Customer discounts: surely always a good thing?

The answer to that question is "yes...most of the time" says senior associate Torrin Crowther in this article on the competition issues surrounding straight and bundled discounts to customers.

Offering customers discounts and rebates is standard practice in many industries, and as a general rule straight discounts – where customers receive a discount to reflect the efficiencies associated with increasing volumes – do not raise competition law issues.

However, bundled discounts – where discounts are available if a customer buys a number of different products (or a certain volume of different products) from the same supplier – can give rise to competition law issues, depending on their structure. In many cases bundled discounts simply reflect efficiencies in the form of reduced transaction costs, etc. and are a function of competition at work. However, in some cases they can be anticompetitive, often where they are used to leverage market power in one market into another more competitive market, or artificially raise entry barriers and impact the competitive process in a real way.

Identifying when bundled discounts are anticompetitive has exercised the minds of competition regulators, lawyers, academics and economists for some time. In fact, US regulators recently argued to the US Supreme Court that it should refuse to grant leave for a particular appeal because the current thinking on bundled discounts was insufficiently developed, with the result that the court "would be well served to await further development of the case law, and further insights from academic commentary". All of which is cold comfort for practitioners asked to advise on the legality of bundled discounts today.

In Commerce Act terms, the issue is whether the bundled discount amounts to: (i) a taking advantage of a substantial degree of market power for a prohibited purpose; or (ii) an agreement having the purpose, effect or likely effect of substantially lessening competition. A relatively recent Commerce Commission report on a Telecom discount structure provides an insight into the approach the commission may take.

In early 2004, Telecom introduced a bundled discount whereby customers received a $10 per month discount on broadband internet access if they also used Telecom for local calling and toll calls. Broadband competitors claimed their margins were being squeezed with the result they could not compete in the face of the $10 discount.

The commission considered a number of different tests to assess whether the bundled discount breached the Act, noting that the appropriate test will depend on the circumstances. In the case of Telecom, it concluded the "competitive bundle test" was the most appropriate. This test involves applying the overall discount (in Telecom's case, $10) to the price of only those products within the bundle for which the firm faced direct competition (in Telecom's case, toll calls and broadband internet access) in order to test whether efficient competitors offering the same bundle could earn positive margins. If the average margin was negative, such that equally efficient firms could not replicate Telecom's offer, then the commission's view was that the 'take advantage' limb of a misuse of market power would be satisfied. This in turn would give rise to a breach of section 36 of the Act if the 'substantial market power' and 'prohibited purpose' limbs were also satisfied. The commission concluded that on the facts there was unlikely to have been a 'taking advantage' and hence there was no such breach.

On whether the discounts substantially lessened competition in a market in breach of section 27 of the Act, the commission said its analysis did not reveal any exclusionary purpose or anticompetitive effect sufficient to substantially lessen competition in any market. In reaching that view, the commission took comfort from the fact an equally efficient competitor in the provision of broadband access and toll call services could compete with Telecom, despite the discount.

While the commission's analysis provides some helpful guidance, it is important to recognise that the competitive bundle test – like all the various tests advanced on the issue – has been criticised by commentators as not always appropriate. It is certainly not the case that a discount that fails the competitive bundle test will necessarily give rise to an issue, although it would certainly justify careful consideration. Unfortunately, the flip side is that a discount structure that satisfied the competitive bundle test could, depending on the circumstances, in theory give rise to a breach.

Ultimately, the issue is whether the conduct breaches the plain wording of the Commerce Act. While the competitive bundle test is a useful tool to employ, consideration of the following factors will also help to focus the issue.

• Does the competition offer similar bundled discounts?

• Will the discount structure "lock up" sufficient customers such that competition as a process is likely to suffer?

• What is the rationale for the discount structure? Can it be justified on the basis of volume/efficiencies?

• (Where the firm has substantial market power) would a firm without substantial market power but otherwise in the same circumstances implement such a discount structure?

This article was first published in NZLawyer, 2 May 2008.

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.