UNIVERSITY OF ESSEX
LAW DEPARTMENT
LL.M in
INFORMATION TECHNOLOGY, MEDIA AND E – COMMERCE
2007 – 2008
Supervisor: Prof. Steve ANDERMAN
DISSERTATION
Margin Squeeze Abuses within the Scope of EC Competition Law and
Telecommunications Regulations
NAME
: Aynur GULCU
REGISTRATION NUMBER
: 0702236
NUMBER OF WORDS
: 19.933
DATE SUBMITTED
: 15 September 2008
TABLE OF CONTENTS
List of Figures ........................................................................................................................i
List of Tables ........................................................................................................................ ii
1.
INTRODUCTION ........................................................................................................ 1
2.
MARGIN SQUEEZE ................................................................................................... 4
2.1 Anticompetitive and Pro-competitive Motives for Margin Squeeze .......................... 6
2.2 Types of Margin Squeeze ........................................................................................... 8
2.2.1
Raising Wholesale Prices .................................................................................. 8
2.2.2
Lowering Retail Prices .................................................................................... 10
2.2.3
Decreasing the Margin between Wholesale and Retail Prices ........................ 12
2.3 Basic Economic and Legal Conditions..................................................................... 13
2.3.1
Vertical Integration .......................................................................................... 13
2.3.2
Dominant Position in the Supply of an Essential Upstream Input .................. 14
2.3.3
Imperfect Downstream Competition ............................................................... 16
2.3.4
Objective Justification ..................................................................................... 18
2.3.5
Sufficient Duration .......................................................................................... 18
2.3.6
Relevant Tests.................................................................................................. 20
2.3.6.1
Test-1: Equally efficient competitor test ................................................... 22
2.3.6.2
Test-2: Reasonably efficient competitor test ............................................. 24
2.4 Margin Squeeze and Other Abuses .......................................................................... 25
3.
2.4.1
Predatory Pricing ............................................................................................. 26
2.4.2
Cross-subsidisation .......................................................................................... 28
2.4.3
Excessive Prices .............................................................................................. 29
2.4.4
Price Discrimination ........................................................................................ 31
2.4.5
Refusal to Deal ................................................................................................ 31
TELECOMMUNICATIONS SECTOR AND MARGIN SQUEEZE ................... 33
3.1 Evolution of the Telecoms Law................................................................................ 33
3.1.1
Liberalisation and Competition (1998 Regulatory Package) .......................... 34
3.1.2
Legislation in Force (2002 Regulatory Package) ............................................ 35
3.2 Margin Squeeze in Telecommunications ................................................................. 37
4.
3.2.1
Full Regulation ................................................................................................ 39
3.2.2
Partial Regulation ............................................................................................ 40
3.2.3
Wholesale and Retail Markets Unregulated .................................................... 40
ANALYSIS UNDER COMPETITION/TELECOMMUNICATIONS LAWS ..... 41
4.1 Relevant Market ....................................................................................................... 41
4.2 Dominance ................................................................................................................ 42
4.3 Abuse and Relevant Imputation Test........................................................................ 44
4.4 Remedies .................................................................................................................. 46
5.
UNRESOLVED ISSUES............................................................................................ 49
5.1 Margin Squeeze in Emerging Markets ..................................................................... 49
5.2 Costs ......................................................................................................................... 50
5.3 Need to Show the Effects ......................................................................................... 53
5.4 Ex-ante vs Ex-post Intervention ............................................................................... 55
6.
CONCLUSION ........................................................................................................... 59
BIBLIOGRAPHY ............................................................................................................... 63
i
List of Figures
Figure 1 Margin Squeeze by Raising Wholesale Prices ......................................................... 9
Figure 2 Margin Squeeze by Lowering Retail Prices ........................................................... 11
Figure 3 Margin Squeeze and Other Abuses ........................................................................ 26
Figure 4 Imputation Test Parameters.................................................................................... 45
ii
List of Tables
Table- 1: The Authorities’ Decision Making Process .......................................................... 41
1
1.
INTRODUCTION
In the European Union (EU), the four clauses of Article 82 can be applied to exploitative
and/or exclusionary abuses as it was mentioned in Continental Can1 that Article 82 “is not
only aimed at practices which may cause damage to consumers directly, but also at those
which are detrimental to them through their impact on an effective competition structure”.
This situation is further clarified by the Discussion Paper2 stating that Article 82 prohibits
exclusionary conduct which produces actual or likely anticompetitive effects in the market
and which can harm consumers in a direct or indirect way (Akman, 2006:823). Therefore,
Elhauge and Geradin mention that the conduct in question must in the first place have the
capability to foreclose competitors from the market. Thus foreclosure can be found even if
the foreclosed rivals are not forced to exit the market: it is sufficient that the rivals are
disadvantaged and consequently led to compete less aggressively (Elhauge&Geradin,
2007:304).
In the Discussion Paper, two types of exclusionary conduct are mentioned: horizontal and
vertical exclusion. The former concerns the exclusion of direct rivals on a horizontal level
(i.e. predatory pricing); the latter concerns the exclusion by a dominant upstream supplier
of downstream rivals (i.e. margin squeeze) (O’Donoghue&Padilla, 2006:201). Margin
squeeze (or price squeeze) describes a situation in which a vertically-integrated firm with a
dominant position in an upstream market prevents its downstream rivals from achieving as
economically viable price-cost margin through applying high wholesale input prices, low
retail prices or both (Crocioni&Veljanovski, 2003:30).
However, if the costs of the dominant firm are reduced or otherwise its efficiency is
increased as a result of the conduct, it will normally be considered as an example of
competition on the merits, even if it results in eliminating competitors (Faull&Nikpay,
2007:350). Nonetheless, there is not a concrete list of the conducts which fall into the
1
Case 6/72 Continental Can [1973] ECR 215, para.26.
DG Competition Discussion Paper on the Application of Article 82 of the Treaty to Exclusionary Abuses,
2005.
2
2
competition on the merits and thus, it is not so easy to distinguish growth as a result of
competition on the merits based on a superior product from growth resulting from
exclusionary conduct that distorts competition and reduces consumer welfare (Ottervanger,
2005:157). As a result, sometimes the very same conduct can be considered as
“competition on the merits” in the United States (US) and meanwhile it may not be
considered as “normal competition” in the EU (Elhauge&Geradin, 2007:302). However, if
a company is aware of the fact that it could be held to be “dominant”, it should also realise
that it has “special responsibilities” and it should be pro-active in the regulatory process
and should not simply hide behind sector-specific authorities when it sees that regulatory
intervention would result in doubtful outcomes (Ottervanger, 2005:157). The Court of First
Instance (CFI) clarified the term special responsibility as “only a dominant undertaking
may be prohibited from conduct which is legitimate where it is carried out by nondominant undertakings” (O’Donoghue&Padilla, 2006:177). This situation was confirmed
in the recent CFI decision, Deutsche Telekom3, regarding margin squeeze stating that
“122…the applicant was able to influence the level of its retail charges through
applications to RegTP for authorisation….In the context of the applicant’s special
responsibility as an undertaking in a dominant position”. Deutsche Telekom case is not
important just because it has clarified the situation regarding dominant operators’ position
in front of the competition rules in a regulated sector, here in telecommunications, but it is
also important because it has mostly clarified the issues related with margin squeeze abuse
which has been long debated issue among economists, lawyers and academics. As the
definition of margin squeeze suggests, there must be some conditions related with the
abuse to be held such as vertical integration, provision of essential input, imperfect
downstream competition and so on. Thus, this study aims to provide information about
margin squeeze abuse, including economic and legal analysis of the abuse, particularly in
the EU and touching to the US approaches wherever possible.
3
Case T-271/03 Deutsche Telekom OJC 128/29 10/04/2008. In 2003, the Commission found that Deutsche
Telekom (DT), incumbent fixed operator in Germany, held a dominant position on both, the markets for
wholesale and retail access to the local loop. The Commission concluded that DT was abusing its dominant
position through unfair prices and fined DT for €12.6 million. The CFI upheld the decision in 2008 by
rejecting DT’s arguments. DT appealed the CFI decision on 26 June 2008 (Case C-280/08-P) by reiterating
its arguments defended before the CFI.
3
Within this respect, in the second chapter of this study margin squeeze abuse will be
elaborated in terms of its definition, legal basis, anticompetitive and pro-competitive
motives, types, basic legal and economic conditions and finally its relationship with other
abuses, such as predatory pricing or excessive pricing. The relationship with other abuses is
important such that it enables to understand the margin squeeze as a stand alone abuse both
economically and legally.
In the following chapter, third chapter, the margin squeeze issue will be considered in the
telecommunications sector in which the market structure mostly enables vertically
dominant operators to squeeze their rivals profit in the retail market. Thus, the National
Regulatory Authorities (NRAs) try to prevent margin squeeze by applying several
economic regulations, ex-ante regulation which are going to be mentioned by considering
EU wide communications regulations.
Fourth chapter will be devoted to the comparative analysis of margin squeeze under
competition law and telecommunications law. Within this respect, the relevant market,
dominance, relevant tests for the abuse and remedies will be scrutinised according to both
laws.
Even though most of the conditions attached to the margin squeeze have been clarified with
the case law, there is still room for further clarification regarding margin squeeze in
emerging markets, costs to be used in the tests, need to show the likely effects of margin
squeeze in the market and finally ex-ante vs ex-post intervention for margin squeeze.
Finally, in the sixth chapter the conclusions of the analysis regarding the topics mentioned
in the study will be provided.
4
2.
MARGIN SQUEEZE
A margin squeeze arises when a vertically-integrated undertaking, with market power in
the provision of an “essential” or “key” upstream input, prices its upstream product and/or
downstream product in such a way that its equally or more efficient downstream
competitors are rendered uneconomic as a result of this disproportionate margin
(Crocioni&Veljanovski, 2003:30). In the EC Access Notice4, the Commission explains the
situations under which margin squeeze may arise. Within this context, Grout mentions that
there are several ways that can constitute a margin squeeze however either of the two
suggested by the Commission in the EC Access Notice certainly results in margin squeeze.
Therefore, the conditions mentioned in the EC Access Notice are sufficient but not
necessary for a margin squeeze to exist (Grout, 2003:77):
117. A price squeeze could be demonstrated by showing that the dominant company's own
downstream operations could not trade profitably on the basis of the upstream price charged to its
competitors by the upstream operating arm of the dominant company.
118. ….a price squeeze could also be demonstrated by showing that the margin between the price
charged to competitors on the downstream market….for access and the price which the network
operator charges in the downstream market is insufficient to allow a reasonably efficient service
provider in the downstream market to obtain a normal profit.
Since squeeze can take place either from the upstream or downstream or from both sides,
margin squeeze abuse can be seen in the form of predatory or excessive pricing abuses.
Therefore, there has not been a prevalent understanding amongst academics, lawyers and
economists as to whether there is a separate form of abuse called “margin squeeze” or
whether this is nothing else but a refusal to deal, predation or excessive prices in cases of
vertical integration (Palmigiano, 2006:1). There have been some cases which support this
4
Notice on the application of the competition rules to access agreements in the telecommunications sector,
OJ 1998 C265/2.
5
complexity instead of clearing it. For example, National Carbonising5, the oldest margin
squeeze case in the EU, treats the margin squeeze as a variation on an exclusionary refusal
to supply and it merely states that an upstream dominant firm supplying an essential input
to rivals may “have an obligation to arrange its prices so as to allow a reasonably efficient
manufacturer of the derivative a margin sufficient to enable it to survive in the long-term.”
(Geradin&O’Donoghue, 2005:379).
Even though Napier Brown/British Sugar6 was the first Commission decision that actually
found a “margin squeeze” abuse, the case treats the margin squeeze as a variant on a
predatory pricing case, in the context of an exclusionary scheme or plan. Furthermore, CFI,
in Industrie des Poudres Sphériques (IPS)7, does not appear to regard a margin squeeze as a
separate form of abuse at all, but rather as a description of a form of anticompetitive harm
that can arise from either excessive pricing (of the input) or predatory pricing (of the
derivative product) (Kallaugher, 2004:16). Even in the most recent Commission document,
in the Discussion Paper, the Commission puts margin squeeze in the section on refusal to
supply in the part dealing with termination of an existing supply relationship.8
While in some cases it is possible to frame margin squeeze as an excessive price in the
upstream market, or as a predatory price in the downstream market, there might be
circumstances where neither of the two mentioned exclusionary abuses are actually in
place, but the margin squeeze derives from a combination of the two. Under such
circumstances, if margin squeeze cannot be challenged as an independent abuse from
5
National Carbonising, 0J 1976 L35/6. National Coal Board, whose subsidiary also produced coke in
competition with National Carbonising Company (NCC), was dominant in both upstream and downstream
markets. NCC was unable to operate economically because of increases in input prices. The Commission
concluded that there was no margin squeeze, since for both companies, industrial coke was profitable and
domestic coke was not (due to competition from gas and electricity).
6
Napier Brown/British Sugar, OJ L284/41. The Commission found British Sugar (BS) dominant in the UK
market for the sale of bulk sugar and the derived product. Napier Brown (NB) was a buyer and reseller of
sugar in competition with BS. The Commission found that there was an insufficient margin for a sugar
merchant as efficient as BS to survive, based on BS's own costs, which showed it operating at a loss.
7
Case T-5/97 IPS [2000] ECR II-3755. The Commission rejected a complaint by IPS against Pechiney
Electrometallurgie (PEM), the sole producer of calcium metal in Europe, which also marketed its derivative,
broken calcium metal in competition with IPS.
8
Discussion Paper, para.220.
6
excessive or predatory pricing, it would be possible for the dominant firm to foreclose
equal or more efficient competitors without breaching Article 82 (Bravo&Siciliani,
2007:250). Nonetheless, the Deutsche Telekom ruling, for the first time constitutes the
margin squeeze abuse as a distinct, stand-alone form of abuse under Article 82(a), separate
from predatory pricing, excessive pricing, or refusals to supply (Amory&Verheyden,
2008:4; O’Donoghue&Padilla, 2006:303; Kallaugher, 2004:33). In the Deutsche Telekom
case, the CFI, by confirming the approach taken by the Commission in its decision,
provided for a general definition of margin squeeze, clarifying its constitutive elements and
the methodology to be applied for its assessment. According to the CFI’s Deutsche
Telekom case, a margin squeeze can be found if (Buigues&Klotz, 2008:3):
107. … the difference between the retail prices charged by a dominant undertaking and the wholesale
prices it charges its competitors for comparable services is negative, or insufficient to cover the
product-specific costs to the dominant operator of providing its own retail services on the downstream
market.
