1 DG COMP’s Discussion Paper on Article 82: Implications of the Proposed Framework and Antritrust Rules for Dynamically Competitive Industries Christian Ahlborn, Vincenzo Denicolò, Damien Gerardin, and A. Jorge Padilla May 2006 Global Competition Law Centre Lunch Talk

2 The art of being wise is the art of knowing what to overlook - William James (1842 –1910)

3 Introduction The important contribution of dynamically competitive industries to the European economy has recently been acknowledged by the European Commission in its i2010 strategy The economic evidence shows that a healthy ICT sector plays a key role for the growth of the economies of the Member States. However, Europe lags behind the United States in R&D investment and in the development of the information society According to the Kok Report, “companies will only invest in innovation and R&D if they have the certainty that they will be able to reap the rewards of that investment.”

4 Introduction Because it can affect the return to innovation and investment, competition policy can have a significant impact on the development of the ICT sector and other dynamically competitive industries in Europe The impact of competition policy on investment and innovation depends crucially on the rules applied to the assessment of the business practices of dominant firms This is why the Discussion Paper is so important. It “sets out possible principles for the Commission’s application of Article 82 of the Treaty to exclusionary abuses” and “presents the analytical approach that could be used by the Commission” in assessing the business practices of firms with market power

5 Outline Part I. Dynamically Competitive Industries: Economic Features Part II. Assessing DG COMP’s Discussion paper: Analytical Framework Part III. Assessing DG COMP’s Discussion paper: Abuses

6 Part I Dynamically Competitive Industries: Economic Industries

7 Dynamically Competitive Industries Economies of Scale on the Supply Side Network Effects Durable Goods – The Coase Conjecture Dynamic Competition – Competition For the Market Competition in these markets has little to do with undercutting prices at the margin and much more to do with the introduction of drastic innovations, which results in massive transfers of market share

8 Dynamically Competitive Industries The Role of IP Rights – Short Term Competition v Long Term Innovation? Standardization and Compatibility – De Facto Standards v Standard Setting Organisations Competition in these industries involve both substitutes and complements Technological Convergence – Evolving Market Definitions

9 Part II Assessing DG COMP’s Discussion paper: Analytical Framework

10 Overview Overview of the Proposed Framework  harm to competition  defenses and efficiencies  balancing of harms and efficiencies Antitrust goals and implications  consumer welfare maximisation  implications General Issues  two steps forward…  …two steps back Specific Issues for Dynamically Competitive Industries  key considerations  implications

11 Key Questions What is the right legal framework? What is the right legal rule? What is the right safe haven? What is the right standard of proof for competitive harm and efficiencies? On whom should the burden of balancing fall?

12 Antitrust Goals and Implications Antitrust Goals consumer welfare rivalry Other Implications error cost analysis competition rules as a system of deterrence rather than a system of regulation

13 Error Cost Analysis (1) Actual Impact Legal Standard HarmfulNot Harmful IllegalCases that are both harmful and illegal Cases that are not harmful even though they violate the legal rule LegalCases that are harmful even though they do not violate the legal rule Cases that are benign and legal Key Factors frequency of harmful cases rate of false acquittals and false convictions error costs

14 Per Se Legality Rule of Reason Per Se Illegality Standard of proof for competitive harm EC law Economic Analysis Chicago SchoolPost-Chicago Classical Approach Error Cost Analysis (2)

15 The Framework of the DP Antitrust goals consumer welfare maximisation Analytical Framework harm to competition / foreclosure objective justifications and efficiencies balancing

16 General Issues Two steps forward…. focus on consumer welfare move towards an effects based policy …two steps back two stage analysis standard and burden of proof

17 Per Se Legality Rule of Reason Per Se Illegality New Art. 82 approach Old Art. 82 approach Standard of proof for competitive harm EC law Economic Analysis Chicago SchoolPost-Chicago Classical Approach Error Cost Analysis (3)

18 Specific Issues for Dynamically Competitive Industries No reason to exclude dynamically competitive industries from antitrust The characteristics of these industries make the assessment of unilateral behaviour more difficult In dynamically competitive industries, the cost of prohibiting efficient practices tends to far outweigh the costs of permitting anticompetitive practices

