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Suffering at the Hands of the EU Antitrust Police

Mises Daily: Wednesday, January 10, 2007 by

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Mr. Smith walked into the electronic department, searching for a new plasma TV. He has decided that he will buy either a Grundig or a cheaper Chinese brand. Grundig TVs are tempting because, even if they cost more, they offer an outstanding after-sales service: if the TV breaks, for whatever reason, a substitute will arrive in 24 hours.

To make sure that he is right about his choice, Mr. Smith decides to take a break and come back later. Meanwhile, his attention turns to a basket of bananas in front of the grocery store. His choice is between a Chiquita, which costs one Euro and smells fresh and delicious, and an unbranded banana, which costs 70 cents but shows slightly the signs of age.

When Mr. Smith comes back to the electronic department with the hope of buying a TV that will never give him a problem, a surprise is waiting for him. Unhappily, he discovers that the Grundig's offer has changed: they now sell cheaper TVs with an after-sales service that takes thirty days instead of one day.

Irritated by Grundig's lack of reliability, he decides to retaliate by picking the Chinese super-cheap offer. At least he can now dull the pain with a juicy Chiquita banana, which he prepares to buy. Two minutes later he finds himself standing still in front of the fruit basket, with the big TV box in his hands: Chiquita's are sold at 80 cents but don't have a very nice look to them.

"What is going on with the market," he wonders.

As consumers, we evaluate and respond to changes in the offer of the products we want to buy. Often a producer changes the offer to obtain a higher profit. When he does so, he submits his action to the judgment of the consumer, who will reward or punish according to a subjective valuation. However, when the change in the offer is mandated by public authorities and comes in the form of a restriction, we as consumers are denied the opportunity to judge that offer. If we wanted to reward it, not only has the authority chosen for us, but in addition, our benefit has been diminished — that is, we are worse off.

Mr. Smith's experience reveals the consequences of the intervention of the European antitrust authorities in the free market, which can be illustrated by two landmark cases, the Grundig case and the United Brands case.[1]

The Grundig case[2] represents the first and still the most important decision in the area of "vertical agreements"[3] and it shows the difference between a restriction introduced voluntarily in the market by a private company and a restriction mandated by the public authorities. In the 1960s, Grundig was a famous German producer of TV sets. With the goal of selling in the French market, they signed a deal with a French distributor. It was an agreement favorable to those consumers who place a high value on after-sales services. Grundig asked the distributor to provide a superior after-sales service and, in exchange, gave an exclusive contract for Grundig products in France.

The prices of Grundig products were higher in France than in Germany, and this attracted the attention of a company (UNEF) that saw a business opportunity in buying Grundig TVs in Germany and reselling them in France (this practice is called "parallel import").[4] Having foreseen this potential threat to the French distributor, Grundig had inserted in the agreement some clauses that basically forbade parallel imports. This, in turn, allowed the distributor to forget about rival Grundig distributors and focus its business model on the distribution of the product and on the delivery of a quality after-sales service.

A legal battle erupted and was taken to the European antitrust authorities. With their first decision on competition, they ruled "illegal" the deal signed by Grundig and its local distributors.[5] By prohibiting parallel imports, Grundig allegedly segregated the national markets of its products. In other words, the authorities did not want to leave to the consumers the judgment of whether Grundig products in France were too expensive. Instead, they ruled that a superior after-sales service did not constitute a benefit to consumers. Consumer benefit was to be associated only with a lower price.

The Grundig case was the first of an endless series where the Commission subverted those vertical agreements that, directly or indirectly, forbade parallel import. And even when a legal agreement was not signed, but the managers of two companies cooperated informally in any way that jeopardized parallel imports, the companies were sued and punished.[6] A company called Pioneer was prosecuted just for calling a meeting in order to coordinate informally with its local European distributors a countermeasure to parallel imports.[7]

Is a market without agreement-restricted parallel imports really better for competition and consumer welfare?

