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Comments on the Discussion paper on the application of Article 82 of the EC Treaty to exclusionary abuses31 MARCH 2006

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1 INTRODUCTION

Herbert Smith LLP, Gleiss Lutz and Stibbe welcome the opportunity to comment on the DG Commission discussion paper on the application of Article 82 of the EC Treaty to exclusionary abuses (the “Discussion Paper”).

The Discussion Paper provides a detailed review of the current application of Article 82 EC to certain exclusionary abuses. It also raises a number of issues and questions. Herbert Smith LLP, Gleiss Lutz and Stibbe have limited their review to the Commission's general framework and approach and to specific points that require clarification. This review does not purport to be exhaus-tive.

We hope that the comments contained in this submission are of assistance to the Commission in formulating the guidelines, which we understand are to be the final outcome of the Discussion Paper.

2 EXECUTIVE SUMMARY

Herbert Smith LLP, Gleiss Lutz and Stibbe consider the Discussion Paper a useful first step in providing a much needed framework on the application of Article 82 EC to exclusionary practices.

The Discussion Paper advocates a shift from what could be perceived as a potentially rigid per seapproach towards an effects-based analysis of exclusionary practices under Article 82 EC. We welcome this change of approach, particularly in the case of rebate schemes where the problems with the existing practice were particularly acute (and also well documented)1.

However, despite the clear indication that an effects-based analysis is to be applied and the Com-mission's attempt to provide a general framework, some uncertainty remains. The Discussion Paper does not set out a clear and concise summary of the current legal position or provide a workable framework to assess the abuses covered by the Discussion Paper. The Commission has also not addressed some of the most difficult issues, such as cost allocation. In other areas, where the Discussion Paper has introduced new legal concepts or a new economic model, there is some additional uncertainty as the Commission has not always adequately defined its suggested ap-proach. Providing concrete, illustrative examples would help minimise these uncertainties.

Our six key concerns with the Commission's approach are as follows:

1 One of the concerns, of which the Commission is no doubt aware, was the inability of a dominant firm to obtain legal comfort

for any rebate scheme given the potentially rigid application of Article 82 EC to rebate schemes, which the Commission ap-peared to require (e.g. MEMO/99/42, 22 July 1999).

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• the need for an even more coherent and consistent framework which could help clarify the Commission's analysis;

• the need for practical illustrative examples based, where possible, on existing Commission decisions or court judgments;

• an indication of whether and in what respects the approach in the Discussion Paper departs from existing Commission practice;

• the omission of other key exploitative abuses from this Discussion Paper, including dis-criminatory practices, margin squeeze and cross subsidisation. Given the relationship be-tween these abuses and those covered by the Discussion Paper, these omissions are difficult to justify2 and could lead to conflicting case law and misapplication of the new framework;

• no clear attempt to address some problematic issues in exclusionary abuses such as cost al-location and temporary below cost pricing;

• insufficient consideration of the implications of the effects-based approach on complain-ants, potential claimants in civil cases and national courts.

Our general points on the Commission's framework and approach are set out in section 3. The more specific points are addressed from section 4 onwards.

3 POTENTIAL CONCERNS WITH THE COMMISSION'S FRAMEWORK ANDAPPROACH

3.1 Legal Uncertainty

In a number of areas, the approach and test proposed by the Commission is not clear. An example of this is the Commission's description of the applicability of the “meeting the competition” defence (paras 81-83).3 The Commission first sets out the three conditions that need to be met for anundertaking to successfully invoke the meeting competition defence, but later concludes that:

“In case the abuse concerns pricing above average avoidable cost the meeting competition defence can be applied only if all the conditions of the proportionality test described in the

2 See for such an analysis and link with the rules regarding discrimination: L. Gyselen, “Rebates: Competition on the Merits or

Exclusionary Practice?”, in Ehlermann, Claus-Dieter / Atanasiu, Isabela (eds): European Competition Law Annual 2003: What Is an Abuse of a Dominant Position?, Oxford/Portland Oregon, Hart Publishing.

3 This section of the Discussion Paper is at the same time a good illustration of a useful building on, on some general statement of the Courts and indications in that respect by the Commission (see for example the speech of Mr. Lowe: http://europa.eu.int/comm/competition/speeches/text/sp2003_040_en.pdf. )

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previous paragraph are fulfilled, which in general is considered unlikely to be the case.”[emphasis added]

The Commission's conclusion appears to contradict the earlier statements and also introduce a per se approach which seems neither desirable nor correct. The Commission's basis for this conclusion is not clear4 and, further, appears to indicate that the working assumption is that the “meeting competition defence” will hardly ever be available.

