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1 Commitment Excellence Innovation CLIENT ADVISORY EUROPEAN COMMISSION ENDORSES A MORE ECONOMICS-BASED APPROACH TO EXCLUSIONARY UNILATERAL CONDUCT BY DOMINANT COMPANIES New Guidance Paper on Article 82 EC Treaty On 3 December 2008, the European Commission set out for the first time in a single document (the Guidance Paper) its approach to, and enforcement priorities in, assessing exclusionary conduct by dominant companies under EU competition law. 1 Largely in line with a preparatory Commission staff discussion paper of December 2005, 2 the new Guidance Paper lays out a more economics-based approach to exclusionary abuses, which emphasizes the need to establish the conduct s actual or likely detrimental effects on consumers before a violation of Article 82 EC Treaty can be found. Overall, the Guidance Paper suggests a less form-based approach than has been applied in several previous Commission decisions and judgments of the European Courts. In some significant points, the Guidance Paper also raises the bar for finding a violation of Article 82 EC Treaty compared to the 2005 Discussion Paper. DECEMBER 2008 London +44 (0) Brussels +32 (0) Washington, DC New York Los Angeles San Francisco Northern Virginia Denver The Guidance Paper nevertheless shows a greater willingness to intervene against exclusionary conduct than the report on Competition and Monopoly: Single-Firm Conduct Under Section 2 of the Sherman Act, which the US Department of Justice (DOJ) published in September this year, 3 and which the majority of the US Federal Trade Commission (FTC) criticized precisely for its lack of teeth. Overview The Guidance Paper covers three main issues. It: (i) explains the concept of single firm dominance; 4 (ii) provides a general framework for the assessment of all types 1 Guidance on the Commission s Enforcement Priorities in Applying Article 82 EC Treaty to Abusive Exclusionary Conduct by Dominant Undertakings, available at eu/competition/antitrust/art82/guidance.pdf. The final authoritative text will be published in the Official Journal. 2 Available at 3 Available at 4 Unlike the 2005 Discussion Paper, the Guidance Paper does not address market definition issues and collective dominance. This summary is intended to be a general summary of the law and does not constitute legal advice. You should consult with competent counsel to determine applicable legal requirements in a specific fact situation. arnoldporter.com Arnold & Porter (UK) LLP is a limited liability partnership organized under the laws of the State of New York, is regulated by the Law Society, and is an affiliate of Arnold & Porter LLP, a limited liability partnership organized under the laws of the District of Columbia. A list of the firm s partners and their professional qualifications is open to inspection at the London office. All partners are either registered foreign lawyers or solicitors.

2 of exclusionary abuses; and (iii) contains more specific guidance on exclusive dealing (including loyalty rebates), tying and bundling, predation, and refusals to supply or license (including margin squeezes). The Guidance Paper does not address non-exclusionary conduct that may violate Article 82 EC Treaty, such as discrimination against specific customers, the prevention of parallel trade or the imposition of excessive prices or other so-called exploitative practices. Practical Relevance The Guidance Paper will strongly influence the enforcement practice of Article 82 EC Treaty for years to come. 5 The Commission can be expected to follow it in most cases, although unlike Commission Guidelines for other areas of EU competition law the Guidance Paper says it is not a statement of the law but merely a nonbinding description of enforcement priorities that the Commission can deviate from. Member State competition authorities and courts can be expected to take the Guidance Paper into account when applying Article 82 and similar national rules. However, it is possible that some Member State authorities will continue to invoke the arguably less demanding jurisprudence of the European Court of Justice (ECJ) and the Court of First Instance (CFI) to intervene against exclusionary conduct even when the conditions of the Guidance Paper (and notably the requirement of demonstrated consumer harm) are not met. This risk is significantly greater with regard to Member State courts, which may have a natural tendency to follow ECJ and CFI precedent rather than a non-binding expression of agency enforcement priorities. The Guidance Paper might also influence the developing enforcement practice in non-eu countries, such as China. 5 In contrast, the practical relevance of the DOJ Report is uncertain, because (i) the DOJ may deviate from it (or expressly abandon it) under the new Obama administration, (ii) the majority of the FTC strongly criticized it and made clear that the FTC will intervene where the DOJ fails to do so, and (iii) Section 2 enforcement is to a very significant extent shaped by private actions as opposed to agency enforcement. Dominance The Guidance Paper condenses the notion of dominance to the formula that dominance requires the company in question to enjoy substantial market power over a period of time. Normally, two years is sufficiently long, although dominance may also be found if substantial market power is held for a shorter period. Substantial market power exists if the company does not face effective competitive constraints from existing competitors, the threat of expansion of competitors or entry of new competitors, countervailing buyer power, or other sources. Significantly, the Guidance Paper indicates an increased willingness to accept that companies with high market shares might not be dominant. First, the Guidance Paper does not suggest that a specific market share level creates a presumption of dominance. By contrast, the 2005 Discussion Paper stated that dominance is typically possible above 40%, and highly likely above 50%. 