Dominant firms are prohibited by the Competition Act 1998 from charging excessive prices to the detriment of consumers. Why only dominant firms? The presumption is that a small firm will lose its customers to its competitors if it charges excessive prices. Customers might have nowhere to turn if a dominant firm charges an excessive price. What exactly is an excessive price and why is charging an excessive price a competition problem?
One of the objects of the Competition Act is to provide consumers with competitive prices and product choices. There are, however, pro-competitive instances in which prices should be allowed to rise significantly. For example, when there is a shortage of a product, a price rise will serve to ration the available supply to those buyers who value it the most. The high price also acts as a signal to suppliers, calling forth extra supply from those who might not have been interested in producing for the market at a lower price. Without such price signals, shortages would persist.
An "excessive price" is defined in the Competition Act as a price for a good or service which bears no reasonable relation to the economic value of that good or service, and which is higher than that value. But what is meant by "economic value", a term not defined in the Act? And what is meant by a "reasonable relation" between price and economic value?
Theories of value are as old as the study of economics itself. In fact, the old joke is that an economist is someone who knows the price of everything and the value of nothing. The modern, neoclassical approach is that value is indicated by price, which in turn is based upon the interaction of both demand and supply factors in a free market. The prohibition on excessive pricing is perhaps a reaction to circumstances in which it is not possible for prices to be set according to such "cognisable competition considerations", words used by the Competition Tribunal in its recent decision in Harmony v Mittal.
The Tribunal had to consider Harmony’s complaint that Mittal (formerly Iscor) was charging excessive prices for flat steel. Harmony argued that the price it was charged was higher than the price that other favoured customers were being charged, higher than the net export price, and higher than consumers in other countries were being charged for their steel by other steel producers. Harmony also argued that Mittal is a low-cost producer, benefiting from favourable input prices for energy and iron-ore, and that it was pricing too far above cost. Thus, Harmony relied on two common methods of assessing prices for excessiveness: price comparisons and price/cost ratios. Harmony also pointed out the elaborate way in which Mittal set its prices and rebates, determining exactly what price each customer could bear, and exporting via the Macsteel joint venture so there was no reflux of product into the domestic market and therefore no possibility of arbitrage.
In its defence, Mittal relied on a third method of assessing excessive pricing: profitability analysis. Mittal’s expert economist argued that if Mittal had been charging excessive prices, then that would have generated excessive profits, of which there was no evidence.
The Tribunal rejected Mittal’s arguments that it was not profitable, and bemoaned the fact that its prices were not set according to cognisable competition considerations. The Tribunal also roundly condemned Mittal’s "ancillary conduct" of granting rebates only on receipt of proof that products in which steel had been embodied had indeed been exported, and of granting discounts only to sectors in which steel faced credible competition from substitute materials. Mittal’s price-setting conduct was likened to a privately-run industrial policy. The Tribunal ruled that Mittal’s prices are excessive and although the decision has been appealed to the Competition Appeal Court, for now the decision purports to bind the Competition Commission as to the type of cases that the Tribunal will entertain.
The Tribunal has stated that it will only consider cases of excessive pricing against unregulated, uncontested (or "super-dominant") firms, with approximately 100% of an "incontestable" market (one with insurmountable entry barriers), and firms that in addition have set their prices without regard to cognisable competition considerations. These criteria can be analysed as follows:
- The Tribunal will not look at prices charged by firms that are subject to price regulation, for example telecom and electricity prices.
- Ignoring price levels charged by firms that are not super-dominant is a departure from the Act, which states that any dominant firm can be charged with excessive pricing. Section 7 of the Act says that a respondent firm can be dominant even with less than 35% of the market, if the complainant or the Commission can show the respondent has market power. The Tribunal reasoned that without overwhelming market power, a firm would not be able to sustain excessive pricing.
- The Tribunal was of the view that only firms protected by insurmountable barriers to entry would be able to sustain excessive pricing. In other words only a firm in a market that is not contestable, or as the Tribunal put it, an "incontestable" market.
- Finally, the Tribunal wants prices to be set in accordance with cognisable competition considerations (the existence of demand and supply pressures), rather than by calculations of what prices and rebates the market can bear, supported by ancillary conduct to enforce those price differences between favoured and disfavoured customers.
These criteria seem sensible, except for the last one. In setting its price to a customer with options of using a substitute material (e.g. wood or plastic), was Mittal not reacting to cognisable competition considerations? Was the granting of discounts to the automotive sector to prevent manufacturers relocating their factories elsewhere not a direct response to cognisable competition considerations? Doesn’t every firm "charge what the market will bear"?
The Tribunal did not express a view on the reasonableness of Mittal’s prices in relation to economic value, nor did it say what the "right price" is. The Tribunal’s view is that in Europe, competition agencies have too readily assumed the role of price regulator, setting prices as a remedy, whereas the Tribunal is wary of that approach, because of course even the right price must change as demand and supply change over time.
Nevertheless, Mittal is "caught in the middle" between customers complaining of its prices, and a competition agency that wants to levy a penalty and yet will not say how far Mittal should reduce its price so as to avoid further complaints or censure. In effect, there is no obvious remedy for excessive pricing because an administrative penalty provides no instruction to the respondent on how far to go to satisfy the authorities that it is no longer charging an excessive price. Perhaps this is why there is no such prohibition on excessive pricing in the USA.
It is rather like driving down a road with no signs indicating the speed limit, being stopped for speeding all the same, not being told how fast you were going or what the speed limit was, being fined, and then being sent on your way without any indication of how fast or slowly to proceed!
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