SLC/SIEC vs. Dominance: The GAP!

Ioannis KokkorisIoannis Kokkoris EconomistEconomistMergers, Office of Fair Trading, Durham University, City University, King’s College London

presented at the “The Reform of EC and Greek Competition Law”June 1-2, 2007

These views are of the authors and do not represent views of the Office of Fair Trading.

• Main issue of this presentation is the Main issue of this presentation is the existence of the so-called “gap” in the existence of the so-called “gap” in the application of the dominance test to application of the dominance test to mergers that lead to non-coordinated mergers that lead to non-coordinated effects.effects.

• The dominance test was changed to the The dominance test was changed to the SIEC test in 2004.SIEC test in 2004.

• Too much jargon!!!Too much jargon!!!

Old ECMR (Regulation 4064/89)Old ECMR (Regulation 4064/89)• Substantive test for assessing mergers: Substantive test for assessing mergers:

Dominance testDominance test

• Article 2 (3):Article 2 (3):

““A concentration which creates or strengthens a A concentration which creates or strengthens a dominant position as a result of which effective dominant position as a result of which effective competition would be significantly impeded in the competition would be significantly impeded in the common market or in a substantial part of it shall common market or in a substantial part of it shall be declared incompatible with the common be declared incompatible with the common market.market.” ”

• Ex post assessment of the effects of a mergerEx post assessment of the effects of a merger

The “Gap”The “Gap”• Under the dominance test, mergers were likely to Under the dominance test, mergers were likely to

be blocked if:be blocked if:

– they led to a single firm being dominant they led to a single firm being dominant in the market (single firm dominance)in the market (single firm dominance)

or or – a number of firms colluding (collective a number of firms colluding (collective

dominance).dominance).

• What about mergers that lead neither to a firm What about mergers that lead neither to a firm being dominant, nor to firms colluding?being dominant, nor to firms colluding?

SLC/SIEC vs. Dominance TestSLC/SIEC vs. Dominance TestDominance testDominance test

In favourIn favour

• Follows a structural approach that places Follows a structural approach that places excessive emphasis on market definition and excessive emphasis on market definition and market shares and gives greater weight to market shares and gives greater weight to competitor concerns. competitor concerns.

• Most EU Member States adhere to the dominance Most EU Member States adhere to the dominance test. A move to SLC would inhibit the test. A move to SLC would inhibit the harmonisation of national competition laws and harmonisation of national competition laws and would enhance legal uncertainty.would enhance legal uncertainty.

AgainstAgainst

• May fail to forbid anti-competitive mergers May fail to forbid anti-competitive mergers between non-dominant firms. between non-dominant firms.

• The two tests, whilst differently worded, pursue The two tests, whilst differently worded, pursue the same objective of preventing the anti-the same objective of preventing the anti-competitive effects of concentrations. competitive effects of concentrations.

• Any discrepancy in the outcomes of the two tests Any discrepancy in the outcomes of the two tests will not be the result of different analysis or will not be the result of different analysis or different assessment factors. different assessment factors.

• But will depend on the diverse implications that But will depend on the diverse implications that these factors may have in the various market these factors may have in the various market structures. structures.

SLC/SIEC testSLC/SIEC test

In favourIn favour

• Suitability of the test as an economics-based tool Suitability of the test as an economics-based tool used to assess the competitive effect of mergers.used to assess the competitive effect of mergers.

• The SLC/SIEC test would bring the ECMR in line with The SLC/SIEC test would bring the ECMR in line with other international competition regimes (UK, USA), other international competition regimes (UK, USA), making international cooperation more likely.making international cooperation more likely.

• The SLC/SIEC test detaches the substantive test for The SLC/SIEC test detaches the substantive test for mergers from the control of abusive behaviour mergers from the control of abusive behaviour under Article 82 which also focuses on under Article 82 which also focuses on “dominance”. “dominance”.

