Competition Laws
July 10th, 2008 Posted in Business TipsThe aims of competition (anti-trust) laws are to ensure that consumers pay the lowest possible price (=the most efficient price) coupled with the highest quality of the goods and services which they consume. This, according to current economic theories, can be achieved only through effective competition. Competition not only reduces particular prices of specific goods and services - it also tends to have a deflationary effect by reducing the general price level. It pits consumers against producers, producers against other producers (in the battle to win the heart of consumers) and even consumers against consumers (for example in the healthcare sector in the USA). This everlasting conflict does the miracle of increasing quality with lower prices. Think about the vast improvement on both scores in electrical appliances. The VCR and PC of yesteryear cost thrice as much and provided one third the functions at one tenth the speed.
Competition has innumerable advantages:
It encourages manufacturers and service providers to be more efficient, to better respond to the needs of their customers, to innovate, to initiate, to venture. In professional words: it optimizes the allocation of resources at the firm level and, as a result, throughout the national economy. More simply: producers do not waste resources (capital), consumers and businesses pay less for the same goods and services and, as a result, consumption grows to the benefit of all involved.
The other beneficial effect seems, at first sight, to be an adverse one: competition weeds out the failures, the incompetents, the inefficient, the fat and slow to respond. Competitors pressure one another to be more efficient, leaner and meaner. This is the very essence of capitalism. It is wrong to say that only the consumer benefits. If a firm improves itself, re-engineers its production processes, introduces new management techniques, modernizes - in order to fight the competition, it stands to reason that it will reap the rewards. Competition benefits the economy, as a whole, the consumers and other producers by a process of natural economic selection where only the fittest survive. Those who are not fit to survive die out and cease to waste the rare resources of humanity.
Thus, paradoxically, the poorer the country, the less resources it has - the more it is in need of competition. Only competition can secure the proper and most efficient use of its scarce resources, a maximization of its output and the maximal welfare of its citizens (consumers). Moreover, we tend to forget that the biggest consumers are businesses (firms). If the local phone company is inefficient (because no one competes with it, being a monopoly) - firms will suffer the most: higher charges, bad connections, lost time, effort, money and business. If the banks are dysfunctional (because there is no foreign competition), they will not properly service their clients and firms will collapse because of lack of liquidity. It is the business sector in poor countries which should head the crusade to open the country to competition.
Unfortunately, the first discernible results of the introduction of free marketry are unemployment and business closures. People and firms lack the vision, the knowledge and the wherewithal needed to support competition. They fiercely oppose it and governments throughout the world bow to protectionist measures. To no avail. Closing a country to competition will only exacerbate the very conditions which necessitate its opening up. At the end of such a wrong path awaits economic disaster and the forced entry of competitors. A country which closes itself to the world - will be forced to sell itself cheaply as its economy will become more and more inefficient, less and less non-competitive.
The Competition Laws aim to establish fairness of commercial conduct among entrepreneurs and competitors which are the sources of said competition and innovation.
Experience - later buttressed by research - helped to establish the following four principles:
There should be no barriers to the entry of new market players (barring criminal and moral barriers to certain types of activities and to certain goods and services offered)
A larger scale of operation does introduce economies of scale (and thus lowers prices). This, however, is not infinitely true. There is a Minimum Efficient Scale - MES - beyond which prices will begin to rise due to monopolization of the markets. This MES was empirically fixed at 10% of the market in any one good or service. In other words: companies should be encouraged to capture up to 10% of their market (=to lower prices) and discouraged to cross this barrier, lest prices tend to rise again.
Efficient competition does not exist when a market is controlled by less than 10 firms with big size differences. An oligopoly should be declared whenever 4 firms control more than 40% of the market and the biggest of them controls more than 12% of it.
A competitive price will be comprised of a minimal cost plus an equilibrium profit which does not encourage either an exit of firms (because it is too low), nor their entry (because it is too high).
Left to their own devices, firms tend to liquidate competitors (predation), buy them out or collude with them to raise prices. The 1890 Sherman Antitrust Act in the USA forbade the latter (section 1) and prohibited monopolization or dumping as a method to eliminate competitors. Later acts (Clayton, 1914 and the Federal Trade Commission Act of the same year) added forbidden activities: tying arrangements, boycotts, territorial divisions, non-competitive mergers, price discrimination, exclusive dealing, unfair acts, practices and methods. Both consumers and producers who felt offended were given access to the Justice Department and to the FTC or the right to sue in a federal court and be eligible to receive treble damages.
