OXFORD, FEBRUARY 2006 RBB ECONOMICS

EconomicsRBB

ARTICLE 82 REFORM:AN ECONOMIC PERSPECTIVE(?)

IESTYN WILLIAMS

[These thoughts are preliminary. Comments welcome.]

2

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

OVERVIEW

• General perspective on approach:

─ Does it provide an appropriately economic perspective?

• Market definition and market power: useful filters?

• Differentiating ‘right’ from ‘wrong’ and the “special responsibility”

• Consistency across forms

3

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

EFFECTS- NOT FORM-BASED APPROACH

• Growing recognition (?) that an explicitly economics-based approach is needed

• Common ground among (most) economists that form-based rules are not generally appropriate

– Pro- and anti-competitive motivations for most relevant forms of behaviour

– Overlaps such that form-based bright lines not desirable

– Danger of inconsistent treatment of conduct with equivalent effects

4

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

FOCUS: HARM TO COMPETITION

• Focus on exclusion

• Consensus that (consumer) welfare effect is ultimate economic measure

─ But how practical/appropriate is this as a guide in specific Article 82 cases?

• Develop a coherent fact-based story of harm to competition

– When does foreclosure of particular competitors harm the competitive process and consumers?

– [How should ‘collateral’ damage be treated?]

5

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

CLEAR BUT ARBITRARY RULES DON’T HELP

• Example: Treatment of common costs in DG COMP DP

• DP provides rule on how common costs will generally be allocated in multi-product settings

─ Allocated in proportion to turnover achieved on individual products

• Allows calculation of Average Total Costs associated with a product

• Does not imply, however, that analysis based on this ATC rule makes economic sense

6

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

INTERVENTION IS COSTLY

• Competition authorities need to balance costs of false positives and false negatives

─ In dynamic market settings, impact of mistaken interventions (and precedents created) may easily outweigh effects of non-intervention

• Recognise too that freedom to intervene also creates uncertainty which damages healthy competition

─ Chilling effect on the competitive process

─ Value in non-intervention commitments even if some harmful conduct escapes

7

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

• Filters and safe harbours can play a valuable role in narrowing focus

• For example, in testing a foreclosure story:

– Does the target for investigation possess market power?

– Does the conduct in question actually affect the buyer’s incentives to deal with the competitor?

– Are alternative routes to market available?

• Insufficient emphasis in DG COMP DP?

FILTERS HAVE A VALUABLE ROLE

8

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

IS A MARKET POWER FILTER USEFUL?

• Current Article 82 process involves three distinct stages:

─ Market definition

─ Competitive (dominance) assessment

─ Analysis of conduct

• EAGCP suggested that “an effects-based approach needs to put less weight on a separate verification of dominance”

9

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

MARKET POWER I

• Common ground that only firms with substantial market power can cause harm to competition

• Logic if prove harm, dominance is automatically satisfied

• Only need to focus on conduct?

HARMFUL CONDUCT

DOMINANCE

X

10

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

MARKET POWER II

• In practice risk that abandoning dominance ‘pre-qualification’ will lead to excessive intervention

– Backward implementation (“We know abuse when we see it”)

– Testing for harm not that straightforwardCONDUCTDOMINANCE

HARMFUL CONDUCT

11

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

IS DOMINANCE FILTER TOO RESTRICTIVE?

• Concern sometimes expressed that dominance (market share) precedents prevent action against abuse in some settings

• Example: Electricity generation and OFGEM’s Market Abuse Licence Condition

• 2 responses:

─ From an economic perspective, definition of dominance is not a limitation

─ Value in commitment to non-intervention, even if prevents justified action in some cases

12

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

MARKET DEFINITION: SSNIP TEST

• Dominance assessment requires markets to be defined

• Hypothetical monopolist or SSNIP test provides well-established basis for market definition in competition cases

─ Could a hypothetical monopolist controlling products in hypothesised market raise prices permanently and profitably by 5% - 10%

─ If YES, set of products represent a well-defined market; if NO, broaden

• Provides a framework for assessing strength of demand- and supply-side substitution

13

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

MARKET DEFINITION: PRACTICALITIES

• In practice, the market definition exercise typically involves a rounded assessment,

─ Draws on multiple pieces of evidence

─ An overall picture of competition is assembled

• Relatively rare for test to be applied formally

• Nevertheless, conceptual/organising value of SSNIP framework remains important

14

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

MARKET DEFINITION: CELLOPHANE FALLACY

• A firm with market power might be expected to have raised prices already to point where no further price increases possible

─ ie to point where demand is elastic

• Conducting SSNIP test at prevailing prices would lead to overly broad market definition in this case

─ But not a SSNIP-specific problem

• [Where low pricing concerns, reverse distortion may arise]

• Fundamental problem: What is competitive price (benchmark)?

