4. Competition Law By Amr Abdelaziz, LL.M. 4.1. Why regulate competition? Today, all relevant market economies, including the fast growing new market economies such as China, India and Brazil, have competition laws. The purpose of these competition laws, which in the US are commonly referred to as antitrust laws, is basically to make sure that (1) competitors really do compete with each other, and (2) companies are free to thrive and expand without facing undue restrictions from other market players. In a free market, the prices of goods and services, as well as decisions regarding investment, production and distribution, should be determined based on supply and demand. In an ideal world, a large number of companies will compete for market shares by developing new and better products and by offering them at competitive prices. In practice, however, markets can develop structures, and market participants sometimes adopt practices that prevent consumers as well as other companies from enjoying the beneits of a free market. Competition laws and the regulators and courts that enforce them are there to protect the integrity and function of the market. It should be noted that, in most countries, some sectors of the economy are not organized on a free market basis. For instance, governments sometimes grant monopolies to undertakings that provide certain public services (e.g., water supply, waste disposal and public transportation). In relation to those industries, the competition rules do not (fully) apply. Typically, competition laws rely on three pillars to achieve their purpose: • prohibition of cartels • prohibition of the abuse of market power (abuse of dominance) • merger control The following sections will give you a high-level introduction into these three main pillars of competition law. The aim is to outline how competition law works in general and what the competition issues are that companies and managers should be particularly aware of in practice. 28 4. Competition Law 4.2. Cartels 4.2.1. What is a cartel? When two or more competitors agree to coordinate their market activities to their mutual beneit (and to the detriment of other market participants), such undertakings form a cartel. The agreement between them can also be commonly referred to as a cartel. In a free market economy, the principle of freedom of contract provides that undertakings are free to form contracts without government restrictions. This principle, however, is subject to exceptions, and one such exception is the general prohibition of cartels. Each jurisdiction has its own legislation, so the legal deinition of a cartel will vary from one jurisdiction to another. Generally, a cartel is legally construed as: • an agreement (binding or non-binding, including “gentlemen’s agreements” etc.); or, • a concerted practice (a form of coordination between undertakings, which without having reached the stage where an agreement in the legal sense has been concluded, knowingly substitute practical cooperation between them for the risks of competition), • between undertakings operating at the same level of production, i.e. competitors or potential competitors, • which has a restraint of competition as its object or effect, and • which either eliminates or unduly restricts competition in a speciic market. It is usually not dificult to identify agreements or concerted practices that fulill these requirements and therefore they should be avoided or at least require careful legal analysis. 4.2.2. Markets that typically attract cartels A member of a cartel usually has a short-term incentive to improve his position in the market by cheating on the other cartel members. However, if all cartel members cheat on each other, the cartel will not be effective and will not beneit the members. The result of this prisoner’s dilemma is that cartels tend to be effective only in circumstances that allow each cartel member to monitor whether the cartel agreement is really being implemented by the other members. 29 4. Competition Law Some conditions that allow, or at least facilitate, the monitoring of a cartel are: • Number of undertakings in the industry: The smaller the number of undertakings in a given market, the easier it is for them to negotiate a cartel agreement and to monitor its implementation. • Characteristics of products (or services) sold: The more homogenous the products, the easier it is to negotiate the cartel agreement, and the easier it is to attribute changes in market share to price cuts. In contrast, if the products are differentiated, changes in market share may also be due to changes in consumer preference or demand. • Production costs: If the undertakings involved have similar cost structures, it is easier for them to negotiate and sustain a cartel agreement. • Stability of demand: If demand for the products in question is regular and stable, it is easier to attribute changes in market share to other cartel members’ cheating. On the other hand, if the industry in question is characterized by a varying demand, sales drops may just as well be the result of a change in demand. This is not to say that cartels cannot exist in the absence of the above circumstances. However, undertakings and managers that operate in markets which carry (some of) the above characteristics ought to be particularly vigilant not to engage in cartelistic behavior. 