Ipsofactoj.com: International Cases  Part 8 Case 2 [NZCA]
COURT OF APPEAL, NEW ZEALAND
The Commerce Commission
- vs -
The Southern Cross
Medical Care Society
21 DECEMBER 2001
Richardson P & Tipping J
This appeal concerns the proposed acquisition by the respondent, Southern Cross Medical Care Society (Southern Cross) of all the issued share capital in Aetna Health (NZ) Ltd (Aetna). On 18 July 2000 Southern Cross gave the appellant, the Commerce Commission (the Commission) a notice under s66(1) of the Commerce Act 1986 (the Act) seeking clearance for the acquisition. The Commission registered the notice the same day. On 25 August 2000, an extension of time having been agreed for the purpose, the Commission made a determination, pursuant to s66(3)(b), declining to give a clearance for the proposed acquisition. That determination is known as Decision 399. On 30 August 2000 Southern Cross applied again for clearance, this time on the basis that if clearance was given it would divest itself of part of Aetna’s business. In Decision 404 made on 13 September 2000 the Commission again declined to give clearance. On 18 September 2000 Southern Cross applied a third time for clearance giving different undertakings as to divestment. In Decision 407, delivered on 13 October 2000, the Commission gave clearance subject to those undertakings. Despite that clearance having been given, Southern Cross appealed to the High Court against Decisions 399 and 404.
Argument on that appeal took place on an expedited basis during the vacation on 22-24 January 2001. The argument focused almost entirely on Decision 399. The same applied in this Court. The High Court allowed Southern Cross’ appeal and concluded that the Commission ought to have given clearance to the proposed acquisition without the necessity for a divestment. Both Williams J and Dr Lattimore wrote judgments which were delivered on 8 March 2001. In coming to its conclusion, the High Court made an error of fact which led to an application by the Commission to recall the judgment. That application, in conjunction with an application for leave to appeal to this Court, was argued on 28 and 29 March 2001. The recall application was declined but the High Court gave the Commission leave to appeal to this Court under s97 of the Act on 11 April 2001. A fixture in this Court for the hearing of the appeal in September was adjourned at the request of counsel for Southern Cross without opposition from the Commission.
It is apparent from the foregoing chronology that this Court embarked upon the hearing of the appeal about 10 months after the hearing in the High Court and 15 months after the first determination by the Commission. We were supplied, by consent, with updating material. Each side sought to derive assistance from that material. Both parties accepted that this Court should make its own assessment of the significance of the new material, both in itself and in relation to how it affected the conclusions to which the Commission, and indeed the High Court, had come. This Court was therefore faced with having to assess the case without the direct economic assistance which the Commission enjoys, and which the High Court enjoyed from the presence of Dr Lattimore sitting as a lay member pursuant to s77 of the Act. Subsection 9 of that section makes it necessary (with certain presently immaterial exceptions) to have at least one lay member present to constitute a sitting of the High Court to hear an appeal from the Commission.
We add that an appeal to this Court under s97 is not confined to questions of law. Although leave is required, the criteria underline the point that once leave has been granted, the appeal is a general appeal by way of rehearing, as in the case of an ordinary civil appeal from the High Court. There must of necessity be some de novo element when this Court is asked, as is conventional in cases of this kind, to consider the impact of updating evidence.
THE CLEARANCE PROCEDURE
This case is governed by s66 of the Act as it stood prior to the amendment effected from 26 May 2001 by the Commerce Amendment Act 2001 (2001 No.32). It was then in these terms:
Commission may give clearances for business acquisitions
The section is now couched on the basis that if clearance is not given within the stipulated or extended period, the Commission is deemed to have declined to give a clearance. The position was the reverse before 1991, when s66 was changed to its presently relevant form. Section 66, as it stood in August 2000 (and in this respect the position is still the same), effectively provided that the Commission should only grant clearance if satisfied that the acquisition would not result in an effect described by paragraph (a) or paragraph (b) of s47(1), to which we will refer as a proscribed effect. The significance is that if the Commission is (a) satisfied the acquisition will have a proscribed effect, or (b) is not satisfied that the acquisition will not have a proscribed effect, it must decline to give a clearance. Hence to obtain a clearance the applicant must satisfy the Commission that the acquisition will not result in a proscribed effect.
The proscribed effects can be described for short as actual or likely dominance or actual or likely strengthening of dominance. Bringing the required approach and the criteria together, it is necessary for Southern Cross to show that its acquisition of Aetna will not result in the merged entity either being or being likely to be in a dominant position in the relevant market: s47(1)(a); or strengthening or being likely to strengthen an already dominant position in the relevant market: s47(1)(b). Unless Southern Cross can establish that neither of these effects will result from the proposed acquisition, the clearance it seeks cannot be granted. The standard of proof is the balance of probabilities and the inquiry is necessarily one involving a degree of prediction. We will be referring shortly to the decisions of the Commission and the High Court, and to the effect of the updating material with which we were supplied.
It should also be noted that failure to obtain a clearance does not prevent a further application to the Commission for clearance on a different basis (as here) or a further application as a result of the applicant being able to demonstrate that there have been changes or developments of a factual kind which now justify clearance being given. Nor does a failure to obtain clearance prevent the proposed acquisition from being implemented if the parties are of the view that, if challenged, the transaction will not be shown to have been in breach of the Act. The value of a clearance is that, provided the transaction is implemented within the period specified in s66(5), it is not vulnerable to later challenge under either s27 or s47. This protection is given by s69. What we have said should not be read as casting doubt on the utility of the clearance procedure; but the scheme of that procedure is that a clearance should not be granted unless the Commission is satisfied, on the probabilities, that a proscribed effect will not result from the acquisition.
THE KEY QUESTIONS
Our discussion of the clearance procedure has shown that the ultimate question in this case is whether Southern Cross’ acquisition of Aetna will, or is likely to, place it in a dominant position in the medical insurance market in New Zealand, or strengthen an already dominant position which it holds in that market. That question turns on the application to the facts of this case of the statutory definition of the concept of having a dominant position in a market. Whether a person has a dominant position turns on whether that person, here Southern Cross, is in a position to exercise a dominant influence over the production, acquisition, supply or price of goods or services in the relevant market. Here the primary focus is on the price of services, ie. the premiums charged. For the purposes of determining whether Southern Cross is in a position to exercise a dominant influence over the premiums charged, regard must be had to the three factors set out in s3(9) of the Act. They can be summarised as
the extent to which there are constraints on the exercise of market power by Southern Cross provided by the existence of competitors or potential competitors in the market, and
the extent to which Southern Cross is constrained by the conduct of suppliers or acquirers of services in the market.
The question of the extent to which Southern Cross’ ability to exercise market power may be constrained is conventionally examined against the economic concepts of barriers to entry to and expansion in the market. Whether Southern Cross will become dominant or more dominant in the medical insurance market as a result of its acquisition of Aetna, depends essentially on whether the market power it thereby achieves will be sufficiently constrained. Against that background we turn to examine the Commission’s decision.
THE COMMISSION'S DECISION [DECISION 399]
In its decision the Commission said that its determination was based on an investigation conducted by its staff and their subsequent advice to the Commission. This is the conventional methodology. In the course of their investigation of the proposed acquisition, the Commission’s staff had discussions with, and sought the views and comments of, a number of parties. Those approached included insurance companies, insurance brokers, the New Zealand Treasury, the Health Funds Association of New Zealand, and the New Zealand Private Hospitals Association. A number of written submissions were also received.
Southern Cross is a "not for profit" health care organisation. It is incorporated as a Friendly Society under the Friendly Societies and Credit Unions Act 1982. It owns 13 hospitals which are operated independently by The Southern Cross Hospital Trust. It provides travel insurance, workers’ compensation, and injury prevention activities as well as its presently relevant function of providing indemnity health insurance. Aetna is a health risk management services company. It is ultimately wholly owned by an American corporation and is being sold as part of an international re-organisation by that corporation. Its presently relevant market activity is also the provision of indemnity health insurance.
The Commission noted that there were approximately 30 insurance providers operating in New Zealand. Some of them provide only general insurance products. Others provide a range of health insurance products, and those doing so include mutual societies, friendly societies, non profit organisations and companies. The Health Funds Association (HFA) is the representative body of New Zealand health insurers.
The Commission identified eight insurers which it described as major providers offering a range of general insurance products but not health insurance. Identified next were insurance providers which offered a range of health insurance products. What the Commission described as specialist health insurers were then identified as being: Southern Cross, Aetna, Tower Health Ltd (Tower Health), and Union Medical Care Society (UniMed).
The Commission noted, as is well known, that the public health system in New Zealand does not fund all of New Zealanders’ health requirements. Its focus is on the delivery of urgent services. The Commission described access to elective surgery as rationed. The private health insurance industry complements the public health system by covering a range of costs incurred by insured persons who undergo semi urgent and elective procedures. The Commission noted that the two principal types of health insurance policies available in New Zealand were usually described as "comprehensive care" and "major medical" policies. Comprehensive care policies, which cover a wider range of health needs, are more expensive than major medical policies. Both types of policy generally exclude specific and pre-existing conditions. In recent years the trend has been away from comprehensive policies towards major medical policies. Nevertheless the Commission identified that far more of Southern Cross’ members have comprehensive plans than major medical plans.
Historically there have been two ways of pricing health insurance. The first is known as "community rating" and the second as "age banding". Community rating premiums are set at the average age of policy holders. This approach obviously tends to favour the older age group as against the younger. As the name implies, age banding premiums are set within age bands. The bands are commonly set in five year increments and all those within the same band pay the same premiums, except in the case of different individual risks. The level of premium increases as the insured person moves into an older age band. Southern Cross has in recent years been aligning its premiums more closely with risk, and thus towards age banding and away from community rating.
The percentage of New Zealand’s population with private health insurance has declined from an estimated 51% in 1990 to an estimated 33% in 1999. The market has therefore been shrinking quite significantly. Nevertheless the Commission found that New Zealand has one of the least regulated insurance markets in the world. Basically there are only two regulatory requirements. The first is to obtain a rating from an approved rating agency, and the second is to give security for an amount not less than $500,000 in terms of the Insurance Companies Deposits Act 1953. Annual returns and statements of financial position have to be given to the Ministry of Economic Development.
The Commission next turned to market definition, noting that the purpose of defining a market is to provide a framework within which the competition implications of a business acquisition can be analysed. Section 3(1A) of the Act provides that:
.... the term "market" is a reference to a market in New Zealand for goods or services as well as other goods or services that, as a matter of fact and commercial common sense, are substitutable for them.
The Commission noted that markets are typically defined by reference to three dimensions: product type, geographical extent, and functional level.
