FINKELSTEIN J:
235 The Australian Competition and Consumer Commission charges Boral Besser Masonry Ltd ("BBM") with having a substantial degree of power in the wholesale market for the supply of concrete masonry products, and with misusing that power by pursuing a predatory pricing scheme to eliminate or substantially damage competitors in that market, especially Rocla Pavers and Masonry, a division of Amatek Ltd ("Rocla") and Budget Bricks & Pavers Pty Ltd ("Budget"), and to prevent the entry of C & M Bricks Melb Pty Ltd and Eramosa Pty Ltd (collectively "C & M") into the market.
236 It is generally accepted that a competitive market produces two desirable results: production efficiency and the efficient allocation of resources. Traditional economic modelling holds that a firm which is in a competitive market will seek to maximise profit. In a market that is in long-run equilibrium under competition the marginal cost of goods is equal to price, that is supra-normal profits are absent, and resources are employed at maximum productive efficiency: F M Scherer & D Ross Industrial Market Structure and Economic Performance (3rd ed 1990) ch 2. The Italian economist, Vilfredo Pareto, said there is allocation efficiency when it is not possible through further reallocations to make one person better off without making someone else worse off, and that there is efficiency in production if no further reallocation would permit more of one good to be produced without necessarily reducing the output of some other good.
237 Part IV of the Trade Practices Act 1974 (Cth) (now comprising ss 45 to 51AAA) was enacted to protect competition in Australian markets. It achieves that object by outlawing what is considered as anti-competitive conduct. This case is concerned with s 46, which prohibits a corporation that has a substantial degree of power in a market from taking advantage of that power for certain purposes. The section does not specify what particular behaviour is prohibited. It is clear, however, that predatory pricing, among other predatory and exclusionary conduct, is forbidden. On the second reading of the Trade Practices Revision Bill 1986, which introduced the present form of the section, the Attorney-General said:
"Section 46 in its proposed form, which will be described as misuse of market power rather than monopolisation, is not aimed at size or at competitive behaviour as such of strong businesses. What is being aimed at is the misuse by a business of its market power. Examples of misuse of market power may include in certain circumstances, predatory pricing or refusal to supply."
(see Representatives Hansard, 19 March 1986, at p 1626)
The Attorney-General did not elaborate on what was meant by "predatory pricing". It is to this issue that I now turn.
238 Predation in a market is a concept that has been developed largely by economists concerned with industrial organisation, not by lawyers. It is under the influence of economists that the courts have strived to discover what constitutes predatory pricing. The trial judge produced a definition: "Selling below cost plus recoupment [or the hope or expectation thereof] by supra competitive pricing equals predatory pricing." Was he correct? To answer this question, it is convenient first to consider other definitions of predatory pricing.
239 Professor Hay, the economist called by BBM, has defined predatory pricing as "pricing behaviour by a dominant firm that adversely affects competition either by injuring existing rivals or deterring new entry." This is not the definition that he gave in evidence. It appears in an article he wrote in 1982 entitled "The Economics of Predatory Pricing" published in 51 Antitrust Law Journal 361 at 362. It is a useful definition to which I will return.
240 A well-known definition of predatory pricing is that given by Professor (later Justice) Bork in his influential text The Antitrust Paradox (1978) at p 144:
"[A] firm's deliberate aggression against one or more rivals through the employment of business practices that would not be considered profit maximizing except for the expectation either that (1) rivals will be driven from the market, leaving the predator with a market share sufficient to command monopoly profits, or (2) rivals will be chastened sufficiently to abandon competitive behavior the predator finds inconvenient or threatening."
241 On these views predatory pricing is a strategy to drive a rival out of the market or to deter the entry of a potential rival. That is apparent from the two definitions which characterise predatory pricing by reference to its object. They do not, however, provide any real assistance in enabling a judge to distinguish between price cutting that is predatory and price cutting that is no more than an aspect of competitive conduct between rivals, or potential rivals. Antitrust law generally, and s 46 in particular, should not deter every reduction in the price of goods. So it is still necessary to determine when price cutting is lawful and when it is not.
242 In the United States this task has been undertaken by economists and academic lawyers with an understanding of economics. Their influence on the judiciary has been enormous. Economics rather than law dominate antitrust litigation. Let me explain their influence, without attempting to find a cause.
243 Before the 1960s, predatory pricing had not received much judicial attention: W J Leibler "Whither Predatory Pricing? From Areeda and Turner to Matsushita" 61 Notre Dame Law Review 1052 (1986). In the last thirty years or so there has been a significant increase in litigation in this area and a staggering volume of economic literature has been published where almost countless, often contradictory, views on the topic have been expressed. For the purposes of this appeal, it is necessary to discuss some of these developments. First, I should briefly explain the statutory background.
244 The Sherman Act (15 USC ss 1 to 7) enacted in 1890, the Clayton Act (15 USC ss 12 to 27) enacted in 1914 and the Robinson-Patman Act, which amended the Clayton Act in 1936, all serve the purpose of protecting competition. Section 2 of the Sherman Act provides that "[e]very person who shall monopolize, or attempt to monopolize, … any part of the trade or commerce among the several States, … shall be deemed guilty of a felony …". The purpose of the section is to prohibit monopolisation and attempted monopolisation: Standard Oil Company of New Jersey v United States 221 US 1, 50 (1910). The Clayton Act, as amended, prohibits discrimination "[i]n price between different purchasers of commodities of like grade and quality, … where the effect of such discrimination may be substantially to lessen competition or tend to create a monopoly…": 15 USC s 13(a).
245 There are differences in approach between the sections. Under the Sherman Act, a court must determine whether the defendant has monopolised or attempted to monopolise a defined market. The emphasis is on structural competitiveness: J F Brodley & G A Hay, "Predatory Pricing: Competing Economic Theories and the Evolution of Legal Standards" 66 Cornell Law Review 738, 766 (1981). On the other hand, under the Robinson-Patman Act, a court will focus on unfairness and determine whether the defendant's conduct has injured competition at the defendant's level: Brodley & Hay at 766, fn 82.
246 Before 1975, courts had not formulated a precise definition of predatory pricing. Nevertheless, two elements had to be established. First, goods had to be sold at below their competitive price: Story Parchment Co v Paterson Parchment Paper Co 282 US 555, 561 (1931) where goods were sold below the "point of fair profit"; National Dairy Products Corporation v United States 350 F2d 321, 327-328 (8th Cir 1965) (reversed on other grounds 384 US 883 (1966)) where goods were sold at "unreasonably low prices". Second, it was necessary to show "predatory intent". In this regard, the leading case was Utah Pie Co v Continental Bakery Co 386 US 685 (1967). A local frozen fruit pie manufacturer brought suit against three larger national pie manufacturers, asserting that the defendants had joined in predatory pricing schemes to drive the plaintiff out of business and injure competition. The single issue before the Supreme Court was "whether the evidence against each of the respondents was sufficient to support a finding of probable injury to competition within the meaning of s 2(a) [of the Sherman Act]": 386 US at 688. In this regard, the court focused on the defendant's "predatory intent" to injure Utah Pie: 386 US at 696, fn 12. According to the court, predatory intent could be inferred from sales below cost, although there was no mention of the cost base. The court held that, according to the evidence, the jury was entitled to conclude that at least one defendant had contravened the Act. This was in circumstances where the frozen pie market had expanded greatly during the period under examination and the plaintiff had not only retained its leading position in that market but had expanded its absolute sales volume.
247 Utah Pie Co was roundly criticised by both economists and lawyers. Professor Bork wrote that "[t]here is no economic theory worthy of the name that could find an injury to competition on the facts of the case": R Bork, The Antitrust Paradox (1978) p 387. The court erred, according to Professor Bork, because it failed to analyse market characteristics. Professor (now Chief Judge) Posner, commented that "[b]y linking exclusionary intent and geographical price discrimination, while ignoring the relationship between price and long-run marginal cost in the relevant market, the Supreme Court reached an anticompetitive result in Utah Pie Co v Continental Baking Co": R A Posner Antitrust Law - An Economic Perspective (1976) pp 193-194. Professor (now Judge) Easterbrook said that "the history of antitrust law is filled with decisions that now seem blunders." In 1989 his Honour described Utah Pie Co, while not within that category of precedent "that is dead but unburied", as a case "that is living on borrowed time": A A Poultry Farms, Inc v Rose Acre Farms, Inc 881 F2d 1396, 1405 (7th Cir 1989).
248 In 1975, Professors P Areeda and D Turner of Harvard University published an article entitled "Predatory Pricing and Related Practices Under Section 2 of the Sherman Act" 88 Harvard Law Review 697 (1975). It is one of the most influential pieces ever written on predatory pricing. In their article, Areeda and Turner criticised judicial standards for predatory pricing such as "ruinous competition" (Porto Rican American Tobacco Co of Porto Rico v American Tobacco Co 30 F2d 234 (2d Cir 1929), cert denied 279 US 858 (1929)) and predatory intent. They formulated a test that determined when predatory pricing existed, based on the relationship between the cost of producing goods and the price at which those goods are sold. Professors Areeda and Turner pointed out that economic theory holds that a profit-maximising firm (economic theory presumes that all firms seek to maximise profit) will attempt to maximise profits or minimise losses in the short term. For a monopolist that point would be where marginal cost equals marginal revenue. Marginal cost is the increase in total costs resulting from the production of an additional unit of output. In a competitive market, a price that is equal to marginal cost represents an efficient allocation of resources. Accordingly, Areeda and Turner argued that predatory pricing would exist where a firm set its price below its anticipated marginal cost. They recognised, however, that marginal cost, being an economic and not an accounting concept, would be difficult to ascertain from a firm's records. Accordingly, they proposed that a firm's average variable cost be used as a surrogate for marginal cost. The costs that a firm incurs are either fixed or variable. Fixed costs are those that are incurred regardless of the level of production, eg, rent, the cost of plant and machinery, and taxes. Variable costs will increase with output, eg, materials and direct labour costs. The average variable costs of a firm is the sum of its variable costs divided by output.
