Competition Act: the dot.com impact

How the Competition Act 1998 regime will impact on the dot.com sector in the wake of the Microsoft investigations

1st August 2000 | Richard Cockburn

The Act’s impact – a sectoral study

Having considered the basic provisions of the new UK Competition Act in the February issue, it is useful to look at the effect which the Act will have in a particular business sector. Given the explosion in the size of the e-commerce market, this article briefly examines the relevance of the Act to dot.com businesses. In an article of this length it is not possible to cover every effect which the Act will have on this sector. Instead, consideration is given to two specific areas:

on-line trading practices; and
telecommunications – the underlying infrastructure

Confidentiality clauses, exclusivity clauses and non-compete clauses which appear in dot.com companies’ contracts, though not examined in this article, will need to be drafted to comply with the new Act.

The on-line sector

In 1999, revenue from Internet sales in Europe is expected to have been $288 billion, increasing to $2 trillion by 2002, and UK consumers spent $60 million on-line (KPMG and Datamonitor studies cited in OFTEL’s “Competition in e-commerce: a joint OFTEL and OFT study” (www.oftel.gov.uk/publicat-.htm#Informationsuperhighway) published in April 2000). More and more players are entering the market keen to be part of the so-called third industrial revolution – BskyB recently announced a £250m strategy to roll out over the Internet, following hard on the heels of an announcement by Reuters to spend £500m going on-line.

What place does competition have in this burgeoning sector?

The Internet is a global phenomenon – “internet” stands for international computer network, after all. There is an almost infinite number of p layers on the market and one might have thought that in the face of attempted anti-competitive actions by other companies in the market, there would be a wide choice of alternative trading partners.

Microsoft investigations

It is informative (and particularly topical given the recent judgment in the US Microsoft case) firstly, to consider the instances where Microsoft has been investigated by the EC competition authorities. The new UK prohibitions reflect pre-existing EC competition law and therefore the Microsoft cases are a good indication of the types of trading practices which might be caught by the new Act.

In 1993, in conjunction with the US Justice Department, the European Commission investigated Microsoft’s licensing to PC manufacturers of its MS-DOS and Windows products. The European Commission investigation was initiated by a Novell complaint and was based on Article 81 EC (formerly Article 85 EC). The investigated focused on certain restrictive elements of the MS-DOS and Windows licences (IP/94/653 of 17/7/1994). In particular, Microsoft’s standard licences allegedly prevented competitors from making sales of their products to PC manufacturers. Also, royalties were payable to Microsoft according to the volume of PC’s shipped even if not all of these PC’s were programmed with Microsoft software. Soft software licences containing restrictive conditions may be tackled under competition law and may therefore come under the focus of the new UK Act.

Four years later in 1997, a Californian competitor of Microsoft, Santa Cruz Operation, complained about restrictive elements in its contract with Microsoft, SCO claimed also that Microsoft was abusing a dominant market position. SCO claimed that it was obliged, in producing new versions of particular software (UNIX), to ensure that they were compatible with the first version produced by Microsoft in 1987. SCO also had to pay a royalty for each version of UNIX which it produced., regardless of whether Microsoft intellectual property was used. The matter concluded though when Microsoft agreed to waive its rights under the contractual clauses which were being challenged (RNS 25/11/1997). Everyday business contracts may therefore be subject to competition scrutiny particularly where one of the parties to the contract holds a dominant market position.

Also in 1997, the European Commission was asked to consider Microsoft’s licensing agreements with Internet Service Providers (“ISPs”). The European Commission found the agreements to be compatible with the common market and granted a comfort letter stating that there was no longer any infringement of EC competition rules. The comfort letter, which was issued in May 1999, was only granted to Microsoft, though, following two principal contract amendments by Microsoft. An ISP’s failure to achieve minimum distribution levels of Microsoft’s Internet Explorer browser technology would no longer result in termination of ISP’s agreement. Secondly, ISPs would henceforth be allowed to promote and advertise competing browser software (see IP/00/141 of 10/2/2000). Had these provisions not been changed, clearance would not have been granted by the European Commission.

The European Commission is currently investigating a complaint by a French software wholesaler, Micro Leader, that Microsoft applies different prices to equivalent transactions with trading partners (IP/00/141 of 10/2/2000). Initially, the European Commission had decided to reject Micro Leader’s complaint on the grounds of insufficient evidence, but Micro Leader made a successful appeal to the European Court of First Instance. The European Commission is therefore exploring whether Microsoft had abused a dominant market position by using its intellectual property rights as an excuse to charge higher prices in France than in Canada for operating systems and application programs. So pricing policies and the imposition of discriminatory terms and conditions can also be subject to a competition investigation where a dominant market position is held.