It is only fair to mention the “intellectual competition”, which opposes the above premises. Many important economists thought (and still do) that competition laws represent an unwarranted and harmful intervention of the State in the markets. Some believed that the State should own important industries (J.K. Galbraith), others - that industries should be encouraged to grow because only size guarantees survival, lower prices and innovation (Ellis Hawley). Yet others supported the cause of laissez faire (Marc Eisner).
These three antithetical approaches are, by no means, new. One led to socialism and communism, the other to corporatism and monopolies and the third to jungle-ization of the market (what the Europeans derisively call: the Anglo-Saxon model).
B. HISTORICAL AND LEGAL CONSIDERATIONS
Why does the State involve itself in the machinations of the free market? Because often markets fail or are unable or unwilling to provide goods, services, or competition. The purpose of competition laws is to secure a competitive marketplace and thus protect the consumer from unfair, anti-competitive practices. The latter tend to increase prices and reduce the availability and quality of goods and services offered to the consumer.
Such state intervention is usually done by establishing a governmental Authority with full powers to regulate the markets and ensure their fairness and accessibility to new entrants. Lately, international collaboration between such authorities yielded a measure of harmonization and coordinated action (especially in cases of trusts which are the results of mergers and acquisitions).
Yet, competition law embodies an inherent conflict: while protecting local consumers from monopolies, cartels and oligopolies - it ignores the very same practices when directed at foreign consumers. Cartels related to the country’s foreign trade are allowed even under GATT/WTO rules (in cases of dumping or excessive export subsidies). Put simply: governments regard acts which are criminal as legal if they are directed at foreign consumers or are part of the process of foreign trade.
A country such as Macedonia - poor and in need of establishing its export sector - should include in its competition law at least two protective measures against these discriminatory practices:
Blocking Statutes - which prohibit its legal entities from collaborating with legal procedures in other countries to the extent that this collaboration adversely affects the local export industry.
Clawback Provisions - which will enable the local courts to order the refund of any penalty payment decreed or imposed by a foreign court on a local legal entity and which exceeds actual damage inflicted by unfair trade practices of said local legal entity. US courts, for instance, are allowed to impose treble damages on infringing foreign entities. The clawback provisions are used to battle this judicial aggression.
Competition policy is the antithesis of industrial policy. The former wishes to ensure the conditions and the rules of the game - the latter to recruit the players, train them and win the game. The origin of the former is in the 19th century USA and from there it spread to (really was imposed on) Germany and Japan, the defeated countries in the 2nd World War. The European Community (EC) incorporated a competition policy in articles 85 and 86 of the Rome Convention and in Regulation 17 of the Council of Ministers, 1962.
Still, the two most important economic blocks of our time have different goals in mind when implementing competition policies. The USA is more interested in economic (and econometric) results while the EU emphasizes social, regional development and political consequences. The EU also protects the rights of small businesses more vigorously and, to some extent, sacrifices intellectual property rights on the altar of fairness and the free movement of goods and services.
Put differently: the USA protects the producers and the EU shields the consumer. The USA is interested in the maximization of output at whatever social cost - the EU is interested in the creation of a just society, a liveable community, even if the economic results will be less than optimal.
There is little doubt that Macedonia should follow the EU example. Geographically, it is a part of Europe and, one day, will be integrated in the EU. It is socially sensitive, export oriented, its economy is negligible and its consumers are poor, it is besieged by monopolies and oligopolies.
In my view, its competition laws should already incorporate the important elements of the EU (Community) legislation and even explicitly state so in the preamble to the law. Other, mightier, countries have done so. Italy, for instance, modelled its Law number 287 dated 10/10/90 “Competition and Fair Trading Act” after the EC legislation. The law explicitly says so.
