comments to the dg competition discussion paper on … · selfishness, uncontrolled by competition,...

CRECEDI

2006 | CRECEDI | Centre de Recherches sur le Commerce et l'Economie Digitaux | Paris, France

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Centre de Recherches sur le Commerce et l'Economie Digitaux115-117 Rue Notre Dame des Champs - 75006 Paris

COMMENTS TO THE DG COMPETITION DISCUSSION PAPERON THE APPLICATION OF ARTICLE 82

OF THE EU TREATY TO EXCLUSIONARY ABUSES

Louis Bertone(a)

Guillermo Cabanellas(b)

(a) Professor, Faculté Libre de Droit, d'Economie et de Gestion; Module Leader, University of Westminster(b) Professor, University of Illinois; Director, Department of Law & Economics, Universidad de San Andrés. FormerResearch Fellow, Max Planck Institute.

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ABSTRACT

The Discussion Paper is a highly commendable effort, the first one in many years, to renew with empiricism,provide guidance to national government officials and judges called to take new responsibilities in an optimalenforcement of competition law, and take into account the growing contribution of post-industrial (digital andbiotech) businesses to consumer welfare.

Except between the lines, it still falls short of fully dusting outdated concepts, such as Stackelberg's seventy-year-old definition of dominance, adopted by European case law for the past thirty years. Theirmodernisation would have been needed to fully liberate competition law from a more or less populist priorthat prevailed during its first hundred years of existence: a dominant firm, by nature, can only abuse itsdominance - unless it paradoxically selects a non-dominant strategy

(*).

The real-life cases that land on the desks of judges and government officials show no trace of the "landmarkindependence" of dominant firms: These firms, and even outright monopolies, adopt business practicesinteracting with a) elasticity of demand, b) availability, closeness and pricing of substitutes; c) reactionfunction of competitors; d) apparently unrelated actions taken by other firms in related or unrelated markets;and e) own and competitors marginal costs, when they happen to exist.

(*) In his memorable address to the US Senate urging the adoption of the Sherman Act, Senator John Sherman said that"[the sole object of a dominant firm] is to make competition impossible. It can control the market, raise or lower prices

as will best promote its selfish interests, reduce prices in a particular locality and break down competition, and

advance prices at will where competition does not exist. Its governing motive is to increase profits […]. The law of

selfishness, uncontrolled by competition, compels it to disregards the interest of the consumer…" See CongressionalRecord 2459-60 [1890]. In more popular, less populist terms, "there is a reciprocal relationship between the concept ofabuse and that of a dominant position" (see Kapteyn P.J.G. and VerLoren van Themaat, P., Introduction to the Law ofthe European Communities (Third edition, 1998), at p. 892.

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TABLE OF CONTENTS1 INTRODUCTION 52 INTERACTION BETWEEN ARTICLE 82 AND OTHER LEGAL PROVISIONS 83 MARKET DEFINITION 84 DOMINANCE 154.1 INTRODUCTION 154.2 SINGLE DOMINANCE 194.2.1 THE SUPPLY SIDE 194.2.2 BARRIERS TO EXPANSION AND ENTRY 204.2.3 THE DEMAND SIDE 224.3 COLLECTIVE DOMINANCE 235 FRAMEWORK FOR ANALYSIS 245.1 GOAL OF COMPETITION LAW AND EVIDENCE OF ABUSIVE FORECLOSURE 255.2 PRICE AND NON-PRICE BASED EXCLUSIONARY CONDUCTS COMPARED 265.3 HORIZONTAL AND VERTICAL FORECLOSURE 275.4 ABUSE OF COLLECTIVE DOMINANCE 285.5 DEFENCES 285.5.1 OBJECTIVE NECESSITY 295.5.2 MEETING COMPETITION 305.5.3 EFFICIENCY GAINS 306 PREDATORY PRICING 326.1 INTRODUCTION 326.2 ASSESSMENT 336.2.1 PRICING BELOW AVERAGE AVOIDABLE COST 346.2.2 PRICING ABOVE AVERAGE AVOIDABLE COST BUT BELOW TOTAL AVERAGE COST 356.2.2.1 DIRECT EVIDENCE 356.2.2.2 INDIRECT EVIDENCE 366.2.3 PRICING BELOW LONG-RUN AVERAGE INCREMENTAL COSTS 376.2.4 PRICING ABOVE ATC 386.2.5 DEFENCES 397 SINGLE BRANDING AND REBATES 397.1 INTRODUCTION 407.2 ASSESSMENT 417.2.1 SINGLE BRANDING OBLIGATIONS AND ENGLISH CLAUSES 427.2.2 CONDITIONAL REBATE SYSTEMS 437.2.2.1 CONDITIONAL REBATES ON ALL PURCHASES 437.2.2.2 CONDITIONAL ERBATES ON INCREMENTAL PURCHASES ABOVE A THRESHOLD 477.2.3 REBATES IN RETURN FOR THE SUPPLY OF A SERVICE BY THE BUYER 487.2.4 UNCONDITIONAL REBATES 487.2.5 DEFENCES 488 TYING AND BUNDLING 498.1 INTRODUCTION 498.2 ASSESSMENT 508.2.1 DOMINANCE IN THE TYING MARKET 508.2.2 DISTINCT PRODUCTS 518.2.3 MARKET DISTORTING FORECLOSURE EFFECT 528.2.4 DEFENCES 549 REFUSAL TO SUPPLY 559.1 INTRODUCTION 559.2 ASSESSMENT 589.2.1 TERMINATION OF A SUPPLY RELATIONSHIP 589.2.1.1 DEFINITION 589.2.1.2 DOMINANCE 599.2.1.3 DISTORTING FORECLOSURE 609.2.1.4 DEFENCES 609.2.2 REFUSAL TO START SUPPLYING 619.2.2.1 CHARACTERISTICS 619.2.2.2 DOMINANCE 61

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9.2.2.3 CRITICALITY 629.2.2.4 DISTORTING FORECLOSURE 619.2.2.5 DEFENCES 629.2.2.6 REFUSAL TO LICENSE IP RIGHTS 639.2.3 REFUSAL TO SUPPLY INFORMATION NEEDED FOR INTEROPERABILITY 6310 AFTERMARKETS 6410.1 INTRODUCTION

10.2 ASSESSMENT

10.2.1 MARKET DEFINITION

10.2.2 DOMINANCE

10.2.3 ABUSE OF DOMINANT POSITION

10.2.4 DEFENCES

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COMMENTS TO THE DG COMPETITION DISCUSSION PAPER ON THE APPLICATION OFARTICLE 82 OF THE EU TREATY TO EXCLUSIONARY ABUSES

1. INTRODUCTION

1. The Discussion Paper published by the EU clarifies some misunderstood or ill-understood Europeanapproaches to dominance and abuse thereof, in particular with reference to exclusionary practices.

At least two of its salient features are extremely welcome. One is renewed empiricism, a badly neededstep towards reconciliation with economic science, for law contaminated by populism since itsinception

1, and thus made vulnerable to no less populist criticism

2. Another is the explicit focus on

consumer gains, and business practices that might hamper them, as opposed to those that hurtcompetitors but are beneficial to consumers

3.

It still falls short, however, of reconciling law and economics at a level that would satisfy a majority ofEuropean citizens

4. The 134 occurrences of the word "likely" are an example, with the first such

occurrence right in the first paragraph of the Discussion Paper (to define exclusionary practices asthose "likely" to discourage entry or profitable expansion of competitors

5, or encourage their exit).

What is or is not "likely" depends to a large extent on informal priors6, as opposed to what is or is not

"probable", contingent on formal probability calculus. Scientifically, only the latter is an acceptablecriterion.

1 The first antitrust act was passed in 1890, in the United States; these "Gilded Age" years saw the rise and fall of thePopulist Party. See Twain, M. and Warner, C.D., The Gilded Age [1873] and "People's Party Platform [1896]",http://usinfo.state.gov/usa/infousa/facts/democrac/29.htm. Although the antitrust act was drafted by Senator JohnSherman and sponsored by his fellow Republicans, it responded to Populist concerns about concentration of economicpower. See Justice Harlan's memorable dissent in the Standard Oil case (cited in note 12 below): "All who recall thecondition of the country in 1890 will remember that there was everywhere, among the people generally, a deep feeling

of unrest. The nation had been rid of human slavery, fortunately as all now feel, but the conviction was universal that

the country was in real danger from another kind of slavery sought to be fastened on the American people; namely the

slavery that would result from aggregations of capital in the hands of a few individuals and corporations controlling,

for their own profit and advantage exclusively, the entire business of the country, including the production and sale of

the necessaries of life. Such a danger was thought to be then imminent, and all felt that it must be met firmly...".2 Positive or negative actions and statements (including legislation and opposition thereto) are populist when inspiredby feeling (such as envy, rancor, or pride). Arrow's theorem does not exclude the possibility that outcomes may beranked on this basis (see Arrow, K.J.. Social Choice and Individual Values, [1951, 2nd edition, 1970]). Thus envy orjealousy can, when widespread among a constituency, cause lawmakers to vote irrationally. See note 1 above.3 For a recent indication that the European position was, until now, perceived as insufficiently consumer-focused, seeKolasky, W.J., "United States and European Competition Policy: Are There More Differences than we Care to Admit?"[2002], available from http://www.usdoj.gov/atr/public/speeches/10999.htm.4 The 27 occurrences of the term "competition" in the text of the European Constitution submitted to referendum in twofounding Member States (France and the Netherlands) might have been one of the causes of the cross-party "no" thatemerged.5 In only 13% of the 78 occurrences of "antagonism" or any of its derivatives in the Discussion Paper might the termpoint to enmity between firms operating in different markets or advocating different consumption paradigms; there isthus an 87% probability that the terms "rival" and "competitor" are used as synonyms. The origin of the two terms isdifferent, with "rival" coming from "neighbour" - with all the friction and negative feelings often implied in thisrelationship. A firm involved in the distribution of pears naturally advocates the consumption of this fruit rather thanneighbouring bananas; it is thus a "rival" of a neighbour firm such as United Brands. But under established Europeanlaw, pears are not substitutes for bananas - see note 33 below.6 En everyday English, "priors" are underlying beliefs and assumptions, based on one's experience, training and best

intelligence of the subject. More technically, statisticians call prior distributions of θ the quantity p(θ) of knowledge

about θ prior to input of any data, and posterior density of θ the quantity p(θ/Y) of knowledge about θ given the dataY. See Heyer, K., "A World of Uncertainty: Economics and the Globalisation of Antitrust", Antitrust Law Journal 72[2005].

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2. The analytical model presented in the Discussion Paper could, in many respects, improve thesubstance and image of European competition law. The presentation is conceptual and can afford toskip much of the detail. Whether the EU will ultimately adopt this model will depend, amongst otherfactors, on comments that will be provided by interested parties. Consistent with its empirical spirit, theDiscussion paper reminds that the application of this (or any other) model will always take into accountthe particular facts and circumstances of each case.

3. Certain otherwise admissible practices constitute abuse of dominance when adopted by a dominantfirm. Consistent with the language of Article 82, the Discussion Paper does not intend to list them all.Nor does it cover "exploitative" or "discriminatory" practices, although economic players would be welladvised to start taking into account the ideas behind the 13 relevant occurrences of "discriminatory" and"discrimination"

7.

4. The Discussion Paper contains an useful teleological indication: Article 82 protects competition againstexclusionary abuses, because competition is instrumental to enhance consumer welfare and ensureefficient allocation of resources. This is a welcome statement relating to the "soul of competition law"

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and requires two caveats only.

a) Most often, competition brings indeed benefits to consumers, such as low prices, high qualityproducts

9, a wide selection of products and services, and innovation.

• Lowest prices, however, are contingent on lowest costs; if insignificant marginal costs andabsence of capacity constraints are typical of the digital economy, then in this area lowestcosts correspond to a market share of 100%. Standard theory expects a firm with this marketshare (monopoly) to have price-naming ability, and exercise it sooner or later to charge thehighest prices that elasticity of demand will allow. But the same theory expects this kind ofmonopoly to face the Coase paradox, under which its price-naming ability is limited to namingprices lower and lower. There is no empirical evidence of "monopoly pricing" by firms withmarket shares in excess of 80%, but there is empirical evidence of discounts in percentagesequivalent to their market share - thus contradicting also the prior under which a monopolygrants no discounts.

• Consumer choice is a net benefit for consumers whenever its cost is lower than the gain. Forconsumers, cost depends on the number of alternatives, the losses entailed by a wrongchoice, and ability to eventually transfer the latter to new suppliers at the time of switching

10.

For firms, consumer choice might be at the expense of optimal average costs and thus lowestprices or highest profits or both; and is always at the expense of market share. For the non-digital economy, the costs of choice and the benefits of standardization have beendemonstrated since the days of Henry Ford; and for the digital economy, since the days of theso-called "bubble" and its subsequent burst.

• Innovation is a desirable consequence of competition, but it is also conversely proportional toits degree of perfection. Under perfect competition, zero profits in the long run and productsthat are by definition perfectly undifferentiated make innovation perfectly improbable. Thus thecloser actual competition comes to perfect competition, the lesser the probability thatinnovation will occur. Monopolies are said to have no incentive to innovate; but what is true forState-owned monopolies or monopolies with demand rendered captive by law, is not true for

7 In Atlantic Container Line and Others v Commission (Sept 30 2003) available from http://curia.eu.int/, for instance,the plaintiffs success in maintaining a discriminatory price structure comforted an assumption of dominance in the fact.8 See Fox, E., "The Battle for the Soul of Antitrust" (California Law Review 75, [1987]). A clear focus on consumerwelfare is useful guidance to the extent it dismisses the position of economists who advocate a broader "total welfare"standard. Remains the question of whether the sole relevant "consumer" is the one located farthest downstream in thevalue chain. Consumers are often at the same time employees, shareholders, taxpayers and voters; they may feel thatthey lose in these capacities what they gain from competition as consumers and vote accordingly (see notes 2 and 4above).9 In these comments, we follow the Discussion Paper's terminology, using "products" to encompass both products andservices.10 See Chen, Y., "Paying Customers to Switch", Journal of Economics and Management Strategy 6 [1997].

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those subject to paradigm shifts. There is abundant empirical evidence of such shifts, rangingfrom 19th century "networks" (railways and canals) to the IBM case in the late 20th century.

b) The reasons to be cautious with exclusionary conduct are detailed in section 5 below. When themost efficient firm excludes less efficient competitors from the most efficient channels, itaccelerates their exit, containing waste of resources and advancing consumer gains. This will onlyharm consumers if neither Coase or Bertrand conjectures

11 hold, and the last firm standing has not

competed out monopoly rents before monopoly is achieved, and this can actually charge abovethe average cost of its most efficient competitor. Empirical evidence ranging from Standard Oil

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and Paramount13

to Microsoft14

rather suggests that firms facing legal charges of (successful)exclusionary conduct reduced rather than increased prices, both before and after such charges.

5. The Discussion Paper draws from the European Commission's evolving experience with the applicationof Article 82, and case-law established by the Court of Justice and the Court of First Instance of theEuropean Communities.

These comments similarly draw from well known European and American cases, placed in context ofthe uncertainty of contemporary economic theory. The gap between expectations, intent, and actualoutcomes is sometimes highlighted using standard regression analysis.

6. The Discussion Paper avoids excessive conditional phrasing typical of position papers, and is fairlyeasy to understand, even for readers with limited economic and competition law backgrounds.

These comments focus on the applicability of the analysis described in the Discussion Paper to thedigital economy, which makes them digital by purpose. This purpose is justified by the hypothesis thatthe players in the digital economy may not yet be the main contributors to consumer welfare, but theyare for certain a major contributors and definitely the fastest growing ones.

11 At non-cooperative equilibrium oligopolists set identical prices; when costs are not identical, the most efficient firmprices at the level of the costs of the least efficient firm. See Bertrand, J., "Théorie Mathémathique de la RichesseSociale", in Journal des Savants [1883]; Edgeworth, F. Y., "The Pure Theory of Monopoly", in Papers Relating toPolitical Economy [1925], and more recently Tirole, J., The Theory of Industrial Organization [1989]. Edgeworth'sprior that in a price-mediated oligopoly it would be more rational to assume capacity constraints came to invalidateBertrand's theory in the eyes of many. But this prior came in turn to be invalidated by the digital economy; Bertrandconjectures capture this reality better, to the extent they assume constant and identical per unit cost without a finiteoptimal output level.12 Standard Oil of N.J. et al v. U.S., 221 U.S. 1 (1911). The strong point in this case was that Standard Oil hadaccumulated "infinite potency for harm", to an extent that its very existence constituted a "dangerous example". Theweak point was that harm that can never become actual is not even potential. Chief Justice White's opinion noted thatStandard Oil had actually "stimulated and increased production, and widely extended the distribution of the products ofpetroleum at a cost largely below that which would have otherwise prevailed". In the course of congressionaldiscussion of the Sherman Act some twenty years earlier, Congressman William Mason had noted that "trusts havemade products cheaper, have reduced prices; but if the price of oil, for instance, were reduced to one cent a barrel, itwould not right the wrong done to the people of this country by the trusts, which have destroyed legitimate competitionand driven honest men from legitimate business enterprises." Senator George F. Edmunds added that "although for thetime being the sugar trust has perhaps reduced the price of sugar, and the oil trust certainly has reduced the price of oilimmensely, that does not alter the wrong of the principle of any trust". See Congressional Record, 51st Congress, 1stSession, House, June 20, 1890, p. 4100; and p. 2558 respectively.13 Paramount Famous Lasky Corporation v. United States, 282 U.S. 30 (1930) and United States v. ParamountPictures, Inc., 334 U.S. 131 (1948). Paramount's block-booking practice consisted in licensing films in packagescontaining several feature films, or one feature film together with shorts, cartoons and reel news. This practice averagedrisk and pulled revenue even from films featuring less popular artists, or films that despite critical acclaim would provecommercial failures.14 See U.S. v. Microsoft, available from http://www.usdoj.gov/atr/cases/ms_index.htm (all filings before the DistrictCourt and the Court of Appeals, from the Findings of Fact by the former to the latter's final Opinion) and in particularthe expert witness statements of Professor Fischer and Dean Schmalensee. See also the European Commission'sMicrosoft decision, available from http://europa.eu.int/comm/competition/antitrust/cases/decisions/37792/en.pdf andthe ongoing judiciary appeal, equally available from http://www.curia.eu.int.

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They are also digital by methodology, to the extent the repeated counting of occurrences of certainconcepts and the probability calculus as to the meaning of any of them was made possible thanks todigital tools.

Finally, they are digital by design, because the paragraph numbers correspond to those of theDiscussion Paper, to facilitate digital reading.

7. The Discussion Paper provides a basis for open discussion, and is not intended to create rights orprovide guidance as to the current or future enforcement policy of the European Union.

The CRECEDI (Centre de Recherches sur le Commerce et l'Economie Digitaux) is a non-profitorganisation oriented towards the development, publication and funding of higher education research inthe fields of law and economics of digital trade and economy. It aims at closing the gap between thegrowing importance of the so-called digital economy for consumer welfare and the increasing deficit ofscholarly analysis applicable to its own specific cost structure and pricing constraints. In this sense, theCRECEDI is interested in both providing these comments and volunteering for further analysis left asto-do by the Discussion Paper. .

2. INTERACTION BETWEEN ARTICLE 82 AND OTHER LEGAL PROVISIONS

8. Articles 81 and 82 of the EU Treaty pursue the common goal of maintaining effective competition andcan be applied together. Consistency excludes the application of article 81(3) to restrictive agreementsthat constitute an abuse of a dominant position, but nothing excludes dominant firms from the possiblebenefit of article 81(3) of the EC Treaty, when they meet the conditions for exemption

15.

In addition, if a conduct of a dominant company generates efficiencies and all other conditions of article81(3) are met, such conduct does not qualify as an abuse under article 82.

9. Public-owned firms and other firms to which monopolies have been granted may infringe article 82 ifthey make an abusive use of such monopolies; in other terms, law securing captive demand for them isno excuse.

Although the matter is not within the scope of the Discussion Paper, Member States may also violatearticle 86 when then enact or maintain in force law under which firms are led to, or cannot avoid,abusing their dominant position.

10. Under article 10 of the EU Treaty, Member States have to take all appropriate measures to ensurefulfillment of their obligations under the Treaty. Possible violations of this obligation obviously includemaintaining in force or enacting law which might render ineffective articles 81 and 82.

3. MARKET DEFINITION

11. The definition of the relevant market is the first step towards the assessment of dominance and abusethereof, and the first major difficulty faced by judges and government officials in all OECD economies

16.

The need for such definition flows naturally from the fact that dominance is a position of economicstrength in a market. It can thus only be assessed, through direct or indirect evidence, by reference tosuch market.

The fact that a Court may reject the definition of the relevant market proposed by the plaintiff and stillmove forward to examine the defendant's ability to control prices or exclude competition does notmean, obviously, reasoning in a vacuum

17.

15 See "Commission Notice Guidelines on the Application of Artcile 81(3) of the Treaty", OJEC 101, 27.04.2004.16 There are no clear fact-finding guidelines for this purpose. See Van Miert, K., "International Cooperation in the Fieldof Competition: A View from the EC" [1997]; this speech delivered at the Fordham 24th Annual Conference isavailable from http://europa.eu.int/comm/competition/speeches/text/sp1997_073_en.html17 See U.S. v. E.I. Dupont de Nemours & Co., 351 U.S. 377, 391 (1956). Regardless of the merits of the definitionproposed by the plaintiff, the Court still reasoned by reference to what it believed to be a reasonably fenced market;

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12. This definition is not solely or even mainly needed to calculate market share18

, but rather tocomprehensively identify all possible constraints on a firm's conduct, and their nature and significance.

The market, from the Latin "mercatus" (a noun in turn derived from "mercari", to deal) was and still is aterritory where deals are concluded, except for the change in the meaning of "territory": in contemporarysales parlance, this term embraces a geography, a customer profile, and all other parameters listedbelow as relevant for the perimeter of the market

19.

Due in part to what is perceived in contract law as an "active" role for offer and a "passive" role foracceptance, there is a deficit of demand-side analysis of markets. A market is an abstract universe ofdeals (in legal terms, contracts) concluded or possibly concluded about some product, and the questionis how consumers compare prices, to include or exclude products from that universe

20.

13. In a previous Notice on the Definition of the Relevant Market, the EU had already provided usefulindications as to the methodology used to fence a relevant market, based mainly on substitutability,geography, characteristics of the product and intended use

21.

All could be wrapped-up into properly defined substitutability, if it weren't that the term "substitute"belongs to the large set of words assumed self-explanatory, and therefore used loosely - and not only inthe Discussion Paper. This paragraph comments certain shortfalls of the parameters most frequentlyused to assess substitutability, to the extent they are insufficiently focused on the consumer problem,i.e. maximising utility under constraint.

a) In informal economics, the term "substitutes" is used to designate pairs of products where theincrease in price of one causes an increase in demand for the other; if popcorn and peanuts aresubstitutes, an increase of price in the former causes demand to shift to the latter

22. This is not too

useful: substitutability is to be assumed and cannot be inferred, because a hike in the price ofpopcorn reduces demand and accordingly leaves a higher budget available for ice-cream (which isnot a substitute).

When an increase (or fall) in demand for one product causes a fall (or increase, respectively) indemand for the other, there is a fair probability that the products are substitutes. On the otherhand, the audience of the reality show aired at the same time as the parliamentary debateincreases because people are not watching the latter, but this doesn't prove that one program is asubstitute for the other, namely in terms of consumer utility.

It has thus become standard practice, for two goods a and b, to use the positive or negative sign of

δxa / δpb in the Slutsky equation to tell substitute from complement, although the proof is notabsolute, because income effects may outweigh the substitution term in that equation.

see, however, paragraph 16 below. See Areeda, P., Hovenkamp, H. and Solow,J., Antitrust Law [2002] for a surprisingshortcut: the definition of a relevant market would merely be a surrogate for market power.18 See Tops Markets, 142 F. 3d. Toys R. Us, Inc v. FTC, 221 F. 3d (7th Cirri. 2000). "Market share" is just a derivativeof contracts concluded by one firm and the total contracts of all firms in one competitive round, regardless of whethermarket share is presented in terms of revenues earned, products sold, needs satisfied, or other units.19 With this proviso, the market can be defined as the surface (in geographical and geometrical terms) where dealsoccur. The concept of "market price" reflects this, and suggests that the surface may be very limited (in fact allcontracts would be concluded at a same and single price). Sugar sold at 45 cents a pound (utility = 0.45) and sugar soldat 100 cents a kilogram (utility = 1) comply with this condition and have the same price.20 Underscoring the utility element of the example in the previous note, assume charter operators A and B propose,respectively, an A-320 for 2,595 and an A-321 for 3,195: which is the lowest price?21 "Commission Notice on the Definition of Relevant Market for the Purposes of Community Competition Law" [OJECC 372, 1997].22 Lesser demand is expected when prices are higher; so much so that goods for which this happens are labelled"normal" goods, as opposed to Giffen goods, for which demand increases with price.

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b) It is not easy to collect empirical evidence of actual demand shifts, prove a cause / effectrelationship and actual strict convexity of consumer preferences along the dimension of theproduct concerned.

Some of these difficulties could be avoided by intuitively considering that products regarded byconsumers as interchangeable are indeed substitutes and belong to the same market

23. But

collection of reliable evidence as to what consumers think is just as hard, mainly because thiswould be related to the unobservable utility function; which means that substitutability has to relyon revealed consumer beliefs.

To the extent the consumer problem is, again, one of constrained maximisation of utility, thereshould be a wide range of degrees between full substitutability (same utility at the same cost) andno substitutability (opposite utility regardless of cost). What seems a rather simple exercise formoderately complex and rather stable products, such as hydrochloric acid and sulfuric acid,becomes more involved with the complex and evolving products of the digital economy.

Thus if one operating system has the utility of being "the greatest threat to the business models ofall suppliers of digital content"

24 while another has the utility of being the opposite, there is slight if

any probability that consumers who prefer one will switch25

to the other, at least while suchpreferences remain stable. This holds regardless of whether both products meet some commonfunctional definition

26, and of whether the prices of one or the other increase or decrease

27.

Paragraphs 14 and 15 below focus on demand-side substitutability, or demand's ability to switch readilyto a substitute in response to a small but permanent increase in prices

28. Supply-side substitutability

exists when other suppliers can readily switch production to the relevant product or a close substitute,and sell it on the relevant market

29.

Decisions of Courts or government that may depart from consumer perception should be supported bystrong empirical evidence. Examples of assessments made by Courts or administrative authorities inthe EU and the US include:

23 See Discussion Paper, § 18; and in the United States, FTC v. Cardinal Health, 12 F. Supp. 2d (1998).24 See Moglen, E., "Microsoft, Antitrust and the Movement", Columbia Law School (2000) available from theColumbia Web site at http://emoglen.law.columbia.edu/publications/lu-03.html25 See note 10 above. See also Farrell, J., and Klemperer, P., "Coordination and Lock-In: Competition with SwitchingCosts and Network Effects", available from http://esnie.u-paris10.fr/pdf/textes_2004/Wilkie_Farrell-Klemperer.pdf.26 See in Microsoft v. Commission (Court of First Instance, 2005), "software which controls the basic functions of acomputer"27 To simplify, one single dimension of utility is isolated in the example. For a more realistic appraisal, the sameexercise needs to be reiterated for every possible dimension of utility, including stability, fault tolerance, net resilience(probability of attacks and vulnerability thereto), and the most widely explored to date, availability of useful,functionally rich and reasonably priced applications. See note 14 above.28 The Discussion Paper identifies "small" as any percentage between 5 and 10%; the 5% figure is used in the US and inthe examples of paragraph 14 below. Language concerning "weighed evidence relating to recent price variations" in theCommission Notice cited in note 21 above suggests a reference to "price tags" rather than prices measured by utilityunit. Price tags are attractive to the extent they allow minimum effort calculus, although at the cost of less reliableresults. On the other hand, prices calculated by utility are just as numerical, and grasp better the reality of differentiatedmarkets in general, and the digital economy in particular. In the A-320 and A-321 example of note 20, utility dependsin part on their 150 and 185 seats, respectively; and for the rest, on actual needs. If the charterer needs to transport 149people only, the A-320 has a better price per utility unit, unless 10% of such people must travel first class. For a digitaleconomy example based on consumer welfare, a TV or computer program with utility 3 and a price tag of 45 is lessexpensive than substitutes with utility 2 and price tags of 36 (prices of 15 and 18 per utility unit, respectively).29 "Readily", as used in the Notice cited in note 21 above and the Discussion Paper should be qualified by theconditions under which the supply side operates and its general pace of innovation and creativity. Supply-sidesubstitutability clearly points at entry. Obviously, a firm which is not already producing a reasonably close substitute isnot in the market.

