Towards a more effects-based approach to understand the use of Dominant Position by a vertically-integrated undertaking

Picture Source: Vakilno1.com

–Adrika Bisen

(IInd year, Gujarat National Law University,

Gandhinagar)

The basic legal concept of dominance

The working definition of ‘dominance’ established in United Brands case is that “dominance relates to a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market. Such a position gives the dominant undertaking power to behave to an appreciable extent independently of its competitors, customers and ultimately of its consumers.”[1] This definition was cited with approval in Hoffmann-La Roche, although the Court of Justice added the caveat that “such a position does not preclude some competition, but enables the dominant undertaking, if not to determine, at least to have an appreciable influence on the conditions under which that competition will develop. Such an undertaking continues to act largely in disregard of the anti-competitive effects of its conduct as long as such conduct does not operate to its own detriment.”[2]

For the application of this principle, it is a precondition to define the ‘relevant market’ of the undertaking in question. The legal and economic concept of relevant market–“The concept of ‘relevant market’ is different from other definitions of market often used in other contexts. For instance, companies often use the term ‘market’ to refer to the area where it sells its products or to refer broadly to the industry or sector where it belongs.”[3] The relevant market is established by a combination of the market’s two dimensions –the relevant product market and the relevant geographic market

• The relevant product market– “comprises all those products and/or services which are regarded as interchangeable or substitutable by the consumer, by reason of the products’ characteristics, their prices and their intended use.”[4]
• The relevant geographic market– “comprises the area in which the undertakings concerned are involved in the supply and demand of products or services, in which the conditions of competition are sufficiently homogenous and which can be distinguished from neighbouring areas because the conditions of competition are appreciably different in those areas.”[5]

The basic economic concept of dominance

The economic concept of dominance does not fully correspond with the above legal definition. In economics, the notion of dominance is broadly associated with the concept of market power. A firm enjoys a dominant position if it has significant market power, i.e., if it is able to charge prices significantly above competitive levels or restrict output significantly below competitive levels for a sustained period of time. However, a firm may enjoy significant market power (i.e., setting supra-competitive prices), even if it cannot behave to an appreciable extent independently of its competitors, customers, and ultimately consumers. That is, for example, the case of all firms operating in oligopolistic markets. Their pricing policies are constrained both by the prices set by actual and potential competitors and the behaviour of their customers, who in most cases will cut down their consumption in response to a price increase. Strictly speaking, only a monopolist operating in a market protected by insurmountable barriers to entry and facing a completely inelastic demand would be able to behave independently of its competitors, customers, and consumers. The term “dominance” is also sometimes used in the economic literature to describe a situation in which a firm with market power (the “dominant” firm) competes with a number of smaller, price-taking firms (which comprise the so-called “competitive fringe”).[6] The dominant firm has the ability to set the market price, which is accepted by all members of the competitive fringe. But it cannot be said to be capable of behaving independently of rivals and consumers because it must take into account the aggregate capacity of the competitive fringe. The dominant firm enjoys market power because the competitive fringe cannot produce enough output to clear the market. However, its power to raise prices is restricted to its residual demand, i.e., the portion of market demand that cannot be satisfied by the fringe.

The central importance of dominance

Once the relevant market as discussed previously on which the allegedly dominant undertaking operates is defined, its potential dominance falls to be assessed. If dominance is not proven, no abuse can be made out, regardless of the anticompetitive effects of the conduct in question.  Although under Section 2 of The United States Sherman Act 1890, a firm that is not yet dominant may commit a violation if its conduct would lead to monopolisation or, in the case of attempted monopolisation, there is a dangerous probability that it would succeed in doing so. Thus, at least in theory, a firm with a small market share could violate Section 2 as long as there was a dangerous probability that its attempt to monopolise would eventually succeed. In contrast, it is essential under Article 102 of TFEU (Treaty on the Functioning of the European Union) to establish dominance at the time of the alleged abuse.[7] There exists a contrast between the Article 102 of TFEU and Section 2 of The United States Sherman Act 1890 because Article 102 policy has traditionally been influenced by the ‘ordo-liberal school’. In essence, this school of thought emphasises individual freedom as the primary objective for competition policy and considers that the presence of dominant firms weakens the competitive process and reduces the economic freedom of other market participants.[8]

