What is a dominant supplier & what does competitive restraint mean?
Price discrimination refers to a difference in prices charged to different customers. The Act has a very specific set of requirements that need to be proven if the price discrimination is to be considered as a prohibited practice. Before anything else can be considered, the supplier must be dominant. Note that price discrimination deals with a supplier and a customer, and the differences in prices between different customers.
The Act defines a dominant supplier and more on that a little later. First we need to determine what is known as the relevant market. After all, a supplier can only be dominant in a market in the context of economic activity. This is not to say a supplier cannot be dominant in more than one market or activity at the same time. In the South African condition, this is often the case.
In price discrimination cases, the relevant market is the first matter that needs to be determined. Only then can the questions regarding proof of dominance be considered. Motta, someone learned in these matters tells us that;
“Since market definition is instrumental only to the assessment of market power, the relevant market should not be a set of products, which ‘resemble’ each other on the basis of some characteristics, but rather the set of products (and geographical areas) that exercise some competitive constraint on each other.’’
Motta’s comment is revealing and two important considerations are present. Firstly, that in competition matters it is market power that is the most important factor in determining dominance. This it appears is what we are trying to assess. Secondly, that the “set of products” comprising the market should be substitutes for each other. That is, each of the products should discipline the competitive responses available to the other products.
Market power implies that a firm has freedom to act without consideration as to the competitive response posed by potentially competitive products. In other words, it appears that a market in this context comprises those products that can be considered by the consumer as being substitutes for each other. Obviously we need to consider who the consumer is and why the product is important in the life of that consumer. The consumer after all purchases the product.
Substitutability between products does not suggest perfection. Degrees of substitution appear to be possible. In the words of Prof. Roberts, “good substitutes exert competitive discipline on each other in terms of prices, and their prices would thus be expected to follow similar patterns. For good substitutes, a significant price increase would be expected to see buyers switching en masse to the alternative product. For perfect substitutes this switch would be total.”
Pricing patterns can therefore be used to determine market power. Consumer buying patterns are determinative of the levels of competition in the presence of price differences between substitutes. The level at which price similarities or consumer switching indicate a competitive restraint has not yet been decided. It is unlikely that price similarities or differences will be the only factor to be considered in determining the substitutability of products. Other factors may also be important, depending on the circumstances of the apparent competition between products.
For those who have some knowledge of economics, the above arguments relate to the price elasticity’s of demand of the products. Dissimilar price elasticity’s of demand indicate a divergence in the ability of two products to compete. However, the simple concept of price elasticity of demand taught in first year economics may not be appropriate, due to problems associated with other influences on market demand etc. Other influences such as time series seasonality and aberrations may also affect the calculations. Expect a technical debate at an advanced level in this regard.
High margins earned by a product indicate a lack of competition for that product. But a lack of competition may not be the only reason for high margins. Technological and other cost advantages may temporarily contribute to high margins, even in the presence of other good substitutes. Excessively high margins earned over a sustained period indicate market power, and a compromised competitive market. This is so because in a competitive market, excessive profit will be attacked by new entrants into that market. Absent such an entry, we must ask why and how competition was compromised.
This brings us to the question of barriers to entry to a market. If the barriers to entry to a market are high, for whatever reason, then it is likely that the competitive process within that market has been compromised. Freedom to enter and leave the market is constrained by factors such as the costs of entry, access to raw materials, technological advantages, patent protection etc. Since freedom to enter and leave a market is essential to the operation of any competitive market, barriers to entry compromise the presence of a competitive market. In the presence of high barriers of entry it can be argued that a competitive market cannot be presumed to exist.
Supplier behaviour is an indicator of the health of a market and hence the competitive processes at work in that market. Suppliers that do not negotiate prices do not, on the face of it, exhibit a proper competitive response. However the absence of price negotiation by a supplier could also indicate that prices are already at an economic minimum and cannot be further reduced. For this reason, refusal to negotiate is anti-competitive only when excessive profit is earned on the sale of the product.
The Definition of Market Power.
When reading the Act, it is easy to focus on the percentages necessary in order to prove dominance. These are readily accessible, and easily understood. But these percentages merely tell us that in what relevant circumstances, dominance is deemed to be present. We must look further in order to understand why this is so.
As suggested by Motta, competitions law relates to the assessment and abuse of market power. Market power is defined in the Act. In the presence of market power, a firm is deemed to be dominant. Therefore, the definition of market power becomes the crux of the proof of dominance. To understand what is contemplated by market power, we must consult the Act. Market power is defined as follows:
‘market power’ means the power of a firm
1. to control prices, or
2. to exclude competition or
3. to behave to an appreciable extent independently of its competitors, customers or suppliers;
Proof of any one of these three criteria is determinative of the presence of market power. If it is possible for a firm to exercise any of the three items detailed above, then it has market power, for the exercise of that power is necessary in order to achieve these ends. Additional comment is warranted as all is not a simple as it as first glance seems.
