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0867: Remembering dial-up, and reinforcing the counterfactual test

01 July 2008

Around the turn of the century, the Commission claimed that Telecom’s decision to introduce a free internet access number range (0867 xxx xxx), while implementing a charge for residential local number dial-up access to the Internet, was a breach of s36 of the Commerce Act.

Section 36 at the time (since amended) prohibited firms in a dominant market position from using that dominance for anti-competitive purpose. The High Court has held that Telecom neither used any dominance it may have had, nor had any anti-competitive purpose: instead, it was engaged in "normal profit maximising behaviour, to be expected of any firm, dominant or otherwise".

Background: interconnection, congestion, and Internet access charges

The background to Telecom’s introduction of the 0867 scheme was:

  • unprecedented growth and volume of residential Internet access calls in the later 1990s, made free as residential local calls under the terms of the Kiwi Share Obligation, but incurring termination charges to be paid by Telecom when the traffic was directed to another network

  • heavily asymmetric traffic (thus undermining the symmetric foundation for termination charges), made up of very much greater individual call times. On Telecom’s network, substantial network congestion was experienced and more was predicted, but the investment necessary to meet that demand was not met by any increased revenues, and would be stranded by then-nascent broadband technology; and

  • migration of ISPs to (principally) Clear’s network, to share in the termination payments received by Clear from Telecom, which wildly exceeded Clear’s costs of termination.

Under the 0867 scheme, use of the 0867 prefix meant that such internet traffic would be subject to the disciplines of Telecom’s Intelligent Network. Congestion could be avoided by rerouting traffic, or constraining it at its point of origin (rather than of termination). If ISPs’ customers were to avoid a charge for local Internet access calls made over their Telecom local access, ISPs had to change their local access number to one in the 0867 number range. If an ISP was located on another network, that network could take up 0867 numbers from Telecom to allocate to its ISPs.

Before its introduction in 1999, the Crown accepted the 0867 scheme as an extension of the KSO (and subsequently, on enactment of the Telecommunications Act 2001, as part of the TSO).

Specific legal/competition analysis in judgment

To succeed in a s36 case (under pre-2001 law) a plaintiff had to establish (a) dominance in a market (now a "substantial degree of power"), and (b) use thereof (now "take advantage") for (c) an anti-competitive purpose.

‘markets’

The Court found there were relevant national markets for:

  • fixed-line residential phone service to residential customers (i.e. the service by which residential customers transmit, among other things, data to and from the Internet);

  • wholesale network terminating access (i.e. the means by which each carrier can access the network of another to terminate calls). The Court allowed that the market may extend to access between networks for origination of calls from another network, but found that such access was not relevant to its analysis here.

‘dominance’

The Court held that, despite the constraining operation of the KSO (which left Telecom without freedom over price or supply), Telecom was dominant in the fixed line market. But Telecom was not – at least by 1999, when 0867 was introduced – dominant in the access market. This was due to the growth, presence and influence of competitor carriers, specifically in the main CBD areas.

‘use’

In terms of its dominance in the first market the Court held that Telecom acted as any firm in Telecom’s position but otherwise in a competitive market would have. So there was no use of dominance. (The same would apply, if the Court had concluded differently on the second market, that Telecom was dominant in access as well.)

‘purpose’

While strictly unnecessary to be decided, the Court also found that Telecom lacked anti-competitive purpose: rather it was engaged in "normal profit maximising behaviour, to be expected of any firm, dominant or otherwise. It would be strange indeed if it had not sought to stem the ever-increasing flow of termination payments". Indeed, the Court observed that "Telecom’s relative freedom from competitive constraints did not make it wrong to secure business advantages which might not have been so readily achievable in a competitive environment".

Core of issue for determination: what would a non-dominant firm have done?

The Commission’s case was that – while accepting the growth of Internet traffic challenged Telecom’s infrastructure to some extent – Telecom had a range of choices in responding. The Commission asserted that Telecom’s actual response used its dominance, in that it was conduct in which no other person (lacking Telecom’s dominance) could have engaged. On that theory, but for Telecom’s dominance in residential access markets, another firm could not have imposed internet access charges without risk of losing the customers to another network. But for Telecom’s dominance in the wholesale network access market, another firm could not have required interconnecting networks to waive payment of termination charges.

However, the Court instead accepted Telecom’s counterfactual: any provider of local access would seek to recoup increased costs in providing that access, even at the risk of loss of that customer. On loss of that customer to another network, either that other network would face the same increased costs (if the customer’s ISP resided on a third network to which termination charges were payable), or could not provide continuing subsidy of the ISP. The latter subsidy would not be made either because the ISP was located on the same network, or termination charges were not payable to the other network. Any provider of network access would seek to avoid incurring termination charges for rapidly rising internet traffic.

The Court held that "[t]his analysis leads inexorably to the conclusion that a non-dominant firm in Telecom’s position in a competitive market would have been able to introduce the 0867 service in order to deal with the termination fee and network capacity issues which concerned Telecom".

The counterfactual test – reinstated

The judgment is one of the first to grapple in a meaningful way with a specific application of the counterfactual test. This test was confirmed by the Privy Council in the Carter Holt Harvey litigation in 2004 as the correct test to establish use of dominance (harking back to its application in the foundation decision in the original Telecom/Clear proceedings of the 1990s). Simply put, there is no "use" of dominance if a non-dominant firm otherwise in more or less the same commercial position as Telecom could or would have acted similarly.

Here, the High Court has now given the development of the counterfactual central stage in its reasoning, and was critical of the Commission in conducting its case with a lack of attention to the practical detail of that construct.

Is there a need, or a platform for change to s36?

Most commentary on the judgment has largely taken preconceived positions, or focused on the length of time taken for this (complex) case to come to trial. Some voices have argued that notwithstanding the counterfactual’s "beguiling rationality and sense", there may be a basis for policy change or Parliament to intervene and amend s36 (again).

Some have commended consideration of the European Union’s position, which rejects the counterfactual standard, and adopts a significantly lower threshold in which dominant firms have ‘special responsibilities’ not encumbering others in the marketplace.

As with many areas, however, the European position is quite different and reflects the reality of an economic bloc of 27 countries and 495 million citizens, with various treaty arrangements.

The Treaty of Rome’s relevant provision simply prohibits "abuse… of a dominant position". The European courts have held that that does not require any causal connection between the dominance and the abuse: rather, the dominant firm "has a special responsibility not to allow its conduct to impair undistorted competition".

Thus the European standard asks whether the impugned conduct is objectively justifiable by reference to legitimate commercial behaviour, and is proportionate to the achievement of that objective. Whether that is materially different in outcome from application of the "counterfactual test", preferred by other jurisdictions, remains to be seen. Since the 2001 amendment to s36, moving from "use of dominance" to "taking advantage of substantial market power", there may not be much in it.

But it is worth noting also that the European Commission has been reviewing its dominance rules since 2004 in any event, and outcomes are not yet clear. The European Commission appears to favour the onus shifting to the dominant firm, to claim specific defences along the lines of the objectively justifiable and proportionate thresholds previously mentioned.

New Zealand economic conditions, and the natural tendency towards concentration in many sectors within a small remote economy, tend to sound a caution against wholesale adoption of European legal standards. And the relevance of the European approach for New Zealand has already been doubted in the 2004 Privy Council judgment in Carter Holt Harvey. There, the Court cautioned that "in the light of… the way Article 82 has been applied by the European Court, that it is unsafe for any conclusions to be drawn in the context of section 36 of the 1986 Act".

Disclosure: Chapman Tripp, led by Jack Hodder and Pheroze Jagose , represented Telecom.