European Commisions Investigation Of The Michelin Case
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Published: Mon, 5 Dec 2016
This case involved Michelin being accused by the EU of attempting to ride on and abused its dominant position in the new replacement tyres and retreaded tyres for heavy vehicles like trucks and buses market in France.
Michelin owed its significant influence on this particular form of tyre industry to various factors. The firm made itself sufficiently vital since supply of tyres from Michelin accounted for slightly more than 65 percent of the total possible production by tyre-makers. Next, Michelin gained ownership of the chain Euromaster with over 330 specialised sales outlets carrying the Michelin’s brand together with those of other competitors’. Hence, Michelin was seen to possess a major share of the network of distribution channels. This may well determine the success or failure for a business of this nature because customers perceived the size of distribution network to indicate the reputation and reliability of the producer. In this instance referring to Michelin selling via Euromaster therefore the paper is suggesting a subtle relationship between the provider of the tyres and the retailers who are the dealers or the final consumers. There must be an element of mutual trust and reliance on the expertise of Michelin to input specific knowledge, precise skills and technologies into retreading the tyres. As tyres are a critical part of the main components in keeping vehicles operational, thus dealers and consumers tend to emphasise on the durability. Recognition and trustworthiness of the quality came into play with Michelin considered and thought of as the established brand of tyres provider and an effective channel of delivery to reach customers in France.
Furthermore, Michelin’s main competitor Bandag focused on pre-cure retreading which according to the writer was thought to readily replaced the mould-cure retreading of Michelin with respect to any changes in price of the retreaded tyres, ceteris Paribas. The growing market for Bandag also posed direct risks to Michelin signalling intentions to wrestle for market shares in the retreaded tyres industry. In response, Michelin manipulated its relations with dealers and end consumers tactically. Through the implementation of Michelin’s commercial policies including several rebates and discount programs the firm aimed to attract and retain the customer base.
In addition to the standard of pricing tyres using the official ‘invoicing scale’ which was a list price being charged, Michelin offered dealers a variety of rebates. Firstly, the quantity rebate scheme led to a direct relation between the volume of purchases and the amount of cost savings that dealer would receive. Moreover, relative to unexpected adjustments in the volume of tyres bought the effect of actual discount on the marginal basis turn out to be greater accordingly. The consideration would be net effect of cash flow due to delay in receiving rebates so it could be necessary to incorporate the principle of discounting.
Service bonus scheme was related to how well dealers adhered to the commitments they have undertaken with Michelin. The point system worked on the basis of fulfilling commitments which ranged from features regarding the quality of services rendered by dealers, how dealers behave towards Michelin’s clients and retreading as Michelin tyres automatically assigned to be retreaded by Michelin. The progress bonus scheme designed such that dealers who decided to enter into contracts with Michelin at start of year could set minimum sales quota for which the dealers would benefit profitably should they manage to exceed it. Individual agreements scheme could only be applied to large buyers whom reached the maximum volume of purchases. They would be cooperating with Michelin under binding agreement however the positive was a string of advantages for both the dealers and Michelin.
The commercial policy consisted of two other components a “PRO Agreement” scheme and the Michelin friends’ club which consolidated Michelin’s position in the French tyres market. The “PRO Agreement” allowed both parties, Michelin to give discounts for retreading each tyre and dealers in turn, commit to have Michelin retread all Michelin truck tyres that were due in tread wear. Bonuses earned in this scheme would translate into credit for purchasing new Michelin tyres in future. (M.Motta, 2006, p.p10, Michelin II) The “Club des amis Michelin” is an agreement that Michelin signed (bilaterally) with a large number of sales outlets (375 in 1997, accounting for some 20% of the truck tyres markets). This business cooperation established that Michelin should contribute to help members raise their professionalism and eventually to do better. While, the club members on their parts would have to ensure that they maintained an agreed level of Michelin’s brand in the outlets and help promote and encourage Michelin among the consumers. As a result, expectations that dealers and Michelin would progress together increased.
The European Commission discovered Michelin to hold market shares exceeding 50 percent in the retreaded truck tyres replacement market in France. Michelin continued to yield considerable market power even with a recent decline and more findings pointed out that Michelin as a market leader took up commercial policy in favour for the firm to compete on an unfair advantage against main rival and potential new entrants so as to uphold and consolidate its position.
Thus, in 2001 Michelin was judged by the EC to have breached Article 82 of the EU Treaty by abusing its dominance in the French market for new replacement and retreaded tyres for heavy vehicles. Michelin was fined EUR19.76 million and the Commission’s decision was upheld by the Court of First Instance later in 2003.
