Essays on Price Discrimination – Part 1 – Price Discrimination – So what and who cares anyway!
This essay is the first in a series of comments regarding a price discrimination hearing awaiting judgment by the Competition Tribunal. Its purpose is to create awareness of the Competition Act, and the rights and obligations that it confers. The views expressed are entirely those of the author and reflect the experience of bringing a case to the Tribunal without the assistance of legal representation. It is written not by a lawyer but by a small businessman, who writes these comments in order to awaken awareness to the Competition Act and specifically to price discrimination practices.
We make no excuses for being biased in these essays. The process of getting to the point of awaiting a judgment has been long and hard. This is a path we chose because of moral conviction. The future of our people depends on our ability to compete on the worldwide stage. We must ensure that this can happen. The presence of properly competitive domestic markets is the first step in creating the conditions ripe for economic empowerment. So here goes:
Picture if you will, the view in front of the competition tribunal. On the right sit a delegation of two Eastern Cape wood workers, representing the interests of Nationwide Poles in a complaint brought against Sasol. On the left, and beginning from the right, the city is represented. First sits senior counsel, then the advocate, then senior lawyer, and so on until the most junior lawyer is reached. In the row behind, sit a senior economist, then the less senior economist, then even less senior economist. Behind them sits Sasol management, and witnesses for the defence. Finally, behind management sit the Sasol in-house legal fraternity and a smattering of journalists. Someone notes that this seems an uneven contest. This is the scenario that small businesses face if they entertain a fight about competition.
If price discrimination were not so serious an issue, one could be excused from thinking that the scene is a parody of the competitive process of a complaint involving unfair business practices. Perhaps even a satire at the Grahamstown festival. However this is the real world that we describe. The issues involved affect real people in the world of commerce. The affair is not a moot anxiously attempting to seek academic understanding and explanation. It involves the world of business, the protagonists, small and large business. The referee is the Competition Tribunal, and the playing field, the market relating to the supply of creosote.
We all know that the world of commerce is not balanced. The playing fields are not level and the rules of the game favor some more than others. This is the conventional wisdom. It is an accepted fact of life in the South African economy. Some say the game cannot be changed, others disagree. Very few understand why the game must change. Simply put, the rules changed when the new Competition Act was promulgated, and the Tribunal was established.
Money is not at issue in this hearing. The Tribunal can not make any awards other than costs. It can only issue a piece of paper indicating that a prohibited practice has occurred. So why then present is this host of legal and economic advisors defending a simple and minor allegation of price discrimination? Even if the Tribunal could make an award, the amount at issue is patently not important to Sasol. But the principles that underlie price discrimination are vital to the economic interests and practices employed by big business in their commercial activities.
Price discrimination is a common practice, frequently used to the advantage and profit of big and dominant business. This makes this complaint very, very important. The case could change the way we all do business. It will determine that which is allowed and that which is prohibited. It will explain what is intended by the Act.
The question posed to the Tribunal concerns the circumstances in which price discrimination by a dominant firm can be considered unlawful. The Tribunal must answer the question, one way or another. It appears the referee must for the first time interpret the rules, and the players hardly know what game it is they are supposed to be playing.
This is the first time that the Tribunal is to hear a case concerning price discrimination. No small business has ever managed to persuade the Competition Commission to prosecute such a case. The Commission (the public prosecutor in competition matters) has previously said to Nationwide, prosecute this case if you will, but we want no part of it. There is no prior judgment that considers price discrimination practices and nobody present knows how Tribunal will view the issues. Price discrimination cases are new to everyone including the members of the Tribunal. So what are the issues involved?
Sasol’s view is that volume discounts are common in our economy. It suggests that these discounts are proper and unobjectionable. Nationwide takes an opposing view, suggesting that in the circumstances of a market dominated by few suppliers, price discrimination is a prohibited practice, unless justified by economic imperatives, and in those particular circumstances permitted by the Act.
Sasol charges Nationwide about 20% more than other larger firms and could not or would not justify why it did so. The product in question, creosote, is delivered (transport costs aside) in similar quantities and in a similar way to all bulk customers. Nationwide thinks this is unfair, and Sasol disagrees. Both sides absolutely believe they are correct in their beliefs. Negotiation cannot decide the issue. Sasol continue to supply product, Nationwide continue to buy and object to the higher price demanded. Hence the Commission and the Tribunal and the picture painted above.
The next part of this series will examine the views of Parliament when the 1998 Competition Act was passed. It is sufficient at this stage to know some of the intentions of the Act. In 1997, Parliament had grave concerns regarding the inherited structure of our economy. In particular it intended that all businesses, both large and small, should have a fair and equitable right to participate in the economy. Furthermore, Parliament suggested that international competitiveness is vital to our prospects as a country.
In order to promote these aims, price discrimination by a dominant supplier was prohibited by the new Act, subject to certain provisions. It is the job of the Commission and Tribunal to make sure that the Act is properly applied. Section 9 of the Act prohibits price discrimination by a dominant supplier.
Why then is price discrimination prohibited, and what could be the underlying assumptions and theory behind traditional volume discount practices? The argument goes something like this.
In a competitive market, economic theory generalizes that prices will fall to a level at which time inefficient businesses will leave the market. If prices are too high, new entrants to the market will create additional supply. Fresh competition for existing customers will reduce prices to an economic minimum and the unfit will then leave the market. Price pressure is created by the presence of many competing suppliers and buyers.
In a competitive market, volume discounts are unobjectionable. Volume discounts are a means to encourage increased purchases of a product, in order to reduce the average cost of the product to a minimum. Buyer pressures reduce profit earned on a product to an economic minimum. Lower prices are to the benefit of the purchaser of input products and eventually, the ultimate consumer.