As there was no significant dispute between the parties about the Commission’s definition of the relevant market, it is unnecessary to examine the Commission’s discussion of this topic in any detail. It should be mentioned, however, that the Commission noted that it had previously considered the subject of indemnity health insurance when it gave clearance in 1993 to Southern Cross for its then proposed acquisition of First Medical Corporation Ltd (Medic Aid). It was in this respect that the High Court’s error of fact, earlier mentioned, took place. While the Commission gave clearance in 1993 for Southern Cross to acquire Medic Aid, it did not in fact do so. Medic Aid was actually acquired by Aetna. The High Court proceeded on the basis that it had been Southern Cross rather than Aetna which had acquired Medic Aid, albeit in its recall judgment the High Court indicated, for reasons which will be mentioned later, that its factual error made no difference to its conclusion.
The Commission noted that, both in respect of the Medic Aid acquisition and for another purpose which it is not necessary to go into, it had defined the relevant market as being the market for the provision of medical insurance throughout New Zealand. The Commission adopted the same market definition in the present case, and noted that Southern Cross had accepted this market definition for the purposes of its clearance application, as had most industry representatives. The Commission also noted that Southern Cross had commented on the Commission’s market definition by saying that the precise market boundaries could not clearly be drawn in the health industry. Southern Cross had also observed that the existence of important alternatives just outside what it described as an artificially drawn market boundary, were important when interpreting the effect of market share on market behaviour. The alternatives referred to were self funding, income protection insurance, and the public health system. The Commission noted that the impact of such matters as these on the medical insurance market would be considered in its competition analysis. It did not, however, consider that income protection insurance was a substitute for health insurance so as to bring it within the medical insurance market.
The Commission moved next to consider the differences between individual and group medical insurance. It noted different estimates as to the amount of the market made up of each type of insurance. The differing estimates ranged from about half of the market being in the group sector, up to about three-quarters being in that sector. The Commission appropriately considered the substitutability of individual and group insurance, and concluded that the two types were in the one market. No issue arose on this score before us. The Commission did note, however, that those in group schemes are generally in a better position, as regards pre-existing conditions, than those who take out individual cover. In most cases a prospective insurer will not accept a pre-existing risk, but group schemes generally provide for employees with pre-existing conditions to be covered on the same terms as other employees. The Commission made the point that, as a result, those with pre-existing conditions in a group scheme have a disincentive to move from such a scheme to individual cover.
The next section of the Commission’s decision contains what it described as its competition analysis. The Commission directed itself appropriately as to the requirements of s66. It referred to the definition in s3(9) of the Act of when a person has a dominant position in a market:
.... if that person as a supplier or an acquirer .... of goods or services is .... in a position to exercise a dominant influence over the production, acquisition, supply, or price of goods or services in that market.
In determining whether a person is in a position to exercise a dominant influence, regard must be had to:
The share of the market, the technical knowledge, the access to materials or capital of that person ....;
The extent to which that person is .... constrained by the conduct of competitors or potential competitors in that market;
The extent to which that person is .... constrained by the conduct of suppliers or acquirers of goods or services in that market.
The Commission then set out the following passage from McGechan J’s judgment in Commerce Commission v Port Nelson Ltd (1995) 6 TCLR 406, 441, which was approved in this Court (see Port Nelson Ltd v Commerce Commission  3 NZLR 554):
The test for ‘dominance’ is not a matter of prevailing economic theory, to be identified outside the statute. .... ‘Dominance’ includes a qualitative assessment of market power. It involves more than 'high' market power; more than mere ability to behave 'largely' independently of competitors; and more than power to effect 'appreciable' changes in terms of trading. It involves a high degree of market control.
How high? Clearly, not absolute control. There need not be monopoly. There need not be ability to act totally without regard to competitors, suppliers, or customers. Expression of the required degree of control in terms of mastery – eg as 'commanding', 'ruling', or 'governing' – is perhaps to that extent misaligned, and needs to be read down.
[Emphasis as in original]
Against that background, the Commission turned to consider what it described as "constraints from competition within the medical insurance market". It took as a useful starting point for analysing the effect of the proposed acquisition in terms of the constraints Southern Cross would face from other market participants, what it described as an examination of concentration in the market. The Commission observed that in general, the higher the share of a market held by the merged entity, the greater the probability that a proscribed dominant position will, or will likely, be acquired or strengthened in that market. The Commission went on, however, to make the correct observation that market shares are insufficient in themselves to establish a dominant position in a market. As well as market structure, behavioural factors, including the extent of actual or potential rivalry in the market, must be considered and assessed. The Commission might also at this point have made specific reference to the important subjects of barriers to entry and expansion.
The Commission then set out various estimated market shares for Southern Cross and other participants in the market, both on a lives covered and on an earned premiums basis. On a lives covered basis the Commission indicated that as at 1999 Southern Cross had 60% of the market, Aetna 11.4%, with the remaining participants having the balance between them, but with none of them having a greater than 7% share. On this basis the post-acquisition share of the combined entity would have been 71.4%. It is interesting to note that the estimates of Southern Cross and the HFA in this respect are almost identical. On an earned premium basis Southern Cross’ share was 65% with Aetna’s being 15%. Thus the combined entity’s total share on this basis would have been 80%. Southern Cross had, however, made the point that an earned premium approach tended to overstate the market share of those insurers such as itself and Aetna which provided more comprehensive plans which commanded higher premiums to cover higher risks and costs.
The Commission compared its 1999 figures with those which it had identified in 1993 for Southern Cross’ proposed acquisition of Medic Aid. These figures, which derived from a survey conducted by the Consumers Institute, showed that, on a lives covered basis, Southern Cross had 66.6% of the market, Medic Aid 13.8% and Aetna 6.9%, with the balance being shared by four other insurers. On that basis the combined share of Southern Cross and Medic Aid, for whose acquisition clearance was being sought, would have been 80.4% (9% above the present merged entity figure). The proposed acquisition was nevertheless cleared on that basis. The Commission observed that a comparison of the 1999 figures with those for 1993 showed that Southern Cross’ current market share was more or less the same as it was in 1993. That is not entirely correct. If, as appropriate, one compares the 1993 figures, which were for lives covered, with the 1999 corresponding figures for lives covered rather than earned premiums, Southern Cross’ market share had in fact fallen during the six year interval by 6.6%, albeit that percentage figure cannot be taken at face value because the 1993 figures came from the Consumers Institute whereas those for 1999 came from the HFA. But the supposed stability of Southern Cross’ market share was derived by a method which did not compare like with like.
A further feature of the 1999/1993 comparison is that following Aetna’s acquisition of Medic Aid in 1993, the combined firm had a market share of 20.7% on a lives covered basis. In 1999 that share had reduced to 11%. The Commission described this as a decline of about 5% but it is in fact a decline of about 10 points (ie. 50%), on a lives covered basis. Again the Commission’s 5% (really 5 point) drop was derived from a lives covered as against earned premium comparison and the 10 point drop to which we have referred suffers from the Consumers Institute/HFA dichotomy.
The Commission was also influenced by the fact that the comparisons, in its view, showed that there had not been any significant movement of market shares among the minor health insurers over the preceding seven years. What seems significant in these comparisons, albeit they cannot be regarded as exact, is that on a lives covered basis Southern Cross’ market share had significantly declined and that of Aetna, post the acquisition of Medic Aid, had declined even more significantly. We do not therefore consider that the thesis of stability of market share which the Commission adopted in respect of Southern Cross, and its thesis of comparative stability for Aetna, were particularly secure foundations from which to build.
In its discussion of existing competition in the market, the Commission observed that the medical insurance market was currently characterised by a high number of market participants. In addition to various major corporates the market was also supplied by niche operators. That said, the Commission noted that group schemes were predominantly underwritten by Southern Cross, Aetna and two others who were relatively minor participants. Other health insurers, including Tower, Sovereign and State, were said currently to choose to underwrite individual cover. The Commission mentioned Southern Cross’ proposition that existing general insurers had the capacity to expand into the medical insurance market, and that this capacity provided a constraint on existing suppliers, such as Southern Cross, should they decide to raise prices or reduce output or quality. But the Commission recorded that it had contacted some of what it had described as these "new entrants". One named company had indicated the possibility of its entering the medical insurance market; others had said that they had no such plans in the near future. Those observations, however, do not appear to have addressed the position if Southern Cross engaged in supra-competitive pricing or other conduct.
The Commission then turned to identify a number of features relating to existing competition in the market. These features had been mentioned by various participants including Southern Cross. They included Southern Cross’ ownership structure, the fact that it was not liable to pay income tax, and that it did not face the same commercial incentives as its corporate rivals. There was then the overall decline in the size of the market, the fact that profit margins were seen as low, to the point of acting as a deterrent to expansion or new entry, and the fact that group schemes were perceived by many insurers to be commercially unattractive because of the low margins in this sector. Interestingly the Commission recorded it had been told that this state of affairs arose largely because of strong competition for group scheme business, a feature hardly consistent with any existing or likely dominance of Southern Cross in this sector of the market. A further matter was the economies of scale which Southern Cross’ high market share gave it, the need for health insurers to have a diversified pool of risks, and the fact that substantial increases in premiums for comprehensive cover had led to what the Commission described as a large scale migration by customers to major medical cover plans. Similarly, increasing costs in respect of comprehensive cover had seen some insurers tending towards a greater focus on major medical plans.
The Commission then turned to consider the important question of barriers to entry or expansion in the market. As the Commission noted, new entry or expansion can act as a constraint on behaviour in the market. The Commission was therefore correctly of the view that an assessment of the nature and extent of the threat of market entry or expansion should be a significant part of its analysis of competition and market dominance. To determine whether the threat of entry or expansion was or was likely to be a constraint on existing market participants, the Commission applied the LETS test, namely whether such entry or expansion, in response to the exercise of market power, would be Likely, sufficient in Extent, Timely and Sustainable.
Referring to its determination in 1993, the Commission noted that at that time it had found Southern Cross was not dominant in the medical insurance market and that given what it found to be the absence of significant entry barriers to, the history of, and the number of providers of cover in that market, the then proposal would not result in and would not be likely to result in dominance in the market. The Commission recorded that it had found this to be so even though, as earlier noted, Southern Cross’ acquisition of Medic Aid (which did not in fact take place) would have increased its market share from around 66% to about 80%.