2.1
Anticompetitive and Pro-competitive Motives for Margin Squeeze
Many forms of leveraging conduct are inherently pro-competitive such as the case with
economies of scope which enable the firm to produce two products together cheaper as a
result of legitimate leveraging. However, a dominant firm may use its dominance on one
market to unlawfully exclude rivals on a horizontally or vertically related market in which
it is not dominant (O’Donoghue&Padilla, 2006:208-210). This anticompetitive leveraging
may result in troublesome outcomes, which cannot be reversed easily, especially in markets
where there are strong network externalities9, e.g., in telecommunications (Crocioni,
2008:450). For example, in the US, as a result of the 1996 Telecommunications Act's
failure to prevent Regional Bell Operating Companies (RBOCs)10 from leveraging their
monopoly power in the long-distance market, the largest pure long-distance companies
9
Network externality can be defined as “The effect which existing subscribers enjoy as additional
subscribers join the network, which is not taken into account when this decision is made” (ERG, 2006:126).
10
In 1984 US Department of Justice separated AT&T into RBOCs and a long distance provider after which it
is claimed that the modern US telecommunications history begins (Bell, 2007:79).
7
were practically driven out of the residential long-distance market, followed by acquisitions
by the upstream monopolists (Economides, 2007a:136). Within this context, the conditions
for the vertically-integrated firm to have an incentive to exclude downstream rivals can be
summarised as follows (Frontier Economics, 2008:4; Geradin&O’Donoghue, 2005:364):
•
more profitable downstream operation relative to the upstream one;
•
lack of upstream suppliers;
•
homogeneous products and imperfect competition in the downstream market;
•
ease of expanding downstream output and picking up exiting rivals customers; and
•
important competitive constraint from the rivals.
If most of the conditions above do not hold, then it will not be meaningful for the
vertically-integrated firm to squeeze its rivals in the downstream market who are also
customers in the upstream market. Hence, under some circumstances, the verticallyintegrated firm may prefer downstream rivals to be present in the market. For example, the
higher the degree of product differentiation in the downstream market, the lower the
incentives for foreclosure (Hovenkamp&Hovenkamp, 2008:9). Furthermore, if the
vertically-integrated firm does not have enough downstream capacity to expand sales, then
as Chicago school’s “single monopoly profit” theorem claims that a firm with an upstream
monopoly has no incentive to foreclose downstream rivals, as there is only a single
monopoly rent to be earned in the industry (O’Donoghue&Padilla, 2006:307-308).
However, modern economic analysis has gone beyond the Chicago school critique and
identified several reasons why a firm may use its dominant position in one market to distort
competition in vertically related markets (Gual, 2005:29).
An obvious starting point is to consider whether there is any concrete evidence that an
alleged margin squeeze has resulted in market foreclosure, particularly if the abusive
conduct is supposed to have continued for a significant period of time (Frontier Economics,
2008:4) Only a margin squeeze that excludes a competitor that is more efficient than the
vertically-integrated firm would be anticompetitive and should be condemned (Motta & de
Streel, 2006:116). Therefore, negative margins of a vertically-integrated firm may not be an
indication of anticompetitive behaviour all the time. For example, the prices may be
8
temporarily below the cost because of promotional sales in a growing market. Furthermore,
a margin squeeze may have efficiency gains in terms of allowing output to expand and
achieve economies of scale through network externalities (O’Donoghue&Padilla,
2006:309).
Within this context, upstream dominant firm might carry out its downstream activities more
efficiently than its competitors and squeeze those less efficient downstream competitors
through lower prices by lowering costs and thus save economic resources. In other words,
if the rivals are squeezed because of their costs, then the dominant firm cannot be charged
with margin squeeze abuse. For example, in IPS the CFI rejected the notion that a dominant
supplier’s wholesale price could be deemed abusive solely because a wholesale customer
competing downstream sold at a loss due to its own higher processing costs (Genevaz,
2008:19). Moreover, prices that squeeze a downstream firm will benefit consumers
whenever the downstream firm is itself a monopolist (Elhauge&Geradin, 2007:423).
2.2
Types of Margin Squeeze
There are mainly three ways to squeeze rivals, (i) raising wholesale price provided to the
rivals while keeping the retail price constant, (ii) keeping wholesale price constant whereas
decreasing the retail price and finally (iii) decreasing the margin by using wholesale and
retail prices at the same time.
2.2.1
Raising Wholesale Prices
The first way to achieve a margin squeeze can be done by a dominant firm through
increasing the wholesale price of the essential input to its rivals.
9
Vertically
Integrated
Company
Wholesale Price
UPSTREAM
DOWNSTREAM
COMPETITORS
DOWNSTREAM
Retail Price-1
Retail Price-2
CONSUMERS
Source: Palmigiano, 2007.
Figure 1 Margin Squeeze by Raising Wholesale Prices
Instead of decreasing the retail price to squeeze the rivals, in some situations, increasing the
wholesale price may be more promising. This allows the integrated firm to keep the
downstream price at its profit-maximizing level, which may or may not be changed after
the rivals exit the market (Hovenkamp&Hovenkamp, 2008:14). This can be discriminatory
where the operator charges its downstream rivals a higher wholesale price than it (explicitly
or implicitly) charges to its downstream operation (Veljanovski, 2006:2). However, price
discrimination such that will be caught by Article 82 irrespective of whether it constitutes a
price squeeze (Crocioni&Veljanovski, 2003:32).
Since the wholesale input is necessary for the downstream competitors to live in the retail
market, applying higher wholesale prices (even if they are not necessarily excessive) may
have the similar effects as refusal to deal, raising rivals’ costs or vertical foreclosure
(O’Donoghue&Padilla, 2006:305; Fernández, 2006:255). Under these conditions,
alternative providers may be forced to exit the market or they may be rendered ineffective
to compete. The United Kingdom (UK) Office of Fair Trading (OFT) claims that if the
10
dominant firm squeezes the margin through raising the wholesale price, the only way for
the small rivals to survive in the market may be offering higher quality niche services and
applying higher prices as a result of differentiating their products (OFT, 2006).
On the other hand, an excessive wholesale price may aim to strengthen or maintain the
market power of the dominant firm by putting rivals at disadvantage (Motta&Streel,
2006:91). However, foreclosure in the retail market, as a result of excessive wholesale
prices, will occur only if there are no other upstream producers that sell close substitute
inputs. According to Motta and de Streel, this can only happen where the verticallyintegrated firm enjoys a monopoly (or a near monopoly) of an input for which there is no
good substitute (Motta&Streel, 2006:122).
2.2.2
Lowering Retail Prices
Second way of offending a margin squeeze is lowering retail prices while keeping the
wholesale prices constant. When the vertically-integrated firm lowers its retail price, rivals
usually follow suit to avoid their customers are seized by the vertically-integrated firm.
This situation gets worse when the switching costs are low and it is easy for the verticallyintegrated firm to increase its downstream capacity to meet increased demand.
Crocioni and Veljanovski explain this kind of margin squeeze such that the verticallyintegrated firm lowers its downstream price below the joint costs of upstream production
and downstream transformation, and an adequate margin. Furthermore, within this kind of
margin squeeze, they propose to use an assessment for the vertically-integrated firm to
recoup short-term losses after the exit of the rivals (Crocioni&Veljanovski, 2003:33). The
principle of recoupment of losses may be important in terms of showing that the incumbent
is profitable on an aggregate end-to-end basis although its downstream activities are lossmaking; therefore, there is a margin squeeze (Fernández, 2006:256).
11
Vertically
Integrated
Company
Wholesale Price
UPSTREAM
DOWNSTREAM
COMPETITORS
DOWNSTREAM
Retail Price-1
Retail Price-2
CONSUMERS
Source: Palmigiano, 2007.
Figure 2 Margin Squeeze by Lowering Retail Prices
Hovenkamp has the view that the defendant's downstream prices below marginal or
average variable cost should be subject to ordinary predatory pricing rules and since such
claims are not of a margin squeeze at all (Hovenkamp&Hovenkamp, 2008:30). In Napier
Brown/British Sugar, the Commission decided that BS infringed its dominant position by
reducing its prices for retail sugar to the extent that an insufficient margin existed between
its prices for retail and industrial sugar. Prices on the secondary market are set at a level
such that they are lower than the prices charged on the primary market for the sale of raw
sugar. Nihoul and Rodford conclude that the “primary price” is not the cost for the activity
developed on the secondary market and thus there is a possibility that the undertaking may
not have operated at a loss (Nihoul&Rodford, 2004:432). When the marginal or average
costs are not known precisely, relying upon margin squeeze assessment, by taking into
account that the difference between wholesale and retail prices are not sufficient for an
efficient rival to compete with the vertically-integrated firm in the downstream market,
without any requirement to show the recoupment possibility may result in solution in a
shorter time.
12
2.2.3
Decreasing the Margin between Wholesale and Retail Prices
Hovenkamp describes a situation in which a dominant firm, with market power in both the
upstream and the downstream markets, charges both prices well above cost and yet there
would not be enough margin between them to permit a downstream rival to survive
(Hovenkamp&Hovenkamp, 2008:20). This can be figured out by an example. For instance,
the vertically-integrated firm produces wholesale input for a cost of 10. Furthermore, the
cost of producing retail product is 5, and thus, total cost for the final good including
wholesale price is 15. Suppose that the marginal cost of producing the retail product is also
5 for the rival firm in the downstream market. Under these conditions, if the verticallyintegrated firm sells the wholesale input to the rival at 13 and further if it sells the retail
product at 17, then it cannot be argued that there is either excessive pricing or predatory
pricing. This is because; as Motta and Streel argue, an excessive price action is unlikely to
be successful, as the upstream firm is earning a 30% margin, which is probably not
excessive. A predatory pricing action would not be justified either, since the verticallyintegrated firm is making profits of 2 (its total costs is 15). However, the rival will only be
able to sell below cost, as its total costs are 18, which is higher than the final price charged
by the vertically-integrated firm (Motta&Streel, 2006:117).
Motta and Streel bring two reasons for a margin squeeze may be anticompetitive even
though excessive or predatory prices may not be proven. Under first option, the margin
squeeze abuse may lack of sufficient data to be proven with regard to excessive or
predatory pricing doctrine even though the abuse in fact includes either excessive or
predatory prices or both. Besides, there may not be any other abuse other than low profit
margin which is not enough for the rivals to cover their costs. Therefore, under these
conditions, intervention would be appropriate and authorities should be able to condemn
margin squeeze independently (Motta&Streel, 2006:117). Hence, in Deutsche Telekom, the
CFI defined the margin squeeze in a way that “167. …the abusive nature of the applicant’s
conduct is connected with the unfairness of the spread between its prices for wholesale
access and its retail prices”.
13
2.3
Basic Economic and Legal Conditions
To ensure that the margin squeeze is successful and there are no new firms who can capture
the profits left from the exiting firms, there must be barriers to entry and re-entry in both
upstream and downstream markets (O’Donoghue&Padilla, 2006:306-307). Moreover,
according to the EC Access Notice and CFI’s decision in Deutsche Telekom, a number of
minimum conditions are required to substantiate a margin squeeze abuse which can be
arranged as follows:
1) vertical integration,
2) dominant position in the supply of an essential upstream input,
3) imperfect downstream competition,
4) objective justification,
5) sufficient duration,
6) relevant imputation test.
In addition, even though it is not stated in the definitions done by the Commission or the
Courts, some commentators claim that sufficient duration is also required for the margin
squeeze abuse to be successful (O’Donoghue&Padilla, 2006:310; Case Associates, 2002;
Fernández, 2006:251).
2.3.1
Vertical Integration
When the wholesale input price is concerned, a non-integrated firm would be expected to
behave prudently not to lose its customers and sell its input at a price which in turn allows
its customers resell at a profit. Furthermore, regarding the end-user price, a non-integrated
firm would be expected to sell at a price that covers its costs and allows a profit margin.
Otherwise, diverging from these two models would mean sacrifice for the non-integrated
firm (Kallaugher, 2004:28).
With regard to the margin squeeze definition, there must be two different markets which
are vertically integrated and there must be leveraging in between these two markets to have
a margin squeeze abuse (O’Donoghue&Padilla, 2006:311). To tackle the margin squeeze
14
abuse different from excessive pricing or predatory pricing and for the existence of margin
squeeze, there must be a vertically-integrated firm who operates in two markets included in
the same production chain (Fernández, 2006:249). Otherwise, if there is not a vertical
integration, then margin squeeze cannot arise.
2.3.2
Dominant Position in the Supply of an Essential Upstream Input
The input supplied by the dominant upstream firm to downstream rivals must in some
sense be “essential” for competition on the downstream market. For example, in the UK, in
Genzyme11, the Competition Appeal Tribunal (CAT) described the margin squeeze abuse as
including essential wholesale input for the downstream rivals. Furthermore, in IPS the
margin squeeze allegation was rejected by both the Commission and the CFI by mentioning
that alternative sources of the raw material in question were available from China and
Russia (O’Donoghue&Padilla, 2006:312). Therefore, for the wholesale input to be essential
in the downstream production process, there must not be close substitutes for the wholesale
input supplied by the vertically-integrated firm (Crocioni&Veljanovski, 2003:40). For
instance, in Deutsche Telekom, the Commission demonstrated that there was no alternative
to DT local loop access for competitors (Whelan, 2004). Furthermore, the Discussion Paper
explicitly states “indispensability” as a requirement for finding of a termination of an
existing supply relationship which includes margin squeeze as abusive (Palmigiano,
2006:16).
On the other hand, The French Supreme Court held that there is no need to show that there
is no alternative for the rivals to get the wholesale input. This implied that the Court did not
require indispensability as part of the margin squeeze test and thereby confirmed in France
Télécom/SFR Cegetel/Bouygues Télécom12 that “a margin squeeze could be deemed
11
Genzyme v OFT, Case No.1016/1/1/03, 11/03/2004. The Office of Fair Trading (OFT) found that Genzyme
had abused its dominant position for the provision of the Cerezyme drug by bundling it with the provision of
homecare services at a price which included a margin squeeze against its downstream competitors. The
decision was confirmed by the CAT.
12
French Competition Council decision of 14/10/2004, France Télécom/SFR Cegetel/Bouygues Telecom,
Case 04-D-48, (confirmed by Paris Court of Appeals, 02/04/2008). The Council designated each mobile
15
abusive provided competitors were unable to use alternative inputs to an extent significant
enough for them to avoid the squeeze” (Genevaz, 2008:28). However, as O’Donoghue
suggests limiting margin squeeze cases to situations akin to essential facilities will decrease
the risks of falsely imputing a margin squeeze where none exists or non-imputing where
there is (O’Donoghue, 2008:20).
In addition to being essential, for a margin squeeze to be successful, the wholesale input
must be used by the downstream competitors as a relatively high, fixed proportion of the
downstream costs (Geradin&O’Donoghue, 2005:358). Otherwise, inferring that the
downstream rivals’ lack of profitability is caused by the dominant firm’s input pricing will
not be so clear. In Napier Brown/British Sugar, industrial sugar was essentially repackaged
to product sugar for retail use, showing that the raw material was used in high, fixed and
constant proportions in order to produce the final product (O’Donoghue&Padilla,
2006:312; Crocioni&Veljanovski, 2003:40).
