Australia: Proposed Changes To Predatory Pricing Laws Abandon Small Business

The Rudd Government today introduced into Parliament the Trade Practices Legislation Amendment Bill 2008 (Bill). This Bill will amend the Trade Practices Act in a way that the small business lobby has claimed will emasculate the recently strengthened laws against predatory pricing. In response to the Exposure Draft of the Bill, the President of the South Sydney Retailers Association, Mr Craig Kelly, said:

Senator Barnaby Joyce, the author of the jingoistically named Birdsville Amendment – which strengthened these rules in September of last year – says that the proposed changes "...put[s] another nail in the coffin of diversified market participation". This article argues the so-called Birdsville Amendment did not deliver the simplicity that Senator Joyce claims. The new prohibition against predatory pricing that the Birdsville Amendment ushered in is dogged by uncertainty in its terms and scope, making it no easier for the ACCC to win cases. To that extent, the new Bill will not sacrifice any advantages for small business that the current law delivers. Moreover, the nature of the protests from small business smack of protectionism, which runs counter to the essential tenet of competition policy – the need to protect competition and not individual competitors. If the Government had have acceded to these demands of the small business lobby, the result would have been an unnecessary hampering of innovation and efficiency in this country.

This article addresses the following questions:

1. what is the existing law;
   
   
2. what are the areas of uncertainty under the existing law; and
   
   
3. how will the Bill address these difficulties and what new difficulties will it introduce?
   
   

The existing law of predatory pricing

In order to start the discussion, let us call predatory pricing any pricing strategy that involves substantial discounts that damage competitors and are intended to do so. Since 25 September 2007, there have been two prohibitions in the Trade Practices Act 1974 (TPA) governing this practice:

1. the specific prohibition against predatory pricing in section 46(1AA), the prohibition introduced into the TPA by the Birdsville Amendment; and
   
   
2. the more general prohibition against taking advantage of market power, predatory pricing being one manifestation of that (section 46(1) of the TPA).
   
   

In practical terms, the former applies where prices are below cost. The latter applies where prices are above cost or where the statutory requirements of section 46(1AA) are not satisfied, primarily where the discount is not over a sustained enough period.¹

A company discounting below cost will breach the new specific prohibition against predatory pricing if:

1. the company has a "substantial market share";
   
   
2. it supplies or offers to supply goods or services, the price of which is less than cost and that is maintained for a "sustained" period; and
   
   
3. it does that for one of the three proscribed purposes.
   
   

The three proscribed purposes are fundamentally the same as those purposes under the general prohibition against misusing market power – eliminating or substantially damaging a competitor, preventing market entry, and deterring or preventing competitive conduct.

As noted above, a company that discounts, but does not breach the new prohibition, may nevertheless breach the general prohibition against taking advantage (or misusing) market power under section 46(1) of the TPA. To do so, the company must possess substantial power in a market (which is not simply a substantial share of that market) and it must use that power for one of the three proscribed purposes mentioned above. One point of interest here is that many more companies are caught by the new prohibition against predatory pricing than would have been the case under e general prohibition against misusing market power, simply for the fact that many companies – possibly, a significant number of companies - will have a substantial share of a market, but not possess market power.

In light of the High Court's decision in Boral², it can be said that a company will breach the general prohibition against taking advantage of market power by discounting if:

1. it targets a competitor through its discounting, which could involve the company still making a profit; and
   
   
2. it expects and there is a real prospect of it recouping any losses sustained (which, would include margin losses that the company would otherwise have earned) during the period of predation through supra-competitive prices after the targeted competitor leaves the market.
   
   

It is also fairly clear from Boral that a company will not breach the general prohibition against taking advantage of market power if its pricing is defensive, as opposed to offensive. In this regard, there is not only a lack of any targeting, targeting having a very clear offensive connotation, but defending oneself if under attack is something any company would do, irrespective of its power. On the current law, no conduct can amount to a taking advantage of market power if it can be justified in response to competitive, as defensive action could.

The point needs to be stressed that the misuse of market power is not in discounting or even the extent of the discounting. Illegality under section 46(1) comes from the targeting of a competitor through that discounting. This was expressed best by Gleeson CJ and Callinan J in the Boral case, when their Honours said as follows:

Abstracting from the new prohibition against predatory pricing (section 46(1AA)) for the moment, the structural beauty of the existing law, indeed the existing law against taking advantage of market power more generally, is the implicit dividing line between lawful and unlawful conduct. This is the dividing line between fair and unfair competition. And that dividing line is identified by what a company could (and, indeed, is likely) to do if facing competition. This could be described as economically rational conduct.

The result is that we retain the benefits of competition – low prices and optimal variety and innovation. The problem is proving a breach and the cost of it. Misuse of market power cases invariably require expert evidence of what a company would do in a competitive market. Discovery is also extensive. In addition, there is the uncertainty of the Court's assessment of likely conduct in a competitive market. As judges, by and large, have never run businesses, their assessment of likely commercial conduct will differ, sometimes markedly. This makes prosecution difficult, which is one of the primary complaints of small business. Abandoning this structure, however, risks much more. There are signs already that the so-called Birdsville Amendment has made large companies much more circumspect. This could inhibit the exploitation of efficiencies, making us all worse off as a result.