The Commission then observed that although it had given due consideration to that earlier determination, it now considered that the earlier determination should be distinguished from the proposed acquisition which it was presently considering. It noted that the market had seen significant contraction and "at best modest increases in the market shares held by market participants". The Commission therefore concluded that its current analysis should be more rigorous than simply relying on the determination made seven years earlier. There can be no criticism of that observation in the abstract. The key question is whether the conclusion reached by the Commission on that more rigorous basis was appropriate and, more specifically, whether it remains appropriate in the light of all the material now before this Court. It is, however, of moment to note that the Commission expressed the view that new entry into the medical insurance market remained relatively straightforward, ie. it was of the view that the barriers to entry had remained at the low level they were in 1993. It observed that the number of participants presently in the market supported the view that entry was not difficult. New entrants did not face major barriers to entry in respect of regulatory approval, access to investment capital, access to or the ability to generate data to facilitate risk profiles and premium settings, or brand recognition or market credibility.
Similarly the Commission did not consider that any other requirements for entry would deter existing financial and insurance organisations from entering the medical insurance market. The Commission observed that there were significant organisations, either presently within the medical insurance market or within the wider financial and insurance sectors, for whom matters such as investment capital and the other issues earlier identified, would not pose significant barriers in the event that they chose to enter or expand in the medical insurance market. All this was said in the context of entry. Except for this passing reference, no other reference was made by the Commission at this point to the question of expansion by existing participants.
The Commission then observed in an important paragraph of its decision:
Despite the apparent ease of new entry by medical insurers, past entry into and expansion in the medical insurance market tends to indicate to the Commission that the likelihood of future significant entry or expansion is unlikely (sic). While there has been some new entry in the last several years (see Table 4), the impact of this entry has been insignificant. Competitors have not been able to make significant inroads to capture market share from Southern Cross. The third largest market share, based on earned premiums, after Southern Cross and Aetna, is no greater than % (see Table 2). Even Aetna seems to have reached its existing market share more through acquisition of other market participants than through competition, and that market share has subsequently declined. Indeed, as noted earlier, it has been suggested to the Commission that much of the new entry has only occurred in order to enable diversified insurers to offer their customers a full insurance portfolio, rather than because of a strong interest on the part of the participants in the medical insurance market.
The Commission’s observation that the impact of new entry in the last several years had been insignificant is not persuasive: see paragraphs  and  above. The picture of a static market in which competitors had not been able to make significant inroads, does not appear entirely accurate in relation to Southern Cross’ share, and certainly cannot be said to have been the position as regards Aetna.
The Commission then continued:
In considering whether post-acquisition entry or expansion in the medical insurance market in response to the exercise of market power will be likely, sufficient in extent, timely and sustainable, the Commission notes:
The Commission concludes that, taking into account the history of the medical insurance market, the structure of the market (including factors unique to Southern Cross), and the lack of expansion in the market, the likelihood of significant expansion by current participants or new entrants in the market is low. The Commission also concludes that the extent of entry or expansion following the acquisition is likely to be on a small scale and more likely to be in niche areas of the market.
While in the introductory part of paragraph , the Commission was considering the matter from the point of view of likely response to the exercise of market power by the combined entity, it appears that the focus shifted in paragraph  to a more historical appraisal and it is not entirely clear that the Commission’s overall focus was on what response might occur to an attempt by the combined entity to raise its prices above a competitive level, that being the primary dimension against which the question of constraint must be assessed.
Having set out some of its conclusions in paragraph , the Commission then set out in the final section of its decision headed "Conclusions", what it had concluded from its competition analysis. The first point was that the proposed acquisition would result in what was described as a very high level of market concentration. The acquisition would lead to economies of scale for Southern Cross, to its advantage, and to the detriment of its competitors. Southern Cross had contended that economies of scope across the various more general insurance markets were more important than its own economies of scale in an individual market. The Commission stated that, based on the response of general insurers to its inquiries, it considered that economies of scope were less important for entry into the insurance market than economies of scale. The Commission considered that having critical mass and economies of scale gave Southern Cross an advantage which served as a barrier to expansion of other market participants.
The Commission then noted that Southern Cross’ acquisition of Aetna would have the effect of removing from the market its principal competitor and the market participant with the best chance of matching Southern Cross’ economies of scale. In the Commission’s view this would remove the most important current constraint on Southern Cross’ level and quality of service. Interestingly, however, the Commission did not say that the acquisition would remove a constraint on Southern Cross’ level of pricing.
Addressing the question of barriers to entry and expansion again, the Commission observed that they did not appear to be particularly onerous or high but notwithstanding "the apparent low barriers to entry or expansion, new entry had not been able to secure market share from Southern Cross to any significant extent". That is not entirely correct in itself and the crucial point is rather whether there would be any significant barriers to entry or expansion if Southern Cross started to act in a supra-competitive manner. The only feature briefly mentioned by the Commission as a barrier to expansion was the issue of Southern Cross’ critical mass and economies of scale, which, in any event, the Commission regarded as constituting only a low barrier.
The Commission then mentioned various other points which it is not necessary to traverse. Finally, in what amounts to the essence of its reasoning, the Commission said:
The Commission has considered whether the merged entity would be able to initiate and maintain an increase in premiums, or reduction in the level or quality of service, consistent with dominance, or whether it would be constrained from doing so by competitive pressure. In assessing the level of competitive pressure that would apply in such circumstances, the Commission considers it relevant to take into account the lack of significant expansion by new entrants since 1993. In the Commission’s view, the lack of expansion raises doubts as to the degree of competitive constraint that new entrants or existing participants would provide in the event of an increase in premiums, or a reduction in the level or quality of service, consistent with dominance.
Southern Cross has identified the shrinking market for health insurance and the commercial unattractiveness of this market as the key factors contributing to the lack of expansion by other market participants. Despite these factors, Southern Cross considers that the threat of a competitive response will still constrain Southern Cross from attempting to raise prices, or reduce services or benefits significantly following the acquisition. The Commission considers that these factors, together with other factors identified by the Commission such as economies of scale, may constitute disincentives to expansion that are sufficiently strong to limit the competitive response to an increase in premiums, or a reduction in the level or quality of service, consistent with dominance. In these circumstances, the Commission cannot be satisfied that the acquisition will not result in an effect described in paragraph (a) or paragraph (b) of section 47(1) of the Act.
It is apparent that the Commission’s conclusion was based on its not being
satisfied that the acquisition would not result in a proscribed effect. The
Commission did not say it was satisfied that a proscribed effect would or was
likely to take place. In its view the lack of expansion raised doubts. We are
therefore faced with a situation in which the Commission was not affirmatively
satisfied one way or the other but was obliged to decline a clearance because
Southern Cross had not brought it to the point of being satisfied that dominance
would not or was not likely to result or be strengthened. It must also be said
that while it followed the statutory language, the way in which the Commission
framed its decision means that it is not clear whether it considered that the
acquisition might create dominance or might strengthen dominance. At best it can
be inferred that the Commission was in doubt in both respects.
HIGH COURT JUDGMENTS
The judgments delivered in the High Court are reported at (2001) 10 TCLR 25. The Commission suggested to us that, in view of the error of fact made by the High Court, and the updating material, it would be appropriate for this Court to view the appeal more as an exercise in determining whether the Commission’s decision was still valid. Mr Farmer likewise did not give a great deal of attention to the High Court decision, preferring to base his case on the proposition that the Commission’s conclusion had been wrong from the outset but was clearly wrong in the light of the new material now before this Court. We will adopt the Commission’s suggested approach but will nevertheless make reference to the judgments in the High Court as we proceed and to the extent we consider helpful.
Williams J referred to the Commission’s decision and then made a number of citations from several of the leading cases. He discussed market share and dominance issues, referring to the statistical data in detail. The factual error whereby the Judge understood Southern Cross to have acquired Medic Aid rather than simply a clearance for its acquisition, led to his taking the view that Southern Cross had suffered a much greater diminution in its market share than was in fact the case.
Reference was made to the shrinking overall market. The Judge’s conclusion was based substantially on his correct observation that a large market share is unlikely to lead to dominance in the absence of barriers to entry. In support of this proposition he cited the decision of the High Court in New Zealand Magic Millions Ltd v Wrightson Bloodstock Ltd  1 NZLR 731 at 755 and 757. Williams J, referring to himself as the Court, concluded his judgment by saying:
In sum, therefore, again not relying on the earlier comments about self-funding and the public health system, this Court reaches the view that while the Commission was correct to conclude that
the Commission was, with respect, incorrect to conclude that future significant entry or expansion in the market was unlikely, that the impact of participants in the market since 1992 on the market shares of Southern Cross and Aetna has been insignificant and that new entry or expansion was likely to be in "niche" areas only, complementing participants’ other products, and unlikely to be sustainable. The facts are that against a background of declining coverage of the New Zealand population seven of the ten existing medical insurers have entered the market since 1992, all have increased their market share over that period, a significant expansion has occurred since Decision 399, none of the participants propose to quit the market, and a number of those not currently in the market are contemplating entry. Though competitors’ market penetration since 1992 is modest in percentage terms, the business is plainly sustainable to participants, all of whom are vigorous competitors likely to compete even more vigorously in the event Southern Cross’ acquisition of Aetna proceeds and it attempts to increase premiums or reduce service.
It follows that the Court reaches the view that the Commission was incorrect to find that, despite Southern Cross’ considerable market share following its acquisition of Aetna, Southern Cross would be dominant in the health insurance market following that acquisition or, if it is dominant now, that that dominance would be strengthened. It is also of the view, again for the reasons outlined, that it has not been shown that there would not be significant constraints on Southern Cross by existing or potential competitors if, following its acquisition of Aetna, it increased premiums or reduced cover or service to any significant degree. In those circumstances, the Court takes the view that the Commission should have been satisfied that Southern Cross’ acquisition of Aetna would not result in breach of s47 and should have cleared the same.
Dr Lattimore commenced his judgment by saying he agreed with all the facts presented in the judgment of Williams J, thereby adopting the latter’s error of fact. He indicated that his judgment was designed to summarise his conclusions "in an economic fashion". Dr Lattimore noted that the demand for private medical insurance was in general considered to be quite elastic. He equated elastically demanded goods (here services) with discretionary consumer items which have to compete with items with similar demand characteristics. He observed that markets exhibiting elastic demands are not the preferred territories of monopolists because attempts to constrain supply in order to reap higher prices result in lower revenues. Here of course it is not necessarily a constraint on supply which is the concern but the general point is still significant. A market in which demand is elastic results in demand for an individual firm’s product being more elastic than that for the market as a whole. In this case Dr Lattimore considered that the demand for a particular firm’s medical insurance, and hence that of Southern Cross, was "very elastic".