249 Although there was a good deal of debate about the appropriate price-cost relation (eg, F M Scherer "Predatory Pricing and the Sherman Act: A Comment" 89 Harvard Law Review 869 (1976); O E Williamson "Predatory Pricing: A Strategic and Welfare Analysis" 87 Yale Law Journal 284 (1977)) the Areeda-Turner test was adopted almost immediately by a number of federal circuit courts, particularly the second and fifth circuits. On the other hand, other circuits focused not on average variable costs but on average total costs as the level of price below which predatory pricing would be inferred. The Areeda-Turner test was rejected by some circuits because it did not place any weight on predatory intent. For a comprehensive survey of the case law, see B O Bruckman (ed) "Predatory Pricing Law - a Circuit-by-Circuit Survey" (1995) published by the Antitrust Law Section of the American Bar Association.
250 The Supreme Court had the opportunity to consider whether the Areeda-Turner test, or some other price, would provide the appropriate threshold to determine whether there has been predatory pricing, but has declined to do so. The first occasion was in Matsushita Electric Industrial Co, Ltd v Zenith Radio Corp 475 US 574 (1986). The plaintiffs, manufacturers of television sets in the United States, alleged that the defendants, Japanese television set manufacturers, imported and sold sets at low prices to drive the American firms from the market. The plaintiffs argued that the defendants used their monopoly profits from the Japanese markets to fund the predatory price campaign. The defendants sought summary judgment. The trial judge granted that judgment. This was reversed by the Court of Appeals. The decision of the majority in the Supreme Court was delivered by Powell J. His Honour noted that predatory pricing referred to cases in which a single firm having a dominant share of the relevant market cuts prices in order to force competitors out of the market. He said "[i]n such cases, 'predatory pricing' means pricing below some appropriate measure of cost": 475 US at 585 fn 8. He did not stipulate the appropriate measure. The Supreme Court said much the same in Cargill, Inc v Monfort of Colorado, Inc 479 US 104 at 117 fn 12 (1986) and in Brooke Group, Ltd v Brown & Williamson Tobacco Corp 509 US 209 (1993).
251 It is convenient now to return to the economists and mention the views of those from the so-called Chicago School of modern economics. These economists are not always regarded as in the mainstream of industrial organisation economics. The Nobel Prize-winning economist, George Stigler, referred to them as "that hypothetical kingdom, the Chicago School of Economics", in his essay on Henry Calvert Simons published in 17 Journal of Law and Economics 1 (1974). For a more favourable treatment, see R A Posner "The Chicago School of Antitrust Analysis" 127 University of Pennsylvania Law Review 925 (1979). The members of this school defend monopolies as short-lived and often beneficial. They argue that monopoly power rarely exists, and if it does, it is transient and cannot have important effects, as a matter of economic logic. They contend that a monopoly is merely an embodiment of efficiency. A superior firm will grow larger than others and obtain higher profit rates.
252 Further, these economists assert that price predation is economically irrational: the cost would be substantial and its rewards deferred and problematic. Professor Bork has written that "[u]nsophisticated theories of predation abound, leading to drastic overestimations of its likelihood": Bork at p 144. He says that a rational profit-maximising firm will make an investment in predation only if it can be sure that the future flow of profits will exceed the losses incurred during the predatory price war. Hence there developed the notion of recoupment. It was explained by Professor Easterbrook in his well known article "The Limits of Antitrust" 63 Texas Law Review 1 at 26 (1984):
"The logical story of any exclusionary practice is that a firm with market power adopts a strategy to increase its rivals' costs. This strategy is costly to the aggressor too, but it plans to recoup the costs by raising its prices after expelling the rival from the market or scaring the rival out of entering. The aggressor may reduce its price, and rivals must match the cut or lose sales; the aggressor may build a very large plant or introduce new products, making entry less attractive or diminishing the attraction of rivals' products to consumers; the aggressor may buy upstream or downstream suppliers, forcing rivals to search elsewhere for supplies; the list could be extended. These and other strategies are ambiguous. Low prices and large plants may be competitive and beneficial, or they may be exclusionary and harmful. We need a way to distinguish competition from exclusion without penalizing competition. If the practices are exclusionary, they will be profitable only if the aggressor can recoup. If the aggressor cannot, there is no reason for antitrust concern. Either the business losses during the period of aggression will act as the penalty, or the conduct will turn out to be efficient."
Because predation is unlikely to be profitable, there is really no need for litigation to deter it, according to Professor Easterbrook (63 Texas Law Review 1 at 29):
"The costs of the judicial process - including the costs of errors, which deter beneficial practices - suggest the wisdom of letting the competitive process rather than the courts deal with conduct that does not create profits by reducing competition. If the practice really is anticompetitive and privately unprofitable, it will go away in time. If it persists, the appropriate inference is that it has competitive benefits. We may not yet understand these benefits, but our understanding is not a condition of legality."
However, even the Chicago School economists accept that there are some cases where predatory pricing could be successful. This will be when the incumbent could maintain monopoly power long enough to both recoup the predation losses and make additional gains.
253 When members of the Chicago School (Professors Posner, Bork, Easterbrook and others) were appointed to the federal judiciary, their treatment of predatory pricing overtook the Areeda-Turner test. For example, in Matsushita Powell J, after referring to Professor Bork's discussion of predatory pricing, said (at 589):
"As this explanation shows, the success of such schemes is inherently uncertain: the short-run loss is definite, but the long-run gain depends on successfully neutralizing the competition. Moreover, it is not enough simply to achieve monopoly power, as monopoly pricing may breed quick entry by new competitors eager to share in the excess profits. The success of any predatory scheme depends on maintaining monopoly power for long enough both to recoup the predator's losses and to harvest some additional gain. Absent some assurance that the hoped-for monopoly will materialize, and that it can be sustained for a significant period of time, '[t]he predator must make a substantial investment with no assurance that it will pay off.' Eastbrook, Predatory Strategies and Counter Strategies 48 U Chi L Rev 263, 268 (1981). For this reason, there is a consensus among commentators that predatory pricing schemes are rarely tried, and even more rarely successful."
254 This decision caused dismay among many commentators. Professors Adams and Brock said that if it was correctly decided it meant that "…if a species of observed behaviour cannot be explained by a theory of economic rationality, we may be reasonably certain that it did not occur": W Adams and D Brock "Predation, 'Rationality', and Judicial Somnambulance" 64 University of Cincinnati Law Review 811 (1996). According to a journalist writing for the Wall Street Journal, the Supreme Court in Matsushita held that the alleged predators "wouldn't, couldn't, and didn't": "Predatory Pricing, RIP" Wall Street Journal, 1 April 1986, p 32.
255 More recently, in Brooke Group, the Supreme Court made it clear that unless there is a "dangerous probability" of recoupment, a predation case will fail. The plaintiff, known by its former name, Liggett, a cigarette manufacturer, brought action alleging that the defendant was engaging in predatory pricing in generic cigarettes. The trial lasted 115 days and the jury found in favour of Liggett, with an award of damages of $148.8 million. The District Court set aside the verdict: Liggett Group, Inc v Brown & Williamson Tobacco Corporation 748 FSupp 344 (1990). The Court of Appeals (964 F2d 335 (4th Cir 1992)) affirmed that decision, holding that because the cigarette market was an oligopoly, recoupment was not possible. The court noted (at 339) that predatory pricing must involve, in addition to below-cost pricing, a reasonable expectation of later realising monopoly profits. The defendant had a 12 per cent share of the market and the court said that no theory could explain how the defendant could attain the necessary monopolistic position. This decision was affirmed by the Supreme Court. Writing for the court, Kennedy J said that in a claim alleging predatory pricing under s 2 of the Sherman Act, it was necessary for the plaintiff to establish two propositions. First, the plaintiff:
"must prove that the prices complained of are below an appropriate measure of its rival's costs." (509 US at 222).
The second prerequisite:
"is a demonstration that the competitor had a reasonable prospect, or, under s 2 of the Sherman Act, a dangerous probability, of recouping its investment in below-cost prices … Recoupment is the ultimate object of an unlawful predatory pricing scheme; it is the means by which a predator profits from predation. Without it, predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced. Although unsuccessful predatory pricing may encourage some inefficient substitution toward the product being sold at less than its cost, unsuccessful predation is in general a boon to consumers": 509 US at 224.
