Competition Law Economics

The Competition and Consumer Act prohibits certain conduct which has the purpose or effect of substantially lessening competition or which constitutes a misuse of market power. This requires an understanding of what constitutes a market, what will be considered market power and the nature of competition (so as to determine whether certain conduct will result in a lessening of competition).

Markets may take many forms. At the extremes, a perfectly competitive market is generally said to feature:

• Large number of suppliers and buyers
• Small market share held by each
• Homogeneous product
• Low barriers to entry
• Perfect information between all firms (on supply and demand side)

In such a market no single seller or buyer can influence the price of the product; the market forces of supply and demand establish the price. Such a market will generally maximise efficiency as firms have incentives to allocate resources to products consumers want and to do so in as efficient (cost-effective) manner as possible to maximise profits.

Conversely, in a monopoly, characterised by a single seller and high barriers to entry, these incentives do not exist; consumers lack the choice to shop elsewhere so a monopolist can simply pass on costs of inefficient production to consumers. Monopolists also have limited incentives to innovate (dynamic efficiency) in order to retain custom.

Most markets are neither perfectly competitive, nor monopolistic, but the comparison serves to demonstrate why competitive markets are considered desirable.

In relation to market structures, Justice Emmett, in his trial judgment in Metcash stated:

[161] In a perfectly competitive market, there will be many sellers, each lacking the ability to influence price through its own actions.  Each seller will, in such circumstances, lack market power.  Participants in such a market must sell their products at marginal cost, being the cost associated with producing additional units of a good or service.  On the other hand, in a classic monopoly market, there is only one seller, usually with significant discretion over price.  A firm that has no significant competitive constraints on its pricing discretion will be regarded as having monopoly power or significant or substantial market power.

[162] Between the extremes of a perfectly competitive market and a classic monopoly market, there are various kinds of imperfectly competitive markets.  In an oligopolistic market, there are a few sellers of identical or similar products.  Participants in such markets are generally aware of their influence over price, are cognisant of their interdependence and can often earn rates of return that exceed normal levels.  Some markets can be described as being monopolistically competitive, in that they contain many sellers of similar products.  Because monopolistically competitive firms sell similar products, they have some degree of market power and can charge prices exceeding marginal costs.

[163] In a workably competitive market, some or even all participants may have some market power, in the sense that they all have some discretion over price, but no participant will have a substantial degree of market power.  In such a workably competitive market, at any given time, prices might deviate from underlying costs and the deployed technologies might deviate from the most efficient ones currently available.  Economic forces drive such a market towards efficient prices, outputs and costs, but not instantly.

The role of market definition in competition policy remains a contentious issue in Australia and elsewhere.

For discussion of market definition issues in Australia, with some comparative assessment of the changing role of market definition in the United States, see Rhonda Smith, 'Market definition: Going, going, gone? Developments in the United States' (2010) 18 Competition and Consumer Law Journal 119.

Maureen Brunt identified some of the difficulties in the following passage (in Maureen Brunt, Economic Essays on Australian and New Zealand Competition Law, Kluwer Law International, The Hague (2003) at 211 - as quoted in Smith's paper):

the outer boundaries of a market are not necessarily sharp and obvious. Sometimes there will be a break in substitution possibilities which does not admit of much argument. At other times, substitutability, competition, and market power are all matters of degree, requiring the exercise of some judgment in the delineation of relevant markets.

See also markets page

Section 4E of the Act expressly refers to substitutes in the context of defining markets:

For the purposes of this Act, unless the contrary intention appears, market means a market in Australia and, when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are substitutable for, or otherwise competitive with, the first-mentioned goods or services.

