Margin squeeze strategies in the Telecom sector : a comparative analysis of US and European competition case-law Frédéric MARTY CNRS Fellow Research Group on Law, Economics and Management Innovation in Network Industries : accounting, economic and regulatory implications Innovation & Regulation Chair Paris, March 16 th,

According to the OECD, a margin squeeze is an exclusionary abuse of dominance that arises when a vertically-integrated monopolist sells an upstream bottleneck input to rival firms that also compete in a downstream market with the monopolist in the provision of a downstream product. If the price of an essential input is higher than the retail price, the dominant firm can squeeze its rivals. 2

A model of margin squeeze (OECD, 2009) 3

The margin squeeze according to the EU competition case law A margin squeeze is observed when the spread between price at which a vertically integrated monopolist sells the downstream product and the price at which it sells the upstream bottleneck product to its rivals is not sufficient to allow an efficient downstream rival to effectively compete 4

A transatlantic divide in competition policy Margin squeeze as an autonomous abuse of dominant position (Europe) A rejected concept in US Antitrust Law Sidak J.G., (2008), Abolishing the Price Squeeze as a Theory of Antitrust Liability, Journal of Competition Law and Economics, 4(2), pp European and US conflicting views

The margin squeeze test (DT case, access to the telecommunications local loop for Internet providers) There is an abuse of a dominant position where the wholesale prices that an integrated dominant undertaking charges for services provided to its competitors on an upstream market and the prices it itself charges end-users on a downstream market are in a proportion such that competition on the wholesale or retail market is restricted Case 2003/707/EC, May 21th 2003 – Deutsche Telekom, §106 6

In DT, the spread was negative in a first period (e.g. upstream price > downstream price) and not sufficient in a second one (§102) A margin squeeze exists if the charges to be paid to DT for wholesale access are so expensive that competitors are forced to charge their end-users prices higher than the prices DT charges its own end-users for similar services 7

A margin squeeze could also arise since the spread between upstream and downstream prices does not allow a competitor which is as efficient as the undertaking to compete for the supply of those services to end user. Such insufficient spread could either mean that the competitor could only operate at a loss on the retail market, or at reduced level of profitability Court of Justice, case 52-09, February 17 th, 2011, TeliaSonera, §

The European treatment of margin squeeze cases sharply contrasts with the US one. According to Grimmes (2010), the Linkline decision of the US Supreme Court (2009) constitutes, considering the European competition authorities in DT, the higher point of divergence between US and European competition policies. The same phenomenon as the Essential Facilities Doctrine : a concept built from US case-law (resp. Terminal Railroad, 1912 and Alcoa, 1945), finally extensively used in Europe and rejected by US Antitrust (cf. Trinko, 2004) 9

Linkline (2009) : a very similar case (ADSL), a very opposite decision The Supreme Court rules if there is no [antitrust] duty to deal at the wholesale level and no predatory pricing at the retail level, then a firm is not required to price both of these services in a manner that preserves its rivals profit margin (§1120) According to the Supreme Court, the margin squeeze does not have to be considered as a violation of the Section 2 of the Sherman Act by itself. It is necessary to prove an excessive pricing at the wholesale level (if a duty to deal arise from antitrust law) and a predatory pricing at the retail one. 10

An economic analysis Two issues to underline Some economics about margin squeeze strategies A theoretical explanation of such transatlantic divide : Chicago vs Freiburg We do not consider in this presentation the issue of the interaction between sector specific regulation and competition law, which has also a strong influence on the transatlantic divergences In a nutshell : If a sector specific regulation exists, no room for Antitrust law in the US case In Europe, even if the upstream price was approved by the regulator, the dominant firm could infringe article 102 TFEU, as soon as the firm did not use its room for manoeuvre to adjust its retail price in order to prevent the squeeze 11

The margin squeeze at the crossroad of different abuses (Spector, 2008) 1.Excessive pricing at the upstream level 2.Predatory pricing at the downstream one 3.Price discrimination 4.An abuse on its own (by the interplay of the two prices) The economic appraisal of margin squeeze 1.The no economic sense test 2.The as efficient competitor test 3.The consumer welfare test 4.The sacrifice test 12

The no-economic sense test o According to the Chicago argument, the upstream monopolist has no incentive to evict its downstream rivals (single profit theorem) o The post Chicago synthesis and the squeeze rationality 1.Raising rival cost strategies 2.Protecting upstream monopoly power by leveraging a)Preventing downstream competitors entry into upstream one b)Depriving potential competitors on the upstream market from outlet on the downstream one 13

