Competition Law Case Study of Transportation Business

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23/09/19 Law Reference this

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Introduction

Rival firms always try to gain control of the market and may use specific methods to eliminate or interfere with the competition. European Competition law seeks to promote fair competition by companies through regulating any anti-competitive practices. The European Commission enforces these laws found in articles 101 to 109 of the Treaty on the Functioning of the European Union (TFEU).[1] In this case study, there are five firms in the transportation business that is Alfa, Bravo, Charlie, Delta, and Echo. These firms are specializing in using lorries to transport goods from Continental Europe into the UK. Alfa is the dominant firm in the market with 41% share, and Bravo follows closely with 31%. However, Charlie, Delta, and Echo have a significantly smaller combined market share of 28%. This paper seeks to examine and provide legal advice and use precedents to determine whether Alfa’s actions in the past year suggests that it has abused its dominant position.

Alfa’s Market dominance

The company will continue to enjoy market dominance because of three reasons. First, it exclusively acquired from the government ownership of a key installation in the distribution process that is a depot. Each of the four rivals uses it for their fleet operations of loading and unloading goods. Second, the depot has a large capacity useful for storing huge consignments, and its convenient location makes it easily accessible from continental Europe. Third, there is a minimal possibility of any of Alfa’s rival or an investor getting planning permission to set up a similar depot. This situation is due to the environmental concerns of another depot increasing pollution levels. Therefore, Alfa enjoys substantial market power because it controls a significant infrastructure in the transport business.

Abuse of Dominant Position

 

Alfa’s justification of the price hike is to cover for its limited capacity and to renovate the depot to improve their services. However, these are not good enough reasons because Alfa is a company with a broad capital base and being the market leader it generates significant revenue. Therefore, it has the capacity to covering these expenses of renovating or expanding its capacity without passing the costs to users. This move of increasing the depot fees is a suspicious move meant to maintain its profitability. It abuses its dominant position through margin squeezing and exploitation.

Alfa is a vertically integrated firm and controls a critical infrastructure or input in the distribution process. It pays no depot access fee, and so has no additional operating costs. Alfa, therefore, has a wider margin between its wholesale and retail prices and can generate substantial profit than its competitors. When it almost doubles its service charges for depot’s access, it makes the input fee high and increases the operating costs of rival firms. This rise narrows the gap between their wholesale and retail prices, squeezing the profit margin of competitors.[2] 

Bravo with 31% market share is also a dominant player in the market. This means it has a significant capital base. It generates considerable revenue from its vast fleet network. This situation puts the firm in a position to deal with Alfa’s price hikes. As a result, they can still maintain their profitability. However, the other three firms are as efficient in competition but have a smaller market share which means a limited capital base and revenue compared to Alfa and Bravo.

Also, an effects-based test can be conducted. This test seeks to check whether the spread between wholesale and retail costs is insufficient and can exclude a competitor. An effects-based analysis would conclude that Alfa’s action would prevent market entry and eliminate a competitor. This situation is evident when we take the example of Delta which already is suffering due to the high overhead costs of maintaining and repairing its older fleet of Lorries, and the high depot expenses will push it out of business. Echo will also be threatened as the high access costs will hamper its low-pricing strategy and limit competitiveness. Therefore, the squeezed margin will exclude the rivals from competing. The commission’s guidance views margin squeeze as a constructive form of a refusal to grant access by a dominant undertaking. [3]

The Deutsche Telekom 2010 competition law case in the Court of Justice of the European Union (CJEU) sets a precedent. The commission found Deutsche Telekom to have abused its dominant position in the telecommunication industry based on the provisions of Article 102. That is the commission can intervene if the dominant undertaking takes actions that hamper the competitiveness of its rivals and causes an exclusionary effect. [4] The German company owned the local loop, which are localized cables used to connect users to the main network, and had a sole legal mandate to provide access to its competitors. However, DT charged its rivals higher prices compared to retail end-users. The CJEU found it guilty of margin squeeze where there was uneven spread between the wholesale and retail prices leading to as efficient competitors finding it difficult to provide their retail services.[5]

 The increase of depot access fee exploits competitors. Alfa has the economic advantage of owning the major depot which gives it power over its rivals. Being a dominant undertaking, it has a special responsibility not to limit competitors’ growth. It’s abuse if the behavior of a dominant firm influences the internal market structure by using methods contrary to normal competition that weaken the degree of competition.[6] Alfa has used excessive pricing which does not promote healthy competition. This exploitative behavior has the effect of hindering provisions by strengthening its market position and leaving its rivals struggling to compete.

Predatory pricing

The significant drop in prices from 10,000 to 7,000 pounds distorts competition. This pricing means that Alfa is selling its services far below the market price. There are three objectives to such kind of pricing: to prevent new entrants into the market, to attract new customers and to eliminate competition.[7]  Echo is a recent entrant into the lorry transport business and has used an aggressive low-pricing strategy to increase its market share. However, Alfa in a bid to counter its challenge lowers its price to a level where every sale generates a loss. If Echo were to align its price in line with Alpha, it would become complicated for Echo to continue being an active competitor. Echo won’t be able to sustain any further drop in prices, and the losses that will result in the long term will lead to exclusion from the market. However, for Alpha to be guilty of abuse, it has to be proven that the lowering of prices will result in an exclusionary effect in the market. 

