15 May 2008 Kyriakos Fountoukakos Partner, Herbert Smith LLP, EU/Competition Group

1. The Eighth Annual Trans-Atlantic Antitrust DialogueExclusionary pricing in Article 82 cases – recent case-law of the Community Courts 15 May 2008 Kyriakos Fountoukakos Partner, Herbert Smith LLP, EU/Competition Group Disclaimer:The content of this presentation does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

2. Summary • Commission stated desire to move away from per se rules and adopt a more effects (and economics) based approach to Article 82 • Examples of recent case-law of the Community Courts on exclusionary pricing abuses • Existing case-law should not prevent an evolution of the Commission’s approach • Potential issues to consider

3. Commission’s stated desire for an evolution in future approach in respect of Article 82 • “In applying Article 82, the Commission will adopt an approach which is based on the likely effects on the market”. • “With regard to exclusionary abuses the objective of Article 82 is the protection of competition on the market as a means of enhancing consumer welfare and of ensuring an efficient allocation of resources”. • “The central concern of Article 82 with regard to exclusionary abuses is…foreclosure that hinders competition and thereby harms consumers”. • “…in general only conduct which would exclude a hypothetical “as efficient” competitor is abusive…the question asked is whether the dominant company itself would be able to survive the exclusionary conduct in the event that it would be the target”. • DG Competition discussion paper on the application of Article 82 of the Treaty to exclusionary abuses (December 2005)

4. Framework for Commission action • “…even if its administrative practices were to change, the Commission would still have to act within the framework prescribed for it by Article 82 as interpreted by the Court of Justice” • Advocate General Kokott, Case C-95/04 British Airways v Commission • “…any possible interpretation of Article 82 is without prejudice to the interpretation that may be given by the Court of Justice or the Court of First Instance of the European Communities” • DG Competition discussion paper on the application of Article 82 of the Treaty to exclusionary abuses

5. ECJ definition of abuse • “The concept of abuse is an objective concept which is such as to influence the structure of a market where, as a result of the very presence of the undertaking in question, the degree of competition is weakened and which, through recourse to methods different from those which condition normal competition in products or services on the basis of the transactions of commercial operators, has the effect of hindering the maintenance of the degree of competition still existing in the market or the growth of that competition” • Case 85/76 Hoffman-La Roche v Commission

6. Predatory pricing Case T-340/03 France Telecom v Commission (Wanadoo) (January 2007) • CFI upholds Commission decision condemning Wanadoo’s pricing policy on the high speed internet market • Reaffirms test in previous case-law (AKZO, Tetra Pak I & II, Compagnie maritime belge): - prices below average variable cost give grounds for assuming that a pricing practice is eliminatory - prices below average total costs but above average variable costs must be regarded as abusive if they are determined as part of a plan for eliminating a competitor (Wanadoo’s internal documents being held in this case to provide sufficient evidence of such a plan) • Such conduct is liable to have the effect of restricting competition and therefore no demonstration of the actual effects of the practices is required – failure to achieve the predatory object is not sufficient to prevent conduct from being an abuse

7. Predatory pricing – cont. • No absolute right to align prices; upholds Commission decision that a dominant undertaking should not be permitted to align its price where costs would not be recovered • Proof of recoupment of losses not a precondition for a finding of predatory pricing • NB On appeal to the ECJ (Case C-202/07 P) (including on alignment of prices and recoupment)

8. CFI in France Telecom v Commission Presumption that prices below average variable cost (AVC) are abusive Prices above AVC but below average total costs are abusive if they are determined as part of a plan for eliminating a competitor – i.e. evidence of plan to pre-empt necessary No demonstration of the actual effects of the practices is required Proof of recoupment of losses not necessary No absolute right to align prices – not possible to use as justification where conduct aimed not only at protecting the interests of the dominant company, but also at strengthening and abusing its dominant position (in this case, where costs would not be recovered) Commission discussion paper Presumption that prices below average avoidable cost (AAC) are abusive (but recognition that possible to rebut) Presumption that prices above AAC but below average total costs (ATC) are abusive if the dominant company has a predatory intent – i.e. objectively speaking it is part of a strategy or plan to predate Absent direct documentary evidence of a predatory strategy or evidence that the pricing behaviour only makes commercial sense as part of a predatory strategy, it is necessary for Commission to show that a foreclosure effect is likely Dominant company can rebut by showing that pricing has not and will not have the alleged exclusionary effect Proof of recoupment of losses not necessary (as dominance is already established this normally means that entry barriers are sufficiently high to presume the possibility to recoup); dominant company can rebut, however, by showing that recoupment will never be possible Meeting competition defence unlikely where pricing below AAC Predatory pricing – cont.

