The consultation on these draft Guidelines will run until 26 February 1999.
Comments are invited on any aspect of these draft Guidelines.
Written comments should be submitted to:
David J O'Neill
Consultation on Telecoms Competition Act Guidelines
Oftel
50 Ludgate Hill
London EC4M 7JJ
Fax: 0171 634 8949
Comments on this document can also be sent to Oftel by e-mail
Written comments will be made publicly available on Oftel's website except where
respondents indicate that their response or parts of it are confidential. Respondents are
therefore asked to separate out any confidential material into a confidential annex which
is clearly marked as such. In the interests of transparency, respondents are requested to
avoid confidentiality markings wherever possible.
Oftel is willing to set up a link between this document on Oftel's pages and any responses
placed on respondents' own Internet pages. Please contact Lauren Ryner at Oftel on 0171
634 8753 should you wish to arrange this.
Confidential responses should not be sent via the Internet.
Alternative formats
Oftel documents are also available in alternative formats. Copies on disk in various
formats and in large print are available. We also offer braille and tape copies of the
summary on request. Please contact the Oftel Research & Intelligence Unit on 0171 634
8617, or e-mail , or call Textphone 0171
634 8769 for more information.
Summary
1. The Competition Act
Purpose of competition
policy and the Competition Act
Guidelines relating to the Competition
Act
An
overview of the Competition Act
Precedent
2.
Concurrency and the extent of the Director General of Telecommunications' concurrent
powers
Concurrency
Extent of
the Director General of Telecommunications' concurrent powers
3.
The need for Competition Act Guidelines specific to the telecommunications sector
The need for
Guidelines
The need for
Guidelines specific to the telecommunications sector
Scope of
these Guidelines
Further
reviews of these Guidelines
4.
Relationship with Telecommunications Act licence conditions
Taking
action under the Telecommunications Act or the Competition Act
Interaction
between the Competition Act and the Telecommunications Act
The Competition Act and the
Fair Trading Condition
5. Market definition
The purpose of market definition
Approach
to market definition
Market definition in the
telecommunications sector
Applied market
definition in the telecommunications sector
6. Assessment of market power
Factors relevant to assessing market
power
Applied assessments of
market power in telecommunications
Market
power related concepts: Dominance, Significant Market Power and Market Influence
7. Assessment of
individual agreements and conduct
Pricing
issues
Non-pricing
issues
Anti-competitive
agreements
Annex I Other relevant sources
Annex II Area of activity within which the
Director General of Telecommunications has concurrent powers
The Competition Act (which is based on Articles 85 and 86 of the EC Treaty) is enforced
concurrently by the Director General of Fair Trading and the sector regulators. In
conjunction with the regulators, the Director General of Fair Trading is required to
prepare and publish advice and information, in the form of Guidelines, on the application
and enforcement of the prohibitions. The regulators can also issue Guidelines specific to
the sectors in which they have concurrent jurisdiction with the Director General of Fair
Trading. These Guidelines are issued by the Director General of Telecommunications in
conjunction with the Director General of Fair Trading. The Guidelines are intended to set
out the general principles that the Director General of Telecommunications and the
Director General of Fair Trading (hereafter referred to as 'the Director General') expect
to apply when exercising powers under the Competition Act in the telecommunications
sector.
As the telecommunications sector in most European Union Member States has only been
recently opened up to competition, there is limited jurisprudence in the application of
Articles 85 and 86 of the EC Treaty to the sector. This, combined with the technological,
economic and historical factors that make the sector different, necessitates sector
specific Guidelines so that those involved in the telecommunications sector, and those who
consider themselves to have been affected by anti-competitive behaviour, are better able
to assess for themselves the circumstances in which particular types of behaviour are
likely to be prohibited.
These Guidelines, which are consistent with the Guidelines produced by the Office of Fair
Trading and the regulators, set out the approach that will be taken in applying and
enforcing the Competition Act in the telecommunications sector. They focus on market
definition, the assessment of market power and the assessment of individual agreements and
conduct in the telecommunications sector. The Guidelines do not set out to reproduce the
Guidelines produced by the Office of Fair Trading and the regulators on these subjects
which are generally as relevant to the telecommunications sector as they are to other
sectors of the economy. They instead concentrate on areas where the idiosyncrasies of the
telecommunications sector mean that a different emphasis or a slightly different approach
in the application of the Competition Act is likely while at the same time ensuring
consistency with the Guidelines produced by the Office of Fair Trading and the regulators.
The contents of the Guidelines are as follows;
1. The Competition Act
Purpose of
competition policy and the Competition Act
1.1 Competition is an essential element in the efficient working of markets. It encourages
enterprise and efficiency, and widens choice. It enables consumers to buy the goods and
services they want at the best possible price.
1.2 The aim of competition policy is to encourage and enhance the competitive process, but
the line between vigorous but fair competition and anti-competitive or abusive conduct can
be a fine one. Competition policy does not protect particular businesses which may be
adversely affected by fair competition inevitably there are winners and losers from
competition but it is designed to protect the competitive process itself.
1.3 The Competition Act 1998 replaces a number of Acts of Parliament which had previously
sought to safeguard competition by allowing for intervention in response to
anti-competitive behaviour, but which, for the most part, did not prohibit any
particular kinds of behaviour, and which had become increasingly cumbersome to operate.
The Competition Act is based on Articles 85 and 86 of the Treaty of Rome and introduces
into United Kingdom competition law prohibitions of anti-competitive agreements, decision
or practices, and of the abuse of a dominant position in a market, with the possibility of
imposing penalties in the form of civil fines for breach of the prohibitions. The
Competition Act is about protection as well as prohibition: protection of the
competitive process which, in turn, protects the interests of consumers. It provides a
mechanism under which competitors who believe they are suffering from unfair competition
can make their position known and for the allegations to be investigated thoroughly and
effectively, with the possibility of imposing interim measures to restore the status quo
where necessary while the investigation continues.
Guidelines relating to the
Competition Act
1.4 The Competition Act is enforced concurrently by the Director General of Fair Trading
and the sector regulators. In conjunction with the regulators, the Director General of
Fair Trading is required to prepare and publish advice and information, in the form of
Guidelines, on the application and enforcement of the prohibitions. The regulators can
also issue Guidelines specific to the sectors in which they have concurrent jurisdiction
with the Director General of Fair Trading. These Guidelines are issued by the Director
General of Telecommunications in conjunction with the Director General of Fair Trading.
1.5 These Guidelines are intended to set out the general principles that the Director
General of Telecommunications and the Director General of Fair Trading (hereafter
collectively referred to as 'the Director General') expect to apply when exercising powers
under the Competition Act. However, they do not form part of the Competition Act and they
do not affect its legal scope. The Director General would normally expect to follow them
and to give his reasons if he departed from them. The Director General cannot legally
fetter his discretion in advance and therefore he retains the ability to depart from the
Guidelines where the circumstances warrant it. The Guidelines are, therefore, not legally
binding on the Director General. The Guidelines will be updated from time to time to take
into account developments in the telecommunications sector in the future.
An overview of the Competition Act
1.6 The Competition Act is based on Articles 85 and 86 of the EC Treaty, although it does
not allow the Director General to apply those Articles directly. The Competition Act has
two main features:
Precedent
1.7 The Competition Act aims to ensure that, as far as possible, the UK prohibitions are
interpreted, and develop, consistently with EC competition law. Section 60 of the
Competition Act therefore requires that those applying the prohibitions should act so as
to seek to ensure no inconsistency (subject to relevant differences such as single market
objectives) with the way in which Articles 85 and 86 have been interpreted by the European
Court. There is also a duty to have regard to any relevant decision or statement of the
European Commission. For example, the appreciability test laid down by the European Court
will be imported into the interpretation of the UK prohibition of anti-competitive
agreements, so that only agreements with 'appreciable' effects on competition are caught.
1.8 EC competition law, which is the model for the prohibitions, applies to restrictive
agreements, decisions, concerted practices and to abuses of a dominant position where they
may affect trade between Member States of the European Union. UK businesses may,
therefore, be subject to EC legislation as well as the prohibitions in the Competition
Act.
1.9 There is a considerable volume of EC case law, and, while it is reflected in
these Guidelines, the Guidelines should not be regarded as an authoritative interpretation
of EC law.
Concurrency
2.1 For a number of industries the application and enforcement of the Competition Act is
carried out by the existing regulator concurrently with the Director General of Fair
Trading. The Office of Fair Trading and the regulators have produced Guidelines (Concurrent
Application to Regulated Industries hereafter referred to as the 'Concurrency
Guidelines') which deal with concurrency as it applies to all the industry sectors where a
regulator has concurrent powers with the Director General of Fair Trading. Those
Guidelines provide further detail on certain aspects of concurrency and how it will work
in practice.