Dr Lattimore then made the same factual error as Williams J had done, thereby ascribing to Southern Cross a much larger drop in its market share since 1993 than was actually the case. His conclusion that the medical insurance market appeared to be "vibrant and innovative in spite of the contraction it had experienced in overall size" is weakened by the factual error but is not, in our view, wholly undermined by it. Dr Lattimore also expressed the view that barriers to entry were low and there was ample evidence to support that conclusion. He then made the following significant observations:
New entrants have typically been large insurance companies with established market reputations in various product areas and with well-known brand names. Furthermore the evidence is that insurance firms have little difficulty entering the medical insurance market: the barriers to entry are low. The low barriers to entry include low barriers to risk management in the medical insurance field. The Commission reported Southern Cross as saying that the acquisition was important to it inasmuch as a larger membership base would avoid statistical clustering of its risks. This issue did not arise significantly for other insurance firms interviewed, with good reason. Southern Cross is a multi-product firm but with a high concentration of its activities in medical insurance. It is a multi-product firm because it markets a wide variety of medical insurance products. Southern Cross needs a balanced risk profile (to reduce costs) within the medical insurance market. More general insurers (potential entrants) have wider possibilities to spread or balance risk across a range of insurance markets. In short, statistical clustering is perhaps an issue for Southern Cross but it is a lesser issue for the market as a whole.
The possibilities for risk spreading across insurance markets is an example of economies of scope.
The next topic which Dr Lattimore addressed was what he called "Firm Structure and Market Framework". He did so in these terms:
The medical insurance market may be usefully viewed as a market comprised of a group of monopolistically competitive firms. The concept of monopolistic competition can be useful in distinguishing two different types of economies of scale. The Commission reports Southern Cross in its application to merge as attempting to reap economies of scale: decreasing its average costs for the particular policies it sells as part of the medical insurance market. In its Decision 399, the Commerce Commission appears to interpret such views of economies of scale in quite a different fashion: the economies of scale that result from increasing returns to scale (decreasing average costs) applying across a whole market. This latter variant of economies of scale is that associated with the phenomenon of natural monopoly so problematic in constraining market power in networks and the like. The evidence appears to use the term economies of scale in these two radically different contexts from a (economic) market power perspective.
Monopolistic competition has been described by Chief Judge Posner in In re Brand Name Prescription Drugs Antitrust Litigation, No.99-1167, 1999 U.S. App. LEXIS 15621 as follows:
Paradoxical as it may seem, market power is found in many highly competitive markets, for example the markets for scholarly books and journals. (The phenomenon is sometimes referred to as monopolistic competition.) Publishers of scholarly books commonly publish the same book in hardcover and paperback versions at prices that differ by far more than the difference in costs, and publishers of scholarly journals commonly charge a much higher price to libraries than to individuals even though the cost of making and selling the journal is identical to both classes of purchaser.
Monopolistic competition is the chosen framework here because each firm produces a large number of products that are not identical to those produced by the other firms. At a minimum, the well-known brand name of the policy is different. In other words each firm fills certain niches in the market that arise from time to time. The market is actually comprised of a whole series of niches. There is no basic commodity in this medical insurance market in the sense that all firms market an identical medical insurance product.
He then mentioned that the evidence suggested that profits in the market were low. He made the significant comment that the low profit levels might be related to the contracting overall market, but they also suggested that whatever rents (reflecting market power) might appear from time to time for a particular firm when a new product was developed, were quickly eroded by the product developments and market incursions of the other firms. He continued:
.... This suggests that most of the time the firms competing in this market appear to be in equilibrium in the monopolistically competitive sense: prices equal average costs (more or less), rents (market power) are low or transitory and each firm’s products are close substitutes for one another.
In this environment the firms will be operating at more than minimum average cost and each firm has spare capacity. In this sense each firm has economies of scale, as that term appears to be used by the Commission. If Southern Cross could increase output, its average costs would fall and this prospect is being described as economies of scale. In this way Southern Cross is hoping to be able to attract new customers either through lower prices for existing products or higher prices for new products it might devise which contain added consumer value. This freedom of action is the very limited form of market power described above by Chief Judge Posner as monopolistic competition. It is not the market power associated with a dominant firm’s ability to influence a whole market (appropriately defined).
The facts in this case, however, do not suggest that this limited version of market power is significant within the context of the whole medical insurance market. The economies of scale benefits to Southern Cross are severely limited by the particular demand for this firm’s niche products. Any attempt to exploit economies of scale of the monopolistically competitive type seen here is limited by a number of important factors. First, there are low, perhaps very low, barriers to entry to this market by firms who can readily produce close substitutes for Southern Cross products. Second, some new entrants and potential entrants are general insurers with economies of scope by virtue of their risk spreading options, brand recognition and other factors. Third, Southern Cross intends, by its acquisition, to lower its costs and this may be described as gaining economies of scale. The monopolistically competitive firm, Southern Cross, can do this by reducing its average costs. Any market power gained by the added cost competitiveness to Southern Cross may slow down its loss of market share: indeed, Southern Cross may actually gain market share. Any additional market power, however, is highly likely to be transitory, on the evidence. The evidence for these conclusions is the extent of new entry into the market over an eight-year period as the whole market contracted.
Dr Lattimore concluded that low profits with new entry were best interpreted, in the circumstances of the present case, as a sign of a healthy competitive market. He noted there had been significant recent entry into the market and there appeared to be economies of scope across insurance products. Low profits were therefore best seen as a sign of rents being quickly eroded by competitive forces. As his final point, Dr Lattimore expressed his conclusion on what is really the key question. He said that there would be significant restraints on the market power of Southern Cross by existing or potential competitors if, following its acquisition of Aetna, it increased premium rates or reduced its level of cover or services to any significant degree.
THE RECALL JUDGMENT
We will set out only what we regard as the key paragraph in the judgment delivered by Williams J, for the Court, in relation to the factual error and the Commission’s application to recall the substantive judgments on that account. In this respect Williams J said:
The Court is not prepared to consider amending its findings but it is appropriate to add that those findings would not have altered irrespective of whether the correct position concerning the takeover of MedicAid had been known and included in the original judgments or whether or not the application for recall or amendment had been granted. The reason for that is that the focus of the appeal to this Court was whether the Commission was right to conclude under s47 (sic) that it was not satisfied that Southern Cross’ purchase of Aetna would not result, or would not be likely to result, in its acquiring or strengthening a dominant position in the medical insurance market. In reaching its decision the Commission plainly balanced a large number of factors one against the other before reaching a view on that central issue. This Court did likewise. Considering evidence as to market share of Southern Cross and its competitors over the seven years leading up to the Commission’s decision was but one factor to be weighed in that balancing exercise. An error in market shares at the commencement of the seven year period to which the evidence related which reduced but did not overcome the evidence as to Southern Cross’ declining market share over the relevant years was not critical to the outcome. This is particularly the case when one of the factors both the Commission and this Court were considering were the combined market share for Southern Cross and Aetna both before and after the former’s acquisition of the latter and simply transposed MedicAid’s share from the latter to the former (sic).
In view of the way we are approaching the decision we have to make (paragraph  above), it is unnecessary for us to examine in any detail the validity of the criticisms made by the Commission of the High Court’s reasoning in the passage set out in the preceding paragraph. We need say only that the method of expression of the last two sentences, and our inability to feel wholly convinced by the High Court’s reasoning, have reinforced us in the view that the most appropriate way for us to proceed is by regarding the appeal to this Court as, in effect, an appeal directly from the Commission’s determination by Southern Cross on the basis which Mr Fogarty suggested. We consider that this is the fairest way of dealing with what, on its face, was an error of fact by the High Court apt to undermine confidence in its reasoning process.
The principal updating and supplementary material supplied to this Court comprised statistics from the HFA and from the Consumers Institute, the latter having a somewhat narrower focus than the former. We address first the HFA earned premium figures, while recognising that developments in the way premiums are calculated (eg. age banding as opposed to community rating) and the capacity of earned premium figures to produce a misleading picture, make it necessary to take some care with those figures.
For the period June 1999 to June 2001 the HFA figures show Southern Cross’ market share of earned premiums has remained static with a slight drop in 2000. Aetna’s share has declined, and the share of all the other market participants has increased accordingly. On a lives covered basis, Southern Cross’ market share has declined by about 2% over the period. As at the end of June 2001 its share was 59.27%. Aetna’s share has declined to 10.15% from about 12%, and the share of the other insurers has increased to 30.58%. It should also be noted that Southern Cross’ decline in market share over the longer period from 1993 to 2001, on a lives covered basis, has been 7.3 percentage points or 11.06%. In the past two years Sovereign has grown more than 2½ times to its June 2001 lives covered figure of 3.9%. Tower/AXA has increased its market share over the same period from 12% to 13.3%, taking it well above Aetna’s share of 10.15% as at 30 June 2001.
The Consumers Institute figures are broadly consistent. They refer only to lives covered. From 1993 to 2001 Southern Cross’ share of the market has been in slow decline. Aetna’s share shows a much steeper decline. There has been a corresponding increase in the share of all the other participants combined. All in all therefore the updated picture is one of a continuing slow decline of Southern Cross’ market share, a continuation of Aetna’s substantial decline, and a corresponding increase of the share of the other participants, albeit they each individually have small shares. The combined market share of Southern Cross and Aetna on a lives covered basis as at 30 June 2001, in terms of the HFA data, can be compared with their combined position in 1999 in this way: In 1999 the combined share was 73.76%; in 2001 it was 69.42%. On an earned premiums basis, the comparison is: 1999 combined share 82.47%; 2001 combined share 78.59%.
A further facet of the updating material should be mentioned here. In November of this year (2001), Sovereign, in conjunction with the Gallagher Group, issued a flyer addressed to all Southern Cross and Aetna members. The flyer drew attention to what was called a "new age competitive product". The addressees were informed they had the chance to roll over their existing policy to a Sovereign "Majorcare" policy on the same terms and conditions. The virtues of Majorcare were then set out and the addressees were urged to review their Southern Cross and Aetna policies on the basis they were policies of a "robbing Peter to pay Paul" kind. Our purpose is not to comment on the terms of the offer but rather to point to this recent evidence of strongly rivalrous behaviour in the market, posing a direct competitive challenge to Southern Cross and Aetna. The evidence has a significance which the following sectors of this judgment will demonstrate.
There is similar evidence in relation to Tower. In November 2000, at the time of its acquisition of AXA, Tower’s managing director issued a press statement saying that the acquisition would give the Tower Group a business with excellent competitive potential. He added that the acquisition would enhance the range of services available to Tower’s 600,000 customers in New Zealand. It should be noted that Sovereign’s general customer base is of broadly similar size.