Given the Commission's potentially conflicting messages, clarification on the applicability of this defence would be welcomed.

Further areas where clarification is sought include, among others, the relevance of recoupment, temporary below cost pricing and IP licensing (these are discussed in more detail below).

3.2 Wide scope for interpretation of key concepts

The economic models adopted by the Commission employ certain concepts which are unfamiliar to dominant undertakings and European competition law practitioners. The uncertainty that will result from the use of these concepts is compounded by the fact that the Commission does not provide adequate guidance as to their intended application.

For example, the test employed for conditional retroactive rebates requires the calculation of the “commercially viable share” of “an efficient competitor” which is compared with the “required share”. The commercially viable share in turn requires the determination of the “minimum efficient scale” which is in itself a key concept, the calculation of which may be subject to a number of iterations.

The Commission should set out in more detail the economic model used and the extent to which the Commission has considered or applied it in the past5. This will allow dominant undertakings and counsel to review past application of the model and obtain a better understanding as to how it works in practice. The Commission should also provide detailed examples as to how they intend to treat each type of rebate, demonstrating not just the mathematical calculation but also how these vari-ables will be determined with reference to realistic examples.

Equally, in respect of the “meeting the competition” defence, it is not clear what is meant in the second condition of the proportionality test (para 82) where the Commission states that the conduct must be limited in time to the absolute minimum and that the response must be proportionate.

4 The approach also appears to seriously depart from the US approach in section 2(b) of the US Robinson-Patman Act

5 Please see footnote nine below. We understand that the Commission has applied the economic model for conditional retro-active rebates to petrol retailing in Spain.

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An example illustrates the potential scope for debate, and hence uncertainty for a dominant under-taking:

Suppose a dominant product manufacturer (X) has a range of 20 products at prices A-1 to A-20. X's competitor, Y offers a range of 15 products (each of which compete with X’s products) at prices B-1 to B-15, "B" prices being each time below the equivalent "A" prices. Y's pricing offer is valid for two years.

Does the Commission intend that X should be prevented from offering its equivalent prod-ucts at the same price as Y and that in the case of some products, "A" prices needs to be above the equivalent "B" prices? Further, is X prohibited from offering its products at equivalent prices to Y for the full two years period of Y's offer? Should X ensure that its of-fer is limited for 1 year (but is X then able to renew the offer)? What about the range of products offered? Is X able to offer equivalent prices for all 15 competing products in the range, or must X's offer be more limited?

3.3 Impracticality of application

As set out above, the tests proposed by the Commission require the calculation of a number of different variables. Even if there are more concrete examples of how the variables are to be applied (for instance, after case law or further guidelines have been prepared) there will clearly still be significant scope for debate in the calculation and attribution of the variables in each case.

Further, a dominant undertaking is unlikely to have the information required to determine, for example, whether a new entrant could obtain a commercially viable share given the loyalty induc-ing effect of a conditional, retro-active rebate scheme. The Commission should bear in mind, when establishing such criteria that a dominant undertaking will need to be able to apply this criterion prospectively in order to determine whether there is an abuse, and attempt to provide a degree of certainty wherever possible.

3.4 Implications for the national enforcement of competition law

The Commission should keep in mind the impact of any guidelines it publishes, including the guidelines which will result from the Discussion Paper, on the application of European competition law, and national competition law at the Member State level.

First, the Commission should consider the likely legal position of the guidelines in each Member State. Will a national competition authority or more importantly a national court consider them-selves bound by the Commission guidelines in their application of both (or either) their national competition law or European competition law? For example, in the UK, the relevant provision -section 60(3) of the Competition Act – appears to provide that this is the case: “The Court must, in

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addition have regard to any relevant decision or statement of the Commission.” In other Member States, including Belgium, the application of EC competition law by the Commission and the Court of Justice may be (at least to some extent) a binding rule of interpretation for the application of national competition law.6

Secondly, the Commission should ensure that the guidelines are sufficiently clear to be of use to national competition authorities, specialised competition courts (or tribunals) and most importantly, the ordinary courts that are required to consider principles of competition law.

