April 3 2003 High Court Delivers Greater Certainty on Misuse of Market Power Ashurst | Competition & Antitrust - Australia Competition & Antitrust Background Observations and Implications Comment BackgroundThe recent case of Boral Masonry Ltd v Australian Competition and Consumer Commission  HCA 5 provides greater certainty in relation to where the line is drawn between aggressive and vigorous competition and proscribed anti-competitive conduct. By a six-to-one majority (Justices Gleeson, Gaudron, McHugh, Gummow, Hayne and Callinan, with Justice Kirby dissenting), the High Court allowed an appeal by Boral against the finding of the full court of the Federal Court that Boral had engaged in predatory conduct and taken advantage of its market power in contravention of Section 46 of the Trade Practices Act 1974.Observations and ImplicationsMarket power The majority of the High Court comprehensively rejected the Federal Court's approach to assessing market power.The majority stated that a process of reasoning which begins by finding a proscribed purpose to eliminate or damage a competitor, and which then draws the inference that a firm with that objective must have and be exercising a substantial degree of market power, is likely to be flawed.According to the High Court, market power is determined by reference to a firm's ability to act without constraint. This is to be examined in light of the firm's ability to increase prices for a product over a reasonable period of time, without losing sales to competitors.McHugh endorsed the US proposition that "competition is a ruthless process ... injuries to rivals are by-products of vigorous competition", and that "antitrust laws are for the benefit of competition, not competitors".The High Court held that in arriving at their conclusion that Boral had a substantial degree of market power, the majority of the Federal Court misunderstood what was meant by 'a substantial degree' of market power. In adopting its approach, the Federal Court appeared "to have been affected by an error of the same kind" as was corrected by the High Court in Melway Publishing Pty Ltd v Robert Hicks Pty Ltd. The court held that: "to reason ... from purpose to ... substantial market power, is to invert the reasoning process which, consistently with the provisions in Section 46, is mandated by the decisions in Queensland Wire and Melway."The High Court held that market power can only be determined by examining what a firm is capable of doing over a reasonable period of time, and that such an analysis requires an examination of: the market structure; the business practices of market participants; market shares; and barriers to entry. The court's emphasis on time is significant, as it indicates that the courts should not be caught up with transitory trends and need to take a medium to long-term view of the market.The High Court held that if the remaining firms remain in strong competition following the exit of a competitor as a result of a price war, then its departure does not achieve or show market power.Evidence of pricing constraint is of significant probative value in assessing whether the firm has a substantial degree of market power.The High Court also confirmed that financial strength is not market power. Consistent with this approach, the High Court held that the ability to survive a price war is not market power, or a manifestation of characteristics that give market power, if the market is still highly competitive after the price war. The fact that Boral was part of a financially strong, vertically integrated group was of no relevance to the consideration of market power.While an expansion of capacity may demonstrate financial strength, this does not necessarily equate to market power. Market shares The High Court appeared to endorse US authorities which held that, as a matter of law, single-firm shares of 30% or less cannot, of themselves, establish market power. This has significant implications for firms with market shares around the 30% range and may also have implications for the Australian Competition and Consumer Commission (ACCC) in light of the position taken in its merger guidelines that 40% market share is an indicator - albeit an inconclusive one - of unilateral market power.Barriers to entry Barriers to entry are features of a market that inhibit the ability of firms to enter or exit that market. Where a market is characterized by low barriers to entry, it is unlikely that any firm can possess a substantial degree of market power.The High Court accepted that strategic barriers to entry may exist (and may underpin a finding of market power), although they were not present in this case. This is a significant finding, as the High Court recognized for the first time that a concerted pattern of exclusionary conduct may constitute a barrier to entry, notwithstanding the absence of traditional structural barriers (eg, IP rights or high sunk costs).Pricing conduct and its implications Low prices cannot, of themselves, be a barrier to entry in any circumstances and competitive cost-cutting cannot be regarded as a strategic barrier or proof of substantial market power. Unattractiveness of entry is different from entrenched practices that might act as true strategic barriers.Recoupment At first instance, Justice Heerey adopted the US recoupment test for determining whether conduct constitutes predatory pricing. He held that predatory pricing can only occur where the alleged predator's prices are below cost and there is also a likelihood of the alleged predator recouping its losses through subsequent supra-competitive pricing (ie, pricing which is higher than that which would prevail in a competitive market). However, the Federal Court held that recoupment was not an element in a predatory pricing claim under Section 46, and further held that in some cases, above-cost pricing could be 'predatory'.A majority of judges in the High Court held that the concept of recoupment is a useful tool for analysis in cases where pricing behaviour is alleged to contravene Section 46, and evidence of no prospect of recoupment would point away from a contravention of Section 46. McHugh went even further, holding that recoupment was a legal requirement that had to be satisfied in cases involving allegations of predatory pricing under Section 46.Despite the fact that the majority judges other than McHugh did not include recoupment as a legal requirement, it is implicit in different aspects of their judgments that the role of recoupment is greater than merely as a tool of analysis.According to Gleeson and Callinan, market power lies in a firm's "ability to target an outsider without fear of competitive reprisals from an established firm, and to raise prices again later" (emphasis added). They also held that the elimination of a competitor, unless done out of pure malice, "is ordinarily a means to the end of being able to raise prices". While this statement was made in the context of an analysis of market power, the overlap with recoupment demonstrates the difficulty in assessing any alleged predatory pricing conduct without regard to recoupment.Taking advantage If a course of action can be demonstrated to be a 'legitimate' business decision (in the sense that it would have been adopted in a competitive market), then it is unlikely to constitute a 'taking advantage' of market power. The High Court accepted Heerey's findings that Boral's commissioning of new plant was undertaken in an attempt to increase efficiency and reduce costs, and that the decision to continue pricing below cost merely reflected a decision by Boral to stay in the market and weather the storm, notwithstanding that Boral needed to sell some products below cost in order to win work.Pricing If the evidence demonstrates (as it did in this case) that an alleged predator set its prices by reference to the market, and no lower than was necessary to attract customers, then this is likely to be permissible pricing behaviour.Below-cost pricing (by itself) does not carry with it any automatic presumption of predation where the pricing was driven by the market and not instigated by the alleged predator. The High Court held that the fact that its prices were often lower than Boral's variable costs was inconclusive, if Boral's prices were forced upon it as a result of competitive market pressure.CommentThe High Court's decision provides significant direction for businesses as to how Section 46 is to be applied in the context of competing with existing competitors and new entrants. In arriving at its conclusion, the High Court emphasized the need to understand that the purpose of the Trade Practices Act is to protect competition and that the consequences of healthy competition may well include the failure of some participants in a market. For further information on this topic please contact John Kench at Blake Dawson Waldron by telephone (+61 2 9258 6000) or by fax (+61 2 9258 6999) or by email ([email protected]).