22 February 2007

The Supreme Court and predatory bidding - lessons for the EU

Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co. Inc. (20 February 2007)

Defendant and plaintiff were competitors, both operated sawmills and purchased red alder sawlogs for their mills. Some of the logs are purchased through long term contracts, some are obtained from the mill owner’s property, and some are acquired through bidding. Plaintiff alleged that defendant placed bids at very high prices, forcing the price of logs to go up, thereby forcing plaintiff to pay more for his logs too, which forced plaintiff to increase his sales prices. The result was that defendant’s predatory strategy drove plaintiff out of business. In the lower courts plaintiff was successful in an action based on s.2 Sherman Act, in particular the courts did not think that predatory bidding was comparable to predatory pricing, so the strict standards set out by the Supreme Court in Brooke Group (1993) did not apply.

The Supreme Court disagreed, ruled that predatory bidding is judged by the same standards as predatory pricing, and because plaintiff admitted it was unable to prove the elements required by Brooke Group, the claim was unsuccessful. The judgment comes a short time after the CFI ruled on predatory pricing (see earlier entry in this blog) and holds two lessons for the EU: (1) how to use economics to analyse disputes; (2) how to write judgments.

(1) The use of economics

First, the Court explored whether predatory bidding (the exercise of monopsony power; that is, buyer power) is comparable to predatory pricing. The logic is similar: in a first period the predator engages in a measure that raises rivals’ costs (here by bidding high, increasing the price of the inputs and forcing competitors to pay more); in a second period, once competitors have been driven out of business, the predator uses its monopsony power to force sellers of input to lower the prices. As with predatory pricing, the first period represent’s the predator’s ‘investment’ – he suffers losses of profit and his dominance allows him to survive while competitors go out of business. The second period is when he recovers that investment by getting low prices for the inputs, recovering the losses made in the first. Accordingly, the legal standard for predatory bidding should be the same as that for predatory pricing.

Second, the Court held that aggressive commercial tactics are the very essence of competition, and that there were a myriad of reasons why buying inputs at high prices could be innocent, or even pro-competitive: (1) miscalculation of input needs; (2) a response to increased consumer demand; (3) a more efficient firm might bid up input prices to gain market share in the output market; (4) a firm that adopted an input intensive production process might bid to increase the inputs; (5) a firm might buy a lot of inputs today to hedge against future shortages. ‘There is nothing illicit about these bidding decisions. Indeed, this sort of high bidding is essential to competition and innovation.’

Third, the Court noted that like predatory pricing, a failed attempt of predatory bidding is benign. The monopsonist who buys more goods, will be in a position to sell more to consumers, and provided he does not have monopoly power on the selling side, this means that consumers get more goods at competitive prices.

Two things follow from this analysis: (a) predatory bidding is a high risk strategy that has many efficiency justifications; (b) a failed attempt to achieve the rival’s exclusion does not harm consumers. Therefore, a high standard of proof is necessary or there is a ‘risk of chilling pro-competitive behaviour with too law a liability standard.’

The legal test therefore is the same as for predatory pricing: (1) the predatory bidding results in below cost output sales; (2) there is a dangerous probability that the losses in the first period will be recouped through the exercise of monopsony power.

When will European courts think about aggressive commercial behaviour in this way?

Even those who think that a more lenient standard should apply and that Europe is right to be tougher on predators might take an interest in the lower court’s decision. The 9th Circuit held that three things needed proof: anticompetitive conduct through predatory overbidding, intended specifically to eliminate competition, and a dangerous probability of achieving monopoly power .

On intention, the court used evidence which in my mind is more compelling than that in the Wanadoo case. The court used three types of evidence: (1) Defendant’s anticompetitive conduct itself, (2) the testimony of Defendant’s employees, and (3) Defendant’s business projections regarding sawlog prices. Note that (2) is trial based testimony, not internal memoranda. Note also how items (1) and (3) show that Defendant had calculated what it would take to outs plaintiff. This evidence is much more specific than that which the CFI relied upon.