Most recently, the European Commission announced that it is investigating under the Article 82 EC prohibition (on the abuse of a dominant market position) complaints in respect of Microsoft’s new product, Windows 2000 (IP/00/141 of 10/2/2000). On 3 August, the European Commission announced that it had sent a statement of its objections to Microsoft. It has been alleged that Microsoft is ‘bundling’ its PC operating system with its own server software and other Microsoft middleware products. The end result is that (1) in order to obtain full use of Windows 2000 for PCs, customers also need to purchase Windows 2000 for servers, (2) Microsoft competitors therefore face a new barrier to entry into the servers market, and (3) Microsoft, by this use of Windows 2000, is extending its strong market position in PC operating systems into the market for server operating systems.

Finally, in parallel with these investigations, Microsoft has, of course, been subject to scrutiny from the US competition authorities (Civil Actions NO. 98/1232 (TPJ) & No. 98-1233 (TPJ)). The findings of fact were issued on 5 November last year and the conclusions of law were issued on 3 April.

The main issues included accusations that Microsoft had breached Section 1 of the Sherman Act. This bans unreasonable restraints of trade. Judge Jackson concluded that this section had been breached by Microsoft through its requirement on customers who wanted to take Microsoft’s operating system, Windows, also to have Internet Explorer, Microsoft’s Internet browser. This was found to be an unlawful “tying” arrangement.

Judge Jackson also found that Microsoft had breached Section 2 of the Sherman Act. This section outlaws monopolisation and attempts or conspiracies to monopolise. He held that Microsoft had attempted to monopolise the market for Intel-compatible PC operating systems through the use of a number of practices including tying and exclusive arrangements such as those with ISPs obliging them to promote only Internet Explorer and no other Internet browser. He also concluded that Section 2 had been breached by a number of practices aimed at driving competing browsers, such as Netscape’s Navigator product, out of the market. One means of undermining Netscape Navigator had been the creation of a Windows-specific version of Java (a programming language for computer operating systems) to be compatible only with Windows and Windows applications.

Again, this reveals that a range of trading practices in the on-line world can fall within the ambit of competition law.

Microsoft is repeatedly investigated under competition law – so what?

Microsoft, it is argued, is in a unique position. It has been in this industry almost from the start and, it is alleged, has obtained an almost uniquely dominant position due to its grip on the operating systems sector through its product, Windows. No other company is likely to find itself in this position these days. And in any event, it is said, companies trading on-line are unlikely to be engaging in or subject to these types of practices.

But look again at the Microsoft activities investigated by the European Commission:

Restrictive conditions in software licences. Every dot.com company will have software licences. Much of the software will be crucial for the successful operation of the company’s business on the web. How often has the licensor had the stronger hand in negotiating those licences? How many licences has the dot.com agreed to which are standard form and have not been negotiated? Are there restrictive provisions in those licences?
Restrictions on advertising. Increasingly, advertising is what makes the dot.com world tick – with more and more ISPs offering free Internet access for instance, advertising is the main generator of money. Typically, web-sites will feature a number of advertisements. The customer will click on an advertisement if it proves sufficiently interesting. By use of a hyper text link, clicking on that advertisement will automatically transfer the customer to the advertiser’s own web-site. The contracts between the operator of the initial web-site and the advertiser are frequently complex. The advertiser may be obliged to pay the initial web-site operator an up-front charge (possibly an annual charge) together with a pro rata fee linked to the number of ‘hits’ which the advertiser receives from that advertisement. The advertiser itself will wish to ensure that the web-site where it is advertising contains no other advertisements promoting competing products. There will therefore frequently be a provision in the contract that the site where the advertisement is to appear will not contain competing adverts. Generally, this is tied into a period of exclusivity. Alternatively, it will be provided that competing adverts can appear on the site but only if they are smaller and less prominent. Perhaps, for instance, there will be a ban on other competing advertisements appearing on that web page in a ‘banner’ format or ‘above the fold’ (visible on screen without having to scroll up or down).

Care will need to be taken in drafting such agreements that there are no excessively restrictive conditions which have an appreciably anti-competitive effect on the market.

Discriminatory pricing. Does the software licensor grant the licence to the dot.com company on the same terms as to other dot.coms? Are the price or the royalties markedly different from the rates payable by other dot.coms? Why is that? Might there be a remedy under competition law if a dot.com believes it is being overcharged?
Bundling. A dot.com company requests that the supply of a software licence to accelerate the ordering process on its web-site. The licensor will only meet that request if the dot.com also takes a license of a different software package for the design web-site. The dot.com already has an operational site; it does not need the latter software package. Look to competition law – again, there might be a remedy available which will oblige the licensor not to ‘bundle’ its products in this way.

