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Prometheus unbound : towards the more precise proscription of the socially undesirable market conduct… Colvin, Craig Grierson 1993

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PROMETHEUS UNBOUND:TOWARDS THE MORE PRECISE PROSCRIPTIONOF THE SOCIALLY UNDESIRABLE MARKET CONDUCTASSOCIATED WITH DOMINANCEbyCRAIG GRIERSON COLVINB.Juris. (hons.), The University of Western Australia, 1983Ll.B. (hons.), The University of Western Australia, 1984A THESIS SUBMITTED IN PARTIAL FULFILMENT OFTHE REQUIREMENTS FOR THE DEGREE OFMASTER OF LAWSinTHE FACULTY OF GRADUATE STUDIESLaw ProgrammeWe accept this thesis as conformingto the required standardTHE UNIVERSITY OF BRITISH COLUMBIASeptember, 1993©  Craig Grierson Colvin, 1993In presenting this thesis in partial fulfilment of the requirements for an advanceddegree at the University of British Columbia, I agree that the Library shall make itfreely available for reference and study. I further agree that permission for extensivecopying of this thesis for scholarly purposes may be granted by the head of mydepartment or by his or her representatives. It is understood that copying orpublication of this thesis for financial gain shall not be allowed without my writtenpermission.(Signature)Department of  LawThe University of British ColumbiaVancouver, CanadaDate 24L September, 1993DE-6 (2/88)AbstractThe regulation of the market conduct of dominant firms is an entrenched part of thecompetition laws in many jurisdictions. The conduct which such laws proscribe has beenvariously described as "abuse of dominance", "anticompetitive conduct", "monopolization"or "improper use of market power". Each description is used by way of contrast to "normalcompetitive conduct". In all jurisdictions the courts have experienced considerable difficultyin articulating the distinction between lawful competitive behaviour and unlawful marketrivalry, principally because both may exclude rivals and lead to concentrated markets, andthe same conduct may be competitive or anticompetitive depending upon context.We argue, based upon an understanding of competition as a dynamic process (acycle of innovation and imitation), driven by rivalry between firms in which the possibilityof achieving dominance is a necessary element of the dynamic, that there is no marketconduct unique to dominant firms that is socially undesirable. Rather, the prospect ofdominance motivates all firms to pursue either competitive or rent seeking strategies tosecure the supra-normal profits attendant to a dominant position. Competitive strategiesare socially desirable as they seek to meet (or influence) consumer needs and therebypromote total welfare. Rent seeking strategies are undesirable as their purpose is toprevent other firms from meeting (or influencing) consumer needs and thus representinvestments in the distribution rather than the creation of wealth.We propose the rejection of existing laws, which require proof of dominance, andtheir replacement by a law which proscribes rent seeking by all firms. We contend thatsuch a law would articulate with greater precision the distinction between desirablellcompetitive behaviour and unlawful rivalry providing the courts with improved direction asto the evidentiary enquiry to be undertaken when a complaint of anticompetitive conductis made. It would also relieve dominant firms from the vagaries of the uncertaintiesinherent in the existing approach to the regulation of market conduct associated withdominance.iiiTable of ContentsAbstract^ iiTable of Contents^ ivAcknowledgement viChapter 1: Introduction: Are We Binding the Promethean Spirit?^1Chapter 2: What is Competition?^ 12The Market System 14Understanding Competition 19The Paradox of the Process of Competition^ 22Static and Dynamic Perspectives of the Process of Competition^28A Definition of Competition in terms of Innovation and Imitation 30Competition and Dominance^ 32Competition and Rent Seeking 35An Addendum - The Language of Competition^ 39Chapter 3: What are the Welfare Effects of Dominance? 41Conduct Associated With Dominance^ 42The Welfare Effects of Innovation 45The Welfare Effects of Rent Seeking 51The Welfare Effects of Imitation 54The Welfare Links Between Innovation and Rent Seeking^55An Aside Concerning Significant Exogenous Barriers to Diffusion^61Summary of Welfare Links Between Innovation, Rent Seeking andExogenous Barriers to Diffusion^ 67Conclusion Concerning Welfare Effects Associated with Dominance^68Whose Perspective of Welfare? 69The Regulatory Issue^ 71Chapter 4: Is Dominance Socially Undesirable?^ 73Equitable Distribution of Wealth and Power 73The Rationale for Regulatory Intervention 79ivChapter 5: Do Dominant Firms have a Unique Powerto Engage in Rent Seeking in the Market Place?^ 81Market Power^ 82Barriers to Entry 85Monopoly Power 89Strategic Motive and Advantage^ 91Dominance as a Filter^ 95A Synthesis^ 96Chapter 6: Precisely What is the Difference BetweenCompetition and Rent Seeking?^ 98A Proposal for a Model Law 103The Proposed Law^ 111Four Applications of the Model Law^ 125Taprobane 125NutraSweet 132Aspen^ 138United Shoe Machinery^ 142The Issue of Predatory Pricing 145Other Advantages of Rejecting Dominance as a Basis for Regulation^147Chapter 7: Conclusion: Prometheus Unbound^ 149Bibliography^ 151Appendices 161Appendix 1: Countries Which have an Existing Dominance Law^161Appendix 2: Dominance Laws of Australia, Canada, European Community,New Zealand and the United States^ 162Appendix 3: Proposed Model Law for the Regulation of Socially UndesirableMarket Conduct Associated with Dominance^ 167AcknowledgementThe author is grateful for the critical review and many helpful comments of ProfessorsMarilyn MacCrimmon and Thomas Ross, together with their encouragement to apply, andcareful instruction in, economic principles. The author also thanks Lyn, Rebecca and Katiefor their patient support. Of course, any errors are those of the author.viChapter 1: Introduction: Are We Binding the Promethean Spirit?0 divine air and sky and swift-winged breezes, springs of riversand countless laughter of sea waves, earth, mother of everythingand all-seeing circle of the sun, I call on you. See what I, a god,suffer at the hands of the gods.The words of Prometheusbound in torment in ScythiaPrometheus Bound, AeschylusIn Greek mythology, Prometheus brought not only fire, but also carpentry,knowledge of the stars, wings of sail, docile horses, numbers and letters, soothing remedies,indeed all the arts to mankind. Yet Prometheus, the benefactor of mankind, the bringerof technology and hope was taken, in accordance with the commands of Zeus, to theuninhabited land of Scythia, and there bound and pinned by a stake through his chest todesolate crags. Each day an eagle would come and feed on his immortal liver, which wouldbe restored in equal measure each night. Despite this torment, the spirit of Prometheusremained unyieldingl . For some, the Promethean myth finds current expression in theregulation of dominant firms2. Competition laws, it is argued, are cruel punishment forE Hamilton, Mythology: Timeless Tales of Gods and Heroes (Boston, Mass.: Little, Brown & Co, 1940)and M.P.O. Morford & R.J. Lenardon, Classical Mythology, 3rd ed. (New York: Longmann, 1985) at 50-60.2 Definition of the term "dominant firm" is central to the issues discussed in this paper. Any attempt todefine what is meant by dominance raises a number of contentious questions. However, in common parlancethe term "dominant firm" is used in an imprecise way to refer to any firm that is significantly larger or morepowerful than its rivals in the marketplace. We will use the term in this way for the purposes of introduction.For our definition of dominance see below, c.2 - An Addendum - The Language of Competition.1those firms that bring wealth to our society3. Others are concerned to control the superiorpower of today's Prometheans, wary of the hope that they brine.Nevertheless, the regulation of the market conduct of dominant firms is anentrenched part of the competition laws in many jurisdiction s. Dominance is also thefundamental concept underlying the attempts to formulate international codes for theregulation of market conduct6. Such provisions are unique amongst competition laws.3 Amongst those who, like Hercules, would come to slay the eagle who preys upon Prometheus are R.H.Bork, The Antitrust Paradox (New York: Basic Books, 1978); J.S. McGee, In Defense of IndustrialConcentration (Seattle: University of Washington Press, 1971); D.T. Armentano, Antitrust and Monopo•Anatomy of a Policy Failure (New York: John Wiley & Sons, 1982) and others of the Chicago School whoargue for the repeal of most or all competition laws on the basis that dominance is the evidence of superiorefficiency unless it is secured through naked cartel.4 It was Prometheus who ensured that amongst the evils to be found in Pandora's box and unleashed uponmankind was "blind hope". Many would argue that those who trust in the hope that dominance causes nosignificant social harm are blind to the costs of monopoly - both in terms of efficiency (F.M. Scherer,Industrial Market Structure and Economic Performance, 2nd ed. (Chicago: Rand McNally, 1980); W.G.Shepherd, The Economics of Industrial Organization, 2nd ed. (Englewood Cliffs, N.J.: Prentice-Hall, 1979);Hay & Morris, Industrial Economics and Organization: Theory and Evidence, 2nd ed., (Oxford: OxfordUniversity Press, 1991); and KG. Elzinga, "The Goals of Antitrust: Other than Competition and Efficiency,What Else Counts" (1977) 125 U.Pa.L.R. 1191) and other social goals (E.M. Fox, "The Politics of Law andEconomics in Judicial Decision Making: Antitrust as a Window" (1986) 61 N.Y.U.L.R. 554; R. Pitofsky, "ThePolitical Content of Antitrust" (1979) 127 U.Pa.L.R. 1051).5 See Appendix 1 for a list of jurisdictions which have enacted dominance laws. We focus upon therelevant laws (and their judicial interpretation) in Australia (s.46 of the Trade Practices Act (C'wealth) 1974[hereinafter the Trade Practices Act]), Canada (ss. 78 & 79 of the Competition Act R.S., 1985, c.19 (2ndSupp.) [hereinafter the Competition Act]), the European Community (art. 86 of the Treaty of Romeestablishing the European Economic Community [hereinafter the E.C. Treaty]), New Zealand (s.36 of theCommerce Act 1986 [hereinafter the Commerce Act]) and the United States (s.2 of the Sherman Act 26 Stat.209 (1890) as amended by 88 Stat. 1708 (1974) [hereinafter the Sherman Act]) each of which are set out infull in Appendix 2.The General Assembly of the United Nations has adopted the Set Of Multilaterally Agreed EquitablePrinciples and Rules for the Control of Restrictive Business Practices (1980) 19 Int. Leg. Mat. 813. For adiscussion of the Restrictive Business Practices Code see J.M. Czako, "The Set of Multilaterally AgreedEquitable Principles and Rules for the Control of Restrictive Business Practices" (1981) 13 Law & Pol. ofInt. Bus. 313. Also, the Organization for Economic Co-operation and Development: CouncilRecommendation Concerning Restrictive Business Practices Affecting International Trade focuses upon useof market power (1986) 25 Int. Leg. Mat. 1629. The Council Recommendation followed an earlier reportof the Organization for Economic Co-operation and Development Committee of Experts on RestrictiveBusiness Practices Market Power and the Law (0.E.C.D. Publications: Paris, 1970). There were earlierattempts by the League of Nations to address the same issues; see J.T. Haight, "The Restrictive BusinessPractices Clause in United States Treaties: An Antitrust Tranquillizer for International Trade" (1960) 70 YaleL.J. 240.2Whereas other provisions regulate a specific type of conduct - such as the formation ofcartels, resale price maintenance, exclusive dealing, price discrimination or mergers -dominance laws regulate a specific type of firm. As to conduct, dominance laws lackspecificity. The conduct which such laws proscribe has been variously described as "abuseof dominance", "anticompetitive conduct", "monopolization19" or "improper use ofmarket power11". Each description is used by way of contrast to "normal competitiveconduct". However, there remains considerable ambiguity as to the precise meaning of suchdistinctions.An examination of the decisions in leading dominance cases in Australia, Canada,the European Community, New Zealand and the United States reveals that the courts haveFor some of the uncertainty that arises see, in Australia, F. Hanks & P.L. Williams, "Implications ofthe Decision of the High Court in Queensland Wire" (1990) 17 Melb. U.L.R. 437; in Canada, D.N. Thompson,"Monopolization and Abuse of Dominant Position: The Unanswered Questions" in R.S. Khemani & W.T.Stanbury, eds., Canadian Competition Law and Policy at the Centenary Halifax N.S.: The Institute forResearch on Public Policy, 1991, 315; in Europe, V. Korah, An Introductory Guide to EEC Competition Lawand Practice, 4th ed. (Oxford: ESC Publishing, 1990) c.4; and in New Zealand, L.F. Hampton, "Section 36(1)of the Commerce Act 1986: An Analysis of its Constituent Elements" in RJ. Ahdar, ed., Competition Lawand Policy in New Zealand (Sydney: Law Book Co., 1991) 179. In the United States the debate as to themeaning of the monopolization law is prolific. For a comprehensive review of the material see P.E. Areeda& D.F. Turner,Antitrust Law: An Analysis of Antitrust Principles and Their Application (Boston: Little, Brown& Co., 1982) vol. 3.8 An expression which originates from the provision in the article 86 of the E.C. Treaty; Korah, ibid. at55-6. It appears as a heading to ss. 78 & 79 of the Competition Act, and is a term used in the literature inCanada (Thompson, ibid; and B. Dunlop, D. McQueen & M. Trebilcock, Canadian Competition Policy: A legaland Economic Analysis (Toronto: Canada Law Book, 1987) at 201ff) although not in the decisions of theCompetition Tribunal (eg., Director of Investigation and Research v. Laidlaw Waste Systems Ltd (1992) 40C.P.R. (3d) 289 at 331ff [hereinafter Laidlaw] and Director of Investigation and Research v. NutraSweet Co.(1991) 32 C.P.R. (3d) 1 at 33ff [hereinafter NutraSweet]).9 See the Competition Act and decisions of the Competition Tribunal in Canada; e.g., Laidlaw andNutraSweet, ibid. It is an expression that is also used in the United States Supreme Court; e.g., CopperweldCorp. v. Independence Tube Corp. 467 U.S. 752 (1984) at 767-8.' See the Sherman Act. It was also formerly the marginal note describing s.46 of the Trade Practices Act.11 See s.46 of the Trade Practices Act in Australia. The provision in New Zealand refers simply to the"use of a dominant position"; s.36 of the Commerce Act.3had persistent difficulty in articulating the dichotomy between lawful and unlawful conductwhen interpreting attempts by the legislatures in those jurisdictions to regulate the activitiesof dominant firms. The essence of the difficulty lies in the fact that both successfulcompetition and its abuse result in the exclusion of competitors and lead to lesscompetition. The difficulty arises because, in regulating to promote competition, it mustbe recognized that the paradox of the market place is that "[e]ach contestant strives to win,but if one of them wins completely, then monopoly comes to exist!"12 In other wordsVigorous competition 'excludes' rivals. The more successful afirm is at reducing the cost of its product or making thatproduct more attractive to consumers, the more it sells. In theend a very successful firm will wind up with the whole market.The objective is to find ways to separate this from the kind ofexclusion that injures consumers 13.It is an objective which the courts have adopted, but have struggled to achieve.The earliest jurisprudential attempts to grapple with the distinction occurred in theUnited States which has a long standing dominance law. Its terms are contained in s.2 ofthe Sherman Act and are rather brief and cryptic. The section provides, inter aliaEvery person who shall monopolize, or attempt to monopolize,or combine or conspire with any other person or persons, tomonopolize any part of the trade or commerce among theseveral States, or with foreign nations, shall be deemed guiltyof a felony...Understandably, the cases focus upon an explication of the activity of "monopolization".12 Shepherd, supra, note 4 at 11.13 F. Easterbrook, "On Identifying Exclusionary Conduct" (1986) 61 Notre Dame L.R. 972 at 973. Fora discussion of how long the issue of distinguishing between competition and unlawful exclusionary behaviourhas been the unresolved issue central to the regulation of socially undesirable market conduct associated withdominance; see V.H. Kramer, "Competition Chasing the Tail of Efficiency" in H. First, E.M.Fox & R. PitofskyRevitalizing Antitrust in its Second Century (New York: Quorum, 1991) 254.4In a landmark decision in 1945, United States v. Aluminium Co. of America lt JusticeLearned Hand summarized the state of the law at the time in the following way...from the very outset the courts have at least kept in reservethe possibility that the origin of a monopoly may be critical indetermining its legality...This notion has usually been expressedby saying that size does not determine guilt; that there must besome "exclusion" of competitors; that the growth must besomething else than "natural" or "normal"; that there must bea "wrongful intent," or some other specific intent; or that some"unduly" coercive means must be used...What engendered thesecompunctions is reasonably plain; persons may unwittingly findthemselves in possession of a monopoly, automatically so tosay: that is, without having intended either to put an end toexisting competition, or to prevent competition from arisingwhere none had existed; they may become monopolists byforce of accident...A single producer may be the survivor outof a group of active competitors, merely by virtue of hissuperior skill, foresight and industry. In such cases a strongargument can be made that, although the result may exposethe public to the evils of monopoly, the Act does not mean tocondemn the resultant of those very forces which it is its primeobject to foster...The successful competitor, having been urgedto compete, must not be turned upon when he wins 15 .Judge Learned Hand's views were endorsed by the United States Supreme Court inAmerican Tobacco Co. v. United States 16. The court quoted with approval the statementby Judge Learned Hand that it does not follow from the fact that Alcoa had a monopoly"that it 'monopolized' the ingot market; it may not have achieved monopoly; monopoly mayhave been thrust upon it" 17. To achieve the outcome of monopoly is not monopolization.However, once it is accepted that the outcome of monopoly may be the consequence14 148 F.2d 416 (2d Cir. 1945) [hereinafter Alcoa).15 Ibid. at 429-30.16 328 U.S. 781 (1946).17 Ibid. at 786.5of desirable (and lawful) market conduct, one is left with the question what is the differencebetween normal competitive behaviour, which, when successful, may lead to lesscompetition, and "monopolization" 18. It is an issue that persists 19. As recently as 1984,in Copperweld Corp v. Independence Tube Corp2° the United States Supreme Courtagain expressed the difficulties in distinguishing competition from exclusionary conduct 21 .The same doubts arise in Australia where the High Court is yet to describe with anyprecision the nature of unlawful rivalry by dominant firms. The relevant provision is s.46of the Trade Practices Act which prohibits a dominant firm from taking advantage of itsmarket power for the purpose of eliminating or damaging a competitor or preventingcompetitive behaviourn. In the leading case, Queensland Wire Industries Pty Ltd v. Broken Hill Proprietary Co. Ltd n, Dawson J. statedThe difficulty in determining what conduct constitutes takingadvantage of market power and what conduct does not, stems18 The earliest cases in the United States were not so generous in their treatment of existing monopolies.There were certainly cases in which the very existence of monopoly was considered to be undesirable, andprima fade evidence of the practice of "monopolization"; e.g., Standard Oil Co. v. United States 221 U.S. 1(1911) at 75." See Berkley Photo v. Eastman Kodak Co. 603 F.2d 263 (2d Cir. 1979) [hereinafter Kodak] where at 273Kaufman C.J. described the distinction as the "fundamental tension" and "the paradox" of s.2 of the ShermanAct.20 467 U.S. 752 (1984).21 Ibid. Burger J. at 767-8 ("It is not enough that a single firm appears to "restrain trade" unreasonably,for even a vigorous competitor may leave that impression. For instance, an efficient firm may captureunsatisfied customers form an inefficient rival whose own ability to compete may suffer as a result. This isthe rule of the marketplace and is precisely the sort of competition that promotes the consumer interests thatthe Sherman Act aims to foster. In part because it is sometimes difficult to distinguish robust competitionfrom conduct with long-run anticompetitive effects, Congress authorized Sherman Act scrutiny of single firmsonly when they pose a danger of monopolization").22 The provision states that a firm "with a substantial degree of power in a market shall not takeadvantage of that power" for any one of a number of proscribed purposes. Power is defined to mean marketpower in s.46(4) of the Trade Practices Act. The full text of the provision is set out in Appendix 2.23 (1988) 167 C.L.R. 177 [hereinafter Queensland Wire].6inevitably from the need to distinguish between monopolisticpractices, which are prohibited, and vigorous competition,which is not. Both here and in the United States the searchcontinues for a satisfactory basis upon which to make thedistinction. For the most part, all that emerges are synonymswhich are not particularly helpful. Words such as "normalmethods of industrial development", "honestly industrial", "anti-competitive", "predatory" or "exclusionary conduct" merely begthe question2A.His Honour made no express attempt to articulate a distinction that would end the search.In Canada, where an order may be made prohibiting the practice of anticompetitiveacts by a person substantially in control of a class or species of business25, the CompetitionTribunal has recognized the same problems. In Laidlaw', Reed J statedA review of the literature indicates that attempting to establishsome general criteria as to when an act or practice is anti-competitive and should be restrained, as opposed to when it isa sign of healthy or at least normal commercial competition, isnot easy...To the extent that any general criteria exist theyseem to require an assessment of the nature and purpose ofthe acts which are alleged to be anti-competitive and the effectwhich they have or may have on the relevant market. Ananalysis is required which takes into account the commercialinterests of both parties served by the conduct in question andthe degree of restraint or distortion of competition whichresultsy .The European cases also address similar issues. In attempting to extract the judicialinterpretation of the term "abuse" in art. 86 of the E.C. Treaty which provides that a firmshall not abuse a dominant position in the common market, Vogelenzang statesAs a result we may define "abuse" in Article 86 of the EEC24 Ibid. at 202.25 See s.79 of the Competition Act.26 Supra, note 8.27 Ibid. at 333.7Treaty as "market behaviour damaging either consumers, thecompetitive process, or other market participants"... However,the following complication arises: the freedom to compete ofany company, including dominant ones, must be recognized asone of the interests to be protected by the EEC Treaty.Competition is the fight for the consumer's dollar. If a largecompany obtains an order to the detriment of a smallercompetitor such cannot be held per se to be undesirable underthe EEC Treaty merely because of the fact that the smallercompany, is indeed, "damaged as .Again, in New Zealand, which has a dominance law that is similar to the Australianprovision29, the courts have struggled with the distinction between competitive conduct andan improper use of a dominant position. In one of the first cases under the provision (arelatively recent addition to the law in New Zealand), Tipping J. observedI would venture the following proposition. It is not a breachof s.36 if a person, albeit with a dominant position, simply actsin a competitive manner. It would be an irony if such conductcould be attacked because it is competition which the Act isdesigned to promote...The line may well be a fine one incertain cases but it will be a matter of fact and degree andultimately of judgment in the individual case whether the linebetween what one might call legitimate competition andillegitimate competition has been crossed".It is evident that in each jurisdiction the courts recognize that accuratelydistinguishing between lawful competitive behaviour and unlawful market rivalry is a keyissue in interpreting the dominance law. However, the judicial decisions are singularly28 "Abuse of a Dominant Position in Article 86; The Problem of Causality and Some Applications" (1978)13 Common Mkt LR. 61 at 64." See s.36 of the Commerce Act which provides "No person who has a dominant position in a marketshall use that position" for any one of a number of proscribed purposes. The full text of the provision is setout in Appendix 2." New Zealand Magic Millions Ltd v. Wrightson Bloodstock Ltd [1990] 1 N.Z.L.R. 731 at 761 where theHigh Court also cited with approval the passage from the judgment of Dawson J. in Queensland Wire, supra,text relating to fn. 23. See also the reasoning of the New Zealand High Court in Union Shipping NewZealand Ltd v. Port Nelson Ltd [1990] 2 N.Z.L.R. 662 [hereinafter Union Shipping] at 706ff.8unhelpful in articulating the distinction. It is this issue that we address in this thesis, viz.precisely what is the socially undesirable market conduct associated with dominant firms (ifany) and how may it be distinguished from ordinary competitive behaviour.We argue that the undesirable market conduct associated with dominance can beprecisely identified only once the concept of competition is properly understood. Underthe influence of modern economic theory, a static view of competition pervades thejurisprudence. Instead, we emphasize the fact that competition is a dynamic process (acycle of innovation and imitation) which is driven by the opportunity for competitors to earnadditional profits by pursuing strategies which place them in a position of relative freedomfrom competitive constraint (market dominance) - at least for a time. By competing, firmsincrease the total welfare of society because profits are to be made in serving the needs ofconsumers at a lower price than their rivals. Where there are competitive markets, pursuitof the private goal of profit maximization promotes the public goal of maximizing totalwelfare. We conclude that as the opportunity to achieve dominance, at least for a time, isan integral part of the way the process of competition promotes total welfare, dominanceis socially desirable.However, profits may also be made by firms preventing rivals from supplyingconsumer needs in competition with them, an activity which reduces total welfare.Economists describe such behaviour as rent seeking. Such behaviour reduces total welfare.It is the prospect of dominance that motivates rent seeking. Therefore, both competitivebehaviour and rent seeking are associated with dominance. But, whereas competitivebehaviour is desirable because it serves consumer needs, rent seeking is undesirable becauseit consumes resources in the non-productive activity of preventing rivals from meeting9consumer needs more efficiently.Nevertheless, although dominant firms have a substantial motive to invest in rentseeking practices to prevent the erosion of the additional profits they already enjoy byreason of their relative freedom from competitive constraint, any firm may be motivatedto pursue rent seeking practices if it believes that it will be able to secure a dominantposition as a result. Therefore, the practice in the market place of the socially undesirableactivity of rent seeking will not be limited to dominant firms 31. Further, althoughdominance is often viewed in pejorative terms because it is said to effect inequitabledistributions of wealth and power by concentrating both in the hands of dominant firms, weargue that, properly understood, the process of competition, though it may result indominance for a time for successful firms, in fact operates to both build and break downdominant positions because the substantial profits earned by dominant firms in turn attractsstrong competition. The real concern is not conduct of dominant firms per se, but the waydominance motivates investment in strategies designed to exclude competition. We arguethat the distinction between such rent seeking behaviour on the one hand and innovationand imitation (competitive behaviour) on the other hand is the answer to the difficultywhich the courts have experienced in interpreting dominance laws. We explore in detailthe notion of rent seeking behaviour and how it may be distinguished from "ordinary"competition. We conclude by proposing a law which proscribes rent seeking by all firmsto replace existing dominance laws.Such a law has a number of advantages. Like other competition laws, a law which31 The fact that a position of dominance facilitates certain rent seeking strategies is discussed in detailbelow, c. 5 - Strategic Motive and Advantage. However, it remains possible for non-dominant firms to pursuerent seeking strategies in other contexts.10proscribes rent seeking applies to a specific type of conduct rather than a specific type offirm. As a result it forms part of a law which outlines a code of acceptable competitivebehaviour for all firms. It does not require a conclusion to be reached as to the "relevantmarket" an enquiry which is productive of much uncertainty and cost in dominance cases32.In sum, we reject the tendency to view market dominance in pejorative terms. Suchdominant firms ought not be subjected to the vagaries of a rule which fails to distinguishwith any precision between acceptable and unacceptable market conduct. To that extentwe argue for the release of today's Prometheans from the torment 33 of existing regulationswhich fail to recognize adequately that market dominance may be the outcome of asuperior ability to meet the needs of consumers in the market place, an ability that issocially desirable.32 See A. Bollard & D. White, "The Interface Between Law and Economics in the Context of theCommerce Act 1986" in R.J. Ahdar, ed., Competition Law and Policy in New Zealand (Sydney: Law Book Co.,1991) 4 at 52 ("Economic and legal analysis of the "market" concept has bedeviled competition law litigationand commentaries"); and Dunlop, McQueen & Trebilcock, supra, note 8, at 230 describe the enquiry as therelevant market as "the always-difficult task of defining the appropriate market, of determining the marketshare..., and of examining other indicia of market power". These issues are considered in more detail below,see c.6 - Applying the Model Law.33 There are substantial penalties for the breach of dominance laws. The level of fines are; in Australiaand New Zealand up to $5,000,000 for corporations and $250,000 for individuals; in Canada, up to$10,000,000; in the European Community fines of up to 1 million ECUs or 10% of the turnover for theprevious year of the offender (calculated to include the turnover of all subsidiaries - Re "Pioneer" Hi-FiEquipment [1980] 1 CM.L.R. 457) and in the United States $1,000,000 for corporations and $100,000 forindividuals. Civil actions for damages are also possible (including actions for treble damages in the UnitedStates). Injunctions, divestment and other remedial orders with substantial commercial consequences mayalso be ordered in all jurisdictions.11Chapter 2: What is Competition?One of the striking aspects of economics in informing competition policy is that itdoes not advance a definition of competition TM. To some degree that fact is unremarkable.After all competition is a relatively simple concept embracing the idea of rivalry betweenbuyers and sellers in the market place. Buyers and sellers negotiate between each otheras to all of the attributes of a good or service that may be exchanged between them suchas quality, function, terms of payment, liability for defects, time and place of delivery andprice. In doing so they take into account similar activities by rival buyers and sellers. Theycompete with each other.The origins of economics lie in the study of competition as such a behavioralphenomenon. The notion of competition as rivalry was adopted by Adam Smith in theWealth of Nations35. However, under the influence of Cournot and others competitionDunlop, McQueen & Trebilcock, supra, note 8, at 1-2. R.C. Bernhard, "Divergent Concepts ofCompetition in Antitrust Cases" (1970) 15 Antitrust Bulletin 1099 describes the diversity of meaning givento the term competition by lawyers, economists and businessmen in the following terms "Competition is astandard by which the law judges the legality of many business practices; competition is an abstraction whicheconomists use to pass judgment on economic institutions and policies; competition is a plague upon firmswho feel their share of the market is insecure. Competition is a protection for consumers and a charter offreedom for individuals and firms in their productive activities. Competition is a law of nature. Competitionis a violation of moral and ethical principles, a destructive, vicious and unscrupulous form of economicaggression. It is all these things in addition to being the economist's technical specification for perfectionin economic life; and, at other times, the economist's description of a reality that is far from perfect".ss An Enquiry into the Nature and Causes of the Wealth of Nations (Dublin: Whitestone, Chamberlaine,1776). G.J. Stigler, "Perfect Competition, Historically Contemplated" (1957) 65 J. Pol. Econ. 1 at 1-2 creditedSmith with establishing competition as the pervasive concept upon which economics was subsequently built.He described Smith's use of the term competition as follows "'Competition' entered economics from commondiscourse, and for long it was connoted only the independent rivalry of two or more persons. When AdamSmith wished to explain why a reduced supply led to a higher price, he referred to the 'competition [which]will immediately begin' among buyers; when the supply is excessive, the price will sink more, the greater 'thecompetition of the sellers, or according as it happens to be more or less important to them to getimmediately rid of the commodity'. It will be noticed that 'competition' is here (and usually) used in thesense of rivalry in a race - a race to get limited supplies or a race to be rid of excess supplies. Competitionis a process of responding to a new force and a method of reaching a new equilibrium." P.J. McNulty, "ANote on the History of Perfect Competition" (1967) J. Pol. Econ. 395 at 396-7 subsequently offered a12came to be associated with the state of affairs in which every action by a seller could bematched by a rival; pure or perfect competition36. McNulty explains the distinctionbetween Smith's original perspective of competition and that which became the focus ofeconomic study through the model of perfect competition as followsThe concept of competition, originating with Cournot, on theother hand, is totally devoid of behavioral content. This isbecause Cournot's focus was entirely on the effects, rather thanthe actual workings, of competition 37.The problem was that in focusing upon effects, competition was assumed out of theequation. Within the constraints of the model of perfect competition there could be nocompetitive behaviour. Indeed the description "perfect competition" is something of amisnomer in that it describes not the process of competitive rivalry, but the theoreticalresult once all opportunities for competitive behaviour have been exhausted38. In short"if the state of affairs assumed by the theory of perfect competition ever existed, it wouldnot only deprive of their scope all the activities which the verb 'to compete' describes butwould make them virtually impossible" 39.The legacy of the model of perfect competition has been a tendency amongst policymakers to ignore the essential role which the potential for a relative absence of competitioncorrection. "Rather than considering Adam Smith as the progenitor of a concept whose refinement came atthe hands of a group of successors, it is more accurate, as far as the history of competition is concerned, tothink of Smith's work as marking the end of one era and the beginning of another". Importantly, for ourpurposes, both agree that competition was originally used to describe behaviour and that "Smith's use of theterm seems to have been largely independent of market structure"; McNulty, ibid, at 397.38 Stigler, ibid; and J.M. Clark, Competition as a Dynamic Process (Washington: Brookings, 1961) at c.2.37 McNulty, supra, note 33 at 398.38 P.J. McNulty, "Economic Theory and the Meaning of Competition" (1968) 82 Q.J. Econ 639.39 F.A. Hayek, Individualism and Economic Order (Chicago: University of Chicago, 1948) at 96.13plays in the process of competition°. The significance of the distinction between theprocess of competition (or competitive behaviour) and the theoretical outcome ifcompetition is pursued to its logical extreme (or the state of perfect competition) is notalways articulated by economists or understood by lawyers. It is a distinction that lies at theheart of competition policy. In particular, it is the key to understanding the rationalebehind the current regulation of market conduct of dominant firms. To the understand thesignificance of the distinction it is first necessary to comprehend the nature and function ofthe market system and the way competition operates as its driving force.The Market SystemCompetition policy is informed by a view of markets as the most effectivemechanism41 for optimizing the welfare of its citizens by maximizing the total value ofgoods and services produced by that society 42. Although there remains underlying4° T.M. Jorde & DJ. Teece, "Introduction" in T.M. Jorde & DJ. Teece, Antitrust Innovation, andCompetitiveness (New York: Oxford University Press, 1992) 3 at 5-7.41 By the term "mechanism" we refer to the means by which a society decides what commodities toproduce from its available resources and in what quantities. Alternatives include competitive markets,bureaucracies or customs. Although one mechanism may be dominant, societies use a number ofmechanisms. In a market economy, firms exist because of the efficiencies associated with bureaucracy; R.H.Coase, "The Nature of a Firm" (1937) 4 Economica 386. Indeed the trend towards larger firms in the latterpart of the twentieth century can be seen as a consequence of the efficiencies to be derived from the planningof good management; Peter F. Drucker, Management: Tasks, Responsibilities, Practices (New York: Harper& Row, 1985) at 11-26. As to the role of customs in the allocation of resources see Manning Nash, Primitiveand Peasant Economic Systems (Scranton, Penns: Chandler, 1966) and Robert L. Heilbroner The Making ofEconomic Society 6th ed. (Englewood Cliffs, NJ.: Prentice Hall, 1980), 24-44. Customs continue to have arole in "market" economies. They are seen in the way families distribute income between family members.42 Whilst we adopt such a perspective for our present purposes, we note that there are at least fourcriticisms to the assumption that welfare is optimized by maximizing the total value of goods and services.First, there are limits to growth; D.H. Meadows et. al. The Limits to Growth (New York: Universe Books,1972) and F. Hirsch, The Social Limits to Growth (London: Routledge, 1977). Second, technology andgrowth, though improving the quantities of goods and services produced by society result in significantspillover effects, particularly in terms of environmental impacts and social dislocation, which are ignored bya preoccupation with increasing the total value of goods and services produced by an economy; EJ. Mishan,14philosophical support for markets as an expression of the individual rights and freedomsconsistent with a liberal view of democracy43, amongst regulators the case for competitivemarkets is most commonly made in terms of economic welfare. With the collapse ofcommunism, competitive markets are championed as the most efficient means ofmaximizing wealth from scarce resources.Today, most governments adopt the market as the primary mechanism by which toallocate resources45. The total welfare of all citizens is seen as being maximized byTechnology and Growth (New York: Praeger, 1969) and J. Ellul, The Technological Society (New York: Knopf,1964). Third, an increase in total welfare may occur without growth in the production of goods and servicesin that the total wellbeing of society and its members is also affected by changes in culture, art, environment,relationship and leisure amongst other considerations. Fourth, the welfare (or wellbeing) of society will onlybe increased if an ideology of contentment and mutual concern for the welfare of others replaces theinsatiable pursuit of wealth maximization based upon an individualistic perspective; AK Sen, "PersonalUtilities and Public Judgements: What's Wrong With Welfare Economics" (1979) Econ. J. 537; J. Ellul, Moneyand Power, trans. L Neff (Downers Grove:Inter-Varsity, 1984), R. Goudzwaard, Capitalism and Progress,trans. J. van N. Zylstra (Toronto: Eerdmans, 1979) and D. Hay, Economics Today (Leicester: InterVarsity,1989).' F.A. Hayek, The Road to Serfdom (Chicago: University of Chicago Press, 1976); M. Friedman,Capitalism and Freedom; and Clark, supra, note 36 at 85-6.44 E.g., P.K. Gorecki & W.T. Stanbury, The Objectives of Canadian Competition Policy 1888-1983(Montreal: The Institute for Research on Public Policy, 1984) at c.4; Shepherd, supra, note 4 at c.2; Dunlop,McQueen & Trebilcock, supra, note 8 at c.4; Korah, supra, note 7 at 6; Areeda and Turner, supra, vol. 1, at7. For a qualified adoption of the goal of maximizing total welfare see E.M. Fox, "The Modernization ofAntitrust: A New Equilibrium" (1981) 66 Corn. L.R. 1140; and R.J. Ahdar, Introduction in R.J. Ahdar ed.,Competition Law and Policy in New Zealand (Sydney: Law Book, 1991) 1.' Recent developments in Eastern Europe witness a marked swing from planned to market economies.The popular press has portrayed the winds of change sweeping Eastern Europe and the Soviet Union as thefallout of the failure of planned economies to match the wealth generation of market economies. However,there is far more to the dynamics of "successful" Western economies than the market mechanism alone.Indeed many so-called Western market economies exhibit substantial government regulation. There isempirical data that questions the superiority of an unregulated market over central planning as a generatorof wealth; see the survey of empirical research by P. Murrell, "Can Neoclassical Economics Underpin theReform of Centrally Planned Economies?" (1991) 5 J. of Econ. Persp. 