The first serious attempt at international harmonization of national antitrust laws was the Havana Charter of 1947. It called for the creation of an umbrella operating organization (the International Trade Organization or “ITO”) and incorporated an extensive body of universal antitrust rules in nine of its articles. Members were required to “prevent business practices affecting international trade which restrained competition, limited access to markets, or fostered monopolistic control whenever such practices had harmful effects on the expansion of production or trade”. the latter included:
Fixing prices, terms, or conditions to be observed in dealing with others in the purchase, sale, or lease of any product;
Excluding enterprises from, or allocating or dividing, any territorial market or field of business activity, or allocating customers, or fixing sales quotas or purchase quotas;
Discriminating against particular enterprises;
Limiting production or fixing production quotas;
Preventing by agreement the development or application of technology or invention, whether patented or non-patented; and
Extending the use of rights under intellectual property protections to matters which, according to a member’s laws and regulations, are not within the scope of such grants, or to products or conditions of production, use, or sale which are not likewise the subject of such grants.
GATT 1947 was a mere bridging agreement but the Havana Charter languished and died due to the objections of a protectionist US Senate.
There are no antitrust/competition rules either in GATT 1947 or in GATT/WTO 1994, but their provisions on antidumping and countervailing duty actions and government subsidies constitute some elements of a more general antitrust/competition law.
GATT, though, has an International Antitrust Code Writing Group which produced a “Draft International Antitrust Code” (10/7/93). It is reprinted in §II, 64 Antitrust & Trade Regulation Reporter (BNA), Special Supplement at S-3 (19/8/93).
Four principles guided the (mostly German) authors:
National laws should be applied to solve international competition problems;
Parties, regardless of origin, should be treated as locals;
A minimum standard for national antitrust rules should be set (stricter measures would be welcome); and
The establishment of an international authority to settle disputes between parties over antitrust issues.
The 29 (well-off) members of the Organization for Economic Cooperation and Development (OECD) formed rules governing the harmonization and coordination of international antitrust/competition regulation among its member nations (”The Revised Recommendation of the OECD Council Concerning Cooperation between Member Countries on Restrictive Business Practices Affecting International Trade,” OECD Doc. No. C(86)44 (Final) (June 5, 1986), also in 25 International Legal Materials 1629 (1986). A revised version was reissued. According to it, ” …Enterprises should refrain from abuses of a dominant market position; permit purchasers, distributors, and suppliers to freely conduct their businesses; refrain from cartels or restrictive agreements; and consult and cooperate with competent authorities of interested countries”.
An agency in one of the member countries tackling an antitrust case, usually notifies another member country whenever an antitrust enforcement action may affect important interests of that country or its nationals (see: OECD Recommendations on Predatory Pricing, 1989).
The United States has bilateral antitrust agreements with Australia, Canada, and Germany, which was followed by a bilateral agreement with the EU in 1991. These provide for coordinated antitrust investigations and prosecutions. The United States thus reduced the legal and political obstacles which faced its extraterritorial prosecutions and enforcement. The agreements require one party to notify the other of imminent antitrust actions, to share relevant information, and to consult on potential policy changes. The EU-U.S. Agreement contains a “comity” principle under which each side promises to take into consideration the other’s interests when considering antitrust prosecutions. A similar principle is at the basis of Chapter 15 of the North American Free Trade Agreement (NAFTA) - cooperation on antitrust matters.
The United Nations Conference on Restrictive Business Practices adopted a code of conduct in 1979/1980 that was later integrated as a U.N. General Assembly Resolution [U.N. Doc. TD/RBP/10 (1980)]: “The Set of Multilaterally Agreed Equitable Principles and Rules”.
According to its provisions, “independent enterprises should refrain from certain practices when they would limit access to markets or otherwise unduly restrain competition”.
The following business practices are prohibited:
Agreements to fix prices (including export and import prices);
Collusive tendering
Market or customer allocation (division) arrangements;
Allocation of sales or production by quota;
Collective action to enforce arrangements, e.g., by concerted refusals to deal;
Concerted refusal to sell to potential importers; and
Collective denial of access to an arrangement, or association, where such access is crucial to competition and such denial might hamper it. In addition, businesses are forbidden to engage in the abuse of a dominant position in the market by limiting access to it or by otherwise restraining competition by:
Predatory behaviour towards competitors
Discriminatory pricing or terms or conditions in the supply or purchase of goods or services
Mergers, takeovers, joint ventures, or other acquisitions of control
Fixing prices for exported goods or resold imported goods
Import restrictions on legitimately-marked trademarked goods
Unjustifiably - whether partially or completely - refusing to deal on an enterprise’s customary commercial terms, making the supply of goods or services dependent on restrictions on the distribution or manufacturer of other goods, imposing restrictions on the resale or exportation of the same or other goods, and purchase “tie-ins.”