4.2.3. Hardcore cartels Undertakings can compete on different parameters such as price, quantity, quality, service, and innovation. Generally, however, some parameters are more important than others. Cartel agreements affecting these important parameters are considered particularly harmful and are thus referred to as hardcore cartels. Typically, hardcore cartels include: • price-ixing arrangements • agreements to limit the quantities of goods or services to be produced, purchased or supplied • market-allocation agreements Hardcore cartels are often per se illegal, i.e., they are legally presumed to be harmful. Competition authorities all over the world pursue them with vigor, and members of hardcore cartels may suffer enormous reputational damage 30 4. Competition Law and potentially face heavy ines and damages claims in every affected jurisdiction. In short, price-ixing, quantity-ixing and market-allocation agreements are considered to be the worst types of cartels and therefore are a no-go for any responsible manager. 4.2.4. Lawful horizontal co-operation Competitors are primarily supposed to compete, but under certain conditions it can be perfectly legitimate for competitors to join forces. For instance, agreements between competitors on joint research and development, production, purchasing, commercialization, standardization or exchange of information can – depending on the circumstances – be pro-competitive and lead to substantial economic beneits. However, horizontal co-operation can also lead to serious competition problems, especially if the competitors involved have market power. Therefore, horizontal co-operation agreements must be drafted and reviewed carefully, and it is essential to ensure that the competition restraints they entail do not outweigh the economic beneits in question and that the co-operation agreements are necessary to achieve those beneits. 4.2.5. Practical example: the Phoebus cartel Competition authorities all over the world continuously conduct dawn raids and investigations against suspected cartels, and especially against hardcore cartels. It is thus quite easy to ind plenty of examples of cartels that have been detected in the last years. The cartel discussed in the next paragraphs dates back to the irst part of the 20th century but has remained a textbook example of how international cartels work. In the 1920s, around half a dozen of the world’s leading producers of light bulbs established the “Phoebus cartel” in order to control the manufacture and sale of light bulbs. The following characteristics of the Phoebus cartel are particularly instructive: • One of the main objectives of the cartel was to prevent the cartel members from penetrating each other’s geographical markets. The world’s lamp markets were divided into three categories, which shielded the members from competition by other members in their spheres and enabled them to charge higher prices. 31 4. Competition Law • The cartel members agreed to cap the life expectancy of the light bulbs at 1000 hours. This not only lowered the cartel members’ R&D costs but also served to maintain sales at a high level. • In public, the cartel justiied the limiting of the light bulbs’ life expectancy as a standardization effort and claimed that 1000 hours was a reasonable optimum life expectancy for most bulbs, and that a longer lifetime could be obtained only at the expense of eficiency. • The cartel, which included illustrious corporations such as General Electric and Philipps, set up a Swiss corporation (“Phoebus S.A. Compagnie Industrielle pour le Développement de l’Éclairage”) to organize the cartel and control each other’s compliance with the agreed rules. The parties even agreed on the exact penalties that had to be paid by members whose lamps were found to exceed the agreed standard life expectancy. With the foregoing sub-sections in mind, the above features of the Phoebus cartel illustrate how international cartels work, what market circumstances favor the formation of cartels, and how competitors can be tempted to maximize their proits by allocating markets and inhibiting technical innovation. Although horizontal co-operation can be legitimate, and even pro-competitive in certain circumstances, such co-operation can, on closer examination, turn out to be a hardcore cartel in disguise. 4.3. Verticals 4.3.1. What are verticals? State-of-the-art competition laws not only prohibit cartels, but also vertical agreements or verticals, i.e., agreements between undertakings operating at different levels of product, to the extent that they eliminate or unduly restrict competition. Typical verticals are distribution agreements between suppliers and dealers. Whereas there is a broad consensus among competition practitioners that cartels are harmful to the economy and must be banned, the regulation of verticals is more controversial. Cartels prevent inter-brand as well as intrabrand competition, while verticals only restrict intra-brand competition. If, for instance, all airline companies were to resolve that a ticket from New York to Paris must not cost less than USD 1,000, and assuming they were