1. Economics RBB OXFORD, FEBRUARY 2006RBB ECONOMICS ARTICLE 82 REFORM: AN ECONOMIC PERSPECTIVE(?) IESTYN WILLIAMS [These thoughts are preliminary. Comments welcome.]

2. IESTYN WILLIAMS Economics RBB 2 RBB ECONOMICS OXFORD, FEBRUARY 2006 OVERVIEW General perspective on approach: ─ Does it provide an appropriately economic perspective? Market definition and market power: useful filters? Differentiating ‘right’ from ‘wrong’ and the “special responsibility” Consistency across forms

3. IESTYN WILLIAMS Economics RBB 3 RBB ECONOMICS OXFORD, FEBRUARY 2006 EFFECTS- NOT FORM-BASED APPROACH Growing recognition (?) that an explicitly economics- based approach is needed Common ground among (most) economists that form-based rules are not generally appropriate –Pro- and anti-competitive motivations for most relevant forms of behaviour –Overlaps such that form-based bright lines not desirable –Danger of inconsistent treatment of conduct with equivalent effects

4. IESTYN WILLIAMS Economics RBB 4 RBB ECONOMICS OXFORD, FEBRUARY 2006 FOCUS: HARM TO COMPETITION Focus on exclusion Consensus that (consumer) welfare effect is ultimate economic measure ─ But how practical/appropriate is this as a guide in specific Article 82 cases? Develop a coherent fact-based story of harm to competition –When does foreclosure of particular competitors harm the competitive process and consumers? –[How should ‘collateral’ damage be treated?]

5. IESTYN WILLIAMS Economics RBB 5 RBB ECONOMICS OXFORD, FEBRUARY 2006 CLEAR BUT ARBITRARY RULES DON’T HELP Example: Treatment of common costs in DG COMP DP DP provides rule on how common costs will generally be allocated in multi-product settings ─ Allocated in proportion to turnover achieved on individual products Allows calculation of Average Total Costs associated with a product Does not imply, however, that analysis based on this ATC rule makes economic sense

6. IESTYN WILLIAMS Economics RBB 6 RBB ECONOMICS OXFORD, FEBRUARY 2006 INTERVENTION IS COSTLY Competition authorities need to balance costs of false positives and false negatives ─ In dynamic market settings, impact of mistaken interventions (and precedents created) may easily outweigh effects of non-intervention Recognise too that freedom to intervene also creates uncertainty which damages healthy competition ─ Chilling effect on the competitive process ─ Value in non-intervention commitments even if some harmful conduct escapes

7. IESTYN WILLIAMS Economics RBB 7 RBB ECONOMICS OXFORD, FEBRUARY 2006 Filters and safe harbours can play a valuable role in narrowing focus For example, in testing a foreclosure story: –Does the target for investigation possess market power? –Does the conduct in question actually affect the buyer’s incentives to deal with the competitor? –Are alternative routes to market available? Insufficient emphasis in DG COMP DP? FILTERS HAVE A VALUABLE ROLE

8. IESTYN WILLIAMS Economics RBB 8 RBB ECONOMICS OXFORD, FEBRUARY 2006 IS A MARKET POWER FILTER USEFUL? Current Article 82 process involves three distinct stages: ─ Market definition ─ Competitive (dominance) assessment ─ Analysis of conduct EAGCP suggested that “an effects-based approach needs to put less weight on a separate verification of dominance”

9. IESTYN WILLIAMS Economics RBB 9 RBB ECONOMICS OXFORD, FEBRUARY 2006 MARKET POWER I Common ground that only firms with substantial market power can cause harm to competition Logic  if prove harm, dominance is automatically satisfied Only need to focus on conduct? HARMFUL CONDUCT DOMINANCE X

10. IESTYN WILLIAMS Economics RBB 10 RBB ECONOMICS OXFORD, FEBRUARY 2006 MARKET POWER II In practice risk that abandoning dominance ‘pre- qualification’ will lead to excessive intervention –Backward implementation (“We know abuse when we see it”) –Testing for harm not that straightforward CONDUCT DOMINANCE HARMFUL CONDUCT

11. IESTYN WILLIAMS Economics RBB 11 RBB ECONOMICS OXFORD, FEBRUARY 2006 IS DOMINANCE FILTER TOO RESTRICTIVE? Concern sometimes expressed that dominance (market share) precedents prevent action against abuse in some settings Example: Electricity generation and OFGEM’s Market Abuse Licence Condition 2 responses: ─ From an economic perspective, definition of dominance is not a limitation ─ Value in commitment to non-intervention, even if prevents justified action in some cases

12. IESTYN WILLIAMS Economics RBB 12 RBB ECONOMICS OXFORD, FEBRUARY 2006 MARKET DEFINITION: SSNIP TEST Dominance assessment requires markets to be defined Hypothetical monopolist or SSNIP test provides well- established basis for market definition in competition cases ─ Could a hypothetical monopolist controlling products in hypothesised market raise prices permanently and profitably by 5% - 10% ─ If YES, set of products represent a well-defined market; if NO, broaden Provides a framework for assessing strength of demand- and supply-side substitution