Re Queensland Co-operative Milling Association Ltd; Re Defiance Holdings Ltd (1976) 25 FLR 169

The seminal definition of 'the market' in Australia is contained in the decision of the Trade Practices Tribunal in this case (at 190)

We take the concept of a market to be basically a very simple idea. A market is the area of close competition between firms or, putting it a little differently, the field of rivalry between them. (If there is no close competition there is of course a monopolistic market.) Within the bounds of a market there is substitution-substitution between one product and another, and between one source of supply and another, in response to changing prices. So a market is the field of actual and potential transactions between buyers and sellers amongst whom there can be strong substitution, at least in the long run, if given a sufficient price incentive. Let us suppose that the price of one supplier goes up. Then on the demand side buyers may switch their patronage from this firm’s product to another, or from this geographic source of supply to another. As well, on the supply side, sellers can adjust their production plans, substituting one product for another in their output mix, or substituting one geographic source of supply for another. Whether such substitution is feasible or likely depends ultimately on customer attitudes, technology, distance, and cost and price incentives.

It is the possibilities of such substitution which set the limits upon a firm’s ability to “give less and charge more”. Accordingly, in determining the outer boundaries of the market we ask a quite simple but fundamental question: If the firm were to 'give less and charge more' would there be, to put the matter colloquially, much of a reaction? And if so, from whom? In the language of economics the question is this: From which products and which activities could we expect a relatively high demand or supply response to price change, i.e. a relatively high cross-elasticity of demand or cross-elasticity of supply?

Metcash (2011)

In the context of mergers, Emmett J set out the relevant principles in his trial judgment in Metcash (at para 151) [emphasis in original] - in this case the functional market definition was particularly important.

[151] Defining a market delineates an area of close competition relevant to a firm’s products and conduct, and involves identifying the relevant competitive constraints on firms, so that the competitive implications of the conduct in question can be assessed.  Substitution, either in demand or in supply, defines that area of competition.  If two products are substitutes, an increase in the price of one relative to the price of the other, all other things being equal, results in a decrease in the sales of the first product and an increase in sales of the second product.  It is necessary to identify close substitutes, since close substitutes will impose competitive discipline on a firm and its prices.  Substitution can be inferred from quantitative or qualitative information.  In quantitative terms, 'substitutability' is captured by measuring elasticity of demand and cross-elasticity of demand.  The former provides a measure of overall constraint on prices.  The latter provides a measure of substitutability between or among different products.  The scenario in which a large number of consumers of a product would switch to a similar product in response to even a small increase in the price of the first product, meaning that any effort to increase the price of the first product would be doomed to failure, is an example of high cross-elasticity of demand between the two products.

[His Honour then discusses supply-side substitution, as provided for in the merger guidelines]

[153] A critical market definition test is the hypothetical monopolist test.  That test involves determining whether a hypothetical monopolist supplier in a market could profitably impose a small but significant non-transitory increase in price, most commonly between five and ten per cent, for the supply of relevant products, or whether substitution by buyers or suppliers would make such an increase unprofitable.  If the hypothetical monopolist supplier could profitably impose such an increase, to which I will refer as a relevant increase in price, the market is correctly defined. 

[154] However, if the hypothetical monopolist supplier could not impose a relevant increase in price, a smaller and smaller market must be postulated until a positive answer can be given to the question of whether it could impose the increase profitably.  The relevant market is identified as the smallest area, in terms of either product or geographic space, over which a hypothetical monopolist could profitably impose a relevant increase in price.  If there are several products that compete within the same market, it is the cumulative switching to all those alternative products by consumers that determines whether close demand-side substitutes exist.  If the cumulative effect is sufficient to make the relevant increase in price unprofitable, all close substitutes would be included in the market, even if the consumer switching to each individual product in isolation might be insufficient to make the relevant increase in price unprofitable.

...

Market dimensions

[156] Markets can be defined in terms of product, function and geography (see AGL at [378]). ...  Occasionally, time and consumer dimensions are used ...

[157] Definition in terms of function refers to the link in the chain of production for a specific product.  Different functional levels, such as manufacturing, wholesaling and retailing, for a specific product, are often complements rather than substitutes.  Accordingly, care must be taken to ensure that different functional levels are not combined into a single product market in cases where hypothetical monopolists at separate functional levels could each profitably impose a relevant increase in price.  If they could do so, combining the functional levels into a single relevant market may violate the principle of identifying the smallest market under the hypothetical monopolist test.