2.2 The Director General of Telecommunications is entitled to exercise, concurrently with
the Director General of Fair Trading, almost all of the functions of the Director General
of Fair Trading insofar as those functions relate to;
2.3 "Commercial activities connected with telecommunications" is defined in Section 4(3) of the Telecommunications Act 1984 as follows:
"commercial activities connected with telecommunications means any of the
following, that is to say, the provision of telecommunication services, the supply or
export of telecommunications apparatus and the production or acquisition of such apparatus
and the production or acquisition of such apparatus for supply or export"
The Telecommunications Act goes into further detail as to what is meant by this definition
and Annex II of these Guidelines contains the full text of Section 4. Throughout these
Guidelines the area of activity within which the Director General of Telecommunications
has concurrent jurisdiction with the Director General of Fair Trading will be referred to
as the 'telecommunications sector'.
2.4 As stated in the Concurrency Guidelines, agreements or conduct which fall within the
concurrent jurisdiction of the Director General of Telecommunications would normally be
dealt with by the Director General of Telecommunications. The Director General of
Telecommunications and the Director General of Fair Trading will, however, always consult
with each other, and in some cases the Director General of Fair Trading will deal with a
case that falls within the area of concurrent jurisdiction.
Extent
of the Director General of Telecommunications' concurrent powers
2.5 Where cases fall within the jurisdiction of the Director General of
Telecommunications, the Director General of Telecommunications has almost all of the
powers of the Director General of Fair Trading to apply and enforce the Competition Act.
The Director General of Telecommunications may:
2.6 The Director General of Fair Trading alone, however, has powers to issue guidance on penalties and to make and amend the Director's Rules which set out the procedures to be followed in enforcing the provisions of the Competition Act.
The need for Guidelines
3.1 The Director General of Fair Trading and the regulators are required to publish advice
and information in the form of Guidelines on the application and enforcement of the
Competition Act. To that end a suite of Guidelines covering many issues that arise out of
the Competition Act has been published (see Annex I for a full list). The regulators can
also issue Guidelines specific to the sectors in which they have concurrent jurisdiction
with the Director General of Fair Trading.
The
need for Guidelines specific to the telecommunications sector
3.2 The European Commission recognises that the telecommunications sector is different in
some respects to other sectors and that, given that the telecommunications sector in most
European Union Member States has only been recently opened up to competition, there is
limited jurisprudence in the application of Articles 85 and 86 of the EC Treaty to the
sector. Therefore, licensees and others require guidance about the types of behaviour and
agreements which are likely to be prohibited in the context of the telecommunications
sector and to that end the European Commission has published Guidelines specifically
dealing with the application of Articles 85 and 86 to the telecommunications sector in the
EU context (Guidelines on the application of EEC competition rules in the
telecommunications sector (91/C 233/02) [hereafter referred to as the 'EC
1991 Guidelines'] and the 1998 Notice on the application of the competition rules to
access agreements in the telecommunications sector (98/C 265/02) [hereafter referred
to as the 'EC Access Notice']).
3.3 The distinctive features of the telecommunications sector are, in part, the reason why
telecommunications is subject to sector specific regulation (by way of the
Telecommunications Act 1984 and certain EU Directives). The Director General, in line with
the EC, also recognises that the distinctive features of the telecommunications sector
necessitate a different emphasis or a slightly different approach in the application of
competition rules (the Competition Act being based on Articles 85 and 86 of the EC Treaty)
in some instances. The following paragraphs (3.4 3.6) outline the distinctive features
of the telecommunications sector. They also indicate some of the implications that these
features will have for the application of competition rules these implications are
dealt with in more detail in Section 7.
3.4 One factor which makes the telecommunications sector different arises from a
combination of technological and economic features. While some of these features are found
in other sectors of the economy, they are particularly significant and prevalent in the
telecommunications sector;
3.5 A second major factor is the prevalence of 'externalities'. Few sectors in competitive markets exhibit the range of externalities that exist in the telecommunications sector which arise because of its network nature and the fact that a call always involves two participants. The externalities fall under three headings;
3.6 A third factor which makes the UK telecommunications sector different is its history. Until 1984 BT was the only provider of telecommunications services in most of the UK. The transition from monopoly to competition in the UK telecommunications sector is now well under way. However, during the remainder of the transitional period, the ex-incumbent monopolists will be in a position to abuse their positions in fairly predictable ways. Section 7 discusses some of these potential abuses in detail. The history of the telecommunications sector also means that:
By their nature, the historical factors that make the telecommunications sector
different are likely to be short term.
3.7 EC jurisprudence relating to the application of Articles 85 and 86 sets the framework
for the application of the Competition Act prohibitions to the telecommunications sector
as it does in all other sectors. The Director General will therefore be guided by EC
jurisprudence relating to the application of Articles 85 and 86 from outside the
telecommunications sector, although that jurisprudence will, because of the idiosyncrasies
of the telecommunications sector, be less relevant in some instances. The Director General
will also be guided by relevant cases that DGIV have dealt with, particularly under the
European Community Merger Regulation. However, the lack of EC jurisprudence relating
directly to the telecommunications sector, combined with the factors outlined in
paragraphs 3.4 3.6 that make the sector different, necessitate sector specific
Guidelines so that those involved in the telecommunications sector, and those who consider
themselves to have been affected by anti-competitive behaviour, are better able to assess
for themselves the circumstances in which particular types of behaviour are likely to be
prohibited.
Scope of these Guidelines
3.8 These Guidelines, which are consistent with the Guidelines produced by the Office of
Fair Trading and the regulators, set out the approach that the Director General will take
in applying and enforcing the Competition Act in the telecommunications sector. They focus
on market definition, the assessment of market power and the assessment of individual
agreements and conduct in the telecommunications sector. The Guidelines do not set out to
reproduce the Guidelines produced by the Office of Fair Trading and the regulators on
these subjects which are generally as relevant to the telecommunications sector as they
are to other sectors of the economy. They instead concentrate on areas where the
idiosyncrasies of the telecommunications sector mean that a different emphasis or a
slightly different approach in the application of the Competition Act is likely while at
the same time ensuring consistency with the Guidelines produced by the Office of Fair
Trading and the regulators. These Guidelines also highlight some of the salient points
contained in the EC Access Notice which the Director General is required by Section 60 of
the Competition Act to have "due regard to".
3.9 Guidelines produced by the Office of Fair Trading and the regulators (listed in Annex
I) relating to other aspects of the Competition Act (eg Transitional Arrangements,
Form N) are as relevant to the telecommunications sector as they are to any other
sector but do not require specific application in the telecommunications sector and are
therefore not dealt with at all in these Guidelines.
Further reviews of these Guidelines
3.10 The telecommunications market and its structure are changing rapidly. This will mean
that the potential for behaviour to have anti-competitive effects may vary over time as
the market changes. Competition in telecommunications, even in the UK, is still relatively
new and there is a corresponding lack of relevant jurisprudence. Whether particular
behaviour is an abuse of a dominant position or whether particular agreements have an
appreciable anti-competitive effect may therefore emerge only as the telecommunications
sector matures.
3.11 It is the Director General's intention to update these Guidelines from time to time,
following appropriate consultation with the industry, to take into account developments in
the telecommunications sector, experience in enforcing the Competition Act (including
decisions on appeal by the Competition Commission) and developments in the application of
Articles 85 and 86 of the EC Treaty. Users of these Guidelines are, therefore, recommended
to check that they have the most up-to-date version and for any developments since their
publication, by reference to the decisions on enforcement activities which are published
in Oftel's Competition Bulletin on a quarterly basis. The latest version of these
Guidelines are also available from the Oftel library.
4.1 A number of European Union Directives (including the Licensing Directive, the
Interconnection Directive, the Revised Voice Telephony Directive, and the Amended Leased
Lines Directive) prescribe various conditions and obligations that can or must be imposed
on telecommunications operators. In the UK, these conditions and obligations are included
(or are being included) in the Telecommunications Act licences of operators. References to
'Telecommunications Act licence conditions' will therefore include references to the
conditions inserted into licences as a result of European legislation.
4.2 There will be occasions where the behaviour covered by the Competition Act is also the
subject of conditions in the Telecommunications Act licences of those operating in the
telecommunications sector or requirements placed on a licensee or operator by some other
means. In practice this means that:
a. licensees will have to meet any more specific requirements placed on them by specific
licence conditions. The Competition Act does not therefore remove any obligations
that might arise under a licence condition. For example, all licences to public
telecommunications operators prohibit undue discrimination against any person, or any
class of person, in the supply of particular services, irrespective of whether or not this
is an abuse of a dominant position or whether it has an anti-competitive effect (although
in practice the Director General will take into account the effect on competition). This
means that for those services these operators will need to ensure they do not breach the
condition prohibiting undue discrimination as well as the Competition Act. (BT's licence
includes a number of other conditions that contain more specific requirements such as:
conditions governing connection obligations; conditions relating to unfair cross subsidy
and subsidy; and a condition dealing with the control of retail prices that are below
fully allocated costs.)
b. the Competition Act (under Paragraph 5 of Schedule 3) will not prohibit action that is
specifically required in order to comply with a statutory obligation including licence
conditions or a decision made under a licence condition (for example, the condition of
BT's licence which imposes a requirement on BT to provide certain services to deaf users).
