New Commission Guidance for European Competition Law Enforcement Against Dominant Firms: Towards an Effects-Based Application of Article 82 EC?

New Commission Guidance for European Competition Law Enforcement Against Dominant Firms: Towards an Effects-Based Application of Article 82 EC?

Publications

On 3 December 2008, the European Commission unveiled its long-awaited interpretive guidance on the application of Article 82 EC to single firm conduct (Guidance).1 The Guidance comes almost three years after the Commission published its Article 82 EC Discussion Paper (Discussion Paper), which explored a more rigorous economic effects-based approach to the enforcement of European competition law against exclusionary market behavior by dominant firms.

The Guidance is less ambitious in scope than what was initially expected after the Commission issued its Discussion Paper. In the interim, rumours circulated that no final guidelines would be issued at all, due to ongoing disputes within the Commission and the European Competition Network about how Article 82 should be enforced.

Although the Guidance contains a prominent disclaimer that it does not constitute a statement of the law, the Commission has for the first time provided valuable written guidance concerning its Article 82 EC enforcement approach and priorities. If applied as expressly intended, the Guidance should provide greater predictability for Article 82 enforcement by the Commission and ultimately channel the Commission's discretion in handling and assessing Article 82 complaints.

All firms that are or could be targets of complaints--or might complain against perceived anticompetitive conduct by a dominant firm--should familiarize themselves with the Guidance.

Scope of the Guidance

Not only does the Guidance provide greater predictability about the European Commission's enforcement priorities, but national competition authorities in Europe are likely to follow the principles in the Guidance where possible. However, the Guidance is drafted more loosely than the Discussion Paper, and intentionally leaves more discretion and policy options open for competition law enforcement authorities. This may reflect a policy compromise with national competition law enforcement agencies as well as possible differences in views within the Commission.

The Guidance may also provide national courts with some help in interpreting and applying Article 82. However, it will disappoint stakeholders who were hoping for significantly more legal certainty because it does not purport actually to give direction to other enforcement agencies or national courts, which have authority to apply Article 82 in parallel to the Commission.

Notwithstanding the somewhat limited scope and ambition of the Guidance, it is notable that the Commission has tried, for the first time since 1957 when Article 82 EC was included in the Treaty of Rome, to circumscribe its discretion in handling and assessing complaints under that provision. The Commission has also sought to define the role that economic analysis will play in the Commission's future enforcement of Article 82 EC. The Guidance is the fruit of lengthy discussions involving many stakeholders and should have lasting influence on enforcement practice.

It is particularly notable that the Guidance takes a significantly more interventionist, but economics-based approach, to regulation of single firm conduct than the lengthy report that the US Department of Justice issued on the same subject just three months ago.2 The Federal Trade Commission (FTC) refused to join that Report and three of the five Commissioners issued a statement harshly criticizing it as unduly protecting "firms that enjoy monopoly or near-monopoly power." Moreover, those Commissioners said the FTC "stands ready to fill any Sherman Act enforcement void that might be created if the Justice Department actually implements the decisions expressed in its Report," and that the FTC would "continually seek to strengthen our relationships with our foreign counterparts, as we look around the world for additional perspectives on dominant firm conduct and other competition issues." In this regard, it will be interesting to see going forward whether the FTC takes enforcement positions that are closer to those set forth in the Guidance than in the Report of its sister US agency, particularly given the new leadership at the Justice Department and the FTC that will come with a new US administration.

