What is margin squeezing?

'Margin squeezing' or 'price squeezing' occurs where a firm which is active in two levels of a supply chain (a vertically integrated firm), and which controls an important input to the finished product or service, uses this control to threaten the survival of, or drive out, competing firms that sell the finished product.

A margin squeeze will breach the Second Conduct Rule (SCR) where it has this impact on one or more efficient competitors. For a comprehensive discussion of the SCR, you can read last week's alert here.

Not all margin squeezing conduct will breach the SCR. However, if you are a vertically integrated firm with a substantial degree of market power that sells a key input on substantially less favourable terms to your competitor (compared to your own downstream unit which sells the finished product or service), which in turn fetters your competitor's ability to compete on the price of the finished product or service effectively, we recommend you consider this conduct under the SCR prohibition.

When will margin squeezing be an abuse of substantial market power?

When assessing whether a margin squeeze amounts to an abuse of substantial market power, the following factors will be important:

  • The important nature of the input – if the input is indispensable to providing the relevant finished product or service in the downstream market, an anti-competitive effect is more likely to occur where there is a margin squeeze. However, just because a competitor may be able to obtain the input from an alternative supplier will not necessarily preclude a finding that an abusive margin squeeze has occurred.
  • The size of the margin squeeze – if the supply price of the input product or service is too high or the downstream market price of the finished product or service charged by the vertically integrated firm is too low to allow a downstream only competitor, which is as efficient, to survive, an abusive margin squeeze is likely to have occurred. A downstream market price will be considered too low where the vertically integrated firm uses the profits it charges its downstream rivals to subsidise its losses.

Regulated maximum prices

Regulated maximum prices do not mean that abusive margin squeezes will not occur. Where prices are subject to a maximum price by regulation, but not all prices are regulated, it may not be sufficient for a firm to argue that it could not have engaged in margin squeezing. Whether the firm can control its own prices will be a question of fact in the circumstances.

Margin squeezing and the duty to deal

A firm - whether or not it has a substantial degree of market power - does not owe a general duty to deal, or to deal fairly, with its competitors.

However, it has been recognised in a number of jurisdictions that some firms with substantial market power are subject to special responsibilities that firms without market power are not. The Competition Commission's guidelines are silent on whether the SCR operates only to prevent firms with substantial market power from engaging in prohibited conduct or whether it can also compel firms to positively engage in conduct (eg compel them to supply to a downstream competitor) if they do not want to or where it would harm their commercial interests.

Further, where a duty to deal is imposed under an industry or legislative framework, it will be difficult for a business to argue that it did not have a duty to deal.

Do any exemptions or exclusions apply to this prohibition?

Smaller companies that have an annual gross global turnover of not more than HK$40 million will benefit from the "conduct of lesser significance" exclusion, and are therefore not subject to the Second Conduct Rule, under which the practice of margin squeezing is assessed.

Nevertheless, smaller and medium sized companies, that are as or more efficient than their competitors, should understand when margin squeezing will be prohibited as they are more likely to fall victim to such practices.

What are the consequences of engaging in abusive margin squeezing?

There are a number of enforcement approaches the Competition Commission can take where it has reasonable cause to believe a firm has engaged in illegal margin squeezing. They are:

  • issue a draft infringement notice, providing the firm with an opportunity to respond;
  • after considering the response it may decide not to press the issue or issue a final infringement notice, providing the firm with an opportunity to refrain from the conduct and /or to take specified action; or
  • institute proceedings in the Competition Tribunal.

If the Competition Tribunal finds that a firm has breached the SCR, it can issue a fine of up to 10 per cent of the firm's group turnover in Hong Kong for the duration of the infringement (with a three-year cap) for each offence.