(2) Judicial Style

This decision is 16 pages of a pdf file. The first paragraph is a concise statement of the key points. The facts are examined in a succinct manner. Quotes from previous cases are brief and to the point. Academic literature is mentioned. The case can easily be read, and understood, while commuting on the tube. It is unfortunate that the style of judgment in the European Courts cannot be as clear and as concise.

Interestingly perhaps, the Court eschews mention of wider debates about the nature of S.2 monopolisation claims, a topical issue in light of the current hearings on single firm conduct. Perhaps the Court thinks it best if the law develops incrementally rather than setting out general standards for anticompetitive behaviour like the no economic sense test, or the as efficient competitor test.

12 February 2007

Predatory Pricing - bad intentions and no economic sense

Case T-340/03 France Télécom v Commission (judgment of 30 January 2007)

The Commission’s Wandoo decision fining the firm for predatory pricing in the sale of high-speed internet access, was affirmed by the Court of First Instance. The Commission immediately issued a press release to show its delight. In this press release is an important passage: “Broadband is a strategic sector highly important to the European economy and the Commission's strategy for growth and jobs. The Commission is determined to prevent exclusionary practices by incumbent operators on strategic markets.” This is in line with its 2004 Communication, which sought to align competition law enforcement with the Lisbon Strategy (a bold attempt to make Europe more competitive). This is the ‘Community interest’ that guides competition enforcement post-modernisation. But if the pursuit of this interest leads to decisions like this one, we must wonder whether Europe is not made less competitive by competition law enforcement.

After a hundred or so paragraphs where the CFI rejects procedural points and checks the Commission’s arithmetic, the Court wrestles with several interesting points of principle that Wanadoo raised. Their rejection shows a complete failure to understand predatory pricing.

Meeting competition
There is some doubt as to whether a dominant firm can react aggressively when challenged by competitors. The CFI said that the dominant firm “cannot rely on an absolute right to align its prices on those of its competitors in order to justify its conduct. Even if alignment of prices by a dominant undertaking on those of its competitors is not in itself abusive or objectionable, it might become so where it is aimed not only at protecting its interests but also at strengthening and abusing its dominant position.” (para.187)

This is not novel, but it confirms that there is no meeting competition ‘defence’ in EC competition law. The only defence is for the dominant firm to prove that there was no abuse. But it is too easy for the Commission to prove abuse.

Prices above average variable cost (AVC) and below average total cost (ATC) are abusive only if there is a plan to eliminate competition. More clearly than in earlier cases, the CFI states that this requires proof of ‘intention’.

In this case, the Commission proves intention with a raft of internal documents where the dominant firm’s management explained how it wished to pre-empt the challenge of new entrants by selling goods more cheaply. The firm’s intention to acquire and hold on to market power is evidence of abuse. This is unwise. In previous cases, intent was shown by selective price cuts designed to harm certain rivals, this was a little more probative. In contrast here, intent is proven by evidence that I suspect we can find in any company. What company does not want to beat its competitors? To gain and hold on to a higher market share? Is the intention to compete evidence of abuse? Yes, it seems.

Admittedly Wanadoo was somewhat unwise to write in language that so fits the Commission’s legal standards, look at this note: ‘The high-speed and ADSL market will, for the next few years, continue to be conquest-driven, the strategic objective being to gain a dominant position in terms of market share, the period of profitability only coming later.’ (cited at 215) Nevertheless, can this really be sufficient evidence of anticompetitive intent?

Perhaps as a last throw of the dice, the defendant thought that if the Commission’s burden of proof is so light in showing intention, that the Court would see sense and rectify this by requiring proof that predatory pricing would create a dominant position and that Wanadoo would be able to recoup its losses. No such luck. In Tetra Pak 2 the ECJ said that on the facts of that case recoupment need not be shown. The CFI says that there is never any need to prove recoupment. (227). This removes the caution of the ECJ and is in line with the Advocate General’s view in Tetra Pak 2 that all predatory pricing should be condemned without the need to show the possibility of recouping losses.