Indeed, in an FAQ accompanying publication of the Guidance, the Commission observed that the Guidance is a "step towards more convergence with the approach to unilateral conduct followed thus far by some other jurisdictions, such as the US." But the Commission also pointedly observed that the FTC had not supported the Department of Justice Report, and that the Report "differs from the Article 82 Guidance Paper on a number of issues such as the way to balance pro and anti-competitive effects of a conduct, the role of market shares in assessing dominance and the assessment of pricing conduct."3

The Guidance

The structure of the Guidance is essentially the same as the original Discussion Paper:

  • A first part sets out the Commission's general approach to exclusionary conduct, including (i) the notion of market power; (ii) the factors that will generally be relevant to assessing likely consumer harm; and (iii) possible justifications for the conduct (objective necessity and efficiencies).
  • A second part of the Guidance addresses the factors the Commission will take into account to assess whether it should intervene in cases involving specific types of exclusionary abuse, including (i) exclusive dealing; (ii) tying and bundling; (iii) predation; and (iv) refusal to supply and margin squeeze.

The Guidance sets out a key unifying principle for future enforcement: the Commission's enforcement will target conduct that is likely to lead to "anticompetitive foreclosure," i.e., exclusionary conduct that is liable to cause "likely consumer harm." It remains to be seen how the Commission will apply and develop this principle in practice, and whether it signals a real shift towards an effects-based approach in applying Article 82 to exclusionary conduct, grounded in rigorous economic analysis. Notably, even relatively recent Commission enforcement decisions have been based on the more formalistic case-law of the EC Courts, rather than close analysis of the harmful economic effects of a particular market practice.4

As the Commission recognizes, a true shift towards effects-based analysis requires a focus on consumer harm rather than simply on harm to the competitive structure, i.e., harm to competitors. The Guidance contains many encouraging statements suggesting that this is what the Commission intends for the future, although they are often somewhat compromised by language that would allow the Commission to depart from this approach, should it be deemed necessary for enforcement policy purposes.

The Guidance clearly raises the bar for complaints. Complainants will need to show cogent and convincing evidence of the likely impact of an allegedly anticompetitive practice on consumers, whether in the form of higher prices than would have prevailed, but for the conduct at issue, poorer quality, reduced consumer choice, or other harm to consumers. The Commission is likely to reject questionable or speculative complaints if consumers appear not to have been harmed but rather to have enjoyed lower prices or better products from dominant firms. Thus, while the Commission has long said that dominant firms have a "special responsibility" in how they compete (and the Guidance repeats this), the Commission now also warns competitors that they must be efficient and innovative if they wish to seek protection from exclusionary behavior by dominant firms under Article 82. As the Guidance pointedly states, "[t]his may well mean that competitors who deliver less to consumers in terms of price, choice, quality and innovation will leave the market."5

The main points to note in the Guidance are the following:

I) The Commission's general approach to exclusionary conduct

The enforcement principles on exclusionary conduct set out in the Guidance apply only to single firm dominance--there are no references to collective dominance. Although guidance on collective dominance would be welcome in highly concentrated, oligopolistic markets, such guidance may be premature given the sparse precedent in this area.

Market power. A finding of dominance remains the key initial step in applying Article 82. Single firm dominance requires substantial and durable market power, i.e., the ability to profitably increase price above the competitive level (or reduce output, choice, quality or innovation below competitive levels) for at least two years.

The competitive constraints that the Commission will take into account in assessing whether a firm is dominant relate to (i) its market position and the position of competitors, (ii) the likelihood and ease of expansion or potential entry, and (iii) countervailing buyer power of customers.

-A firm may be deterred from increasing prices if expansion or entry is likely, timely, and sufficient, or countervailing buyer power is of a "sufficient magnitude."

-The Commission will not view countervailing buyer power as a factor likely to offset dominance if it insulates only some, typically large and sophisticated customers from the dominant firm's behavior, but prices can still be increased profitably for a sufficient number of weaker customers.

The Commission notes that except in specific circumstances (e.g., capacity constraints) low market shares--below 40%--are a good indicator that a firm lacks market power, and hence lacks a dominant position.