AgainstAgainst

• Uncertainty it would introduce at least for a transitional Uncertainty it would introduce at least for a transitional period. Considerable precedent on the dominance test period. Considerable precedent on the dominance test thus unpredictability would arise regarding the thus unpredictability would arise regarding the interpretation of the new standards of the SLC/SIEC test. interpretation of the new standards of the SLC/SIEC test.

• The Commission might adopt an interventionist approach The Commission might adopt an interventionist approach to mergers. to mergers.

• The The main differencemain difference between the two tests appears to between the two tests appears to be the emphasis that is placed on market definition. be the emphasis that is placed on market definition.

• Under the dominance test, market definition plays a Under the dominance test, market definition plays a crucial role as a prima facie indication of anti-competitive crucial role as a prima facie indication of anti-competitive effects, effects,

• Whilst the focus of the SLC test lies on the impact of the Whilst the focus of the SLC test lies on the impact of the merger on existing competitive constraints. merger on existing competitive constraints.

Recast ECMR (Regulation 139/2004)Recast ECMR (Regulation 139/2004)

• New substantive test: New substantive test: Significant Impediment to Significant Impediment to Competition Test (SIEC)Competition Test (SIEC)

• Article 2(3): “Article 2(3): “a concentration which would a concentration which would significantly impede effective competition, in the significantly impede effective competition, in the common market or in a substantial part of it, in common market or in a substantial part of it, in particular as a result of the creation or particular as a result of the creation or strengthening of a dominant position, shall be strengthening of a dominant position, shall be declared incompatible with the common marketdeclared incompatible with the common market” ”

• Reversal of the two “limbs” of the test.Reversal of the two “limbs” of the test.

• Thus, creation or strengthening of a dominant position Thus, creation or strengthening of a dominant position is only one of the possible cases under which a merger is only one of the possible cases under which a merger may be incompatible with the common market.may be incompatible with the common market.

• ““Closes the gap”. It captures “non-collusive oligopolies” Closes the gap”. It captures “non-collusive oligopolies” or “mergers leading to non-coordinated effects”.or “mergers leading to non-coordinated effects”.

• Although such mergers lead neither to single firm Although such mergers lead neither to single firm dominance, nor to collective dominance, they dominance, nor to collective dominance, they significantly reduce the competitive constraints on the significantly reduce the competitive constraints on the incumbents.incumbents.

Caselaw Draft Commission

Notice

Guidelines

Single firm dominance

Paramount market position

Non-coordinated effects

“The Gap” Non-collusive oligopolies

Collective dominance

Coordinated effects Coordinated effects

How many “gap” cases if any?How many “gap” cases if any?• It would be interesting to see how many cases It would be interesting to see how many cases

already exist in the current caselaw.already exist in the current caselaw.

• Some possible examples: Some possible examples: Airtours/First Choice Airtours/First Choice (dominance test-blocked), (dominance test-blocked), Oracle/PeoplesoftOracle/Peoplesoft (dominance test-cleared), (dominance test-cleared), Sony/BMG Sony/BMG (dominance (dominance test-cleared), T-Mobile/Tele.ring (SIEC-cleared).test-cleared), T-Mobile/Tele.ring (SIEC-cleared).

• As caselaw develops under the SIEC test, more As caselaw develops under the SIEC test, more gap cases will be identified.gap cases will be identified.

Airtours/First ChoiceAirtours/First Choice

• The relevant product market: supply to tour The relevant product market: supply to tour operators of seats on charter flights to short-haul operators of seats on charter flights to short-haul destinations. destinations.

• The relevant geographic market is the United The relevant geographic market is the United Kingdom.Kingdom.

• Major tour operators in 1998 were Thomson Major tour operators in 1998 were Thomson (30.7% of the market), Airtours (19.4% of the (30.7% of the market), Airtours (19.4% of the market), Thomas Cook (20.4% of the market) and market), Thomas Cook (20.4% of the market) and First Choice (15% of the market).First Choice (15% of the market).

