New Zealand: 0867 Not The Right Number For Abuse Of Market Power

Competition and Market Regulation Update
Last Updated: 22 September 2010
Article by Jason Woolley

On 1 September the Supreme Court delivered the final coup de grace to the Commerce Commission's case in the long running '0867' saga1. In so doing the Supreme Court has clarified the law on section 36 of the Commerce Act 1986.

Section 36 contains the key restriction in the Act on the unilateral use or abuse of market power2. The Commerce Commission unsuccessfully alleged that Telecom had breached section 36 by introducing the 0867 package, thereby stemming the outflow of termination payments to its competitors hosting internet service providers (ISPs) on their networks. The decision will be of interest to anyone operating in an industry where one or two companies command a large market share or otherwise arguably have substantial market power.

The key part of section 36 currently reads as follows:

A person that has a substantial degree of power in a market must not take advantage of that power for the purpose of:

(a) restricting the entry of a person into that or any other market; or
(b) preventing or deterring a person from engaging in competitive conduct in that or any other market; or
(c) eliminating a person from that or any other market.

At the time of the introduction of the 0867 package section 36 was worded slightly differently. It read:

No person who has a dominant position in a market shall use that position for the purpose of—
[Clauses (a), (b), (c) were substantially the same]

To establish a breach of section 36 it is necessary to show three things in relation to the person accused of breach:

  1. that person has a substantial degree of market power (a dominant position, on the old wording);
  2. that person took advantage of that power (used that power, on the old wording); and
  3. that person had one of the proscribed anti-competitive purposes at (a) to (c) (which are substantially the same under the old and new wording).

The Supreme Court's decision dealt only with the second of these elements - whether Telecom had taken advantage of or used its substantial market power / dominant position. This has always been the hardest element to prove in cases under section 36. Although the 0867 case was decided under the old wording of section 36 (as that was the wording that applied at the time of Telecom's alleged breach) the Supreme Court confirmed that it saw no difference between the old wording 'use' and new wording 'take advantage of' on this point as 'use' necessarily implied advantageous use3. The case will therefore be of ongoing relevance and importance.

The 0867 package was designed by Telecom to encourage residential customers and ISPs on competitor networks to migrate to Telecom and to encourage competitors to adopt the 0867 prefix for ISPs on their networks, thereby reducing the significant termination costs that were at that time being paid by Telecom to its competitors. It was controversial because for Telecom's residential customers who wanted to stay with their existing ISP it potentially increased the costs to them of using the internet. The Commerce Commission alleged that in a competitive telecommunications market where Telecom did not own the only public switched telecommunications network or PSTN, it would not have been possible for Telecom to introduce the 0867 package without the risk of losing these valuable retail customers, and therefore it would not have introduced it. It reasoned from this that because introducing 0867 was not something Telecom would have done in a competitive market it must have used / taken advantage of its dominant position / substantial market power in breach of section 36 in order to introduce it. As we will see, the Commission's allegation was rejected by the Supreme Court, largely because the Commission did not produce evidence to establish that the allegedly valuable customers that Telecom was at risk of losing were indeed valuable - on the contrary the evidence suggested that because of the system of termination payments in place between Telecom and its competitors at the time, these customers were costing Telecom money every time they used the internet.

As indicated above, the 0867 case dates back to 1999 when Telecom introduced the 0867 package. Key dates are as follows:

  • 18 June 1999 - Commission opens its investigation
  • 31 July 2000 - 0867 proceedings filed in High Court
  • 20 August 2007 - High Court trial
  • 18 April 2008 - High Court decision in favour of Telecom
  • 23 May 2008 - Appeal to Court of Appeal lodged by Commission
  • 23 March 2009 - Court of Appeal hearing
  • 4 August 2009 - Court of Appeal decision in favour of Telecom
  • 1 September 2009 - Commission seeks leave to appeal to Supreme Court
  • 1 September 2010 - Supreme Court decision in favour of Telecom

With the Supreme Court decision Telecom achieved a 3-0 clean sweep of Court decisions. In explaining its decision to appeal against the Court of Appeal judgment the Commerce Commission said that it was because of the unsatisfactory state of the New Zealand law on section 36, as laid down by the Privy Council in the Carter Holt case in 20044. The result of the Carter Holt case was, in the Commission's view, that New Zealand law deviated substantially from Australian law on the unilateral exercise of market power - the Australian equivalent to section 36 of the Commerce Act 1936 being section 46 of the Trade Practices Act 1974. The Commerce Commission said5:

