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Countervailing buyer power in telecoms regulation

This entry was added to http://www.reckon.co.uk/headlines-franckblog on 18 February 2006.
Full blog table of contents available at Contents | viewpoint: Franck.

The Competition Appeal Tribunal's judgment (79 pages, PDF or HTML) in Hutchison 3G v Ofcom [2005] CAT 39 adds an interesting perspective on countervailing buyer power to the simple points noted in my earlier article Countervailing buyer power and buyer market power.

The dispute between Hutchison 3G, the operator of the mobile phone network 3, and Ofcom arose because of Ofcom's decision to designate 3 as having significant market power (SMP) in the provision of call termination to its users, meaning that 3 would come under a higher level of regulatory control (e.g. obligations to justify prices by reference to costs) than would otherwise be the case.

3 claimed that it did not have significant market power because BT, the main customer for its call termination services, had countervailing buyer power. Specifically, 3 argued that its termination rates were constrained by the fact that it was dependent on BT to interconnect with its network, rather than the other way around.

Ofcom's designation decision was based on the idea that any such constraint was not a competitive constraint — since there was no credible way for a competitor to offer to terminate calls to 3's users without purchasing 3's call termination service — and therefore that 3 was in a dominant position in the supply of call termination to its network, and thus had significant market power. Essentially, Ofcom's view was that the BT might be dominant too in various markets did not cancel the finding of significant market power in the market(s) for terminating calls on 3's network.

At this level, Ofcom's approach seems consistent with what I have argued before: the concepts of countervailing buyer power (which undoes the market power of a supplier) and buyer market power (market power held over suppliers) are separate: BT may have all sorts of buyer market power but that does not mean that it has countervailing buyer power. Instead it is perfectly possible, and indeed very likely in this case, that the situation is one of bilateral monopoly where both sides are dominant, in the sense that they are not constrained by competition.

CAT rejected an approach based solely on competitive constraints

At first sight, the CAT's judgment quashing Ofcom's decision contradicts my view that market power is characterised by the absence of competitive constraints, and therefore that countervailing buyer power is only relevant insofar as it establishes a competitive constraint, perhaps through the ability of a powerful buyer to establish a self-supply arm or to sponsor a new entrant in order to circumvent an otherwise dominant supplier.

In fact, it could be argued that the judgment contradicts itself on this: compare

110. ... a) The underlying principle in a case like this is whether there is effective competition. SMP is a tool in determining this question — indeed, it is the central tool.

and

111. We turn first to OFCOM's treatment of, and reliance on, the "no alternative supplier" point. It is, of course, obviously true as a matter of fact. On the facts there is no other way in which BT can procure termination on H3G's network other than by purchasing termination from H3G itself. However, we do not accept that taken by itself it is sufficient to negate bargaining power to an extent sufficient to destroy any CBP that might otherwise have existed. Such an approach is too mechanistic. The assessment of SMP is not a mechanical one. It is one in which a number of factors have to be assessed, and they have to be assessed in their context. One of them is the buying power of the buyer. Various factors will contribute to, or detract from, the power of the buyer, and they will have various strengths depending on the market in question. Doubtless the ability of a buyer to find alternative sources will be very telling, but we do not consider that either of the two cases referred to or paragraphs 64 and 65 of the merger Guidelines require one to elevate that factor to be a touchstone in every case. In some cases it might well be conclusive. It happened to be a very important factor in the Alcatel/Telettra decision, and its absence was significant in CVC/Lenzing, but those were cases on their facts. Paragraph 64 of those Guidelines correctly identifies the exercise as being one in which the key question is bargaining strength. The three factors identified there (relative sizes, commercial significance and the ability to switch suppliers) should not be taken as being necessarily exhaustive factors.

My initial feeling was that 110(a) was right and therefore that I was in agreement with Ofcom's argument quoted at paragraph 116 of the judgment:

[Ofcom] contended that: "...once it is clear that BT has an obligation to provide end-to-end connectivity and therefore must do a deal with H3G, which is the only source of access to subscribers on its network, BT has no effective negotiating ploys to counter H3G's market power derived from its 100% of the market and the absolute barriers to entry to that market. BT cannot walk away if it does not like the terms on offer. If it delayed unreasonably in reaching agreement it would face regulatory intervention. The inevitable conclusion therefore is that BT does not have sufficient buyer power to off-set H3G's position on H3G's own network."