In actual fact then, the Microsoft cases are very relevant. And it is not just huge companies the size of Microsoft which can be dominant – remember the rule of thumb that there may be a presumption of dominance where a 40%+ share is held of a market, and the market itself may be very small.

For example, it was recently reported (Daily Telegraph, 25 February 2000) that Kickon, an Internet start-up, had complained to OFT that the equestrian magazine Horse & Hounds was allegedly abusing a dominant position in the market for equestrian publications. Horse & Hounds had been refusing to carry Kickon’s launch advertising. So if it can be argues that Hose & Hounds is dominant, with a circulation of little more than 68,500, clearly it is not just the corporate giants of this world which are open to attack.

The relevance of the UK Act

The Microsoft cases described above, therefore, serve as good examples of how competition law in general can apply in the on-line sector. But as regards, specifically, the UK’s Competition Act 1998, what impact might this have on the UK on-line sector now that it has come into force?

The UK Act prohibits restrictive practices or agreements and the abuse of a dominant market position in the UK or, importantly, in a part of the UK (sections 2 and 18).

Whereas the Microsoft investigations have been considered at the EC level because of their effect on EC trade, the focus of the UK Act will be on activities which affect trade in the UK or a part of the UK.

Therefore, trading practices which have an anti-competitive object or effect and which affect to a significant degree on-line trade in the UK may become the focus of the new Act. What types of practices might be caught?

In the first article on the Competition Act in February’s edition of The Journal, a number of practices were set out as examples of what may be prohibited under the Act and certain practices are mentioned above in the discussion of the Microsoft enquiries.

Where a company has a particularly dominant position in a market, then the following practices, which have particular relevance in the on-line sector, may be regarded as being abusive (and therefore a breach of the Act’s Chapter II prohibition on the abuse of a dominant market position):

Bundling where for instance, two software products are sold together and customers are not free to buy one product without buying the other. Hardware and software may also be bundled together for example;
Refusal to supply: where the dominant market players is, for example, a chip manufacturer or other component manufacturer and it refuses to supply to a PC assembler, such a refusal to supply might constitute an abuse;
Discriminatory trading: where a dominant player treats customers discriminatorily – i.e. by applying similar sales conditions/prices to dissimilar transactions or dissimilar trading conditions/prices to similar transactions, again the UK authorities might find this to be abusive.

Under the Act’s Chapter I prohibition on anti-competitive agreements or practices, what types of activities might be caught?

Price fixing cartels: this is an obvious example. Wall Street Journal Interactive (18/2/2000) recently reported that the American Society of Travel Agents had complained to the US competition authorities about 27 US and foreign air carriers who were to participate in an industry-wide-web-site selling flights to customers. ASTA alleged that the airlines were trying to fix lower prices so as to drive competitors out of the market – a good example, perhaps, of how e-exchanges (which are becoming increasingly common) can potentially fall foul of competition law.
Exclusivity: where a supply contract for components is exclusive and is for an excessive period of time, then this may be attacked under Chapter I. The competition authorities authorities recognise that exclusivity is desirable, and even necessary, in an actively competitive market. However, there are limitations to the permitted duration of such exclusivity. In the case of industrial supply contracts, there is no one permitted duration of any exclusivity – the acceptability to the competition authorities of an exclusive period will depend on the circumstances of the case – but care would need to be taken when drafting this type of contract.

Infrastructure issues

The relevance of the Act will not, however, be restricted to on-line trading. It will also apply in a number of other respects, one of which is the infrastructure upon which e-commerce depends. That is to say, the application of the Act to telecommunications is vitally important for on-line trading.

Major operators already have in their public telecommunications operator licences a Fair Trading Condition (“FTC”) which, similar to the new Act, reflects anti-competitive agreements and practices and the abuse of a dominant market position. Whilst the FTC will be superseded by the introduction of the Competition Act, it is sufficient to note that the major telecoms operators are already largely aware of the implications which the Act will have for them.

