Customer discounts: surely always a good thing?

By Torrin Crowther, Partner | Friday 2 May 2008

First published in Competition Matters, NZLawyer, 2 May 2008.

The answer to that question is "Yes...most of the time".

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?

Torrin Crowther is a corporate partner at Bell Gully specialising in competition law.

*Closer Enforcement Relations Update

Competition Matters (Issue 83, 7 March 2008) discussed the Trans-Tasman Working Group's recommendations on the enforcement in Australia of New Zealand penalties and fines under the Commerce Act 1986. We noted that, in the case of criminal proceedings, the Commerce Commission is unable to serve the proceedings on a defendant outside New Zealand and that any fine imposed is unenforceable overseas (see Part IV of the Working Group's August 2005 Discussion Paper). The Working Group's recommendations did not address these issues.

In its judgment of 3 April 2008, the Court of Appeal has clarified the position on service of criminal proceedings in Australia. In Civil Aviation Authority v Heavylift Cargo Airlines Pty Limited [2008] NZCA 76, the Authority had laid an information under the Civil Aviation Act 1990 against Heavylift, which did not have any presence in New Zealand. The Authority sought to effect service under section 19 of the Mutual Assistance in Criminal Matters Act 1992 (MACMA). Section 19 provides that, in criminal matters, the Attorney-General may request a foreign country to assist in effecting service of any process where satisfied that this is necessary or desirable. The High Court had held that even if service was possible under the MACMA, which it doubted, service had not been carried out validly. On appeal, the Authority accepted that, unless section 19 applied, it could not serve Heavylift. However, the Court held that section 19 did permit service of the information, referring to both the Commonwealth "Harare Scheme" and United Nations General Assemble Resolution on mutual assistance in criminal matters that gave rise to the MACMA. Service must be as specified in the Attorney-General's request and, if the request does not specify a service method, the requested country should serve in accordance with its own procedural requirements.

The Court did not express an opinion on the powers of the New Zealand courts if Heavylift ignored a properly served summons, so the position now appears to be that service is possible under the MACMA but any fine obtained remains unenforceable overseas. - Simon Ladd, litigation senior associate, Bell Gully.