While many Member States have established specialised courts or tribunals to consider competition law, the extent to which ordinary courts are required to have regard to principles of competition law should not be underestimated. An obvious example is the use of the so-called “Euro defence” where in response to a claim seeking enforcement of a contractual obligation, the respondent invokes the violation of the agreement with Article 82 EC, and the subsequent nullity of the invoked clause or the entire agreement. Further, in some Member States “straight” competition law cases which involve a civil aspect, such as a damages claim for infringement of competition law, will often be dealt with by ordinary courts.

These courts face considerable difficulties in applying competition law principles and the compli-cated economic reasoning behind these principles. While some national competition law cases may warrant the use of the significant resources required for in-depth consultation and the use of expert economic analysis, cases at the national level will often not justify the use of such resources.

The guidelines that result from the Discussion Paper should therefore aim to provide a clear and coherent guide to the application of Article 82 EC to exclusionary abuses. This could alleviate the heavy burden on ordinary courts when they are required to apply Article 82 EC. The Discussion Paper, as it currently stands does not always provide this level of clarity. Indeed, there is the risk that without further guidance a national court which is required to apply Article 82 EC, may well apply the economic principles and models set out in the Discussion Paper incorrectly. While the Commission has means to mitigate against the risk of incorrect application of Article 82 EC (such as acting as amicus curiae7 and organising training courses for national judges8) these measures will not fully address the risk identified.

6 This can be seen in the decision of the Supreme Court of 9 June 2000, Revue de droit commercial, 2000, 493 and also in the

parliamentary documents.

7 We understand that the European Commission's practice is to intervene at appeal level and for a limited number of very important cases only.

8 Which it currently does according to the information provided on DG COMP’s website

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3.5 Effects on complainants and private enforcement

The Commission should also consider the consequences of the effects-based approach for non-dominant undertakings that are either the complainant in a Commission (or national competition authority) investigation or the claimant in a case of private enforcement.

An effects-based approach will require a careful analysis of the dominant undertaking's cost information and reasoning. This information, which will clearly be commercially sensitive to the dominant undertaking, will be the principal basis on which the Commission's decision is made. Without access to such information, a complainant will be unable to determine whether there are grounds to appeal a non-infringement decision by the Commission (or a national competition authority as the case may be). While the confidentiality of the dominant undertaking's costs should clearly be respected, we ask that the Commission keeps in mind the position of the complainant in these circumstances and considers whether there are any options available which could balance the interests of the complainant and the dominant undertaking (this could include, for example, disclo-sure to the complainant's external advisors).

The effects-based approach and the resulting reliance on the dominant undertaking's cost informa-tion will also have implications for customers or competitors considering a stand alone civil claim against a dominant undertaking. A customer or competitor will bear a significant procedural risk as they will not have the necessary cost data and will be unable to determine the merits of a case. As a result, the stand-alone private enforcement of Article 82 EC (as opposed to a follow-up claim after the decision) will be hampered. Given the Commission's intention to encourage and strengthen private enforcement (see the Green Paper on Private Enforcement), the Commission should at least consider the implications for private enforcement of the proposed “reform” of Article 82 EC and the Commission should also consider how the private enforcement of Article 82 EC can be strengthened.

The Commission should also keep in mind the need for clear and simple rules to guide civil claim-ants, and as set out above, national courts required to apply Article 82 EC.

We suggest that the Commission considers including a separate section on the implications on private enforcement and the position of complainants in the Discussion Paper.

3.6 Need for Examples

As set out above, in order to increase the clarity and applicability of the Discussion Paper, we strongly advocate the use of practical examples. The Commission has used examples in its Guide-lines on the applicability of Article 81 EC to horizontal co-operation agreements where they proved to be extremely helpful.

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These examples should be based on Commission practice9 and should not simply involve the placing of figures into a formula. The examples could be used to provide guidance on some of the difficult issues, such as cost allocation or the calculation of minimum efficient scale. An example (preferably from the Commission's own experience) on the treatment of a rebate scheme would be particularly useful. The examples could also be used to help indicate where and to what extent the Discussion Paper departs from existing case law or where the legal position has been clarified.

4 DOMINANCE

We understand that the intention of the Commission in section 4 of the Discussion Paper is to restate the current legal position on the assessment of dominance.10 This intention is not, however, clear from the description provided in the Discussion Paper and there is room for argument that the Commission has lowered the threshold for both dominance and “super-dominance” 11. The Com-mission could avoid unnecessary speculation and provide a greater degree of certainty if it referred and relied upon existing case law. The Commission should also clarify that its intention is to simply restate the current legal position on the assessment of dominance.

