Margin Squeeze /
Refusal to deal
Valérie MEUNIER
Service économique
Autorité de la concurrence
12 mars 2010
Outline
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Introduction - Context
Margin squeeze definition
Simple margin squeeze model
Transatlantic divide
Examples
Conditions for a margin squeeze
Margin squeeze test
Links with other infringements
Conclusion
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Antitrust duty to share property/input?
 Should competition law require a firm with market power to share
its property/input with its rivals?
 Context:
• Physical infrastructure – e.g. telecommunication networks
• Input – e.g. raw material, electricity
• Intellectual property
 Does the incumbent firm have a duty to supply?
• Shouldn’t a firm be free to trade with whoever it chooses to?
• If antitrust duty to deal, on what terms?
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Guidance on the Commission’s enforcement
priorities in applying Art. 102
 In general, any undertaking, whether dominant or not, should have the right to
choose its trading partners and to dispose freely of its property
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The existence of an obligation to supply— even for a fair remuneration — may undermine
undertakings' incentives to invest and innovate and, thereby, possibly harm consumers
 Refusal to supply covers broad range of practices:
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Refusal to supply products to existing or new customers,
Refusal to license intellectual property rights
Refusal to grant access to an essential facility or a network
Margin squeeze: trading conditions that may impede competition
 Standard of proof
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Product/service is objectively necessary to compete effectively on downstream market
Refusal is likely to lead to elimination of effective competition on downstream market
Refusal is likely to lead to consumer harm
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Definition
 A margin squeeze is an exclusionary abuse of dominance
 Context: A vertically integrated firm that has a dominant position on the
upstream market (bottleneck input)
• uses the input for the production of the good or service sold on the
downstream market
• sells the input to rival firms that compete on the same downstream market
 A margin squeeze arises if the spread between (i) the price at which the
vertically integrated firm sells the final good on the downstream market,
and (ii) the price at which it sells the upstream input to its rivals is “too
small” to allow an efficient downstream rival to effectively compete
 Theory of harm: The integrated firm could use (leverage) its dominant
position on the upstream market to exclude downstream rivals, in order to
monopolize the downstream market
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Definition
Vertically integrated firm – Firm 1
U operates at
variable cost c0
U
D1 operates at
variable cost c1
D1
Downstream competitor – Firm 2
Input price a
D2
D2 operates at
variable cost c2
Price P2
Price P1
Consumers
Margin squeeze if P1 – a < c1 (“as efficient competitor”)
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Simple price squeeze model
 Vertically integrated firm, Firm 1, faces a competitor (Firm 2) on the
retail market (homogenous good)
 Final demand: D(P1, P2)
 If Firm 1 had no competitor: monopoly profit 1M=(P1M-c0-c1)D(P1M)
 Firm 2 will make a non-negative profit if P2 – a – c2 ≥ 0 and P2 ≤ P1
• i.e. if a + c2 ≤ P2 ≤ P1
Firm 2’s best response function
p2
P2M
p2(p1)
P2= P1
a+c2
a+c2
p1
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Model (2)
 Firm 1’s choice of retail price and access charge
• 1(p1, a) = (a-c0)D(p2M) if p1 > p2M
(1)
• 1(p1, a) = (a-c0)D(p1) if a + c2 ≤ p1 < p2M (2)
• 1(p1, a) =(p1-c0-c1)D(p1) if p1 < a + c2
(3)
 In case (1), Firm 1 exits the downstream market, and lets Firm 2
choose its monopoly price.
 In case (2), Firm 2 is active but sets a lower price – constrained
monopoly.
• Note that, since p1< p2M  D(p1)> D(p2M) 
Firm 1 is better off constraining Firm 2’s price  ( p , a)   ( p M , a)
1 1
1
2
• Therefore, in this range, Firm 1 sets p1 = a + c2
 In case (3), Firm 2 is not active. Only Firm 1 serves demand
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Model (3)
 If c1 < c2 (Firm 1 is more efficient), then Firm 1 sets monopoly retail
price (P1M that maximizes (P1-c0-c1)D(P1)), and input/access price at
a = P1M – c2
• In that case, a = P1M – c2 < P1M – c1 : no margin squeeze
 If c1 ≥ c2 (Firm 2 is more efficient), then Firm 1 lets Firm 2 serve the
retail market:
• Firm 1 sets access price at aM that maximizes (a – c0)D(a + c2),
• Firm 2 sets its price P2 (=P1) = aM + c2
• In that case, a = P1 – c2 > P1 – c1  P1 – a < c1 : margin squeeze even
though no intention of exclusion !!
• Vertically integrated firm extracts all Firm 2’s profit through access charge a
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European Commission versus the US
 Debate between EU and US about liability of margin squeeze under
antitrust laws
• Chicago school: only one monopoly profit. The vertically integrated firm has
no incentives to restrict downstream competition, as long as it can extract
monopoly rents on the upstream market
 Margin squeeze antitrust liability may do more harm than good:
• Either the vertically integrated firm will charge higher retail prices
• Or it will exit the downstream market, letting potentially less efficient firms
serve final demand, which also may lead to higher retail prices
 US Supreme court judgment in LinkLine: No margin squeeze
antitrust liability. One should demonstrate
• Either a refusal to deal on the upstream market
• Or a predatory conduct on the downstream market
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Margin squeeze liability?