Public authorities believe that a market without parallel imports is less competitive because of the absence of rivalry between all European Grundig distributors.[8] However, it is wrong to think of the market for TV sets as a homogeneous whole where every producer offers the same product. Every market is segmented into many smaller markets, according to the different types of customers. The segment for low-priced TV sets is different from the segment for "TV sets with quality after sales service".[9] If a company decides to be competitive in the latter, the most effective strategy to do so is, actually, to prevent competition between distributors, so that each one of them can focus its efforts not on a price war but on the provision of a very good after-sales service.

If public authorities discourage a company from following this business model, this company will have to reorient its market focus toward price. In other words, as far as competition is concerned, when Brussels officials force the presence of rivalry between distributors, they cause two negative distortions in the market structure. First, since their decision represses the companies willing to compete in the segment of "TV sets with quality after-sales services," many of these companies will abandon that segment to move toward the low-price segment.

As a consequence, the spectrum of different televisions offered in the market will narrow.

Second, because of the migration of companies toward the low-price segment, we may well see lower prices, but at the expense of other segments that will become less competitive.

After the antitrust measure, then, the market is not more competitive. Instead it simply has a different competitive structure. Is the post-intervention structure more efficient than the unhampered one? Because this intervention favors one group of customers at the expense of another, it is impossible to tell. What we can know is that the structure of the competition has been changed away from the pattern driven by consumer demand toward a criterion arbitrarily determined by the antitrust authority.

And if we believe that it is more efficient to favor the production of what the consumer actually demands, as opposed to what a public authority mandates, then we can know that the antitrust decision has created a less efficient competitive structure.

At this point we have seen that the exclusive offering of parallel imports from a voluntary contract does not represent a threat to competition and, conversely, that the public authorities' imposition against the adoption of this business practice is a threat to competition.

Let us now turn to consumer welfare. The argument in favor of the imposition goes as follows: because competition reduces prices, if one obliges Grundig to allow parallel imports, the general price level of its products will decrease.

This position, though, is blind to the fact that the obligation of using parallel imports produces consequences that Mr. Smith had personally suffered in my opening example. He did not want a cheaper Grundig TV. He wanted a TV with better after-sales service. After the intervention of antitrust authorities, Grundig's after-sales service deteriorated because the French distributor had to refocus its business not only on that task but also on competing against other Grundig sellers.[10]

In other words, the victims of the decision were the Grundig customers, those who preferred the brand because it offered a better after-sales service for a slightly higher price. Another type of customer that suffered the consequences of this intervention was anyone who preferred a wider variety of options. Since the decision caused the market structure to converge away from a wider spectrum of choice toward low-price products, these customers were worse off too.

Why such a severe intolerance against companies that applied voluntarily a ban on parallel import of their product and against their clients? In order to be able to appreciate the gravity of the damage provoked to the consumer, we need to look at the United Brands Case.

This case is one of the most important ones dealing with "abuse of dominant position,"[11] the old warhorse of free-market opponents.[12] United Brands had revolutionized the market for bananas and quickly gained a large share of the market. They achieved this position by conceiving an innovative production process that increased the quality of bananas[13] and by being the first to venture into large-scale advertising of a banana brand.[14]

In 1975, the European Commission accused United Brands of abusing its market position by applying discriminatory prices, in view of the fact that they charged a different price in different countries (Belgium, Luxembourg, Denmark, Germany, Ireland, and the Netherlands).

In order to charge a company with abuse of dominant position, the authorities have to prove, first, that the company held a dominant position; and second, that this position was exploited anti-competitively.

United Brands was considered in a dominant position by the European antitrust authorities because of their size and because of the fact that competitors did face "almost insuperable" barriers to entry.[15] However, these barriers represented only the cost of the initial investment required to enter a similar business.[16] From an economical point of view, however, the cost of entry cannot be considered a barrier to entry. Of course, every business requires initial investments and the larger the business the higher will be the upfront cost. But to consider the cost of entry an illegitimate barrier is to say that anyone — no matter how poor, inexperienced, or inefficient — should be able to compete with United Brand. In a free market, an entrepreneur who demonstrates the potential to be more efficient than United Brands will soon find the investors for his venture.

Having seen that the rationale for considering United Brands to hold a dominant position is shaky, let's now move to the second part of the accusation, the alleged abusive behavior.