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a) Educational materials intended for young children belong all within the same market30

; but mid-sizereflex photo-cameras are a market on their own, and do not belong with other reflex photocameras

31.

b) UHT milk and fresh pasteurised milk are not substitutes, and even less so filling machines andbricks for the former and filling machines and gable top containers for the latter, at least while wedon't have a filling technology applicable to both

32.

c) Bananas do not belong with other fresh fruits: the unique characteristics of bananas33

satisfyunique needs that would not be satisfied by other fruits. There is no substitutability between sugarand other sweeteners such as saccharin, cyclamates or aspartame, for a number of reasons, someof which are economic and some of which are legal

34.

Certain groups of consumers may not agree with some of the above definitions, but this is irrelevant tothe extent such is not the perception of "a sufficiently large number of consumers"

35. Exceptionally,

when consumers with more elastic demand are prevented from reselling to those with less elasticdemand, the latter group may delimit a separate market, even they are not "significantly large" innumber

36.

14. The SSNIP test sometimes used for market-fencing purposes owes its name to the acronym of "SmallSignificant Non-transitory Increase in Price". It was first described in the 1982 US Department of JusticeMerger Guidelines and was adopted by the EU in the 1997 Notice on Market Definition. Under this test,the relevant market is the smallest market in which a hypothetical monopolist could impose a SSNIP.

To define the boundaries of this market, so to say by trial and error, the SSNIP test iteratesassessments of profitability of a possible SSNIP

37, in terms of elasticity of demand and expected loss of

sales.

In its elasticity of demand variation, the test sizes critical elasticity of demand, the elasticity necessaryfor profits to remain unchanged [e = 1/(m+t), where m is the price/cost margin and t is the minimumprice increase considered significant]. With m = 40% and t= 5%, e = 1/(0.4+0.05) = 2.22. The increaseis profitable even if demand is elastic, but less elastic than 2.22.

When elasticity cannot be estimated, the loss of sales variation shows the maximum loss in salestolerable for unchanged profits, y = t/(m+t), with m and t defined as above. With the same figures asabove, y = 0.05/(0.4+0.05) = 11.1: the increase is profitable if the loss of business is 11.1% or less

38.

30 Ranging from printed and multimedia material intended for nine-year-old children to puzzles and sensory stimulationmaterial intended to develop awareness and manipulation material intended for two-year-old children. TheCommission's Decision dated July 5 2000 in Nathan, [2001] OJEC L 54/1 (23/2/2001) apparently disregards the factthat for parents of a nine-year-old child, material intended for two-year-old children lacks utility to an extent such thatswitching between the two is highly improbable.31 Hasselblad v. Commission [1984] ECR 883.32 Tetra Pak / Commission, ECR [1990 - II] 309. UHT milk is machine-filled into sterilised bricks under strictly asepticconditions. Fresh pasteurised milk does not need to meet these high thresholds. Tetra Pak had market shares of about90% in the former and about 50% in the latter. If Elopak had succeeded in developing a machine usable for both UHTand pasteurised milk been successful, the two markets might have merged into one.33 United Brands v. Commission [1978], ECR 207 noted in this respect that bananas are seedless. For the implicationsof this fact on the respective meanings of "antagonism" and "competition", see note 5 above.34 Among the former, lack of bulking quality and prices; among the latter, Community quotas. See Irish Sugar, [1997],OJEC L 258.35 The Discussion Paper (paragraph 17) does not provide additional guidance as to whether a minority of consumerscould possibly be regarded as "sufficiently large".36 For instance large, as opposed to small, restaurant chains; or those with low -as opposed to high- volume of sales peroutlet; see note 53 below. See note 43 below concerning sugar for human consumption as opposed to sugar for otheruses.37 5% under the American variant, 5 to 10 percent under the European variant; see note 28 above. Obviously,understanding SSNIP requires some command of price theory, as the following paragraphs will show.38 See O'Brien, D.P. and Wickelgren, A.L., (2003): "A Critical Analysis of Critical Loss Analysis", Federal TradeCommission Working Papers [2003], http://papers.ssrn.com/sol3/papers.cfm?abstract_id=402100.

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In the traditional economy, both versions fail when the costs of the firm, or its actual per unit prices, areunknown. In the digital economy, where negligible marginal costs are supposed to be known, bothversions equally fail. With marginal costs of zero, computing m requires a division by zero and aborts.Manually setting m = 1/( + 0.05) = 0 similarly fails, yielding an elasticity of less than zero

39. With costs

an epsilon above zero, arbitrarily setting m to 100, e = 1/(100 + 0.05), meaning that an increase of 5%is profitable when elasticity is less than 0.01; and y = 0.05/(99.99+0.05) = 4.9998, a perpetual logicalloop for all practical purposes.

15. The Discussion Paper does not address these shortfalls of the SSNIP test, but rather notes the risk ofover-broad market definitions, attributable to the use of prevailing prices in the SSNIP test, the so-called"cellophane fallacy" discussed in the next paragraph.

If SSNIP based on prevailing prices happens to be inadequate, then proper definition of the relevantmarket requires a variety of methods to check the robustness of possible alternative market definitions.

In the Virgin / British Airways merger case40

, the EU had already indicated that the SSNIP test is onlyone out of a larger set of possible tests of market definition. This might well be the case, but theDiscussion Paper misses the opportunity to provide guidance as to what alternative methods might befeasible, and what empirically verifiable parameters these alternatives would take into account. Thenext paragraph addresses the questions of feasibility and reliability of such other methods.

16. The "cellophane fallacy" owes its name to the case referred to in paragraph 11 above41

, in which afirm's virtual monopoly on cellophane went undetected. The market definition retained by the Courtincluded competitive constraints at prevailing prices, but ignored those resulting from a possible pricingat lower "competitive" prices.

A slick demonstration of the fallacy relies on SSNIP's failure to reveal which competitive constraintswould exist at "competitive prices", assumed lower than prevailing prices. The proof, however, is slickbecause it bumps against empiricism and feasibility: The Discussion Paper admits that reconstructingthis "competitive price" with any degree of accuracy is unfeasible. In addition, if calculus somehowpermitted a reliable reconstruction, there would be no possibility of empirical validation.

Thus whether there is or isn't an underlying fallacy is both unclear and irrelevant for legal fact-findingpurposes in general, and for market fencing in particular.

A firm's ability to price above the competitive level might be indicative of dominance, i.e. absence ofeffective competitive constraints, or just imperfect competition, i.e. a real life situation in which themutual constraints of firms are limited. In the oligopoly, all firms (dominant or dominated) price aboveown cost, i.e. above perfectly competitive level. Pricing beyond both own cost and cost of the mostefficient competitor may instead be indicative of either dominance, collusion or non-cooperative profit-maximisation

42.

17. There may be abuse of dominance in markets in which there is no dominant firm, whenever a firmleverages dominance in one market to extend it to other some other market. There is abundanteconomic literature concerning "extension of monopoly", but this literature is strictly neutral on whetherextension of dominance (absent any exercise in a manner that is harmful for consumers) constitutesabuse. In markets where no dominant firm exists, the "cellophane fallacy" objection to the SSNIP testdisappears, because there is no reason to suspect that prices are already above "competitive" levels.Unless, obviously, the other market is an oligopoly, too.

39 While elasticity is often expressed positively for convenience, it is supposed to be a negative number; in this case,"less than zero" as used above means "less negative than zero", or in other terms a positive number.40 Available from http://europa.eu.int/comm/competition/antitrust/cases/index/by_nr_69.html#i34_78041 See also note 17 above.42 Integrating utility as revealed by willingness to pay, see notes 19 and 20 above. Paramount (see note 13 above)placed higher price tags on films featuring popular artists. Because these artists were best-selling, the utility of thesefilms was higher, and exhibitors found that actual prices were lower than those of other films with lower price tags andutility.

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The Discussion Paper does not address, instead, the case of oligopoly (or even duopoly) with morethan one dominant firm, when these firms adopt a strictly non-cooperative conduct and do not meet theconditions for an assessment of collective dominance. This is not the right place to discuss the point,and it will be addressed in section 4 below.

18. Another parameter of substitutability relates to the characteristics and intended use of the product43

.They may differentiate a product to such an extent that there is only little substitutability, a situation fromwhich little competitive constraint can be inferred. It would have been preferable to skip here thereference to "competitive constraint at competitive prices", mainly because as indicated in paragraph 16above the "competitive price" cannot be reconstructed with any degree of scientific reliability.

For the reasons indicated in paragraph 13 above, specific intended uses command expected utility, andmarket signaling provides useful information about both the characteristics of a product

44, and also

about how a firm intends to play the competitive game45

.

For products with versatile uses, such as certain computer programs, the assessment of characteristicsand intended use, and its influence on substitutability may be more difficult to perform.

The Discussion Paper indicates that the needs of marginal consumers are specially relevant to assessexpected characteristics and intended use and thus contribute to the market definition. The "marginalconsumer" is the one who, in a price-driven market, would end up with one unit of the product if it wasmade available. The notion is generally used to model market prices, because it points to the consumerwho has willingness to pay an epsilon below such prices. Because this epsilon keeps the marginalconsumer out of the market anyway, the Discussion Paper's statement is hard to decrypt.

This willingness to pay keeps the "marginal consumer" away from the demand side of the market, atboth prevailing and competitive prices, and the "marginal unit of product" seems ruled out in the digitaleconomy, where production is on demand and the question of who gets a marginal unit of product doesnot arise.

The Coase conjecture contradicts in part this first impression; illustrated with the example of alithography, the conjecture captures the reality of the digital economy. Arbitrarily setting demand for alithography at D = 3,000 - p, the author maximises profits printing 1,499 copies priced at 1,501 apiece; ifcosts are 1 per copy, profits amount to 2,248,500. When those copies are sold, the willingness to pay ofthe 1,499 actual consumers falls to zero, as anticipated by standard theory; but here are still 1,501"marginal consumers" with willingness to pay assumed (for simplicity) to range between 1 and 1,500,an epsilon below prevailing prices. To make additional profits of 500,000, the author could now print asecond series of 500 copies, priced at 1,001, capturing the "marginal consumers" willing to pay thisprice or more; and iterate again and again until price equals cost, to capture the last marginalconsumer.

43 For example, sugar for human consumption, in any of its forms (white granulated sugar, liquid sugar and specialtysugars), belong to a market different from that of sugar for denaturalization. See Suiker Unie v Commission [1975]ECR 1663.44 For some products (nails and pincers come spontaneously to mind), knowing whether they are peaches or lemonsmay be enough. See Akerlof, G. "The Market for Lemons: Quality Uncertainty and the Market Mechanism", QuarterlyJournal of Economics 89 [1970]. In the consumer's eyes, lemons could be substitutes for peaches to which they wouldreadily switch depending on their price per utility unit; see note 27 above.45 If the characteristics of a product make it less useful in the eyes of certain consumers, given intended use, theavailability of converters could make it viable substitute. The 110 volt electric razor intended for use in France is anexample: useless without a transformer, it becomes a viable substitute for every consumer owning one. WINEs (orWindows emulators) are the most popular example in the digital economy: when the editor of an operating systemadvertises such a converter, a) it adds to expected utility of the product, namely the ability to run plentiful andinexpensive applications designed for Windows ; and b) it signals to the market non-cooperative conduct and intent toachieve compatibility without side-payments. There is abundant literature on one-way and two-way converters ; seeChoi J. P., "Do Converters Facilitate the Transition to a New Incompatible Technology?: A Dynamic Analysis ofConverters," International Journal of Industrial Organization 14 [1996]; David P. and Bunn, J. A., "The Economics ofGateway Technologies and Network Evolution", Information Economics and Policy 3 [1988]; and Farrell, J. andSaloner, G. "Converters, Compatibility, and the Control of Interfaces", Journal of Industrial Economics 40 [1992].

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Provocatively stated, the Coase conjecture thus proposes that a monopolist has no monopoly power,and short of dramatic actions such as breaking the plate to limit output, a profit-maximising lithographerwill, in quest of marginal consumers, name prices lower and lower

46.

Thus the "marginal consumer", who is not active on the demand side of the market as it is, could aswell inspire supplier behaviour in every segment of economic activity in which marginal costs arenegligible.

The Discussion Paper's reference to the needs of such "marginal consumers" is not easy to decrypt.The main difficulty is not with irrelevance, demonstrated by Coase to be apparent only, despite the factthat insufficient willingness to pay keeps by definition the marginal consumer away from the market atwhatever price. The main difficulty is with the virtual impossibility of guessing right the needs,expectations and preferences of potential future consumers.

To illustrate the difficulty of anticipating the needs of the "marginal consumer", ten years ago the DistrictCourt for the District of Columbia guessed that marginal consumers of operating systems might need"browserless operating systems"

47, and two years ago the European Commission guessed that

marginal consumers of operating systems would not want them to include embedded media streamingfunctionality, even if that functionality could be disabled to allow them to use a separate programinstead

48.

19. The Discussion Paper considers geography as a possible parameter of the market definition.Traditionally, excessive emphasis had been placed on the relevance of the economic space, i.e. thedistance between suppliers and consumers: the costs possibly associated with such distance, includingtransportation costs, were thought to reduce the competitive constraints imposed on a firm by supplierslocated in other geographies. With the advent of the digital economy, an universe of frictionlesstransactions conducted and fulfilled on-line regardless of distance was dreamed of, leading instead tounderestimation of the geographic factor. Indeed, digits do not travel on carts, but transactions with adistant supplier may, except in case of instant fulfilment, imply higher transaction costs

49.

The Discussion Paper does not refer to other parameters of the market definition; some of them,however, are relevant to assess demand-side substitutability.

a) Consumer Ownership is one. Public ownership, for instance, yields different choice grids, not onlydue to different elasticity but also to output and pricing patterns. Public-owned consumers maypursue a public service rather than profit maximisation objective, or be subject to tighter budgets orpurchasing rules, or all three.

b) Quantity is another. Wholesale and retail markets are in principle separate. But whenevercompetition is "for the market" rather than "in the market", because marginal costs are de minimisand Bertrand and Coase conjectures apply, consumers buying in large quantities for own usedemand discounts no lesser than those granted to wholesalers. In the software industry, these

46 See paragraph 4 above. See also Coase, R.H., "Durability and Monopoly" Journal of Law and Economics 15 [1972];and for the role of lithography in the manufacture of microprocessor chips, Aizcorbe, A., "Product Introductions andPrice Measures for Microprocessor Chips in the 1990s", Economics Working Papers Archive [2005], available fromhttp://econwpa.wustl.edu/eprints/io/papers/0502/0502004.abs.47 U.S. v. Microsoft, Findings of Fact (http://www.usdoj.gov/atr/cases/f3800/msjudge.pdf.) at §§177, 188, 190, 202,410. The Judge perceived actual demand for such operating systems, at §§ 150-152, because a "substantial percentageof corporate consumers do not want a browser at all" and "also, for businesses desiring to inhibit employees' access tothe Web while minimising system support costs, the most efficient solution is often using PC systems withoutbrowsers".48 In Microsoft, cit. note 14 above (notes 926 - 927 under recitals 802-804) the EU detected separate demand foroperating systems and media players and ordered Microsoft to market its flagship operating system in two flavours, onewith and the other without, media streaming functionality.49 See Salop, S., "Monopolistic Competition with Outside Products", Bell Journal of Economics [1979], and Ohta, H.,Spatial Price Theory of Imperfect Competition [1987]. Included in transaction costs are different tongues and conflictof laws, together with expectations as to reliability and enforceability of contracts.

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discounts are in excess of 90%, because such are the discounts off monopoly price granted toOEMs.

c) Risk aversion is another. Firms unwilling or unable to give guarantees (such as intellectual property,compliance with laws and regulations, mission criticality, etc.). Non-infringement guarantees are abanal utility-enhancing demand in the pre-purchase screening process, for every consumer buyingin large quantities or, in other terms, for every consumer with a purchasing department worth itssalt. Risk-aversion is often directly proportional to quantity: litigation against supposedly cash-richentities is more probable, and damage awards are proportional to the significance of the violation ofintellectual property, i.e. higher. Other guarantees frequently demanded in the course of thescreening process include compliance with law and regulations

50, fault tolerance, upward

compatibility, and non-regression.51

d) Specific sales channels or purchasing mechanisms, in isolation or together with sensitivity to pricechanges, specific sales channels or purchasing mechanisms may also be relevant for the purposesof market fencing in some cases

52. But not always: by way of example, "fountain-dispensed soft

drinks distributed through independent service distributors to large restaurant chains which are notheavily franchised and have a low fountain volume per outlet"

53 belongs with all other "fountain-

dispensed soft drinks", regardless of channel, size and status of the restaurant and volume peroutlet.

4. DOMINANCE

4.1 INTRODUCTION

20. The definition of "dominance" (in Europe) or "market power" (in the United States) is the second majorproblem that judges and government officials face. The Discussion Paper reminds that since longago

54, dominance is defined as "a position of economic strength enjoyed by an undertaking

55 which

enables it to prevent effective competition being maintained on the relevant market by affording it thepower to behave to an appreciable extent independently of its competitors, its customers and ultimatelyof the consumers". Four problems belong with this solution:

a) First, lack of an unit to measure scientifically "strength", "power" or otherwise "forceful position" inEconomics, equivalent to newtons or dynes in Physics. Thus "to an appreciable extent" a rule ofthumb applies to define the threshold beyond which a firm may be regarded as dominant.

b) Second, involved syntax. Replaced in order, the three parameters of the definition would be: (a) aposition of economic strength (b) sufficient to allow the firm to behave with appreciableindependence; (c) such that the firm is immune from effective competitive pressures.

c) Third, loose semantics. "Appreciable" is not used with its scientific meaning of "observable" nomatter how tiny; but rather with its popular meaning of "significant", "over-average", "verysignificant", or "majority". Obviously, in a free market every firm behaves as it wishes within thelimits set forth by the law, which does not make it dominant. In monopolistic competition, wheredominance is not ascertained, each firm behaves in this manner

56.

50 For instance for banking-related, HR management, accounting, and replenishment software.51 These guarantees may be related to risk-aversion or be simply a demand for market signals.52 See AD/SAT V. Associated Press, 181 F. 3d 216, 226 (2d Cir. 1999); Brown Shoe Co. v. United States, 370 US, 294,325 (1962).53 Pepsico, Inc. v. The Coca-Cola Company. In this case, franchisees (a group excluded by the proposed definition)purchased no less than 63% of the fountain syrup delivered by independent distributors, a group allegedly controlled bythe defendant. See note paragraph 11 and note 17 above.54 United Brands v. Commission [1978] ECR 207 (see note 33 above) and Hoffmann -La Roche [1979] ECR 461 (withan identical definition of dominance) are two cases initiated in 1976.55 Undertaking is the European law term for firm as used in this paper.56 By contrast with differentiated oligopoly, the firms are numerous in monopolistic competition; when a firm adjustsquantity or price, competitors perceive a very small change in their own demand and do not adjust, thus validating the

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d) Fourth, Stackelberg's model of the dominated oligopoly, and its legal equivalent in United Brands57

,hold while the dominated firms have Cournot conjectures, and the dominant firm knows and usesthis fact. They fail, instead, when competitors do not acknowledge any firm's dominance, do nothave Cournot conjectures and do not adjust; or when quantity is not the adjustment variable.

In a digital economy, where no pre-set quantity is to be produced, firms adjust output as a function ofthe demand they face. Increased audience for a TV program or increased demand for a computerprogram does mean that there will be less audience or demand for substitutes, but not that competingTV channels or software editors have to adjust their output.

Thus some advance that ability to constrain competitors to adapt, rather than independence, is thehallmark of dominance. But empirical evidence rather suggests that there is no need for such coercion,because either the dominated firms adjust as a function of their conjectures, or do not need to adjust atall.

The Discussion Paper suggests that "dominance" is another word for "market power"58

as used in theUnited States. This would pave the way to use in Europe the abundant literature available in the UnitedStates in this respect. Unfortunately, this literature is far from unanimous or unambiguous.

21. The Discussion Paper underscores the close relationship existing between the three United Brandsparameters of the definition of dominance. As indicated above, the syntax is involved, perhapsvoluntarily, to point to this intimate relationship between a forceful position and immunity fromcompetitive pressures, no matter the business decisions of the firm.

22. The dominant firm has a leading position compared to its competitors; but not every market leader isdominant: parameters (b) and (c) of the definition relate to the way the dominant firm and itscompetitors interact in the market

59.

The market in question should be subject to Edgeworth constraints60

; and there are strong indicationsthat it should in addition be an oligopoly. Stackelberg developed the model that went virtuallyunchanged into European case law for this market structure; the dominated firms need to be just a fewfor the dominant firm to guess right their reaction curves. In addition, Stackelberg's language was firstadopted by the European Court in two oligopoly cases

61.

23. The dominant firm is "independent", or "constrains", or "leads competitors into their own conjectures",whatever the language preferred; it is itself immune from pressures coming from competitors,distributors and end users

62. The second and third elements of the definition concern the link between

the position of economic strength and the competitive process, i.e. the way competitors interact in themarket. The "independence" characteristic of dominance points towards the degree of competitiveconstraint; a firm is thus dominant if it is "to an appreciable extent" immune from such constraints.

firm's hypothesis that they wouldn't. See Chamberlin, E., The Theory of Monopolistic Competition [1933] and Kreps,D., A Course on Microeconomic Theory [1990}.57 Comp. Stackelberg, H. Marktform und Gleichgewicht. Springer (1934); United Brands v. Commission, cit. note 33above. Stackelberg also refers to the "independence" of the dominant firm, but not meaning that it can just "ignore"competitors. Much to the contrary, the dominant firm knows pretty well the reaction curves of such competitors andhow they will adjust. Stackelberg's theory and its legal equivalent lead to random results when dominance is notacknowledged by the dominated firms. .58 Standard economic analysis suggests that the conditions are met when a firm faces a negatively sloped demandcurve, as opposed to the flat (perfectly elastic) demand curve in perfect competition A measure of market power wouldthus be the deviation between both curves; but this measure leads to disconcerting implications, because it requiresbreaking the link between market power and anti-competitive effect, for instance admitting that the firm's average priceis constrained to equal the average cost of an efficient competitor. See Klein, B. and Wiley, J.S. Jr. "Market Power inEconomics and in Antitrust, A Reply to Baker" Antitrust Law Journal 70 [2003].59 With one of them relatively immune from competitive pressures60 See note 11 above. The firms should be profit-maximising as a function of costs, output and capacity.61 Respectively, bananas and pharmaceuticals.62 Thus answering the question raised in paragraph 4, note 8 above.

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24. The Discussion Paper defines market power as the ability to influence market prices, output, innovation,the variety or quality of goods and services, or other parameters of competition

63. For an audience new

to the American literature on market power64

, this may be misleading. Actually, this does notdiscriminate the situation of the dominant firm from that of other firms, because every competitor has (toa varying degree) this ability, in particular in markets in which innovation is critical.

The Discussion Paper often uses "increase prices" as shorthand for a large set of consumer harms,while it is unclear whether "reduce prices" refers accordingly to a set of consumer benefits.

The Discussion Paper posits that a firm's ability to increase prices above the competitive level for asignificant period of time, could be indicative of substantial market power, and of dominance as definedabove. This, however, is subject to two provisos.

The first one relates to economics in general. At Cournot equilibrium, all firms in the oligopoly pricebelow monopoly and above competitive levels, regardless of whether they are dominant or dominated.depending on the meaning of "competitive level". At Stackelberg equilibrium, the dominant firmmaximises profits setting output at the point where one of its iso-profit curves is tangent to the reactioncurve or the dominated firm

65; both firms may still be pricing above the competitive level. At Bertrand

equilibrium, instead, both firms in principle charge equal prices and prices equal costs66

; but at Bertrandequilibrium with Edgeworth constraints, both the dominant and dominated firms are making positiveprofits

67.

The second one is specific to the digital economy. Cournot conjectures are ruled out because quantityis not the decision variable. Stackelberg requires both Cournot conjectures and acknowledgement ofdominance on the side of the dominated firms, and thus falls after Cournot. Edgeworth constraints areabsent due to instant production of the quantity required to meet own demand, at costs assumed anepsilon above zero.

The pure Bertrand equilibrium is then p1 = p2 = ε; and if one of the price tags is ε or even zero, then

these price tags do not reflect actual prices, and need to be equalised68

.

The Discussion Paper indicates that unlike firms subject to the constraints of effective competition, thedominant firm is able to price above the competitive level: this firm can increase prices by reducing itsown output, or by causing competitors to reduce theirs. While it is true that the dominant firm can act inthis manner, it is no less true that a dominated oligopolist also makes positive profits; inference ofdominance from profitability is thus not allowed. With particular reference to the digital economy, areduction of output reduces (instead of maximising) profits - an irrational conduct for any firm, and evenmore so for a dominant firm. And when output is not a decision variable, the dominant firm cannotcause competitors to reduce it.

Finally, the Discussion Paper rightly notes that the foreclosure of competitors may therefore allow thedominant company to further raise price or keep prices high. The deduction is flawless, as was that of

63 See note 58 above.64 This literature generally defines market power in a more operative way, as the ability to charge higher prices thanthose which would prevai lunder effective competition; see Hovenkamp, H., Economics and Federal Antitrust Law(1985).65 Again, this assumes that output levels are the decision variable for each of the firms, and that this decision is relevantbecause it has an impact on costs; for instance, the dominated firm produces a quantity equivalent to aggregate demandless the output of the dominant firm.66 And any division of demand between the firms ("market share") can be an equilibrium. See Kreps [1990] cit. note 56above. Bertrand reasons in terms of undifferentiated products, and empirical validation requires means to un-differentiate differentiated products with different price tags. One way to do this is forcing price tags into equal pricesper utility unit, as revealed by consumer willingness to pay; see notes 19, 20 and 28 above.67 Because costs are strictly increasing and firms can turn down a fraction of the demand they face.68 Some TV or computer programs have price tags of zero, but the market does not tip in their favor; pay-TV andcomputer programs licensed for a price have sometimes even larger market share. To empirically validate the Bertrandequation, prices per revealed utility unit need to be reconstructed as suggested in note 65 above.

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the U.S. Supreme Court in Standard Oil69

, but still lacks empirical support. Intuitively and subject toempirical confirmation, we would expect comparative increases in price tags to reveal increasedproduct utility not matched by substitutes.

25. Both suppliers and buyers can have market power. The Discussion Paper, however, follows thetradition using "market power" for suppliers ("buyer power" is reserved for buyers, but the issuesresulting from buyer power are not dealt with in the Discussion Paper).

26. The Discussion Paper suggests that higher than normal profits might be an indication of dominance, ormarket power, or in other words, lack of competitive constraints on an firm. While this is true, aninference of dominance from profitability is subject to the provisos indicated above.

If "normal profits" are (under the definition usually employed in Economics) the minimum profitsrequired to keep factors in their current use in the long run, they occur at the intersection between theaverage cost and average revenue curves.

Thus higher than normal profits persist in the long run in every imperfectly competitive market, oligopolyin particular. So this level of profits indicates that the firm belongs to an oligopoly (which was alreadyknown, or an attempt to assess dominance would be irrational), rather than that it is dominant withinsuch oligopoly.

The Discussion Paper rightly notes that a firm's dominance cannot be assessed on the basis ofprofitability. In some cases, short-run losses are not incompatible with dominance; in others, adominated firm prices as-if it had market power, and is more profitable than the dominant firm.

The Discussion paper further finds a possible indication of dominance in the conduct of a given firm perse, for instance where it increases prices while benefiting from falling costs. Others include the incometerm of the Slutsky equation, or increased willingness to pay prompted by increased utility not matchedby substitutes. In this sense it does not seem that per se such a conduct would justify a finding ofdominance.

27. A dominant firm does not need to have eliminated all opportunity for competition in the market to meetthe definition of dominance. This is implicit in the language mentioned in paragraph 20 above:regardless of whether some remains of competition subsist, the dominant firm is "to an appreciableextent" immune from them, which means that competitive pressures are no longer "effective" or will inthe future become ineffective.

The Discussion Paper notes, obviously, that price reductions operated under the pressure of similarreductions operated by competitors rule out independence and therefore dominant position. In a classicCournot duopoly, the firm will experience a shift to the left in the demand curve it faces, which shouldnormally result in a fall in its equilibrium or profit-maximisation price, and the same is true in morecompetitive environments; this, again, does not discriminate the features of the dominant firm fromthose of other firms. And in the digital economy, price reductions can occur based on Coase contexts,independently of whether there are or aren't competitive constraints. What would seem to be the reallytypical feature of the dominant firm is the ability, even in the context of competitors' price drops (as theyhappen in actual markets, not in theory

70) to charge significantly higher prices.

