In the case of a vertically integrated undertaking with SMP on the wholesale market (case 1), three standard competition problems have been identified in Chapter 2 which are based on the wholesale and/or the retail price as a strategic variable:
1.9. price discrimination 1.10. cross-subsidisation 1.11. predatory pricing
These competition problems have in common that all three lead to a margin squeeze.
The incentives for such behaviour and possible remedies against it shall now be
discussed for each of the problems in turn. As in the case of non-price issues, this is an application of principle 2 of Chapter 4.
5.2.6.1 Price discrimination
A vertically integrated undertaking with SMP at the wholesale level may subject its downstream competitors to a margin squeeze if it charges them a price which is higher than the price implicitly charged to its own retail affiliate for products or services
considered to be within the same relevant market.
Incentives for such behaviour exist whenever the dominant undertaking can increase its profits by foreclosing the retail market and the outright denial of access is for some reason impossible. In such cases the undertaking might simply maintain its price on the retail market and increase the wholesale price charged to its competitors to a level where the retail price is insufficient to cover their costs.
If the access price is regulated at a cost-oriented level, however, the undertaking will only be able to charge a price above costs to its competitors if either the access price has been calculated incorrectly by the NRA or if it transgresses the rules set by the regulator. Thus, if an access obligation according to Art 12 AD together with a cost-oriented price regulation according to Art 13 AD is in place already (possibly backed by Art 9 and 11 AD obligations), the task of the NRA is to ensure compliance with the obligation it has imposed. These monitoring costs need to be considered when
choosing cost orientation as a remedy. When calculating a cost-oriented access price, NRAs have to make sure that the access product is sufficiently unbundled (see section 5.2.3.3.), and that the SMP undertaking does not artificially increase the costs at which it is providing the service to the alternative operator (‘gold plating’). Inflated costs can be dealt with by the NRA in course of the access price calculation. Further
considerations have to be given to economies of scale and scope at the retail level, to allow the alternative operator to compete with the incumbent on a level playing field.
These issues are discussed in the Annex.
Under a wholesale price set according to the retail-minus methodology, on the other hand, a dominant undertaking is able to raise the price for its wholesale product. This does not result in a margin squeeze, however, as – according to retail-minus – the retail price has to be increased as well whenever the wholesale price is increased. The task of the NRA thus is to ensure compliance with the retail-minus rule.
5.2.6.2 Unfair cross-subsidisation
A similar reasoning as for price discrimination can be applied to the case of unfair cross-subsidisation. Unfair cross-subsidisation of below-cost retail prices with profits from the access business is only possible when the price on the wholesale market is above costs. This is impossible under a cost-oriented access price regulation.
Unfair cross-subsidisation will also be impossible under a retail-minus regime, as an above-cost access price will automatically feed into an above-cost retail price and a predatory price on the retail market will result into an access price below costs.
Again, the task of the NRA thus is to ensure compliance with the access price it has set or the retail-minus rule. In order to be able to ensure compliance, an obligation of accounting separation (Art 11 AD) may be required.
5.2.6.3 Predatory pricing
When access prices are regulated, the possibility exists for an operator deemed to have SMP on the wholesale market to impose a margin squeeze on its downstream competitors by charging a low retail price. The incentives for such behaviour are similar to the incentives in other cases of predation. If the dominant undertaking is running at a loss during the predation period, predation will only pay if, once competitors have left the market, the retail price can be increased again without immediately attracting entry.
This will be the case if barriers to entry exist or the SMP undertaking can build a reputation to resist new entry aggressively. Furthermore, predation is more likely to be successful if there is some asymmetry between the firms, in particular with regard to their access to financial resources.159 There may also be incentives for dominant undertakings to sell at a retail price that covers short run marginal costs, which may be very small, but makes little or no contribution to joint or common costs, particularly where they are large multi-product firms operating in several markets and where their competitors sell a much more restricted product range. In this case competitors may have to cover a larger proportion of their common costs from the product in question and be unable to compete with the retail prices of the SMP undertaking. In these circumstances, the use of a combinatorial test may be appropriate.160
If the situation is such that predation can be expected to be profitable for the SMP undertaking, and wholesale remedies are likely to be insufficient, NRAs may want to impose some form of regulation on the undertaking’s retail price. The retail price (which is the strategic variable in this case) can be targeted by Art 17 USD (regulatory controls on retail services), which allows NRAs, amongst other things, to impose obligations on the SMP undertaking in order to prevent it from inhibiting market entry or restricting competition by setting predatory prices. A common practice is, for example, to require the SMP undertaking to pre-notify changes in the retail price to the NRA. If the NRA considers the price as predatory, leading to a margin squeeze, and likely to have significant anti-competitive effects, it might prevent the undertaking from changing prices in the intended way. In such cases, NRAs may publish guidelines according to
159 See, for example, Martin (1994, pp. 452-489).
160 See, for example, OFT (1999b, paras 7.11 and 7.16).
which the effects of a certain price will be assessed. Retail pricing is, however, considered to be a tool of last resort.161
If the access price is regulated by means of retail-minus, a predatory price at the retail level will lead to a price below costs for the access service and therefore will not result in a margin squeeze.
5.2.6.4 Conclusion on pricing issues
With a cost-oriented access price, the problem of margin squeeze reduces to a problem of compliance with the access regulation at the wholesale level and/or to a potential predation problem at the retail level. If a danger of predation exists, it might be appropriate – after due consideration – to regulate the retail price by means of Art 17 USD (regulatory cost controls on retail services) ex ante.
A retail-minus approach in general should rule out the possibility of a margin squeeze as it links wholesale and retail prices exactly in a way such that all operators that are equally efficient as the dominant undertaking will usually be able to compete.
A margin squeeze thus can also be precluded by linking the retail price to the (cost-oriented) access price in a retail-minus-like fashion. This is sometimes referred to as
‘imputation requirement’. Given the variety of retail prices in many communication markets, however, such a rule may be difficult to enforce. Furthermore an imputation requirement might be ineffective under certain circumstances, for example, if new entrants have to bear consumer switching costs which are not born by the SMP undertaking.162 This could be allowed for by increasing the ‘minus’ to the level which allows entrants to compete. NRAs should consider taking into account economies of scale and scope when determining the access price to ensure that incumbent and entrant are competing on a level playing field on the retail market (cf. Annex).
5.3 Case 2: Horizontal leveraging
Case 2 as set out in Chapter 2 deals with leveraging issues which may arise in a situation where an undertaking is operating on two or more markets which are not vertically related, and is dominant on one of them, and the links between the two markets are such as to allow the market power held in one market to be leveraged into the other market. Two standard competition problems have been identified in this context:
2.1. bundling/tying
2.2. cross-subsidisation
Although in most cases only retail markets are involved, there may be cases where market power is leveraged between two wholesale markets or between a wholesale and a (not vertically related) retail market. As a particular remedy of the new regulatory framework can only be applied either to the wholesale or to the retail level, all possible cases will have to be discussed.
161 Directive 2002/22/EC, Recital 26.
162 See Beard et al (2003).
By preventing the dominant undertaking from leveraging its market power to
horizontally related markets, NRAs promote competition in those markets and protect consumers from the exercise of market power (principle 2 of Chapter 4)