Taking
action under the Telecommunications Act or the Competition Act
4.3 In some circumstances a particular agreement or practice may fall within the scope of
the Director General of Telecommunications' sector specific powers (eg; the prohibition on
undue preference and undue discrimination) and his concurrent powers under the Competition
Act. In such cases, where the Director General of Telecommunications is satisfied that the
most appropriate way of proceeding is under the Competition Act, his duty to take licence
enforcement action does not apply where the Director General of Telecommunications gives
notice to this effect under Section 16(5) of the Telecommunications Act 1984.
4.4 Where, therefore, the agreement or practice in question could be dealt with under the
Director General of Telecommunications' sector specific powers or his concurrent powers
under the Competition Act, he has some discretion as to which to use. There are relative
advantages and disadvantages with either route depending on whether it is viewed from the
perspective of the complainant or the complainee as set out below;
The Competition Act
The ability to impose fines for past conduct should act as a strong deterrent leading
to less likelihood of breach in first place.
The Competition Act is directly enforceable by third parties through the Courts.
Interim directions may be made to prevent serious, irreparable damage to a particular
person.
There are no statutory time limits for confirming interim directions.
Precedent exists in the form of EC case law relating to the application of Articles 85 and
86 although there have been a limited number of cases in the telecommunications sector.
The Competition Act can be used to deal with one-off practices or agreements: there does
not have to be a possibility of a further similar practice or agreement taking place.
Appeals can be made to the Competition Commission by either the complainant or the
complainee on the factual (as well as legal) basis of decisions the
Competition Commission can substitute its own view for the view of the Director General or
refer the matter back to the Director General for reconsideration. Requests for judicial
review can also be made by the complainant or complainee on the legality (both
substantive and procedural) of decisions by the Competition Commission Appeal Tribunal.
Strong powers of investigation mean that alleged breaches may be less difficult to prove.
The Telecommunications Act
There are no fines for breach of a Telecommunications Act licence condition.
Third party action through the Courts for damages can only take place after an order has
been made and that order is subsequently breached.
Provisional orders may be made where any person is likely to sustain loss or damage in the
period before a Final Order can be made.
Provisional orders must be confirmed within two months.
There have been a significant number of enforcement decisions concerning the application
of the Telecommunications Act to competition cases in the UK telecommunications sector.
In order to take action under the Telecommunications Act a breach must have occurred and a
further breach must be likely.
The complainee can make appeals under the Telecommunications Act concerning orders made
against it on the legality of the order (both in terms of whether the correct
procedures were followed when making the order and whether the making of the order was
within the Director General's powers under the Act). Requests for judicial review can also
be made by the complainant or complainee on the legality (both substantive and
procedural) of other decisions.
The Telecommunications Act potentially represents a faster route to resolving competition
cases.
4.5 Oftel would very much welcome the views of respondents to this
consultation on which approach the Director General of Telecommunications should take when
a practice or agreement can be dealt with under the Competition Act or the
Telecommunications Act. A non-exhaustive list of possible approaches would include: always
using the Competition Act; always using the Telecommunications Act; or deciding on a case
by case basis which Act to use.
Interaction
between the Competition Act and the Telecommunications Act
4.6 The statutory sectoral duties of the Director General of Telecommunications are set
out in Section 3 of the Telecommunications Act. The Competition Act has amended the
Telecommunications Act so that the Director General of Telecommunications' sectoral duties
do not apply when exercising his concurrent powers under the Competition Act provided he
gives notice to that effect. However, the Director General of Telecommunications may have
regard to matters covered by his sectoral duties provided that they are matters to which
the Director General of Fair Trading could have regard in exercising his powers under the
Competition Act. For example, in the context of a specific Competition Act case it may be
legitimate for the Director General of Telecommunications to have regard to matters
covered by his sectoral duty to "maintain and promote effective competition [in the
telecommunications sector]".
4.7 Following the approach of the European Commission as set out in the EC Access Notice
and the EC 1991 Guidelines, when considering a case or an issue under the Competition Act,
the Director General will take into account the principles established by the
telecommunications sector specific regulatory rules and will seek to ensure that the
competition rules and regulatory rules are applied in a manner as consistently and
coherently as the legislation will allow. Recognising the need to ensure that sector
specific regulation and the competition rules are applied consistently, the EC Access
Notice states:
"When appropriate, legislation such as the ONP [Open Network Provision] framework
will be used as an aid in the interpretation of the competition rules. Given the duty
resting on the National Regulatory Authority to ensure that effective competition is
possible, application of the competition rules is likewise required for an appropriate
interpretation of the ONP principles."
4.8 Thus, sector specific regulatory rules will be used as an aid to the interpretation
and application of the Competition Act. For example, the information that is generated and
the principles that are established by regulatory rules relating to accounting separation
and cost accounting requirements will be taken into account where appropriate when
considering cases under the Competition Act. This approach is consistent to that which the
European Commission will adopt as set out in the EC Access Notice when applying Articles
85 and 86 in the telecommunications sector. The EC Access Notice gives some
(non-exhaustive) examples of how this might work in practice; accounting separation
requirements may assist in the calculation of market shares; transparent cost-accounting
systems will facilitate the consideration of cases involving pricing issues (such as
excessive pricing), and; accounting separation requirements (and associated transfer
charging principles) will facilitate investigations of 'price squeezing' by vertically
integrated operators.
The Competition Act
and the Fair Trading Condition
4.9 The Fair Trading Condition (FTC) appears in all major Public Telecommunications
Operator licences at present. The FTC, like the Competition Act, is modelled on the
concepts and terminology used in Articles 85 and 86 of the EC Treaty.
4.10 The FTC contains a clause stating that it shall cease to apply to any behaviour
prohibited by or any prohibition enforceable under new legislation (primary or secondary)
which:
a. contains a prohibition enforceable by the Director General of Telecommunications, or
gives to the Director General of Telecommunications the power to enforce an existing
prohibition, of any behaviour prohibited under the Condition;
b. gives to third parties in respect of a breach of that prohibition at least the rights
they have under section 18 of the Telecommunications Act in respect of a breach of a
Provisional or Final Order; and
c. permits the imposition on the licensee of monetary penalties in respect of the breach
of that prohibition.
4.11 Oftel is, at present, of the view that the Competition Act appears to meet these
criteria and consequently the FTC would automatically cease to apply to all types of
agreements and conduct which would otherwise be caught by both the FTC and the Competition
Act once the provisions of the latter come into force in March 2000. The FTC might in
theory have a residual application to certain agreements or conduct not prohibited by the
Competition Act. However, to ensure that the FTC does not apply in these cases and to
ensure otherwise that Telecommunications Act licences do not contain a dormant condition,
Oftel will seek to remove the FTC from all licences with effect from 1 March 2000 to
coincide with the Competition Act coming into force.
5.1 The general Market Definition guidelines issued by the Office of Fair
Trading and the regulators discuss the process of market definition at some length. The
guidelines reflect current practice by competition authorities in Europe, North America
and elsewhere. In particular the guidelines have taken the approach of the European
Commission as set out in its Notice on the definition of the relevant market for the
purposes of Community competition law into account.
5.2 The Director General proposes to adopt the same approach to market definition in the
telecommunications sector as that set out in the Market Definition guidelines and
therefore these sector specific guidelines should be read in conjunction with those
produced by the Office of Fair Trading and the regulators. This section summarises the
main concepts that are relevant to this process and discusses some of the issues that are
particularly relevant to the telecommunications sector.
The purpose of market definition
5.3 The prohibitions in the Competition Act are primarily designed to prevent firms from
entering into agreements or practices which adversely and materially affect competition or
abusing a dominant position: eg where firms, individually or collectively, can
consistently charge higher prices, or supply goods of a lower quality, than they would if
they faced effective competition.
5.4 In order to establish whether a firm is in a position of dominance in respect of the
supply of certain products or to establish whether a restrictive agreement has an
appreciable effect on competition, it is necessary to define the relevant market (or
markets) and then to set the analysis of market power against the background of the
operation of competition in the relevant market(s).
5.5 Market definition can thus be regarded as one stage of a competition analysis, with
the investigation of the operation of competition in the relevant market being a closely
related stage. The purpose of defining the relevant market is to provide a framework
within which to analyse the operation of competition market definition is not an end in
itself.
5.6 However, it is important to be clear that these two stages (the third stage being the
assessment of whether the agreement or practice in question has an exclusionary or
exploitative effect as discussed in section 7) should not be regarded as separate,
self-contained exercises. There is an interaction between the two stages, not least
because there is often an overlap in the sort of information required to define the
relevant market and to assess the extent of competition. In any case, market definition is
not an exact science and therefore invariably involves some element of judgement; it
cannot be based purely on mechanistic rules. A consideration of the factors that are
important in market definition is a useful discipline in that it should involve a careful
review of the information required to build up a picture of the relevant product market
and the way in which firms operate and compete within it.