6 Second, the Guidance Paper lifts from 25% (2005 Discussion Paper) to 40% the market share level below which it is unlikely, although not excluded, that dominance can be found (so-called soft safe harbor ). 7 This new approach widens companies possibilities to argue against dominance in the future, but it remains to be seen whether in practice fewer companies with shares above 40% will be held to be dominant than in the past. It cannot be expected that the Commission will raise the bar for intervention to market share levels of 70% or more, which are typically required for a finding of a monopoly under Section 2 of the U.S. Sherman Act. Framework For Assessing Exclusionary abuses The Guidance Paper s general framework for the assessment of all types of exclusionary abuses largely follows the 2005 Discussion Paper. 6 The 50% presumption of dominance is, however, supported by significant court precedent, such as case C-62/86, AKZO Chemie v Commission, [1991] ECR I The DOJ Report does not contain a similar bright-line soft safe harbor rule, but makes clear that market shares below 50% would be extremely unlikely to lead to a finding of monopoly power. The report does not, however, address the minimum share that would be required to find the dangerous probability of success required to support an attempted monopolization claim under US law. 2

3 Commitment Excellence Innovation Anticompetitive foreclosure Foreclosure occurs when the dominant company makes access to customers more difficult or impossible for actual or potential rivals. 8 But more explicitly than the 2005 Discussion Paper, the Guidance Paper makes clear that foreclosure will only be a concern for the Commission if the foreclosure leads to consumer harm (referred to as anticompetitive foreclosure, a notion not used in the 2005 Discussion Paper). As in the United States, the weakening or elimination of individual competitors is not sufficient absent consumer harm. This increases the evidentiary burden for the Commission and complainants and suggests that in the future, the Commission will attribute more significance than arguably would be required under recent European court judgments 9 to facts that could indicate the absence of anticompetitive foreclosure, such as declining market share and sales prices of the dominant company during the period investigated. The emphasis on consumer harm coincides with a more explicit recognition of the consumer benefits that result from competition on the merits by dominant companies. This does not mean, however, that an abuse can only be found when consumer harm has already occurred. The Commission will also intervene if the dominant company s conduct creates a sufficient likelihood that anticompetitive foreclosure will occur in the future. Relevant factors for a finding of anticompetitive foreclosure The Commission will take qualitative and, where possible and appropriate, quantitative evidence into account when assessing anticompetitive foreclosure effects. This relatively cautious endorsement of potentially timeconsuming quantitative evidence requirements may reflect a concern to ensure that the effectiveness of Article 82 EC Treaty is not undermined by undue procedural delays. 8 The Guidance Paper acknowledges that anticompetitive foreclosure can also result if competitors are foreclosed from access to inputs/supplies. However, input foreclosure is more fully discussed only in the Guidance Paper s sections on refusal to supply and mentioned in a footnote regarding exclusive supply obligations as a form of exclusive dealing. 9 Cases T-203/01 Michelin v. Commission, [2003] ECR II-4071, and T-219/99 British Airways v. Commission, [2003] ECR II- 5917, upheld by the ECJ in case C-95/04 British Airways v. Commission, [2007] ECR I For all exclusionary abuses, the following factors are relevant (additional factors are identified in the sections on specific types of abuses): The position of the dominant company (notably its market share); barriers to entry and expansion and other relevant market conditions; the position (and notably the market shares) of the dominant company s competitors; the position of the customers or input suppliers; the extent of the allegedly abusive conduct, notably the duration of the conduct and the percentage of total market sales affected by it; possible direct evidence of actual anticompetitive foreclosure, such as increases of the market share or sales price of the dominant company; and direct evidence of an exclusionary strategy. Anticompetitive effects must be specifically assessed for all types of exclusionary abuses, with one exception: If it appears that the conduct can only raise obstacles to competition and does not create efficiencies, the Commission can infer anticompetitive effects without a detailed analysis. Examples given in the Guidance Paper include situations where a dominant company prevents its customers from testing competitor products or pays customers to delay the introduction of a rival s product. The as efficient competitor test for pricing abuses When rebate schemes or other pricing behavior of the dominant firm are investigated, consumer harm can arise under the Guidance Paper normally only if the pricing conduct tends to foreclose actual or hypothetical competitors that are at least equally efficient as the dominant company (the as efficient competitor test ). The Commission typically will not intervene if only less efficient rivals are foreclosed. The as efficient competitor test compares the dominant company s sales prices for the products in question to its long-run average incremental cost (LRAIC) 10 and average 10 Long-run average incremental cost is the average of all the (variable and fixed) costs that a company incurs to produce a particular product, and often will correspond to average total cost. 3