256 The recoupment theory is not without its critics. They contend that even on strictly rational grounds, predatory pricing is far more rational and is more likely to occur than the Chicago School is prepared to concede. The points they make include the following. (1) It may be rational to sacrifice present profits in order to preserve the long-term stability of an existing market structure. (2) An aspect of the first point is that it may be rational for a firm to seek to maximise total output, thus fulfilling management's intentions rather than those of the shareholder. (3) The notion that it is irrational to suffer large losses as a result of price predation confuses absolute losses with relative burden. (4) If the long run objective of a predator is to contain or eliminate competition then signalling that it will do so by short-term below-cost pricing can create an effective barrier to entry (as to which see later). (5) Maintenance of market control, stability of an entrenched position and the preservation of an existing power structure may be viewed as reasons of utility. See by way of example the following articles: K Elzinga and D Mills "Trumping the Areeda-Turner Test: The Recoupment Standard in Brooke Group" 62 Antitrust Law Journal 559 (1994); J B Baker "Predatory Pricing After Brooke Group: An Economic Perspective" 62 Antitrust Law Journal 585 (1994); S Beck "Intent as an Element of Predatory Pricing under Section 2 of the Sherman Act" 76 Cornell Law Review 1242 (1991).
257 I can now return to the question whether it is necessary to show "selling below cost plus [the likelihood of] recoupment by supra competitive pricing" for there to be unlawful predatory pricing under s 46.
258 The left side of the equation is comprised of two addends: (1) selling below cost, and (2) the likelihood of being able to recoup the losses incurred by an ability to extract a monopoly rent. The first addend is covered by cases to which I will refer in a moment. At present, I wish to concentrate on the second.
259 One thing that is clear is that there is no universally accepted meaning of predatory pricing. Further, the definition adopted by the trial judge has been advanced by economists whose primary view is that predatory pricing is unlikely to occur because it is irrational and even when it does occur there is no real need for intervention because predatory pricing can only ever be a short term strategy.
260 The effect of accepting the definition that found favour with the trial judge should be considered. As the United States decisions demonstrate, it will be almost impossible to maintain a successful predatory pricing prosecution against a firm other than a monopolist. Although the Supreme Court in Brooke Group paid lip service to the possibility of an oligopolist being liable under s 2 of the Sherman Act, it is tolerably clear that this will not occur unless the oligopolist acts in concert with other firms.
261 It is also necessary to bear in mind the reason why the United States courts have sought to give a precise meaning to the notion of predatory pricing. It was an attempt to provide a standard that could be applied rationally to all circumstances, a "bright line test" that would not depend upon the alleged predator's intent, which was regarded as an unsatisfactory criterion upon which to found liability.
262 The terms of s 46 suggest that adoption of the test developed in the United States would frustrate the objects of the provision. It must also be remembered that in the United States antitrust legislation is concerned with constraining the behaviour of a monopolist. That is not the focus of s 46. Our section is aimed at regulating a firm with a substantial degree of market power, which would include, but not be limited to, a monopolist. While a monopolist may have the ability to extract a monopoly rent and thus recoup its losses, a firm with only a substantial degree of power may never be in that position. Thus, the test proposed by the trial judge will, for all practical purposes, make it impossible to establish a case of a predatory pricing scheme against a firm that is not a monopolist. Moreover, under s 46 there is no need to have recourse to a test such as "selling below cost plus recoupment" because intent is at the heart of the offence. In my view the trial judge was in error in adopting recoupment as an element of predatory pricing.
263 It remains to consider whether below-cost pricing is an essential element of predatory pricing. Here again, the answer must be in the negative. The authorities, such as they are, suggest that below-cost pricing is not a necessary condition for a contravention of s 46. Before turning to the cases, it is convenient to refer to the Explanatory Memorandum that accompanied the Trade Practices Revision Bill 1986 which introduced the current s 46. Paragraph 55 of the Explanatory Memorandum reads:
"On the other hand, a corporation which is able to price its goods very competitively by reason, for example, of economies of scale or the acquisition of new efficient production facilities, would not be inhibited from doing so by reason of the fact that it enjoys a substantial degree of market power. By reflecting in its pricing policy its efficiency it would not, without more, be taking advantage of its market power notwithstanding any effect of its pricing on its competitors".
264 That parliament did not intend to circumscribe s 46 by requiring proof that a predator sold goods below a particular measure of cost, is suggested by the cases. Victorian Egg Marketing Board v Parkwood Eggs Pty Ltd (1977-1978) 33 FLR 294 is a case where predatory pricing was found to exist. In considering what level of price should be considered predatory Bowen CJ said (at 303) that he need not resolve:
"[w]hether in the ordinary course a monopolist can engage in predatory price-cutting only if the price is below some particular cost, and not where the price set, although it may deter competitors, is one which merely does not maximize the monopolist's profit. It may be that where one can infer the requisite purpose from other evidence, price-cutting may be predatory in the sense referred to and a "taking advantage" of power derived from the substantial control of a market, notwithstanding that it is not below marginal average variable cost and does not result in a loss being incurred."
Trade Practices Commission v CSBP & Farmers Ltd (1980-1981) 53 FLR 135 was an unsuccessful claim of predatory pricing. Fisher J said (at 147):
"Here where the behaviour of the defendant which is challenged is its reduction in price, I would see this as predatory behaviour if it be proved that the defendant charged an unreasonably low price with the intent to keep [a competitor] out of the urea industry in Western Australia"
He added (at 152):
"…[C]ounsel was prepared to concede that a subjective element such as purpose or motive must be established. He conceded that it is not sufficient merely to look at the effect of the exercise of the power, but that consideration must be given to what the exercise of the power was directed at."
There was no evidence that the defendant had taken advantage of its market power.
265 In Eastern Express Pty Limited v General Newspapers Pty Limited (1991) 30 FCR 385 Wilcox J said (at 407):
"Predatory pricing may be established in one of a number of ways: by express admission; by inference from facts other than the extent of the price cuts themselves; or by analysis of the effect of the price cuts, giving rise to an inference as to the purpose behind their adoption."
Later his Honour said (at 409):
"If there is no loss, it would be difficult to infer a proscribed purpose."
On appeal ((1992) 35 FCR 43 at 72) Lockhart and Gummow JJ (with whom Beaumont J generally agreed) said:
"No pre-ordained and fixed categories as to the level of pricing or economic theory or practice of costing necessarily control the drawing of that inference [as to proscribed purpose] in any particular case."
266 In my opinion the existence of predatory pricing should not be determined by reference to some precise formula or definition. Predatory pricing is no more than a price set at a level designed to eliminate a competitor or keep a potential competitor from the market. That is the gist of the definition given by Professor Hay that I mentioned earlier in these reasons. It is all that is necessary for the purposes of s 46. In particular, in my view, it does not matter that the price charged might exceed either the average total cost or average variable cost. In the circumstances of a particular case it may nevertheless be a predatory price.
267 This is not to say that it may not be important to determine whether price has been reduced to below average variable cost. On the one hand, if goods are sold at a loss for a sustained period, it might be wrong to hold that an anti-competitive purpose exists. To take one example, incurring losses as a means of putting excess capacity into operation may be justifiable competition, although cut-throat and ruinous. On the other hand, a firm with a substantial degree of market power usually has no interest in setting prices at such a level (that is, at a price where it will necessarily incur a loss) except to eliminate a competitor or to keep a potential competitor out of the market.
268 It is of some interest to note the position in Europe. Under Article 86 of the Treaty of Rome, exclusionary behaviour by a dominant firm is prohibited. Since the decision in AKZO Chemie BV v Commission of the European Communities [1994] ECR I-3359 it is an established principle that below cost pricing by a dominant company is predatory where eliminatory intent is found. The Court of Justice identified as an object of Article 86 the prohibition of a dominant firm from eliminating a competitor and thereby strengthening its position by using methods other than those which come within the scope of competition on the basis of quality. The Court recognised, however, that not all competition by means of price can be regarded as legitimate. In this regard the Court said (at I-3455 to I-3456):
"Prices below average variable costs (that is to say, those which vary depending on the quantities produced) by means of which dominant undertaking seeks to eliminate a competitor must be regarded as abusive. A dominant undertaking has no interest in applying such prices except that of eliminating competitors so as to enable it subsequently to raise its prices by taking advantage of its monopolistic position.....
Moreover, prices below average total costs, that is to say, fixed costs plus variable costs, but above average variable costs, must be regarded as abusive if they are determined as part of a plan for eliminating a competitor. Such prices can drive from the market undertakings which are perhaps as efficient as the dominant undertaking but which, because of their smaller financial resources, are incapable of withstanding the competition waged against them."
See also the decision in Irish Sugar plc v Commission of the European Communities [1999] ECR II-2969. Irish Sugar had a policy of offering selectively low prices to potential customers of rival sugar suppliers. Those prices did not significantly undercut those of its competitors. Nevertheless, the Commission held that Irish Sugar, a dominant firm, had deliberately attempted to shut out competitors. This decision was upheld by the Court of First Instance.
269 I do not agree with the view that there is a cost (eg average variable cost) below which there must be a per se finding of predatory pricing. I would accept, however, that for the purposes of a prosecution under s 46, if a dominant firm persistently prices its goods below average total cost, predatory intent may be inferred, and the inference would be much stronger if the price was set below average variable cost. At least in the latter case it would be for the firm to show that there was a legitimate purpose for its conduct.