A Coase-constrained firm may not be subject to any additional constraints coming from competitors, butthe outcome seems fairly comparable. In the pursuit of optimal profit, it achieves monopoly in the longrun but makes normal profits, as if in perfect competition. The question of whether the firm can be saidto be dominant remains open, in particular when all competitors are similarly Coase-constrained.

69 See note 12 above.70 On prices, see note 28 above.

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4.2. SINGLE DOMINANCE

28. After setting the perimeter of the market, an assessment of dominance remains a no less perilousexercise, for the reasons indicated above. Typically the existence of a dominant position is assessedtaking into account several factors that, in isolation, would not support an inference.

Among such factors are the "market positions" of the all competitors, the barriers to expansion andentry, and the market position of buyers.

4.2.1 THE SUPPLY SIDE

29. The relative "positions" of firms can indeed provide useful insight as to the degree of competitionprevailing in the market. The importance of firms' positioning is unsurprising, to the extent the wholeexercise aims at ascertaining the existence of a "dominant position" or absence thereof. Translating"dominant position" as "market power"

71, it aims at ascertaining the relative power of firms over the

market.

Unfortunately, the Discussion Paper fails to provide guidance as to how to bridge the gap betweenmarket share and market position, in particular in terms of independence. Market share even inpresence of barriers to entry or expansion and weak buyers "position", does not allow an inference of"independence".

30. The Discussion Paper indicates that a persistently high market share is an indicator of dominance, or"proxy" for market power. This approach is popular with enforcement authorities both in Europe andAmerica, but is not supported by theory.

Market share, if anything, indicates consumer preference as a function of business policies pursued todate and expectations as to future policies; thus persistent market share is indicative of a persistentpreference. It does not mean that the firm would have been free to pursue policies or createexpectations other than those causing such preference.

Current market shares (or, when the market shares have been volatile, historic market shares) arefrequently used for the purposes of competitive analysis

72. It is true that historic market shares can

provide useful information about the competitive process and the prospective position of each firm; butit is no less true that these raw data are hard to decrypt, and have more often than not led enforcementagencies to the (wrong) impression that a firm's position is simply unassailable

73.

In IBM, for instance, the Commission reached this conclusion on the basis of persistent market sharesin the range of 80% of the relevant market

74; under the settlement, IBM disclosed the technology

required by competitors to produce IBM-compatible disks, thus gaining additional endorsers for a dyingtechnology

75.

71 As authorised by the terminology employed in the Discussion Paper.72 Concerning the calculation of market shares, see the Commission Notice on the Definition of the Relevant Market,cit. notes 15 and 21. Market shares are a function of market definition, shown above to be one of the major problemsfaced by competition law enforcement agencies and courts.73 See IBM, Case IV-29479 (cited as precedent in Microsoft, cit. note 14 above at #737 and note 883).74 Defined as computer storage devices intended for mainframes.75 Firms who reached the opposite conclusion successfully assailed IBM and the IBM-compatible manufacturers withRAIDs (Redundant Arrays of Independent Disks) with caches and microprocessors. These devices were cheaper, fasterand safer, they were recognized just as well by IBM machines, and had been developed without need for a technicaldisclosure, as an improvement and not a catch-up. Chronically understaffed government agencies may support more orless effortless technology sharing, in the assumption that compatibility is socially optimal and favors competition in themarket. But when competition is “for” (rather than “in”) the market, the supposedly pro-competitive result may damagethe fresh competitors, while the incumbent moves effectively to the actual arena where competition is to happen next.

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31. The Discussion Paper suggests that a market share of 50 % or more supports an inference of marketpower whenever competitors hold a much smaller share of the market. In other terms, in a duopoly inwhich both firms hold equal market shares, dominance cannot be assessed.

But the same is true for any other market share such as 40 to 50 percent, or less76

, although firms withmarket shares of no more than 35% are "not probable" to enjoy a (single) dominant position on themarket concerned.

32. For the reasons indicated above, market share neither proves or disproves freedom to adopt oppositeor different pricing schemes or business policies in general. Furthermore, an estimate of market shareis contingent on the perimeter selected for the relevant market, a difficult exercise indeed

77.

33. The above conclusions concerning the virtual irrelevance of market share hold regardless ofdifferentiation. The level of advertising, and generally market signaling, provides indication as to eachfirm's effort to position own products as different; in some cases there may be only weak differentiationby brand, while in others there may be a strong technical differentiation, resulting in totally differentutility. For undifferentiated commodities, competitive constraints imposed by one firm on the others aremore intense, but even for these commodities an oligopoly can reach equilibrium, a status in whichneither firm has an inducement to modify its conduct

78.

At equilibrium, the mutual competitive constraints are nil, and this rather proves that neither firm is freeto adopt a different rational conduct than the opposite.

4.2.2 BARRIERS TO EXPANSION AND ENTRY

34. A more interesting question is whether market share, in association with other factors such as barriersto entry allow an assessment of dominance. With high barriers to expansion or entry, a firm may beable, for instance, to increase prices without attracting expansion or new entry.

35. Except in the case of monopoly mandated by law, it can safely be assumed that sooner or laterconsumer-unfriendly business policies will attract such new entry or expansion; the relevance ofbarriers lies in the fact that they can defer it for some time. Thus a main focus of competition lawenforcement agencies and courts, in Europe and elsewhere, has been whether expansion or entry isimmediate and persistent enough to constitute an effective competitive constraint.

36. This focus rests on two assumptions. One is that depriving a dominant firm of maximum profitsotherwise than durably and immediately is not a sufficient competitive pressure, which in turn assumesthat firms do not intend to profit maximise in the long run. The other is that the market is not bound toirremediably tip, and that the process is reversible. In the Internet search, software and entertainmentindustries there are examples of market overturns in a very short period of time, generally accompaniedby a paradigm shift.

37. Entry is particularly probable when suppliers in other markets already possess production facilities thatcould be used to enter the market in question, thus reducing the sunk costs of entry. The same is trueof the digital economy, where the fixed costs are assumed limited to R&D. The profitability of expansionand entry depends on both cost and prices after it has occurred. In the digital economy, a firm's fearthat after its own entry the product may to some extent become a commodity, together with awareness

76 In United Brands, cit. note 33 above, dominance was assessed with a market share in the range of 40 to 45%; andGøttrup-Klim e.a. Grovvareforeninger v Dansk Landbrugs Grovvareselskab AmbA [1994] ECR I-5641,with marketshares of 36 % and 32 %. In Regulation 772/2004, on transfer of technology transactions, a 30% market share is used todiscriminate firms eligible for blanket exemption and those who are not. An effort to explain these different thresholdswould have been welcome, and these comments suggest the need of additional work in this sense after the responsesfrom interested parties are compiled, to improve EU competition law rules and compliance therewith.77 See paragraph 11 and note 16 above. See also notes 72 and 73 above: RAIDs meet the definition of "storage devicesintended for mainframes", or "IBM mainframes", even. If they had been take into account, the market share of IBMwould never have been 80%, which -again- neither proves or disproves this firm's dominance.78 In particular, lower prices to attack another firm's market share. This equilibrium may happen at any market sharesplit.

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that efficiency in production is optimal only when the market share reaches 100%, may have kept somefirms away from entering or expanding

79.

38. Barriers to entry surround all oligopolies, regardless of whether they are dominated or not; in addition,internal barriers to expansion may exist, fencing each firm's position.

39. Prices may drop after entry or expansion due to reduced willingness to pay, reaction by competitors, orthe emergence of a new technology

80. The existence of such a competitive reaction excludes a finding

of dominance to the extent the firm is clearly not "independent" enough to disregard entry or expansionof competitors. Strong expectations as to such a reaction, in turn, demonstrate that actual or potentialcompetitors do not acknowledge the dominance of the incumbent

81.

40. When identifying possible barriers to expansion and entry it is important to focus on whethercompetitors can reasonably replicate circumstances that give advantages to the allegedly dominantfirm. Barriers to expansion and entry can have a number of origins relating to the legal or economicenvironment that pertains on the relevant market:

• Legal barriers may, in their mildest form, consist in limitations as to the number of firms allowed toparticipate in a tender or auction. Much more frequently, they take the form of a concession of legalmonopoly, which may be supported by the pursuit of economies of scale or not. In other cases, theytake the form of state-aid to incumbent firms, allowing them to pursue a deterrence policy. Finally,they may take the form of tariff trade barriers, the most extreme case being the imposition of quotassuch as those applicable under the European Agricultural policy.

Intellectual and industrial property is, technically speaking, another such legal barrier. Empiricalanalysis shows, however, that it never precluded entry, and that sometimes firms' actual strategydoes not grant the worries of enforcement agencies.

• Capacity constraints, when they exist, are a barrier or an incentive to enter depending on whetherthey impact the candidate or the incumbent. Their opposite, cases of excess capacity, act asbarriers that are typically lowered through mergers intended, precisely, to use resources moreefficiently

82. In the digital economy, there is neither excess capacity or a capacity limitation, unless

one labels "excess capacity" the emergence of a large number of competing firms that, for sometime, threatened the typical oligopoly.

• Economies of scale and scope drive average costs down until an optimal level of output is reached.The firm outputting at this level is more efficient than smaller competitors producing at sub-optimallevel, and matches their inefficiency or becomes even less efficient when producing at over-optimallevelsl

83. Expansion or entry at an inefficient scale provides a dreamed of opportunity for the most

efficient firm to increase prices84

. In the digital economy, where the optimal output equals aggregatedemand, and production capacity is virtually costless, the risk and cost of entry and expansion issubstantially less than in the traditional economy.

• Absolute cost advantages are those related to preferential access to essential facilities, naturalresources, innovation and R&D, intellectual property rights and capital. They confer a competitiveadvantage on the allegedly dominant firm, which makes it difficult for other firms to competeeffectively. In the large majority of cases financial strength is not an issue. However, in some casesit may be one of the factors that contribute to a finding of a dominant position, in particular in those

79 This applies to profit-seekers, but not to non-profit groups, or state-owned or state-aided entities.80 When a technology is seen as "standard", there is an incentive to introduce a "premium" technology. See notes 71-73above.81 Under these conditions, Stackelberg's model no longer applies; see paragraphs 20 and 25 above.82 Investments committed to expand capacity under wrong expectations are not thus "sunk", because in the event of amerger or transfer of assets they are sold at book value.83 This is due to the combined effect of strictly increasing marginal costs and bureaucratic costs inherent to size.84 As indicated above, this may happen while the firm's costs remain stable or drop; and if entry occurs while the firmwas engaged in an entry-deterrence policy, this failure alone would grant the assumption of absence of dominance, orfreedom to impose its own views to the market.

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cases where (i) finance is relevant to the competitive process in the industry under review; (ii) thereare significant asymmetries between competitors in terms of their internal financing capabilities; and(iii) particular features of the industry make it difficult for firms to attract external funds.

• Privileged access to supply includes vertical integration and contractual influence over supply. Butvertical integration can be countered by similar verticality, and venture capital will fund it if it is goodbusiness at all. If it is not, the vertically integrated firm will divest. The allegedly dominant firm maybe vertically integrated or may have established sufficient control or influence over the supply ofinputs that expansion or entry by smaller competitor firms may be difficult or costly.

• A highly developed distribution and sales network is seldom a sound business option in the moderneconomy. Distribution has its own cost structures and business values, and is a business on its own,best left to a specialist. Naturally, when an exclusive agreement exists between a producer and onesuch distribution network, other producers are precluded from signing with the same network; butsuch exclusive agreements are rare when there is only one such possible network.

• A firm's established position, in terms of experience or reputation may function as a barrier to entry,but not as one to expansion. Consumer loyalty to a particular brand, and close relationshipsestablished between suppliers and customers may be as many obstacles to switching.

• Other strategic barriers include factors that make switching costly85

. Two reasons, instead, make ithard to imagine the lower utility of substitutes (due to either intrinsic quality or consumptionexternalities) as a strategic barrier: one is that it cannot be assumed to be permanent, if investmentin R&D is at all meaningful; and the other is that smaller networks are expected to grow faster, andtherefore yield a more rapidly growing utility.

4.2.3 THE DEMAND SIDE

41. The market position of buyers is indicative of their ability to constrain the independence of a firm. TheDiscussion Paper suggests that the ability of certain strong buyers may be able to extract betterconditions from a firm does not rule out its dominance, unless it is probable that they would, in responseto a SSNIP, pave the way for effective new entry or expansion

86

The underlying idea is that only these would defeat the price increase. In other words, a firm could stillbe independent enough to be regarded as dominant when it lacks independence towards distributorsand the major consumers farthest down the value chain, who -collectively- represent almost 100% of itssales. The strong buyers should not only protect themselves, but effectively protect the otherconsumers, including their competitors, paving the way for additional supply of equally useful products.

A practical application of this concept to the digital economy is hard to find. Powerful buyers restrain theindependence of their suppliers (including major studios, large software editors, and bandwidthproviders) by forcing them into Coase-like prices, which dispenses them from reacting to a SSNIP thathas not occurred.

These buyers bargain prices because they can do it, and would instead be powerless to prompt thecompetitors of a supplier to come up with a product of equivalent utility, if they do not expect that thiswould be profitable. The reasons for these expectations include but are not limited to sub-optimal scale(i.e. any scale below 100%).

85 Training costs may, however, be transferred to the new supplier. Long-term agreements may also act as a deterrent,in particular when individual transaction costs are high and the new supplier is unwilling to pick these costs. See note10 above: in Chen's model, the firm effectively treats old and new customers as belonging to unconnected markets, thusallowing a pricing that is independent from previous market share, i.e. revealed preference, as suggested in paragraph30 above. For a demonstration that this "independence" does not persist when there is functional differentiation inaddition to switching costs, see Arbatskaya, M., "Behavior-based Price Discrimination and Consumer Switching",Advanced in Applied Microeconomics [2000].86 See Irish Sugar plc v Commission [1999] ECR II-2969

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42. The Discussion Paper indicates, however, that if one or more strong buyers are able to extract betterconditions from the allegedly dominant firm, it may be appropriate to define separate relevant marketsfor, respectively, strong and weak buyers

87.

4.3 COLLECTIVE DOMINANCE

43. A single firm may hold a dominant position, and the same is true of two or more firms collectively. Thisis the phenomenon known as collective dominance.

44. The Discussion Paper describes collective dominance as a situation in which two or more firms,together, enjoy the independence and immunity from competitive constraints indicated as the hallmarkof dominance

88. Such can be the case regardless of whether the firms adopt an identical policy in

every respect; what matters instead is that they can adopt a common policy in the market and act "to aconsiderable extent independently of their competitors, their customers, and also of consumers"

89.

This definition of collective dominance does not seem to be of major practical significance for whatthese comments believe to be the primary audience of the Discussion Paper

90. A description of the set

of firms enjoying a collectively dominant position as an "entity" is a mere change in terminology withlimited practical advantages for the purposes of identifying actual market structure or behaviourcharacteristics of collective dominance, which is at the end of the day what judges, enforcementauthorities and firms need.

Furthermore, if collective dominance required a "common policy" it would merely duplicate theprovisions prohibiting collusion. Collective dominance is best perceived as a species of the broadernotion of dominance. When a set of firms is involved, there is a) a lack of effective competition withinthe set and b) a lack of effective competition between the set and the other firms operating in therelevant market.

45. The connection between the firms concerned may result from the nature and terms of an agreementbetween the firms in question or from the way in which it is implemented

91, provided that the agreement

leads the firms in question to present themselves or act together as a collective entity92

. This may, forinstance, be the case if firms have concluded cooperation agreements that lead them to coordinatetheir conduct on the market. It may also be the case if ownership interests and other links in law leadthe firms concerned to co-ordinate

93.

87 See Commission Notice, cit. note 15 above.88 See Compagnie Maritime Belge Transports (16 mars 2000) available from http://www.curia.eu.int As to theimportance of the degree of dominance for finding abuse, see Irish Sugar, cit. notes 34 and 86 above. Regarding"independence", time has come to question whether stare decisis alone is keeping it as a decisive defining element ofdominance, in an universe in which no monopoly, let alone dominant firms, can operate independently from marketforces.89 See French Republic and Société Commerciale des Potasses et de l'Azote (SCPA) and Entreprise Minière etChimique (EMC) v Commission [1998] ECR I-1375. "Common policies" are rather indicative of concerted, collusivepractices, except when they are an equilibrium point reached through non co-operative behaviour.90 The Discussion Paper is believed to be a source, in particular, for national judges who have been assigned new andbroader jurisdictions by the "Modernization Package".91 The concept of collective dominance is (or should be) of huge importance when the collectively dominant firms havebeen cautious enough for any evidence of collusion to be absent..92 "Common policy", "Common entity", and -even worse- "common entity" empty the notion of collective dominancefrom much of its substance and interest. More frequently, common dominance is found on the basis of a) actual lack ofcompetition between firms belonging to a given set labelelled "collectively dominant", and b) the firms of thecollectively dominant set suffer no competition from firms external to that set.93 For the reasons indicated above, the probability of finding evidence of blunt collusion is low. What can be found isthat firms belonging to a set labelled "collectively dominant" a) do not actively compete against each other; and b) donot suffer competition from other firms outside such set. The theory of collective dominance closes one of the biggestloopholes in competition lawallows regulators to focus, rather than on the hopeless attempt to collect evidence ofcollusion collectively dominant firms do not actively compete against each other, and suffer no competition from others

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These elements, however, are different from the two characteristics regarded by these comments aspertinent for the assessment of collective dominance, as indicated in the previous paragraph.

46. However, the existence of an agreement or of other links in law is not indispensable to a finding of acollective dominant position. Such a finding may be based on other connecting factors and depends onan economic assessment and, in particular, on an assessment of the structure of the market inquestion. It follows that the structure of the market and the way in which firms interact on the marketmay support a finding of collective dominance

94.

47. Oligopolists may raise prices above competitive levels without need for an explicit agreement or even aconcerted practice. Co-ordination may emerge in markets where it is relatively simple to reach acommon understanding on the terms of co-ordination. The simpler and more stable the economicenvironment, the easier it is for firms to reach a common understanding. Indeed, they may be able toco-ordinate their conduct by observing and reacting to each other's conduct. In other words, they maybe able to adopt a common strategy that allows them to present themselves or act together as acollective entity, subject to the proviso of paragraph 45 above.

Coordination may take various forms, but these comments consider "common understanding" and"common strategy" as too strong expressions, closer to the realities governed by Article 81 than to anypossible useful application of the notion of collective dominance, other than applying a per se approachto agreements between dominant firms.

More promising appears the possibility of finding collective dominance without need for "directcoordination" as suggested by the Discussion Paper.

48. Rather than the ability of each firm to monitor compliance of others, as suggested by the DiscussionPaper, a first condition of collective dominance is the ability to observe the behaviour of others andadopt a rational conduct. Awareness of the profitability of the common conduct is not sufficient,because each firm is known to be tempted to increase its own market share by "cheating on" anddeviating from the common strategy. The market transparency must be sufficient for all firms to beaware, accurately and quickly enough, of the market conduct of the others

95.

49. A second condition is the sustainability of the behaviour over time, which implies that deterrencemechanisms and retaliation possibilities must be effective enough to persuade all the firms that it is intheir best interest to adhere to the common policy.

50. A third condition is that competitive constraints should not be there to put in jeopardy theimplementation of the common strategy. As in the case of single dominance, the key point in thisrespect is the market position and strength of competitors that do not form part of the collective entityand of buyers the potential for new entry as indicated by the size of entry barriers.

5. FRAMEWORK FOR ANALYSIS

51. This section of the Discussion Paper proposes a general framework for analysis of exclusionaryabuses. It does not address directly the question of what an exclusionary practice is.

52. The Discussion Paper focuses on the practices that, statistically, are more frequently regarded asexclusionary abuses, i.e. predatory pricing, single branding and rebates, tying and bundling, and refusalto supply.

53. Thus the fact that a specific practice is not mentioned does not constitute a clearance. Examplesinclude and are not limited to "excessive" pricing. Other practices that may also amount to abuse, suchas discrimination, are considered only to the extent they amount to exclusionary abuses.

94 See also the Commission's Guidelines on the assessment of horizontal mergers under the Council Regulation on thecontrol of concentrations between firms, OJ C 31, 05.02.2004, pp. 5-18, paragraphs 39-57.95 See cases T-342/99, Airtours plc v. Commission [2002] ECR II-2585 and T193/02 Piau available fromhttp://www.curia.eu.int/fr/content/juris/t2.htm

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5.1 GOAL OF COMPETITION LAW AND EVIDENCE OF ABUSIVE FORECLOSURE

54. The Discussion Paper repeatedly mentions harm to consumers as an element of prohibitedexclusionary conduct. This is correct, because aggressive research and innovation, or aggressive whileprofitable pricing may have exclusionary effects (they do exclude inefficient firms from the market),which are neither abusive or illegal, but are or should be rather a main purpose of a competition policyaimed at increasing competitiveness.

Higher utility, better price / quality ratios or otherwise more efficient delivery are equally desirable.Competition, and not competitors as such, are protected as a means of enhancing consumer welfare,and of ensuring an efficient allocation of resources. To avoid harm to consumers, exclusionaryconducts are prohibited when they limit the remaining competitive constraints on the dominant firm.They are similarly prohibited when distortions or impairments to competition introduced by the dominantfirm prevent competitors from entering or expanding, thus harming consumers in the short, medium orlong term

96.

55. The prohibition concerns the conducts with actual or probable anti-competitive effects and are thusdirectly or indirectly harmful to consumers. The longer the conduct has already been going on, the moreweight will in general be given to actual effects. Harm to intermediate buyers is generally assumedharmful to final consumers.

56. Exclusionary practices resulting in foreclosure are prohibited whenever they hinder competition and"thereby harm consumers". A battery of tests detailed in the following sections is supposed to providewith an answer as to whether a practice harms consumers and is therefore abusive.

57. A business practice adopted by a dominant firm is abusive if it influences [negatively] the structure of amarket where, due to the very existence of the dominant firm the degree of competition is weakenedand if it hinders the maintenance of the degree of competition still existing in the market or the growth ofthat competition, through methods different from those which condition normal competition

97.

58. If a practice has no foreclosing potential, then it cannot be regarded as exclusionary abuse ofdominance. In what looks much like wishful thinking, the Discussion Paper suggests that evidence ofsuch capability flows in general "from the form and nature of the conduct in question". Foreclosure maydiscourage entry or expansion of competitors or encourage their exit, but abuse of dominance can alsobe found even when the competitors are not compelled to exit, only placed at a disadvantage leadingthem to compete less aggressively.

The Discussion Paper indicates that competitors may be disadvantaged when the dominant firm is ableto directly raise their costs or reduce demand for their products. The two situations, however, should notbe lumped together: while artificially raising a competitor's costs without own economies or consumergains is probably abusive, gaining demand for own products and thus reducing demand for competitors'products is legal or illegal depending on the circumstances

98.

59. If instead a practice has foreclosing potential, the next question is whether it has a potential to distortthe market. It is assumed to have such potential when it will or probably will prevent the preservation ofthe existing level of competition or its growth. Prices will probably increase or remain at supra-competitive levels. To establish whether a practice may be market distorting, the nature and form andthe conduct should be considered together with its incidence. Other market characteristics (includingnetwork effects and economies of scale and scope) may also be relevant, in addition to the degree ofdominance: the higher the capability to foreclose and the wider its application and the stronger thedominant position, the higher the probability that an anti-competitive foreclosure effect results.

96 Practices solely aimed at inducing higher costs for competitors fall, obviously, in this group of prohibited practices.97 Here and in other occurrences throughout the Discussion Paper, the meaning of "normal competition" is not totallyclear. We assume the reference is to "workable competition".98 By way of example, it is illegal to "bribe" a customer with prizes or not buying a competitor's products, but it is ofthe very essence of competition to fight for consumer preference with better products and reasonable margins instead ofoutrageous ones (reducing demand for competing products accordingly).

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59. Exclusionary effects may just result from legitimate competition on the merits, but they may also createno efficiencies and just raise obstacles to the remaining competition, in which case they may beassumed to be abusive

99. However, the assumption is subject to rebuttal based on evidence that the

conduct does not and will not have the alleged exclusionary effect, or that the conduct is objectivelyjustified

100.

60. Exclusionary abuses may be price-based or non-price based. Examples of non-price based abuses arecontractual tying, single branding contracts and "naked" refusals to supply. In these situations it is clearthat some "foreclosure" takes place; the question is whether this foreclosure may be characterized asanti-competitive.

5.2 PRICE AND NON-PRICE BASED EXCLUSIONARY CONDUCTS COMPARED

61. Foreclosing effects may be achieved through pricing. High stand-alone prices in comparison to abundled price for two products may "tie" these two products together as effectively as contractual tying.High rebates given on condition of single branding may have the same effect as contractual exclusivedealing. High prices applied to retailers, distributors and integrators, combined with low prices in directsales may amount to refusal to supply. Furthermore, predatory pricing is, of course, also a price-basedexclusionary abuse.

62. Pricing conducts have different exclusionary effects depending on how efficient the competitors are. Avery efficient competitor may be able to resist in a market where the dominant firm prices low, while aless efficient competitor will be excluded from the market. In general only conduct capable of excludinga hypothetical "as efficient" competitor is abusive

101, and the foreclosure of this competitor can only

result from pricing below cost by the dominant firm.

63. Which such cost is an appropriate benchmark is a matter subject to heated debate. Candidates are themarginal cost (MC), the average variable cost (AVC), the average avoidable cost (AAC), the long-runaverage incremental cost (LAIC) and the average total cost (ATC). This means that a dominant firmwhose conduct would be abusive under one of those tests still has an opportunity to prove that it is notpricing below the relevant cost benchmark.

64. In the case of multi-product firms, the ATC per line of business, even more so per product, is hard tocalculate, because certain common costs cannot be allocated with certainty. In this case, theDiscussion Paper proposes an allocation proportional to revenues, except when other cost allocationsare the industry standard, or when the revenues of certain lines of business are distorted, precisely, dueto abuse of dominance. Multi-product firms (and perhaps the Discussion Paper does not stress thispoint sufficiently) are the rule rather than the exception, and therefore as a rule, ATC cannot becalculated with certainty.

65. By contrast with ATC, LAIC reflects only the variable and fixed costs specific to a line of business orproduct, including specific costs incurred before the period in which an abuse of dominance may haveoccurred

102. AAC reflects specific fixed costs of the abuse of dominance.

Finally, MC measures the additional cost made to produce one extra unit of output and does notconcern an average, so it can be (when it exists) lower or higher (more rarely identical) than all theother costs, depending on the actual output and capacity constraints of the firm in question (when suchcapacity constraints exist). Increases in production may command faster depreciation, and itsconsequences are to be taken into account for an accurate calculation of marginal cost; unfortunately,this kind of calculation is seldom performed, so the actual calculations of marginal costs are very rarelyaccurate.

99 The case in which a practice creates no own efficiencies and just raises the costs of others appears theoretical ratherthan empirically verifiable. What judges and government officials actually see in the files submitted to them arepractices that generally do both (improve own efficiency and make life harder for competitors).100 See paragraph 80 below.101 This "as efficient" competitor has the same costs as the dominant firm102 Which, in turn, is a function of the definition of the relevant market, adding to the difficulty generally perceived byjudges and government officials to properly fence it.

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There is no price-based abuse when a competitor "as efficient as" the dominant firm can competeagainst it at actual prices (those set in the price schedule or those applicable after discount and rebatesystems). There is abuse, instead, when the "as efficient" competitor, or the dominant firm itself wouldnot survive the exclusionary conduct if it was its target rather than its initiator.

66. The "as efficient competitor" test requires reliable information on the pricing conduct and costs of thedominant firm. In the (likely) case of unavailability of such information, it may be necessary to feed intothe test data from apparently efficient competitors. Rather than merely checking revenues and costs ofthe dominant firm to determine if the former cover the latter for the market concerned, incrementalrevenues may need to be considered when the dominant firm's conduct negatively affects its revenuesin other markets or of other products.

67. It may however be necessary, in the consumers' interest, to prohibit the exclusion of competitors whoare not, or not yet, "as efficient as" the dominant firm

103. The "as efficient" competitor requires market

context, taking into account economies of scale when they exist, learning curve effects or first moveradvantages that later entrants cannot be expected to match even if they were able to achieve the sameproduction volumes as the dominant firm.

68. The next sections of the Discussion Paper describe the steps of the assessment of possible abuse ofdominance, but these steps do not need to be necessarily taken in the order described. It seems,however, that the relevant market needs to be defined before dominance can be demonstrated, anddominance needs to be demonstrated before abuse can be assessed. We find troubling the DiscussionPaper's suggestion that proceedings for abuse of dominance (with their associated cost including therisk of a false positive) may be instated relegating cost issues (and therefore the very point of whether afirm is or is not selling below cost) to a later stage because the analysis of cost levels is too difficult.