4 avoidable cost (AAC) 11 for these products: 12 If the sales price is above LRAIC, equally efficient rivals normally are not foreclosed - no abuse. If the sales price is below AAC, foreclosure of equally efficient rivals is presumed. If the sales price is between AAC and LRAIC, a more detailed assessment is required. Justifications If the above analysis suggests that anticompetitive foreclosure occurs, the dominant company can still escape a finding of abuse on the basis of a successful efficiency defense. 13 In parallel to the requirements of Article 81(3) EC Treaty, an efficiency justification requires the dominant company to submit evidence showing that: (i) identifiable efficiencies result from the conduct; (ii) the conduct is indispensable to the realization of these efficiencies; (iii) the efficiencies outweigh any negative effects on competition and consumer welfare resulting from the conduct; 14 and (iv) the conduct does not eliminate effective competition by removing all or most existing sources of actual or potential competition. The last condition is not fulfilled if the dominant company s market position is approaching that of a monopoly. Just as in the Commission s Article 81(3) Guidelines, 15 the Commission expresses in the Guidance Paper its fundamental belief that continued (long-term) rivalry between companies is more important and thus should be given priority over (mostly short term) efficiency gains that can be realized by a specific conduct of a dominant firm. 11 Average avoidable cost is the average of the costs that could have been avoided if the company had not produced the extra output to which the conduct in question relates. Often, AAC will correspond to average variable costs. 12 The Commission will rely on the dominant company s cost data to establish AAC and LRAIC, but if this is not available, cost data of competitors or other comparable reliable data can be used. 13 Only exceptionally can anticompetitive foreclosure be justified by health, safety or other reasons of objective necessity under the Guidance Paper. 14 The DOJ Paper appears to allocate greater weight to efficiencies. Unless a conduct-specific test applies, the DOJ Paper generally endorses the disproportionality test, under which conduct violates Section 2 only if the anticompetitive effects substantially outweigh the procompetitive benefits. (This disproportionality test was expressly criticized by the FTC.) Under the Guidance Paper, a violation of Article 82 EC Treaty occurs as soon as the negative consumer effects (slightly) outweigh the efficiency benefits O.J. C 101/97. But in marked contrast to the 2005 Discussion Paper, the Guidance Paper does not set a presumption that a near monopoly position is normally present above a market share level of 75%. Unlike the 2005 Discussion Paper, the Guidance Paper does not mention the meet the competition defense, which would potentially justify a dominant company s pricing behavior if this was adopted to match aggressive pricing by competitors. Exclusive Dealing Exclusive dealing is described as exclusive purchasing obligations and other practices (such as the granting of rebates) 16 of a dominant company that make a customer buy a specific product only or mainly from the dominant company so that competitors do not have sufficient access to the customer. Exclusive Purchasing While customers often extract a benefit from the dominant company when agreeing to exclusive purchasing, consumer harm is likely to arise if demand is dispersed and the cumulative effect of exclusive purchasing obligations with a multitude of buyers prevent entry or expansion of rival firms. Regrettably, however, the Guidance Paper does not indicate which degree of total market foreclosure might typically be seen as problematic or unproblematic. 17 According to the Guidance Paper, competitive harm is more likely to arise if competitors cannot compete for the entire demand of each customer because the dominant company is an unavoidable trading partner or the competitors are capacity constrained. Rebates The Guidance Paper explains in some detail the application of the AAC and LRAIC cost/price thresholds for retroactive rebates (which apply to a customer s total purchases from the dominant company over a period 16 Unlike the 2005 Discussion Paper, the Guidance Paper does not mention English clauses as a form of exclusive dealing, although this is likely due to an effort to simplify the Guidance Paper and does not indicate a policy change. 17 In contrast, the DOJ Report suggests that foreclosure of less than 30 percent of existing customers or effective distribution should not be illegal. 4

