Competition Bureau submission to the OECD Competition Committee roundtable on The Role and Measurement of Quality in Competition Analysis
June 19, 2013
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- Merger analysis
- Quality improvements as a justification for vertical restraints
- Cartels and the ancillary restraints defence
- Canada’s Competition Bureau (the "Bureau") is pleased to provide this submission to the OECD Competition Committee’s June 2013 roundtable on "The Role and Measurement of Quality in Competition Analysis". The Bureau, headed by the Commissioner of Competition (the "Commissioner"),Footnote 1 is an independent law enforcement agency responsible for the administration and enforcement of the Competition Act (the "Act")Footnote 2 and certain other statutes. In carrying out its mandate, the Bureau strives to ensure that Canadian businesses and consumers have the opportunity to prosper in a competitive and innovative marketplace.
- This submission discusses the role of quality considerations in several competition law enforcement areas including merger analysis and abuse of dominance and cartel investigations.Footnote 3 Admittedly, quality can be a subjective concept; however, for the purposes of this submission, it will be viewed as product attributes that enhance the consumer’s utility from consuming a product holding prices and consumer preferences constant.
- It may not always be possible to draw clear distinctions between product quality and other dimensions of competition such as product service and innovation. For the discussion that follows, competition in the provision of a service will be considered within a broader notion of competition in the product quality dimension. This submission does not consider competition in innovation, which can loosely be defined as the rate of development of entirely new products and services.
- In merger review, an antitrust agency may, among other things, consider product quality issues when determining whether a merger is likely to give rise to competitive effects.Footnote 4 Evaluating the effects of a transaction on product quality may include cases where a merger could affect the variety of products available to consumers when products are differentiated according to different quality tiers.Footnote 5 In cases involving allegations of abuse of dominance, product quality issues may arise when evaluating possible business justifications for the alleged anti‑competitive behaviour of a dominant firm. Finally, product quality could be an issue within cartel investigations, where, for example, there is an agreement among competitors to reduce the quality of components used in a product. Product quality issues could also arise in the context of the ancillary restraints defence.
2. Merger analysis
- To challenge a merger under section 92 of the Act, the Bureau is required to provide evidence before the Competition Tribunal (the "Tribunal") that the merger or proposed merger prevents or lessens, or is likely to prevent or lessen, competition substantially. In doing this, the Bureau has regard to the various factors specified in section 93 of the Act including, but not limited to
- the extent to which acceptable substitutes are available for the products of the merging firms;
- barriers to entry into the market; and
- the extent to which effective competition remains.
- When investigating the potential competitive effects of a merger, the Bureau does not limit its analysis to an examination of potential price effects. Rather, the Bureau’s Merger Enforcement Guidelines ("MEGs") state that:
- In general, when evaluating the competitive effects of a merger, the Bureau’s primary concerns are price and output. The Bureau also assesses the effects of the merger on other dimensions of competition, such as quality, product choice, service, innovation and advertising—especially in markets in which there is significant non‑price competition.Footnote 6
- The OECDFootnote 7 raises the idea of defining a relevant market based on product quality by replacing the customary SSNIP test (small but significant non‑transitory increase in price) with a SSNDQ test (small but significant non‑transitory decrease in product quality). The implementation of such an approach could present numerous challenges. For example, the components of product quality may be difficult to observe or measure in certain cases; even when a component of product quality is quantifiable, consumers may have varied tastes, and may not agree as to what features of a product constitute better or worse quality; the quality of a product is often measured along multiple dimensions, making it difficult for consumers to rank products whose attributes may contain a mixture of good and bad quality components; and in response to survey or market contact questions, consumers may find it difficult to conceptualize small relative changes in product quality, especially if it requires them to consider a quality level that does not exist in the market.
- To date, the Bureau has not defined a relevant market based on a SSNDQ type test. Rather, the Bureau has defined relevant markets in the traditional manner using the standard hypothetical monopolist test based on the concept of a SSNIP above levels that would likely exist in the absence of the merger. The Bureau typically considers a five percent price increase to be significant and a one‑year period to be non‑transitory.Footnote 8 Importantly, the Bureau recognizes that market definition is not necessarily the initial step, or a required step in merger review. The ultimate inquiry is not about market definition, but rather about whether a merger prevents or lessens competition. Given this, the difficulties of defining a relevant market in terms of quality do not prevent the Bureau from focusing on whether a merger is likely to create competitive effects, in either a price or a non‑price dimension.