 Liberalized markets : Allow entry at downstream level and provide
incentives to climb the “investment ladder”
 Real life examples not as simple as model:
• Differentiated products
• Fixed / sunk cost of entry on downstream markets
• Dynamics : incentives for (gradual) entry
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Examples
 Raw material:
 Industrie des poudres sphériques (CFI, 2000)
 Napier Brown – British Sugar, DG Comp decision, July 18, 1988
British Sugar is the unique producer of beet sugar in the UK (production quotas); BS is
also active at the downstream level on the market for granulated sugar (beet or
cane sugar)
Napier-Brown is a wholesaler that buys bulk sugar, re-packages and sells at the retail
level.
Beet sugar covers approximately half of British consumption. Importations of beet
sugar (5 to 10%). Importation and refining of sugar cane (40%).
BS has 58% market share – dominant position (can fix price independently of
competitors, customers and consumers)
(65) “…BS has engaged in a price cutting campaign leaving an insufficient margin for a
packager and seller of retail sugar, as efficient as BS itself in its packaging and
selling operations, to survive in the long term.”
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Examples (2/2)
 Telecommunication sector
 Deutsche Telekom (DG Comp decision, May 21, 2003 – CFI, April 10, 2008)
 Telefónica (DG Comp decision, July 4, 2007)
 Connect ATM (Conseil de la concurrence, 00-MC-01, 04-D-18, 05-D-59)
Upstream market: wholesale access to local networks (local loops)
Vertically integrated firm is the former legal monopoly; Still holds a monopoly position
on infrastructure
Downstream market: retail Internet access services
 In France
• Telecommunication sector (Connect ATM, Ténor)
 Tenor: margin between retail price of fixed-to-mobile calls and (upstream) call
termination charges
• Energy sector: Direct Energie
Access to base-load electricity (produced at low marginal cost by nuclear plants
operated by EDF)
Context of market liberalization
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Conditions for a margin squeeze
1 - Upstream dominant position
 The vertically integrated firm must hold a dominant position on the
upstream market
• If not, downstream firms could be supplied by others, and the incumbent’s
strategy to restrict downstream competition would fail
• More than often, the vertically integrated firm holds a monopoly position
on the upstream market
 Deutsche Telekom, Connect ATM, Telefonica: Context of liberalization
 Historic operator still has (quasi) monopoly over access to local loop
 In cases involving phone services, operator has monopoly position on call
terminations
 In Direct Energie, EDF is sole producer of nuclear power, which constitutes
80% of total French consumption
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Conditions for a margin squeeze
2 – Access/input necessary for effective competition
 The input must be necessary for rivals to effectively compete
• If a substitute can be used to produce the final good/service, then the
vertically integrated firm cannot prevent a downstream rival from being
supplied
 DT: alternatives to local loop are fibre-optic networks, wireless local loops,
satellites and upgraded cable-TV networks. But not sufficiently developed
to be substitutable
 Direct Energie: alternative sources of electricity are not equivalent, in
terms of price
 Tenor: During some periods of time, alternative solutions were available,
such as
• International rerouting of calls (FT was charging less for some international calls on
its mobile network than for national calls from competing operators)
• “Mobile boxes” – transformed a fixed-to-mobile call into a mobile-to-mobile call
(lower CT charge)
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Conditions for a margin squeeze
3 – Margin squeeze could be avoided
 When regulation exists, it must allow for the integrated firm to set
prices that could avoid margin squeeze.
 Tenor: call termination charges are capped by regulator
 But operators still had enough economic space to prevent margin squeeze
 DT: Wholesale charges are imposed by the regulatory authority
 Cost oriented, not possible to reduce access charge
 Retail prices are also capped (for bundle of services)
 But Commission and CFI considered DT was “able to influence the level of
its retail charges through applications to the *regulator+”
 Direct Energie: the downstream segment examined by the Conseil was
the one constituted by customers on the “free market”, not those who
were supplied at regulated prices
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Conditions for a margin squeeze
4 – Coordination between branches
 Coordination between upstream and downstream branches of the
group
 Tenor : Fixed network operator (Cegetel) and mobile network operator
(SFR) were not vertically integrated, but were two subsidiary
companies of a common holding
 Cegetel-SFR argued that the two firms did not act as a single economic
entity
 The Conseil retorted that Cegetel’s tariffs themselves proved coordination
(price of a call on FT’s network was higher than price of a call on SFR’s
network)
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Margin squeeze test
 “As efficient competitor” test
 Check whether the vertically integrated firm’s margin on the
downstream market (P1-c1) is high enough to cover the price of the
input (a)
 The vertically integrated firm knows its cost and can verify the test
 Distinguishes between exclusion of efficient competitor and
exclusion of less efficient competitors
 Link with ECPR rule (efficient component pricing rule)
• Optimal access charge = cost of providing access (production and
opportunity cost)
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Elements of the test
1.