Furthermore, the vertically-integrated firm must have dominance in the upstream market to
successfully squeeze its rivals. According to Motta and Streel, instead of dominance, the
investigated firm must enjoy a monopoly or quasi-monopoly at one stage of the production
(Motta&Streel, 2006:122). Nonetheless, it has been argued by Advocate General Fennelly
in Compagnie Maritime Belge13 that for a dominant undertaking to commit a margin
squeeze it must be “super dominant”, which has a market share of over 80%14 (Garzaniti,
2004:8; Crocioni&Veljanovski, 2003:39). Even though all of the margin squeeze cases pass
this super dominant threshold, it was not stated either by the Commission or the Courts that
the firm under investigation should have a market share of 80% or above. Grout explains
phone operator (France Telecom, SFR, and Bouygues Telecom) as having a dominant position on the
upstream market for call termination on their respective networks and determined the level of call termination
charges independently. Furthermore, it was decided that France Telecom’s and SFR’s retail prices for fixedto-mobile calls did not cover incremental costs for the provision of such services by equally efficient
operators.
13
Cases C-395 and C-396/96P Compagnie Maritime Belge [2000] 4 CMLR 1076.
14
EU cases have allowed a dominant position to be proven with smaller market shares than those necessary to
prove monopoly power under US law since Section 2 of the Sherman Act applies only to "monopolists,"
which generally has a market share of at least 70% (Elhauge&Geradin, 2007:233; Hovenkamp&Hovenkamp,
2008:8).
16
this in a way that if the vertically-integrated firm has barely dominant on the upstream
market then it will find difficult to exclude competitors. In contrast, if the test only applies
to those companies where their upstream input is essential then exclusion is far more likely
to arise if they engage in margin squeezing (Grout, 2003:83).
2.3.3
Imperfect Downstream Competition
Another condition for a margin squeeze to be successful is that the downstream market
should not be effectively competitive and the upstream dominant firm should have some
amount of market power on the downstream market. Therefore, it should be determined
whether, for antitrust intervention to be justified, the investigated firm would have to be
dominant on both markets or only on one of them (Motta&Streel, 2006:115). Faull and
Nikpay argue that the firm should be dominant in both an upstream and a downstream
market (Faull&Nikpay, 2007:380).
Similarly, economists consider that downstream dominance is also required to use the retail
prices for squeezing rivals; since a high input price will be ineffective as a margin squeeze
tool if downstream rivals can pass the costs on to consumers (O’Donoghue&Padilla,
2006:306-307). Furthermore, some tend to think that a margin squeeze abuse is in effect a
form of predatory pricing that arises in the context of vertical integration and; therefore,
proof of a margin squeeze abuse would also seem to require downstream dominance as it is
the case in pure predation. Another reason for downstream dominance is stated as that a
firm controls the prices on two vertically-related markets can squeeze the margin between
those two prices (Geradin&O’Donoghue, 2005:407).
17
In most of the margin squeeze cases (Deutsche Telekom, Napier Brown/British Sugar and
etc.) the Commission or the Courts found the defendants having market power in both
upstream and downstream markets, however, the Commission stated in Telefónica15 that
243. As the case law of the Community courts clearly confirms… it is not necessary under Article 82
to demonstrate that Telefónica is dominant in the relevant retail market for proving the existence of an
abuse of dominant position in the form of a margin squeeze.
Therefore, it seems that there is not any formal requirement under Article 82 margin
squeeze cases that the dominant firm must also have a dominant position in the retail
market. In Genzyme, the investigated company was not dominant in the relevant
downstream market at the commencement of the period of the abuse, but the CAT accepted
that the effect of its pricing was to “monopolise” the downstream market and to “eliminate
any competition” from this market (Palmigiano, 2006:18). Furthermore, in some cases they
even did not make any adequate market definition and/or competitive analysis for
downstream markets. For instance, in Freeserve16 Oftel (former Director General of
Telecommunications in the UK) did not define a relevant downstream market before it
applied the imputation test (Veljanovski, 2006:9).
Besides, it is well established under Article 82 EC that dominance and abuse may occur on
different markets through leveraging of market power from one to another associated one,
e.g. in Tetra Pak II17 (PricewaterhouseCoopers, 2007:12). Thus, several commentators
argue that margin squeeze abuse is a kind of leveraging strategy and it does not involve the
use of power on the downstream market to exclude rivals. Instead, the vertically-integrated
15
Telefónica, Case-COMP/38.784, 04/07/2007. The Commission found that Telefónica, Spanish incumbent
operator, held a dominant position on regional and national markets for wholesale and retail broadband access
and abused its dominant position in the from of margin squeeze and imposed a fine almost €152 million.
Afterwards, Telefónica appealed the decision on 10 September 2007 (Case T-336/07) and the Spanish
government also appealed the decision on 31 October 2007 (Case T-398/07).
16
Freeserve v The Director General of Telecommunications, Case-No.1007/2/3/02. Freeserve appealed to the
CAT against Oftel to withdraw or vary his rejection of its complaint against BT in which the complaint
alleged that BT was conducting an orchestrated campaign of anti-competitive behaviour including margin
squeeze.
17
Case C-333/94P Tetra Pak [1996] ECR I-5951.
18
firm uses control over an essential upstream input to gain market power on the downstream
market by excluding competitors (Motta&Streel, 2006:115; Geradin&O’Donoghue,
2005:408; Crocioni&Veljanovski, 2003:39).
2.3.4
Objective Justification
If there is an objective justification, generally there will not be an abuse. However, the
dominant company must explain and demonstrate why seemingly realistic and less
restrictive alternatives would be significantly less efficient according to “objective
justification” rule applied related with Article 82.18 (Craig&Búrca, 2007:1037). Objective
necessity, meeting competition or efficiency defences are examples of objective
justification in which the dominant undertaking’s conduct is necessary either because of
external factors such as capacity limitations or market-expanding or other efficiencies.
(O'Donoghue&Padilla, 2006:228). Moreover, some other legitimate reasons may be stated
as follows (Palmigiano, 2006:21):
•
temporarily bad market conditions;
•
introduction of a new product with low volumes;
•
decline in market conditions and as a result exit of competitors;
•
misjudgement about the scale of the firm;
•
currently inefficient but in time having progress in efficiency and so on.
2.3.5
Sufficient Duration
Margin squeeze must be held for a sufficient period of time for an exclusionary effect.
Otherwise, it would only result in temporary changes which do not enable the verticallyintegrated firm to exclude its rivals from the downstream market (Fernández, 2006:251).
For example, in Napier Brown/British Sugar, the Commission concluded that “…should BS
have maintained this margin in the long term, NB, or any company equally efficient in
repackaging as BS without a self-produced source of industrial sugar, would have been
18
Discussion Paper, para.86.
19
obliged to leave the United Kingdom retail sugar market.”. The US Supreme Court also
concluded in Alcoa19 that Alcoa had engaged in a margin squeeze for seven years from
1925 to 1932 (Crocioni&Veljanovski, 2003:41).
In its 2003 decision regarding the margin squeeze allegations by British Telecom (BT) in
the broadband sector, Oftel accepted that it would not be an abuse for a firm to lose money
in
the
short-term
if
it
had
a
legitimate
plan
to
recover
present
losses
(Geradin&O’Donoghue, 2005:384). Furthermore, in BskyB20 the UK OFT concluded that
BSkyB incurred distribution losses. However, it did not consider that these amounted to an
anticompetitive margin squeeze since they were not large, they were temporary and they
were associated with the launch of BSkyB's digital platform. Likewise, Spiwak argues that
in addition to last long enough, margin squeeze must be severe enough to produce effects
on actual or potential competition in the secondary market (Spiwak, 1993:75). Within this
context, in the US, in City of Groton21 case, by taking into account both the duration and the
amount of the losses, the court concluded that a five-month period is sufficient to support a
margin squeeze claim if the sums involved are “substantial.”, which were over $1 million
in that case (Spiwak, 1993:75-85).
Nonetheless, it must be taken into consideration that even though short time period analysis
may bring wrong decisions about the abuse, long time frames can also create scope for a
vertically-integrated company to selectively squeeze entrants by adopting volatile prices.
Despite these difficulties, Grout argues that persistence should be a central part of a test
19
Alcoa 148 F.2d 416 (2d Cir. 1945). Alcoa was accused to monopolise the market for primary aluminium
and engage in a margin squeeze by selling some aluminium sheet at prices that were too close to the price of
primary aluminium ingot to allow independent producers to achieve adequate margins on their sales of
aluminium sheet.
20
BSkyB Investigation CA98/20/2002, 17/12/2002. The OFT examined whether BSkyB had acted abusively
assuming that BSkyB’s input cost was the wholesale prices charged to its distributors. Losses continued for
over a year while recovering the costs of investing in a new platform. However, the case against BskyB was
not proven on the basis of BSkyB's return to profitability and irreducible uncertainties in modelling.
Afterwards, in 2003, the OFT got two applications to vary its former decision. However, OFT did not change
its decision and found no abuse of BSkyB (BSkyB Decision CA98/20/2002, 29/07/2003).
21
City of Groton 662 F.2d 921 (2d Cir. 1981). Several municipalities brought margin squeeze claims against
Connecticut Light & Power on the basis that the retail price was below the wholesale price.
20
and only be set aside when there is good objective evidence of intent to exclude through
variability of pricing (Grout, 2003:89).
2.3.6
Relevant Tests
After the determination of the input as “essential” and the upstream provider as dominant,
the next step is to assess whether an abuse has taken place in terms of margin squeeze.
There are several tests that can be applied to analyse the abuses, namely; (i) profit sacrifice
test, (ii) consumer welfare test, (iii) equally efficient competitor test.
(i) The profit sacrifice test assumes that a firm would not rationally engage in
exclusionary conduct unless it considers that any short-term sacrifice of profits would
be less than any expected gains as a result of the exclusion or discouraging of rival firm
if the conduct is successful (i.e. predatory pricing). However, it is criticised for not
taking into account some conducts which do not have any profit sacrifice but have been
recognised as exclusionary, such as non-price predation or anticompetitive forms of
raising rivals’ costs. In recent cases the US Department of Justice used no economic
sense test, arguing that it is relevant to ask whether the conduct would make economic
sense for the defendant but for its tendency to eliminate or lessen competition. The no
economic sense test may deem conduct to be exclusionary unless it has a positive
expected payoff, net of costs and not including any payoff from eliminating
competition (Werden, 2006:304; O’Donoghue&Padilla, 2006:187-188).
(ii) Consumer welfare test has a clear basis under Article 82(b), which mentions
conduct that limits production to the prejudice of consumers22. In all events, consumer
harm requires a showing of either higher prices or of reduced output, quality, or variety
in the downstream market (Hovenkamp&Hovenkamp, 2008:12). Within this context,
the first objective of the French Conseil de la Concurrence was mentioned by its
22
International Chamber of Commerce has the view that harm to consumers, which is expressly referred to in
Article 82(b), is the ultimate test for abuse of dominance and further suggests to use consumer welfare test
together with profit sacrifice test or equally efficient competitor test (ICC, 2005:2).
21
president as applying legislation on unilateral conducts is to protect consumers, not
competitors and thus an anticompetitive conduct, harmful for rivals, but which overall
benefits consumers should not be prohibited (Laserre, 2008:4). Moreover, in various
Microsoft proceedings in the US and the EU, consumer harm test was applied
(O’Donoghue&Padilla, 2006:192).
(iii) Equally efficient operator test takes into account that a certain conduct may have
different exclusionary effects depending on how efficient rivals are. There should only
be an infringement of Article 82 to the extent that the competition is impacted by the
elimination of an efficient competitor (Faull&Nikpay, 2007:381). Thus, the Discussion
Paper focuses on assessing alleged price based exclusionary conduct which could
exclude a hypothetical “as efficient” competitor as abusive.23 O'Donoghue and Padilla
argue that less efficient firms should not, in general, receive any protection from
aggressive competition, since consumers are best served by more efficient firms
(O’Donoghue&Padilla, 2006:191). However, it is worth to note that it may allow for
the extinction of new entrants which are less efficient in the beginning but have the
potential of becoming at least equally efficient in time. Moreover, less efficient firms
may exert competitive pressure on the dominant undertaking, especially if there are
many, whereas it is not certain that one equally efficient firm would be able to apply
competitive pressure to the dominant firm (Mertikopoulou, 2007:246). Nevertheless,
the Commission has the view that in exceptional circumstances, it may be necessary to
protect firms that are less efficient in the short-term but would become equally efficient
over time (O’Donoghue&Padilla, 2006:201).
Margin squeeze, which resembles raising rivals' costs strategy, does not impose a loss to
the dominant firm, thus “but for” test is not significant at all. Moreover, anti-consumer
effects are not a necessary condition for margin squeeze to be condemned
23
The “as efficient” competitor is a hypothetical competitor having the same costs as the dominant company.
Discussion Paper, para.63.
22
(Bravo&Siciliani, 2007:251). Hence, according to the EC Access Notice a margin squeeze
could be demonstrated by showing that:
•
Test-1; the dominant company's own downstream operations could not trade
profitably on the basis of the upstream price charged to its competitors by the
upstream operating arm of the dominant company or
•
Test-2; a reasonably efficient downstream operator paying the wholesale input price
cannot earn a normal profit.
Both tests have four main elements: 1) the wholesale price charged by the dominant
supplier for the essential input, 2) other costs of the downstream activity, 3) the
downstream (retail) price, and 4) the ‘normal’ return to the downstream activity (Case
Associates, 2004). The difference between Tests-1 and Tests-2 is whose downstream costs
to use. Test-1 uses the costs of the vertically-integrated firm; Test-2 those of a “reasonably
efficient” downstream rival.
2.3.6.1 Test-1: Equally efficient competitor test
Exclusion of less efficient competitors is seen within the scope of the competition on the
merits whereas; the exclusion of equally efficient rivals is not regarded as competition on
the merits. To test exclusionary effect of margin squeeze, the best way is considered as
using the dominant firm's costs since it is a test of competition on the merits
(Geradin&O’Donoghue, 2005:393). Furthermore, Vickers defines margin squeeze as that if
the dominant firm's downstream unit would be loss-making if it paid the wholesale prices
charged to rivals, there is a margin squeeze; otherwise there is not (Vickers, 2004:11). The
advantages of Test-1 can be stated as that:
•
Margin squeeze can exclude an equally efficient rival only if the upstreamdownstream price differential is lower than the defendant’s own downstream costs
(Elhauge&Geradin, 2007:418).