- Canadian case law does not require anti‑competitive effects, whether price or non‑price, to be quantified in order to be considered when assessing competitive harm from a merger. However, the Federal Court of Appeal has expressed a preference for quantification "whenever it is reasonably possible to do so" and that "any weight given to the remaining unquantifiable qualitative effects must be reasonable, i.e., it must be supported by the evidence".Footnote 9 The focus, therefore, is an objective, evidence‑based analysis.
- In that regard, when reviewing a transaction to determine whether it could create a competition issue with respect to product quality, the Bureau generally considers the following:
- The views of customers, competitors and other third parties gathered from market interviews; and
- Documents from the merging firms that indicate the important dimensions of competition and the importance of product quality to customers.
- If this initial step indicates that product quality plays an important role in the competitive process, then additional analysis could be undertaken to assess and, if reasonably possible, quantify the potential competitive harm from the merger arising along the quality dimension. Such analysis may involve examining the nature of the products that comprise the relevant product market to determine whether there is a substantial amount of variation among the products in terms of attributes, customer perceptions or characteristics. If products are relatively homogeneous in terms of quality, an investigation may focus on determining whether a merger is likely to result in a general reduction in the quality of the products of the merging firms.Footnote 10 If there are a variety of products with each being a perceived distinct quality level and produced by a separate firm, analysis could be undertaken to determine whether the merger would result in either a product being discontinued or whether the merger results in products becoming more homogeneous, such that the overall level of quality available to consumers is reduced. To date, the Bureau has not blocked a merger on quality considerations alone.
2.1 Products of similar quality
- To be able to assess a merger’s potential effects on product quality, there is a need to first identify the key components that define product quality for the products comprising the relevant market and the metrics that could be used to evaluate the components of product quality. Once these have been identified, a search for evidence could be undertaken to determine whether the quality of any market participant’s product has changed over time. If product quality has been observed to change over an appreciable period of time due to changing market conditions (such as the entry/exit of competitors), this would indicate that quality change is possible and may be a competitive element that could change as a result of the merger. If not, then quality effects may be less susceptible to quantification.Footnote 11
- To determine whether it would be practical or feasible for the merged entity to change one or mponents of product quality post‑merger, a merger examination may explore questions such as the following:
- What are the likely costs of changing one or more components of quality?
If quality is costly to change relative to the ultimate cost savings that could be realized, change is less likely (e.g., a shift to cheaper, lower quality inputs could involve retooling/retraining costs).
- Prior to purchase, how easily can the consumer discern product quality?
If quality cannot be easily observed, the merged entity may have an incentive to reduce quality knowing that consumers may not detect the change and substitute with alternative products.
- How frequently is the product purchased?
If it is purchased infrequently, a firm may be better able to decrease quality, particularly if product quality is also difficult to discern prior to purchase.
- Is the product an input that is used to produce a final product?
If the demand for the input product is derived from the demand of another downstream product, then this may give less scope for a firm to reduce product quality. That is, a certain level of quality of the input product may be necessary in order for the final downstream product to meet particular quality standards or a level of acceptability.
- What are the likely costs of changing one or more components of quality?
- If it is determined that it is practical and feasible for quality to be changed, a further assessment could be undertaken to determine if the merger is likely to reduce product quality and create a substantial lessening or prevention of competition.Footnote 12 When price and product quality can both be changed through the exercise of market power, this requires information as to how consumers’ valuations for quality vary with their willingness to pay. That is, it would be necessary to determine whether consumers with higher willingness to pay for the good (holding product attributes constant) value quality more or less than consumers with lower willingness to pay. If consumers with high willingness to pay value quality more than other consumers, a firm that has acquired market power and raises price would also have an incentive to increase product quality. In general, the results of empirical studies or simulations may be useful in order to predict how a merger would affect prices when the underlying quality components of products can and do change but can be quantified in a meaningful way. Therefore, when undertaking a merger review it may be worthwhile to consider doing the following:
- Determine whether any empirical studies exist involving the products and industry in question that examine how changes in concentration affect prices that reflect product quality differences and, if not available, determine whether such studies are possible given data availability and market conditions.
- In cases where the market has a history of changes in concentration, review a firm’s historical strategic documents after such changes in regard to product quality metrics were made and evaluate the reason for such changes.
- In cases where the market has a history of changes in concentration, review relevant trade journals, consumers’ views and other third party assessments of how product quality may have changed.