5.7 Market definition is therefore an important stage in any investigation for a number of
pragmatic reasons:
a. the Chapter I prohibition will generally apply only to agreements which have an
'appreciable' effect on competition. The test for an 'appreciable' effect requires the
definition of the relevant market and demonstration that the agreement would have an
appreciable effect on competition within that market;
b. the Chapter II prohibition only applies to firms that have a dominant position in a market. In order to establish whether an undertaking has a dominant position it is first necessary to define the relevant market to allow an assessment of whether the firm in question is in a position of dominance within that market;
c. market shares, which are used as an indicator of market power, can be calculated only after the boundaries of the market have been defined. The relationship between market share and market power in the context of the Chapter I and Chapter II prohibitions is discussed in Section H of these Guidelines. Market shares are also important as firms that are party to an agreement or concerted practice with small market shares (see the Major Provisions Guidelines published by the OFT and the regulators) may be immune from fines under Section 40(2)(b) even where that agreement does have an appreciable effect on competition;
d. Section 60 of the Competition Act requires the Director General to have regard to
any relevant decision or statement of the European Commission. He must also ensure that
his decisions are not inconsistent with any decisions of the European Court. In Continental
Can (a case concerned with an alleged abuse of dominance) the Court overturned the
Commission's decision because of its failure to define the market correctly. Section 60
therefore places an obligation on the Director General to establish market definitions.
Approach to market definition
5.8 Firms often use the term 'market' to refer either to the area where they sell their
products (the terms 'products' and 'services' are used interchangeably throughout the
text) or more generally the sector to which they belong. However, in the context of
competition analysis, the term 'market', or more specifically the relevant market, is used
with a specific economic meaning and combines both a description of the product(s) that
make up the market and an assessment of the geographical dimension of the market.
5.9 The approach set out in the Market Definition guidelines focuses on
identifying the constraints on the price-setting behaviour of firms. There are two main
competitive constraints to consider: how far it is possible for customers to
substitute other services or products for those in question (so-called demand-side
substitution) and how far suppliers not presently supplying the relevant products
could increase or switch production capacity to do so (so-called supply-side
substitution). It is also important to consider the geographical scope within which demand
and supply-side substitution can take place.
5.10 In terms of examining the pricing constraints on a firm, the concept of the
'hypothetical monopolist' can be a useful analytical tool for identifying close
demand-side and supply-side substitutes. Although it is not intended to be a
representation of the actual market situation, the 'hypothetical monopolist' concept can
be constructive in trying to set the boundaries to the relevant product market in
practical terms.
The Hypothetical Monopolist Test
5.11 On the demand-side the concept of the 'hypothetical monopolist' focuses on whether
alternative (but not necessarily identical) products are available to customers to which
they could switch, without significant effort and expense, if a monopoly supplier of the
product in question tried to implement a small but significant, non-transitory price
increase. The idea behind this concept is that if customers are able and likely to switch
to other similar products in sufficient numbers for the initial price increase to be
unprofitable, then that monopolist's product is in direct competition with those other
products and they should be included in the relevant product market because they would
constrain the price-setting behaviour of the 'hypothetical monopolist'. This process of
assessing customer behaviour in response to a small but significant non-transitory
increase in price is then repeated for this larger group of products until a set of
products is arrived at where a 'hypothetical monopolist' for all the products would be
able to maintain an increase in the price it charged for these goods. The concept thus
involves a series of iterations, each time involving an examination of the likely reaction
of customers to the change in relative prices.
5.12 The same iterative process can be repeated on the supply-side as well but in this
case the focus would be on the reaction of firms currently supplying related products.
5.13 In terms of what is meant by the term 'a small but significant non-transitory price
increase', The Director General proposes to adopt the same measure set out in the Market
Definition guidelines, namely a price increase in the region of 5-10%. The small but
significant and non-transitory increase in price is used solely as an analytical tool and
not as a judgement about what are acceptable price increases.
5.14 In terms of assessing the scope for demand- and supply-side substitution, the factors
that the Director General would take into account would include:
evidence of how customers/other suppliers had reacted to previous changes in relative prices;
the extent to which consumers would incur costs in switching from one product to another and also the time frame which consumers would need to organise such a shift;
evidence that suppliers base their business decisions on the prospects of consumer substitution between products in response to relative price changes.
5.15 This list is not intended to be exhaustive but rather it is intended to illustrate the sorts of evidence that could be used to support arguments about the extent of substitution. The Market Definition guidelines provide a fuller discussion of the sort of evidence that the Director General will consider when considering the issue of market definition. However, the key aspect of market definition is to try to identify the actual behaviour of customers and suppliers and consequently any investigation is likely to involve a dialogue with both groups.
5.16 The Market Definition guidelines also discuss some other aspects of
market definition such as the treatment of captive customers, the use of 'chains of
substitution' arguments and complementary and secondary products. Again, it is intended
that these guidelines should be read in conjunction with the Market Definition
guidelines issued by the Office of Fair Trading and the regulators which discuss in detail
how these factors can impact on the process of market definition.
Market definition in
the telecommunications sector
Regulated prices
5.17 In the case of the telecommunications industry where there are certain products which
are subject to price control, there might be an issue as to the appropriate price level to
be used in the assessment of demand-side and supply-side substitution. There is a risk
that if the current price level is too high ie because there is little competition for
a particular product an assessment of demand-side substitution based on this level
might encompass products which would not in fact be close substitutes if the price were
closer to the competitive level. Any assessment of market definition must therefore be
aware of this potential difficulty. However, it is intended to proceed on the basis that
the prevailing price levels provide a reasonable basis from which to start the analysis unless
there is evidence to suggest that this is not in fact the case.
Geographic markets
5.18 The relevant market is defined not only in terms of the products or services but also
in terms of a particular geographic area: eg part of the UK, the whole UK etc. In trying
to define the geographical boundaries to a product market the aim is to identify the
extent to which the proximity of rival suppliers can impose competitive constraints on the
firm in question. As with the analysis of the demand-side and the supply-side, the
definition of the geographical scope of the market is based on an assessment of
substitutability in response to changes in relative prices. The European Commission notice
on market definition states that:
"The relevant geographic markets comprises the area in which the undertakings
concerned are involved in the supply and demand of products or services, in which the
conditions of competition are sufficiently homogeneous and which can be distinguished from
neighbouring areas because the conditions of competition are appreciably different in
those areas."
5.19 The issue of the appropriate geographical market will be an important aspect of
market definition for telecommunications markets because for certain telecommunications
products, geographical location can be an important determinant on the choices available
to customers and the likely supply-side response of other firms. For instance, the
geographical dimension is particularly relevant to products such as the provision of
exchange lines or private circuits where the scope for demand and supply-side substitution
is likely to depend crucially on operators being located close to the customer.
5.20 It is thus possible that the geographical market could be defined in terms of a
region in the UK or even more specific areas. For instance, because of the special
circumstances with regard to Kingston Communications' provision of telecommunications
services in the Hull area, Oftel considered that the relevant geographical market for the
purpose of considering the supply of certain telecommunications services (eg exchange
lines, certain call services) was limited to the geographical area in which Kingston
operated (for example, BT's licence does not authorise it to run systems in the Hull area
and although a cable franchise was available for the area, it had yet to be awarded).
Applied
market definition in the telecommunications sector
5.21 It should be noted that it is not practical to pre-define the relevant markets for
examining competition issues in any sector and any market definition is, particularly in a
sector subject to rapid technological and regulatory change such as telecommunications,
likely to become obsolete. The EC Access Notice recognises this and
states;
"any attempt to define particular product markets in [the EC Access Notice] would
run the risk of rapidly becoming inaccurate or irrelevant. The definition of particular
product markets... is best done in the light of a detailed examination of an individual
case."
This is consistent with the main purpose of market definition, which is to identify firms
with market power or those that are in a position of dominance rather than market
definition being an end in itself.
5.22 For the purposes of these guidelines, the Director General believes that it would be
useful to give practical examples of how Oftel has in the past approached the issue of
market definition in the context of specific competition investigations and the way in
which it has made judgements about the importance of demand- and supply-side factors.
While these examples of market definitions were arrived at for the purposes of the
Telecommunications Act rather than the Competition Act, the approach to market definition
adopted was identical to that set out here.
General telecommunications market definition (March 1996)
5.23 In the consultation process that formed part of the review preceding setting BT's
Retail Price Control for the period 1997-2001, Oftel published a document Pricing
of telecommunications services from 1997 (March 1996) which sets out the market
definitions that Oftel was proposing to use to examine the development of competition in
the UK. The Director General would tend to use these market definitions as a reference
point for competition investigations but, as indicated above, it would still be necessary
to review them to see whether they are continue to be appropriate.
Internet access market definition (November 1997)
5.24 In a Statement published by Oftel in November 1997 (BT Internet Services
Investigation) which discussed the position of BT Internet and BTnet, Oftel
indicated that it proposed to regard the relevant market as the provision of Internet
access in the UK and that it was not proposing at that stage to make a distinction
between a market for dial-up Internet access and a market for permanent (ie leased line)
Internet access.
5.25 In the first instance, Oftel believed that it was appropriate to define a separate
product market for access to the Internet compared to other forms of on-line information
services. There was then an issue of whether the different means of accessing the Internet
eg dial-up access via a modem or a permanent connection via a leased line constituted
separate product markets.
