Complaint of price related anti-competitive practices

In this short note I will consider price-related anti-competitive practices from a regulatory authority point of view, where considerations on competition authorities are sometimes very similar. From my viewpoint to understand the situation better, a separate and more detailed description of the context is needed.

Introduction

Price-related anti-competitive practices could exist when an alternative operator is not able to effectively replicate the offer of the SMP operator within a sufficient reasonable margin (margin squeeze) or when the offer is below cost (predatory pricing). In fact, there are many types of behaviour that could be regarded as anti-competitive by nature, namely

a. Predatory pricing, or selling a certain good or service below a certain cost threshold

b. Price squeeze, or the setting of margins between upstream and downstream services at levels which are insufficient for alternative operators to trade profitably

c. Cross subsidies, or the use of funds from a market to compensate losses in another market

d. Price discrimination or discounting, which implies the use of offers and discounts as a mechanism to drive competitors out of the market.

Predatory pricing can be defined as the situation where an undertaking is deliberately incurred through losses or foregoing profits in the short term, also called “sacrifice”. It can occur within the telecommunications sector when the SMP operator charges a price for the product on the retail market which, when compared to the price it charges on the wholesale market, does not allow a competitor buying equivalent services to trade profitably in the retail market. In other words the SMP Operator either sells equivalent regulated services to its own internal business units at a price below costs in order to have a competitive advantage on price, leveraging its market power, in the retail market.

Context

As a starting point I will investigate the two principal cases in which a pricing issue could be identified. Following this I will outline and discuss the remedies that could be imposed.

Regulatory authorities are usually able to identify pricing issues in two main non-exclusive contexts, these are:

1) During a market analysis

2) As a result of complaints from players in the market

A market analysis can identify pricing issues by comparing the wholesale and retail prices (see figure 1). By comparing the two it could be possible to establish the existence of competitive problems. If the investigation into market players is carried out to a greater extent, and if further requests are made on the preliminary high level costing data from operators, it may just make the identification of an issue more viable.

A market player can also file a complaint to the regulatory authority for anti-competitive behaviour on behalf of the SMP operator. Usually, alternative network operators (Altnets) explain with simple calculations that the margins are insufficient to trade in the market, for example this could be:

Retail Costs - Wholesale Costs = Loss

Other times, the pricing practice of the SMP operator would implicitly give an unfair vantage to its own retail business via volume discounts or by a complex pricing list for services. LLU services, for instance, could be the right usher to premises, security, air condition and rack spaces.

Finally, it is possible that the SMP operator is using non-regulated wholesale service prices to leverage its market power or that it bundles retail services together taking a loss in the non-regulated services.

Remedies

In the case where a regulator is confronted with pricing issues it has two key tools at its disposal:

- reducing wholesale rates to a level that permits an efficient operator to trade efficiently

- impose non-discrimination, cost orientation and price control remedies

I consider that, for both instances, a test to determine either the right level of wholesale rates or to approve the retail offer of the incumbent is needed to evaluate the entire situation.

As a final comment to this it should be noted that by reducing wholesale rates as such it may lead to the start of a vicious circle whereby the retail prices would follow the wholesale rates, which in turn would further reduce the margins of both SMP Operators and Altnets. Although this circle can be seen by some stakeholders as positive for consumers and far from self-destructing, in the long-run, and especially in competitive markets, this would deter investments in the communications market. For this reason a price control tool is usually recommended to monitor margins.

Predatory pricing in the broadband market

A pricing issue, and more precisely predatory pricing in the broadband market, could arise when the wholesale rates for direct (e.g. LLU) and/or indirect access (e.g. bitstream access) are considered by a party (the complainer) to be too high to be able to trade profitably in the retail market.

For detecting a pricing issue the most common methodology used is a predatory (or margin squeeze) test. In general mathematical terms this can be expressed as

P – C ≤0 [1]

Where (1) P is the price of the service or product and (2) C is the related costs incurred in the production of the product of service being tested.

When related to electronic communication services a predation can be identified as

P- (CW+CR+CN)≤0 [2]

Where (1) P is the price of the service, (2) CW is the wholesale costs, (3) CR is the retail costs and (4) CN is the specific own network costs.

The test would evaluate if an operator buying wholesale services at regulated rates from the incumbent operator could be profitable, in other words ending in the “replicability” of retail services.

The cost standard against which a predation is tested is an operator (either as efficient as the incumbent or as alternative operators) serving the national market with direct and indirect access technologies. It is important to clarify that from the equations presented above P and C do not refer to specific profits and costs of a specific operator (e.g. the complainer) but most frequently to an efficient operator.

How to evaluate a complaint in practice

The first step for the regulator is to perform a standard administrative analysis in order to evaluate the scale and weight of the complaint. The analysis has the option to incorporate four main steps:

Verification of compliance with competition obligations: the tariff should be produced by a SMP Undertaking, no other case similar to this should be opened by the competition authority

Verification of compliance with regulatory obligations: the tariff’s analysis should be the consequence of a remedy imposed during a market analysis

Assessment of technical replicability: The assessment of technical replicability applies only to those service components within a service that affects markets where an obligation to provide non-discriminatory access has been imposed as a remedy to the SMP operator. In other words, an SMP operator will not be obligated to guarantee the technical replicability of other operators with those retail service components within the service that lies outside the markets affected by the aforementioned obligation.

Assessment of type of bundling (if relevant): the regulator will examine the bundle characteristics to determine whether the proposed bundle constitutes mixed-bundling, pure-bundling, tying or commercial packaging.

In the case where the bundle is found to constitute pure bundling or tying, the regulator will not approve it.

If the tariff is found to constitute mixed-bundling, the approval process will continue and the tariff will be subject to an economic analysis to detect potential anti-competitive pricing.

If the bundle is found to constitute commercial packaging - that is, if all the components within the bundle can be bought individually and the price of the bundle is equal to or higher than the sum of the corresponding stand-alone retail services, the tariff will be approved without the need for further investigation.

The second step involves the evaluation of the tariff under investigation in a testing tool that calculates wholesale, retail costs and profits of an efficient operator. To ensure a successful calculation there are some key elements that need to be factored in: size and demand of the operator, cost standard used, time value for money, source of data and cost of capital.

Subsequently, with reference to broadband services, there could be a discussion on the inclusion of costs and revenues of natural services to broadband (e.g. calls and other services, such as voicemail) or bundles (e.g. line rental for not naked ADSL) that should or should not be included.

There are three possibilities that could be concluded from the testing tool, namely

Pass: A tariff passes the test when there is a profit to be made in the sale of the reference tariff. The tariff is approved.

Not pass: A tariff does not pass the test when there is a loss. When the tariff fails the test the tariff is rejected or conditionally approved (for example, season offers).

Grey area: A tariff is in a grey area when the model does not give net results. In this case the service should be tested with direct costs only (no common and joint costs).

Conclusions

In case of review or complaint regarding pricing issues, it is usually recommended to perform a detailed analysis of the market, the scale and weight of the complaint and finally the replicability of the retail offer. In case of broadband services and in mature markets the existence of bundles (multi-play offers) increases the complexity of the exercise.