The Commerce Commission is charged with promoting competition. Yet applying the law, developed in 2004 by the Privy Council on a predatory pricing case, to every type of unilateral conduct in the market poses real difficulty. The law as it currently stands is affecting the Commission's ability to fulfil its role in enforcing section 36. This case represents the first opportunity for the Supreme Court to consider whether the counterfactual test as formulated by the Privy Council should continue to be the sole test for 'use' [of substantial market power in breach of section 36], or whether the test needs to be brought into better alignment with Australian law. The case presents a very good opportunity to determine the future direction of this important area, and for the courts to decide whether the response to unilateral conduct on both sides of the Tasman can continue to move forward in parallel, as the law makers originally intended.

The 'counterfactual' test referred to was used by the Privy Council to determine whether a party had 'used' its market power in breach of section 36. Under the counterfactual test a party did not use its market power in breach of section 36, if it behaved in the same way that a party would have behaved in a hypothetical competitive market (ie in a market that was counterfactual to the actual (much less competitive) market in which the person actually operated). Whereas in New Zealand the counterfactual test was, following the Privy Council decision, the sole test of whether a party had 'used' its market power, in Australia the courts can look at whether the company's market power materially facilitated the conduct, whether the company relied on its market power, whether the company would have engaged in the conduct if it did not have market power and/or whether the conduct is otherwise related to the company's market power.

The Supreme Court however refused to make any fundamental change to the previous New Zealand law as determined by the Privy Council. It rejected the Commerce Commission's contention that there was any substantial difference between Australian and New Zealand law on unilateral exercise of market power. The Supreme Court said:

[30]...We cannot accept the Commerce Commission's argument to the extent it contended some of the language in the Australian authorities represented permissible alternative approaches to use of dominance which were divorced from, and independent of, making a comparison between the actual market and a hypothetical workably competitive market. It is important when addressing the statutory concept of use of market power to take an approach which gives firms and their advisers a reasonable basis for predicting in advance whether their proposed conduct falls foul of s 36 and risks a substantial financial penalty. Having a range of tests, all potentially applying, depending on the circumstances and whether a comparative approach can "cogently" be adopted, would not assist predictability of outcome. Nor is such an approach consistent with the Australian cases when they are appropriately analysed.

[31] The survey we have undertaken of the principal authorities demonstrates a factor common to the reasoning of both the Privy Council and the High Court of Australia. It is important that the approach to the issue under consideration be broadly the same on both sides of the Tasman. ... All the relevant reasoning involved, either expressly or implicitly, consideration of what the dominant firm would have done in a competitive market; that is, in a market in which hypothetically it is not dominant. The essential point is that if a dominant firm would, as a matter of commercial judgment, have acted in the same way in a hypothetically competitive market, it cannot logically be said that its dominance has given it the advantage that is implied in the concepts of using or taking advantage of dominance or a substantial degree of market power. Conversely, if the dominant firm would not have acted in the same way in a hypothetically competitive market, it can logically be said that its dominance did give it the necessary advantage. This is because it can then reasonably be concluded that it was its dominance or substantial degree of market power that caused, enabled, or facilitated its acting as it did in the actual market.

[32] The comparative exercise is designed to pose and answer the question whether the presence of competition in the hypothetical market would have restrained the alleged contravener from acting in that market in the same way as it acted in the actual market. If the answer is yes, the alleged contravener has taken advantage of its market power. If the answer is no, it has not done so, because the presence of that power gave it no material advantage. The need to make this comparison is inherent in the idea of "use" of dominance or substantial power under section 36 whatever the conduct in issue may be, albeit the comparison may be more easily made in some cases than others. And the need to make this comparison is also supported by the concepts of dominance and market power themselves. It is helpful to bear in mind what those concepts involve when considering what section 36 envisages by its reference to their use.

[33] A firm has market power when it is not constrained in the way in which it would be constrained in a competitive market. Any firm that is substantially unconstrained by competitive pressures has substantial market power. Market power gives some advantage if it makes easier - that is, materially facilitates - the conduct in issue. The question whether dominance or substantial market power exists implies a comparison between the position of the firm in the actual market and a firm in the same general circumstances but otherwise in a workably competitive market. The contrast inherent in the concepts of dominance or substantial degree of market power is the contrast between the actual market and a hypothetically competitive market. That same contrast is inherent in the inquiry into whether market power has been "used" within the meaning of section 36.