Abuse of the Dominant position

It is prerequisite to understand the meaning of ‘vertical integration’ to further understand the abuse of a dominant position by a vertically integrated undertaking. ‘Vertical integration’ is when a company controls more than one stage of the supply chain. That’s the process businesses use to turn raw material into a product and get it to the consumer. There are four phases of the supply chain: commodities, manufacturing, distribution, and retail. A company vertically integrates when it controls two or more of these stages. There are two types of vertical integration. Forward integration is when a company at the beginning of the supply chain controls stages farther along. Examples include iron mining companies that own “downstream” activities such as steel factories. Backward integration is when business at the end of the supply chain takes on activities “upstream.” An example is when a movie distributor, such as Netflix, also manufactures content[9]. Once dominance in the relevant market by a vertically integrated undertaking is established, it’s important to note that sometimes the conduct of such an undertaking can give rise to various anti-competitive effects. One of the anti-competitive effects is margin squeeze or constructive refusal to supply. Margin squeeze occurs when a dominant firm in the upstream market sets the price of the input at such a level that those who purchase it do not have a sufficient profit margin to remain competitive in downstream market. Simultaneously, the dominant undertaking uses the same input to compete downstream against its purchasers of the input.[10] Constructive refusal to supply is generally liable to eliminate, immediately or over time, effective competition in the downstream market. The Guidance paper states that there exists a high incentive for the dominant firm to eliminate a competitor when:

(i) the dominant firm is not constrained (relative to its competitors in downstream market) from achieving more output at the upstream market;

(ii) there exists very little product differentiation in the downstream market; and,

(iii) the greater proportion of competitors is affected by the conduct of the dominant firm; the greater proportion of demand is diverted from the eliminated competitors to the advantage of the dominant firm.[11]

Although there might be an opportunity cost to the dominant firm in a margin squeeze or constructive refusal to supply case (e.g., raising the input price may reduce its sales and its customers may switch to other suppliers of the same input charging lower prices), so the extent of the opportunity cost may be an informational asymmetry between the dominant firm and rivals.[12]

Constructive refusal to supply falls under the ambit of ‘limiting production, markets or technical development to the prejudice of consumers’ as under Article 102(b).[13] It is not limited to practices causing direct consumer harm but also includes practices which are indirectly detrimental to the consumers through an impact on an effective competition structure.[14] The Court held that if a dominant undertaking strengthens its position in such a way that the degree of dominance reached, fetters competition, it shall be considered abusive.[15]

Leveraging concept

It is considered an infringement of laws governing competition in a country when a firm reserves to itself an ancillary activity which might be carried out by another undertaking as part of its activities on a neighbouring but separate market.[16] The infringing nature of leveraging by a monopolist firm has been challenged by the Chicago school, inspired by Augustin Cournot, a nineteenth century economist.[17] The Chicagoans contend that leveraging market power from one market to another is not necessarily anti-competitive as it often results in the saving of transaction costs and economies of scope. Consumers would not be harmed as a monopolist can only extract the monopoly price once, i.e. on the upstream market.[18] In order to assess the anti-competitiveness of a leveraging strategy in an economically sound manner, antitrust authorities should, therefore, follow a three step test[19]: the monopolist has incentives to expand its market power to an adjacent market (i), the monopolist’s conduct will get rid of competitors (ii) and the elimination of competitors is harmful to consumers (iii).

