The ‘Birdsville’ amendment – Getting back on track

A new standard – A new opportunity

On 25 September 2007, the Trade Practices Act was amended to include the now infamous ‘Birdsville’ amendment prohibiting corporations with a ‘substantial market share’ pricing below ‘relevant cost’ in certain circumstances—conduct with the popular but misleading label of ‘predatory pricing’.

This new prohibition appears to be a significant departure from the existing legal approach to below-cost pricing and it has generated considerable (often ill-informed) comment. Now passions have subsided, it is time to assess the true significance of the change. Will the amendments bite? What should business do in response?

Because the new law is intended to overcome perceived difficulties faced by the Australian Competition and Consumer Commission (ACCC) and others in regulating below-cost pricing they are relevant to small and large businesses across a wide range of Australian industries and in relation to many commercial pricing practices.

One of the unintended consequences of the new law is the introduction of fresh uncertainty, and uncertainty bears a cost. However, instead of deterring business from engaging in aggressive price competition, this amendment gives business the opportunity to focus on the fundamentals of good corporate strategy. If firms can give an explanation for their ‘below cost’ pricing that is consistent with proper business practices, they have nothing to fear.

What is prohibited?

The existing prohibition of misuse of market power, which has been used to regulate predatory pricing conduct in the past, requires proof of:

• substantial market power
• that the conduct is taking advantage of that power, and
• a proscribed purpose.

The language of the new prohibition is quite different, with the key elements being:

• substantial share of a market
• a price less than the relevant cost
• conduct for a sustained period, and
• a proscribed purpose.

Under the new law:

• The requirement for market power has been dropped. Substantial market share is now the governing criterion.
• A specific concept of below cost pricing has been introduced, requiring new terminology—‘sustained period’ and ‘relevant cost’—which are not defined.
• There is no causal link between the governing criterion and the conduct in question—‘the new prohibition does not require the substantial market share to give rise to the below cost pricing. Under the existing law this link was provided by the concept of ‘taking advantage’ of market power. Now, market share merely identifies the category of person subject to the new law.

Under the existing and the new law the proscribed purposes are textually the same, namely:

• eliminating or substantially damaging a competitor
• preventing the entry of a person into a market, or
• deterring or preventing a person from engaging in competitive conduct.

Although purpose is often seen to be one of three discrete elements of the existing law (market power, taking advantage, proscribed purpose) the prohibition against misuse of market power should in reality be seen as a single test. The proscribed purposes take their meaning from the other elements.

The new law will be read in the same way, with the important difference being that the examination of a firm’s purpose occurs in a context of the firm having market share, but not necessarily market power. This may be significant, as firms having market power have obvious incentives to harm the competitive process. Firms with market share, but no market power, have no such incentive. If a court assumes, as it should, that firms act rationally, a question of characterisation arises: is the purpose of the firm one of the proscribed purposes, or is it vigorous price competition?

How will the new law be interpreted?

The text of the new law is the starting point for any analysis of how it will be interpreted. However, in this case, the text itself is ambiguous:

• what is a ‘substantial share of a market’?
• what is a ‘sustained period’?
• what is the ‘relevant cost’?

In giving meaning to these phrases courts should have regard to the object of the Act and the broader policy underlying it. This object is to ‘enhance the welfare of Australians through the promotion of competition’. The broader policy is that set out in National Competition Policy, which recognises the primacy of market processes. On many occasions courts and the ACCC have emphasised that  the purpose of promoting competition and the competitive process is not necessarily the same as protecting the private interests of particular persons or corporations.

Such an approach should significantly ameliorate the risks associated with the uncertain statutory language. This is seen by examining each of the new concepts.

What is a ‘substantial share of a market’?

A ‘market’ for the purposes of the Act (the ‘relevant market’) is a legal and economic concept that does not necessarily match the ‘trading market’ that appears to be the one in which the firm operates. The current case law has firmly established the need to take a ‘purposive’ approach to defining markets. This means starting with the problem in hand and identifying the area of competition, in terms of product, geographic area, functional level and time frame, that best aids the purpose of the analysis.

Below-cost pricing can only be a genuine competition concern if the market share can give rise to an ability and incentive to price in such a fashion as to achieve an anti-competitive purpose. The law assumes rational economic agents and a rational person will not attempt to drive out competition when there is no prospect of success.

Matters such as barriers to entry, the nature and extent of vertical integration, import competition and countervailing power are all relevant in determining whether the market share held by a corporation is of real substance—that is, makes a difference to the conduct.
Thus, for example, a numerically large share of supply or production in a market may not be ‘substantial’ if:

• barriers to new entry or expansion are low
• the market is highly dynamic or linked to a single contestable contract, or
• customers have strong bargaining power.

In such a market, a numerically large share can be taken away within the relevant time frame and there is no ability to achieve any of the proscribed purposes.

What is a ‘sustained period’?

Markets have a time period and an analysis of market conduct must take account of those time periods. Conduct which occurs for a ‘sustained period’ must be capable of achieving one of the proscribed purposes.