•
As explained by the Commission in Telefónica, testing the dominant firm’s
upstream charges against its own cost structure ensures that efficiency gains derived
23
from vertical integration are reflected in the margin squeeze test (Genevaz,
2008:20).
•
Most of the time, incumbent’s costs are known whereas those of the efficient
downstream rivals are not. Therefore, the dominant firm cannot be expected to find
out whether its prices are lawful on the basis of its competitors’ costs
(Geradin&O’Donoghue, 2005:392).
According to the UK OFT, Test-1 is the correct test because it allows the more efficient
downstream rivals to benefit from their superior efficiency (Case Associates, 2004). Within
this context, in BSkyB the UK OFT claimed Test-1 had the following advantage "if DisCo
[BSkyB's downstream division] failed the test, then rivals with similar efficiency to DisCo
would be prevented by BSkyB's pricing strategy from competing on the merit to expand
their businesses, or perhaps even from staying in the market at all".24 Henceforth, the OFT
rejected the need to consider the performance of third parties to determine whether BSkyB
had abused its dominant position by exercising an anticompetitive margin squeeze. If
DisCo (retail arm of BSkyB) is profitable, then distribution rivals as (or more) efficient as
DisCo would also be profitable, while less efficient rivals might not be.25
Furthermore, Deutsche Telekom case showed that the Commission also favoured Test-1 by
using the downstream costs of the vertically-integrated telecommunications operator and
with upholding, CFI also shared the same view as the Commission. However, the
Commission’s approach towards the calculation of the retail revenues in Deutsche Telekom
is criticised on the basis of that it is contradictory to the rationale of the equally efficient
competitor test. The Commission excluded call traffic revenues from margin squeeze
calculations reasoning that “it cannot be assumed that all competitors have the same
revenue structure as the established operator, and thus the same scope for offsetting one
source of revenue against another.” Nevertheless, as Genevaz mentions that the reason
stated by the Commission is the very meaning of the equally efficient competitor test
24
25
BSkyB investigation CA98/20/2002, 17/12/2002, para.368.
BSkyB, Decision CA98/20/2002, 29/07/2003, para.156.
24
(Genevaz, 2008:22). Therefore, in Deutsche Telekom, it would have been economically
much more meaningful to include total aggregate revenues from access and calls, since this
more accurately captures the economic reality of how competitors use access to the local
loop (generally competition on bundles of access and individual call services)
(O’Donoghue, 2008:16).
2.3.6.2 Test-2: Reasonably efficient competitor test
Even though it has a lot of advantages over Test-2, Test-1 will be inappropriate in some
cases, e.g. where the vertically-integrated firm incurs additional costs in supplying its
competitors (Case Associates, 2004). Furthermore, applying Test-1 might be difficult under
circumstances that the products supplied by the vertically-integrated firm and its
competitors are not homogeneous. If competitors have differentiated products, then they
have the opportunity to charge higher prices and get supra-normal profits even where Test1 appeared to provide evidence of a margin squeeze. Under these conditions, it may be
appropriate to use the rival's rather than the vertically-integrated firm's data (Crocioni,
2005:563). However, it is worth to note that the double marginalization26 may result in
higher costs for the downstream competitors if there is any positive price/cost margin in the
upstream market (Hovenkamp&Hovenkamp, 2008:19).
Even though the number is limited, there are some cases which were mainly based on the
Test-2 to find out margin squeeze abuse. For instance, in Albion Water27, the UK CAT
confirmed the validity of the reasonably efficient competitor test, ruling that its application
may require a notional cost analysis without necessarily leading the competition authority
to favour inefficient market entry. In a recent judgment of Court of Appeal of Brussels,
26
Double marginalization occurs when a firm’s variable costs include an above-cost mark-up set by another
firm (Hovenkamp&Hovenkamp, 2008:7).
27
Albion Water v The Director General of Water Services [2006] CAT 23, [2007] CompAR22. It was about
whether a new entrant to a water market could claim margin squeeze on the part of the incumbent provider
where it had not engaged in a transformative activity or displaced the incumbent, and where the incumbent
had not avoided costs as a result of the new entrant's activities.
25
Tele2 v. Belgacom28, also affirmed the applicability of the reasonably efficient competitor
test (Amory&Verheyden, 2008:10).
2.4
Margin Squeeze and Other Abuses
Margin squeeze abuses can occur in different forms, such as “discriminatory” prices for the
firms’ own downstream services as opposed to the “excessive” upstream price for the rival
firms in the wholesale market combined with “predatory” downstream price including
“cross subsidisation” and refusal to supply conditions. Within this context, Fernández
claims that under economic considerations, margin squeeze does not constitute a new type
of abuse neither different from predatory pricing, nor from a refusal to deal. However, she
adds that from a legal standpoint each of them has different standards of proof (Fernández,
2006:255-256).
As mentioned in earlier chapters, even though there are similarities between margin
squeeze and other abuses, margin squeeze has a separate consideration under Article 82.
Nevertheless, analysing margin squeeze without looking at other abuses may be missing.
Therefore, the relationship between margin squeeze and other abuses can be seen from the
following figure drawn by the European Regulators Group (ERG)29.
28
TELE2 v Belgacom, 18/12/2007, ECLR 2008, 29(9), N133. The Brussels Court of Appeal annulled a
decision of the President of the Belgian Competition Council dismissing a request for interim measures in a
dispute over alleged margin-squeezing in the telecommunications sector.
29
ERG was set up by the Commission as to encourage cooperation and coordination of national regulatory
authorities, in order to promote the development of the internal market for electronic communications
networks and services, and to seek to achieve consistent application of the provisions set out in the EU
Communications Framework (Framework Directive, 2002/21/EC, Recital.36).
26
VERTICAL LEVERAGING
Pricing Issues
wholesale price
price discrimination
margin squeeze
cross-subsidisation
raising rivals’ costs
predatory pricing
restriction of
competitors’ sales
foreclosure retail
retail price
Source: ERG, 2006:39.
Figure 3 Margin Squeeze and Other Abuses
As it can be seen from the figure, price discrimination, cross-subsidisation or predatory
pricing in vertically-integrated sector may result in margin squeeze abuse which will end in
foreclosure retail. Since this figure just involves pricing abuses in vertical leveraging,
refusal to deal is not mentioned in it. However, a very high wholesale input price leads to
competitors deny buying that input and hence it will give rise to refusal to deal.
Furthermore, a very high input price may be deemed as excessive; thus in this part, price
discrimination, cross-subsidisation, predatory pricing, excessive pricing and refusal to deal
will be elaborated in terms of their relationship with margin squeeze.
2.4.1
Predatory Pricing
Margin squeeze resembles predatory pricing, in which the dominant firm forgoes short-run
profits with the aim of excluding competitors through applying abnormal price cuts and
then recovering those short-run losses with long-run profits in a monopolized market
(Bellamy&Child, 2008:993). However, different from predatory pricing, the dominant firm
can realize margin squeeze by using either of wholesale or retail prices (or both) without
waiting for long-run profits and without having dominance in the retail market (Polo,
2007:455). Therefore, it can be concluded that the incentive to engage in a margin squeeze
is higher because it is a less costly strategy than predation (Veljanovski, 2006:2).
27
The differences between a margin squeeze and "classical" predation can be summarised as
follows:
•
In a predation case all the relevant costs of the dominant firm are taken into
account, whereas in a margin squeeze case, only the costs of the downstream
market including wholesale input price
as a cost item, are realised
(Geradin&O’Donoghue, 2005:367).
•
In a margin squeeze case, the dominant company may remain profitable end-to-end
basis without losing money overall (Palmigiano, 2006:23). It might be taking its
profit upstream rather than downstream as it was the case in Napier Brown/British
Sugar, the price could be set at a lower level on the secondary market without the
undertaking undergoing a loss (Nihoul&Rodford, 2004:430). Further the UK OFT
concluded in BSkyB that if the undertaking as a whole is profitable, a margin
squeeze implies that it is subsidising its loss making retail business with the profits
from its wholesale business.30
•
In a margin squeeze case, incentives to exclude rivals from a downstream market
are considerably reduced, since the competitor will also be an upstream customer,
which is not the case in predation (Palmigiano, 2006:23).
•
In the short term customers benefit from low prices as a result of predation whereas
in a margin squeeze it may not be the situation which includes sacrificing shortterm profits, and furthermore, a margin squeeze does not necessarily lead to
excessive prices in the future (Palmigiano, 2006:24).
•
Finally, predation and margin squeeze differs in terms of the remedies applied after
the abuse takes place. In a pure predation case, the remedy is usually to increase the
(loss-making) price31. In a margin squeeze case, the dominant firm could be
required to lower the input price, increase the retail price, or slightly adjust, either
upwards or downwards, the upstream and retail prices (O’Donoghue&Padilla,
2006:324).
30
31
BSkyB Investigation, CA98/20/2002, footnote 318.
However, in Wanadoo the predation was ended with the lowering of wholesale charges by France Telecom.
28
2.4.2
Cross-subsidisation
If an undertaking in a dominant position engages in cross-subsidisation from the market
where it is dominant to a market where it is not, then the dominant firm would not compete
purely on the basis of efficiency in this second market, which could distort competition.
The UK OFT also shares this view and states that where the undertaking uses revenues
from a market where it is dominant there may be a breach of the Chapter II prohibition.32
Faull and Nikpay mention that the possibility of finding a cross-subsidisation abuse has
only been considered in relation to companies enjoying monopolies and, in particular,
when the activities in these reserved markets subsidise activities in markets open to
competition (Faull&Nikpay, 2007:392-393). Indeed, the Commission defined crosssubsidisation in Deutsche Post33 as follows:
Cross-subsidisation occurs where the earnings from a given service do not suffice to cover the
incremental costs of providing that service and where there is another service or bundle of services the
earnings from which exceed the stand-alone costs.34
As a result of cross-subsidisation the firm may charge its competitive product cheaper,
which does not need to be predatory. In other words, there would be no need to prove that
the prices are predatory in order for cross-subsidisation to be considered abusive. The
cross-subsidised low prices of the dominant firm may be deemed as evidence for that the
dominant company is not competing on the merits. In the absence of such evidence,
predation may be necessary to accuse the dominant company for cross-subsidisation under
Article 82 (Faull&Nikpay, 2007:392). However, as Geradin and O’Donoghue highlight, in
most cases, there will not be a transfer of ‘funds’ in between upstream and downstream
products, but cross-subsidisation takes place through allocation of the downstream costs to
32
OFT ‘The Application of the Competition Act in the Telecommunications Sector’, OFT-417, para.7.20.
Deutsche Post AG, OJ 2001 L125/27, [2001] 5 CMLR 99, para.6.
34
The tests, encapsulated in this definition, are formulated by some economists as to find unlawful crosssubsidies as (1) the incremental cost test in which incremental revenues from a service or a combination of
services must less than incremental costs of that service or combination of those services (2) the standalone
cost test in which incremental revenues from a service or a combination of services must be equal to exceed
the stand-alone costs of that service or combination of those services (Crandall&Singer, 2005:22).
33
29
upstream (Geradin&O’Donoghue, 2005:369). Under these circumstances, if the dominant
firm is obliged to keep separate financial records, as it is the case in telecommunications
where the dominant firms should keep separate accounts for the markets in which they
have significant market power (SMP), then it is considerably easier to detect these kinds of
either transfer of costs or revenues.
Van Bael and Bellis define margin squeeze as a form of cross-subsidisation. According to
that definition, margin squeeze involves predation in the retail market and upstream profit
is used to cross-subsidise the losses of the retail arm, thus squeezing the margin of
competitors at the retail level occurs (Van Bael and Bellis, 2005:1242). Geradin and
O’Donoghue criticise using cross-subsidy analysis in a margin squeeze case by stating that
the competition-law effects of conduct are likely to be the same whether the funds
concerned come from the upstream market, another totally unrelated market, or from
capital market sources (Geradin&O’Donoghue, 2005:369). However, as mentioned earlier,
if the funds are coming from the profitable upstream market on which the verticallyintegrated firm has a higher degree of dominance (nearly monopoly), then subsidising the
losses of the retail arm with these funds, which are mainly coming from the retail arm’s
competitors, imply that the dominant firm is not competing on the merits. This can be a
challenge for the dominant firm with regard to Article 82.
2.4.3
Excessive Prices
The European Court of Justice (ECJ) identified excessive pricing in United Brands35 as
“Charging a price which is excessive because it has no reasonable relation to the
economic value of the product supplied would be such an abuse.”. However, what “the
reasonable relation to the economic value of the product” constitutes is not so clear. Within
this context, one way to measure it comes in Napp Pharmaceutical36 case, the UK CAT
accepted the UK OFT’s proposal regarding the method “(i) Napp's prices with Napp's
35
36
Case 27/76 United Brands [1978] ECR 207.
Napp Pharmaceutical v OFT [2002] CAT 1, [2002] CompAR 13, paras.390-392.
30
costs; (ii) Napp's prices with the costs of its next most profitable competitor; (iii) Napp's
prices with those of its competitors; and (iv) Napp's prices with prices charged by Napp in
other markets.”.
There is limited case law on standalone excessive pricing in the EU. On the other hand, in
the US, there is not an approach that excessive pricing is an abuse on its own right. This is
the result of thinking that the competitive process should be protected not any particular
outcome. The US Supreme Court in Trinko37 emphasised that the possession of monopoly
power and applying monopoly prices are not unlawful. Furthermore, the Court considers
charging of monopoly prices as an important element of the free market system for the sake
of
innovation
and
economic
growth
(Grout&Zalewska,
2008:156;
PricewaterhouseCoopers, 2007:5).
According to Geradin, O’Donoghue and Padilla the legal basis and normative content of
excessive pricing and margin squeeze are different since the excessive prices are
exploitative under Article 82(a) and margin squeeze is a kind of exclusionary abuse which
should be dealt under Article 82(b). In addition, they argue that the analysis of the costs in
excessive pricing and margin squeeze also differs. An excessive price is abusive because of
its relation to the relevant costs of supplying a single product, whereas an exclusionary
margin squeeze is concerned with the excess of the price relative to price and profit margin
on a downstream market. (O’Donoghue&Padilla, 2006:322; Geradin&O’Donoghue,
2005:365-366). Nevertheless, the CFI concluded in the Deutsche Telekom that “The abuse
committed takes the ‘form of a margin squeeze generated by a disproportion between
wholesale charges and retail charges for access to the local network’ ….. and is described
as ‘the unfair pricing’ abuse.” and the infringement was caught by Article 82(a).
Therefore, the legal basis for margin squeeze is explained as Article 82(a) under the name
of unfair pricing.
37
Trinko, 540 U.S.398 (2004), para.407. Trinko sued Verizon for raising the costs of its retail rival and
otherwise disadvantaging it through anti-competitive conduct (including discrimination in fulfilling customer
transfer orders to entrants) under section 2 of the Sherman Act. The Supreme Court decided that Trinko failed
to state a claim under section 2 of the Sherman Act and dismissed the complaint.