270 The trial judge found that BBM did not have the capacity to recoup the losses that it incurred during the price war between the concrete masonry block manufacturers (the details of which I discuss later) by charging non-competitive prices when the battle was over. For that reason alone, the trial judge would have given judgment in its favour. As I have been at pains to demonstrate, the trial judge was in error in his approach to this aspect of the case. It will be necessary later to consider whether there was in fact predatory pricing for a relevant purpose. To deal with that question, and other aspects of the decision under appeal that must be considered, it is necessary to turn to the facts.
271 BBM manufactures concrete masonry products, namely blocks, bricks and pavers. The blocks and bricks are used for walls: walls for houses; walls for factories; walls for multistorey developments; walls for large commercial premises; even walls where once a fence was used. Many other products are used to make walls: eg, steel, glass, plasterboard, wood, concrete slabs (made on site), precast concrete panels (manufactured at a factory) and clay bricks.
272 There was a time when the walls of most houses, factories and commercial premises were constructed from clay bricks. Internal walls might be made from glass, plasterboard, timber or some other light product. By the 1960s concrete masonry blocks had become the favoured material used for external walls of commercial buildings. Concrete blocks and concrete bricks were also used in the construction of houses when it was intended that the wall be painted or bagged; almost all concrete blocks and bricks are grey in colour and unsightly in appearance.
273 In the 1980s many inner-city multistorey residential buildings were being developed. Concrete blocks were used in their construction. By then clay bricks were confined for use mostly in domestic buildings. Concrete masonry blocks did not, however, remain the chosen material for commercial and multistorey buildings. During the building boom of the 1980s brick and block layers began to charge too much for their work. Builders started to look for an alternative product. Precast slabs and tilt-up panels became the preferred product for the construction of factories, warehouses and multi-storey buildings. Precast slabs and tilt-up panels had advantages over other products, including a reduction in the cost of labour and ease of construction. The introduction of this material had a dramatic effect on the sale of masonry blocks. Some estimates are that the sale of concrete blocks fell by 65 to 70 per cent in just a few years.
274 Concrete blocks still had their use. There were some circumstances in which precast concrete or tilt-up panels could not be used. These products do not have the same fire rating as a concrete block. It may not be possible to use tilt-up panels or precast concrete in certain locations or for internal walls.
275 Tilt-up slabs and precast concrete panels remain popular in the construction of warehouse and factories, while blocks are often used for commercial and industrial buildings. Clay bricks are now predominantly used for domestic construction. When external walls can be bagged or rendered, masonry bricks are sometimes used instead of second quality clay bricks.
276 A major recession occurred in the building industry in Victoria in late 1989 or early 1990. It followed on from the collapse of three major financial institutions, Tricontinental Corporation, Pyramid Building Society and Estate Mortgage. Building work almost came to a standstill. The industry did not begin to recover from the effect of the recession until about 1996.
277 At the beginning of the recession there were four main concrete masonry product manufacturers in Melbourne: BBM, Besser Pioneer Pty Ltd ("Pioneer"), Rocla and Budget. BBM accounted for approximately 30 per cent of the sale of concrete masonry products. There is no direct evidence of the share of sales held by the other three manufacturers. However, from the evidence of their respective shares held two years later it can be inferred, on a rough and ready estimate, that Besser Pioneer had held approximately 22 per cent of sales, Rocla approximately 19 per cent and Budget approximately 14 per cent.
278 Over the next two years BBM's share of sales declined dramatically. From a high point of 31 per cent in August 1990 it slipped to 12 per cent by the beginning of 1992 before settling at around 16 to 18 per cent later in the year. BBM attributed its decline over this period to bad management, inefficient plant, poor customer service and a lack of product range. All in all, BBM was operating a very run down business.
279 BBM was not the only manufacturer with inefficient or out-of-date plant. Each of BBM, Rocla and Pioneer used block-making machines manufactured by either Besser or Columbia. This machinery was not as advanced as machines that were available from other European and United States manufacturers. However, BBM's performance was worse than that of its rivals. At least that was the view of the chief general manager of its masonry division, Mr Magnus (Tim) Cormack; a view that was confirmed when BBM made a negative return (of approximately 7 per cent) on capital during the 12 months ended 30 June 1992.
280 BBM could not allow this position to continue. If it was not to close down operations, BBM had to dramatically improve its performance. Mr Cormack knew that two things had to be achieved; a reduction of expenses (that is become more efficient) and an increase in production (that is reduce per unit costs). However, an increase in production required an increase in sales. This was the key. BBM had to recover its share of the sales of masonry products for its business to become profitable. And this required dramatic action.
281 There was a step that could be taken that would produce a dramatic increase in sales. Concrete blocks and concrete bricks are largely generic products. There is little that distinguishes one manufacturer's product from another. There are some exceptions. To attract business some manufacturers did produce concrete bricks of different colours and textures. But in the area where most sales take place, size and colour are uniform. The difference is in price. So, to attract more business BBM decided to reduce its prices. Accordingly, Mr Cormack instructed his general manager, Mr Rawnsley, who was in charge of sales, to beat the price of competitors to win business. Mr Rawnsley was told not to "leave any money on the table" to attract custom.
282 The task of recovering market share proved more difficult than was first anticipated. There was a small masonry block manufacturer, Concrete & Masonry Pty Ltd, in country Victoria. From late 1989 this manufacturer had been supplying paving products to distributors in Melbourne. In mid 1992 the proprietors of this manufacturer established C & M Brick (Melbourne) Pty Ltd to sell concrete masonry products in Melbourne. For this venture C & M purchased a new block making machine (manufactured by Hess) that would produce blocks in larger volumes and at a lower cost than blocks made by a Besser or Columbia machine. With a Hess machine C & M could sell blocks at a profit whereas if its competitors sold them at the same price, they would either break even or incur a loss.
283 The risk to the incumbents of an efficient competitor was evident. Mr Cormack made a note: "Knock off C & M at any price". Mr Rawnsley knew he had to increase market share "at the expense of the other operators particularly Budget and C & M". At that stage no-one was aware that C & M was intending to compete with a Hess machine. When this was discovered in the middle of 1993, the threat to the existing manufacturers was all the more apparent.
284 BBM began its assault on the market in 1992 and continued its attack throughout 1993. (Here I am referring to the market in concrete masonry products. Whether this is a relevant market for the purposes of s 46 is a matter to be considered later). By the end of 1993 BBM had recovered its position to the point where it held approximately 30 per cent of the market. According to a note made by Mr Rawnsley around this time:
"Rocla Eureka and Pioneer Besser are known to be reeling from our assault on the market and Rocla within the past few weeks have totally withdrawn from the block market relying instead on their strong paver market. This market is now being heavily targeted with good results."
His view was that "[b]oth C & M and Budget will collapse in the near future."
285 Although BBM had recovered its market share, this had come at a cost. To achieve a significant increase in sales over a relatively short period BBM was required to sell concrete blocks (its largest selling product) at below cost prices. At the same time, the price at which BBM was offering to sell concrete blocks caused C & M, a more efficient producer, to defer the commencement of production of concrete blocks. Instead C & M concentrated on the manufacture of concrete bricks, pavers and retaining wall products.
286 Speaking generally, a profit maximising firm will not operate at a loss for an extended period unless it perceives long term benefits. In any event, in the face of efficient competition, a profit maximising firm might think it rational to purchase the competitor's business rather than drive that competitor out of business by below cost pricing. Mr Rawnsley believed that if it acquired C & M, BBM could "achieve 50% of the concrete masonry market by end 1997." He also believed that the acquisition would enable BBM "to drive at least one competitor out of the market." Not surprisingly then BBM made two attempts to acquire the business of C & M.
287 In 1994 BBM offered to purchase the Hess plant from C & M. There was a financial motive for C & M to sell its plant. It was finding it difficult to survive in view of the low price at which it had to sell its products to meet competition. However, it decided not sell the plant. Instead it raised equity capital. With this capital C & M was able to remain in business although its accounts showed that but for an accounting treatment recording depreciation at 1 per cent, it was trading at a loss. In 1996 there were further discussions between BBM and C & M about a possible sale of the C & M business, but without result.
288 Although there had been substantial discounting by BBM since mid 1992, Mr Rawnsley said that "a major price war" between the concrete block manufacturers began in late 1993. BBM says the price war was started when Rocla submitted a very low tender for what was known as the Eastland Shopping Centre project and when Pioneer distributed a price list setting very low prices for its products. What caused the price war is immaterial. In reality it seems to have been no more than a continuation of a state of affairs which had begun when BBM dramatically reduced its prices in 1992 to attract business. This reduction was often matched by competitors who wished to retain their customers. The price war continued for 3 years or so, until 1996 or thereabouts. During the period of the war BBM increased its share of the market substantially by selling concrete blocks below average variable cost.
289 BBM was engaged in the price war not only to obtain or maintain market share. It should be remembered that by 1993 BBM had regained its 30 per cent share of the market. BBM knew there had to be a "shake out" in the market. Not all concrete masonry manufacturers could survive. Mr Rawnsley wanted to "drive at least one competitor out of the market". One method of achieving this objective, in addition to a continuation of the price war, was to increase BBM's capacity to supply masonry products. Not only would an increase in capacity reduce its costs of production (by economies of scale) but giving notice of an intention to increase capacity when the concrete masonry market was already in a state of over-supply would have an obvious effect on competition. BBM decided to upgrade its plant at Deer Park, one of its two plants in Melbourne. Mr Cormack told Mr Rawnsley "to make sure the market knew that it was BBM's intent to upgrade Deer Park. This was to put psychological pressure on our rivals".
