Competition Commission of South Africa

Comments on the Liquor Bill [B – 2003]

The Competition Commission is concerned about the proposals in Chapters 3 and 4 of the Liquor Bill, to separate vertically the ‘three tiers’ of the liquor industry: manufacture, distribution and retail.

1. CHAPTER 3

Section 12 (2) states:

"No person may be registered–

(a) as a manufacturer, if that person is–

    1. registered as a distributor;
    2. licensed as a micro-manufacturer, … ; or
    3. licensed to sell liquor … .

(b) as a distributor, if that person is–

    1. registered as a manufacturer;
    2. licensed as a micro-manufacturer, … ; or
    3. licensed or registered to sell liquor … .

 

There are usually efficiencies to be had from vertical integration in any industry, and it is not clear why players in the liquor industry should be prevented from exploiting these efficiencies.

There are four points concerning vertical integration that the Commission would note.

2. CHAPTER 4

Section 24(1) states:

"Subject to subsection (5), a registered manufacturer may sell liquor only to–

(a) another registered manufacturer;

(b) a registered distributor;

(c) a registered or licensed micro-manufacturer;

(d) a producer of liquor related products; or

(e) persons outside the Republic."

Except that according to section 24(5):

"The Minister may permit, as a term or condition of registration, a registered manufacturer to sell liquor–

(a) to a person registered under this Act to sell liquor for consumption;

(b) to a person licensed under any provincial legislation to sell liquor for consumption; or

(c) for consumption on or off the premises."

It appears from the above that micro-manufacturers are not affected by these rules of vertical separation. In other words, if a firm is defined as a micro-manufacturer then it may sell to final sellers of liquor, which implies that micro-manufacturers can perform their own distribution.

It does not appear to have been considered in the policy, what would happen once a micro-manufacturer grows in the market at either regional or national levels. Is it envisaged that such micro-manufacturers would be advised by the dti that they require registration as manufactures once they pass the threshold? Clearly, their differential treatment is inconsistent with competition objectives and principles, which are premised on the impact on competition of new entrants (usually small players initially) to a market. In fact, evidence shows that smaller players in a market tend to provide greater benefits for consumers by, inter alia, cutting prices and doing a "little extra" for the consumer to get more market share. They also tend to be more innovative. But how are small players to be treated once they graduate above the threshold?

As for distributors, section 26(1) and 26(2) are inconsistent with each other and presumably there is an error here. Section 26(2) states that a registered distributor may supply liquor only to a person referred to in subsection (1), and only pursuant to a sale to that person. But it is not clear to which ‘person’ in section 26(1) that section 26(2) refers.

Nevertheless, section 26(3) states:

"A registered distributor may buy liquor only from a–

(a) registered manufacturer;

(b) a registered or licensed micro-manufacturer; or

(c) holder of an import certificate … ."

Finally, as regards sellers for consumption, section 27(1) states:

"A registered seller of liquor for consumption–

(a) may buy liquor only from–

    1. a registered distributor;
    2. a registered manufacturer … ; or
    3. a holder of an import certificate … ."

 

3. POLICY OBJECTVES

According to the provisions in the Bill as cited above, the three tiers of the liquor industry will be vertically separated for all participants, except those that fall below the size threshold and are defined as micro-manufacturers.

In looking for reasons as to why such a drastic structural stipulation should be put in place by means of the Liquor Bill, one only has recourse to the objects of the proposed Act.

In section 2(1), the objects of the proposed Act are:

"(a) to reduce the socio-economic and other costs of alcohol consumption by –

(ii) regulating the manufacture and wholesale distribution of liquor;

(b) to maintain economic unity in the structuring of the liquor industry into three tiers of enterprise, to promote –

    1. the entry of new participants into the liquor industry;
    2. diversity of ownership in the industry; and
    3. an ethos of social responsibility in the industry."

 

(i) Objective (a) – to reduce the socio-economic costs of alcohol consumption –

Given the social ills caused by alcohol, it is not surprising that Government should want to single out the liquor industry for special attention, but it is difficult to see how vertical separation of the three tiers of the industry can contribute to reducing the socio-economic costs of alcohol consumption (but see the next paragraph). Furthermore, when it comes to the objective of reducing the other costs of alcohol consumption, the vertical separation of the three tiers might well have the opposite effect: it could impose additional transaction costs on market participants and undo efficiencies previously realized by vertical integration.

