On 22 May 2008 the Court of Appeal dismissed an appeal brought by Dwr Cymru Cyfyngedig (“Dwr Cymru”) against the Competition Appeals Tribunal (“CAT”) judgments in the Albion Water v Water Services Regulation case (Ofwat). The Court of Appeal held that the CAT had not applied the wrong legal test in finding that Dwr Cymru had imposed an unlawful margin squeeze and also that the CAT had not erred in law by finding that it had jurisdiction to decide whether Dwr Cymru was in a dominant position in the relevant market at the material time.
The decision arose following a complaint to the Director General of Water Services (the “Director General”; now the Water Services Regulation Authority (the “Authority”)) by Albion Water Limited (“Albion”) in respect of the cost of using the water supply network of Dwr Cymru to carry non-potable water purchased from an alternative supplier (United Utilities), rather than Dwr Cymru, to Shotton Paper Mill on Deeside. Albion complained that the quotation (i.e. the “common carriage cost”) from Dwr Cymru to transport the non-potable water supplied by United Utilities was excessive and, therefore, discriminatory because it gave rise to a margin (or price) squeeze which was an abuse of a dominant position and therefore a breach of Chapter II of the Competition Act 1998. The Director General dismissed the complaint and Albion appealed to the CAT. The CAT found inter alia that the Director General’s conclusion on the issue of margin squeeze was “erroneous in law and incorrect, or at least insufficient…”, although it remained silent on what consequential action it should take in relation to the margin squeeze and whether or not it in fact had jurisdiction to make a decision on it. Dwr Cymru sought a further appeal and was granted permission to appeal the decision to the Court of Appeal in order to decide the correct legal test for finding a margin squeeze and whether or not the CAT had jurisdiction to decide the issue of dominance.
Whilst margin squeeze is a recognised form of abuse of a dominant position, it is a concept currently being clarified by recent developments in both UK and EC competition law. There have been various cases, both at EC and domestic level, which have discussed margin squeeze and the judgments have confirmed that there is no definitive test to be applied in all circumstances. However, there are features common to the various open-ended formulations which are being utilised by the respective courts. The common features (in broad terms) necessary for margin squeeze, as noted in the Dwr Cymru case, are:
- the existence of two markets (an upstream market and a downstream market);
- a vertically integrated undertaking which is dominant on the upstream market and active (whether or not also dominant) on the downstream market;
- the need for access to an input from the upstream market in order to operate in the downstream market; and
- the setting of upstream and downstream prices by the dominant undertaking that leave an insufficient margin for an efficient competitor to operate profitably in the downstream market;
although, if there is an objective justification for the conduct in question it will not be considered abusive behaviour.
The common margin squeeze feature of whether an efficient competitor can operate profitably raises two possible tests. Firstly, the “equally efficient competitor” test, which focuses on the costs of the dominant undertaking’s own downstream operation; and, secondly, the “reasonably efficient competitor” test, which focuses on the costs of an actual or potential competitor in the downstream market.
Under the “equally efficient competitor” test, one looks at the costs of the dominant undertaking’s downstream activities in order to determine the sufficiency of the margin between upstream and downstream prices. The focus is on whether the dominant undertaking would be able to trade profitably if it had to pay the upstream price as an internal transfer price for its own downstream price. Therefore, if the dominant undertaking could not trade profitably then it would mean that an equally efficient competitor would not be able to trade profitably, and consequently such conduct would result in a margin squeeze. The “reasonably efficient competitor” test, on the other hand, looks at the margin between the prices charged to actual or potential competitors on the downstream market for access (including the dominant undertaking’s own downstream operations, if any) and the prices which the undertaking actually charges in the downstream market. If the margin is insufficient to allow a reasonably efficient service provider in the downstream market to obtain a normal profit then it amounts to a margin squeeze, unless the dominant undertaking can show that its downstream operation is exceptionally efficient.
The Court of Appeal discussed these two tests at great length noting that OFT and European Commission guidance indicates that either test could be used, although the Court of First Instance in the Deutsche Telekom case endorsed, very clearly, that the “equally efficient competitor” test is to be preferred over the “reasonably efficient competitor” test. This position has remained unchanged following the Dwr Cymru case given that the Court of Appeal did not explicitly deal with which test should have been applied but merely stated that the ultimate ruling of the CAT was correct irrespective of the test applied: “If the [CAT] was wrong to apply the “reasonably efficient competitor” test, nothing turns on it, since it reached the same decision by reference to the alternative ‘equally efficient competitor’ test.”
It was also argued, although unsuccessfully, that there were additional features required for market squeeze. These were: firstly, a ‘transformative activity’ (or some ‘added value’) by the competitor on the downstream market is required; secondly, some evidence of ‘avoided costs’ associated with the transformative activity by the dominant undertaking; and lastly, some evidence of the competitor displacing (rather than merely duplicating) the activities of the dominant undertaking in the downstream market, thereby relieving the incumbent of the costs associated with the relevant activities. However, the Court of Appeal expressly concluded that these were not necessary features of the margin squeeze test and concluded that the CAT had not applied the wrong legal test in finding that Dwr Cymru had imposed an unlawful margin squeeze.
Source: Dwr Cymru Cyfyngedig v Albion Water Ltd (Water Services Regulatory Authority and others intervening)  EWCA Civ 536, 22 May 2008