2.
3.
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Revenues of the integrated firm on the downstream market
Costs of the integrated firm on the downstream market
Price of the bottleneck input
Which revenues should the test take into account when many
services or goods are provided for on the downstream market?
•
In Telecom sector, many services can be sold thanks to broadband access
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Scope of services to take into account
Energy sector: consumers can have many different consumption profiles
 Downstream costs can be difficult to evaluate when upstream and
downstream operations are tightly linked
•
Lack of separation between upstream and downstream levels of the group
 Non linear relationship between costs or revenues and
consumption
•
Need for segmentation before aggregation
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Elements of the test
1 – The “as efficient competitor” test
 The test must refer to the situation of the vertically integrated firm
• Costs and revenues of the vertically integrated firm
• Structure of the demand addressed by the vertically integrated firm
 A competitor should not be restricted to address specific niches
 Legal safety: if the incriminated firm had to compute margin squeeze test
on its competitors’ data, it could not verify the legality of its conduct.
 Cost concept: Long-run average incremental cost (LRAIC) [CMILT in French]
• Total downstream costs incurred to produce all goods/services – downstream
costs that would be incurred if all goods/services were produced but for the
ones under scrutiny
• Take into account possible economies of scope that can be passed on to
consumers
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Elements of the test
2 – Scope of costs and revenues
 In principle, costs and revenues for an as efficient firm if it
replicates the vertically integrated firm’s offers on the retail market
 In Deutsche Telekom, the Commission (approved by the CFI)
 Only took into account revenues from provision of telephone lines to endusers
 Did not take into account DT’s revenues from local or long-distance calls,
call termination and sending, and other higher-value services.
 Justification: historically, high price of long-distance calls compensated low
subscription prices. Several Directives recommended tariff rebalancing, to
terminate cross subsidy effects, and to ensure full competition on the
market. Margin squeeze test should then be consistent with Directives
principles, and should not allow for compensations between call and
connection charges
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Elements of the test
3 – Segmentation and aggregation
 Complex relationship between quantities, costs and revenues
• E.g. think of the many different mobile services offered
• E.g. Electricity consumption differs widely; depending on activity, size of
industry or household,…
• Non-linear tariffs
 In Tenor, the Conseil identified 19 consumption profiles.
 In Connect ATM, set of assumptions regarding the number of subscribers,
the cost incurred depending on population density,…
 The test must be verified not on subcategories of consumers, but on the
total portfolio of consumer groups
 An “as efficient competitor” should be able to replicate the structure of
the offers made by the vertically integrated firm, i.e. to address the same
demand structure, not just some niches
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Elements of the test
4 – Time consideration
 The Conseil has computed its margin squeeze tests on a period by
period basis
 In Telefonica, the Commission also presented a dynamic test, based
on the net discounted value of the operator’s activity over several
years
• Appropriate in nascent markets (or in rapid development): reasonable to
assume that the operator, when setting its tariffs, anticipates future cost
reductions (due to economies of scale, learning, innovations)
• But how to agree ex post on the ex ante anticipations of market growth?
• Maybe market growth resulted from anticompetitive behavior of
incumbent?
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Link with other infringements
1 – Refusal to deal
 Very similar approach
 Liability should not undermine firms’ incentives to invest and innovate
 But the Commission considers that in certain circumstances, imposing an
obligation to supply clearly does not undermine those incentives
(regulatory obligations; dominant position on infrastructure resulting from
special or exclusive rights or has been financed by state resources)
 Connect ATM :
 First decision: The Conseil fined FT for not complying with injunction (interim measures),
since offers to access “virtual network” were squeezing
 Second decision (on the merits): the Conseil concluded that FT had infringed competition
law, by refusing to deal with rival operators
 Telefonica:
 Company argued the Commission should have followed a refusal-to-deal standard of
proof
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Link with other infringements
2 – Predation
 In a margin squeeze, the vertically integrated firm sacrifices part of its
profit in order to exclude downstream rivals. However, this sacrifice does
not necessarily result in net losses; the vertical structure can still be
profitable
 Margin squeeze conduct is one of several strategies aiming at raising
rivals’ costs
•
Two strategic levers: upstream access price and retail price
 Predation
• The predator incurs losses first, and then recoups when rivals have exited dynamic strategy
• The prey’s profits are eroded until it has to exit – Its costs are not directly
affected by the predator
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Conclusion
 Margin squeeze test: verify that an as efficient competitor has
enough economic space to operate on downstream market.
 Balances willingness to allow new operators to enter markets and
incentives to “climb the investment ladder”
 Many important cases in context of liberalization
• Competition authorities may have legal instruments that regulators lack
that can facilitate markets’ opening
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