Since its introduction, the as-efficient competitor (AEC) test has played a pivotal role in the economic assessment of price-based exclusionary conducts under Article 102[1] of the European Commission (the Commission) and competition authorities throughout Europe.
On 27 March 2023, the Commission proposed a series of amendments to its 2008 guidance paper on enforcement priorities in applying Article 82 to abusive exclusionary conduct by dominant undertakings (the Guidance Paper) with the view to adopt guidelines on exclusionary abuses in 2025.[2] In one of the amendments, the Commission intends to move away from a generalised use of the AEC test in determining whether a dominant firm’s pricing conduct is likely to foreclose a hypothetical competitor as efficient as itself.[3]
In this article, we evaluate the importance of the role of the AEC test in assessing price-based exclusionary conduct by dominant firms. We consider, in particular, the context of the postal sector where we have advised multiple stakeholders on implementing the AEC test during the course of competition law investigations. We conclude that the AEC test still has an important role to play in assessing price-related abuses in highly concentrated postal markets and securing efficient market outcomes by reducing legal uncertainty faced by dominant postal operators.
The key economic rationale of the AEC test is to balance two competing forces: on the one hand, to prevent the foreclosure of competitors which can be important to the competitive process and, on the other hand, ensure that dominant firms are allowed to set prices competitively.
The underlying principle is that the normal process of competition may result in the foreclosure of less efficient firms and, therefore, only firms ‘as efficient’ as the dominant firm should be protected.
In simple terms, the test is conducted by comparing the dominant firm’s price against a benchmark capturing the cost of a hypothetical firm facing the same cost structure. In practice, the test uses the dominant firm’s own cost as the benchmark to establish whether its pricing is abusive, as illustrated in Figure 1. In particular:
Determining the exact cost is often a crucial element of the discussion surrounding the AEC test and has been the central issue in some past pricing abuse decisions.[4] However, this is beyond the scope of this article.
The example can be extended to other pricing strategies, such as conditional or exclusivity rebates. In such cases, the first step would be to calculate the ‘effective price’ that a competitor would have to offer to match the dominant firm’s offering. For example, if a portion of a customer’s volume is not contestable by virtue of the dominant firm’s position, then the effective price should be calculated only against the volumes which a competitor could potentially gain.[5] This effective price is then compared against the cost benchmark as described above.
In a policy brief setting out the thinking behind its proposed amendments to the Guidance Paper (the Policy Brief)[6], the Commission takes the view that ‘the use of an AEC test is warranted in predatory pricing and margin squeeze cases’ as ‘in these types of abuse, it is the price that is charged in itself that may be liable to be abusive, rather than the conditions associated with such price’.
The Commission is, nevertheless, cautious about drawing conclusions on abuse based solely on the results of the AEC test. In particular, it takes the view that ‘an AEC test remains only one element in the overall competitive assessment’ and that its outcome ‘should be factored in the Commission’s analysis of all relevant facts and circumstances’.[7]
Furthermore, the Commission is sceptical about applying the AEC test in the context of rebate cases. In its Policy Brief, it argues that the AEC test ‘is generally not warranted’ in cases involving exclusivity rebates (i.e. retroactive rebates conditional on a customer purchasing all or most of its requirements from the dominant firm) due to their ‘high anticompetitive potential’ and the ‘difficulties inherent in the drawing up of an AEC test’.[8]
The Commission’s reluctance regarding a generalised use of the AEC test partly builds on past European case law decisions in the postal sector.
In Post Denmark II, the European Court of Justice (ECJ) dismissed the suitability of the AEC test based on the view that the structure of the postal market in Denmark made it practically impossible for a firm as efficient as the postal incumbent to exist (see Box 1).[9]
In Royal Mail v Ofcom, the UK Competition Appeal Tribunal (CAT) discarded evidence of an AEC test showing that Royal Mail’s pricing for access to its delivery network would allow a competitor as efficient as itself to operate. This was based on the argument that a postal operator less efficient than the incumbent may still exert a competitive constraint that confers significant benefits to postal users (see Box 2).
In our view, the limitations of the AEC test in these cases should not lead to a wholesale dismissal of the test (and the legal certainty it provides) but could instead lead to the application of adjusted versions of the test.[10] Our long-standing experience[11] suggests that postal operators across Europe rely extensively on the AEC test as part of their competition law compliance exercise.
Post Denmark had been operating a retroactive rebate scheme in 2007 and 2008 with respect to bulk mail advertising across all its customers. The Danish Maritime and Commercial Court considered that while it was established that the rebate scheme could have an exclusionary effect by its nature, the criteria to be applied to decide whether it did were uncertain. It therefore asked the ECJ to clarify the relevance of the AEC test in assessing a rebate scheme under Article 102. The ECJ argued that the test was not necessary because of the specific market circumstances ‘characterised by the holding by the dominant undertaking of a very large market share and by structural advantages conferred, inter alia, by that undertaking’s statutory monopoly, which applied to 70% of mail on the relevant market’. In that context, ‘applying the as-efficient competitor test is of no relevance inasmuch as the structure of the market makes the emergence of as-efficient competitor practically impossible’.
