Canada Pipe Wins Landmark Abuse of Dominance Case under the Competition Act

Article by Geroge Addy, Ed Babin, Anita Banicevic, Milos Barutciski, James Doris, Hillel Rosen, Kent Thomson and Charles Tingley

Today, the Competition Tribunal released its long-awaited decision in the contested abuse of dominance and exclusive dealing case brought by the Commissioner of Competition against Canada Pipe Co. Ltd., a Canadian manufacturer of cast iron drain, waste and vent ("DWV") products. In the first fully contested abuse of dominance case to be decided in seven years, the Competition Tribunal found in favour of Canada Pipe and dismissed the Commissioner's application in its entirety. Canada Pipe was represented by Davies Ward Phillips & Vineberg LLP.

The following outlines the highlights of the case and the key aspects of the decision.

In a notice of application filed on October 31, 2002, the Commissioner alleged that the loyalty program operated by Canada Pipe's Bibby Ste-Croix division (referred to as the "Stocking Distributor Program" or "SDP") contravened the Competition Act's (the "Act") abuse of dominance and exclusive dealing provisions. The SDP offers distributors quarterly and annual rebates, as well as point of purchase discounts should they purchase all of their cast iron DWV product needs from Canada Pipe. The Commissioner also alleged that Canada Pipe had abused its dominant position by acquiring a number of competitors in the cast iron DWV industry. The Commissioner asked that Canada Pipe be required to abandon its SDP and that Canada Pipe be prevented from completing any acquisitions in the Canadian cast iron DWV industry for the next three years. The Tribunal rejected all of these allegations on the basis that the Commissioner failed to show: (i) that the practices in question were anticompetitive; and (ii) had resulted in a substantial prevention or lessening of competition. The issue of costs has been left to the parties to agree upon, or alternatively, make further submissions to the Tribunal.

Key Aspects of Competition Tribunal's Decision:

• The Tribunal found that there were three relevant product markets comprised of cast iron DWV pipe, fittings and couplings, and that these markets did not include DWV products made from other materials. The Tribunal's conclusion on the relevant product market was based on the lack of evidence demonstrating that cast iron pricing was disciplined by the prices of other products, and evidence that while cast iron DWV products are substitutable with DWV products made from other materials for most end uses, some end uses favoured cast iron.
• Based largely on Canada Pipe's high market shares and evidence of Canada Pipe's ability to lower its prices in response to competition, the Tribunal concluded that Canada Pipe possessed market power within the relevant markets.
• Despite finding that Canada Pipe is "dominant" in the relevant markets, the Tribunal rejected the Commissioner's argument that Canada Pipe's loyalty discount program constituted an abuse of this dominance.
• The Tribunal concluded that the SDP was not itself anti-competitive as its presence had not deterred entry and its structure allowed customers to leave the SDP without incurring significant switching costs. Specifically, the Tribunal considered the following characteristics of the SDP as part of its determination that the SDP is not anticompetitive:

1. its terms are transparent and well known;
2. the greatest discount was a point of purchase discount immediately available to all SDP participants;
3. the quarterly rebate component of the SDP was more significant than the small annual rebate component;
4. distributors were not contractually bound to stay on the SDP for any length of time; and
5. the Tribunal also accepted that there were some valid business justifications for the SDP which resulted in benefits to consumers.

• The Tribunal held that the limitation period imposed by section 79(6) of the Act prevented any further review of Canada Pipe's acquisitions as anticompetitive acts since the acquisitions had been completed more than three years before the filing of the Commissioner's application. In addition, the Tribunal held that the acquisitions were not anti-competitive acts because they were a rational response to a declining industry.
• Finally, the Tribunal concluded that the SDP had not resulted in a substantial lessening or prevention of competition as there had been significant entry and competitive pricing since the SDP was implemented. The Tribunal relied on essentially the same reasoning to dismiss the Commissioner's exclusive dealing claim as well.

As in most contested abuse of dominance cases, there were three main questions to be decided by the Tribunal: (1) does Canada Pipe have market power; (2) do Canada Pipe's SDP and/or acquisitions in the DWV industry constitute a practice of anti-competitive acts; and (3) did the alleged anti-competitive acts result in a substantial lessening or prevention of competition? Although the Tribunal answered the first point in the affirmative, finding that Canada Pipe has market power, it rejected the Commissioner's arguments that the SDP and Canada Pipe's acquisitions constituted a practice of anticompetitive acts and that these acts had resulted in a substantial lessening or prevention of competition.

One of the most notable aspects of this case was the Commissioner's novel approach to assessing market power. In contrast to the approach followed by the Tribunal in prior cases, as well as by the Bureau in its own "Abuse of Dominance Guidelines", the Commissioner argued that "direct evidence" of Canada Pipe's alleged market power made it unnecessary to define the relevant market. The Commissioner's "direct evidence" of market power included margin and pricing analysis provided by its economic expert, who argued that Canada Pipe's "high" margins and "supra-competitive" prices in certain regions of Canada relative to others were indicative of Canada Pipe's market power.