5 of time provided the total purchase amount exceeds the chosen threshold level) and incremental rebates (which reduce the purchase price only for the quantities purchased in excess of the chosen threshold). 18 The relevant issue is whether, as a result of the rebate, the dominant company s effective price for a minimum viable quantity (the relevant range ) for which a competitor could compete becomes so low that an equally efficient competitor cannot profitably compete for this demand, with the consequence that the customer will purchase from the dominant company. Anticompetitive foreclosure is normally excluded if the effective price is above the dominant company s LRAIC, and normally present if the effective price is below the dominant company s AAC. If the dominant firm prices between AAC and LRAIC (or average total cost), the 2005 Discussion Paper took the view that it would be very difficult and possibly even impossible for as efficient competitors to compete, so that foreclosure would normally occur. In contrast, the Guidance Paper also requires an assessment of whether other factors confirm that as efficient competitors could not efficiently compete in that case. But the Commission maintains the view that rebates can be anticompetitive even if they do not make the pricing predatory. 19 Exclusive dealing can be justified by relationship-specific investments made by the dominant company to supply the customer in question and other types of efficiencies. Tying and Bundling Tying or bundling occurs in different variations when, in essence, a dominant supplier forces (by means of technical integration or contractual arrangements) or incentivizes (notably by rebates) a customer of the product for which the supplier is dominant (the tying product) to purchase also other distinct products (the tied products) 18 Again, likely for purposes of simplification, the Guidance Paper dropped the discussion of unconditional rebates (which are automatically granted to the customer s entire purchase volume and do not depend on the reaching of a triggering threshold). 19 The DOJ Report also recognizes that single-product loyalty discounts can be anticompetitive even where a monopolist prices above cost. The Report recognizes, however, that there is no consensus as to how likely such a scenario is and how courts or enforcers can determine whether such activity is anticompetitive. The DOJ states, therefore, that the standard predatory-pricing approach to single-product loyalty discounts is likely to be applied in most cases. from the dominant supplier. This can create foreclosure effects on the tying and/or the tied market. Whether anticompetitive foreclosure effects are likely to occur must be assessed in light of the general factors outlined above, supplemented by a few specific factors, such as the duration of the tying practice, the number of products in the bundle for which the supplier is dominant, and, where customers can use the tying and the tied products in variable proportions, whether the tying practice prevents customers from substituting the tying product with the tied product. Interestingly, the Guidance Paper identifies technological tying (technical integration of two distinct products into one) as particularly harmful, because technological tying is more costly to reverse than contractual tying and reduces the possibility of sales of individual components. 20 Regrettably, the Guidance Paper is silent on the highly relevant question of whether there are threshold levels for the dominant company s market share in the tied market (where the company typically is not yet dominant) that would indicate either the presence or absence of anticompetitive effects in the tied market. If bundling is achieved by multiple-product rebates, the issue is again whether equally efficient competitors can profitably compete, which is normally the case if the incremental price that customers pay for each of the dominant company s products in the bundle remains above the LRAIC of the dominant firm. If that is not the case, an equally efficient competitor may be prevented from expanding or entering. If competitors can offer similar bundles as the dominant firm, competition for the bundles will be compared. In the area of tying and bundling, the Guidance Paper acknowledges several types of efficiencies that a dominant company may invoke as a justification, and the overall tone of this section suggests that the Commission may be particularly receptive to efficiency arguments in the area of tying and bundling By contrast, the DOJ Report identifies technological tying as the form of tying that requires the most cautious interventionist approach in order not to chill innovation. 21 Similarly, the DOJ Report stresses that tying often leads to consumer benefits and advocates a standard under which tying is a Section 2 violation only where the anticompetitive harm is substantially disproportionate to the procompetitive benefits. 5

6 Predation Predation will only be a Commission enforcement priority if the dominant company makes a deliberate financial sacrifice (that is, it incurs a loss or foregoes a profit it could have generated otherwise) and this leads to anticompetitive foreclosure of competitors. In a significant shift from the 2005 Discussion Paper, a showing of an intention to predate is not a pre-condition for predation. A sacrifice is presumed to occur if the dominant company s sales price is below its AAC. Otherwise, a sacrifice occurs if the actual price is below a level that the dominant company reasonably could have achieved. However, the Guidance Paper also states that predation is unlikely to be found if the conduct concerns a low price applied generally for a long period of time. Apparently, therefore, pricing that leads to a sacrifice will not be qualified as abusive provided that it is applied generally for a long period of time. Unfortunately, there is no indication of what long means in this context. Finally, under the as efficient competitor test, abusive predatory pricing cannot normally occur if the price charged by the dominant company is above its LRAIC. When assessing the likelihood of foreclosure, the Commission will take the factors identified in the general framework into account and also look at whether the