On 3 December 2008, the European Commission published guidance on enforcement priorities in applying Article 82 to abusive exclusionary conduct by dominant undertakings. This guidance contributes to the process of a more economics based approach in the enforcement of EC competition law. The finalised guidance paper is, however, considerably streamlined and shortened as compared with the original discussion paper issued by the Commission in December 2005. The guidance sets out the Commission’s intended enforcement principles in relation to identifying market power, anti-competitive foreclosure and price-based exclusionary conduct, before analysing specific forms of abuse, namely exclusive dealing, tying and bundling, predation and refusal to supply (including margin squeeze). This article summarises the main principles set out in the guidance in these areas.
The Commission states that it will normally intervene under Article 82 where, on the basis of cogent and convincing evidence, the allegedly abusive conduct is likely to lead to anti-competitive foreclosure. The Commission will consider the position of the dominant undertaking, conditions on the relevant market, position of the dominant undertaking’s competitors, the position of customers or input suppliers, the extent of the allegedly abusive conduct, possible evidence of actual foreclosure and any direct evidence of an exclusionary strategy. The Commission also states as a general policy in relation to price-based exclusionary conduct, the principle derived so far from its margin squeeze decisions, that it will normally intervene only where the allegedly abusive conduct has already been or is capable of hampering competition from competitors which are as efficient as the dominant undertaking. In certain areas, in particular predation and refusal to supply, the principles set out in the guidance go beyond the position established in the existing case law.
In determining dominance, the Commission will follow the position established in case law particularly United Brands, that dominance is a position of economic strength which enables an undertaking to prevent effective competition being maintained on a relevant market, by affording it the power to behave independently of its competitors, customers and ultimately consumers. Competitive constraints are not effective and the firm enjoys substantial power over a period of time, even if some actual or potential competition remains. Therefore, a dominant position is derived from a combination of factors, and although market shares are a useful first indication, they have to be interpreted in the light of relevant market conditions. Although experience has shown that dominance is not likely at a market share under 40% in the relevant market, there may be exceptions where dominance is found below this threshold. The level of market share and the duration that share is held are important preliminary indicators of dominance.
Competitive constraints may also be exerted by customers, due to their size or commercial significance, they may have the ability to switch quickly, promote new entry or vertically integrate, and threaten to do so. If this countervailing buyer power is sufficient it may deter attempts of dominant undertakings to profitably increase prices.
A dominant company can have advantages such as economies of scale and scope which are barriers to expansion or entry in a market, and may create barriers to entry, by making significant investment, which new entrants or competitors would have to match, or where it has concluded long-term agreements with customers which have appreciable foreclosing effects. If behaviour appears only to raise obstacles to competition, and not create efficiencies, anti-competitive effect may be inferred.
Price-based exclusionary conduct
The Commission will intervene in price-based exclusionary conduct where behaviour is, or is capable of, hampering competition from competitors which are considered to be as efficient as the dominant undertaking. The cost benchmarks the Commission is likely to use are the average avoidable cost (AAC) and the long-run average incremental cost (LRAIC). The AAC includes fixed costs if incurred during the period under examination. The LRAIC is the average of all variable and fixed costs to produce a particular product, and includes product-specific fixed costs made before the period in question; therefore the LRAIC is usually above the AAC. The average total cost and LRAIC are good proxies for each other, although true common costs are not taken into account in LRAIC. Failure to recover LRAIC indicates that the dominant undertaking is not recovering all the attributable fixed costs of producing the goods or services and that an efficient competitor could be foreclosed from the market.
A dominant company may try to foreclose competitors by use of exclusive purchase obligations or rebates which in the guidance are together termed “exclusive dealing”. The foreclosure effect will be greater the longer the duration of the obligation. However, if the dominant firm is an unavoidable trading partner for all or most customers, even an exclusive purchasing obligation of short duration can lead to anti-competitive foreclosure.