Canada Pipe argued that the relevant product market should include DWV products made from all materials, including plastic, copper, asbestos-cement and cast iron. In contrast, the Commissioner argued that the alleged direct evidence of market power, while arguably making market definition a redundant step, was nevertheless indicative of a product market limited to cast iron DWV products (with each of pipe, fittings and couplings representing a separate market). The Commissioner thus showed that, in certain cases, she is prepared to depart from the hypothetical monopolist test for market definition adopted in the Bureau's Abuse of Dominance Guidelines. In its reasons, the Tribunal followed the approach taken in all previous Canadian abuse of dominance cases and began by defining the relevant product and geographic markets.

The key market definition issue to be decided by the Tribunal was whether the relevant product market included DWV products made from other materials. In this regard, the Tribunal acknowledged that, in most applications, Canada Pipe faces competition from DWV products manufactured from plastic and other materials. Nonetheless, the Tribunal concluded that because cast iron DWV products have distinct physical characteristics and are preferred in certain DWV applications, these products form a separate product market. The Tribunal also referred to evidence that suggested industry participants considered cast iron DWV products to be distinct products.

The Tribunal stated that the relationship between the prices of cast iron and plastic DWV products is an important indicator of market definition. On this point, the Tribunal noted that Canada Pipe had not led evidence to suggest that the prices of plastic had disciplined the prices of cast iron. This reasoning may suggest that, where there is evidence of a divergence in the price of alternative products, a respondent bears the burden of proving the wider product market and that anecdotal evidence of competition between two products may not be sufficient on its own to demonstrate that two products are in the same product market. Furthermore, the Tribunal's approach in this regard appears to imply that products must be substitutable across the full range of end uses in order to be within the same product market. However, in the absence of an ability to price discriminate against customers purchasing for such specialized applications, such a position would be inconsistent with prior Canadian and U.S. jurisprudence.

With respect to the relevant geographic market, the Tribunal relied heavily on the variations in prices between different regions across Canada to find that there were six separate geographic markets within Canada. Significant imports from Asia were not sufficient to expand the market beyond Canada.

In analyzing whether Canada Pipe possessed market power, the Tribunal looked at indirect indicators (such as market share and barriers to entry) and considered the Commissioner's arguments concerning direct evidence of alleged market power (i.e., the margin and pricing analysis supplied by the Commissioner's economic expert).

In its indirect analysis of market power, the Tribunal considered Canada Pipe's market shares and the barriers to entry in the cast iron DWV industry as a whole. Having found that the relevant product market did not include DWV products made from materials other than cast iron, the Tribunal held that Canada Pipe's market shares were between 80 to 90%.

On the issue of barriers to entry, while the Tribunal found that the evidence was "not entirely conclusive", it specifically rejected the Commissioner's argument that the SDP is itself a barrier to entry. The Tribunal concluded that while the SDP had an effect on the marketplace, there was "no direct evidence that would support the conclusion that it is a barrier to entry". Although the Tribunal noted that actual entry in the cast iron DWV market provided a "powerful counterargument to [the Commissioner's expert] Dr. Ross' contention that barriers to entry are preventing new entry", the Tribunal nonetheless appears to have considered the lack of large scale entry as reflective of some form of barrier to entry. In its conclusions on barriers to entry, the Tribunal again pointed to Canada Pipe's market shares and stated that "entry is limited as shown by [Canada Pipe] maintaining a considerable market share". However, given that the cast iron industry is acknowledged to be declining, such limited entry may be unrelated to the presence of barriers to entry.

With respect to the Commissioner's "direct evidence" of alleged market power, the Tribunal noted that Dr. Ross' analysis was incomplete and that his analysis appeared "strained" on certain critical points. The Tribunal noted that the Commissioner had failed to offer a competitive benchmark for its pricing and margin analysis and rejected the Commissioner's contention that the price of imported cast iron products should be such a benchmark. Yet, despite noting these shortcomings in Dr. Ross' analysis, the Tribunal accepted his evidence that Canada Pipe's ability to lower its prices in response to competition is indicative of supra-competitive pricing. On the basis of this evidence of supra-competitive pricing, together with Canada Pipe's market shares, the Tribunal concluded that Canada Pipe did possess market power in the relevant markets.

The Bureau alleged that Canada Pipe engaged in the following anti-competitive acts: (i) the SDP; and (ii) acquisitions of competitors or their inventory and the non-compete agreements obtained in connection with two of the three acquisitions.