Difficulties with the current law

The difficulties with the Birdsville Amendment can be easily stated. The general point is that the amendment opened up questions for which there is no judicial guidance. The first of these concerns the threshold question of market share. This was made the test for the application of the new prohibition in an attempt to address the perceived difficulties of proving that a perpetrator possesses substantial market power – the requirement under the general prohibition against taking advantage of market power. Indeed, in response to the Government's publication of the exposure draft of the Bill, Mr Kos Sclavos, National President of the Pharmacy Guild of Australia, said:

Ignoring the reference to market dominance, rather than market power, Mr Sclavos's views could not be further from the true position. There is anything but clarity about the threshold requirement of a substantial market share. Under the existing law, the ACCC is still going to have to prove the existence of a particular market, which is highly problematic. The question then is what proportion of the market is "substantial". The one thing that is certain in this regard is that there will be no figure that applies in all cases – for instance, a 40% market share will not be the accepted standard of substantiality. It would be convenient if it were otherwise, only then could the adherents of the new prohibition claim simplicity. However, it will not be the case because of the inherent relativity in the concept of "substantial", a point that is well accepted in antitrust jurisprudence. What is substantial in one market will be insubstantial in another.

The second difficulty with the new prohibition against predatory pricing is the requirement that discounting below cost must be "sustained" – or, as the provision states, apply over a "sustained period". This is anything but clear. The period over which the perpetrator must maintain the price below cost must certainly be long enough to justify judicial interference, to attract the opprobrium of legal sanction. However, that raises many of the same questions that plague the general prohibition against taking advantage of market power. A couple of approaches to the question suggest themselves:

1. it could be said that the period is "sustained" if it is long enough for a competitor to sustain damage, although this seems to exhibit a certain circularity; and
   
   
2. a reasonable approach could be to characterise any period that a company could not have justified in a competitive market as sustained.
   
   

The second approach would ask the Court to speculate how a company was likely to behave in a competitive market – the same question posed in the general prohibition against taking advantage of market power. That involves all the same cost implications of the general prohibition that he Birdsville Amendment was introduced to overcome.

Finally, there is the issue of "cost", the cost under which price must fall and remain at for a sustained period. The prohibition is at least clear on the definition of cost. It is the cost of supplying the goods or services in question. The difficulty is quantifying that. It would inevitably require expert accounting evidence, which, of course, would be contested. This injects a further element of cost and uncertainty into the new prohibition.

How does the Bill address these difficulties?

The Bill proposes a number of amendments to both the new prohibition against predatory pricing and to the general prohibition against taking advantage or market power. The principal amendments are as follows:

1. the requirement that a perpetrator has the capacity to recoup losses or the expectation of doing so is no longer a element that needs to be proved before a Court can find that predatory pricing constitutes a breach of the general prohibition against taking advantage of market power⁴;
   
   
2. the Bill clarifies the meaning of "take advantage" in the general prohibition against taking advantage of market power; and
   
   
3. the existing threshold question of market share in the new prohibition against predatory pricing is to be replaced by the traditional formulation of a substantial degree of power in a market and only where the perpetrator takes advantage of that power by pricing below cost.
   
   

For the sake of completeness, it should also be noted that these cases may now be heard (if the Bill passes that is) in he Federal Magistrates Court. This is clearly a cost saving measure, but one has to query the ability of the Federal Magistracy to hear and decide complex questions of economics, a task the Federal Court judges are now used to.

Dispensing with market share as the threshold for illegality in the new prohibition against predatory pricing avoids those as yet unanswered questions posed in the last section. To that extent, the amendment is to be applauded. However, if amended, the prohibition will apply to substantially fewer companies in Australia. As noted already, there is no question that many companies could be said to possess a substantial share of the market in which they trade (however the word "substantial" is defined), but would not posses substantial power in that market. The Bill will result in those companies no longer being subject to legal restraint, at lest in terms of predatory pricing. That potentially exposes small business. However, restricting the application of the prohibition is a good thing in my view. It reasserts the classical structure of the prohibition against taking advantage of market power, making unlawful only that conduct made possible by the exploitation of market power, in other words allowing all companies to engage in any economically rational conduct. The protests that the proposed amendment would make the prohibition against predatory pricing more difficult to prove is unsustainable when one considers the difficult questions that the existing law raises.

The new difficulty that the Bill introduces is a definitional one. The High Court defined predatory pricing in the Boral case. The majority considered the capacity of the perpetrator to recoup the losses it incurs during the period of predation as an element of that definition, as an indispensable requirement. If that is no longer an element of the definition, what is predatory pricing?

The obvious place to look is the judgments of those judges on the High Court that did not go along with the majority in requiring recoupment. They suggest that a company will break the law if it targets another by discounting. The Chief Justice and Justice Callinan held that predatory pricing could be established by evidence of discounting that targets a competitor. They did acknowledge that relevance of evidence on recoupment, saying that it will be "useful". Justice Kirby, even though is dissent, agreed with this position.⁵

If this is correct, the focus on predatory pricing cases will be on the objective of the company. That will entail a forensic exercise involving company documentation and oral evidence of relevant company officers. But will this avoid the problem the Bill apparently seeks to address? That problem is the difficulty of proving predatory pricing cases because of the need to demonstrate recoupment. However, Gleeson CJ and Callinan J were of the view in Boral that the absence of recoupment is indicative of the lack of market power.⁶ That suggests that, even though no longer a mandatory requirement, without it, the ACCC may not get past first base – it will lose cases by failing to prove the existence of market power.

Footnotes

^{1. Technically, section 46(1AA) does not expunge the pre-existing law in respectof below cost pricing, as is stated in section 46(4A). However, section 46(1AA) is easier to satisfy and, therefore, is more likely to be satisfied than the general prohibition in section 46(1) where the perpetrator sells below cost. Having said that, any prosecutor or applicant should nevertheless be expected to plead both prohibitions.}

^{2. Boral Besser Masonry Limited v ACCC (2003) ATPR 41-915}

^{3. (2003) ATPR 41-915, [139]}

^{4. This is achieved by the insertion of a new section 46(1AB) and (1AC).}

^{5. (2003) ATPR 41-915, [436-437, 438]}

^{6. (2003) ATPR 41-915, [130, 138-139]}

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