5.26 In terms of the demand-side, it was not clear that all customers would be able to
switch between these different access technologies in response to a change in relative
prices. For instance, low-users which would typically be residential or small business
customers would be unlikely to pay the additional cost of a leased line if the cost of
dial-up access were to be increased. However, it was the case that a substantial
proportion of dial-up customers were medium-sized and large corporate customers which were
not only heavier users of the Internet but also better placed to consider upgrading their
access connections in response to changes in price. It was thus possible that the ability
of the larger corporate customers to upgrade their access connections would be sufficient
to protect lower use customers.
5.27 However, on the supply-side it was clear that there was considerable scope for
substitution between providing dial-up access and providing leased line access ie an
Internet Service Provider (ISP) that only provided leased line access would be able,
quickly and easily, to switch its existing Internet platform to offer dial-up access
without incurring significant additional expenditure and vice versa. In fact even at that
time, most ISPs and certainly most major ISPs were already offering a range of
different access technologies to their customers. They perceived the various access
technologies as a portfolio of services which they could offer to customers wanting to
arrange Internet access.
5.28 In terms of the geographical scope of the product market, it was clear that the
geographical location of an ISP was not a significant factor in determining the
competitive conditions as customers were able to choose between ISPs located virtually
anywhere in the UK. Based on this consideration of demand- and supply-side factors, Oftel
thus defined the relevant market as the provision of Internet access in the UK.
5.29 It is important to again emphasise that market definitions can and do change over
time as new opportunities for demand and supply-side substitution arise. The implication
of this is that in considering issues under the Competition Act, it will always
be necessary to revisit the issue of market definition to examine whether the demand or
supply conditions in the market in question have altered.
6.1 Some agreements between firms, such as price-fixing agreements, might be prohibited
even if the firms involved did not possess market power (either individually or
collectively). Apart from those Chapter I cases, an investigation under either Chapter I
or Chapter II of the Competition Act should normally involve assessing the extent to which
particular firms possess market power or indeed whether a particular firm could be
considered to be dominant.
6.2 This section reviews some of the factors that may be taken into account when assessing
market power and dominance in the context of telecommunications markets. The Office of
Fair Trading and the regulators have produced a guideline on the Assessment of Market
Power. Those guidelines go into further detail on the assessment of market power.
Factors relevant to assessing
market power
6.3 There are a number of factors which need to be considered when assessing whether a
firm is likely to have market power or be in a position of dominance. These include:
Market share
6.4 Although market share alone is a poor measure of market power, it is unlikely that a
firm without a significant share of the relevant market would have sufficient market power
to behave anti-competitively on its own. However, a large market share may not be
sufficient to establish market power for example, if entry into the market is easy,
there may be a strong threat of competition from new entrants. There could also be
countervailing buyer power. If the relevant market has been defined correctly and firms
have very low market shares, then they will almost certainly not possess market power, and
an investigation can normally be dropped at an early stage.
6.5 Where the Chapter I prohibition is concerned the market shares of all parties to the
agreement will be taken into account. There are no strict market share thresholds which
determine whether or not an agreement will have an 'appreciable' effect on competition.
The Major Provisions Guidelines indicates that agreements will not generally have
appreciable effects if the combined market share of the parties is less than 25%.
Exceptions to this general rule are agreements between competitors which directly or
indirectly fix prices or share markets; instances where the cumulative effects of networks
of similar agreements restrict competition and agreements to impose minimum resale prices.
At market shares in excess of 25% agreements will be considered on a case-by-case basis
and the Director General may still find that effects on competition are not appreciable.
6.6 Where the Chapter II prohibition is concerned the European Court of Justice held in
the AKZO case that there was a presumption of dominance, in the absence of evidence to the
contrary, if a firm has a market share persistently above 50%. Above this level the onus
would normally be on the firm to demonstrate that the specific market conditions meant it
was not dominant. In United Brands the Court held that 40 45% may be
sufficient but it would depend on other factors, notably the shares of other competitors
and entry conditions.
6.7 High market shares at a given point in time are not necessarily indicative of market
power: the AKZO case explicitly refers to a market share persistently in excess
of 50%. There is thus a need to examine changes in the pattern of market shares over time.
This will also mean that just because a firm is first into a new market that firm would
not automatically be presumed to be dominant.
Barriers to entry
6.8 The extent to which the actions of existing players in a market are constrained by the
threat of new entry into the market is a significant factor in assessing the degree of
competition in a given market. The Assessment of Market Power guidelines
distinguish three sources of entry barriers: absolute advantages; strategic advantages,
and exclusionary behaviour, and discuss each source of entry barrier in some detail.
6.9 In the context of markets for telecommunications services there may exist regulatory
or technological barriers to entry and these barriers to entry may confer an absolute
advantage on incumbent firms. For instance, in terms of the provision of mobile networks,
there is a finite amount of radio spectrum available for mobile communications with the
result that only four firms are currently licensed to operate mobile networks. Similarly,
prior to December 1996, only BT and CWC were permitted to own and operate international
facilities (ie the infrastructure for handling international telecommunications traffic).
This regulatory restriction on market entry was an important factor in assessing the
extent of competition between BT and CWC prior to full liberalisation of international
facilities.
6.10 When assessing market power, the Director General will need to take into account
whether there is any prospect of any relevant regulatory restrictions being eased or any
relevant technological barriers being surmounted in the short to medium term and, if so,
to gauge how quickly entry might occur.
Prices and profitability
6.11 In looking at the competitiveness of a market and whether an undertaking is dominant
the Director General will examine whether there is genuine independent price competition
in the market or whether pricing changes are, for example, better characterised in terms
of a leader-follower situation. Such an analysis would need to include the impact of price
regulation, where relevant, on pricing structures. In addition, the profitability of firms
in the market can also be indicative of the extent of price competition sustained
excess profits could indicate not only a lack of effective price competition between
existing firms but also that there are barriers to entry which prevent excess profits from
being competed away by new entrants. However, the Director General recognises the role of
profit in stimulating innovation and encouraging market entry, from which consumers
benefit.
Vertical integration
6.12 Vertical integration in itself does not imply that a firm is dominant. However, where
a firm is dominant or has market power in one market and is vertically integrated into
upstream or downstream markets around that market, then it may have the ability to affect
adversely competition in the upstream or downstream markets. Consequently, the potential
for vertical integration to lead to an abuse of a dominant position is likely to be a
significant aspect of the analysis of market power in telecommunications.
6.13 In some cases other operators and independent service providers may rely on a
vertically integrated company, which provides both the network and downstream services
which are conveyed over it, for the provision of network inputs while at the same time
competing with that vertically integrated operator in certain downstream markets. If the
vertically integrated operator were dominant in the provision of certain network inputs
there could be scope for it to leverage its position of dominance into the downstream
market. The EC Access Notice states that the European Court of Justice analysis in the Tetrapak
case (which concerned the leverage of dominance between closely related horizontal
markets) is "equally applicableto closely related vertical markets". The EC
Access Notice goes on to state that where an operator has;
"a very high degree of market power on at least one of those [closely related
markets]it may be appropriateto find that the particular operator was in a situation
comparable to that of holding a dominant position on the markets in question as a
whole."
Joint dominance
6.14 The EC Access Notice acknowledges that "the circumstance in which a joint
dominant position exists, and in which it is abused, have not yet been fully clarified by
the case law of the Community Courts or the practice of the Commission." However, a
position of joint dominance may arise in highly concentrated, or 'oligopolistic' markets
where two or more firms "together have substantially the same position vis-ą-vis
their customers and competitors as a single company has if it is in a dominant
position". Thus, one or more firms may behave in an abusive manner (by tacitly
colluding on prices, for example) without any individual firm being dominant, and without
any formal (or informal) agreements and concerted practices between them (see paragraphs
7.72 7.85 below). Such joint dominance is particularly likely to be found where there
are economic links between the companies involved (see for example the Italian Flat Glass
Case Societą Italiano Vetro v Commission). Similarly, joint dominance may
also arise where there are significant barriers to entry because the incumbents, apart
from any economic links, also have special, or privileged, access to necessary inputs and
these access rights are limited for example radio spectrum for the provision of mobile
services or the control of access to cables for international operators.
Applied
assessments of market power in telecommunications
6.15 For the purposes of these guidelines, the Director General believes that it would be
useful to give a practical example of how Oftel has approached the assessment of market
power in the context of a specific case. While this example of a market power assessment
was arrived at for the purposes of the Telecommunications Act rather than the Competition
Act, the approach to identifying market power adopted was similar to that set out here.
6.16 In April 1997 Oftel published a statement (Fair Trading in the Mobile Telephony
Market) which examined the positions of both Vodafone and Cellnet. In terms of the
way in which the analysis of competition was developed, Oftel first of all addressed the
issue of the relevant market. Taking in to account a number of factors, Oftel considered
mobile telephony to be a separate product market from fixed telephony. Oftel did, however,
consider that analogue and digital mobile systems were part of the same market.
