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Friday, September 26, 2008

Separating Pro-Competitive from Anti-Competitive Loyalty Rebates: A Conceptual Framework

Posted by D. Daniel Sokol

Damien Geradin, Tilburg University - Tilburg Law and Economics Center (TILEC) and College of Europe  has produced a worthwhile read - Separating Pro-Competitive from Anti-Competitive Loyalty Rebates: A Conceptual Framework.

ABSTRACT:  In its submission to the recent OECD Roundtable on Bundled and Loyalty Discounts and Rebates (the "OECD Roundtable on rebates"), Korea observed that "loyalty discounts are getting growing attention both academically and practically" and that "this issue was now on top of the agendas of many seminars and workshops on competition law, with many papers devoted to the theme." It then explained that this trend was attributable to the fact that loyalty discounts has become an important marketing tool, which raised several competition issues in the process.

While discounts or rebates - this paper will generally refer to rebates - have been used by businesses for centuries to sell greater amounts of products to customers, it is true that the compatibility of rebates with competition law has become a particularly acute issue in recent years. There are several reasons for this. These last few years have witnessed several major court judgments in the European Union (the "EU") and the United States (the "US"), which have been abundantly commented upon, hence explaining the large number of papers and seminars devoted to the subject. But, more generally, the assessment of rebates seems to be one of the most unsettled areas of competition law.

In the EU, for instance, the decisional practice of the European Commission and the case-law of the Community courts have been harshly criticized as being unnecessarily strict, following a form-based approach that is poorly in line with economics. While these decisions have been sometimes misinterpreted, it is true that they were generally unhelpful in large part due to the fact they focused on the wrong questions. As a response to such criticisms (and more general criticisms about the manner in which Article 82 EC was implemented), the European Commission published in December 2005 a Discussion Paper, which promotes an effects-based approach to the assessment of rebates. While US courts have generally applied an effects-based approach to the assessment of rebates, the case-law is still unsettled, notably in the area of bundled rebates. This certainly led Korea to conclude its OECD submission by stating that "even in jurisdictions such as the US or the EU which have accumulated a considerable amount of enforcement experience regarding loyalty discounting often do not have a clear analysis method regarding this practice."

While this observation is in many ways true, there are, however, encouraging signs that EU and US law are converging, and will increasingly do so, around a set of sound legal and economic principles to assess guidelines. Both the EU and the US contributions to the recent OECD Roundtable on rebates emphasize the importance of relying on objective economic criteria for the assessment of rebates. While the views of the European Commission and the US antitrust agencies still diverge on some issues, there seems to be a consensus that a price-cost test should play an important role in screening rebates that can (i.e., are able to) foreclose a dominant firms' rivals to supply one or several customers. There is also a consensus that such tests should only be a component of a broader test that should also determine whether the rebates in question substantially foreclose the relevant market and, in such cases, whether the foreclosure effect can be compensated by efficiencies. While price-cost tests help determining whether the rebates granted can have the effect of foreclosing competitors because the dominant firm's customers cannot turn to alternative suppliers without incurring substantial switching costs, it should also be demonstrated that these customers represent a substantial share of the market to which equally efficient rivals can turn, depriving them of the possibility to profitably enter and/or expand. Moreover, both EU and US law recognize the importance of taking into account in the assessment process the various efficiencies that can be generated by loyalty rebates and the extent to which they can counterbalance foreclosure effects.

Against this background, this paper aims at providing a framework - based on sound legal and economic principles - designed to help competition authorities and courts to separate pro-competitive loyalty rebates from anti-competitive ones. It starts with the widely acknowledged view that in the vast majority of cases dominant firms grant rebates to their customers for legitimate reasons, i.e. not to exclude competitors but to engage in legitimate forms of price competition and to realize a variety of efficiencies, as discussed below. In fact, rebates are not only used by dominant firms, but also by firms without any market power and thus unable to exclude competitors. This paper also takes as a starting point the view - which is recognized in the vast majority of antitrust regimes - that the goal of competition law is not the protection of competitors, but the protection of competition. Hence, rebates that cause less efficient firms to lose market share should not be banned as they lack anti-competitive effects. As will be seen below, these rebates enhance consumer welfare as they ensure that customers are served by the most efficient firms and benefit from their more competitive offers.

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