C. ANTI - COMPETITIVE STRATEGIES
Any Competition Law in Macedonia should, in my view, excplicitly include strict prohibitions of the following practices (further details can be found in Porter’s book - “Competitive Strategy”).
These practices characterize the Macedonian market. They influence the Macedonian economy by discouraging foreign investors, encouraging inefficiencies and mismanagement, sustaining artificially high prices, misallocating very scarce resources, increasing unemployment, fostering corrupt and criminal practices and, in general, preventing the growth that Macedonia could have attained.
Strategies’ for Monopolization
Exclude competitors from distribution channels - this is common practice in many countries. Open threats are made by the manufacturers of popular products: “If you distribute my competitor’s products - you cannot distribute mine. So, choose.” Naturally, retail outlets, dealers and distributors will always prefer the popular product to the new. This practice not only blocks competition - but also innovation, trade and choice or variety.
Buy up competitors and potential competitors - There is nothing wrong with that. Under certain circumstances, this is even desirable. Think about the Banking System: it is always better to have fewer banks with bigger capital than many small banks with capital inadequacy (remember the TAT affair). So, consolidation is sometimes welcome, especially where scale represents viability and a higher degree of consumer protection. The line is thin and is composed of both quantitative and qualitative criteria. One way to measure the desirability of such mergers and acquisitions (M&A) is the level of market concentration following the M&A. Is a new monopoly created? Will the new entity be able to set prices unperturbed? stamp out its other competitors? If so, it is not desirable and should be prevented.
Every merger in the USA must be approved by the antitrust authorities. When multinationals merge, they must get the approval of all the competition authorities in all the territories in which they operate. The purchase of “Intuit” by “Microsoft” was prevented by the antitrust department (the “Trust-busters”). A host of airlines was conducting a drawn out battle with competition authorities in the EU, UK and the USA lately.
Use predatory [below-cost] pricing (also known as dumping) to eliminate competitors - This tactic is mostly used by manufacturers in developing or emerging economies and in Japan. It consists of “pricing the competition out of the markets”. The predator sells his products at a price which is lower even than the costs of production. The result is that he swamps the market, driving out all other competitors. Once he is left alone - he raises his prices back to normal and, often, above normal. The dumper loses money in the dumping operation and compensates for these losses by charging inflated prices after having the competition eliminated.
Raise scale-economy barriers - Take unfair advantage of size and the resulting scale economies to force conditions upon the competition or upon the distribution channels. In many countries Big Industry lobbies for a legislation which will fit its purposes and exclude its (smaller) competitors.
Increase “market power (share) and hence profit potential”
Study the industry’s “potential” structure and ways it can be made less competitive - Even thinking about sin or planning it should be prohibited. Many industries have “think tanks” and experts whose sole function is to show the firm the way to minimize competition and to increase its market shares. Admittedly, the line is very thin: when does a Marketing Plan become criminal?
Arrange for a “rise in entry barriers to block later entrants” and “inflict losses on the entrant” - This could be done by imposing bureaucratic obstacles (of licencing, permits and taxation), scale hindrances (no possibility to distribute small quantities), “old boy networks” which share political clout and research and development, using intellectual property right to block new entrants and other methods too numerous to recount. An effective law should block any action which prevents new entry to a market.
Buy up firms in other industries “as a base from which to change industry structures” there - This is a way of securing exclusive sources of supply of raw materials, services and complementing products. If a company owns its suppliers and they are single or almost single sources of supply - in effect it has monopolized the market. If a software company owns another software company with a product which can be incorporated in its own products - and the two have substantial market shares in their markets - then their dominant positions will reinforce each other’s.