59 and the comparison between privateand state owned firms in A.E. Boardman & A.R. Vining, "Ownership and Performance in CompetitiveEnvironments: A Comparison of the Performance of Private, Mixed and State Owned Enterprises" (1989) 32J. of Law & Econ. 1.46 We use the term "total welfare" to refer to the aggregate production of goods and services within aneconomy. In doing so we do not reject the critiques of such productivity measures, supra, note 42. Rather,we contend that such a definition reflects the limited public policy objectives of competition laws directed15competition between buyers and sellers in the market place. In general, it is believed thatwhere there is competition there is no need for government to control or organize privateindustry to ensure that the correct amount of each good and service is produced at thelowest cost. Competition will do the job far better than any bureaucracy. The collectivedemands of every person in the market place act like an "invisible hand" to direct businessto produce that which is most needed by society. Further, provided that there is adequatecompetition, the pursuit of self interest by individual firms, in the form of profits, will ensurethat goods and services are supplied by those firms producing the best product at the lowestprice, thereby serving the public interest of using resources as efficiently as possible.Competition between buyers will ensure that the market price reflects the benefit toconsumers of those goods and services. Firms continually adjust their production of goodsand services to respond to the demands of their customers. Those that do not will go outof business. The process of competition is the means to the desired end of increasing thetotal welfare of the community.An understanding of the outcomes produced by the process of competitive rivalryis derived by economists through the model of perfect competition. As we have seen themodel assumes a market in which each firm faces an immediate response by a rival to anyaction which it takes. In a perfectly competitive market there is an identical product madeby all firms; there are numerous buyers and sellers so that no single firm or customer caninfluence prices; there are no transaction costs; all participants are aware of all informationrelevant to the transaction; and firms may freely enter or exit the market at any time. Suchassumptions mean that there is the potential for all buyers and sellers to become aware ofat making the market work as effectively as possible. There are other policy instruments concerned with thebroader issue of wellbeing in society; see below c.3.16the cheapest method of producing the product and that there is a finite limit upon thecompetitive rivalry that may take place in that no new product may be developed by thesellers47. However, within the constraints of the assumptions it is possible to establishthat, over time, the process of competition within such a market will reach an equilibriumwhere the cost of production (including normal profits48) equals the value to the marginalconsumer; or the market price. If above normal profits are earned new firms will enter themarket; if lower than normal profits, firms will leave. Any firm selling at a price equal tothe cost of production will sell all of its output. Firms charging a higher price will make nosales; firms charging a lower price will have an incentive to leave the industry and makebetter profits elsewhere or will go out of business. It is not possible to charge differentprices to different buyers, because all buyers know that the product is the same. If toomuch of the product is produced then the price will fall forcing firms out of the market; iftoo little is produced the price will rise and new firms will be encouraged to enter. As allparticipants are aware of all relevant information, all sellers are able to imitate any costsaving methods of production adopted by other sellers, and all buyers are aware of thecheapest seller.The market tends toward an equilibrium which occurs at the point where the price47 Perhaps the most comprehensive treatment of the conditions or assumptions underlying the conceptof perfect competition was undertaken by F. Knight, Risk Uncertainty and Profit (New York, 1921) at 35-8.For a discussion of the historical development of the model of perfect competition; see Stigler, sup-a, note35. Two of the landmark treatments of the conclusions that may be derived from the model for industrialpolicy are set out in J.S. Bain, Industrial Organization (New York: John Wiley & Sons, 1968) and G.J. Stigler,The Organization of Industry (Homewood, Ill.: Richard D. Irwin, 1968). For a more current perspective onthe implications of the model for industrial policy; see J. Thole, The Theory of Industrial Organization(Cambridge, Mass.: M.I.T. Press, 1988); and Hay & Morris, supra, note 4.48 Normal profits are part of the costs of production. They represent the average return on capital thatmay have been expected from a similar investment. As such they are the cost forgone (or the opportunitycost) of an investor in putting time and money into the firm. In a small business, normal profits are oftensimply the cost of the proprietor's labour.17of the product equals both its value to the last customer and its cost to the firm. There isthen no change that can be made to increase welfare and as a result not only does themanagement of the firm ensure that the product is produced as cheaply as possible(ensuring internal efficiency"), but allocative efficiency is also reached". That is to say,there is no better use that can be made of the resources that are being expended toproduce the product. It is that single price which a perfectly competitive market sets, andis the price at which all sales will take place. At that price all customers will buy and allfirms will sell. At a higher price no customers will buy. At a lower price no firm will sell.The state of perfect competition reaches equilibrium at the point of maximum internal andallocative efficiency.However, the constraints of the model are such that once equilibrium has beenreached the process of competition has been exhausted 51. There is nothing that a sellercan do to distinguish its product from that of its rivals, and all buyers are aware of that fact.A perfectly competitive market in equilibrium exhibits none of the dynamic rivalry whichhas driven the market to its efficient goal. The insight of the model of perfect competitionis that, taken to its logical extreme, the process of competition produces a market in whichInternal efficiency is maximized when commodities are produced as cheaply as possible; Shepherd,supra, note 4 at 18. The term "productive efficiency" is also used to describe the same measure. It is a staticmeasure because it refers to the maximum that may be produced by a firm from available inputs. It is theoutcome of excellent management over time. It is to be distinguished from "dynamic efficiency" which refersto the additional output that may be produced from available inputs through the process of change, orinnovation, over time." Allocative efficiency is maximized when there is no improvement that can be made in the total valueof goods and services that may be produced from available resources by reallocating them from theproduction of one commodity to another. For a full statement of the theoretical analysis that perfectlycompetitive markets lead to the maximization of allocative efficiency see W.J. Baumol, Economic Theory andOperations Analysis, 4th ed. (Englewood Cliffs, NJ.: Prentice-Hall, 1977).51 McNulty, supra, note 38 at 642.18internal and allocative efficiency are both maximized. For a significant period theimplication of the model was thought to be that regulators must adopt policies whichproduce, as near as possible, the state of perfect competition 52. However, such aconclusion assumes that there can be no increase in total welfare through "imperfections"in the marketplace that result in additional profits for firms due to something less thanperfect competition. In fact, a proper understanding of the dynamic nature of competitivebehaviour reveals that periods of imperfection are an inherent part of the way the processof competition increases total welfare.Understanding CompetitionOne way of understanding competitive behaviour and its effects is to consider theeffect of an absence of competitive rivalry in the marketplace. This has traditionally beenthe approach of economists - comparing the insights of the model of perfect competitionwith the model of monopoly in order to understand the effects of competition 53. Ofcourse, a monopoly is a market in which there is a complete absence of competitivebehaviour. If a monopolist increases the price for its product then the only choice forbuyers is to pay the additional price, or not to buy the product at all. Indeed, a monopolisthas every incentive to increase price above the equilibrium price that would result fromperfect competition. Its profits will be maximized where the marginal cost of producing anadditional product equals the marginal revenue to be obtained from selling that product.The marginal revenue will always be something less than the monopolist's average revenue52 See the summary of the relevant material by E.M. Fox & LA. Sullivan, "Antitrust - Retrospective andProspective: Where Are We Coming From? Where Are We Going?" (1987) 62 N.Y.U.LR. 936 at 942-4.53 See, for example, Stigler, supra, note 35 at 5-22.19(which itself will be equal to the demand for the product, because all of the product issupplied by the monopolist54). Any additional products produced after the point wheremarginal cost equals marginal revenue will produce less revenue for the monopolist thanthey cost to make causing a reduction in profits. The result is that the most profitableoption for a monopolist will be to sell less at a supra-competitive price rs. In doing so themonopolist extracts supra-normal profits56 .Supra-competitive pricing has three immediate consequences. First, it increases theprice to consumers. Secondly, it results in producers 57 receiving a greater share of thedifference between the cost to produce the product and the benefit to the buyer of theproduct. As this difference is generally known as the "total surplus", it is usual to describethis second effect of monopoly pricing as a transfer of surplus from consumers to producers.Thirdly, as the price increases, some consumers 58 buy substitutes when it would be morecost effective for the needs of those consumers to be met by the purchase of the originalproduct at a competitive price. So, monopoly pricing also causes inefficiency in the54 We assume that all of the product is sold at the same price. The same general principle applies ifdifferent prices are charged to different customers, although the analysis would be more complex.55 In it usual to refer to the practice of pricing above the price that would prevail in a perfectlycompetitive market as monopoly pricing. However, monopoly pricing has pejorative overtones. The termalso suggests that it is associated with the practices of large firms controlling a market for an extended period.Our argument is that the practice of "monopoly pricing" is part of the process of competition and as such hasa benign effect as part of the dynamic of competitive rivalry. The basis for this conclusion is developed inthe balance of this chapter. We therefore adopt the more neutral term "supra-competitive pricing" to describethe practice of pricing above the competitive equilibrium price and the term "supra-normal profits" insteadof "monopoly profits" to describe the additional revenue to be earned form such a practice.56 Baumol, supra, note 50 at c.16; Dunlop, McQueen & Trebilcock, supra, note 8 at 85-8.57 Market power would be shared between firms in the case of a cartel, or in the case of conscious parallelbehaviour in an oligopoly.58 Those at the margin, for whom the difference between cost and benefit is only small and therefore forwhom a small increase in price will result in the price exceeding the benefit to them of the product.20allocation of resources or dead weight loss.Further, these three outcomes are interconnected. As the price for consumers isincreased above that which would otherwise prevail in a competitive market, the priceexceeds marginal cost by an increasing amount giving producers an increasing share of totalsurplus. As a result, consumers pay more and so lose some of the benefit of their purchase,that benefit being transferred to producers. Those consumers at the margin now find thatthe product costs more than it is worth to them and buy other products. In fact they wouldprefer to buy the original product if the lower market price prevailed. These "second best"purchases, caused solely by the price increase, are inefficient because the same need couldbe met at a lower price if the competitive market price still prevailed for the originalproduct. Finally, for a monopolist there is no longer any competitive pressure to keep coststo a minimum. The costs of a monopolist tend to be higher than those of firms selling incompetitive markets, a phenomena referred to as X inefficiency 59. From the perspectiveof the goal of maximizing total welfare, the equilibrium which results from an absence ofcompetition is internally and allocatively inefficient. In short, the monopolist is better off,but society and consumers are worse off.It is evident that the concepts of monopoly and perfect competition represent twotheoretical extremes. In the case of a monopoly there is no competitive behaviour in themarket. In the case of perfect competition the potential for competition has beenexhausted. A monopoly is allocatively inefficient, a perfectly competitive market maximizesallocative efficiency. It is at the point of attempting to understand what lies between the59 X inefficiency describes the particular internal inefficiencies associated with monopoly; see H.Leibenstein, Beyond Economic Man (Cambridge, Mass.: Harvard University Press, 1976) c.3; and Dunlop,McQueen & Trebilcock, supra, note 8 at 60-4. The effects of X inefficiency are discussed in more detailbelow; see c.3.21two theoretical extremes that the consequences of the failure of economics to defineprecisely what is meant by competition become starkly apparent. From our discussion itappears that the way a market in which the state of competition is close to monopoly maybe changed to a market in which the state of competition is close to perfect competitionis the process of competition - that is rivalry between firms. Indeed, one might concludethat there is simply an inverse relationship between the level of competition and the abilityto charge supra-competitive prices - as competition increases the ability to charge supra-competitive prices is gradually eroded, leading to increased internal and allocative efficiency.However, the simplicity of such a conclusion ignores the dynamic nature of competitivebehaviour. The process of competition itself changes the state of competition in the marketplace. Indeed, the paradox of competition is the fact that it is the opportunity to earn thesupra-normal profits of monopoly that encourages firms to compete and thereby increasethe state of competition60. The potential for monopoly is the means to perfectcompetition. It is this paradox that moulds competition policy in general, and the regulationof dominant firms in particular. It is the key to the formulation of effective competitionlaws.The Paradox of the Process of CompetitionThe process of competition is best viewed from the perspective of the seller since,6° Compare, Shepherd, supra, note 4 at 11 ("There lies a troubling paradox: Each contestant strives to win,but if one of them wins completely, then monopoly comes to exist! Even a partial victory (say a market shareof 70 percent) creates a degree of monopoly. That outcome of competition itself moves the market awayfrom competitive conditions, and it will prevent effective competition in the future. In contrast, effectivecompetition requires an enduring balance of power, so that many comparable competitors continue,neutralizing one another. Therefore, each competitor must win enough to reward its best efforts, but notenough to eliminate of even dominate the other competitors. Any market power it does obtain must not lastvery long").22ultimately, it is the seller that decides whether to offer a product for sale in themarketplace61 . Further, it is the likelihood that sellers will supply, at the lowest possibleprice, the goods and services that are most desired by buyers that will maximize totalwelfare. Although this involves buyers signal their preferences to sellers in a cost effectivemanner, if sellers are competing with each other to meet buyers' needs we can expect theinterest of society in maximizing total welfare to be served. Therefore, although it is theinteraction between buyers and sellers motivated by their own interests that producescompetition, we adopt the perspective of the seller in examining the process of competition.Sellers aim to maximize their profits 62. The state of perfect competition reducesprofits to a minimum level, or normal profits. Porter 63 expresses the impact of the processof competition upon profitability as followsCompetition in an industry continually works to drive down therate of return on invested capital toward the competitive floorrate of return that would be earned by the economist's"perfectly competitive" industry. This competitive floor, or"free market" return, is approximated by the yield on long-termgovernment securities adjusted upward by the risk of capitalloss. Investors will not tolerate returns below this rate in thelong run because of their alternative of investing in otherindustries, and firms habitually earning less than this return willeventually go out of business...The strength of the competitiveforces in an industry determines the degree to which...inflow ofinvestment occurs and drives the return to the free market61 Of course, buyers do influence the conduct of sellers to a significant degree. It is buyer demand thatdictates whether a firm will have a market for its product. As to whether buyers pose any significant threatof engaging in socially undesirable market conduct if they are in a position of dominance; see below, c.6 -Dominant Acquirers.62 The assumption that firm behaviour will be motivated by the desire for profits is not without itsqualifications in the real world. Managers, depending upon the degree to which they have a personal stakein the profits of the firm, may trade off profits for "the quiet life", security of their own position (adoptinga risk averse strategy), prestige, power or philanthropic motives; Scherer, supra, note 4 at 31-3.Competitive Strategy: Techniques for Analyzing Industries and Competitors, (New York: The Free Press,1980).23level, and thus the ability of firms to sustain above-averagereturns.Porter goes on to argue that the strength of the various "competitive forces" - entry, threatof substitution, bargaining power of buyers, bargaining power of suppliers, and rivalryamong current competitors - jointly determine "the intensity of industry competition andprofitability"65. He equates competitive strategy with "offensive or defensive action inorder to create a defendable position against the five competitive forces'" and "therebyyield a superior return on investment for the firm" 67. Ironically, we see a picture in whichthe competitive behaviour of firms comprises attempts to stem the tide of competition.Profitability lies in securing a position that is relatively free from competition and thendefending it from attack by the forces of competition. Of course, some firms lead the wayin striving to create opportunities for supra-normal profits. Some react to the actions ofothers when they find their business is no longer profitable.How does this happen? The process of competition is simply the interactionbetween firms selling the same or similar products as they try to out bid each other in themarket in order to attract buyers. Another way of expressing the dynamic is that each firmmust do something which reduces the level of competition which it faces. One way is tostrive to reduce its costs below those of its competitors. Another is to develop a newproduct, or method of production desired by customers and not available from competitors.A third is for a firm to differentiate its product from that of its rivals. The more successful64 Ibid. at 5-6.65 Ibid. at 6."Ibid. at 29.67 Ibid. at 34.24the strategy, the more it will reduce the level of competition faced by the firm and the moreit will be able to price supra-competitively. In the following landmark passageSchumpeter68 captured the significance of the role of such innovative behaviour...it is still competition within a rigid pattern of invariateconditions, methods of production and forms of industrialorganization in particular, that practically monopolizesattention. But in capitalist reality as distinguished from itstextbook picture, it is not that kind of competition which countsbut competition from the new commodity, the new technology,the new source of supply, the new type of organization (thelargest scale unit of control for instance) - competition whichcommands a decisive cost or quality advantage and whichstrikes not at the margins of the profits and the outputs of theexisting firms but at their foundations and their very lives. Thiskind of competition is as much more effective than the otheras bombardment is in comparison with forcing a door, and somuch more important that it becomes a matter of comparativeindifference whether competition in the ordinary sensefunctions more or less promptly...69Once a firm establishes a competitive advantage through successfully pursuing suchstrategies, then one can expect existing or new competitors to imitate or better thecompetitive advantage that is producing supra-normal profits. In response, the original firmmay seek to defend its advantage. It may do so through a patent which prevents imitation,or requiring secrecy on the part of its employees as to the source of its cost advantage, orengaging in strategic behaviour to dissuade the entry of new competitors to an existingmarket, or it may redouble its advertising efforts to promote an allegiance by customers toits brand.The important point is that the process of competition is a dynamic response to theopportunity for supra-normal profits. It operates through firms introducing changes68 Capitalism, Socialism and Democracy, 3rd ed. (New York: Harper, 1950).Ibid. at 84-5, a process described by Schumpeter as "creative destruction".25directed at securing a competitive advantage (or relative freedom from competition)followed by rivals seeking to imitate or better the advantage. The profit incentives are suchthat firms will also strive to defend their advantage from the tide of competition attractedby the supra-normal profits resulting from the relative freedom from competitive pressures.To understand the significance of the incentive of possible supra-normal profitscreated by the prospect of a period of less competition let us return to the world of perfectcompetition. Assume that a firm discovers a new method of production. The structure ofthe model of perfect competition requires that the discovery is immediately known to allrivals and that there are no barriers to firms immediately imitating the innovation. Withinan instant any advantage which the innovator had has been eroded. Unless the costs ofdeveloping the innovation were zero, the innovator would lose out from adopting the newmethod of production because it would have no opportunity to recoup its investment inresearch and development. Viewed in another way, there is no incentive to innovate in aperfectly competitive market".However, the dynamic process of innovation and imitation itself substantiallyimproves the total welfare of society. The fact that buyers are prepared to buy newproducts (or those produced using new methods) instead of established alternatives, showsthat they are valued by society71 . It is now recognized that this dynamic efficiency,7° W.D. Nordhaus, Invention, Growth, and Welfare: A Theoretical Treatment of Technological Change(Cambridge: Mass.: M.I.T. Press, 1969) at 39. This negative effect upon innovation also arises as a result ofthe notion of ultra free entry associated with theories of perfect contestability. There is no incentive toinnovate where there is perfectly free entry and exit. Supra-normal profits will always attract entry. In thisrespect perfectly contestable markets have the same undesirable aspects as perfectly competitive markets interms of promoting dynamic efficiency.71 There are two ways in which innovation may produce improvements in welfare. First, through newmethods of production, or process innovation, which leads to increases in productivity. Second, through newproducts that are demanded by customers, or product innovation, which increases the quality of consumption;Scherer, supra, note 4 at 407-8. We will use the term innovation to refer to both types of welfare improving26resulting from changes introduced by rivals in the market, stands with internal and allocativeefficiency as an important way in which competitive markets increase the total welfare ofsociety72. Indeed many argue that innovation, even though it leads, for a time, to a stateof less competition (and therefore internal and allocative inefficiency) will invariably confera net benefit on total surplus73 .Once the innovative nature of the competitive process is taken into account we cansee that what is important for improving total welfare is not the creation of a static marketin which the state of competition approaches the perfect model, but rather theencouragement of the process of competition, which may initially lead to a state of affairswhere there is less competition. It is only when the position of monopoly after theinnovation is taken as the starting point for analysis (thereby ignoring the role which theopportunity for such monopoly created in motivating the monopolist to innovate in the firstinstance) that the existence of the monopoly is seen as reducing total welfare due to thedead weight loss associated with supra-competitive pricing. But such an approach ignoresthe fact that without the incentive to innovate, created by the opportunity to earn supra-normal profits, the first gain in total welfare through innovative change would not havebeen made. Further, the existence of supra-normal profits will attract firms to attempt toovercome the advantage of the original innovator. As has been observed by others, supra-normal profits are the cost of ensuring that firms innovate. In summary, the process ofchange.72 E.g., Hay & Morris, supra, note 4 at 566-86; Dunlop, McQueen & Trebilcock, supra, note 8 at 61-4; andShepherd, supra, note 4 at 17-23.73 E.g., Scherer, supra, note 4 at 114-5; and E. Mansfield, "Entry, Gilbrat's Law, Innovation and theGrowth of Finns" (1962) 52 Am. Econ. R. 1023.74 Dunlop, McQueen & Trebilcock, supra, note 8 at 64.27competition through innovation results in a cycle whereby total welfare is continuouslyimproved. The paradox is that the same incentive that drives individual firms to secure anopportunity to earn supra-normal profits through relative freedom from competitive forceswill continually drive other firms to be the agents of those competitive forces and bid awaythose profits through the process of competition.Static and Dynamic Perspectives of the Process of CompetitionThe models of perfect competition and monopoly exclude the effects of change. Ina world without change, competition is limited to responding to the fixed demands of buyersusing existing technology and known resources to produce well defined goods and services.In such a world, rivalry between firms, over time, is limited to producing the best qualitygoods and services as cheaply as possible. Competition is inward looking. A monopolistneed not be concerned about new entrants, because the monopoly cannot be overcomethrough new ideas. In a perfectly competitive market a seller accepts the market price asa given. Everything that can be produced can be sold at that price. The process ofcompetition in such a static world is limited to the issue of internal management. We haveadopted the phrase internal efficiency to describe the outcome of competitive activity insuch a static environment.However, once dynamic elements are introduced the field of competitive rivalry isexpanded dramatically. Buyer preferences are continuously changing. They may beinfluenced by advertising. The process of competition itself redistributes resources changingdemand. People change. "Baby boomers" have had a dramatic impact upon the demandfor certain products as they have aged. New methods of production and new products may28be invented and given competitive applications. The result is that competitors can exploitchange (both by being a catalyst for change and responding to change caused by others) tocreate new profit opportunities. Of course, internal efficiency is still part of competitiveactivity. But in industries where the rate of change in customer preferences, fluctuationsin the level of demand, new products and new methods of production is rapid, the profitopportunities are dramatically increased for the innovator. The profit incentive for firmsto be agents of change through advertising, research and development is considerable. Withchange the potential for increases in total welfare, or increases in dynamic efficiency, issubstantial - limited only by the innovativeness of the competitors in the market. Dynamicefficiency is so significant that it "must eventually affect standards of living more potentlythan differences in the efficiency of static resource allocation and utilization" 75 .We now see the distinction between static competition and dynamic competition76.As the models of perfect competition and monopoly are static models, they portray theprocess of competition in static terms. Within the assumed limits of such models, over time,the process of competition leads to equilibrium because change is not possible. However,in the real world change is ever present. Competitive behaviour is dramatically influencedby change. It continually creates opportunities for profit - and in the process increases totalwelfare. It is the cycle of innovation and imitation that promotes total welfare.However, the dominant images that have influenced competition policy have beenScherer, supra, note 4 at 140.76 For an excellent summary of the distinctions see Hay & Morris, supra, note 4 at 565-70.29those of static competition within a market structure that is perfectly competitive. Wecontend that they ought to be replaced by a singular emphasis upon dynamic competition.By dynamic competition we mean not only innovation to earn supra-normal profits, but alsothe contest which is encouraged by the opportunity created by the innovator which, overtime, leads to allocative efficiency. Competition is a dynamic process. It is not associatedwith any particular market structure as it necessarily changes the market structure. Indeed,it is driven by change.A Definition of Competition in terms of Innovation and ImitationBased upon the above analysis, we define innovation as change introduced by a firm.Such change may be a response to factors external to the firm, such as, for example, a shiftin consumer demand or a decline in the availability (and increase in cost) of an essentialinput. Or the firm may be a catalyst for change through its own inventiveness or throughadvertising designed to influence consumer demand. The areas for potential profitablechange in any business may be divided into three areas - product, production process orcustomer demand.77 E.g., in Borden v. ReaLemon 92 F.T.C. 669 (1978); aff 674 F.2d 498 (6th Cir., 1982); vacated 461 U.S.940 (1983) the remedy proposed by the trial judge was that ReaLemon be required to licence its brand namebecause that deviation from the model of perfect competition was the source of its market power. See also,B. Klein, "Perfect Competition as a Criterion for Antitrust Policy: Brand Names, Entry Barriers and ExclusiveDealing in the Fisher & Paykel Case" in R.J. Ahdar, Competition Law and Policy in New Zealand (Sydney:Law Book, 1991) 65 at 68 ("It is crucial to distinguish between an unrealistic assumption of a possibly usefultheoretical model and an assumption as a desired policy goal. For example, a model in physics may assumea frictionless world in order to illustrate the basic physical forces at work. However, when an engineer isbuilding a bridge, it would not make sense to pour grease over everything to see how close we can come toapproximating an assumption of the pure physical model. Similarly, although the perfectly competitive modelmay be a useful tool of analysis for some purposes, it makes no sense to attempt to force the world into sucha model by attempting to approximate an unrealistic assumption...of the model"). In his influential book,Bork, supra, note 3 at 91 refers only to productive and allocative efficiency and states "These two types ofefficiency make up the overall efficiency that determines the level of our society's wealth or consumerwelfare". The economic analysis which follows is expressed in static terms.30It follows that innovation is any change made by a firm in its product, its productionprocess or its attempts to influence customers. Imitation is the activity of copying successfulinnovations by other firms. Competition is the dynamic interaction of the two. Successfulinnovations are imitated by others.The dynamic nature of competition has often been ignored because competition hasbeen viewed as a structural concept. That is, as a function of the extent to which thestructure of the market approaches the theoretical model of perfect competition. Wherethere are few rivals, and little threat that new firms may contest the market, competitiveconduct in the market will be low and the market will be inefficient. Within such astructure-conduct-performance paradigm the welfare benefits of competition are seen asbeing promoted by ensuring that there are many rivals in the market. Increasingcompetition is equated with increasing the number of firms in the market. Such a structuralperspective must immediately be qualified to recognize that there will be cases where aconcentrated market structure will be the only way to allow firms to achieve scale and scopeeconomies and other cases where atomistic competition is not possible because productssupplied by rivals are imperfect substitutes". Further, there will be little incentive toinnovate where the structure of the market is such that any gain from innovation will betransitory". It follows that the type of competitive conduct that is the outcome of adeconcentrated market structure does not lead to dynamic efficiency as a matter of course.The dynamic process of competition may well be absent from a market that is structurally78 Hay & Morris, supra, note 4 c.2.79 Scherer, supra, note 4 at 127.31"competitive"80.Competitive behaviour must be understood as a process that transcends transitorymarket structures. It is a dynamic, not a structural, phenomenon.Competition and DominanceOur analysis of the process of competition leads us to an important conclusion in thecontext of the regulation of the market conduct of dominant firms. The most profitable anddominant firms will tend to be those that excel in creating and exploiting the potential forsupra-normal profits. The potential for such profits arises where a firm develops a costsaving or a new product or method of production, or persuades a customer that there is noalternative for its product. The scope of the potential (the length of the period in whichit may be exploited) depends upon the extent to which the cost saving, the new product ormethod of production or the change in customer perception makes the products of otherfirms in the market no longer substitutes in the minds of buyers. It also depends upon theability and responsiveness of others to imitate the firm exploiting the potential and join thecontest for the new profit opportunity, the ability of investors in existing technology tothwart any change to exploit the potential and the barriers which exist (or may be created)to prevent others from exploiting the potential.In short,There is a pervasive duality to the effects of competition on thepace of innovation. More competition stimulates andaccelerates innovation within limits, but when competitionbecomes so intense that any given rival can