Economic freedom of dominant undertaking is threatened due to many regulations

Too many regulations governing the supply and production chain on the upstream and downstream market do not allow the dominant undertaking to realise an adequate return on the investments required to develop its input business. In the TeliaSonera case, TeliaSonera was not under a regulatory obligation to supply the upstream product to its downstream competitor and had done so voluntarily.[20] The Commission, however, observed that imposing an obligation is justified only in particular circumstances where a regulation compatible with Community law already imposes an obligation to supply on the dominant undertaking. The rationale behind this is that the necessary balancing of incentives has already been made by the public authority while imposing such an obligation to supply. However, it is not the case always as there is an exception to this principle where an obligation to supply has a negative effect on the dominant undertaking. If there is no duty to deal in the upstream market and no predatory pricing in the downstream market, then a firm is certainly not required to price both of these services in a manner that preserves its rivals’ profit margins.[21]

It was held that careful consideration must be given to the dominant firm’s economic freedom to contract with whosoever it wishes to.[22] In the Oscar Bronner case, the Commission has considered claims by the dominant undertaking that its own innovation will be negatively affected by the obligation to supply, thereby, harming consumers.[23] On the contrary, it is generally pro-competitive and in the interest of consumers to allow a firm to retain for its own use, facilities, which it has developed for the purpose of its business.[24] The mere fact that by retaining a facility for its own use a dominant undertaking retains an advantage over a competitor cannot justify requiring access to it. Also, competitors may be tempted to free ride on investments made by the dominant undertaking instead of investing themselves. Neither of these consequences would, in the long run, be in the interest of consumers, thereby contrary to Article 102 of the TFEU (Treaty on the Functioning of the European Union (Rome Treaty).[25]

Conclusion: Balancing of interests is necessary

In Commercial Solvent[26] the Commission considered that intervention on competition law grounds requires careful consideration where the conduct of a dominant undertaking is in question. One of the fundamental shortcomings of the current approach towards ‘dominance’ is that dominance is used as a shortcut to infer anticompetitive effects. This approach has attracted a lot of criticism over the years and has been regarded as very legalistic and interventionist. Article 102 of the TFEU as discussed above protects competitors rather than competition. One of the fundamental shortcomings in the current application of Article 102 is the virtual per se prohibition of certain practices once a firm is deemed to be dominant—in other words, dominance is used as a shortcut to infer anticompetitive effects. This can be misleading, as the implied link between dominance and effects does not always hold. The notion that the mere existence of dominant firms is dangerous for the competition is still deeply embedded in EU law.[27] A dominant firm is in effect regarded as the proverbial bull in a china shop—it must be restrained to prevent it from inflicting further damage to its already fragile surroundings. As formally established in Michelin (1983), a dominant firm has a ‘special responsibility not to allow its conduct to impair genuine undistorted competition on the common market’[28] This policy approach can be problematic. From an economics perspective, the competitive effects of any business practice will depend on, first, the type of practice in question, and second, the degree of market power of the firm in question. The current ‘one-size-fits-all’ dominance threshold—the traditional market share rule of thumb of 40–50% (combined with some indications of entry barriers) still seems to be the norm which has become problematic.[29]

Hence there has been a demand from various scholars for reform in Article 102 of E to move towards a more effects-based approach like the US in Various commentators have stressed the desirability of moving towards an approach that emphasises the actual or expected economic effects of allegedly abusive behaviour by dominant firms, rather than its form.[30] A move to some form of the effects-based test has been advocated. From an economics perspective, this would be a more appropriate approach towards ‘dominance’ as it would allow greater emphasis on efficiency and consumer welfare.

References:

[1] Chiquita, OJ 1976 L 95/1, confirmed on appeal in Case 27/76, United Brands Company and United Brands Continentaal BV v Commission [1978] ECR 207 (hereinafter “United Brands”), para. 65.

[2] See Vitamins, OJ 1976 L 223/27, confirmed on appeal in Case 85/76, Hoffmann-La Roche & Co AG v Commission [1979] ECR 461 (hereinafter “Hoffmann-La Roche”), para. 39. See also United Brands, ibid., para. 113.

