The General Court clarifies the legal test for non-coordinated effects in oligopoly cases
On 28 May 2020, in a landmark judgment the General Court of the European Union annulled the European Commission's 2016 decision to block the proposed merger between Hutchison 3G UK with its brand “Three” and Telefónica UK with its brand “O2”.
Facts of the case
On 11 September 2015, Three notified the European Commission that it was acquiring O2. At this time, since there were four mobile network operators (MNOs) present on the mobile telephone market in the UK, the merger would have reduced this number to three. A particularity of the market was that both Three and O2 shared their networks through network-sharing agreements, each with another of the remaining two MNOs. Following the merger, Three/O2 would have been connected to all other MNOs on the market.
Following an intensive review and rejecting remedies offered by the parties as insufficient, the Commission blocked the merger on 11 May 2016. Firstly, the Commission decided that the reduction from four to three competitors would probably lead to an increase in prices for mobile telephone services in the UK and a restriction of choice for consumers. Secondly, the Commission was concerned that since both parties participated in competing network-sharing agreements prior to the merger, the development of the mobile network infrastructure in the UK would likely be hindered. Thirdly, the Commission considered that on the wholesale level, the merger would have reduced the numbers of mobile network operators being prepared to host other mobile operators without its own network – so-called Mobile Virtual Network Operators (MVNOs) and Service Providers – on their networks. Importantly, the Commission did not consider that the merger would lead to single dominance by Three/O2 or collective dominance of the three remaining MNOs by increasing the likelihood of the companies coordinating their behaviour. Rather, all three theories of harm related to non-coordinated effects in the oligopoly situation on the UK market.
Under the old EC merger control regulation (Council Regulation (EEC) No 4064/89 of 21 December 1989), the Commission could only prohibit mergers that created or strengthened a dominant position that resulted in a significant impediment to effective competition. Consequently, in situations without a single dominance, the Commission could only intervene if companies in an oligopoly market could be qualified as collectively dominant. However, in regard to such collective dominance through coordinated effects, the Commission was confined by the General Court’s judgment in the Airtours Case (Case T-342/99 DEP, 28 June 2004, Airtours v Commission), which set out strict conditions for finding collective dominance in accordance with economic theory. The lack of ability to examine oligopoly cases also regarding unilateral (i.e. non-coordinated) effects was widely considered as a “gap” in the old merger regulation.
When the merger control was reformed in 2004 (Council Regulation (EC) No 139/2004 of 20 January 2004), it aimed, inter alia, to close that gap. The condition of dominance in the substantive test was removed. However, dominance remained as an example ("in particular..."). In the context of the reform of the Merger Regulation the Commission also published guidelines it had drafted with the help of the back then newly created chief economist team which set out the factors the Commission considers in its assessment of mergers between competitors (horizontal merger guidelines).
Judgment by the General Court
As it is the first time a European Court had to deal with non-coordinated effects in oligopoly situations, the Court dedicated the first part of its judgement to an interpretation of the law and definitions of legal standards. For this purpose, the Court first examined the circumstances that led to the change in the new merger regulation and noted that it was adapted to achieve an extension of the scope of the review ("closing the gap"), but also to maintain and strengthen the concept of a dominant position and to increase legal certainty. The new regulation should allow the Commission to catch mergers in oligopolistic markets that – without creating or strengthening an individual or collective dominant position – have led to a situation where companies could determine the parameters of competition (i.e. becoming a price maker instead of remaining a price taker post-merger). In this context, the Court refers to recital 25 of the new merger control regulation, which says that while “many oligopolistic markets exhibit a healthy degree of competition under certain circumstances, concentrations involving the elimination of important competitive constraints that the merging parties had exerted upon each other, as well as a reduction of competitive pressure on the remaining competitors, may, even in the absence of likelihood of coordination between the members of the oligopoly, result in a significant impediment to effective competition". The Court concludes that while the revised regulation now allows the Commission to catch cases without finding dominance, the circumstance that a merger takes place in a tight oligopoly situation is not sufficient for a prohibition decision. Instead, the test for non-coordinated effects in oligopolistic markets necessarily requires the elimination of important competitive constraints that the merging parties had exerted upon each other. The reduction of competitive pressure on the market was not sufficient for demonstrating for a prohibition of a merger – such an interpretation would lead to the Commission being able to prohibit any merger in an oligopoly at its own discretion. It is precisely such a discretionary approach that the Commission has been repeatedly accused of in recent times.
Burden of proof and standard of proof
When investigating the case, the Commission had initially pursued a theory of harm based on coordinated effects (i.e. joint dominance by the three remaining MNOs post-merger). However, the Commission did not base the final decision on this theory. The Court made it clear in this respect that the standard of proof to establish non-coordinated effects on an oligopolistic market is the same as establishing coordinated effects. This means that the Commission must produce “convincing evidence”. In other words, if the Commission concludes that the evidence found is not sufficient for a joint dominance case, it cannot simply switch the theory of harm and use the same evidence to build a unliteral effects case. Regarding the standard of proof in such cases, the Court defined the prospective analysis that the Commission must conduct. Firstly, the Commission must assess what will be the most likely future conduct by the merged entity and other companies following the merger. The second step is an assessment of whether that future conduct will probably lead to a situation in which effective competition in the relevant market is significantly impeded.