290 The upgrade of Deer Park took place in 1996 at a cost of between $3 to $4 million. Mr Cormack, who pressed for the upgrade, believed that the market for blocks would decline for 2 years but that "if the additional capacity was installed then BBM would [nevertheless] attempt to increase its market share even though there was an absolute reduction in the market."
291 It is true that the Deer Park plant was outdated and inefficient, and that sooner or later it would have to be replaced. Nevertheless, it is the timing of the upgrade that is important for this case. Significant capital expenditure was required to be spent in an unprofitable market, and in the expectation that the market would decline further. BBM could not have expected a return on the capital cost of the upgrade for some time. In other words, there would be additional losses incurred as a result of the capital expense incurred, at least in the short term.
292 Most wars have their victors and their vanquished. The concrete masonry products price war was no exception. The first casualty was Rocla. Because of low prices, Rocla decided to discontinue production of bricks and blocks and concentrate efforts on face bricks for domestic buildings and advanced technical products. These were "value added" products at the upper end of the market and offered greater profit margins than concrete blocks. However the decline in demand in 1995 forced Rocla to shut down operations altogether. It was not prepared to operate unprofitably for an extended period.
293 The second casualty was Budget. It only had a small share of masonry product sales, around 5 per cent. Budget had a small number of customers, some of whom had undertaken large construction projects which were sufficient to enable Budget to maintain its market share for a number of years. But the losses it was making in the years 1991 through 1996 could not continue. Those losses were increasing each year, and capital reserves were being depleted. In 1996 it was decided to close the business. By then Budget was hopelessly insolvent and its principal shareholder and director lost not only the business but most of his personal assets, which had been pledged to the company's banker.
294 C & M was not a casualty but it suffered injury. It was forced to confine its operations to the manufacture of concrete bricks and pavers. BBM did not "go after" the concrete brick business to the same extent as it sought to increase its sales in concrete blocks. This is not to suggest that BBM did not substantially reduce its price of concrete bricks to attract business. To return a reasonable profit, bricks had to be sold at $250 per thousand, and at $225 per thousand to cover production costs. BBM sold bricks for as low as $170 per thousand, well below its average total cost or average variable cost of production. It was content to reduce the level of its sales of bricks presumably because it did not wish to increase its losses.
295 BBM did not escape the price war unscathed. While business was won over as a result of tenders offering prices below that of its competitors, the cost to BBM was significant. Losses on the sale of concrete bricks have just been mentioned. BBM also suffered considerable losses on the sale of concrete blocks. The most popular selling item was the block known as '10.01'. Before discounting began, this block was sold for around $0.87. The direct evidence discloses that during the price war, BBM sold this block for as low as $0.39, and that it discounted other blocks by as much as 50 to 60 per cent and perhaps more.
296 Vigorous competition will often harm rivals. The active pursuit of more business, or of increasing market share, will, if the pursuit is successful, prejudice competitors. That is the inevitable consequence of such conduct. Was BBM's intention merely to increase its share of the market so that in due course it could operate a profitable business? That is what BBM contends was its object. The trial judge did not agree. He found that BBM's purpose was to eliminate or substantially damage its competitors (the incumbents) or prevent a person (C & M) entering the market. These are among the purposes that s 46 mentions.
297 The finding on purpose was made largely because of the "smoking gun" documents found during discovery or in reliance on the Commission's statutory right to obtain the production of documents. The finding was made in spite of evidence given by senior executives of BBM, including the authors of the incriminating documents. Those witnesses denied that it was BBM's intention to damage competitors or prevent anyone entering the market. The authors of the incriminating documents gave detailed explanations as to the "true" meaning of, or the "proper interpretation" to be given to, the documents. Their evidence was not accepted. The finding that there was a relevant purpose for the conduct is consistent only with the rejection of the evidence of the witnesses on this issue. It is a finding that in part reflects the opinion of the trial judge on the credit of the witnesses. Although BBM now seeks to challenge the finding, it faces an impossible task. On the basis of authorities such as Jones v Hyde (1989) 63 ALJR 349; 85 ALR 23, Abalos v Australian Postal Commission (1990) 171 CLR 167, Devries v Australian National Railways Commission (1993) 177 CLR 472 and State Rail Authority of New South Wales v Earthline Constructions Pty Ltd (in liq) (1999) 73 ALJR 306; 160 ALR 588, the trial judge's ruling is unassailable.
298 How was BBM able to sustain a loss of revenue, which resulted in actual trading losses, for so many years? Remember that as its share of the sale of masonry products increased so did its losses. That is to say, in a price war the higher the share of sales the larger will be the loss. BBM suffered a significant loss of revenue, in the millions of dollars. BBM's Victorian operations reported operating losses for every month during the period from May 1992 until June 1997. In the four years concluding with the twelve months ended 30 June 1997 its trading losses amounted to at least $1.3 million; some evidence suggests that its trading losses were much higher. Price warfare is a war of attrition. To succeed the victor must have the capital resources to outlast its rivals or be able to inflict disproportionate losses on the victim. BBM had the ability to wage a long term conflict. The company was a member of a vertically integrated group. Related companies produced the fine aggregates, sand and concrete that constituted the raw materials for the manufacture of concrete masonry products. BBM purchased its raw materials from related companies at arm's length prices enabling those companies to return a satisfactory margin on sales. Overall the Boral group of companies returned a profit from the sale of concrete masonry products, although one company in the group, BBM, suffered losses.
299 BBM's conduct in persistently selling at below average variable cost for the purpose of eliminating or damaging its competitors, Rocla and Budget, or preventing the entry of C & M into the market (that is, predatory pricing on any view) will contravene s 46 only if it can be shown that BBM "ha[d] a substantial degree of power in a market [and had taken] advantage of that power for [that] purpose": s 46(1).
300 The first element of the offence is the possession of a substantial degree of power in a market. This makes it necessary to delineate the relevant market. As the definition of "market" in s 4E shows, a market is comprised of those goods or services that are reasonably interchangeable. Section 4E provides:
"For the purposes of this Act, unless the contrary intention appears, market means a market in Australia and, when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are substitutable for, or otherwise competitive with, the first-mentioned goods or services."
301 The critical factors to be considered are: (a) what products are sufficiently close substitutes (the relevant product market) and (b) what firms are sufficiently proximate to compete effectively (the relevant geographic market).
302 Defining the product market presents no difficulty when identical goods are involved, assuming that the purchasers or potential purchasers are informed and rational. It is when the products are not the same that difficult issues may arise. Products in a market are defined by describing those products that are sufficiently close substitutes such that if a firm or group of firms tried to raise its prices substantially on any product in that market it or they would promptly lose substantial business to these substitutes: R Pitofsky "New Definitions of Relevant Marketand the Assault on Antitrust" 90 Columbia Law Review 1805, 1810 (1990). In Industrial Market Structure and Economic Performance Professors Scherer and Ross give the following definition of a market (at p 75):
"The ideal definition of a market must take into account substitution possibilities in both consumption and production. On the demand side, firms are competitors or rivals if the products they offer are good substitutes for one another in the eyes of buyers. But how, exactly, does one draw the line between 'good' and 'not good enough' substitutes? The essence of the matter is what happens when price relationships change. If the price of Product A is raised by a small but meaningful percentage and as a result consumers substitute Product B for Product A in significant quantities, then A and B are good substitutes and ought to be included under a common market definition."
303 But it is not only demand substitutability that must be considered. An ideal definition of a market should also take into account when a seller will substitute one product for another. Groups of firms making non-substitutable goods may be competitors if they employ similar skills and equipment and could easily move to other product lines if conditions become favourable: R Hubbard "Potential Production: A Supply Side Approach for Relevant Product Market Definitions"48 Fordham Law Review 1199 (1980); United States v Columbia Steel Co 334 US 495 at 510-511 (1947); Brown Shoe Co, Inc v United States 370 US 294 at 325 fn 42 (1961).
304 Supply or demand substitutability is not, however, the only defining feature of a market. The borders of a market may be determined by practical considerations. For example, industry or public recognition of a market as a separate economic entity is a factor to be taken into account. So also are the peculiar characteristics of a product and whether there are specialised vendors, distinct customers and other features. Further, the purpose for identifying the market must always be borne in mind. Here the purpose is to determine whether BBM has a substantial degree of market power. If the market is defined too narrowly important sources of competition will be ignored and BBM's power will be overstated. Conversely if there is too broad a definition, real market power will go undetected: see generally G Hay, J C Hilke and P B Nelson "Geographic Market Definition in an International Context"64 Chicago-Kent Law Review 711 (1988).