2.2 Products of varying levels of quality
- When considering the possibility that a merged entity may adversely change product quality post‑merger, the possibility that the entity may discontinue or change one or several of the products in the relevant market may also be considered. If the merging firms each produce a product of differing quality pre‑merger, the acquisition of market power could provide the merged entity with the incentive to stop producing one of the products of the merging firms or make the products less differentiated. In this way, the average quality of products available to consumers post‑merger could be reduced. To determine whether a merger would result in a reduction in product quality through a loss of product variety, an analysis posing the same questions and seeking the same information as described above could also be relevant. In addition, economic models of vertical product differentiation (i.e., oligopoly models where competing products are of different qualities) could also be useful tools in this context to predict whether firms would have the incentive to discontinue products and, if so, to determine the effects in terms of prices and quality levels of the products that would continue to be supplied.
3. Quality improvements as a justification for vertical restraints
- When dominant firms impose vertical restraints, their conduct may be reviewed under the abuse of dominance provision of the Act (section 79).Footnote 13 This provision requires the Bureau to prove three elements:
- that the firm engaging in the conduct is dominant in the sense that it has market power in one or more relevant markets;
- that the firm is, or has, engaged in a practice of anti‑competitive acts; and
- that the conduct has resulted, is resulting, or will result in a substantial lessening or prevention of competition.
- Similar to its MEGs, the Bureau’s Enforcement Guidelines on the Abuse of Dominance Provisions take a broad view of the term "price":
- Unless otherwise indicated, the term "price" in these Guidelines refers to all aspects of firms’ actions that affect the interest of buyers. References to an increase in price encompass an increase in the nominal price, but may also refer to a reduction in product quality, choice, service, innovation or other dimension of competition that buyers value.Footnote 14
- The test of whether the conduct has substantially lessened or prevented competition under section 79 is substantively the same as the competitive effects test used in the context of merger review. In both circumstances, evidence of price and non‑price effects are relevant when assessing whether a firm has preserved or enhanced its market power.
- The Act’s abuse of dominance provision provides for business justifications to be considered when determining whether a firm engaged in a practice of anti‑competitive acts. As stated by the Federal Court of Appeal, possible business justifications are relevant for identifying the overall purpose of the firm’s conduct:
- … a valid business justification can, in appropriate circumstances, overcome the deemed intention arising from the actual or foreseeable negative effects of the conduct on competitors, by demonstrating that such anti‑competitive effects are not in fact the overriding purpose of the conduct in question. In this way, a valid business justification essentially provides an alternative explanation as to why the impugned act was performed, which in the right circumstances might be sufficient to counterbalance the evidence of negative effects on competitors or subjective intent in this vein.
- The valid business justification doctrine is not an absolute defence … Rather, a business justification is properly employed to counterbalance or neutralize other evidence of an anti‑competitive purpose…
- A valid business justification must provide a credible efficiency or pro‑competitive explanation, unrelated to an anti‑competitive purpose, for why the dominant firm engaged in the conduct alleged to be anti‑competitive. The business justification must therefore be attributable to the respondent, for it is the latter’s allegedly anti‑competitive conduct which is sought to be explained.Footnote 15
- The Bureau considers a valid business justification as an action undertaken by a firm that goes beyond its mere self‑interest (e.g., raising price, reducing output or maintaining dominance), such actions that lower costs or improve the firm’s product offerings.Footnote 16
- Below are a couple examples of cases relating to quality issues.
3.1 Canada (Director of Investigation and Research) v. Nutrasweet Co.Footnote 17
- On June 1, 1989, the Bureau filed an application with the Tribunal against the NutraSweet Company ("NSC") alleging that many of NSC’s provisions in its contracts with customers excluded rivals; thereby, substantially lessening and preventing competition. One of the contract terms at issue included a trademark display allowance or logo display allowance, which provided a substantial discount from the gross price of aspartame to the customer if the customer displayed the NutraSweet name and logo on its packaging and in print and television advertising featuring the product containing NutraSweet brand aspartame. The allowance was fixed at a certain amount per pound calculated on the total number of pounds of aspartame the customer purchased and not on the number of uses made of the trademark. NSC dictated what had to appear on the packaging (the "NutraSweet/NutraSuc" brand name and NSC’s swirl logo) and in what colours and sizes.
- Witnesses for NSC stated that the purpose of promoting NutraSweet brand aspartame was to dispel consumers’ concerns regarding the safety of aspartame. At the time, consumers were expected to have concerns given the adverse publicity associated with high‑intensity sweeteners, such as cyclamates and saccharin. Surveys conducted on behalf of NSC had indicated that at least some customers believed that the presence of NutraSweet brand aspartame in products was a positive thing.