When investigating more complex theories of harm, the Court gives the Commission the benefits that its assessment is based on a hypothesis. Nevertheless, it expects that the theories of harm must appear sufficiently realistic and plausible and cannot be solely theoretical. The Court sets the standard for the Commission to demonstrate with a "strong probability" the existence of significant impediment following the concentration. This standard is stricter than "more likely than not", which the Commission had favoured, but less strict than "being beyond all reasonable doubt".
First theory of harm: non-coordinated effects on retail market
After setting the stage in this way, the Court examined the theories of harm and – unsurprisingly after that introduction – rejected all of them.
The Commission found that the merger would have a negative effect on prices and the quality of services for consumers. It based this theory of harm on its finding that the merger would have eliminated Three as an important competitive force and that Three and O2 were close competitors. The theory was supported by quantitative evidence, but the Court found that none fulfilled the legal standard.
Important competitive force (ICF)
According to the Commission’s horizontal merger guidelines, a merger can create negative competitive effects if it eliminates an “important competitive force”. The guidelines explain that some firms have more of an influence on the competitive process than their market shares or similar measures would suggest. A merger involving such a firm may change the competitive dynamics in a significant anti-competitive way, particularly when the market is already concentrated. In its decisional practice, the Commission has relied heavily on this concept to justify competitive concerns in oligopoly situations. Also, in the case at hand the Commission had claimed that Three constituted an important competitive force that would be eliminated by the merger. However, according to the Court, not only this finding but also the general approach pursued by the Commission concerning the concept of the important competitive force was erroneous. The Court points out that the Commission confined itself to finding that the undertaking in question had attributed to competition on the market. However, such an approach, which is solely based on a reduction of competitive pressure, would de facto give power to the Commission to prohibit any horizontal merger in an oligopolistic market and would infringe the principle of legal certainty. The Commission was criticised for confusing three concepts: the concept of significant impediment to effective competition as the substantive test set out in the merger control regulation; the elimination of an important competitive constraint stated in recital 25 of the EU Merger Regulation; and the elimination of an important competitive force in the Commission's own horizontal merger guidelines. Instead, the concept of important competitive force must be interpreted in such a way that the removal of such a company from the market leads to an elimination of an important competitive constraint as described in recital 25 of the Merger Regulation and thus fulfils the significant impediment to the effective competition test. It follows from this that to qualify as an important competitive force, the company in question needs to stand out from its competitors in terms of impact on competition. The evidence the Commission sought to rely on to show that Three played such a role was clearly not sufficient, which the Court set out in detail without sparing criticism of the Commission. For example, the Court pointed out that Commission had relied on Three’s steady growth – a “painfully slow” growth of 1% per year.
Closeness of competition
The Commission’s horizontal guidelines explain that products may be differentiated within a relevant market such that some products are closer substitutes than others. The higher the degree of substitutability between the merging firms' products, the more likely the merging firms will raise prices significantly. Thus, the fact that rivalry between the parties has been an important source of competition on the market may be a central factor in the analysis of the competitive effects of a merger. Similar to the "important competitive force" concept, "closeness of competition" is an argument that the Commission regularly uses to raise competition concerns in oligopoly markets. Also, in the case of Three and O2, the Commission had classified them as close competitors to justify its prohibition decision.
The Court did not accept this argument either. Again, it sets out that the horizontal merger guidelines the Commission relied on must be read in light of recital 25 of the merger control regulation, which requires the elimination of important competitive constraints the merging parties had exerted upon each other. As in oligopolistic markets, everyone is necessarily close to some degree, closeness can only be relevant if it results in a competitive constraint, which the merger threatens to eliminate. The parties must therefore be “particularly close” competitors. The Court found that the Commission had failed to provide evidence that the merging parties met this requirement. First of all, the Court questioned whether the products on the mobile telephone market are sufficiently differentiated to generate relevant effects through "closeness of competition". (The Commission itself had taken the view during the proceedings that the products were relatively homogenous when it still pursued its theory of harm based on joint dominance, which is unlikely in cases of highly differentiated markets). In any event, the evidence produced by the Commission only showed that all companies on the market were somehow “close” – which is not enough since any four-to-three mergers could be prohibited.
