Abuse of substantial market power
Firms with substantial market power have a special responsibility not to abuse their position of power in a way that harms competition.
The Second Conduct Rule makes it illegal for firms with substantial market power to abuse that power, if it has the object or effect of harming competition in Hong Kong. The purpose of the rule is to prevent powerful companies from using their power to compete unfairly and foreclose efficient competitors. It is not intended to prevent firms from gaining market power.
What is market power?
Market power is generally described as the power to act relatively unconstrained by your competitors. An indicator of market power is the ability to profitably raise prices above the competitive level for a sustained period. But it can also arise with respect to other competitive parameters, for example, if the company can reduce the quality or limit the range of its products or services, lower customer service levels, or impair innovation without fear of competitive constraint.
The first step to determine whether a firm has market power is to define the relevant market. This is not necessarily how you view the market within your industry and can in fact be much narrower than first thought. Defining the market involves identifying the product, the geographic scope and any other specific market characteristics. The usual process is to first identify the product in question and then expand the potential market to include substitute products customers would purchase should the price of that product increase.
Once the relevant market (or markets) is defined, factors such as:
- the firm's current, historical and relative market share;
- the firm's ability to take pricing decisions without fear of competitive constraint;
- the existence and strength of barriers to entry to the market(s); and
- the degree of countervailing power which can be exercised by customers of, and suppliers to, the firm,
will all be relevant to assessing the degree of a firm's power in that market.
What is substantial?
Unhelpfully there is no straightforward answer as to when a firm's market power will be 'substantial'. Unlike the EU and many other competition regimes in the Asia Pacific region, the Competition Commission has not provided specific guidance, such as a market share threshold, for determining when a firm is more likely to have the requisite market power.
While high market shares can be indicative of market power, their existence alone does not necessarily mean a company has market power. One of the central factors is whether the firm can charge prices above, or restrict output or quality below, normal competitive levels for a sustained period. The Competition Commission has indicated that it would normally consider a sustained period to be two years, but it could be longer or shorter depending on the context.
What is abuse?
Abuse is conduct that has the object or effect of harming competition, but not all conduct that harms competition is necessarily an abuse of power. In determining the 'object' behind the conduct, subjective intention (eg to charge below cost for an extended period of time to force out a competitor) or the factual way in which the conduct is implemented, is important. In determining the 'effect' of the conduct, what actually happened (eg a competitor was foreclosed) or is likely to happen, is important.
Examples of conduct that can amount to abuse of market power are:
- Predatory pricing - this is where a firm sets its prices so low so as to drive out or weaken competitors, with the aim of then charging supra-competitive prices. If a firm with substantial market power sets prices below the average variable cost of production of its goods or services the Commission may infer that the firm has the object of harming competition. If a firm sets its prices below the average total cost, the Commission may be more likely to assess the actual or likely anticompetitive effect of such conduct.
- Tying and bundling products - this is illegal where a firm with substantial power in one market leverages that power in another related market to harm competition.
- Margin squeezing - this occurs where a vertically integrated firm sells an essential input to a competitor at a price that 'squeezes' the margin of its downstream competitors, which threatens its competitor's survival or prevents it from competing effectively.
- Refusal to deal - all firms are free to decide with whom they do business. This will only be illegal where a firm with substantial market power refuses to supply, or will only supply on unreasonable terms, to foreclose the competitor or prevent it from competing effectively.
- Exclusive dealing - this is illegal where a firm with substantial market power ties up a key resource and this conduct has the object or effect of excluding existing or new competitors from the market.
Do any exemptions or exclusions apply to this prohibition?
Smaller companies that have an annual gross global turnover of not more than HK$40 million will benefit from the "conduct of lesser significance" exclusion, and are therefore not subject to the SCR.
Nevertheless, the SCR is important to smaller and medium sized companies as they are more likely to fall victim to abuse of market power. Smaller firms should understand what types of conduct is prohibited and when they can resist conduct by larger more powerful firms that prevent them from being efficient and effective competitors in the market.
What are the consequences of abusing your market power?
There are a number of enforcement approaches the Competition Commission can take where it has reasonable cause to believe a firm has contravened the SCR:
- Issue a draft infringement notice, providing the firm with an opportunity to respond;
- After considering the response it may decide not to press the issue or issue a final infringement notice, providing the firm with an opportunity to refrain from the conduct and /or to take specified action; or
- institute proceedings in the Competition Tribunal.
If a firm agrees to comply with the infringement notice, this may include a requirement that it admits it has contravened the SCR. This will expose the firm to follow-on actions by third parties seeking damages.
If the Competition Tribunal finds an offence has been committed, it can issue a fine up to 10 per cent of the firm's group turnover in Hong Kong for the duration of the infringement (with a three-year cap) for each offence.
Next week we will discuss margin squeezing, a specific type of conduct that contravenes the SCR. For a more detailed consideration of exclusivity clauses you can read last week's alert here.
You may also wish to read our 'Are you ready for the Hong Kong Competition Ordinance check list' to see how prepared you are for the new law, which you can find here.