On October 9, 2007 Canada’s Competition Bureau released for public comment revised draft guidelines (Draft 2007 Guidelines) on the Bureau’s enforcement approach to the predatory pricing provisions of the Competition Act (Act). The business and legal community should welcome the Draft 2007 Guidelines as they clarify the Bureau’s enforcement approach on a number of issues following a long period of uncertainty about when and how the criminal predatory pricing provisions of the Act are to be applied.
Most significantly, in our view, the Draft 2007 Guidelines clearly indicate that the Bureau will analyze complaints about alleged predation under the civilly reviewable abuse of dominance provisions of the Act (sections 78 & 79) and that only in limited circumstances will the Bureau prosecute under the criminal predatory pricing provisions (section 50(1)(c)). The Bureau’s position on this issue reflects modern economic thinking on the appropriate enforcement approach to predatory pricing practices. Importantly, the Draft 2007 Guidelines also reaffirm the role of recoupment in predation cases, and provide greater and much-desired clarity to the cost analysis applied to assess whether pricing is “unreasonably low.”
Distinguishing between predatory pricing and aggressive pricing that is “pro-” rather than anti-competitive is fraught with difficulties. As price competition resulting in lower prices is a fundamental component of a competitive marketplace, there has been considerable debate about whether continuing to treat predation as a criminal offence under section 50(1)(c) of the Act risks chilling legitimate price competition. In addition, others have focussed on the concern that the predatory pricing provisions may be used to protect inefficient competitors rather than the process of competition. As a result of these concerns, the proposals to amend the relevant provisions and the guidelines which reflect the Bureau’s enforcement practice have been the subject of vigorous and often divisive debate
Predatory pricing is addressed in a specific criminal provision of the Act as well as by the broader civil abuse of dominance provisions of the statute. Under section 50(1)(c), it is illegal to engage in a policy of selling products at unreasonably low prices if the policy has the effect or tendency of substantially lessening competition or eliminating a competitor or is designed to have that effect. In addition, under sections 78 and 79, predatory or below cost pricing can be an anti-competitive practice which, if engaged in by a dominant firm, may result in civil enforcement action if it is or is likely to result in a substantial lessening or prevention of competition.
The Bureau published its original Predatory Pricing Enforcement Guidelines in 1992 (1992 Guidelines). The 1992 Guidelines technically remain in effect, although they no longer reflect the Bureau’s enforcement approach in a number of respects. For example, in Canada(Director of Investigation and Research) v. Air Canada in 2003, the Bureau advocated the use of the “avoidable cost” standard of measurement and this was endorsed by the Competition Tribunal. However, the 1992 Guidelines state that the “average total cost” and “average variable cost” standards of measurement will be used by the Bureau.
Revised draft Enforcement Guidelines for Illegal Trade Practices: Unreasonably Low Pricing Policies Under Paragraphs 50(1)(b) and 50(1)(c) of the Competition Act (Draft 2002 Guidelines) were released for public comment in 2002. The Draft 2002 Guidelines were never finalized, likely as a result of broad criticism about certain aspects of the proposed approach and the subsequent legislative proposal in 2004 (as part of Bill C-19, which died on the Order Paper in November 2005) to repeal paragraph 50(1)(c) of the Act. That proposal would have left predatory pricing conduct to be examined solely under the abuse of dominance provisions. A non-criminal approach to predatory pricing was recommended by the House of Commons Standing Committee on Industry Science and Technology. New legislative amendments to implement this aspect of Bill C-19 have not been proposed to date.
Highlighted below are the principal features of the 1992 Guidelines and the Draft 2002 Guidelines, reflecting the Bureau’s evolving enforcement approach to predatory pricing.
The 1992 Guidelines set out a two-stage analysis of predation complaints:
Stage one determines whether the alleged predator has sufficient market power to unilaterally affect industry pricing and whether the predator will be able to recoup losses in the future. Stage two examines the relationship of the alleged predator’s price to its cost of production. For Stage 2, the 1992 Guidelines state that the Bureau will use the average variable cost/average total cost measures to assess whether pricing is unreasonably low. Average variable cost includes the costs of labour, materials, energy, promotional allowances, use-related plant depreciation and all other costs that vary with the levels of output. Average total cost is described as the sum of average variable cost and average fixed costs; that is, costs associated with investment in real plant and machinery and any other fixed assets which do not vary with output produced.