These past case law decisions brought to light some of the limitations of the AEC test in certain market contexts. Nevertheless, the AEC test carries important benefits to competition and consumers which would be lost if the test was scrapped entirely.
First, the test allows dominant firms to compete with efficient entrants. In fact, without the test, a dominant firm may have to set prices at a level that would accommodate higher-cost entrants. In that setting, both the dominant firm and competitors have a weakened incentive to invest in lowering their costs. The overall effect could be higher prices, less innovation and consumer harm.
Second, the test is useful in providing ex-ante legal certainty to dominant firms in their pricing decisions. Conducting an AEC test as part of a systematic compliance exercise allows dominant firms to lower their prices without fear of being sanctioned by competition authorities. Put differently, without the test, dominant firms would be more cautious in lowering their prices for fear of being fined even in situations when their pricing would pass the AEC test. This would hurt consumer welfare directly (consumers would face higher prices by the dominant firm) and indirectly (the incentive of new entrants to reduce costs would be weakened).
Third, the AEC test provides a disciplining mechanism for competition authorities as it ensures that only those conducts which are more harmful to consumers are sanctioned.[12]
In 2014, Royal Mail announced plans to raise zonal tariffs to access its wholesale services of mail delivery into rural areas. Whistl, a nascent entrant at the wholesale level with primary operations in urban areas, relied on Royal Mail’s wholesale services to deliver mail to rural areas and was thus impacted by the tariff increase. Whistl complained to Ofcom arguing that the proposed tariff change meant that it would have to procure delivery services from Royal Mail on worse terms than access operators with no desire to enter the delivery market. Royal Mail contested this claim by presenting evidence that an as-efficient competitor could operate profitably under the disputed tariff plan. However, Ofcom (and ultimately the UK CAT) discarded this evidence on the grounds that competition law should not only protect as-efficient rivals, therefore it had no obligation to conduct an AEC test. In particular, the CAT highlighted that entry and competition from a less efficient rival can benefit competition and consumers, notably where an unconstrained monopoly would otherwise prevail.
[1] Article 102 on the Treaty of the Functioning of the European Union or similar provisions in national competition laws.
[2] Amendments to the Communication from the Commission – Guidance on the Commission’s enforcement priorities in applying Article 82 of the EC Treaty to abusive exclusionary conduct by dominant undertakings (“Amending Communication”), available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=OJ%3AJOC_2023_116_R_0001
[3] Ibid.
[4] In AKZO v Commission, the European Court of Justice established that pricing below ‘average variable cost’ must be regarded as abusive and that pricing between ‘average variable costs’ and ‘average total costs’ must also be abusive if that pricing is part of a plan for eliminating a competitor. In Post Denmark I, the Danish competition authorities established the ‘average incremental cost’ or AIC as the relevant cost benchmark to determine whether Post Denmark’s selective discounts offered to customers of a rival amounted to an exclusionary abuse. The AIC was defined as the cost that would disappear in the short or medium term (three to five years) if Post Denmark were to give up distributing unaddressed mail.
[5] Consider a situation where the unit price is 10 EUR, and each customer buys 20 units. If the customer buys 20 units from the dominant firm, they get a 50 EUR rebate. In this case, the effective price per unit if the customer buys all their needs from the dominant firm is 7.5 EUR (20 units x 10 EUR – 50 EUR = 150 EUR / 20 units = 7.5 EUR). If, however, the customer can only buy 10 units from the competitor (e.g. because some volumes can only be fulfilled by the dominant firm) then the rebate is fully allocated to these contestable volumes, In this case the effective price for the contestable volume is 5 EUR (10 units x 10 EUR – 50 EUR = 50 EUR / 10 units = 5 EUR).
[6] European Commission (2023), Competition Policy Brief No 1/2023, A dynamic and workable effects-based approach to abuse of dominance.
[7] Ibid.
[8] Ibid.
[9] The necessity to carry out the AEC test in all rebate cases was also dismissed in the General Court’s final judgement on the Commission’s Intel decision that conditional rebates to chip manufacturers amounted to an abuse of a dominant position. However, the General Court also held that ‘where the Commission has carried out an AEC test, that test is one of the factors which must be taken into account by the Commission to assess whether the rebate scheme is capable of restricting competition’ (General Court (2022), Case T‑286/09 RENV, 26 January, para. 126).
[10] An alternative to the AEC test is the “reasonably efficient operator” (REO) test, which has been developed in the telecommunications sector in the context of margin squeeze cases. That test is notably well grounded in the analytical toolkit of telecom regulators in Germany and the Netherlands when investigating the pricing behaviour of the vertically integrated dominant operator. It looks at whether the margin between the access price it charges to a competitor for access to downstream activities and the retail price it charges in the downstream market is sufficient for a reasonably efficient competitor to enter. In doing so, it takes into account competitors’ asymmetric conditions, that are for instance due to the presence of economies of scale or scope.
[11] Copenhagen Economics have been involved in multiple national case investigations including price compliance matters in postal markets across more than 10 different countries in the EU in the past 10 years.
[12] This assumes that the cost to society of a type I error (i.e. finding an abuse when there is no abuse) is larger than that of a type II error (i.e. failing to find an abuse when there is an abuse).
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