Captive in the Octopus' Embrace

We all have corporate Stockholm syndrome: We come to love the monopolies ruling our lives.

"It's about the worst monopoly of them all. It has an iron grip on our balls and cannot be shaken off. If you're interested, contact me." This message arrived at TheMarker weekend edition last week, following reports on the many monopolies involved in our lives.

The message was from S., who lives in a tall apartment building in the center of the country. "There are four elevators in the building," he says. "I've been here a year and every day stand open-mouthed at the nerve and iron grip of the elevator company. The residents are simply miserable. There are 150 apartments here and the elevators are a central artery. You can't climb up 35 stories."

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The result is that the elevator company has the building by the short hairs, S. says.

TheMarker: There are a lot of elevator companies. Get another offer.

"I tried. They won't give service because the elevator was made by another manufacturer. You won't take your Volkswagen to a garage with Subaru parts. There are several companies on the face of it, but in practice I can't switch."

A company that builds an elevator has a captive client for decades: "So every stupid switch I need that costs NIS 10 on the outside - they want NIS 1,000 for it. Buying four elevators for a building like this one costs two, three million shekels and their maintenance, under a full-service contract, costs NIS 15,000 to NIS 20,000 a month."

Under the law elevators need to be inspected every six months, and have to meet certain standards. "So the manufacturer employs an external inspector who is ostensibly independent, but they work together. It's a kind of loony micro world."

S. wasn't the only reader to contact TheMarker after reading about the monopolies. There are many monopolies that readers know well, without realizing it. Shimrit has a monopoly over yeast. Tivall has a monopoly in its niche of meat substitutes. Unilever has a monopoly over margarine, and there are many more, beyond foodstuffs and elevators, monopolies that leave the consumer powerless from cradle to grave.

Not all the companies mentioned herein are formally declared monopolies by the Antitrust Authority, whether because they did not reach a 50-plus percent share of the market, because of the definitions of the market in their sector or because nobody asked the Antitrust Authority to investigate them. Let us start the journey with the first consumer item babies encounter: formula. Substitute mother's milk. Soon enough the growing infant meets breakfast cereal. Once puberty arrives comes the need for razor blades, where a single company dominates the roost, but come army days, the Israeli drinks coffee supplied by one chief source. And after the army when our Israeli buys a home, he falls into the unyielding embrace of the elevator manufacturer. Unless things change, their children will simply repeat the cycle.

In February 2011, Dan Propper quit the board of directors at Teva Pharmaceutical Industries. Propper, an appointment by the legendary former board chairman Eli Hurvitz, left one of the most desirable board seats in the land after just three and a half years. He didn't do it in good spirit, either. His reason was Teva's plan to get into milk substitutes, where it would compete directly with the company with which Propper is most identified - Osem. He owns 5% of its stock and chairs its board.

Teva's move placed him in a conflict of interest, as Osem owns 51% of milk substitute maker Materna, which reportedly has a 58% share of the market. Almost all the rest of the market belongs to Similac.

Marketing from the maternity ward

Osem is a giant with sales of almost NIS 4 billion a year. Israelis know it by many other products beyond baby formula. Ostensibly it shouldn't have been bothered by a market in which its sales are around NIS 334 million a year. But its margins on Materna are substantially wider than the company's average. Its profit from routine Materna business - NIS 54 million in 2010 - was equivalent to 16.1% of Osem's turnover. Its profit from routine business was 12.7% last year.

Last week, eight months after Propper resigned, Teva launched its Nutrilon brand of infant formula. Its introductory price, NIS 35 for a 400-gram container, was 25% below the price of competing brands. They did not hasten to react, either, but finally had to announce special deals, lowering Materna to NIS 36 and Similac to NIS 37. A few months ago the same containers cost NIS 55.

It seems Teva's entry brought welcome competition. But is this a happy end? Will the shock to the duopoly caused by the advent of a well-established rival manage to lower prices over the long run? Probably not.

The underlying conditions of the baby formula market are not conducive to competition. The first reason is that price is not the main criteria by which many parents choose formula. The tendency to look beyond price has been especially marked after the Remedia scandal in 2003. Absence of a key vitamin in soy-based formula caused the deaths of three babies and irreversible damage to 20 more, eventually wiping out the company. That left Israel with just the two dominant players. Another fallout of the Remedia affair is that Israeli parents are afraid of new, unknown milk substitutes, which creates high entry barriers. Newcomers have to invest heavily in gaining parents' trust.

Teva might make it by virtue of its credibility as a global pharmaceuticals company. But a lot of other sectors, like cellular, have proven that it isn't hard to maintain equilibrium with three competitors.