anticipateappropriating only a small share of the innovator's benefits, still8° Clark, supra, note 36 at 88.32more competition retards innovation 81 .At any point in time the competitive strategy of a firm may be based entirely upon itsability to exclude competitors from exploiting the potential for supra-normal profits that ithas been able to secure. As a result, an inconsistency arises. On the one hand eliminatingall barriers to the ability and responsiveness of other firms to contest for the potential toearn supra-normal profits reduces the incentive to innovate and create such potential.Without a clear profit advantage such innovations will only be made where they arerelatively costless or where they are necessitated by the behaviour of rivals82.On the other hand, the erection of absolute barriers to competitive exploitation ofany potential for monopoly profits will entrench the allocative inefficiency of monopoly83.Sustained monopoly is allocatively inefficient. It also results in X inefficiency. Arguably,there is also less incentive for a firm which is comfortably earning supra-normal profits,without threat of competition, to invest in further innovation 84.It is evident that there must be some form of balance. It is the cycle of innovationand imitation through the process of competition that is the means by which the marketsystem improves the total welfare of society. Although the equilibrium of perfectcompetition may never be reached, the competitive process continually improves totalwelfare through advancing internal, allocative and dynamic efficiency. The difficulty lies in81 F.M. Scherer, "Antitrust, Efficiency and Progress" (1987) 62 N.Y.U.L.R. 998.82 Of course, rivals will face the same inertia so far as innovation is concerned if, as soon as they innovate,all competitors will be able to immediately respond and imitate.83 Economists of the Chicago School argue that the ability to sustain dominance is weak and that existingantitrust laws, for the most part, are too great a barrier to the exploitation of monopoly profits, stifling thewelfare enhancing innovations that are attracted by the rewards of supra-normal profits; Bork, supra, note3; and Armentano, supra, note 3.84 Scherer, supra, note 4 at 425ff; and Shepherd, supra, note 4 at 37.33ensuring that there is sufficient incentive for individual firms to pursue strategies which leadto lower costs, new products and methods of production and respond to changes inconsumer preferences, without entrenching opportunities to earn supra-normal profits inperpetuity from a single stratagem° .In part, incentive is created simply by the fact that some innovations are inherentlydifficult for competitors to reproduce in a relatively short period of time. It may take timefor a rival to build the necessary plant or to establish an equivalent reputation in the marketor to secure adequate sources of supply of inputs or distribution channels to imitate theinnovation of a rival. However, other innovations are relatively easy to imitate. Unlessfirms are able to recoup the cost of innovating from supra-normal profits then there is noincentive to innovate and the potential increase in total welfare that would result frominnovation is lost.To summarize, it appears that it is the dynamic process of competition whereby firmsinnovate and imitate, rather than the state of affairs of perfect competition, that is themeans by which markets increase the total welfare of a society. The process of competitioninvolves a continuous cycle of innovation and imitation. Both elements seem to be requiredto increase welfare and, at any point in time, the process of competition may result inmarket structures that tend towards monopoly or perfect competition. What is significantis not the structure of the market, but the behaviour of the participants in the market. Thepromotion of competitive behaviour is materially different to the promotion of perfectas It is important to distinguish the case where a firm which earns supra-normal profits over a long perioddue to its ability to continually innovate and continually create fresh potential for supra-normal profits, eventhough the process of competition through imitation gradually erodes the opportunities created by pastinnovations from the case where a firm is able to extract supra-normal profits over an extended period of timedue to some protection from competition.34competition. Importantly, a proper perspective of the dynamics of the process ofcompetition leads to the recognition that the prospect of dominance is an inherent part ofthe stimulant for competitive behaviour and it is competitive behaviour that promotesinternal, allocative and dynamic efficiency.We ought not be surprised by this conclusion. Indeed, when we consider our basicunderstanding of a competitive market, it is to be expected that the prospect of dominancewould be an essential part of the dynamic. Markets are driven by the interactions betweenindividual firms seeking to maximize profits and individual buyers seeking to maximizeconsumer surplus. Dominance is no more than the attainment of the possibility whichdrives the market mechanism - greater profits.However, the effects of dominance are not exclusively benign. The market powerthat results from market dominance leads to the outcomes of increased prices and thetransfer of surplus to the owners of dominant firms, as well as internal and allocativeinefficiency. The incentive of greater profits also encourages behaviour other thaninnovation and imitation, which behaviour is a social cost of dominance. We have yet toconsider such behaviour explicitly.Competition and Rent SeekingThe process of competition is not endogenous in a free market economy. Justas the potential for supra-normal profits can be created by innovations which give a firma competitive advantage over its rivals, such potential can be created by excluding the86 At this point, we assume the validity of the argument that competition is desirable due to its ability topromote total welfare through improvements in internal, allocative and dynamic efficiency; see Clark, supra,note 36 c.4; and the discussion above, c.2.35process of competition from the market place. The propensity of firms to pursue suchexclusionary strategies is so great that one must work vigorously to ensure the maintenanceof free competition87. Firms soon learn that the exclusion of competition can be effectedthrough cartels, strategic behaviour to dissuade the entry of new competitors to an existingmarket, monopoly ownership of inputs or exclusive dealing arrangements and that it isprofitable to pursue such strategies.The impressive evidence of the prevalence of limit pricing behaviour 88 suggests thatmany firms pursue exclusionary rather than monopoly pricing strategies which enable themto preserve, as far as possible, the potential to earn supra-normal profits from attack by theforces of competition89.In addition, there are markets in which the level of demand is such that the processof competition itself leads to the concentration of production in the hands of a few firms,or in some cases a single firm. Some goods or services can be produced at low cost onlyif produced on a large scale. These economies of scale may be so significant that it is mostefficient for all or most of a particular product necessary to satisfy the demand in a marketto be supplied by a single firm. Also, some goods and services can be produced at muchlower cost if produced together with other goods or services by one firm. Such economiesof scope may also mean that it is cheaper for a few firms, or perhaps one firm, to supplythe entire market. Competition drives firms to exploit scale and scope efficiencies and inmany cases leads to concentrated markets.87 Scherer, supra, note 4 at 23.88 P.S. Crampton, Mergers and the Competition Act (Toronto: Carswell, 1990) at 233." Ibid.36More generally, the process of competition itself tends to break down circumstancesin which a firm faces competition from a rival supplying a product which is a directsubstitute for its own product. Indeed it has been observed that the attempts by rivals tooffer a product which is not available from a competitor (thereby creating the opportunityto earn supra-normal profits) itself ensures that perfect competition will never be reached....there are many reasons why a customer buys from oneproducer rather than another besides the simple one ofdifference in the prices which they charge, and since the rivalproducers make it their business to exploit all these influencesupon the customer's choice, the very existence of competition,in the plain sense of the word, ensures that the market will notbe perfect. Rival producers compete against each other inquality, in facilities, and in advertisement, as well as in price,and the very intensity of competition, by forcing them to attractcustomers in every possible way, itself breaks up the marketand ensures that not all the customers, who are attached invarying degrees to a particular firm by the advantages which itoffers them, will immediately forsake it for a rival who offerssimilar goods at an infinitesimally smaller price".Finally, in markets in which production has become concentrated in the hands of afew firms, rivalry91 takes on an added dimension. The participants in such a market, oroligopolists, are able to pursue cooperative strategies, instead of competitive strategies inorder to share the potential for supra-normal profits that would otherwise only be availableto a monopolist. Such practices do not require express agreement. Competitors in anoligopoly will learn over time the profit advantages of a cooperative strategy. However,9° J. Robinson, The Economics of Perfect Competition 2nd ed. (New York: St Martin's Press, 1969) at 88.91 It is important to recall that our definition of "rivalry" encompasses any behaviour undertaken by a firmin pursuit of profits. It includes co-operative strategies or "friendly rivalry". Of course, there are those whoadvocate the welfare improving benefits that are associated with co-operative strategies in a number ofcontexts; e.g. T.M. Jorde & D.J. Teece, "Innovation, Cooperation, and Antitrust" in T.M. Jorde & D.J. Teece,eds.,Antitrus4 Innovation, and Competitiveness (New York: Oxford University Press, 1992) 47. However, ourconcern herein is unilateral action.37from the perspective of total welfare, such strategies are as damaging as supra-competitivepricing by a single firm. They also result in additional costs in that efforts are directedtowards maintaining the cooperation between competitors resulting in allocativeinefficiency.The same profit motive that drives firms to innovate and thereby create anopportunity to earn supra-normal profits through relative freedom from competitiveconstraint, also motivates firms to pursue other market strategies, either alone or incooperation with competitors, to reduce the level of rivalry in the market place. However,resources expended solely in creating, protecting or entrenching an opportunity to earnsupra-normal profits are wasted. Not only do they fail to improve the total welfare ofsociety, they direct resources away from productive activities causing allocationalinefficiencies. Such activities are described by economists as rent seeking. They simplyconsume resources in securing the right to earn supra-normal profits. Rent seekingactivities result in no productive output. They do not serve the demands of customers.They are investments solely in the distribution of profits.However, rent seeking, like innovation and imitation, is motivated by the prospectof dominance. In other words, rivalry in the marketplace includes rent seeking. Therefore,although we have argued that dominance is a necessary part of the dynamic process of92 See the summary of the relevant research in J. Howard & W.T. Stanbury, "Oligopoly Power, Co-ordination and Conscious Parallelism" in F. Mathewson, M. Trebilcock & M. Walker, The Law andEconomics of Competition Policy (Vancouver: The Fraser Institute, 1990) 219." Tirole, supra, note 47 at 76-8 ("Consider the rent associated with monopoly pricing...It is clear that theexistence of this potential rent may lead to rent-seeking behaviour. Firms will tend to spend money and exerteffort to acquire the monopoly position; once installed in that position they will tend to keep on spendingmoney and exerting effort to maintain it"); J.A. Brander, Government Policy Toward Business (Toronto:Butterworths, 1992) at 49 ("rent seeking is the process of trying to obtain (or retain) economic benefits byhaving them redistributed from others rather than by creating new wealth").38competition and therefore desirable, we must also acknowledge that rent seeking behaviourwill be an inherent outcome of a system which invites firms to pursue strategies whichmaximize their own profits. Dominance motivates both competition and rent seeking. Itfollows that any final conclusion about the desirability of dominance requires an evaluationof the total welfare effects of all market conduct motivated by the prospect of dominance.Certainly, to the extent that a society relies upon competition as the primary methodof maximizing its total welfare, it is evident that a regime of free enterprise alone isinsufficient to ensure that the welfare promoting aspects of the process of competition aremaintained. It appears that there is ample need for effective regulation to ensure that theprocess of competition, with its apparent ability to continually increase internal, allocativeand dynamic efficiency, prevails in the market place, thereby maximizing total welfare. Atthe same time, such regulation must discourage rent seeking.In the next chapter we examine in detail the welfare effects of dominance. However,before proceeding, the semantic breadth of the word "competition" evident in our discussionrequires us to adopt the following terminology. As our definitions differ materially frommuch of the common usage of the terms defined, they should be especially noted.An Addendum - The Language of CompetitionWe will use the term rivalry to refer to all activities undertaken by firms in themarketplace in the pursuit of profits. Such conduct may have positive, negative or neutraleffects upon total welfare. Competition or competitive behaviour will be used to refer tothe process or activity of innovation and imitation. We have already defined innovation asa change in a product, production process or demand created by a firm and imitation as the39activity of copying successful innovations by other firms. The term dominant firm ordominance will be used to refer to firms which enjoy a relative absence from the effects ofcompetitive behaviour by other firms. When referring to the competitive structure of amarket we will use the term concentration. Finally, we will use the term rent seeking torefer to the process or activity of preventing innovation or imitation.40Chapter 3: What are the Welfare Effects of Dominance?In the previous chapter we reached an important conclusion. Rather thancharacterizing dominance as a state which arises when there is relatively less competitionin the market place, we illustrated how the rise and fall of dominant firms, over time, isconsistent with the dynamic of the process of competition. As a result instead of beingviewed as the antithesis of competition, dominance is seen as an integral part of thecompetitive process. Dominance is the manifestation of competitive success within a systemthat invites rivals to strive to maximize profits. It is a logical outcome in a market systembecause markets are driven by the pursuit of profits. Therefore, when it comes toconsidering the welfare effects of dominance, we must understand dominance as a motive,rather than a static market structure. Dominance is an inherent part of the way the marketsystem operates94. The prospect of dominance, and its associated supra-normal profitsmotivates firms to act 95 . The question is whether all actions motivated by the prospectof dominance are socially desirable or undesirable. In that context, our approach to theissue of regulation of the market conduct of dominant firms has been the adoption of theconcept of maximum social benefit (expressed in terms of the total value of goods and94 Compare J. Reinganum, "Innovation and Industry Evolution" (1985) 99 Q.J. of Econ. 81 where theauthor argues that an incumbent earning supra-normal profits has less desire to innovate. As a result thereis innovation by successive entrants who become dominant for a time. A static picture taken at any timereveals a dominant firm market structure, but over time the identity of the monopolist is continuallychanging.95 Often, this truth is expressed in negative terms. The Darwinian metaphor of survival of the fittest isused. However, competition is a struggle for success, not survival. Certainly, in the process some firms,affected in a negative way by the successful strategies of other firms, strive to survive as they are overtakenby competitors. However, the reason some firms have to strive to survive is because others are striving towin supra-normal profits, not vice versa. The dynamic within a market system originates in firms seekingadditional profits. It is their activities which provide competitive pressures on other firms.41services produced) as the measure of utility of any particular laws. Put shortly, thequestion we would ask in order to determine whether the market behaviour motivated bydominance is socially desirable or undesirable is "will it increase total welfare? 97".In this chapter we will differentiate the types of market conduct which are motivatedby the prospect of dominance and then consider whether they increase or decrease totalwelfare.Conduct Associated With DominanceIt can be said that within a dynamic perspective of competition firms exist "in orderto create and obtain economic rents and perhaps as well...[to] attempt to minimize the risksassociated with their operations by minimizing competition and avoiding themarketplace"98. As we have argued, dominance can be viewed as the manifestation ofsuccess in the rivalry between firms motivated by the pursuit of profits. In the market placethere are just three ways that a firm may seek to secure a position which is relatively freefrom the effects of market behaviour by rivals or market dominance.The first is to be a catalyst for change. The firm may take a leadership roleinvesting in research and development, adopting new marketing and advertising techniques,exploring new approaches to business organization, or location of premises - doing thingsdifferently to rivals. When a firm discovers a new product, a new way of producing a96 See above, c.2 - The Market System. We will consider some of the criticisms of an approach basedexclusively upon the maximization of total welfare below in c.4 - The Equitable Distribution of Wealth andPower.97 For a summary of the empirical research attempting to measure the welfare outcomes of the existenceof market power see Hay & Morris, supra, note 4 at 581-9.98 F. Lazar, "Monopolistic Competition - A Stable Market Structure" (Faculty of Law: University ofToronto, 1983) [unpublished] at 25.42product, or a new way of packaging and marketing a product, which is wanted by customers,it finds itself, for a time, relatively free from competitive constraint. To a degree it becomesa dominant firm able to earn supra-normal profits". It is the prospect of earning suchprofits that motivates the firm to be innovative, investing in new products, new methods ofproduction and new ways to influence customers. Therefore, the first behaviour that maybe adopted by a firm coincides with our earlier definition of innovation.The second approach is to copy the successful changes made by others, or tocontinue to use those strategies which have been successful in the past. Such a strategyenables a firm to avoid the risk associated with investment in new ideas. Once a firm hasestablished a new strategy in the market place that is successful, and is earning supra-normal profits (or even is showing the potential to do so) the strategy can be copied byothers. A firm may be able to learn from the mistakes of the innovator and introduce thechange more cheaply. Research shows that such follower strategies can be very profitable,enabling the imitator to share in the opportunity for supra-normal profits discovered by theinnovator, albeit during a period when the level of such profits are declining due to theincrease in competitionl®. Such follower strategies coincide with our earlier definitionof imitation.The third approach involves changing the market so that there are less competitorsaffecting the business of the firm, or, as is more common, preventing changes in the marketthat would tend to increase the effect which competitors may have upon the business of thefirm. Absent from such a strategy is any attempt to supply that which is demanded by" E. Mansfield, supra, note 73 has shown that in the case of smaller firms successful innovation has adramatic impact upon growth100 Hay & Morris, supra, note 4 at 480ff; and Tirole, supra, note at 402ff.43customers, which is the essence of the strategies of innovation and imitation. In such anapproach, relative freedom from competitive constraint, or market dominance, is createdor protected by preventing rivals from supplying the same customers as the firm. That suchentry deterring strategies are pursued by firms has been the subject of extensiveanalysien. They are profitable where the opportunity to earn supra-normal profits isworth more than the cost of ensuring that a rival is not able to compete for those profits.Such exclusionary strategies coincide with our earlier definition of rent seeking.To summarize, firms may secure a position that is relatively free from competitiveconstraint by introducing a new idea that is desired by customers, copying a successful newidea introduced by another, or by preventing innovation or imitation by other firms thatwould make them competitors of the firm. The attractiveness of innovation or thedifficulty of imitation also may be heightened by factors external to the market conduct offirms. However, the market conduct which is motivated by the prospect of achievingdominance is innovation, imitation and rent seeking.Once dominance has been achieved there are two ways in which the activities of adominant firm differ from those of a firm subject to competitive constraint. They wereconsidered in detail in the previous chapter. Dominant firms engage in supra-normalpricing thereby extracting supra-normal profits, a practice that is allocatively inefficient.Further, dominance tends to lead to X inefficiency.It is the interaction between these five behaviours - innovation, imitation, rentseeking, monopoly pricing and X inefficiency - that is the market conduct associated withdominance. Understanding the welfare effects of dominance requires a clear picture of how' E.g., T.G. Krattenmaker & S.C. Salop, "Anticompetitive Exclusion: Raising Rivals' Costs to AchievePower Over Price" (1986) 96 Yale L.J. 209.44these behaviours are inter-related. We can begin by distinguishing between the first threebehaviours and the second two. The first three - innovation, imitation and rent seeking -are expressions of the rivalry between firms. The second two - monopoly pricing and Xinefficiency - result when a relative absence of rivalry between firms occurs. It is the firstthree behaviours that are the dynamic elements. The second two behaviours are outcomes,rather than a part of the dynamic. Therefore, in order to understand the welfareoutcomes of rivalry we will focus upon innovation, imitation and rent seeking. In thischapter we will consider the welfare effects of each behaviour in turn. We acknowledgethat this division is somewhat artificial as there is an inter-relationship between innovation,rent seeking and imitation. Therefore, in our discussion we will also address the inter-relationship. However, it is helpful to begin by thinking of rivalry in terms of these threecategories of behaviour, each motivated by the prospect of dominance.An evaluation of the change in total welfare resulting from each type of rivalrousbehaviour involves an evaluation of the net effect upon three outcomes; dynamic efficiency(the value of any innovation - or loss of innovation); allocational efficiency (the combinedeffect of addition or elimination of rent seeking and deadweight loss); and internalefficiency (increase or decrease in X inefficiencies).The Welfare Effects of InnovationWe argue that innovation will usually increase total welfare. Consider first whetherthe increase in dynamic efficiency resulting from the innovation is likely to be larger thanany deadweight loss resulting from monopoly pricing by the innovative firm. The broaddynamic resulting from innovation is as follows. As one firm in a market obtains a45competitive advantage through innovation it will start to earn supra-normal profits.Competitors will lose sales to the firm with the advantage. Those competitors will be forcedto imitate the successful strategy that gave the innovative firm an advantage (or better thatadvantage), or be forced out of business. In the latter case, the firm with the advantage willbecome a monopoly. However, provided it prices the product below the previous marketprice there will be an increase in total surplus measured against the historical base. Indeedthe cost base of the former competitors will likely operate as a ceiling on any price increaseby the innovating firm because at such prices it would be profitable for the formercompetitors to re-enter102. The process of competition through innovation leads to astate of affairs where there is less competition, but the process itself increases total welfare.A merger which results in efficiencies is one example of innovative behaviour thatcreates market power. Williamson has shown103, and his basic intuition is generallyacceptedl", that small cost efficiencies dominate much larger increases in market powerin terms of qualitative importance°. Indeed, where the market price after a merger islower than the market price before the merger there has clearly been an increase in total1°2 Such limit pricing, though evidence of market power, is to be preferred to monopoly pricing whichmaximizes supra-normal profits for the dominant firm.103 Williamson, 0.E., "Economies as an Antitrust Defense: The Welfare Tradeoffs" (1968) 58 Am. Econ.R. 18; Williamson, 0., "Economies as an Antitrust Defense Revisited" (1977) 125 U. Pa L.R. 699 [hereinafterRevisited]; Williamson, 0., "Economies as an Antitrust Defense: Correction and Reply" (1968) 58 Am. Econ.R. 1372; and Williamson, 0., "Allocative Efficiency and the Limits of Antitrust" (1969) Am. Econ. R. Papers& Proc. 105 [hereinafter Limits of Antitrust].104 A. Fisher & R. Lande, "Efficiency Considerations in Merger Enforcement" (1983) 71 Cal. L.R. 1580at 1583 & 1624-51; Hay & Morris, supra, note 4 at 573-4; and Crampton, supra, note 88 at 100.Williamson, Revisited, supra note 103 at 709 ("...a relatively modest cost reduction is sufficient to offsetrelatively large price increases even if the elasticity of demand is as high as 2, which for most commoditiesis probably a reasonable upper bound").46welfarel". Of course, the difference between a merger and an innovation is that amerger may eliminate rivals and create barriers to future entry (or the potential for suchbarriers to be raised through strategic conduct by the merged entity). In the case ofefficiency gains through innovation there is no necessarily negative impact upon competitivebehaviour. Therefore, the argument is even stronger that the dynamic efficiencies willoutweigh the allocative inefficiencies because the rivals remain to limit monopoly pricingand to compete away the competitive advantage of the innovator. Indeed if one considersthat the limit price is likely to be the market price prior to the innovation, then the effectsupon total welfare of the innovation are likely to be positive in most cases 107 .Of course, such an analysis is subject to the criticisms of Williamson's "naive" model.The first criticism has been that where the market was not competitive prior to the efficientchange, then the effect of enhanced market power may outweigh the efficiency gains 108.However, such an analysis presumes that there was no welfare benefit created by theoriginal relative absence in competition. If the original market structure resulted frominnovation, then, measured from a competitive historical base, the welfare differencebetween the dynamic efficiency of the innovation and the allocative inefficiency of themarket power will be positive. Further, any policy which promotes the process ofcompetition will encourage imitation which, in turn, will have the effect of limiting theperiod of any relative absence of competition. We advocate laws which promote the cycle1°6 See A.A. Fisher, F.I. Johnson & R.H. Lande, "Price Effects of Horizontal Mergers" (1989) 77 Cal. LR.777 cited with approval in Director of Investigation and Research v. Hiisdown Holdings (Canada) Ltd (1992)C.P.R. (3d) 289 at 343; and Crampton, supra, note 88 at 529ff.107 A conclusion for which there is empirical support; see R.T. Masson & J. Shaanan, "Social Costs ofOligopoly, and the Value of Competition" (1984) 94 Econ. J. 520.See, M. DePrano & J. Nugent, "Economies as an Antitrust Defense: Comment" (1969) 59 Am. Econ.R. 947 at 951.47of innovation and imitation.The second criticism concerns elasticities of demand. It has been argued thatWilliamson's analysis only holds where, at prices surrounding the market price prior tomerger, demand is relatively elastic; that is to say where there remain other products towhich buyers are likely to switch if the merged firm was to raise its prices 1®. However,competition laws focus upon mergers that increase concentration in a market. Bydefinition, where a merger leads to relative concentration in a market, demand for themerged firm's product will be relatively inelastic as there are no substitute products towhich buyers may switch if prices are increased. So, it is argued, in material cases demandis likely to be relatively inelastic11°. However, such an analysis does not translate tomarket power that is the outcome of innovation rather than merger. Innovation is part ofthe dynamic nature of competition. It is only where there is attendant to the innovationsome power to exclude imitation that demand for the innovative product will remaininelastic. The tide of entry, attracted by the supra-normal profits, will ensure that, in time,demand is relatively elastic. The result is that the dead-weight loss resulting from theinnovation will diminish over time, whereas the welfare gains from the innovation willremain111 . Therefore, we argue that over time (and provided the dynamic process ofcompetition is allowed to function) Williamson's naive model shows that the gains from1°9 Fisher & Lande, supra, note 104 at 1643.1" Because the social returns from innovation are higher than the private returns (innovation has publicgood characteristics) there is often a public policy concern that there is under-investment in innovation; Jorde& Teece, supra, note 91 at 53. Even the welfare benefits that are evident in the success which the innovatorhas in marketing its new product (or cheaper product produced with a process innovation) are difficult toquantify; R. Brenner, "Market Power: Innovation and Anti-trust" in F.Mathewson, M. Trebficock & M.Walker, The Law and Economics of Competition Policy (Vancouver: The Fraser Institute, 1990) 179 at 187-90.111 S. Littlechild, "Misleading Calculations of the Social Costs of Monopoly" (1981) 91 Econ. J. 348.48innovation are likely to outweigh the deadweight loss created by the market powerassociated with the freedom from competition associated with innovation.There is another respect, beyond the immediate benefit to buyers of the innovativeproduct, in which innovation has a positive impact upon welfare which is difficult to expressin quantitative terms. The benefits of the innovation are rarely limited to the productivitygains or improvement ins the quality of consumption created by the innovator. There areoften significant spill over effects which contribute to increases in total welfare as theinnovative insight is developed and applied in other areas 112. Spill over effects are likelyto be more significant where the market is competitive 113. In short, the benefits frominnovation in a marketplace where there is dynamic competition, will outweigh the costs ofdeadweight loss.Now, as discussed above, dominance will also bring rent seeking and X inefficiency.Let us consider the likely effects of such behaviour upon the equation. Importantly, bothare internalized by the innovative firm. They directly affect profitability. Therefore, theinnovating firm itself will provide a check upon welfare losses through exclusionary conductand internal inefficiency. Further, as we propose a regulation which prohibits rent seekingpractices designed to protect or entrench market power 114, the remaining concernbecomes internal efficiency. As to X inefficiencies, to the extent that a firm with marketpower does not have the same intensive competitive pressure to control costs and invest in112 These may be seen as tending to inhibit innovation; see Jorde & Teece, supra, note 91 at 53. This isdiscussed below; see section in this chapter - The Welfare Links Between Innovation and Rent Seeking.113 W.J. Baumol & J.A. Ordover, "Antitrust: Source of Dynamic and Static Efficiencies" in T.M. Jorde &D.J. Teece, eds., Antitms4 Innovation, and Competitiveness (New York: Oxford University Press, 1992) 82.114 See c.6 below.49further innovation, the relative freedom from competition resulting from innovation mayreduce total welfare lls. However, X inefficiency is generally associated with entrencheddominance and may be overcome by the use of the wasted resources in the production ofoutput by the dominant firm - a result that could be achieved through strict cost controlmeasures116. Where innovation leads to a short term advantage which is soon overcomeby imitators there is not the same likelihood of X inefficiency. It has also been argued thatan efficient capital market operates as a constraint upon X inefficiency 117. Therefore, Xinefficiency is not a necessary outcome of innovation.Further, that which is perceived as increased costs may be more accuratelycharacterized as the sharing of supra-normal profits between owners, managers and workersin the form of higher salaries and benefits 118. To the extent that managers and workersmust be induced to develop supra-normal profit opportunities through innovation, suchadditional "costs" may be seen as an inherent part of the incentive necessary to drive thedynamic process of competition. To summarize in terms of our opening "equation", weconclude that where rivalry is manifested as innovation, the welfare value of the innovationwill generally be greater than the dead weight loss flowing from the resultant monopolypricing based upon three factors - the Williamson model, the tendency of the process ofcompetition to reduce deadweight loss over time through imitation and the spill over effects115 Leibenstein, supra, note 59 c.3; and Dunlop, McQueen & Trebilcock, supra, note 8 at 160-4.116 W. Comanor & H. Leibenstein, "Allocative Efficiency, X-Efficiency and the Measurement of WelfareLosses" (1969) 36 Economics 304.117 Dunlop, McQueen & Trebilcock, supra, note 8 at 181ff review the literature on this issue. There issupport both for and against the view that a merger and acquisition market promotes internal efficiencyamongst prospective targets.118 R. Parish & Y. Ng, "Monopoly, X-Efficiency and the Measurement of Welfare Loss" (1972) 39Economica 301.50of innovation. Although rent seeking may well be greater than this net gain, we proposethat rent seeking be kept to a minimum through laws prohibiting such behaviour. Finally,the functional links between X inefficiency and the existence of market power are not directand, again, are less likely to be evident in a dynamically competitive environment.Therefore, in broad terms, total welfare may be seen as being positively affected byinnovation.The Welfare Effects of Rent SeekingNow consider the case where rivalry is expressed as rent seeking behaviour insteadof innovation. As foreshadowed above, we contend that rent seeking will have a negativeeffect upon competition. Using slightly different terminology to that which we haveadopted, Posner119 has articulated the cost to society of rent seeking behaviour designedto protect supra-normal profits in the following wayThe existence of an opportunity to obtain monopoly profits willattract resources into efforts to obtain [and, by analogy, sustain]monopolies, and the opportunity costs of those resources aresocial costs of monopoly too 129 (parenthesis added).Although in the case of rent seeking behaviour the factors that combine to affect totalwelfare are the same, their interaction is materially different 121. The functional links inthe equation are not inverse.1" The Social Costs of Monopoly and Regulation" (1975) 83 J. Pol. Econ. 807. See also F. Fisher, 'TheSocial Costs of Monopoly and Regulation: Posner Reconsidered" (1985) 83 J. Pol. Econ. 807.120 Posner, ibid. at 807. Stigler, supra, note 47 at 23-8 develops similar ideas in respect of non-pricecompetition among members of a cartel.121 So empirical studies which focus upon the outcome of supra-normal profits without identifying theircause do not accurately measure the social cost of dominance; Hay & Morris, supra, note 4 at 584-5.51With respect to innovation, it is important to differentiate two issues - bigness anddominance. As to bigness, although the risk, scope and cost of innovation may favourlarger enterprises, there is a bias away from imaginative new ideas in large organizationsdue to the personal risk to managers who may be associated with a failure and thebureaucratic burdens of over-organization 122. A survey of the literature leads to theconclusion thatNo single firm is uniquely conducive to technological progress.There is room for firms of all sizes. What we want, therefore,may be a diversity of sizes, each with its own specialadvantages and disadvantages 123 .As to dominance, the argument must be that because dominant firms are more innovative,rent seeking, which protects and entrenches dominance, thereby encourages innovation.Although Schumpeter argued that relative monopoly was necessary before there would beinvestment in innovation124, research has shown that the competitive structure of marketshas little impact upon irmovation 125. Monopoly is not a precondition to innovativebehaviour. Rather, from a dynamic perspective, dominance is the outcome ofinnovation126. It is a reward that encourages innovation. Any argument that rent seeking112 Scherer, supra, note 4 at 414.123 Ibid. at 418.124 Schumpeter, supra, note 68 at 101.125 See W.M. Cohen & R.C. Levin, "Empirical Studies of Innovation and Market Structure" in R.Schmalensee & R. Willig, eds., Handbook of Industrial Organization vol. 2 (Amsterdam: North Holland, 1989);and J.F. Brodley, "The Economic Goals of Antitrust: Efficiency, Consumer Welfare, and TechnologicalProgress" (1987) N.Y.U.L.R. 1020 at ("there is increasing evidence that small firms are the most fertile sourceof innovation. Since small firms are also the most likely victims of exclusionary practices, the costs of anunderinclusive rule are likely to be higher than previously thought, making the tradeoff in favour of vigorousenforcement more dearly beneficial to social welfare").126 There has been some research which adopts a dynamic perspective to the question of the connectionbetween dominance and inventiveness. Such studies conclude that concentration is the outcome ofinnovation; e.g. R.N. Nelson & S.G. Winter, "Forces Generating and Limiting Competition under52behaviour leads to