The CJEU case of two companies ECS and AKZO provided two tests that can be used to determine any anti-competitive intention. The companies specialized in the production of benzoyl peroxide. ECS used it for making bleaching products while AKZO used it for plastics. Later, ECS ventured its operations into making plastics and in the process took a major AKZO client. This sparked a conflict, where AKZO threated ECS that it will expand its activities in flour production and sell it at significantly low prices. The CJEU determined that AKZO was guilty of abusive behavior because its pricing was above AVC but below ATC and was designed to eliminate ECS from the market. [8]Additionally, pricing below AVC is an elimination strategy. 

Alfa is likely setting its price above AVC but below ATC. Due to its dominance and longer duration in the market, it’s able to cope with any losses that it may incur in the long term. Echo has smaller financial resources and won’t withstand it. Echo will be eliminated from the market.[9]  Alfa would, therefore, be guilty of predatory pricing.

Merger Control

 

Echo remains an active competitor in the market. Its primary strengths are the innovative use of technology that helps it cut out a niche in the market. Due to Alfa’s significant market share and experience gained from operating over a more extended period, it already enjoys a dominant position.  Alfa merging with Echo is an example of horizontal merging. Both firms work in the same lorry transport business. Alfa will achieve five benefits that will give it a more significant competitive advantage.[10] 

Impact of Merging

 

First, when Alfa absorbs Echo, the market will be less one firm hence reduce competition. Second, Alfa will inherit the Echo’s previous customers and market share and will strengthen its dominance. If we assume that all Echo’s customers will switch to the merged entity, then Alfa will have close to 50% share of the market. Also, since Echo was gaining popularity, the combined entity will likely push for a broader share of the market. Third, Alfa will obtain a superior technology, and this will boost its overall performance in its operations. Alfa will be able to offer better customer service delivery by using Echo’s innovative tracking technology.

Fourth, it will benefit from the services of the specialized personnel that managed Echo and incorporating them into their operations will result in greater managerial efficiency. Fifth, the merged entity will have substantial revenue that will cause it to have more control of pricing in the market. Further, Echo had already developed a low-pricing strategy, despite using Alfa’s depot, and integrating such a policy with Alfa’s vast resources in the merged entity will potentially harm the competition. Alfa justifies its intention to merge as a means to improve customer satisfaction which is a positive reason.

However, we must look at its competitive impact on the market. The situation would be much different if the smaller firms that are Charlie, Delta and Echo combined to form one entity. This event would have made it possible for the three firms to effectively compete with the market’s dominant players that is Bravo and Alfa on the same level.

It is important to note that a concentration arises when an undertaking takes over the assets and controlling the power of another firm. In this situation, through the acquisition, Alfa takes control of Echo’s assets and will able to manage their operations.[11] To determine the legality or compatibility of Alfa’s possible merge with Echo, we will take a look at the European and UK Merger Control Regulations. They provide us with two tests according to EU and UK regulations. First, is the Significant Impediment to Effective Competition (SIEC) under EU and Substantial Lessening of Competition under UK (SLC).

SIEC test

This regulation states that if a merger between firms’ results to a strengthening of a dominant position to the extent that it interferes with effective competition in the common market or a significant part of it then it is declared incompatible. This also means that if a merger doesn’t impede effective competition, then it is compatible.[12] In this case, Alfa’s position is significantly strengthened in the market, and the other firms are not in a position compete effectively. Because Alfa already enjoys economic strength by owning the largest depot in the UK. Further, it will again be in possession of the best technology in the market. These two reasons set Alfa far apart from the competition. Alfa fails this test as the merge contravenes the European Union merger regulations. It would negatively affect the transporting of goods by lorry business and the firms involved would either suffer losses or leave the market. Therefore, the merge is incompatible.

SLC test

Under this provision, if the merger results in the lessening of competition due to the strengthening of the dominance, then it is incompatible. This provision also means that if a merger results in stronger competition in the market, then it is compatible.[13] For example, assuming the case was about the three smaller firms in the market merging that is Delta, Echo, and Charlie and forming an entity we’ll call Deca. It would have immense benefits to consumers in the market. First, the combined market share of the three entities will be 28%, while Bravo and Alfa are 31% and 41% respectively. The significant resources, experience, and innovative technology joined together will create a third force in the market that will pose a severe threat in the market. This will promote competition and customer satisfaction. However, in this scenario, Alfa is removing an active competitor while increasing its market share. This reduces competition, and the move is incompatible. Based on these two tests, it is evident that this merge offers an adverse competitive impact as it gives Alfa significant power over its rivals. The merge is incompatible and won’t be accepted by either UK or EU competition authorities.