6.17 In terms of analysing the extent of competition between the various mobile networks,
Oftel took into account the fact that the number of operators licensed to provide mobile
networks was limited to four and that lack of spectrum constituted an effective barrier to
entry for new mobile operators conferring an absolute advantage on incumbents. Oftel also
took into account the fact that Orange and One-2-One were still in the process of building
out their networks.
6.18 In terms of market shares Oftel noted that although the advent of One-2-One and
Orange had had an impact on the market structure, the trend decline in market shares was
fairly slow. At that time Vodafone and Cellnet accounted for 41.1% and 39.4%
(respectively) of all subscribers. In the digital segment of the market Vodafone accounted
for 35.5% of subscribers and Cellnet for 25.7%. Oftel also took into account the fact that
number portability had yet to be introduced for mobile networks.
6.19 In terms of prices there was evidence to suggest that the entry of Orange and
One-2-One had resulted in increased price competition. However, there was a clear
distinction in terms of profitability between the two established networks and the new
entrants. For example, Vodafone was highly profitable and there was little to suggest that
high rates of return on sales and capital were being eroded.
6.20 Based on the information summarised above, Oftel concluded at the time that although
Vodafone and Cellnet were not necessarily dominant, they did each individually possess
market power.
Market
power related concepts: Dominance, Significant Market Power and Market Influence
6.21 Under the Open Network Provision (ONP) Directives (eg the Interconnection Directive),
the European Commission has adopted the concept of Significant Market Power (SMP). This
concept is explained in some detail in Oftel's Effective Competition Review,
although it is worth mentioning here that Significant Market Power is not intended to be
assessed in relation to a relevant market or markets as defined in section 5 above. It is
the policy both of the European Commission and of Oftel that decisions about SMP are
without prejudice to an organisation's position under EU or UK competition rules. The EC
Access Notice, for example, states;
"...that an undertaking has significant market power under the ONP rules will
generally therefore not lead to a presumption of dominance, although in a particular
situation this may prove to be the case. One important factor in this consideration,
however, will be whether the market definition used in the ONP procedures is appropriate
for use in applying the competition rules."
6.22 The UK telecommunications regulatory regime also makes use of the concept of 'Market
Influence' (the term 'Market Influence' will, subject to the consultation on the
implementation of the Licensing Directive, replace the term 'Well Established Operator'.
The concepts are, however, identical so the following text applies equally to both terms).
Like dominance, the concept of Market Influence is assessed in relation to a relevant
market or markets. The Market Influence concept however represents a level of market power
(the ability to raise prices above the competitive level for a non-transitory period
without losing sales to such a degree as to make this unprofitable) below that of
dominance. In terms of the interaction between dominance and Market Influence, it is not
necessary for the Director General of Telecommunications to have declared an operator as
having Market Influence before that operator can be found to dominant in a particular
market. However, if a firm is found to be dominant in a particular market it is then
likely to be determined to have Market Influence in the market.
7.1 Anti-competitive behaviour can take one of two main forms under the Competition
Act: abuse of a dominant position; or the making of anti-competitive agreements, decisions
or concerted practices. In fact, in some cases the behaviour in question may take both
forms. Many of the examples referred to in this section concern the abuse of dominance,
but even where there is no dominance such behaviour when engaged in by two or more
parties, may be caught by the prohibition on anti-competitive agreements and concerted
practices.
7.2 There are two broad categories of anti-competitive behaviour;
Exclusionary behaviour; the abuse of a dominant position or the making of anti-competitive
agreements, decisions or concerted practices for the purposes of foreclosing market entry
or gaining an unfair competitive advantage against incumbent competitors (this can take a
variety of forms such as predation, refusal to supply, etc).
Exploitative behaviour; the abuse of a dominant position or the making of
anti-competitive agreements or concerted practices for the purposes of exploiting
customers or suppliers (again this can take a variety of forms such as parallel pricing,
excessive pricing, etc).
7.3 It should be noted that these two broad categories of behaviour are not mutually
exclusive. For example, in a situation where a vertically integrated operator controlled
certain services which formed the key inputs for firms competing with its downstream
subsidiary, it could be in a position to increase the price of those inputs while at the
same time reducing its retail prices. If it were to behave in this way, it is possible
that that this could be considered either as an example of exclusionary or exploitative
behaviour depending on the effect on competition and the nature of any complaint about
this pricing strategy.
7.4 The purpose of the following paragraphs is to give guidance on the application of the
Competition Act in the light of some of the specific characteristics of the
telecommunications industry. It is consistent with the approach set out in the Assessment
of individual agreements and conduct guidelines issued by the OFT and the regulators.
It constitutes a non-exhaustive list of the factors which the Director General would be
likely to consider when deciding whether certain practices and agreements will fall within
the scope of the Competition Act.
Pricing issues
Cost concepts relevant to examining pricing issues in the telecommunications sector
7.5 Paragraphs 3.4 3.6 discussed some of the distinctive economic, technological and
regulatory characteristics of the telecommunications sector. In particular it is the cost
structure and the presence of externalities for telecommunications networks that
complicates the analysis of the structure and competitive effect of specific pricing
policies.
7.6 The supply of telecommunication services is characterised by economies of scale in the
provision of networks (stemming from large fixed costs) and economies of scope in the
provision of services (stemming from common costs costs of production that are shared
between two or more products). This means that telecommunications companies tend to be
multi-product firms and that their pricing policies need to take into account the recovery
of both fixed and common costs. In particular, the incidence of low marginal costs and the
existence of substantial common costs between products means that a dominant firm, subject
to regulatory constraints, potentially has a great deal of pricing flexibility both in the
range of prices it can offer and the freedom it has to choose from which markets to
recover its costs. This can put the firm at a significant advantage over its competitors
who, because of their size or because of the more limited range of products they produce,
do not have the same degree of freedom. There is nothing wrong with a dominant firm having
such advantages provided it does not abuse its dominant position.
7.7 In principle, prices derived from marginal costs (the cost of producing an additional
unit of output) are likely to be economically efficient and to reflect the resource costs
of meeting customer demand. However, the economic characteristics of telecommunications
networks mean that the short-run marginal costs may be very low (or even zero) and
therefore of little use in arriving at sensible pricing decisions, especially in the
context of the recovery of fixed costs. An alternative and more satisfactory cost basis is
that of the long run incremental cost (LRIC) of output. The LRIC measure takes into
account the total long-run costs of a specified increase in output eg the provision of a
new service. If the price for that new service covers its incremental costs (with any
common costs being recovered through charges for the firm's other products) then it will
be profitable for a company to offer this service and it should be sustainable in the long
term. In turn, charges which are derived from incremental costs are better able to reflect
the economic costs of providing a given service.
7.8 In relation to pricing and cost concepts, as elsewhere, the Director General will have
regard to the statements, decisions and rulings of the EU and UK competition authorities.
The use of LRIC as the cost base for examining pricing issues in the telecommunications
sector is in line with the approach set out in the EC Access Notice. The EC Access Notice
recognises that in "network industries a simple application of the above rule [a
reference to the AKZO rule which approximates marginal costs through the use of
average variable costs] would not reflect the economic reality of the network
industries". The EC Access Notice goes on to state that;
"a price which equates to the variable cost of a service may be substantially lower
than the price the operator needs in order to cover the cost of providing the service.the
costs considered should include the total costs which are incremental to the provision of
the service.[therefore,] the Commission will often need to consider the average
incremental costs of providing a service.."
Combinatorial tests
7.9 While LRIC is, therefore, a more satisfactory cost basis for examining pricing issues
than marginal cost or average variable costs in the telecommunications sector, the
presence of economies of scope means that if all prices are set equal to LRIC they will
not result in full cost recovery for the firm: certain common costs will not be
remunerated. In order to ensure that a firm was not abusing its pricing flexibility in
such a situation, it would need to be able to demonstrate that its individual prices were
at or above incremental costs and that the prices of groups of services which
share common costs taken together covered the incremental and common costs of the
provision of those services.
The use of LRIC in practice
7.10 Under the Network Charge Control arrangements, BT sets charges for interconnection
services derived from the long run incremental costs of conveyance (with an appropriate
mark up to cover common costs). Incremental costs are 'forward looking' and are based on
current valuation of assets this provides appropriate signals to new entrants
(especially those providing infrastructure investment) and for investment decisions. To
inform future investment and pricing decisions, costs based on historic valuation of
assets are unlikely to be relevant.
7.11 The arguments presented here and the reasoning in the EC Access Notice in favour of
using incremental costs as a basis for applying competition rules on interconnection
prices apply equally to retail prices in the telecommunications sector. BT has recently
developed a methodology in consultation with Oftel to produce cost information based on
LRIC for retail products. It is intended that this methodology will be utilised from
January 1999 in appropriate competition cases.
7.12 By establishing a series of reference points, for general guidance only, the cost
concepts discussed above help to define the framework within which the Director General
will analyse the effect on competition of any particular pricing strategy for the purposes
of applying the Competition Act. In practice, when looking at pricing (and other) issues
under the Competition Act, the Director General will make use of the information generated
by Telecommunications Act licence conditions (including those conditions that implement
ONP Directives) where that information is relevant (for example, in establishing the LRIC
of a service). This is consistent with the approach of the European Commission to Article
85 and 86 cases in the telecommunications sector as set out in the EC Access Notice;
"Pricing questions in the telecommunications sector will be facilitated by the
obligations under the ONP Directives to have transparent cost-accounting systems."