As a dominant firm, Michelin is expected to set monopoly price at Pm(T.Kendall,2010) for the heavy vehicle tyres being a price maker. On the contrary, the firm gave discounts and rebates for purchases to dealers instead. This can be explained by the Coase conjecture as Michelin operates as a dominant firm in the retreaded tyres industry selling a type of durable good, which refers to the retreaded tyre. The conjecture is based upon lowering price charged below monopoly price, assuming after a period of time(n) and kept sufficiently low for the good in order to continually attract new customer base. It is largely in support of the potentiality whereby Michelin may be seen as applying the theory of limit pricing.
There are certain grounds to believe that Michelin according to (J.Sloman,2006) takes up the practice as it faces the risk of having to cope with emerging competitors trying to enter the industry. This can be justified by the article which had mentioned the presence of new entrants. Thus, a probability that Michelin attempts to charge the highest price possible without attracting new firms into the market is logical. While pricing set above the incumbent average cost and at the same time below monopoly price, this show Michelin takes into consideration the long-term profitability and deterrence of entrants by giving up some profits in the short-run. In setting price, Michelin could have related to both the Coase conjecture and limit pricing theory before reaching its decision. This means that the price of Michelin’s tyres does not simply follow the stated official ‘invoicing scale’ in charging a specific list price on the volume bought as the article had discussed.
A second argument points to Michelin not being able to charge monopoly price due to the fact that its nearest rival Bandag, can produce pre-cure retreading tyres which are close substitutes in supply and demand with the mould-cure retreading tyres. Hence, the reasonably close elasticity increases the likelihood of dealers switching providers if they detect big enough change in price, ceteris Paribas. Michelin has to monitor its output closely together with the industry demand for mould-cure retreading tyres. It must be kept updated of the evolving and growing market for Bandag’s pre-cure retreading tyres so as to respond timely and appropriately to the actions of its main rival. This is also for Michelin to better control and plans its productive capacity, allocating resources efficiently to where production need instead of having instances of overproduction or underproduction which do not align with changing level of industry demand. Otherwise that will be costly to the firm and detrimental to the society in terms of loss in efficiency and wastage of resources.
Monopoly price will be the higher price charged at short-run profit maximising level(MC=MR) to generate as much profits sometimes supernormal profits is possible. High prices shall lead to a loss of consumer welfare and total welfare decreases in theory however this is not necessary the case with Michelin.
A lower than monopoly price charged is fairly similar to the Cournot duopoly model whereby the Cournot price(Pc) is between the monopoly price(Pm) and perfect competition price(Ppc). Therefore the final price of tyres is below the monopoly price set but above the perfect competition price charged. As for the quantity produced by Michelin, evidences may be in favour of duopoly output(Qc) which also lies between perfect competition quantity(Qpc) and monopoly(Qm). But, from the article the actions of Michelin prompt that actual output may differ relative to level of demand of such tyres from the dealers instead of using the duopoly quantity as a benchmark. Since the price of tyres is now lower than monopoly price charged, the likely effect will be a decrease of the loss in consumer surplus. This indicates that welfare of dealers rises as consumers become better off with a greater area of consumer surplus than compared to at monopoly price. For the producer Michelin, the area of producer surplus reduces since the portion of consumer surplus gained by charging at Cournot price will replace the producer surplus to become consumer surplus now in addition to the area of monopoly price set. As a result, Michelin becomes worse off than in monopoly because the size of profits shrink in proportion to the increase in area of CS. With reference to the transfer of welfare from producer back to consumer, this is opposite to the monopoly-perfect competition case which has a welfare transfer of consumer to producer surplus as the original area of CS becomes part of PS. The total welfare still decreases with the creation of deadweight loss but this time, the loss of economic welfare is to a smaller extent unlike in monopoly-perfect competition. Thus, there may be improvement in the economic welfare since deadweight loss is lesser.
Although Michelin paid a hefty fine for abusing its dominant market power, it does not mean that this is good enough to compensate for the anti-competition the firm has brought about to its rivals, other private suppliers and new entrants. The actions of Michelin may have caused competitors to suffer especially in the aspects of producer welfare and total welfare. A lower producer surplus for Bandag and the other private suppliers in the market may turn out to be long-run with prices charged by these firms maintained at a highly competitive level close to the Cournot price or even at P=MC for the new entrants. Deadweight loss will be inevitable resulting in the loss of economic welfare. Michelin may be able to correct the situation if it is willing to cooperate with the rest of the firms to reinvest profits for innovation and invention. Cost savings and efficiency savings from the investments in research and development will then raise the economic welfare through dynamic efficiency. Apart from the dynamic efficiency by Schumpeter to attain product and process innovations, competitors are able to achieve the elimination of some deadweight loss.