dominant company has a reputation to aggressively price against new entrants or has better access to financing or market information. Foreclosure by predation not only occurs when competitors exit the market. Disciplining of competitors, that is, preventing them from competing vigorously against the dominant company, is sufficient. For the foreclosure to be anticompetitive, the dominant company must be able to reasonably expect that its market power will increase after the predatory behavior so that the dominant company is likely to be in a position to benefit from its prior sacrifice (the term recoupment is not used in this context.) It would appear, however, that a showing of expected benefit will succeed rather easily. The Guidance Paper explicitly does not require a calculation showing that the future benefit compensates or exceeds the sacrifice and even appears to allow the Commission to infer from the fact that foreclosure has or might take place that this will also lead to anticompetitive effects, provided other factors, such as the presence of entry barriers, also suggest that anticompetitive effects will result. 22 Under the Guidance Paper, predation is unlikely to lead to efficiencies that could justify predatory pricing that leads to anticompetitive foreclosure. Refusal to supply, refusal to license and margin squeeze The Guidance Paper assesses all types of refusal to supply (existing or first time customers, actual or constructive refusal), refusal to license, margin squeeze, and refusal to grant access to an essential facility under the same general analytical framework, although with variations in detail. 23 The Commission is likely to intervene if three conditions are met: 24 First, the refusal must relate to a product that is objectively necessary (or indispensable) to compete effectively on the downstream market. An input is not indispensable if the downstream competitors are able to duplicate the input in the foreseeable future in an efficient way. Second, the refusal must be likely to lead to the elimination of effective competition on the downstream market. The Guidance Paper identifies several aspects under which this is more likely to occur, but states that the refusal to supply an indispensable input by itself is normally liable to eliminate effective competition. Third, the refusal to supply must lead to consumer harm, which is the case if the likely negative consequences of the refusal to supply outweigh over time the negative 22 The DOJ Report continues to recognize two key elements a plaintiff must establish to succeed on a predatory pricing claim: (1) that prices were below an appropriate measure of defendant s costs in the short term, and (2) that the defendant had a dangerous probability of recouping its investment in below-cost prices. The DOJ Report suggests that above-cost pricing should remain per se legal and that, where it can be determined, average avoidable cost should be the appropriate cost measure. 23 However, the Guidance Paper only deals with refusal to supply scenarios where the dominant input supplier also competes in a downstream market with the company that requested to be supplied. 24 If a dominant company is under a duty to supply already under applicable regulation, then a refusal to supply may be held to be abusive even if these three conditions are not met. 6

7 consequences that an obligation to supply creates. More openly than the 2005 Discussion Paper, the Guidance Paper acknowledges that obliging a dominant company to supply its rivals reduces incentives to innovate and invest not only for the dominant company, but for suppliers generally, and that this can lead to consumer harm. However, the Commission retains significant flexibility in weighing these negative effects against the loss of competition that results from the refusal to supply and will likely impose a duty to supply if the downstream competitors can be expected to bring new or improved products to the market. 25 The Guidance Paper finally recognizes that a refusal to supply can lead to relevant efficiencies and may also be justified to ensure an adequate return on investment for the dominant company or to prevent a negative impact on the dominant company s innovation efforts. This has to be shown by specific evidence. A general assertion to this effect is not sufficient. If you would like more information on Arnold & Porter LLP or the application of Article 82 EC Treaty, please feel free to contact your Arnold & Porter attorney or: Axel Gutermuth +32 (0) Axel.Gutermuth@aporter.com Marleen Van Kerckhove +32 (0) Marleen.VanKerckhove@aporter.com Luc Gyselen +32 (0) Luc.Gyselen@aporter.com Tim Frazer + 44 (0) Tim.Frazer@aporter.com Susan Hinchliffe +32 (0) Susan.Hinchliffe@aporter.com Julie Goshorn Julie.Goshorn@aporter.com Conclusion Overall, the Guidance Paper increases the transparency and predictability of the Commission s future enforcement activity regarding exclusionary conduct. It also raises the hurdles for complainants. However, the fact that it has not been possible for the Commission to publish binding guidelines shows that there still is significant disagreement within the Commission and among Member State enforcers about the correct application of Article 82 EC Treaty. There remains a significant possibility that Article 82 EC Treaty will continue to be applied differently in different procedural and substantive contexts. 25 In marked contrast to this approach, the DOJ Report states that unconditional refusals to deal with rivals should not play a meaningful part in Section 2 enforcement, although it also recognizes that Section 2 claims are not entirely excluded under the US Supreme Court s case law. 7