305 Without further elucidation these statements of market definition are not always helpful. For example, when market definition is based on a movement in price, different results will occur depending upon the magnitude of the price movement assumed and upon the time frame analysed. Value judgements cannot be avoided. As Deane J said in Queensland Wire Industries Proprietary Limited v Broken Hill Proprietary Company Limited (1988-1989) 167 CLR 177 at 195-196:
"The identification of relevant markets and the definition of market structures and boundaries for the purposes of determining whether B.H.P.'s refusal to supply Y-bar to Q.W.I. contravened s. 46(1) involves value judgments about which there is some room for legitimate differences of opinion. The economy is not divided into an identifiable number of discrete markets into one or other of which all trading activities can be neatly fitted. One overall market may overlap other markets and contain more narrowly defined markets which may, in their turn, overlap, the one with one or more others. The outer limits (including geographic confines) of a particular market are likely to be blurred: their definition will commonly involve assessment of the relative weight to be given to competing considerations in relation to questions such as the extent of product substitutability and the significance of competition between traders at different stages of distribution."
For reasons that will soon become apparent, no issues of real difficulty present themselves in this case.
306 The trial judge found, on evidence which he described as "all the one way", that concrete masonry products compete with and are substitutable for other walling products. His Honour said:
"A wall is a wall whether it is made of concrete blocks or tilt-up or concrete bricks or clay bricks. The only need of the builder is to have a wall which will perform as a wall, and for the lowest possible cost."
In a market where walling products include masonry blocks and bricks, clay bricks, tilt-up panels, precast concrete, plasterboard, timber, glass, aluminium, steel products, and fibro-cement sheeting, BBM could not have significant market power. But was the trial judge correct in his determination of the product market? Or did the evidence in fact establish the existence of a narrower market, such as the one for which the Commission contended, namely a market for concrete masonry products?
307 A simple approach in this case would have been to follow what was said by the Supreme Court of the United States in United States v E I du Pont de Nemours & Co 351 US 377 (1956). The government alleged that du Pont had monopolised interstate commerce in cellophane in violation of s 2 of the Sherman Act. It was necessary to define the market which it was alleged du Pont dominated. Either it was a market for cellophane or a market for flexible packaging materials. The judgment of the Court was delivered by Reed J. In discussing the relevant principles his Honour said (at 393):
"Determination of the competitive market for commodities depends on how different from one another are the offered commodities in character or use, how far buyers will go to substitute one commodity for another. For example, one can think of building materials as in commodity competition but one could hardly say that brick competed with steel or wood or cement or stone in the meaning of Sherman Act litigation; the products are too different."
308 It is apparent that the Supreme Court would have had little difficulty in rejecting the views of the trial judge. It appeared self-evident to that court that diverse building products, such as are under consideration here, could not possibly be in the same market. As I will show, the evidence adduced at trial leads inevitably to the same conclusion, even upon a traditional rather than an instinctive analysis.
309 The specification of what products are to be used in the construction of a building occurs at the stage when plans for the building are drawn. The choice of products is usually made by the architect (not the builder to whom the trial judge was directing attention in the passage quoted), sometimes in conjunction with an engineer or other consultant such as a quantity surveyor. Cost is but one factor, albeit an important factor, that is taken into account in choosing the appropriate product. Structural requirements, aesthetic considerations, site requirements, performance characteristics and the like are also important factors. Very often there will be little choice in the selection of the appropriate material. The choice will be dictated by the requirements of a particular project. One of BBM's witnesses, Mr Mould, an experienced architect, said that in only approximately 10 per cent of projects will there be a choice of building materials, which are of similar cost implications and performance characteristics, for use in a particular application.
310 When it comes to selecting the product which is to be used for a wall the following features, among others, are taken into account: whether the wall is interior or exterior; the wall load bearing; the risk of fire and safety requirements; sound transmission requirements; whether windows or doors are required in the wall; building code requirements concerning matters such as impact, hygiene and security.
311 Each walling product has its own characteristics that make it more or less capable of satisfying a particular requirement. For example a timber or plaster wall does not have the fire rating of a concrete block. Tilt-up walls are porous and transmit sound more readily than clay brick or concrete brick. Pre-cast concrete has certain technical limitations. All in all, one thing that comes across quite clearly from the evidence is that a wall is not just a wall.
312 When the design of a building is completed the specification will include details of all the building material to be used in the design. When the building material is a generic product, for example, a concrete block or a clay brick, the specification will mention the generic type. It is at the point when tenders are called that one finds intense competition to supply the selected material. When the selected material is concrete block, the masonry manufacturers will compete for the job, almost always on the basis of price. When some other building material is specified there may be some attempt to alter the choice, but this will meet limited success for it is usually too late in the day to make a change.
313 To be sure, manufacturers of concrete masonry products do make some attempt to influence the decision of the architect when choosing the product that is to be specified. BBM described the evidence as establishing "vigorous" competition with the manufacturers of other walling products. This is not a realistic characterisation of the evidence. In the fifty or so lever arch folders of evidence, comprising thousands of pages, there are but a few scattered sentences that attest to some effort in this regard. No doubt it was not worthwhile to press too hard.
314 The evidence upon which the trial judge based his conclusion that any one walling product is substitutable for another took into account, in a significant way, the dramatic extent to which tilt-up panels and pre-cast concrete had taken business from concrete masonry manufacturers in the 1980s and early 1990s, the use of stud walls in preference to masonry concrete products for internal use in high rise buildings and the fact that concrete masonry bricks have been taking sales from clay bricks since mid-1994.
315 It is true that the evidence established that, for a number of years before the recession, concrete bricks (if they were to be rendered or bagged) were interchangeable with clay bricks in residential constructions, concrete blocks were interchangeable with tilt-up panels and pre-cast concrete for external walls in commercial and high-rise apartments, and concrete blocks were interchangeable with plasterboard for internal walls, when other factors permitted the substitute product to be used. But the evidence also shows that once tilt-up panels and pre-cast concrete in particular, being products which for practical purposes were new products in the 1980s, had acquired a degree of acceptance, they did not thereafter compete to any significant extent with the products they had originally displaced.
316 A number of witnesses, Mr Steele, the managing director of Shannon Tower Pty Ltd, a company that carried on the business of reselling and distributing clay and masonry products (trading as 'Brick N Pave'), Mr Whiteford, the general manager of Rocla, and Mr Pearson, the executive director of the Concrete Masonry Association of Australia, all said that the explanation for he reduced sales of concrete blocks during the 1980s and early 1990s was the increased use of tilt-up and precast concrete in commercial construction. Mr Steele said that tilt-up had reduced the block market by 65 to 75 per cent. This he attributed to be a direct result of the sharp increase in labour costs for laying blocks.
317 But there is very little evidence of any significant substitution between alternative building materials in the 1990s, especially during the period of the price war. This is the most revealing feature of the evidence as regards the determination of the product market. There was a substantial reduction in the price of concrete blocks and a similar, although not as sustained, drop in the price of concrete bricks over an extended period. The two largest suppliers, BBM and Pioneer, were suffering heavy losses as a consequence. Professor Hay said that products will be close substitutes when "any attempt to charge more and give less with respect to one of the products would result in a significant loss in sales to the other product." Professor Hay highlights the obvious point that substitution between products that in fact compete with one another will take place when the seller of one product either raises or lowers his prices. If there is 'cross-elasticity of demand' (the favoured expression of the economist) the raising of prices will result in lost sales and the lowering of prices will gain sales. When this occurs the products are usually in the same market.
318 If the trial judge was correct, one would expect to find a substantial movement away from pre-cast and tilt-up concrete slabs, clay bricks and any other material used to make walls, and a corresponding increase in the sale of concrete masonry products during the price war. Moreover, this is one of those seemingly rare cases where there is no need to speculate on what would occur. Economic theory can be proved by actual market behaviour. Indeed, I cannot stress too highly my view that the court should consider actual patterns of market behaviour, as these are more likely to produce a better market analysis than hypothetical markets and even historical evidence. For example, past sales patterns may have occurred for reasons that are idiosyncratic and may not be repeated.
319 What do the facts show? Certainly not enough to sustain the finding of the trial judge. As regards tilt-up panels and pre-cast concrete, a number of witnesses, Mr Rawnsley, Mr Pethica, an estimator and contracts administrator, Mr Byrne, the manager of a bricklaying company, and Mr Coghill of Budget, all said that as the cost of concrete blocks fell, tilt-up panels and pre-cast concrete was used in preference. To what degree, in what quantity, and in which situations we are not told. Mr Vella of BBM said that the low prices offered by C & M for its render bricks caused a dramatic increase in demand for that product. The evidence was that C & M won over business from competing concrete brick manufacturers (for example BBM and Pioneer) as well as from clay brick manufacturers. Other suppliers, including BBM on the occasions when it matched the price for concrete bricks, also took away business from the manufacturers of clay brick. The extent to which this occurred is not explained, although many witnesses would have been in a position to explain. Importantly also, is the fact that Mr Vella, one of BBM's key witnesses, spoke only of "competition" in render bricks and not in other products.
320 This scant evidence certainly does not support a finding that there was sufficient substitution of walling products to conclude that they share the same market. Indeed I am of the firm opinion that the evidence, especially the absence of evidence of substitution during the price war, established the opposite position. If confirmation of this conclusion be necessary I note that if products are in the same market one would expect to find that over a period of time the price movement of each product would correlate. When price movements do not correlate the chance of the products being in the same market is not great: G J Stigler and R A Sherwin "The Extent of the Market" 28 Journal of Law and Economics 555 (1985). Here the evidence does not show that the price of the building materials which the trial judge considered to be in the same market followed the same movement from 1992 through to the end of the price war. The evidence, such as it is, suggests the opposite. An example is the evidence of Mr Mould that I mentioned earlier. Thus, there was a market for the sale of concrete masonry products, in my opinion. The geographic dimensions of that market (Melbourne) were not in dispute on this appeal.