increases in total welfare through innovation is dependent upon a linkbetween existing dominance and innovation.Are dominant firms greater innovators? There is a proliferation of evidence which,properly reviewed, "does not support the hypothesis that market structure (concentration)and firm size are significant determinants" of investment in innovation once asymmetriesin technological opportunity are taken into accountiv. Indeed, there is evidence thatentrenched monopoly reduces the incentive to innovate in that there is a tendency for themonopolist to settle for a comfortable lifestyle rather than the riskier path of pursuingfurther profits through innovation128. There is not the same profit incentive for amonopolist to innovate as there is for the firm faced with strong competition restricting itsability to earn supra-normal profits 129. Thus, although rent seeking practices arefunctionally linked to the level of successful innovation 13°, innovation is not increased bythe level of successful rent seeking practices 131 .Schumpeterian Competition" (1978) 9 Bell J. of Econ. 524.127 Hay & Morris, supra, note 4 at 489, following extensive review 473ff; and Scherer, supra, note 4 at 423-38.12° It is a tendency summarized in the oft quoted statement of J.R. Hicks, "Annual Survey of EconomicTheory: The Theory of Monopoly" (1935) Econometrica 1 at 8, "The best of all monopoly profits is a quietlife".129 Leibenstein, supra, note 59; Shepherd, supra, note 4 at 146-7 and Scherer, supra, note 4 at 414.Further, a dominant firm has less incentive to invest in an innovation that will simply replace its existingmarket power; K. Arrow, "Economic Welfare and the Allocation of Resources for Inventions" in R. Nelson,ed., The Rate and Direction of Investment Activity (Princeton University Press, 1962). It is the threat ofcompetitive entry that motivates a dominant firm to invest in innovation; Tirole, supra, note 47 at 392-3.Rent-seeking practices exclude competitive entry.130 Successful innovation being that which creates the opportunity to earn supra-normal profits and supra-normal profits being that which justifies rent-seeking expenditures.131 Successful rent seeking practices being those that protect existing market power. The case where rentseeking practices are necessary to create a barrier to imitation in order to encourage innovation is consideredbelow - The Welfare Links Between Innovation and Rent Seeking.53Also, rent seeking practices have a different effect upon dead weight loss toinnovation. Absent any barrier to imitation that exists independent of the conduct of thefirm with market power, rent seeking practices will stem the tide of innovation that wouldusually be attracted to any opportunity to earn supra-normal profits. Whereas innovationtends to attract investment that will itself reduce, over time, the deadweight loss resultingfrom a successful innovation, rent seeking practices entrench (and may increase) theallocational inefficiency caused by the exercise of market power.Therefore, we conclude that the effect of rent seeking upon total welfare will benegative132.The Welfare Effects of ImitationIn order to complete our analysis we need to consider the welfare effects ofimitation. They may be shortly stated. The process of imitation, encouraged by theopportunity to earn supra-normal profits created by the innovator reduces deadweight lossand X inefficiency. The entry of imitators moves the market towards allocational andinternal efficiency. Although, imitation does not generate innovation directly, it does soindirectly because the fact that firms faced with direct competition become limited byexisting technology to earning normal profits, encourages firms to be innovative and restartthe cycle of innovation and competition 133. Therefore, the welfare outcomes of imitation' We do so subject to our discussion of the welfare links between innovation and exclusion below - TheWelfare Links Between Innovation and Rent Seeking.133 Scherer, supra, note 4 at 437-8 states "There is abundant evidence from case studies to support the viewthat actual and potential new entrants play a crucial role in stimulating technical progress, both as directsources of innovation and as spurs to existing industry members". However, some would argue that too muchcompetition stifles innovation in that there are no surplus funds for investment in new technology (a viewthat originated with Schumpeter, supra, note 68).54are positive - and more so if they are seen as part of the dynamic process of competition.The Welfare Links Between Innovation and Rent SeekingTo this point we have almost invariably expressed the process of competition insequential terms - innovation followed by imitation. However, the investment of a firm ininnovation will be materially affected by the firm's perception of the length of the periodbefore imitation will compete away the opportunity to earn supra-normal profits createdby the invention. Before investing in innovation, a firm will appraise the prospect ofcompetition in the future. An assessment will be made of how quickly the invention maybe expected to diffuse through the market place so that it becomes part of the technologicalbase available to all rivals in the marketplace lm. Without a lag between imitation andinnovation, there is little incentive to innovate. Indeed, in such cases, there may beconsiderable advantages in waiting to imitate the innovations of others 135 .Many of the factors that contribute to the delay in imitation will exist independentlyof any exclusionary conduct by the firm. They may be the incidental outcome ofcompetitive behaviour. For example, the complexity of the innovation and the timerequired to imitate, the time required to train employees136, investment in significant134 The term "diffusion" is often used in the literature to describe the period of lag between innovationand imitation; e.g. W.E.G. Salter, Productivity and Technical Change 2nd ed., (Cambridge, 1966) & S. Davies,The Diffusion of Process Innovations (Cambridge, 1979).135 For a discussion of such strategies see Hay & Morris, supra, note 4 c.13.136 Firms learn from mistakes. The way such experience may deter entry is expressed in the phenomenaof the learning curve "the more one produces of something such as an innovative item just coming into massproduction, the more one lowers costly mistakes and quality-control rejections - and therefore, the more onelowers average unit cost. A new entrant must not only be aware of the technology, but also the experiencein its application in order to be able to compete successfully.55plant capacity in order to meet expected future demand137, advertising138, release ofnew products139, or vertical integration to ensure availability of inputs and channels ofdistribution for the innovated product140. In other cases they may be influenced by themarket behaviour of the firm in taking advantage of exclusive property rights recognizedby the law. So imitation may be delayed by the exclusive right to a brand or trade mark,existing market reputation, trade secrets, fiduciary obligations of employees, patents or awell known business location. Still others may be the outcome of factors independent ofthe market behaviour of the firm, such as government regulation, or geographical barriers.All such factors combine to delay imitation significantly beyond the immediate and timelessresponse that would be associated with the model of perfect competition. We describefactors that create a lag between innovation and imitation as barriers to diffusion.Importantly, they are an incidental outcome of the process of competition within theexisting property law structure, rather than the result of any strategic investment inexclusionary behaviour by the firm.To a significant degree, barriers to diffusion may be seen to be sufficient toencourage investment in innovation. Of course, there is no precise correlation between theheight of barriers to diffusion and the delay in innovation that is necessary to encourage a137 In doing so it may make entry more difficult for prospective entrants; Lieberman, M., "Excess Capacityas a Barrier to Entry: An Empirical Appraisal" (1987) 35 J. of Ind. Econ. 607.138 Advertising may operate as a sunk cost that deters entry; see the summary of the literature in Hay &Morris, supra, note 4 at 227-8.1" The use of "fighting brands" is expressly referred to in s.78 of the Competition Act; see Eddy MatchCo. Ltd v. The Queen (1953) 20 C.P.R. 107. The use of numerous brands as an exclusionary tactic,inconsistent with normal competition, was argued in Re Kellox Co 99 F.T.C. 8 (1982).14° Such conduct would have the incidental effect of requiring competitive entry at a number of functionallevels in the market simultaneously - which would be logistically more difficult as it would accentuate thedifficulties at each level by combining them all.56particular innovation. In theory, the barriers to diffusion should be kept to the minimumnecessary to encourage innovation. Indeed, Shepherd has argued that[t]he social aim is to obtain the benefits of the good actions,while minimizing the social costs that are imposed by themonopoly rewards. Therefore, the efficient reward for thedominant firm should be identified and the actual rewardshould not go above that level.Because the benefits are finite, the efficient reward will alwaysbe finite in amount, rather than unlimited. Therefore an open-capture basis for rewards can be immediately rejected. It hasno place in an efficient economy, operating in line withneoclassical economic theory. There, all factors are paid finiteamounts, related to the value of their contributions toproduction. Only a finite reward to dominant firms isconsistent with that efficient system141 .The difficulty with such an approach is that, despite the author's assurance that it can guidethe broad thrust of policy, it assumes that the value of an innovation can be measured withsome precision. Such an approach would require that there be a limit upon profits thatmay accrue to a firm from an innovation (even without exclusionary behaviour). It wouldalso, presumably, condone exclusionary behaviour where it was necessary to create enoughprotection from subsequent imitation to induce a firm to innovate. Rather than thedichotomy between competitive behaviour and rent seeking behaviour that we havearticulated, Shepherd would regulate on the basis of the minimum profit incentive necessaryto encourage an innovation.There are a number of practical difficulties with such an approach. First, thediversity of returns that may be generated from innovations is extreme and dependent uponthe factual circumstances of each case. The result is that it is not possible to formulate a141 W.G. Shepherd, "Efficient Profits vs. Unlimited Capture, as a Reward for Superior Performance:Analysis and Cases" (1989) 34 Antitrust Bulletin 121 at 124-5.57rule of general application. Second, by its nature innovation is an uncertain and riskybusiness. The specific returns that are needed in order to encourage a particularinvestment are usually only apparent after the fact 142. Third, reducing the returns froman innovation to the margin may well undermine the incentive that drives the process ofcompetition. Why invent if all that is going to be earned is the same level of profits thatwould be earned without inventing? Fourth, it is difficult to see how Shepherd's approachcould be implemented without substantial bureaucratic intervention which has its own cost.A rule which allowed exclusionary behaviour would have to be qualified in terms whichlimited such behaviour to the degree necessary to encourage innovation. Such a rule wouldbe difficult to supervise due to its dependence upon a detailed assessment of the facts ineach case.However, Shepherd's analysis does expose one deficiency in our characterization ofrent seeking practices as necessarily welfare reducing. We have not addressed the questionwhether, in cases where the barriers to diffusion within the economy are insufficient toencourage investment in a particular innovation, rent seeking practices ought be allowedin order to encourage the innovation. The question is whether allowing exclusionarypractices in addition to the barriers to diffusion inherent in the existing marketplace willincrease total welfare. We argue, for the reasons which follow, that where barriers todiffusion are insufficient to encourage welfare improving innovations, regulations other thancompetition laws are the most efficient means of improving total welfare.First, in overall terms, the welfare losses associated with unrestricted rent seekingare likely to be greater than the welfare gains through innovation stimulated by such an142 Nordhaus, supra, note 70 at 55.58approachm. Though not without criticism, studies which have attempted to calculate theloss from rent seeking associated with monopoly have shown it to be a dramatically largerconcern than the allocative inefficiency resulting from supra-normal pricing 144. Rentseeking is the means by which dominance may be entrenched. It is open ended. There isno way that exclusionary conduct that encourages innovation can be differentiated incharacter from exclusionary conduct that simply leads to entrenched profits far exceedingthat which was necessary to induce the investment in developing the innovation.Second, in the context of a consideration of the welfare value of the patent system(a legalized form of exclusionary conduct in which firms may invest) Scherer argues, afterreviewing the research, that barriers to diffusion are already widespread in an industrializedeconomy and operate as a substantial incentive for innovation in most cases.We find that business firms may invest in innovation withoutpatent protection if natural imitation lags are substantial, ifthere are major competitive differentiation advantages frombeing first in the market with a new product, and/or if themarket is oligopolistic. All three characteristics are widespreadin a modern industrialized economy...It is only when thebarriers to widespread and rapid imitation are weak, or whenthe advantages of competitive leadership are modest, or whenthe profit potential of the innovation is small, or when there issome adverse combination of the three, that patent protectionbecomes an important incremental stimulus 145 .By analogy, the same reasoning refutes the argument that rent seeking practices ought be143 Shepherd, supra, note 141 at 127 and authorities cited therein.144 See K Cowling & D.C. Mueller, "The Social Costs of Monopoly Power" (1978) 88 Econ. J. 727 (forcriticisms of their study, see Hay & Morris, supra, note 4 at 584-5).145 Scherer, supra, note 4 at 447.59allowed because they encourage innovation146.Third, and more important, is Scherer's conclusion that the benefits of the patentsystem are probably confined to two categories of innovation - "those whose economic valueis modest in relation to development costs, and those that represent unusually bold, riskydepartures from known technology" 147. Only the second category is of considerablewelfare significance. In such cases, other policy interventions which encourage investmentin riskier innovations such as taxation incentives, government research programmes,research grants and subsidies and special patent protection are to be preferred to theenactment of a competition law which allows exclusionary behaviour (with its attendantwelfare loss) in all cases148.Fourth, the more significant the welfare effects of an innovation, the lower thebarriers to diffusion required to recoup the investment in the innovation - and therefore toencourage private investment in the innovation. Such innovations require only a shortperiod in which to recoup their cost their large benefits bring substantial opportunities forsupra-normal profits 149.Fifth, to accommodate a rule which prohibited exclusionary behaviour only in caseswhere it resulted in a net welfare loss taking into account the effects upon dynamicefficiency would create substantial administrative costs.Sixth, there is significant support for the view that there are greater incentives for' There have been variable outcomes from empirical research concerning the rate of diffusion ofinnovations in the marketplace. However, such studies fail to differentiate between "barriers to diffusion" and"exclusionary behaviour"; Salter, supra, note 134.147 Scherer, supra, note 4 at 454.148 Hay & Morris, supra, note 4 at 660; Scherer, supra, note 4 at 457-8.149 Nordhaus, supra, note 70 at 76-82.60firms that are subject to competitive pressure to innovate, than for entrenched dominantfirms15°. Rent seeking practices, in creating barriers to competition, directly reduce theincentive for dominant firms to innovate.An Aside C.oncerming Significant Exogenous Barriers to DiffusionThere remains a further issue raised by the fact that the dynamic of the marketplaceincludes the possibility that there may be barriers to diffusion independent of the marketbehaviour of the firm. In some cases, factors exogenous to the conduct of a firm may playa significant role in the dynamic. Competition will be deterred by such factors. Forexample, the innovative behaviour of a firm which results in the position of dominance maycomprise obtaining the only government licence to supply a particular product, or theestablishment of its business in a superior geographical location for which there is nophysical alternative, or supplying a market in which the level of demand results in one firmbeing the only efficient scale to supply the product. In such cases, the context in which theinnovative firm changes its market behaviour makes it inherently difficult for other firmsto imitate the strategy. These factors prevent imitation as effectively as rent seekingbehaviour, but, importantly, they are not part of the conduct of the dominant firm. At bestsuch factors provide a motive for certain innovative behaviour by firms. Their existencemeans that firms may be expected to invest in change which will secure a position that islikely to be relatively free from competitive constraint due to factors external to the conductof the firm which will prevent imitation. In other words the competitive conduct of firmsmay be expected to exploit opportunities created by exogenous barriers to diffusion.150 See the summary by Shepherd, supra, note 4 at 146-7.61Often no distinction is drawn between the dynamic created by such exogenousbarriers to imitation, on the one hand, and the opportunities to exclude competitive conductthrough rent seeking barriers to imitation, on the other151. However, we wish toemphasize the distinction as it is a significant one in the context of our concern to identifywith precision the socially undesirable market conduct of dominant firms. In such a contextit is important to focus upon the conduct of the firm, not exogenous barriers to diffusion.Recognizing that exogenous barriers exist is a necessary part of understanding the dynamicof market conduct that results from the prospect of dominance. However, such barriers areexternal to the conduct of the firm.An example assists in understanding the distinction. Assume that the governmentgrants a single television licence for a particular region. Firms will compete for the licenceinvesting in innovative and imitative strategies in order to secure it. Firms may also engagein rent seeking behaviour to prevent or persuade other firms from competing for thelicence. The outcome of all such conduct will be the grant of the licence to a particularfirm. That firm will be dominant in the region in which the licence operates. The fact thata licence is required to compete with the firm will operate as an absolute barrier preventingnew firms from adopting innovative or imitative strategies in order to secure a share of thesupra-normal profits enjoyed by the licence holder. However, no conduct by the incumbent151 Bain, supra, note 47 at 255ff makes no distinction between the source of the barrier. Any conditionof entry "that permits established firms to elevate price at least somewhat above minimal average costswithout inducing new firms to enter obviously reflects the existence of some barrier to entry"  (emphasisadded). Stigler, supra, note 47 at 67ff approached the issue in a slightly different way defining barriers toentry as "a cost of producing (at some or every rate of output) which must be borne by a firm which seeksto enter an industry but is not borne by firms already in the industry". Stigler intended to exclude thosebarriers which are merely the expression of past successful strategies; ibid. 67-8. This comes closer to ourdistinction, but still characterizes barriers as external to the firm whereas we distinguish barriers which arethe outcome of conduct (either competitive or rent seeking) and barriers which are the outcome of externalconsiderations or context (e.g., location, market size relative to scale efficiencies or a system of governmentlicensing).62creates or sustains that barrier. Certainly the licence holder may be expected to engage insupra-competitive pricing and to operate with X inefficiency. But that conduct is anexpression of dominance, it is not the conduct that creates or sustains dominance. In suchcases, the conduct that creates or secures the position of dominance will still be eithercompetitive or rent seeking behaviour.Nevertheless, our analysis of the social desirability of dominance was dependentupon the prospect that investment in innovation and imitation would be attracted by theopportunity to earn supra-normal profits thereby ensuring the overall benefits of thedynamic of the process of competition. In cases where the barriers to diffusion independentof the market behaviour of the dominant firm make the position of dominance relativelyunassailable, there is a strong argument for some regulatory intervention to replace thediscipline that would, in the absence of such exogenous barriers, be provided by thedynamic of the process of competition. However, there are substantial difficulties informulating a conduct based rule to deal with such cases.In the United States the courts have attempted to develop a rule 152. It is knownas "essential facility doctrine" or "bottleneck theory" 153. In various decisions the DistrictCourts in the United States have described conduct as monopolization where there iscontrol of an essential facility and no reasonable prospect of competition in the supply of152 Although the rule has not been developed in the context of exogenous barriers to diffusion, we willendeavour to show that it is an attempt to deal with those cases where such barriers are the predominantfactor influencing the conduct of the dominant firm.133 For a discussion of the development of the doctrine see D.M. Podel, "The Evolution of the EssentialFacilities Doctrine and its Applications to the Deregulation of the Natural Gas Industry" (1989) 24 Tulsa L.J.605 at 613-21; J.R. Ratner, "Should There Be an Essential Facility Doctrine?" 21 U. of Cal. Davis L.R. 327;and D.E. Troy, "Unclogging the Bottle Neck: A New Essential Facility Doctrine" (1983) 83 Col. L.R. 441.63the facility. Though the reasoning has been diverse 154, four principles expressing its keyelements have received approval in a number of cases155. They are as follows1. Control of the essential facility by a monopolist;2. The competitor's inability practically or reasonably to duplicatethe essential facility to a competitor;3. The denial of the use of the essential facility to a competitor;and4. The feasibility of providing the facility156.The key element in the context of our current discussion is the second principle -inability to duplicate. The factual contexts in which the doctrine has been argued revealthat it is applied where there are barriers to entry which are not supported by ongoingconduct of the dominant firm, and which cannot be overcome by competitive behaviour.Examples include, the unique geographical location of a crossing point on the MississippiRiverl", access to a unique sports stadium158; and control of telephone distributionnetworks 159.We suggest that the underlying intuition that has led to the development of thedoctrine is the recognition that in certain cases external factors prevent firms fromcompeting for the supra-normal profits of a dominant firm, even when the dominant firm154 Ratner, ibid. at 328 ("Various circuit decisions have addressed the theory directly with differing tests,analyses and results").155 Originally stated in Hecht v. Pro-Football Inc. 570 F.2d 982 (1977) (D.C. Cir) [hereinafter Hecht], thefour requirements for the application of the doctrine were summarized in MCI.  Communications Corp. v.American Telephone and Telegraph Co. 708 F.2d 1081 (19830 (7th Cir) [hereinafter Communications]at 1133 and have been followed in Flip Side Productions Inc. v. Jam Productions Ltd. 843 F.2d 1024 (1988)(7th Cir) at 1033, Ferguson v. Greater Pocatello Chamber of Commerce Inc 848 F.2d 976 (1988) (9th Cir) at983 and McKenzie v. Mercy Hospital of Independence 854 F.2d 365 (1988) (10th Cir) at 369.158 M.C.I. Communications, ibid. at 1133.157 United States v. Terminal Railroad Association 224 U.S. 383 (1912).158 Hecht, supra, note 155.158^Communications, supra, note 155.64is relatively passive, save for restricting supply of its commodity. Such a firm will act torestrict supply and thereby command a supra-normal profit, but such action does not havean impact upon competition. It is not exclusionary. It is not the conduct of the firm thatis preventing the forces of competition from eroding the position of dominance - it is simplythe context. The context may be a unique physical location or a scale efficiency that doesnot warrant a new entrant or a government licence that prevents new entry. The firm neednot act to protect its monopoly by rent seeking practices because the factors external to thefirm - its unique market context - mean that it can rely upon exogenous barriers to diffusionto protect its position.In such cases the regulatory issue is not the prevention of conduct which isanticompetitive or an abuse of dominance - conduct designed to exclude competition ratherthan compete16° - rather it is the prevention of the practice of supra-competitive pricing.For such a firm, dominance is more than a transitory phenomenon. To promotecompetitive behaviour will not eliminate the inefficiency. The firm the subject of complaintis succeeding because of competitive strategies. What is necessary is to eliminate theexternal barrier or to prevent the restriction of supply attendant to supra-competitivepricing. It is no small coincidence that cases concerning the application of the essentialfacility doctrine usually concern an application for an order requiring supply "on competitiveterms"161 .Clearly, in the long-run, the promotion of total welfare requires some basis for160 An important aspect of the cases decided under the essential facilities doctrine is that they concernthe activities of lawful monopolists - those that have acquired their monopoly position through "skill,foresight and industry" or which are natural monopolists. The cases articulate the circumstances in whichsuch lawful monopolists will have a duty to deal; see Troy, supra, note 153 at 442-6.161^_z g., see the cases listed supra, note 155.65regulating the continuous practice of supra-competitive pricing, but only by firms operatingin markets that are protected by exogenous barriers to diffusion 162. However, the natureof the issue suggests an administrative or supervisory regulation, rather than a conductbased regulation. The determination of a "competitive price", the calculation of a fairsupra-normal return where there has been innovative investment in a risky venture whichhas, in the result, secured a protected stream of supra-normal profits and the difficulty inidentifying when the facility is legitimately required by the owner for its own purposesrequire case by case decisions. In Australia and New Zealand such concerns have led tothe rejection of the essential facilities doctrine 163.As we are unable to regulate any unique conduct by firms protected by externalbarriers to diffusion, the regulatory alternatives are to supervise the pricing practices of thedominant firm; or to require the dominant firm to supply its product at a "competitive"price to all who wish to purchase it, thereby preventing it from restricting output and raising162 It is important at this point to recall our earlier analysis that supra-competitive pricing, per se, is notsocially undesirable. It is part of the means by which the dynamic of the process of competition operates.What our present discussion identifies is that in limited cases, where the ability to earn supra-normal profitsis facilitated by factors external to the conduct of the firm, there is support for regulations proscribing supra-normal pricing. Part of the confusion attendant to the essential facilities doctrine has arisen because of anemphasis upon the definition of the power to monopolize (often described as monopoly power) as the abilityto raise price or exclude competition. However, our analysis shows that the exercise of such monopoly powerdoes not determine whether conduct is socially desirable. It may be the outcome of competitive behaviour(in which case it should be encouraged), or rent seeking (in which case it should be discouraged); see thedetailed discussion of these issues below; c.5 - Monopoly Power. In the present context we must resist anytendency to equate the power to price supra-competitively (which follows form the exclusion of competitionby any means) as necessarily being the outcome of socially undesirable market activity. It is the context, notthe conduct, that is the concern in cases involving the essential facilities doctrine; compare Troy, supra, note153 at 459-62.163 See, in Australia, the decision of the Full Court of the Federal Court in Queensland Wire, supra, note23 and, in New Zealand, the decision of the High Court in Union Shipping, supra, note 30, at 704-5.However, compare Auckland Regional Authority v. Mutual Rental Cars (Auckland Airport) Ltd. [1987] 2N.Z.L.R. 647 at 679ff. in which Barker J. applied Hecht, supra, note 155. The case concerned a classicexample of exogenous barriers to diffusion. The Auckland Regional Authority was a statutory body withexclusive statutory power to grant rights to car rental companies to operate from the Auckland Airport.66price to supra-competitive levelsiM. The very different regulatory issues raised by suchalternatives compared to the issue of precise articulation of the dichotomy between normalcompetitive conduct and socially undesirable market conduct the subject of this paper causeus to exclude any attempt to provide for such factual situations in our analysis. Rather wecontend that the problems of exogenous barriers to diffusion must be addressed by meansother than a competition law which seeks to proscribe, as precisely as possible, marketconduct associated with dominance that is socially undesirable irrespective of context.To summarize, where there are substantial exogenous barriers to diffusion, thedynamic of the process of competition is interrupted. There is no change that can be madeto attack the incumbent dominant firm. In such cases regulation requires the facilitationof change. Just as patent laws deal with the problem of insufficient barriers to diffusion,price control deals with the problem of insurmountable barriers to diffusion. However, inboth cases the issue involves regulating the context, not the conduct, of market conduct byfirms. It is impossible to proscribe investment in markets which are protected by exogenousbarriers to diffusion. It would undermine the dynamic of the process of competition toproscribe the practice of supra-competitive pricing. Competition laws, concerned as theyare with market conduct that is socially undesirable in most cases, are not the appropriateregulatory instrument to deal with the issue.Summary of Welfare Links Between Innovation, Rent Seeking and Exogenous Barriers toDiffusionWe conclude that the role of exclusionary behaviour in creating barriers to diffusion164 Compare the discussions by G.J. Werden, *The Law and Economics of the Essential Facility Doctrine"(1987) 32 St. Louis U.L.J. 433 at 474ff and Troy, supra, note 153 at 483-6.67necessary to encourage innovation is not substantial; the welfare costs of allowing all rentseeking behaviour would outweigh the benefits that would flow from increased innovationthrough allowing firms to engage in exclusionary practices to raise barriers to diffusion; andto the extent that existing barriers to diffusion may be too low to encourage some welfareimproving innovations, or too high to enable welfare improving imitation, policy tools otherthan competition laws will be a more effective means of redressing the concern.Conclusion Concerning Welfare Effects Associated with DominanceIn summary we make three conclusions as to the welfare effects of market behaviourassociated with dominance. First, innovative behaviour will be welfare improving. Second,to the extent that innovative behaviour establishes inefficiency, imitation after innovationwill further improve welfare. Third, rent seeking, in preventing imitation will be welfarereducing unless it is undertaken to encourage an innovation with substantial welfarebenefits. Where the process of imitation will be so rapid that it will discourage innovationentirely, complementary regulations that protect, for a time, the supra-normal profits thatare required to attract innovation are justified. Patent laws and taxation incentives thatreduce the cost of innovation fall into this category of regulation. Such laws may beconsidered to be a part of the barriers to diffusion necessary to encourage innovation.Where the process of innovation and imitation will be discouraged by exogenous barriersto diffusion, complementary regulations that control pricing or supply practices, or thatfacilitate competition are required. Such laws may be considered a necessary part offacilitating the process of competition.68Whose Perspective of Welfare?One of the issues which an emphasis upon dynamic efficiency raises is whetherinnovative change actually brings increases in total welfare, even if demanded by consumers.As Areeda has put it, in somewhat biased terms "puritan commentators see not the virtueof greater perceived value but the vice of misled sheep"165. If a new product actuallyperforms identical functions to, and is not materially different from, existing products whichare supplied by a highly competitive industry at prices approaching the equilibrium thatwould arise in a perfectly competitive market, but is seen as more fashionable and thereforedesirable than existing market offerings, thereby producing market power for the seller ofthe new product, is total welfare actually increased by the change? There are three issuesraised by such a question.The first concerns informational market failure. As we have seen from theassumptions underlying the models of perfect competition, it is necessary for buyers andsellers to have symmetric information concerning the commodity being offered for sale. Inmany cases a buyer may be persuaded to overvalue a product simply because she or he isunaware that there is an equivalent product available from another seller. An importantelement of the process of competition are laws and practices in the marketplace whichencourage honesty and discourage misrepresentation. Most legal systems have laws thatdeal with such issues. In a number of jurisdictions "consumer protection" laws have beenenacted as complements to competition laws 166. However, such concerns transcend165 P. Areeda, "Antitrust Law as Industrial Policy: Should Judges and Juries Make it?" in T.M. Jorde &D.J. Teece, eds., Antitnts4 Innovation, and Competitiveness (New York: Oxford University Press, 1992) 29 at36.' E.g., ss. 52-59 of the Competition Act and ss.51A to 75A of the Trade Practices Act.69dominance and relate to the regulation of the marketplace generally. They need not beaddressed in a law concerned with socially undesirable market conduct associated withdominance.Nevertheless, it is important to recognize that the existence of informationalasymmetries in the marketplace may be exploited by dominant firms. For example, the firstfirm to introduce a new product in the marketplace often achieves a reputation associatedwith its product of reliability, durability or established parts and after-sales service. Thereputation itself may be the incidental outcome of competitive behaviour. However, it maybe strategically exploited to prevent the entry of imitators into the market. The difficulttask of distinguishing between competitive and exclusionary behaviour in such contexts isconsidered in detail below167.The second welfare issue concerns the extent to which a society is prepared to valueconsumer sovereignty. In one sense it may be more efficient for identical products to beproduced instead of the proliferation of brands and product differentiation that isencouraged through the process of competition as firms strive to achieve a degree offreedom from competition. However, to regulate the proliferation of brands involves themaking of value judgements as to whether the existing or proposed product differences bysome mechanism other than the market. The cost of a bureaucratic mechanism make itunlikely that it will increase efficiency. Clark summarizes the role of consumer choice inthe market mechanism in the following wayThe process of consumer choice is necessarily a decidedlyimperfect mechanism for selecting those producers who bestserve the consumers' interests; nevertheless it is a good deal167 See below, c.6.70more effective than might be thought, from an analysis thatfocuses upon its weakest links. To sum up, the consumerneeds protection against his own mistakes, where health andsafety are threatened...There is room for prohibition of someproducts..., for minimum standards of health and safety, forrequirements that labels disclose content, where that isessential to consumer judgments".However, wholesale rejection of consumer sovereignty in which individuals signal to themarket what they want is to reject the market system as an efficient allocator ofresources169.The third welfare issue arises due to externalities and public goods. There are somewelfare consequences for society that are not factored into the equation when a transactionis made between a buyer and a seller. These welfare outcomes may be significant, but arenot taken into account by a market system. To some extent buyers and sellers may beforced to take them into account through regulations which make them part of the marketsystem170. However, as important as it is to recognize that the welfare outcomes of amarket transaction go beyond the effects upon individual buyers and sellers, such issues maybe addressed by other policy interventions171. They are issues that are not unique todominant firms.168 Supra, note 36 at 242.169 See above, c.2. For an interesting discussion of the "consumer as limited sovereign" in the context ofmarkets in which there is product differentiation; see Clark, supra, note 36 at 230ff.170 For example, through regulations which impose a cost upon polluters; see Brander, supra, note 93 at282ff.171 For a discussion of the significance of external effects upon a cost-benefit analysis; see E.J. Mishan,Cost-Benefit Analysis: An Informal Introduction 3rd ed. (London: George, Allen & Unwin, 1982) at 111-49.71The Regulatory IssueTherefore, the specific welfare concern raised by the existence of dominance is thefact that it is an outcome that encourages rent seeking. Our analysis suggests that rentseeking conduct by all firms ought to be the focus of regulation.However, two questions remain before we may conclude that existing dominancelaws should be replaced by a regulation which proscribes rent seeking by all firms. First,is there any other