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.
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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.
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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
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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.
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• 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
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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
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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
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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”).
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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.
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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
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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
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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.
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