Excessive pricing to the detriment of consumers

April 1st, 2018

By Mfundo Ngobese

The definition of ‘excessive price’ in s 1 of the Competition Act 89 of 1998, as amended (the Act), is a price that ‘bears no reasonable relation to the economic value of that good or service.’ A product does not appear to assist the understanding of what is likely to be regarded as excessive pricing. Pinar and Garrod note that this definition ‘leaves undefined terms such as “reasonable” and “economic value”’ (Pinar Akman and Luke Garrod ‘When are Excessive Prices Unfair?’ CCP Working Paper 10-04. https://papers.ssrn.com, accessed 1-3-2018).

I submit that the adoption of this definition may well have been a deliberate position on the part of the legislature. Due to the openness of this definition it provides a good basis for adapting it to the South African economic context through case law.

There are a few considerations that can assist in guiding the decision makers – both at the firm and at regulatory authorities – in determining whether a price is excessive to the detriment of consumers. The view herein is that familiarising oneself with the market concerned, one can guide competition authorities, in determining what is likely to constitute excessive pricing, which is prescribed by the Act. As for competition authorities, in order to understand the market one can look at pricing over time, for example, the pricing to different customers and pricing by firms in other markets whether those markets are competitive or not. This could assist in determining whether a firm is unfairly exploiting its dominant position as perceived by its customers.

In this regard, it should be noted that the provisions of s 8 of the Act state that:

‘It is prohibited for a dominant firm to –

(a) charge an excessive price to the detriment of consumers’.

The operative feature of this section is that it is only excessive pricing that is detrimental to consumers that are impugned and not just any excessive price. In this regard I submit that the preoccupation of the legislature was not just with excessive pricing per se, but with the welfare effects of such pricing on consumers. The only consideration, which requires dedication and time of the courts to ascertain, is not whether the price is excessive but whether it is detrimental to consumers. The kind of anxiety with the first aspect of this provision can be seen in cases such as Mittal Steel South Africa Ltd and Others v Harmony Gold Mining Company Ltd and Another (CAC) (unreported case no 70/CAC/Apr07, 29-5-2009) (Davis JP, Malan JA and Tshigi JA) and Sasol Chemical Industries Ltd and Another v Competition Commission 2015 (5) SA 471 (CAC). Misplaced emphasis has created significant difficulties in the enforcing of the provisions of this section, despite the fact that there is almost an intuitive feeling of unfairness to the consumer arising from tariffs charged by certain firms, especially when such tariffs cannot be justified by innovation, investment or superior production processes.

The provision in the Act regarding the excessiveness of the price is not in my view intended to be a bone of contention of such a nature that a case will literally turn on it despite the fact that an unjustified extraction of consumer surplus by a firm exists. If one bears in mind that in an economic textbook all prices, above average costs, that a firm might charge for are potentially exploitative, in that the firm is utilising whatever market power it possesses to extract more profit at the expense of its customers. The conclusion seems inescapable that the mention of excessive pricing is only given as an indication of the type of anti-competitive behaviour that the legislature sought to impugn provided it is not to the detriment of consumers.

In this regard, implicating oneself in all types of price-cost determination, in order to ascertain with precision the level of margin derived by the firm is, an activity tantamount to barking up the wrong tree or beating an empty husk for grain. There is difficulty in knowing upfront that a price is excessive to the detriment of consumers. By only ascertaining that it is indeed above costs irrespective of the measure of costs one is using, or the level above such costs, the price concerned is ultimately found to be. I submit that the legislature only sought to provide a guide as to the type of pricing conduct it sought to impugned by s 8. In other words, the legislature is simply pointing out that it is not a conduct, which relates to unfairly low prices (also known as predatory pricing) and it is not a conduct which relates to unfairly discriminatory prices charged to customers (also known as price discrimination) but it is unfairly high prices. The legislature being keenly aware of the basic economic principles that all prices above costs will consequently fall foul of this section cleared its intention that the prices must be so excessive that they are to the detriment of consumers.

In this regard, it is my view that all prices, which are above the appropriate measure of costs, in most cases average costs, may be found to be excessive irrespective of how far above costs such prices are found to be. In this regard the key determinant of liability is not in the excessiveness or the percentage above costs a price is, but whether a price is unfair, in other words to the detriment of consumers. Daniel Kahneman, Jack Knetsch and Richard Thaler provide an example which illustrates this point in ‘Fairness as a Constraint on Profit Seeking: Entitlements in the Market’ The American Economic Review (1986) 76(4) 728 (www.princeton.edu, accessed: 1-3-2018) at 735 states:

‘A grocery chain has stores in many communities. Most of them face competition from other groceries. In one community the chain has no competition. Although its costs and volume of sales are the same there as elsewhere, the chain sets prices that average 5 percent higher than in other communities.’