19 Per Se Legality Rule of Reason Per Se Illegality Approach DCIs Approach toward standard industries Standard of proof for competitive harm EC law Economic Analysis Chicago SchoolPost-Chicago Classical Approach Error Cost Analysis (4)

20 Part III Assessing DG COMP’s Discussion paper: Abuses

21 Market Definition and Dominance Market Definition – Narrow Markets Focus on “immediate” competitive constraints and “actual” competitors product characteristics Implications for dominance and efficiency defences Dominance – Thresholds Lack of a clear, sufficiently high market share threshold Barriers to entry – me too entry v drastic innovation

22 Predation Modified AKZO Test – Presumptions Average avoidable costs Indirect evidence of intent requires evidence of likely foreclosure Are Those Presumptions Justified? The Role of Intent Evidence of Foreclosure Recoupment Is dominance enough? Above cost predation “To boldy go where no-one has ever gone before”

23 Rebates Unconditional Discounts – Predatory Pricing Conditional Discounts Retroactive rebates Incremental rebates Incremental Rebates ATC rule Incidence rule Retroactive Rebates Non-contestable demand – Assumed? Required market share

24 Rebates Retroactive Rebates... Commercially viable share - ??? Incidence Aggravating factors:  Individualised scheme  Uncertainty  Duration  Evidence of foreclosure Too Difficult – Too Costly Fixed cost recovery Incentives – Common agency Hold up problems – Market Share Discounts

25 Tying and Bundling Three Specific Objections First, No Efficiency Defence “For tying not to be abusive...” Tying may be abusive even when it is in accordance with normal commercial practice Second, Price Discrimination as an Offence The Discussion Paper’s price-cost benchmarks in connection with mixed bundling and the use of bundled rebates (LRAIC) make it impossible to rely on mixed bundling to price discriminate efficiently Especially problematic in two-sided industries

26 Tying and Bundling Third, Technological Integration Placing tight constraints on the ability to integrate features that were traditionally supplied separately may thus reduce innovation and harm consumers Solution - an appropriate “separate product test”: Material demand for both products A and B is required for the decision to offer only AB to restrict consumer choice in a way that is meaningful. And a General Concern – the Burden of Proof Regarding the Balancing of Pro-Competitive and Anti-Competitive Effects Lies on the Dominant Firm

27 Refusals to License Impact on Incentives to Innovate of All Industry Participants Discussion Paper Restricts Intervention to Exceptional Circumstances - Are They Really Exceptional? Separate Upstream and Downstream Markets The Discussion Paper’s language potentially means that dominant firms may be forced to share every technological advance they have made to improve their production processes with competitors, even if there is no existing market for such technology.

28 Refusals to License The New Product Test Lack of clarity - novelty is a vague term Copyrights v patents and the indispensability test Follow on innovation  “A refusal to licence an IPR protected technology which is indispensable as a basis for follow-on innovation by competitors may be abusive even if the licence is not sought to directly incorporate the technology in clearly identifiable new goods and services.”  A rule that implies costs: Almost any technology may be slightly improved when is used.  And entails no benefits: Main effect of compulsory licensing is to shift bargaining power

29 Refusals to License The New Product Test Follow on innovation  …  Restrict intervention to situations when the IP is indispensable to search for the follow-on innovation. More precisely, what we have in mind is the case in which the protected technology is a pure research tool, i.e. a piece of knowledge with zero stand-alone economic value, which however is indispensable to conduct the research that may eventually lead to valuable follow-on innovations.

30 Conclusions The analytical framework and the antitrust rules that are proposed in the Discussion Paper fail to take into account the special characteristics of dynamically competitive industries, such as the ICT industries The rules proposed in the Discussion Paper are likely to cause numerous false convictions (or Type I errors) in these industries: unilateral practices that are efficient and benefit consumers may be found to be anticompetitive incorrectly

31 Conclusions In our view, the right approach towards this industry involves (a) limiting intervention to circumstances where the pro- competitive effects of intervention are large (because, for example, the exclusionary effects of a given practice risk eliminating all competition and prevent the emergence of new products or markets), and the disincentive effects of intervention are small and non-existent; and (b) allocating the burden of proof as regards the balancing of the pro-competitive and anti-competitive effects of a practice to the plaintiff or the enforcement agency The art of being wise is the art of knowing what to overlook