[158] The identification of a relevant market by functional dimension requires consideration of the differences between horizontal economic relationships and vertical economic relationships.  Horizontal economic relationships generally involve rivalry, whereas vertical economic relationships are generally co-operative.  Generally, horizontal interactions are characterised by rivalry among entities selling the same or similar products to the same or similar customers.  Such entities attempt to win custom from their competitors.  In contrast, vertical interactions are generally characterised by co-operation among entities engaged in a supply and acquisition relationship.  That is to say, such entities are engaged in different functions along a supply chain and would ordinarily work collaboratively to win sales at each level in that chain.  In the Australian grocery industry, the self-supplying major supermarket chains, such as Woolworths and Coles, are often described as vertically integrated.  Further, there are vertical relationships between Metcash, on the one hand, and the IGA retailers, on the other hand.

[159] Because the different functional markets in any distribution chain for a given product are generally considered to be economic complements, rather than substitutes, in the supply of the product, whether goods or services, the functional market concept is quite different in nature from the product market concept and the geographic market concept.

Australian Competition and Consumer Commission v Liquorland (Australia) Pty Ltd [2006] FCA 826; (2006) ATPR 42-123

Justice Allsop (at 429):

Market definition is not an exact physical exercise to identify a physical feature of the world; nor is it the enquiry after the nature of some form of essential existence. Rather, it is the recognition and use of an economic tool or instrumental concept related to market power, constraints on power and the competitive process which is best adapted to analyse the asserted anti-competitive conduct.

Justice Finkelstein (president), Grant Latta and Professor Round

[1009] ... to a businessperson, a market is a place or area where goods may be sold or, more broadly, where there are people who are sufficiently aware of a firm’s product to consider buying it. This concept of a market concentrates its attention on buyers rather than sellers.

[1010] We are not here concerned with the businessperson’s understanding of a market but rather with the analytical definitions developed by economists. Several classical economists have offered definitions. Cournot defined a market as: “The entire territory of which parts are so united by the relations of unrestricted commerce that prices there take the same level throughout, with ease and rapidity” ...

[1011] This economic (or relevant) market, then, consists of groups of buyers and groups of sellers in a geographic region who seek each other out as a source of supply of, or as customers for, products. The interaction of the buyers and sellers determines the price for the products.

[1012] We have not referred to a “group” of products because implicit in the classic economists’ definition of a market is the assumption that there is only a single homogeneous product and that the firms in the market produce perfect substitutes.

[1013] In the real world it is not only homogeneous products of rival sellers that affect price; price is also affected by the products of rival sellers that are close substitutes. Hence it is necessary to expand the definition of a market to include not only identical goods but also close substitutes.

[1014] The output of the process of defining the relevant market – the identification of the participating firms, a description of the products exchanged and the borders within which the exchange occurs – is critical to an assessment of the behaviour of firms in the market (ie whether or not they impose competitive constraints upon one another) and, importantly, whether or not a firm has, or a group of firms have, power to control price or reduce competition (ie to shift the price away from that which would be obtained in a competitive market, namely the marginal cost of the product).

[1015] In QCMA (at 517), the Tribunal defined a market to be a "field of rivalry" between firms in which there is "substitution between one product and another, and between one source of supply and another, in response to changing prices."

[1016] Section 4E was introduced in 1977 to give statutory recognition to the concept of substitution. It provides that "for the purposes of this Act, unless the contrary intention appears, 'market' means a market in Australia and, when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are substitutable for, or otherwise competitive with, the first-mentioned goods or services."

[1017] It is often difficult, and sometimes impossible, to define with any precision the relevant dimensions (product, geographic, functional and temporal) of a market. On occasion, it can be particularly difficult to describe the relevant product market and its geographic borders. The process often involves judgments as to matters of degree that can be difficult to measure.

[1018] As regards the product market, the notion of substitution refers on the demand side, to a customer’s practical ability to switch from one product to another and, on the supply side, to the capacity of a supplier to switch production from one product to another. There are various conventional approaches to determining substitutability. [emphasis added]

[1019] The first significant approach developed by the courts and leading economists in the US is the “reasonable interchangeability of use or the cross-[price] elasticity of demand between product itself and substitutes for it”: Brown Shoe Co. v United States 370 US 294 (1962) at [15]. Cross-price elasticity of demand measures the extent to which consumers will change their consumption of a product in response to a price change in another product. A high cross-price elasticity value suggests that products are good substitutes and are probably in the same product market.