PARTIES CONTENTIONS IN SUMMARY
Both Mr Fogarty QC for the Commission, and Mr Farmer QC for Southern Cross, agreed that the crucial question in the case concerned the level of constraint on Southern Cross’ ability to increase prices or reduce services following its acquisition of Aetna. More specifically, the question is the likelihood of Southern Cross being able to increase its prices significantly above marginal cost without encountering a timely, sufficient and sustainable reaction by other insurers which would have the effect of taking custom from Southern Cross, to the point of making uneconomic its supra-competitive pricing or reduction of services. A sufficient threat of such a reaction would itself be a constraint on any introduction by Southern Cross of what for convenience we will refer to as a supra-competitive pricing regime or other supra-competitive conduct.
There was at times, during counsel’s submissions, a suggestion that the proposed acquisition might lead to what might be called concealed inefficiencies on Southern Cross’ part and that this risk was an aspect of dominance which ought to be borne in mind. We do not, however, see any justification in the evidence for taking the view that the question of concealed inefficiencies is a material factor in this case. Nor does this dimension appear to have any support from s3(9) of the Act. The key question is whether the merged entity would, in terms of s3(9), be in a position to exercise a dominant influence over the price of services in the health insurance market, ie. the premiums charged for the different levels and types of cover in existence or on offer.
On the crucial issue of constraint, Southern Cross emphasised that there were, in terms of the Commission’s own decision, low barriers to entry and also low barriers to expansion. Thus it argued that any inference of dominance or likely dominance which might be drawn from the merged entity’s market share alone, could not appropriately be drawn when all relevant factors had been taken into account; particularly as there were, as a facet of the low barriers to entry and expansion, high elasticities, particularly of demand but also of supply.
By contrast, the Commission argued that what it called the persistence of Southern Cross’ large market share since 1993, raised concerns which were still as valid now as they were when it made its determination in August 2000. In addition, the Commission argued that it was not appropriate to aggregate the market shares of Southern Cross and Aetna pre-merger, and then use the erosion of that aggregated share as an indicator of the likely retention of market share by the merged firm.
Further, the Commission argued that Southern Cross’ critical mass of risk and economies of scale were barriers to expansion. Its already large relative size, which would increase post-acquisition, gave it economies of scale in risk bearing and organisationally that other participants could not match. Hence the Commission says it was entitled to take the view that a clearance should be declined and that this Court should take the same view on an appraisal of all the information before it. The proposition inherent in this argument, namely that the barriers to expansion are significant is, in our view, somewhat at variance with the Commission’s statement in its decision that the barriers to expansion were "apparent[ly]" low. We are not persuaded that this inconsistency is satisfactorily explained by Mr Fogarty’s submission that the Commission was using the word apparent to signify a structural connotation. If that had been the Commission’s intention, we feel sure it would have expressed itself more clearly. We read the Commission as saying, when using the expression "the apparent low barriers to .... expansion", that this was the inference it drew from a consideration of the evidence as a whole. It was the barriers to expansion that the Commission said were apparently low, not some aspect of them.
CONSTRUCTION OF s.66(3)
There was some difference between the parties as to the correct approach to s66(3) which is set out in paragraph  above. Paragraph (a) of subsection (3) speaks of the Commission being satisfied, and paragraph (b) of the Commission not being satisfied, that the acquisition will not result in a proscribed effect. The double negative inherent in paragraph (b) is conceptually awkward. Mr Farmer argued that either the Commission would be satisfied or it would not. Mr Fogarty suggested that there were really three possibilities –
satisfaction that a proscribed effect would not result,
satisfaction that such an effect would result, and
doubt as to whether the acquisition would result in a proscribed effect.
For the purposes of s66, Mr Fogarty’s second and third possibilities amount to the same thing because a clearance can be given only if the Commission is satisfied, on the balance of probabilities, that a proscribed effect would not result from the acquisition. Satisfaction that a proscribed effect will result, and not being satisfied that such effect will not result, both mean that clearance cannot be given.
This interpretation of s66(3) is consistent with the approach of the full Court of the High Court in Foodstuffs (Wellington) Co-operative Society Ltd v Commerce Commission (1992) 4 TCLR 713, 721, and of this Court in Power New Zealand v Mercury Energy Ltd & Commerce Commission  2 NZLR 669, 674. Viewing the Commission’s decision as a whole, we do not consider it misdirected itself in law in this respect. After a conscientious and thorough investigation and review of all material before it, the Commission came to the conclusion that it was not satisfied the acquisition would not result in a proscribed effect. It was therefore obliged in terms of s66(3)(b) to decline to give a clearance. It is unnecessary to say anything more on this topic.
Section 47 of the Act, which is incorporated by reference into s66(3), speaks of a person being in a dominant position in a market. The concept of having a dominant position in a market is, for the purposes of s47, defined in s3(9). The definition has already been noted in earlier paragraphs: see paragraphs ,  and  above. Dominance is the statutory concept which represents the economic concept of market power without sufficient constraint. A perfectly competitive market is one in which no one seller or buyer has market power in the sense of being able to influence the prices at which transactions occur. If a seller can raise its prices above a competitive level, without losing sales to the point that the price increase becomes unprofitable, the seller is regarded, for competition law purposes, as possessing market power. In the case of an acquisition by one firm of another, the two firms must, for predictive purposes, be deemed to be one: on these matters see Landes & Posner, Market Power in Anti-Trust Cases (1981) 94 Harv. L. Rev. 937, and Richard Schmalensee, Another Look at Market Power (1982) 95 Harv. L. Rev. 1789 at 1790. As Schmalensee says, market participants will almost always possess some degree of market power as perfectly competitive markets are seldom, if ever, encountered except in textbooks.
The crucial question is therefore not whether a particular firm has market power but whether such power as it has, or will acquire, is likely to or will enable it to act in an insufficiently constrained manner in the sense that it will have the ability to set prices or conditions without significant constraint from competitors or consumers: see Port Nelson (supra) at 441-442. Market share is relevant to the level and significance of market power but it is not in itself the determinant of market power. What level of market power a firm has, as a result of its market share, will depend substantially on the level of barriers to entry and expansion which apply to the market. If the barriers are low, a high market share is unlikely to result in an insufficiently constrained level of market power. Conversely, if the barriers are high, a high market share is likely to lead to such a result. The level of market share and the level of market power have no direct relationship in themselves. The levels of barriers to entry and expansion provide the linkage and must be brought to account when considering the level of a firm’s market power. The lower the barriers to entry or expansion, the more an incumbent firm with a high market share is constrained from using its position in a supra-competitive way. The level and quality of market power a firm enjoys is therefore the product of its level of market share viewed against the level of barriers to entry or expansion. In practical terms, if market power is insufficiently constrained the firm possessing such power has the ability to increase its prices above marginal costs both sustainably and profitably.
This analysis of the relationship between market share, barriers to entry and expansion, and market power has a long and respectable pedigree, both judicially and academically. The best chronological starting point in judicial terms is the decision of the Australian Trade Practices Tribunal in Re Queensland Co-Operative Milling Association Ltd – Proposed Merger (the QCMA case) (1976) 8 ALR 481; 25 FLR 169. Next comes the decision of the High Court of Australia in Queensland Wire Industries Pty Ltd v Broken Hill Proprietary Co Ltd (1989) 167 CLR 177; 83 ALR 577. This was followed by the judgment of the High Court of New Zealand in Magic Millions (supra). In that case the Judge observed that a substantial market share without barriers to entry would seldom, if ever, be indicative of dominance. Next is the decision of this Court, broadly to the same effect, in Telecom Corporation of New Zealand Ltd v Commerce Commission (the AMPS-A case)  3 NZLR 429, and then the decisions of the High Court and this Court in the Port Nelson case decided in 1996 and noted above.
As recently as the middle of this year (2001) the central theme developed above has been applied by the United States Court of Appeals for the District of Columbia in United States of America v Microsoft Corporation 253 F.3d 34 (2001). At 14, under the heading Monopoly power – the equivalent of dominance in our legislation – the Court of Appeals said ".... monopoly power may be inferred from a firm’s possession of a dominant share of a relevant market that is protected by entry barriers". And at 20 the Court observed that ".... looking to current market share alone can be misleading .... In this case however the District Court was not misled. Considering the possibilities of new rivals, the Court focused not only on Microsoft’s present market share, but also on the structural barrier that protects the company’s future position". The Court then proceeded to discuss a barrier to entry which resulted from the characteristics of the software market. The combination of the market share which Microsoft possessed and this substantial entry barrier justified the inference of monopoly power (dominance) which the District Court had drawn.
Various references are made elsewhere in this judgment to supporting academic literature from both the United States and from Australia. But it is convenient specifically to mention here a lucid discussion of barriers to expansion by Mike Walker in London Economics: Competition and Regulation Bulletin, ed 8 (December 1997). His article, entitled Barriers to expansion: small firm, large effect?, also usefully considers the related concepts of elasticities of supply and demand, and economies of scale and scope. The author’s central thesis is that even if barriers to entry are high, the same may not apply in the case of barriers to expansion. There is no suggestion of cases where barriers to entry are low, yet barriers to expansion are high. In a key passage the author says (omitting citations):
There are therefore two key determinants of this residual supply elasticity: barriers to expansion which limit the response of actual competitors, and barriers to entry which limit the response of potential competitors. If barriers to entry into the relevant market are low, the residual supply elasticity will tend to be high because of the hypothetical supply provided by new entrants. And if barriers to expansion are low, the residual supply elasticity will tend to be high because of the hypothetical supply provided by existing competitors. Thus, if either barriers to entry or barriers to expansion are low, then a high market share will not necessarily confer market power.
And then, under the heading Barriers to entry and barriers to expansion, Walker says:
While entry barriers prevent firms which hitherto were not supplying products within the relevant market from doing so, barriers to expansion prevent firms which are already supplying such products from increasing their share of the market. Although these two concepts are based on the same logic, they do not necessarily go hand-in-hand, and we now consider a range of situations where new entry may be difficult and yet barriers to expansion are low. In such cases, too great a focus on market share and barriers to entry may result in some firms being found dominant that have little actual market power.
Sunk costs, not a significant feature of the present market, are then addressed and the author concludes, in a summary focussing specifically on barriers to expansion:
There are good arguments in support of the use of market share as an indicator of dominance. However, the fundamental economic thinking that links market shares to market power also indicates circumstances in which a large market share will not necessarily confer market power. This will be the case where competitors, even though they have a small market share, are able and willing to expand output quickly and at a relatively low cost. In other words, market share will not confer market power when small competitors face low barriers to expansion and, thus, are able to contest the whole of the relevant market.
For reasons to be developed below, we consider the evidence in the present case establishes that expansion by existing market participants, fulfilling the LETS test (see paragraph  above), would be likely if the merged entity priced or otherwise behaved in a supra-competitive manner. The threat of this occurring would be a substantial and sufficient constraint on the exercise of market power by the merged entity.