Post MergerPost Merger• No single firm being dominant: No single firm being dominant:

– Airtours/First Choice: 34.5%Airtours/First Choice: 34.5%– Thomson: 30.7%Thomson: 30.7%– Thomas Cook: 20.4%Thomas Cook: 20.4%– Cosmos/Avro: 2.9% Cosmos/Avro: 2.9%

• Certain features of the market such as the high Certain features of the market such as the high degree of price transparency and multi-market degree of price transparency and multi-market contacts among the major airlines may facilitate contacts among the major airlines may facilitate coordinated behaviourcoordinated behaviour

•CFI annulled Commission’s decision.CFI annulled Commission’s decision.

– the demand was volatile, the demand was volatile, – capacity planning was complex with slow capacity planning was complex with slow

capacity changes, capacity changes, – the market was not transparent in the capacity the market was not transparent in the capacity

planning period, planning period, – lack of barriers to entry and lack of barriers to entry and – consumers could easily switch to other types of consumers could easily switch to other types of

foreign package holidays such as long haul foreign package holidays such as long haul package holidays. package holidays.

•No factors indicating likelihood of collective No factors indicating likelihood of collective dominance as also outlined in an MMC report on dominance as also outlined in an MMC report on foreign package holidays in UK in 1997.foreign package holidays in UK in 1997.

Is it a “Gap”?Is it a “Gap”?• Yes the merger would lead neither to single firm Yes the merger would lead neither to single firm

dominance nor collective dominance.dominance nor collective dominance.

• Commission blocked the merger because it Commission blocked the merger because it alleged it would lead to collective dominance. alleged it would lead to collective dominance.

• CFI annulled the decision in 2002 and set out CFI annulled the decision in 2002 and set out strict criteria for a finding of collective dominance strict criteria for a finding of collective dominance such as: such as:

– transparency, transparency, – retaliatory mechanisms, retaliatory mechanisms, – reaction of competitors and consumers.reaction of competitors and consumers.

Oracle/PeoplesoftOracle/Peoplesoft• Relevant markets: high-function FMS and HR software Relevant markets: high-function FMS and HR software

applications of global dimension.applications of global dimension.

• Market for software applications for mid-size Market for software applications for mid-size enterprises formed a separate market from the enterprises formed a separate market from the markets for high-function FMS and HR solutions.markets for high-function FMS and HR solutions.

• SAP would remain the strongest player in the FMS SAP would remain the strongest player in the FMS market, followed by Oracle/PeopleSoft. Other market, followed by Oracle/PeopleSoft. Other significant players: Sage, Microsoft MBS, Hyperion, significant players: Sage, Microsoft MBS, Hyperion, Systems Union and Lawson. Systems Union and Lawson.

• HR mid-market: Oracle/PeopleSoft would become the HR mid-market: Oracle/PeopleSoft would become the strongest player, closely followed by SAP. Other strongest player, closely followed by SAP. Other significant players: Kronos, Lawson, Sage, Microsoft significant players: Kronos, Lawson, Sage, Microsoft MBS.MBS.

Para 187 of the Para 187 of the Oracle/PeoplesoftOracle/Peoplesoft: :

““In the statement of objections the Commission In the statement of objections the Commission based its concerns in part on the finding that based its concerns in part on the finding that significant non-coordinated effects would arise from significant non-coordinated effects would arise from the transactionthe transaction. In the reply to the statement of . In the reply to the statement of objections, Oracle objections, Oracle contested the Commission’s contested the Commission’s competence to assess such effects under the competence to assess such effects under the dominance testdominance test incorporated in Regulation (EEC) No incorporated in Regulation (EEC) No 4064/89. It is not necessary to address Oracle’s 4064/89. It is not necessary to address Oracle’s submission on the lack of competence as, on the submission on the lack of competence as, on the basis of the new evidence obtained after the Oral basis of the new evidence obtained after the Oral Hearing, it has been concluded that no such Hearing, it has been concluded that no such anticompetitive effects are likely to result from the anticompetitive effects are likely to result from the mergermerger.”.”