Rebates are not usually capable of foreclosing in an anti-competitive way as long as the effective price remains consistently above the LRAIC of the dominant firm, as usually this would allow an equally efficient competitor to compete profitably. As a general rule when the effective price is below the AAC, the rebate scheme is capable of foreclosing even “as efficient” competitors. When the effective price lies between the LRAIC and the AAC, the Commission will investigate what other factors are likely to affect the entry or expansion by an equally efficient competitor. This will include the extent to which rival firms have realistic and effective counter-strategies available. This analysis will include the type of rebate, whether it is an individualised threshold perhaps based on a percentage of the total requirements of the customer, or a standardised volume threshold for all or a group of customers. Where a standardised volume threshold approximates to the requirements of an appreciable proportion of customers, the Commission is likely to consider that such a standardised system of rebates may produce anti-competitive foreclosure effects.
Tying and bundling
Tying and bundling may be used by a dominant firm to foreclose the market. Tying occurs where customers purchase one product, the tying product, and are also required to purchase another product, the tied product, from the same firm. Bundling usually refers to how products are offered or priced. Pure bundling is where the products are only sold jointly in fixed proportions and mixed bundling is where products are available individually, but cost less when sold together (this is also called a multi-product rebate). While recognising that tying and bundling are marketing practices to offer products in a cost-effective way, a dominant firm can use this strategy to foreclose the market. The risk of anti-competitive foreclosure is expected to be greater where the tying or bundling strategy is long-lasting, for example through technical (as opposed to contractual) tying, which can only be reversed at a high cost.
In the case of multi-product rebates, it is noted that assessing incremental revenue is complex; it is not easy to see whether the incremental revenue covers the incremental costs for each product in the dominant undertaking’s bundle. The Commission states that in practice the incremental price will therefore be taken as a good proxy. If the incremental price that customers pay for each of the products in the bundle remains above the LRAIC (of including the product in the bundle), intervention by the Commission is unlikely since an equally efficient competitor with only one product should in principle be able to compete profitably against the bundle. However if the incremental price is below the LRAIC, enforcement action may be warranted, as an equally efficient competitor may be prevented from expanding or entering the market. By contrast where rivals also sell in similar bundles, the Commission will consider the relevant question to be one of predation rather than bundling.
The Commission will generally intervene when there is evidence that a dominant firm engages in predatory conduct by deliberately incurring losses or foregoing profits, termed a “sacrifice” so as to foreclose, or where the dominant firm is likely to foreclose, one or more of its actual or potential competitors with a view to strengthening or maintaining market power, and by doing so, cause consumer harm. Pricing below AAC will in most cases clearly indicate sacrifice. AAC is considered a better benchmark by the Commission than Average Variable Costs (AVC) as it reflects for instance, sunk costs of extra capacity obtained in order to predate. In addition, the Commission may also investigate whether the net revenues were lower than could have been expected from reasonable alternative conduct.
The Commission states that normally only pricing below LRAIC is capable of foreclosing as efficient competitors from the market. However the Commission states that it does not consider it necessary to show that competitors have actually exited the market in order to show that there has been anti-competitive foreclosure, insofar as the dominant undertaking may prefer to prevent the competitor from competing vigorously and have it follow the dominant firm’s pricing, rather than eliminate it from the market altogether. Generally, consumers will be harmed if the dominant undertaking can reasonably expect its market power after the predatory conduct ends, to be greater than it would have been had the firm not engaged in such conduct. However, the Commission in turn states that it is not necessary to show that the dominant firm will be able to increase its prices above the pre-predation level, but that it may be sufficient for instance that the conduct would be likely to prevent or delay a decline in prices that would have otherwise occurred.
The Commission further states that it may be easier for the dominant undertaking to predate if it selectively targets specific customers with low prices, as this will limit the losses incurred by the dominant undertaking, but that it is less likely that the dominant undertaking predates if the conduct concerns a low price applied generally for a long period of time. It can be observed that in relation to the effects of predation on competitors, the Commission is broadening the grounds on which it may intervene and is in effect proposing a broader definition of predation as an abuse of dominant position, as compared with the existing case law.