It was found in this scenario despite the fact that the affected community experienced a price that is just only 5% higher than other communities, 76% of the consumers regarded the price as being unfair. Given that there already exists a high degree of perceptions of unfairness of the price even at this low level it can be concluded that large increases will only serve to intensify the detrimental effect of the price and not whether it becomes detrimental or not.

Therefore, whether the firm’s prices are excessive or not is not a simple question of cost price analysis but an involved process, which rests, primarily on fairness. A determination of fairness is predicated on many factors, which include the manner in which the firm obtained its current dominant position and the need to recoup investments made in the development of superior products or the production process.

Another factor to take into account when trying to decipher the intention of the legislature in s 8 is to note that the legislature avoided reference to a precise measure of cost that should be utilised or any such detail in the definition of what constitutes an excessive price. Yet elsewhere the legislature chose to set out in cost terms what constitute predatory price. The legislature chose to use broad terms imported from other legal systems, in particular the European Union in the definition of excessive pricing. Excessive pricing is defined as follow in the Act:

‘“Excessive price” means a price for a good or service which –

(aa) bears no reasonable relation to the economic value of that good or service; and

(bb) is higher than the value referred to in subparagraph (aa).’

The courts in Mittal and Sasol have grappled with this definition, which relates to the first part of s 8 expending a lot of effort looking at what constitutes economic value. The legislature could never have purported to require this level of precision when basic economic
theory itself offers no satisfactory guidance in this regard. The question that had to be answered is a simple one, namely, whether the price is above a measure of costs that is applicable for that industry. Effort should not have been expended as it was done in Sasol in attempts to arrive at estimates of how much the price is above costs. The determination of whether the price bears no reasonable relation to the economic value of the product applies to all prices above the applicable cost measure.

Again I emphasise that it is the detriment to consumers that should, in most cases, be telling. In order to demonstrate that higher than normal prices were not regarded by consumers as unfair irrespective of the circumstances faced by the firm, the following example from Kahneman et al (op cit) is illustrative at p 732 – 733:

‘Suppose that, due to transportation mixup, there is a local shortage of lettuce and wholesale price has increased. A local grocer has bought the usual quantity of lettuce at a price that is 30 cents per head higher than normal. The grocer raises the price of lettuce to customers by 30 cents per head.’

In this scenario only 21% of the respondents regarded the price as unfair. Accordingly, it is not the fact that the price is higher than normal, which gives rise to a concern about excessive pricing, but rather the basis for such high prices. It is for this reason that once prices are found to be above a suitable measure of costs, the inquiry should – as soon as possible – turn into answering the question of whether the price is to the detriment of consumers.

In consideration of the fact that the drafters of the Act could not have envisaged a precise determination of what constitutes as excessive pricing, those who enforce these provisions should not detain their analysis of the conduct on this point before moving on to the inquiry of whether the prices are to the detriment of customers. This is more so since the price has already been charged and, therefore, direct evidence of the effect of the price on consumers could be obtained.

A competition authority, proceeding from a position that the effects of the conduct have already been felt in the market, will be able to gather information that is telling on whether the price charged by the firm is excessive or not to the detriment of consumers.

The case for intervention by competition authorities in excessive pricing in our economy is made even stronger by the fact that abuses of dominance such as excessive pricing are unlikely to attract effective entry at least in the short to medium term. The caution with which authorities in developed countries approach the issue of excessive pricing, which is informed by the high likelihood that interventionist approaches in those jurisdiction could discourage investments, may not be an appropriate approach in the South African economic context. The foundation of this cautious approach is that the very decision to invest and take risks is informed by the prospect of being able to charge prices above breakeven as an endgame. Remove that prospect by installing a regulator to regulate monopoly pricing you also destroy the urge to enter and compete.

However, in markets that are dominated by a few firms for a long time, such as steel and petrochemicals, there is clear empirical evidence of lack of entry. The basis for the limited risks of false positives (over enforcement) in these circumstances originates from the understanding that firstly, incumbent firms did not obtain their dominance purely from their own enterprising and, secondly, the conditions for effective entry into these markets do not exist due to significant structural limitations such as lack of skills and access to capital resources.

A case for continued role of competition authorities in enforcing the provision of s 8(a) of the Act cannot be over emphasised despite the disappointingly narrow approach of the courts in a few cases that came before them.

Mfundo Ngobese BA LLB (UKZN) Hons Economics (Unisa) is an attorney at the Competition Commission of South Africa.

  • The views expressed in this article are strictly the author’s and should not be taken as reflecting the views of the Competition Commission of South Africa.

 This article was first published in De Rebus in 2018 (April) DR 36.