5.3 HORIZONTAL AND VERTICAL FORECLOSURE

69. Telling whether an exclusionary practice adopted by a dominant firm targets an upstream or adownstream competitor may be useful whenever the notions of "upstream" and "downstream" aremeaningful. In some cases there is more than one related market; the dominant firm A may be or wantto be present on all, while firm B is present in only one or a few of these related markets. In a typicalexclusionary practice, firm A attempts to force firm B to exit one or more of markets in which it ispresent, for instance through bundling, to cut firm B from demand coming from, say X and Z

70. The first group of exclusionary, possibly abusive, practices reviewed in the Discussion Paper concernshorizontal foreclosure, i.e. practices that may exclude, discipline or relegate to a niche a competitoroperating at the same supply chain level as the dominant firm, by restricting its access to customers.

71. The term "exclude" includes relegating to marginal niches. "Exclusion" and "exclusionary" should not beunderstood in the literal sense of complete exclusion, but rather as also covering impairment of thatcompetitor's ability to compete in an effective way.

103 In the US, the "as efficient" test is sometimes called the "less efficient" test; this terminology has been subject tocriticism for its implication that consumers cannot be harmed by the exclusion of a "less efficient competitor"; seeGavil, A.I., "Exclusionary Distribution Strategies by Dominant Firms: Striking a Better Balance", Antitrust LawJournal (2004). The underlying idea behind this test is in the US, much like in Europe, that there is abuse of dominancewhen the exclusionary practice under scrutiny has the capability of excluding an equally or more efficient competitor;see Posner, R.A., Antitrust Law (2nd ed. 2001). The Discussion Paper suggests that abuse of dominance may also beinvolved in the exclusion of a "not just as efficient" competitor. Gavil (cit. above) provides the example of a dominantfirm with costs of 1 and charging 2 and a less efficient competitor with costs of 1.25 and charging 1.50, and theexample works better for entry deterrence than for outright exclusion. See however paragraph 4.b and note 11 above:under unconstrained Bertrand conjectures, the firm charging a higher price faces no demand; again, for the meaning of"price" in differentiated oligopolies, such as those populating the digital economy, see note 28 above.

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72. The second group of exclusionary, possibly abusive, practices reviewed in the Discussion Paperconcerns "vertical" foreclosure

104 such as refusal to supply, which here includes margin squeeze cases.

Whereas the aim in the situations described above is to exclude a competitor in the upstream market, inthe typical refusal to supply case the aim is to exclude an already active or a potential participant in thedownstream market.

73. From a competition policy point of view, this is mostly only a worry if the dominant firm A is itself activedownstream. This is the subject matter of section 9 below

105.

5.4 ABUSE OF COLLECTIVE DOMINANCE

74. The proof of collective dominance relies on evidence that the collectively dominant firms have, undertacit or explicit agreement, pursued a common policy in the market, at least inasmuch as the allegedlyabusive conduct is concerned. For instance, the firms concerned may follow a common policy ofdenying potential competitors access to infrastructure or a policy to charge allegedly excessive prices totheir customers. However, the abuse does not need to result from the action of all the firms in question,it just needs to be one of the manifestations of the collective dominant position

106.

75. This could, for instance, be the case if it could be shown that the dominant firms had different tasks, forinstance that each should "defend" a certain area or group of customers in case of entry, and that theallegedly abusive conduct had only been observed on the part of one of the dominant firms as entryhad only occurred in the area or customer group that it was supposed to defend.

This situation, however, is closer to a collusive practice than to collective dominance as such. Collusion,which is not a subject matter of the Discussion Paper, is generally easier to deal with than abuse ofdominance, it might be less confusing not to bring the two notions closer than they actually need to befor all practical purposes.

76. The case law so far with respect to exclusionary abuse of a collective dominant position has dealt withsituations where there were strong structural links between the firms holding the dominant position

107.

5.5 DEFENCES

77. As a terminology issue, it may be worth reminding that at law, a defence defeats the plaintiff's orclaimant's case; in the specific case of competition law, and more restrictively with respect to abuse ofdominance cases, a successful defence leads to a finding that the conduct under scrutiny was notabusive.

In a due process of law, the burden of proof relating to a defence rests with the defendant, while that ofthe claim rests with the plaintiff, hence the importance of distinguishing between what is defence andwhat is claim. By way of example, in a battery case, the paradigm of defence is denial, placing theburden of proof

108 on the plaintiff - this may help clarify what is claim and what is defence. Another form

of defence is the so-called affirmative defence; again, in a case of battery, consent and self-defencewould fall in this category, best labelled "excuse", because affirmative defences acknowledge the factsalleged, but not the legal consequences derived by the plaintiff

109.

104 Following the methodology used in the Discussion Paper, these comments assume that "vertical", "upstream" and"downstream" are meaningful, which is not always the case, unless one includes under "vertical" all "lateral" relationsin a multi-dimensional framework.105 Sometimes an apparent refusal to supply constitutes in reality single branding or tying requiring analysis in theseframeworks rather than that of refusal to supply. Such would be the case when A refuses to supply Z if Z also buysfrom B (a form of single branding) or unless Z buys a whole range of products from A (a form of tying).106 See Irish Sugar, cit. notes 34 and 86 above; Joined Cases T-191/98, T-212/98 to T-214/98, Atlantic Container Line,cit. note 7 above.107 Compagnie Maritime Belge, cit. note 88 above; Irish Sugar, cit., notes 34 and 86 above; Atlantic Container Line, cit.note 7 above; Piau, cit. note 95 above.108 In the case of battery, of physical contact.109 An affirmative defence of self-defence acknowledges physical contact and denies wrongdoing, because the conductis permitted by law.

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Things may be somewhat more complicated in competition law. The Discussion Paper indicates that anexclusionary conduct does not constitute abuse of dominance when there is evidence that the conductis objectively justified, or produces efficiencies which outweigh the negative effect on competition andultimately yield higher consumer gains

110.

More logically, this should be stated in a non-negative manner, indicating that there is abuse ofdominance when there is evidence that It should be for the firm invoking the benefit of a defenceagainst a finding of an infringement to demonstrate to the required legal standard of proof that theconditions for applying such defence are satisfied

111.

Surprisingly, the allocation of the burden of proof has become the subject matter of heated debate inEconomics, in particular in terms of cost of "false positives" and "false negatives"; markets, it has beenargued, are self-correcting -and so are accordingly false negatives; false positives, instead, are not andcannot be self-correcting. Although the Discussion Paper does not mention this, the allocation of theburden of proof is part of the allocation of cost of a possible false positive.

78. The Discussion Paper describes two types of possible objective justifications. One is proof that theconduct is actually necessary, in view of objective factors external to the parties involved and inparticular to the dominant firm; this is called an "objective necessity defence"

112. The other is proof that

the conduct is actually a loss minimising reaction to competition; this is called the "'meeting competitiondefence"

113.

79. The probability of efficiency gains may be higher than the probability of negative effects on competitionresulting from the conduct, and therewith the probable harm to consumers; the burden of this proof lieswith the dominant company.

5.5.1 OBJECTIVE NECESSITY

80. A defence based on objective necessity defeats the plaintiff's case by destroying the allegation ofdominance (which drags abuse in its fall). A firm compelled to adopt a conduct that is objectivelynecessary is by definition not "independent" to adopt another.

This defence should typically rely on the denial paradigm as indicated above. The Discussion Papersuggests that the defendant may be able to prove that without the conduct under scrutiny the productsconcerned can not or will not be produced or distributed in that market, i.e. produce negative evidence.It is true that the condition of indispensability should be construed strictly, and it is not the task of adominant firm to take steps on its own initiative to eliminate products which it regards, rightly or wrongly,as dangerous or inferior to its own product

114.

But it remains that denial should operate to reverse the (apparently) intended burden of proof under dueprocess of law, leaving it to the claimant or plaintiff to produce evidence that a non exclusionary policyexists that would still allow production or distribution.

110 See Sirena S.r.l. v Eda S.r.l. and others [1971] ECR 69; Deutsche Grammophon GmbH v Metro-SB-GroßmärkteGmbH & Co. KG [1971] ECR 487, paragraph 19; United Brands v. Commission, cit. note 33 above.; Benzine enPetroleum Handelsmaatschappij BV and others v Commission [1978] ECR 1513; Ministère Public v Jean-LouisTournier [1989] ECR 2521; Centre Belge d'Etudes de Marché - Télémarketing (CBEM) v SA Compagnieluxembourgeoise de télédiffusion (CLT) and Information publicité Benelux (IPB) [1986] ECR 3261; Radio TelefisEireann (RTE) and Independent Television Publications Ltd (ITP) v Commission (Magill) [1995] ECR 743; Hilti,http://www.curia.eu.int/fr/content/juris/t2.htm; Tetra Pak International SA v Commission (Tetra Pak II); Irish Sugar,cit. notes 34 and 86 above; Portuguese Republic l v Commission [2001] ECR 2613111 See Council Regulation (EC) No 1/2003 of 16 December 2002 on the implementation of the rules on competitionlaid down in Articles 81 and 82 of the Treaty, OJ L 1, 04.01.2003, recital 5 and article 2112 See paragraph 80 below.113 See section 5.5.2 below.114 Hilti, cit., note 110 above; 1 Tetra Pak II, cit. Note 110 above.

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5.5.2 MEETING COMPETITION

81. A firm is entitled to "meet competition", i.e. defend its own commercial and economic interests againstaction taken by competitors

115. In other words, minimising short-term losses prompted by competitors'

actions is a legitimate aim, and even more so losses over a protracted period of time confining to longterm. This defence relies on evidence that the conduct under scrutiny is merely a response to lowpricing by competitors, thus showing competitive pressures and rebutting the assumption of dominance(and by way of consequence abuse thereof); it fails when there is evidence that the aim pursued withthe conduct is the foreclosure of competitors.

The "meeting competition" defence applies to individual (as opposed to collective) conducts, and issubject to a proportionality test. The proportionality test checks whether the conduct under scrutiny is aproportionate response, given the interest of the dominant firm to minimise its losses and the interest ofits competitors to enter or expand, with the protection of the consumer's interests in mind.

82. The Discussion Paper describes a proportionality test in three steps, first checking whether the conductunder scrutiny is a suitable way to achieve the legitimate aim. It checks next that the conduct isnecessary, i.e. that there is no less anti-competitive alternative capable of similarly achieving thelegitimate aim, and it finally checks whether the conduct is limited in time to the absolute minimum. Thisphrasing may be misleading to the extent it suggests an "absolute" mathematical certainty as to theminimum time span a policy needs to be pursued to deliver as expected, which is impossible tocompute in theory - let alone verify empirically.

The Discussion Paper suggests that a conduct is not likely to pass the proportionality test if it requiresadditional investments in capacity and therefore does not minimise losses caused directly by the actionof competitors. This reference to additional investments is to some extent a non sequitur, and a conductis either legitimate because it is a loss minimising reaction to competition or it is not; the cost ofadditional investments is already logically implied and mathematically computed when assessing lossminimisation.

Here again, the Discussion Paper might be misconstrued as placing the burden of a negative proof(absence of economically practicable and less anti-competitive alternatives to limit short term losses)with the dominant firm. As indicated above, under due process of law rules, a negative proof isgenerally regarded as impossible; it seems that the existence and practicability of alternatives shouldrather be demonstrated by whoever claims that they exist.

83. The Discussion Paper suggests that pricing below AAC would not even pass the first step of theproportionality test, because this is in general neither suitable nor indispensable to minimise thedominant firm's losses. Still according to the Discussion Paper, pricing above AAC may pass the testinstead, although the probability is rather low.

There are, however, quite exceptional circumstances under which even pricing below AAC passes thetest. Selling below AAC may be required to meet competition and maintain a presence in the relevantmarket; losing such presence may impose higher costs that those implied by pricing below AAC

5.5.3 EFFICIENCY GAINS

115 See United Brands cit. note 33 above; BPB Industries Plc and British Gypsum Ltd v Commission [1993] ECR II-39;T-228/97 Irish Sugar, cit. notes 34 and 86 above. For an example related to the digital economy, see US v. Microsoft,cit., note 14 above, Findings of Fact at paragraph 140: "Even absent the strategic imperative to maximize its browserusage share at Netscape's expense, Microsoft might still have set the price of an Internet Explorer consumer license atzero. It might also have spent something approaching the $100 million it has devoted each year to developing InternetExplorer and some part of the $30 million it has spent annually marketing it. After all, consumers in 1995 were alreadydemanding software that enabled them to use the Web with ease, and IBM had announced in September 1994 its plan

to include browsing capability in OS/2 Warp at no extra charge. Microsoft had reason to believe that other operating-

system vendors would do the same. See also sections 6 and 8 below, on predation and on bundling.

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84. This defence looks much like an "affirmative" defence, resting on evidence that a) efficiencies are actualor probable; b) the conduct concerned is indispensable to gain such efficiencies; c) these efficienciesbenefit consumers; and d) competition in respect of a substantial part of the products concerned is noteliminated. When all four conditions are met, the net effect of a conduct is pro-competitive, i.e. in thesense of the very essence of the competitive process, which is to attract consumers by offering betterproducts, better prices, better price/quality ratios, or all of the above.

85. The Discussion Paper mixes objective and subjective elements when it makes the defence rest onevidence that the practice under scrutiny is adopted "to contribute to improving the production ordistribution of products or to promote technical or economic progress". The examples given ("forinstance by improving the quality of its product or by obtaining specific cost reductions or otherefficiencies") change nothing to this point.

A clear choice in favour of, say, objective outcomes would have been preferable116

. Even in this case,two questions would remain. One concerns the dominant firm, and its ability to produce empiricalevidence to the effect that a given conduct does produce efficiencies, or even inferential evidenceconcerning the probability that such efficiencies may be generated

117. The other concerns regulators

and judges, and relates to their ability to understand process economic data, while protecting theirconfidentiality and assessing their evidentiary weight.

The example included in the Discussion Paper (protection of client-specific investments made by thedominant firm) clearly illustrates the above points. Measures adopted (subjectively) to protect client-specific investments may end up yielding zero consumer gains; the sensitivity of these data is huge,and the risk associated with their disclosure to the court (and therefore to an opponent in acontradictory process) is conversely proportional to their decisiveness, i.e. to the Court's ability tounderstand them and use them as basis for a decision.

86. The Discussion Paper posits that the defence should rest on the fact that the conduct under scrutiny,and only that conduct, can yield the expected efficiencies.

This is correct in theory, and a dominant firm (assumed defendant) may expect to bear the burden todemonstrate that seemingly realistic and less restrictive alternatives would be significantly less efficient,or that all rational alternatives are significantly less realistic or less efficient, or insignificantly lessrestrictive or all of the above.

It is however wrong in practice, because should a dominant company be at all willing to discloseevidence in any of the above senses, a normally trained regulator or court using normally availableanalysis tools (at least in Europe and America) would not be able to weigh it against opposite evidencefrom the plaintiff.

87. A defence should also rest on evidence that the probable efficiencies stemming from the conduct underscrutiny outweigh the probable harm to consumers, namely by restriction of competition. Such will bethe case when evidence points to probable efficiencies of the conduct and probable higher ability andincentives for the dominant firm to pass efficiency gains to consumers.

88. Again, competition is just a detected tool to enhance consumer welfare and promote efficient allocationof resources. The benefits passed on to consumers must be at least equivalent This requires that thepass-on benefits must at least compensate consumers for any actual or probable negative impactcaused to them by the conduct concerned. If consumers in an affected relevant market are worse offfollowing the exclusionary conduct, that conduct can not be justified on efficiency grounds.

89. The value of a gain for consumers in the future is not the same as a present gain for consumers. Ingeneral, the later the efficiencies are expected to become effective in the future, the lesser their weightas a defence. To be fully effective as a defence, efficiencies must be timely.

116 What matters from the consumer's point of view is efficiencies that generate consumer gains. Practices adopted withthe worst conceivable intentions may yield actual benefits, and vice-versa.117 Informal "probability" of efficiency gains would probably not regarded as such evidence, regardless of theterminology used in the Discussion Paper.

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90. The incentive for the dominant firm to pass cost efficiencies to consumers is often related to thecompetitive pressure from the remaining firms in the market and from potential entry, but it may alsoresult absent any competition, from Coase constraints. The greater the risk of a false negative, thehigher the threshold of evidence that efficiencies are substantial, and will in all probability becomeactual and substantially passed on to consumers.

The Discussion Paper suggests that the probability that efficiency gains from exclusionary conduct of adominant firm will ever pass on to consumers is conversely proportional to its market share

118. This

seems in contradiction with the very definition of dominance provided by the Discussion Paper anddiscussed above.

The Discussion Paper rightly posits that when demand is very inelastic, it is highly improbable thatabusive conduct of a dominant firm which strengthens its dominant position can be justified on theground that efficiency gains would be sufficient to counteract the actual or probable anti-competitiveeffects and would benefit consumers. This, however, needs to be qualified by the fact that it is not easyto compute correctly elasticity of demand, which varies with the price levels at which it is calculated.

91. Last but not least, the Discussion Paper suggests a requirement that competition in respect of asubstantial part of the products concerned should not be eliminated, immediately or in the future. Whencompetition is eliminated the competitive process is brought to an end and short-term efficiency gainsare outweighed by longer-term losses, unless the market works under conditions in which rent-seeking,misallocation of resources, reduced innovation and higher prices (all typical of monopoly understandard theory) . Such is the case when monopoly rents are competed out before the achievement ofmonopoly, and factors other than competition guarantee low prices, high levels of innovation and properallocation of resources.

Indeed, antagonism between firms is an essential driver of economic efficiency, including dynamicefficiencies in the shape of innovation, and should be given priority over efficiency gains, although it isonly one of such drivers. The Discussion Paper is rather dismissive as to the possibility thatexclusionary conduct by a dominant firm with a market position approaching that of a monopoly, or witha similar level of market power, might ever meet the requirement that efficiency gains outweigh anti-competitive effects and do not entirely eliminate competition. The position seems over-broad, to theextent much will depend on the characteristics of the industry concerned.

92. The Discussion Paper suggests that a dominant firm probably has a market position approaching thatof a monopoly if its market share exceeds 75% and there is almost no competition left from other actualcompetitors in the market, for instance because they are producing at considerably higher costs and/orare severely capacity constrained for a longer period of time, and entry barriers are so substantial thatrelevant entry can not be expected in the foreseeable future

119.

6. PREDATORY PRICING6.1 INTRODUCTION

93. Predatory pricing is a reduction of prices such that the firm deliberately incurs losses or foregoes profitsin the short run so as to enable it to exclude or discipline one or more competitors, or to prevent entryby one or more potential competitors thereby hindering the maintenance of the degree of competitionstill existing in the market or the growth of that competition.

94. Predatory pricing is not in practice easy to distinguish from normal price competition. The lowering ofprices, the directly visible part of predation, is also an essential element of competition. Pricing is notpredatory merely because a firm is lowering its price.

118 In other terms, the probability is zero when the firm is a monopoly, and very slight in near-monopoly situations. Seeparagraph 92 below.119 See Hoffman-La Roche, cit. note 54 above; Irish Sugar cit. notes 34 and 86 above.

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95. Pricing is also not predatory just because the lower price means incurring losses or foregoing profits inthe short run. An investment in temporarily lower prices may for instance be required to enter a marketor to make more customers familiar with the product.

96. Lower prices, to all or certain customers, are not predation; there is predation instead when thepredator deliberately makes a sacrifice (consisting in short term losses) in order to exclude or disciplinea prey or prevent its entry

120. The predator will make this sacrifice when it expects to recoup the losses

or lost profits at a later stage, after its actions have had the desired foreclosure effect121

. The exclusionshould thus allow the predator to return to, maintain or obtain high prices afterwards. Althoughconsumers may have benefited from the lower predatory prices in the short term, in the longer termthey will be worse off due to weakened competition resulting in higher prices, reduced quality and lesschoice.

97. An exclusionary strategy can normally be effective and profitable only if a firm already has substantialmarket power. Predation is abusive when it is instrumental in protecting or strengthening the predator'sdominant position and thereby allows the predator to return to, or obtain, high prices afterwards. In acompetitive market with many competitors, the exclusion of some of them will probably not lead to aweakening of competition such as to allow the predator to recoup the 'investment'. Also in a market withonly a few but strong competitors, predation has low probability of success. Predatory pricing is a riskystrategy because the self-inflicted losses may not be regained if the predator makes a mistake aboutmarket conditions (for instance, if the prey is more resilient than expected, if mainly competitors benefitfrom the exclusion, or if entry or re-entry occurs at a later stage). In other words, predation is probablyself-deterring to a certain extent, and this explains why it is rarely used. However, it is certainly notimpossible, for instance in the case of multiple markets where reputation effects are important and thedominant firm is less dependent on external financing than (potential) entrants.

98. Predation by collectively dominant firms is less probable, because they may find it difficult to predate anoutsider without increasing price competition between them, and because they usually lack a (legal)mechanism to share the financial burden of the predatory action. But again, collective predationrequires rather sophisticated pricing arrangements that are in practice easier to deal with as collusiverestraints than as collective abuse.

99. Predation may aim not only at the exclusion of competitors but also at disciplining them. Actually,predation usually falls short of exclusion stricto sensu, because the assets of the competitor, sold at alow price, stay in the market at least latently, creating a possible low-cost entrant. The dominant firmmay be best placed to acquire the assets, but this may be ruled out due to merger regulations. Thus apredator may prefer to discipline the competitor (leading the competitor to compete less sharply, andrather follow the pricing of the dominant firm) rather than exclude it; in addition, this strategy is lesscostly to the dominant firm.

6.2 ASSESSMENT

120 The Discussion Paper underscores the intentional element with the phrase "with the intention to exclude"; it wouldseem that there is no predation when the firm inadvertently incurs short term losses, or when it does due to a seriousmiscalculation or an exceptionally foresighted calculation totally unrelated to the121 Note the assimilation between incurring losses and foregoing profits as suggested in the Discussion Paper. In theUS, it has been suggested that this "sacrifice test" could serve to merge the price- and non-price predation analyticalframeworks, thus closing the gap between Matsushita / Brooke Group and Aspen / Kodak; see respectively 475 US(Matsushita) and 509 US (Brooke Group), where the defendant prevailed, and 472 US Aspen [1985] and 504 USKodak [1992] where the plaintiff prevailed. In US v. Microsoft (253 F.3d 34 [2001] ), Professor Franklin Fisher, actingas an expert witness for the plaintiffs, proposed a novel theory of predation, in an effort to catch costless conduct(resulting for instance from the firm's ability to tap costless resources): any action that would not have been profitableif it weren’t for its anti-competitive effects is predatory. Thus pricing above marginal or even average cost, could be

predatory, provided the anti-competitive effect is proved separately. The main difficulties with this definition, and withthe "sacrifice test" in general are similar to those of the but-for test, with two additional drawbacks: one is that it fails tocatch the reality of costless activity, and the other is that it requires a comparison between data that will seldom beavailable.

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100. Predation is relevant for the purposes of competition law to the extent it may constitute abuse ofdominance.

101. Predatory pricing constitutes abuse of dominance when the dominant firm uses it to protect orstrengthen its dominant position. The exception to this rule is the EU policy in sectors where activitiesare protected by legal monopoly: a firm does not need to predate to protect a monopoly that is assuredby law anyway, but there is risk of cross-subsidisation (see below paragraph 125).

Although predation usually occurs in the very market in which the firm is dominant, it may occur in arelated market. Predatory pricing by a dominant firm in an unrelated market where it is not dominantand where the predation will only have effects in this unrelated market will normally not be an abuse ofdominance

122.

102. Under most market conditions a dominant firm will not have to price below ATC and thus make a loss.Its market share, the preference of consumers for its product, the entry barriers, the absence orweakness of competitive constraints, and the resulting price-naming power allow the dominant firm toprice well above ATC. Furthermore, a firm constrained to make losses would hardly qualify asdominant. An assumption of predation (aimed at the exclusion of a competitor )is instead reasonablewhen a firm proved to be dominant deliberately lowers prices to levels in which it makes a loss.

103. Several cost benchmarks123

are used to comfort or rule out this assumption. Ideally, data of thedominant firm should be fed into such benchmarks. When reliable data concerning the dominant firmare not available, data relating to an apparently efficient competitor may be used instead, but the resultsare less reliable. build on other arguments a credible case of predatory abuse. Where the case isargued on the basis of cost data of competitors, the dominant firm may rebut by showing that it is orwas actually not pricing below the appropriate cost benchmark. .

104. The prior definition of the relevant time period over which to measure costs is a prerequisite of any costbenchmark. This is important because what is a fixed cost in the short run may become a variable costin the longer run. In the long run all factors of production become variable as the production process,the plant and machines will be replaced. What are fixed and variable costs can only be determined inthe actual situation of the case.

105. The relevant period over which to measure the costs will in principle be the time period in which thealleged predatory pricing has taken place or, if still continuing, is expected to take place. However, incertain cases a different period of time may be appropriate. For instance, in particular liberalisedsectors LAIC is used.

6.2.1 PRICING BELOW AAC

106. By contrast with the suggestion of the Discussion Paper, the appropriate cost benchmark is the one thatmost accurately measures whether there is predation or not. The relevant question in that context iswhether the dominant firm, by charging a lower price for all or a particular part of its output over therelevant time period, incurred or incurs losses that could have been avoided by not producing that(particular part of its) output. If such avoidable losses are incurred, an assumption of predatory pricingseems reasonable. At the same time the benchmark must be practical enough to be implemented.

107. In theory, the MC benchmark answers the question for each individual unit of output separately; a pricebelow MC means that the production and sale of that unit led to an immediate loss that could havebeen avoided by not producing that unit. However, not only is the per unit approach cumbersome, inmost cases there will be no data available to calculate MC.

122 See Tetra Pak II, cit. note 110 above. The markets of bricks and gable top containers for, respectively, UHT andpasteurised milk were regarded as closely related, despite the absence of a filling technology applicable to both. Seehowever note 32 above: the enforcement authority's concerns about the acquisition by Tetra Pak of filling technologyapplicable to both proved a false positive. Converting Tetra Pak I (and arguably II) into economic games using standardregression techniques shows that the false positive proved ultimately more detrimental to the competitor.123 These benchmarks are reviewed in the following subsections.

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108. The AAC benchmark answers the question of avoidable losses. If a dominant firm prices below AACthis means that the price it is charging for (that particular part of) its output is not covering the costs thatcould have been avoided by not producing that (particular part of its) output. This obviously, works aslong as the MC is not zero; in other terms, it does not work in the digital economy.

The AAC and AVC benchmarks provide the same answers as long as variable costs are the onlyavoidable costs, and would similarly fail if such variable costs did not exist. If the dominant firm had toexpand capacity to predate, then also the fixed cost (or "sunk investment") required to install thisadditional capacity are also taken into account; in this case, the results of the AAC benchmark arehigher than those of the AVC.

109. If a dominant firm prices below AAC, it incurs a loss that it could have avoided; it is thus not minimisinglosses or maximising profit. As indicated above, an assumption of sacrifice aimed at predation follows,with an ensuing reversal of the burden of proof.

The Discussion Paper makes room for rebuttal of the assumption, but suggests that the circumstancesunder which a price below AAC may be justified are quite exceptional

124. Like much of classic predation

theory, this rests on the hypothesis that an increase in prices will follow125

.

110. The Discussion Paper suggests that below AAC the pricing of a dominant firm is probably predatory,and there is no need for further proof of actual or probable exclusion of the target, predatory intent, andprobability that losses will be recouped in the future through the bargains-then ripoffs mechanism.

The Discussion Paper makes room for rebuttal of the assumption126

either because the AAC costbenchmark is not relevant or because although it is, this pricing should not be considered predatorypricing because there is no possibility that it could have an exclusionary effect. A one-off temporarypromotion campaign to introduce a new product, limited in time and scope in a manner such thatexclusionary effects are excluded would not, for instance, constitute abuse of dominance.

6.2.2 PRICING ABOVE AAC BUT BELOW ATC127

111. The Discussion Paper suggests that "but-for" its predatory effects, a dominant firm has no incentive toprice below AAC because this does not maximise profits in the short term; actually, it maximises losses.A firm may instead have legitimate reasons not caught by the but-for test to price above AAC, but stillbelow ATC, for instance when a serious fall in demand causes the short term profit maximising price totemporarily fall below ATC. Pricing below ATC will not entail losses by the mere production of thatparticular fraction of output; for sure sales do not cover total costs, but they still cover all variable costsand a part of the fixed costs.

Thus pricing above AAC does not support per se an inference of predation. There may be, however,direct evidence of deliberate choice of this pricing as a pivotal element of a strategy geared towards theexclusion of a competitor. Prices above AAC and below ATC may force the exit of just "as efficient"competitors with lesser financial resources

128.

112. In other terms, pricing above AAC and below ATC is objectionable on a subjective basis, when there ispredatory intent. The burden of proof, obviously, does not rest with the alleged predator.

