05 October 2004
Key Points:
The decision illustrates the difficulty of applying a counterfactual test, particularly if the rationale for conduct in question is put to one side.
In a recent New Zealand case, a dominant competitor which sold products below variable cost over a sevenmonth period, at prices matching those of a new competitor, was found not liable for predatory pricing, despite having acted with the purpose of eliminating the competitor.
In Carter Holt Harvey Building Products v The Commerce Commission, the Judicial Committee of the Privy Council, by a 3-2 majority, reaffirmed that monopolists are entitled to compete on price and are not required to stand by as their market share was "being eaten into by others".
The products in question were insulation batts. Carter Holt sold both fibreglass pink batts ,in which it was the dominant supplier, as well as woollen batts, which it introduced as a "fighting brand" in response to a competitor's new woollen batts. Faced with declining sales of its new woollen batts, Carter Holt produced its prices of the woollen batts below variable cost by a "2 for 1" offer, while maintaining higher prices for its fibreglass product.
In these circumstances, despite Carter Holt having lost in the intermediate and trial courts, the Privy Council held that Carter Holt’s conduct was not a "use" of market power - (or in the words of the Australian Trade Practices Act, there was no "taking advantage" of market power).
Carter Holt's appeal was allowed on the basis that it had not been shown that a firm not in a dominant position, but otherwise in the same circumstances would have acted any differently. This is the so called "counterfactual test" which has been employed in various Australian section 46 cases.
However, we have some reservations as to whether the test was correctly applied in this case.
Recent High Court decisions in cases such as Boral and Rural Press have expressed this test - which is notoriously difficult to apply - slightly differently. The High Court asked whether it has been shown that a firm without market power "could have" acted in the same manner, whereas the Privy Council asked the question whether the firm "would have" acted in the same manner.
A weakness in the majority reasoning is the lack of detailed analysis of why the conduct in question was regarded as no different from that which a non-dominant firm, of equivalent financial strength would have resorted to in the same circumstances. The majority decision proceeds on the basis that the Commerce Commission had failed to show that Carter Holt's conduct was any different from that in which another non-dominant firm would have engaged.
The dissenting minority judgment describes the counterfactual as "highly unreal" unless the rationale for the conduct was analysed. The minority considered that a firm which was not in a dominant position could not be expected to act in the same way as Carter Holt to protect its share of its favoured high margin product.
Carter Holt was concerned about the commercial fate of pink batts, the flagship of its insulation products which enjoyed a high market share in premium pricing. The competing wool product was eating into pink batts' market share and Carter Holt launched its wool product in response.
In those circumstances the minority said it was highly unreal to suggest that a competitor not in a dominant position would expect to protect the share of favoured product in a competitive market by selling a wool product at a highly uncommercial price. There were findings that Carter Holt was not concerned about the commercial success of the wool product.
The minority therefore concluded that, as the price of pink batts was not reduced to meet competition from the wool product, it was not a case of defensive price matching but rather the strategic use of a fighting brand to see off the new competitor.
Implications of the decision
The decision illustrates the difficulty of applying a counterfactual test, particularly if the rationale for conduct in question is put to one side.
Where a firm of substantial market power employs a "fighting brand" strategy to compete against a rival, and sells its "fighting brand" below variable cost, while maintaining prices and margins on its leading brand, there is a real question whether that is conduct which could (or would) be engaged in by a firm lacking market power.
The ability to maintain prices and margins for a leading product in the face of such competition is evidence of real market power. The counterfactual posed by the majority seems internally inconsistent, because it that assumes a "powerless" firm could continue to sell its main product without reducing price in response to new competition.
The decision can be expected to add further fuel to those critics of section 46 of the Act who maintain that reform is needed because of the difficulties experienced in applying the current section.
For further information, please contact Kirsten Webb.
