The BT Margin Squeeze Case

Paolo Palmigiano

Head of Competition Law

BT Retail

London, 10 December 2004

History - The Beginnings

• March 2002 Complaint by Freeserve to Oftel

• May 2002 Oftel’s case closure summary

• September 2002 Freeserve’s appeal of case closure summary

• Competition Appeal Tribunal’s decisions

– November 2002 On admissibility

– April 2003 On validity

• Oftel’s two investigations

– Historical investigation : prices from March to May 2002

– Investigation of current prices (suspended in 07/03, reopened in 02/04)

• November 2003Oftel’s decision on the historical investigation

Oftel’s decision of 20 November 2003

Decision of non infringement of the Competition Act 1998• “the balance of evidence does not support the

conclusion that BT was operating a margin squeeze”• For completeness, Oftel considered the issue of effect

on competition : “no material effect”.

Since there was no infringement• no need to decide dominance at the wholesale level;• no finding of dominance against BT at the retail level• Ofcom determined that “the retail market was

competitive”.

Oftel’s decision of 20 November 2003

“Oftel has concluded in this decision that the margin between BT downstream consumer broadband prices… and BT’s upstream services… is sufficient to cover its downstream costs. Put differently, Oftel has concluded that the above margin is sufficient to allow an equally efficient retail competitor to compete effectively with BT’s consumer broadband services”. (para 7.1)

“The assessment was conducted on the basis of information which could have been reasonably available to BT at the time the relevant pricing decisions were made, announced and implemented”. (para 5.58)

Oftel’s legal test for margin squeeze

Oftel considers that a margin squeeze generally occurs when

• The firm is vertically integrated;

• The firm is dominant on the relevant upstream market so that downstream competitors have a degree of reliance upon the firm’s upstream input;

• The firm sets a margin between downstream retail price and upstream wholesale charge insufficient to cover its downstream costs;

• On an end to end basis the firm may be profitable;

• But an equally (or more) efficient downstream operator could be unable to compete.

Oftel’s economic test for margin squeeze

Oftel construed financial test that examined BT’s expected profitability

Discounted cash flow (DCF) and Cohort analysis

DCF: Expected cash flows are forecast and discounted by a company cost of capital, to arrive to a single measure, the net present value (NPV). If positive, activity is profitable. If negative, loss making.

Cohort analysis : profitability of individual groups of subscribers over their lives. It looks at whether the revenues from each such cohort over its expected lifetime are sufficient to cover the total cost of acquiring and servicing those subscribers over time.

Oftel’s methodology

Complex test which required 8 months of investigation

Oftel used DCF, rejected by OFT in BSkyB : based on forecasts and therefore uncertain

Oftel rejected the use of historical data (applied by OFT in BSkyB and Commission in Wanadoo and DT)

Oftel’s reason : BT’s business had been operating only for 2 months and there were no reliable historical data

Oftel used long run incremental costs (LRIC)

Open questions (1)

What is the relationship between margin squeeze, predation, excessive pricing and cross subsidy?

Is margin squeeze a separate type of abuse which need not involve predation or excessive pricing?

Do you need to show that there has been or there might be a material effect on competition?

Level of upstream market power required. Dominance/ essential input?

Relevant cost floor? LRIC or AVC?

Open questions (2)

How to distinguish legitimate start-up losses from illegal losses in emerging markets?

• Is DCF a valid methodology here?

• “How far a firm allegedly dominant in one market may incur ‘start-up losses’ or losses resulting from measures to stimulate demand, when entering a neighbouring market, without infringing article 82?” (para 243 CAT)

Update : developments in 2004

January 2004 Wanadoo UK appeals Oftel’s decision

February 2004 Ofcom reopens current investigation

Spring 2004 CAT ‘suspends’ Wanadoo’s appeal pending Ofcom’s new third

decision

August 2004 Ofcom sends BT a statement of objections