•SAP and Oracle/Peoplesoft had:SAP and Oracle/Peoplesoft had:

– similar market sharessimilar market shares– in an innovative bidding marketin an innovative bidding market– with differentiated products with differentiated products

•Thus, a credible allegation of single firm Thus, a credible allegation of single firm dominance was difficult to allege.dominance was difficult to allege.

•The merger would decrease the intensity of The merger would decrease the intensity of competition in the market, leading to significant competition in the market, leading to significant adverse effects on customers in terms of price, adverse effects on customers in terms of price, product variety, product quality, and innovation. product variety, product quality, and innovation.

•Price was not necessarily the most important factor Price was not necessarily the most important factor in the choice of a customer; (non-price factors such as in the choice of a customer; (non-price factors such as breadth and depth of the functionality offerings, the breadth and depth of the functionality offerings, the proven track record of the supplier, the capability to proven track record of the supplier, the capability to offer EAS solutions to complex organisations and the offer EAS solutions to complex organisations and the scalability of those solutions were more important). scalability of those solutions were more important).

•The merger, would reduce the choices of customers.The merger, would reduce the choices of customers.

•Remaining incumbents (smaller firms-Lawson, Remaining incumbents (smaller firms-Lawson, Microsoft etc.) would not fully and effectively Microsoft etc.) would not fully and effectively counteract this loss in choice with a selection of equal counteract this loss in choice with a selection of equal in quality and effectiveness products. in quality and effectiveness products.

•In such an innovative market, barriers to entry might In such an innovative market, barriers to entry might have been high, and the likelihood of new entry low. have been high, and the likelihood of new entry low.

•During the US trial more credible competitors were During the US trial more credible competitors were identified. The Commission adopted this amended identified. The Commission adopted this amended market definition.market definition.

•The Commission did not uphold its preliminary The Commission did not uphold its preliminary conclusion that customers would be confronted with a conclusion that customers would be confronted with a de facto de facto absence of choice post-merger, and cleared absence of choice post-merger, and cleared the merger.the merger.

ButBut

•Lawson, Intentia, IFS, QAD and Microsoft. Those Lawson, Intentia, IFS, QAD and Microsoft. Those vendors won in only a limited number of bids. vendors won in only a limited number of bids.

•Remaining smaller players were not in a position to Remaining smaller players were not in a position to pose a significant competitive constraint on the pose a significant competitive constraint on the merged entity as well as on SAP.merged entity as well as on SAP.

•They would not offer a credible alternative to SAP They would not offer a credible alternative to SAP and Oracle/Peoplesoft. and Oracle/Peoplesoft.

•Based on the nature of competition in this market, Based on the nature of competition in this market, characterised by product differentiation, characterised by product differentiation, customisation, knowledge of the customer, as well as customisation, knowledge of the customer, as well as innovation, the merger was likely to induce innovation, the merger was likely to induce anticompetitive effects.anticompetitive effects.

•Conducting an event study analysis for the merging Conducting an event study analysis for the merging parties as well as for rival firms, would provide useful parties as well as for rival firms, would provide useful insights of the likely expectation of the market of the insights of the likely expectation of the market of the profitability of the firms resulting from a merger. profitability of the firms resulting from a merger.

•In an event study we compare the actual stock In an event study we compare the actual stock price returns of the merging parties and price returns of the merging parties and competitors around the announcement date of the competitors around the announcement date of the merger with a counterfactual measure of what the merger with a counterfactual measure of what the return would have been had the merger not taken return would have been had the merger not taken place.place.

•Both the market analysis and event study Both the market analysis and event study illustrated that the market expected illustrated that the market expected Oracle/Peoplesoft Oracle/Peoplesoft to induce an adverse impact on to induce an adverse impact on competition in the post-merger market. competition in the post-merger market.