9. Rebates/bonuses • Case C-95/04 P British Airways v Commission (March 2007) • ECJ dismisses appeal against CFI judgment affirming Commission decision in relation to travel agent commission scheme • Reaffirms test in previous case law (Michelin): - whether the discounts/bonuses can/tend to produce an exclusionary effect, i.e. whether they are capable of: (i) making market entry very difficult or impossible for competitors; and (ii) making it more difficult or impossible for customers to choose between various sources of supply or commercial partners; and - whether there is an objective economic justification for the discounts/bonuses • Relevant factors are stated to be whether the discounts/bonuses relate to the purchases of all products in the reference period and whether targets are individualised • The CFI was therefore entitled to hold that the commission scheme did have a fidelity-building effect and therefore produced an exclusionary effect

10. Rebates/bonuses – cont. • ECJ does accept that it must be examined whether the in principle exclusionary commission scheme had an objective economic justification, and this examination must be on the basis of the “whole circumstances of the case”, to determine whether any exclusionary effect may be outweighed by advantages in terms of efficiency which also benefit the consumer • No discussion by the ECJ of target thresholds, or of the effective price of the products/services as a result of the bonuses and whether in light of this price an ‘as efficient’ competitor would be able to compete (despite BA’s arguments) • Holds BA’s claim that CFI failed to take sufficient account of evidence showing no exclusionary effect as inadmissible, given appeal limited to questions of law (the CFI concluded that it was not necessary to prove such an effect by examining market evidence of exclusion, but that in any event that such an effect had been demonstrated by the Commission) • Does refer to CFI assessment that the progressive nature of the bonuses had a ‘very noticeable effect at the margin’, and to the CFI’s assessment that BA’s competitors would not have been in a position to operate a similar scheme • In relation to discrimination, ECJ held that it was sufficient that the practice tends to lead to a distortion of competition, rather than it being necessary to prove actual quantifiable deterioration in the competition position of the other trading party

11. ECJ in British Airways v Commission Two-stage test: - whether the discounts/bonuses tend to produce a fidelity building and therefore exclusionary effect (i.e. whether they are capable of (i) making market entry very difficult or impossible for competitors and (ii) making it more difficult or impossible for customers to choose between various sources of supply or commercial partners); and - whether there is an objective economic justification for the discounts/bonuses On the first aspect, whether targets are individualised, and whether rebates apply to all purchases or just incremental purchases, are relevant factors On the second aspect, objective justification to be assessed on basis of the “whole circumstances of the case” (including looking at efficiencies) ECJ does not address question of whether effect on the market in practice needs to be shown Commission discussion paper Commission will look at likely and actual foreclosure effects, including possibilities of competitors countering the fidelity enhancing potential of the dominant company's conduct (i.e. whether an as efficient competitor is hindered from supplying commercially viable amounts to the customers) When looking at potential negative/foreclosure effects Commission will consider: - thresholds for rebate/discount - whether rebate/discount applies to all purchases or only incremental purchases (where the latter, Commission will conclude there is an abuse only if resulting price for incremental purchases is a predatory price) - incidence – size and importance of ‘tied’ market share (that part sold under the rebate system) - whether goods are homogeneous and whether competitors are capacity constrained - effective price of a commercially viable amount after rebate/discount and whether this is below average total costs; if it is above average total costs, unlikely that Commission will conclude that there is a foreclosure effect Possible defences – objective justifications and efficiencies Rebates/bonuses – cont.