to fully implement such agreement, (a) all airline companies will charge USD 1,000 for their tickets (which reduces inter-brand competition among airline 32 4. Competition Law companies), and (b) each airline company will instruct its resellers not to sell the tickets at less than USD 1,000 (which reduces intra-brand-competition among resellers of each airline company). In contrast, if only one airline company were to decide that its tickets from New York to Paris shall no longer be sold at less than USD 1,000 and provided that the airline company were to instruct its resellers accordingly, this would reduce intra-brand competition regarding this airline’s tickets, but inter-brand competition (between this airline company and all other airline companies) would remain fully intact. This having been said, and despite the on-going controversies in this matter, it is important to note that verticals are regulated in most competition laws. They regularly raise competition concerns, unless they do not have an appreciable effect on the market(s) concerned or if they can be justiied on grounds of economic eficiency. In this respect, the statements made in sub-section 4.2.4 about lawful co-operation apply to verticals as well. 4.3.2. Hardcore vertical restrictions As with cartels, some verticals are typically considered to be particularly harmful and are therefore a no-go unless they have been analyzed in detail: • vertical price-ixing agreements (resale price maintenance) • clauses in distribution contracts regarding the allocation of territories to the extent that sales by other dealers into these territories are not permitted (vertical market allocation) Other verticals that attract the attention of competition authorities include noncompete obligations, selective distribution agreements and restrictions on online sales. 4.3.3. Practical example: the BMW case Again, there is plenty of case law on verticals and on hardcore vertical restrictions. The following case was dealt with by the competition authorities of Switzerland. In this context, let’s recall that Switzerland is a small and relatively wealthy European country whose 8 million inhabitants enjoy considerable spending power. Undertakings doing business in Switzerland are therefore naturally tempted to charge higher prices in Switzerland than in the surrounding countries. In May 2012, the Swiss competition commission hit the German car maker BMW with a CHF 156 million ine for impeding direct and parallel imports from the European Economic Area into Switzerland (the EEA comprises the 33 4. Competition Law countries of the European Union plus Iceland, Norway and Liechtenstein). The case can be summarized as follows: • In October 2010, more than a dozen Swiss residents sent letters of complaint to the Swiss competition commission alleging that BMW dealers in Germany (near the Swiss border) refused to sell them cars. Around the same time, a consumer affairs television program conirmed that the German BMW dealers were instructed by BMW not to sell cars to Swiss customers. • An investigation opened by the Swiss competition authorities indeed revealed that the dealer agreements between BMW and its dealers in the EEA contained a clause prohibiting the selling of cars to customers outside the EEA. • The competition commission opined that this clause was a hardcore vertical restriction aimed at maintaining a high price level in Switzerland by shielding the Swiss BMW dealers from competition by dealers located in the EEA. Therefore, BMW was ined and was ordered to lift the ban on exports to Switzerland. The Swiss BMW case exempliies that verticals are to be taken seriously and that especially hardcore restrictions (resale price maintenance and vertical market allocation) can trigger lengthy antitrust investigations and lead to hefty ines. 4.4. Abuse of market power The second main pillar of competition laws is in regard to the abuse of market power. 4.4.1. Market power and dominance Perfect competition would require market conditions that do not exist very often in the real world, namely homogenous products and numerous purchasers and suppliers, none of which can be powerful enough to dictate trading conditions. Therefore, competition rules do not aim to achieve perfect competition but, instead, are based on the concept of “workable competition”. Under this concept, dominant market players and even monopolies are not per se illegal. Quite the contrary, it is natural in competitive markets that some participants do better than others, and if an undertaking is so successful so as to gain, and perhaps for some time maintain, a dominant position in a given 34 4. Competition Law market, this is ine as long as the success is a result of fair competition and not of exclusionary practices. There is no standard answer to the question of when an undertaking or a group of undertakings (collective dominance) will be qualiied as dominant in a speciic market. As the European Court of Justice puts it, an undertaking is dominant if it is able to behave “to an appreciable extent independently of its competitors, [its] customers and ultimately [] its consumers.” Usually, a high market share (more than 33 %) is an important indicator of dominance. Yet even then there may be suficient constraints on such an undertaking’s conduct, for instance by existing competitors and their output, by a possible expansion or entry of rivals or by countervailing buying power. The assessment of whether an undertaking is dominant can be further complicated if it is not clear how broad the relevant market is to be deined. For instance, an undertaking holding a very high market share in Canada is likely to be dominant there if, geographically, Canada is the relevant market. If, however, the relevant geographic market is broader (e.g., North America), dominance is unlikely. 