The as efficient competitor test o to protect competition not competitors o to consider dominant firm costs (legal certainty) o An inflection in the European decisional practice from DT (October 2010) to TeliaSonera (February 2011) Where an undertaking introduces a pricing policy intended to drive from the market competitors who are perhaps as efficient as that dominant undertaking but who, because of their smaller financial resources, are incapable of withstanding the competition waged against them, that undertaking is, accordingly, abusing its dominant position (TeliaSonera, §40) When incumbent cost level is specifically attributable to the competitively advantageous situation in which its dominant position places it ( TeliaSonera, §45) A notion of potential comparable efficiency (cf. the new product criterion in EFD ?) Even a less efficient competitor could deprive a monopolist from its quite life ? 14

The consumer welfare test o Is the squeeze profitable for consumer (efficiency defense)? o Taking into account some purpose as consumer choice diversity or liberty to access the market o The special responsibility of the dominant firm vis-à-vis an effective competition market structure o a system of undistorted competition can be guaranteed only if equality of opportunity is secured as between the various economic operators (DT, §230) o A dominant firm would not impose on all its equally efficient competitors a competitive disadvantage such as to prevent or restrict their access to that market or the growth of their activities on it (DT, §234) 15

The profit sacrifice test According to US jurisprudence, a price strategy violates the Section 2 if: An excessive price is imposed at the upstream level such price must violate an antitrust duty to deal if not applicable, a dominant firm is free to charge the price it chooses and to contract with whom it decides A predatory price at the downstream level The plaintiff must demonstrate The dominant firm prices below its costs… … and enjoys a significant chance to recoup its losses. On the contrary in EU case law Recoupment is not necessary to characterize predatory prices A predation does not mandatorily imply that the dominant firm prices below its costs 16

US and European economic tests What economic test to implement ? 17 United StatesEuropean Union Excessive upstream prices ? an upstream monopolist with no duty to deal is free to charge whatever wholesale price it would like : antitrust law does not forbid lawfully obtained monopolies from charging monopoly prices (Linkline, §14) A special responsibility of the dominant firm Predatory downstream prices? Brooke (1993) Pricing below its cost A strong probability to recoup its losses at the second stage Price discrimination as an abuse of dominant position The spread between prices constitutes a self-standing abuse

Protecting an effective competition market structure? A dominant firm could not impair by its conduct (actively or by omission) the durability of a structure of effective competition The practice in question, adopted by a dominant undertaking, constitutes an abuse within the meaning of Article 102 TFEU, where, given its effect of excluding competitors who are at least as efficient as itself by squeezing their margins, it is capable of making more difficult, or impossible, the entry of those competitors onto the market concerned (TeliaSonera, §63) 18

The economic test built by the ECJ in TeliaSonera 1. If the wholesale product is indispensable to downstream competitors, a squeeze is probable as soon as competitors are unable to operate other than at loss or with a reduced profitability 2. If the wholesale product is not indispensable : 1.If the margin between downstream and upstream price is negative, the squeeze is probable 2.If the margin is positive, an exclusionary strategy has to be demonstrated 19

Conclusion ECJ decisions strongly reflects an ordo-liberal influence A dominant firm abuses from its position as soon as its strategy has the effect of hindering the maintenance of the degree of competition still existing in the market or the growth of that competition (DT, §174) Protecting the competition process itself and not its result (consumer welfare) Preventing dominant firms to use their coercive powers (exploitative or exclusionary abuses) Promoting liberty to access the market and consumer freedom of choice 20

Conclusion US Supreme Court is more influenced by Chicago School economics Judge Learned Hand recognized margin squeeze in Alcoa… in 1945 Alcoa violated Section 2 by depriving its competitors of a living profit Alcoa had to charge a fair price In Linkline, a footnote on Alcoa : Given developments in economic theory and antitrust jurisprudence since Alcoa, we find our recent decisions in Trinko and Brooke Group more pertinent to the question before us (§1120) 21

Conclusion The purpose of Antitrust is focalized on consumer welfare maximization The Great Fear of false positives theoretical explanation The limits of antitrust according to Easterbrook No matter of false negatives as soon as markets are self regulating The economic cost of false positives in terms of incentives Institutional explanation Restricting the scope of Section 2 liability while suits for damages are increasing Court based antitrust vs an administrative based competition policy, which aims at constructing competitive markets and at regulating national regulators? 22