6.2.2.1 DIRECT EVIDENCE

124 See section 6.2.5 below.125 In AKZO Chemie BV v Commission [1991] ECR I-3359, the ECJ relied on the AVC benchmark, and indicated thatprices bellow AVC must be regarded abusive. The so-called "bargains-then-ripoffs" theory has however been underincreasing fire for the past 15 years. Its validity is, obviously, contingent of the absence of Coase constraints on prices,which effectively prevent a price increase.126 See paragraph 130 & ss. below.127 This measure becomes relevant when cost levels can not be ascertained128 See note 114 above. Modern economic analysis shows, however, that venture capital is often willing to back theprey if it is generally regarded as a viable business, and even more so if is meets the "as efficient" standard.

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113. Direct evidence of a predatory strategy can consist of documents from the dominant firm, such as adetailed plan demonstrating the use of predatory prices to exclude a competitor, to prevent entry or topre-empt the emergence of a market, or evidence of concrete threats of predatory action. TheDiscussion Paper requires that such evidence be clear and specific about the predatory strategy andsteps to implement it

129.

We think that the intent needs in addition to be attributable to the firm, i.e. emanate from or be endorsedby officers with delegation to implement it, and thus constitute more than "small talk" often used ininternal communications for purely internal or personal reasons

130.

114. When there is direct evidence, there is no need to ascertain whether other elements also point towardspredation. The Discussion Paper considers the existence of an objective intent as an indication ofprobable effect: a dominant firm's clear strategy to predate supports inference that it has the means toimplement it, and that its pricing conduct does or will exclude or discipline the competitor in questionand thereby have a negative effect on the existing levels of competition or their expected increase

131.

6.2.2.2 INDIRECT EVIDENCE

115. The Discussion Paper mentions as admissible inferential evidence resulting 1) from the fact that thepricing only makes commercial sense as part of a predatory strategy

132, 2) from the actual or probable

exclusion of the prey, 3) from selective targeting of certain firms, 4) from specific costs incurred forinstance to expand capacity, 5) from the scale, duration and continuity of the low pricing, 6) from theconcurrent application of other exclusionary practices, or 7) from the possibility for the dominant firm torecoup its losses with profits earned on other sales or through a return to high prices.

116. A pricing conduct that only makes commercial sense as part of a predatory strategy will support aninference of predatory intent, when there are no other reasonable explanations

133.

117. In all other cases a finding of predation can only rest on evidence of probable foreclosure effect, in thelight of the scale, duration and continuity of the low pricing, as necessary although not sufficientelement.

118. Low prices selectively available for specific areas of demand (namely those who also demandsubstitutes) may constitute evidence of a predatory strategy, although they may also indicate healthycompetition and rational exercise of buying power. Abuse of dominance may be involved when thedominant firm's prices are designed to damage a competitor's viability and to foreclose the market whilelimiting own losses to those arising from the targeted sales; or when such low prices are selectively

129 In AKZO, cit. note 124 above, the Court agreed with the Commission that there was clear evidence of AKZOthreatening ECS in two meetings with below cost pricing if it did not withdraw from the organic peroxides market. Inaddition there was a detailed plan, with figures, describing the measures that AKZO would put into effect if ECS wouldnot withdraw from the market.130 Examples include communications made within the framework of internal bargaining between departments of thefirm in the course of a related or unrelated decision-making process, or opportunistic individual communications frommiddle or upper managers desirous of building, for instance, a reputation for aggressiveness.131 Because predation seldom succeeds, it is rarely attempted; see notes 114 and 118 above.132 This is the "but-for" test used in the US with fluctuating rates of success. In Verizon v. Trimko 124 S. Ct. 872 (2004)the US government used it in its petition for certiorari, but abandoned it in its writ on merits. In Verizon, the petitionerindicated that "a conduct is not exclusionary unless it would make no economic sense for the defendant but for itstendency to eliminate or lessen competition". The Discussion Paper suggests instead that there is exclusionary conductwhenever the but-for test is met. For a general comment on the but-for test see Salop, S. and Craig, R., "PreservingMonopoly: Economic Analysis, Legal Standards and Microsoft", George Mason Law Review 617 (1999).133 The but-for test still suffers from major flaws. One is that it is narrative appealing to the omniscient narrator: whenthe enforcement agency or court does not see a reason why a conduct would be adopted if it weren't for its exclusionaryeffects, these reasons do not exist; worse, when a court or enforcement agency does not perceive their rationality, thedominant firm cannot really structure a defence around them. Conversely, the test fails to catch conduct with, say, avalue of 100 to the dominant firm, when 25 are attributable to efficiency gains and 75 are attributable to exclusionaryeffects (the firm would still have adopted the conduct for the sole efficiency gains).

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targeted at those customers that might switch to a potential entrant if entry is imminent. On the otherhand, it is hard to understand why these customers would not impose position to their supplier.

119. Evidence related to scale, duration and continuity of a practice possibly regarded as predatory willconcern its implementation in one market or period of potential entry or more. In the latter case, it couldmake more sense for the dominant firm to 'invest' in a reputation of aggressiveness sacrificing moreprofits. In this sense, evidence relates to the existence of such multiple markets or periods, and to theperceptibility of the dominant firm's actions and their expected effects for potential entrants.

120. There may be evidence of predation, when the target is a firm depending on financing and lower priceswould undermine seriously its access to further finance. This evidence includes proof of the negativeeffects on the target firm's financial situation, of lesser dependence of the dominant firm on financing,and knowledge (or reasonable expectation of knowledge) of the difference by the dominant firm.

121. The fact that the dominant firm can offset its losses with profits earned on other sales will probablyneither prove or disprove predatory pricing. For instance, the dominant firm might be less dependent onexternal financing, or already recouping while predating. On the other hand, the firm's inability to recoupin the same period does not rule out predation. While ability to directly finance the losses incurred maybe relevant, but not as much as the existence of both incentive to predate and possibility to recouplosses (in future periods).

122. The issue of the ability to recoup the losses incurred points at the heart of the entire matter of thefeasibility of predation. Is predation a good investment from the dominant firm's point of view?

Delicate issues surround rationality and profitability. The Discussion Paper suggests that predation canstill be found when later price raises, without need for a raise above previous levels. But why would afirm incur all the risks associated with predation

134 just to break even? Indeed, by so doing, the predator

may have avoided or delayed a decline in prices that would otherwise have occurred as a result ofincreased competition, but an empirical proof relating to what would have happened if things had nothappened as they did is impossible

135.

123. The Discussion Paper posits that a probability, or even "likelihood" of break-even could provide enoughbasis for a finding of predation. This does not really solve much, because no regulator or judge canattribute a percentage of probability of break-even making economic sense, when the predator itselfcan't, despite business intelligence, data navigation and decision-aid tools that clearly outclass those ofregulators and judges

136.

The Discussion Paper further suggests that a finding of predation may rest on evidence of the effect onbarriers to entry, gains in the predator's market power and the probable changes in the future structureof the market. It actually goes as far as suggesting there is no need to support a finding of predationwith a separate proof of possibility to recoup: because dominance is already established, the barriers toentry are sufficiently high to assume that there is a possibility to recoup

137.

Obviously, if there was evidence that the dominant firm's price fluctuated towards lower levels uponentry, and increased again after exit or disciplining of the entrant, this could be indicative of a probabilityto recoup losses, supporting a finding of predation. But what when such evidence does not exist.

134 Including the financial risk of inability to recoup losses and the legal risk of fines and damages for predation.135 Predation may not target an identified competitor, and aim at building a building a reputation of aggressiveness withentry deterrence effects. The credibility of this reputation, however, is highly volatile.136 These systems rely on entire data warehouses of secret and highly sensitive data; not available to either regulators orcourts.137 In Tetra Pak International SA v Commission [1996] ECR I-5951, the ECJ found that proof that the predator hadactually recouped losses was not required. Intriguingly, there is no case law showing that losses were actually everrecouped, starting with Standard Oil. In Wanadoo Interactive (Commission Decision of 16 July 2003), the EU foundthat it still made sense to continue the predatory strategy found to have been initiated some time before, despite itsrather dubious success; the strategy in question was found to have been initiated when the predator was a subsidiary ofa public-owned firm, which to some extent restores rationality.

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6.2.3 PRICING BELOW LAIC

124. An assumption that pricing below LAIC is predatory is justified for activities protected by a legalmonopoly. In these cases a firm dominant in the protected market should not be allowed to use theprofits made in that market to establish itself or defend its position in another, often related, marketwhich is open to competition. In order to prevent such cross-subsidisation the decisional practicerequires the dominant firm to cover with its pricing in the free market at least all the variable and fixedcosts it makes in order to be active on that market, in other words to price above LAIC

138. In these

cases pricing below LAIC can justify an assumption of abuse, not only if the dominant firm is in additiondominant in the free market but also if it is not dominant in that market and the predation will only haveeffects in that market (see paragraph 101 above).

125. In addition, an assumption that pricing below LAIC is predatory is justified in sectors which recentlyhave been liberalised or which are undergoing liberalisation, such as the telecom sector

139.

Liberalisation efforts in these sectors should not be undermined by predatory conduct by the incumbentdominant firms, which may try to protect and maintain their monopoly positions that resulted from theirprevious legal monopoly or access to state funds. These sectors concern network industries, with veryhigh fixed costs and very low variable costs, where the use of an AVC or AAC benchmark would notreflect the specific economic realities of these industries.

126. The EU telecommunications policy provides that "[i]n order to trade a service or group of servicesprofitably, an operator must adopt a pricing strategy whereby its total additional costs in providing thatservice or group of services are covered by the additional revenues earned as a result of the provisionof that service or group of services. Where a dominant operator sets a price for a particular product orservice which is below its ATCs of providing that service, the operator should justify this price incommercial terms: a dominant operator which would benefit from such a pricing policy only if one ormore of its competitors was weakened would be committing an abuse."

140

6.2.4 PRICING ABOVE ATC

127. When the net price remains above ATCs, the probability that predation is involved will be low becausesuch pricing can usually only exclude less efficient competitors

141. Firms that are equally or more

efficient will, if challenged by the dominant firm, be able to follow such price cuts and the ensuing pricecompetition would normally be characterised as competition on the merits. Where it thus can beestablished that the price, also after the price cuts, remains above ATC the pricing will not be assessedas predatory, unless exceptional circumstances indicate that such price cuts have led or will lead tosubstantial harm to consumers.

128. An example of such an exceptional situation is where firms in a collective dominant situation apply aclear strategy to collectively exclude or discipline a competitor by selectively undercutting thecompetitor and thereby putting pressure on its margins, while collectively sharing the loss ofrevenues

142. The exclusion or relegation to niche markets conducted by a group of firms holding a

collective dominant position through selective price-cutting to match those of a competitor, therebyeliminating the principal, and possibly only, competitor is prohibited

143. Financial losses or losses of

revenue of the "fighting vessels" were distributed among the collectively dominant firms, thus over themembers of the conference, each of whom were suffering proportionately much less than the non-

138 See Case COMP/35.141-Deutsche Post AG (Commission Decision 2001/354/EC of 20.03.2001, OJ L 125,05.5.2001, p. 27). See also Notice, cit., note 15 above139 See Notice, cit., notes 15 and 21 above; and Access Notice, cit. note 217 below140 See Notice, cit., notes 15 and 21 above; and Access Notice, cit. note 217 below141 This assessment may be different if the price cuts are combined with other exclusionary practices. See the criticismto the "less efficient" test in note 103 above.142 Such a case can in general fall under both under Articles 81 and 82143 See Compagnie Maritime Belge Transports, cit., notes 7, 88 and 107 above. The collectively dominant firms in thisliner "conference" used "fighting ships" (vessels sailing in competition with the non-conference carrier), calling at thesame ports as the non-conference competitor, and charging the same or lower rates, while such rates were well belowthe conference tariff. As an alternative to lowering prices in this manner the conference could also predate by addingcapacity to the route in question.

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conference carrier while at the same time charging higher rates on their other business. If in such anexceptional case it can be shown that there is a clear strategy to exclude or discipline including amechanism to share the sacrifice in lost revenues between the collectively dominant firms and thatthere are negative effects on competition in the market or that there is a high probability that sucheffects will materialise, then also selective price cuts above ATCs will be assessed as predatory.

129. Another example of such an exceptional situation where price cuts above ATCs could be deemedpredatory is where a single dominant firm operates in a market where it has certain non-replicableadvantages or where economies of scale are very important and entrants necessarily will have tooperate for an initial period at a significant cost disadvantage because entry can practically only takeplace below the minimum efficient scale. In such a situation the dominant firm could prevent entry oreliminate entrants by pricing temporarily below the ATC of the entrant while staying above its own ATC.For such price cut to be assessed as predatory it has to be shown that the incumbent dominant firm hasa clear strategy to exclude, that the entrant will only be less efficient because of these non-replicable orscale advantages and that entry is being prevented because of the disincentive to enter resulting fromspecific price cuts.

6.2.5 DEFENCES

130. If an assumption of predatory pricing is justified, the dominant firm may rebut that finding by justifying itspricing conduct even if the price is below the relevant cost benchmark.

131. A defence could be that although the price is below the relevant cost benchmark and although there isa probable exclusionary effect, the dominant firm is actually minimising its losses in the short run.Although as indicated above, this defence has a low probability of success for pricing below AAC, itmay exceptionally succeed when valid reasons for temporary pricing below AAC exist. Examplesinclude cases in which there are re-start costs or strong learning effects. The probability of success ishigher when pricing is above AAC: there may be evidence that the low price is, for instance, a short runloss minimising response to changing conditions in the market, such as a fall in demand leading toexcess capacity. There may also be evidence that perishable inventory needs to be disposed of orphased out, or the costs of storage have become prohibitive

144; there may be other examples.

132. The entry of a competitor can also change market conditions. If the competitor prices lower than thedominant firm, the latter may act to "meet competition", provided the action minimises its short runlosses. By contrast, the meeting competition defence cannot to justify a predatory price deliberatelyadding to losses to prevent, frustrate or slow down the entry. The meeting competition defence cannotdefeat an abuse of dominance case based on pricing below AAC, because this pricing is notindispensable, or even suitable to minimise. The defence could instead defeat the case when thepricing is above AAC if the dominant firm's reaction is suitable, indispensable and proportionate: thereshould not be less anti-competitive means to minimise the losses, the conduct should be limited in timeto the absolute minimum; the Discussion Paper adds that it should not significantly delay or hamperentry or expansion by competitors.

133. The possibility of an efficiency defence is doubtful. Evidence of clear efficiency gains is not easy toproduce, and predation is seldom the least restrictive way to achieve them. The Discussion Paperdoubts that efficiency gains will be passed on to consumers in the longer run, and that they will in anyevent outweigh the loss of competition caused by the predation.

7. SINGLE BRANDING AND REBATES7.1 INTRODUCTION

144 Sometimes a certain pricing conduct may be justified for more than one reason. For instance, the need to sell offperishable inventory or phased out or obsolete products at a loss making price may just as well indicate that there willbe no (lasting) exclusionary effect on competitors. In such cases it may also have to be taken into account that certaincosts that would under normal circumstances be considered variable costs may have become fixed costs at the time ofsale.

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134. There are several tools to channel demand towards own products exclusively145

. The product, in termsprice/quality ratio

146, may just be more attractive than competing products

147; this competition on the

merits does not raise per se any competition law issues, although predation may be involved asdiscussed in section 6 above. The issues raise instead when the firm contractually imposes single-branding obligations or proposes rebates that to attract more demand, to an extent unwarranted by theabove preference.

135. Single branding obligations require the buyer to concentrate its purchases to a large extent with onesupplier. The Discussion Paper defines the "English clause" as one requiring the buyer to report anybetter offer and allowing it only to accept such an offer when the supplier does not match it. Although itcan be expected to have the same effect as a single branding obligation towards with one supplier,especially when the buyer has to reveal who makes the better offer. It seems however highlyimprobable that a lawyer worth his or her salt would draft a clause in this manner. The clause generallyobliges the supplier to match a better offer, but the initiative is left to the buyer - there may be enoughincentives for the buyer to proceed in this manner.

136. Rebate systems are variously labelled and structured, and the Discussion Paper does not intend orattempt to provide an exhaustive list, nor does it deal with the case in which rebates are imposed by thebuyer. The firm may simply offer a rebate, in general out of a list price, on an individual order of thebuyer, but can also be much more complex, involving several orders or volumes of business.

137. Rebates may be unconditional or conditional. The former are granted to certain customers and not toothers

148, but apply to every purchase of these particular customers, thus differentiating prices between

customers or groups of customers independently of their purchasing behaviour149

. Conditional rebatesare instead granted to customers to reward a given purchasing behaviour, such as the amountpurchased, in absolute terms or as a function of this customer's needs, thus differentiating pricesbetween purchasing behaviours rather than between customers or groups of customers.

138. Single-branding obligations and rebate systems may be implemented for efficiency reasons or for anti-competitive reasons. In order to recoup an investment made to supply a specific customer, the firm mayneed a minimum volume of purchases, and a single branding obligation or a rebate system couldprovide a guarantee or an inducement, respectively. More simply, and absent any such investment, thesize and predictability of purchases by significant buyers may bring the firm closer to optimal efficiencyor help it maintain an existing combination of factors

150.

The Discussion Paper, however, relegates the possible positive effects of single branding obligationsand rebate systems to the section on possible defences

151. Most frequently, there will be at the same

time positive and negative effects, depending on the form, scope and surrounding circumstances of thesingle branding obligation or rebate system.

139. The main possible negative effect rebates is horizontal foreclosure, and this this may be abusive to theextent it maintains or strengthens the dominant position; as because it hinders the maintenance orgrowth of residual or potential competition. The effect may be cumulative when several, collectivelydominant, suppliers are involved, further facilitating collusion. When the demand impacted is that ofretailers selling to final consumers, the foreclosure may also lead to a loss of in-store inter-brandcompetition.

145 Conversely, some significant buyers may induce suppliers to sell them all or at least a significant fraction of theiroutput, assuming output is finite. The Discussion Paper, however, does not deal with buyer power; see paragraph 25above.146 Or simply "price", calculated per utility unit as suggested in note 28 above.147 In economic terms, preferred.148 For instance, to customers that might switch more easily149 Such rebates are termed unconditional because they are granted independently of the purchasing behaviour of thecustomer in question. However, an unconditional rebate is not available to all customers as it would otherwise be ageneral price decrease, but is only made available to certain customers depending on characteristics other than theirpurchasing behaviour.150 In everyday terms, to avoid the stress of massive layoffs and the associated cost of severance packages.151 Thus, apparently, allocating the burden of proof and cost of a possible false positive. See paragraph 77 above.

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140. Another possible negative effect of rebate systems is price discrimination between the different buyers.The Discussion Paper suggests that in most cases a negative effect on competition between thecustomers in the downstream market is unlikely unless competitors are foreclosed from the upstreammarket.

141. The Discussion Paper does not deal with the possible intent or effect of directly exploiting certaincustomers

152; such may for instance be the outcome when unconditional rebates are used

153. The

exclusionary rebates dealt with in this section do not result in higher prices for those customers thatcannot and do not switch, but in higher prices for the customers that are less loyal to the supplier, i.e.the customers that do switch. Exclusionary rebates are in general conditional rebates which maydifferentiate the price for each customer, depending on its purchasing behaviour, in order to obtainmore purchases from these customers. To the extent that this may also lead to discrimination betweencustomers, this may have the effect of distorting competition between the buyers on the down-streammarket as described in the previous paragraph.

7.2 ASSESSMENT

142. Single branding obligations and rebate systems implemented by a dominant firm may constitute abuse,when they have negative effects in the market in which such firm is dominant. Single brandingobligations and rebate systems with effects on other markets are dealt with in section 8 below. Rebatesystems that lead to mixed bundling of different products in the same market are also addressed in thesame section 8 (tying and bundling) of the Discussion Paper and these comments..

143. The Discussion Paper suggests that if the firm is dominant, buyers would on average buy a large partor even most of their purchases from it, even without loyalty enhancing measures. This typically wouldhappen because there are no proper substitutes, or the product is preferred by many consumers, orbecause the capacity constraints on the other suppliers are such that a good part of demand can onlybe attended by the dominant supplier

154. For distributors it may be necessary to trade in the dominant

firm's products in order to be able to satisfy an important part of their customers' demand and in order toreach a viable scale of business

155.

144. The Discussion Paper suggests that single branding and rebate systems may constitute abuse ofdominance when they "differ from the methods typical of normal competition and hinder themaintenance of the degree of competition still existing in the market or the growth of thatcompetition"

156.

Whatever the meaning of "normal competition", a lower price should "normally" increase the alreadynotorious preference mentioned in the previous paragraph, possibly also reflected in a very high marketshare. An increase in such preference pulls additional demand towards the dominant firm, andaccordingly away from the suppliers of improper substitutes

157; there is no doubt that their very survival

is at stake if they already have a comparatively less efficient cost structure; and even if they don't,lesser sales may kick them away from optimal output level.

152 For instance charging more to customers with a higher willingness to pay and lesser switching possibilities.Generally these customers with higher switching possibilities make themselves known and demand higher discounts.The comparatively lower price charged to other customers may also induce additional customers of the same profile topurchase or to purchase more, but in the digital economy most significant customers will neither take that commitmentor adopt such conduct. .153 See in paragraph 138 the example of a rebate offered only to customers that might more readily switch:unconditional rebates can also be used for exclusionary purposes.154 89 See section 4 on dominance. See also British Airways, cit., note 154 above and Van den Bergh Foods Ltd vCommission [2003] ECR II-4653. Distributors may strongly demand the dominant firm's products, rather that suffer itas "necessary".155 See section 4 on dominance. See also British Airways, http://curia.eu.int and Van den Bergh Foods Ltd vCommission cit., previous note.156 SeeHoffmann-La Roche, cit., note 54 above. The notion comes back severally in the Discussion Paper157 See paragraph 143 above.

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Following this logic, rebates granted by the dominant firm would always reduce a competitor's ability tomaintain a competitive pressure, let alone increase it, and would thus always be abusive, regardless ofthe refinements brought to the assessment of the probable and actual foreclosure effects.

Now if a "dominant" firm can never grant rebates for the benefit of the demand it faces, no matter howimperatively demanded or how justified in a Coase-constrained environment, then it lacks the hallmarkindependence required for an assessment of dominance. If competitors can replicate the rebatesbecause they are "as efficient", the firm looks rather as a "sitting duck" than as "dominant". Airlines,trains, and telephone companies (i.e. networks in general) have low or insignificant marginal cost forthe additional passenger on board or the additional minute of communication. All used to enjoymonopolies established by law and (with the exception of trains) all now play in a competitive arena. Alluse loyalty bonuses for volume users, and all are confronted to low-cost carriers.

145. Several factors influence the intensity of potential negative effects and thus make a finding of abuse ofdominance more or less probable. The Discussion Paper mentions the size of the tied market share(the fraction of demand facing the firm to which the single branding or rebate system applies). It alsomentions the consumer profile (for instance demand that is most likely to switch to alternative suppliers,or comes from areas that would make it attractive for a new entrant). Other factors include economiesof scale and scope, network effects or learning curve effects

158, and the fact that the practices may be

aimed at fighting a specific competitor.

146. The Discussion Paper reminds that when markets do not meet the conditions of paragraph 143, i.e.when more or less perfect substitutes exist, and even more so when the product is homogeneous andcompetitors are not capacity constrained, rebate systems will generally not have a market distortingforeclosure effect. One would even go beyond, saying that no dominance is involved and therefore anabuse case should be dismissed in limine.

147. The Discussion Paper suggests that single branding and rebate systems may constitute abuse ofdominance when they "differ from the methods typical of normal competition and hinder themaintenance of the degree of competition still existing in the market or the growth of thatcompetition"

159.

For the reasons indicated above160

, the Discussion Paper would seem to consider with distrustconsumer preference when combined with high levels of loyalty, arguably enhanced even further byrebates. In the digital economy, where consumers and distributors expect extremely high discountseven for purchases of moderate significance, preference and actual prices after rebate may go togetherto an extent such that the "dominant" company cannot disregard such expectations - which wouldparadoxically make it "non-independent" and therefore non-dominant.

7.2.1 SINGLE BRANDING OBLIGATIONS AND ENGLISH CLAUSES

148. Single branding obligations require the buyer to purchase all or a significant fraction of its requirements(or a minimum quantity amounting to such significant fraction) from the dominant supplier and thushave a capability to foreclose. The higher the fraction, the stronger the foreclosure potential; but marketdistortions may occur, too, even if the obligation weighs on just a modest part market demand: TheDiscussion Paper posits that, as indicated above, the dominant firm is already in a position to preventactual effective competition, let alone potential entries; it is thus vital to protect the limited degree ofcompetition still existing, and promote its growth

161.

158 The so-called "network effects" are visible when consumers perceive greater utility in a product because manypeople own the same. Examples include telephone networks where users directly derive value from being able tocommunicate with many other users, but also networks of computers where users derive an utility directly proportionalto the quantity of executable or non-executable content available over the network.159 SeeHoffmann-La Roche, cit., note 54 above.160 See paragraph 143 above.161The intention is commendable indeed; it is however reminiscent of the charge led by Congressman Mason in thecourse of the debates surrounding the adoption of the Sherman Act: "Some say that the trusts have made productscheaper, have reduced prices; but if the price of oil, for instance, were reduced to one cent a barrel it would not right thewrong done to the people of this country by the trusts which have destroyed legitimate competition and driven honest

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The Discussion Paper addresses here the case of purchasing obligations imposed by the dominantfirm. Interestingly, some consumers and buyers perceive gains from standardising on a single brand,such as lesser training expenses, and easier implementation of redundancy and substitutability. Theywould not need an obligation to this effect inserted in a contract to behave in this manner; but they oftenwant it inserted as an argument to demand better volume discounts, knowing it is "optimal", i.e.corresponds to behaviour they would adopt anyway. By contrast, the Discussion Paper seems at timesto assume that every single branding obligation (by definition mutually agreed upon) was imposed bythe dominant firm.

149. The Discussion Paper suggests that when single branding obligations apply to a significant fraction ofthe demand facing a dominant firm, it will affect if not most, at least a substantial part of marketdemand, thus providing grounds for a finding of abuse of dominance. The probability, however, variesas a function of the "degree of dominance" and the exact percentage demand that is tied, and isreduced to nil when there is evidence suggesting that no market distortion will result. For instance,there may be circumstances in which the short term or the right to terminate render foreclosureimprobable

162; or, as indicated in the previous paragraph, the obligation may just correspond to

behaviour from which the demand side has no interest in deviating.

150. Subject to the provisos of paragraph 135 above, the same applies to the so-called "English clauses";they have the same effect as a single branding obligation because the dominant firm will only have tolower its price when customers threaten to switch

163.

7.2.2 CONDITIONAL REBATE SYSTEMS

151. Conditional rebates usually reward customers who exceed a certain purchase threshold during adefined reference period. The assessment of the dominant firm's conduct varies depending on whetherthe rebate is granted on all purchases during that period or only on incremental purchases above thethreshold. It also varies as a function of the terms used to define the threshold, for instance as apercentage of total requirements of the buyer, as an individualised volume target or as a standardisedvolume target. Another feature of the rebate system with influence on the assessment is the existenceof a single threshold and rebate, as opposed to a grid of thresholds and rebates

164.

7.2.2.1 CONDITIONAL REBATES ON ALL PURCHASES

152. Conditional rebates that are granted on all purchases in the reference period once a certain threshold isexceeded can have a strong foreclosure effect

165. To induce such an effect it is necessary that the

dominant supplier sets the threshold above the level that the buyer would purchase from the dominantfirm in the absence of any loyalty enhancing obligation or rebate. For the same reasons advanced inparagraph 143 above, most buyers are anyhow expected to purchase most of their requirements fromthe dominant firm. If the threshold is only set at the level that would anyhow be purchased by the buyerfrom the dominant firm, the rebate will not have a loyalty enhancing effect. If the threshold is set abovethe amount that would otherwise be purchased, the rebate may induce the buyer to purchase morethan it would otherwise do, assuming demand is elastic, and thus buying less from other suppliersunable or unwilling to replicate the rebate.

men from legitimate business enterprises. (See 21 Congressional. Record 4100). Also speaking for the bill, SenatorGeorge (Mississippi) said "By use of this organized force of wealth and money the small men engaged in competitionwith them are crushed out, and that is the great evil at which all this legislation ought to be directed. (21 CongressionalRecord 3147). For more than a hundred years now, the dilemma of law enforcers and judges has been guessing righthow much inefficiency is to be tolerated by consumers to preserve "honest" and "small" competitors. .162 In general, however, short term and right to terminate are regarded in Europe as illusory, based on the assumptionthat dominance and absence of proper substitutes go together, see BPB Industries, cit., note 115 above.163 See in the context of Article 81 BP Kemi (Commission Decision 79/934) OJ L 286, 14/11/1979 p. 32-52, paragraphs64-65; In the context of Article 82, see IRI/ AC Nielsen Firm, reported in the XXVIth Report on Competition Policy1996, and Hoffmann-La Roche, cit., note 54 above.164 If a firm uses different conditional and/or unconditional rebate systems for the same product, the Commission willboth assess their individual and their collective effects.165 Case 322/81 Michelin I, ECR 3461 [1983]

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153. The strength of the inducement to purchase more from the dominant supplier, i.e. the loyalty enhancingeffect, will depend amongst other things on the rebate percentage and on the level at which thethreshold is set

166. A so-called "suction" effect is detected when exceeding the threshold not only

reduces prices for all purchases above the threshold, but also for all previous purchases during thereference period: the last units before the threshold may be for free or have a negative price, becausethe rebate will then apply to all the purchases, even those below the threshold

167. The firm uses the

inelastic or "non contestable" portion of demand of each buyer, i.e. the amount that it would havepurchased anyway, as leverage to decrease the price for the elastic or 'contestable' portion of demand,i.e. the amount for which the buyer may prefer and be able to find substitutes.