Among the various countries the selling price of the Chiquita banana was sometimes quite different. Because of this, United Brands was accused of abusing its market strength: they allegedly extracted the highest profit from each country.[17] However, economically we cannot condemn a company for doing exactly what a consumer does at the supermarket: picking the best offer!

This is precisely the free working of the law of supply and demand: the producer seeks to extract the highest price and the consumer the lowest. The producer may obtain a high price, but always while serving the consumer, because otherwise the consumer will stop buying its products.

If, when putting together their business model, United Brands had decided they could not capitalize their investment by obtaining the highest possible market price, even after winning a sufficiently large stake of the market, they would probably not have attempted such a risky venture. In turn, better-quality bananas would not reach the market, and this would have been damaging to the consumer, who would benefit from a wider array of choices.

The first problem with this market intervention, then, is the fact that if a company suspects that they won't be able to work freely to meet demand, they may not even risk the venture.

Secondly, even if the price in Belgium was 80% more than in Ireland, would it mean that in Brussels they should have mandated lower price by decree? It is wrong to claim that consumer benefit coincides only with lower prices. As long as the purchase of the bananas is voluntary, it reflects a cooperative exchange between the consumer and United Brands; therefore any price agreed to between the parties will be economically and socially the right price.

Finally, consider that the European Commission, by pointing out that the gap between prices in the five countries was excessive, was implicitly asking to United Brands to establish a "single priced banana market" in Europe.[18] Here we are touching on an interesting problem. European authorities attempted to modify the workings of the market by arbitrarily introducing "price leveling," meaning that the market price of bananas in Europe had to tend to a homogenous price. However, it is perfectly normal to have different market prices in different markets or in different geographical areas.[19]

Think about the different conditions of transportation and distribution that we may have in different countries.[20] In any case, just for the sake of the argument, what would happen if Brussels mandated the price leveling of all bananas? Some consumers would pay more than they were paying before, while other consumers would pay less. The former would be furious with the politician who decreed a doubling of the price of bananas, while the latter would be happy to pay less.

However, it is not possible to maintain the same product quality while lowering the price. For fresher bananas, the producer needs to employ faster methods of shipment, which are notoriously more expensive. In other words, where United Brands would have to lower its prices, they in turn would probably lower the product quality as well. Shall public authorities decide whether Mr. Smith should or should not enjoy the opportunity to buy Chiquita bananas for 1 Euro instead of 80 cents?

Let us now look at the origin of the problem with these antitrust policies.

The Treaty of the European Community[21] was built upon the idea of a European Common Market, hence the integration of the various national markets became one of the main objectives. Market integration might have meant the abolition of the protectionist barriers against free trade erected by national governments. In fact the elimination of governmental barriers to trade had actually been the guiding principle for the foundation in 1951 of the precursor of the European Common Market, the European Coal and Steel Community.

Moreover, to let the various European national markets integrate spontaneously with each other under the free market's hand would have meant to let this integration be realized according to the principle of consumer demand. In other words, the consumers would have driven this process just by following their own individual interests.

However, matters did not work out this way. The European Commission decided to guide the integration process, substituting its arbitrary judgment for the consumers' judgment. We may summarize here the arbitrary principles used by the European authorities:

Discouraging business strategies that segregated single national markets

For example, those companies that wanted to customize their product in each of the different national markets (maybe because in each national market the demand had its own peculiarities, hence a slightly different product had to be offered) operated with the fear of an attack from the antitrust authorities.[22]

Imposition of the type of distribution strategy

With the Grundig case, we have seen that with its decisions the Commission mandated the type of business model companies had to apply in the distribution of their products (with or without interbrand competition).[23]

Tendency to apply the principle of price leveling within the European market

With the United Brands case we have seen how the Commission attempted to favor a model of European economy where all prices tend to be leveled.

Tendency to identify the consumer benefit only with the price of the product

Both the previous cases show that the European authorities tended to limit the consideration of the consumer benefit to the price of the product.

Abrogation of consumer judgment in alleged cases of excessive price

In both cases we have witnessed how the antitrust authorities tried to substitute themselves for the consumers in the judgment of whether a price is or is not excessive.