[1020] Reasonable interchangeability of use is established by looking at actual and potential buyer substitution patterns. Relevant evidence will include product characteristics (including differences in grade or quality), price differences (including price trends), past buyer responses, the views of firms regarding who their competitors are, and the existence or absence of different distribution channels. [emphasis added]

[1021] On the supply side, cross-price elasticity is also relevant. Products will be in the same market if a firm can readily switch production from one product to another. What is important is the ease with which the switch can take place. It may be immaterial that consumers do not regard the products as substitutes, that a price difference exists, or that the prices are not closely correlated. [emphasis added]

[1022] The geographic market is the area of effective competition in which sellers and buyers operate. What is relevant, as a starting point, are actual sales patterns, the location of customers and the place where sales take place, and any geographical boundaries that limit trade. But it is not sufficient to measure only historical and current market behaviour. It is also necessary to consider whether customers would readily turn to more remote suppliers in response to a price increase by local suppliers or whether remote suppliers would choose to enter the local market.

[1023] In the United States, geographic markets are occasionally defined based on shipment flows. ...

[1024] A more recent (and increasingly popular) approach is to define a market as a group of products and a corresponding geographic area within which a hypothetical monopolist would be able to raise prices profitably. ...

[1026] The hypothetical monopolist test has been adopted by the ACCC. ... [emphasis added]

[1027] The test works this way. One looks at the effect of a price increase on a single product. If so many buyers would shift to alternative products that the monopolist would find the price increase to be unprofitable, the group of products is too narrow to constitute the market. The market should include all those products for which the hypothetical monopolist’s price increase would be profitable.

[1028] The factors that the guidelines use to determine whether the test is satisfied are conventional. The factors include buyers’ perceptions, similarities and differences in price movements between different sets of products over a period of years, similarities or differences in product characteristics and evidence of sellers' perceptions.

[1029] The test for the existence of significant market power is phrased in terms of the magnitude of the price increase that could be imposed by the hypothetical monopolist. It is generally accepted by both US and Australian regulators that a price increase is significant in size and length if it is at least 5% (sometimes 10%) and for at least one year, but there is flexibility in both the magnitude and the time period. It should be noted that these are not tolerance levels for anti-competitive price increases; they are merely a benchmark for assessing substitution. [emphasis added] ...

[1031] Geographic markets are defined in an analogous manner. One identifies tentatively a small geographic area such that a hypothetical firm that is the only present producer of the relevant product or service is not able to profitably impose a price increase. If the product or service could be obtained elsewhere, an attempt to raise the price could not be profitable and the tentative geographic area would be too small. The geographic area is expanded until the hypothetical monopolist’s price increase would be profitable.

[1032] The hypothetical monopolist definition was designed to satisfy three objectives: (1) To connect the relevant market in antitrust case law to economic policy justifications in merger cases; (2) To arrive at a standardised definition of a market; and (3) To develop a test that fell within existing jurisprudence that relied on the product and geographic dimensions of a market.

[1033] The hypothetical monopolist test has its critics. ... The test is, in essence, a "thought experiment". ... But the trend is towards acceptance of the test ... not only in merger cases, but wherever it is necessary for competition purposes to define the boundaries of a relevant market ...

[1034] Notwithstanding the criticisms, or in spite of it, the hypothetical monopolist test has gained currency in Australia ... [emphasis added]

Australian Gas Light Company v Australian Competition and Consumer Commission (2003) 137 FCR 317 (cited with approval in ACCC v Flight Centre Limited (No 2) [2013] FCA 1313 (6 December 2013) [para 108]

[para 378] The concept of market describes, in a metaphorical way, an area or space of economic activity whose dimensions are function, product and geography. A market may be defined functionally by reference to wholesale or retail activities or a combination of both. The concept of product encompasses goods and services and, having regard to the definition of “market” in s 4E, includes the range of goods or services which are substitutable for or competitive with each other.