A supplier cannot resist price pressures from buyers in a competitive market. In such a market, customers would vote with their feet and simply buy cheaper product elsewhere. The result is efficient production and distribution of the product. But what happens if the market is not competitive?
If a supplier has market power, and more about how that is defined later in this series, the seller can resist price pressures because there are but few sellers. The seller knows that due to the structure of the market, the buyer cannot obtain the product either cheaper if at all from alternative suppliers. The buyer has no choice but to pay the price demanded by the supplier. Supplier dominated markets will in many instances also have present but few customers. These characteristics are often present in a non-competitive market.
The seller in a non-competitive market, having market power, controls the price of the product. Because the seller controls the price, the seller ultimately determines the input costs to its customers. By definition, there are few other options (if any) available to source the product. By controlling price, the seller either directly promotes or harms the ability of its customers to compete in their own markets. Cheaper product confers a cost advantage and visa versa. If one business is favored over another by way of price, all other things being equal that favored business can charge a lower price to its own customers in turn.
Guess who survives in the long run - the business with the lower cost of its inputs, the favored business. Consumers are not stupid and will generally switch to a supplier that charges the lower price (unless principle dictates otherwise). The disfavored business ultimately faces extinction as its costs are just too high relative to the competition it faces. It is for this reason that price discrimination can become and often is a competitive weapon in the hands of big business.
Large customers know that they gain a competitive advantage if they pay less for an item than do their competitors. So they apply pressure on the supplier. This is the conventional and standard wisdom. The supplier concedes to the demands of large customers and by discounting the average price, loses a chunk of revenue in the process. To regain the lost revenue the supplier then increases the price charged to its smaller customers. The supplier is on average no better or worse off. But the larger customer gains a major strategic and cost advantage relative to its smaller competitors.
In a market dominated by a single supplier, competition that drives prices down is often absent or substantially reduced. The justification for volume discounts relies on the discounts reducing the market price of a product in the long term, to the ultimate benefit of consumers. Implicit in this justification however, is the presence of a competitive market. The conventional wisdom that underpins conventional volume discounts is therefore imperfect if the market itself is imperfectly competitive. Market distortions are created which directly and adversely affect the costs of downstream products and consequently the ability of businesses selling those products to compete.
Price discrimination and volume discounts have the same effect. One buyer pays more than another for the same product. Price discrimination (and volume discounts) now becomes a means of favor and oppression, to be used as an economic tool to manipulate markets. Price differences may also punish unattractive customers, as can happen in the event of a dispute or following a clash of personalities. The downstream markets then become competitively distorted. Is it likely then, that market distortions will enhance our general economic prospects?
If we seek to succeed as a nation, then it essential that our businesses compete, and compete vigorously. Proper competition rewards efficiency and punishes waste, and the consumer ultimately benefits. Competitive domestic prices and markets enable us to compete more effectively in international markets. Competition flourishes if the energies of the entrepreneur are encouraged, and permitted to develop. These attributes should be encouraged.
The difference between successful nations and those less successful will be determined by the endeavors and opportunities available to the entrepreneur. Today we live in a world of instant communication between markets, buyers and sellers. Trade agreements encourage competition between nations, and competition by imports has become commonplace. The energy and determination of the entrepreneur becomes an essential ingredient in the formation of a competitive nation.
If the entrepreneur is to be saddled with the pressures of price discrimination, then this is a disincentive to do business. This disincentive is likely to dissuade new businesses from being formed, and hence fewer jobs. Fewer businesses mean less competition and less pressure to become truly competitive. Our nation eventually becomes less able to compete in international markets.
Competitive ability at a macro level is therefore ultimately reduced by price discrimination. If unlawful price discrimination exists, it entails an unjustified transfer of scarce cash from the customer to the supplier. Suppliers earn unjustified profit on such sales at the expense of the customer. By the supplier earning this supra-economic rent, the cash resources of the customer are reduced.
The diminished cash resources of the aggrieved business restrain its ability to compete even further. An unwarranted surplus profit generates an unhealthy sense of comfort for the supplier, diminishing the perceived need for competitive innovation. The supplier initially appears to be doing well, but in the long run it loses its fitness to compete at a higher level. Everyone loses in the long run, and small business bears the initial and immediate brunt of the burden. Unfortunately for small business, for too long nobody appears to have figured this out. Perhaps more critically, nobody has managed to do anything about the situation.
We should all care greatly about our prospects. We all want a country where perseverance and diligence can flourish. Our children need this country to be successful, if they are in turn to flourish. The seeds we now sow will determine our future. To be successful we must be fit enough to compete.
So why then does the practice of price discrimination continue to exist if it is harmful to our prospects? Is it because price discrimination has existed since time immemorial? And is it right that it should exist in every conceivable circumstance? Just because something has existed is of itself no reason to permit a continuation of a practice. As South Africans, we of all nations should know this. We must question whether and in what circumstances price discrimination should be permitted. This is the question that Nationwide has placed before the Tribunal.
The question we as a society must ask of ourselves is this. Does price discrimination enhance or lessen the ability of businesses in the greater sense to compete? This I leave for the reader to contemplate at leisure. But I will add this. I think this fundamental and simple question is mired with complexity and later we will deal with how the Act approaches the problem.
Each and every business, both large and small, should be concerned with competition issues. But there is something else, a far greater question, and it concerns us all. And the question is this. To what extent is competition policy seen as a tool in the arsenal of social and economic change, designed to redress some of the injustices of the past, and what can business anticipate if this is so?
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Disclaimer: This site does not profess to offer legal assistance or interpretation. It’s content reflects the view and experience gained by of the author during a hearing at the Competitions Tribunal of South Africa. It may help you to figure out what happens & why.