BARRIERS TO ENTRY / EXPANSION
Anything is capable of being a barrier to entry or expansion if it amounts to a significant cost or limitation which a person has to face to enter a market or expand in the market and maintain that entry or expansion in the long run, being a cost or limitation that an established incumbent does not face. The height of the barrier is a function of the degree of the differential. A barrier to entry or expansion reflects the extent to which an established firm can, in the long run, raise price above marginal cost (supra-competitive pricing) without inducing potential competitors to enter or expand in the market. It is not necessary to explore the subject of barriers to entry in any detail because the Commission was of the view that they were low. It did not separately address the concept of barriers to expansion, albeit, as earlier noted, the Commission observed that they too appeared to be low. Subject to the discussion which follows, we can see no logical reason why the barriers to expansion in this case should be higher than the barriers to entry.
We note that in its paragraph , in which the Commission set out its conclusions from the competition analysis it had undertaken (briefly referred to in paragraph  above), the Commission said in relation to barriers to expansion:
Southern Cross notes in the application that high market shares can in some instances give rise to competition issues where, for example, the cost structures of smaller rivals are higher than that of the merged firm due to economies of scale. The Commission considers that the acquisition would lead to economies of scale for Southern Cross. Southern Cross itself notes that a large membership base can assist in avoiding statistical clustering of risks. With substantially smaller market shares, its competitors would have higher average cost structures. Their fixed costs would be spreadable over a smaller premium base. Southern Cross has argued that research into insurance markets strongly suggests that economies of scope across various markets are more important than economies of sale in any one market. Based on the responses of general insurers which offer medical insurance, the Commission considers that economies of scope are less important for entry into the medical insurance market than economies of scale. The Commission considers that having critical mass and economies of scale in the medical insurance market gives Southern Cross an advantage which serves as a barrier to expansion.
This aspect was one of the key planks in Mr Fogarty’s argument. He pointed to the fact that the Commission in its paragraph  had concluded that the likelihood of significant expansion by current participants or new entrants was low. Mr Fogarty criticised the High Court’s approach to this issue and, in particular, Dr Lattimore’s analysis of monopolistic competition and economies of scale. He pointed out that Dr Lattimore had himself accepted that within the medical insurance market Southern Cross would in fact enjoy economies of scale and decreasing average costs for particular policies. Mr Fogarty then went on to address the evidence which the Commission had gathered on this issue and referred to a statement from a representative of another insurer to the effect that the main factor in Southern Cross’ market position was its critical mass/volume and hence its ability to lower its costs. Reference was also made by Mr Fogarty to the question of pre-existing conditions in respect of which a firm with economies of scale has advantages, making it better placed to take on the additional level of risk which group policies entail in this respect.
In relation to the possibility of other insurers entering or expanding into the group segment of the market, the Commission was of the view that Southern Cross' economies of scale, which new entrants would lack, were credible evidence of a barrier to expansion despite new entrants having economies of scope. The concept of economies of scale in the present context means that an insurer with a larger pool of risks comes closer to an actuarial profile than competitors with a smaller pool, and therefore has an advantage in setting premiums and in respect of overall risk management. We do not consider there is sufficient evidence of significant fixed costs to render material their spread across a smaller premium base as mentioned by the Commission in the passage cited in paragraph  above.
The concept of economies of scope in an insurance market means that an insurer offering cover across a greater range of risks (eg. fire, burglary and motor vehicle, as well as health) has greater scope to spread the risks than an insurer operating, as does Southern Cross, in only the health field. The Commission’s response to Southern Cross’ reliance on economies of scope as an advantage which the general insurers possessed, which advantage should be set against its own economies of scale, was to this effect. It said at its paragraph  no more than, based on the responses of those general insurers which offered medical insurance, the Commission considered that economies of scope were less important for entry into the medical insurance market than economies of scale. Specific responses supporting that view were not identified. Dr Lattimore discussed economies of scope at paragraph  of his judgment. Mr Fogarty submitted that his conclusions suffered from the lack of any evidence that any of the general insurers were spreading or balancing risk across different insurance fields. Dr Lattimore was, however, speaking in terms of potential, albeit as Mr Fogarty pointed out, the impression the Commission derived from its discussions with general insurers was that they sought to limit their risks in the insurance market and hence were in any event reluctant to enter the group market.
Mr Farmer challenged the weight the Commission had attributed to barriers to expansion in respect of a market where the barriers to entry were low. It is not apparent from its decision how high the Commission considered the economies of scale barrier to expansion was. It did not itself describe that barrier as high; indeed its description was that this barrier was low. But, from the way in which the Commission’s case was presented in this Court, it can reasonably be inferred that it sees this aspect as a central feature of the case, albeit this is not apparent in its decision. Mr Farmer suggested that if the economies of scale point had general validity, it was illogical for it to be regarded as a significant barrier to expansion, but not as a significant barrier to entry. He also argued that although Southern Cross obviously had certain economies of scale, the Commission had placed undue weight on this aspect. The real question in his submission was what constraints existed which might inhibit the use Southern Cross could make of its market power. Those constraints were such, he contended, that, after its acquisition of Aetna, Southern Cross would not possess sufficient market power to give it a position of dominance – it would not be able profitably to raise its prices significantly above a competitive level. The elasticities of demand and supply were sufficiently high, so Mr Farmer argued, that Southern Cross would be substantially constrained in its market behaviour. In this case we do not find it necessary to discuss elasticities nor, in any event, would it be productive to do so in the absence of appropriate statistical data. In this latter respect we accept the Commission’s argument.
THE PERSISTENCE OF SOUTHERN CROSS' SHARE SINCE 1993
In its summary of argument, the Commission contended that the persistence of Southern Cross’ large market share since 1993 "raised concerns" as to the ability of incumbent or new firms to constrain the merged entity. We have already discussed aspects of constraint under the previous heading, but it is now necessary to examine the topic from the perspective of this facet of the Commission’s argument. We accept that Southern Cross’ market share has remained reasonably static over the past eight years or so. The present issue relates not so much to the size of Southern Cross’ share but rather to its stability. The significance of the failure of other participants in the market to make serious inroads into Southern Cross’ share is what is here at issue. Is that because of its dominance or near dominance, or is it because it is behaving competitively in a competitive market? A subsidiary issue which must not be overlooked when one is seeking to predict the position of the merged entity, is that Aetna’s market share has materially declined and continued to decline, and thus the size of the merged entity will be correspondingly smaller than when the Commission made its determination.
The impression we derive from Decision 399 is that the Commission regarded Southern Cross’ stable market share as a major, if not the major, factor in its not being satisfied that Southern Cross’ acquisition of Aetna would not result in a proscribed effect. The Commission did not, however, expressly find that during the period from 1993 to the time of its determination, Southern Cross had been in a dominant position in the market. Nor do we read the Commission as having implicitly found this to be the case. There is a link here with the Commission’s failure to say whether it saw the case as one of potential dominance or potential strengthening of dominance. The present point is that there was no finding that Southern Cross’ market share had remained stable as a result of its having had a dominant or near dominant position in the market. That being so, the existence of such stability does not lead necessarily to the inference that the lack of erosion of Southern Cross’ share has been the result of its having occupied an insufficiently constrained position in the market.
In these circumstances it behoves the Court to take care before inferring barriers to entry or expansion simply from the fact of there having been a lack of entry or expansion; albeit there has, over recent times, actually been a significant amount of new entry and expansion. Indeed since 1992 nine new insurers have entered the market. In any event, lack of or limited entry or expansion may well be better interpreted as an indicator of a competitive market into which there was little incentive for entry or expansion. That was the view Dr Lattimore expressed. It seems to us to be a valid view and one which should not be seen as undermined by his error of fact.
This interpretation is also consistent with the evidence of low profitability in the market, a factor which is indicative, at least prima facie, of a competitive environment.
LOW PROFITABILITY IN THE MARKET
The suggestion made by the Commission that the historically low profit margins in the market may simply have reflected the competitive constraints exercised by Aetna, which would be removed following its acquisition, does not, in our view, sit comfortably with Aetna’s own fairly rapid decline and the evidence that its performance was generally seen as poor.
There is material which suggests that the earlier comparative lack of entry or expansion should not be interpreted as being the result of barriers to entry or expansion. While there is some variance in the views expressed to the Commission, the general tenor of the evidence from Southern Cross’ competitors, who can be expected to be familiar with the market, is that the market was competitive and Southern Cross was constrained in terms of its ability to raise prices. Indeed, as noted in paragraph  above, the Commission recorded in its decision that it had been told that there was strong competition for group scheme business. To infer dominance from lack of substantial entry or expansion by others, when objectively the reason appears to be the existence of the type of market which the Act is designed to encourage, would be to draw an inference against Southern Cross from the very thing which competition law is designed to foster.
As was stated by the United States Court of Appeals for the Ninth Circuit in US v Syufy Enterprises, 903 F.2d 659 (1990), competition laws "protect competition not competitors". The Court added:
As we noted earlier, competition is essential to the effective operation of the free market because it encourages efficiency, promotes consumer satisfaction and prevents the accumulation of monopoly profits. When a producer is shielded from competition, he is likely to provide lesser services at a higher price: the victim is the consumer who gets a raw deal. This is the evil the antitrust laws are meant to avert. But when a producer deters competitors by supplying a better product at a lower price, when he eschews monopoly profits, when he operates his business so as to meet consumer demand and increase consumer satisfaction, the goals of competition are served, even if no actual competitors see fit to enter the market at a particular time. While the successful competitor should not be raised above the law, neither should he be held down by law.
DETERMINATION OF ISSUES
Whatever the size of the merged entity’s market share, it is elementary that its market power will not be insufficiently constrained unless there are barriers to entry or expansion which protect it from effective rivalrous reaction to the exercise of its market power. In order to demonstrate that its proposed acquisition of Aetna will not result in a proscribed effect, Southern Cross must show that such barriers to entry and expansion as exist, as regards the medical insurance market in New Zealand, are at a level that the threat of entry or expansion is a sufficient constraint on its ability to exercise such market power as its market share might otherwise involve. It is common ground that the barriers to entry are low. On its face this factor must act as a constraint on the exercise of market power by Southern Cross post the acquisition.
The key question therefore concerns the nature and quality of barriers to expansion and whether they are at a level which likewise provides practical and effective constraint on the merged entity, deterring it from supra-competitive pricing. We do not consider that the Commission’s decision or its submissions gave sufficient attention to the context in which the height of the barriers to expansion must be addressed. That context is the hypothesis that the merged entity, having the ability, engages in supra-competitive pricing. The Commission’s premise that there has been little, if any, expansion or entry into the market in the past, a premise which the updating material somewhat undermines, does not in our view justify the inference that supra-competitive pricing by the merged entity would also be met by little, if any, entry or expansion.