$20

Antitrust policies applied against Grundig and United Brands represent a deplorable distortion of the workings of free competition. In these milestone cases the European antitrust authorities have ruled not by following the rule of consumer welfare, but by applying those arbitrary measures we have listed, in order to be able to control by decree the process of market integration. And when the free market has presented a product or a business practice that violated this decree, even if it was beneficial for the consumer, the European antitrust authorities declared it illegal.

If we were allowed to see only the final part of Mr. Smith's story, we would find a world made of cheaper and lower quality products, obtained because of European antitrust regulations. Is this the best option for the consumers? No, they obviously would have been better off with less regulation and more freedom of choice. They would have been better off in a situation identical to the first part of Mr. Smith's story. Unfortunately, the problem with antitrust regulation is not what we see, but what we don't see.


Massimiliano Neri is a PhD student in economics. He studies in Madrid with Jesus Huerta de Soto. Send him mail. Comment on the blog.

Notes

[1] Producer of the "Chiquita" brand bananas.

[2] See C. Fulda, 65, Columbia Law Review 625, 1965

[3] An example of a vertical deal is a contract between a producer and a distributor (hence between two companies that collaborate and are not rivals) in order to fix the details for the distribution of the product. The agreements usually contemplates features such as exclusive distribution, fixing of resale prices (otherwise called Resale Price Maintenance: RPM), after-sales service to consumers, etc. They are treated in the United States in the Section 1 Sherman Act (Restrictive Trade Practice) and in the European Union in Article 85 of the Treaty of Rome (Article 81 of the subsequent Treaty of Amsterdam).

[4] Technically, UNEF realized price arbitrage between different countries. The practice is called "parallel import" because the product are imported not only through the official distributor but also, in parallel, via other channels.

[5] The decision was taken by the Commission in 1964 and substantially upheld by the Court of First Instance in 1966. Grundig had signed a number of similar deals in other countries in the European market, consequently all of them were annulled.

[6] This business behavior is technically defined "concerted practices."

[7] Pioneer Europe tried to coordinate its European distributors over a problem of price gaps between France, Germany and UK (which created opportunities for parallel imports). The Commission, after investigating, found it a concerted practice between Pioneer and it distributors. The relevant fact was the meeting called by the parent company to deal with parallel imports. The case is known as Musique Diffusion Françaises v. Commission (C 100/80), and a brief description of it can be found in Goyder, Ibid., p. 103

[8] The concept of rivalry between distributors of the same brand is also known as "interbrand competition."

[9] The clients for this product may be various. From those who need a TV set for leisure (a bar, for their soccer fans; a senior center that offers social activities) to those that need it for working reasons (a school that complements didactics with recorded material, a security system, etc.).

[10] Moreover, think about the advertisement strategy for selling in France. The distributor may desire to spread advertising costs over all national customers, avoiding the unpleasant situation of having a parallel importer that free-rides the benefits of the ad.

[11] A company "abuses" its market position if they use it in order to obtain a benefit at the expense of consumers and competitors. The abuse of dominant position is treated in the United States in Section 2 of the Sherman Act and in Section 7 of the Clayton Act (USA); in the UK, it is covered in the monopolies and mergers provisions of the Fair Trading Act and the anti-competitive practices provisions of the Competition Act (UK); finally, in the EU, it is covered by Article 86 of the Treaty of Rome (Article 82 of the subsequent Treaty of Amsterdam).

[12] The definition of "abuse of dominant position" is a wide one and "represents a potent weapon in the hands of the Commission and of complainants." Goyder, Ibid, p. 350. Economists do not agree on the subject, neither the definition of the term nor the content of the economic policies to take. Somebody may think that the best example of abuse of dominant position is Microsoft, because of its overwhelming market share (over 90%). However, the fact that a company has a large market share does not mean that they are "abusing" the consumers. As far as the buyers are free to choose other alternatives, no abuse is committed. Conversely, a clear example of real abuse is a governmental monopoly, where the government mandates that the players of a given industry (for example the tobacco industry) shall be aggregated under one public agency controlled by the government. Here the consumer is deprived, by law, of the possibility to choose the producer he prefers.

