17 October 2008
On 10 April 2008, the Court of First Instance (the CFI) confirmed the European Commission’s (the Commission) decision1
that Deutsche Telekom (DT) abused its dominant position on the markets for direct access to its fixed telephone network by engaging in a margin squeeze.2
A margin squeeze occurs where a vertically integrated company provides an important input into a downstream market in which it also competes, and prices this input at such a level that the competitors it supplies cannot make a margin for profit. The CFI has confirmed this conduct can amount to an infringement of Article 82 EC Treaty under certain conditions.
In summary, the CFI clarified the following points:
- The fact that a dominant company’s tariffs are subject to price caps approved by a national regulatory authority is not an exemption from competition law;
- The vertically integrated company’s own costs are the correct benchmark to assess whether a reasonable margin is possible for competitors; and
- A comparison of the prices of the upstream input with a weighted average of the prices of the bundle of downstream services for which the upstream input is needed can provide evidence of a margin squeeze.
This judgment is binding on the Commission and the national courts of the EU Member States in their assessment of alleged margin squeezes. In practice, national competition and regulatory authorities will also likely follow it in their application of Article 82 EC to this type of practice in the future. This article summarises the background of the case, and then discusses the main findings of the CFI in relation to some of the key issues concerning the practical assessment of an alleged margin squeeze.
In its contested decision, the Commission found that DT held a dominant position on the upstream market for wholesale local loop access, and the corresponding downstream market for retail access to narrowband connections (analogue and ISDN) and broadband connections (ADSL lines). Both markets were defined as being national. According to the Commission, “even after five years of competition,” DT still held 100 percent of the upstream market and around 95 percent of the downstream market, while the remaining 5 percent was divided among a large number of DT’s competitors.
The Commission concluded that DT charged new entrants higher fees for wholesale access to the local loop than DT’s own subscribers were paying for their connections at retail level. By doing so, DT abused its dominant position. As a result, the Commission imposed a fine on DT, but limited it to €12.6 million by accepting “mitigating circumstances due to the fact that under the German sector-specific regulation there was some degree of legal uncertainty about the tariffs under scrutiny.” In particular, under German telecommunications law, DT was required to comply with price caps both at wholesale and retail levels and its tariffs had been approved by the national regulator, RegTP. DT appealed the Commission’s decision before the CFI, which rejected the appeal on all grounds. In doing so, the CFI clarified the following practical issues of law.
State Action Defence
On appeal, DT argued that it simply complied with national telecommunications law. The jurisprudence of the Court of Justice clarifies that where State regulation requires a company to take a particular course of action that is anti-competitive, there is no liability on the part of the company for the infringement of EC competition law.3
However, the case law also makes clear that EC competition law may apply if it is found that the national legislation leaves open the possibility for the regulated company to act independently, even if only to a limited extent. In this case, the CFI held that DT could adjust its retail prices for ADSL after obtaining the prior authorisation of RegTP, and should have done so. By not doing so, DT infringed EC competition law and no “state action” defence was available to it.
Accordingly, dominant companies that are subject to ex ante price approvals must ensure that they use any discretion permitted by the relevant regulatory regime to avoid infringing Article 82 EC.
The Imputation Test
According to the Commission’s own previous practice in the electronic communications sector,there are two “imputation” tests to determine whether a margin squeeze has occurred:4
- The dominant company’s downstream division cannot trade profitably (using its own downstream costs) on the basis of the price charged to competitors upstream; or
- The difference between upstream and downstream prices is not sufficient for a reasonably efficient competitor to make a normal profit (using its own downstream costs).
In the Deutsche Telekom case, the Commission applied the first test, despite DT’s arguments that the right test to be applied was to demonstrate the abusive nature of the retail prices given that DT had no control over its wholesale access prices, which were set by RegTP. The CFI approved the Commission’s approach and, in doing so, stated that the appropriate “imputation” test is the vertically integrated company’s own charges and costs, rather than those of actual or potential competitors.
The same test has also been used in more recent margin squeeze cases at the national level.5
The “Indispensability” of Upstream Input
Key to an analysis of the alleged margin squeeze is the definition of the relevant markets, both upstream and downstream. Indeed, access to the upstream input is necessary for downstream competitors to provide the downstream product, as well as for ensuring competition in the downstream market.6
During the course of proceedings, DT sought to distinguish two separate wholesale markets relating to narrowband services and broadband services respectively, but that argument was declared inadmissible because, in its application, DT had not challenged the definition of the relevant markets.
In the electronic communications sector, the relevant markets often will be the same as those defined in the Commission’s recommendation on the relevant markets for the purpose of sector specific regulation.7
However, this may not always be the case. For example, narrower or wider markets may be defined depending on the period of time taken into account for the assessment (e.g., peak or off-peak times) or the type of customer groups (e.g., residential or business).8
Accounting Issues – Costs and Profitability
In assessing a margin squeeze, the Commission is called upon essentially to assess costs, revenues and profitability. This is difficult in practice for various reasons: for example, there are various methods to calculate costs (e.g., short run or long run; historic or forward-looking; fully allocated or average incremental), to allocate “common costs” to different services and to measure profitability (e.g., return on capital employed or return on turnover). In the DT case, the upstream local loop access service was “common” to a bundle of retail access services (namely, analogue, ISDN and ADSL connections).