[34] A firm with a substantial degree of market power has the potential to use that power for a proscribed purpose. To breach section 36 it must actually use that power in seeking to achieve the proscribed purpose. Anyone asserting a breach of section 36 must establish there has been the necessary actual use (taking advantage) of market power. To do so it must be shown, on the balance of probabilities, that the firm in question would not have acted as it did in a workably competitive market; that is, if it had not been dominant. Translating that approach to the circumstances of the present case the Commerce Commission was obliged to show, on the balance of probabilities that Telecom would not have introduced 0867 in a workably competitive market; in other words, that it would not have done so had it not been dominant in the markets involved. If that is shown, it follows that Telecom used its dominance in that its dominance gave it an advantage which caused, enabled or facilitated its introduction of 0867.

[35] A necessary assessment must be undertaken on the basis that the otherwise dominant firm will act in a commercially rational way in a hypothetically competitive market. The assessment is also likely to involve an examination of the factors that might constrain the firm from acting in the same way in the hypothetically competitive market. The court is involved in making what is essentially a commercial judgment. That judgment must be made objectively and should be informed by all those factors that would influence rational business people in the hypothetical circumstances which the enquiry envisages. Economic analysis may be helpful in constructing the hypothetically competitive market and point to those factors which would influence the firm in that market. But it must always be remembered that the "use" question is a practical one, concerned with what the firm in question would or would not have done in the hypothetically competitive market. As the question is one of rational commercial judgment, the test should be what the otherwise dominant firm would, rather than could, do in the hypothetical market.

[36] It is also important to point out that for the comparative exercise to be effective in identifying when a dominant firm takes advantage of its dominance, the hypothetically competitive market must genuinely deny that firm all aspects of its dominance. The constraints acting upon the firm in the hypothetical market must neutralise the dominance in the actual market. The hypothetical market should, however, replicate the actual market, save for eliminating the dominance of the alleged contravener. The means of achieving that elimination is to posit in the hypothetical market as well as the alleged contravener (Company X) at least one other firm (Company Y) in effective competition with Company X.

In the end the Commerce Commission failed on the facts of the 0867 case because it could not show that Telecom would not have acted as it did, had it been operating in a workably competitive market. The Supreme Court accepted on the evidence before it that the potential loss of customers from the introduction of 0867 was a risk that even a firm operating in a hypothetically competitive market would have been prepared to run. This was because of the relatively low value to Telecom of those customers under the system of termination payments applicable at the time - the evidence indicated that Telecom was losing money every time those customers used the internet. The Commerce Commission argued before the Supreme Court that the view of those customers as being of relatively low value was not sound as it ignored the possibility of substantial additional revenues accruing to Telecom from those customers from services that were not the subject of the 0867 case. However the Supreme Court was critical of the submission as no evidence had been led in the High Court to establish that there were such additional revenues. The Supreme Court commented:

[48]...It is quite unsatisfactory for the Commission on appeal to attempt to remake its case on what is really a speculative basis. Without supporting financial evidence it would be grossly unfair to Telecom to make assumptions about the significance of revenue from other services or the significance of economies of scale. As the loss of "other services" was not made part of the Commission's case against Telecom, it would not have believed that it had to adduce evidence or cross-examine on the subject. It is entirely possible that if the subject had assumed relevance at trial Telecom may have had a good deal that it could have said in response. Without financial evidence, it is not possible to assess how these factors may have impacted on a non dominant Telecom.... The Commission's argument, that on any rational consideration the potential loss of customers would necessarily and inevitably have outweighed the other matters at issue, relies on speculation rather than evidence.

The Supreme Court's decision represents a substantial clarification of the law although not in the way that the Commerce Commission had hoped. Going forward the 0867 case will be a key authority for those seeking guidance on such issues as:

  • Whether they can legitimately refuse to supply inputs or services to competitors and/or demand the supply of inputs or services from competitors.
  • How such inputs or services should be priced.
  • To what extent it is permissible to engage in below-cost pricing.

1. In The Commerce Commission v Telecom Corporation of New Zealand Limited [2010] NZSC 111.

2. In contrast other sections of the Act focus on the exercise of market power as a result of agreement between multiple parties.

3. Paragraph [1] of the decision.

4. Carter Holt Harvey Building Products Group Ltd v Commerce Commission [2006] 1 NZLR 145.

5. This quote is taken from the Commission's media release dated 1 September 2009.

© DLA Phillips Fox

DLA Phillips Fox is one of the largest legal firms in Australasia and a member of DLA Piper Group, an alliance of independent legal practices. It is a separate and distinct legal entity. For more information visit www.dlaphillipsfox.com

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances.

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