IT is not infrequent for an undertaking to offer not only end-user products to consumers at the retail level but also access to an essential input for its downstream competitors at the wholesale level. This raises the possibility of market foreclosure by manipulation of the margin between wholesale and retail prices. In C-280/08 P Deutsche Telekom v. European Commission (judgment of 14 October 2010, not yet reported), the Court of Justice of the EU has confirmed that a dominant undertaking might have abused its market position by such a margin squeeze, in breach of Article 102 TFEU. The case shows that an abusive margin squeeze may occur even where the undertaking is subject to sector-specific economic regulation at the wholesale or retail levels. While this important decision clarifies a number of technical points regarding this abuse, the extension of its application to regulated sectors raises worrying questions in terms of legal certainty for regulated firms. More generally, the judgment contains a strong policy statement supporting the concurrent application of EU competition law in areas already subject to sector-specific EU regulation, with implications potentially extending far beyond the margin squeeze context.

Deutsche Telekom (“DT”) is the former monopoly telecommunications operator in Germany. Since 1997 it has been required, under national legislation implementing EU telecommunications Directives, to provide competitors with access to its fixed infrastructure at the local loop level, thus creating competition in the retail internet services market. A Commission Decision (Deutsche Telekom AG, O.J. [2003] L 263/9) had found that the spread between the prices charged by DT for wholesale local loop access and its retail prices for end-user internet services was anti-competitive as it would exclude as-efficient competitors from the downstream market. As DT had sufficient scope – in essence by increasing its retail prices – to avoid squeezing competitors, its failure to do so violated Article 82 EC (now Article 102 TFEU). DT's appeal was dismissed in its entirety by the (then) Court of First Instance in T-271/03 Deutsche Telekom v. Commission [2008] E.C.R. II-477, an approach now confirmed by the Court of Justice on further appeal.

The essence of margin squeeze, as accepted by the Court of Justice, is the unfairness of the spread between wholesale and retail prices charged by the dominant firm. In effect, the profits of the downstream competitor, relying upon access to a key input provided by the dominant firm at the wholesale level, are “squeezed” to such an extent as to exclude the competitor from the market. The emphasis is upon the spread of prices rather than precise values; evidence of excessive pricing at the wholesale level or predation at the retail level is not required.

It might be argued that the focus on pricing spread is unobjectionable in theory. Nonetheless, when applied to regulated sectors, significant difficulties arise, particularly where one or both prices are set or approved by the regulatory authority. In Deutsche Telekom, the Commission had proceeded on the assumption that DT's wholesale prices were set by the German regulator, whereas its retail prices, whilst subject to approval by the regulator, were ultimately set by DT itself. While the Commission focused on the spread between prices, it assumed that DT could alter only one parameter, that is, by increasing its retail prices. Yet, DT was not accused of predatory pricing. Price increases in predation cases are justified on the utilitarian basis that higher returns encourage entry, bringing the benefits of competition—but in any event, the dominant firm has priced below cost. This was not the case in Deutsche Telekom. As DT argued, a dominant firm must be wary of increasing its prices to a level too high above its costs, as excessive pricing is also prohibited by Article 102 TFEU.

In reality, the difficulty lay at the wholesale level, where the access prices set by the regulator were simply too high. The rational solution would have been to fix the broken regulation and reduce wholesale prices to the competitive level. Unfortunately, the Commission chose to pursue an abuse of dominance case against DT rather than bringing infringement proceedings against Germany under Article 258 TFEU, while DT failed to raise the excessive nature of the wholesale prices at first instance and so the issue was not considered under competition law on appeal. Ultimately, this case involved the sub-optimal use of competition law to correct a problem caused by inadequate regulation, in circumstances where the regulation itself was essentially immune from review. The problem is all the greater because margin squeeze is most likely to occur in markets with mandatory access requirements.

The case thus raised the additional question of the place of ex post competition law enforcement in markets already subject to ex ante sector-specific regulation. With Trinko (540 U.S. 398), Credit Suisse (551 U.S. 264) and the recent margin squeeze case of LinkLine (judgment of 25 February 2009), the US Supreme Court has taken the view that ex ante regulation removes a sector from the purview of antitrust. Accordingly, the entirety of the offending conduct must occur in unregulated sectors for a violation to be established. The Court of Justice in Deutsche Telekom adopted a wholly different tack. It held that

According to the Court, the presence of ex ante regulation does not, therefore, exclude ex post competition law review. To the extent that sector-specific regulation allows an undertaking any scope for autonomous market conduct, that behaviour can be reviewed under the competition rules – even where that behaviour was encouraged or facilitated by the regulation (at [80]–[85]). The Court nonetheless approved the Commission practice of granting reductions in fines to take account of the impact of the regulatory environment (at [279]), even though such an approach fails to account for follow-on actions or recidivism as an aggravating factor in future offences.

The impact of this approach in terms of legal certainty for firms that have acted in compliance with the regulatory requirements was not considered by Court of Justice. The fundamental issue of fairness for dominant firms faced with overlapping and not wholly compatible requirements under distinct legal regimes thus remains unexamined and unresolved. To an extent, the judgment also highlights the inadequacy of the existing definition of dominance in EU law with respect to regulated markets. Not only is it difficult to maintain that an undertaking has the ability to act independently where it is subject to detailed pricing and access requirements, but arguably the regulatory regime exists precisely because effective competition, without regulation, is impossible in such circumstances.

In margin squeeze, the Commission has at its disposal a powerful tool to address the pricing practices of dominant firms. It is to be hoped, however, that both the Commission and the Court will give greater consideration in the future to the policy implications of margin squeeze as an abuse, as well as to the concurrent application of competition law and sector-specific regulation.