7.13 Using the cost concepts set out above, a series of pricing issues are examined in
paragraphs 7.19 7.49 below. However, these examples are for guidance and do not
represent rigid pricing rules. As a point of principle, Oftel does not generally approve
the retail price BT charges for new services. The merits or otherwise of a specific
pricing strategy can properly be determined only on a case-by-case basis. Guidance on
Oftel's policy in relation to specific cases is published in its quarterly Competition
Bulletin.
Pricing issues and sector specific regulation
7.14 Pricing issues also need to be considered in the context of any sector specific
regulatory restrictions on price movements. The Competition Act contains a general
exclusion (Schedule 3, paragraph 5) for any agreements, concerted practices or conduct
(including pricing) which would otherwise be caught by the Competition Act but is carried
out in order to comply with a requirement imposed by or under UK statute (including,
therefore the Telecommunications Act and telecommunications licences) or EC law.
Accordingly, although in practice it is unlikely that Oftel would require an operator to
charge a price that had an anti-competitive effect, specific prices which a licensee is
required to offer as result of a licence condition or other pricing that is required to be
offered by law will not be caught by the Competition Act. However, where an operator is
required to set prices between a floor and a ceiling (eg BT's interconnection prices under
the Network Charge Control) such prices are not excluded from review under the Competition
Act.
7.15 The Schedule 3 exclusions will be strictly applied by the Director General and will
not be allowed to justify activities which are not wholly covered by any relevant
exclusions. This is particularly true of the exclusion in paragraph 4 for services of a
general economic interest. The Director General will follow the practice of the European
Court and the European Commission when applying the equivalent EC exclusion (in Article 90
of the EC Treaty). The increasingly competitive nature of the telecommunications sector in
the UK means that it is unlikely that the exception would apply to any telecommunications
companies. Further information on the Schedule 3 (4) exception is given in the Concurrency
guidelines.
7.16 There may also be situations where, although price discrimination is not an explicit
legal obligation, such discrimination may not be considered abusive. In the
telecommunications sector BT offers uniform national prices for a range of services as
part of its universal service requirement even though the costs of providing these
services in remote geographical areas may be greater than the cost in urban areas. In this
instance, the pricing structure may not be regarded as an abuse. In a similar vein, the
'network externality' (discussed in paragraph 3.5) means that the addition of more
customers to the network increases the value of the service to all other customers. This
value is not captured in the price for the service. In these circumstances a price below
incremental costs may be justified recognising the added value from having more customers
supplied with the service.
7.17 The effect of regulatory restrictions may also need to be taken into account when
examining the acceptability of price changes. For example, where charges are controlled
within an overall price cap a reduction of charges in one area may be offset by an
increase in charges in another area. In the absence of other safeguards, this might
increase incentives for predatory behaviour: any such behaviour could be in breach of the
Competition Act. Where a regulatory requirement to price below (or above) a level that
would otherwise be caught by the Competition Act is removed, the Director General would
have regard to the possible undesirability of sharp price movements for consumers, and
would not necessarily regard a failure by an operator immediately to raise prices above
(or reduce them below) such a level as anti-competitive. More generally, regulation may
cause pricing behaviour in one market to be influenced by pricing in another market.
7.18 Further pricing issues are examined below; these should be treated as guidance rather
than strict pricing rules as the merits or otherwise of a specific pricing strategy can
properly be determined only on a case-by-case basis. Guidance on Oftel's policy in
relation to specific cases is published in its quarterly Competition Bulletin.
Predatory pricing
7.19 Low prices or price reductions are normally seen as a benefit from, and the
successful result of, the process of competition. However, it is an established principle
of competition law that not all price competition is legitimate. In particular, predatory
pricing where the predator deliberately sacrifices short term profit by setting
excessively low prices to eliminate or weaken competitors so that longer term profit will
be enhanced is anti-competitive because it seeks to exclude competition.
7.20 The Guidelines published by the Office of Fair Trading and the regulators set out
three factors that are important to consider in the context of evaluating whether a price
reduction is evidence of a predatory strategy:
Feasibility: This involves examining the structure of the market and the characteristics of the alleged predator in order to establish whether predation (including recoupment of profit once rivals are driven out or weakened) is a feasible strategy It may be possible to infer feasibility from the fact that a firm is in a dominant position in a market;
Incremental losses: a predatory pricing strategy involves the deliberate sacrifice of short-term profit which means that it is necessary to consider the effects of the alleged predatory action upon the profitability of the alleged predator. One way in which the incremental profitability of a price reduction could be assessed is to use a net revenue test; and,
Intent: whether there is evidence that the alleged predator intends to drive a
specific competitor out of the market.
7.21 In the context of the telecommunications sector, these three criteria require some
further exploration. As set out above (see paragraph 7.7), the relevant cost basis for
examining pricing issues on telecommunications is that of long run incremental costs. The
Director General will start from the (rebuttable) presumption that prices below LRIC are
predatory. This is consistent with the approach set out in the EC Access Notice which
recognises that cost structures in network industries tend to be different to most other
industries and a straightforward application of the AKZO test (using average variable
costs as the cost floor) is inappropriate.
7.22 There is no absolute bar to prices below this level but where a dominant operator
wishes to price below LRIC it would need to justify that the price did not have an
anti-competitive object or effect (for example, by providing information to demonstrate
that predation, including subsequent profit recoupment, was infeasible in the specific
circumstances). To this end, the Director General is aware that circumstances may arise
where pricing below LRIC would be a rational strategy for a company, reflecting
competition, in addition to being good for customers. An example of this might occur in
the future where there is a degree of excess capacity as competition in telecommunications
markets becomes established. Such a pricing strategy would need careful analysis and the
operator would need to be able to demonstrate that it was not behaving anti-competitively.
Prices above LRIC would not normally be predatory (unless, for example, there was evidence
of predatory intent) but might nevertheless be viewed as anti-competitive for other
reasons. Although the use of such rebuttable presumptions will be a very important part of
the Director General's analysis of predatory pricing, it will not be the sole determinant.
The Director General will take into consideration all other relevant factors in making its
final decision in any particular case.
7.23 In terms of assessing the incremental profitability of a particular price change, a
net revenue test examines whether the action taken by the alleged predator to reduce its
prices worsens its profitability in comparison with an alternative 'benchmark' strategy
(for example, a strategy where prices are not reduced). If profitability were not
adversely affected by the reduction in price because the demand increased sufficiently to
offset the price reduction and at the same time the price remained sufficiently high to
cover the incremental costs of the increase in output then the price reduction may be
viewed as legitimate competitive behaviour. There will, of course, be the need to define
the output increment that is relevant to the case under consideration.
7.24 The net revenue test can also provide an indication of intent: if a firm had no
realistic expectation that a profit would be made (or made no attempt to assess changes in
profitability as a result of a price reduction) and, having incurred an incremental loss
made no attempt to correct it, that would at least be an indication of intent.
Anti-competitive pricing and packages of services
7.25 An additional factor that will need to be taken into account when assessing predatory
pricing is the extent to which there is strong complementarity between two or more
services with different economic characteristics (both in supply and demand), for example,
the provision of access (ie line rentals and connections) with calls across the network.
Where there is strong complementarity, it may be more appropriate to conduct the tests on
the comparison between costs and revenues for all the services together although it
would also be expected that individual elements of the package would be priced so as to
cover their own incremental costs. Similarly, where there are economies of scope the LRIC
test will need to be carried out on combinations of services (where these costs will
include any which are common to the combinations) as well as on individual services (where
these costs will not be included).
Subsidies and cross-subsidies
7.26 The assessment of subsidy and cross-subsidy raises similar issues to those raised by
predatory pricing and in practice will tend to be investigated in a similar manner.
Predatory pricing involves the short-run sacrifice of profits in order to force
competitors to exit followed by the recoupment of those loses in the longer run through
pricing above the competitive level. However, whereas predation might be characterised
mainly as a single-product issue (dealing with a pricing strategy in respect of one
particular product) cross-subsidy and subsidy could perhaps be characterised mainly as a
cross-product issue (low prices for one product being funded by high prices for other
products) and does not necessarily, therefore, involve a short-run sacrifice of
profits.
7.27 Thus, in the context of the Competition Act, the term cross-subsidy or subsidy
refers to the situation where, as the EC 1991 Guidelines state;
"an undertaking allocates all or part of the costs of its activity in one product or
geographic market to its activity in another product or geographical market"
7.28 A cross-subsidy will normally be deemed to exist where an undertaking's revenues
from an activity (eg a new business or a new product) fail to cover the costs associated
with that activity (or, equally, fail to generate an 'adequate return') over its economic
lifetime. That is, the fact that accounting profits for a particular period, such as
a year, are negative, would not be sufficient to establish that an activity was in receipt
of a cross-subsidy or subsidy. From an economic perspective the question of a whether or
not a cross-subsidy or subsidy exists has to be related to the economic life of the
underlying assets involved and this will entail not just a consideration of past losses
but also future revenue streams ie it is the profitability of the activity as a whole over
time which matters.