Regarding the power to control prices, this is somewhat difficult to prove. We are unsure as to quite what is required by way of proof in this regard. Certainly prices substantially in excess of those charged by competitors and charged over a sustained period would indicate market power. The ability to set prices well in advance and then stick to these prices may also be determinative of price control. Finally, the ability to influence the market price of a product would determine the presence of price control.
Regarding the ability to exclude competition, we need to note a number of things. Firstly, the Act does not define whether the competition it refers to relates to the upstream or downstream markets. The Act is silent in this regard. Clearly the ability to exclude competitive activity in the upstream market is contemplated. Any firm that has the power to prevent the entry into its markets by competitors exercises market power. The mechanisms whereby this power is exercised are many and varied. They can take the form of raw material control, the propensity to set prices at a predatory level, sanctions against deviant customers that break a code of compliance etc.
But if a supplier is in cahoots with its customers, and acts in such a way as to affect the competitive process in the downstream market, then it equally can affect competition. It is for this reason that we believe the Act does not limit the effect on competition to any particular market. Had the Act intended that only the upstream market be considered in this context, then surely it would have said so. If we are correct, then any action that exercises the power to exclude competition in any market will trigger the presence of market power.
Perhaps the most important of the criteria determining market power is that relating to the ability to act independently of customers, suppliers or competitors. The definition does not require an absolute ability to act independently. It is sufficient if this independence is shown to be present to an appreciable extent. If a firm has the ability to set prices, demand and enforce particular terms and conditions of trade, ignore its alleged competitors or force prices upon its suppliers then these facts would be sufficient to evidence market power. They evidence more than a power to act to an appreciable extent independently. Such power is absolute and unequivocal. The extent to which the requirement of “an appreciable extent” is evidenced in the proof of market power will be a matter of debate and argument in the absence of absolute proof. Circumstances will therefore be important in determining market power by this means.
If market power as defined above is present, then the Act tells us that it is a dominant firm. This is the primary requirement for dominance, and is effective even in the presence of low market shares.
If market shares are above 45%, then a firm is dominant. This is the reason why the relevant market definition is so important. If a firm has a market share of between 35% and 45%, then it is presumed to be dominant, unless the firm can prove that it does not have market power. Note that the onus of proof is on the firm to prove it does not have market power if its market shares are between 35% and 45%.
We should consider the reasons why the Act has two different methods of proving market power. This is important if one understands the traditional tactics of litigation. The defence traditionally goes something like this. If the defence can broaden the market definition by including additional products or services, then market shares reduce accordingly, and the burden of proof on a complainant increases by way of diminished market shares. Such an approach by a defence could become impenetrable in the absence of the market power proof. The effect of the market power proof is to include balance against this overused tactic. For every circumstance that the market definition is unnecessarily broadened by the defence, opportunity is opened to prove that the supplier acts independently of the competing product it suggests to be present in the market definition. The following example demonstrates how such a situation may come about.
Let is consider the scenario of a supplier of soft drinks that defines the relevant market to be that of thirst quenching liquids and prices its product materially higher than the price of water. By pricing its product materially higher than that of water, the supplier acts independently of its own alleged competitor in the market definition, the thirst quenching liquid, water. The price difference evidences a lack of competitive restraint. After all, competing products must constrain each others prices in order to be substitutes. If products do not engender competitive restraint, then the products cannot be competing in the same market. Market power provides opportunity to prove dominance even in the absence of market shares. For this reason, market power is probably easier to prove than market share data.
There exist many sources of market share data. The obvious source is an industry body if such a thing exists. Customs & excise figures may also assist in determining market volumes. By obtaining data from all the competitors in a market, it is possible by dint of hard work to estimate market shares. However, this is not the end of the story. Geographical considerations may separate markets. For example if the costs of transport are prohibitive relative to the sales price of the product, product competition may be separated through the costs implicit in their availability at particular places.
Take for example cement. It has a relatively low cost compared to the mass of the product. It would not be possible for a Johannesburg cement manufacturer to transport cement to Cape Town and compete with a local Cape cement manufacturer, unless local market prices were well in excess of the economic prices needed to produce the cement. Sure there are assumptions in this scenario, but it demonstrates the principles involved.
Some markets are national in scope. Others are local in nature. The geographical extent of the market should be considered against the test of competitive restraint. It is this test that appears to be the most important test in determining the scope of a market in the context of this discussion. It is for this reason that the test of competitive restraint becomes a strategic business matter, essential to the formation of pricing policy and response. Absent competitive constraint by competing products or services, and we mean constraint in the proper sense, dominance can be assumed by any business assessing its competitive strengths.
Dominant businesses are suggested to have special duties of care in the competitive context but more on this subject later in the series.
Free Sub domain hosting from www.family.nu
Disclaimer: This site does not profess to offer legal assistance or interpretation. It’s content reflects the view and experience gained by of the author during a hearing at the Competitions Tribunal of South Africa. It may help you to figure out what happens & why.