CAT adopts a purposive definition of SMP

But the next 12 pages of the judgment reversed that initial feeling, and provide a basis for the Tribunal's finding that Ofcom had been wrong. In the course of that explanation, the judgment went a long way towards resolving one of the things that had been worrying me about the 2003 regulatory framework for telecommunications, namely the widespread idea that significant market power (SMP), which triggers the application of price controls and other telecoms-specific regulatory rules, is equivalent to the concept of a dominant position under Article 82.

Having reviewed (and quoted at length from) the relevant legislation and licences, the judgment establishes that:

The simple fact that BT therefore had a regulatory alternative — asking Ofcom to adjudicate — even though it did not have a competitive alternative is irrelevant: as the Tribunal notes, such a regulatory constraint cannot be considered to remove dominance if it would otherwise exist.

Instead, the basis for the Tribunal's decision to quash Ofcom's decision is limited to a finding that Ofcom failed to consider properly the question of countervailing buyer power arising from BT's ability to negotiate with 3:

128. ...[Ofcom] failed to consider the full possible scope and effect of [countervailing buyer power]. Its consideration stopped short of a full consideration. It is, of course, quite possible that it would have arrived at the same conclusion had it conducted the full exercise, but we have not been invited to determine that.

The Tribunal also rejected (as a mistaken understanding of the law) Ofcom's contention that its power to determine the rate payable by BT to terminate calls on 3's network could or should only be exercised if 3 had been the subject of an SMP determination. Instead Ofcom had parallel powers:

This removes the basis for any view that an SMP determination was necessary to achieve a sensible outcome.

Overall, it seems that, in the Tribunal's view, Ofcom was wrong to make the simple logical and "mechanical" step from the lack of competition to significant market power, and in doing so to disregard countervailing buyer power as it did not affect the lack of competition, because it did not need an SMP determination to achieve regulatory objectives. Instead of this mechanistic approach, CAT was expecting Ofcom to judge whether 3 had SMP on the basis of whether there was a need to make an SMP determination.

So what is SMP then?

Because it does not go on to determine whether 3 had SMP or not, the judgment does not fully resolve the question of what SMP is. My impression from the judgment is that the Tribunal was working with a sort of purposive definition, in the sense that it would define SMP in such a way that SMP status would be given to cases where regulatory controls over behaviour (rather than ad hoc determinations of disputes or contracts) were required to achieve the objectives of the regulatory system. Within that frame of thought, countervailing buyer power simply means that someone — BT in this case — may have enough power of one sort or another to cause 3 to behave as desired under the regulation using only the threat of regulatory determination. By contrast, for example, operators seeking to access an unbundled local loop on BT's fixed line network are presumably considered to be in need of the protection of an ex ante price control of some sort on BT, in addition to powers for Ofcom to determine disputes.

And this approach is the only way of making sense of a requirement to make SMP designations. If SMP really meant dominance then the task of imagining all the cases in which someone somewhere may not face competition would surely overwhelm any telecoms regulator.

It seems to me that this reality has caused the Tribunal to stray quite a long way from the words in Section 78(1) of the Communications Act 2003:

For the purposes of this Chapter a person shall be taken to have significant market power in relation to a market if he enjoys a position which amounts to or is equivalent to dominance of the market.

There seems to be nothing in Ofcom's errors that goes to the findings that:

That is surely enough for a dominant position under Article 82. For example, if 3 offers termination directly to other mobile networks, with the same technical set-up, and charges higher termination rates to Vodafone than to O2 then there is surely no doubt that this is discriminatory abuse.

Should Ofcom decide that 3 does not have SMP because of the countervailing buyer power that it faces, would it be barred from pursuing such an abuse under Article 82 (or the Competition Act 1998) because it would have been deemed to have made a finding that 3 does not enjoy a dominant position in the relevant market? If so, the UK would seem to have been pretty bad at protecting Vodafone's right under Article 82 of the EC Treaty not to be placed at an unfair competitive disadvantage by 3's hypothetical abusive conduct.