4.4.2. Abuse of a dominant position As already mentioned, dominance per se is generally not illegal. However, dominant undertakings are subject to behavioral restrictions that do not apply to non-dominant market players. Typically, the following practices can be qualiied as an abuse of a dominant position: • refusing to deal with a potential trading partner (e.g., refusal to supply or to purchase goods); • under-cutting prices or other conditions directed against a speciic competitor (“predatory pricing”); • directly or indirectly imposing unfair purchase or sale prices or other unfair trading conditions; • limiting production, markets or technical development to the prejudice of consumers; • applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage (“discrimination of trading partners”); • making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts (“bundling” or “tying”). 35 4. Competition Law Since the abuse of a dominant position is usually considered a grave infringement of competition law (similar to hardcore cartels or hardcore vertical restrictions), a dominant undertaking (or an undertaking that reasonably could be found to be dominant in a possible investigation) must avoid the above exclusionary practices unless it is conident that it is capable of justifying such practices by legitimate business reasons. Further, note that in some jurisdictions some of the above trading practices may be illegal regardless of whether the undertaking practicing them is dominant (see the Phonak case below). 4.4.3. Practical example: Microsoft / Phonak From the end of the 1990s until the end of the irst decade of the new millennium, Microsoft was the target of the competition authorities of the US and the EU for abuse of its dominant position as the world’s largest software developer. For instance, Microsoft’s practice of integrating its internet browser (Internet Explorer) and streaming media (Windows Media Player) into its Windows operating system (“bundling”), along with other practices, was found to constitute an abuse of the undertaking’s dominant position in the market for computer operating systems, in that it unduly restricted the market for competing web browsers and streaming media. The ines that the European Commission alone imposed on Microsoft for these practices exceeded USD 2 billion. In 2009, the Bundeskartellamt imposed an EUR 4.2 ine on one of Germany’s leading producers of hearing aids, Phonak (subsidiary of Swiss-based Sonova). In that case, an online hearing aid retailer had offered Phonak hearing aids at prices well below the price level used in the market at the time. Even after complaints by other hearing aid retailers from across the country, Phonak refused to sell to the “price-breaker” until it raised its resale prices. In other countries, Phonak’s behavior would have been dealt with based on the rules on verticals (resale price maintenance), but under German law, such refusal to supply was considered as an illegitimate unilateral act to the extent that it was reasonably construed to inluence the online retailer and cause him to adopt anti-competitive behavior (without the need to prove that Phonak held a dominant position in the market for hearing aids). 4.5. Merger control The third main pillar of competition laws concerns merger control. 36 4. Competition Law 4.5.1. Mergers, aquisitions, JVs, etc. The rules on cartels and verticals limit the freedom of independent undertakings to co-ordinate their market behavior, while the prohibition of the abuse of market power deals with illegitimate unilateral acts of powerful undertakings. Merger control as the third pillar of competition law aims to ensure that undertakings do not, through mergers or acquisitions, create monopolistic or oligopolistic market structures that signiicantly impede effective competition. A merger control regime usually captures mergers of previously independent undertakings and any transaction by which one or more undertakings acquire direct or indirect control of one or more previously independent undertakings or parts thereof. This not only includes acquisitions but also certain joint ventures. 4.5.2. Merger control procedure The merger control procedures vary from one jurisdiction to another. Typically, regulators need to be notiied once a relevant merger is agreed upon but before its implementation. Whether a merger is considered relevant and thus whether notice needs to be given to the regulator in a given jurisdiction will depend on whether certain criteria and thresholds are met. In particular, these criteria and thresholds are the (world-wide and country-speciic) turnovers, assets and market shares of the undertakings involved. Therefore, most mergers involving small- and medium-sized undertakings need not notify merger control regulators. But multi-jurisdictional ilings may be necessary if large corporations are involved. Merger control procedures usually take one to two months in simple cases and up to six months in more complex cases. 