[13] It was a highly vertically integrated process. Plantations were concentrated in Central and South America, spread over a large area, and specialized in those species more robust to diseases. Additionally, they were counting on the support of independent producers that complied with their quality requirements. It is curious to note that "this situation was borne out by the way in which United Brands was able to react to the consequences of hurricane 'Fifi' in 1974." They were the only company able to transport oversea 2/3 of their product with their own fleet. Moreover, they had "perfected new ripening methods in which its technicians instruct the distributor/ripeners of the Chiquita banana." This production structure was the result of a company policy that since 1967 had only one focal goal: "the quality of its Chiquita brand banana." See case 27/76, Chiquita Bananas, Ibid, par 69–96.

[14] They were the largest banana group, accounting in 1974 for 35% of all banana exports on the world market, and in 1975 for about 40–45% of the European market. See case 27/76, Chiquita bananas, ibid, par 97 and 108.

[15] Case 27/76, Chiquita bananas, ibid, par 129.

[16] The alleged barriers to entry identified by the Court were the following: a) large capital investments, b) need of a particular system of logistics, c) need to leverage economies of scale which does not allow to obtain immediate benefit, d) the cost of entry the European market (setting up of an adequate, commercial network, large-scale advertising campaigns , and other financial risks). See case 27/76, Chiquita bananas, ibid, par 122 and 123.

[17] "United Brand policy was to try to sell its products at prices which […] sought to extract the highest possible profit from all these countries." Distributors were left with a relatively low margin which had to be accepted because of United Brands' market strength. Goyder, Ibid, p. 353.

[18] See case 27/76, Chiquita bananas, ibid, par 221.

[19] Ludwig von Mises affirmed that the same physical product may be considered the same economical product only in the same point in time and space. That's why if the geographical location changes, the price is perfectly allowed to vary. Additionally, in its pricing strategy, United Brands had also to consider fluctuating market factors such as the weather, different availability of seasonal competing fruit, holidays, strikes, government measures, currency denominations. See case 27/76, Chiquita bananas, ibid, par 220.

[20] M. Rothbard, Ibid, p. 564–6. There isn't space here to explore the other accusation of abuse of dominant position for exploiting excessive prices. The reader may intuit that it would be interesting to inquire the rationale employed by antitrust authorities to determine when a price is excessive. On this matter, see in M. Rothbard, "The Illusion of Monopoly Price", Man, Economy, and State, 1993, Ludwig von Mises Institute, p. 586–620. Actually, all of chapter 10 is strongly recommended to those critical readers who suspect there is something wrong with today's antitrust policies.

[21] The treaty we are referring to is the one approved in Rome in 1958. Before going on, the reader should note an interesting fact about the intellectual climate of the mid-1960s. At that time, the European Commission chose against socialist planning of the European market not because of a profound belief in the benefit created by the free market, but because of the difficulties of building a bureaucracy capable of managing the process in a way that would satisfy different national interests. Goyder claims that "the Commission realized that a system of centralized planning of industrial and commercial objectives […] was impossible, firstly because of the size of the bureaucracy needed to enforce such a scheme throughout the Community, and secondly because the ground rules for such common policies could never have been agreed among the Member States in view of their widely differing views on industrial structures and their differing interpretations of national interests" (Ibid, p. 70). Compare this fact to the spirit truly in favor of economic freedom that inspired, just less than 10 years earlier, the funding of the European Coal and Steel Community (the precursor of the Treaty).

[22] Note that "market segmentation" represents one of the most advanced business practices companies have in order to act in each segment with the most appropriate strategy, henceforth with a different product offer. And market segmentation means market segregation, whatever type of boundaries chosen to define a market (geographical, social, technological, etc). By asking to "desegment" the market (that is, to homogenize the market) the antitrust authorities were ordering the society to take a huge step backward with respect to the history of the evolution of entrepreneurial knowledge and practices.

[23] The Grundig case outcome was to affirm that the aim was to establish market integration as the foremost principle to be considered in applying art 85(3). See Goyder, Ibid, p. 71–72.