13. IESTYN WILLIAMS Economics RBB 13 RBB ECONOMICS OXFORD, FEBRUARY 2006 MARKET DEFINITION: PRACTICALITIES In practice, the market definition exercise typically involves a rounded assessment, ─ Draws on multiple pieces of evidence ─ An overall picture of competition is assembled Relatively rare for test to be applied formally Nevertheless, conceptual/organising value of SSNIP framework remains important

14. IESTYN WILLIAMS Economics RBB 14 RBB ECONOMICS OXFORD, FEBRUARY 2006 MARKET DEFINITION: CELLOPHANE FALLACY A firm with market power might be expected to have raised prices already to point where no further price increases possible ─ ie to point where demand is elastic Conducting SSNIP test at prevailing prices would lead to overly broad market definition in this case ─ But not a SSNIP-specific problem [Where low pricing concerns, reverse distortion may arise] Fundamental problem: What is competitive price (benchmark)?

15. IESTYN WILLIAMS Economics RBB 15 RBB ECONOMICS OXFORD, FEBRUARY 2006 CELLOPHANE FALLACY: IMPLICATIONS Significant damage to application of market definition test in conduct settings ─ cf. merger settings where prevailing price is relevant benchmark Is there any value in undertaking market definition exercise? ─ SSNIP still provides important conceptual framework for analysis ─ Not all evidence is contaminated However, emphasises need for careful analysis of effects

16. IESTYN WILLIAMS Economics RBB 16 RBB ECONOMICS OXFORD, FEBRUARY 2006 TREATMENT OF CONDUCT: PREDATION EXAMPLE Summary of DG COMP DP Approach: AAC ATC Predation presumed Focus on intent, broadly defined. Documentary evidence may lead to presumption Broad range of indicators, eg selective price cutting, actual exclusion. Predation finding possible, where “non-replicable” advantages in play

17. IESTYN WILLIAMS Economics RBB 17 RBB ECONOMICS OXFORD, FEBRUARY 2006 HOW FAR SHOULD “SPECIAL RESPONSIBILITY” EXTEND? Should a dominant firm be obliged to forego actions whose (incremental) profitability does not depend on excluding rivals? ─ Classic example: Selective price cutting on “marginal” sales Must a dominant firm price to allow less efficient firms to survive? ─ DG COMP DP says yes … sometimes ─ Is this a reasonable obligation? ─ Is it desirable?

18. IESTYN WILLIAMS Economics RBB 18 RBB ECONOMICS OXFORD, FEBRUARY 2006 INTENT Helpful recognition in DG COMP DP that “general talk” is not evidence of intent Nevertheless, direct evidence claimed to allow presumption of predation ─ Avoids need to test coherent theory of harm Broad range of factors identified as contributing to “indirect evidence” ─ Example: Above avoidable cost selective pricing

19. IESTYN WILLIAMS Economics RBB 19 RBB ECONOMICS OXFORD, FEBRUARY 2006 INDISPENSABILITY AND “SACRIFICE” TESTS Meeting the competition: Could losses be avoided/efficiencies achieved in a less distorting way? Generally imposes to high a burden on firms –Impact of genuine mistakes etc –How much sophistication reasonable? Useful as a guide to exploring business motivations BUT not a definitive test

20. IESTYN WILLIAMS Economics RBB 20 RBB ECONOMICS OXFORD, FEBRUARY 2006 CONSISTENT TREATMENT OF COMMON THEMES Example: Selective price cuts and rebates (& predation) –Common concern is abusive low pricing –Consistent analytical framework Focus on possible foreclosure of equally efficient competitors – Avoidable cost tests appropriate Identify and focus on sales range that is open to competition

21. IESTYN WILLIAMS Economics RBB 21 RBB ECONOMICS OXFORD, FEBRUARY 2006 CONSISTENT TREATMENT II Consistent treatment of low pricing effects required Example: Rollback rebate of 20% on 80% sales target DG COMP DP appears to endorse ATC as floor for low pricing in rebates context Assured base of sales ‘Open’ to competition Cost threshold % of needs60% 20 80%

22. IESTYN WILLIAMS Economics RBB 22 RBB ECONOMICS OXFORD, FEBRUARY 2006 FORM AND EFFECT REVISITED Form-based predation tests need thoughtful application Example: Roll-back rebates Form: -ve pricing for some ranges Effect: Are these ranges competitively relevant ?

23. IESTYN WILLIAMS Economics RBB 23 RBB ECONOMICS OXFORD, FEBRUARY 2006 END NOTE: EMPHASIS ON FORMAL MODELS EAGCP emphasised role of formal models Formal modelling offers transparency and rigour –An important weapon in the armoury However, can gain a momentum of its own –Spurious confidence in predictions –Risk ignoring important factors because less easily modelled Relying on implications of a particular theoretical model generally over-optimistic and potentially harmful

24. IESTYN WILLIAMS Economics RBB 24 RBB ECONOMICS OXFORD, FEBRUARY 2006 CONCLUSIONS Focus for investigation must be a coherent fact-based theory of harm Consistent effects-based analysis required Can’t escape serious implications of cellophane fallacy Recognise benefits of not intervening Demands made of dominant firms in abuse context must be: ─ Base on standards (eg cost benchmarks) that the firm can reasonably be expected to know ─ Motivated by serious concerns of harm to the competitive process