[para 379] The process of market definition was expounded in QCMA where the Tribunal defined “market” as the area of close competition between firms and observed that substitution occurs within a market between one product and another, and between one source of supply and another in response to changing prices (at 190):

So a market is the field of actual and potential transactions between buyers and sellers amongst whom there can be strong substitution, at least in the long run, if given a sufficient price incentive.

In Re Tooth & Co Ltd (1979) 39 FLR 1, the Tribunal identified the task of market analysis as involving:

1. Identification of the relevant area or areas of close competition.

2. Application of the principle that competition may proceed through substitution of supply source as well as product.

3. Delineation of a market which comprehends the maximum range of business activities and the widest geographic area within which, if given a sufficient economic incentive, buyers can switch to a substantial extent from one source of supply to another and sellers can switch to a substantial extent from one production plan to another.

4. Consideration of long run substitution possibilities rather than shortrun and transitory situations recognising that the market is the field of actual or potential rivalry between firms.

5. Selection of market boundaries as a matter of degree by identification of such a break in substitution possibilities that firms within the boundary would collectively possess substantial market power so that if operating as a cartel they could raise prices or offer lesser terms without being substantially undermined by the incursions of rivals.

6. Acceptance of the proposition that the field of substitution is not necessarily homogeneous but may contain submarkets in which competition is especially close or especially immediate. This is subject to the qualification that competitive relationships in key submarkets may have a wide effect upon the functioning of the market as a whole.

7. Identification of the market as multidimensional involving product, functional level, space and time.

• ACCC v Australian Safeway Stores Pty Limited [2003] FCAFC 149 (30 June 2003)
  Misuse of market power, exclusive dealing, price fixing (relating to bread)
• ACCC v Liquorland (Australia) Pty Ltd [2006] FCA 826
  Exclusionary provisions, anti-competitive agreements, market definition
• ACCC v Metcash [2011] FCA 967 (trial judgment and appeal)
  Mergers - at first instance Justice Emmett set out relevant economic principles in some detail from para 147.
• Auskay International Manufacturing & Trade Pty Ltd v Qantas Airways Ltd (2008) ATPR 42-256; [2008] FCA 1458
  Alleged cartel - specificity of market
• Australian Gas Light Company v Australian Competition and Consumer Commission (2003) 137 FCR 317
• Emirates v ACCC [2009] FCA 312
  Validity of s 155 notice - issue of market definition
• QIW Retailers Ltd v Davids Holdings (1993) ATPR 41-226
  Mergers; Trade Practices Economics
• Re QIW Ltd (1995) 132 ALR 225
  Merger, Market definition
• Re Queensland Co-Op Milling Association Limited and Defiance Holdings Limited (QCMA) (1976) 8 ALR 481
  Mergers; Trade Practices Economics
• In Re Tooth and Co Limited; In Re Tooheys Limited (1979) ATPR 40–113 (Tribunal)
  Market definition
• Top Performance Motors Pty Ltd v Ira Berk (Qld) Pty Ltd (1975) 5 ALR 465
  Market definition
• Trade Practices Commission v Australian Meat Holdings (1988) 83 ALR 299
  Mergers; Market Definition
• Seven Network Ltd v News Limited [2007] FCA 1062; [2009] FCAFC 166 (the C7 case)
  Anti-competitive agreements; misuse of market power; market definition

• Rhonda Smith, 'Market definition: Going, going, gone? Developments in the United States' (2010) 18 Competition and Consumer Law Journal 119
• Martin Algie & Brian Kewley (1998) Competition Law Market Definition in Practice (First published John Libby & Co 1997)
  Internet publication by the Publication Trust, 2008
  (available online; includes useful comprehensive analysis of cases and compreensive bibliography)
• See also reading room

Section 46(1) prohibits a corporation with substantial market power taking advantage of that market power for a prohibited purpose. On the issue of market power (in a case relating a merger) Justice Emmett in his trial judgment in Metcash stated:

[164] Realistically, almost every participant in a market has some economic market power in the sense that the participant has some discretion over its prices and its level of product quality.  However, the degree of market power that is of concern in relation to competition policy is higher than economic market power in that sense.  Thus, for example, s 46 of the Competition Act employs the concept of substantial degree of market power as the threshold of concern.  Substantial market power is the ability to earn returns substantially in excess of the opportunity cost of capital, without attracting the entry of participants who would be likely to impose significant competitive constraints.

