South Africa: New Dominance in Troubled Times - When Greatness is Thrust Upon You

Last Updated: 21 September 2010
Article by Neil MacKenzie and Stephen Langbridge

Originally published February 2009

Being dominant is not a problem. It is the abuse of a dominant position that is forbidden by the Competition Act. This note deals with the possibility of firms inadvertently finding themselves in a dominant position and reminds us of the obligations of a dominant firm1.

With recession having descended on the global economy it is becoming increasingly important for businesses to adapt their strategies to suit volatile trading conditions. Financial continuity by diversification of services or products supplied, cutting down on large financed projects and spreading of risk are at the fore of a firm's "recession strategy". Equally important is the impact of economic adversity on the market within which the firm operates. When conducting itself during times of recession a firm must be mindful of the potential for infringement of competition regulations resulting from the firm's position amongst changing market conditions.

Generally speaking, when an economic downturn occurs, markets become more concentrated. Fewer players hold greater market shares. One reason for this is that firms will merge in order to broaden their capital base and thereby improve their resilience to fluctuations in demand. In addition, larger firms tend to snap up struggling smaller firms whose future is in jeopardy and some firms simply go insolvent and drop out of the market completely. The result is fewer, bigger firms.

These conditions call for the strategy employed by regulators to be adapted. The authorities are given the awkward task of having to intensify the enforcement of competition rules in order to protect consumers who are particularly vulnerable to abuse by dominant firms, while at the same time adopting policies which stimulate economic activity and growth. The South African authorities have outlined a strategy to accommodate these conflicting policy directions2. Competition law enforcement must become more robust, but must be applied more selectively. This may entail permitting mergers which have anticompetitive effects and cartel activity in strategic industries in order to 'bail out' certain industries and maintain South Africa's export competitiveness in those areas. However, increased regulation will be required in the fields of industrial and social policy. From a competition perspective this may entail increased scrutiny of the prices in industries such as the production of food, pharmaceutical products and energy.

The implications for individual firms of this enforcement strategy and of the economic conditions which necessitates it are increased uncertainty and a need for increased awareness both of competitive conditions prevailing in the market in which the firm operates, and of the competition laws themselves.

New Dominance

One effect of increased concentration is a new found status of dominance for expanding firms. Section 7 of the Competition Act provides certain tests for dominance. A firm is dominant if it has at least 45% of the market or, where a firm has between 35% and 45% of the market a firm is presumed to be dominant unless it can show that it does not have market power. A firm with less than 35% of the market may be dominant if it is shown to have market power. Market power means the power of a firm to control prices, or to exclude competition or to behave to an appreciable extent independently of its competitors, customers or suppliers. Dominance is therefore inextricably linked to the size and concentration of the market.

With dominance comes new responsibility3. Certain practices which are acceptable when conducted by a firm that is not dominant become prohibited. Section 8 of the Act prohibits 'abuse of dominance'. Acts which constitute an abuse of dominance include charging an excessive price, refusing a competitor access to an essential facility, requiring or inducing a supplier not to deal with a competitor, refusing to supply scarce goods to a competitor when it is economically feasible to do so, selling goods below their marginal or average variable cost and buying up a scarce supply of intermediate goods or resources required by a competitor. In addition, section 9 prohibits price discrimination by a dominant firm. Price discriminating effectively entails charging different prices for goods or services of like grade and quality to different customers if the differentiation cannot be justified by cost considerations.

In a relatively small and developing economy such as ours a common market structure is one of oligopoly. The nature of an oligopoly is such that firms often teeter on the brink of dominance but the competitive environment is maintained by the collective countervailing power of other firms in the market. As described above, in a recession participants in such a market may have dominance thrust upon them. A firm may inadvertently step over the 'dominance line' and may be unaware of its new obligations.

Accordingly, when a firm selects the course to be followed in navigating the harsh economic landscape, it is crucial not only to adjust the firm's internal operations, but also to keep a keen watch on the implications of adjustments to the market structure within which the firm exists. On the one hand, the firm itself may become dominant and require business to be conducted with increased vigilance. On the other hand a close eye should be kept on competitors in a concentrated market who may stumble upon unwanted dominance and be vulnerable to competition complaints or investigations. Although firms should certainly not be afraid of dominance (or having dominance 'thrust upon them'), failure to be alert and seek legal advice where appropriate may result in unwelcome attention from the competition authorities.

'Tacit Collusion' and Recession

The Competition Amendment Bill is in the final stages of parliamentary approval and its promulgation seems imminent. The latest version of the Bill empowers the Competition Commission to launch an investigation into suspected participation in a complex monopoly. According to section 10A of the Bill a complex monopoly exists where at least 75% of the goods or services in a market are supplied by or to five or fewer firms. Competition concerns are raised when two or more of those firms conduct their affairs in a "conscious parallel manner or coordinated manner without agreement between or amongst themselves".

This provision is widely criticised as creating an offence of simply being involved in a market structured in a particular way. No explicit collusion is required for an investigation into the market to be launched.

During a recession, and with the passing of the Bill into law, firms in a concentrated market which meets the criteria set out by section 10A need to be particularly careful when any decision is made to adjust its strategy to cope with the associated slump in profits. In times of suppressed demand there is a natural tendency to decrease prices or reduce supply to insulate the firm from the negative effects of the demand decrease. In addition, cost-push inflationary pressures tend to induce firms to increase prices in relatively sharp increments.

Because this reactive strategy may be adopted by most or all players in the market simultaneously, there would be strong grounds for an investigation into that market for tacit collusion. Although regulators have stated their clear intention to strictly differentiate inflation from the effects of collusion, should the Bill be passed in its current form the authorities will have little option but to regard simultaneous changes in price with scepticism.

Should the Bill become law, economic decline should be accompanied by increased care when amending strategy. A firm must ensure that the adjustment made in reaction to market conditions can not be construed as adjustments made in reaction to the behaviour of competitors.

Conclusion

As luck would have it, it appears that the passing of the Competition Amendment Bill will coincide with troubled times in the economy. The economic conditions lend themselves to a more tolerant merger approval framework and even, as noted by the Competition Tribunal Chairman David Lewis, possibly 'a greater tolerance of cartels' in certain sectors of the economy and more rigorous regulation in others, and the Bill proposes the somewhat drastic sanction of personal liability for acquiescing directors, the potentially far reaching offence of complex monopoly participation and extensive powers to initiate market investigations for the Competition Commission.

While this apparent paradox seems set to provide a fascinating and increasingly dynamic environment for practitioners of competition law to apply their trade over the next period, the implications for businesses are less inspiring. One thing that is clear, however, is that more so than ever before an acute awareness of a firm's operating environment and a shrewd understanding of prevailing competition rules and regulations will be crucial to ensure a passage through these times of lean economic pickings.

Footnotes

1. Following the Competition Tribunal's lead in quoting William Shakespeare, the subtitle to this note reminds us, "Be not afraid of greatness; some are born great, some achieve greatness, and others have greatness thrust upon them." - Twelfth Night (II, v, 156 - 159)

2. For more information see David Lewis's paper, "Competition Law in Bad Times", presented at the DPRU Conference on Regulation available at http://www.comptrib.co.za/publications.htm

3. As Winston Churcill points out, "The price of greatness is responsibility."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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