The European Commission Goes 2 for 2 in the Telecoms Abusive Pricing Cases

April 15, 2008

The 10 April 2008 Court of First Instance (“CFI”) judgment in Deutsche Telekom AG v Commission of the European Communities upheld the Commission’s 2003 decision finding that Deutsche Telekom (“DT”) had been abusing its dominant position on the markets for access to its fixed network by creating a margin squeeze between the prices charged to its competitors for wholesale access and its own retail access charges.[1] 

DT argued that the Commission erred in finding that it had infringed Article 82 EC because: (i) DT’s conduct was not abusive, since it did not have sufficient scope of action to avoid the margin squeeze; (ii) the methodology adopted by the Commission to establish margin squeeze was unlawful; (iii) the Commission’s margin squeeze calculations contained errors; and (iv) the margin squeeze identified had no effect on the market.

The Court’s judgment addresses a number of key issues:

• It is clear that dominant undertakings operating in regulated sectors must ensure that their pricing does not infringe Article 82 EC.  Dominant undertakings that are subject to ex ante price approvals must ensure that they use any discretion permitted by the regulatory system to avoid abusive pricing.
• “Approval” of pricing by a National Regulatory Authority will not necessarily protect against a Commission finding that Article 82 EC has been infringed, particularly where the Authority has not expressly stated that it is applying Article 82 EC in approving the prices.  
• A margin squeeze can exist where the retail prices are not in and of themselves abusive.  The sole issue is the fairness of the spread between wholesale and retail prices.
• The Commission is not required to produce evidence that a margin squeeze actually impairs competition.

The CFI’s judgment sees the Court again afford the Commission a broad discretion in relation to its economic methodology, and apparently continues the divergence from the US approach (as seen in Trinko and Brooke Group) of not finding an antitrust violation where pricing does not cause or threaten to monopolise a market where there is no prior course of voluntary dealings between the parties.  Looked at through the Trinko prism, it could be seen as discouraging price cuts so that consumers are deprived of the benefits of lower prices.

Article 82 EC Applies When a Dominant Entity Has Scope to Avoid a Margin Squeeze

Dealing with DT’s major grounds of appeal in turn, the CFI reaffirmed the application of Articles 81 and 82 EC where national legislation leaves open the possibility of competition which may be prevented, restricted or distorted by the autonomous conduct of undertakings.  As the Court said “…if national law merely encourages or makes it easier for undertakings to engage in autonomous anti-competitive conduct, those undertakings remain subject to Articles 81 and 82”.[2] 

In this context, it is worth recalling the scope of the German law regulating DT’s pricing at the time.  Between 1 January 1998 and 31 December 2001, DT’s retail prices for access to analogue and ISDN lines had to be approved by the German communications sector regulator (“RegTP”) within a price cap regime.  Under the price cap, the aggregate prices for specified baskets of services had to be reduced by a specified percentage.  Within that framework, DT could adjust its retail prices (with prior authorisation from RegTP).  The Court found that DT had sufficient scope to fix its charges at a level that would have enabled it to end or reduce the margin squeeze.  As a matter of fact, rather than exercise its discretion to reduce the margin squeeze, DT had actually lowered its ISDN line retail pricing (exacerbating the margin squeeze). 

However, DT argued that RegTP’s obligation to examine whether charges conformed with “other legal provisions” meant that, in approving DT’s charges, RegTP had concluded that they conformed with Article 82 EC.  The Court noted that, at the time, RegTP was the telecommunications regulator, rather than the competition authority.  Further, none of the RegTP decisions to which DT referred included any reference to Article 82 EC.  In particular, while RegTP had found a negative spread between wholesale and retail prices, it had not objected to the charges, despite noting that DT’s competitors would have to cross-subsidise to offer competitive retail pricing.  The Court concluded that these decisions showed that RegTP either did not consider the compatibility of the charges with Article 82 EC, or applied it incorrectly.  It went on to note that (even assuming that RegTP was obliged to consider whether the retail charges were compatible with Article 82 EC) the Commission would not be precluded from finding that the charges infringed Article 82 EC, and that the Commission cannot be bound by a decision taken by a national body pursuant to Article 82 EC.  

The regulatory regime in force from 2002 capped DT’s annual retail price increases for analogue and ISDN connections.  Accordingly, the Commission had concluded that adjusting retail DSL charges was the only legal means available to DT to reduce the margin squeeze.  DT’s ability to increase its DSL retail charges was constrained only by the application of Article 82 EC.  However, DT argued that changes to its retail DSL charges (services falling into a distinct retail market) could not have decreased the margin squeeze for analogue and ISDN services (services falling into another retail market).  However, the Court noted that, since the relevant wholesale input could be used to provide retail services in a number of markets, DT’s ability to increase its DSL charges was capable of reducing the margin squeeze between the price of the wholesale input and the prices for all of the retail products.  In the Court’s view, an analysis combining the range of retail services was required not only because they amounted to “…a single supply of services at wholesale level”, but also because retail DSL cannot be offered on its own to end-users since it always involves the upgrading of narrowband connections.

Determining Whether a Margin Squeeze Exists

In relation to DT’s arguments that the methodology used by the Commission to establish a margin squeeze was unlawful, the Court reached a number of significant conclusions.  First, the CFI expressly stated that the Commission need not demonstrate that DT’s retail prices were abusive.  The abusiveness of conduct (in the margin squeeze context) is determined exclusively by the fairness of the spread between wholesale and retail prices. 

Further, the Court addressed a number of key methodological issues, finding that:

• The abusive nature of a dominant undertaking’s pricing practices is determined on the basis of its own charges and costs, rather than those of actual or potential competitors.
• Even if the retail services in issue are provided as a “cluster” to end-users, the Commission is entitled to consider only the revenues generated by the provision of the services potentially involved in the margin squeeze (e.g., it was appropriate for the Commission to consider revenues from the provision of retail access services, and to exclude revenues from the provision of retail call services).
• It is appropriate to include “discontinuance” charges in the wholesale revenues taken into account, since these charges are part of the total cost of the wholesale service that must be reflected in competitors’ retail prices.
• The fact that the Commission’s calculations contained errors did not affect the lawfulness of its decision, because the unfairness of the pricing stems from the existence of a margin squeeze, rather than its precise spread.

Finally, DT argued that the finding of a margin squeeze does not constitute an abuse per se, and that the Commission should have considered the effects of the conduct (i.e., it should have produced evidence that the margin squeeze has actually impaired competition).  DT also submitted that the principles developed by the Court in relation to predatory pricing should be applied to margin squeeze in cases where wholesale prices are fixed by a regulatory authority. 

Having considered these submissions, the Court found that, where a dominant entity provides inputs that are indispensable in enabling competitors to enter a downstream market (and to compete with the dominant entity on that market), a margin squeeze between the indispensable input and the downstream service will in principle hinder competition in the downstream market(s).  If the spread between the wholesale and retail charges is insufficient for an equally efficient potential competitor to cover its product-specific costs of supplying the retail service, it would be unable to enter the retail market without suffering losses.  While it may be that competitors cross-subsidise services subject to margin squeeze in an effort to find a way to provide the service subject to the squeeze, the effect of this is to distort competition not only on the market affected by the margin squeeze, but also on the market used to cross-subsidise.  The Court went on to review the market structure, and relative lack of success of new entrants that are dependent on the indispensable input, before going on to conclude that the margin squeeze between the indispensable input and the downstream service had hindered competition in the downstream market.

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