C&M E-ALERT: CCI issues revised regulations for calculating ‘cost of production’ in predatory pricing cases

WHAT HAS HAPPENED?

BACKGROUND: RELEVANCE OF COST FOR PREDATORY PRICING UNDER THE COMPETITION ACT

Predatory pricing occurs when a dominant entity prices its products or services below production cost to eliminate competitors. It involves sacrificing short-term profits to recoup them later by increasing prices once competitors have been driven out of the market due to unsustainably low pricing.

Assessment of predatory pricing: To establish predatory pricing, prices should have been lowered below the additional cost of producing each unit of a product or service (referred to as ‘marginal cost’ in economic terms). However, marginal cost is notoriously difficult to calculate for most products or services, necessitating the prescription of alternative benchmarks through regulations.

The 2009 Regulations use average variable cost as a proxy for marginal cost. In specific cases, the CCI could use metrics such as avoidable costs, long-run average incremental costs and market value, depending on the nature of the industry, market and technology used.

The 2024 Regulations continue to use average variable cost as a primary metric and replace ‘market value’ with ‘average total cost’ as an alternative metric.

DIFFERENCES BETWEEN THE 2009 REGULATIONS AND THE 2024 REGULATIONS

Economic Concept	2009 Regulations	2024 Regulations
Average variable costs	✔	✔
Average total costs	✗	✔
Average avoidable costs	✔	✔ *The 2024 Regulations add “average” before the expression “avoidable costs” in the operative regulation.
Long run average incremental costs	✔	✔
Market value	✔	✗

KEY HIGHLIGHTS OF THE COST DETERMINATION REGULATIONS

Revised definitions of ‘total cost’ and ‘total variable cost’: ‘Total cost’ now includes ‘depreciation’ and excludes ‘financial overheads’. ‘Total variable cost’ has been clarified to include only those relevant aspects that are attributable to the product or service in question.

Introduction of ‘average total cost’: The 2009 Regulations did not use ‘average total cost’ as an alternative metric for marginal cost. This metric accounts for both fixed and variable costs of production, thereby offering a clear benchmark to ascertain predatory pricing. This is in line with position in the European Union, which has previously used average total cost in its predatory pricing analysis[1].

Revised definition of long-run average incremental cost: The 2024 Regulations provide a much clearer definition of long run average incremental cost, in line with international best practices. It also clarifies that multi-product companies need only consider the proportionate share of common costs attributable to specific products or services in question.

Removal of ‘market value’: The 2009 Regulations included market value as an alternative metric to average variable cost, which was calculated based on the consideration paid by customers. It was heavily criticised for being vague and difficult in application. The 2024 Regulations, in a welcome change, eliminate this metric.

Despite some stakeholders' suggestions to retain it, the CCI maintained that while market value reflects external factors like consumer willingness to pay and perceived value, is not a cost benchmark.

[1] For example, in ECS/AKZO (OJ [1983] L 252/13), the European Court of Justice noted that: (a) below average cost: indicates predatory pricing; (b) above average variable cost but below average total cost: may indicate predatory pricing, but “intent” to eliminate competition must also be considered; and (c) above average total cost: does not indicate predatory pricing.

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