4.5.3. Clearance, prohibition, remedies If a notiied merger does not raise competition concerns with the regulator in question, it will be cleared and the parties can proceed with the transaction and implement the merger (subject to the decisions of other competent regulators to whom the merger had to be iled). If the merger threatens to substantially lessen competition, the parties will be ordered not to implement the merger unless they manage to alleviate the regulators’ concerns through appropriate remedies. Such remedies typically consist of divestments or other structural measures (e.g., the sale of a business entity 37 4. Competition Law or of a production facility). Occasionally, regulators accept behavioral remedies (e.g., a commitment to supply other market participants for a certain period at regulated conditions). In merger situations that raise competition concerns, a main challenge is to develop and propose remedies which on one side allow the merger to go through, and on the other side, do not affect the main beneits the parties intend to derive from the merger. Most mergers are cleared either without conditions or based on proposed remedies. Outright prohibitions do happen, but are relatively rare. 4.5.4. Practical example: GE/Honeywell One such failed merger attempt happened at the beginning of the new millennium. In 2000, General Electric announced its intention to acquire Honeywell and iled the merger with the US Department of Justice and with the European Commission. The DOJ did not identify fundamental competition issues, and the parties reached an agreement in 2001 whereby the merger would be cleared on the condition that GE would divest Honeywell’s helicopter engine business and license a new competitor to maintain and repair certain Honeywell engines. In contrast to the DOJ, the European Commission found GE to be dominant in the market for large jet engines, adding that the merger would enable Honeywell to gain a dominant position in the small engine, avionics and non-avionics markets. The EC concluded that the merger would raise the scope for exclusionary practices, such as product bundling, without creating any eficiency to justify or outweigh such restrictions. As the parties failed to propose remedies deemed satisfactory to alleviate the EC’s concerns, the merger was prohibited and could not be implemented. The failed GE/Honeywell merger not only illustrates that mergers of large undertakings can be subject to merger control in a number of jurisdictions. It also shows that the regulators’ assessment of one and the same merger can be different at times. In complex cases, it is therefore essential to identify relevant markets that could be lessened as a result of the merger early and to check if these issues can be justiied by eficiencies or be dealt with through speciic remedies. 4.6. Enforcement Typically, the enforcement of competition rules is entrusted to specialized agencies such as the Department of Justice or the Federal Trade Commission 38 4. Competition Law in the US, the European commission in the EU or the Bundeskartellamt in Germany. The investigations of these agencies and regulators are governed by procedural rules and their decisions are subject to appeal and judicial review. Infringements of competition rules, especially hardcore cartels and verticals and the abuse of dominance, can be punished with heavy ines in all affected jurisdictions. In some countries such as the US and Canada, individuals (managers, for example) who engage in anti-competitive activities can face individual sanctions such as imprisonment or ines. Many jurisdictions have introduced leniency regimes that offer substantial ine reductions to cartel members who “blow the whistle” and help uncover the cartel. Finally, more and more countries have used legislative amendments to encourage the victims of anti-competitive practices to ile lawsuits and claim damages from the wrongdoers (“private enforcement”). 4.7. Conclusion For a market economy to work, undertakings need to enjoy a considerable degree of freedom to operate and do business. Competition law is there to ensure that undertakings are free to develop and sell new products or expand into new markets without being unduly hindered in doing so by other undertakings. Managers must at all times be aware that anti-competitive practices are illegal and may result in heavy ines, individual sanctions and horrendous damage claims. This particularly applies to hardcore cartels (e.g., horizontal priceixing or market-allocation), hardcore vertical restrictions (e.g., resale price maintenance or vertical market-allocation) and to the abuse of market power or dominance (e.g., predatory pricing or bundling). Finally, it is important to remember that mergers can be subject to merger control in the affected jurisdictions and that competition issues may have to be resolved before a merger can be implemented. 39