The OFT explained in a statement that, before the January 2011 merger, Headland and Kerry were “by far” the largest suppliers of frozen ready meals to UK retailers.
Almost all of Kerry's and Headland’s main customers had expressed “strong concerns” about the merger, said the authority.
Following the deal, Kerry Group closed Headland Foods' frozen own-label ready meals factory in Flint, Wales (which employed 318 staff) at the end of April. However, a consultation on a possible shutdown began last November, before the transaction.
The OFT said that retail customers were bothered by "significant price rises" in the aftermath of the merger and the supposed lack of alternative producers capable of supplying large volumes and wide ranges of frozen ready meals.
Recent poor performance
Despite noting “substantial increases in raw material costs”, the OFT supported customer concerns upon the basis that, despite poor performance in recent years, Headland's withdrawal from the market would not have been inevitable if the acquisition had not taken place.
Therefore, the OFT assessed the merger upon the basis that competition would have continued at the same level if it had not occurred.
Amelia Fletcher, OFT chief economist, said: “Significant price rises after any completed acquisition give the OFT cause for concern.
“In this case, the merged company's large share in the frozen ready meals market compared with that of its competitors corroborated that concern, as did the strength of complaints from retail customers."
Flether added: “Though increases in raw material costs may justify part of the increase, this did not fully allay our concerns. The merger will therefore be referred to the CC for an in-depth investigation.”
However, one industry source told FoodManufacture.co.uk that prior to the takeover Headland Foods was struggling to such an extent that it was artificially depressing prices, which consequently forced them down for other sector players.
Kerry Foods director of corporate affairs, Frank Hayes, said the company was "surprised" by the referral decision, "but confident that the CC investigation will not find any issues with this transaction".
Asked whether he was surprised by the OFT's concerns, given low margins in frozen ready meals, tough competition and costly raw materials, Joe Gill, director of research at Irish stockbrokerage Bloxham, said: "This is a tricky one, and presumably the OFT has done its own extensive work.
"But it is ironic that a highly consolidated retail sector (I think four players in the UK and Ireland control around 70% of the market), should object to this move by manufacturers to consolidate on the supply side."
Whenever food firms moved to rebuild margins, Gill said, they risked having "war declared" by retailers. But he added: "If you look at food manufacturers in the UK, Premier Foods' big recent contract loss, Dairy Crest as well. It seems they can't have jam on both sides of their bread."
Gill added that food firms "seem to get sucked in by the allure of large retailers", entering into contracts that sometimes soured a year or so later when these customers demanded lower prices.
The OFT has a statutory duty to refer a merger to the CC if the former believes it has led, or will lead to, a ‘substantial lessening’ of competition within any UK market.
To qualify for a referral under the Enterprise Act 2002, the value of the enterprise being taken over must exceed £70m, or the deal must involve the creation or enhancement of a 25% share within a specific UK market for goods and services.
The CC will now produce a report within six months, and its powers to improve competition include requiring a company to sell off part of its business.