European Court Gets it Right on Abusive Margin Squeeze in Regulated Industries

(by Bruce Lyons) Last week’s decision by Europe’s highest court provides admirable clarity and a welcome constraint on specialist regulators.  This seems to contrast with the apparently muddled situation in the USA.  The Court of Justice of the EU (formerly known as the ECJ) has finally confirmed the earlier judgements of the Commission and General Court (formerly CFI) in relation to the Deutsche Telekom (DT) case.  The case has been much debated, but it is worth reflecting on some of the consequences for the economic application of competition law.

DT lost its legal monopoly of retail fixed-line telecom services in 1996.  In 1998, the German federal government required it to offer unbundled access to the local loop (‘the last mile’), which is ‘indispensible’ for other firms to be able to compete for retail customers.  The access price was authorised by the Regulator based on DT’s long run incremental cost information.  The Regulator was already setting a price cap on a basket of DT’s services, including retail call charges.  So far, apparently so good, but the problem was that that the access charge was higher than the internal charge within DT to its retail services unit, leaving a potential entrant who would be ‘as efficient’ as DT still unable to compete (i.e. there was a ‘margin squeeze’).  The Commission fined DT €12.6m for ‘unfair pricing practices’ that were an abuse of dominance under Article 102 (formerly Art. 82).

Perhaps not surprisingly, DT claimed that: a) no final consumer had been hurt; and b) DT was acting within the constraints set by the Regulator so it was the Regulator, if anyone, who was to blame.  On the first point, the Court found that it was not necessary for the Commission to demonstrate that wholesale or retail prices were individually abusive.  It was sufficient to show that the combination would exclude an ‘as efficient competitor’.  The Court appreciated an attraction of this test in terms of legal certainty because it requires the dominant firm to reflect only on its own costs.  DT did not have to speculate on whether potential entrants with different cost structures would be excluded. 

The Court’s reasoning in terms of the welfare standard also confirmed that abuse is not solely determined by current or foreseeable prices.  Consumer choice between alternative suppliers and longer run cost reductions expected from the competitive process were both legitimate considerations.  Now in other circumstances, this might look like ‘protecting competitors, not competition’.  However, it seems reasonable in the context of the ‘as efficient competitor’ test and as long as we are considering an inherited local loop (i.e. it would be different if a successful network investment had been made in a previously competitive market, and to which others demanded access – which would undermine the incentive to take risky investments).  Provided these specific circumstances are appreciated, this provides an important depth of definition of consumer welfare, but is a potential source of transatlantic tension in antitrust.

On the culpability of the Regulator, the Court left open the possibility that the Regulator indeed may have infringed European law.  However, so did DT which could have adjusted prices within the basket subject to a price cap, or renegotiated suitable prices with the Regulator.  This is another possible transatlantic difference, though it is difficult for a European economist to tweak out the nuances of US law in this area (e.g.  ‘Trinko’, ‘Linkline’).

On the role of the regulator, a key issue for me is that the DT decision provides a way to move away from excessive price regulation over time.  Even if access price regulation may have to continue for a network that is too expensive to replicate, sufficient downstream competition removes the need for retail price regulation.  But downstream competition cannot develop if a margin squeeze persists.  Entry into retail provision is surely preferable to retail price regulation continuing indefinitely into the future.  Of course, a Regulator may have a self-interest in continuing the regulatory regime and may furthermore get captured by the dominant firm. It is therefore an excellent institutional constraint that a Regulator can be challenged by an independent competition authority.

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