EU Competition law and the European paper industry

(Originally posted 3.2.2012)

Last year, UPM-Kymmene completed the acquisition of Myllykoski Oy, after this merger was approved by the European Commission on the 13th of July. The merger was approved, apart from market share criteria, because

“Following a detailed investigation, the Commission found that the parties’ competitors have significant spare capacity which would enable them to react to attempts by Finland’s UPM to raise prices.”

All this was still under the assumption that it was a merger in the traditional sense, i.e. an expansion of UPM-Kymmene through the take-over of a competitor. In the paper industry (and not solely in Finland) it had been widely known that Myllykoski was not in the best of shapes, and initially, the reaction of the Finnish Paper Workers’ Union was one of relief regarding the take-over (link in Finnish), as it removed uncertainty about ownership. The merger had been in the works since the beginning of 2011, and the CEO of UPM-Kymmene has expressed the merger’s benefits in clear terms (translation by author):

“UPM sees the acquisition of Myllykoski as an unique possibility to improve profitability and create added value to the company’s paper business. According to CEO Jussi Pesonen the advantages of the merger have been confirmed already in the early stages of the merger planning.”

After the Commission approved the merger, though, UPM-Kymmene announced in November that it will close the Myllykoski paper mill and reduce capacity at some of Myllykoski’s German holdings:

“The Myllykoski mill has been making a loss for several years despite numerous measures aimed at making the operations more efficient. The mill’s cost competitiveness is weak. The high costs of raw materials and energy have further increased total costs and permanently damaged the mill’s opportunities to reach a profitable level,” states Jyrki Ovaska, President, Paper Business Group.”

Although it can be argued that, since Myllykoski was part of UPM-Kymmene after the approved merger, UPM could do with the business units what it sees as the best strategy, there is an awful discord between the initial statements by UPM and its ‘sudden’ decision to close the Myllykoski paper mill. It may be that UPM saw the ‘added value’ mentioned above only in some parts of the Myllykoski Groups’ assets – the Madison paper mill in Illinois at the moments is not part of capacity reduction programs. The press kit on Myllykoski includes these reductions:

• permanent closure of the UPM Myllykoski mill in Kouvola in Finland
• permanent closure of the UPM Albbruck mill in Germany
• permanent closure of the paper machine 3  at the UPM Ettringen mill in Germany

Given these permanent closures, it is not too far-fetched to question UPM’s motivation to merge with Myllykoski; nominally in the name of synergy benefits and competitiveness improvement, it does look like UPM-Kymmene wanted to buy a competitor off the market. This brings me to the main point of this post: the compatibility of the original merger decision with UPM’s actions afterwards. For the sake of the argument, it is important to keep in mind that it was no secret that Myllykoski had been performing poorly for many years, and UPM most certainly did not need many more assessments to establish Myllykoski’s situation.

Above, I mention that according to the Commission, the competitors have enough spare capacity to counteract price increases by UPM. This statement presumes two issues: first, that by controlling a larger share of production capacity than pre-merger, UPM would also gain some extra market share by which it can actually increase prices. Second, the statement presumes that by increasing production, price increases can be counteracted.

Regarding the first issue: UPM gained possibly some market share by the Myllykoski merger. But by closing a large part of Myllykoski’s operations, UPM has achieved two things – a reduction of excess market capacity while preserving Myllykoski’s clients/orders for UPM. This is business-wise undeniably a smart move. But in terms of the competition policy there might be a problem here, since it means the merger has in fact led to competitive advantages for UPM. The second presumption relates to this issue.

According to the Commission, existing overcapacity might be used to counter-act price increases. The logic used is that with a larger share of production capacity (and market share), UPM could influence prices. This reasoning is, however, not compatible with the situation in the European paper industry. For many years there has been excess capacity (and still new capacity is built, often with European money). In order to increase profitability, it is not possible to raise prices but capacity has to be reduced, because any increase in prices by a single actor can be counter-acted by increased production of competitors, given the existence of excess capacity. This logic ignores the (long-term) weak demand for paper, which is made worse by the economic crisis.

One plausible explanation for UPM’s actions is exactly the aim to restore or improve profitability, but not in the way the Commission argues. Instead, the merger with Myllykoski and its subsequent closure can be seen as a shrewd attempt to buy excess capacity off the market without hurting UPM’s pre-Myllykoski operations (which have seen many ‘competitiveness enhancement’ programs over the last years). When we keep in mind that the Commission argues that competitors have enough excess capacity to counter-act price increases, this means that if UPM can cut excess capacity by buying an unprofitable competitor instead of cutting its existing capacity (which is potentially in better shape than Myllykoski was), UPM has created competitive advantages through this merger, because relative to its competitors, UPM will have ‘free’ excess capacity which it could cut, while competitors in this situation have to cut of their existing capacity to restore profitability, which in turn hurts their capacity to counteract price increases by UPM in the future.

It is useful to compare this scenario with the case that Myllykoski would have gone bankrupt: then, its clients/orders would have gone also to other companies than UPM and UPM would not have had the potential to cut capacity freely. Overall paper industry production capacity would of course still have been reduced, but it would not have solely benefitted UPM, as (plausibly) in the case above.

The argument can be summarized as follows: UPM bought Myllykoski with the express intent to reduce overall capacity within Europe, in order to improve (the potential for) profitability. In the absence of a price increase the reduction of capacity and/or production might have quite the same effect, at least inasmuch it might affect a reduction in the capacity of competitors in order to stay profitable. Whereas UPM could easily cut capacity through its approved merger with Myllykoski, competitors in the short term do not have this option. This plausible chain of events shows that EU competition policy does currently not fully incorporate the possibilities of competitive advantages through other consequences of mergers. It is important not only to assess potential market shares, market capacity etc post-merger, but also the effects of blatantly buying a competitor off the market.

This alternative analysis of the decision to approve of the merger of Myllykoski and UPM-Kymmene does not anymore benefit the workers of Myllykoski that lost their job, in an economic downturn and at a time when finding alternative employment for relatively ageing employees in the paper industry is hard, to put it mildly.

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