It is not intended to give a review of the application of the new Act in the telecoms area in this article. It is enough o point out, for the moment, that a number of particular activities will be focused on by OFTEL in conjunction with the DGFT. OFTEL’s January 2000 guidelines . “The Application of the Competition Act in the Telecommunications Sector” (www.oftel.gov.uk/pulicat.htm#Competition) refer in Chapter 7 to a number of activities which the authorities will particularly look to tackle. These include the following:

Predatory pricing – deliberately making short term losses to eliminate one or a number of competitors such that, in the long term, excessive prices can be charged to consumers;

Cross subsidisation – using profits from one market to subsidise losses in another market thereby, for instance, undercutting competitors in the loss-making market;

Price squeezing – where a business offers a service or product in a related downstream market but provides that service or product to competing companies on more unfavourable terms than those offered to an affiliated company in that same downstream market.

Refusal to grant access to facilities – this last example is particularly important for the use of the Internet.

Internet access

To date, it has been widely recognised that the level of Internet usage in the US is well above that of the UK due to the ability in the US to have unmetered Internet access. Until recently, this was not available in the UK. Regulatory pressure however has been brought to bear on BT such that it has announced proposals for a series of revamped Internet pricing packages (particularly its “Surftime” product) which will permit cheaper Internet access. Telewest and NTL are now using such packages to offer unmetered Internet access in their franchise areas. This issue has highlighted the preferential position still held by BT based on its ownership of important parts of the existing telecoms infrastructure. BT’s local loop (i.e. the final link in the telecoms infrastructure between the local exchange and the customer’s premises) has frequently been pinpointed as an obstacle to true competition from offering, for instance, the unmetered Internet access which has taken so long to arrive in the UK. The Chancellor of the Exchequer, Gordon Brown, announced in a key note speech in February that BT’s unbundling (i.e. making available) of the local loop will be brought forward to July 2001 and across the EC, Member States will be required, by 31 December 2000, to enact legislation to unbundled local loops nationally. It is liberalisation measures such as this which OFTEL will seek to use the Competion Act to force through in the UK.

Therefore, the new Act will continue the impact already being experienced in the telecoms sector by virtue of the FTCs and the EC directives aimed at liberalising the telecoms sector.

That is not to say that the major telecomes operators never face allegations of anti-competitive activity though. OFTEL’s monthly Competition Bulletin is usually packed with details of complaints made against various operators, particularly BT.

Competition issues, then, have a very high profile in the telecoms sector. When it comes to opening up the underlying infrastructure, so as ultimately to reduce the costs to on-line business, both the regulator and the regulated can be expected to make much use of the new Act.

Conclusion

The article has considered, though only very briefly, the impact which the new UK Act might have on one sector – the on-line sector. Given the US Justice Department’s desire to break up Microsoft, there should be no doubt that an infringement of competition law can have serious consequences. Where a company is found to have infringed the UK Act, heavy fines of up to 10% of annual UK group turnover for reach of a maximum of 3 years of infringement can be imposed. Also, directors and employees who obstruct the OFT’s investigations can face unlimited personal fines or imprisonment of up to 2 years.

Businesses in all sectors of the economy are adopting competition law compliance programmes in order not to fall foul of this new Act. This article has shown that even activities in the on-line sector can be caught by the Act and dot.coms would, themselves, be advised to consider implementing a compliance programme.

Executive summary

This article follows upon the discussion of the new Competition Act 1998 (www.oft.gov.uk/html/comp-act) in February’s edition of The Journal (“The Competition Act 1998 – The New Regime” JLSS, February 2000, page 16). The new UK Act will:

outlaw specific anti-competitive practices to which on-line players might be subject or which they might engage in;
facilitate Microsoft-type anti-trust actions at the UK level;
impact upon the infrastructure which on-line businesses rely on;
have implications for contractual terms in the on-line sector.

All businesses, no matter their size, should consider implementing a competition compliance programme.

New prohibitions

The new Act, which came into force on 1 March 2000, introduces (subject to certain transitional arrangements) two new prohibitions reflecting equivalent prohibitions at the EC level. There is now in the UK a ban on anti-competitive agreements and practices. Secondly, there is a ban on the abuse of a dominant market position in the UK.

Heavy Sanctions

Heavy sanctions (including, principally, fines of as much as 10% of annual group UK turnover for each year of infringement up to a maximum of 3 years) can be imposed on companies breaching the prohibitions. Directors and employees who obstruct Competition Act investigations can also be subject to unlimited fines or up to two years’ imprisonment.

Enforcemetn/Investigation

The OFT (www.oft.gov.uk) now has much stronger enforcement and investigatory powers than under the old competition law regime. The Office’s investigatory powers range from the power to request selected information through to forced entry and search of premises.

Concurrency

Other regulators, such as OFTEL, ORR and OFGEM can exercise most of the powers granted to the Director General of Fair Trading (“DGFT”) under the new Act, as an alternative to their existing sectoral powers.