It is more essential to focus on the welfare of main rival, competitors and entrants than the dealers. This is because empirical evidence from the article suggests that there is an imbalance of allocating welfare towards consumers as Michelin’s policy inclined to benefit dealers and limit competitors. Therefore there is a need for the Commission to shift focus of welfare to other firms in the retreaded tyres industry as EU also considers the interests of firms. This is in line with the objective of the competition authority aiming to encourage fairness and freedom in competition among firms.
Examining the effects of the series of rebates, the quantity discounts scheme present a case for intervention by the EC due to the policy inducing loyalty of the dealers. This is because the additional volume of purchases entitles dealers to a larger discount on total volume bought. In this way, Michelin attempts to prevent dealers from buying the tyres of rivals as they will have more incentives shown by the rebates granted to purchase Michelin tyres rather than those of the competitors. At the same time, this becomes limiting on the choices available for the consumers since the obvious choice and priority is to purchase from Michelin. It may be damaging on the dealers as they will have to buy Michelin tyres or do without it. Another hold back will be the need to account for the principle of discounting whereby dealers are more concerned and generally prefer receiving the rebates today than delay to the future. The dealers may have to consider the value of the discounts receivable in future at the present value in order to measure whether they should take up the purchases. The EC may have to carry out further investigations to determine if Michelin truly pass on the cost savings in the form of benefits of economies of scale transferred to its customers since dynamic efficiency allows the firm to achieve lower costs of producing tyres. Can it be that Michelin as a large firm is able to absorb all the costs incurred via implementing the various forms of rebates? These are some issues that the Commission will have to ponder before deciding how best to intervene in Michelin’s policy.
While the service bonus scheme encourages dealers to raise their performances and standards of services provided so as to reap the rewards of scoring points and enjoying bonus, this can make the competing firms worse off but beneficial to the dealers. The scheme presents a weaker proposition than quantity discounts for intervention by EC since the welfare of consumers and total surplus are better off. Competing firms as mentioned earlier will be a factor of concern arising repeatedly. Under the “PRO Agreement”, EC must tackle the restrictive practice of ‘tying’ to resolve the tacit agreements that Michelin developed with dealers so as to provide a more level competitive field. However, this is very difficult in reality as there is a lack of clear accurate information for the competition authority to work on. Furthermore, dealers may be reluctant to give up the lucrative deals offered by Michelin.
In defence, Michelin argued that the introduction of the rebate system did not have any effect on competition in the market as reflected by declining prices and market share of the firm. The evidences prove otherwise with Michelin guilty of trying to control dealers through close monitoring of their businesses and exclude or drive rivals out of business. EC could impose antitrust policies on Michelin and promote equity together with more horizontal competition. This is more important than reinvestments of profits for dynamic efficiency. The issue of an integrated network of plants, specialised sales outlets and distribution channels will be controversial with Michelin building on strength to create barriers to entry that are deemed to be anti-competitive. (D.Harbord & T.Hoehn,1994) Sunk costs are a powerful form of entry barrier in which Michelin, likewise uses to deter entrants since the firm has an incumbency advantage. Michelin being an established firm can forego the costs that are sunk as opportunity costs of production. This present an unfair advantage to Michelin so EC will rightly point out that an abuse of dominance has occurred.
List of References of Sources
Main Journal Article
Motta,Massimo. 2006. Michelin II-The Treatment of Rebates European University Institute,Florence and Universitat Pompeu Fabra,Barcelona
Other Journal Article
Harbord,David. and Hoehn,Tom.(1994) “Barriers to Entry and Exit in European Competition Policy”, International Review of Law and Economics 14 pp.411 to 428.
Ehlermann,D.Claus and Atanasiu,Isabela. 2004. “Michelin, Commission Decision of 20 June 2001,Case”, European Competition Law Annual 2002:Constructing the EU Network of Competition Authorities p.305 and p.466.
Europa-European Commission, European Commission Competition Antitrust[Online] (October 6,2010) http://ec.europa.eu/competition/antitrust/overview_en.html [November,15 2010]
John Sloman. 2006. Economics Sixth Ed. Edinburgh Gate Essex UK; Prentice Hall Pearson Education Ltd. Part C: Microeconomics “Profit-Maximising under Perfect Competition and Monopoly”
Dr Toby Kendall. 2010. Markets, Competition and Regulation Part A
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