There is also an argument that the Commission should have actually used this opportunity to lower the threshold for intervention, i.e. to increase the safe harbour for a finding of dominance. Domi-nance, as an assessment of market power, is used as a proxy for determining the extent to which a practice is likely to have an effect on the market. Given the adoption of an effects-based analysis, this step is arguably or at least in theory not required. While dominance remains a useful concept in order to provide a degree of legal certainty and to avoid the possibility of excess intervention, its role is clearly diminished under an effects-based analysis. The Commission should acknowledge this consequence, and at least make it clear that it has considered, but not decided to lower the threshold for dominance.

9 We understand that the Commission has applied the economic model for conditional retro-active rebates set out in the

Discussion Paper in its consideration of petrol retailing in Spain: Presentation by Michael Albers to the Law Society Euro-pean Group, Brussels 21 March 2006: “How should exclusionary conduct be analysed under Article 82 EC Treaty?”

10 Presentation by Michael Albers to the Law Society European Group, Brussels 21 March 2006: “How should exclusionary conduct be analysed under Article 82 EC treaty?”.

11 The Commission appears to have indicated that the safe harbour for a non-dominance finding is 25%, while "near-monopolisation" can be found at 75%.

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5 FRAMEWORK FOR ANALYSIS OF ABUSE

5.1 Emphasis on competition not competitors

The Discussion Paper makes it clear that it is not competitors but competition which is to be protected by Article 82 EC (para 54):

“This means that it is competition, and not competitors as such, that is to be protected.”

While the distinction between competitors and competition appears theoretically convincing, in practice, such a distinction is not clear cut. Competitive pressure arises from competitors and the public interest in effective competition often cannot be separated from the individual interest of competitors to compete on a level playing field. This was recently confirmed by the ECJ in IMS Health where the President of the Court overruled the CFI, in this respect, and recalled that the main purpose of Article 82 EC was to preserve a competitive market structure12:

“On the other hand, the reasoning in paragraph 145 cannot be accepted without reserva-tion, in so far as it could be understood as excluding protection of the interests of compet-ing undertakings from the aim pursued by Article 82 EC, even though such interests cannot be separated from the maintenance of an effective competition structure.”

The Commission's focus on competition rather than competitors in the Discussion Paper therefore appears unconvincing. If the Commission intends to continue to highlight this principle, we ask that the Commission sets out its interpretation and application of this principle.

5.2 Competition on the Merits

The Commission assumes that there is an “equal right of dominant undertakings and of residual undertakings to compete on the merits” (Philip Lowe, IBC conference, Brussels, 31 January 2006). The Discussion Paper also refers to the term “competition on the merits” at paras 56, 60, 127 and 134. However, there is no definition of the term or a description of precisely how the Commission intends to apply “competition on the merits” as a test or concept.

In Hoffman La Roche v Commission, the ECJ recognised that commercial conduct can harm competition even it is solely price and quality related:

“objective conduct relating to the behaviour of an undertaking in a dominant position which is such as to influence the structure of a market where, as a result of the very presence of the un-

12 ECJ, Order of 11 April 2002, Case C- 481/01 P(R), NDC Health v IMS Health and Commission, [2002] ECR I-3401, para 84

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dertaking in question, the degree of competition is weakened…”.13 [Emphasis added]

This recognition that a dominant undertaking has a “special responsibility” to refrain from certain commercial practices which may, if carried out by non-dominant undertakings be considered legitimate is a clear principle of Community competition law.14 However, this does not fit well with the concept of “competition on the merits”. Given the ambiguity of the concept and indeed the potential inconsistency, we ask that the Commission clarify its position and provide a definition of “competition on the merits”.

It is also worth noting that the equivalent term in German competition law, Leistungswettbewerbhas been found overly simplistic. Originally, Leistungswettbewerb, which describes a situation where undertakings compete solely on the parameters of price and quality, was considered an achievable aim, however it has recently been recognised that this concept fails to accurately reflect the conditions for competition on the market, and ignores the harm to competition that can be caused by the commercial conduct of a dominant undertaking even if it is solely price and quality related.