- The Tribunal found that the fact that some customers reacted positively to the NutraSweet brand is an outcome for which any company engaging in extensive promotion of its product hopes to achieve and did not affect the Tribunal’s conclusion that the overall purpose of NSC’s contractual terms was to pursue exclusivity.
3.2 Canada (Commissioner of Competition) v. Canada Pipe Co.Footnote 18
- On October 31, 2002, the Bureau filed an application with the Tribunal against Canada Pipe Company Ltd./Tuyauteries Canada Ltee ("Canada Pipe") alleging that the respondent’s Stocking Distributor Program ("SDP") foreclosed potential competitors and existing rivals. The SDP provided rebates to customers depending on the share of their requirements of cast iron pipe, fittings and couplings that they purchased from Canada Pipe. The respondent argued that the program was needed to enhance its reputation to customers as an important and reliable supplier that would be able to fill any order for cast iron pipe and fittings. To do this, Canada Pipe argued that the SDP facilitated high volumes of high margin products that allowed it to maintain production of less frequently sold items, such as pipe and fittings of unusual sizes but nevertheless used as essential components in any building. Witnesses testified that Canada Pipe was, in fact, an important and reliable supplier that could fill any order for cast iron pipe and fittings.
- The Tribunal accepted Canada Pipe’s argument as valid, recognizing that there were advantages for customers in having a reliable source able to manufacture and supply a full line of cast iron pipe products for the Canadian market. However, the Federal Court of Appeal rejected the Tribunal’s approach on the basis that Canada Pipe did not provide a credible efficiency or pro‑competitive explanation attributable to itself, unrelated to an anti‑competitive purpose, for the SDP.
4. Cartels and the ancillary restraints defence
- Section 45 of the Act is a criminal provision that treats agreements among competitors that are so likely to harm competition and to have no pro‑competitive benefits as per se offences that do not require a detailed inquiry into their actual competitive effects.Footnote 19 In particular, subsection 45(1) of the Act proscribes agreements among competitors to:
- fix, maintain, increase or control the price for the supply of a product;
- allocate sales, territories, customers or markets for the production or supply of a product; and
- fix, maintain, control, prevent, lessen or eliminate the production or supply of a product.
- The third category of agreements described above captures all forms of output restriction, including those intended to reduce product quality. On this point, the Competitor Collaboration Guidelines, which set out the Bureau’s enforcement policies with respect to collaboration between competitors, state as follows:
- Paragraph 45(1)(c) of the Act, prohibits all forms of output restriction agreements between competitors, including agreements between competitors to limit the quantity or quality of products supplied, reduce the quantity or quality of products supplied to specific customers or groups of customers, limit increases in the quantity of products supplied by a set amount or discontinue supplying products to specific customers or groups of customers ... Accordingly, agreements between competitors to impose production quotas, permanently or temporarily close manufacturing facilities, reduce the quality of components used in a product, or other agreements to reduce the quantity or quality of products that are produced can violate paragraph 45(1)(c).Footnote 20
- Section 45 includes a provision that provides a defence for ancillary restraints. An ancillary restraint is an agreement or term of an agreement that contravenes the prohibitions in subsection 45(1) of the Act, but which is directly related to, and reasonably necessary for giving effect to, a broader and lawful agreement. It is possible that firms that enter an agreement to reduce product quality could claim that the agreement is an ancillary restraint which is reasonably necessary to support a broader or separate agreement, or that an agreement to fix prices is reasonably necessary to support a broader agreement to enhance product quality. However, because of the likely serious competitive harm caused from cartels, the Bureau would review such claims carefully. The onus would be on the parties to the agreement to establish on a balance of probabilities that the challenged restraint is ancillary to a broader or separate agreement, and that the restraint is directly related to, and reasonably necessary for giving effect to, the objective of the broader or separate agreement.Footnote 21 To date, there is no jurisprudence regarding an agreement to change product quality either as an ancillary agreement or otherwise.Footnote 22
- This submission has provided an overview of Canada’s competition law framework for addressing quality considerations in merger review, when evaluating legitimate business justifications for dominant firm conduct, and when considering possible cartel conduct. In the Bureau’s experience, the Act provides the Bureau with the tools to examine the issue of product quality, and other non‑price dimensions of competition, in the same manner that it does for the examination of traditional pricing issues. Although not many of the Bureau’s past enforcement matters have raised issues with respect to product quality, the Bureau will not hesitate to use its enforcement tools under the Act, where appropriate, to preserve and enhance competition along this important dimension.
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