socially undesirable outcome of dominance that is addressed by theexisting laws? Often dominance is viewed in pejorative terms because it is said to effectinequitable distributions of wealth and power by concentrating both in the hands ofdominant firms. Do such concerns justify a law which applies especially to market conductby dominant firms? Second, do dominant firms have any special power to engage in rentseeking behaviour? A survey of the leading cases reveals that implicit in many of thedecisions interpreting dominance laws is the belief that dominant firms have a power toengage in certain market conduct which is unique to dominant firms. If such a uniquepower exists it may justify a law which only applies to dominant firms. We address thesetwo important questions separately in the two chapters that follow.72Chapter 4: Is Dominance Socially Undesirable?To this point we have argued that the possibility of achieving market dominance, orrelative freedom from competitive constraint, is an inherent part of the dynamic of theprocess of competition. We have proposed that dominance itself ought not be of regulatoryconcern, rather competition laws ought to focus upon rent seeking conduct which inhibitsthe responsiveness of other firms to compete for the supra normal profits being earned bythe innovator. In this chapter we consider whether there are any other socially undesirableaspects of market dominance which justify the existing regulation of dominant firms. Weemphasize that we are concerned with competition policy, not government policy in general,a distinction the significance of which will become apparent in the balance of this chapter.Aside from arguments based upon the effects of dominance upon total welfare (an issueconsidered in detail in the previous chapter), dominance is usually attacked as effecting andsustaining inequitable distributions of wealth and power by concentrating both in the handsof dominant firms172.Equitable Distribution of Wealth and PowerIt is common for the wealth distribution effects of the market system to be ignoredin framing competition policy. It is usually argued that the market is an instrument formaximizing total welfare and that the issue of distributional equity should be addressed byin Compare, Fox, supra, note 44; Pitofsky, supra, note 4; and H. Hovencamp, "Distributive Justice andthe Antitrust Laws" (1982) 51 Ge. Wash. LR. 1.73other government interventions such as taxation and welfare policy 173. There are notableexceptions which argue for an integration of the two objectives of wealth maximization anddistributional equity in framing competition laws 174. Therefore, it is important tounderstand the impact of the process of competition upon the distribution of the wealthwhich it generates. There are two main ways in which the market system may be perceivedas causing the inequitable distribution of the wealth which it maximizes.The first arises because there must be ownership of resources by individuals for amarket to be created. Once ownership is established there can then be an exchange ofgoods and services175. But, at any point in time resources will be unevenly dividedamongst the population. This inequality in distribution raises a number of issues. Theallocation of resources by the market mechanism is based upon demand for those resources.Demand is significantly affected by wealth. The more an individual owns the more thatperson will value certain goods and services; such as yachts, vacations, restaurants, fineclothes and jewellery. Therefore, the distribution of resources dictates the allocation ofresources that results from exchange in the marketplace. If, on a global scale, resourceswere to be transferred from the world's wealthiest nations to the people of the world's mostimpoverished nations we would expect a substantial rise in the global demand for food,173 This is the basic approach adopted by applied welfare economics generally; A. Harberger, "ThreePostulates for Applied Welfare Economics: An Interpretive Essay" (1971) 9 J. Econ. Lit. 785. For adiscussion of the interaction between policies which evaluate the net benefits of a regulatory policy withoutregard to the individuals who receive those benefits (and those who may lose in order to create the netbenefit) and the issue of redistributive taxation; see Hay & Morris, 568-90.174 ozinga, supra, note 4 at 1202 argues that equity goals in general and distributional goals in particularare promoted by a law directed at promoting efficiency. "Equity goals such as more egalitarian distributionof income and the deterrence of racial discrimination are indirectly and costlessly promoted by a direct attackon inefficient, anticompetitive market structure and practices. See also, Pitofsky, supra, note 4.175 L.G. Telser "Cooperation, Competition and Efficiency", (1985) 28 J. of Law & Econ 271 at 272-7.74clothing and education and a fall in demand for luxury goods and services. In one sensethe "demand" for these goods has not changed, just the capacity of certain people to givethem value.The demand to which the market mechanism responds, and the efficient equilibriumwhich it generates, is a function of current resource allocations. At any point in time, anychange in the distribution (or ownership) of existing resources will produce a dramaticchange in their allocation amongst goods and services. But from the perspective of themarket mechanism, even though the equilibria reached will differ depending upon thedistribution of ownership of resources, each will be allocatively efficient 176.The significance of such observations in the context of dominant firms is that, as wehave already observedm, the monopoly pricing of dominant firms results in a transfer oftotal surplus from buyers to sellers. Therefore, it may be argued that dominance ought tobe proscribed as it results in an allocation of resources which tends to prefer the demandsof the owners of dominant firms.There have been attempts to create markets that redress the impact of existingdistributional inequities178. However, it is important to recognize that the impact ofdistributional inequity cannot be wholly redressed by continuously equalizing resourceownership through welfare distributions or by state ownership or, indeed, be eliminating176 Hay & Morris, supra, note 4 at 569.177 See above, text relating to note 57.178 Nevertheless there are those who argue that private markets remain the most efficient and equitableway to organize the provision of education because people will invest in the human capital of education inproportion to the potential of each individual which leads to allocational efficiency. The only governmentintervention that is needed is to redress failures in finance markets that are reluctant to finance educationcosts; P.K. Porter and M.L. Davis, "The Value of Private Property in Education: Innovation, Production andEmployment" (1991) 14 Harv. J. of Law & Pub. Pol. 397.75dominance. To do so would be to destroy the underlying incentive effect of the marketmechanism, namely the private interest to maximize profits 179. However, to the extentthat such transfers go beyond what is the necessary incentive for innovation, they may beseen as being inequitable. Therefore, it may be said that an absence of competitionproduces not only allocational inefficiencies, but also inequities in the distribution ofincome. This is an issue which we addressed in detail in the previous chapter where weargued that our approach to the regulation of the socially undesirable market conductassociated with dominance will prohibit unnecessary profit incentives for innovation. Thatis to say, it will tend to limit supra-normal profits to those which are necessary in order toencourage innovations which improve the welfare of society as a whole 180.Secondly, in societies which value democracy, there are those who argue thataggregations of wealth in the hands of a few producers (or the owners of capital in suchfirms) is undesirable as it creates economic power which enables such firms to have anunreasonable influence upon society, even though such power may be simply the outcomeof successful competitive strategies 181 . Therefore, equity and fairness requires societiesto trade off the goal of maximizing welfare against the goal of maximizing the voice of eachmember of society in its political structures. Such an approach necessarily questions theabsolute importance of wealth maximization which has been the unspoken premise behindour analysis of the process of competition to this point 182.179 The result is a tension between goals of efficiency and equity; Elzinga, supra, note 4 at 1194ff. Thisis a consequence which is evident in the formulation of taxation policy.le* See above, c.3 - The Welfare Effects of Rent Seeking.181 Pitoisky, supra, note 4; E.M. Fox, supra, note 4; and Unger, The Critical Legal Studies Movement (1983)96 Harv. L.R. 561, 585-6.182 ibid.76Whilst these observations show that it is possible to question the equity of thedistribution of wealth effected by the market system, there is no means by which the marketsystem may be regulated to achieve a particular distributional outcome. To the extent thatpolicies are required to redress perceived inequities in existing distributions of wealth in amarket economy, those policies must be external to the market mechanism 183. Thereason is well articulated in the following recent statement by the Director of Investigationand Research of the Bureau of Competition Policy in Canada concerning wealth transfereffects of markets. The statement was made in the specific context of merger policy, butapplies to competition laws in general.Economists have advocated treating wealth transfer neutrallyowing to the difficulty of assigning weights a priori on who ismore deserving of a dollar. Even considering that some systemof weighting could be articulated, the practical implications ofthis are likely insurmountable - for, who is losing and who isreceiving the transfer? Shares are often widely held in publiccompanies. Are the shareholders of pension-fund investors ina firm more or less deserving than the customers of that firm?Moreover, who are the customers? In cases of intermediateproducts, is one looking to the shareholders of the consumingcompanies or to their customers? 184Whilst there must be policies that ensure an equitable distribution of wealth within society,it is extremely difficult to formulate any regulation that adjusts the distributional outcomesof the market system to conform to any given perspective of equity 185. The process of183 Areeda & Turner, supra, note 7, vol. 1 at 21-31.184 Consumer and Corporate Affairs Canada, Speech S-10'728\92-07, "Decisions and Developments:Competition Law and Policy, Remarks Delivered by Howard I. Wetston, Q.C. Director of Investigation andResearch Bureau of Competition Policy to the Canadian Institute, Toronto" (June 8, 1992).185 One of the advantages of the market system is that choices do not need to be made between who ismore deserving of "wealth". See also, Williamson, Limits of Antitrust, supra, note 103 at 108("Macroeconomic policy instruments (taxes, transfers, expenditures) with which to correct distributionalconditions are not only available but superior to the use of antitrust for this purpose").77competition requires the potential for innovators to earn supra-normal profits 186. Equityrequires that such profits be kept to a level which is necessary to serve the common goodthrough the encouragement of innovation. Arguably, considerations of distributional equity,suggest that, so far as possible, competition laws should ensure that supra-normal profitsare kept at the minimum level necessary to encourage innovation. However, it is quitepossible, through the redistribution of wealth, to reduce, or even eliminate, the incentiveto innovate. Further, the point at which incentive is reduced will vary depending upon thecontext187 .The distributional consequences of competition are diffuse. Without a doubt, aninherent aspect of the market system is the creation and exploitation of the ability to earnsupra-normal profits. Supra-competitive pricing redistributes wealth from buyers to sellers.Over time it prefers the needs and preferences of those able to charge supra-competitiveprices over others. But to focus on the wealth distribution effects of supra-normal profitsignores the other part of the cycle of competition in which the market system itself directsthe efforts of others in the market towards the elimination of that profit opportunitythrough imitation. In a very real sense there is distributional equity inherent in the processof competition as the tide of competition itself eliminates supra-normal profits over time.While a direct assault on inequality through income distributionmight lead to a reduction in efficiency, a direct assault oninefficiency through antitrust will not necessarily result in areduction in equality. It is far more likely to lead to an actualgain for equality...In the long run, more competition will mean186 Although there is research to suggest that inventiveness is unrelated to the profit opportunities thatit may present, we are concerned with a much broader concept of innovation which encompasses any changeby a competitor in order to create an opportunity for supra-normal profits no matter how small or transitorythat opportunity may be.187 See above, text relating to note 142ff.78less accumulation of wealth from capitalized monopolypositions...In sum, the pursuit of efficiency through antitrustenforcement is consistent with the objective of equitabledistribution of income188 .Competition laws which promote the process of competition and reduce exclusionarypractices can be seen as part of a package of regulations which achieve distributional equity.Their compliment is a taxation policy which allows the deduction of expenditure relatingto attempts to innovate, but which taxes the actual gains of innovation after the event(coupled with welfare policies for the redistribution of wealth). It is contended that suchpolicies will advance distributional equity without significantly distorting the ability of themarket system to increase total welfare. The only alternative is to attempt to regulate allsupra-competitive pricing on the basis that it is distributionally inequitable. But such anapproach would destroy the market system's substantial ability to maximize total welfare,by eliminating the driving force behind competition - supra-normal profits.Nevertheless, there are concerns associated with dominance. They relate to theimpact which dominance has upon the tendency of the market to harness the self interestof firms to promote total welfare. Some rivalry in the market place promotes self interestto the detriment of total welfare. It is such rent seeking conduct that provides the rationalefor competition laws.The Rationale for Regulatory InterventionHaving explored in some detail what might be the socially undesirable marketconduct associated with dominance we now propose a basis for regulatory intervention using188 Elzinga, supra note 4 at 1195.79competition laws. First, any law should promote the process of competition )". That is,it should ensure that there is a balance between the maintenance of the incentive of supra-normal profits to drive firms to innovate and increase dynamic efficiency on the one handand the opportunity for firms to imitate and increase productive and allocative efficiencyon the other hand. Second, the law should recognize that the process of competition mayresult in markets which, from time to time, are closer to the state of monopoly than perfectcompetition. Third, the law should eliminate rent seeking practices because they arenecessarily inefficient and, without regulation, they are encouraged by rivalry in themarketplace. Fourth, the law should be viewed as only a partial solution to the challengeto achieve distributional equity and democracy. Without taxation and welfare policies, themarket system maximizes the production of those goods and services which are needed anddesired by the wealthy and arguably concentrates economic and political power in the handsof innovators. Fifth, the law should recognize that, in some cases, there are factorsexogenous to the conduct of firms that entrench dominance.However, before considering the form which such regulation should take, we mustfirst explore one further question which our approach to dominance raises. In short, giventhe propensity of the profit motive to drive firms to pursue rent seeking strategies are thereany rent seeking strategies uniquely available to dominant firms which justify their especialregulation?189 T. Calvini & M.L. Siborium, "Antitrust Today: Maturity or Decline" (1990) Antitrust Bulletin 123 at125, argue that the debate, at least in the United States, as to the objectives that should be adopted forantitrust is now in the fourth quarter "with the preservation of competition the clear winner".80Chapter 5: Do Dominant Firms have a Unique Powerto Engage in Rent Seeking in the Market Place?In the dialogue between economists, policy makers, the legislature and the courtsthat produces competition laws, often "dominance" has been defined or described in wayswhich suggest that dominant firms have powers or abilities which other firms do not. Weresuch power to exist, it may justify a law directed specifically at dominant firms. In thischapter we argue that dominant firms have no unique powers in the market place. Weaccept that an existing dominant position may provide a significant motive to engage inconduct designed to protect that position and prevent the erosion of the additional profitswhich flow from a relative absence of competition as well as certain strategic advantagesto do so. Such conduct will be directed at preventing other firms from competing with thedominant firm. However, we argue that any firm may engage in similar practices if itbelieves that it will be able to secure a dominant position as a result.There are a number of concepts which tend to associate dominance with specialpower or ability in the market place. We will consider each in turn in order to show thatit is wrong to characterize dominant firms as having special power in the market place.Rather, we will show it is more accurate to view the present existence or future prospectof dominance as an equally compelling motive for any firm to engage in conduct designedto prevent other firms from competing with it. The concept most commonly associated withdominance is market power.81Market PowerIn economic terms a firm is dominant if it has a substantial degree of market power.Market power is the ability to profitably raise price above the level which would otherwiseprevail in a perfectly competitive marketl" - a definition that has been adopted in manycases191. Viewed in another way, market power is a measure of the degree to which afirm can engage in supra-competitive pricing and earn supra-normal profits. Measures ofmarket power, as a result, tend to focus upon the profitability of firms in comparison tosome form of established norm for profits 192. As was evident from our discussion ofcompetition, the potential to earn supra-normal profits is a key aspect of the process ofcompetition. Indeed our analysis of the process of competition can be expressed in termsof market power.Firms which are innovative in the broad sense in which we have used that term, willacquire market power. In doing so they will improve total welfare, though the extent to199 Landes & Posner, "Market Power in Antitrust Cases" (1981) 94 Harv. L.R. 937 ("market power is theability of a firm (or group of firms acting together) to raise price above the competitive level without losingso many sales so rapidly that the price increase is unprofitable and must be rescinded); V. Korah,"Interpretation and Application of Art. 86 of the Treaty of Rome: Abuse of a Dominant Position Within theCommon Market" (1978) 53 Notre Dame Lawyer 768 at 770; Brenner, supra, note 110 at 44 ("Market poweris the power of a firm to increase its profits by raising its price above marginal cost").191 In Australia, Queensland Wire, supra, note at 188 ("Market power can be defined as the ability of a firmto raise prices above the supply cost without rivals taking away customers in due time"); In Canada, Laidlaw,supra, note at ("In deciding whether a firm has substantial or complete control of a market, one asks whetherthe firm has market power in the economic sense. Market power in the economic sense is the power tomaintain prices above the competitive level without losing so many sales that the higher price is notprofitable. It is the ability to earn supra-normal profits by reducing output and charging more than thecompetitive price for a product"); and in the United States, N.C.A.A. v. Board of Regents 468 U.S. 85 at 108("market power is the ability to raise prices above those that would be charged in a competitive market").192 G.K Ottosen, Market Power: How is it Measured and How has it Changed (Salt Lake City CrossroadsResearch Institute, 1990); and H. Hovencamp, "The Measurement of Market Power: Policy and Science" inF. Mathewson, M. Trebilcock & M. Walker, eds., The Law and Economics of Competition Policy (Vancouver:The Fraser Institute, 1990) 43. The problem with such measures is well articulated by Brenner, supra, note110 at 45 ("...market power...is a widespread phenomenon. No markets are perfect; as a result, most firmsin the real world maximize their profits at prices above marginal cost". Further, such measures do notidentify the source of market power - whether it derives from innovation or rent seeking behaviour).82which they do so depends upon the value of the innovation. However, because marketpower is created by a move away from the competitive equilibrium, to maintain theallocative efficiency of the market mechanism requires the elimination of market power.The existence of market power will itself attract firms to imitate the strategies of theinnovative firm. In addition, the profits to be earned through market power will motivateall firms with market power to find ways other than innovation to exclude competition andthereby prevent the erosion of that market power by others.However, the fact that a firm has market power does not mean that it willautomatically have the power to prevent the process of competition from eroding thatpower. An example is the computer industry'". Although IBM was able to be theleading innovator in the industry and, for a significant period, extract supra-normal profits,in time the process of competition through imitation and further innovation by other firmseroded that power.Of course, initially the innovativeness of IBM made it difficult for other firms tocompete with IBM thereby sustaining IBM's market power. But the fact that a firm hasmarket power at any point in time, evident through its ability to extract supra-normalprofits, does not mean that it has any ability to entrench that position through conductwhich stems the tide of the process of competition. Although the extent to which imitationis delayed can create and entrench market power, the possession of market power does notlead necessarily to the ability to delay the erosion of that power. Certainly IBM has beenaccused of adopting strategic exclusionary practices designed to delay the process of193 Shepherd, supra, note 141 at 146.83competition194. Such practices are not innovative, they are merely designed to makethings more difficult for rivals. Without such practices, the only obstacles to imitation wouldbe the ability of rivals to imitate the successful actions of IBM and the time taken to do so.In short, market power is the outcome of a delay in the competitive process that maybe endogenous or exogenous to the firm. A firm with market power has the ability toengage in supra-competitive pricing, but the true power lies in that which is the source ofthe ability to earn supra-normal profits. A firm with market power may well be impotentwhen it comes to protecting that power. On the other hand the strategies that may bepursued to secure or protect market power are available to all firms. As a result, it mightbe said that to define dominance in terms of market power is to miss the main point.Certainly, the exercise of market power leads to allocative inefficiency and internalinefficiency and transfer of surplus l". However, it is the source of the market power,rather than the mere fact of its existence, that is relevant to the promotion of total welfare.If its source is innovativeness, then it will be welfare enhancing. If its source is strategicexclusionary conduct to entrench or protect market power (rent seeking), then it is likelyto reduce welfare through allocative inefficiency. If its source is external to the conduct ofthe firm, such as the result of a statutory licensing scheme, then it is also likely to reducewelfare through allocative inefficiency (and perhaps also X inefficiency). However, in thelast case no complaint may be made concerning the market conduct of the dominant firm.Market "power" is something of a misnomer. The power to engage in supra-normalpricing is sustained not by dominance per se, but by the source of the dominant position.194 Ibid.T.G. Krattenmaker, R.H. Lande & S.C. Salop, "Monopoly Power and Market Power in Antitrust Law"(1987) 76 Ge. L.J. 241.84As to the source of dominance, all firms have the power to engage in innovation or rentseeking that may create or sustain dominance.Barriers W EntryThose structural factors which differentiate a market from the state of perfectcompetition (and tend to create the state of monopoly) are termed "barriers to entry".Dominance is often described in terms of barriers to entry suggesting that the barriersoperate as a form of permanent shield protecting dominant firms from the forces ofcompetition and enabling them to engage in activities which are not possible for firmssubject to competitive constraint 196. Significant entry barriers have been described asthe "sine qua non of monopoly and oligopoly, for...sellers have little or no enduring powerover price when entry barriers are nonexistent" 197 .[I]f there are absolutely no barriers to entry, there can be noeffective exercise of market power...This...is the basic messageof contestability theory. If outsiders can enter and insiders canexit at will, as if on roller skates, then no one can raise priceswithout drawing entry; no one can predate without inducingcostless exit; and concentration does not matter. Withperfectly free entry and exit, everything is competitive as amatter of logic" 8.Such analysis leads to the conclusion that because of the barriers to entry, dominant firmshave a special ability to maintain their supra-normal pricing. However, such an approachfalls into error because it lacks any temporal perspective. The inference is that a market196 E.g., Korah, supra, note 190 and Queensland Wire, supra, note 23 at 201-2.197 Scherer, supra, note 4 at 11.1" R. Schmalensee, "Ease of Entry: Has the Concept Been Applied Too Readily? in H. First, E.M. Fox& R. Pitofsky, eds., Revitalithw Antioust in its Second Century (New York: Quorum, 1991) 338 at 338.85either has relatively "high" or "low" barriers to entry. Indeed, Bain, in the firstcomprehensive study of entry barriers, statedWe have emphasized throughout that the condition of entry isa structural concept, and that it is evaluated by the extent towhich established firms can, on the average over a long period,elevate price above a long-run competitive level while stillforestalling entryl".Bain's perspective was framed by the state of perfect competition and he defined barriersto entry in terms of those aspects of industrial organization which prevent the state ofperfect competition from being established. The extent to which this pervades his analysisis evident in his characterization of the process of change as external to the competitiveforces in the market". Bain posits that conditions of entry are "usually stable and slowlychanging through time, and are not generally susceptible to alteration by prospectiveentrants to various markets"". Thus, the process of competition is seen as taking placewithin the structural limitations created by barriers to entry.However, others have emphasized how many barriers to entry have been created orinfluenced by conduct by incumbent firms". Barriers may be unrelated to the processof competition, but in many cases they may be explained by reference to conductundertaken by firms in the pursuit and protection of supra-normal profits". Market' J.S. Bain, Bafflers to New Competition: Their Character and Consequences in Manufacturing Industries(Cambridge, Mass: Harvard University Press, 1965) at 17.2°° Ibid. at 17-8.2°1 Ibid. at 18.202 Stigler, supra, note 47 at 67-70; and Krattenmaker, Lande & Salop, supra, note 195 at 254-5.203 W.G. Shepherd, "Theories of Industrial Organization" in H. First, E.M. Fox, & R. Pitofsky, RevitalizingAntitrust in its Second Century: Essays on Lega4 Economic, and Political Policy (New York: Quorum, 1991)37 at 53-4 sets out a comprehensive summary of imperfections in market structures (barriers to entry) whichpermit "average or inferior firms to attain dominance", many of which may be influenced by the firm seeking86structure itself is influenced significantly by competitive behaviour" 4. To view dominanceas the outcome of a market structure in which competitive entry is difficult due to theheight of barriers to entry ignores the role which the process of competition plays increating those barriers, and exploiting other barriers external to the conduct of the firm, inorder to protect supra-normal profits. The causal relationship between market structuresand the process of competition is not linear (in either direction) - they shape each other.To define dominance as a function of structural considerations external to the firmsuggests that there is a distinct "dominant firm" market structure with its own equilibriumin which the profit motive causes the dominant firm to exploit its market power in muchthe same way that the competitors in an oligopoly are portrayed as being driven by theprofit motive to pursue welfare reducing cooperative strategies through parallel behaviouror collusion. Dominance itself and the barriers to entry that sustain it are seen as the evil,irrespective of the factors that have led to the creation of the position of dominance °.Further, structural constructs lead to solutions which are perceived to move themarket closer to the structure of perfect competition in order to remove the "power" whichdominance allegedly affords2". In the past, recognition that the theoretical extreme ofperfect competition is unattainable due to the divergence of the real world from theassumptions that underlie the model led to the development of the concept of "workabledominance.2°4 S. Salop, "New Economic Theories of Anticompetitive Exclusion" (1987) 56 Antitrust L.J. 57 at 63("exclusion itself can create or raise entry barriers and thereby give a firm power over price").'6 E.g., Bain, supra, note 4 at 503ff.2°6 The result is a competition policy that focuses upon reducing concentration; Fox & Sullivan, supra,note 52 at 6ff; Stigler, supra, note 47 at 261ff; Bain, ibid; Gorecki & Stanbury, supra, note 44 at 131; and J.P.Niewenhuysen, "The Theory of Competition Policy" in W. Ransom & W. Pengilley, Restrictive Trade Practices:Judgments, Materials and Policy (Sydney: Legal Books, 1985) 20.87competition" to describe a market structure in which there was sufficient competition toconstrain the development of market power. Though some understood workablecompetition as a behavioral concept, describing the conduct of firms in themarketplace207, the mainstream expressed it in structural terms m. Invariably therewere expressions of the nature of barriers to entry associated with the structure of workablecompetition209. However, the problem with any structural perspective is that barriers toentry are perceived as conferring especial power in the market place (and therefore asnecessarily undesirable and something to be dismantled by regulation) when they should beseen as an outcome of many types of rivalrous activity without which there would be nobarriers to entry and no "power". Barriers to entry may be the result of welfare enhancingconduct by a firm, such as innovation or the exploitation of economies of scale, or factorsexternal to that firm which are also welfare enhancing, such as demand that makes one firmscale efficient, or a unique geographical location.Further, barriers to entry are not impervious to change. It is to be expected thatdominant firms will attract competition due to the supra-normal profits that they enjoy.Therefore, the pressures in a dominant market comprise a struggle between the incumbentto protect market power and entrants wishing to contest for those profits. In that context,a structural perspective of dominance fails to address the key issue whether the barriers toentry are the outcome of changes in the market which are welfare enhancing, or the result207 Clark, supra, note 36 c.l.S.H. Sosnick, "A Critique of Concepts of Workable Competition" (1958) Q.J. of Econ. 381.209 C.D. Edwards, Maintaining Competition (New York: MacMillan, 1949) at 901 ("New traders must haveopportunity to enter the market without handicap other than that which is automatically created by the factthat others are already well established there"); and Scherer, supra, note 4 at 42 ("There should be no artificialinhibitions on mobility and entry").88of rent seeking conduct by the dominant firm which is successfully stemming the tide ofentry, or the consequence of external factors which are beyond the influence of theincumbent or prospective entrants.Importantly, any firm may engage in market conduct which creates or exploitsbarriers to entry. Further, there is nothing about the existence of the barriers per se thatempowers a dominant firm to maintain them. Once again the regulatory issue is not thebarriers per se, but the conduct by firms which may create such barriers and whether suchconduct is socially desirable.Monopoly PowerThe courts in the United States have often referred to dominant firms as those withmonopoly power210. Although economists use the terms market power and monopolypower interchangeably to mean the power to profitably reduce output and raise prices 211 ,the American courts use monopoly power in a different sense. An example is the followingpassage from the decision of the District Court in United States v. Gnffith212Section 2 [of the Sherman Act] is not restricted to conspiraciesor combinations to monopolize but also makes it a crime forany person to monopolize...So it is that monopoly power,whether lawfully or unlawfully acquired, may itself constitute anevil and stand condemned under s.2 even though it remainsunexercised. For s.2 of the Act is aimed, inter alia, at the210 the context of s.2 of the Sherman Act, the courts have referred to monopolization (or creation ofdominance) as the outcome of monopoly power which, in turn, has been defined as "the power to controlprices or exclude competition"; United States v. E.I. du Pont de Nemours & Co 351 U.S. 377, 391 (1966)[hereinafter Cellophane]; and United States v. Grinnell Corp 384 U.S. 563, 571 and Aspen Skiing Co. v. AspenHighlands Siding Corp. 472 U.S. 585, 596 (1985) [hereinafter Aspen].211 1Cratteumaker, Lande & Salop, supra, note 195 at 179; and Shepherd, supra, note 4 at 2-3 (where theterms are used interchangeably).212 334 U.S. 100 (1948).89acquisition or retention of effective market control...Hence theexistence of power "to exclude competition when it is desiredto do so" is itself a violation of s.2, provided it is coupled withthe purpose or intent to exercise that power...It follows, afortiori that the use of monopoly power, however lawfullyacquired, to foreclose competition, to gain a competitiveadvantage, or to destroy a competitor, is unlawful 213.Putting to one side the emphasis upon the bare existence of monopoly power being acontravention of the law214, it is apparent that what is meant by monopoly power is theability to exclude competition on an ongoing basis215. As discussed at the outset of thischapter it is conduct which has the effect of excluding competition that creates marketpower. Market power itself does not exclude competition. Rather, it is the ongoing abilityto exclude competition that sustains market power. It follows that in the sense in which theterm is used in the Griffith Case, monopoly power is not a synonym for market power.Instead monopoly power is used to describe that ability which is the source of marketpower. Dominant firms have monopoly power, or, in other words, the power to excludecompetition216. As such, monopoly power is really the dynamic complement to barriersto entry. Barriers to entry are the means by which dominant firms may excludecompetition. Monopoly power is the ability to create and exploit barriers to entry.However, as in the cases of market power and barriers to entry, monopoly power213 Ibid. at 106-7.214 Such emphasis does not reflect the current law in the United States which focuses upon purpose; seeKodak, supra, note 19 and Aspen, supra, note 209 and the discussion below; see c.6.215 See also, Cellophane, supra note 210 at 391 ("the power to control prices or exclude competition" is"the primary requisite to a finding of monopolization"); and Kodak, supra, note 209 at 272ff. A similarconcept has been expressed in the European cases; e.g., Deutsche Grammophon v. Metro (1971) E.C.R. atpara. 