Opening address 2010 competition law conference

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SYDNEY, 29 MAY 2010

  1. In Stepping Stones (edited by Dennis O’Driscoll, faber and faber, 2008) the Nobel Laureate Seamus Heaney in discussing the influence of Beowulf on English literature noted the apocryphal story of the Irishman who, when asked by an Englishman in Magherafelt (which lies between Derry and Belfast), “How do you get to Dublin?”, gave the reply, “If you’re going to Dublin, I wouldn’t be starting from here” which Heaney says is an accurate way of saying that if you don’t start in the right place you won’t end up in the right place.

  2. The right time and place to start a discussion of market definition is 5 March 1975 when the Tribunal published its reasons in its very first decision under the Trade Practices Act 1974 (Cth) in Re Queensland Co operative Milling Association Ltd; Re Defiance Holdings Ltd (1976) 25 FLR 169 and what an influential decision it proved to be. The Tribunal was comprised of Woodward J, Mr Shipton and Professor Brunt. Mr Bob McComas who became Chairman of the Trade Practices Commission appeared for Queensland Co operative Milling. Mr F.G. Brennan QC, as he then was, appeared for the Commission leading Mr I Gzell.

  3. I mention Queensland Co operative Milling not simply for historical reference but rather to address important questions of emphasis as a matter of principle. In C7, Sackville J placed great emphasis upon the distinction between competition (which he described as competition per se) and close competition which he said was a “critical” distinction.

  4. The Tribunal proceeding concerned a challenge to the Commission’s rejection of a clearance application or, alternatively, an authorisation for bids for the acquisition of shares in a milling company which, by s 50(1) of the TPA, as it was then framed, raised the question of whether the acquisition would be likely to have the effect of substantially lessening competition in a market for goods or services.

  5. At that time, a market was defined under s 4 as meaning “a market in Australia”.

  6. The Tribunal said that since it gave such importance to the relevance of competitive considerations in proceedings for an authorisation, a few comments should be made, without wishing to be “unduly restrictive” of the “very rich concept” of competition, on how the Tribunal views competition. The Tribunal said that the focus must be upon the economic role competition plays in allocative decisions. Prices and profits are the signals which register the play of forces of demand and supply and the manner in which goods or services may be supplied “in the cheapest possible way”, that is, in an economically efficient way which imposes disciplines and penalties upon incurring inefficient costs. Competition reduces, in principle, a market survivor’s costs to the efficient cost of survival which is why Part IIIA regulatory price setting models often adopt analogues of efficient cost pricing in determining the supply price of natural monopoly services. Internal rate of return models are also used among other techniques. Firms disregard these signals at their peril as other firms “either currently in existence or as yet unborn would be only too willing to supplant them”: p 188. Competition is a dynamic process generated by market pressure from alternative sources of supply and the desire to keep ahead. The Tribunal endorsed at p 188, the view that:

The basic characteristic of effective competition in the economic sense is that no one seller, and no group of sellers acting in concert, has the power to choose its level of profits by giving less and charging more. Where there is workable competition, rival sellers, whether existing competitors or new potential entrants into the field, would keep this power in check by offering or threatening to offer effective inducements. Or again, … the antithesis of competition is undue market power, in the sense of the power to raise price and exclude entry.

[emphasis added]

  1. Further, at p 188, the Tribunal said:

… where there is significant market power the firm (or group of firms acting in concert) is sufficiently free from market pressures to “administer” its own production and selling policies at its discretion.
... if their business [firms] conduct is not subject to severe market constraints this is not competition.

[emphasis added]

  1. The Tribunal noted that in such a case, the values, incentives and penalties of management are substituted for the efficiency disciplines of the marketplace. The Tribunal then expressed its well known observations at pp 188 and 189 which ought to be repeated here:

Competition expresses itself as rivalrous market behaviour
In our view effective competition requires both that prices should be flexible reflecting the forces of demand and supply and that there should be independent rivalry in all dimensions of the price product service packages offered to consumers and customers.
Competition is a process rather than a situation. Nevertheless, whether firms compete is very much a matter of the structure of the markets in which they operate. The elements of market structure which we would stress as needing to be scanned in any case are these: (1) the number and size distribution of independent sellers, especially the degree of market concentration; (2) the height of barriers to entry, that is the ease with which new firms may enter and secure a viable market; (3) the extent to which the products of the industry are characterised by extreme product differentiation and sales promotion; (4) the character of “vertical relationships” with customers and with suppliers and the extent of vertical integration; and (5) the nature of any formal, stable and fundamental arrangements between firms which restrict their ability to function as independent entities.
Of all these elements of market structure, no doubt the most important is (2), the condition of entry. For it is the ease with which firms may enter which establishes the possibilities of market concentration over time; and it is the threat of the entry of a new firm or a new plant into a market which operates as the ultimate regulator of competitive conduct.
[emphasis added apart from the reference “vertical relationships”]

  1. Having regard to these structural considerations in determining the process of competition within a market, it followed for the Tribunal that “the identification of markets must be the essential first step in assessment of present competition and likely competitive effects. However, the Tribunal noted that the “usefulness” of the market concept goes beyond the determination of concentration ratios, to the “identification of rivalrous relationships between sellers”. Nevertheless, the Tribunal notes at p 189 that the analytical process of market definition is “but a first step” and “mere speculation of markets cannot be determinative, by itself, of some ultimate issue”.