5.3 Categorisation of Abuses

The Commission's table at para 73 of the Discussion Paper is a useful illustration of the Commis-sion's approach to the categorisation of abuses. However, it is not clear why the Commission has chosen to narrowly limit its review of exclusionary abuses, and in particular why it has not ex-tended its analysis to cover other types of exclusionary pricing based abuses such as margin squeeze and cross subsidisation. The decision to exclude margin squeeze from the Commission's review of exclusionary abuses on the grounds that it is in some instances a form of exploitative behaviour or an example of vertical as opposed to horizontal foreclosure (para 72) seems inappro-priate as the same circumstances will often give rise to allegations of both margin squeeze and predatory pricing. While we note that the Commission has never reached an infringement decision on cross subsidisation alone, other regulators still categorise it as a separate abuse15 and it would be helpful if the Commission used this opportunity to clarify its view on this abuse.

5.4 Description of Cost Benchmarks

The description on the costs benchmarks set out in the Discussion Paper (paras 64 et seq) provides limited guidance to counsel and dominant undertakings. The descriptions lack practical application

13 ECJ, Case 85/76, Hoffman La Roche v. Commission, [1979] ECR 46, para 91

14 For example, ECJ, Case 322/81, Michelin v Commission, [1998] ECR 3461, para 57

15 OFtel Guidelines: Competition Act 1998: The Application in the Communications Sector, OFT 417. While OFcom has replaced OFtel as the UK regulator for telecommunications, these guidelines still appear applicable.

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and fail to acknowledge the difficulties in cost allocation and measurement. For example, while the general distinction between fixed and variable costs appears theoretically clear cut, problems arise when one has to allocate specific cost items to a category. These differences can be illustrated from case law. For example in AKZO16, the ECJ overturned the Commission’s decision17 on this point and treated labour costs as fixed costs,18 despite the fact that labour costs were normally considered variable costs under general accounting standards.

It would be helpful if the Commission could endeavour to provide some guidance as to how the Commission envisages the cost standards will be applied, or at least a summary of principles of cost allocation from case law.

The Commission should also attempt to address the difficult issues in cost allocation. For example, how will the cost of utilising spare capacity be treated? Over what period will costs be calculated when the service or product provided involve a subscription over a period of time? How are advertising costs and the costs of acquisition to be treated?

6 PREDATORY PRICING

6.1 Need for a coherent framework

The Commission's analysis of the predatory pricing offence is not sufficiently coherent to act as a guide to the legal treatment of predatory pricing in the Community.

The AKZO19 presumptions provide a framework for the analysis of predatory pricing and while the Commission appears to have implicitly followed this framework, it would be helpful if this was explicitly set out. This would provide a reasoned and logical structure to the Commission's analysis and would enable dominant companies and potential complainants to apply the guidelines (which will result from the Discussion Paper) directly to their facts.

In its analysis of predatory pricing, the Commission should first include extended definitions of the relevant cost measures (or cross refer to those contained in paras 64-66) and provide examples of how each cost measure would be calculated preferably using facts from actual case law. Again, as set out above, the Commission should acknowledge the difficult issues in cost allocation and (at least attempt) to provide some guidance as to how it envisages these issues could be resolved.

16 ECJ, Case C-62/86, AKZO Chemie v Commission, [1991] ECR I-3359.

17 Commission, IV/30 698 - ECS/AKZO, OJ 1985 L374/1

18 Ibid, at para 95

19 Ibid, para 69-72

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Following the principles in AKZO, the Commission should then engage in a full analysis of the relevance of intent, both subjective and objective referring to the circumstances contained in paras 112, 128 and 129 of the Discussion Paper. Examples from case law of when there was sufficient evidence of intent should also be provided.

The objective justifications set out in paras 130 to 133 of the Discussion Paper should also be described by reference to examples. The theoretical instances of where the first justification may apply20 - when a dominant undertaking is in fact minimising its losses in the short term - are helpful, but again, reference to a specific example, preferably taken from case law would be helpful.

6.2 Simplistic approach to key issues

The Commission's approach to some key issues has been simplistic. In respect of the crucial issue of the time period of the predation, the Commission has indicated that the appropriate timeframe is the “period of the predation”. While instinctively supportable, the Commission ignores the obvious circularity of such an approach21. The Commission also does not take into account the risk that, if predation is assessed over an extended time period, then a period of recoupment may be included which would, by definition, have the effect of ensuring the dominant undertaking's costs are recovered. The Commission's failure to acknowledge these simple issues leaves a reader with the concern that the Commission's analysis is an incomplete discussion of the law relating to predatory pricing.