17; and United Brands v. Commission (1978) E.C.R. 207 [hereinafter United Brands].216 The classic definition of market power in the United States is "the power to control prices or excludecompetition" (see above, note 210), a definition which seems to incorporate the notion of market powerreferred to above.90may be obtained and exercised by all firms. The United States courts have long recognizedthat monopoly power may be derived from competitive "skill, energy and initiative" 217.Much of the case law in the United States is devoted to distinguishing between those firmsthat have dominance thrust upon them due to their superiority in the marketplace andthose firms that achieve dominance through exclusionary conduct 218. The courts haverepeatedly stated that having been encouraged to compete, dominant firms must not bepenalized for their competitive success. Although dominant firms may be defined as thosethat have the power to exclude competition, dominance itself may be socially desirable orundesirable depending upon the nature of the monopoly power that sustains it. Monopolypower that is derived from superior innovation may be socially desirable. All firms mayengage in exclusionary conduct and will be motivated to do so provided that they expect thesupra-normal profits that will be secured as a result will outweigh the cost of investing timeand money in excluding competition.Strategic Motive and AdvantageTo this point we have argued that the conclusion, implicit in the concepts of marketpower, barriers to entry and monopoly power, that dominant firms have a unique ability toengage in socially undesirable market conduct is invalid. Properly understood thoseconcepts simply confirm our analysis that the prospect of achieving a position of dominanceis a motive for all firms to adopt strategies that result in relative freedom from competitiveconstraint. Of those strategies, it is only rent seeking behaviour that is socially undesirable.217 A concept originating in Alcoa, supra, note 14.218 See below, c.6.91However, it is wrong to suggest that a dominant firm is as likely as a firm subject tocompetitive constraint to invest in rent seeking activities. It must be acknowledged thatdominant firms have a greater propensity to engage in such activities for two reasons. First,because they have a greater interest to do so in order to protect their existing supra-normalprofits. Second, and more importantly, there will frequently be certain strategic advantagesassociated with an existing dominant position that assist in pursuing certain rent seekingstrategies. In short dominant firms have strategic motive and advantage when it comes torent seeking.As to motive, not only does the dominant firm have an existing line of supra-normalprofits that it will want to protect, it will often have substantial investments in existingtechnology. It has a substantial interest in preventing others from adopting innovations thatwill make such technology redundant 219 .As to the advantage of dominant firms the literature is substantial. Rent seekingstrategies depend upon a number of factors, many of which are likely to favour dominantfirms. Rent seeking is more likely to be successful where there are financial orinformational asymmetries22°. Dominant firms are characteristically well established withsubstantial retained earnings, both of which lead to lower financing costs for dominantfirms. The lower cost of capital, or financial advantage may be exploited in rent seeking219 As observed by Scherer, supra, note 4 at 428 "a company that already dominates the market it supplieshas little to gain by speeding up the introduction of product improvements as long as other firms refrain fromdoing so". By extension, it has much to gain from preventing the introduction of such improvements byothers. There is also evidence that new entrants play a crucial role in technological progress which supportsthe view that incumbents are less motivated to invest in innovations that would make the technology thatsustains their dominant position redundant, ibid. 438.2" D.G. McFetridge, "Predatory and Discriminatory Pricing" in F. Mathewson, M. Trebilcock & M.Walker, eds., The Law and Economics of Competition Policy (Vancouver: The Fraser Institute, 1990) 71 at75-83; Salop, supra, note 101.92strategies. One interesting example is the use of oppressive litigation, particularlycompetition law suits in those jurisdictions where private actions are possible, to burden thefinancially weaker entrant m. As to informational asymmetries, being the incumbent inan industry a dominant firm is likely to have an informational advantage over a new entrantthat can be exploited222. A dominant firm may exploit its informational advantage byinvesting in developing a "tough" reputation which discourages new entry. Also adominant firm may often have the ability to invest in sunk costs which may be an effectiveentry deterring strategy.An appropriately positioned incumbent confronts a potentialentrant with the certainty that if entry occurs both will fail tocover their total cost. The incumbent cannot avoid this, havingsunk his capital. The potential entrant can avoid these lossesby staying out and presumably does sow.Despite these advantages, rent seeking is not exclusively the province of incumbentdominant firms. The literature concerning raising rivals costs, a form of rent seeking, is notpreconditioned upon an existing position of dominance. It shows how any firm may investin strategies which raise the costs of rivals in order to achieve relative freedom fromcompetition and attendant market power225.Even if a firm does not have single firm market power [ie. it isnot dominant] - that is, even if the firm has no power to raiseprice by restricting its own output, it may still have the power221 Baumol & Ordover, supra, note 113 at 87. See also, Laidlaw, supra, note 8; and (Australian case inwhich has been argued) in which it was alleged that resort to competition law litigation was itself an abuseof dominance.222 See McFetridge, supra, note 220.223 McFetridge, supra, note 220 at 78-9; Dunlop, McQueen and Trebilcock, supra, note 8 at 223.224 McFetridge, supra, note 220 at 78.223 Krattenmaker & Salop, supra, note 101.93to raise rivals' costs and thereby gain power over price. Ratherthan restricting its own output, and thereby driving price up[which it does not have the power to do], it can push price upby raising its competitors' costs. Once their costs are raised,they will then be forced to reduce their output, and if theyreduce their output, then price will rise, as night followsday2.Equally, there may be cases where the information asymmetries give the advantage to anew entrant. This may well be so where the entry results from an innovation the precisecost benefits of which are unknown to the incumbent dominant firM 227 .Therefore, we must be careful not to view the strategic advantage which dominanceprovides to enable some firms to engage in rent seeking as a defining element of rentseeking. Dominance is not a part of the definition of rent seeking conduct. As a result, toinclude dominance as an element of any offence will have two effects. First, it will excludefrom the operation of the law all rent seeking by firms which are not in a position ofdominance at the time that they engage in rent seeking behaviour. Second, it requires theproof of an unnecessary element. It would be similar to requiring, in an assault case, proofthat the person perpetrating the assault met a "dominance" standard that was likely toproduce a physical advantage. Size is relevant in an assault case. A larger and physicallystronger person has certain advantages when it comes to perpetrating an assault. However,that is no reason to exclude smaller, weaker persons from our assault laws. Simply becausedominance is one means of facilitating rent seeking does not mean that it should be226 Salop, supra, note 204 at 62.227 E.g., consider the facts in Alcoa, supra, note 14. The investment by Alcoa in excess capacity may havebegun prior to its attainment of a dominant position. Assuming such investment was motivated solely by adesire to exclude future entry, and not by the belief that it was necessary in order to serve the needs ofcustomers in a timely manner by preventing shortages in the future, it would represent an investment in rentseeking practices prior to achieving dominance.94included as an element of any law regulating socially undesirable market conduct associatedwith dominance228 .In short, although dominance may be a powerful motive to engage in rent seekingpractices and, in certain contexts, may facilitate some types of rent seeking, such activitiesdo not lie exclusively within the capability of dominant firms. Rent seeking is just asdetrimental to total welfare if it is adopted by a firm that is not dominant.Dominance as a FilterPublic policy analysis requires the cost of any economic regulation to be less that thesocial cost of the conduct being regulated229. Can the regulation of dominant firms alonebe justified on a cost-benefit basis? Will dominant firms be more likely to engage in themore socially damaging rent seeking? Intuitively, the research concerning entry deterringstrategies and the advantages which dominant firms enjoy in many instances (referred toabove' 0) may suggest an affirmative answer. However, should dominance be used as thefilter to ensure that the regulation only applies to those activities with a significant negativeimpact upon total welfare - sufficient to outweigh the costs of enforcement? If, as ouranalysis suggests, it is rent seeking that is the socially undesirable market conduct associated(i.e. motivated by) dominance, why not qualify the rent seeking behaviour to which anyregulation applies to ensure that any de minimus conduct is excluded? Such a rule would228 In addition dominance has proven to be an extremely complex concept, raising difficult issues of proof;see below, c.6 - Other Advantages of Rejecting Dominance as a Basis for Regulation.229 Mishan, supra, note 171 at c.23.230 See above, c.5 - Strategic Motive and Power.95ensure that only market conduct with a significant welfare effect was proscribed 231. Thequalification to the regulation would then relate to the nature of the rent seeking conduct,rather than some questionable link between existing dominance and the most serious rentseeking activities. The form which such a qualification may take is discussed helow 232.We reject any argument that dominance should be retained as a filter in any law proscribingrent seeking behaviour233.A SynthesisDominant firms will have market power and monopoly power and they will beprotected by barriers to entry which enable them to act in a way which firms subject tocompetitive constraint are unable to act. However, such power may be the reward for asuccessful competitive strategy. Such strategies are only socially undesirable if they aresustained by rent seeking. A position of market dominance (that is, relative freedom fromcompetitive constraint) is not a necessary precondition to engaging in rent seeking. Adominant position is not the means by which firms engage in rent seeking, rather a positionof dominance is the motive for such behaviour. Any firm can engage in rent seeking.Certainly, there are more incentives for the incumbent dominant firm. It is protecting itsexisting profits, whereas another firm would be investing in the prospect of future supra-231 E.g., consider the facts in Cellophane, supra, note 210. The result was governed by a finding that duPont was not a dominant firm, due to a finding of a comparatively broad "relevant market" as the basis forassessing whether du Pont had a substantial degree of market power. The decision as to the relevant markethas been often criticized. The result may well have been different if the focus of the court had been theconduct of du Pont, rather than the "preliminary issue" of defining the relevant market.232 See below, c.6.233 Excluding the concept of dominance from any regulation has other advantages; see below, c.6 - TheAdvantages of Rejecting Dominance as a Basis for Regulation.96normal profits. Some rent seeking strategies are uniquely available to dominant firms.Nevertheless, it must be acknowledged that non-dominant firms may engage in rent seekingand will do so provided they see an opportunity to secure dominance (and the resultantsupra-normal profits) as a likely outcome. It is true that rent seeking is uniquely associatedwith dominance. However, it is more accurate to consider the prospect of dominance asthe motive for rent seeking, rather than an existing dominant position as providing thepower to engage in rent seeking practices. There should be a law that proscribes significantrent seeking behaviour by all firms.97Chapter 6: Precisely What is the Difference BetweenCompetition and Rent Seeking?The question which now arises, and the point to which we have been leading, iswhether it is possible to formulate a rule which applies to conduct by all firms that inhibitsthe ability and responsiveness of other firms to compete for the supra-normal profits beingearned by an innovator, without eliminating the incentive to innovate. This is the enquirywhich we contend will reveal the efficacy of any proposed alternative to the existingregulation of dominant firms. Put shortly, will the proposal prohibit the socially undesirableaspects of rivalry (rent seeking) whilst still preserving the socially desirable aspects(innovation and imitation)? The task is to differentiate between conduct which is a welfareimproving response to the profit incentive which drives the market system and conductwhich is welfare reducing. Our analysis shows that it involves differentiating betweencompetitive and rent seeking conduct in order to prohibit rent seeking conduct in themarketplace.At the outset we must recall that, to a significant extent, we have already articulatedthe distinction between competition and rent seeking. We have defined competition as "theprocess or activity of innovation or imitation"; innovation as "a change in product,production process or demand created by a firm"; and imitation as "the activity of copyingsuccessful innovations by other firms". These are definitions that reflect our understandingof competition as a dynamic process - profits are to be made in producing, as cheaply aspossible, those products which consumers desire (a process which also may involveconvincing consumers that a product is desirable). If one firm does not supply whatconsumers demand as efficiently as possible, then its competitor will because there will be98profits to be made in doing so. In this way competition encourages firms to adopt changeswhich promote total welfare because such changes are profitable for the reason that theyare demanded by customers. Competition also motivates firms to copy and maintain thosechanges for which demand exceeds existing supply and to reject those changes which, byreason of the lack of demand, are evidently not welfare improving. Of course, the reasonsuch strategies are rejected is not due to any altruistic desire on the part of the firm toincrease the total welfare of society. Rather, they are rejected because they areunprofitable. However, it is the fact that competition motivates firms to reject such welfarereducing activities that is significant. In short, our analysis shows that the dynamics of thecompetitive process are welfare improving because they are a response to customerdemand.Rent seeking, however, is the antithesis to competition. We have identified such rentseeking behaviour as "the process or activity of preventing innovation or imitation". Rentseeking does not meet customer demand. Rather, it is guided by the profit opportunity tobe derived from preventing other firms from meeting an existing or prospective customerdemand. As a result, economists usually define rent seeking behaviour as investment indistribution, rather than creation, of wealth. Rent seeking activities are parasitic234. Theyproduce nothing. In the context of supra-normal profits, rent seeking is usually defined aswasteful expenses incurred to secure or maintain a monopoly position235. A rent seekingfirm need make no change in product, production process, or attempt to influence demandin order to earn supra-normal profits. Rather, such a firm simply prevents imitation or234 Brander, supra, note 93 at 49.233 Tirole, supra, note 47 at 76.99innovation by other firms that would enable them to earn a share of the opportunity to earnsupra-normal profits which the rent seeker wants to monopolize. Rent seeking behaviourmakes no positive contribution to total welfare, it simply distracts energy and effort intodistributing existing wealth to the rent seeker.Therefore, in dynamic terms, the distinction between competitive behaviour and rentseeking behaviour can be expressed simply in terms of the extent to which the conduct isa response to, or an attempt to influence, consumer demand. Competitive behaviour meetsconsumer needs. Rent seeking behaviour prevents others from meeting consumer needs,or to put it another way, rent seeking behaviour prevents competitive behaviour. Rentseeking is simply not part of the dynamic by which the competitive process improves totalwelfare because it is does not seek to meet (or influence) consumer needs. A similarconclusion has been expressed by Fox, within the specific context of a discussion of whena refusal to deal is an abuse of dominance, as followsA refusal to deal is allowed if it is simply an instance ofchoosing one's customers and of deciding how best to providethe goods and services that the consumer wants. A refusal todeal by a firm in a monopoly is impermissible if its naturaleffect is to lessen competition and thereby raise prices toconsumers or otherwise degrade the price/service packageoffered to them.The analysis may be guided by a series of questions. Was therefusal to deal a product of defendant's plan to wage moreeffective competition and to sell more goods and services byincreasing consumers' satisfaction? Or was it a pressure tacticto eliminate or impose costs on a competitor and thereby toincrease monopoly power or, at least, market share236.To summarize, dominance is an inherent part of the process of competition because236 E.M. Fox, "Monopolization and Dominance in the United States and the European Community:Efficiency, Opportunity and Fairness" (1986) 61 Notre Dame L.R. 981 at 1001.100it is the logical outcome of a system which is driven by profit maximization. The processof competition is driven by the pursuit of profits amongst rivals. Profits are to be made byserving customers more efficiently than any rival, or preventing any rival from servingcustomers with equal or greater efficiency. We argue in the balance of this chapter thatrecognizing that firms make profits from either serving customers or preventing other firmsfrom doing so focuses the issue of differentiating between desirable and undesirable rivalryassociated with market dominance in a way which is absent from existing regulatoryapproaches. In doing so, we contend that it is the failure to recognize such a distinctionthat has led to the difficulty which courts in all jurisdictions have experienced indifferentiating "normal" competition from anti-competitive behaviour. The key to makingthe distinction lies in discerning whether the purpose of the conduct is directed at servingthe needs of customers or frustrating the attempts of others to serve those needs.It is important to note that by referring to the needs of customers we do not advancea rule based upon the customer's perspective as to whether particular market conduct isdesirable, nor do we advocate some overall measure of the change in total welfare effectedby the market conduct said to be socially undesirable. A customer perspective may supportany conduct that results in lower prices and greater product variety over time. However,our analysis recognizes that the process of competition is driven by the potential forproducers to earn supra-normal profits - a potential that may be realized only when a firm,due to the limited product variety available, is able to charge prices which are higher thanthose consistent with maximum allocational efficiency. We have argued that in order tomaximize total welfare it is necessary to trade off allocational efficiency to secure thegreater welfare returns generated through dynamic efficiency. Any regulation must promote101the cycle of innovation and imitation that makes up the process of competition. Consumerswill not be able to enjoy the welfare gains that flow from innovation unless they areprepared to accept that there must be the opportunity to earn supra-normal profits for theinnovator. Whilst, ultimately, consumers desire both maximum dynamic efficiency andmaximum allocational efficiency, the former cannot be achieved without a trade off in thelatter.Therefore our point in referring to conduct which has the purpose of meeting orinfluencing the needs of consumers is not to refer to that competitive behaviour which willresult in an optimal outcome so far as consumers are concerned, but instead to recognizethat provided the strategies of producers are directed at supplying or influencing consumerneeds then they will be promote the process of competition rather than frustrate or preventit. It is not a consumer perspective that is material. Whereas a consumer perspectivewould support any legislative intervention that encouraged lower prices, our analysissupports innovative or imitative strategies that reduce prices, but advocates the proscriptionof rent seeking strategies such as strategic entry deterrence through predatory pricing. Thatwhich distinguishes the two is not the perspective of the consumer. Instead, it is the factthat in the first case the purpose of the producer is to supply the needs of the consumer,whereas in the second case there is only an attempt to prevent others from supplying thoseneeds. The point is that in order to secure the welfare benefits of the innovation, theconsumer must settle for something less than maximum allocational efficiency (at least untilthere is imitation in the market). The fact that differentiates the shortfall in maximumallocational efficiency inherent in offering the incentive of supra-normal profits to theinnovator from the shortfall that results from rent seeking is the purpose of the producer.102Our approach does not involve an assessment as to whether the particular market conductmaximizes or promotes consumer welfare. Rather, having concluded in the previouschapter that innovation and imitation promotes total welfare and rent seeking reduces it,we now have shown that rent seeking is to be distinguished from innovation and imitationby asking whether the purpose of the producer was to serve or influence consumer needs.We intend this to be a factual enquiry divorced from the concepts of consumer or totalwelfare. In short, the conclusion we have reached is that total or consumer welfare ismaximized through conduct by producers that is directed at serving or influencing the needsof consumers. Therefore, we need not invoke traditional concepts of total or consumerwelfare in our proposed rule - and we do not do so.In the following section we state our proposed model law. Then, we apply ourproposed law to the facts in a number of decided cases. In doing so we endeavour toillustrate how a rule proscribing rent seeking by all firms articulates with greater precisionthe distinction between competitive conduct and socially undesirable market conductassociated with dominance.A Proposal for a Model LawThe conclusion that must be drawn from our discussion to this point is that thedistinction between competition and rent seeking is to be found in the purpose behind themarket conduct. Our attempts to articulate, with greater precision, the socially undesirablemarket conduct associated with market dominance show that it is not possible to expressthe dichotomy between competitive and anticompetitive behaviour in objective terms.There is no conduct that will be socially undesirable irrespective of purpose. Conduct which103results in an increase in concentration is not necessarily anticompetitive because it may bethe outcome of the very process of competition which such laws are intended to promote.Conduct which damages or excludes rivals falls into the same category. An outcome ofexclusion per se is insufficient to characterize socially undesirable market conduct associatedwith dominance. The fact is that much competitive conduct has an "exclusionary" function.This is a difficulty that was well articulated by the High Court in Australia in OueenslandWire237 in the following wayCompetition by its very nature is deliberate and ruthless.Competitors jockey for sales, the more effective competitorsinjuring the less effective by taking sales away. Competitorsalmost always try to "injure" each other in this way. Thiscompetition has never been a tort...and these injuries are theinevitable consequence of the competition s.46 is designed tofoster238 .So we are drawn to purpose as the key to articulating the dichotomy.However, the fact that successful competition involves exclusion of rivals means thatthere will always be a predatory element to the conduct of firms in the market place,competitive or otherwise239. Competition itself may manifest a hostile intent. As we haveseen, the dynamic of the competitive process involves rivals striving to secure relativefreedom from competitive constraint - or, in other words, to secure dominance. The factthat a firm is motivated by a desire to damage its competitor is consistent with bothcompetitive and anticompetitive behaviour. The result is that any regulation must focus237 Supra, note 23.238 Ibid. at 191; see also, Easterbrook, supra, note 13 at 973.238 Ibid. at 191.104upon the purpose of the actor, but it must go beyond a bare hostile intent enquiry24°.As a result, not surprisingly, the trend in the regulation of market conduct associatedwith dominance in Australia, Canada, New Zealand and the United States has been todefine that conduct which is unlawful by reference to purpose. The precise nature of theunlawful purpose is expressed in a number of different ways.The Canadian law uses the following phrases in defining the term "anti-competitiveact"241 (the operative term in the substantive provision which proscribes the practice ofanti-competitive acts by dominant firms 242): "the purpose of impeding orpreventing...entry into, or expansion in, a market"; "to discipline or eliminate a competitor";and "with the object of withholding the facilities or resources from a market".In Australia, the relevant law provides that a dominant firm shall not take advantageof its power...for the purpose of -(a) eliminating or substantially damaging a competitor...;(b) preventing the entry of a person into... any...market; or(c)^deterring or preventing a person from engaging incompetitive conduct... 243The New Zealand law has a similar structure and provides that a dominant firm shall notuse its dominant position...for the purpose of -24 The courts have rejected the use of hostile intent standards in recent cases; see, Aspen, supra, note 210at 2857; Barry Wright Corp. v. I. T.T. Grinnell Corp. 724 F.2d 227 (1st Cir. 1983) at 232; Queensland Wire, supra,note 23 at 190-1 & 149-5; and Union Shipping, supra, note 30 at 707-9.241 s.78 of the Competition Act.242 s.79(1) of the Competition Act.243 s.46 of the Trade Practices Act.105(a) restricting the entry of a person into ...any...market;(b) preventing or deterring any person from engaging incompetitive conduct...; or(c)^eliminating any person from...any... market.In the United States, the recent monopolization cases have been decided byreference to the purpose of the conduct. In Kodak the Supreme Court held that Kodakhad acted "in furtherance of a purpose to monopolize"245. In Aspen246, the SupremeCourt framed its enquiry in terms of an efficiency purpose. The question which theSupreme Court posed was, in essence, whether the conduct of the defendant, Aspen Skiing,was consistent with an efficient purpose or whether its purpose was exclusionary 247 .However, there is much ambiguity in such provisions insofar as they attempt toexpress the difference between competitive and unlawful conduct in terms of purpose. Allthe purposes described are equally consistent with competitive behaviour which, as we havediscussed in previous chapters, may restrict entry, deter competitive conduct or eliminatea person from a market. As a result, the courts have developed a necessary gloss upon theprovisions themselves in order to sharpen the distinction. It involves enquiring whether theconduct in question is atypical of that which would be expected in a competitive market.The notion of characteristically competitive behaviour has been expressed by Kaysen andTurner248 as followsA firm possesses market power when it can behave persistentlyin a manner different from the behaviour that a competitive244 s.36 of the Commerce Act.245 Supra, note 19.246 Supra, note 210.247 ibid.248 Antitrust Policy (1959).106market would enforce on a firm facing otherwise similar costand demand conditions 249 .It is a concept that was adopted by the Australian High Court in Queensland Wire25°. Asimilar idea has been stated by the courts in the United States 251. It also finds expressionin the decisions of the courts of the European Community, the classic statement being inRe Continental Can Co. 252Undertakings are in a dominant position when they have thepower to behave independently, which puts them in a positionto act without taking into account their competitors, purchasersor suppliers. That is the position when, because of their shareof the market, or of their share of the market combined withthe availability of technical knowledge, raw materials or capital,they have the power to determine prices or to controlproduction or distribution for a significant part of the productsin question253 .The notion is that anticompetitive conduct may be identified by comparing the conduct ofthe dominant firm with the conduct that may be expected in a competitive market. Inessence the court asks whether the conduct which is alleged to be unlawful would berational for a competitive firm.In theory, it is a distinction which has validity. A refusal to supply a large andfinancially sound customer on commercially attractive terms as to price would be irrationalfor a competitive firm. Therefore, it may be concluded in the absence of other evidence249 lbid. at 75.25° Supra, note 23 at 200.1S1 In Telex Corporation v. I.RM. 510 F.2d 894, the court held that a dominant firm may engage inpractices that could be performed by any firm regardless of market share and it would then not be engagingin the practice of monopolization.252 [1972] 11 CM.L.R. D11.253 /bid. at D27.107that such conduct is likely to have an exclusionary, and not a competitive, purpose254 .However, there are problems with such an approach. Competition must beunderstood as a dynamic concept which includes periodic dominance. Socially desirablemarket conduct is not limited to that which might be associated with atomistic markets inwhich there are numerous competitors all with access to the same technology sellingrelatively identical products 255. Once "imperfect competition" is recognized as being aninherent part of the way markets increase efficiency it is far more difficult to identify thatconduct which is atypical of a competitive firm. For example, exclusive dealing would beirrational in a highly competitive market, but as has been emphasized in the recent debate,exclusive dealing may serve a number of pro-competitive purposes 256.Also, the effect of such an approach is to require the defendant to justify its conduct.This is an important consideration, the significance of which has been well captured byEasterbrook in the following commentThis means that the plaintiff wins whenever the defendant doesnot know or cannot explain the true function of its conduct. Inbusiness, the only thought may be to make as much money aspossible, and entrepreneurs often flounder from one practiceto another trying to find one that works. When they do, they2% This was precisely the approach of the High Court in Queensland Wire, supra, note 23 at 202. DawsonJ. stated at 202 that the refusal of B.H.P. to supply Queensland Wire was "made possible [for which onemight read logical] only by the absence of competitive conditions". Mason C.J. & Wilson J., in a jointjudgment, at 192 "It is only by virtue of its control of the market and the absence of other suppliers thatB.H.P. can afford, in a commercial sense, to withhold [supply]...from the appellant". Toohey J. stated, at 216"The only reason why B.H.P. is able to withhold Y-bar (while at the same time supplying all other productsfrom its rolling mills) is that it has no other competitor in the steel product market who can supply Y-bar".255 See above, c.3.F. Hanks & P.L. Williams, "The Treatment of Vertical Restraints Under the Australian Trade PracticesAct" (1987) 15 Aus. Bus. L.R. 147; F. Mathewson & R. Winter, "The Law and Economics of VerticalRestraints", in F. Mathewson, M. Trebilcock & M. Walker, The Law and Economics of Competition Policy(Vancouver: The Fraser Institute, 1990); and R.A. Posner, "The Next Step in the Antitrust Treatment ofRestricted Distribution: Per Se Legality" (1981) 48 U.Ch.L.R. 6.108may not know why it works, whether because of efficiency orexclusion. They only know that it works. If they know why itworks, they may be unable to articulate the reason to theirlawyers - because they are not skilled in the legal and economicjargon in which such "business justifications" must be presentedin court, or perhaps because their lawyers cannot understand(or translate for a jury) what they have been told257.Further, rivalrous conduct in the marketplace is often ambiguous. Discounting maybe competitive or predatory258. Advertising may be competitive or exclusionary259. Inmany cases the real difficulty is deciding whether the conduct is characteristic of that whichwould be adopted by a rational competitive firm. As a result, to a considerable degree, thetest begs the question. What was it about the refusal to supply referred to above thatdifferentiated it from a refusal to supply by a seller subject to competition? What makesa lease only policy by one firm rational competitive conduct and "monopolization" byanother?26° When are logo and advertising discounts and exclusive supply contracts theexpression of competitive behaviour and when are they anti-competitive acts? 261 Whenis the simultaneous release of a new film with an innovative new camera part of acompetitive marketing strategy and when is it exclusionary? 262 When is a policy ofexclusive dealerships an outcome of a desire to ensure dealers are competitively promotinga manufacturer's product in the market place and when is it an abuse of a dominant257 Supra, note 13 at 975.258 McFetridge, supra, note 220.259 Hay & Morris, supra, note 4 c.5.266 United States v. United Shoe Machinery Corp. 110 F. Supp 295 (D. Mass. 1953) affd. 391 U.S. 244 (1954)[hereinafter United Shoe Machinery].261 NutraSweet, supra, note 8.262 Kodak, supra, note 19.109position?263 When is a refusal to continue a cooperative marketing strategypredatory? When is the leasing of premises about to be leased by a new entrant tothe market just part of ordinary business and when is it unlawful? 265These are the questions which the courts face. It is no answer to say "when thecontext is such that the conduct is not rational for a competitive firm". That is simply tostate the issue, not to advance its resolution. In each of the above examples, drawn fromactual decisions which have provoked comment, the court lacked a rule which articulatedwith any precision the distinction between competitive and anticompetitive behaviour. Inshort, the existing laws as interpreted by the courts make no specific statement of thenature of the purpose that identifies with precision the socially undesirable market conduct.Against that background, we now turn to our proposed rule. It is based upon thedichotomy between rent seeking and competition we have articulated in previous chapters.We contend that, in each of the examples referred to above, our rule would have focusedthe issue in the proceeding to a significantly greater degree than the existing purposeprovisions - even with the gloss that has been added by the courts. After stating ourproposed law we will consider its application to the factual context in four decided casesto illustrate both the often superfluous nature of enquiries as to market definition andmarket power and the way such a rule assists in the identification of the socially undesirablemarket conduct associated with dominance.263 United Brands, supra, note 210; and Fisher & Paykel [1990] 2 N.Z.L.R. 731 [hereinafter Fisher & Paykel].Aspen, supra, note 210.Williams v. Papersave Ply Ltd (1987) 16 F.C.R. 69 [hereinafter Papersave].110The Proposed LawIn the formulation of our proposed law we adopt the term "exclusionary conduct"instead of rent seeking. We do so on the basis that it is more likely to be understood bya wider audience. To this point we have avoided the term, for the most part, because itis often used in an imprecise way as an antonym for competition266. However, now thatwe have established precisely how we contend the antithesis of competition should beexpressed in the context of market dominance, we adopt the more common expression. Indoing so, we intend our definition of exclusionary conduct to be synonymous with theconcept of rent seeking which we have used throughout.Our law begins with a short statement of the conduct to be proscribed thesubstantive explanation of which we reserve for later definitional provisions.(a) A person shall not engage in exclusionary conduct'.Consistent with our argument, the provision applies to all firms without qualification. Theresult is that the difficult questions of market definition and quantification of degree of"control" (usually in terms of market power), which are a substantial part of the existingdominance laws, are absent. As these two issues account for much time and expense inlitigation under current dominance provisions 268, we argue that our approach will result2 ^Easterbrook, supra, note 13 at 973-4; and Krattenmaker, Lande & Salop, supra, note 195 at 255.247 The proposed model law is set out in full in Appendix 3.26S See below, c.6 - Other Advantages of Rejecting Dominance as a Basis for Regulation.111in considerable time and cost savings269. As a public policy instrument a law which doesnot require proof of dominance as an element has much to commend it. It also has theadvantage, as a result, of removing the potential for such laws to be used as a means ofrent seeking in themselves in those jurisdictions which permit private actions 270 .Nevertheless, we expect that dominance may remain relevant in actions broughtunder the proposed law in one respect. As we observed in the previous chapter, an existingposition of dominance has a strategic role both as a motive for, and facilitator of, certainrent seeking practices. An applicant271 under the proposed law may choose to reinforcean argument that certain conduct is less likely to be ordinary competitive conduct (an issuethat will arise under the definitional provisions set out below) because the respondentenjoys an existing dominant position. However, the choice will be an evidentiary one forthe applicant, in contrast to the existing laws which oblige an applicant to prove dominanceas an element of every alleged contravention272. Further, we contend that the weightwhich a court will afford such evidence will reflect the fact that dominance will motivateboth competitive and exclusionary conduct, a factor discussed in detail below.The next two provisions are the key to our proposal. The first, defines exclusionaryconduct. As it does so by including a proviso which excludes competitive conduct, the269 Although our approach will result in all market conduct (not just the conduct of dominant firms) beingsubject to scrutiny, we contend that cost savings will still result due to the lack of emphasis upon the timeconsuming and difficult issues of market definition and market power.270 See above, text relating to note 220 and authorities cited therein; and Bork, supra, note 3 at 347-8.211 Under existing laws the applicant may be a public official or an aggrieved party or either, dependingupon the jurisdiction. Private actions are relatively frequent in Australia, New Zealand and the UnitedStates, but not in Canada and Europe under the existing dominance laws.2n  s.2 of the Sherman Act is the only exception. It seems that "monopolization" may be engaged in bynon-dominant firms.112second provision defines that term. Taken together, the two definitions express thedistinction between rent seeking on the one hand and innovation and imitation on theother, which has been the thrust of our thesis. As articulated in the opening to this chapter,they focus upon the issue whether the conduct is part of the person's competitive effortsto serve the demands of customers (including attempts to influence those demands) or partof an effort to prevent other firms from doing so.(b) In this section, exclusionary conduct means market conduct, other thancompetitive conduct, which prevents, or is likely to prevent, directly or indirectly,any person from engaging in market conduct necessary in order to(i) supply a product or products demanded by a customer or customers; or(ii) influence the demand of a customer or customers for a product orproducts.(c) In this section, competitive conduct means conduct which has the substantialpurpose of enabling the person engaged in the conduct to(i) supply a product or products demanded by a customer or customers; or(ii) influence the demand of a customer or customers for a product orproducts.