•The merger could not be blocked though under the The merger could not be blocked though under the dominance test applied by the Commission. Had it dominance test applied by the Commission. Had it applied the SIEC the merger could have been applied the SIEC the merger could have been blocked/cleared with remedies.blocked/cleared with remedies.

Sony/BMG•Sony/BMG would be the second strongest firm in Sony/BMG would be the second strongest firm in the post-merger market.the post-merger market.

•The majors (BMG, Sony, Universal Music Group, The majors (BMG, Sony, Universal Music Group, EMI and Warner Music Group) accounted for a large EMI and Warner Music Group) accounted for a large share of the market for recorded music, and share of the market for recorded music, and especially for international acts. especially for international acts.

•A national market for recorded music which the A national market for recorded music which the parties considered as including A&R, and the parties considered as including A&R, and the promotion, sales and marketing of recorded music. promotion, sales and marketing of recorded music.

•In addition, the Commission defined national In addition, the Commission defined national markets for online music markets, music publishing. markets for online music markets, music publishing.

•The Commission further analysed whether the The Commission further analysed whether the markets for recorded music were characterised by markets for recorded music were characterised by features facilitating collective dominance. features facilitating collective dominance.

•Due to the deficits in actual transparency, the Due to the deficits in actual transparency, the partly heterogeneous product characteristics and partly heterogeneous product characteristics and the lack of actual evidence as regards retaliatory the lack of actual evidence as regards retaliatory action in the past, such allegation was not sustained. action in the past, such allegation was not sustained.

•Given the emerging state of the online music Given the emerging state of the online music market and the current structure of prices and market and the current structure of prices and usage conditions, as well as limited transparency usage conditions, as well as limited transparency and lack of retaliation a collective dominant position and lack of retaliation a collective dominant position could not be alleged. could not be alleged.

•The market characteristics of the recorded music The market characteristics of the recorded music business and the heterogeneity of the product might business and the heterogeneity of the product might result in post-merger price increases. result in post-merger price increases.

•The incumbent large players would not fully The incumbent large players would not fully compensate for the decrease in the quantity by the compensate for the decrease in the quantity by the other incumbents or benefit from the other other incumbents or benefit from the other incumbents’ increase in price. incumbents’ increase in price.

•The independents were not close competitors of the The independents were not close competitors of the majors and could not impose effective competitive majors and could not impose effective competitive constraints. constraints.

•Neither countervailing buyer power nor Neither countervailing buyer power nor de novo de novo entry was likely to pose credible constraints on the entry was likely to pose credible constraints on the likely harmful conduct of the incumbents in the post-likely harmful conduct of the incumbents in the post-merger market. merger market.

•Post-merger the majors were likely to have less Post-merger the majors were likely to have less incentive to compete.incentive to compete.

•They could benefit from price increases due to, They could benefit from price increases due to, inter inter aliaalia, the heterogeneity of the product, the ineffective , the heterogeneity of the product, the ineffective competitive constraints imposed by the independents, competitive constraints imposed by the independents, and the likely significant barriers to entry. and the likely significant barriers to entry.

•The results arising from an event study indicated that The results arising from an event study indicated that the Commission’s decision contradicts the investors’ the Commission’s decision contradicts the investors’ perception on the day of the initial significant perception on the day of the initial significant dissemination of information. dissemination of information.

•Both the market analysis and event study illustrated Both the market analysis and event study illustrated that the market expected that the market expected Sony/BMGSony/BMG to induce an to induce an adverse impact on competition in the post-merger adverse impact on competition in the post-merger market.market.

T-Mobile/Tele.ring•T-Mobile and Tele.ring were a provider of mobile T-Mobile and Tele.ring were a provider of mobile and fixed telephony services in Austria. and fixed telephony services in Austria.

•A single national market existed for the provision A single national market existed for the provision of mobile telephony services to end customers, in of mobile telephony services to end customers, in so far as they could be provided on both a 2G and a so far as they could be provided on both a 2G and a 3G basis. 3G basis.