On the balance of probabilities we consider the comparative lack of any erosion of Southern Cross’ market share (the same does not apply to Aetna) has resulted from the health insurance market having been contestable and efficient over the period from 1993 to date. The evidence points clearly in that direction and there is certainly no cogent evidence to suggest otherwise. On this premise, Southern Cross has been operating in a competitive market and the purposes of the Commerce Act have thereby been served. The low level of new entry or expansion (and the level has increased in recent years) and the lack of significant erosion of Southern Cross’ share do not raise anti-competitive concerns. The recent Tower/AXA merger and the Sovereign/ASB marketing initiatives suggest the market in recent times has been quite dynamic. As Professor Brunt has said, the leading firms can be constrained by a collection of more specialist rivals: Australian and New Zealand Competition Law and Policy (1992) 19th Fordham Corporate Law Institute – Annual Proceedings, at 32.
We have therefore come to the conclusion that the historical position does not support an inference of significant barriers to expansion. Mr Fogarty submitted that this critical question of barriers to expansion should be approached neutrally rather than pursuant to an assumption, absent any evidence. We agree that assumptions should not be made without any supporting evidence. But reasonable inferences may and should be drawn from the evidence available. What we are saying on the point just made, is that no reasonable inference of significant barriers to expansion should be drawn, in the circumstances, from any lack, until recently, of significant expansion. Indeed the evidence demonstrates that market participants other than Southern Cross and Aetna (including Medic Aid) have expanded their shares of the market from 16.9% in 1993 to 28.37% in 2000, almost all of that increase being since 1997. Even if one takes the view that there has been a lack of significant entry or expansion, it must be remembered, as Schmalensee has said at 49 in Ease of Entry: Has the concept been applied too readily? (1987) 56 Antitrust Law Journal 41, that lack of entry because profits are competitive or market growth prospects are poor, does not shed any light on whether entry, and logically we suggest expansion, would occur if prices were to rise above the competitive level. In short, lack of entry or expansion must not be allowed to beg the question whether there are barriers to entry or expansion.
That leads on to the question of economies of scale and the counter-point question of economies of scope. The conventional view is that economies of scale may constitute a barrier to entry only when "the minimum size for an efficient firm is very large, relative to the size of the market": see Queensland Wire at 190. Bain, in Barriers to New Competition (1956) at 212, wrote that economies of scale in production and distribution do not loom large as the basis of barriers to entry: see also Schmalensee Economies of Scale and Barriers to Entry (1981) 89 Journal of Political Economy, 1228, 1236. It is difficult to see how the position could be otherwise in this case in relation to barriers to expansion. Dr Lattimore observed in his paragraph  that there was no evidence that Southern Cross’ economies of scale were those of a natural monopolist, that being the one circumstance posited in Queensland Wire where economies of scale can constitute a barrier to entry. Furthermore, the economies of scope available to the general insurers are not available to Southern Cross. Amongst other things, some of them have a ready client base: see paragraph  above.
We recognise that in its discussion at paragraph , the Commission said that critical mass and economies of scale gave Southern Cross an "advantage" which served as a barrier to expansion. It is not, however, sufficient to point simply to economies of scale to establish a barrier to entry or expansion. In the absence of a natural monopoly, or significant sunk costs, or other like advantages, the incumbent is unlikely to be insufficiently constrained. This was the general tenor of Dr Lattimore’s judgment and is also the effect of the summary of academic opinion referred to in the Commission’s publication Barriers to Entry and Competition Law: Philosophical and Policy Links by Melanie Tollemache, Occasional Paper No. 3 (November 1988). The argument that Southern Cross has, and the merged entity will have, an advantage in relation to the group segment of the market giving it the ability to accommodate more easily the extra risks involved with pre-existing conditions, is no more than an ingredient of the economies of scale point.
For these various reasons we do not accept the soundness of the Commission’s view that the reluctance it perceived on the part of other market participants to expand without having the economies of scale enjoyed by Southern Cross and despite the potential for economies of scope, was evidence of a significant barrier to expansion. We are not persuaded the economies of scale enjoyed by Southern Cross and the merged entity would constitute or be likely to constitute a significant barrier to expansion if the merged entity raised its premiums to a supra-competitive level or otherwise behaved in a supra-competitive manner.
After a full appraisal of the evidence, we are of the view that the ability of the merged entity to price or otherwise behave in a supra-competitive manner will, on the balance of probabilities, be sufficiently constrained by the threat of or the happening of new entry or expansion. The probability of such constraint is such that this Court should find that the acquisition of Aetna by Southern Cross will not result in either of the effects which are proscribed by s47(1) of the Act. Specifically, on the balance of probabilities, we are satisfied that as a result of Southern Cross’ acquisition of Aetna, the merged entity will not be nor will it be likely to be in a dominant position in the market. We are also satisfied that there is no dominant position that will be or will be likely to be strengthened by the acquisition.
In accordance with the views of the majority the appeal is dismissed. The unconditional clearance ordered by the High Court will therefore stand. We order the Commission to pay Southern Cross’ costs of this appeal in the sum of $20,000 plus disbursements including the reasonable travel and accommodation expenses of both counsel, to be fixed if necessary by the Registrar.
I am not persuaded that the Commerce Commission erred in its decision 399 given on 25 August 2000 or that the updating information covering the later period establishes that the decision is now to be seen as wrong. Accordingly, I dissent.
I state the issue before this Court in the first sentence in the way I do because I agree with the majority, for the reasons they give, that the appropriate way to proceed is to consider the matter before us as effectively an appeal directly to this Court by Southern Cross from the Commission’s decision (paras  and ).
I give my reasons briefly. They relate in turn to the Commission and the appeal system, the attacks on the Commission decision and the significance of the updating material.
THE COMMISSION AND THE APPEAL
The Commission is to consist of three to five members, one at least being a barrister or solicitor of five years standing. They are appointed on the recommendation of the Minister of Commerce who is to consult with the Attorney-General in the case of persons who are barristers or solicitors. Those recommended are to be qualified for appointment, having regard to the Commission’s functions and powers, by virtue of their knowledge of or experience in industry, commerce, economics, law, accountancy, public administration or consumer affairs (Commerce Act 1986 s9). Those qualities can be demonstrated by the qualifications of the three members (including the Chair of the Commission) who made decision 399. It may also be noted that, in exercising its powers, the Commission is to have regard to the economic policies of the government as transmitted to it by the Minister (s26).
The applicant for a clearance, Southern Cross in this case, is to provide such documents and information relating to the acquisition as the Commission requires (s68(1)). The Commission may also consult with any person able to help it in making the clearance determination (s68(5)). It also has the power to hold a conference which is to have as little formality and technicality as the requirements of the Act and the proper consideration of the application permit (ss69B and 64). We were told that this power is not used in clearance cases and it was not used in this case. What did however happen within the agreed extended period of 28 working days (the initial period is ten days, s66(3)), in accordance with the Commission’s standard practice, was that its staff had discussions with and sought the views and comments of a number of parties. The Commission on average receives between 20 and 40 clearance applications a year. It is helped in its consideration of the range of applications by an experienced staff.
In this case the staff contacts included correspondence, meetings and telephone conversations with over 20 insurance companies and insurance brokers (including the Corporation of Insurance Brokers), several hospitals, various medical groups, the Private Hospitals Association, the Health Funds Association and the Ministry of Health. The Commission also received several submissions. The total documentation exceeds 800 pages and includes about 200 pages of confidential information (including summaries of discussions) from sources other than the applicant and Aetna. Their confidential material and related exchanges with the Commission amount to another 200 pages. Those exchanges include one between Southern Cross’ lawyers and the Commission in which the Commission said that it was its practice to put any significant arguments which were potentially damaging to the applicant’s case to the applicant. The lawyers accepted that approach.
Three other features of the clearance process may be noted. The first is that the application might be varied in the course of its consideration through the means of the Commission accepting an undertaking that specified assets or shares are to be disposed of (s69A). The second is that successive applications may be made, as indeed was the case here, with the third application, subject to an undertaking, being granted in October 2000. (No attention was given to that decision in the appeal, for instance by relating the proposal actually cleared to changes in the market since that time.) Thirdly, while the grant of a clearance gives legal protection to the applicant (ss69 and 66(5)) the refusal of a clearance does not in law prevent the applicant proceeding with the acquisition. Were the application to be challenged the onus would then be on the Commission or other person making the challenge to establish its case. It is consistent with that aspect of the scheme of the Act that if the applicant does not satisfy the Commission that its acquisition will not have the forbidden effects, it simply states that it is not satisfied. In such a situation, in terms of s66(3) (from which para (b) could, it seems to me, be deleted without any change in function or effect), the clearance sought is simply not granted.
The High Court has jurisdiction to hear appeals against determinations of the Commission (s75(1)(e)), but when it does the Court must consist of a Judge of the Court and at least one lay member of the Court (s77(9)). The lay members are appointed by the Governor-General as qualified by virtue of their knowledge of or experience in industry, commerce, economics, law or accountancy (s77(2) – compare the qualifications for Commission members (para above)). In this case Dr Lattimore sat in the High Court with Williams J. The purpose of that requirement is plain enough. That purpose is not however carried forward into the provision of the Commerce Act enabling appeals to be made (with leave) to this Court from decisions of the High Court on determinations of the Commission. It simply provides that s66 of the Judicature Act 1908 (the general appeal provision) applies and that the decision of this Court is final (s97(1) and (4)). There is however a part answer to the question raised by the differences between the appeal arrangements. That appears in ss99B-99D of the Judicature Act, enacted in 1999.
Under those new provisions this Court may on application or its own initiative appoint a technical adviser. The person is to be suitably qualified to assist the Court by giving it advice in a civil appeal involving a question arising from evidence relating to scientific, technical or economic matters or from other expert evidence. It is for the Court to decide what weight to give to the advice. That facility – and again its broad purpose can be gathered, among other things, from the comparable position in patent cases – was mentioned by the bench to counsel. The response suggested that no thought had been given to making use of it.
In my view, the position of this Court, compared with that of the Commission in making the assessment required by s66, is affected not just by the availability of relevant expertise but also by the information available to the Commission and the Court. While the Court has been provided with some updating information about market shares (something I consider in the final part of this judgment), nothing has been done to match the extensive and intensive gathering of information and opinion from those immediately involved in the health insurance market undertaken by the Commission and its staff over the six weeks that the Commission was considering the application.
It is against that background of relative expertise, different procedures and the different quality and extent of the updating information that I address two substantive issues. In the circumstances I do not need and do not attempt to go further and spell out the different roles of Court and Commission.