(d)^In this section, prevent includes substantially restrict or hinder.The qualification to paragraph (b) excluding "competitive conduct" is necessary113because the definition would otherwise encompass much competitive conduct. It isunnecessary to include a purpose element in paragraph (b) as it is expressed in paragraph(c). To the extent that exclusionary conduct may be motivated by factors entirelyextraneous to commercial considerations, such as religious or political beliefs, a defenceprovision is proposed to ensure that the economic regulation does not incidently proscribethe general freedoms which people have to do business with whomsoever they choose forwhatever reason they choose. As such motivations are likely to be peculiarly within theknowledge of the actor, and often not readily apparent from the conduct itself (taken in itsmarket context), we have formulated the provision as a defence instead of an exclusion tothe substantive provisions. It is as follows.(e) It shall be a defence to any proceedings under this section if the person is shownto have acted for a purpose other than a commercial purpose.(f) For the purpose of this section, a person shall be deemed to have acted for acommercial purpose if the person has acted for the purpose of increasing theprofitability, or reducing the losses, of any business.It is then necessary to deal with the evidence that may be used to prove purpose.To what extent does the competitive purpose have to be the only purpose in order for theproviso to paragraph (b) to apply? To what degree does the non-commercial purpose inparagraph (e) have to be the sole purpose for the exclusionary conduct? Is the standardobjective or subjective? In order to deal with these issues we propose the following114provisions based upon the existing dominance laws in Australia and New Zealand 273 .(g) Without in any way limiting the manner in which the purpose of a person maybe established, a person may be taken to have acted for a purpose referred to inthis section notwithstanding that after all the evidence has been considered theexistence of that purpose is ascertainable only by inference from the conduct ofthat person or any other person or from other relevant circumstances.(h) For the purposes of this section, a person shall be deemed to act or have actedfor a particular purpose ifN^the person acts or acted for purposes that included or include thatpurpose; andthat purpose is, or was, a substantial purpose.The effect is to require the court to reach a conclusion as to the substantial purposemotivating the conduct in each case. Also, although purpose is a subjective concept, theprovision allows for proof by way of inference from surrounding circumstances274. The2' See ss. 4F & 46(7) of the Trade Practices Act and ss.2 & 36 of the Commerce Act.274 There remains some dispute as to the relevance of subjective intent. We suggest that the reason is thatmost jurisdictions enable proof of intent by inference (which imports an "objective" standard), although suchinferences may be negated by credible evidence of subjective intent. Compare, in Canada Laidlaw, supra, note8 at 342-3 ("Proof of subjective intention on the part of a respondent is not necessary in order to find thata practice of anticompetitive acts has occurred. Such intention is almost impossible of proof in many casesinvolving corporate entities unless one stumbles upon what is known as a "smoking-gun". Section 79 of theAct provides for a civil proceeding and civil remedies. In that context corporate actors and individuals aredeemed to intend the effects of their actions*); and NutraSweet, supra, note 8 at 35 ("The determination ofan anticompetitive act, and particularly its purpose component, is a difficult task. The Director submits thatevidence of subjective intent (through verbal or written statements of personnel of the respondent) or aconsideration of the act itself (the premise that a corporation can be taken to intend the necessary and115result is that an applicant may prove purpose objectively, but a defendant may leadevidence of a subjective intent which may excuse conduct which may otherwise have beencharacterized as rent seeking on the basis of inferences drawn from the facts viewedobjectively. It now falls to illustrate how the proposed law would have applied to the factsin a number of decided cases. However, before doing so it is necessary to emphasize thesignificance of our conclusion that a finding of exclusionary purpose is not preconditionedupon a finding of dominance.There is, in many of the recent cases, the suggestion that some power uniquelyassociated with the position of dominance must be exploited for a predatory purpose to beestablished. It is an integral part of our thesis that such an approach is erroneous. It fallsinto error because it is based upon the misconception that only dominant firms have theability to exclude competition through their behaviour. As we noted in the previouschapter, an incumbent dominant position may facilitate certain exclusionary strategies 275.However, two other statements are also true. First, dominant firms are likely to haveadopted superior competitive strategies which will "exclude" competition and it is easy toconfuse such strategies with rent seeking. Second, non-dominant firms may engage in rentseeking in order to secure a position of dominance in the future. Therefore, in order toforeseeable consequences of its actions) can be used to establish purpose. The Tribunal finds nothingobjectionable in these submissions"). In Australia, a distinction is drawn between purpose to be inferred fromcertain conduct and purpose to be inferred from the natural result of that conduct, the latter not beingevidence of purpose; Jewel Food Stores Ply Ltd v. Amalgamated Milk Vendors Assoc. Inc. (1990) A.T.P.R. 40-997 at 50,985; and Eastern Express Ply Ltd v. General Newspapers Ply Ltd (1992) A.L.R. 297. In New Zealand,Union Shipping, supra, note 30 at 707-8 ("Refusal to supply may be designed to eliminate, but it may be dueto poor performance or credit rating. The activity covered will not be prohibited, despite foreseenanticompetitive effects, if it arises for unrelated legitimate business reasons, without purposive pursuit of theanticompetitive purposes in themselves. It however, the anticompetitive effects are within the defendant'spurpose, questions of motive and morality become irrelevant").2" See above, c.5 - Strategic Motive and Advantage116identify conduct which is exclusionary, a criterion which goes beyond dominance is required.We have proposed a definition of rent seeking as conduct the purpose of which is toprevent others from meeting or influencing the demands of customers. The determinationof such a purpose does not require an investigation of whether a firm is dominant, norwhether the firm has a power which a competitive firm does not. In this respect it isdramatically different from existing laws which are often interpreted in ways which suggestthat the offending anti-competitive conduct must involve the exercise of a power unique todominant firms.Two recent examples illustrate the point we are making. In 1980 the state of theinterpretation of s.2 of the Sherman Act was reviewed in Kodak276 . Chief Judge Kaufmansummarized the "fundamental doctrines" of s.2 in the following terms...there is little argument over the principle that existence ofmonopoly power - "the power to control prices or excludecompetition" ..."is the primary requisite to a finding ofmonopolization."If a finding of monopoly power were all that were necessary tocomplete a violation of s.2, our task in this case would beconsiderably lightened. Kodak's control of the...markets clearlyreached the level of a monopoly...But our enquiry into Kodak'sliability cannot end there.To understand the reason for this, one must comprehend thefundamental tension - one might almost say the paradox - thatis near the heart of s.2..."The successful competitor, havingbeen urged to compete, must not be turned upon when hewins"The key to analysis, it must be stressed, is the concept ofmarket power...A firm that has lawfully acquired a monopolyposition is not barred from taking advantage of scaleeconomies... These benefits are a consequence of size and not276 Supra, note 19.117an exercise of power over the market...The mere possession ofmonopoly power does not ipso facto condemn a marketparticipant. But, to avoid the proscriptions of s.2, the firmmust refrain at all times from conduct directed at smotheringcompetition. This doctrine has two branches. Unlawfullyacquired power remains anathema even when kept dormant.And it is no less true that a firm with a legitimately achievedmonopoly may not wield the resulting power to tighten its holdon the market277 .Evident throughout the above reasoning is the court's struggle to differentiate competitivefrom exclusionary behaviour. Later, the Chief Judge distinguished gains that accrue to anyintegrated firm, regardless of its market share, from the "use of monopoly power" 278. Hishonour used purpose to monopolize or "smother" competition to express the qualitativedifference. So, how did the court in Kodak go about determining whether Kodak wasmotivated by such a purpose?The facts were as follows. Kodak invented a new camera. At the same time itmarketed a new film which could only be used with the camera. There was sufficientevidence at trial for a jury to conclude that the new film was not necessary 279. Kodak'scontrol of the film market reached the level of a monopoly. The material question on theissue of purpose was why would Kodak develop and promote a new film for exclusive usewith the new camera? On appeal, the court was unable to resolve the ambiguity as towhether the introduction of the new film was an intentional use of monopoly power in thefilm market to sell the new camera, or the competitive marketing of a new system of277 Ibid. at 272-5.278 Ibid. at 276.279 Ibid. at 285-6.118photograph?" to the benefits of which it was entitled because "the process of innovationand invention" was the outcome of aggressive competition 281. It was unable to do sobecause its distinction between competition and monopolization involved an assessment asto whether Kodak had used its monopoly power. The ability to exclude competition wascharacterized as involving an exercise of the power attendant to a position of dominance.This is an error which is reflected in the following passage from the judgmentIn sum, Kodak's ability to gain a rapidly diminishingcompetitive advantage with the introduction of the 110 systemmay have been attributable to its innovation of a new systemof photography and not to its monopoly power. On the otherhand, we cannot dismiss the possibility that Kodak's monopolypower in other markets was at least a partial root of its abilityto gain an advantage over its photofinishing competitors...Wecannot resolve this ambigui 2However, our analysis refutes the suggestion that predatory purpose is onlymanifested in the exercise of some power attendant to an existing position of dominance.Instead we have shown that the relevant enquiry is simply whether the purpose of theconduct was to serve the needs of customers, or to prevent others from doing so. In thefactual context of Kodak, the issue becomes focused upon an assessment of whether thenew film was part of a strategy to make the package of the film and the camera moredesirable to customers than the new camera alone, or whether the fact that the new filmwas technologically unnecessary supported the inference that it was part of a rent seekingstrategy. The manifestation of an exclusionary purpose does not require an existingdominant position. Difficult issues of dominance and attendant monopoly power are29° Ibid. at 292.281 ibid.282 Ibid.119removed from the case283 .In Queensland Wire, the High Court in Australia also considered the argument thatpredatory purpose will be evidenced by conduct which is uniquely possible for a dominantfirm. The case concerned the refusal by B.H.P. (Australia's largest steel producer) tosupply Queensland Wire ("Q.W.I.") with Y-bar - a product manufactured in B.H.P.'s steelmills. Y-bar was used exclusively for the production of "star pickets" which, in turn, wereused in fencing. All Y-bar manufactured by B.H.P. was sold to its subsidiary whichmanufactured star pickets and sold fencing systems which included star pickets. Q.W.I. soldfencing systems in competition with B.H.P.'s subsidiary and purchased star pickets from itscompetitor. Q.W.I. wished to purchase Y-bar in order to manufacture its own star pickets.Toohey J. summarized the argument of counsel for B.H.P., the respondent inQueensland Wire in the following wayAt the core of B.H.P.'s argument was the submission that theconcept of market power means absence of constraint...[It wasargued that] one can never find as a fact that a person is usingor exercising, let alone taking advantage of, market powerunless one finds as a fact that the conduct in which the personis engaging is something in which he would not or could notengage but for the absence of constraint. In other words, itwas said that there can only be a use of market power if whatthe corporation does it does only because of the absence of acompetitor284.His honour's response to the argument was to stateThe only reason why B.H.P. is able to withhold Y-bar (while atthe same time supplying all the other products from its rollingmills) is that it has no other competitor on the steel productmarket who can supply Y-bar. It has dominant power in thesteel products market due to the absence of constraint. It is283 The facts reported in Kodak do not permit an analysis based upon our approach.284 Supra, note 23 at 216.120exercising the power which it has when it refuses to supplyQ.W.I. with Y-bar at competitive prices; it is doing so preventthe entry of Q.W.I. into the star picket market; and it has beensuccessful in that attempt 295.The use of the word "able" suggests that His honour accepted that the "use of marketpower" must involve an activity that is impossible for a firm subject to competitiveconstraint. However, the tenor of the passage is not that B.H.P.'s conduct was only possiblefor a dominant firm, but that it was only rational from the perspective of dominance. Inother words, B.H.P.'s strategy would not make sense if there were competitors who wouldsupply Y-bar to Q.W.I. What is not addressed by that observation is the fact that B.H.P.did not engage in an act which was irrational for a firm subject to competitive constraint.After all, it simply refused to supply a customer - an action that is possible for any firm andmay be undertaken for any number of commercial considerations.The facts in Queensland Wire show that exclusionary purpose is evident in theexercise by dominant firms of abilities which any firm may exercise. Though the conductmay be rational because of the prospect of dominance, the ability to act is not attendantto the position of dominance. Queensland Wire is an example of a case where theincumbent dominant firm had a strategic advantage, in the form of its existing investmentin plant sufficient to serve the entirety of the Australian market. That advantage meantthat an investment in rent seeking behaviour could preserve its position of dominance.However, B.H.P.'s dominant position may also have been preserved by competitivebehaviour and a competitive strategy may also have warranted a refusal to supply Q.W.I.It is not the fact that B.H.P. was able to secure or protect dominance through refusing to25 Ibid.121supply Q.W.I. that established the contravention, despite the suggestion to that effect in thepassages quoted from the judgment of Toohey J. quoted above. B.H.P may also have been"able", by refusing to supply Q.W.I., to achieve substantial cost savings in producing Y-barthat were dependent upon the integration of the production of Y-bar with the productionof star pickets. The exercise of both "abilities" may result in, or protect, dominance.However, dominance per se, does not taint either action with an exclusionary or rent seekingpurpose. Nor does it assist, in distinguishing between the two, to ask whether by the refusalto supply B.H.P. is "able" to remain dominant distinguish between the two. The onlydetermining factor that refusals to supply is purpose.Where the substantial purpose is to achieve cost savings through vertical integrationthe conduct is competitive (even though it may make it harder for a non-integratedcompetitor to be able to supply the same product at a competitive price). However, whatestablished the contravening purpose in Queensland Wire was the obvious inference to bedrawn from the fact that B.H.P. was refusing to supply a large and viable customer, viz itspurpose was not to serve customers needs, but rather to prevent Q.W.I. from doing so. Itwas an inference that was reinforced by the absence of any competitive explanation forB.H.P.'s actions. The evidence of dominance was equivocal when it came to the task ofdifferentiating between competitive and exclusionary behaviour. Dominance was not themeans, it was the motive - and an ambiguous motive at that. The prospect of dominancemotivates competitive strategies which also exclude competitors. As illustrated by thehypothetical example of vertical integration listed above, those competitive strategies mayinclude a refusal to supply. Proving the existence of dominance does not advance theresolution of the issue whether the conduct is competitive or anticompetitive. It does not122show whether B.H.P. acted simply in order to prevent Q.W.I. from supplying star picketsas its competitor, or whether B.H.P. acted because vertical integration was essential to itsendeavours to supply customers with a timely product as cheaply as possible. The only factswhich established that distinction were those which evidenced the purpose for which B.H.P.acted.The finding implicit in the decision of the High Court in Queensland Wire was thatthe only purpose for which B.H.P. acted was to exclude Q.W.I. The determination of thecase did not require a finding as to the relevant market or the degree of power whichB.H.P. had in that market. Certainly, it was material to consider whether there was anyother product that may have been purchased by Q.W.I. as an alternative to that which wassupplied by B.H.P., but that fact did not involve a determination of market definition ormarket power. The other relevant evidence concerned what was necessary for B.H.P. tosupply or influence the demands of its customers. If integration of the manufacture of Y-bar and star pickets could not be explained as a necessary part of the way that B.H.P.meets or influences its customers requirements as cost effectively as possible, the inferenceis that either it is acting for the purpose of preventing Q.W.I. from competing, or it is actingfor a non-commercial purpose. In the latter case B.H.P. could lead evidence of the fact,for example, that it disapproves of Q.W.I.'s exploitation of labour in a foreign market andthat its refusal to supply is an expression of that disapproval which, if accepted, wouldnegate the inference that its purpose was exclusionary.A proper consideration of the facts in Queensland Wire shows that market structurecould not have been the basis for the court's decision on the question of purpose. Marketstructure is ambiguous. It explains both successful competitive behaviour and exclusionary123behaviour. It is only through a consideration of the evidence of purpose motivating theconduct alleged to be offensive (both direct and inferential) that competitive behaviour canbe distinguished from anticompetitive behaviour. Because market structure is ambiguous,it can never be used to resolve the issue of purpose. Dominance will be the reason why anyfirm acts. An existing position of dominance may even be part of the reason why the firmis able to act. But it will be purpose alone that differentiates competitive from exclusionaryconduct.To summarize, dominance is relevant to purpose in two respects. First, the prospectof dominance motivates rent seeking. However, it also motivates competitive behaviour.Second, a position of dominance may facilitate rent seeking. However, the only fact thatwill invariably distinguish a use of a dominant position for rent seeking from competitiveconduct by a dominant firm is the purpose for which the dominant firm acts. Further, thepurpose of the actor may be discerned without reference to whether the actor is dominant.Indeed reference to dominance is likely to result in confusion between successfulcompetitive strategies and rent seeking, because both will be directed at achievingdominance. Therefore, although proof that conduct is unlikely to create, protect or' The alternative is to focus upon the effect of conduct upon competitors or total welfare. The problemwith such an approach is that there is nothing to differentiate the effect of successful competition and rentseeking from the effect of rent seeking upon competitors. Both threaten the viability of competitors. In thecase of successful competition it is a threat that is inherent in the efficiency of the process of competition.In the case of rent seeking it is a threat that entrenches inefficiency. However, to measure the effect of anaction in the market place in order to determine whether it is "efficient" or "inefficient" is generallyacknowledged as being beyond the capability of existing economic analysis; see H. Hovencamp, "TheMeasurement of Market Power: Policy and Science" in F. Mathewson, M. Trebilcock & M. Walker, eds., TheLaw and Economics of Competition Policy (Vancouver: The Fraser Institute, 1990) 43; and Moschel, W."Antitrust and Economic Analysis of Law (1984) J. of Inst. & Theo. Econ. 154 at 169 ("Up to the present,propositions as to the average effects on efficiency in merger cases have been - given the measurement andevaluation incertitudes - anything but reliable, and the record of prediction on an individual case basis hasbeen, as Fisher and Lande point out correctly, 'shockingly poor'. There are great doubts as to whether suchmethods - in the actual state of knowledge - could meet the standard of proof required in judicial proceedingsand could be handled by courts in a predictable manner"); and Fisher & Lande, supra, note 104.124enhance a dominant position will refute an inference that the motivating purpose for theconduct is exclusionary, the inverse is not true.Therefore, our proposed law makes purpose the only basis for liability. Thereremains the practical issue whether it is possible to establish the purposes referred to in ourproposed law or whether the theoretical analysis raises practical difficulties in the courtroom. In the next section we illustrate, by reference to decided cases, how readily suchevidence may be adduced and weighed in order to resolve the issue of purpose. We alsoexplore the validity of the conclusions expressed above.Four Applications of the Model LawWe will consider the application of our proposed law to three recent cases and onecelebrated case of the past - the first from Australia, Taprobane Tows (WA) Ply Ltd v.Singapore Airlines Limited287; the second, NutraSweet, a Canadian case; the third, Aspen,a United States monopolization case that was finally decided by the Supreme Court; andthe fourth, United Shoe Machinery, a United States case in which the distinctions betweenexclusion through successful competition and exclusion through "monopolization" wereconsidered in a factual context that was reported in some detail in the reasons for decision.TaprobaneTaprobane illustrates how the preoccupation with market definition and marketpower under the existing law, which requires proof of dominance as an element, not only287 (1991) 104 A.L.R. 633 [hereinafter Taprobane].125consumes enormous amounts of court time 288, but also directs the attention of the courtaway from an examination of the market conduct alleged to be offensive. The caseconcerned the marketing of wholesale package tours from Australia to the Maldive Islands.In the period 1984 to 1986 Taprobane Tours marketed wholesale package tours tothe Maldives. During that period discount airline services for travel between Australia andthe Maldive Islands were supplied by Singapore Airlines to Taprobane Tours and otherwholesalers of Maldivian package tours. Singapore Airlines was the only supplier of suchairline services, there being no feasible or economic alternative for travel by air to theMaldives for Australian tourists289. Taprobane Tours and other wholesalers incorporatedthe airline services with accommodation, airport transfers and land tours to form packagetours which were sold as a bundled product to retailers. From March, 1986 SingaporeAirlines commenced selling its own wholesale package tours to the Maldives in competitionwith Taprobane Tours and other wholesalers. In 1987 Singapore Airlines refused tocontinue the supply of discount airline services to Taprobane Tours. On 6 November, 1987Taprobane Tours brought an action in the Federal Court against Singapore Airlines allegingthat Singapore Airlines had contravened s.46 of the Trade Practices Act and claimingdamages29°.A significant issue in Taprobane was whether Singapore Airlines had a substantialdegree of power in a market. Although Taprobane Tours was successful at first instance288 The considerable court time spent in considering issues of market definition and market power wasthe subject of comment by the trial judge in awarding costs of the trial. His honour observed that theconsiderable amount of court time expended in addressing such issues was necessary for the applicant toestablish the dominance of Singapore Airlines; unreported decision of Lee J. delivered 4 September, 1990.289 Supra, note 287 at 658.29° The report of the decision at first instance in Taprobane is at (1990) 96 A.L.R. 405.126on this issue, an appeal by Singapore Airlines led to the decision being reversed on theground that the relevant market encompassed package tours to many island destinations,a market in which many airlines competed in the provision of airline services. The resultwas that the appeal court found it unnecessary to explore the purpose for the conduct. Theappeal was allowed solely on the question of market definition. That is, because SingaporeAirlines was not a dominant firm it had not contravened the relevant statutory provision.However, we have concluded that the material issue from the perspective of totalwelfare is to determine whether the conduct was competitive or rent seeking in purpose.In Taprobane, on the issue of purpose, the trial judge found that Taprobane Tours was "anefficient operator with a competitive product and that it conducted its business on properfinancial terms"291 . There was no evidence to suggest that there was any financial riskto Singapore Airlines associated with Taprobane Tours continued operation as a wholesalerand it was conceded by Singapore Airlines that there had been no complaints againstTaprobane Tours in the history of its operation of tours to the Maldives 292. After therefusal to supply Taprobane Tours, Singapore Airlines offered to sell airline tickets toTaprobane Tours, but was shown to have imposed a discriminatory fare. No commercialexplanation for the fare was forthcoming293.His honour also found "on the totality of the evidence" that Singapore Airlines hadacted "to rationalize or redefine the operations of the wholesalers...by restricting the ability291 /bid at 418.292 Ibid.293 Of course, the burden of proof remained upon Taprobane Tours throughout. But, once thecircumstances of the refusal to supply had been established, inferences could be drawn in the absence of anycommercial explanation from Singapore Airlines.127of Taprobane to engage in competitive conduct". Taprobane Tours was SingaporeAirlines closest competitor in the market place offering packages that were very similar tothose offered by Singapore Airlines own wholesaling operations. Although not expresslyquoted in the reasons for decision of the trial judge, the evidence at trial included aninternal report by Singapore Airlines' marketing services manager which recommended thediscontinuance of a number of wholesalers, including Taprobane Tours, on the basis thatthey "conflicted" with the market position of Singapore Airlines own wholesale operationsand the continuance of other wholesalers because there was "no conflict" as they served"specialist" markets. Also, other documents showed that Singapore Airlines' wholesale salestargets for package tours to the Maldive Islands could not have been achieved without theelimination of Taprobane Tours from the market.All the evidence referred to above was able to be adduced by Taprobane Tourswithout great difficulty. Taken together it gave rise to an inference that Singapore Airlineshad acted to improve its profitability by excluding Taprobane Tours rather than attemptingto improve its service of customers. Under our proposed law such evidence would establishthat Singapore Airlines had engaged in exclusionary conduct that was not competitiveconduct (that is, it was not conduct directed at serving the needs of customers or influencingcustomer demand). Such evidence would meet the evidentiary burden without requiringthe court to reach any conclusion as to the relevant market or the degree of market powerof Singapore Airlines. Of course, the inference as to exclusionary purpose is derived in partfrom an appraisal of how close a competitive relationship existed between Taprobane Toursand Singapore Airlines. However, that conclusion could be reached by considering theIbid. at 419.128products supplied by the two parties, the geographical area in which each made sales, andthe extent to which customers switched between the two. Absent is the need to adducesuch evidence for all possible competitors in the market however defined (evidence that isrequired under existing laws which require proof of a dominant position).Of course, one can conceive of competitive explanations for Singapore Airlines'decision not to supply a particular wholesaler notwithstanding its commercial viability in thepast. One hypothesis may be that Singapore Airlines decided to make a strategic changeto in-house marketing on the basis that it could train its own staff more cheaply than itcould train agents, and could ensure that its staff provided a highly specialized level ofservice that suited the multi-lingual traffic to the Maldives or customized tours demandedby most travellers. Had such a defence been raised to explain the inferences that wouldotherwise be drawn from the available evidence, then Taprobane Tours in turn may haveadduced evidence that it was given no opportunity to demonstrate the ability of its staff toprovide multi-lingual, customized services to prospective customers, or that it had suchcapability and that it was known to Singapore Airlines. Inferences may be drawn from thefact that Singapore Airlines could produce no marketing report reflecting such a policy.We see that the focus of the inquiry becomes the discernment of the purpose ofSingapore Airlines from the surrounding circumstances. Certainly, in Taprobane there wasno necessity for the court to undertake a market analysis and make findings as to therelevant market or the degree of market power presently held by Singapore Airlines inorder to draw inferences that Singapore Airlines conduct was motivated by its desire toprotect its market power by means other than serving or influencing customers.In Taprobane Singapore Airlines argued that its actions had been motivated by two129purposes; improving its profitability by ensuring that it dealt only with established operatorswho might be expected to provide regular and reliable custom to Singapore Airlines, andavoiding financial loss. Both "explanations" were found to be without foundation on theevidence - and could be addressed without resort to issues of market definition and marketpower.The problem with the existing Australian law is that it is preconditioned upon afinding as to market power, an issue about which there may be much conjecture 295. Thefact is that the clear exclusionary purpose of many actions by firms is excused on the basisthat the firm is not "dominant". The irony is not only that such an approach excuses muchrent seeking behaviour on the erroneous basis that it is only of concern when engaged inby a dominant firm, but also that it ignores the fact that it is the prospect of future,continuing or improved dominance that motivates all market conduct. Aside from caseswhere markets approach the theoretical model of perfect competition (at least for so longas there is such perfect competition), in which case dominance is an impossibility, all marketbehaviour is driven by the possibility of dominance. The real issue is whether the drivingforce of dominance is inducing exclusionary (or rent seeking) conduct instead ofencouraging competition. It is a far more focused enquiry to ask why Singapore Airlinesrefused to supply Taprobane Tours, than to first ask whether Singapore Airlines was adominant firm. Indeed, within a dynamic marketplace, establishing dominance at any point295 The trial judge's approach was to conclude that the relevant market was the market for the supply ofairline services to the Maldives because, as the evidence showed, Singapore Airlines had the ability topromote or retard a wholesaler in the wholesale tour market without fear that the airline would be able toincorporate the services of a competing airline. The Full Court disagreed and found that because customerscould substitute a holiday to another destination for the holiday to the Maldives, the relevant market wasmuch broader. Of course, both factors influence the market decisions of buyers and sellers of airline services.No firm conclusion may be reached.130in time may be as elusive (and pointless) as attempting to pick up quicksilver between one'sfingers. It is far more to the point, and less time consuming to simply ask why did the firmact the way it did!The point could not be better illustrated by another recent Australian case. InPapersave', one of the directors of Papersave discovered that one of its formeremployees, Williams, was about to acquire a lease of certain premises in order to establisha business in competition with Papersave. The director then attempted to lease the samepremises for Papersave. An injunction was sought. It was found that a substantial purposefor the director seeking to lease the premises was to frustrate the new entry by Williams.However, it was found at trial297 and upheld on appeal, that the actions of Papersavedid not amount to a use of market power. Therefore, Papersave had not contravened thedominance law.As we have argued above, there need be no connection between the position ofdominance and socially undesirable market conduct. Papersave illustrates perfectly thesituation where dominance motivates, rather than facilitates, rent seeking conduct. Thereneed be no special power attendant to the dominant position that is exploited. Papersavewould have contravened our proposed law because the sole purpose of its conduct was toprevent Williams from supplying Papersave's customers. However, its socially undesirablemarket conduct would not be proscribed by existing dominance laws.The evidence necessary to reach a conclusion as to whether Papersave was motivated2% Supra, note 265.297 (1987) 9 A.T.P.R. 40-781.299 Supra, note 265.131by an exclusionary purpose is amply illustrated by the trial judge's reasons which report indetail the evidence adduced at tria1299. Papersave was looking for new premises in arather general way. Its existing premises were 100,000 square feet, of which at least 25,000square feet was fully occupied. The premises to be leased by Williams were only 15,000square feet. However, the director of Papersave who had offered to lease the premisesdesired by Williams, did so urgently, "more or less on the spot", and there was noexplanation as to why the decision was made with such haste". No estate agent hadbeen engaged by Papersave to seek out desirable premises. No other premises had beeninspected. The premises were smaller than Papersave's current requirements. Materialwitnesses who might have explained the urgency of the decision to lease the premises werenot called. As a result the trial judge concluded that a substantial purpose of Papersave'sactions was to frustrate Williams entry into the market. It was a finding that was notchallenged by Papersave on appeal.NutraSweetIn NutraSweet, one of the first cases decided under the new dominance law inCanada's relatively recent overhaul of its competition law, there was extensive considerationof issues of market definition and market powerm. The Director of Investigation andResearch contended that NutraSweet had engaged in a series of acts which constituted anabuse of its dominant position in the Canadian market for artificial sweeteners. NutraSweet299 Supra, note 297 at 48,517 to 48,522."'Ibid. at 48,524.301 The consideration of the evidence on the issues of market definition and market power occupies thefirst 31 pages of the reported decision.132had secured certain patents for the production of aspartame. During the currency of thosepatents it had embarked upon a "branded ingredient strategy" which involved promoting abrand - "NutraSweet" - for an industrial product - aspartame - directly to consumers. It wasan innovative strategy. In order to implement it NutraSweet advertised its branded productdirectly to consumers. At the same time it persuaded Coke and Pepsi, through certaindiscounts, to include its brand name on their products.The result was that, upon the expiry of NutraSweet's patent for aspartame, an extrademand was created for NutraSweet over aspartame which may be supplied by othermanufacturers. One of the principal complaints against NutraSweet was that it had usedexclusive supply contracts together with rebates for displaying the NutraSweet logo onproducts to be sold to consumers as part of its marketing strategy. The tribunalsummarized the effect of such conduct upon entry in the market for the supply ofaspartame as followsThe logo and advertising discounts create an "all-or-nothing"choice for customers. In the event that customers decide thatthey would prefer not to use the logo for a particular productline or not to commit themselves to use it on all of that line,they are forced to purchase all of their supply from anothersupplier because it is too expensive to buy from NSC withoutthe logo and advertising discounts. This means that newsuppliers must become sufficiently established so that potentialcustomers are willing to entrust all of their needs for a productline to the new supplier3°2.The suggested inference is that the effect of making entry difficult was the goal thatmotivated NutraSweet to adopt the exclusive supply contracts and advertising rebates.However, as we have argued at length, the fact that market conduct results in difficulties3°2 supra, note 8 at 41.133for entry by prospective competitors is indeterminate. Successful competitive strategiesmake entry difficult. True, such outcomes may also be secured or protected by rentseeking behaviour. The question is whether the means by which NutraSweet secured itsrelative independence from competition was anticompetitive. The fact that NutraSweetdesired a dominant position is perfectly consistent with a competitive purpose. However,the Tribunal concluded that provisions in the agreements between NutraSweet on the onehand, and Coke and Pepsi on the other, had an exclusionary purpose, and that NutraSweethad contravened the dominance provision by including them in its agreements. Theparticular provisions were an exclusive supply clause which required that the customerpurchase all of its requirements of aspartame from NutraSweet and a trade mark displayallowance clause which gave a discount for the inclusion of the NutraSweet logo on theproducts manufactured by buyers of aspartame.The tribunal relied upon internal documents of NutraSweet that showed that itsoverall branded ingredient strategy was adopted "to prevent price from falling to the levelof marginal costs of production, which tends to occur with other chemicals that are sold ascommodities" and that NutraSweet was attempting to capture and keep as much market aspossiblem. This evidence