Anticompetitive foreclosure: likely consumer harm. The Commission states that it will focus its enforcement efforts on exclusionary conduct that is likely to lead to "anticompetitive foreclosure," i.e., conduct that is ultimately able to harm consumer welfare, whether in the form of higher price levels, poorer quality, reduced consumer choice, or other harm. The Commission will have concerns about anticompetitive foreclosure when dominant firm conduct hampers or eliminates actual or potential competitors' access to inputs or markets, thereby allowing the dominant firm profitably to increase prices (or restrict output, innovation, product choice or product quality). As noted above, however, the Commission will not intervene absent cogent and convincing evidence of such consumer harm.

The Guidance lists the factors the Commission will take into account in determining whether to take enforcement action under the anticompetitive foreclosure test. They include the degree of dominance and the position of competitors; network effects and entry barriers; the position of customers and input suppliers; the extent of the allegedly abusive conduct; possible evidence of actual foreclosure; and evidence of an explicit exclusionary strategy. The Guidance, however, does not offer bright line tests on what conduct in which situations will or will not constitute an abuse of dominance in violation of Article 82. The main immediate change that the focus on consumer harm is likely to bring is that the Commission will require stronger evidence of likely consumer harm causally linked to specific market conduct to support a finding of an abuse. This would imply that the Commission's future enforcement actions will be more selective than in the past.

The concept of abuse. The Guidance confirms that, as a general rule, the potential for given market conduct to foreclose may not simply be inferred from the nature or type of the conduct, but must be established based on the specific facts of the case. This contrasts with the Discussion Paper, in which the Commission proposed a two-step test--under which it would first identify "conduct which, by its nature, has the capability to foreclose competitors from the market" and then determine whether the conduct has "a likely market distorting effect" in the specific market context.

Proving likely consumer harm. In past decisions, the Commission had inferred consumer harm from damage to the competitive structure, i.e., harm to competitors. Under the Guidance, however, analysis of whether consumer harm has occurred must go beyond such theoretical inferences. Where possible and appropriate, the Commission will make use of economic evidence to substantiate its findings about likely consumer harm. In some circumstances, however, the Commission may determine that it can conclude that conduct is likely to result in anticompetitive foreclosure without a detailed assessment, for instance, when it appears that the (allegedly abusive) conduct creates obstacles to competition and creates no efficiencies. In such cases the anti-competitive effect of the conduct may be presumed. As examples, the Commission cites a ban on testing competitors' products imposed by a dominant firm on its customers, payment incentives to the same effect, or payments to distributors or customers to delay introduction of a competitor's product.

Pricing abuses: as efficient competitor test. The Guidance provides a general framework for analyzing exclusionary pricing. The Commission will normally intervene only when the conduct at issue has already been or is capable of hampering competition from competitors that are deemed as efficient as the dominant firm. The issue will be whether such a competitor can compete effectively with the dominant firm's pricing conduct. In some cases, though, the Commission will also consider on a dynamic basis whether a less efficient competitor may be foreclosed as a result of allegedly abusive pricing conduct. The Commission notes that this could be the case where, absent such conduct, a competitor could become more efficient by benefiting from network or learning effects over time.

In analyzing pricing, the Commission will compare sales prices with costs to determine whether a dominant firm is pricing below cost. The Commission states that it will generally use the dominant firm's own cost and pricing data. Where this is not available, the Commission may use cost data of competitors or data of comparable reliability. The Guidance notes that pricing below average avoidable cost (in most instances similar to average variable cost) sacrifices profits, and means that an as efficient competitor would have to price at a loss to compete. The Commission also observes that pricing below long-run average incremental cost (similar to average total cost) could lead to foreclosure of an as efficient competitor from the market over time. Finally, the Commission states that in assessing potential below cost pricing, it will take into account the wider market context, including, for example, revenues and costs for sales of complementary products (e.g., printers and ink cartridges).

Justifications: Objective necessity and efficiencies. The Guidance distinguishes between conduct that is justified on the grounds that (i) it is objectively necessary or(ii) produces substantial efficiencies that outweigh any consumer harm. In the past, a finding of objective justification meant that the conduct at issue could not be deemed abusive under Article 82. The Guidance seems, however, to restrict this notion of objective justification to factors external to the dominant firm, such as health or safety concerns with a specific product.