It seems that the only way in which separating the three tiers from each other could reduce the socio-economic costs of alcohol consumption is by the following reasoning. First, assume that a decrease in alcohol consumption leads to a corresponding decrease in the socio-economic costs (ills) of alcohol consumption. Now, by vertically separating the three tiers, inefficiencies are introduced, which results in cost increases. In turn, these might lead to increases in final prices and, by the law of demand, to a decrease in quantity consumed (which we have assumed in the first place will lead to a decrease in the social costs of alcohol consumption). However, the same result (reduced consumption) could be achieved by increasing the excise taxes on liquor. The benefit of relying on taxes (rather than hobbling the industry by stipulating vertical separation) would be the extra revenues flowing to the State, which would represent the dividend of allowing the liquor industry to continue distributing its product as efficiently as possible.

(ii) Objective (b) – maintaining economic unity in the structuring of the liquor industry into three tiers of enterprise.

Here again it is unclear what is meant by the "economic unity of the industry" and how it can be maintained by vertically separating the three tiers of the industry. Indeed, separating the tiers might have the opposite effect, of dividing the interests of the industry into three camps, with opposing interests. That has happened in the USA, where it is very difficult for a manufacturer to terminate a distribution agreement, if that distributor turns out to be inefficient.

The objectives under (b) are also designed to promote entry, diversity of ownership and an ethos of social responsibility, and some of these noble intentions are echoed in the Competition Act, No. 89 of 1998, section 2 (Purpose of Act):

"The purpose of this Act is to promote and maintain competition in the Republic in order –

  1. to promote employment and advance the social and economic welfare of South Africans;

  1. to ensure that small and medium-sized enterprises have an equitable opportunity to participate in the economy; and
  2. to promote a greater spread of ownership, in particular to increase the ownership stakes of historically disadvantaged persons."

One can only speculate as to how the drafters of the Bill envisage that the separation of the three tiers (for the big players) will enhance entry by smaller players and diversity of ownership in the sector. Certainly, the premise appears to be that vertical integration by large players could lead to problems referred to in the Competition Act as ‘abuses of dominance’. Vertically integrated market participants that are large enough within their relevant markets to be defined as dominant, might exclude new entrants by refusing to distribute their products for them.

The first opportunity for entry and diversity of ownership would of course be created when vertically integrated participants divest themselves of their upstream or downstream businesses. That might present an opportunity for smaller firms to undertake distribution of liquor products, but equally those distributorships might be awarded to major logistics firms.

Secondly, a functionally separated industry might be easier for a new firm to enter, if that functional separation makes it easier for the new firm to enter at one level only. Certainly, barriers to entry are higher if a new entrant must enter at more than one level (e.g. manufacture and distribution). It is not clear, however, that a new entrant at one level only would necessarily be foreclosed from access to the other two levels.

Furthermore, if a liquor supplier is dominant in a particular market, then according to the Competition Act that supplier can be required to make its product available to independent wholesalers and retailers, for failure to do so might constitute a vertical restrictive practice, according to section 5 of the Act. However, a manufacturer would not normally want to restrict its distribution channels; rather, it would want to see its product distributed as widely as possible.

CONCLUSION

In the absence of a clear indication that vertical integration in the industry is foreclosing the entry of new participants, it does not appear that separation of the three tiers is a justifiable policy. The Competition Commission is therefore not in a position to lend its support to such a structural measure, without such evidence that new entrants are being stymied or that vertical integration is harming the development of the industry. A policy that stipulates a certain structure and way of doing business for an industry is at odds with objectives (a) and (b) of section 2 of the Competition Act. The purpose of the Act is to promote and maintain competition in the Republic in order (a) to promote the efficiency, adaptability and development of the economy, and (b) to provide consumers with competitive prices and product choices. A policy of prohibiting vertical integration also appears to be at odds with the dti’s own Industrial Manufacturing Strategy.