As for formula, another issue is that the parents' decision which formula to buy for baby is determined back in the hospital. New parents can spend nine months discussing which carriage to buy, or car seat, but they usually make their decision on formula on the spot, based on the formula the nurses chose to give the baby after birth. That's why the big battlefield in the market is the hospitals' tenders, where the companies compete for the right to give their products for free to the new mothers, and in parallel they get permission for their representatives and marketing content to enter.

In July, the Knesset voted in favor of a bill sponsored by Likud MK Danny Danon to require hospitals to pay for formula, making price an issue, and to limit the access of corporate representatives to the wards. If the bill passes it could bring change, as access to new parents is key to success. Note the fate so far of Optimal, a rival formula with 1.5% of the market. It sells 450-gram containers for NIS 25, but isn't distributed at hospitals and failed to win the public's trust and thereby to lower prices. If however it becomes available in hospitals, it could be a player.

Unless the barrier of the hospitals is broken down, we may assume that the ripples of competition by Teva's Nutrilon will fade away fast.

Materna commented that it is the leader in its market because of mothers' choices. "Consumers know that in Materna they find the best product at the best price," the company said.

Fondly identifying with the product

Once past the bottle, the Israeli child remains in the octopus-like grip of the dominating food companies. Take Telma, which sells 60% of all breakfast cereal in Israel. It is not a declared monopoly in cereal because of the sheer variety of products in stores. The cereals section in supermarkets looks like a cornucopia of plenty - most of which are made by Telma. The second-biggest player, Nestle-Osem, has a 26% market share. That doesn't leave much room for competition.

Telma began making breakfast cereals when that American fashion reached Israel in the 1980s. The public responded to its introductory campaigns with gusto, and today is willing to pay handsomely for the pleasure. Telma's leading brand, Kariyot (cereal with a nougat filling ) commands 16% of the breakfast cereal market in general and 36% of cereal consumption by children. It costs NIS 27 to NIS 33 for a 750-gram box. Even a kilo of meat would probably cost less.

Another sign of the absence of competition is the anti-consumer move Osem took lately, reducing the weight of the Multi Cheerios box by 15% but lowering the price by just 5%.

Concentration in the cereals sector carries another price. Two months ago Telma changed the recipe of Kariyot, increasing the fat content from 15% to 17%, and the saturated fat content from 3.7% to 5.8%. In parallel it lowered the vitamin and iron content. This step, just as the world moves toward healthier foods, shows Telma's confidence against the competition.

As for price, a 750-gram box of Kellogg's cornflakes sells for NIS 21.50 at Super-Sol Direct, while Telma's cornflakes cost NIS 17.50 and the private-label brand cost NIS 14. Once cornflakes could be had cheaper. In 2010 the Israeli consumer could buy a standard box of cornflakes for less than NIS 11. That was from a company called Tirpaz, which went broke. Was it selling too cheaply?

"A company has to make money," points out its former manager, David Weissman.

Manufacturers in Britain, Germany or France can sell bulk and compromise on profitability, but in little Israel that isn't an option, he elaborates. Also, in Israel prices are imposed on them, says Weissman. "We simply couldn't get more money for the product. To compete with Telma it had to stay within a certain price range, but smaller manufacturers are by the nature of things less productive than big ones, which means their costs are relatively higher."

In other words, how low does a manufacturer have to go to compete with the monopoly, undeclared or otherwise? Does the small manufacturer stand a chance?

Now that the big retailers in Israel have launched low-cost private label brands, can small manufacturers compete with them too? What location on the supermarket shelf (which is key to sales ) will a small manufacturer's product have compared with the private-label brands?

"Telma was the first to develop the market for breakfast cereals in Israel," Telma said. Competition in the cereals sector today is fierce: It has to contend with the big international brands as well as private brands mostly produced abroad, the company said. There is a wide range of Telma cereals, which are adapted to Israeli taste and are of the highest quality, it said, adding that its plant in Arad provides employment to hundreds of families. It also invests in developing new quality products.

"The price of Telma cereals is especially reasonable and in some products, it's the cheapest in their category," the company continued. There are plenty of special sales and in any case, at the end of the day the retailer is the one setting prices, not it. As for the Kariyot nougat-filled puffs, that's an indulgent product not positioned as a health food, the company adds: "We found that consumers do not see added value in supplements of vitamins and minerals in that product. On the contrary - their appearance on the label could induce a lack of faith in the product. We accordingly removed those components."

Importers competing with themselves

Having spent childhood with Telma, at adolescence our Israeli encounters one of the supreme rulers of the consumption roost. At some point in high school, our Israeli will start to shave. It is all but certain they will do so using a Gillette razor, made by Procter & Gamble.

Gillette controls about 95% of the market for razors in Israel. TheMarker checked earlier this year and found that four Mach Turbo blades cost NIS 60 in Israel, while the British male pays 35% less.