321 Having established the dimensions of the relevant product market it is necessary next to consider whether BBM had a substantial degree of power in that market. Monopoly power and market power must be kept distinct. Section 46 does not require monopoly power to be shown, but of course if it exists it will, of necessity, suffice. All that need be established is that BBM had considerable and not a minimal degree of market power: Dowling v Dalgety Australia Limited (1992) 34 FCR 109 at 138-139; see also Explanatory Memorandum for the Trade Practices Revision Bill 1986, para 42 ("substitution … [does] not … require the high degree of market power connoted by … being in a position substantially to control a market").
322 Whether a firm has market power is not a matter of measurement, but of judgment. But what is it that must be judged? Various definitions have been put forward, usually in the context of considering the power of a monopolist. L Sullivan in Antitrust (1977) at p 30 defines market power as:
"the power of a firm to affect the price which will prevail on the market in which the firm trades."
W M Landes & R A Posner in "Market Power in Antitrust Cases" 94 Harvard Law Review 937 (1981) at 937 define market power as:
"the ability of a firm (or a group of firms, acting jointly) to raise price above the competitive level without losing so many sales so rapidly that the price increase is unprofitable and must be rescinded."
P E Areeda, J L Solow & H Hovenkamp in Antitrust Law (1995) vol IIA p 85 define market power as:
"the ability to raise prices by restricting output…[or the ability] to raise price without a total loss of sales."
In these and most other definitions, the reference to "price" is misleading. It is not intended to be confined to the actual price of goods or services. It includes the ability of a firm to supply inferior goods or services, and the ability to impose unfavourable terms and conditions.
323 According to Landes & Posner a simple meaning of market power is the ability to set price above marginal cost, that is the minimum cost, including an appropriate rate of return, that an efficient firm would have to incur to produce the product in question. In a competitive market, price will equal marginal cost. If a firm can raise price above marginal cost without losing business it has market power: Queensland Wire at 188. Presumably, when a firm can raise its price above marginal cost by more than a trivial amount, the firm will have substantial market power. The greater the discretion to raise price above marginal cost, the closer the power will approximate that of a monopolist.
324 To decide whether there is an ability to increase price, it is necessary to consider the extent to which the ability of the firm is constrained by its competitors, potential competitors, suppliers and customers. Both economic theory and s 46(3) require that consideration be given to these issues. It is for these reasons that reference to matters such as the firm's market share, the size of its profits and barriers to entry (as to which see later) have been the common ways of establishing the existence of market power. No doubt these factors must also be taken into account when determining the degree of market power that is held. In its decision in Re Continental Can Co Inc [1972] CMLR D11, the European Court of Justice said (at D27):
"Undertakings are in a dominant position when they have the power to behave independently, which puts them in a position to act without taking into account their competitors, purchasers or suppliers. That is the position when, because of their share of the market, or of their share of the market combined with the availability of technical knowledge, raw materials or capital, they have the power to determine prices or to control production or distribution for a significant part of the product in question. This power does not necessarily have to derive from an absolute domination permitting the undertakings which hold it to eliminate all will on the part of their economic partners, but it is enough that they be strong enough as a whole to ensure that those undertakings and overall independence of behaviour, even if there are differences in intensity in their influence on the different partial markets.
325 However, even if a firm is not in an immediate position to set its price above marginal cost, it may still have market power. Market power can exist when a firm has power to exclude competition. This was recognised by the Supreme Court of the United States in du Pont. Reed J, delivering the opinion of the court, said (at 389):
"This court has pointed out that monopoly at common law was a grant by the sovereign to any person for the sole making or handling of anything so that others were restrained or hindered in their lawful trade… However, as in England, it came to be recognized here that acts bringing the evils of authorized monopoly --unduly diminishing competition and enhancing prices - were undesirable and were declared illegal by s 2. Our cases determine that a party has monopoly power if it has, over 'any part of the trade or commerce among the several States', a power of controlling prices or unreasonably restricting competition." (Authorities omitted)
Later (at 391) Reed J said:
"Monopoly power is the power to control prices or exclude competition."
326 Thus, according to the Supreme Court, a firm will have monopoly power if either test (the ability to control prices or the ability to restrict competition) is satisfied. Some economists have criticised this formulation. In an article entitled "Market Power in Antitrust" 60 Antitrust Law Journal 807 (1992), Professor Hay argues that for the economist the power to control prices depends on the absence of competition. Hence, the "power to exclude competition" permits "the power to control prices". He says that the two statements are the same phenomenon.
327 Be that as it may, courts in the United States do not agree and have continued to adopt and apply the two tests as separate tests. See, eg, United States v Grinnell Corp 384 US 563, 571 (1965); TV Signal Company of Aberdeen v American Telephone and Telegraph Company 462 F2d 1256, 1261 (8th Cir 1972); Jack Winter, Inc v Koratron Company, Inc 375 FSupp 1, 68-69 (1974); Bhan v NME Hospitals, Inc 669 FSupp 998, 1019 (1987); Betaseed, Inc v U & I Incorporated 681 F2d 1203, 1231 (9th Cir 1982); US Anchor Manufacturing, Inc v Rule Industries, Inc 7 F3d 986, 994 (1986); American Key Corporation v Cole National Corporation 762 F 2d 1569, 1581 (11th Cir 1985).
328 In their article 'Market Power in Antitrust Cases', Landes and Posner comment on the definition of market power in du Pont (94 Harvard Law Review at 977):
"The first part of this definition [power to control prices] seems equivalent to the economic definition of market power …. The second [power to exclude competition] is puzzling. The Court may just have been making the corollary point that any firm that has and exercises the power to raise price above the competitive level must be able to exclude entrants; otherwise it would not be able to maintain the higher-than-competitive price …. Finally, the Court may have had in mind the exclusion of equally or more efficient competitors through predatory pricing or other exclusionary practices - a dimension of the monopoly problem to which our analysis does not speak directly."
329 Although not the subject of analysis by Landes and Posner, the second test was considered in some detail by T Krattenmaker, R Lande and S Salop in, "Monopoly Power and Market Power in Antitrust Law" 76 Georgetown Law Journal 241 (1987). The authors argue that the core concept underlying the notion of market power is a firm's ability to increase profits and to harm consumers by charging prices above competitive levels. They point out that this can be achieved directly by restricting output: the classic formulation of market power. On the other hand, the authors explain that the same result may be achieved indirectly by raising a rival's costs, thereby causing it to restrict its output. This, the authors say, is at the bottom of the claimed harm to competition by excluding competitors. On this analysis, the second test formulated by the Supreme Court in du Pont is not so easily dismissed.
330 More importantly for present purposes, the fact that market power can be exercised by means other than the power to raise price by restricting output was accepted by Dawson J in Queensland Wire. There his Honour said (at 200):
"But market power has aspects other than influence upon the market price. It may be manifested by practices directed at excluding competition such as exclusive dealing, tying arrangements, predatory pricing or refusal to deal. The ability to engage persistently in these practices may be as indicative of market power as the ability to influence prices. Thus Kaysen and Turner define market power as follows: 'A firm possesses market power when it can behave persistently in a manner different from the behaviour that a competitive market would enforce on a firm facing otherwise similar cost and demand conditions. (Kaysen and Turner, Antitrust Policy (1959) p.75).'… Market power is thus the advantage which flows monopoly or near monopoly…"
(Of course, for the purpose of s 46, in its current form, it is not necessary to show the power of a monopolist or near monopolist.)
331 Generally, an analysis of abuse of market power involves a two-stage process: first, it is necessary to determine whether a firm has market power, second it is necessary to examine whether that power has been abused. However, when the existence of market power is defined by reference to a firm's ability to exclude competition, the two step investigation is not appropriate. The evaluation of market power and the abuse of that power is part of one analysis. The existence of market power based on this approach cannot be examined independent of the alleged exclusionary conduct. It is the exclusionary conduct that establishes market power, not the reverse.
332 I mentioned earlier that any consideration of market power must necessarily take into account barriers to entry. Scherer & Ross have referred to entry barriers as the sine qua non of monopoly: FM Scherer and D Ross, Industrial Market Structure and Economic Performance at p 18. Barriers to entry are perhaps the single most important determinant of a firm's ability to exercise market power, although the extent to which it faces competition from existing rivals is obviously important.
333 It may be accepted that if there are absolutely no barriers to entry, that is where entry is free (not disadvantageous) and exit is costless (no sunk costs) there can be no effective market power. In such a market, a perfectly contestable market as it is usually referred to, an incumbent enjoys no advantages because cost and demand conditions are symmetrical between all firms, actual and potential, and sunk costs are presumed to be zero. Of course, there is no perfectly contestable market to be found outside the economists' model. Every real market has real barriers.
334 The issue of what constitutes a barrier to entry has given rise to a body of literature. Indeed, it is difficult to find a definition that commands wide acceptance. Here it will be sufficient to refer to the more popular meanings. The main definitions are in terms of cost symmetries or in terms of the ability of the incumbent firm or firms to earn supra competitive profits in the long run without attracting entry.
