Explainer: what is the competition ‘effects test’?

The Harper competition policy review recommendations include changing the way misuse of market power can be prosecuted. Image sourced from www.shutterstock.com, CC BY

Extensive lobbying by the Australian Competition and Consumer Commission (ACCC) and some interest groups appears to have brought an “effects test” one step closer, following the recommendations of Ian Harper’s Competition Policy Review panel.

But what is an effects test, and what would it mean?

All the fuss relates to section 46 of the Competition and Consumer Act: the provision of our competition laws which regulates unilateral conduct. There are numerous laws affecting arrangements between two or more parties, but only section 46 - which prohibits the misuse of market power - focuses on big business acting alone.

How does section 46 work now?

Section 46 has had several formulations. But for most of the last three decades, it has had the same basic structure. One must prove that the relevant party had substantial market power, that it took advantage of that power, and that it did so for a “proscribed purpose” (generally described as an anti-competitive purpose).

Section 46 as currently drafted is notoriously difficult to establish. The threshold of substantial market power is very high (more than half of the cases fail on this point alone). It is also extremely difficult to prove “taking advantage” - while the courts have said this means no more than to “use” market power, this element accounts for most of the other court failures.

Oddly, proving a company’s purpose does not seem to be a sticking point before the courts, although the ACCC tells us that there are many cases it would have pursued but for this issue.

What do we mean by an effects test?

The effects test as proposed by Professor Harper retains the first element of the current section 46 - substantial market power - but removes the other two.

In their place, an effects test has been inserted.

An effects test is a shorthand way of referring to whether conduct has the purpose or likely effect of substantially lessening of competition. This test appears in a number of other provisions of the Competition and Consumer Act, and is perhaps best known in the context of mergers.

Back in 2013, Small Business Minister, Bruce Billson, went on the record as a fan of the effects test, saying that it would make it easier for the ACCC to win section 46 cases.

We are just trying to make sure that the toolkit available to the Australian Competition and Consumer Commission is fit for purpose. In my mind, the toolkit needs to be revisited to deal with the modern and emerging economy. There are some deficiencies.

Why is an effects test controversial?

Why then does the effects test strike fear in so many? The big end of town thinks it will prohibit good (“pro-competitive”) conduct. At the same time, others worry that it makes a difficult test even harder.

Confusingly, both points are valid.

Could it catch too much? A: yes!

By looking at effect, not purpose, attention is only focused on the outcome of conduct, not its rationale. But as the High Court said back in its first consideration of section 46:

Competition by its very nature is deliberate and ruthless. Competitors jockey for sales, the more effective competitors injuring the less effective by taking sales away. Competitors almost always try to “injure” each other in this way… and these injuries are the inevitable consequence of the competition s46 is designed to foster.

The trouble is that “injuring” your competitors can result in a lessening of competition. So observing such injuries tells you nothing about whether they have occurred due to competition that ultimately benefits consumers or because of a misuse of market power that will harm consumers.

Traditionally, we have relied on the taking advantage element to resolve this dilemma: we have been comfortable with the cut and thrust of competition, so long as the company concerned isn’t taking advantage of its special position in the market. If it is only doing what everyone else is capable of doing, that’s fine.

But the Harper Panel says that taking advantage currently fails to do the job of distinguishing good from bad, as its interpretation by the courts is too unpredictable. It’s not clear, however, how an effects test will do any better. In its draft report, the Harper Panel proposed a defence to discern whether conduct was pro- or anti-competitive. But that defence was widely criticised and has been dropped from the final recommendation.

In its place, the panel has suggested that legislative guidance be provided to the courts in applying the new provision. It further recommends that companies be able to seek authorisation (never before allowed for section 46 conduct): this would allow parties to obtain statutory immunity in advance of engaging in conduct if it can prove that there is a sufficient benefit to the public. Finally, it calls for the ACCC to issue guidelines.

Could an effects test catch too little? A: yes!

Completely contrary to the position of big business, some are concerned that an effects test makes proving a contravention of section 46 even harder. Why? Well, there are numerous prohibitions in the legislation which already use the effects formulation, and such cases don’t get to court with any more frequency than do section 46 cases.

Furthermore, the ACCC’s long-term success rate in effects cases is not materially different to its success under section 46. Proving anything substantially lessens competition is extremely difficult.

It is also notable that we’ve had an effects test for misuse of market power for almost two decades with no result. In the telecommunications sector, there is a special effects test applied in addition to the standard section 46. This forms part of a suite of laws that were brought in to keep Telstra in line as the market was deregulated (these laws have also been slated for review). But, despite regular concerns with Telstra’s conduct over the years, the ACCC has never prosecuted an effects case under these provisions.

Will an effects test mean more cases?

The real proof will be in the pudding: if an effects test is introduced, will it mean more cases? Whatever the merits of the current test, it is clear that we have too few matters going to Court.

Competition cases are extremely complicated and expensive. Legal costs would start in the vicinity of $2-4 million with the risk of much more if the matter is appealed (as is often the case) or you lose (in which case, you need to pay a significant proportion of your opponent’s costs).

The ACCC’s budget is constrained and private litigants have been missing in action over recent years, so don’t hold your breath for more cases.

All that said, this is just a recommendation. Australian competition policy is a poster child for the saying, “many a slip twixt cup and lip”.