Further, the simple rule for determining the time period of the predation set out in the Discussion Paper does not actually reflect the Commission's case law which has recognised that, in certain instances, a different measure will be employed. For example, in Wanadoo Interactive,22 the Commission assessed costs over a 48 month period, having regard to the fact that the service in issue entailed subscriptions over a period of time rather than a one-off sale. The Commission should at least acknowledge the circumstances in which it will be appropriate to employ a different time period, such as the economic lifetime of the product or service concerned.

The Commission's views on recoupment also need clarification. While the Commission's discussion of recoupment (paras 122 -123) appears to follow the case law, there is an indication that a domi-nant undertaking could rebut a finding of an abuse if it was able to establish that there is no possi-bility for recoupment: “the dominant company may rebut [a case of predatory abuse] by establish-ing that its conduct is wrongly assessed as predatory, for instance by showing that it has not and will not have the alleged exclusionary effect or that recoupment will never be possible and consum-

20 i.e. where there are start up costs, strong learning effects or a need to sell off obsolete stocks

21 As noted by the Competition Appeal Tribunal in Aberdeen Journals and OFT [2003] CAT II, para 354

22 Commission, Comp/38.233 Wanadoo Interactive, 16 July 2003, not published in the OJ.

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ers are not and will not be harmed.” If an absence of recoupment does offer a defence, this should be made clear and it should be included in the list of objective justifications. Guidance as to the appropriate standard of proof should also be provided.

The Commission has also not provided guidance on some of the other difficult issues in predation (in addition to those involving cost allocation). For example, the position of temporary below cost pricing in the form of promotions is not addressed in the Discussion Paper. Guidance on this area from the Commission would be helpful given the indication that some national competition authori-ties consider that below cost pricing for a limited period of time (3 months) and for promotional purposes not problematic23. This issue is of particular concern given the indication that an eco-nomic, effects-based approach will be followed: does this mean that below cost pricing which does not have an easily quantifiable effect on the market (because it is only for a limited period of time) is not an abuse?

7 REBATES

Unlike the analysis of predatory pricing, the Commission's analysis of rebate systems extends the scope of the existing law and provides a new framework for the analysis of rebate systems. The guidance set out by the Commission is generally to be welcomed: the price/cost based approached more closely reflects the economic effects of rebate systems and appears to offer a logical frame-work for advice. Nevertheless we would like to draw the Commission’s attention to the potential dangers linked with a formulaic approach as well as to the need for further clarification on the economic model used.

7.1 Consequences of the Commission's formulaic approach

The Commission's approach is highly formulaic. This gives rise to two concerns.

First, the legality of a dominant undertaking's rebate system will be dependent on a number of variables, the calculation of which in each case will no doubt be the subject of considerable debate. For example, the test employed for conditional retroactive rebates requires the calculation of “the commercially viable share” of “an efficient competitor” which is compared with the “required share”. The commercially viable share in turn requires the determination of the minimum efficient scale which in itself is an iterative approach. Clearly, there will be significant scope for debate in the calculation and attribution of all these variables, and there is a concern that a rebate system could be condemned by a small difference in estimates of one of the input variables. This will not only lead to potentially “unjust results” but will also make it difficult for a dominant undertaking to determine in advance whether its rebate system amounts to an abuse.

23 The approach of Director General of Telecommunications as set out by the Competition Appeal Tribunal in Freeserve Com

Plc v Director General of Telecommunications [2003] CAT 5, para 232-238

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Secondly, some of the variables employed by the Commission are new concepts in European competition law and will be difficult to apply in the absence of more precise guidance. For exam-ple, it is not clear how the “minimum efficient scale”, which is a crucial component of the analysis of conditional rebates applied to all purchases, will be calculated. While we understand that the minimum efficient scale is used to calculate what market share a new entrant would require in order to have a stable, profit making business (although we note that this not expressly set out), it is not clear how the efficiency scale is to be determined. It will clearly be inappropriate to use the costs of the dominant undertaking as a proxy for efficiency given that the aim of the Commission is to determine the minimum commercially viable share, but whose costs should be used as the model? Will the costs of the hypothetical entrant simply be those of an importer (if appropriate in the relevant market)? Will the costs of licensing a known brand need to be included, if this is the only way market share could be obtained? Will research and development costs be included?