Quantitative analysis of pricing effects
The Commission further supported its decision in the present case with a quantitative economic analysis, the result of which suggested that “the transaction is likely to generate an incentive for the merged entity to significantly increase prices". More specifically, the Commission had applied a GUPPI (Gross Upward Pricing Pressure Index) analysis, which measures the upward pricing pressure following from a merger based on diversion ratios and margins of the parties, taking into account (unlike the basic UPP-test) the likely reactions of competitors. The Court rejected criticism from the parties that the analysis always necessarily predicts a price increase and is therefore generally irrelevant, pointing out that the analysis applied by the Commission was more sophisticated and generally a suitable tool for the analysis. However, with respect to the application of the analysis in the present case, the Court first noted that the Commission itself had included a disclaimer in its decision according to which “the results should not be interpreted as providing a precise quantification of the exact increase in prices […] but only as an approximation of the change in pricing incentives…" It concluded that the Commission did not regard the quantitative analysis as decisive evidence. Moreover, the Court found that the Commission had not demonstrated that a quantified price increase would be significant. While the Court did not require the Commission to apply a de minimis or safe-harbour threshold, it held that the Commission must demonstrate any increase with a sufficiently high degree of probability. Therefore, when the Commission decides to use quantitative analyses, it must take into account all the relevant factors, which may affect the price level, including standard efficiencies that could arise from the merger. In this respect, the Court clarified that these standard efficiencies as a component of a quantitative model must be distinguished from particular efficiencies, which are taken into account in the overall competitive appraisal of the concentration, in order to ascertain whether they are likely to counteract the restrictive effects of the concentration. For these efficiencies, the burden of proof lies with the parties. In conclusion, the Court found that the quantitative analysis carried out by the Commission lacked probative value and that the Commission could not rely on it.
Therefore, the Commission's whole first theory of harm collapsed. Importantly, the Court did not only reject the individual pieces of evidence submitted by the Commission. It also raised the fundamental point that the Commission did not at any point specify in the contested decision whether the non-coordinated effects identified would be ‘significant’ or would result in a significant impediment to effective competition in the present case.
Second theory of harm: Negative effect on infrastructure
The Court also did not find that the Commission's second theory of harm constituted a SIEC.
The Commission relied in its prohibition decision on a novel theory of harm according to which the development of the infrastructure of the networks would be hindered because the merged entity would be a party to both networks. The Commission was concerned that since Three and O2 each had a network-sharing agreement with each of the other MNOs, the merged party would be able to have an overview of both network plans and could abuse this position. The Court made clear that the mere fact that a theory is innovative does not, in itself, lead to the conclusion that it is unlikely or unfounded. The Commission does not need to limit its analysis to theories of harm developed in previous decisions. But the more prospective the analysis with the chains of cause and effect dimly discernible, uncertain and difficult to establish, the more demanding the evidence produced by the Commission must be. The Commission’s analysis did not meet this standard. In the Court’s view, the reasoning of the Commission was too speculative and in particular did not realistically assess the impact on competition and competitors. The theoretical scenario that the combined entity would continue to operate two network sharing agreements, which could lead to negative competitive effects through the connection of all MNOs on the market, was clearly not sufficient for the Court to justify blocking the transaction. Neither was the possible negative effect on the respective partner of the network-sharing agreement, which Three / O2 would possibly choose to terminate. In this context, the Court re-stated that EU competition rules are primarily intended to protect the competitive process as such, and not competitors.
Third theory of harm: non-coordinated effects on the wholesale market
The third theory of harm applied by the Commission related to the wholesale market on which MNOs supply services to mobile operators that do not own a network, but use the MNOs infrastructure to provide their service. Again, the Commission had qualified Three as an important competitive force, the loss of which would have placed virtual operators in a weaker negotiating position. And again, the Court rejected this qualification of Three, pointing out that the mere fact that it was considered an important competitor was not enough.
Implication of CK Telecoms
It is no coincidence that the judgment repeatedly cites the landmark Airtours judgment, which re-defined the assessment of coordinated effects or joint dominance in EU merger control. In CK Telecoms, the Court has in a similar way provided the Commission with clear guidance for the assessment of unilateral effects in oligopoly situations. The key message from the Court is that the EU Merger Regulation allows the Commission to catch anti-competitive mergers in non-dominance cases, but that in such cases the Commission must produce convincing evidence that the merger will lead to the elimination of important competitive constraints and will result in a significant impediment to effective competition. The Court accepted the concepts set out in the Commission’s guidelines but pointed out that they have to be interpreted in light of the EU Merger Regulation and its substantive test. An interpretation of the concepts of "important competitive force" and "closeness of competition", which would allow the Commission to qualify any company in an oligopoly market as such a force or as a close competitor of the other merging party, is not compatible with the EU Merger Regulation. If this were sufficient, it would give the Commission full discretion to prohibit any merger in an oligopoly situation and would be in breach of the principle of legal certainty. In practice, the Commission must now sharpen these concepts. It can be expected that their scope of application will be more limited than in the past. Regarding quantitative economic analysis, the Commission has to decide on the evidential value it wants to give the results of such analyses. If the Commission wants to base a prohibition on such an analysis (because there is no or insufficient qualitative evidence), it has to take into account all relevant factors and cannot only look at individual effects. For more complex theories of harm, the Court clarified that the Commission is only expected to rely on them if it can produce convincing evidence to demonstrate with a strong probability the existence of significant impediments to competition following the concentration.