 discussed the treatment of uncertainty in the context of
negligence and a loss of chance. Loss of chance evaluation involves a
analysis,162 similar to that undertaken in merger
analysis. In that context the Court found that uncertainty could either be
evaluated on an “all-
or-nothing” basis by reference to the balance
of probabilities or on a proportionate basis.163 The Court held that
where the question is how would the plaintiff have acted in the absence of a
breach of duty it should be evaluated
on an all-or-nothing
basis.164 However, uncertainties as to how third parties
would have acted should be
157 M Brunt, “Antitrust in the Courts: The Role of Economics and of Economists" in M Brunt (ed.), Economic Essays on Australian and New Zealand Competition Law (Kluwer Law International, The Hague, 2003), 353, 354.
158 See Gollier, above n 96.
159 The danger with such an approach is that “When merger review addresses uncertainty
by overemphasising the likelihood of particular outcomes and discounting the importance of those outcomes, except perhaps when that importance reaches
‘extraordinary’ scale, a small effect that has a high probability of occurring may weigh much more heavily in enforcement decisions than an effect whose probability is lower but whose consequence is of greater magnitude. Such an approach could have perverse effects on consumer welfare.” (Katz and Shelanski, above n 88, 545)
160 Commerce Act 1986, s 66(3)(a).
161  NZCA 385;  1 NZLR 66.
162 Ibid, .
163 Ibid, .
164 Ibid, .
evaluated on a proportionate basis.165 Similarly in merger
analysis, when evaluating the ‘likely’ effect of a merger, it is
necessary to evaluate how customers
and other participants in the market
are likely to react. Extending the Benton v Miller ratio, the
evaluation of what is ‘likely’ in merger analysis should use a more
sophisticated method than a simple all-or-nothing
approach. As a result, not
only is it open to the courts to interpret ‘likely’ as allowing an
Expected Value approach,
it is more consistent with the legislation to do
Returning to the observation made at the introduction to this paper, the change in the legal test of merger analysis in 2001 provided the Commission and the courts with an opportunity to improve merger analysis. While sophisticated economic analysis is used in some areas of merger analysis, its absence in other areas materially reduces the quality of the analysis. The Real Risk approach expressed by the Court of Appeal in the Warehouse Case perpetuates this lack of sophistication. The most serious shortcoming of the Real Risk approach is its treatment of events with a low probability as if they did not exist and events with a high probability as if they were certain to occur, which can have perverse effects on consumer welfare. It also fails to link effects to their probability. The impressionistic aspect of this approach, as expressed by the Court of Appeal, injects unnecessary vagueness into this flawed assessment of likelihood.
As an alternative, this paper advocates an Expected Value approach to the
evaluation of uncertainty in merger clearance applications.
Expected Value is
commonly used by businesses to evaluate risk in cost-benefit analysis and
guide decision-makers.166 This approach allows the Commission and
the courts to consider the merger’s entire quantitative effect using a
figure that denotes the merger’s ‘likely’ effect. At
the same time Expected Value provides a clear and simple measure
applicants to determine what the Commission and the courts will consider the
merger’s ‘likely’ effect
to be. Since it would be open to the
courts to adopt an Expected Value approach under current legislation, it is
submitted that they
should do so.
165 Ibid, .
166 Heyer, above n 95, 376.