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Horizontal Restraints National Training Workshop on Competition Policy and Law Gerald Gregory (CUTS Fellow)

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1 Horizontal Restraints National Training Workshop on Competition Policy and Law Gerald Gregory (CUTS Fellow)

2 The Law (1) EU Law (Article 81 of the EC Treaty) provides a general prohibition on agreements between companies which have as their object or effect the prevention, restriction or distortion of competition and which may affect trade within the common market Such agreements can form either horizontal or vertical restraints on trade But today we are talking about horizontal restraints only...

3 Horizontal Restraint: Definition “A restraint of trade involving an agreement among competitors at the same distribution level for the purpose of minimising competition” MANUFACTURER AMANUFACTURER B RETAILER 1 RETAILER 2 RETAILER 3

4 The Law (2) EU Law specifically prohibits agreements which: Directly or indirectly fix purchase or selling prices or any other trading conditions Limit or control production, markets, technical development or investment Share markets or sources of supply Apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage Make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts

5 The Law (3) The list above isn’t exhaustive, any agreement, the object or effect of which is to prevent, restrict or distort competition, may fall within the prohibition Collusion of types a), b) and c) ALWAYS prohibited as they are deemed by their very nature to restrict competition For other horizontal agreements the effect on competition must be ‘appreciable’ (significant) to fall within the prohibition (dropped if market share of firms involved <10%) Little variation in law on horizontal agreements across jurisdictions

6 a) Price Fixing Competition drives prices towards costs (allocative efficiency) as each firm tries to win customers. It also provides incentives for firms to produce as cost effectively as possible (productive efficiency) It can also provide incentives for firms to innovate processes and products (dynamic efficiency) But firms can, under certain market conditions, make higher profits and reduce risk if they agree not to compete, fixing prices

7 b) Limiting or controlling production In some markets firms are quantity-setting rather than price-setting Limiting production creates a shortage which must be rationed Price increases ration the shortage, so limiting production has a similar effect to price fixing A good example is the OPEC cartel which decides on output, as prices are determined by demand and supply conditions on the international exchanges

8 c) Sharing Markets Firms may agree to share markets by territory or type of customer This can be complemented by a price fixing agreement Some agreements can have an effect of sharing markets without this being the object, for example each firm agreeing to specialise in products in a range to produce more efficiently Such agreements still fall within the Article 81 prohibition if the effect is a restriction, prevention or distortion of competition

9 Sustainability Cartels are generally unstable as there is always an incentive to 'cheat' on the agreement to take market share Firms are less likely yo deviate if the future profits foregone outweigh the short-term gains to cheating Collusive agreements can be sustained if: - deviations can be detected - deviations can be punished The longest running cartel uncovered by the European Commission was the organic peroxides cartel which ran for 29 years.

10 Conditions for Collusion Concentration Entry barriers Demand stability Cost symmetry Product homogeneity Regularity and value of sales Price transparency Information exchange

11 Conditions for Collusion (1) Concentration - As number of firms increase detection of cheating becomes more difficult, so greater incentive to cheat Entry barriers - Entry decrease stream of future profits from collusion so reduces the cost of cheating Demand stability - If demand is unstable it is difficult for a firm to know whether a change to its market share is due to demand fluctuation or cheating

12 Conditions for Collusion (2) Cost symmetry - Firms with different cost structures have different profit maximising strategies so negotiation is more difficult - Changes in technology may give a firm a cost advantage over rivals so would prefer to compete Product homogeneity - Differentiated products make monitoring difficult as it is hard to know if changes to market share are due to changing consumer preferences or cheating Regularity and value of sales - Infrequent, high value sales provide a greater incentive to cheat than those with frequent, low value sales

13 Conditions for Collusion (3) Price/output transparency - The ability to monitor other firms' prices or output facilitates detection, reducing incentives to cheat Information exchange - Facilitates to collusion either by allowing agreements to be reached or by giving firms the tools needed to act in concert without explicit agreement - The latter is more likely as firms, where possible, try to coordinate without entering in to explicit agreements

14 Detection (1) Collusion can occur via: - Explicit agreement between firms - Decisions of trade associations - Concerted practices Concerted practices occur where there is informal cooperation without any formal agreement or decision Need to establish a knowing substitution of cooperation for the risks of competition

15 Detection (2) Collusion can be inferred from data: - Prices are similar and move in concert - Prices do not seem to be consistent with competition given underlying costs But price data is often incomplete Determining whether profits and prices are supra- competitive is difficult (structure v behaviour) However, inferences from price data can form the basis of suspicion and hence further investigation

16 Detection (3) Investigative powers under competition law can be used to confirm or refute suspicion of collusive activity Legal burden of proof generally requires hard evidence of communication on prices, volumes, market sharing - faxes, emails, phone calls etc. - witness testimony Such evidence can be gathered via dawn raids as a last resort

17 Enforcement Any agreement falling within the Article 81 prohibition is immediately void Penalty up to 10% of the worldwide turnover of an infringing firm can be imposed by the competition authority Criminal proceedings can also be brought against individuals leading to maximum 5 year prison term and unlimited fine Affected third parties affected can seek damages in the courts

18 Leniency 'Whistle blowers' who confess cartel activity can be given immunity from penalty under a leniency policy (although in some jurisdictions provisions relating to leniency are found in the law) The mere act of whistle blowing doesn't guarantee immunity; 'continuous and complete' cooperation to bring about successful prosecution is needed Leniency improves the likelihood of effective enforcement and so increases the financial risk of collusion Both firms and individuals can be granted immunity The OFT’s decision on RBS and Barclays is a recent example, RBS was fined ₤29m while Barclays escaped a fine

19 Deterrence Successful cartel busting deters other would-be colluders from entering anti-competitive agreements The deterrence effect is dependent on i) the likelihood of being caught and ii) the costs associated with being caught A well resourced competition authority enforcing a strong competition law improves deterrent Study by Deloitte found OFT enforcement activity on agreements to have a deterrence ratio of 5:1

20 Price Fixing Example - BA BA and Virgin price-fixing fuel surcharges at a time of rising fuel prices Virgin qualified for immunity under the OFT’s leniency policy BA admitted discussing proposed changes to price surcharges with Virgin on six occasions BA, by cooperating fully with the investigation, qualified for a reduced fine of ₤121.5m under the leniency policy Criminal investigations of individuals are ongoing

21 Concerted Practice Example – School Fees 50 fee paying independent schools found to be exchanging information regarding future pricing intentions Found that the concerted practice had as its object the prevention, restriction or distortion of competition – so effect did not need to be established As there was no explicit agreement it had to be proved that the schools were substituting cooperation for the risks of competition An exceptional feature was that all the schools participating are non-profit charitable bodies

22 Sharing Markets Example – UK Construction One way of sharing markets is to share customers through bid-rigging, where firms agree to take it in turns to submit the winning bid OFT uncovered a bid rigging operation among 103 firms in the construction sector in the UK 199 tenders between 2000 and 2006 mostly involving ‘cover pricing’ on projects worth in excess of ₤200m Fines totaling ₤129m imposed with 86 firms benefiting from leniency

23 Sharing Markets Example – UK Construction There is often a trade-off between market power and efficiency as larger firms can exploit scale economies This is why consideration is given to efficiency gains in merger analysis as well as competition effects So horizontal agreements are not barred 'per se' - only those with object or effect of restricting competition Joint ventures, cross-licensing and patent pooling are horizontal agreements which can be efficiency enhancing

24 Thank you for your attention!

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