To provide further guidance, the European Commission has set out two separate documents relating to the Guidelines on the Assessment of Horizontal mergers [2004] and Non-horizontal mergers [2008]. The UK has Merger Assessment Guidelines [2008] which combines both mergers. Under EU guidelines on horizontal mergers indicators of the extent of dominance are the market shares and concentration levels. For example, a market share of above 50%. While under the UK Merger Assessment Guidelines will not investigate if the merge results in a combined market share below 40%. Based on those guidelines Alfa already has 41% share and when it combines with Echo, it will have close to 50 % which will make it a cause for concern for the UK CMA.

Let’s consider the case of T-mobile acquiring tele.ring to highlight the loss of competitive force. Here, tele.ring used aggressive low-pricing strategies to take away customers from its rivals T-mobile and Mobilkom. Despite having a lesser market share than TM and MK, it posed a significant competitive impact in the market. The commission cleared TM with commitments.[14] This because although the acquisition resulted in the loss of competitive force, it did not strengthen the dominance of T-Mobile in the market. It is comparing this case with Alfa. Echo has a significant effect on the market due to its aggressive low-pricing strategy and innovative tracking technology that makes it attract more customers. Without the merger, the company was likely to continue posing a serious threat considering the other firms still don’t have the superior technology. However, what makes the merge incompatible is the fact that there will be the loss of competitive force and the strengthening of a dominance position. This situation will make the commission prohibit this merge.

 The Hutchison 3G UK versus Telefonica UK case in 2016, also provides further insights. Here three which had the 4th highest number of subscribers was prevented from acquiring O2 the leader in subscribers. The Commission prohibited the acquisition because of the competitive impact of 3. Despite being a new entrant, the firm was setting standards in the industry with its innovative technology. Its aggressive use of technology made it compete strongly in the market. Therefore, combining the subscription numbers of O2 and the cutting-edge technology of 3 would significantly strengthen the dominance of 3 as it would give it a broader market share.[15]

Similarly, Alfa’s acquisition of Echo, which has had a significant competitive impact, would be prohibited. This is because Alfa would be able to combine its broader market share and superior technology and the cumulative effect would be a much powerful force. It would effectively lock out competitors from the market. Therefore, the commission wouldn’t allow it.

Alfa’s accountants are convinced that the acquisition would have a “community dimension” which means that satisfies the turnover thresholds as found in Article 1 of the EU merger regulation. In line with Article 21 that is the European “One-Stop Shop” if a concentration has a community dimension then no member state will be able to apply their national legislation regarding competition.[16] This means that the UK can’t intervene. However, the commission can consider certain factors to determine whether to clear or prohibit the merge. Its based on evaluating the effect of the merge on the competition. Article 2(1) of EUMR stipulates that the commission will consider the competitors market position, economic and financial power, barriers to entry, access to suppliers, does not hinder competition and offers benefits to consumers.[17]

Conclusion

The commission is likely to prohibit the possible acquisition of Alfa because it’s going to impede competition and strengthen its dominance. This situation will cause an anti-competitive effect on the market. However, Alfa is determined to acquire Echo and can offer possible remedies that will promote competition. The Commission Notice on remedies states that it can accept commitments if they eliminate any competition concerns, they are useful and implemented within the shortest time possible. It adds that it may involve putting in place divestiture commitments such as allowing fair access to a critical input.[18] There is a slim chance Alfa’s proposal will still be permitted if it grants rivals access to its depot at a lower fee. Alfa won’t be permitted to merge with Echo.

Bibliography

  • AKZO Chemie v Commission [1991] ECR I-3359
  • Consolidated Version of the Treaty on the Functioning of the European Union 2008 OJ C 115/47.
  • Deutsche Telekom [2003] (CD); [2008] (GCEU); [2010] (CJEU).
  • Gao, N., Peng, N., & Strong, N. ‘Market power and efficiency in horizontal mergers: Evidence from wealth transfers between merging firms and their customers’ (2018).
  • Guidance on the Commission’s Enforcement Priorities in Applying Article 102 [2009]
  • Hutchison 3G UK/Telefónica UK [2016] (CD)
  • Regulation 139/2004 on the control of concentrations between undertakings [2004] OJ L24/1.
  • T-Mobile/tele.ring[2007] (CD)

[1] Guidance on the Commission’s Enforcement Priorities in Applying Article 102 [2009] [1].

[2] Ibid [80]

[3] Commission’s Guidance on Article 102 [2009] [79].

[4] ibid [23]

[5] Deutsche Telekom [2003] (CD); [2008] (GCEU); [2010] (CJEU) [169].

[6] Commission’s Guidance on Article 102 [2009] [1].

[7] ibid [66].

[8] AKZO Chemie v Commission [1991] ECR I-3359 [71].

[9] Ibid [72]

[10] Ning Gao, Peng Ni, Strong Norman, ‘Market power and efficiency in horizontal mergers’(2018)

[11] Regulation 139/2004 on the control of concentrations between undertakings [2004] OJ L24/1 (“EUMR”),      Article 3(1).

[12] EUMR Article 2(3)

[13] EA02 s35 & s36

[14] T-Mobile/tele.ring [2007] (CD)

[15] Hutchison 3G UK/Telefónica UK [2016] (CD)

[16] EUMR, Article 21

[17] EUMR Article 2(1)

[18] Commission Notice on Remedies [2008] [9]

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