154. However, what is relevant for an assessment of the loyalty enhancing effect is not competition toprovide an individual unit, but the foreclosing effect of the rebate system on commercially viableamounts supplied by (potential) competitors of the dominant supplier. The rebate system should nothinder "as efficient" competitors to expand or enter. These competitors are assumed unable to competefor an individual customer's entire demand

168 and the question is whether the rebate system hinders

them from supplying commercially viable amounts to individual customers. If the prices at whichcompetitors should sell is below the dominant firm's ATC, they will find it very difficult or impossible tocompete. If prices are above cost, efficient competitors will be able to replicate the dominant firms netprice, although arguably still experiencing some deterrence. The ATC benchmark is used here,because the leveraging between the 'non-contestable' and the 'contestable' fractions of demand allowsthe rebate system to operate without a profit sacrifice and thus to operate for a long time. The customermay not derive a direct benefit from the rebate system as the rebate may only bring the average pricedown to the level existing without the rebate system.

155. To determine whether a rebate system is abusive or not, the first thing to do is calculate the demand (orshare of customers' requirements) that an entrant should as a minimum capture with prices equal to theATC of the dominant firm ("the required share") or higher. By itself, the size of this "required share"may already show, by comparison with actual market shares of competitors and their shares of thecustomers' requirements, that the rebate system under scrutiny forecloses entry.

156. In other cases, the measure of the "required share" alone will not provide conclusive indications. Thenext step is then the calculation of the commercially viable share of total output that an efficientcompetitor or entrant can be expected to supply, and to compare this with the "required share". Theremay be a foreclosure effect if the "required share" is larger than the commercially viable share. If rebatepercentages differ between customers, the required share may exceed the commercially viable sharefor certain customers but not for others, or in the case of a grid of thresholds and rebates (when there isuncertainty about the optimal level, for instance because of changing loyalties or because of overalldemand changes, the thresholds are sometimes formulated in the form of a grid of targets with differentrebates). The question is then the commercial significance of each of the groups of customersconcerned.

157. The measure of the commercially viable share should be carried out in market and sector context. Asindicated above, the dividing line will be set as a function of the possible entrant at minimum efficientscale possibly selling the same percentage to each customer in the market.

158. The threshold is also significant for the assessment of whether the rebate system is abusive.Thresholds, indeed, can be formulated as a percentage of total requirements or as raw volume targets(customer-specific or generic). The Discussion Paper underscores the importance of this formulation,although customer-specific raw volume targets and percentages of total requirements areinterchangeable for a firm with decent business intelligence tools. In addition, a generic threshold may

166 If the rebate is granted not in the form of a percentage but in the form of a lump sum payment once the threshold isexceeded, the inducement will be higher if the lump sum rebate increases. However, in such a case the inducement feltnear the threshold will not be related to the level of the threshold.167 This has been recognised in the case law. Michelin I, cit., note 165 above; Michelin II, ECR-II 4071 [2003]; andBritish Airways, cit. note 154 above168 Probably due to capacity constraints, see paragraph 143 above. The remark is inapplicable to the digital economy, tothe extent it follows Bertrand conjectures not constrained by Edgeworth.

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also be interchangeable when as a rule every customer buys the same quantity. If this holds, much ofthe speculation about which creates a higher loyalty-enhancing effect are superfluous

169. The loyalty

enhancing effect may increase if the threshold is adjusted to the individual demand of the customer insuccessive periods

170.

159. If the threshold is a standardised volume, it is less probable that the rebate system will have a loyaltyenhancing effect, except in the cases mentioned in the previous paragraph.

160. The intensity of market distortions resulting from the loyalty enhancing and foreclosure effects of arebate scheme is directly proportional to uncertainty of customers about thresholds or rebate levels orboth. Such uncertainty may, for risk-averse demand, induce further loyalty

171. The effect is the same, for

the same fraction of demand, when there is uncertainty as to ability to reach the thresholds. Evidence tothis effect may be available from the demand faced by the dominant firm. The effect is heavier when therebate is so high that without it the customer cannot make a profit using or reselling the product

172.

161. The above uncertainty is in turn directly proportional to the duration of the reference period, but theDiscussion Paper regards such duration as unrelated to the loyalty enhancing effect, except when thedominant firm is no longer an unavoidable trading partner

173. This could also be the case where the

product is homogeneous, in which case a long reference period and a high threshold may work as adisincentive to switch supplier after having started to purchase from the dominant supplier

174.

162. The Discussion Paper posits that the foreclosure will probably distort the market175

when the fivefollowing conditions are met: (a) the rebates are conditional but apply to all purchases in the referenceperiod after a give threshold has been attained; (b) the threshold is set high enough to hinder switchingin a significant proportion to other suppliers; (c) the required share exceeds the commercially viableamount per customer, and (d) rebates apply to a significant fraction of demand faced by the firm; and(e) entry, expansion or switching are not aggressive or significant enough to wipe away the foreclosureeffect.

If the first condition is not met, the question shifts to whether or not the fraction of demand eligible forrebates matters, regarding the possibilities of entry and expansion of competitors. The probability firstmentioned above will be higher or lower depending on evidence of actual foreclosure, such as exit ordeclining market shares of competitors.

Additional to-do after this broad approach includes closer analysis of actual market dynamics, inparticular, in condition e) above, entry and expansion. Rebate systems are part of the complexdynamics of price competition. For the sake of clarity, it is indeed preferable to regard a dominatedoligopoly as a stable structure, not really subject to challenges from inside or outside. This, however, isneither an empirically verifiable or necessary feature of such markets.

169 They show, however, the gap between the more or less rudimentary tools available to judges and governmentofficials and the sophisticated decision-assistance software available to firms. See Hoffmann-La Roche, cit., note 54above; BPB Industries, cit., note 115 above; Soda-ash-Solvay (Commission Decision 91/299) OJ 152, pp. 21-39.170 See Hoffmann-La Roche, cit., note 54 above; Michelin I, cit., note 165 above; Irish Sugar, cit., notes 34 and 86above; Michelin II, cit., note 167above; and British Airways, cit., note 154 above.171 See Hoffmann-La Roche, cit., note 54 above; Michelin I, cit., note 165 above; Case T-203/01 Michelin II, cit., note167 above172 This is for instance clearly the case if the list price, i.e. the price without the rebate, is above the resale price on thedownstream (distribution) market.173 Such could be the case when the reference period is very short and the customer's requirements in that period are solow that the different competitors can compete for all of its requirements, in which case the rebate system will normallynot have a loyalty enhancing effect. Moreover, this context would seem to rule out dominance; because by definitiondominance has been assessed first, a finding in this sense at this stage suggests that something was wrong with theassessment of dominance.174 There is a similarity here with the conclusion that in general the duration of single branding obligations is notrelevant for their assessment under Article 82175 Thus providing support for a finding of abuse of dominance.

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Much like with predatory pricing, it could be acceptable practice to first approach a rebate system as aninvestment in the short-term (in the form of lower prices) yielding higher long-term income, dueprecisely to its foreclosure effects. In a closer analysis, however, the higher long-term income is not tobe taken for granted; it is actually subject the absence of competitors who viably replicate the rebatesystem, thus holding (or possibly gaining) ground against the dominant firm if it were to be legallyprecluded from using the rebate system

176; the barriers to entry or growth should be such as to prevent

new or expanding competitors from taking advantage themselves of the exclusionary effects of therebate system.

A rebate system is a competitive weapon, and may indeed have market distorting effects. But thedistortion may be much higher, to the detriment of consumers, if a firm cannot use it while itscompetitors can use it freely. Also, in "live-and-let-live" markets (a popular although debatableexpression for collectively dominated markets) preventing rebates may greatly increase the stability ofimplied price arrangements.

163. The Discussion Paper suggests that in the event the above leads to an assumption of dominance, thedominant firm may structure its defence around evidence that the rebate system does not and will nothave a foreclosure effect, for instance, because conditions (b) or (e) of the previous paragraph are notmet

177. Evidence that an action does not (let alone will not) produce certain effects is negative proof,

and its burden should not, under due process of law rules, be imposed on any party.

In this context, it would seem, after the previous paragraph, that the failure of the claimant or plaintiff toproduce evidence relative to the five conditions required to demonstrate that there is a case at allshould not be supported by the other party (the dominant firm in this case).

Most dangerous in this sense is the above use of the term "assumption"178

. Hopefully, what theDiscussion Paper really meant is that when proceedings are initiated on the basis of weak, wrong orinsufficient evidence, the defendant can challenge such evidence on its merits. This would neitherrelease the other party from bearing its own burden of proof, or reverse it, or impose a negative proofon the dominant firm.

164. The Discussion Paper suggests using cost data of apparently efficient competitors when it is notpossible to establish accurately the required share, because reliable information on the dominant firm'scosts is not available; the ensuing drop in empirical verifiability causes a proportional surge in the risk ofa false positive that markets will not be able to correct. Furthermore, the Discussion Paper proposesthat when it is not possible to compute either way the "required share" or the "commercially viableshare", proceedings could still start, based on analysis of the market performance of the dominant firmand its competitors, preferably by comparing the situation before and after the rebate system wasintroduced. This analysis should compare the size of the rebate to the full price per unit of product, toinfer or rule out a foreclosure effect, possibly leading to the exit, or decline of the market shares, ofcompetitors or de-listing of their products.

165. The Discussion Paper suggests that although with pricing above ATC a market distorting foreclosure isimprobable, it may exceptionally still be found, for instance based on evidence that the dominant firmoperates in a market where it has certain non-replicable advantages and that the rebate system willprobably exclude entrants that would improve he competitive level in the market. In this case an entrantis only less efficient due to such advantages, and rebates could deter entry or push entrants to exit,while prices remain above the dominant firm's own ATC.

Unqualified, this language would seem to point to the much derided "duty to assist competitors". Inoligopolies with "efficient competition"

179, all firms (dominant or dominated) apply some form of limit

176 By reason, precisely of its economic ability to use it, i.e. its dominance.177See paragraph 162 above. In other terms, thresholds are low and switching or buying substantial additional amountsfrom other suppliers will not cause the loss of the rebate, or entry and expansion are higher than calculated.178 An assumption typically reverses the burden of proof, which does not appear possible here, mainly for reasonsrelated to constitutional law. The possibility that imposing the burden of a negative proof be even considered has beenseverally criticised in these comments.179 As opposed to theoretical, perfect competition.

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pricing so as to preserve the oligopolistic structure. Pushing the Discussion Paper's logic to extremes,to be safe from proceedings on the grounds of abuse, and the huge cost of a false positive, a dominantfirm with "non-replicable advantages" should charge higher prices, to accommodate inefficiencies ofcompetitors and to the detriment of consumers…

7.2.2.2 CONDITIONAL REBATES ON INCREMENTAL PURCHASES ABOVE A THRESHOLD

166. Whether the conditional rebate is available to all purchases (below and above the threshold) once thelatter is exceeded, or only to incremental purchases above the threshold, is of paramount importancefor the assessment of how loyalty enhancing effects are managed. In the latter case, the dominant firmcost-efficiently creates a loyalty enhancing effect by setting the threshold at the level that the buyerwould purchase anyway, regardless of any loyalty enhancing scheme through rebates or otherwise.

Rebates may allow a firm (dominant or not) to maintain margins while gaining market share. Becausethis means that the value of the ATC figure is expected to change with the volume of sales

180, the

classic argument on rebates goes about the lower marginal and average costs reflected by rebates181

;the argument, however, will fail when marginal costs are flat or cannot be lowered or both. Thedevelopment of a workable model to address this two-way relationship using the guidance provided bythe Discussion Paper would be a most welcome to-do.

167. The intensity of the inducement to purchase more from the dominant supplier is directly proportional tothe percentage of rebate and conversely proportional to the threshold level. When the latter is set at thelevel that the buyer would purchase anyway, the effects are more intense, regardless of whether thethreshold is expressed in terms of volume or percentage of the buyer's needs.

Right as this is in theory, a practical decision-support grid cannot be established without rathersophisticated computing tools

182 because the optimal threshold varies depending on all factors of

changing loyalties and changes in demand volume or nature.

168. Thus conditional rebates on incremental purchases only should not be abusive, unless the price afterrebate is predatory

183. By contrast, leveraging between the "non-contestable" and the "contestable"

fractions of demand allows the operation of the rebate system without sacrifice of profits for a long time,and abuse is probable if a) the resulting price does not cover average total cost and b) the fraction ofdemand eligible for the rebate is significant enough to create a foreclosure effect.

The Discussion Paper remains here at the level of static analysis, and this type of analysis is usuallynot very useful in practice

184. As indicated above, a firm may be selling below ATC for predatory and

non-predatory reasons and (very often) a mix of the two. Thus when there is, for instance, a fall indemand, excess capacity or the like, one very pertinent question concerns the time span over whichsuch conditions are expected to prevail.

169. Similarly conditional rebates on incremental purchases with a threshold defined in terms of an identicalvolume target for all buyers have a lower probability of enhancing loyalty, with the provisos noted insection 6 of the Discussion Paper and of these comments.

The uncertainties resulting the assumptions of the previous paragraph mean that the firm could well setthe threshold too high for smaller buyers or too low for large buyers or both, and thus miss the expectedloyalty enhancement. Besides the case of predatory pricing

185, there are two other situations in which a

standard threshold could still be found abusive. One concerns the case in which most buyers actually

180 Unless the arguments in Microsoft and US v. Microsoft cit., note 14 above are right, i.e. marginal costs are virtuallynon-existent.181 The typical "volume purchasing" argument of all buyers, hard to dismiss (even when marginal costs are alreadyzero, as in the digital economy)182 This is true both for the dominant firm, the buyer, and the officials responsible for evaluation of the practice in termsof admissibility under competition law.183 Predatory pricing is a separate section of the Discussion Paper (section 6).184 For instance by compliance officers, counsels, enforcement officials and judges.185 When the conditions set forth in section 6 of the Discussion Paper are met.

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purchase more or less the same amount (the "standard" threshold has the same effects as those of anindividual threshold). Another is the case in which the threshold is set a level such that it targets buyerswith special significance in terms of barriers to entry and expansion of competitors.

The practical difficulty with this otherwise theoretically correct approach is that when the firm's actualprices are lower than ATC, it would not be allowed to use conditional rebates at all, which obviouslyweakens the competitive pressures and hurts consumers whenever such pressures are the real sourceof consumer gains. Pricing lower than ATC is instead perfectly conceivable when the firm is undergoinga reorganisation that will ultimately lower costs (including ATC), thus letting unchanged prices above,and not below, ATC.

7.2.3 REBATES IN RETURN FOR THE SUPPLY OF A SERVICE BY THE BUYER

170. In some cases rebates are contingent on the "supply of a service" by the customer, such as a rebate forpayment in cash or shorter payment terms; these should not be abusive per se. However, this does notmean that conditional rebate systems as described in the previous paragraphs are automaticallyjustified by the fact that buyers are encouraged but not obliged to use the rebates (typically, "marketingfunds") for promotion or other activities.

7.2.4 UNCONDITIONAL REBATES

171. Unconditional rebates as defined in paragraph 137 above differentiate prices between customers andmay have "exploitative effects" not addressed in the Discussion Paper. But they may also haveexclusionary effects when they preclude switching. The methodology suggested by the DiscussionPaper to set a dividing line is similar to that proposed in section 6. A finding of abuse is possible basedon evidence that the exclusionary effect either inhibits or delays entry and competition for customersthat may more easily switch.

7.2.5 DEFENCES

172. In presence of evidence that a single branding obligation or a rebate system will probably have anappreciable foreclosure effect, the dominant firm may structure a defence based on efficiencyconsiderations. This defence can be successful if it meets the four conditions of paragraph 84 above.

173. A rebate system could be indispensable to achieve cost advantages and pass them on to thecustomers. These cost advantages may be related to the size of the individual transaction or deliveryand to the size of total purchases by a customer in a particular period, or even the length of the salescycle. A rebate system may be indispensable to achieve such cost savings, but the probability ofsuccess of this defence is lesser when the threshold is set in terms of a percentage of totalrequirements of the buyer or an individualised volume target or its equivalents.

174. It could also be a prerequisite to induce distributors to purchase and resell a higher volume with singleprofit maximisation. The Discussion Paper suggests that the success of this defence is contingent onevidence that 1) the customer has buying power and 2) without the rebate system the retail price wouldbe higher than the price a vertically integrated monopolist would charge and thus without the rebatesystem total output would be lower. The Discussion Paper further expresses scepticism about thechances of success of this defence when the rebate system impacts all purchases.

The language of this paragraph of the Discussion Paper seems to invite risk-averse dominant firms toaccept higher transaction costs which, by definition, will be passed over to customers and consumerswithout buying power in the form of higher prices per utility unit. It would even seem to invite verticalintegration for a fool-proof demonstration, and further assumes demand elasticity. These comments arein turn sceptical as to the practical use that judges, government officials and compliance officers offirms could make of this guidance.

175. A rebate system or single branding obligation might also be required to provide the incentive for thedominant supplier to make certain relationship-specific investments in order to supply a particularcustomer. This may even be true in certain segments of the digital economy.

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An investment is considered relationship-specific if, after termination of the supply contract with thatparticular customer, the investment cannot be used by the supplier to supply other customers and canonly be sold at a loss - or not sold at all. General or market-specific investments in capacity arenormally not relationship-specific investments, but developers hired to deliver code for a specific projectare, in particular when the customer owns the IP on the product. The Discussion Paper notes that adominant firm may not want to commit relationship-specific investments without specific supplyarrangements are fixed; we would even question whether a firm willing, although conditionally, to makeinvestments demanded by a specific customer can at all be regarded as dominant, i.e. immune from thewishes of its consumers or customers.

Under the prevailing definition of dominance, which may need to be revised as severally suggested inthese comments, only non-dominant firms should acknowledge the need of these investments to takeinto account the expectations, hopes or wishes of demand. Thus the defence should here rest on theabsence of dominance rather than on proof of customer-specific investments or their depreciation.

176. Meeting competition can in general not be used as a justification for single branding obligations186

. Thisholds both for those obligations already in place before a competitive action took place as forobligations introduced upon a competitive action in the market.

8. TYING AND BUNDLING8.1 INTRODUCTION

177. Tying occurs when the supplier makes the sale of one product (the tying product) conditional upon thepurchase of another distinct product (the tied product) from the supplier or someone designated by thelatter. Bundling occurs when a package of two or more goods is offered. There is pure bundling whenonly the bundle is available, and not the components. There is mixed bundling when both the bundleand the components are offered, but the bundle is sold at a discount compared to the arithmetical sumof the prices of the components

187. Tying and bundling may have similar effects on competition.

178. Tying and bundling are common practices that often have no anti-competitive consequences. Bothfirms with and without market power engage in tying and bundling in order to provide their customerswith better products or offerings in cost effective ways. At the most basic level, bundling or integratingtwo or more components into one product is a fundamental part of many economic activities. Suchbundling can lead to significant savings in production, distribution and transaction costs and toimproved quality. Firms may also engage in tying for reasons related to the quality, reputation and goodusage of their machines.

179. However, tying and bundling can lead to the following possible anti-competitive effects: foreclosure,price discrimination and higher prices. The present section deals only with the foreclosure effects oftying and bundling.

180. A dominant firm selling certain "tying products" can foreclose the tied market and also the tying market(horizontal foreclosure) if it engages in tying or bundling. The dominant firm thus reduces the number ofpotential customers that remain available for its competitors in the tied market, possibly relegatingexisting competitors to marginal niches, forcing their exit, or creating a barrier for new entrants.Economies of scale, network effects and high entry barriers in the tied market all make such a strategymore probable and more successful.

181. The foreclosure of the tied market may allow the dominant firm to achieve larger profits, for exampleexpanding its share of that market. Moreover, tying may allow the dominant firm to protect or strengthenits dominant position in the tying market. If the tied good is important for buyers of the tying good, areduction of the number of alternative suppliers of the tied good can make entry in the tying marketmore difficult, since it may in the end make it necessary to enter both the tying and the tied market inorder to compete effectively. Furthermore, the dominant firm may through tying force the exit from the

186 See Irish Sugar, cit., notes 34 and 86 above. A contrario, they are an acceptable defence for rebate systems.Guidance in this respect would have been most welcome.187 The distinction between mixed bundling and pure bundling is not necessarily clear-cut. Mixed bundling may comeclose to pure bundling when the prices charged for the individual offerings are high

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tied market of a product which is or may become itself a threat to the dominant product in the tyingmarket

188.

.8.2 ASSESSMENT

182. Under European law it is abusive to make "the conclusion of contracts subject to acceptance by theother parties of supplementary obligations which, by their nature or according to commercial usage,have no connection with the subject of such contracts". However, past European case law showsfindings of abuse even when tying is consistent with the commercial usage in the market

189 and when

no additional obligations are involved.

Tying is a practice under which at the initiative of the dominant firm, the contract deprives the customerof the choice of separately obtaining the tying product without the tied product. Naturally, telling whowas "at the initiative" of a mutually agreed clause with efficiency gains for both parties is a quandary;efficiency gains for the supplier result from closer-to-optimal output, and efficiency gains for thecustomer result from single-stop-shopping, an interesting alternative when transaction costs are high.

Bundling is a practice that similarly deprives customers and arguably consumers from this choice; ithappens when the dominant company selects not to list both products, but the bundle only, in its pricelist. Technical tying occurs when the tied product is physically integrated in the tying product, andbundling is hard to tell from functionality enrichment. The Court of Appeals and, more important,hundreds of millions of consumers proved wrong an American judge who thought that adding browsingfunctionality to an operating system amounted to bundling. A similar case is pending in Europe.

The dominant firm may reduce customer choice in less direct ways, for instance refusing to grantguarantees unless customers use its components, consumables or services. Nothing is more distinctthan a car or even a tyre and QA services, and nothing is less efficient than managing dozens of QAs,each for a few tyres or spare parts

190, and yet the lives of consumers are at stake. Nothing was easier

than switching and combining carriers for certain fractions of an air journey, but again security reasonscalled for regulatory intervention.

For the purposes of the above demonstration, an infringing producer and an independent producer arethe same; while many car-makers market-signal their IP enforcement as a concern for security, and itwould be unthinkable to run a QA department for infringing dealers, it is just as inefficient to run aseparate QA for any type of independently produced component.

183. Tying is prohibited when (i) the firm concerned is dominant in the tying market191

; (ii) the tying and tiedproducts are distinct; (iii) the tying will probably have a market distorting foreclosure effect; (iv) the tyingpractice is not justified objectively or by efficiencies.

8.2.1 DOMINANCE IN THE TYING MARKET

184. The first condition is met when the firm is dominant in the tying market192

. It does not need to bedominant on the tied market also. However, dominance this market too increases the probability of afinding of abuse. In order to assess this properly the definitions of the relevant markets (i.e. those onwhich the tying and tied products are traded.

188 Pure and mixed bundling can have similar foreclosure effects to those described above for tying. However, theterminology used for tying may not be appropriate, since in a sense both markets become tied in the case of purebundling, while none of them are "tied" in the traditional sense in the case of mixed bundling. Paragraph 181 wouldappear to be a pro domo plea to provide theoretical support to the second part of the European Microsoft decision (cit.,note 14 above) or an ex post plea in support of the District Court's Findings of Fact in US v. Microsoft, also cited innote 14 above. The idea that the Netscape browser combined with server-side middleware meant a potential threat forthe Windows client software was admitted by this District Court, but discarded by the Court of Appeals.189 See Tetra Pak II, cit. note 110 above.190 The Discussion Paper severally cites Michelin I and Michelin II, hence the pertinence of the example.191 The analysis differs in the special case of tying in aftermarkets, as indicated in section 10192 In the event of bundling, dominance in one of the markets concerned is necessary

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8.2.2 DISTINCT PRODUCTS

185. The Discussion Paper suggests that products are or are not distinct as a function of demand. Whichdoes not clarify if joint demand goes beyond simultaneous demand or not: cars and gasoline aredemanded jointly, although not necessarily at the same time, except for rental cars -en even in thiscase, to a limited extent.

Right-foot shoes and left-foot shoes are demanded jointly and simultaneously instead. And even whenthey are not for some reason, they are still sold together, because it would be inefficient to sell themseparately as a general practice. The cost of unbundling should always be a major consideration in theassessment of whether the products are distinct as indicated in the next subsection.

193.

186. The Discussion Paper indicates that there is direct evidence that two products are distinct when, giventhe choice, customers purchase the products separately. Unfortunately, this language forecloses anypossible anticipation of the future shape of demand. There is indirect evidence, the Discussion Papergoes on to say, when firms with little market power, particularly in competitive markets, do not tie thetwo products.

While the Discussion Paper could assume that this happens because these firms believe that this bestserves the demand of customers, we would rather believe that it does because these firms cannot or donot want to deliver a full-fledged product. You cannot fly to every destination with a low-cost company,which does not prove or disprove that non-stop flights are bundling.

The Discussion Paper also suggests indirect evidence of bundling behind the fact that certain firms arealready delivering already the tied product, although commercial usage may indicate that two productsare not distinct, and that the tying happens for causes totally unrelated to exclusionary purposes

194.

Often combinations have become accepted practice because the nature of the product makes ittechnically difficult to supply one product without also supplying the other

195. The Discussion Paper

suggests that the probability that such combinations be regarded as abusive is lower than that ofcontractual tying or bundling, which penalises firms with a vision of future consumption paradigms, with(at least) a higher risk of being caught by a false positive. Beyond a purely conservative view, a firmmay need to resort to contractual tying and bundling to impose a view that is not yet shared by many.

187. Similarly, the Discussion Paper detects a particular problem in the event a new product comes tointegrate two products that previously were distinct. It further suggests that an assessment ofdominance should take into account whether demand has shifted as a consequence of the integrationso that there is no more independent demand for the tied product.

There is, subject to the provisos of paragraph 205 below, an inherent chicken-and-egg limitation fencingthis line of thought. The consumption paradigm may well shift as a consequence of the dominant firm'sdecision; and it might as well be that the firm became and remains preferred thanks to its ability toanticipate consumption paradigm shifts.

193 See notes 13 and 42 above. Declaring the block-booking illegal may have proved a false positive, at least inasmuchas shorts are concerned. Paramount increased the unitary price of blockbusters and cut the cartoon and shorts lines ofbusiness, until literally asked to reinstate them to contain unemployment, under the National Industrial Recovery Act(an Act later declared unconstitutional). Disney would later prove the separate profitability of cartoons, but theperception of shorts as unprofitable was never been revised.194 Things become more involved when one takes into account that, as indicated in paragraph 182 of the DiscussionPaper, commercial usage does not automatically condone a practice. Commercial usage can only be ascertained byreference to the past, and is therefore of little use to anticipate paradigm shifts. Unless one adopts as strictlyconservative view, ill-adapted for markets in which innovation is of essence, commercial usage proves nothing eitherway.195 Similar evidence may come from the conduct of a dominant firm before it achieved dominance. By the time apractice is acknowledged as "accepted practice" by a court or enforcement authority, the market and the consumptionparadigm altogether may have shifted miles away.

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8.2.3 MARKET DISTORTING FORECLOSURE EFFECT

188. The main direct anti-competitive effect of tying and bundling is the possible foreclosure in the market ofthe tied product

196. The dividing line between abuse of dominance and normal exercise of dominance is

defined in two steps: First, assessing whether customers are "tied" in the sense that competitors of thedominant firm cannot compete for their business. Second, assessing whether these customersrepresent a sufficient fraction of demand pertaining in the market where the tied product is traded.

Although it is possible to proceed in one single step to size together the effect on the market and thestrength of the dominant position, the rebuttal of a positive will be easier. This is due to the difficulty ofassigning empirically verifiable mathematical values to all factors involved.