The Commissioner alleged that the SDP is anti-competitive because it "locks in" distributors, and thus, forecloses distribution channels to Canada Pipe's competitors. In evaluating whether the SDP constitutes a practice of anticompetitive acts, the Tribunal considered the specific terms of the SDP, its business justification, the impact of the SDP on Canada Pipe's competitors and the costs to customers of leaving the SDP. After having reviewed all of these factors, the Tribunal held that the Commissioner had "failed to establish that the SDP is a practice of anti-competitive acts". The following are the key aspects of this finding:

• The Tribunal concluded that the "most striking argument" against the alleged anti-competitive effect of the SDP is the fact that it has not prevented entry or competition in certain regions. The Tribunal pointed to the fact that since the implementation of the SDP in 1998, there have been increased imports as well as the establishment of the first new domestic manufacturer of cast iron DWV products in 30 years.
• The Tribunal also found that the SDP's terms are transparent and well known, distributors are not contractually bound to stay on the SDP for any length of time, and the greatest savings to distributors comes from the discounts applied at the point of purchase rather than the quarterly or annual rebates. The Tribunal also pointed to the fact that distributors are free to terminate their participation in the SDP without losing any rebates at the beginning of the calendar year and can review their participation at the beginning of any quarter, without jeopardizing accrued quarterly rebates or point of sale discounts. Annual rebates, by contrast, were relatively small.
• With respect to the business justification for the SDP, the Tribunal accepted Canada Pipe's explanation that the SDP is necessary to maintain a sufficient manufacturing volume of a full line of DWV products, thus allowing Canada Pipe "to maintain in inventory smaller, less profitable but nevertheless important products". The Tribunal recognized that maintaining these less popular items ultimately benefits consumers.
• The Tribunal accepted the analysis provided by Canada Pipe's economic expert, Dr. Roger Ware, on the topic of switching costs. Dr. Ware's evidence showed that the costs incurred by customers wishing to leave the SDP are zero at the end of each calendar year and remain low throughout the rest of the year. These low switching costs allow Canada Pipe's competitors to entice Canada Pipe's customers to leave the SDP. As the Tribunal noted, the economic experts on both sides "agreed that switching costs were the determining factor in deciding whether the SDP was anti-competitive or not".

The Commissioner also alleged that the "pattern" of acquisitions by Canada Pipe and its use of restrictive covenants are anti-competitive and part of a strategy to eliminate competition. The Commissioner took this position despite the fact that: (a) all of the acquisitions in question were completed more than three years prior to filing of the Commissioner's application; and (b) the Bureau reviewed two of the acquisitions at the time that they were completed.

In response, Canada Pipe had argued that its acquisitions had been previously reviewed by the Commissioner and she was statute barred from challenging them. The Commissioner countered with the argument that the three-year limitation period for section 79(6) of the Act did not begin to run until the seven-year noncompete agreements had expired. However, the Tribunal rejected the Commissioner's arguments on three grounds. First, it held that the three-year limitation period in section 79(6) of the Act applied and prevented any further review of these acquisitions. Second, it stated that the acquisitions "can be seen as a rational move" and are indicative of the consolidation which occurs in a "harvest market" in a mature industry, such as the cast iron DWV industry. Finally, the Tribunal held that Canada Pipe's restrictive covenants are a "normal part of business" and were not shown to be unreasonable.

Even though the Tribunal decided that the SDP did not constitute a practice of anticompetitive acts and that the Commissioner failed to establish grounds for a remedial order, in the event that it had erred in this assessment, the Tribunal went on to consider whether the SDP had resulted in a substantial lessening or prevention of competition. On this point, the Tribunal found that the Commissioner had failed to discharge her burden of establishing that there had been a substantial lessening or prevention of competition in any of the 18 separate markets (i.e., six geographic markets and three product markets).

In dismissing the Commissioner's arguments on this point, the Tribunal pointed to the "significant evidence of competitive pricing, notwithstanding the SDP" and noted the effective entry by domestic suppliers and importers of cast iron DWV products. The Tribunal also noted that the Commissioner did not present any historical data which would have allowed the Tribunal to measure the state of competition before and after the SDP came into effect. Thus, the Tribunal concluded that there was insufficient evidence to find that the SDP was responsible for any potential substantial lessening or prevention of competition.

The Tribunal concluded that the SDP should be considered de facto exclusive dealing because it provided an inducement to exclusivity, even though it did not require exclusivity as a condition of supply. Nonetheless, the Tribunal rejected the Commissioner's arguments on the exclusive dealing provisions on the same basis and reasoning provided in its analysis of the abuse of dominance allegations. The Tribunal concluded that the Commissioner had failed to establish that the SDP had substantially lessened competition and dismissed the Commissioner's application under this section.

The Tribunal's decision is the result of almost eight years of investigation by the Commissioner, including over two years of proceedings before the Tribunal. As the first fully-contested abuse of dominance decision to be released in seven years, this decision is an important confirmation of the underlying principles of the Act itself. The Tribunal's decision confirms that, in the absence of compelling evidence of anti-competitive intent and effect, competitive conduct, including aggressive competition, is to be permitted and encouraged under the Act.

The Tribunal's decision is available on the Tribunal's website at http://www.cttc. gc.ca/english/CaseDetails.asp?x=68& CaseID=163#216