[165] Market power is not necessarily correlated with market share, although participants with relatively high market share often exercise substantial market power and participants with relatively low market share seldom exercise substantial market power.  Participants are generally able to exercise substantial market power not only as a consequence of having a high market share, but also because the relevant market is protected by barriers to entry and expansion.  Markets that are easy to enter are generally characterised by intense competition.  On the other hand, where barriers to entry into a market are high, incumbents can more easily exercise market power because the threat of entry is more remote.

Section 46(1AA) prohibits predatory pricing, defined as a corporation having substantial market share supplying goods or services below cost for a sustained period for one of the three prohibited purposes (the same prohibited purposes as for s 46(1). This provision was introduced in 2007 and no cases have yet been brought in relation to it. It remains controversial.

On the correlation between market share and market power Justice Emmett, in his trial judgment in Metcash, stated:

[165] Market power is not necessarily correlated with market share, although participants with relatively high market share often exercise substantial market power and participants with relatively low market share seldom exercise substantial market power.  Participants are generally able to exercise substantial market power not only as a consequence of having a high market share, but also because the relevant market is protected by barriers to entry and expansion.  Markets that are easy to enter are generally characterised by intense competition.  On the other hand, where barriers to entry into a market are high, incumbents can more easily exercise market power because the threat of entry is more remote.

See also the substantial lessening of competition glossary page

Anti-competitive agreements (s 45), dual listed company arrangements (s 49) and exclusive dealing (other than third line forcing - under s 47) are prohibited only if they have the the purpose, effect or likely effect of substantially lessening competition (SLC)

Mergers (s 50) are prohibited only where they have the effect or likely effect of SLC.

On the issue of counterfactuals (relating to mergers) Justice Emmett in his trial judgment in Metcash stated:

[166] ... Counterfactual assessments are necessarily prospective, in that assessments of the state of competition as it would be with the proposed acquisition, and without the proposed acquisition, both involve a prediction of the future.

[167] Ordinarily, the state of competition expected to prevail if an acquisition does not occur will be a continuation of the state of affairs existing prior to the implementation of the proposed acquisition, which is, in the present case, the acquisition of Franklins by Metcash.  Thus, ordinarily, one would endeavour to define the relevant product and geographic market and to measure the existing level of concentration.  That level of concentration would then be compared with the level of concentration expected to prevail if the acquisition proceeds.  If the market would be relatively unconcentrated both before and after a proposed acquisition, there is a presumption that the proposed acquisition would not adversely affect competition.  Even if the market is relatively concentrated, but the proposed acquisition will have only a small impact on the level of concentration, a conclusion may be drawn that there would be no adverse effect on competition.

The Hot Tub
The University of Melbourne's Competition Law & Economics Network (CLEN) has released of a video demonstrating Australia’s approach to expert evidence in competition law cases - a mock 'hot tub', based on the facts in Boral and presided over by retired the Hon Peter Heerey QC who was the first instance judge in that case. In addition to the Hon Peter Heerey QC, the expert roles were played by Dr Philip Williams (for the ACCC) and Richard York (for Boral) and counsel were played by David Shavin QC (who acted for the ACCC in the Boral case) and Jack Fajgenbaum QC.

View relevant articles in the reading room.

Books for lawyers

Maureen Brunt, Economic Essays on Australian and New Zealand Competition Law, Kluwer Law International, The Hague (2003)

Roger D Blair and D Daniel Sokol (eds), The Oxford Handbook of International Antitrust Economics, OUP, 2015 (Volumes 1 and 2)

Gunnar Niels, Helen Jenkins, James Kavanagh, Economics for Competition Lawyers, OUP 2011