7.29 The fact that an activity is in receipt of a cross-subsidy subsidy is not itself an
infringement of the Competition Act the key issue is whether the subsidy has the object
or effect of preventing, restricting or distorting competition. Where a firm is financing
losses in a market where it is not dominant from profits made in another market where it
is dominant there could be a significant effect on competition in breach of the Chapter II
prohibition; as the EC 1991 Guidelines state:
"subsidising activities under competition, whether concerning services or equipment,
by allocating their costs to monopoly activitiesis likely to distort competition in
violation of Article 86 [Article 86 is equivalent to the Chapter II prohibition]."
While this statement refers to "monopoly activities" it is likely that an abuse
could also occur where a firm was dominant, short of holding an absolute monopoly.
7.30 Cross-subsidy can have a detrimental effect on those companies competing with the
subsidised business or activity and also on any customers which are being charged
excessive prices to fund the cross-subsidy (excessive pricing is dealt with in paragraphs
7.41 7.44). Although the customers of the subsidised service benefit in the short run
from the low prices implied by the fact that revenues are not sufficient to cover costs,
in the longer run they would lose out on the dynamic efficiency gains that competition can
have if the cross-subsidy has the effect of excluding efficient competitors. Thus there
is, in addition to any exclusionary or exploitative effects, the potential for a
cross-subsidy to distort the signalling properties of the price mechanism and this could
lead to an inefficient allocation of resources.
7.31 Given that the concern over cross-subsidy mainly relates to profit from markets in
which a firm is dominant being used to cover losses in markets within which the firm is
not dominant, the issue of cross-subsidy has been associated more with the regulated
industries many of which are in transition from monopoly to competition.
7.32 There are various ways of assessing subsidy using both economic and accountancy
concepts. For the purposes of investigations under the Competition Act, the focus will be
on the measurement of cross-subsidy in economic terms. The Assessment of individual
agreements and conduct guidelines issued by the Office of Fair Trading and the
regulators discuss the assessment of cross-subsidies in some detail.
7.33 The proper economic basis for assessing cross-subsidy is a LRIC approach; the use of
LRIC implies that the renewal/replacement of the underlying assets is explicitly taken
into account ie long-run costs are based on the assumption that all costs or inputs are
variable. The use of LRIC would therefore lead to a general principle that as long as the
revenue from a product covers the LRIC of providing that product, then it is sustainable
to supply it in the long term: ie the provision of the product does not detract from the
firm's profits and the product could not generally be said to be in receipt of a
cross-subsidy.
7.34 Where economies of scope arise between the activity under investigation and other
activities it may be that a group of products sharing a common cost are all individually
priced above LRIC. It could not therefore be said that any individual service is being
subsidised. However, it may be that prices are not sufficiently high to cover those costs
that are common among the services. This would indicate that the group of
services in question is being subsidised and the Director General may find this behaviour
in breach of the Chapter II prohibition.
7.35 The use of LRIC as the cost base can be equated to the concept of Discounted Cash
Flow (DCF). It is most appropriate to apply a DCF analysis to a new service or a service
in a start-up phase where a forward-looking analysis is in any case most appropriate and
initial losses may be expected. A properly constructed DCF analysis should relate to the
incremental cashflows that result from the project in question it thus reflects the
incremental costs as well as the benefits of the project. Thus, if a project passes an
investment appraisal based on a DCF analysis, it cannot be said that the project is in
receipt of a subsidy over its lifetime: the project covers the proposed 'floor' of
long-run incremental costs and it is incrementally profitable for the firm in question to
undertake that investment.
7.36 One important element of a DCF analysis is the underlying assumptions that are made
about the development of the project and in particular those relating to the future
competitive conditions in the market. It would be unreasonable to expect a firm to meet
the targets set out in a business plan for a new service in their entirety. However, where
a business case has been developed on the basis of unjustified and implausible assumptions
at the outset and/or there has been a failure of a firm to take remedial action once it
had become apparent that it would not meet the targets set out in the business plan, this
could be regarded as evidence of an anti-competitive intent behind the cross-subsidy.
7.37 For long-lived, mature products there will be circumstances where a rate of return
analysis based on accounting data (together with an allowance for the return on capital)
may be used to analyse allegations of cross-subsidy. In such situations, it would expected
that a firm would be able to justify the cost of capital figure it has chosen to use in
relation to the activity it had undertaken. For example, in activities having a higher
level of risk than normal a higher rate of return than is typically assumed for the firm
might be appropriate.
7.38 These approaches to calculating whether or not a cross-subsidy exists need to be
based in a market context ie it will need to be related to an impact on competition in a
relevant market. This could mean that the cross-subsidy analysis would relate just to one
product line or it may cover several products depending on the definition of the relevant
market.
Price squeeze
7.39 Where a firm is vertically integrated (vertical integration is discussed in
paragraphs 6.12 and 6.13) and in particular is dominant in an upstream market which
supplies a key input to companies that are in competition with its downstream subsidiary,
there is scope for it to act in a way that has a detrimental impact on competition. The
vertically integrated firm is in a position to conduct a price (or a 'margin') squeeze on
its competitors in the downstream market by raising the cost of the key input and/or
lowering its retail prices in the downstream market. The effect of this pricing strategy
is to reduce the gross margin available to its competitors so that competing firms which
are no less efficient than the integrated firm are subject to a 'price squeeze' rendering
them unprofitable the integrated firm's total revenue may of course remain
unchanged. Thus, when examining allegations of price squeeze it is important to note that
the relevant comparison benchmark is not in terms of the margin available to a competing
firm but whether the dominant firm's own downstream operation would be profitable if they
were to pay the same input prices as their competitors.
7.40 In examining price squeezes and other instances of vertically integrated operators
attempting to raise rivals costs anti-competitively, the Director General will use the
information generated by sector specific regulation including the Interconnection
Directive accounting separation requirements. This approach is consistent with the EC
Access Notice, which in the context of price squeezes, recognises that:
" a price squeeze could be demonstrated by showing that the dominant company's own
downstream operations could not trade profitably on the basis of the upstream price
charged to its competitors by the upstream arm of the dominant operator. A loss making
downstream arm could be hidden if the dominant operator has allocated costs to its access
operations which should properly be allocated to the downstream operations, or has
otherwise improperly determined the transfer prices within the organisation. The
Commission Recommendation on Accounting Separation in the context of Interconnection
addresses this issue by recommending separate accounting for different business areas
within a vertically integrated dominant operatorHowever, the existence of separated
accounts does not guarantee that no abuse exists."
Excessive pricing
7.41 Charging excessively high prices may amount to an abuse of a dominant position.
Excessive pricing is of particular relevance in wholesale markets if the excessive charges
are for a necessary input supplied to rivals of the dominant supplier in a downstream
market and on which they were dependent. In the telecommunications sector, for example,
the EC initiated proceedings in 1997 against Deutsche Telekom allegedly charging excessive
interconnection tariffs and Deutsche Telekom subsequently agreed to reduce its tariffs.
7.42 The European Court of Justice (Case 26/75, General Motors Continental NV v CEC) has
defined an excessive price as being, "excessive in relation to the economic value of
the service provided" where the "excess could, inter alia, be determined....by
making a comparison between the selling price of the product and its cost of
production".
7.43 The Assessment of individual agreements and conduct Guidelines issued by the
Office of Fair Trading and the regulators propose two methods which could be used to
determine whether a price (or even a set of prices) is excessive;
An assessment of the profitability of a firm in the particular market: However, there can
be difficulties in assessing profitability when investigating a complaint about excessive
pricing against a multi-product firm as assessing the profitability of a product could
come down largely to a debate about the allocation of those common costs. There is no
single correct way of allocating costs either from an economic or an accounting
perspective; and,
An assessment of the stand alone cost (SAC) of a particular service: SAC captures all
the costs that an efficient firm would incur in supplying just that service on its own.
There might be a reasonable expectation that a firm which is charging more than the
stand-alone cost of a product is earning supra-normal profits. An approach which
concentrated on building up a picture of the cost of providing a service is en line with
the practice of the European Court of Justice and the EC.
7.44 However, while the Director General would expect an operator to be able to show that
prices above SAC were not an abuse, it must be stressed that there are no rules of thumb
that can unambiguously identify when a price is sufficiently excessive in
relation to its costs of production to constitute a breach of the Competition Act. The
cost characteristics and the pattern of prices (both through time and across products
which share the same cost base) will be important considerations. The European Court of
Justice (Case 30/87, Corinne Bodson v SA Pompes Funebras) held that if possible a
comparison could be made between the prices charged by a dominant company and those
charged in other geographic markets which were open to competition; this comparative
approach may prove hard to apply in practice in the telecommunications sector.
Price discrimination
7.45 Price discrimination can be defined in economic terms as a situation in which
different units of the same good or service are sold at prices not directly corresponding
to differences in the cost of supplying them. Where there are objective cost
reasons for a firm chargi