7.2 Need for further clarification

While some of the uncertainty in the calculation and application of these variables is unavoidable before case law is established, the Commission could reduce this uncertainty before it publishes guidelines on exclusionary abuses. The Commission should set out in more detail the economic model used and the extent to which the Commission has considered or applied it in the past. This will allow dominant undertakings and counsel to review past applications of the model and obtain a better understanding as to how it works in practice. The Commission should also provide detailed examples of how they intend to treat each type of rebate, demonstrating not just the mathematical calculation but also how these variables will be determined by reference to a factual situation. Providing context to the Commission's analysis will ensure the Discussion Paper provides dominant undertakings and potential complainants with guidance as to the sort of situations the Commission envisages will be covered by the new framework.

The Commission's analysis and proposed guidelines on rebate schemes pre-supposes the loyalty inducing effect of certain rebates and hence justifies the imposition of a higher cost standard than that applicable in a straight predatory pricing case (i.e. the effective price has to be above ATC rather than AVC). However, as the Commission has acknowledged certain rebates systems such as unconditional rebates and standardised volume rebates are unlikely to have a loyalty inducing effect. These systems, as set out in paras 142-147 and para 171 of the Discussion Paper should therefore be considered under a predatory pricing analysis.

This approach is to be welcomed as it reflects the actual effects of many rebates schemes and avoids the problems of over rigid categorisation. However, the approach the Commission intends to follow in such cases is not clear. Does the Commission envisage a two-step process? Will the Commission first consider whether there is a rebate and if it is not a problematic rebate, will it then apply a predatory pricing analysis? More importantly, is the efficiency defence available to a rebate system which falls to be analysed under predatory pricing rules? And vice versa, if a dominant

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undertaking's predatory pricing takes the form of an unconditional rebate, can the dominant under-taking still avail itself of the (limited) “meeting the competition” defence?

Many of these difficulties and questions could be resolved if the Commission adopted a more coherent framework to its analysis and employed additional and more detailed examples.

8 TYING AND BUNDLING

The Commission's guidance on tying and bundling and in particular the indication that an effects-based approach is to be applied is generally to be welcomed.

However, the Commission's analysis on tying and bundling only applies a “halfway” economic approach. The Discussion Paper appears to assume an abuse in the case of bundling which then has to be rebutted by the dominant undertaking, via proof of efficiency. It is not clear, however, how the potential harm to competition and the efficiency gains will be balanced against each other.

It appears from the Discussion Paper that the Commission intends to apply the efficiency criteriacontained in Article 81 (3) EC in order to achieve consistency between Article 81EC, Article 82 EC and the Merger Regulation. However, the Commission does not recognise that the economics of Article 81 and Article 82 EC may well differ due to the different purposes of these provisions, in particular as bundling and tying are part of common commercial practice and are engaged in by non dominant undertakings.

The Commission should therefore clarify first, where the burden of proof rests in establishing efficiency in the context of tying and bundling and secondly, the standard of proof to be employed. In respect of the standard of proof, the Commission should bear in mind that a high standard of proof could make it virtually impossible to prove efficiency gains.

9 REFUSAL TO SUPPLY

The distinction the Commission draws between the refusal to start the supply of an input at the outset of a commercial relationship, and the termination of an existing supply relationship is in accordance with the case law of the European Courts and the Commission's own application of the law. The key difference is that a refusal to supply a product/service at the outset of a commercial relationship will only be an abuse if that product or service is an indispensable input.

The Discussion Paper also provides (in para 234 et seq) that the refusal to start the supply (of a raw material, intellectual property rights or an essential facility) at the outset of a commercial relation-ship may be objectively justified if the indispensable input is a result of substantial investment. The rationale being that in order to maintain incentives to innovate and invest, a dominant undertakingmust be able to recoup prior investment. This compares to the termination of an existing supply

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relationship which is only justified under narrow circumstances (and it is irrelevant whether the product concerned is an indispensable input to a downstream market). The apparent justification for the inconsistent treatment is that in the case of the termination of existing supply arrangements, it is assumed that the dominant undertaking had already found it efficient to engage in such supply relationships, and that customers may have made a specific investment (para 217). However, we do not consider that there is a sufficient basis for a general assumption that this is the case. The relationship that the dominant undertaking seeks to terminate may have been found to not in fact, or no longer, be efficient.

In its discussion of the objective justifications available to a dominant undertaking (para 236), the Commission states that:

“the circumstances in which a refusal to supply by a dominant firm may be abusive […] more likely to be present when it is likely that the investments that have led to the existence of the indispensable input would have been made even if the investor had known that if would have a duty to supply”. [emphasis added]

We have two concerns with this criterion. First, we are concerned that it is impracticable due to the difficulties in establishing that an undertaking had considered it had a duty of supply. Secondly, we are concerned that the diligence of a dominant undertaking in considering and seeking advice on its legal obligations may in fact disadvantage such an undertaking.