31
2.4.4
Price Discrimination
Price discrimination occurs when products/services are sold or purchased at prices which
are not reflecting cost differences. This may be seen in the form of same products with
different prices or same products having different cost structures but at same prices. Article
82(c) explicitly prohibits the application of dissimilar trading conditions to equivalent
transactions (Craig&Búrca, 2007:1029).
In Genzyme, both the UK OFT and the UK CAT upheld the margin squeeze complaint on
the rationale that Genzyme was discriminating in two ways: its price to its subsidiary was
lower than its price to competitors, and its price to NHS included a service which it did not
provide to or for its competitors. It was discriminating against downstream rivals by
charging a price for one product that was the same as its retail price for that product plus a
service. This was considered by the UK authorities to be exclusionary and discriminatory
(Geradin&O’Donoghue, 2005:385).
A vertically-integrated dominant firm may discriminate between the wholesale input prices
applied to the competitors and transfer prices applied to its own retail arm and therefore, it
may squeeze its competitors’ retail profit margin. If the dominant firm does this explicitly,
then Article 82(c) will capture the abuse. However, if the dominant firm discriminates
implicitly and the financial records cannot provide the details of the accounts for the
transfer prices, then the disproportionate margin left for the competitors may be used as an
evidence for margin squeeze abuse.
2.4.5
Refusal to Deal
Duty to deal obligations must encourage the competition in the market instead of
discouraging it. Therefore, duty to deal obligations should be considered carefully before
applying and margin squeeze cases should be limited to duty to deal situations
(Geradin&O’Donoghue, 2005:399). This point of view is very common among several
commentators coming from both the US and the EU. For example, Elhauge and Geradin
suggest that proving a profit margin lower than the defendant’s downstream costs should
32
not be enough to conclude that there is a margin squeeze unless other elements of a refusal
to deal are not proven (Elhauge&Geradin, 2007:419). O’Donoghue and Padilla share this
view and stress that a margin squeeze can only be illegal if there is a duty to supply the
input in question (O’Donoghue&Padilla, 2006:326). Furthermore, Korah mentions that a
margin squeeze should be treated as a constructive refusal to deal under which it can be
abusive only if there is a duty to permit access (Korah, 2007:320). For example, in the US,
the court found in Covad Communications38 that there could be no liability for a margin
squeeze if the monopolist was free not to deal (Cavanagh, 2007:135; Genevaz, 2008:26).
Hovenkamp stresses that considering margin squeeze claims under refusal to deal law is the
easiest way of tackling margin squeeze abuses. However, he also mentions its difficulty,
particularly after Trinko, to find a legitimate rationale for alleging margin squeezes
regarding
situations
where
the
defendant
has
no
obligation
to
deal
(Hovenkamp&Hovenkamp, 2008:6).
Even though commentators suggest the opposite, margin squeeze cases before Deutsche
Telekom showed no indication that refusal-to-deal-type analysis was required to determine
the existence of an illegal margin squeeze in the EU. For example, in Telefónica, the
Commission held that European case law on refusal to deal did not condition the legality of
a margin squeeze by a regulated firm subject to mandatory access rules. However, in
Deutsche Telekom, even though it was not encapsulated in the legal test part, the CFI
considered the dominant firm’s wholesale services as “indispensable” for downstream
competition in its assessment of the squeeze’s effects (Genevaz, 2008:26-27). Furthermore,
as mentioned earlier, the Commission regarded margin squeeze in the Discussion Paper
under the refusal to deal part, in particular termination of existing supply relationship.
However, this may not hold true especially in the sectors, such as telecommunications,
where ex-ante regulation is also viable to prevent margin squeeze which includes not only
termination of existing relationship but also refusal of new entrants.
38
Covad Communications, 374 F.3d 1044, 2004-1. Covad Communications alleged that Bell Atlantic had
violated §2 of Sherman Act by refusing to sell DSL services to Covad`s customers through applying “a
prohibitively high and discriminating prices for access to its loops”.
33
3.
TELECOMMUNICATIONS SECTOR AND MARGIN SQUEEZE
In this section, margin squeeze issue will be analysed particularly related with the
telecommunications sector.
3.1
Evolution of the Telecoms Law
In addition to the following main features, network industries such as telecommunications
are characterised by structural barriers to entry and asymmetric conditions between
incumbents and new entrants, which are (Buigues&Klotz, 2008:17; Walden&Angel,
2005:31):
•
Economies of scale and scope,
•
Time-varying demands,
•
Capacity constraints and sunk costs,
•
Network externalities,
•
Switching costs,
•
Natural monopoly elements and
•
Vertical structure.
Mainly, because of the significant economies of scale in telecommunications networks, it
was argued that costs would be minimised when there was only one state-owned operator
in the market (Hodge&Weeks, 2006:83). Security issues, large fixed costs, network
externalities and a growing concern about universal services39 supported to keep this stateowned monopolistic structure for a long time (Geradin&Kerf, 2003:5-6). However, thanks
to the international wave of privatization, many activities were moved from public to the
private sector which is estimated as more than $3.24 trillion of assets. As a result of this
policy, along with liberalisation, there have been a lot of large companies that face sectorspecific regulation (SSR) (Grout&Zalewska, 2008:172). Governments impose regulation
39
Universal service is the provision of a defined minimum set of services to all end-users at an affordable
price (Universal Service Directive 2002/22/EC, Recital 4).
34
for a variety of reasons including economic reasons, such as reducing the effect of market
failures; and political reasons, i.e., redistribution of wealth (OECD, 2005:2).
3.1.1
Liberalisation and Competition (1998 Regulatory Package)
The only reason for the governments to intervene the markets should be maximising the
consumer welfare and adjusting market failures of excessive market power, network
externalities or information asymmetries (Streel, 2006:148-149). Therefore, as it was the
case in most parts of the world, the EU has also begun regulating the sector through NRAs
with the aims of liberalisation and
competition through
Liberalisation40
and
Harmonisation41 Directives (Watson, 2007:129). The aim of liberalisation was opening up
national markets to competition whereas harmonisation measures were necessary to
address competition across markets in the EU (House of Lords, 2008:27).
It was common among NRAs that the former state-owned incumbents should have been
regulated through heavy regulation as opposed to the new entrants (asymmetric
regulations) in the early phases of the liberalisation and competition. However, asymmetric
regulations could not be escaped from creating artificial conditions that would never occur
in an unregulated competitive market (Ware, 2000:63). Nowadays, it is suggested that
when the costs of the networks are equal and the networks are forced to charge each other
equal amounts for call termination, then symmetric reciprocity internalizes the vertical
externality, eliminates the double marginalization and results in lower prices (Economides,
2007b:21). This change, towards symmetric regulation, can also be seen from the common
position document of ERG on fixed and mobile termination rates (ERG, 2008).
40
Liberalisation of mobile communications (1996) and liberalisation of infrastructure and public voice
telephony (1996) are examples for Liberalisation Directives.
41
For instance, ONP Interconnection Directive (1997) and ONP Voice Telephony Directive (1998).
35
3.1.2
Legislation in Force (2002 Regulatory Package)
As a result of the rapid development and intensive competition on the markets, 2002
regulatory framework42 was adopted and entered into force in 2003. All forms of
communication or transmission technology, independent from the content (voice calls,
Internet traffic or television programmes) carried over it, were contained in the same
framework. Furthermore, the concept of telecommunications was replaced by the concepts
of ‘electronic communications networks’ and ‘electronic communications services’ (House
of Lords, 2008:27). The other changes took place with the new framework can be
summarized as follows (Nera, 2006:13; Cullen-International, 2007):
•
technological neutrality and convergence,
•
more flexibility to adapt regulation to rapidly changing market conditions,
•
rely where possible on voluntary action by market players, but grant NRAs strong
power to intervene when necessary,
•
streamline the EU legal framework: 5 instead of over 12 directives
•
less regulatory entry barriers for new entrants, and
•
more reliance on general competition law, however, as long as the following
conditions hold, regulatory obligations cannot be lifted
i. the market no longer meets the three-criteria43;
ii. the market still meets the three-criteria, but no operator has SMP; or
iii. there is still an SMP operator in the retail market, but regulation at the
wholesale level would be sufficient.
After the enforcement of the 2002 regulatory package, the first review regarding regulatory
package 2002 was published in 2006. At the end of 2007, the Commission proposed
amendments to the legislation in force which included a change as to include “functional
42
2002 Regulatory Framework included mainly, Access Directive (2002/19/EC), Framework Directive
(2002/21/EC), Universal Service Directive (2002/22/EC), Data Protection Directive (2002/58/EC) and
Competition Directive (2002/77/EC).
43
Three cumulative criteria includes: (i) presence of high and non-transitory entry barriers, (ii) necessity for
the ex-ante regulatory intervention for the market tends towards effective competition (iii) insufficiency of expost regulation.
36
separation” as an exceptional remedy aimed at tackling persistent discrimination (Impact
Assessment, 2007:47). The Commission has the view that 2002 framework is inherently
deregulatory because it foresees a progressive rolling back of ex-ante regulation to be
replaced by general competition law intervention (ex-post) (Impact Assessment, 2007:19).
Nevertheless, Brisby argues that it was not inherent in the transition from the 1998 to the
2002 package that there would be deregulation. Rather, the newer package was designed to
deal with the accelerated pace of change in a flexible and technology-neutral way (Brisby,
2006:118). Nonetheless, the Commission’s ambition to decrease the level of ex-ante
regulation can be seen from the amended Recommendation on relevant markets44 published
in December 2007. In the Recommendation, number of candidate markets for ex-ante
regulation was decreased from 18 to 7. The last Implementation Report of the Commission
also supports the aim of reducing retail markets susceptible for ex-ante regulation and
focusing mainly on the wholesale markets by showing that (13th Implementation Report,
2008);
•
From 2004 to 2006, incumbent operators’ market shares in the fixed telephony
market decreased from 69% to 64% (by volume of calls). The usage rate of an
alternative provider by the EU subscribers to route international calls was nearly
30% for international calls and 28% for national calls in July 2007.
•
As of October 2007, 112% of the EU population had mobile phones, which was
nearly 85% in October 2004. Even though there were some leading mobile
operators having market shares more than 50% (e.g. in Cyprus 85%), the
weighted average market share of the EU-wide leading operators was around
39%, whereas the main competitor’s and other competitors market shares were,
respectively, 32% and 28%.
•
EU broadband penetration rate, as of January 2008, was 20% (which was around
5% in 2003). 80% of total broadband lines use DSL technologies and the fixed
incumbent operators provide 56% of these DSL lines, which was nearly 86% in
2002.
44
Commission Recommendation on relevant product and service markets within the electronic
communications sector susceptible to ex ante regulation, OJ L344/65.
37
Deregulation does not take place just in the EU, but other countries which applied heavy
regulation during the first years of the liberalisation also moved towards deregulation. For
instance, in the US, the Federal Communications Commission (FCC) has decided not to
regulate incumbents’ fibre deployments for five years and require incumbents to offer
substitute services to competitors when they upgrade from copper to fibre networks (Nera,
2006:ii). Furthermore, for all wire-based broadband Internet services, existing regulation
was removed and they were only subjected to light regulation (Larouche, 2006:18).
However, in USTA v. FCC45 case, the FCC was blamed for overstepping its authority and
converting the Telecom Act into a regulatory instead of a deregulatory measure (Cato,
2005:402).
3.2
Margin Squeeze in Telecommunications
In theory, if prices are balanced and properly regulated, margin squeeze should have
limited scope or totally disappear (Garzaniti, 2004:18). In order to ensure that tariffs are
rebalanced and they reflect the underlying costs, particularly for the wholesale services,
Access Directive46 states in Article 13(1) that NRAs may impose cost recovery, cost
accounting and price control obligations in markets where analysis indicates that there is
lack of effective competition (existence of one or more SMP operators in that market) and
operator concerned might sustain a margin squeeze. Within this respect, Access Directive
defines margin squeeze as “the difference between their retail prices and the
interconnection prices charged to competitors who provide similar retail services is not
adequate to ensure sustainable competition”. Furthermore, prices of the local loops should
foster fair and sustainable competition through ensuring that there is no margin squeeze
between prices of wholesale and retail services of the SMP operator.47 In addition, if there
is cost accounting or accounting separation obligation for the operators having SMP, the
methodology used to provide separated accounts should also identify potential margin
45
USTA v. FCC 359 F3d 554 (D.C. Cir.2004).
Directive on access to, and interconnection of, electronic communications networks and associated
facilities, OJL 108/7.
47
Regulation No 2887/2000 on unbundled access to the local loop, 18 December 2000, Recital 11.
46
38
squeeze abuses.48 In the telecommunications sector, wholesale and/or retail markets may be
subject to price regulation under which margin squeeze take place depending on the scope
of the regulation and pricing methodology applied by the NRA. Therefore, concerning
wholesale services NRAs have generally applied mainly two methodologies: LRIC and
retail-minus (ERG, 2006:75; Geradin&O’Donoghue, 2005:374-375):
•
LRIC considers the incremental costs related to the provision of access incurred
in the long-run by taking into account that the incumbent deploys the most
efficient current technology to provide that access. Since the costs of an efficient
operator are considered, the incumbent may not get compensation for the costs it
actually incurs. Hence, the risk of margin squeeze abuses is potentially significant
under LRIC.
•
Retail minus implies that the wholesale price equals the retail price minus the
costs related with the provision of that retail service. Even though it has the
advantages of preventing margin squeeze and enabling efficient entry, without
retail price regulation, it does not bring down excessive wholesale prices to a costoriented level.
ERG suggests using retail-minus as a method to prevent margin squeeze and most of the
NRAs have also been used retail-minus for the wholesale access (e.g., Belgium, Greece,
Spain and etc.) (Implementation Report, 2008). Furthermore, margin squeeze does not
occur solely as a result of wholesale pricing, but retail price control methodologies may
also affect the ability/incentives of incumbents to engage in margin squeeze. Regarding
retail price regulation, NRAs have generally applied two methodologies: rate-of-return
regulation and price caps (Geradin&O’Donoghue, 2005:376-377; Hodge&Weeks,
2006:91).
•
Rate-of-return enables the regulated firm to charge prices which cover its
operating costs and provide a predetermined return on the capital employed in its
operations. It is a cost-based method of setting prices and limits the
48
Commission Recommendation on accounting separation and cost accounting systems under the regulatory
framework for electronic communications, OJ L 266/64, Recital 6.
39
ability/incentives of the incumbent to adopt prices as part of a margin squeeze
strategy. However, given that the operators will earn the same rate of return on
their capital whether they reduce costs or not, there is little incentive for the
incumbent to reduce the costs.