In that regard, the Guidance introduces a new balancing test for claims of efficiencies. The dominant firm has the burden of proving, with sufficient probability, that (i) efficiencies will be realized as a result of the conduct; (ii) there are no less anticompetitive means to realize these efficiencies (i.e., the conduct is indispensable); (iii) these efficiencies outweigh any negative effects on competition and consumer welfare; and (iv) the conduct does not eliminate effective competition. The Commission signals its continued concern with protecting rivalry (perhaps even at a cost to consumer welfare) in observing that where conduct eliminates all residual competition, the protection of rivalry in the market among competitors outweighs any possible efficiency claims.

Where the dominant firm has brought forward objective justifications or efficiencies to justify its conduct, the Commission will assess these claims (in the case of objective justifications) or balance them against the likely anticompetitive effects of the conduct (in the case of efficiencies) to determine whether the conduct at issue is justified.

II) Specific forms of abuse

Exclusive dealing: exclusive purchasing and conditional rebates

Exclusive purchasing. In some cases, a customer will wish to enter into an exclusive purchasing relationship, particularly when a dominant company offers some form of compensation for the loss of supply competition. The Commission is concerned, however, that the cumulative effect of exclusivity obligations in the marketplace may in certain cases prevent competitors from entering or expanding, to the detriment of consumers as a whole. The Guidance thus states that such cases will be a Commission enforcement priority.

Capacity to result in anticompetitive foreclosure. In the Discussion Paper, the Commission stated that by their nature exclusivity obligations have the capability to foreclose. The Guidance provides criteria for assessing this foreclosure potential. In the Commission’s view, exclusivity provisions have the potential to foreclose when, but for the provision at issue, the dominant firm would be subject to an important competitive constraint by potential competitors, or by actual competitors who are not in a position to compete for the full supply of the customers. According to the Commission, if competitors can compete on equal terms for each individual customer's entire demand, exclusive purchasing obligations are unlikely to hamper effective competition. The Commission observes, however, that in practice competitors may not be able to compete on equal terms with a dominant firm, where the latter is an "unavoidable trading partner" for a good part of market demand (e.g., because its brand is a "must stock item" or because competitors are capacity constrained). The frequency with which a dominant firm imposes exclusivity obligations and their duration are additional factors to take into account.

Conditional rebates. The Commission will normally intervene when a rebate system is capable of impeding competition by competitors that are as efficient as the dominant firm, in particular by making it more difficult for them to supply the "contestable" part of a customer’s demand, i.e., that part for which the customer will consider purchasing from a competitor of the dominant firm. The Guidance sets out specific additional factors that have particular importance in making this assessment.

Capability to hinder as efficient competitors from entering or expanding. According to the Commission, any rebate system should not hinder as efficient competitors from expansion or entry. Generally, the likelihood of anticompetitive foreclosure is higher where the dominant firm grants conditional rebates (e.g., rebates conditioned on the customer buying a certain proportion of its requirements from the dominant firm) and competitors are not able to compete on equal terms for the entire demand of each individual customer. Similarly, retroactive and individualized rebates may foreclose the market significantly. The Commission will assess the loyalty-enhancing effect of rebates by comparing the dominant firm's average price to the effective price after rebates to a given customer. In general, where the effective price for the customer's demand is below the dominant firm's average avoidable (or variable) cost, the rebate scheme is capable of foreclosing even “as efficient” competitors. Where the effective price is between average variable cost and total cost, the Commission will take other factors into account. Finally, where the effective price is consistently above average total cost, the Guidance states that a rebate "is normally not capable of foreclosing in an anti-competitive way."

Tying and bundling

Basic conditions for intervention against tying and bundling strategies.The Commission will normally take action where a firm is dominant in the tying market and two other conditions are met: (i) the tying and tied products are distinct products and (ii) the tying practice is likely to lead to anticompetitive foreclosure.