THE COMMISSION DECISION
Market Share and Barriers to Expansion
Critical parts of the Commission’s decision are summarised and set out in the majority judgment (especially paras  - ). I restrict my comment to the critical issue of the impact of Southern Cross’s increased market share (assuming acquisition) on its possible actual or likely dominant influence over the market (bearing in mind that Southern Cross must satisfy the decider that that dominance will not occur). It is clear from s3(9)(a) that the share of the market is relevant. I agree that the share cannot be the sole determinant, but the Commission does not say that it is. It is enough for my purposes to focus on paras  -  of its decision. The majority set out paras  and  (para ). Paragraph  is the first substantive part of the "Conclusions":
The Commission has concluded the following from its competition analysis:
The acquisition would result in a very high level of market concentration.
Southern Cross notes in the application that high market shares can in some instances give rise to competition issues where, for example, the cost structures of smaller rivals are higher than that of the merged firm due to economies of scale. The Commission considers that the acquisition would lead to economies of scale for Southern Cross. Southern Cross itself notes that a large membership base can assist in avoiding statistical clustering of risks. With substantially smaller market shares, its competitors would have higher average cost structures. Their fixed costs would be spreadable over a smaller premium base. Southern Cross has argued that research into insurance markets strongly suggests that economies of scope across various markets are more important than economies of scale in any one market. Based on the responses of general insurers which offer medical insurance, the Commission considers that economies of scope are less important for entry into the medical insurance market than economies of scale. The Commission considers that having critical mass and economies of scale in the medical insurance market gives Southern Cross an advantage which serves as a barrier to expansion.
The acquisition would have the effect of removing from the medical insurance market Southern Cross’ principal competitor and the market participant with the best chance of matching Southern Cross’ economies of scale. In the view of the Commission it would remove the most important current constraint on Southern Cross’ level and quality of service.
Barriers to entry into or expansion in the medical insurance market do not appear to be particularly onerous or high.
Notwithstanding the apparent low barriers to entry or expansion, new entry has not been able to secure market share from Southern Cross to any significant extent.
Whilst the Commission accepts that the options of self funding medical costs (including through downgrading the cover provided by medical insurance) and relying on the public health system for medical treatment and care act as factors that health insurers need to take account of when setting premiums and levels of service, the Commission considers that these factors alone would not be sufficient to place a constraint on a hypothetical monopolist in the medical insurance market from initiating and maintaining an increase in premiums, or reducing the level and quality of service.
The Commission considers that the likelihood of expansion by current participants in the medical insurance market post-acquisition is low, that the extent of entry or expansion post-acquisition is likely to be on a small scale and more likely in niche areas of the market, and that, with the exception of niche areas, entry or expansion post-acquisition is unlikely to be sustainable.
I comment on some of the points made in that paragraph. On the first, the acquisition, on the material before the Commission, meant that post acquisition Southern Cross would have had 80% of the earned premium and 71% of the lives covered on the figures provided by the Health Funds Association. (To anticipate the final part of this judgment the proportions at 30 June 2001 would have been 78.5% and 69.5%.)
The second point, about the balance between economies of scale and economies of scope, which is tied to barriers to expansion rather than to entry, is supported by the information gathered by the Commission’s staff. Tower Health said that Southern Cross should easily be able to deliver products and services at much lower cost than their competitors. They are able to do this simply by being large. They spread their costs over many, many more transactions. "They don’t have to operate all that efficiently to compete." They can get away just with being big. They are not, according to Tower, under the same pressure to be as efficient as their competitors and indeed they are not. And according to AXA, Southern Cross, after the acquisition, would have the ability to raise premiums. Prices in New Zealand were ‘soft’ in comparison to international pricing.
The facts about market share and the statements just summarised are to be seen in the context of the scholarly literature to which we were referred. I take one leading article. Professor William M Landes and Professor Richard A Posner in "Market Power in Antitrust Cases" (1981) 94 Harv L Rev 937 stress the interaction of market share, elasticity of demand and elasticity of supply (different formulations of the matters listed in s3(9)). They provide hypothetical calculations showing that if demand elasticity is low (and here there is the significant drop in the proportion of the population buying health insurance) and supply elasticity is low (a major issue in this case as I understand it), then a lower market share will allow the firm with that share to charge say 20% over marginal costs (eg 958-959). They conclude in these terms :
This Article has sketched an approach to the issue of market power and to the included issue of market definition that so pervade antitrust law today. The Article emphasizes the dependence of market power on the elasticities of demand and of supply in the market in question, as well as on the defendant’s market share. When those elasticities are known or knowable, our analysis provides a method of estimating market power in quantitative terms. The analysis thus should be helpful to enforcement agencies in setting priorities and allocating their resources, and to courts in those cases, which may be few, where estimates of the elasticity of demand and supply are obtainable in a form usable in the litigation process. But even when no quantitative measure of elasticity is available, our analysis is helpful in two ways : it points out common pitfalls in using market shares alone to estimate market power; and it suggests adjustments to simple market share calculations whereby those calculations can be made to yield a truer though still rough picture of the defendant’s market power. And our analysis can be implemented without doing violence to accepted antitrust principles, for we find that the courts have been groping for the kind of assistance that our analysis can, we believe, provide them.
The Commission recognises the general force of this argument and the next point made in para  in its Business Acquisition Guidelines which applicants are to address in preparing their cases. A dominant position is unlikely if the merged entity has under 40% of the market, and up to a 60% share may be accepted if at least one other participant has at least a 15% share of the market.
To move to the next point in para , the removal by the proposed acquisition of the principal competitor was a major concern not just of the Commission but of others in the industry. Thus Police Health Plan Ltd submitted that the principles of the competitive market required a second provider with a major market share to ensure Southern Cross remained competitive. This matter has to be reassessed in the light of the updating information showing a fall in Aetna’s share of the market, considered at the end of this judgment.
The next two points about barriers are to be taken together. Plainly, entry presents no real difficulty. But what of significant expansion by the others in the market? The Commission’s conclusion is about Southern Cross’s market share. It is true as the majority say, by reference to the responses to the Consumer’s Institute, that on a lives covered basis the share has fallen (para ) but any drop in the proportion of premiums is small. Now it may well be that the limited expansion indicates a competitive market : as Dr Lattimore demonstrates that certainly happens. But has it happened here? The Commission has not found that it has. As already indicated, the opinion of some of Southern Cross’ competitors was that its size and the small size of the competitors meant that it did not have to compete and after the acquisition it could increase prices. It could operate at inefficient levels. Also relevant in this context is the final point in para  of the Commission’s decision. The entry into niche markets to which it refers appears to mean that potential competition in the group area (in which Southern Cross has a greater proportionate part, a matter stressed by Tower for instance) is less than it is over the whole market.
In the light of para , the material underlying it and my own consideration of that material and the submissions, I cannot see any error in the conclusions the Commission reached. I would therefore not have allowed the appeal against the decision itself.
THE UPDATING MATERIAL
But does the new information lead me to a different conclusion? I have already mentioned one reason suggesting that it does not – the new information is not of the same extent and quality as that available to the Commission.
The information is about the share of the market on a lives covered basis. As the majority says, Aetna’s has fallen and Sovereign and Tower/AXA have increased their share markedly. But the changes in the earned premium figures are of a different order. Aetna’s share for the year ended 30 June 2001 is 12.7% and remains above Tower’s 9.2%. And, more significantly, Southern Cross’s share is essentially what it was when the Commission made its decision. Next, the combined post acquisition share, as noted earlier, is down to only 78½% from 80% at the time of the decision, essentially because of the fall in Aetna’s share. Relevant to the assessment of market share is that the Executive Committee of the Health Funds Association in August 2000 discussed whether earned premiums or lives covered was the more appropriate determinant of market share. While earned premiums had traditionally been regarded as the measurement of market share the Committee acknowledged the merits of both as market share determinants. That helps confirm me in the view that negligible fluctuations in Southern Cross’ earned premium share and the small drop in the combined figure (showing Aetna’s vulnerability rather than the potential strength of the combination) should not lead to the conclusion that the August 2000 decision is now to be regarded as wrong.
Commerce Commission v Port Nelson Ltd (1995) 6 TCLR 406; Port Nelson Ltd v Commerce Commission  3 NZLR 554; New Zealand Magic Millions Ltd v Wrightson Bloodstock Ltd  1 NZLR 731; Foodstuffs (Wellington) Co-operative Society Ltd v Commerce Commission (1992) 4 TCLR 713; Power New Zealand v Mercury Energy Ltd and Commerce Commission  2 NZLR 669; Re Queensland Co-Operative Milling Association Ltd – Proposed Merger (1976) 8 ALR 481; Queensland Wire Industries Pty Ltd v Broken Hill Proprietary Co Ltd (1989) 167 CLR 177; 83 ALR 577; Telecom Corporation of New Zealand Ltd v Commerce Commission (the AMPS-A case)  3 NZLR 429; United States of America v Microsoft Corporation 253 F.3d 34 (2001); US v Syufy Enterprises, 903 F.2d 659 (1990).
Commerce Act 1986: s.3(1A), s.3(9), s.27, s.47, s.66
Authors and other refernces
Landes & Posner, "Market Power in Anti-Trust Cases" (1981) 94 Harv. L. Rev. 937
Schmalensee, "Another Look at Market Power" (1982) 95 Harv. L. Rev. 1789
Mike Walker, "Barriers to expansion: small firm, large effect?": London Economics, Competition and Regulation Bulletin, ed 8 (December 1997)
Professor Brunt, "Australian and New Zealand Competition Law and Policy (1992)": 19th Fordham Corporate Law Institute – Annual Proceedings
Schmalensee, "Ease of Entry, Has the concept been applied too readily?": (1987) 56 Antitrust Law Journal 41
Bain, Barriers to New Competition (1956)
Schmalensee, "Economies of Scale and Barriers to Entry": (1981) 89 Journal of Political Economy
Melanie Tollemache, "Barriers to Entry and Competition Law: Philosophical and Policy Links": Occasional Paper No. 3 (November 1988)
Professor William M Landes and Professor Richard A Posner, "Market Power in Antitrust Cases": (1981) 94 Harv L Rev 937
G Fogarty QC and B J Horsley for Appellant (instructed by Commerce
J A Farmer QC and A M Peterson for Respondent (instructed by Minter Ellison Rudd Watts, Auckland).
 being: State Insurance Ltd (State Insurance), AXA Insurance (Australia) Ltd (AXA), Sovereign Assurance Ltd (Sovereign), AA GIO Insurance Ltd (AA GIO), Public Service Investment Services Ltd (PSIS), American International Assurance Co Ltd (AIA), New Zealand Police Health Plan Ltd (Police Health Plan), and Manchester Unity Friendly Society Ltd (Manchester Unity).
all rights reserved