The rationale for not imposing an “indispensability” condition on the termination of an existing supply arrangement should also be considered carefully by the Commission and the Commission should acknowledge that the freedom to contract also includes the freedom not to extend a contract that has expired.

According to para 231 of the Discussion Paper, a refusal to supply will only be an abuse when the exclusion of competitors is likely to have negative effects on competition in the downstream market. We do not consider this criterion appropriate. As is apparent in the Discussion Paper, it is difficult to define a threshold at which point a negative effect becomes relevant. We believe that the appropriate criteria should not be whether a refusal has a negative effect on competition, but rather whether the undertaking requesting access would be able to improve competition to a substantial degree, to the advantage of consumers.

The criterion of a “likely market distorting foreclosure effect” of the termination of an existing supply relationship is also very vague. A dominant undertaking will find it difficult to determine whether a termination will be seen as having a foreclosure effect or whether it will be seen as normal commercial behaviour and as an element of the freedom to contract.

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10 REFUSAL TO SUPPLY AND IP LICENSING

We welcome the Commission's attempt to elaborate further on the conditions for the licensing of IPR. First, however, it would be helpful if the Commission clarified whether in its view the prereq-uisites for an abuse in an IP case differ from an abuse in a non-IP case (refusal to licence as distinct from refusal to deal/supply).

Clarification is also sought as to the Commission's interpretation of the “exceptional circumstances”when a refusal by a dominant undertaking to licence its IPR is to be treated as abusive. We are concerned that the case law defines “exceptional circumstances” differently and more narrowly than the Commission.

In the IMS Health case, the ECJ set out 3 cumulative conditions which indicated where “excep-tional circumstance” may exist24:

• the undertaking which requested the licence intends to offer new products or services not offered by the owner of the IPR and for which there is a potential consumer demand;

• the refusal is not justified by objective considerations; • the refusal is such as to reserve to the owner of the IPR the market by eliminating all com-

petition on that market.

The IPR must also be an indispensable input to the provision of the new product or service on the downstream market.

The third condition is directed at the effects on competition. The stipulation that the refusal must be likely to eliminate all competition on that market is a higher standard than that employed in assess-ing whether termination of an existing supply relationship amounts to an abuse, where the Discus-sion Paper stipulates that negative effects suffice; “[t]his should however not be understood to mean the complete elimination of all competition” (para 222). We suggest that the Commission highlights the different standards.

Secondly, we recommend illustrating the first condition, the novelty of the product, in a wider context. In IMS Health, the ECJ explained the condition as follows: “that condition relates to the consideration that, in the balancing of the interest in protection of the intellectual property right and the economic freedom of its owner against the interest in protection of free competition, the latter can prevail only where refusal to grant a licence prevents the development of the secondary market to the detriment of consumers.”25 This rationale should be explicitly referred to in the Discussion Paper as it provides guidance in determining whether the product is “new”. This will be particularly

24 ECJ, Case C-418/01, IMS Health v NDC Health [2004] ECR I-5039, para 52

25 ibid, para 48

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important in industries where there are long product cycles and long introduction periods where an IPR owner might not yet be present on the market but may have made all necessary arrangements to launch the product. The balance of interests should protect an IPR owner from duplication attempts.

Thirdly, the Commission should acknowledge that the condition of indispensability might be decisively determined by network effects. For example, in IMS Health, the ECJ found the degree of participation by users in the development (i.e. pharmaceutical undertakings which were buyers of the services offered by IMS) was a factor to be taken into account in determining whether access is indispensable. Moreover, in a related case the Commission also assessed pharmacies as providers of input information and their limited resources in terms of submitting sales data to different provid-ers.

More generally, however, the condition of indispensability is vague and difficult to apply. The assessment of whether a product is indispensable depends on the market definition. Clearly, the more narrow the market definition that is adopted, the more likely there is to be indispensability. This will make it difficult for a dominant undertaking to itself determine therefore whether or not a product/intellectual property right is indispensable. The Discussion Paper should, at least, acknowl-edge this difficulty in definition.

Herbert Smith LLP Gleiss Lutz Stibbe

Brussels, 31 March 2006