  2. In framing the first step examination, the Tribunal said this at p 190 about the concept of a market:

We take the concept of a market to be basically a very simple idea. A market is the area of close competition between firms or, putting it a little differently, the field of rivalry between them. (If there is no close competition there is of course a monopolistic market). Within the bounds of a market there is substitution – substitution between one product and another, and between one source of supply and another, in response to changing prices.
So a market is the field of actual and potential transactions between buyers and sellers amongst whom there can be strong substitution, at least in the long run, if given a sufficient price incentive.
Let us suppose that the price of one supplier goes up. Then on the demand side buyers may switch their patronage from this firm’s product to another, or from this geographic source of supply to another. As well, on the supply side, sellers can adjust their production plans, substituting one product for another in their output mix, or substituting one geographic source of supply for another.
Whether such substitution is feasible or likely depends ultimately on customer attitudes, technology, distance, and cost and price incentives.
[emphasis added]

  1. The reference to substitution is not any substitution possibility but rather strong substitution, at least in the long run, if given a sufficient price incentive.

  2. The reference to “in the long run” is a reference to the span of operational time required for organising and implementing a re deployment of existing capacity (Re AGL Cooper Basin Natural Gas Supply Arrangements [1997] ATPR 41 593). The policy objectives of the TPA are not served by focusing attention upon a short run transitory situation as doing so is unlikely to reveal the evidence of what is likely to happen to patterns of consumption and production should suppliers raise prices or offer less favourable terms: Re Tooth & Co. Ltd and Tooheys Ltd (1979) 39 FLR 1 at pp 38 and 39.

  3. As to the question that might be asked in determining the outer boundaries of a market, the Tribunal said this at p 190:

It is the possibilities of such substitution which set the limits upon a firm’s ability to “give less and charge more”. Accordingly, in determining the outer boundaries of the market we ask a quite simple but fundamental question: if the firm were to “give less and charge more” would there be, to put the matter colloquially, much of a reaction? And if so, from whom?
In the language of economics the question is this: from which products and which activities could we expect a relatively high demand or supply response to a price change, i.e. a relatively high cross elasticity of demand or cross elasticity of supply?
The distinction between markets and sub markets can be merely one of degree. Sub markets are the most narrowly defined, typically registering some discontinuity in substitution possibilities. Where the defining feature of a market is the existence of close substitutes (whether in demand or supply), the defining feature of a sub market is the existence of still closer and more immediate substitutes.
[emphasis added]

  1. The defining feature of a market therefore is close substitutes by which the Tribunal means strong substitution in the long run if given a sufficient price incentive.

  2. Although the Tribunal made it plain that it was not seeking to establish principles of restriction having regard to the very rich concept of competition, the Tribunal expressed itself in terms that the antithesis of competition is undue market power in the sense of the power to raise price and exclude entry within a field of rivalry characterised by close competition amongst whom there can be strong substitution. Where there is significant market power, the firm is free from the disciplines of the market and if the conduct of firms is not subject to severe market constraints, this is not competition. Moreover, close substitutes in demand or supply are the defining feature of a market.

  3. The Tribunal therefore had expressed itself in reasonably emphatic language as to the strength of substitution and the severity of market constraints which are emblematic of competition. The question of degrees of substitution possibilities arose only in the context of the discussion of the distinction between markets and sub markets.

  4. In framing the question which might test the outer boundaries of a market, the Tribunal used language which was less emphatic. The “quite simple but fundamental question” is if the firm were to “give less and charge more” would there be colloquially put, “much of a reaction”? That question seems to contemplate degrees of substitution.

  5. The question, framed in that way, was said by the Tribunal to be a colloquial analogue of the question framed in the language of economics of, from which products and which activities, could we expect a relatively high demand or supply response to a price change, that is, relatively high cross elasticities of demand or supply.

  6. Notwithstanding the colloquial expression of the economic test, the Tribunal’s formulation in its more emphatic language seems to suggest that the outer boundaries of a market are to be determined by questions of close competition informed by whether there is unconstrained, undue or significant market power and whether a firm in its conduct is free from severe market constraints.

  7. In 1977, the TPA was amended to introduce a new definition of “market” in these terms:

4E. For the purposes of this Act, “market” means a market in Australia and, when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are substitutable for, or otherwise competitive with, the first mentioned goods or services.

  1. In Trade Practices Commission v Ansett Transport Industries (1978) 20 ALR 31, Northrop J took the view that the observations in Queensland Co operative Milling apply to the s 4E definition of the market and also noted that the Tribunal in Re Howard Smith Industries Pty Ltd (1977) 15 ALR 645 had also defined the concept of a market saying that, from the point of view of buyers, a market “represents a range of goods or services which are good substitutes for one another in satisfying the buyer’s requirements of a particular type”.