[3] Commission Notice on the co-operation between the Commission and the courts of the EU Member States in the application of Articles 81 and 82 EC [2004] OJ C101/54, para 3.

[4] Commission Notice, para 7

[5] Commission Notice, para 7

[6] See GJ Stigler, “The Dominant Firm and the Inverted Price Umbrella” (1965) 8 Journal of Law and Economics 167.

[7] Robert O’Donoghue and A Jorge Padilla, The Law and Economics of Article 82 EC (1st edn, Hart Publishing 2006) 107.

[8] Reform of Article 82: where the link between dominance and effects breaks down (revisited),
available at (https://www.oxera.com/agenda/reform-of-article-82-where-the-link-between-dominance-and-effects-breaks-down-revisited/) (April 2015) (last consulted on May 11, 2019).

[9] Vertical Integration, Its Pros and Cons with Examples, available at (https://www.thebalance.com/what-is-vertical-integration-3305807) (last consulted on April 25, 2019).

[10] Napier Brown v British Sugar (Case IV/30.178) Commission Decision 1999/210/EC [1988] OJ L284/41. 

[11] Guidance on the Commission’s enforcement priorities in applying Article 82 of the EC Treaty to abusive exclusionary conduct by dominant undertakings [2009] OJ C45/7, para 85. 

[12] ibid 307.

[13] TFEU, art 102(b). 

[14] TFEU, art 4. 

[15] Case 6/72 Europemballage Corporation and Continental Can v Commission [1973] ECR 215. 

[16] Case 311/84, Télémarketing, 1985 ECR 3261. 

[17] Augustin Cournot, Researches into the Mathematical Principles of the Theory of Wealth (1838).

[18] Robin Cooper Feldman, Defensive Leveraging in Antitrust, 87 GEO. L.J. 3, 659-683 (2001).

[19] F. Lévêque, Innovation Leveraging and Essential Facilities Interoperability licensing in the EU Microsoft case, available at (http://www.cerna.ensmp.fr/Documents/FL-MsWorldCompetition.pdf) (2005) (last consulted on April 15, 2019).

[20] Case C-52/09 Konkurrensverket v TeliaSonera Sverige AB [2011] CMLR 18.  

[21] Catherine Barnard and Okeoghene Odudu, Cambridge Yearbook of European Legal Studies, vol 13 (Hart Publishing 2011) 177. 

[22] Case C-7/97 Oscar Bronner v Mediaprint [1998] ECR I-7791, Opinion of AG Jacob, para 57. 

[23] Case C-7/97 Oscar Bronner v Mediaprint [1998] ECR I-7791, paras 43-46. 

[24] Oscar Bronner (n 29), Opinion of AG Jacob, para 57. 

[25] Jeffrey Kenner, European Union Legislation 2011-2012 (4th edn, Routledge 2013) 529. 

[26] Joined Cases 6 and 7/73 Istituto Chemioterapico Italiano SpA and Commercial Solvents Corporation v Commission [1974] ECR 223.

[27] Reform of Article 82: where the link between dominance and effects breaks down (revisited),
available at (https://www.oxera.com/agenda/reform-of-article-82-where-the-link-between-dominance-and-effects-breaks-down-revisited/) (April 2015) (last consulted on May 11, 2019).

[28] Case 322/81, Michelin [1983] ECR 3461

[29] This rule of thumb for the dominance threshold appears to have been confirmed in the recent Coca-Cola undertakings (Case COMP/39.116/B-2, announced on 19 October 2004) with respect to exclusivity, rebates and tying, which apply to those countries where Coca-Cola’s soft drinks represent more than 40% of national sales (and more than double the share of the nearest competitor).

[30] See Oxera (2009), ‘The new guidance on Article 82—does it do what it says on the tin?’, Agenda, January.