Vodafone's community right to be protected from abuse must surely be unaffected by the various directives setting up the telecoms regulation regime or by the Communications Act 2003 (assuming that there is not a clear purpose stated of this instruments to limit that right — which must be true).

Thus, if community rights under the Treaty are to be respected, and if Ofcom was wrong to infer SMP from the absence of competition, then Section 78(1) must be given a different meaning that what it appears at first to say.

The relevant EC documents do not really clarify whether SMP is intended to be the same as dominance or not:

30. The designation of an undertaking as having SMP in a market identified for the purpose of ex-ante regulation does not automatically imply that this undertaking is also dominant for the purpose of Article 82 EC Treaty or similar national provisions. Moreover, the SMP designation has no bearing on whether that undertaking has committed an abuse of a dominant position within the meaning of Article 82 of the EC Treaty or national competition laws. It merely implies that, from a structural perspective, and in the short to medium term, the operator has and will have, on the relevant market identified, sufficient market power to behave to an appreciable extent independently of competitors, customers, and ultimately consumers, and this, solely for purposes of Article 14 of the framework Directive.

I am not sure how the constitutional niceties work out, but (if CAT is to be believed, and subject to the "just a game" caveat below) then somehow in this case the Commission guidelines seem to speak more truth than the text on the face of the primary legislation.

Or is it all just a lawyers' game?

An alternative interpretation of the judgment is that CAT quashed Ofcom's decision simply on account of its bad drafting and failure to set out the reason why countervailing buyer power could have no effect, even if there was no realistic prospect that the finding of SMP was wrong.

I cannot rule such an interpretation out entirely: CAT has tended, rightly in my view, to see it as part of its role to guide the regulators towards better analysis, and not merely to correct errors or unfairness in individual cases.

But in this particular case this would seem a fairly ridiculous interpretation. Would Ofcom really be asked to reconsider, formally find that whatever countervailing buyer power there is in this case does not affect the lack of competitive constraints, and re-issue a SMP determination? That sounds too much like a waste of time to be the Tribunal's real intention.

So I think that the Tribunal thought that there was a reasonable prospect that re-consideration of countervailing buyer power in the light of its judgment might lead Ofcom to find that 3 did not have significant market power, despite the acknowledged absence of competitive constraints.

Towards a resolution of the absurdities of SMP

Because of the silliness of the "just a game" interpretation above, I prefer to interpret this judgment as an important substantive decision on the European telecoms regulatory regime, which I see as being part of a necessary process of dismantling the fiction that the regulatory concept of significant market power is the same as dominance.

My guess is that the end point of that process will be a return to the common sense position, where regulators have powers to impose obligations (formerly known as licence conditions) where necessary to achieve a legitimate policy objective, such as end-to-end connectivity or the protection of consumers against excessive exploitation of restrictions on competition resulting from spectrum management.

It is already explicit under the Communications Act 2003 that regulatory obligations imposed following a SMP finding must be proportionate to relevant legitimate regulatory objectives. The consideration of competitive constraints and market power will often be part of the assessment of necessity and proportionality of regulatory measures, and it need not be erected (and should not have been erected) as a stand-alone pre-condition for pre-defined categories of regulation.

And what about countervailing buyer power?

If I am right and SMP is an aspect of the analysis of proportionality of regulatory obligations with only a tenuous relationship to dominance, then it is hardly surprising that the notion of countervailing buyer power relevant to SMP should be broader than its role in rebutting dominance under competition law.

Strong bargaining power than does not open up any new competitive constraints may nevertheless act as a constraint on behaviour that would be considered undesirable from a regulatory perspective, much in the same way that (in some cases) someone in a strong bargaining position may be thought unlikely to be a victim of abuse even if it faces a dominant counterparty. But the question of whether a strong bargaining position prevents abuse is not particularly important for competition law enforcement (if something else prevents abuse then there is no need for any enforcement), whereas the equivalent question in respect of regulatory objectives is a necessary part of a regulatory analysis that seeks to foresee and prevent undesired patterns of behaviour (whether or not they amount to abuse).

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Entry added by Franck Latrémolière on 18 February 2006

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Last changed by Franck at 11:01 AM on Thursday 7 February 2008.

Reference for this page:
Reckon Open "Countervailing buyer power in telecoms | viewpoint: Franck" 2008-02-07T11:01:41