Refusal to supply and margin squeeze
The concept of refusal to supply is stated to include a refusal to supply new or existing customers, refusal to license intellectual property rights, including supply of the necessary interface information, or refusal to grant access to an essential facility or a network. It also includes constructive refusal, which could be unduly delaying or downgrading the supply or imposing unreasonable conditions.
Further, instead of refusing to supply, a dominant company may charge a price for the product on the upstream market which compared to the price it charges in the downstream market, does not allow even as an efficient competitor to trade profitably, this is a so-called “margin-squeeze”. The Commission will largely rely on LRAIC of the downstream division of the integrated dominant firm as a benchmark, or a non-integrated competitor when it is not possible to allocate the dominant firms costs between downstream and upstream operations.
These will be an enforcement priority if the refusal (i) relates to a product or service that is objectively necessary to be able to compete effectively on a downstream market and (ii) the refusal is likely to lead to the elimination of effective competition on the downstream market and (iii) the refusal is likely to lead to consumer harm.
However, the Commission states that in the case of obligations to supply in regulated markets, where it is clear from the considerations underlying such regulation, that the necessary balancing of incentives has already been made by the public authority when imposing such an obligation to supply, it is likely that the Commission will make a finding of anti-competitive foreclosure without considering whether the above three cumulative circumstances are present. This may also be the case where the upstream market position of the dominant undertaking has been developed under special or exclusive rights granted by the state or financed by state resources. In this respect, the Commission restates a principle which was set out in its margin squeeze concerning Télefonica regarding a margin squeeze in relation to the grant of upstream access to broadband facilities. The Commission here appears to be generalising a stricter policy in relation to questions of refusal or constructive refusal to grant access to infrastructure derived for example, from the operations of a former statutory monopoly, than are applied in relation to questions of supply of access to infrastructure created through private sector investments. However these cases raise complex issues of law, economics and policy and it can be considered that there is insufficient case law at this stage to regard this Commission policy as equivalent to a general rule that would necessarily be applied in all cases.
A priority for the Commission will be the investigation of refusal to supply where the competitor has no actual or potential substitute in the downstream market. The Commission is placing the onus on the dominant company to demonstrate why circumstances have changed to require it to change existing supply arrangements. Importantly, the Commission states that its general criteria on refusal to supply will be applied both to cases of disruption of previous supply (as per the existing case law) and to refusals to supply goods or services which the dominant company has not previously supplied (de novo refusals to supply). The Commission states that it is more likely that the termination of an existing supply arrangement will be found to be abusive than a de novo refusal to supply. However under the case law to date, de novo refusals to supply have generally only been regarded as abusive in cases involving essential facilities. Therefore the Commission appears to be seeking potentially to broaden the scope of application of Article 82.
The Commission further states that in examining the likely impact of a refusal to supply, it will assess whether the likely negative consequences for consumers will outweigh the negative consequences of imposing an obligation to supply, over time. The Commission states that consumer harm will arise where competitors foreclosed by the dominant undertaking are, as a result, prevented from bringing to market innovative goods or services and/or where follow-on innovation is likely to be stifled, especially where the undertaking requesting the supply intends to produce new or improved goods or services (and not simply to duplicate those of the dominant undertaking) for which there is potential consumer demand, or where the requesting undertaking is likely to contribute to technical development. In this respect, the Commission’s guidance directly reflects the case law as extended by the Commission in its Microsoft decision of 2004 on refusal to supply interoperability data, which was upheld by the European Court of First Instance in September 2007.
Impact of the guidance
The guidance will be used by the Commission in current and future abuse of single dominance cases, and brings the Commission’s Article 82 policy in line with Article 81 and merger cases in using an economics-based approach. The guidance contains some departures from case law. Whilst the guidance sets out the Commission’s enforcement policy the Courts can be expected to follow the case law. The national courts will also follow the current case law, at least until the Commission has adopted formal decisions to apply the principles set out in the guidance. National competition authorities such as the OFT are likely to examine abuse of dominance cases in line with the Commission guideline.