Predatory pricing standards and the Lisbon strategy
To be clear, I am not suggesting predatory pricing should not go unpunished, nor that Wanadoo was not trying to harm its competitors. Rather, that the court sets such a low threshold of illegality that dominant firms are deprived of any incentive to compete hard. First, the fact that
recoupment need not be shown, is economically irrational: if a predator cannot recover the loss of profits, it means predation was unsuccessful, and competitors have not been harmed, so the predator is punished by the market for his irrational attempt to exclude rivals. Second, flimsy evidence of intention makes findings too easy, creating further risks of over enforcement. If dominant firms cannot respond aggressively to maintain their position (Wanadoo has to pay a fine of 10.35 million euros), what incentives are there to be successful?

10 February 2007

Information Exchanges and the Consumer Interest

Case C-238/05 Asnef-Equifax v. Ausbanc judgment of 26 November 2006

Spanish banks agreed to set up an electronic register of credit information that would disclose the credit history of potential customers. The effect is that each bank is aware of each potential client’s credit history and takes this into account when negotiating further loans. A horizontal agreement no doubt, but was it contrary to Article 81? The Spanish Court was in doubt and asked two questions of the ECJ.

Does the agreement restrict competition?
Wisely the Court noted that prima facie the agreement made for more competitive markets, since lenders were now better placed to offer loans based on a more informed understanding of each client’s credit risk (so the solvent client would get preferential loans, and the very risky clients no loans at all, thus preventing him from accumulating even more debt). Moreover, clients can now obtain credit more easily from financial institutions other than the ones from which they have borrowed historically, since all banks have their credit histories.

However, an anticompetitive effect might arise, said the Court, and three factors were relevant (this is not a cumulative test):
(1) The degree of market concentration (that is, how many banks are there, a few or many?)
(2) Whether the register discloses information that allows competitors to see the business strategy of other lenders (accordingly it is imperative that the names of lenders be invisible)
(3) Whether all lenders are able to have access to the register

Condition 3: making markets work better?
The ECJ rightly noted that the agreement, if anything, was more likely to benefit consumers than to harm them. Nevertheless, it is troubling that the Court said that the agreement was lawful only because any lender could join the scheme set up by the parties. The condition makes sense for all lenders because the more lenders join, the more information all have about the credit history of clients. But the Court’s analysis is slightly troubling because even if the first two criteria are met (the market is not concentrated and the information does not allow for parties to understand each other’s business strategies) the exchange of information is lawful only if it is open for newcomers, but the first two conditions are sufficient to prove that the agreement does not restrict competition. The third condition is designed to allow the market to grow, providing opportunities for new lenders to enter. But this is regulation, not the application of competition law.

The Consumer interest
Should the national court find (highly unlikely given the above reasoning) that the agreement restricts competition, the Court offered some guidance on how the consumer benefit test in Article 81(3) might be applied. The Court did not refer to the Guidelines on Article 81(3) that roughly have the same as the judgment: Paragraph 87: ‘The decisive factor is the overall impact on consumers of the products within the relevant market and not the impact on individual members of this group of consumers.’

But after stating that one should look at the benefits for consumers generally, the Court muddies the water, saying that two groups of consumers benefit: those who get better loans, and those who do not get loans because of their bad credit scores, and this is a benefit because it avoids over indebtedness. It is a little patronising for the Court to say that, but also one wonders why a private agreement is necessary to avoid over indebtedness, as surely this is a task for the legislature, not competitors. But this wider conception of consumer interest is part of the Commission’s practice – recall how reduced electricity consumption benefited all members of society in CECED.

In sum, this judgment shows the Court in full regulatory mode: it designs markets to ensure they facilitate the entry of new players, and suggests that agreements can be exempted if big spenders are denied loans, competition law as a device to protect improvident consumers. Real antitrust law shoudl be more humble about its capacities and its scope.