Likely or actual anticompetitive foreclosure. In addition to the factors that generally apply to determining whether conduct can constitute an exclusionary abuse, the Guidance discusses specific factors that are particularly relevant to identifying likely or actual anticompetitive foreclosure in the tied or tying market. For instance, the Commission expects a greater risk of anticompetitive foreclosure where tying or bundling is part of a lasting strategy. In the case of bundling, the risk of anticompetitive foreclosure is likely to be greater where a firm holds a dominant position for more than one of the products in the bundle, especially where the bundle is difficult for a competitor to replicate.

Where rebates are applied to tied products or bundles (multi-product rebates), the Commission may also intervene where the rebates make it impossible for an equally efficient competitor offering only some (or only one) of the components to compete with the discounted bundle without losing money. Where competition in the market is between bundles, the Commission will examine pricing of the bundle of the dominant firm to see whether it is predatory; in such circumstances, the mere fact of bundling cannot alone lead to anticompetitive foreclosure.

Predation

The Commission will intervene when a dominant firm deliberately incurs losses or foregoes profits in the short term so as to foreclose one or more of its actual or potential competitors with a view to strengthening or maintaining its monopoly power. The Commission will pursue predatory conduct not only on the market where the firm enjoys dominance but also on a secondary market where the firm, albeit not dominant, can use its profits to cross-subsidize its activities.

Proving the sacrifice. Except when the Commission can rely on direct evidence of a predatory strategy, it will determine that a dominant firm has engaged in sacrifice when (a) it incurs actual losses by cutting prices for all or a particular part of its output over a relevant period of time (pricing below average avoidable cost) or (b) its pricing, while above average avoidable cost, led to a loss that could be avoided (pricing below average total cost), possibly for strategic reasons. The Commission specifies, however, that a dominant firm can defend itself by offering conclusive evidence showing that its pricing decision was made in good faith.

Proving anticompetitive foreclosure.The Commission also intends to apply the "as efficient competitor" test here, but clarifies that normally only pricing below long range average incremental cost is capable of foreclosing as efficient competitors from the market. Commission intervention will turn both on the general factors for assessing whether conduct can have an exclusionary effect and the factors that could be specific to a finding of predation, such as targeting a competitor for price decreases in order to impede access to external financing that would allow the competitor to expand. The Guidance notes that actual exclusion of competitors from the market is not required, because evidence that conduct has the effect of disciplining competitors may be enough to conclude that it will lead to foreclosure. Indeed, the Commission states that dominant firms may have an interest in ensuring a competitor does not actually exit where the production assets would remain on the market.

According to the Guidance, consumers are likely to be harmed where the dominant firm is likely to be in a position to benefit from the sacrifice. Such a benefit can consist of higher profits but also the prevention or delay of price declines. The Commission emphasizes that determining consumer harm is not a mechanical calculation of profits and losses, and proof of overall profits is not required. Benefit from sacrifice can also be shown by assessing the likely foreclosure effect of the pricing behavior. In that regard, the Commission will take account of the possibility that competitors might re-enter the market. Finally, the Guidance notes that benefits from pricing sacrifices are easier to obtain through low prices selectively offered to some customers, than low prices generally applied to all.

This analysis may represent an important change in Commission policy, if consistently applied and further developed in Commission practice. To date, proof of the possibility of recoupment is not required under EC law for a finding of abusively low pricing. Although it recognizes that other forms of benefit may result from low pricing to the dominant firm, the Guidance makes clear for the first time that the Commission will not view alleged pricing abuses as an enforcement priority where there is no evidence that the dominant firm will benefit from the sacrifice it is making.

Last, low pricing can be justified by economies of scale or efficiencies generated by expansion in the market. Such justifications must, however, satisfy the other conditions that apply to efficiency justifications (set out above).

