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 continues the more economics-based approach to the enforcement of EC competition law. The Commission’s economics-based approach in the guidance has already been used in recent Article 82 cases, including Wanadoo, Microsoft and Télefonica. Cases now under consideration are the alleged anticompetitive actions by IBM in breach of Article 82, in tying the sale of its operating system to its mainframe hardware, and withholding patent licences and certain intellectual property to the detriment of mainframe customers, and the current investigation into Microsoft in relation to alleged illegal tying of various software products (in particular, Microsoft's Internet Explorer) with its dominant Windows operating system.

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 finalised guidance paper is 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 i.e. where competitors are excluded from the market. 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.

Dominance

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. Both the size of market share and the period of time that the share is held are important preliminary indicators of dominance.

Generally, the ownership of an Intellectual Property Right (IPR) will not in itself place the owner in a dominant position. It may, however, be an important factor in determining whether the owner can impede effective competition, and in certain circumstances the IPRs concerned may be of such importance for competition on the market that their possession alone comes close to conferring dominance.

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 longterm 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 pricebased 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 productspecific fixed costs made before the period in question; therefore the LRAIC is usually above the AAC. Failure to recover LRAIC indicates that the dominant firm 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.

Exclusive dealing

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, 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.

Tying and bundling

Tying and bundling may be used by a dominant firm to foreclose the market. Tying occurs where customers purchasing one product, the tying product, 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; 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 costeffective way, a dominant firm can use this strategy to foreclose the market. As an example,Microsoft was found to have breached Article 82 by making the Windows client personal operating system conditional on the acquisition of Microsoft’s Window Media Player software, (bundling) which foreclosed the market for media player software. The risk of anticompetitive 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, 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.

Predation

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”, 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. 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 does not consider it necessary to show that competitors have actually left the market in order to show that there has been anticompetitive foreclosure. This is because 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 otherwise have been. However, it is not necessary to show that the dominant firm will be able to increase its prices above the prepredation level, it may be sufficient that the conduct would stop or delay a fall in prices that would have otherwise occurred.

It may be easier to predate if specific customers are selectively targeted with low prices, as this will limit losses. 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, compared with the existing case law.

Refusal to supply and margin squeeze

The concept of refusal to supply includes 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 “marginsqueeze”. 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 firm’s 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 to 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. 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 to find the termination of an existing supply arrangement 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.

In examining the likely impact of a refusal to supply, the Commission will assess whether the likely negative consequences for consumers will outweigh the negative consequences of imposing an obligation to supply, over time. Consumer harm will arise where, as a result of being excluded from the market, competitors are prevented from introducing innovative goods or services and/or where follow-on innovation is likely to be stifled. In particular, where competitors intend 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 are likely to contribute to technical development. In this respect, the Commission’s guidance directly reflects the case law as extended in itsMicrosoft decision of 2004 on refusal to supply interoperability data, thus preventing competitors from using this information to develop innovative competing products, therefore foreclosing the market. That decision was upheld by the European Court of First Instance in September 2007.

Impact of the guidance

The guidance contains some departures from case law. Whilst the guidance sets out the Commission’s enforcement policy, the European Courts can ordinarily 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.