189. Tying and pure bundling foreclose the access by competitors to customers concerned by the practice -at least until the expiry or termination of contracts in the case of contractual tying. In the case of mixedbundling this is less clear: both products are available but may be priced in such a way that it would notbe rational for customers to buy individual components of the bundle match each of them with "best-of-breed" supposedly complementary products sold by a competitor. Competitors are foreclosed if thediscount is so large that efficient competitors offering only some but not all of the components, cannotcompete against the discounted bundle.

190. If the incremental price that customers pay for each of the dominant firm's products in the bundle justcovered the long run incremental costs of the dominant firm of including this product in the bundle. Inthis highly hypothetical case, an "as efficient" competitor with only one product could profitably competeagainst the bundle, unless transaction costs are high. Long run incremental cost captures the extracosts of the dominant firm's activities in the market(s) in which it is not dominant. If a price charged bythe dominant firm covers its incremental costs, such a price cannot normally be exclusionary, subject tothe provisos of paragraphs 67 and 129 above.

191. The incremental costs of the dominant firm are generally difficult to compute. The Discussion Papersuggests that in this case, proceedings could be started based on information about a competitor ifthere are no good reasons to believe that the competitor is less efficient than the dominant firm. Then, ifcost data are available for such a competitor, the incremental price for the dominant firm can becompared with the costs of the competitor. And even if no such cost data are available, it may bepossible to show that the competitor was actually excluded or relegated to a niche after the bundling bythe dominant firm. These methods are only approximations, and a defence can be structured aroundthe firm's own actual incremental costs.

192. There are various ways to "discount" a bundle. In the simplest case, a bundle AB consisting of twoproducts A and B has a separate price that is lower than the sum of the stand-alone prices of A and B.If things were so easy, then the incremental price of product B could be measured as the price of thebundle AB less the stand-alone price of product A. This, however, is not accurate, and it would be moreappropriate to measure incremental revenue rather than incremental price. The Discussion Paperacknowledges the complexity of calculation of incremental revenue - but does not mention that revenueis measured by lines of business and not by individual components, even when one such component"pulls" present or future revenue. Indeed, as indicated by the Discussion Paper, measuring incrementalprice is more "practical" although less realistic. If the method proposed by the Discussion Paper held,the incremental price of a product C sold in a discounted bundle ABC would be the price of ABC lessthe sum of the stand-alone prices of A and B (or the price of AB if such an option exists), and so on.

193. Even the calculation of the incremental price, as opposed to the incremental revenue, is virtuallyimpossible when a multi-product rebate is involved. Obviously, a simple percentage discount on everypurchase of any component does not tie them together, but things become much more involved whenthe percentage, the eligibility or both are contingent on the purchase of several products. To calculatethe bundling effect of the rebate, one would need to compute the actual price after loss of the rebate if

196 For expositional ease the section on the foreclosure effect uses the terms "tying market" and "tied market". In thecases of pure and mixed bundling, these terms may not be immediately applicable and the analysis should beappropriately adapted.

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the customer ceased purchasing one product, which is obviously not possible when only the bundle isoffered for sale.

194. When the thresholds for the bundled products differ from one customer to another, the actual pricementioned in the previous paragraph will differ too. The foreclosure effect of a multi-product rebate is afunction of its effect on the actual price paid by the various customers - which does not make it anyeasier to compute, even proceeding by customer profiles (and thus accepting some uncertainty as tothe accuracy of the calculus).

195. When competitors of the dominant firm sell similar bundles, the comparison between incrementalrevenues and incremental costs for each product in the bundle (when they exist) becomes much lessrelevant. In this situation, bundles compete against each other and the main question will then bewhether the bundle is or is not priced in a predatory manner as indicated in section 6 above.

196. What is really difficult is the assessment of whether the market as a whole is foreclosed. Indeed, thehigher the tied percentage of total sales, the larger the foreclosure effect. The foreclosure effect shouldbe directly proportional to the overall strength of the dominant firm on both the tying and the tiedmarkets, whatever the difficulty to measure "strength" in scientific units. The higher the relevance of thetied customers for the purposes of entry deterrence, the higher the foreclosure effect. To furthercomplicate matters, the intensity of the foreclosure is also a function of the tied customers' profile, forinstance when they are possible customers of specific, targeted competitors. A growing share of amarket with network effects requires complex dynamic analysis even if the share is still fairly low

197.

The above statements are to a large extent intuitive, but this will not in itself facilitate the task of judges,enforcement authorities and compliance officers, due to the lack of guidance as to what empiricallyverifiable numerical coefficients are appropriate for concepts such as "strength of dominance","relevance for entry deterrence purposes", and "customer profiles".

197. The fact that other firms also tie may add to the foreclosure effect, since this can contribute to makingentry more difficult, the Discussion Paper says. The statement is correct, but doesn't guide as towhether this strengthens or weakens the defendant's case in proceedings for alleged abuse ofdominance.

198. Another factor may count to ascertain or rule out the existence of a market-distorting foreclosure effect:the number of customers that buy both products. For instance, if only a third of the customers in the tiedmarket buy both products, tying may pose less of a risk, since the tying practice may remain containedto at most a third of the market. But even in this case, the Discussion Paper says, the foreclosure mightbe significant, to the extent some or all of the tied customers are, precisely, those particularly significantin terms of entry deterrence.

199. The foreclosure effect will probably be stronger if there are significant scale economies, learning curveor network effects or entry barriers in the tied market. Scale economies and learning curve effects maymean that competitors in the tied market are not able to stay in the market if the dominant firmforecloses part of the tied market through tying or bundling. Similarly, network effects may allow thedominant firm to "tip" the market as the tying can deprive its competitors of the chance to derivenetwork effects through the tied customers

198.

197 Network effects arise when consumers place greater value on larger networks than small ones. Demand mayhowever find higher utility in growth than in raw value, and smaller networks are known to grow faster than largernetworks. Connection to a small network costs less, but its utility grows faster, and subscription to a small networkfollowed by resale when the network has acquired a significant "thickness" is more profitable than outright subscriptionto a large network.198 See case COMP/37.792 Microsoft of 24.3.2004 cit, note 14 above. In this case, the addition of media streamingfunctionality to the Windows Media Player (historically distributed with Windows) was found to constitute an abuse ofdominant position. This goes beyond the previous failed attempt of the US government to prove bundling at the timeof the addition of browsing functionality to Windows, because in the European case there was no addition of another"product" (called a "browser") but just additional functionality to an already existing component of Windows, calledthe Windows Media Player. Although it is still too soon to tell, this finding may well be a typical false positive, in

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200. The stronger the network effects, the higher the likelihood of foreclosure. When the customer perceiveshigher utility in a product as a function of the number of other customers using that product, it is moredifficult for competitors to compete with the tying firm since they have to discount their products tocompensate customers for the lesser utility (lack of a network). "Discount" as used here refers to"discount off the price tag", but not real discount off the price computed per utility unit.

201. Product differentiation in the tied market may reduce the foreclosure effect as the probability thatcompetitors will survive is higher. Customers with strong preferences for the products of competitors inthe tied market may, for instance, prefer to switch to a substitute in the tying market rather than foregotheir preferred product in the tied market, or make a mix of both, in particular when the tied product is ano extra cost.

202. The market performance of the dominant firm and its competitors may provide evidence about theforeclosure effect. The market share of the dominant firm in the tied market may rise after the firm startsor intensifies the tying practice and some or all of its competitors may be relegated or exit. Thereference period is also relevant, because successful entry after the tying practice has beenimplemented provides evidence of absence of foreclosure effects.

203. The Discussion Paper indicates that competitors may have effective counter-strategies available toprotect themselves from those of the dominant firm, such as buying from a producer in the other marketin order to create a bundle that can compete with the bundle offered by the dominant firm.

It falls short, however, of indicating whether the availability of such counter-strategies validates thedominant firm's practice; this would have been precious guidance for all of judges, government officialsand compliance officers.

Generally, significant buyers have effective counter-strategies available. They may implement them, inparticular, with respect to the tied market, especially if the tying firm is not also dominant in this market.If such buyers are not themselves tied, they may be able to prevent the relegation of the competitors ofthe dominant firm or sponsor new entry into the tied market. If they are and they believe that thisstrategy has any chance of success, breach of contract may be efficient.

8.2.4 DEFENCES

204. A defence of the dominant firm may be structured around the objective necessity to tie products forreasons of quality or good usage of the products (such as the examples listed above, relating to theprotection of the health and safety of consumers). This argument will generally follow the patternsuggested in section 5.3.1 above.

Although the Discussion Paper suggests that this defence may be challenged by the counter-argumentpresented in paragraph 80, the value of such counter-argument is very limited when a product liabilitysuit is likely to hit the supplier (among other reasons, because it is assumed to be more solvent, orbecause the causes of the accident are complex). No matter who out of Boeing or Airbus is dominant (ifeither one is), not much should be wrong with some "English clause" in the contract under which planemaker will supply and the airline will purchase genuine parts throughout the plane's life cycle.

Absent contractual tying, most airlines would purchase planes and genuine spare parts anyway -withthe possible exception of risk-prone airlines, including those willing to take the risk of being excludedfrom the European skies or that of being kicked out of business by a major liability suit. The presenceof contractual tying reflects the agreement between risk-averse parties, and there is no reason tobelieve that one of such parties rather than the other imposed it as Diktat. First, the probability that adominant supplier will go out of business after one plane crash is significantly lower than the probabilitythat a small airline will. And second, the insertion of a Nash-like obligation (conduct that the buyerwould adopt anyway because incentives to deviate are absent) is best used by the airline to obtainhigher discounts on both the tying and tied product.

particular as it imposes the cost of managing two separate lines of business… to the OEMs rather than to the licensorallegedly guilty of abuse.

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If this is holds for planes, produced at high marginal cost in capacity-constrained facilities, a fortiori itdoes for digital products where marginal costs are said to be nil and there are no capacity constraints.First, an RTGS system (banking software for real-time gross settlements between banks) will, if it fails,cause damages in the range of billions - and risk-averse central banks hardly gamble that kind ofmoney in mix-and-match or third party maintenance. Second and most important, given the coststructure behind the licence, the buyer expects (and the expectation is self-fulfilling because theunderlying assumption is correct). to obtain a huge discount on the software. No buyer is naive enoughto imagine that maintenance has the same cost structure. But savvy buyers can exploit the "bugs" inthe pricing schemes and compensation plans of many editors. Knowing that the price of maintenanceis often expressed in terms of percentage of the cost of license, they will first negotiate a Coase-likediscount for the license, and then immediately agree to whatever percentage is the price ofmaintenance. Absurd as this may seem, it works in practice every time sales compensation is afunction of total revenue, immediately recognisable or not, thus providing an incentive to sell licenceand maintenance together.

205. The Discussion Paper also mentions a possible efficiency defence: Tying and bundling may help toproduce savings in production, distribution or transaction costs. Combining two independent productsinto a new, single product may be an innovative way to market the product(s). The probability that suchcombinations fulfil the conditions for an efficiency defence is higher than that of contractual tying orbundling.

This paragraph may be misleading to compliance officers, to the extent that no matter how innovative,there is in principle no justification to the imposition of a combination, either by not selling unbundleditems or by offering artificially convenient conditions for the purchase of the bundle. For the practice tobe valid, there must be legitimate reasons for it, the main one being that separate sales damage thefirm's efficiency, as in the example of left-foot shoes and right-foot shoes suggested above.

There may be an exception to this general rule. Sometimes dominant companies show (borrowing fromUS v. Alcoa, 148 F.2d. 416) the exceptional business acumen, superior product, luck, foresight or anycombination of the above that justifies their raise to dominance surfing on legitimate and overwhelmingconsumer preference. It may well be that the market leader alone has the foresight (or "vision", inbusiness parlance) of a shifting consumption paradigm, and it would be unfair

206. The defences for tying are those described in general in section 5.3.3. Would they succeed or fail whena retailer is able to obtain, on a regular basis, supplies of the same or equivalent products on the sameor better conditions than those of the tying dominant firm? The Discussion Paper suggests they wouldfail, because evidently no benefits are passed-on; on the other hand, they should succeed if tying isineffective enough for retailers to be able to obtain regularly a substitute from another source…

Evidence of indispensability may be more or less hard to produce for a defence based on efficiencies,in particular if the price incentive embedded into mixed bundling is higher than effective cost efficienciesachieved. The Discussion Paper further suggests that a defence based on the need to ensure a certainuniformity and quality standardisation may bump against an additional difficulty: in certain cases, a lessanti-competitive requirement to use or resell products in compliance with certain quality standards couldhave achieved the same objective.

9. REFUSAL TO SUPPLY9.1 INTRODUCTION

207. The right to select trading partners is inherent to a free economy. When two items need to be suppliedin a bundle to achieve optimal profits and consumer gains, there is a single product made of twocomponents rather than two separate products. Efficiency gains are best evaluated at firm level,because the firm alone has the entire set of relevant information and can take risks accordingly.Anticipating the behaviour of demand, and guessing right if and when there will be no independentdemand for single components of an item best supplied as part of a bundle is instead a quandary forregulators and judges.

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208. A refusal to supply may have, when the item199

concerned is somehow critical200

, certain exclusionaryeffects. The termination of an existing supply relationship

201, the refusal to enter into one, or threats of

either, are sometimes used to punish buyers for dealing with competitors202

, or force them to acceptexclusive relationships or bundling arrangements

203. These practices may aim at hurting a competitor,

the buyer or neither of those.

209. A refusal to supply may target the buyer, with vertical foreclosing effects. This typically happens whenthe buyer competes or intends to compete with the supplier in a vertically related market, assumingthat the notion of verticality has any meaning at all for multi-dimensional bundles. In addition to thepractices mentioned in the previous paragraph, the Discussion Paper mentions the possibleexclusionary effects of refusal to provide information

204, to license IPRs

205 or to grant access to an

essential facility or a network206

. Practices such as delays in supplying207

, unfair trading conditionsand pricing that makes it unprofitable for the buyer to continue its activity are also listed in theDiscussion paper as equivalents to a refusal to supply

208.

199 As used here, the term designates products, components of a bundle, or inputs of any kind.200 The criticality is not necessarily related to the dominance of a firm as defined above. Nothing proves or disprovesthat Dali was the dominant painter of the 20th century, and yet the license to reprint his ten lithographs is critical for aneditor wishing to reprint the original edition of Freud's Moses and Monotheism.201 See Istituto Chemioterapico S.p.A. and Commercial Solvents Corporation v Commission, [1974] ECR 223.202 See United Brands, cit. note 33 above.203 As etymology may itself suggest, exclusive distribution may be exclusionary. Exclusive and bundling arrangementshave an effect on both own and competitor's output levels, thus improving own efficiency, or reducing that ofcompetitors, or both.204 See notes 73-77 and accompanying text above.205 In AB Volvo v. Erik Veng (UK) Ltd, [1988] ECR 6211, Volvo had apparently refused to license Veng to import andsell body panels protected by design rights, even in return for a reasonable royalty. The Court agreed that an obligationimposed upon Volvo to grant a license to Veng would deprive it of the very substance of the exclusive design rights,but on the other hand enforcing such rights (i.e. suing, as in that case, for infringement) might constitute abuse ofdominance. In this case, fortunately for Volvo, the defendant had produced no evidence of such dominance. In RTE andITP v. Commission, best known as Magill, cit.; and IMS Health GmbH & Co. OHG v. NDC Health GmbH & Co. KG,[2004] ECR I-5039.206 See Commission Decisions B&I Line plc v Sealink Harbours Ltd and Stena Sealink Ltd [1992]; Sea Containers vStena Sealink - Interim Measures, (Commission Decision 94/19/EC of 21 December 1993, OJ 1994 L 15, 18.01.1994,);Port of Rødby (Commission Decision of 21 December 1993, OJ 1994 L 26.02.1994,and British Midland v Aer Lingus,(Commission Decision 92/213/EEC of 26 February 1992, OJ 1992 L 9610/04/1992.207 This is apparently inspired by US v. Microsoft cit., note 14 above. See Findings of Fact, paragraphs 122-124: IBMhad begun negotiations with Microsoft for a Windows 95 license in late March 1995. After the events mentioned innote 209 below, in July 2005, Microsoft terminated the negotiations. IBM did not abandon its policies or increasesupport for Microsoft software, and thus did not obtain the license until fifteen minutes before the start of Microsoft'sofficial launch event in August 1995. In addition, Microsoft declined to endorse IBM-manufactured PCs.208 The supplier will rationally price taking opportunity costs into account. All references made in these comments tovirtual absence of marginal or opportunity cost in the digital economy are to be placed in the context of full respect ofIPRs. Naturally, when the supply of information, IPR licences, or access to networks means lost sales, lower profits andlesser efficiency, the cumulative effect of opportunity costs and increased average costs is taken into account by everyrational firm, regardless of industry. The quandary for the regulator or judge is the appraisal of whether such pricing ishigher than break-even point, and therefore unfair. The Discussion Paper rightly notes that pricing that makes (to pickexamples from the digital economy) the activity of an OEM or a TV channel unprofitable is exclusionary and canamount to abuse of dominance, but what about pricing that makes it less profitable? What about the "refusal to supplyrebates"? See, for firms who grant such rebates, section 7 above. For a derivation of the static monopoly price forWindows, see Economides, N., "The Microsoft Antitrust Case" [2001], available from the Stern University website athttp://www.stern.nyu.edu/networks/Microsoft_Antitrust.pdf. The components of a PC bundle (hardware and operatingsystem) are combined in a ratio of 1:1, and the demand function for the bundle is D(pH + pW) where pH is the price of

hardware and pW is the price of Windows, the monopoly price of Windows is pH/(|∑| - 1), where |∑| is the elasticity ofdemand for the bundle. It is highly probable event that pW = pH, the monopoly price is more than ten times higher thanthe price paid by the most favoured OEMs. Even is under the prevailing enmity between Microsoft and IBM the latterpaid more than Compaq, Dell, and Hewlett- Packard, IBM still benefited from rebates that made its PC businessprofitable (See previous and following notes, and US v. Microsoft, cit., note 14 above, Findings of Fact at 130).

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210. A refusal to supply, may -when implemented by a dominant firm- constitute abuse of such dominance.The target of such abuse is either driven out of the market, relegated to a niche, or precluded fromentering the market. The Discussion Paper reminds here that for a refusal to supply to constituteabuse of dominance, it must have a probable anti-competitive effect and be detrimental to consumerwelfare.

In real life, things are a little more involved, because buyers and competitors are sometimes the samepersons

209, a finding that commands the conclusion that optimal average costs are achieved only

when one single firm attends 100% of demand, i.e. when a natural monopoly is naturally in amonopoly position

210.

Monopoly is, needless to say, the opposite of competition, and there is no need for a particulardemonstration of antic-competitive effects. But at the same time, the higher efficiency achieved wouldnever harm consumers if the monopoly is Coase-constrained to permanently lower prices.

211. A refusal to supply may be abusive regardless of whether it is attributable to a single dominant firm orto a group of collectively dominant firms. The distinction is relevant for the case of composite productsin which at least one of the collectively dominant firms refuses to supply one critical component.

The conduct indicated in this paragraph, however, is generally an illegal collusion: collective refusalsto supply are seldom spontaneous exercise of collective dominance; they rather respond to elaborate(and illegal) agreements between competitors.

212. Assuming that verticality has a meaning at all in complex multi-dimensional products, it could beuseful to distinguish the "upstream" market where an input is traded from a "downstream" marketwhere the product integrating that input is traded

211. A firm may refuse to supply in order to achieve a

larger share of the downstream market, or protect its position in the upstream market, for instancewhen the downstream market is a necessary outlet for the component traded in the upstream market.

If a firm controls the outlets, a challenge to its position in the upstream market appears highlyunattractive. The Discussion Paper also posits that eliminating competition in the downstream marketcan also eliminate competition from a product in the downstream market which is or may become athreat to the input in the upstream market

212.

213. The Discussion Paper suggests that forcing firms to supply can improve the competitive situation inthe downstream market. Whether this implies a gain for consumers or not depends on thecircumstances, but the Discussion Paper anticipates that if a dominant firm is generally expected tobe subject to compulsory supply of differentiating elements to competitors (including elements not forsale, such as secret know-how and IPR licenses), then

• Dominant firms may invest less in innovation and differentiation, or not invest at all.

• Other firms will prefer to free-ride on the dominant firm's investments, and thus reduce their owninvestments themselves, or

209 For an example related to the digital economy, see US v. Microsoft, cit., note 14 above, Findings of Fact at 119 and120: "…At that meeting, IBM informed Microsoft that […] IBM would aggressively promote IBM's software products,would not promote any Microsoft products, and would pre-install OS/2 Warp on all of its PCs, including those on

which it would also pre-install Windows. True to its word, IBM began vigorous promotion of its software products.

This effort included an advertising campaign, starting in late 1994, that extolled OS/2 Warp and disparaged Windows.

IBM's drive to best Microsoft in the PC software venue intensified in June 1995, when IBM […] IBM announced that it

was going to make SmartSuite [a product competing directly with Microsoft Office] its primary desktop software

offering in the United States." .210 Firms with flat costs are named "natural monopolies" in the literature.211 The terminology "upstream" and "downstream" may not always be completely appropriate even in moderatelycomplex spaces.212 Whether a restriction or distortion in the upstream market restricts or distorts the downstream market. The phrase isreminiscent of an argument raised in US v. Microsoft: the Judge in that case found that by launching its own Internetbrowser, and thus challenging the then lonely position of Netscape, the defendant aimed at protecting its huge marketshare for Windows.

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• Increase instead their investment in follow-on research that would otherwise not be possible orprofitable.

It is hard to understand how a competitor can "free-ride" on the dominant firm's R&D, if it has to paythe price of the license - unless what the Discussion Paper really attempts to introduce is the notion ofa free disclosure of proprietary information. There are three aspects in which this analysis appearsunrealistic or objectionable to both an economist and a lawyer:

• One is underlying assumption that the law of a market economy can force a firm to effectivelylicense IPRs or disclose secret information effectively against its will

213, or (in other terms) that in

a non-dictatorial society the law can authorise the State to expropriate a firm from valuabledifferentiating assets, not for purposes of public utility, but rather to favour competitors

214.

• Another is the assumption that firms will invest less in differentiation or cease investmentsaltogether if they are compelled to disclose or license differentiating information to competitors.The real issue appears to be whether differentiation investments will not rather shift from areas inwhich it is more useful to useful to consumers to areas in which such utility is more debatable.This is not to say that the differentiation attached to the QA function of a trademark is not useful,just that it is more "conservative" of existing preference than "revolutionary" differentiation throughbreak-trough technical innovation.

• A last one is the assumption that free-riders will change their investment patterns. The possibilityof free-riding is an incentive to cut investment for followers, not for natural leaders. Whoeverobjects to the existing paradigm will not invest in follow-on research that would only comfort it.

Thus the issues involved range from constitutional matters215

, to the effects of additional competitiongenerated by free-riding (and its effects on market shares and therefore average costs and prices) inthe short and long terms. These will need to be addressed in further to-do, as the core ideasexpressed in this paragraph of the Discussion Paper appear subject to further clarification.

214. The Discussion Paper rightly posits that compulsory supply can be ordered only after a very closescrutiny of the factual and economic context. Indeed the arguments supporting a finding or abusiverefusal to supply are contingent on the specific economic and legal contexts of each case. Thequestion is the ability of regulators and judges to grasp all the parameters of such contexts; and thedesirability of decisions based on their improving understanding of economic theory rather than onprecedent: the former would bring decisions closer to justice (understood in practice of actualconsumer gains), while the other would have the advantage of stability and security of the legalenvironment.

9.2 ASSESSMENT

215. The notion of refusal to supply covers a variety of practices and situations and an attempt to addressthem all in the Discussion Paper would have been meaningless.

Thus the Discussion Paper focuses specifically on refusals to start a supplier / buyer relationship anddecisions to terminate an existing one.

216. Most of the literature concerns access to networks in the electronic communications sector, and in thisrespect the Discussion Paper refers to the Notice concerning competition and access rules.

213 The point was the subject matter of heated debate in the 1970s. With the disclosure contained in a patent, andwithout the accumulated experience, successful production of a patented item is improbable. When the accumulatedexperience is provided "raw" (as the case would probably be in a forced disclosure) it may take years for a competitorto understand how to best proceed, which is enough for the technology to have been superseded in the meantime, andthus made useless to both the original owner and free-riders.214 And hopefully consumers. Compulsory patent licenses are available when the patent owner is leaving demandunattended; this is highly improbable in the digital economy, due to a) low marginal costs; b) sub-optimal average costsand profits whenever demand is left unattended; and c) inability to raise prices in a Coase-constrained environment.215 Such as expropriation and the protection of property in general.

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9.2.1 TERMINATION OF A SUPPLY RELATIONSHIP

217. A firm, assumed dominant for the purposes of these comments, may have found it profitable at agiven point in time, i.e. in one or more rounds of the competitive game, to supply an input to one ormore buyers. In the digital economy, an OS or database provider may have found it profitable tosupply, at high discounts, a critical or globally preferred input to VARs and OEMs.

This firm may have adopted this assumption on a rational basis, on a bounded rationality basis or onan irrational basis. Irrationality cannot be ruled out when fixed costs are low, and variable costs are anepsilon above zero.

Termination costs vary depending on the terms of the contract and the law. Substantial literatureexists concerning the so-called "efficient breach". Damages for termination account for the supplier'spossible control of "downstream" distribution outlets, when they are the necessary or preferredchannels to access customers.

Indeed, buyers may have made substantial investments of own funds in connection with these supplyrelationships, except when they are in a position to pass the cost of any such investments to the nextsupplier, as severally suggested in these comments. The Discussion Paper posits an assumption thatcontinuing these relationships is pro-competitive; but this assumption is subject to rebuttal, inparticular in the case of long-term supply agreements.

218. A termination of an existing supply relationship is abusive, when the firm selecting to terminate isdominant and 1) termination will probably adversely impact competition; and 2) the termination is notjustified objectively or by efficiencies.

9.2.1.1 DEFINITION

219. The definition of termination would appear self-evident if it weren't that the Discussion Paper equatescertain practices to termination, such as unfair trading conditions, excessive pricing and otherconducts permitted by contract, such as contractually-compliant delays, and refusals to grantdiscounts not provided by contract

216.

220. Price squeezes cannot theoretically be prohibited by contract, but when competition is "for the market"rather than "in the market", such squeezes are excluded in practice.

When the supplier of an input is vertically integrated and thus competes with one or more downstreamsuppliers of integrated products, price discrimination with respect to the latter may prevent evenreasonably efficient competitors to do business or remain in business, at least when one-stopshopping is a sales argument and the supplier has not sold the component separately to theconsumer.

The Discussion Paper suggests, as benchmark for a "reasonably efficient competitor", the integratedinput supplier itself; a margin squeeze could be inferred from lack of profitability of that supplier'sdownstream operations, were it to charge the same price it charges to even the most favoured

216 Contract law is not a matter devolved to the EU, and the definition proposed by the Discussion Paper clashes withinternal law of all Member States prohibiting judiciary or regulatory tampering with the valid consent of the parties.One party (assumed to be the dominated party) can instead produce evidence of breach, or of invalidity of its consent(for instance when the economic power of the other party amounted to duress); termination has then retroactive effects.The dominant party's compliance with the agreement suggests all but breach justifying termination by the other party.Waiver, instead, appears as a possible legal issue; some jurisdictions may assume that non-contractual practices, suchas lower prices, longer payment terms or early deliveries, infiltrate the contract and cannot be later withdrawnunilaterally. But if a firm is dominant and can "to an appreciable extent" behave as it pleases (per the definition), whywould it waiver rights or make concessions (on longer payment terms, see section 7 above)? And if it is compelled togrant them under pressure of demand or of other suppliers, is still dominant? The last phrase of this paragraph,equating a refusal to grant discounts not agreed upon to termination of contract, is impossible to defend legally - soprobably it has an economic meaning of some kind.

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downstream channels. But in practice, regulators and judges find this benchmark difficult to use fortwo reasons. One is the typical opacity of transfer pricing, and the other is the probability that a firmmay have already separately sold the input to a relatively large share of customers willing to buyadditional components: double-selling is excluded, even to the least powerful rational buyers.

Inferential evidence derived from pricing applied to most favoured downstream channels similarly failsas a benchmark, due to mutually monopolistic bargaining present in most cases

217.

9.2.1.2 DOMINANCE

221. The termination of a supply relationship raises competition law issues when the input is critical218

. Civiland commercial law provides damages for abusive termination. firm refusing to supply has adominant position on a defined market. This will often be an "upstream" input market, but it may alsobe a distinct market where access is needed to link this market with another market, for example tointerface information.