12. Margin squeeze • Case T-271/03 Deutsche Telekom v Commission (April 2008) • CFI upholds Commission decision that Deutsche Telekom implemented an anti-competitive margin squeeze in relation to access to its local telecommunications network (local loop) • CFI recalls that its review of complex economic appraisals made by the Commission is necessarily limited to verifying whether the relevant rules on procedure and on the statement of reasons have been complied with, whether the facts have been accurately stated and whether there has been any manifest error of appraisal or misuse of powers • Upholds Commission ‘as efficient’ competitor approach, i.e. whether the pricing practices of the dominant undertaking could have the effect of removing from the market an economic operator that was just as efficient as the dominant undertaking • Notes that this approach is necessary given principle of legal certainty and the need for a dominant undertaking to be in a position to assess the lawfulness of its own activities

13. Margin squeeze – cont. • In response to the argument that the margin squeeze identified had no effect on the market the CFI found that: - given DT’s wholesale services are indispensable a margin squeeze between its wholesale and retail charges will in principle hinder the growth of competition in downstream markets as a potential, ‘as efficient’ competitor would not be able to enter the retail market without suffering losses (despite possibility of cross-subsidisation) • CFI does further consider the effects on the market in terms of - small market shares of DT’s competitors - the fall in competitors’ market shares when looking only at analogue connections - the fact that competition has developed to a lesser extent in other Member States does not show that DT’s pricing practices had no anti-competitive effect in Germany • NB Commission decision on margin squeeze in relation to Spanish broadband market in Case COMP/38.784 Telefónica (which contained a more detailed discussion on effects on the market) is also on appeal to the CFI (Cases T-336/07 and T-398/07)

14. CFI decision in Deutsche Telekom v Commission Question is whether the pricing practices of the dominant undertaking could have the effect of removing from the market an economic operator that was just as efficient as the dominant undertaking Given that DT’s wholesale services are indispensable a margin squeeze between its wholesale and retail charges will in principle higher the growth of competition in downstream markets; however, CFI does also consider actual market evidence Commission discussion paper A margin squeeze can be demonstrated by showing that the input owner’s downstream operations could not trade profitably on the basis of the upstream price charged to its competitors by its upstream operating arm (benchmark for the reasonably efficient competitor being the input owner) Will be abusive where there is likely to be a negative effect on competition in the downstream market Possible defences - objective justification and efficiencies Margin squeeze – cont.

15. Example of less formalistic approach in a non-pricing context • Cases C-468/06 to C-478/06 Sot. Lélos Kai Sia EE (and Others) v GlaxoSmithKline AEVE (Advocate General’s opinion, April 2008) • In relation to an alleged abuse by refusal to supply with the intention to eliminate parallel trade, Advocate General Dámaso Ruiz-Jarabo: - noted that more recent Article 82 case law has moved away from per se abuses and the principle that certain behaviour can never be justified - stated that it must be possible for an undertaking to defend its behaviour on economic grounds, including in terms of economic efficiencies and overall consequences for the consumer

16. Relationship between existing case-law and evolution of the Commission’s approach • Recent case law on exclusionary pricing abuses is not necessarily entirely in step with the Commission’s stated wish to adopt an evolved effects-based approach • But - note willingness of CFI to address arguments on effect on competition in Deutsche Telekom, and note in a non-pricing context the approach of AG in the Sot. Lélos Kai Sia EE case • Further, in relation to rebates, the ECJ in British Airways accepted that it must be examined whether the in principle exclusionary commission scheme had an objective economic justification, and that this examination must be on the basis of the “whole circumstances of the case”, including considering whether the exclusionary effects are outweighed by efficiencies which benefit the consumer

17. Relationship between existing case-law and evolution of the Commission’s approach – cont. • Existing case law should not prevent the Commission from adopting a more economics and effects based approach when assessing allegedly abusive behaviour, within the framework established by the Courts as to when the Commission is entitled to conclude that there has been an abuse, or when adopting enforcement priorities • Note reluctance of Community Courts to challenge Commission’s economic analysis, except in cases of manifest error (Deutsche Telekom, Microsoft) • Commission enforcement policy, and the evidence adduced by the Commission in its decisions and in the event of an appeal, will influence future case-law

18. Issues to consider • Guidelines on Article 82 (substantive or priority enforcement guidelines) • How to combine economic and effects based analysis with predictability and certainty so that undertakings may assess ex ante whether certain behaviour is permissible • Private enforcement in national courts – Community court case law v Commission guidelines/practice • Possible challenges to non-infringement decisions by complainants • Case T-282/06 Sun Chemical v Commission (binding effect of merger guidelines on Commission) • Detriment to consumers – not currently addressed specifically in the case law (exclusion considered sufficient)

19. QUESTIONS?

20. Contact • Kyriakos Fountoukakos • Partner, Herbert Smith LLP, Brussels • T: +32 2 518 1840 • GSM: +44 7920 455155 • kyriakos.fountoukakos@herbertsmith.com