•
Price cap provides the incumbent with strong incentives to reduce costs during
the period in which prices are fixed. The flexibility introduced by the reliance on
baskets of prices allows the incumbent to price aggressively on some competitive
markets, by imposing for instance higher prices on other markets where it does
not face competition. Thus, price caps offer greater scope for incumbents to
engage in margin squeeze, in particular when price caps are imposed on baskets
of services, such as the case in Deutsche Telekom.
Even though wholesale and retail price regulations have some advantages and
disadvantages regarding margin squeeze, they may be available in the regulatory
environment since NRAs may have some other objectives to foster the competition in the
market such as enabling efficient entry.
3.2.1
Full Regulation
It can be argued that margin squeeze never occurs, if the wholesale and retail prices are
regulated by the NRA. However, as Geradin and O’Donoghue mention as follows, under
some circumstances margin squeeze is possible in spite of price regulation in both markets
(Geradin&O’Donoghue, 2005:372-373):
•
unbalanced tariffs,
•
price-cap regulation for retail services,
•
global price-cap (wholesale and retail markets are regulated under the same
basket),
•
respond aggressively to price cuts of new entrants,
•
raising rivals' costs by using non-price means, e.g., degrading the quality of
interconnection.
40
Under full regulation, Bouckaert and Verboven stress that “the incumbent has no price
instruments (access or retail), so that it is not appropriate to impose a price squeeze test as
an ex-post instrument.” (Bouckaert&Verboven, 2004:17). However, if the incumbent has
some discretion to determine its prices, even under full regulation, then ex-post intervention
may be possible as it is the case in Deutsche Telekom. On the other hand, if the regulation
is effective enough, then it will not be right to intervene as it is the case in Trinko in the
US.
3.2.2
Partial Regulation
Under partial regulation, the incumbent can squeeze its competitors on downstream
markets by lowering its retail prices since the wholesale prices are determined by the NRA.
To achieve this, the incumbent may directly reduce its retail prices or discriminate in
favour of its subsidiary for the wholesale services (Geradin&O’Donoghue, 2005:373). To
deal with this type of margin squeeze, NRAs develop ex-ante margin squeeze tests
applicable for the retail markets. For instance, in Belgium, in 2007, IBPT/BIPT (NRA)
imposed on the fixed incumbent an obligation to set up a cost accounting system and put in
place a margin squeeze test for retail markets (Implementation Report, 2008:75).
Furthermore, in 2007, the Spanish NRA, CMT, in addition to the remedies of obliging the
incumbent to provide access for certain services such as call origination, notified further
details on the methodology for analysing incumbent’s retail offers to prevent
anticompetitive practices, such as margin squeeze (Implementation Report, 2008:146).
3.2.3
Wholesale and Retail Markets Unregulated
The risk of having margin squeeze abuses increases when there is no regulation for
wholesale and retail markets. This is because the greater the pricing flexibility afforded to
the incumbent, the more likely a margin squeeze will occur. Thus, ex-post analysis of
margin squeeze will be suitable in absent regulation.
41
4.
ANALYSIS UNDER COMPETITION/TELECOMMUNICATIONS LAWS
Margin squeeze issue can be analysed ex-ante or ex-post under the headings summarised in
Table-1. Margin squeeze analysis in terms of market definition, dominance requirements,
imputation test and remedies will be elaborated by mentioning the differences between
telecommunications and competition rules.
Table- 1: The Authorities’ Decision Making Process
Competition Law (Article 82)
Relevant market definition
Electronic Communications
Framework
Relevant market definition
-
Selection of markets
2. Market analysis
Dominance
SMP
3. Conduct
Abusive conduct
Presumed/expected problem
4. Effect
(Effect on competition)
Possible effects
5. Remedies
Remedies
Remedies
1. Starting point
Source: Brunekreeft, 2005:25.
4.1
Relevant Market
Definition of relevant market includes product and geographic market which are analysed
on the basis of demand-side and supply-side substitutability (Korah, 2007:304). In the light
of Article 82, definition of the relevant markets, upstream and downstream, is obviously a
key to an analysis of a suspected margin squeeze to determine whether the input is
“essential” to compete downstream. (Garzaniti, 2004:8; Crocioni&Veljanovski, 2003:42).
Generally, first upstream market is defined and then the related retail market is defined.
However, Case Associates suggest beginning with defining retail market first in which the
input is used to assess the essentiality of the input to the downstream competitor. If it is not
essential, then they conclude that suspected margin squeeze will have a minimal effect on
competition (Case Associates, 2002). Case law both in the EU and US suggest that the
competition authorities gave the most importance to defining the “bottleneck” input, and
therefore, upstream market. On the other hand, in some cases they even did not make any
42
adequate market definition for downstream markets. For example, in Freeserve Oftel did
not define a relevant downstream market before it applied the imputation test (Veljanovski,
2006:9).
Markets which are defined for the purpose of Article 82 are defined on an ex-post basis, in
which the analysis considers the past events that will not be influenced by the future
developments. In contrast, telecommunications regulations necessitate NRAs to take a
forward-looking approach in defining relevant markets and consider the future
developments since ex-ante regulation addresses a lack of effective competition that is
expected to persist over a given horizon. Therefore, for telecommunications, the starting
point for a market analysis is not an alleged abuse of dominance or any other competition
law infringement, but the overall forward-looking assessment of the structure and
functioning of the market (Farr&Oakley, 2006:45). Furthermore, NRAs have predefined
markets in front of them provided in the Recommendation on relevant markets which were
defined in accordance with the principles of competition law (Stoyanova, 2005:360).
However, if NRAs need further market definitions other than the ones stated in the
Recommendation, they should carry out market analysis according to the Guidelines for
market analysis and SMP49 and get approval from the Commission before applying any
remedies. In conclusion, there is no separate market definition for margin squeeze abuses;
however, if the NRA thinks that there is scope for margin squeeze after defining the
markets, it may apply some remedies to prevent the abuse.
4.2
Dominance
Article 82 can be applied only to the dominant firms who have economic strength to
behave to an appreciable extent independently of its competitors, customers and ultimately
of its consumers. Meanwhile, the firms having market shares between 40%-45% are
regarded as having dominant position depending on the strength and number of its
49
Commission guidelines on market analysis and the assessment of significant market power under the
Community regulatory framework for electronic communications networks and services, 2002/C 165/03.
43
competitors.50 Furthermore, in AKZO51, the court stated that a stable market share of 50%
over at least three years was held to be proof of a dominant position. More recently, it was
mentioned in the Discussion Paper that a firm having market share less than 40% may also
be deemed as dominant. However, undertakings with market shares of no more than 25%
are not likely to enjoy a (single) dominant position on the market concerned.52 In the
assessment of the dominance there are some more criteria beside market share: overall size
of the undertaking, technological advantage or superiority, absence or low countervailing
buying power, easy or privileged access to capital markets, product diversification,
economies of scale and scope, vertical integration, highly developed distribution network,
absence of potential competition, barriers to expansion, or the control of essential facilities
(De Streel, 2004:7).
In the telecommunications sector, the previous, more mechanistic approach to regulation
was replaced by an economic approach where regulation is based on competition law
principles.53 Within this context, to ensure that regulation is imposed only on firms with
SMP, the 2002 framework introduced the competition law concept of dominance as a
threshold for ex-ante regulation in telecommunications sector by defining SMP in Article
14(2) of the Framework Directive such that “…equivalent to dominance, that is to say a
position of economic strength affording it the power to behave to an appreciable extent
independently of competitors, customers and ultimately consumers.”. However, the
designation of an undertaking as having SMP in a market identified for the purpose of exante regulation does not automatically imply that this undertaking is also dominant for the
purpose of Article 82.54
For a margin squeeze to be successful, the vertically-integrated firm would need to enjoy a
dominant position in the upstream market which is derived from the fact that it supplies an
50
Case 27/76 United Brands [1978] ECR 207.
Case C-62/86 AKZO [1991] ECR I-3359.
52
Discussion Paper, para.31.
53
Communication from the Commission, Market Reviews under the EU Regulatory Framework,
Consolidating the internal market for electronic communications.
54
See Commission guidelines on market analysis and SMP, para.30.
51
44
“essential” input, or “bottleneck” good. Even though some commentators argue that the
vertically-integrated firm should also be dominant on the downstream market, margin
squeeze is a kind of leveraging market power abuse and upstream dominance would be
sufficient. This situation is also regulated in Article 14(3) of Framework Directive,
Where an undertaking has significant market power on a specific market, it may also be deemed to
have significant market power on a closely related market, where the links between the two markets
are such as to allow the market power held in one market to be leveraged into the other market,
thereby strengthening the market power of the undertaking.
Therefore, under telecommunications regulation, if the vertically-integrated firm has SMP
in the upstream market, it should not have necessarily SMP in the downstream market as
long as the markets are related to each other as it is the case in margin squeeze.
Furthermore, to be regarded as having SMP for a margin squeeze test, there is not a high
threshold for the firm’s market power in the upstream market. On the other hand, to apply
competition law in a margin squeeze case, the vertically-integrated firm should be superdominant or monopoly in the upstream market (since it provides an essential input, this
threshold is not so difficult to be met).
4.3
Abuse and Relevant Imputation Test
An abuse is anything that cannot be regarded as “competition on the merits” based on
quality and price and which has the effect of restricting competition and thus resulting in
either immediately or in the longer term adverse effects on consumers (Bishop&Walker,
2002:187). Under Article 82, only “abuse” is banned: creating or having a dominant
position is not prohibited; however, strengthening the dominant position through an abuse
is not allowed (O'Donoghue&Padilla, 2006:174; Craig&Búrca, 2007:1020). On the other
hand, under telecommunications framework, finding of SMP will give rise to the
imposition of specific obligations by the NRA on the dominant undertaking without
conducting any abuse. In any way, either under competition law or telecommunications
law, to test a real margin squeeze case happened or to test a margin squeeze case which
may be possible in the future, imputation test is the most important tool. Under imputation
45
test, in simple terms, difference between downstream and upstream incumbent’s tariffs
should be greater than incremental cost of production of the downstream service for an
efficient firm. Nonetheless, it is worth to note that an imputation test alone cannot identify
whether a margin squeeze is anticompetitive. It is the final step in an overall competition
assessment (Boisson, 2008). Crocioni and Veljanovski explain the margin squeeze by using
a formula in which the net margin (NM), expressed as a percentage rather than an absolute
margin, faced by a downstream operator is insufficient for an efficient operator to make a
profit in the downstream activity. More formally, a margin squeeze exists if, for a
sufficiently long period of time (Crocioni&Veljanovski, 2003:49):55
)
−( +
NM = P P C ≤ r
(P + C )
d
d
uı
d
uı
Vertically
Integrated
Company
Wholesale Price
ui
P
3rd
UPSTREAM
Pui
DOWNSTREAM
COMPETITORS
DOWNSTREAM
Pd
d
Downstream Cost C
Pdc
Downstream
dc
Cost C
CONSUMERS
Source: Palmigiano, 2007.
Figure 4 Imputation Test Parameters
55
The idea behind writing the imputation rule as an inequality is that it constitutes an “efficient” price floor,
in the sense of ensuring that the incumbent does not deter efficient entry (Bouckaert&Verboven, 2004:13).
46
As discussions mentioned earlier, Test-1 (using incumbent’s data in the test) has superior
advantages over Test-2 (using competitors’ data) which is also supported by the recent
Commission and CFI decisions (Deutsche Telekom and Telefónica). Thus, imputation test
involves downstream price (Pd) and the essential input price (Pui). Furthermore, the price
offered by the vertically-integrated firm to downstream competitors,
P
ui
3 rd
, could reflect
additional costs incurred by the vertically-integrated firm to meet the specific requirements
of downstream firms. In IPS, PEM incurred additional costs in order to process primary
calcium metal that met IPS’ special requirements. The CFI concluded that there was
nothing preventing PEM to pass through these additional costs through to its upstream
input price. Furthermore, it was IPS’ inefficient production process that put it at a
disadvantage, and not PEM’s pricing policy (Crocioni&Veljanovski, 2003:52-53). For the
parameter “r” (rate of return for the downstream activity), competition authorities use
Return on Turnover (ROT) as a measure of required rate of return in industries with either
a low level of fixed assets, or a high level of intangible assets, or both. On the other hand, if
the sector in question has high level of fixed asset investment, such as telecommunications,
then the suitable parameter for rate of return for the downstream activity would be Return
on Capital Employed (ROCE).56
4.4
Remedies
Article 82 prohibits the abuse of a dominant position but it does not make any reference to
the remedies to be applied. However Regulation 1/2003 includes some general rules on this
issue. For example, Article 7 provides the Commission to adopt a decision requiring
undertakings to terminate their infringements. Moreover, in order to secure the
termination of the infringement, the decision may also require the dominant firm to adopt a
certain course of action in terms of behavioural remedies. Finally, the Commission may
impose structural remedies as a last resort solution that can only be imposed when there is
no equivalent behavioural remedy or when the equivalent behavioural remedy would be a
56
BSkyB, Decision CA98/20/2002, 29/07/2003.
47
more burdensome one. For instance, in a situation where an undertaking holding an
exclusive right or clearly dominant position in an upstream market and competing in a
downstream one repeatedly abused its dominant position (Faull&Nikpay, 2007:411-412).
Competition remedies address specific forms of abuse and generally do not require
extensive monitoring of the conduct. On the contrary, regulatory remedies are often
detailed remedies such as wholesale prices or conditions mandating the provision of certain
services (Buigues&Klotz, 2008:16). Therefore, once operators are designated as having
SMP, NRAs shall impose appropriate remedies based on obligations related to wholesale
markets set out in Articles 9 to 13 of the Access Directive and the obligations related to
retail markets set out in Articles 17 to 19 of the Universal Service Directive57, which are:
•
transparency,
•
non-discrimination,
•
accounting separation,
•
access,
•
price control, and
•
cost accounting.
Furthermore, NRAs are required to ensure that their measures are proportionate to the
problem in the market, directly related with the problem and fully justified in the light of
the objectives of the framework (Brunekreeft, 2005:11). In exceptional circumstances,
NRAs may impose other remedies than those set out in the relevant EU provisions, such as
functional separation in the UK. However, before applying any kind of such remedies, the
NRA should get permission from the Commission to apply remedy in question. Functional
separation is not available in the current framework, but in 2007, the Commission proposed
amendment to the legislation in force as to include “functional separation” as an
exceptional remedy. Functional separation is under consideration in Italy and Sweden and
it has already been introduced in the UK and New Zealand. Functional separation may be
57
Directive on universal service and users' rights relating to electronic communications networks and
services, OJ L 108/51.
48
deemed as one of the best remedies to tackle with margin squeeze abuses, however, it
should only be implemented when it can be shown that other mechanisms or remedies
(accounting separation, non-discrimination, etc.) cannot ensure non-discriminatory access
(ERG, 2007:1-2).