A price set at or above the average total cost of the alleged predator will not be regarded as unreasonably low and a price set below the average variable cost of the alleged predator is likely to be regarded as unreasonably low, unless there is a clear legitimate business justification such as the need to sell off perishable inventory. With regard to prices set somewhere between average total cost and average variable cost, the Commissioner’s conclusion about their reasonableness will depend on the surrounding circumstances.
Draft 2002 Guidelines
The Draft 2002 Guidelines proposed significant changes in the Bureau’s enforcement approach, including the following:
- Elimination of Recoupment. The Bureau proposed that the ability to recoup losses would no longer be considered an essential element of the offence. Rather, it would be considered as one of many factors for determining whether unreasonably low anti-competitive pricing policies have been adopted.
- Avoidable Cost Test. The Bureau proposed, in determining whether a price is unreasonably low, to use an “avoidable cost” test rather than the average variable cost and average total cost test used in the 1992 Guidelines. Generally, “avoidable costs” are all those costs that can be avoided by not producing the good or service in question.
The Draft 2002 Guidelines were never finalized.
Draft 2007 Guidelines
The Draft 2007 Guidelines provide greater clarity on a number of issues including: when conduct will be reviewed under the criminal predatory pricing provision rather than under the civil abuse of dominance provision, the role of recoupment in the analysis, and the measure of costs and the cost analysis that will be used to assess whether pricing is unreasonably low.
- Civil vs. Criminal. The Draft 2007 Guidelines state that complaints regarding predatory conduct will be examined under the civil abuse of dominance provisions and that examinations and inquiries under the criminal predatory pricing provisions will generally be reserved for egregious or repeat conduct. The Bureau may determine at any point that conduct merits examination under the criminal predatory pricing provisions (i.e., the Bureau is not bound by selecting to proceed initially on a civil track). However, the Bureau would not generally pursue below cost pricing as a criminal matter, and would only advocate a criminal prosecution in the most egregious cases where there is no question that the evidence is sufficient to make out a case beyond a reasonable doubt.
- Recoupment is Back. The Bureau has clarified that in addition to a finding that the alleged predatory firm possesses market power, recoupment is a central element of a predatory pricing case relevant to both the question of whether the alleged predator has market power and whether the conduct is or is likely to result in a substantial lessening or prevention of competition. This is a welcome clarification, given that it is difficult to see how a below-cost pricing strategy that does not (or would not be likely to) result in higher prices, lower quality or reduced choice is harmful to competition.
However, interestingly, the Draft 2007 Guidelines propose a much broader interpretation of recoupment than suggested by the Bureau in its 1992 Guidelines. The Draft 2007 Guidelines state that recoupment can be achieved by “charging prices above competitive levels or achieving another anti-competitive objective” (emphasis added). Examples of anti-competitive objectives cited in the Draft 2007 Guidelines include: preserving the long-term stability of an existing market structure, raising barriers to entry by acquiring a “reputation for predation,” coercing participation in an illegal conspiracy, or establishing an industry standard to exclude others or maintain market control.
In addition, the Draft 2007 Guidelines appear to suggest that recoupment could result from a rival increasing its prices, or becoming less aggressive or otherwise restraining its competitive activities, following a period of discipline by a predatory firm. The Draft 2007 Guidelines also indicate that losses incurred in one market may be recouped by exercising market power with respect to another product or geographic market(s).
The Draft 2007 Guidelines do indicate that the Bureau will consider whether there are factors that reduce the probability of recoupment, such as the existence of large, sophisticated customers. However, the Bureau’s proposed approach to recoupment suggests that as a practical matter, the ability to recoup losses would be assumed following a finding that a firm has market power (based on factors such as market share and barriers to entry) and lacks a pro-competitive business justification for below cost pricing. The more liberal interpretation of recoupment reduces the likelihood that the Bureau would fail to make out a predatory pricing case due to a difficulty in demonstrating that a firm would be able to recoup its losses following a period of below cost pricing.