led the Tribunal to concludeOn the basis of this evidence and the fact that the strategy wasintroduced when the use patent was in force and customers didnot have a choice of suppliers and marketing approaches, thetribunal is persuaded that the strategy has been and is pursuedfor the purpose of excluding future or existing competition andnot because it is required for efficient distribution or use of theproduct.3°3 Ibid. at 40.3°4 ibid.134But such a conclusion may be drawn in respect of much competitive conduct. Ofcourse, the agreements had an exclusionary purpose. NutraSweet was not investing intrying to create a market opportunity for its competitors. It invested in a strategy designedto maximize profits. Those profits were to be secured through obtaining a relative positionof dominance for as long as possible. The real question, which was not addressed by thetribunal, was whether the exclusionary purpose was part of a competitive strategy or partof an anticompetitive strategy. There was no attempt to recognize that competition maywell have an exclusionary effect, and deliberately so.This is an error which arises, we suggest, because of the emphasis under the existinglaw upon dominance as an element of the contravention. The result is that conductdirected at achieving a dominant position tends to be viewed in pejorative terms. It is allright for firms to have dominance "thrust upon them", but not for firms to seek afterdominance. Such an approach denies the reality of the whole process of competition. Theissue is not whether NutraSweet desired to achieve "exclusivity", but whether its strategyinvolved competitive or rent seeking conduct. So, to conclude, as the tribunal did, thatNutraSweet was "obviously interested in promoting its name and mark, exclusivity in its ownright, rather than exposure of its product name, is clearly at play in the contracts" does notadvance the resolution of the issue.Our approach would direct the enquiry to the resolution of the question whether thepurpose of the exclusive dealing agreements was to persuade customers to buy NutraSweetproducts (and, ipso facto, not purchase other products manufactured with aspartame fromcompetitors of NutraSweet) or, through means other than supplying or influencing customerneeds, to make it more difficult for competitors to enter the market.135Let us return to the facts in NutraSweet. The strategy of attempting to convincecustomers that products which contained NutraSweet were more desirable than productsthat contained other aspartame is entirely consistent with competitive behaviour. Essentialto such a strategy is the identification of products as containing NutraSweet and thepromotion of NutraSweet as an integral part of the product. It involves the jointpromotion, for example, of Diet Coke and NutraSweet as a combination of two desirableproducts. NutraSweet must secure the agreement of the manufacturers of such productsto facilitate such joint advertising. It may do so by means of discounts to its customers whoagree to participate in promoting the NutraSweet logo. It may seek to make its brand sopopular that no consumer will want to purchase diet products that do not have NutraSweetas their sweetening ingredient. These are actions which are consistent with a competitivepurpose.However, as part of its strategy NutraSweet in fact required its customers topurchase all of their aspartame requirements from NutraSweet. This may have been tojustify the investment in joint promotion. It may have been to create scale efficiencies. Itmay have been caused by concern that there will be free riding on NutraSweet's associationwith a particular product by other manufacturers of aspartame. These are all purposes thatwould be consistent with supplying and influencing customer demands. But, withoutconsidering these and other possibilities, the tribunal concluded that the exclusive supplycontracts were anticompetitive because they were part of an overt strategy by NutraSweetto "capture and keep as much of the market as possible for NutraSweet" ms. On the basisof that evidence alone the tribunal concluded that the purpose of the exclusive dealing3°5 Ibid.136strategy was the exclusion of future or existing competition. Again, the fact of intendedexclusion (or, in other words, the fact of intended dominance) seems to have influenced thetribunal. The reality is that any competitor seeks to capture and keep as much of themarket as possible. The tribunal lacked what is explicit in our proposed law, viz. astatement to distinguish such competitive purposes from rent seeking purposes. Thetribunal should have considered whether the "sole supplier strategy" of NutraSweet enabledit to more effectively supply or influence demand for its product. If so, the tribunal mayhave inferred that such was its purpose. If not, an inference of anticompetitive behaviourmay have been supported.There was some evidence that suggested an anticompetitive purpose, but it relatedto the discounts for display of the NutraSweet logo. The discount was applied even thoughthe logo was not displayed or was relatively obscure. However, the ultimate decision by thetribunal rested upon the existence of exclusive supply agreements as being evidence of an"exclusionary purpose". As discussed above, such agreements may have any number ofpurposes in the factual context of NutraSweet.However, the tribunal's failure to address properly the purpose issue does not negateour argument. The tribunal's error did not arise from any difficulty in proving purpose, butrather from a failure to articulate the nature of an anticompetitive purpose and todistinguish it from a competitive purpose. Had it made the distinction there would havebeen a detailed consideration of the operations of NutraSweet and the necessity forexclusive contracts to maintain scale efficiency, prevent free riding or facilitate its marketingprogram as the case may be.The courts are experienced in deciding whether the actions of a firm are consistent137with a particular purpose. The problem with the reasoning in NutraSweet was that thetribunal failed to articulate with sufficient precision the relevant purpose. It is an error thatwould not arise under our proposed law which clearly states the contravening purpose.AspenOf the four ski mountains at Aspen, three are controlled by Aspen Skiing Co("Aspen") and one by Aspen Highlands Skiing Corp ("Highlands"). From 1958 to 1977 jointtickets were offered for skiers which enabled them to use any of the four slopes. Profitsfrom the sale of the tickets were distributed in accordance with usage of the various slopes.In 1978, Aspen decided to discontinue its participation in the joint ticket. It implementedits decision by making Highlands an offer as to a fixed allocation of profits from the saleof joint tickets which was unreasonably low and refused to consider any counterproposalsby Highlands (including a proposal that the profits from the sale of the tickets be allocatedon the basis of independent audits carried out by a firm such as Price Waterhouse atHighland's cost).Highlands' subsequent attempts to introduce its own four mountain ticket by issuingvouchers for its customers to exchange for daily tickets on Aspen's mountains werefrustrated by Aspen refusing to honour such tickets. Eventually, Highlands was successfulin introducing a multi-mountain ticket using travellers cheques and other negotiableinstruments for its customers to purchase single day tickets for Aspen mountains. However,Aspen responded by increasing its single day ticket price significantly in comparison to itsown three mountain pass, which excluded skiing on Highland's slopes. There was noreference to a cost rationale for such a change in pricing practices.138It is apparent from the reports that a considerable issue at trial and before the Courtof Appeals was whether Aspen had a substantial degree of power in a relevant market.Once again such issues would be irrelevant under our proposed law. The important issue,we contend, is why did Aspen refuse to continue its marketing practice of participating inthe promotion of a joint ticket to all four mountains? Was it motivated by a desire to servecustomer demand, or to influence customers to prefer Aspen's mountains, or was it rentseeking behaviour? Proof of dominance was not required to resolve that issue.The strong inference from the market behaviour of Aspen is that it was pursuing arent seeking strategy. Importantly the joint ticket had originated when all four mountainswere independently controlled. Aspen had frustrated Highlands attempts to offer itsown four mountain ticket. It did so not by offering a better price or service to customers,but by refusing to accept the commercial opportunity afforded by Highlands purchasingsingle day tickets from Aspen to form part of Highlands own multi-mountain ticket. Suchevidence supported an inference that Aspen was engaging in exclusionary conduct. Didsuch conduct have a competitive explanation?In a comment upon the decision in Aspen, Easterbrook formulates possibleexplanationsConsider an explanation Skiing [Aspen] might have offered forcutting Highlands out of the multi-mountain ticket. It mighthave said that Highlands was an inefficient "fringe" firm takinga free ride on the fact that Skiing had developed the resort'sprincipal mountains and attracted tourists, which Highlandsdiverted once they were in Aspen. Highlands' mountain was306 In a comment upon the decision in Aspen, Easterbrook, supra, note 13 at 974 argues that it wasimproper for the Supreme Court to draw an inference of exclusionary purpose from the fact that Aspen hadsimply changed a long standing practice. However, it had done more than that. It had changed a longstanding practice that had been established when there was more direct competition.139below average in attractiveness; why else did it get only 13%to 18% of the business from the four-mountain ticket? Thefour-mountain ticket gave Highlands an opportunity to divertskiers at no marginal cost to the skiers. Skiing might believethat it was entitled to compensation for providing Highlandswith a pool of ready customers and facilitating their migrationto Highlands' mountain...Moreover, Skiing might have arguedthat economies of scale called for the use of only three ratherthan four mountainsmi.However, there was no such evidence at trial. Instead Aspen was entirely silent in itsexplanation of its purpose for refusing to supply Highlands 3°8, in the face of theinferences to be drawn from its willingness "to forgo daily ticket sales both to skiers whosought to exchange the coupons...and to those who would have purchased Ski Co. [Aspen]daily lift tickets from Highlands if Highlands had been permitted to purchase them inbulk"309. Its contention that the usage of the mountains could not be monitored wasrefuted by its unreasonable refusal to accept the offer of an audit paid for by Highlands andthe fact that it allowed such multi-mountain tickets at other ski operations which it owned.Its argument that it wanted to dissociate itself from Highlands allegedly inferior services wasrefuted by the fact that customers made their own choice as to which mountain to use andthe fact that "it was willing to associate with what it considered to be inferior products inother markets".Such "purpose evidence", readily available in Aspen, would be all that would be3°7 Supra, note 210 at 975-6.303 If there was a criticism to be made of the direction by the trial judge to the jury it was that she tendedto suggest that it was for Aspen to prove that it had a legitimate business purpose for its refusal to continuethe joint marketing of the four-mountain ticket - rather than clearly stating, as was the case, that it was forHighlands to establish on the preponderance of the evidence (and in the absence of evidence to the contrary)that Aspen had been motivated by an exclusionary purpose. In fact the direction was in the following terms"In other words, if there were legitimate business reasons for the refusal, then the defendant, even if he isfound to possess monopoly power in a relevant market has not violated the law"; Ibid. at 477.309 Ibid. at 484.140required to resolve the case under our proposed law. Detailed and difficult issues ofmarket definition and market power would not need to be considered at all. Moreover, thepurpose enquiry would be more sharply focused. The Supreme Court expressed thepurpose enquiry in the following wayThe question whether Ski Co.'s [Aspen's] conduct may beproperly characterized as exclusionary cannot be answered bysimply considering its effect on Highlands. In addition, it isrelevant to consider whether it has impaired competition in anunnecessarily restrictive way. If a firm has been "attempting toexclude rivals on some basis other than efficiency," it is fair tocharacterize its behaviour as predatory. It is, accordinglyappropriate to examine the effect of the challenged pattern ofconduct on consumers, on Ski Co.'s smaller rival, and on SkiCo. itself '31° .The court went on to conclude that "consumers were adversely affected by the eliminationof the 4-area ticket". Such conclusions are inherently ambiguous. Some consumers maybe adversely affected by what is otherwise a competitive strategy. It is not the fact thatsome consumers are adversely affected, but the fact that there is no apparent benefit to anyconsumer that motivated the refusal to cooperate in joint marketing, that is material. Ourproposal makes it clear that what is material is whether any deleterious impact uponcustomers was merely incidental to an attempt to serve or influence customers generally.The court also emphasized the fact that Highlands was damaged by Aspen's conductbecause its ability to compete was affected. Again such an outcome is ambiguous beingentirely consistent with the implementation of a competitive strategy. Our proposed lawreorientates the enquiry to focus upon the material issue in terms of total welfare - was thepurpose of the act to serve or influence customers. Our provision makes it clear that the310 Ibid. at 482.141only offensive conduct is that which prevents a firm from competing without beingmotivated by the purpose of serving or influencing customers. It assumes that all marketrivalry is about damaging competitors and then identifies, by an express statement ofpurpose, that sub-set of market conduct which is socially undesirable. The problem withmany of the descriptions by the Supreme Court in Aspen as to why Aspen's refusal tocooperate in the marketing of a four-mountain ticket was "monopolization" was that manyof its formulations describe "competitive" conduct. However, the evidence adduced inAspen does illustrate that our proposal would enable the resolution of the issue withoutresort to issues of market power.United Shoe MachineryOne of the celebrated competition law cases in the United States is United ShoeMachinety311. United Shoe had achieved a position of market dominance in the businessof supplying machines for the manufacture of shoes. One of its business strategies was tofollow the practice of "never selling, but always leasing". Such lease-only strategies hadbeen followed by all competitors in the industry since the American Civil War. The leasesincluded free repair and other services. Lease costs were a low part of overall cost for shoemanufacturers, but problems with machinery had the potential to produce substantial down-time costs. Also, small operators preferred to lease machines rather than to outlay theentire cost of purchasing machinery in advance312.311 Supra, note 260.312 The court does not refer to such a factor expressly. However, it does refer to the fact that the lease-only policy facilitated entry into the shoe manufacturing industry, supra, note 262 at 301 & 323, and cites therelevant term in the lease, ibid. at 316.142Therefore, a system of machinery supply which guaranteed prompt and efficientrepairs and required payment based upon usage was highly desired by manufacturers.United Shoe included terms in its leases which made it undesirable for a manufacturer toswitch brands during the currency of any lease, provisions which required the machine tobe used to capacity if work was available and leases were for long terms.In deciding that by the use of the lease-only policy United Shoe had monopolizedthe market, the court observedIn one sense, the leasing system and miscellaneousactivities...were natural and normal for they were..."honestlyindustrial"...They are the sort of activities which would beengaged in by other honourable firms 313 .Yet the court concluded that, within the factual context, the lease-only contracts were"unnatural barriers". While such conduct was lawful for many enterprises it could not beused to effect "the continuance of effective market control based in part upon suchpractices"314. The court accepted that United Shoe did not have a predatory intent andthat the conduct would be lawful in other circumstances, but concluded that as it wassustaining dominance through creating barriers to entry it was unlawful.The emphasis upon structural analysis reflects the economic understanding of thetime. However, the decision fails to adequately address the possibility that the barrierswere the incidental outcome of competitive behaviour. The relevant passage from thejudgment is as followsThey [the lease-only practices] represent something more thanthe use of accessible resources, the process of invention andinnovation, and the employment of those techniques of313 Ibid. at 344.'Ibid. at 344ff.143employment, financing, production, and distribution, which acompetitive society must foster. They are contracts,arrangements, and policies which, instead of encouragingcompetition based upon pure merit, further the dominance ofa particular firm. In this sense, they are unnatural barriers; theunnecessarily exclude actual and potential competition; theyrestrict a free market315.The distinction is between practices which encourage and discourage competition - the laterconstituting the creation of unnatural barriers, or monopolization. However, as our analysishas shown, the very essence of the competitive process involves discouraging competitionby others. There is no altruistic character to the competitive process. The approach usedby the court makes it very difficult to understand why lease-only practices create unnaturalbarriers and the process of invention and innovation does not316. Leasing was a methodthat was preferred by customers, as was evident from its adoption by all competitors in themarket. Why is leasing not "an inevitable consequence of ability" - ability to supplymachinery on attractive terms?Our response is to ask, was the lease-only policy rent seeking. Was its purpose tosupply the needs of customers, or to prevent competitors from doing so? A leasing systemwhich included all necessary repairs would seem to be highly desirable for small shoemanufacturers. The risk of possible breakdown was retained by United Shoe. The focusof attention becomes not the lease-only policy per se, but the conditions attached to it.What does the practice reveal about the purpose of United Shoe? Why were leases for 103" Ibid. at 344.316 The distinction is all the more difficult to comprehend when one considers that the relief granted bythe court included the imposition of a number of obligations upon United Shoe to licence all those whowished to use machinery protected by patents held by United Shoe, for a reasonable fee. This relief wasgranted despite the observation that most patents had expired and that it was relatively easy to invent aroundthose that remained.144years? Were there substantial costs associated with moving the machinery which could bespread over 10 years if United Shoe knew that the machinery was to remain in one placefor that period - leading to lower costs for the shoe manufacturers (an innovative strategy),or was the only rationale for the 10 year term to make it less likely that the manufacturerwould lease a machine from a competitor (a rent seeking strategy)? Was the bundling ofmachine and repairs a case of United Shoe retaining the risk of breakdown (an innovativestrategy), or an attempt to impose additional costs on any entrant into the industry (a rentseeking strategy)? To ask, as the court did, whether the lease-only strategy "restricts a freemarket" is not specific enough. The more focused enquiries raised by our model law wouldenable the court to make more informed and more precise distinctions between competitionand unlawful rivalry.The Issue of Predatory PricingWe conclude our illustration of the application of our proposed law compared toexisting approaches to the regulation of dominant firms by considering an issue which hasled to much discussion in all jurisdictions, predatory pricing317. When is a low priceevidence of competitive behaviour and when does it constitute anticompetitive behaviour?Various measures have been proposed - the most famous being that developed by Areedaand Turner318. However, all such measures are based upon the rationality of pricingbelow some calculation of cost. The argument usually proceeds as follows. Pricing below317 E.g., McFetridge, supra, note 220; O.E. Williamson on Predatory Pricing II" (1978-79) 88 Yale L.J.1183; and Dunlop, McQueen & Trebilcock, supra, note 8 at 222ff.318 P. Areeda & D. Turner, "Predatory Pricing and Related Practices Under Section 2 of the Sherman Act"(1985) 88 Harv. L.R. 697.145certain costs is irrational for a firm subject to competitive constraint. Therefore, pricingbelow such costs is logical only for a dominant firm and when adopted by a dominant firmis likely to be predatory. The analysis is highly dependent upon the equilibrium associatedwith the model of perfect competition in which the process of competition is shown to pushfirms towards marginal cost pricing. However, our analysis has shown competition to bea dynamic process which includes the prospect of dominance. Consistent with such ananalysis we would emphasize that it may be rational to price below the cost that wouldapply if sales were at lower volumes 319 in order to achieve scale efficiency, or as analternative to advertising to attract custom, or as part of a service to customers that assistsin selling other products, or as an attempt to sell off redundant stock or generate short termcash flow32° .As a result it is impossible to evaluate quantitatively whether a particular low pricingstrategy is a desirable part of the competitive process or whether it is predatory. As hasbeen observed elsewhere "the issue of predatory intent keeps forcing its way to centrestage"321. However, existing attempts to accommodate the issue of intent or purpose inthe formulation of a rule to identify predatory pricing are framed in terms of efficiency 322.As we have observed previously, such approaches do no more than state the general issue -namely whether the pricing strategy will increase total welfare. No basis is given for319 Costs may also be projected to be lower due to anticipated learning improvements over time, and suchanticipated savings may be factored into current prices.32° See the analysis by the New Zealand High Court in Union Shipping, supra, note 30 at 707-8.321 Dunlop, McQueen & Trebilcock, supra, note 8 at 230.322 Bork, supra, note 3 at 144 ("Antitrust law has never dearly defined by what it means by predation, butthe concept dearly contains an element of wrongful or specific intent, of a deliberate seeking of market powerthrough means that would not be employed in the normal course of competition"); and Dunlop, McQueen& Trebilcock, supra, note 8 at 227.146determining whether a particular strategy is "efficient". Determinations of efficiency oftenrequire information that is extremely difficult or impossible to obtain, let alone prove in acourt or tribunal setting323. More importantly, efficiency is not a purpose that is pursuedby firms. It is an outcome. A court must identify the purpose of the low price and thendetermine whether that purpose is competitive or predatory. In contrast, our rule wouldexpress the purpose in terms which focus the enquiry. Is the low price an attempt to serve(or influence) customer needs and tastes? Or is the low price an attempt to prevent entryby other suppliers? In the first case the pricing practice is competitive, in the second it ispredatory. Of course, the cost tests would still be relevant to any determination under ourproposed law. What is important is that the court is given clear direction as to the purposethat is unlawful.Other Advantages of Rejecting Dominance as a Basis for RegulationRequiring the proof of dominance has introduced enormous prolixity and difficultyinto litigation concerning dominant firm market conduct 32A. To explore the evidentiaryissues raised by the concept would require many pages. Suffice to say that in alljurisdictions dominance is established by proving the "relevant market" and thendetermining the degree of market power which the defendant possesses in that market. Anenormous amount of evidence is usually introduced in order to establish the relevant323 Supra, note 286.324 E.g., M.Brunt, "Market Definition' Issues in Australian and New Zealand Trade Practices Litigation"(1990) 18 Aus. Bus. L.R. 86; and M. Brunt, "Use of Economic Evidence in Antitrust Litigation: Australia"(1986) 14 Aus. Bus. L.R. 261 [hereinafter Economic Evidence in Australia]; and Gault, T., Hon., "A JudicialPerspective on Competition Litigation" in Ahdar, R.J., ed., Competition Law and Policy in New Zealand(Sydney: Law Book, 1991) 96.147market. The concept of a relevant market is a theoretical abstraction rather than a factualreality. Rules of evidence designed to uncover an objective truth do not lend themselvesto restricting the material that is relevant to an abstract enquiry325. There are difficultiesin stating the role of expert economic evidence in making the determination whether aparticular firm is dominant326.Under our proposal, whilst such issues may still be relevant in a particular case, theywill no longer be determinative327. Courts will not be required to make precise findingsupon such issues in all cases. The focus will be the conduct and its purpose, rather thanthe structure of the market. Instead of usurping the court's role by seeking to drawconclusions about the relevant market or the degree of market power of the relevant firms,expert economic evidence would be directed at explaining market conduct that is consistentwith competitive strategies or rent seeking strategies thereby removing many tensionsinherent in the role of the expert economist under the existing laws. The rule which wepropose reflects the exposition of economic analysis rather than the enshrining of economictheory in a legislative provision. It develops a rule that is instructed by economic theory.The courts are used to determining the purpose which has motivated a particular action.Therefore, we contend that in addition to articulating with greater precision the sociallyundesirable market conduct associated with dominance, our proposed law will result insubstantial cost savings and greater predictability in the law.325 Bollard & White, supra, note 32 at 50; and Brunt, Economic Evidence in Australia, ibid.326 ibid.327 See above, c.5 - Strategic Motive and Advantage.148Chapter 7: Conclusion: Prometheus UnboundWe have argued that the existing regulation of dominant firms should be replacedby a law which proscribes rent seeking by all firms. Our reasoning has been as follows.First, a competitive market is desirable because it promotes total welfare. Second, theprospect of dominance is an inherent part of the dynamic of a competitive market. Itfollows that dominance should not be viewed in exclusively pejorative terms as it is themotive that drives welfare improving behaviour in the market place. Further, properlyunderstood, the process of competition, though it may result in dominance, in fact operatesto both build and break down dominant positions because the supra-normal profits earnedby dominant firms attract strong competition. Therefore, the process of competition worksagainst concentrations of wealth and economic power. Third, the prospect of dominancemotivates both competitive behaviour (innovation and imitation) and rent seeking. Fourth,in the context of the overall dynamic, it is only rent seeking that is welfare reducing. Fifth,dominant firms have strategic motive and power to engage in rent seeking. However, allfirms have the ability to engage in rent seeking and will do so where there is the likelihoodof achieving dominance at a cost that is less than the value of the supra-normal profitsattendant to a position of dominance to be secured through the rent seeking behaviour.Sixth, it follows that rent seeking by all firms should be proscribed. Seventh, rent seekingis to be distinguished from ordinary competition by the fact that its purpose is not to meetor influence consumer demand. Eighth, in addition to being more certain than the existingdominance laws (a characteristic has obvious welfare and fairness advantages), a lawproscribing rent seeking by all firms has the advantage of not requiring a conclusion as to149the "relevant market" in which it takes place, leading to much reduced cost in its applicationcompared to existing laws. 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Rev. 18.160AppendicesAppendix 1Countries Which have an Existing Dominance LawAustralia, Austria, Belgium, Canada, Denmark, the European Community, Finland, France,Germany, Greece, Japan, Luxembourg, Netherlands, New Zealand, Norway, Spain, Sweden,Switzerland, United Kingdom and Unites Statesl .1 See the following loose leaf services, J.J. Marke & N. Samie, eds., Anti-trust and Restrictive BusinessPractices: Internationa4 Regional & National Regulation (New York: Oceana Publications Inc) and Guide toLegislation on Restrictive Business Practices (Paris: Organization for Economic Co-operation andDevelopment).161Appendix 2Dominance Laws of Australia, Canada, European Community,New Zealand and the United StatesAustralia - s.46 of the Trade Practices Act(1) A corporation that has a substantial degree of power in a market shallnot take advantage of that power for the purpose of -(a) eliminating or substantially damaging a competitor of thecorporation or of a body corporate that is related to thecorporation in that or any other market;(b) preventing the entry of a person into that or any other market;or(c)^deterring or preventing a person from engaging in competitiveconduct in that or any other market.(2)^If -(a) a body corporate that is related to a corporation has, or 2 ormore bodies corporate each of which is related to the onecorporation together have, a substantial degree of power in amarket; or(b) a corporation and a body corporate that is, or a corporationand 2 or more bodies corporate each of which is, related to thecorporation, together have a substantial degree of power in amarket,the corporation shall be taken for the purposes of this section to havea substantial degree of power in that market.(3)^In determining for the purposes of this section the degree of powerthat a body corporate or bodies corporate has or have in a market,the Court shall have regard to the extent to which the conduct of thebody corporate or of any of those bodies corporate in that market isconstrained by the conduct of -(a)^competitors, or potential competitors, of the body corporate orof any of those bodies corporate in that market; or162(b) persons to whom or from whom the body corporate or any ofthose bodies corporate supplies or acquires goods or servicesin that market.(4)^In this section -(a) a reference to power is a reference to market power;(b) a reference to a market is a reference to a market for goods orservices; and(c)^a reference to power in relation to, or to conduct in, a marketis a reference to power, or conduct, in that market either as asupplier or as an acquirer of goods or services in that market.(5)^Without extending by implication the meaning of sub-section (1), acorporation shall not be taken to contravene that sub-section byreason only that it acquires plant or equipment.(6) This section does not prevent a corporation from engaging in conductthat does not constitute a contravention of any of the followingsections, namely, sections 45, 45B, 47 and 50, by reason that anauthorization is in force by reason of the operation of section 93.(7) Without in any way limiting the purpose of a person may beestablished for the purposes of the Act, a corporation may be takento have taken advantage of its power for a purpose referred to in sub-section (1) notwithstanding that after all the evidence has beenconsidered the existence of that purpose is ascertainable only byinference from the conduct of the corporation or of any other personor from other relevant circumstances.Canada - ss. 78 & 79 of the Competition Act78.^For the purposes of section 79, "anti-competitive act", withoutrestricting the generality of the term, includes any of the followingacts:(a) squeezing, by a vertically integrated supplier, of the marginavailable to an unintegrated customer who competes with thesupplier, for the purpose of impeding or preventing thecustomer's entry into, or expansion in, a market;(b) acquisition by a supplier of a customer who would otherwise be163available to a competitor of the supplier, or acquisition by acustomer of a supplier who would otherwise be available to acompetitor of the customer, for the purpose of impeding orpreventing the competitor's entry into, or eliminating thecompetitor from, a market;(c) freight equalization on the plant of a competitor for thepurpose of impeding or preventing the competitor's entry into,or eliminating the competitor from, a market;(d) use of fighting brands introduced selectively on a temporarybasis to discipline or eliminate a competitor;(e) pre-emption of scarce resources or resources required by acompetitor for the operation of a business, with the object ofwithholding the facilities or resources from a market;(f) buying up of products to prevent the erosion of existing pricelevels;(g) adoption of product specifications that are incompatible withproducts produced by any other person and are designed toprevent his entry into, or to eliminate him from, a market;(h) requiring or inducing a supplier to sell only or primarily tocertain customers, or to refrain from selling to a competitor,with the object of preventing a competitor's entry into, orexpansion in, a market; and(i)^selling articles at a price lower than the acquisition cost for thepurpose of disciplining or eliminating a competitor.79(1) Where, on application by the Director, the Tribunal finds that(a) one or more persons substantially or completely control,throughout Canada or any area thereof, a class or species ofbusiness,(b) That person or those persons have engaged in or are engagingin a practice of anti-competitive acts, and(c)^the practice has had, is having or is likely to have the effect ofpreventing or lessening competition substantially in a market,the Tribunal may make an order prohibiting all or any of thosepersons from engaging in that practice.164(2)^Where, on application under subsection (1), the Tribunal finds that apractice of anti-competitive acts has had or is having the effect ofpreventing or lessening competition substantially in a market and thatan order under subsection (1) is not likely to restore competition inthat market, the Tribunal may, in addition to or in lieu of making anorder under subsection (1), make an order directing any or all thepersons against whom an order is sought to take such actions,including the divestiture of assets or shares, as are reasonable and arenecessary to overcome the effects of the practice in that market.European Community - art.86 of the E.E.C. TreatyAny abuse by one or more undertakings of a dominant position within thecommon market or in a substantial part of it shall be prohibited asincompatible with the common market in so far as it may affect tradebetween Member States. Such abuse may, in particular, consist in:(a) directly or indirectly imposing unfair purchase or selling prices orother unfair trading conditions;(b) limiting production, markets or technical development to the prejudiceof consumers;(c) applying dissimilar conditions to equivalent transactions with othertrading parties, thereby placing them at a competitive disadvantage;(d) making the conclusion of contracts subject to acceptance by the otherparties of supplementary obligations which, by their nature oraccording to commercial usage, have no connection with the subjectof such contracts.New Zealand - s.36 of the Commerce Act(1) No person who has a dominant position in a market shall use thatposition for the purpose of -(a) restricting the entry of any person into that or any othermarket; or(b) preventing or deterring any person from engaging incompetitive conduct in that or any other market; or165(c)^eliminating any person from that or any other market.(2) For the purposes of this section, a person does not use a dominantposition in a market for any of the purposes specified in paragraphs(a) to (c) of subsection (1) of this section be reason only that theperson seeks to enforce any statutory intellectual property right withinthe meaning of section 45(2) of this Act in New Zealand.(3) Nothing in this section applies to any practice or conduct to which thisPart of this Act applies which has been authorised pursuant to Part Vof this Act.United States - Si of the Sherman ActEvery person who shall monopolize, or attempt to monopolize, or combineor conspire with any other person or persons, to monopolize any part of thetrade or commerce among the several States, or with foreign nations, shall bedeemed guilty of a felony; and, on conviction thereof, shall be punished byfine not exceeding one million dollars if a corporation, or, if any other person,one hundred thousand dollars or by imprisonment not exceeding three years,or by both said punishments, in the discretion of the court.166Appendix 3Proposed Model Law for the Regulation ofSocially Undesirable Market Conduct Associated with Dominance(a) A person shall not engage in exclusionary conduct.(b) In this section, exclusionary conduct means market conduct, other than competitiveconduct, which prevents, or is likely to prevent, directly or indirectly, any personfrom engaging in market conduct necessary in order to(i) supply a product or products demanded by a customer or customers;or(ii) influence the demand of a customer or customers for a product orproducts.(c) In this section, competitive conduct means conduct which has the substantial purposeof enabling the person engaged in the conduct to(i)^supply a product or products demanded by a customer or customers;orinfluence the demand of a customer or customers for a product orproducts.(d) In this section, prevent includes substantially restrict or hinder.(e) It shall be a defence to any proceedings under this section if the person is shown tohave acted for a purpose other than a commercial purpose.(f) For the purpose of this section, a person shall be deemed to have acted for acommercial purpose if the person has acted for the purpose of increasing theprofitability, or reducing the losses, of the business.(g) Without in any way limiting the manner in which the purpose of a person may beestablished, a person may be taken to have acted for a purpose referred to in thissection notwithstanding that after all the evidence has been considered the existenceof that purpose is ascertainable only by inference from the conduct of that personor any other person or from other relevant circumstances.167(h) For the purposes of this section, a person shall be deemed to act or have acted fora particular purpose if(i) the person acts or acted for purposes that included or include thatpurpose; and(ii) that purpose is, or was, a substantial purpose.168

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