Why do Israelis buy Gillette almost exclusively, despite their high price? We sought enlightenment with a top personality in the market for shaving products. "You have to ask yourself," he answers. "Israelis are accustomed to Gillette."

They buy what they're used to buying: If they'd try another razor, they might find out it's just as good, he said.

Gillette achieved its monopoly simply by being first. The American businessman King Camp Gillette (1855-1932 ) invented the disposable razor blade, charming the hirsute worldwide and doing his bit to destroy the planet. Today the company he founded is one of the most profitable in the world, grossing no less than 60% of turnover and running a 15% net profit margin. Gillette maintains its control through aggressive marketing, technological innovation and the human force of habit.

In 1998, when Gillette blades were still being imported by S. Schestowitz, the Antitrust Authority looked into the issue. A source at the Antitrust Authority involved in the inquiry says Schestowitz quashed competing products by controlling display space. "Like every monopoly, the method was to pay more for shelf space at supermarkets, so they wouldn't display competing products," he says.

Gillette was declared a monopoly in Israel. Since then, things have changed. Four years ago, in mid-2007, S. Schestowitz began to import Schick, a rival to Gillette. Semicom began to import the South Korean brand Dorco. Neither has complained about Gillette but a random visit to a Super-Pharm store shows these are hard to find. In any case, there is no drama playing out over pricing. There's no great difference between the brands. Possibly if one of the rivals starts aggressive marketing of its own, the Israeli will notice: Until that time, Gillette will continue to make money hand over fist at our expense.

Black ( coffee) market

Another corporate milestone of maturity arrives, for most Israelis, after they're drafted into the army. It happens at that stage when exhaustion and sleep deprivation rear their ugly heads, forcing our soldier to get used to the bitter nectar popularly known as "black coffee". Irrespective of whether milk is added, this is made by putting ground coffee into the cup and adding hot water, or putting the coffee into a finjan - a designated coffee pot, adding water and boiling it (twice or even thrice for purists ).

In 2007 the antitrust tribunal held a hearing at which Judge Miriam Mizrahi presided over a case in which the sides dwelled at length over the differences between the types of so-called "black coffee": the type cooked on the stove versus the water-in-the-cup type; the type where the grinds float on the surface and the type where they sink.

It wasn't that Judge Mizrahi aspired to serve the perfect black coffee. The reason for the hearing was the demand by Elite that its declaration as a monopoly in black coffee, dating from 2003, be annulled. It was said to have a 70% share of the black coffee market, but, Elite pointed out, if the black coffee market includes coffee from private roasting houses, consumed mainly by Israeli Arabs, it didn't even have a 50% market share. Of course, if one doesn't live in an Arab town, one might have difficulty finding a private roasting company.

Today Elite has rivals, if small. A 100-gram bag of Elite black coffee costs NIS 7.50 at Super-Sol Direct. The same-sized bag by Rejwan costs NIS 6.70 and the private-label Super-Sol brand costs NIS 6.50. A 100-gram bag of Landwer coffee costs NIS 8, more than Elite.

The differences for 200-gram vacuum-packed black coffee are bigger: Elite's costs NIS 19, which is 35% above the price of the Super-Sol private label brand (NIS 14 ). A 250-gram bag of El Nakhleh coffee costs NIS 18, about the same as the private-label Super-Sol brand.

Facebook surfers have been rustling about this and a group has arisen against Elite's black coffee, noting that it has increased by 30% in price over the last three years. Elite explains that the price of raw coffee has increased by 75% in the last two years. Why the premium it charges compared with rival brands? Quality assurance, explains Elite (which is owned by Strauss Group ).

Roni Rejwan, CEO of the Rejwan coffee company, says that like in the case of razor blades - people are just used to Elite. "They'll change their wife before they change their coffee supplier," he quips. Possibly the advent of private labels will change things: They're cheap and get shelf space, he points out. Once people taste something else and realize the roof hasn't fallen in, their loyalty may disappear.

Up and away

Encounters with powerful manufacturers don't end with black coffee. Try buying toothpaste at a drug store: Half the shelf space belongs to Colgate. Look at diapers: Hogla-Kimberly has a 73% market share, and also rules 66% of the toilet-paper scene, 69% of tissues and 53% of the market for paper towels. You want frozen vegetables? Sunfrost controls 70% of the category.

Back to S., with whom we began this saga. Most Israelis taking the elevator don't necessarily realize they are customers of a monopoly, but the Antitrust Authority did. In the early 1990s the Israeli elevator companies - Nechushtan, Maaliyot Tal and IsraLift - were declared a monopoly in maintenance and spare parts for the elevators they had installed. Yet it doesn't have to be so. "I could handle 80% of the elevators in Israel, even if I didn't make them," says Hovav Hadad, service VP at IsraLift.