Such kind of structural remedy may hamper the competition especially in a dynamic
environment where the frames of the bottlenecks change with the developments in the
technology. Crocioni criticises vertical and structural separation in fixed telecoms since
they give rise to considerable problems in terms of finding a clear and stable point of
division especially with the introduction of NGNs, losing economies of scope and thus
efficiencies and finally reducing investment incentives (Crocioni, 2008:466). Therefore, he
proposes to apply a "wait and see" approach under certain circumstances instead of
structural remedies, which are not easily reversible and result in losing the necessary
flexibility to cater for further changes in market conditions. This condition holds true
especially regarding rapidly changing technology (Crocioni, 2008:528). Moreover,
sometimes instead of applying remedies, NRAs may choose to use incentives for
incumbents to encourage them for a greater competition. For instance, in the US
considering that a vertical margin squeeze and raising rivals’ costs strategies can diminish
competition in long-distance, the government regarded long-distance entry as the reward
for allowing competition in the local exchange (Economides, 2007a:130).
In conclusion, under competition law, remedies for a margin squeeze abuse mostly may be
in the form of fines instead of intervention through prices. For example, in Telefónica, the
Commission did not take any remedial action except issuing fines by taking into account
that the NRA has already obliged wholesale price reductions that eliminated a margin
squeeze (O’Donoghue, 2008:14). On the other hand, if a plaintiff proves a claim before the
NRA, the NRA may oblige the incumbent to reduce wholesale price or increase the retail
price. Therefore, according to Spiwak, a successful margin squeeze plaintiff (1) can receive
substantial monetary awards (as opposed to a reduction in the wholesale price), and (2) will
not have to share this award with other wholesale customers, many parties choose to
proceed under competition law (Spiwak, 1993:77).
49
5.
UNRESOLVED ISSUES
Thanks to the recent cases, most of the issues, such as basic conditions necessary for a
margin squeeze, its legal basis, relevant imputation test and so on are mostly clarified by
the authorities. However, there is still room for further common understanding and dealing
with margin squeeze abuse regarding emerging markets, costs and effect of the abuse on
the market mainly because of the reasons stated in the following sections. Furthermore,
there is not a clear way of dealing with margin squeeze abuse in the telecommunications
sector regarding ex-ante vs ex-post assessment.
5.1
Margin Squeeze in Emerging Markets
Classic cases of margin squeeze such as National Carbonising, Napier Brown/British
Sugar, and IPS in the EU and Alcoa in the US dealt with raw material, homogeneous
products and mature markets. These products are in a "steady state", where revenues and
costs do not vary significantly over time. However, recent cases involved products in new
emerging markets where future demand and returns on initial high investment are uncertain
(Crocioni, 2005:566). There are several problems related with the emerging markets, which
can be summarised as follows:
•
Data may be unreliable and cannot provide as strong evidence about the future
boundaries of the market as in more mature markets (Crocioni, 2008:516).
•
There may not be enough accounting information available on costs and revenue
other than the company’s business case and the reasonableness on its projections as
to future profitability (Palmigiano, 2006:29).
•
The high risks or costs of getting a decision wrong in markets where there are
network effects and/or innovation and investment are particularly important and can
be more serious than in cases where these features are not present (Crocioni,
2008:451).
•
Emerging markets have initial heavy investment, marketing, and launch costs.
Thus, they generate losses in the early years of the product cycle. Nonetheless,
initial downstream losses will not be necessarily evidence of a margin squeeze, but
50
can reflect the timing of investment in a competitive market (Crocioni, 2005:566).
Therefore, there must be some other means to analyse the alleged abuse beside the
imputation test. For example, in Wanadoo58, extensive documentary evidence of
exclusionary intent, probable recoupment, and actual or likely exclusionary effects
were
used
as
evidences
before
finding
start-up
losses
as
predatory
(Geradin&O’Donoghue, 2005:403).
•
Finally, it is difficult to determine whether the dominant firm is the price-leader or
the price-follower which will enable to conclude that the dominant firm’s prices are
abusive or competition on the merits (Kallaugher, 2004:30).
In British Telecom/UK-SPN59, Oftel rejected margin squeeze allegations despite evidence
of losses by BT for a new service on the basis that there is no evidence to demonstrate that
the UK-SPN service had a material adverse effect on competition and there is also
insufficient evidence that BT intended to pursue an anti-competitive strategy. The available
evidence would suggest a new business that was unsuccessful in meeting forecast demand
(and as a result has been withdrawn) rather than a deliberate or negligent anti-competitive
strategy. These conclusions are mainly based on forecast numbers.
5.2
Costs
According to the UK OFT, a margin squeeze investigation may raise issues such as the
measurement and allocation of costs and revenues (both between products and between
upstream and downstream operations), the appropriate time period over which to measure
profitability and the appropriate rate of return (OFT, 2004). Thus, Alexiadis claims that
dominant firms are left in the difficult position to ensure that their tariffs are not abusive
with regard to margin squeeze tests (Alexiadis, 2008:11).
58
Case T-340/03 Wanadoo v Commission [2007] 4 CMLR 21.
British Telecom/UK-SPN, Investigation, 23/05/2003. Number of competitors alleged that the UK-SPN
service was being provided by BT below cost, and that BT was funding the shortfall from profits on activities
in other markets where BT was likely to be found to hold a dominant position. During Director's
investigation, BT announced that the UK-SPN service would no longer be available to new customers
service.
59
51
The first issue related with the margin squeeze analysis is deciding on which costs to use.
There are some options, such as incremental or avoidable costs or fully allocated costs
(FAC). The differences between FAC and LRIC can be seen from Figure-4 in which A, B,
C, D, and E stand for different products/services provided on the same level (e.g., retail).
To calculate FAC for A, all of the directly attributable costs (variable and fixed costs) and
some portions of the joint and common costs, which are related to A, attributed to the
product A. On the other hand, LRIC for A is calculated just by taking into account the
directly attributable costs of A. This is because, incremental costs correspond to either the
costs of increasing the volume by the increment or the savings related to a reduction in
volume equal to the increment (Andersen, 2002:15-16).
Fully Allocated Costs (FAC)
A
B
C
Variable costs
Fixed costs
D
Long Run Incremental Costs (LRIC)
E
A
Direct and
attributable
costs
B
C
D
E
Variable costs
Fixed costs
Joint costs
Joint costs
Common costs
Common costs
Direct and
attributable
costs
Source: Andersen, 2002:15-16
Figure-4 Fully Allocated Costs (FAC) and Lon Run Incremental Costs (LRIC)
LRIC was used in Freeserve and UK-SPN by Oftel and by the Commission in Deutsche
Telekom and Telefónica (Frontier Economics, 2008:2). On the other hand, the UK OFT in
BSkyB relied on FAC standard and allocated all common costs and overheads across the
whole range of downstream and upstream services supplied by the vertically-integrated
firm. There are some criticisms about including common and joint costs in the calculations
since they increase the dominant firm’s downstream costs, and with this the likelihood of
incorrectly identifying a price squeeze (Case Associates, 2004). However, as Hovenkamp
mentions, the issue is critical in a situation where the vertically-integrated firm produces
multiple products subject to joint costs while the rival produces only one
52
(Hovenkamp&Hovenkamp, 2008:24). This situation can be best illustrated by a case from
the UK, BT Together Options 1, 2 and 360, in which Ofcom (current Director General of
Communications in the UK) applied FAC and LRIC at the same time and eventually did
not find an abuse. In the case, national calls failed the margin squeeze test on FAC.
However, Ofcom took into account that “low marginal costs and substantial common costs
involved in the provision of telecommunications services mean that an undertaking
involved in a range of markets has (subject to regulatory controls) substantial freedom to
offer a range of prices and to choose the markets from which to recover its costs.”
Therefore, Ofcom applied LRIC to national calls and then found them as profitable.
Furthermore, Ofcom looked for whether common costs were recovered since BT was
applying prices in between FAC and LRIC values and it concluded that if BT had not
recovered its common costs through national and local calls, then it would have been
concluded that BT’s downstream retail operations were not able to trade profitably given
the input prices faced by its competitor (Garzaniti, 2004:10).
Beside the cost standards, the cost bases to be used with these standards are also important.
For example, in FAC historical costs or current costs can be used as cost basis. However,
with LRIC, current costs or more preferably, forward looking costs might be used. At this
point, the decision may be based on the competitive harm: if exclusion of present
competitors from the market is considered, then the relevant costs must those that the
dominant firm and its competitor must bear on an ongoing basis (i.e., current running costs
and a return on the present value of historic costs that could be recovered on exit). If, in
contrast, the competitive harm of the margin squeeze is that potential entrants will be
deterred from entry, then the forward looking costs would be most suitable cost basis as it
is the case in Deutsche Telekom and Telefónica (Kallaugher, 2004:32).
60
BT Together Options 1, 2 and 3, Investigation, Case-CW/00760/03/04, 12/07/2004. A number of
competing Carrier Pre-Selection (CPS) providers claimed that BT's pricing of Together Options packages,
together with the withdrawal of BT's standard line rental offering, was likely to result in the exclusion of
competitors from relevant markets in the provision of calls to end users in the form of margin squeeze.
53
Next question comes about measuring the profitability of the dominant firm’s downstream
division. The period-by-period approach involves a matching of accounting costs and
revenues in each period (for example, over a year) with investment expenditure amortised
over time. The discounted cash flow (DCF) method, on the other hand, involves assessing
the overall profitability of the downstream division over a period of several years in order
to arrive at a net present value (NPV). Competition authorities have tended to favour the
period-by-period approach. However, in Telefónica, the Commission used both, and
concluded that both indicated that a margin squeeze had taken place during 2001-06
(Frontier Economics, 2008:3).
5.3
Need to Show the Effects
A highly debated issue, not only in relation to abusive margin squeeze, but to abusive
behaviour in general, is whether a certain conduct can be considered per se contrary to
Article 82 or it is also necessary to demonstrate the actual negative effects on competition
caused by that conduct to conclude that it is abusive with regard to Article 82
(Buigues&Klotz, 2008:20). The form-based/presumptions approach, which is to be found
in much of the case law of the European courts can be characterized as per se or modified
per se rule (Gorecki, 2006:534). As the UK OFT stresses, considering some conducts
undertaken by a dominant firm as abusive per se, without considering its effect on
competition in the market and, thus, on social welfare, may yield wrong decisions and thus
loss of social benefits (OFT, 2006). Testing for actual or likely anti-competitive effects
therefore helps minimise the welfare costs of wrongly finding an abuse due to the mere
failure of a price to pass an imputation test (Geradin&O’Donoghue, 2005:407). Eventually,
a firm might be found to have violated Article 82 it would still have the opportunity to
rebut such a finding by showing that its conduct benefits consumers through efficiencies
(Arezzo, 2007:16). On the other hand, if it can be evidenced that the dominant firm had the
intention to use its power, Article 82 EC may apply even when the abusive conduct did not
have any anticompetitive effects (Dziadykiewicz, 2007:136). Similarly, in the US, after the
54
first margin squeeze case Alcoa, it was made clear that “price squeezes are not necessarily
unlawful” and in Anaheim61, the court held that margin squeezes by regulated monopolies
could violate Section 2 only if the plaintiff could demonstrate that the defendant
specifically intended the margin squeeze (Jacobson&Rucker, 2008:4).
Within this context, an economics-based approach to the application of Article 82,
particularly as it takes efficiencies into consideration, is likely to promote competitiveness
and growth (ICC, 2005:19). The Commission mentioned in the Discussion Paper that
Article 82 prohibits “exclusionary conduct which produces actual or likely anticompetitive
effects in the market and which can harm consumers in a direct or indirect way”.62 In
Deutsche Telekom, it was stated that once the margin squeeze was shown, it was not
necessary to asses any effects on competition (O’Donoghue&Padilla, 2006:219). However,
in paragraph 181 of the decision, the Commission still undertook some analysis of the
likely effects and looked at the market conditions and further, the CFI noted that, at the
time of the adoption of the Decision, there was no infrastructure in Germany other than
DT’s fixed network. Since DT’s services were indispensable, a margin squeeze between its
wholesale and retail charges in principle hindered the growth of competition in that market.
(Palmigiano, 2006:18; EU Focus, 2008:6).
Meanwhile, Ofcom rejected the margin squeeze allegation of mobile operators in spite of
having found evidence of it. It rejected by reasoning that there remained effective
competition between the four UK mobile operators (and service providers).63 In France,
competition law indicates that sanctions must be proportionate to the damage caused to the
economy. Therefore, the Conseil de la Concurrence has long taken into consideration the
effects of unilateral conducts, potential or actual to weigh the pro-competitive effects that
61
Anaheim 955 F.2d 1373, 1378 (9th Cir. 1992). Several transmission-dependant municipalities sued a fullyintegrated utility claiming that a margin squeeze occurred as a result of applying higher wholesale rate
exceeding the retail rate for one year.
62
Discussion Paper, para 55.
63
Suspected margin squeeze by Vodafone, O2, Orange and T-Mobile, Case-CW/00615/05/03, 21/05/2004.
Three fixed operators in UK alleged that the mobile operators were pricing the delivery of certain fixed-tomobile calls to business customers at levels that constituted a margin squeeze vis-à-vis the wholesale charges
that fixed operators pay for mobile call termination.
55
counterbalance competitive harm (Laserre, 2008:2-11). For instance, in France
Télécom/SFR Cegetel/Bouygues Télécom, the effect of an alleged margin squeeze by
mobile operators between fixed-to-mobile call termination services and downstream
corporate services was examined. It was found that the margin squeeze had the effect of
restricting the emergence of competition from other fixed operators in the downstream
markets for services to corporate customers and imposed €18 million fine on France
Telecom and €2 million fine on SFR (Garzaniti, 2004:14; Genevaz, 2008:10).
In Telefónica, the Commission mentioned that “614. The case law makes clear that it is not
necessary to wait until there are concrete observable effects resulting from a margin
squeeze before concluding that such conduct is abusive.”. Moreover, the Commission
carried out a detailed analysis based on the capability of the margin squeeze practice
enacted by Telefónica of restricting competition in the retail market for access services, the
actual impact of the margin squeeze on the competitive structure of the relevant market and
the detrimental effects for end users (Buigues&Klotz, 2008:22).
5.4
Ex-ante vs Ex-post Intervention
Basically, market failures can be corrected through either ex-ante economic regulation
and/or ex-post competition policy. As opposed to the former which mandates precise
regulations in response to market failure, the latter is less interventionist since it does not
set specific price, quantity or profit controls and action is taken only in response to
behaviour that is deemed to be abusive (Nera, 2006:3). Features of the telecommunications
result in inevitable regulation; however, regulation does not always result in efficient
functioning of the market. As Viviane Reding highlighted, regulation aimed at promoting a
specific sector, company or technology can introduce significant distortion in the markets
(Reding, 2007:4). Indeed, even though the objective of SSR is to induce new entries
necessary for competitive pressure to be exerted on the incumbent, the regulatory process,
itself can be a significant barrier to investment and create unnecessary investment risks
(Melody, 2005:31).