Refusal to supply and margin squeeze

Refusal to supply. The specific situation addressed in the Guidance is the case where dominant firms compete on a downstream market with buyers to whom they refuse to supply an input or refuse to supply on reasonable terms. As explained at greater length in the Discussion Paper, this conduct can allow the dominant firm to foreclose competition in the downstream market.

The Guidance expressly recognizes that imposing a duty to deal on market participants can lead them to refrain from investing or encourage free-riders, lessening innovation or investment in the long term and thereby harming consumers. For that reason, the Commission takes the view that three cumulative conditions need to be satisfied for a refusal to supply to be dealt with as an enforcement priority:

  • Objective necessity of the input. The refused input is objectively needed for a downstream activity, i.e., there is no actual or potential substitute to counter--in the long term--the negative effects of the refusal. The feasibility of creating an alternative source of efficient supply (duplication) is taken into account. The input may also be viewed as indispensable when it has been previously supplied and companies have made specific investments in that regard. If there is a prior history of the dominant firm supplying the input, this will make the Commission more likely to find that the input is objectively indispensable.
  • Elimination of competition. The refusal to supply is likely to eliminate effective competition on the downstream market.
  • Consumer harm. The refusal is likely to harm consumers, with that harm outweighing the negative effects of imposing a duty to supply. Such harm could be found, for instance, when refusal to supply prevents competitors from bringing to market innovative goods, for which there is potential demand. The Guidance notes that stifling follow-on innovation and preventing technical development are further examples of such harm. Similarly, when prices are regulated in the upstream input market but not in the downstream market, a dominant company may try to extract more profits on the downstream market by refusing to supply competitors to exclude them from this market.

The Guidance's approach to defenses to refusals to supply is focused on the preservation of innovation. Thus, refusals to supply may be justified if the conduct is necessary for the firm to realize an adequate return on the investments required to develop the input supply business, thus generating incentives to continue to invest in the future. A refusal may also be justified if the dominant firm can prove that the imposition of a duty to supply would jeopardize its own innovation. These justifications will have to satisfy the other conditions set out above. It does not appear likely, however, that the Guidance actually intends to prevent dominant firms from refusing to supply when the attributes of a customer/competitor means that the dominant firm has a demonstrably objective justification for its refusal to supply, such as solvency, creditworthiness or reputational risk.6

Finally, the Guidance states that if there was a previous supply relationship, any efficiency justifications for a refusal to supply will be closely scrutinized.

Margin squeeze. The Guidance discusses margin squeeze only briefly. The Commission notes that it will generally rely on the long-run costs of the downstream division of the integrated dominant firm to determine the costs of an efficient competitor. When allocating a dominant firm's costs to downstream and upstream operating arms is not possible, the Commission may compare the costs of non-integrated competitors.

Conclusion

While perhaps not the ambitious leap that some had hoped for based on the Commission's Discussion Paper, the Guidance represents a clear step forward in explaining the Commission's approach to analysis of exclusionary conduct under Article 82. Applied and further developed as intended, the Guidance is to be welcomed by national enforcers, practitioners and company advisors.

1 Communication from the Commission--Guidance on the Commission's Enforcement Priorities in Applying Article 82 EC Treaty to Abusive Exclusionary Conduct by Dominant Undertakings, Brussels, 3 December 2008. The Guidance is designated as a draft, to be finalized subject to linguistic revision. In addition to prohibiting conduct aimed at preserving dominance (exclusionary abuses) Article 82 also prohibits conduct seeking to exploit market power to extract monopoly profits (exploitative abuses). The Guidance addresses only exclusionary abuses.

2 See here.

3 See here.

4 Case COMP/E-1/38.113--Prokent-Tomra of 29.03.2006.

5 Guidance at para 6.

6 Joined cases 29/83 30/83, of 28 March 1984, Compagnie Royale Asturienne des Mines SA and Rheinzink case. GmbH v Commission of the European Communities, ECR [1984] Page 01679.

Special thanks to Lee Greenfield for critical editorial suggestions.

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