- Measurement of Cost. The Bureau has confirmed that in carrying out the price-cost analysis, it will use the average avoidable cost test instead of the average variable cost and average total cost tests. The Draft 2007 Guidelines provide more detailed guidance than that contained in the Draft 2002 Guidelines on what avoidable costs entail, now indicating that avoidable costs generally include:
i) labour, materials, energy, use-related plant depreciation, promotional allowances and other variable costs;
ii) the non-sunk portion of product-specific fixed costs, otherwise known as “quasi-fixed costs;” and
iii) incremental fixed and sunk costs associated with sales generated by the firm during the period the low pricing policy is in place.
The Draft 2007 Guidelines also confirm that, where a firm produces multiple products, common costs may be treated as unavoidable and need not be covered in prices charged for individual products. The Draft 2007 Guidelines also clarify over what period costs are to be calculated (generally, the Bureau will direct its price/cost analysis to the time period during which the predatory pricing policy is alleged to have occurred).
With respect to the treatment of bundled products, the Draft 2007 Guidelines state that a product market may consist of a bundle of products in certain markets or industries characterized by multi-product firms. However, the Draft 2007 Guidelines fall somewhat short by not addressing the question of how the Bureau will apply the predatory pricing provisions to a situation where one firm is selling a competitive product as part of a bundle and a single product firm complains that such activity is effectively prohibiting it from competing or forcing it out of the market, thereby resulting in a substantial lessening of competition.
For example, Firm A sells product y and Firm B, having a “dominant” position in product x, sells products x & y separately and as a bundle for a substantial discount such that the price of the bundle is only marginally greater than the price at which Firm A is selling product y. Firm A claims (likely under the abuse of dominance or tied selling provision) that Firm B is engaging in anti-competitive activity including predatory pricing with respect to product y (the product both Firm A and Firm B sell).
A key issue in determining whether pricing of the competitive product (product y) is below cost is whether the discount given by Firm B on the entire bundle of products should be wholly allocated to product y. Most recently, consistent with the recent recommendation of the U.S. Antitrust Modernization Commission but contrary to an earlier decision (LePage’s, Inc. v. 3M), the U.S. Ninth Circuit decided in Cascade Health Solutions v. PeaceHealth that the discount on the bundle should be allocated entirely to the competitive product. While clarity on this point would be welcome, the Bureau may wait for the conclusion of the litigation in Canada Pipe (where alleged anti-competitive bundling practices are at issue) before taking a position on this matter.
Other aspects of the Draft 2007 Guidelines that are worth noting include:
- Profitability Impact. Before looking at costs (i.e., determining whether a firm has engaged in unreasonably low pricing), the Bureau will first determine whether the complainant’s business in the relevant market is, or is likely to become, unprofitable as a result of the alleged predatory conduct. Note, however, that the Draft 2007 Guidelines indicate that it is not necessary to establish that the pricing policy of a rival(s) is the sole reason why the profitability of the complainant’s business in the relevant market has been or could be reduced. The inclusion of this threshold requirement for pursuing a case indicates that the Bureau will continue to investigate predatory pricing in response to complaints, rather than proactively, and that it will pursue complaints only where the profitability of a competitor of the alleged predator has been affected.
- Price Matching et al. The Draft 2007 Guidelines confirm the approach taken by the courts on a number of points, and state that matching (as opposed to beating) a competitor’s price will ordinarily be treated as a reasonable business justification for pricing below average avoidable cost and that selling at prices which are above cost cannot constitute predatory pricing. Other potential justifications for below cost pricing listed in the Draft 2007 Guidelines include selling off excess, obsolete or perishable products and effecting promotional pricing to induce customers to try a new product.
Consultation Process and Public Comment Period
The Competition Bureau has requested comments on the Draft 2007 Guidelines by January 18, 2008. All comments received will be made available to the public and posted on the Bureau’s website, except where confidentiality is specifically requested. Osler, Hoskin & Harcourt LLP will be providing comments to the Bureau on the Draft 2007 Guidelines.