“Find ways to encourage particular competitors out of the industry” - If you can’t intimidate your competitors you might wish to “make them an offer that they cannot refuse”. One way is to buy them, to bribe out the key personnel, to offer tempting opportunities in other markets, to swap markets (I will give my market share in a market which I do not really care about and you will give me your market share in a market in which we are competitors). Other ways are to give the competitors assets, distribution channels and so on providing that they collude in a cartel.
“Send signals to encourage competition to exit” the industry - Such signals could be threats, promises, policy measures, attacks on the integrity and quality of the competitor, announcement that the company has set a certain market share as its goal (and will, therefore, not tolerate anyone trying to prevent it from attaining this market share) and any action which directly or indirectly intimidates or convinces competitors to leave the industry. Such an action need not be positive - it can be negative, need not be done by the company - can be done by its political proxies, need not be planned - could be accidental. The results are what matters.
Macedonia’s Competition Law should outlaw the following, as well:
‘Intimidate’ Competitors
Raise “mobility” barriers to keep competitors in the least-profitable segments of the industry - This is a tactic which preserves the appearance of competition while subverting it. Certain, usually less profitable or too small to be of interest, or with dim growth prospects, or which are likely to be opened to fierce domestic and foreign competition are left to the competition. The more lucrative parts of the markets are zealously guarded by the company. Through legislation, policy measures, withholding of technology and know-how - the firm prevents its competitors from crossing the river into its protected turf.
Let little firms “develop” an industry and then come in and take it over - This is precisely what Netscape is saying that Microsoft is doing to it. Netscape developed the now lucrative Browser Application market. Microsoft was wrong in discarding the Internet as a fad. When it was found to be wrong - Microsoft reversed its position and came up with its own (then, technologically inferior) browser (the Internet Explorer). It offered it free (sound suspiciously like dumping) to buyers of its operating system, “Windows”. Inevitably it captured more than 30% of the market, crowding out Netscape. It is the view of the antitrust authorities in the USA that Microsoft utilized its dominant position in one market (that of the Operating Systems) to annihilate a competitor in another (that of the browsers).
Engage in “promotional warfare” by “attacking shares of others” - This is when the gist of a marketing or advertising campaign is to capture the market share of the competition. Direct attack is then made on the competition just in order to abolish it. To sell more in order to maximize profits, is allowed and meritorious - to sell more in order to eliminate the competition is wrong and should be disallowed.
Use price retaliation to “discipline” competitors - Through dumping or even unreasonable and excessive discounting. This could be achieved not only through the price itself. An exceedingly long credit term offered to a distributor or to a buyer is a way of reducing the price. The same applies to sales, promotions, vouchers, gifts. They are all ways to reduce the effective price. The customer calculates the money value of these benefits and deducts them from the price.
Establish a “pattern” of severe retaliation against challengers to “communicate commitment” to resist efforts to win market share - Again, this retaliation can take a myriad of forms: malicious advertising, a media campaign, adverse legislation, blocking distribution channels, staging a hostile bid in the stock exchange just in order to disrupt the proper and orderly management of the competitor. Anything which derails the competitor whenever he makes a headway, gains a larger market share, launches a new product - can be construed as a “pattern of retaliation”.
Maintain excess capacity to be used for “fighting” purposes to discipline ambitious rivals - Such excess capacity could belong to the offending firm or - through cartel or other arrangements - to a group of offending firms.
Publicize one’s “commitment to resist entry” into the market
Publicize the fact that one has a “monitoring system” to detect any aggressive acts of competitors
Announce in advance “market share targets” to intimidate competitors into yielding share their market share
Proliferate Brand Names
Contract with customers to “meet or match all price cuts (offered by the competition)” thus denying rivals any hope of growth through price competition
Get a big enough market share to “corner” the “learning curve,” thus denying rivals an opportunity to become efficient - Efficiency is gained by an increase in market share. Such an increase leads to new demands imposed by the market, to modernization, innovation, the introduction of new management techniques (example: Just In Time inventory management), joint ventures, training of personnel, technology transfers, development of proprietary intellectual property and so on. Deprived of a growing market share - the competitor will not feel pressurized to learn and to better itself. In due time, it will dwindle and die.