•Four main companies: Mobilkom (a subsidiary of Four main companies: Mobilkom (a subsidiary of Telekom Austria), T-Mobile, ONE and Tele.ring. Telekom Austria), T-Mobile, ONE and Tele.ring.

•Market share of the merged entity was 30-40%, Market share of the merged entity was 30-40%, while Mobilkom had 35-45%, ONE had 15-25% and while Mobilkom had 35-45%, ONE had 15-25% and H3G had under 5%.H3G had under 5%.

•The Commission analysed:The Commission analysed:

– market sharesmarket shares– the HHIthe HHI– customer switchingcustomer switching– price developmentprice development– incentive structuresincentive structures– importance of national networkimportance of national network– network capacitynetwork capacity– the role of other competitorsthe role of other competitors– the future development of Tele.ringthe future development of Tele.ring

• Limited customer switching between the merged Limited customer switching between the merged entity and Mobilkom. entity and Mobilkom.

• Unlikely that H3G or ONE/YESSS! would occupy a Unlikely that H3G or ONE/YESSS! would occupy a place in the market comparable with that of place in the market comparable with that of Tele.ring once the transaction was completed.Tele.ring once the transaction was completed.

• Or that they would be able to discipline the Or that they would be able to discipline the competitive behaviour of the merged entity and competitive behaviour of the merged entity and Mobilkom. Mobilkom.

• Thus, both Mobilkom and Tele.ring/T-Mobile Thus, both Mobilkom and Tele.ring/T-Mobile could unilaterally increase prices in the post-could unilaterally increase prices in the post-merger market. merger market.

•Thus, a finding of non-coordinated effects is not Thus, a finding of non-coordinated effects is not limited to a situation where the merging parties are limited to a situation where the merging parties are the closest competitors to each other. the closest competitors to each other.

•The Commission did not rule out the possibility that The Commission did not rule out the possibility that the proposed merger, may also lead to coordinated the proposed merger, may also lead to coordinated effects. effects.

•Surprising since the market features of coordinated Surprising since the market features of coordinated and non-coordinated effects differ.and non-coordinated effects differ.

•The Commission excluded the analysis of coordinated The Commission excluded the analysis of coordinated effects from the decision. effects from the decision.

•Both the market analysis and event study illustrated Both the market analysis and event study illustrated that the market expected that the market expected T-Mobile/Tele.ringT-Mobile/Tele.ring not to not to induce an adverse impact on competition in the post-induce an adverse impact on competition in the post-merger market. merger market.

Criteria for “gap” cases?Criteria for “gap” cases?•Merging parties are close/closest substitutes;Merging parties are close/closest substitutes;

•Merged entity and other incumbents are not close Merged entity and other incumbents are not close substitutes;substitutes;

•Differentiation between products;Differentiation between products;

•Repositioning of market players is not likely;Repositioning of market players is not likely;

•Entry is not easy; Entry is not easy;

•Lack of post-merger synergies (efficiencies); Lack of post-merger synergies (efficiencies);

•Customers have limited possibilities of switching supplier;Customers have limited possibilities of switching supplier;

•Competitors are unlikely to increase supply if prices Competitors are unlikely to increase supply if prices increase;increase;

•Merged entity is able to hinder expansion by competitors; Merged entity is able to hinder expansion by competitors; andand

•Merger eliminates an important competitive force;Merger eliminates an important competitive force;

Concluding Remarks•There was a gap! There was a gap!

•Other cases include: Other cases include: Syngenta/Advanta Syngenta/Advanta etc.etc.

•Gap cases can exist both under ECMR and national Gap cases can exist both under ECMR and national legislationslegislations

•Change in the Regulation was justified. The SIEC rectifies Change in the Regulation was justified. The SIEC rectifies the gap.the gap.

•Policy implications:Policy implications:

– Some Member States still adhere to dominance test, Some Member States still adhere to dominance test, thus anticompetitive mergers may be clearedthus anticompetitive mergers may be cleared

– ““Forum shopping” towards such Member StatesForum shopping” towards such Member States