Sunday, 1 December 2013

Crime, victimless crime, or no crime at all?

The latest American Economic Review CD arrived in the PO box the other day, and it had an article that reminded me of just how difficult it can be to distinguish competitive from anti-competitive behaviour.

If you've never paddled in this particular pool before, your first thought might be that the job can't be as hard as all that. Standover intimidation of the minnows by the dominant incumbent, hard core cartels, dirty tricks employed against potential new entrants - should be easy to spot, right? Especially as these days there's often a treasure trove of internal corporate e-mails to shed light on what was going through people's minds at the time.

Well, no, actually. I'd say that a range of behaviours are increasingly becoming more difficult to characterise, often because economic theory has been coming up with new ways of analysing and interpreting them.

And it's not just behaviours that fall under Section 36 of the Commerce Act ("Taking advantage of market power") that are difficult to make a call about. While there often important issues at stake in s36 cases, as anyone unfortunate enough to get caught up in one of these things knows they can often be a complete toss-up, and Section 36 cases, when they hit the courts, are infamously arbitrary. In the Pink Batts case*, for example, it went to a penalty shoot-out in the House of Lords, with three judges seeing it as Carter Holt's right to compete vigorously and two judges seeing it as unlawful predatory pricing to drive a new entrant from the market.

Rather, the difficulty extends across a whole range of behaviours. And it's further complicated by the fact that sometimes new theorising leads you to think that formerly unacceptable practices are actually okay from a competition viewpoint, and sometimes it goes the other way, with new theory suggesting that formerly okay things can actually be problematic for competition.

This latest AER article, "Competition with Exclusive Contracts and Market-Share Discounts" (Vol 103, No 6, pp2384-2411) has a bit of both, with one behaviour found less anti-competitive than usually thought, but another pinged.

As the authors point out (p2384), "antitrust authorities view competition by means of exclusive contracts or market share discounts with some suspicion, to say the least. The authorities’ main concern appears to be that a dominant firm can use exclusivity or market-share discounts to eliminate not only potential competitors, but also existing ones", and they note how the EU gave Intel a massive fine for using 100% market-share agreements (i.e. exclusivity) against its rival chipmaker AMD.

However, they find (p2384) that  "exclusive contracts intensify competition, reducing equilibrium prices, whereas market-share discounts have a double marginalization effect and, hence, result in higher prices" and (p2405) that "there is a clear sense in which exclusive contracts are procompetitive and market-share discounts are anticompetitive. If economies of scale are relatively unimportant (and there are no dramatic coordination failures), our  findings imply that when firms are nearly symmetric exclusive contracts should be permitted and market-share discounts prohibited".

But, as they note, and you'd have guessed for yourself anyway, there is always the issue of how the results from one model specification generalise to life more generally (and this is a very mathematical model). They say, for example, (p2405) that "the normative implications are less clear when economies of scale are substantial and differ across firms. In this case, the stronger firm (i.e., that with lower fixed costs) may actually gain from fiercer competition that drives the other’s profit below a level justifying continuing business. Exclusive contracts can thus serve as a market foreclosure mechanism", in which case we are back at square one and regulators' fears could well be justified after all.

Clearly, though, smacking down exclusive contracts isn't the automatic regulatory slamdunk it once was. And neither is retail price maintenance (i.e. manufacturers and/or wholesalers dictating the retail prices the shops must maintain).

This has been a real eye-opener to me, personally. I'd have thought - did think, in fact - that RPM was always and everywhere self-evidently inexcusable as a reduction of competition at the retail level and (potentially) as a mechanism that facilitated tacit collusion at various levels along the supply chain. But then the US Supreme Court decided in the Leegin case (which even has its own Wikipedia entry) that RPM isn't to be condemned out of hand, but each instance must be looked at on its merits to see if there are benefits that outweigh any competitive damage. And I can think of examples where, potentially, a distributor's investment in brand or ambience (a package possibly valued by consumers, who might like the pampering or whatever) won't happen if consumers can get the product cheapo at a parallel importer (for example).

I'm not saying that there are now going to be lots and lots of instances of acceptable RPM. Mostly, I'd suggest, RPM is still generally a bad thing, and I'm right behind consumers using channels like parallel importing to defeat sellers' rorts or sellers' price discrimination. But there could well be instances, as there have been in the US, where on balance buyers might be better off. Not that it matters a hoot what I think, or how many might be okay: this is one of those instances where our competition law hasn't caught up with the state of play. Our Commerce Act (s37 mainly, "No person shall engage in the practice of resale price maintenance") with its outright ban is still back in the pre-Leegin days.

If exclusive contracts and RPM are now (at least) less unacceptable than before, there are also examples where things that were once regarded as completely benign are now being looked at more critically.

Take price matching promises, for example: what could be a clearer example of very vigorous competition than retailers promising to beat or undercut any price the shopper can find at another retailer?

But if you read some research that the UK's Office of Fair Trading commissioned from Lear, a European economic consultancy, and which was published last year, you might want to think again.

The research, 'Can ‘Fair’ Prices Be Unfair? A Review of Price Relationship Agreements', noted among other things (paragraph O.9) that "Promises by retailers to match (or beat) the offer of their competitors may give an impression of fierce price competition, but a common view among
economists is that the adoption of these low price guarantees softens price competition" and that (para O.10) "If the rivals of a ‘lowest price’ retailer know that any price reduction will quickly be matched or beaten, this reduces their incentive to lower prices. Because of the across-sellers price guarantee they know that any price cut is immediately matched by that retailer, thus leading only to lower profits because price cuts do not lead to increased market shares. This reduced incentive to cut prices can in turn imply less vigorous competition, and potentially higher prices than would be observed without the across-sellers price guarantee".

As with RPM, where the latest thinking suggests that while there's the occasional okay example, most are still injurious, the same conversely applies with price matching - while there might be the odd instance where sellers are implicitly deterring each other from cutting prices, for the most part price matching is likely to be what it says in the ad, a signal of vigorous price competition (and my reading of the empirical evidence in Chapters 4 & 5 of the Lear report is that it's rarely malign).

All up, it's getting harder for the likes of our Commerce Commission, the ACCC, businesses, and their legal and economic advisers, to know what's licit and what isn't.

And we're going to get a really good example of that when the ACCC lets us know what's happened to their grocery petrol voucher investigation.

By way of background, the two big supermarket chains in Australia, Coles and Woolworths, have been offering petrol discount vouchers ("shopper dockets") to their customers. The discounts have been getting bigger, and have apparently got as much as 45 cents a litre, though more typically (going by the supermarkets' current websites) they're more like 8 cents per litre.

Now, which is it: vigorous competition (resulting in independent petrol stations going to the wall), or an anti-competitive long-term rort against the petrol retailers, where the supermarkets can "swing" their market power in groceries into another market?  Is it what the then ACCC chairman said in 2004, that "The reality is that the linkage of petrol discounting to retail grocery sales is no more than a loyalty or marketing program like Fly Buys", or is it what the current chairman said in July this year, that "While large shopper docket discounts provide short term benefits to some consumers, the likely harm to other fuel retailers and therefore to competition and the competitive process for petrol retailing could well be substantial"?

The decision's due any day now. Arguably it's already a bit overdue, and I'm not surprised: this is one that's going to be a very difficult call to make.

*More formally, Carter Holt Harvey Building Products Group Limited v Commerce Commission [2004] UKPC 37. If it's all new to you, you can read a case study that the Commerce Commission prepared about it: 'Predatory pricing or competitive price matching?'.

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