  2. The substitution threshold seemed to be a question of “good substitutes”. In Dandy Power Equipment Pty Ltd & Anor v Mercury Marine Pty Ltd (1982) 44 ALR 173 at p 191, Smithers J described competition in a market as “the sum of activity engaged in by persons in promoting the sale to potential buyers of the goods with which the market is concerned” and the concept of substantially lessening competition in a market involved assessing the nature and extent of the market, the probable nature and extent of competition which would exist in it but for the conduct in question, the way the market operates and the nature and extent of the contemplated lessening. In applying that test, Smithers J at p 191 said what is important is “the relevant significant portion of the market”.

  3. In 1989, the High Court decided Queensland Wire: Queensland Wire Industries Pty Ltd v Broken Hill Proprietary Co. Ltd (1989) 167 CLR 177.

  4. In that case, the trial judge had found that BHP was in a position to control the market for steel and steel products; BHP therefore had a substantial degree of power in that market; the barriers to entry to that market were high; and BHP had constructively refused to sell Y bar to Queensland Wire for the purpose of preventing entry into the market for star picket posts. Mason CJ and Wilson J observed that a contravention of s 46 necessarily begins with a description of the market in which the corporation is thought to have a substantial degree of power. At p 187, their Honours said:

In identifying the relevant market, it must be borne in mind that the object is to discover the degree of the defendant’s market power [having regard to the statutory integers]. Defining the market and evaluating the degree of power in that market are part of the same process, and it is for the sake of simplicity of analysis that the two are separated.

[emphasis added]

  1. Their Honours said that if the defendant is vertically integrated, the relevant market for determining the degree of market power will be at the product level which is the source of that power, and once the product level is determined the perimeters of the market must be identified by taking account, as s 4E directs, of those products or services which are “substitutable for or otherwise competitive with” the defendant’s product. Their Honours said that the process of defining a market by substitution possibilities involves including products which compete and excluding those which do not and they accepted that the concept of a relevant market described in Hoffmann La Roche v Commission [1979] 1 E.C.R. 461 implied the presence of effective competition between products forming part of the market and pre supposed a “sufficient degree of interchangeability”. Their Honours adopted the explanation in Queensland Co operative Milling of the defining feature of a market as “substitution”. For the Tribunal, that seemed to involve, strong substitution, at least in the long run, or put differently, close competition, within a field of rivalry. Mason CJ and Wilson J did not use the term close competition in their analysis although it is inherent in the Tribunal’s notion of substitution.

  2. In determining the degree of market power, s 46(3) required the Court to have regard to the extent to which the conduct of the corporation was constrained by the conduct of competitors or potential competitors of the corporation and persons to whom or from whom the corporation supplied or acquired goods. Market power was regarded as the ability of a firm to raise prices above the supply cost without rivals taking away customers in due time, supply costs being the minimum cost an efficient firm would incur in producing the product, and “it is only when, for some reason, it is not rational or possible for new entrants to participate in the market, that a firm can have market power”. New entrants may, “as yet be unborn”.

  3. The trial judge had noted that there were high barriers to entry to the market for steel and steel products without identifying what they were other than the high cost of setting up a rolling mill.

  4. As to the economic view of capital costs, Mason CJ and Wilson J said this:

Economists, with their faith in the efficiency of capital markets and the rational behaviour of businessmen, would question the conclusion that high capital costs could constitute a barrier to entry. But it may be that the high capital costs of the steel industry, the presence of an established and overwhelmingly large producer in a protected market, and large economies of scale may together be sufficient to constitute effective barriers to entry.

[emphasis added]

  1. In the result, Mason CJ and Wilson J considered that it was in the market for rural fencing products where BHP exercised market power.

  2. Deane J noted at p 195 that there is ordinarily little point in attempting to define a relevant market without first identifying precisely what it is that is said to have been done in contravention of a particular section of the Act. In considering the notion of a market, Deane J observed at p 195 that:

… [t]he word is not susceptible of precise comprehensive definition when used as an abstract noun in an economic context. The most that can be said is that “market” should, in the context of the Act, be understood in the sense of an area of potential close competition in particular goods and/or services and their substitutes.
[emphasis added]

  1. The identification of the relevant market, isolating market structures and boundaries, for the purpose of examining the corporation’s conduct said to contravene a provision of the TPA involves, his Honour noted, at p 196:

value judgments about which there is some room for legitimate differences of opinion. The economy is not divided into an identifiable number of discrete markets into one or other of which all trading activities can be neatly fitted. One overall market may overlap other markets and contain more narrowly defined markets which may, in their turn, overlap, the one or more others.
The outer limits (including geographic confines) of a particular market are likely to be blurred: their definition will commonly involve assessment of the relative weight to be given to competing considerations in relation to questions such as the extent of product substitutability and the significance of competition between traders at different stages of distribution.
While actual competition must exist and be assessed in the context of a market, a market can exist if there be the potential for close competition even though none in fact exists. A market will continue to exist even though dealings in it be temporarily dormant or suspended.

[emphasis added]

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