Accordingly, the length of time required to constitute a ‘sustained period’ will depend on the particular circumstances of the case, including why the price discounting is occurring. For example, a short-term price cut for weekly specials is unlikely to be treated as carried out for a sustained period, but a one-off price cut on a significant contract that is critical to the health of a competitor might be.
In ordinary circumstances we would expect that quite a lengthy or strategically significant period of below cost pricing would be required to achieve a purpose of driving out or credibly deterring competition.

What is the ‘relevant cost’?

Existing law on ‘predatory pricing’ (under the existing prohibition of a misuse of market power) shows that courts adopt a flexible approach to analysing business costs. For example, some courts have used the concept of ‘avoidable cost’, being the cost that a business would not incur but for the production and sale of the product in question. Others have adopted a test of marginal cost or, if this cannot be accurately calculated, average variable cost.

The important thing to note is that courts have ordinarily considered economic measures of relevant cost—because these measures tend to fit with the theory of predatory pricing. Supplying goods below avoidable cost/marginal cost/average variable cost does not make sense unless it is driven by strategic (and potentially anti-competitive) considerations.

Economic costs are quite different to accounting measure of costs, because economic costs include opportunity costs. Economic costs also take into account the time period of the market, which might differ significantly from the accounting period.

True measures of (economic) costs are particularly difficult when it comes to allocating costs in a complex production process or across a network business. What appears to be below-cost pricing may simply be an accounting illusion. Indeed, it is difficult to know how any outside observer of commercial conduct can properly form the view that prices are below the ‘relevant’ cost without a major and costly investigation. Even a firm’s own records may not assist this process, because they will typically be using accounting, not economic, concepts of costs.

What does this mean in practice? Most firms do not analyse business decisions using economic measures of cost. Even in circumstances where a business may internally assess a particular sale as being ‘unprofitable’ it may not be less than the ‘relevant cost’ under the new law. This is a major hurdle for a potential litigant seeking to certify that there is an arguable case to be made.

Where does the track lead?

Because the new law is untested and contains new concepts it inevitably creates uncertainty for businesses. In the initial period there is a high risk of some large firms being subject to investigations and even court proceedings (by the ACCC or private litigants) initiated to test legal boundaries and develop precedents.

However, in our view the new law:

• can and should be applied in way that will not prevent otherwise legitimate competitive conduct, and
• should not force firms with strong market positions to adopt onerous new legal compliance procedures or significantly change existing pricing practices.

The Birdsville amendment may have the unintended consequence of chilling vigorous competitive activity to the extent it imposes costs on business (the price of the risk and uncertainty). However, businesses should not be deterred from doing what they should already be doing: identifying a sound business rationale for their conduct and engaging in vigorous competitive practices.

That sound business rationale is to be grounded in a simple test: if the purpose intended to be achieved is ‘exclusionary’ it is not a good rationale.

• Exclusionary conduct is intending to remove merits-based competition from the market—‘permanently increasing market price or reducing total market output (in either the dimension of quantity or quality of output).
• On the other hand, conduct with the purpose of bringing about permanent (long run) reductions in price or increases in output (quantity is increased or quality of customer service is improved) is necessarily pro-competitive. This is so, even if one side-effect of that conduct is the destruction of a competitor. This is the very thing that a competitive economy allows and encourages. 

The types of pricing decisions that will often be supported by a genuine efficiency/pro-competitive business rationale under the existing and new laws include:

• selling excess, obsolete or perishable products at low prices (clearance sales)
• using low prices to induce customers to try a new product (including to aid entry into a new market segment), and
• matching a competitor’s low prices.

Other types of conduct will be more controversial, and include¹:

• sustained discount policies associated with bundling and tying—for example, petrol and grocery shopper-dockets (this is an area already identified by the ACCC)
• price ‘wars’ that break out when new entry or expansion in a market occurs—the Boral case provides a classic example, but such conduct is common in many industries
• sustained ‘loss leader’ selling—often used by mass merchants to attract people to their stores in the knowledge that they will often buy a range of products
• strategic low pricing that appears to be directed a particular competitor—this is a potentially difficult category of conduct, where a simple examination of subjective business ‘purpose’ may not be helpful in distinguishing strong competition from predation.

These matters will be the subject of continuing uncertainty until litigation occurs. To manage this uncertainty we recommend firms with strong market positions consider:

• introducing appropriate compliance protocols and mechanisms, including training for staff with responsibility for pricing decisions
• identifying the legitimate commercial rationale for unusually low pricing conduct (in many instances this will be quite simple), and
• obtaining legal advice when in doubt.

This article was written by Donald Robertson, Partner, Sydney and Peter McDonald, Senior Associate, Melbourne.

Endnote

1.  In the context of some of these examples we note the recent UK Competition Commission provisional findings report in its Market Investigation into the Supply of Groceries by Retailers, dated 31 October 2007, which found that:

temporary promotions on some products, including fuel, to attract consumers and increase total sales (commonly referred to as loss leading) may be efficient pricing for grocery retailers. Competition between grocery retailers on the total value proposition of the store may result in a lower average price for a basket of products. This may be particularly true given the nature of these products and because, typically, buying fuel at the same time as buying groceries is convenient for consumers because it reduces their travel costs.

These findings demonstrate the importance of understanding the rationale of low pricing practices and the particular circumstances in which they occur.

More information

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