9.2.1.3 DISTORTING FORECLOSURE

222. The termination of one single supply relationship does not per se constitute an abuse. Termination willinstead be abusive if it adversely impacts competition in the downstream market; this condition is meteven short of eliminating competition completely. Adverse effects will usually exist when the supplierof an input or component is also present in the downstream market.

The size of the adverse impact depends on the pre-existing competition in the downstream market: insome cases the impact will be too small to be significant, but even though it could snowball into asignificant effects it it somehow prompts or favours collusive practices.

The Discussion Paper ignores here the case in which the dominant firm of the upstream marketeliminates competition in the downstream market without participating in it. The suppression ofcompetition is expected to increase prices in the downstream market, creating quasi-monopolisticrents for firms in that market; the dominant firm of the upstream market holds the key to such rents,and can actually appropriate them by selling at higher prices to the firms in the downstream market.

223. An important element to assess the effect on competition may be the very identity of the target of therefusal to supply. By way of example, the exclusion of a firm following a different model from those ofother competitors will probably have an adverse impact on competition different from the exclusion ofone of the competitors following identical business models.

9.2.1.4 DEFENCES

224. The termination of a supply relationship by a dominant firm may be objectively justified, and thus notconstitute an abuse of dominance. One example may be the case in which a buyer is unable toprovide the appropriate commercial assurances that it will fulfil its obligations. Another is verticalintegration, subject to evidence of expected consumer gains (the terminating dominant firm will bearthe burden of proof of such consumer gains).

The proof may be hard to produce, because it relies on the comparison between an existing situationand expectations about a future situation. In other terms, it is an equation with two unknown variables:1) how would the existing situation evolve absent integration; and 2) the extent to which expectationsof consumer gains further to integration be fulfilled. The appraisal of the proof produced is delicate,because it would neither be realistic to regard the existing situation as static, or to arbitrarily split thegains in efficiency generated by vertical integration between gains for consumers and profits for firms.

Regardless, the notion that a firm might be able to terminate existing supply relationships because itintends to enter the downstream market appears highly and unduly permissive. The dominant firm in

217 See also Access Notice, OJ C 39, 06 /02/1998218 See paragraph 208 above.

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the upstream market would be entering a downstream market in which competition has beendestroyed or diminished; it would thus be extending dominance, rather than just entering.

9.2.2 REFUSAL TO START SUPPLYING AN INPUT

A dominant firm's refusal219

to start supplying220

may be abusive if the input is critical221

, if the refusal has aprobable negative effect on competition, and if it is not objectively justified. In other terms, to be abusive, (i)the conduct needs to qualify as a refusal to supply; (ii) the refusing firm needs to be dominant; (iii) the inputneeds to be indispensable; (iv) a probable negative effect on competition needs to follow from the refusal;and (v) there needs to be an absence of objective justification.

9.2.2.1 CHARACTERISTICS

225. In many cases the refusal to supply may be evident. Other situations require evidence that thebehaviour of the firm amounts, for all practical purposes, to refusal to supply. The Discussion Paperrepeats here the points already mentioned in paragraph 209 above, and the same comments madeabove apply.

9.2.2.2 DOMINANCE

226. The Discussion Paper reminds that refusal to start a supply relationship won't raise competition lawissues unless the firm refusing to supply is dominant. This sounds obvious, but it is always worthnoting that although normally what matters is dominance in the "upstream" market, dominance inanother market may be relevant. The Discussion Paper gives the example of a market "where accessis needed to link this market with another market, for example to interface information"

222.

227. The Discussion Paper goes on to say in some cases, there may not even be a market for the input inquestion as it is used only by the owner in a captive market. For example, an IPR may be nothingmore than an input that is not marketed separately from the goods and services to which the IPRrelates. However, it would be sufficient that a captive market, that is, a potential market, or even ahypothetical market, be identified. Such would be the case when there is actual demand for the inputon the part of firms seeking to carry out the activity for which the input is indispensable

223.

219 See paragraphs 226-227 below.220 See paragraph 225 below.221 See paragraphs 228-230 below.222 Naturally, the Discussion Paper cites here Microsoft, the European Commission's decision cited above in note 14.As anticipated in paragraph 69 of these comments, "upstream" and "downstream" are not always meaningful; see alsonote 211 above: what are client PCs with respect to servers in he moderately complex client/server geometry, upstreamor downstream? Does the answer vary depending on whether the transaction is client-pull or server-push? And in P2Pnetworks, which of the two peers is upstream rather than downstream? The Discussion Paper neither comforts orcontradicts Microsoft, where a) there was no need to "interface information" but rather to authenticate and authoriseclients, regardless of whether one considers them upstream or downstream; and b) there was no "need" to intrude intothe defendant's technology to secure either authentication or authorisation. Standard MIT technology was available forboth purposes, and Microsoft's technology merely improved on that standard. In other terms, two technologies wereavailable, and only one was proprietary. To be consistent with Microsoft, the Discussion Paper should read "whereaccess would be preferable in order to" rather than "where access is needed to"; but we doubt that such consistencywould be a definite advantage.223 What is true in many cases (see IMS Health, cit. note 205 above), becomes hard to admit after calling IPRs "nothingmore than inputs not marketed separately" from the patented or trademarked products, a concept that these commentsregard as wrong. If Polaroid has patents on certain cameras and instant-self-development films, needless to say thatthere is at least a hypothetical market, that Kodak would be happy to enter if it weren't for such patents. Kodak wouldbe happy to "carry out the activity for which a patent licence is indispensable". See Polaroid Corp. v. Eastman KodakCo. (DC Mass) 17 USPQ2d 1711 [1991]

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9.2.2.3 CRITICALITY

228. A refusal to supply is not abusive unless it concerns an input, which is indispensable to carry onnormal economic activity in the downstream market. Without this input firms cannot manufacture theirproducts or provide their usual service levels. Therefore, when real or potential substitutes exist in themarket, the input of the dominant firm is not indispensable. The same holds if it would be legally andeconomically possible for other firms to produce the input in question themselves.

229. A facility is an indispensable input only when duplication of the existing facility is impossible orextremely difficult, either because it is physically or legally impossible to duplicate, or because asecond facility is not economically viable in the sense that it would not generate enough revenues tocover its costs

224. One element that may be relevant for reaching such a conclusion is the switching

costs that customers would have to incur in order to use an alternative structure225

.

230. In the case of IPRs, a possible finding of criticality is contingent on evidence that competitors lack anypossibly workable alternative and just cannot "invent around" the IPR. The Discussion Paper suggeststhat there may be indirect evidence to this effect when the technology has become the standard orwhen interoperability with the product protected by the IPR is necessary for a firm to enter or remainon the product market.

What seems an extension of Microsoft into more abstract and general forward-thinking is not entirelyconsistent with the facts of that case. There is little if any doubt that Windows is the "standard" clientoperating system; although this is also true for stand-alone PCs, only networked clients were relevantfor the purposes of Microsoft. The case concerned the market of authorisation and authenticationservers, and was initiated by firms active in such market.

9.2.2.4 DISTORTING FORECLOSURE

231. Among the criteria listed in the introduction to subsection 9.2.2 above is the probable negative effecton competition. The probable exclusion of one individual competitor from the downstream marketdoes not in itself point towards abuse, but the conduct becomes abusive when there is probability ofan adverse effect on the competition in the downstream market. As indicated in paragraph 222 above,the extent to which the exclusion of a single competitor will impact the level of competition depends onthe pre-existing competition in the downstream market. For instance, if there are several competitorsin the downstream market and the owner of the indispensable input is not active in that market, theimpact on competition of the exclusion may be small unless there is probability that the exclusion willlead to collusion. The probability of a negative effect is higher when the input owner is active in thedownstream market and excludes one of its few competitors.

232. The identity of the actual or potential competitor excluded, and the business model implemented bysuch competitor may also be relevant to assess the probable impact.

233. The Discussion Paper suggests that an exclusionary practice may also adversely impact competitionin an emerging, not yet established, downstream market. Such would be the case, for instance, whena dominant firm refuses to supply an input that is critical for the supply of a new product, and for theemergence of the downstream market. One can just hope that this language does not include IPRs,which would, under paragraph 227 above, be "nothing more than inputs". If it does instead, the risk offalse positives appears huge; as indicated in paragraph 11 above, judges and regulators face hugedifficulties to define properly existing markets, let alone identify emerging ones, or ascertaining whichinputs would potentially be critical to them, in particular due to the expected impossibility to the "inventaround" certain IPRs.

224 See Oscar Bronner GmbH & Co. KG v Mediaprint Zeitungs- und Zeitschriftenverlag GmbH & Co. K, MediaprintZeitungsvertriebsgesellschaft mbH & Co. KG and Mediaprint Anzeigengesellschaft mbH & Co. KG [1998] ECR I-7791.225 "Facility" probably refers to fixed assets, and "legally impossible to duplicate" to cases of State monopoly, such asrailways or (in some countries) alcohol-dispensing stores. The Discussion Paper probably assumes that a certain"facility" is more or less output-capacity-constrained.

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9.2.2.5 DEFENCES

234. As severally indicated above, objective justifications and gains in efficiencies yielding consumer gainsdefeat the case of the plaintiff or claimant because they exclude abuse, and nothing is wrong (at leastin theory) with dominance per se.

The refusal to supply to firms that do not provide assurances that they will comply with theirobligations has already been commented

226 and also applies here. The Discussion Paper further

indicates that the denial of access to a critical facility is similarly justified when capacity constraints aresuch that access would increase costs so as to put in jeopardy the economic viability of the firmoperating such facility. Without climbing to such extremes, a denial of access would also appearjustified when such increases in costs would prompt a price increase, thus reducing consumer gains.

Finally, the Discussion Paper notes that a dominant first denying access does not commit an abuse ifthe firm seeking access is not technically able to use the facility in a proper manner. The scope of thisexception is unclear, and may actually cover cases as diverse as losses due to inefficient use of thefacility (with or without lesser consumer gains), damages caused to the facility (possibly includingdirect repair damages and indirect losses in revenue while the facility is inoperative or operates atsub-optimal levels), and damages caused to the technology (ranging from leaking of secrettechnology to its relegation to a commodity status) or to the goodwill (such as, in US v. Microsoft, thepossibility for a competitor / distributor to free-ride on marketing events to place its own products tothe detriment of those of the sponsor).

235. Whatever the critical input (raw material, essential facility, intellectual property right, information…), ithas usually become available thanks to substantial investments entailing significant risks. This isparticularly visible when the dominant firm out-invests not only each single dominated competitor, butall such competitors together.

The theory under which dominated firms are allowed or should be encouraged to free-ride on suchinvestments while avoiding the risks has unpredictable results. Some suggest that it acts as adeterrent for research and investment, thus reducing innovation: the major investor would cease toinnovate, while the least inventive firms would not change their research and investment patterns.Like all economic anticipations, this one is debatable; what is instead statistically probable and evenprovable is the reversal of permissive law as free-riders are not perceived as deserving, orcontributing to general consumer welfare, or neither.

The Discussion Paper still posits that even dominant firms should be free to seek sufficientcompensation for successful projects to make up for failures and maintain a sufficient incentive toinvest. In this sense, it may be legitimate, even for a dominant firm, to exclude others from access tothe relevant input, facility or technology, regardless of the negative effects on competition, "for aperiod of time sufficient ensure an adequate return on such investment

227, even when this entails

eliminating effective competition during this period.

This last phrase should be read restrictively: while it is legitimate for an IPR owner to enforce it, evenif that excludes competitors, it would not be legitimate for a dominant firm to leverage its market powerin one market to exclude suppliers from other markets. What IP law says is that IPRs procure a ROIby allowing sales at whatever prices elasticity of demand allows, not by extending monopoly to otherproducts for which no IPR exists.

236. The Discussion Paper posits that the probability of abuse is directly proportional to the probability thatthe investments to produce the critical input would have been made even if the investor had knownthat it would be under an obligation to supply. Such is the case when the supplier enjoys or has

226 See paragraph 224 above227 See also Commission Notice Guidelines on the application of Article 81(3) of the Treaty, OJ C 101 27/04/2004, andEuropean Night Services Ltd (ENS), Eurostar (UK) Ltd, formerly European Passenger Services Ltd (EPS), Union

internationale des chemins de fer (UIC), NV Nederlandse Spoorwegen (NS) and Société Nationale des Chemins de Fer

français (SNCF) v Commission [1998] ECR II-3141, paragraph 230.

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enjoyed until a recent past exclusive rights, or when the investment was made primarily for reasonsunrelated to the market for which the input is critical, or when the investment was made by a publicauthority or non-profit organisation under public service criteria. Generally, in all these cases the R&Dinvestments were not particularly significant.

Right as this is, empirical evidence shows that investments are often made under conditions ofuncertainty. It is often impossible for firm managers (let alone regulators or judges) to tell exactly whatincentives are sufficient to justify an investment. Assuming an important audience of the DiscussionPaper consists of national judges to whom new powers have been attributed by the ModernisationPackage, this deficit of guidance should be filled by further analysis left as to-do.

9.2.2.6 REFUSAL TO LICENCE INTELLECTUAL PROPERTY RIGHTS

237. The refusal to license an IPR concerns the "supply" of licences not normally offered to the generalpublic, even less so to competitors or advocates of different consumption paradigm. The DiscussionPaper's approach to IPRs, as indicated in paragraphs 227 and 233 above is one of its few weakpoints. Indeed, if IPRs were "nothing more" than an input, and the same rules applied, there would beno point in owning one at all; symmetrically, the State would have strictly no interest in granting amonopoly at all. Pushing the logic to extremes, either the applicability of the general rules to IPRs iswrong, or the general rules are wrong.

238. There is no general obligation for the IPR holder to license the IPR, even if such right holder is adominant firm. IPRs are exclusive rights, and would be eroded if the owner of a patent, trademark,design or copyright was obliged to grant licenses to competitors, simply because consumers preferthe patented, trademarked or otherwise protected product to an extent such that the right holder hasbecome dominant.

Imposing on the right holder an obligation to grant licences to third parties to allow them to compete,i.e. reduce the right holder's market share, thus forcing (in the digital economy at least) a deviationfrom optimal average cost would deprive the IPR holder from the very substance of the exclusiveright. This applies even for licences granted in return for a reasonable royalty, the Discussion Papersays

228.

239. The Discussion Paper posits that the refusal to license an IPR does not in itself constitute an abuse229

and only under exceptional circumstances can it be regarded as abusive230

. Such would be the casewhen the refusal prevents the development of new products not offered by the IPR holder

231 and for

which there is potential consumer demand.

This language would amount to prohibiting the exercise of process patent rights by firms exposed to afinding of dominance (even if such finding is a false positive). This blatant disregard for the legal valueof these IPRs cannot have been intended by the authors of the Discussion Paper

240. The Discussion Paper suggests that a refusal to licence a patent required for follow-on innovationmay be abusive even if the licence is not sought to directly incorporate the technology in clearlyidentifiable new products: the consumers' ability to benefit from innovation by the dominant firm'scompetitors should prevail

232.

228 The purpose of an IPR is to allow the right holder It seems that a "reasonable royalty" should account foropportunity and other costs, which would paradoxically raise the "reasonable royalty" to "unreasonable" levels. IP lawprovides for limits to the "negative right" of the patent holder, namely in case demand is left unattended or in the eventthe patented invention relates to national security.229 Applying, again, the general rules of refusal to supply.230 See Volvo, Magill, and IMS Health cases, cit. note 205 above. In all of these cases, the dividing line seems to be thedominance of the right holder, and Tetra Pak (cit., note 32 above) would also be a good example; but dominance canhardly be seen as an exceptional circumstance in an oligopoly.231 As opposed to merely duplicating the products offered by the owner of the IPR.232 This phenomenon of patent stockpiling has been detected as a problem in the area of bio-technologies and e-health.,where transaction costs are weigh heavily on the initial steps of research which, by definition, can only be follow-on.Setting aside the constitutional issues involved, and even WTO TRIPs issues, the position adopted by the Discussion

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This paragraph suffers from the same flaw as the previous paragraph. Using patented technology forfollow-on innovation has never been a valid excuse for the violation of an IPR, and should not be acause for compulsory licensing, let alone a finding of abuse of dominance for not doing thisspontaneously.

9.2.3 REFUSAL TO SUPPLY INFORMATION NEEDED FOR INTEROPERABILITY

241. The Discussion Paper addresses the issue of refusal, by a dominant firm, to provide competitors withinformation required for interoperability between the products traded in one market and productstraded in another, rather than the information required to "interoperate" with a product traded in thesame market (substitute such product). There are gains from interoperability, for both the dominantand the dominated firms, and sometimes for consumers, too.

242. The Discussion Paper notes that there is no general obligation, even for dominant firms, to ensureinteroperability

233, while observing that leveraging market power from one market to another

234 may

be an abuse of a dominant position.

10. AFTERMARKETS10.1 INTRODUCTION

243. Aftermarket is a term mainly used in association with the automotive industry and auto parts, andmore rarely used in association with other heavy duty industries and spare parts therefor.Understandably, most of the existing mix-and-match literature has developed around spare parts andaftermarkets. Opposite to what the term might suggest, aftermarkets do not include either "peaches"or "lemons"

235.

The automotive industry is a differentiated oligopoly and spare parts intended for a car of a particularmodel of a particular brand will not "match" into other models of the same brand, and even less sointo other models of other brands

236. Examples include doors, lights, bumpers, and generally all parts

that may be damaged by accident, and also parts affected by tear-and-wear such as dashboards.

These spare parts are generally produced by specialist manufacturers, acting either as subcontractorsunder the authority of the car maker (in which case the parts are regarded as "original") or not (inwhich case the parts are regarded as "compatible").

The mechanism through which spare parts reach the consumer situated at the other extreme of thevalue chain is complicated, with implications on QA, guarantees and therefore differentiation. An"original" spare part is subject to the car maker's QA and guarantee and reaches the consumerthrough the car maker's network of authorised dealers. A "compatible" spare part reaches theconsumer through wholesalers selling to independent garages and retailers

237 or through purchase

Paper remains extremely risky, because any products developed thanks to "follow-on research" conducted on this basiswould be (even assuming the European Courts regarded them as non-infringing) confined to Europe and unmarketableeverywhere else in the world.233 When interoperability is of essence, in networks for instance, regulators can mandate interoperability. What theycannot do without violating the constitutional protection of property, is the disclosure of valuable differentiatinginformation without side payments. The matter of side payments is not addressed in the discussion paper, but theliterature on the topic is abundant. The Discussion Paper suggests instead that when the interoperability informationconcerned is a trade secret, the "standards of intervention" it may be different from those indicated in paragraphs 237-240 above; the exact meaning of the suggestion is unclear.234 For instance by refusing to supply interoperability information.235 Respectively, "good used cars" and "bad used cars" in Akerlof's terminology, see note too above.236 These spare parts are most often intended as replacement of original parts. By contrast, in the DV-camera and DV-cassette, there is adherence to a standard; any DV cassette will "match" into a DV camera; some manufacturers ofcameras also manufacture cassettes, but many manufacturers of cassettes do not manufacture cameras.237 It may in this case be guaranteed by the manufacturer, the wholesaler, the garage or all of the above.

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centres typically selling to rapid repair centres or retailers238

. Understandably much of the marketsignalling performed by car makers points to the differentiation in terms of QA and guarantee and, byinference, security

239.

Aftermarkets are also sometimes called "secondary markets", when the product traded is acomplement or "secondary product" with respect to another product (the "primary product"). Theexample advanced in all Economics books is that of cameras and film.

244. Competition law issues appear when the car-maker endeavours to reserve the aftermarket for itselfand its network of authorised dealers. One typical practice for this purpose is the enforcement of IPRson the spare part against an identical copy

240.

245. When applied to aftermarkets, the SSNIP test often leads to the definition of markets comprising onlythe products of the supplier of the primary product. Although patents and know-how may be involved(for instance in the case of dashboard circuitry), a vast majority of case law and most of the mix-and-match literature has revolved mainly about design rights-based monopoly and QA.

246. The position of a car maker in the aftermarket of spare parts for cars of its own make cannot,obviously, indicate whether there it is or is not constrained by competition in the primary market (i.e.cars).

Whether such competition in the primary market precludes price increases above the competitivelevel in the aftermarket is debatable

241. unprofitable due to its impact on sales in the primary market,

unless prices in the primary market are lowered to offset the higher aftermarket price.

The Discussion Paper uses "aftermarkets" or "secondary markets" with a meaning that clearly goesbeyond auto-parts. There is risk of an implication concerning time or one concerning importance.Consumers do not buy a spare car door before the car, or DV cassettes before a DV camera, but thebusiness opportunity for DV cassettes may be bigger than the one involved in cameras, so it is hard toregard the former as "secondary"

242. The same applies to high-speed trains and rails therefor or

screwdrivers and screws.

To avoid the ambiguity, these comments refer to the "market for product A" and the "market forproduct B" when products A and B are complements.

10.2 ASSESSMENT

10.2.1 MARKET DEFINITION

247. The same market definition issues commented in Section 3 above apply to the endeavours to definethe market for a complement, with the additional complexity resulting from the need to take twomarkets into account. In other words, the focus of the market definition exercise is on the aftermarketsales to customers who have already acquired the primary product and not on potential new futurebuyers of the primary product. The full effects of "bundle" or "systems" competition will thus be takeninto account in the dominance analysis.

248. Consumers do not need to buy products A and B of the same brand. They may select product B froma brand different from that of product A, if prices for product B of the same brand increase. Taking

238 The auto part is in this case guaranteed by the manufacturer, the rapid repair centre and the retailer, or the twoformer only. Guarantees by purchase centres are exceptional, as are guarantees by retailers.239 Investment in this type of market signalling would suggest that car makers regard car owners as risk-averse.240 Such IPRs may include patents, but are most usually limited to design rights over the aesthetic appearance of partssuch as doors and lights. A typical defence against an attempted enforcement of design rights is that the shape of spareparts are dictated by functional rather than aesthetic considerations. This defence succeeds or fails depending on theactual circumstances of the case.241 A price increase in the aftermarket would be unprofitable if it caused sales to be lost to other car makers in theprimary market242 Hence the difficulty to tell if film or cameras are actually the "primary market", except in chronological terms.

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both markets into account, dominance and possible abuse thereof require the analysis of the entiremarket for product B, regardless of brand.

249. It may be possible to switch to another brand of product A to avoid the higher prices of product B ofthe same brand. This happens when switching costs are not so high as to make this optionunattractive

243.

Switching costs may result from a contractual or economic restriction to the resale of product A, orinvestments made on product A of that brand, such as training and changes in industrial organisationthat would be induced by switching to product A of another brand. Prices for second-hand product Aof a given brand are influenced by the same considerations that constitute incentives to switch toproduct A of another brand, but other switching costs may restrain demand from switching evenwhere there the market for second-hand product A functions well.

250. If A and B are not products on their own but rather components of a system, then dominance is to beascertained against power in the system market and not the sub-market of one of the componentsalone. The following paragraphs assumes that A and B are separate products supplied in severalbrands.

10.2.2 DOMINANCE

251. If the market for product B as complement of a given brand of product A is found to be the relevantmarket, then the assessment of a dominant position in the market for product A requires the analysisof the competitive situation in both the market for product A and the market for product B.

252. The same comments severally made above concerning the notion of dominance as employed inEuropean case law apply here, regarding barriers to entry, supply side substitutability, and theexistence of IPRs or proprietary information. The threat of retaliation (entrance into own market) is akey factor of the behaviour of firms operating in complementary markets.

253. The same comments made above concerning substitutability, complementarity and "verticalrelationship" between markets also apply here. Competition in the market where a complement istraded may not be sufficient to restrain the supplier of a product.

254. A dominant position in the market for product B impacts diversely consumers who may buy product Ain the future and consumers who already possess product A

244. Competition in the market for product

A may allow future customers to avoid negative effects of high prices in the market for product B245

,but does not shield consumers who already possess product A, if the supplier changes policy andraises prices or lowers quality after the customer bought product A.

255. A supplier of product A will consider the effects of prices and quality of product B on sales of productA

246. A supplier of product A may select to keep own-brand product B prices low, or compensate high

prices of product B with a reduction of prices of product A.

256. This happens when consumers choose based on total "cost of ownership", or competitors in eithermarket effectively constrain the firm, thus excluding a finding of dominance.

257. The amount of information available to consumers may condition the extent to which they cancalculate the total cost of ownership of the bundle. The Discussion Paper rightly suggests that theprobability that the information available may allow consumers to calculate accurately increases when

243 The switching costs referred to here those effectively borne by the consumer, not those that can be transferred to thesupplier. See note 10 above.244 Although some of those who have already bought the primary product probably are potential future customers aswell; for instance, when they need to replace their existing equipment. However, as noted below, even with respect tofuture purchases their situation may be different from other customers who have not yet bought the primary product.245 In the following, the expression "higher prices" in the aftermarket should be understood to also cover the possibilityof lower quality.246 This is sometimes referred to as "cost of ownership" of product A

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product B is a consumable used with the primary product in fixed proportions, which unfortunately isseldom the case. Thus the real consideration behind consumer choices is expectations, their degreeof fulfilment in the past, and their expected fulfilment in the future.

258. The Discussion Paper suggests that a competitive constraint from the market for product A workseffectively when a sufficiently large fraction of demand engages in life cycle cost calculations, and thefirm is not able to discriminate between the fraction who does and the fraction who doesn't. Thishappens when, for instance, there is professional and private demand for product A, only theprofessional fraction guesses the total cost of ownership right, and the firm is unable to discriminatebetween the two. The ability to discriminate could instead support a finding of substantial marketpower vis-à-vis the other fraction of demand.

Assuming a firm's blindness to the conditions of purchase and the identity of purchasers, however,does not appear highly realistic. Similarly unrealistic is the assumption that the fraction of demandconsisting of professional buyers, retailers and large customers will not use their buying power toforce the firm to price-discriminate in their favour.

259. In some cases, strong competition in the market for product A constrains the behaviour of the firm inthe market for product B even absent right calculation of total cost of ownership of the bundle by anysignificant fraction of demand. right. duct supplier in the aftermarket also if customers are not basingtheir choice on accurate life cycle calculations: low prices in the market for product A make up for highprices in the market for product B.

The Discussion Paper mentions three methods to check whether such is or is not the case: 1) thecomparison of the "system" margin with margins earned in other markets or for other products wherethere is no proprietary aftermarket; 2) the comparison between the price of a system with the price ofsystems in either the same or other markets sold by other firms without a proprietary product market;and 3) the comparison of the return on capital in the relevant market with the average return on capitalfor the industry; an unusually high return on capital could be indicative that competition levels areunusually low.

260. The stronger the competition in the market for product A, and the weaker the firm's position in thismarket, the lesser the probability that the firm will be found to be dominant in the market for product B,due to the links between both markets.

261. A price increase or a restriction of possibilities of other suppliers in the market for product B, bycontrast, indicates that the link between markets is no longer constraining the firm, and may support afinding of dominance.

The Discussion Paper does not address clearly the issue of cause-effect relationship. If a firm raisesprices in the market for product B, this may be because (for other reasons) effective competition hasbecome weaker. Dominance does not result from higher prices, but rather from a combination offactors (including but definitely not limited to barriers to entry) that simultaneously create dominanceand allow the dominant firm to charge higher prices. .

262. These policy changes are sometimes called "installed base opportunism". The adoption of thispractice is more probable when the future prospects for the supplier in the market are poor, forinstance because the market is declining or the supplier has decided to exit or is loosing marketshare. On the other hand, even a supplier in these conditions may hesitate to engage in installed baseopportunism if such conduct can hurt its reputation in other markets.

The relationship between "installed base opportunism" and dominance, however, are relativelytenuous.

263. A fraction of demand may be protected against installed-base opportunism by contractual provisionssuch as long-term contracts, non-discrimination clauses or the possibility to switch to other brands ofproducts A, or B, or both. The damage caused by installed-base opportunism is converselyproportional to the size of the fraction of demand protected by these clauses.

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10.2.3 ABUSE OF DOMINANT POSITION

264. Abuse of dominance is assumed, subject to rebuttal as indicated below, when the dominant firm in themarket for product A excludes competitors from the market for product B, in any of the formsmentioned above, such as tying or refusal to deal.

10.2.4 DEFENCES

265. The dominant firm may rebut the assumption in the same manner indicated above. Examples ofrebuttals cited by the Discussion Paper include the need to certify quality and good usage of theproducts. A major rebuttal not cited by the Discussion Paper is the safety for the life and health of theconsumers, a major argument used by car makers and food and drug makers to discouragecompetition from independent component producers.

Another possible rebuttal relies on gains in efficiency (such as lower production, distribution ortransaction costs) resulting from integrated sales. Another major rebuttal argument not mentioned inthe Discussion Paper is the absence of double margins in integrated sales (the principle known assingle profit maximisation).

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