56
In some situations where generic competition law is able to “fill loopholes left by sectorspecific regulation”, the application of competition law is necessary (Psarakis, 2007:461).
Nonetheless, if the market failures stem from incumbency advantages, then it is often
beyond the power of classical competition law to correct (Watson, 2007:142). Hence, the
application of ex-post regulation in converged markets and services can be unpredictable
because of the relevant market definition process which takes on a special urgency and
complexity (Banerjee&Dippon, 2006:16). Thus, the SSR and competition law has
complementary nature since the concept of SMP was aligned with the concept of dominant
position in the competition law and competition law is mainly required to ensure that
regulatory decisions are more flexible and closer to the market realities (Streel, 2003:541).
In sum, it can be concluded that ex-ante regulation can only be discarded once sustainable
competition has been established. This situation was highlighted by Viviane Reding,
Information Commissioner of the EU, as that making ex-ante regulation practically will be
superfluous by 2018 at the latest and telecom sector is essentially left to market forces
(Reding, 2007:7).
Because of lack of knowledge, data and supervision that specialist regulators can provide,
some issues such as refusal to deal and margin squeeze are best left to NRAs. Otherwise
the risk of transforming antitrust courts into regulatory agencies and “false positives”, in
which competition law will be used to intervene in a case where there should not be an
intervention, will be high (O’Donoghue, 2008:14; Cavanagh, 2007:118). However, the
situations regarding SSR and competition law for margin squeeze cases in
telecommunications are treated differently in the EU and US. In the US, the courts
precluded the application of competition law in favour of the SSR in Trinko case, while the
Commission took the opposite stance in Deutsche Telekom case (Psarakis, 2007:461). In
Trinko, it is apparent that the Supreme Court seeks to avoid the simultaneous application of
both regimes (Larouche, 2006:7). However, in linkLine Communications64 the court ruled
64
linkLine Communications No. 05-56023, USApp. LEXIS 21719 (9th Cir. 2007). linkLine filed a complaint
alleging that Pacific Bell had monopolized and attempted to monopolize the relevant DSL Internet services
market, in violation of §2 of Sherman Act, by, among other things, “creat[ing] a price squeeze by charging
ISPs a high wholesale price in relation to the price at which defendants were providing retail services.” The
57
that an antitrust plaintiff may bring a margin squeeze claim even when the alleged
monopolist had no legal duty to deal with its competitors. The only restriction placed by
the court on bringing this claim was that the plaintiff demonstrate that the defendant had a
“specific intent” and set prices to “serve its monopolistic purposes.” (Olsky, 2008:2).
Nonetheless, Amici Curiae Professors and Scholars have the view that it is imperative that
the Court grant certiorari in linkLine to clarify that the margin squeeze theory is a
regulatory undertaking, not an antitrust cause of action. They reasoned this on the basis of
that making a vertically-integrated firm responsible for ensuring the profitability of its
competitors in the downstream market is not reasonable when the retail prices are increased
and consumer welfare is worsened (Bork&Sidak, 2008:13).
In contrast, in the EU, through its decision in Deutsche Telekom, the CFI clarified that expost competition rules will continue to apply despite the existence of ex-ante regulation,
unless there is no discretion for the dominant to pursue an independent pricing policy
(Alexiadis, 2008:9). Thus, O’Donoghue criticises the CFI for increasing the burden on
regulated firms and reducing the overall effectiveness of regulation through forcing the
incumbent to increase retail prices especially when the regulatory decisions only required
price reductions (O’Donoghue, 2008:3-22). As in Deutsche Telekom, the Commission
rejected Telefónica’s claim on the basis that nothing precluded Telefónica from putting an
end to the margin squeeze (Genevaz, 2008:15). The Commission’s Deutsche Telekom
decision got also some national reflections. For example, in France, the Council held that
the pricing practices in question were subject to competition law and imposed fines in
France Télécom/SFR Cegetel/Bouygues Télécom case even though there was a regulatory
approval of France Telecom’s prices (Genevaz, 2008:11).
In conclusion, there are some reasons for different applications in the US and the EU.
Firstly, the hierarchy of norms is different; in the US, both telecommunications and
antitrust rules are included in the same level of norms, whereas in the EU, electronic
district court and the Ninth Circuit held that “price-squeeze” allegations in this case were sufficient to make
out a claim under Section 2.
58
communications framework is just included in the directives and transposed into domestic
legislation and competition rules are encompassed in the EC primary law, the EC Treaty.
Furthermore, the Telecommunications Act of US is much more detailed and intrusive than
EU communications framework. Therefore, there is more scope for competition law
intervention in the EU. Finally, specific to Trinko and Deutsche Telekom cases, it can be
concluded that the US regulator had taken the appropriate remedy to put an end to the
abusive practises. On the other hand, RegTP (former German NRA) had failed to do so
(Geradin, 2005:26-27; Dziadykiewicz, 2007:128-129; Larouche, 2006:11). Furthermore,
the Commission was expected to issue a reasoned opinion provided for in Article 226 EC
Treaty against Germany and further it could initiate proceedings concerning the
infringement of Articles 3(g), 10 and 82 EC. Dziadykiewicz mentions that this application
is very common in energy sector and the Commission has recently launched 34
infringement proceedings under Art 226 EC (Dziadykiewicz, 2007:129). Alternatively,
Geradin proposes that even if the SSR is not applied by the NRA effectively or not at all,
the Commission was expected to transfer the case to the NRA to take the decision on the
basis of SSR (Geradin, 2005:27).
59
6.
CONCLUSION
Vertical integration occurs when a company participates in more than one stage of
production or distribution of goods and services. Lowering transaction costs, internalising
externalities and reducing impact of regulation are benefits of vertical integration.
However, the vertically-integrated firm may also try to use this vertical integration in a way
to foreclose its rivals in the downstream market through raising their costs or squeezing
their margins.
Within this context, a margin squeeze abuse captures two vertically integrated markets in
which the vertically-integrated firm should have a high level of dominance (quasimonopoly) on the upstream, results from providing an essential wholesale input for
downstream rivals, and the margin between wholesale and retail prices should be
insufficient for the new entrant to live in the market. However, applying temporarily
insufficient margins for the rivals cannot be regarded as anticompetitive which is also
supported by the Commission in cases Deutsche Telekom, Napier Brown/British Sugar and
Telefónica. As the Commission stated in Telefónica that it is not necessary under Article 82
to demonstrate that the vertically-integrated firm is also dominant in the relevant retail
market for proving the existence of a margin squeeze abuse. Finally, to decide on whether
the margin is enough for the rivals to live, there must be some cost and price measures. By
taking into account the advantages and disadvantages of both tests proposed by the EC
Access Notice and absence of clear cut conditions under which deciding on the test that
will be applied, Grout suggests that in principle it makes more sense to require the test to
fail against both the vertically-integrated company’s downstream cost and the downstream
competitor’s cost before one deems such prices as abusive (Grout, 2003:85). It may take
longer time, but it provides more precise information about the alleged margin squeeze
abuse since under some conditions the dominant firm might have extra costs to provide the
wholesale input in question and under some conditions might have less cost as a result of
incumbency advantages or economies of scale.
60
On the other hand negative margins of a vertically-integrated firm cannot be regarded as
anticompetitive behaviour all the time. They may be because there are promotional sales
and/or efficiency gains as a result of economies of scale. Therefore, even though it is not
necessary to prove that an abuse was intentionally committed and lack of intent cannot be
put forward as a defence; intent may provide important context to determining what is
actually going on in terms of providing evidence to understand the likely effects of the
dominant firm’s conduct and thus to interpret facts and to predict consequences
((Faull&Nikpay, 2007:349; O’Donoghue&Padilla, 2006:227; PricewaterhouseCoopers,
2007:12).
Even though resembling predatory pricing, in contrast, in a margin squeeze case, the
dominant company may remain profitable end-to-end basis without losing money overall
such as the case in cross-subsidisation. However, different from cross-subsidisation, under
margin squeeze there is no need for a real loss in any market, insufficient margin will be
sufficient to prove margin squeeze. Consequently, although it has relationship with other
abuses, margin squeeze is different from them both in economic and legal means. Indeed,
in Deutsche Telekom, for the first time, the CFI provided a general definition of margin
squeeze, in which it also elucidated its constitutive elements and the methodology to be
applied for its assessment and thus considered it as a stand alone abuse other than predatory
pricing or excessive pricing which was the case in IPS.
As
in
Deutsche
Telekom,
formerly
state
owned
network
operators
in
the
telecommunications sector have been faced with heavy regulation after the privatisation
and liberalisation took place. This is because; those incumbents have kept their natural
monopolies even after the privatisation through the possession of bottleneck services.
Therefore, the need for regulation is mainly coming from the structural entry barriers,
capacity constraints, sunk costs, network externalities, economies of scale and scope, and
so on. In theory, if prices are balanced and properly regulated, margin squeeze should have
limited scope or totally disappear. Nonetheless, under some situations such as unbalanced
tariffs, price-cap regulation for retail services or global price-cap applications, margin
61
squeeze
is
also
possible
in
spite
of
price
regulation
in
both
markets
(Geradin&O’Donoghue, 2005:372-373).
Thus, NRAs in the EU have several ex-ante tools to prevent margin squeeze applicable for
both wholesale and retail markets besides regulating the prices directly, such as cost
accounting, accounting separation and functional separation. Regarding pricing regulations,
for the wholesale part, they may apply retail-minus to prevent margin squeeze; and for the
retail part they may use rate-of-return regulation. However, different from competition law
applications, NRAs do not necessarily need to show there is margin squeeze abuse before
applying any remedies. They may choose the markets which are defined beforehand by the
Commission where ex-ante regulation is permissible and then according to SMP
assessment they may or may not impose remedies on the undertakings in the relevant
market (if there is no SMP, then ex-post competition law would still apply). Therefore, the
difference between ex-ante and ex-post regulation does not solely come from market
definition or the way of obliging remedies in a margin squeeze case, but the remedies that
can be applied under competition law and telecommunications regulation also differ.
Even though both telecommunications and competition regulations have the same rationale,
“effective competition in the market”, the ways they employ to achieve this object are
different from each other. Hence, in some situations they may coincide and cause some
confusion among lawyers, regulators and the regulated parties, such as the cases in
Deutsche Telekom in the EU and Trinko in the US. Nevertheless, the different hierarchy of
norms, the effectiveness of the regulation and the effectiveness of regulator should also be
considered while analysing these cases.
In telecommunications, margin squeeze cases mostly involve that the new entrants try to
get some bottleneck services from the incumbents and incumbents squeeze their profit
margins. If the entrants cannot get those bottleneck services at reasonable rates or even if
they get them at reasonable rates but they do not have enough margin to compete with the
incumbent in the retail market because of incumbent’s low retail rates, then the entrants
may
be
foreclosed.
Taking
into
consideration
the
scarce
resources
in
the
62
telecommunications and thus naturally restricted number of operators in the market,
intervening after the entrants are foreclosed and weakened may not be an effective way to
adjust the market failure in the market. This is because entry and exit barriers in the
telecommunications sector are very high as a result of sunk costs, scarce resources,
licensing requirements, and regulatory burdens. That is why, dealing with margin squeeze
before the abuse takes place would be more beneficial for the market players. On the other
hand, if the SSR is not effective enough or it is not applied effectively by the NRA to deter
a margin squeeze, then there is scope for competition law to be applied even there is SSR
to ensure that the dominant firms have special responsibilities.
63
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CFI and ECJ Cases
•
Case C-27/76 United Brands v. Commission [1978] ECR 207.
•
Case C-62/86 AKZO v Commission [1991] ECR I-3359.
•
Case C-333/94P Tetra Pak v Commission [1996] ECR I-5951.
•
Cases C-395 and C-396/96P Compagnie Maritime Belge [2000] 4 CMLR 1076.
•
Case T-5/97 Industrie des Poudres Sphériques [2000] ECR II-3755.
•
Case T-340/03 Wanadoo v Commission [2007] 4 CMLR 21.
•
Case T-271/03, Deutsche Telekom AG v. Commission April 10, 2008.
EU Commission Decisions
•
National Carbonising, 0J 1976 L35/6.
•
Napier Brown/British Sugar Case no. IV/30.178, OJ L284, 19/10/1988.
•
Deutsche Post AG, OJ 2001 L125/27, [2001] 5 CMLR 99.
•
Wanadoo España vs. Telefónica Case COMP/38.784, 04/07/2007.
UK Cases
•
CAT, Freeserve v The Director General of Telecommunications, Case No.
1007/2/3/02.
•
CAT, Napp Pharmaceutical v OFT [2002] CAT 1, [2002] CompAR 13.
•
CAT, Genzyme Limited v Office of Fair Trading, Case No.1016/1/1/03, March 11
2004.
•
CAT, Albion Water v The Director General of Water Services [2006] CAT 23,
[2007] CompAR22.
•
OFT, BSkyB investigation: alleged infringement of Chapter II prohibition, 17
December 2002, CA98/20/2002.
76
•
OFT, BSkyB, Decision of the OFT under section 47 relating to decision
CA98/20/2002: alleged infringement of the Chapter II prohibition by BSkyB, 29
July 2003.
•
OFTEL, British Telecom/UK-SPN, Investigation, 23 May, 2003.
•
OFCOM, BT Together Options 1, 2 and 3, Investigation, Case: CW/00760/03/04,
12 July 2004.
•
OFCOM, Suspected margin squeeze by Vodafone, O2, Orange and T-Mobile, Case
CW/00615/05/03, 21 May 2004.
French Cases
•
French Competition Council decision of 14/10/2004, France Télécom/SFR
Cegetel/Bouygues Telecom, Case 04-D-48.
Belgium Cases
•
Court of Appeal of Brussels TELE2 v Belgacom, 18/12/2007, ECLR 2008, 29(9),
N133.
US Cases
•
United States v. Aluminum Co. of America (Alcoa), 148 F.2d 416 (2d Cir. 1945).
•
City of Groton v. Connecticut Light & Power, 662 F.2d 921 (2d Cir. 1981).
•
Anaheim v. Southern California Edison Co., 955 F.2d 1373, 1378 (9th Cir. 1992).
•
Covad Communications v. BellSouth, 374 F.3d 1044, 2004-1.
•
Verizon Comm’ns, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398
(2004).
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USTA v FCC 359 F3d 554 (D.C. Cir. 2004).
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linkLine Communications v. Pacific Bell No. 05-56023, USApp. LEXIS 21719 (9th
Cir. 2007).