Acquire a wall of “defensive” patents to deny competitors access to the latest technology
“Harvest” market position in a no-growth industry by raising prices, lowering quality, and stopping all investment and advertising in it
Create or encourage capital scarcity - by colluding with sources of financing (e.g., regional, national, or investment banks), by absorbing any capital offered by the State, by the capital markets, through the banks, by spreading malicious news which serve to lower the credit-worthiness of the competition, by legislating special tax and financing loopholes and so on.
Introduce high advertising-intensity - This is very difficult to measure. There could be no objective criteria which will not go against the grain of the fundamental right to freedom of expression. However, truth in advertising should be strictly imposed. Practices such as dragging a competitor through the mud or derogatorily referring to its products or services in advertising campaigns should be banned and the ban should be enforced.
Proliferate “brand names” to make it too expensive for small firms to grow - By creating and maintaining a host of absolutely unnecessary brandnames, the competition’s brandnames are crowded out. Again, this cannot be legislated against. A firm has the right to create and maintain as many brandnames as it wishes. The market will exact a price and thus punish such a company because, ultimately, its own brandname will suffer from the proliferation.
Get a “corner” (control, manipulate and regulate) on raw materials, government licenses, subsidies, and patents (and, of course, prevent the competition from having access to them).
Build up “political capital” with government bodies; overseas, get “protection” from “the host government”.
‘Vertical’ Barriers
Practice a “preemptive strategy” by capturing all capacity expansion in the industry (simply buying it, leasing it or taking over the companies that own or develop it).
This serves to “deny competitors enough residual demand”. Residual demand, as we previously explained, causes firms to be efficient. Once efficient, develop enough power to “credibly retaliate” and thereby “enforce an orderly expansion process” to prevent overcapacity
Create “switching” costs - Through legislation, bureaucracy, control of the media, cornering advertising space in the media, controlling infrastructure, owning intellectual property, owning, controlling or intimidating distribution channels and suppliers and so on.
Impose vertical “price squeezes” - By owning, controlling, colluding with, or intimidating suppliers and distributors, marketing channels and wholesale and retail outlets into not collaborating with the competition.
Practice vertical integration (buying suppliers and distributionb and marketing channels)
This has the following effects:
The firm gains a “tap (access) into technology” and marketing information in an adjacent industry. It defends itself against a supplier’s too-high or even realistic prices
It defends itself against foreclosure, bankruptcy and restructuring or reorganization. Owning suppliers means that the supplies do not cease even when payment is not affected, for instance.
It “protects proprietary information from suppliers” - otherwise the firm might have to give outsiders access to its technology, processes, formulas and other intellectual property.
It raises entry and mobility barriers against competitors. This is why the State should legislate and act against any purchase, or other types of control of suppliers and marketing channels which service competitors and thus enhance competition.
It serves to “prove that a threat of full integration is credible” and thus intimidate competitors.
Finally, it gets “detailed cost information” in an adjacent industry (but doesn’t integrate it into a “highly competitive industry”)
“Capture distribution outlets” by vertical integration to “increase barriers”;
‘Consolidate’ the Industry
Send “signals” to threaten, bluff, preempt, or collude with competitors
Use a “fighting brand” (a low-price brand used only for price-cutting)
Use “cross parry” (retaliate in another part of a competitor’s market)
Harass competitors with antitrust suits and other litigious techniques
Use “brute force” (”massed resources” applied “with finesse”) to attack competitors
or use “focal points” of pressure to collude with competitors on price
“Load up customers” at cut-rate prices to “deny new entrants a base” and force them to “withdraw” from market;
Practice “buyer selection,” focusing on those that are the most “vulnerable” (easiest to overcharge) and discriminating against and for certain types of consumers
“Consolidate” the industry so as to “overcome industry fragmentation”.
This arguments is highly successful with US federal courts in the last decade. There is an intuitive feeling that few is better and that a consolidated industry is bound to be more efficient, better able to compete and to survive and, ultimately, better positioned to lower prices, to conduct costly research and development and to increase quality. In the words of Porter: “(The) pay-off to consolidating a fragmented industry can be high because… small and weak competitors offer little threat of retaliation”
Time one’s own capacity additions; never sell old capacity “to anyone who will use it in the same industry” and buy out “and retire competitors’ capacity.”