The Commission took a rather simplistic approach: it excluded revenues from other services, such as call services, and then compared the weighted average of prices of this bundle of retail access services with the price charged to competitors for upstream access to the local loops. It concluded that due to the insufficient spread between the two sets of prices, new entrants did not have the scope to compete with DT for end consumers. The CFI found that the Commission had been correct to take this approach.
A margin squeeze could accordingly exist where the retail prices are not in and of themselves abusive. The sole issue is the fairness of the spread between wholesale and retail prices.
Effect on Competition on the Downstream Market
DT argued that margin squeeze is not an abuse per se and that the Commission should have considered the actual effects on the downstream market. The Commission maintained that it was not necessary to demonstrate an anti-competitive effect, although, in practice, it did examine that effect in the recitals of its Decision. The CFI found that in this case – where DT had a monopoly position on both the wholesale and retail markets – all the Commission was required to identify were the possible barriers to entry resulting from DT’s pricing practices. Because wholesale access to DT’s network was indispensable to enabling a competitor to enter the downstream retail market, the margin squeeze between the wholesale and retail charges was considered to raise entry barriers.
It is open to interpretation whether the CFI’s ruling means that the Commission is not required to produce evidence that a margin squeeze actually impairs competition on the downstream market. Previous cases both at EC and national levels could be read as stating the opposite.9
Additionally, in its recent decision imposing a fine on Telefónica for a similar margin squeeze, the Commission devoted a detailed analysis to the “impact on competition.” The Commission’s decision against Telefónica is currently under appeal and will provide another opportunity for the CFI to shed some light on this issue.
Relationship with Sector-Specific Regulation
In the European Union, electronic communications companies are subject both to competition law and to sector-specific regulations. Accordingly, competition authorities may carry out their own market analysis and impose appropriate remedies alongside any sector-specific measures applied by the national regulators.10
In Deutsche Telekom, the CFI confirmed that such simultaneous application of remedies by different regulators would address different problems in such markets, and are therefore not mutually exclusive.
Accordingly, approval of pricing by a national regulatory authority will not necessarily shelter against a Commission investigation under EC competition rules, particularly where the authority has not explicitly stated that it is also applying Article 82 EC in approving the prices. The CFI’s ruling arguably widens the divergence from the US approach where the US Supreme Court suggested that the scope of US antitrust law in a regulated sector such as electronic communications is limited to situations where no sector-specific remedies are available.11
Position in Emerging Markets?
It has been suggested that the margin squeeze must be demonstrated to have occurred over a sufficiently long period of time.12
While DT met this requirement, little guidance is available for the assessment of an alleged margin squeeze in emerging markets, where the retail offers would often be loss-making for a start-up period of time.
In its judgment, the CFI rejected all pleas advanced by DT and provided further backing to the Commission’s approach to assessing margin squeeze cases, also in other sectors.13
However, DT has appealed to the European Court of Justice (ECJ) challenging the CFI ruling. A case on similar grounds concerning an alleged margin squeeze by incumbent operator Telefónica is also currently pending before the CFI. DT’s legal challenge before the ECJ and Telefónica’s appeal before the CFI mean that the issue of “margin squeeze” remains open.
1 Decision 2003/707/EC, Deutsche Telekom, in OJ 2003 L 263, p.9.
2 Case T-271/03, Deutsche Telekom v Commission, Judgment of 10 April 2008.
3 See Case C-198/01, Consorzio Industrie Fiammiferi v Autorità Garante della Concorrenza e Mercato, Judgment of 9 September 2003.
4 Notice on the application of the competition rules to access agreements in the telecommunications sector — Framework, relevant markets and principles, O.J. (1998) C265/2.
5 See, e.g., Bulgarian Supreme Administrative Court, 9 January 2008, Judgment No. 254, Administrative Case No. 10325/2007, Bulgarian Telecommunication Company (BTC) v Commission for Protection of Competition. Contrast Ofcom, BT Together Options 1, 2 and 3 where account was taken of certain costs inevitably incurred by downstream competitors of BT because they were not vertically integrated (i.e., scale disadvantages and “tromboning”).
6 Case T-5/97, Industrie des poudres sphériques SA v Commission,  ECR II-3755; and Case No IV/30.178, Napier Brown – British Sugar, OJ (1988) L 284/41.
7 Commission Recommendation No. 2007/879/EC.
8 See, e.g., Ofcom, Vodafone/O2/Orange/T-Mobile (provision of call termination for closed group calls).
9 T-5/97, Industrie des poudres sphériques SA v Commission,  ECR II-3755; and Ofcom, Vodafone/O2/Orange/T-Mobile (provision of call termination for closed group calls)
10 Commission Guidelines 2002/C 165/03, on market analysis and the assessment of significant market power under the Community regulatory framework for electronic communications networks and services, in OJ 2002 C 165, p. 6.
11 See Verizon Communications, Inc. v. Law Offices of Curtis Trinko, LLP, 13 January 2004, 540 U.S.
12 In Napier Brown/British Sugar, cited above, the Commission found that if British Sugar had maintained its pricing policy in the long term, rivals would have been forced to exit the downstream market.
13 See DG Competition Staff Discussion Paper on application of Article 82 of the Treaty to exclusionary abuses, available at http://ec.europa.eu/comm/competition/antitrust/art82/index.html.