Few areas in competition law are more prone to dogmatic disputation than predatory pricing - the practice whereby an incumbent firm seeks to force a rival from the market through sustained loss-making low prices.
It is critical for a competition regime to get predatory pricing right, as it intervenes in the very heart of the competitive process, where one firm seeks to gain business from another by undercutting its prices. In a world of omnivorous tech giants and plucky entrants, the boundary where a dominant firm’s discounting crosses into prohibited conduct needs to be clear. In the recent Media 24 v Competition Commission ruling, the Competition Appeal Court has drawn a clear line.
For a case that spells out the law on pricing for a host of new industries, Media24 v Competition Commission carries the distinct whiff of printer’s ink. It concerned a battle between two small community newspapers in the Free State mining town of Welkom in the early to late 2000s. These humble events resulted in a case that ran for seven years and raised many knotty issues.
The Competition Commission argued that Media24’s Forum was loss-making and existed only to eliminate a rival called Gold-Net News. Media24 disputed this allegation and argued that Forum was a legitimate commercial concern; although the title was loss-making on a total cost basis, its revenues (and hence prices) exceeded its incremental costs. On this basis, the title made a contribution to Media24’s bottom line.
The key question for the law on predation is: how does one distinguish between low prices reflecting competition on the merits and prices which seek to stop the competitive process in its tracks? Classically, the approach has been to compare prices to a cost benchmark chosen to differentiate between profit-enhancing prices and those only explicable as attempts at anti-competitive exclusion.
But the Competition Tribunal’s 2015 decision in this case followed a different tack. It elevated the intent of Media 24 to a critical factor. The Tribunal found that pricing below the high benchmark of Average Total Costs, was predatory due to an intention to predate on Media24’s part. But intent in this context is a slippery concept, as competing firms by definition intend to take business from one another – it is therefore not clear when that intent becomes anti-competitive.
The Competition Appeal Court unanimously rejected the Tribunal’s approach. The Court confirmed that section 8(c) of the Competition Act sets a test in which exclusion and anti-competitive effect need to be proven objectively. There is no role for intent. The Court also rejected the requirement that firms set prices above Average Total Costs (ATC). This is to be welcomed, as firms often have legitimate commercial reasons for not covering all allocated overheads, a component of ATC.
Multi-product firms often price below ATC and still make an incremental profit. And when assessing the commercial viability of a new product or service, a firm compares the additional revenues of that product with the additional costs. The ATC standard imposed by the Tribunal would have prevented dominant firms from introducing new products that would add incrementally to overall profits.
Such an approach would also have prevented firms from utilising economies of scope, which are savings derived from having shared infrastructure servicing a portfolio of products. Firms would, remarkably, have been prohibited from passing on such savings to consumers through lower prices. An unnecessary price cushion would have been imposed.
At the same time, the Court sent a clear message to dominant firms: if such firms price in a manner that does not increase incremental profits, they are at risk of being found to be predating. Following the Court’s decision, dominant firms are required to price above the Average Avoidable Cost (AAC) of their products. This means that prices have to cover all costs truly incremental to the production of that product, whether labelled variable, fixed or overhead. It is a standard, which enjoys wide support in international case law and economic literature. This aspect of the decision brings welcome clarity for dominant firms wishing to compete vigorously yet lawfully – and for firms wishing to be protected from predation.
Of further importance is the Court’s rejection of another aspect of the Commission’s case. The Commission had wished to include in the calculations not only costs directly incurred in producing the product, but also those hypothetical profits foregone by not pursuing a different business strategy. The Court held that such opportunity costs by way of foregone profits are not relevant for predation analysis. This decision, too, will aid effective compliance.
The Court also clarified how predation should be tested for under section 8(d)(iv), another part of the Act cited by the Commission, which imposes significant fines on respondent firms of up to 10% of total firm turnover. The decision clarified that predation cases brought under that provision should apply the more forgiving cost cost standards of marginal or average variable cost (AVC), using the conventional economic understanding of these terms. In the short run, marginal cost or AVC will be materially lower than AAC, which makes compliance with section 8(d)(iv) easier.
The threat of predatory pricing by dominant firms is a legitimate concern for the Competition Commission. The Court’s ruling brings clarity for firms wishing to compete in a lawful manner. Equally importantly, it protects smaller firms - in venerable and cutting-edge industries alike - against pricing that seeks to exclude rather than engage in legitimate competition.
The authors are employees of Genesis Analytics, an economics consultancy firm retained by both Media24 and Werksmans Attorneys throughout the duration of this matter.