335 One of the most important definitions is that proposed by J S Bain in his seminal work Barriers to New Competition (1956). Bain described barriers to entry (at p 3) as:
"…the advantages of established sellers in an industry over potential entrant sellers, these advantages being reflected in the extent to which established sellers can persistently raise their prices above a competitive level without attracting new firms to enter the industry."
336 Thus, a barrier to entry exists if an entrant cannot achieve the same profit as the incumbent. Bain also argued that a barrier is fundamentally a structural characteristic of a market. He would not accept, for example, that an incumbent's behaviour was a relevant influence on a potential entrant. Nor would Bain regard as a barrier transitory market conditions such as trade cycles and so forth.
337 According to Bain, barriers would exist if the incumbent had absolute cost advantages such as would flow from legal restrictions (patents and the like), access to limited raw materials, technology and other scarce factors relating to production, and the capital cost of establishing a new firm. Bain also includes as a barrier the advantage flowing from the preference for the incumbent's goods which an entrant could only avoid by lowering prices or engaging in expensive advertising. Probably the most common structural barrier is that which arises from economies of scale. These he characterised as real economies of scale (those existing in relation to production and distribution), pecuniary economies of scale (giving the firm greater bargaining power), and real or strictly pecuniary economies of large-scale advertising and sales promotion.
338 G J Stigler in The Organisation of Industry (1968) at p 67 proposed an alternative definition which is often referred to in industrial organisation literature. According to Stigler a barrier to entry is:
"…a cost of producing (at some or every rate of output) which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry."
By this definition any cost advantage of an incumbent over a potential entrant is a barrier to entry. Thus, inadequate demand resulting from an economic cycle would be as much a barrier as would economies of scale.
339 C C von Weizsäcker widened Stigler's definition to incorporate an explicit consideration of economic welfare. In his article entitled "A Welfare Analysis of Barriers to Entry" 11 Bell Journal of Economics 399 at 400 (1980), von Weizsäcker defined a barrier to entry as:
"a cost of producing (at some or every rate of output) which must be borne by firms which seek to enter an industry but is not borne by firms already in the industry and which implies a distortion in the use of economic resources from the social point of view."
340 More recently, economists have turned from economic models to dynamic market behaviour to determine what is a barrier to entry. P Geroski and J Schwalbach (eds) Entry and Market Contestability: An International Comparison (1991) give this definition:
"Barriers to entry are obstacles which inhibit the ability of firms outside a market to enter and compete with established insiders."
341 This definition has significant advantages over some of the earlier ones. It follows the recent trend of economists to broaden barriers beyond those that are structural, to incorporate the strategic behaviour of incumbent firms. In particular, it is now accepted by many economists that the behaviour of incumbent firms to exclude rivals by a variety of restrictive or uncompetitive practices is as much a barrier to entry as any structural condition that may exist in a market: see, eg, P Geroski, R J Gilbert & A Jacquemin Barriers to Entry and Strategic Competition (1990) p 15ff; A van Witteloostuijn Barriers to Entry and Dynamic Economies - A Survey and Critique (1986). This approach recognises the realities of a market. It also involves the rejection of the Chicago School economists' view that these practices should not be the concern of antitrust law because they are motivated by considerations of efficiency.
342 Incumbents are often willing to take action that will result in short-term reductions in profit to prevent the establishment of a new entrant. Some economists refer to these deterrent activities as "strategic" barriers to entry, "purposely enacted to redress the possibility of entry" as opposed to "innocent" entry barriers "unintentionally erected as a side effect of innocent profit maximisation": S Salop, "Strategic Entry Deterrence" 69 American Economic Review 335 (1979).
343 Two types of exclusionary behaviour are presently relevant. The first is the predatory pricing that was carried out in a sustained fashion between 1993 and 1996. It is of no surprise that an incumbent firm with large financial resources might seek to drive out a financially constrained rival by engaging in price cutting for a sustained period. A rival will exit before the price war has become too prolonged: D Harbord and T Hoehn "Barriers to Entry and Exit in European Competition Policy" 14 International Review of Law and Economics 411, 420 (1994). Further, a prospective entrant may stay out of the market altogether. As Harbord and Hoehn point out, and as common experience shows, the presumption that predation is not a rational strategy has been shown to be false. They also explain that one reason for predatory behaviour is the incumbent's wish to achieve a reputation for predation in order to deter future prospective entrants. See also D L White "Shaping Antitrust Enforcement: Greater Emphasis on Barriers to Entry" Brigham Young Law Review 823, 845-846 (1989), where the author discusses "limit pricing" as a barrier to entry. 'Limit pricing' is the charging of a price low enough to discourage entry but sufficient to provide an economic profit. Moreover, an incumbent can erect a larger barrier to entry if the nature of the group of which the incumbent is a member allows substantial temporary losses. For example, diversified or vertically integrated firms, because of their ability to cross-subsidise, can engage in sustained predatory pricing thereby raising very real barriers to entry.
344 What I have said so far about predatory pricing being a barrier to entry is not a universally accepted proposition. For example, it does not accord with the views of Professor Hay, whose opinion on this issue was accepted by the trial judge. Professor Hay said:
"In the course of this case, the concept of a barrier to entry has been distorted beyond recognition. If only for the benefit of future generations of would-be economists, one point must be made emphatically - low prices are not a barrier to entry. A barrier to entry is a factor that would deter a new firm from entering the market, even though the incumbent firm (or firms) is charging monopoly prices and earning monopoly profits. It is therefore a contradiction in terms to talk about low prices as a barrier."
345 There are a number of comments that can be made about this testimony. The first is that it seems to confine an entry barrier to one that occurs only when the incumbent is earning monopoly profits. This is unnecessarily restrictive and wrong in my view. Second, it echoes the views of economists who believe that barriers to entry are structural and not dynamic. This is no longer a mainstream opinion. Finally, and I mean no disrespect to Professor Hay when I say this, it confuses the ideal market with the real market. The fact is that there are firms that engage in predatory behaviour to be rid of competition, whether or not it is a rational strategy from an economist's stand point. When it is necessary to assess market power it is inevitable that entry barriers resulting from predatory behaviour must be considered. Indeed, I rather suspect that Professor Hay begrudgingly recognises this. In "Predatory Pricing" 58 Antitrust Law Journal 913 (1990), Professor Hay wrote (at 918-919):
"Another potential problem with entry barriers as a filter is that, according to some commentators, the very active predatory pricing can create disincentives for subsequent entry. By way of example, suppose we observed that the private garbage-hauling business in most parts of New York City was effectively monopolized, one company having all the business on the Lower East Side, another company, the Upper East Side, and so forth. If we looked only for the traditional structural barriers to explain the absence of entry, eg, capital market barriers, brand loyalty, or high sunk costs, we might be inclined to characterize the market as contestable. Cynics, on the other hand, might observe that the barrier to entry is that if you tried to enter that business you would end up in the East River with cement overshoes. I don't want to overdo the point, but simply to point out that, according to some economists, a major barrier to entry in certain markets will be the reputation of the monopolist as one who will stop at nothing to get rid of its rivals."
346 For my part, I would accept the views of those economists who consider the dynamics of a market to determine its barriers, in preference to opinion of Professor Hay, in the passage quoted from his evidence. If Professor Hay's thesis be accepted, it will render less effective in the face of damage to a market not only s 46, but also those other provisions in Part IV of the Trade Practices Act a breach of which depends upon the establishment of market power.
347 The second aspect of exclusionary behaviour is the upgrade of the plant at Deer Park to increase BBM's production capacity. Excess capacity should also be regarded as a barrier to entry. van Witteloostuijn notes (at p 7) that:
"An incumbent firm with excess capacity disseminates the threat of increasing output after the appearance of an entrant and hence the threat of reducing prices. Reduced post-entry prices imply less profitable entry."
Hence, he says that excess capacity is a barrier to entry. I agree. More importantly, even if the threat to make use of excess capacity is not usually sufficient to deter entry, it most certainly will during a price war. This is what BBM understood only too well. As I have pointed out, when BBM decided to increase its capacity at Deer Park, it publicised that fact to exert "psychological pressure" on its rivals. What was that "psychological pressure"? BBM intended to signal to its rivals that it was willing to continue to wage the price war for some time and that it would bear whatever losses may result. The case for a strategically-erected barrier to entry could not be more clear.
348 There is another aspect of strategic barriers to entry that should be mentioned. The creation or strengthening of barriers to entry can, in appropriate circumstances, be seen as a misuse of market power. Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (1999) 90 FCR 128 is an example of such a case. There the incumbent had a near monopoly in the supply of street directories in the relevant market. It refused to supply a former customer to keep it out of the market. That refusal was held to be in breach of s 46. Plainly enough, the refusal to supply was a barrier to entry. The case is not much different from one where the incumbent has control of a scarce resource. At the same time as raising an entry barrier, the refusal to supply was an abuse of market power because its purpose was to impede competition in the street directory market.
349 In my opinion, BBM has substantial power in the concrete masonry product market and it misused that power for a relevant purpose when it engaged in a predatory pricing scheme. A similar allegation against Boral Limited, BBM's parent company, was abandoned during the appeal. Accordingly, the appeal should be allowed in part, the orders made below in favour of BBM should be set aside, and a declaration should be made to the effect that BBM has contravened s 46. The matter should be remitted to the trial judge to determine the precise form of that declaration, whether any injunction should be ordered and what penalties