15

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

CELLOPHANE FALLACY: IMPLICATIONS

• Significant damage to application of market definition test in conduct settings

─ cf. merger settings where prevailing price is relevant benchmark

• Is there any value in undertaking market definition exercise?

─ SSNIP still provides important conceptual framework for analysis

─ Not all evidence is contaminated

• However, emphasises need for careful analysis of effects

16

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

TREATMENT OF CONDUCT: PREDATION EXAMPLE

Summary of DG COMP DP Approach:

AAC

ATC

Predation presumed

Focus on intent, broadly defined.

Documentary evidence may lead to presumption

Broad range of indicators, eg selective price cutting, actual exclusion.

Predation finding possible, where “non-replicable” advantages in play

17

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

HOW FAR SHOULD “SPECIAL RESPONSIBILITY” EXTEND?

• Should a dominant firm be obliged to forego actions whose (incremental) profitability does not depend on excluding rivals?

─ Classic example: Selective price cutting on “marginal” sales

• Must a dominant firm price to allow less efficient firms to survive?

─ DG COMP DP says yes … sometimes

─ Is this a reasonable obligation?

─ Is it desirable?

18

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

INTENT

• Helpful recognition in DG COMP DP that “general talk” is not evidence of intent

• Nevertheless, direct evidence claimed to allow presumption of predation

─ Avoids need to test coherent theory of harm

• Broad range of factors identified as contributing to “indirect evidence”

─ Example: Above avoidable cost selective pricing

19

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

INDISPENSABILITY AND “SACRIFICE” TESTS

• Meeting the competition: Could losses be avoided/efficiencies achieved in a less distorting way?

• Generally imposes to high a burden on firms

– Impact of genuine mistakes etc

– How much sophistication reasonable?

• Useful as a guide to exploring business motivations BUT not a definitive test

20

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

CONSISTENT TREATMENT OF COMMON THEMES

• Example: Selective price cuts and rebates (& predation)

– Common concern is abusive low pricing

– Consistent analytical framework

• Focus on possible foreclosure of equally efficient competitors

– Avoidable cost tests appropriate

• Identify and focus on sales range that is open to competition

21

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

CONSISTENT TREATMENT II

• Consistent treatment of low pricing effects required

• Example: Rollback rebate of 20% on 80% sales target

• DG COMP DP appears to endorse ATC as floor for low pricing in rebates context

Assured base of sales

‘Open’ to competition

Cost threshold

% of needs60%

20

80%

22

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

FORM AND EFFECT REVISITED

• Form-based predation tests need thoughtful application

• Example: Roll-back rebates

• Form: -ve pricing for some ranges

• Effect: Are these ranges competitively relevant?

23

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

END NOTE: EMPHASIS ON FORMAL MODELS

• EAGCP emphasised role of formal models

• Formal modelling offers transparency and rigour

– An important weapon in the armoury

• However, can gain a momentum of its own

– Spurious confidence in predictions

– Risk ignoring important factors because less easily modelled

• Relying on implications of a particular theoretical model generally over-optimistic and potentially harmful

24

IEST

YN W

ILLI

AMS

RBB

ECO

NOM

ICS

OXF

ORD

, FEB

RUAR

Y 20

06

EconomicsRBB

CONCLUSIONS

• Focus for investigation must be a coherent fact-based theory of harm

• Consistent effects-based analysis required

• Can’t escape serious implications of cellophane fallacy

• Recognise benefits of not intervening

• Demands made of dominant firms in abuse context must be:

─ Base on standards (eg cost benchmarks) that the firm can reasonably be expected to know

─ Motivated by serious concerns of harm to the competitive process