By Lerisha Naidu, Partner, and Ryan Mckerrow, Associate, Competition Practice, Baker McKenzie, Johannesburg
The Competition Commission of South Africa (commission) is renowned for being one of the most active regulators on the African continent. Having said that and in the context of its unprecedentedly vociferous pursuit of excessive pricing complaints (largely a result of new regulations in response to the COVID-19 national disaster), it appears that the commission has surpassed even its own reputation. Commissioner Bonakele has remarked that intervention by the commission is necessary to protect cash-strapped consumers from price hikes in relation to life-saving products during arguably the worst time in our history. Against this backdrop, commissioner Bonakele has assured the public that the commission will spare no effort in its drive to protect consumers from exploitation.
This is undoubtedly a laudable intention, particularly in the context of ensuring the prevention of prejudice to consumers arising from the sometimes-unequal bargaining power that inhibits their ability to demand products from dominant firms at fair prices and on fair terms.
There can be little argument that the commission’s recent focus should be situated within the four corners of the empowering legislation and regulations to have complete legitimacy. To this end, it bears emphasising that the Competition Act’s (act) prohibition on excessive pricing is one that applies only to firms that are dominant players in the markets in which they operate. Yet, the commission has recently demonstrated a keen interest in pursuing complaints against small, largely unknown firms – firms that may even struggle to secure the necessary specialist legal advice to defend themselves before the competition authorities.
Excessive pricing in terms of the Competition act
The act prohibits a dominant firm from charging excessive prices for its products to the detriment of consumers or customers. A host of factors are to be taken into account when assessing whether a firm’s prices are excessive, including, inter alia, its profit margins, its return on capital, its prices for other products, the prices charged by its competitors for similar products, and the structural characteristics of the market.
Assessing whether a firm’s prices are excessive for the purposes of the act is a notoriously complex task. However, the recently issued Consumer and Customer Protection and National Disaster Management Regulations (regulations), which apply during the COVID-19 national disaster, simplify the assessment when the impugned prices relate to basic food and consumer items; emergency products and services; medical and hygiene supplies; and emergency clean-up products and services. The regulations do so by providing that, in respect of these categories of essential products, a price will be presumed to be excessive if it results from an increase that:
- a) does not correspond, or is not equivalent, to an increase in the costs associated with the product; or
- b) raises the net margin or mark-up on the product to a level that is above the average margin or mark-up for that product for the period from 1 December 2019 to 29 February 2020.
It is important to note that the regulations simply streamline the assessment as to whether price levels are excessive. They do not oust the crucial prerequisite for embarking on that assessment, namely the requirement that the impugned firm be dominant in its particular market.
Without dominance being established, the excessive pricing prohibition does not apply, even if exorbitant profits are being extracted. This does not, however, mean that such prices are automatically legally permissible. They may well fall within the ambit of the unfair pricing prohibition contained in the Consumer Protection act – a prohibition that does not depend on dominance for its application. They may even be the result of collusion between firms through coordinated, concerted conduct, which is prohibited in terms of competition law. What it does mean though, is that the competition authorities should not pursue excessive pricing cases in the absence of dominance, regardless of the public outrage that such prices may cause, bearing in mind that there are other legal avenues to chastise and deter such pricing behavior.
A firm is dominant, for competition law purposes, if it has a market share of at least 45%, or its market share is less than 45% but it has market power. Market power is, inter alia, the ability of a firm to control prices independently of its competitors, customers or suppliers.
A dominant firm that is found to have engaged in excessive pricing may be liable for a penalty of up to 10% of its annual turnover in, and exports from, South Africa during its preceding financial year. This penalty cap is increased to 25% of the offending firm’s annual turnover and exports in circumstances where the alleged pricing practice is substantially a repeat of previous conduct that was determined by the competition authorities to have amounted to excessive pricing.
Prosecutions and settlements
The first excessive pricing case to be instituted since the passing of the regulations was heard by the Competition Tribunal (tribunal) on 23 April 2020. The respondent firm was Babelegi Workwear and Industrial Supplies (Babelegi), a Pretoria-based firm accused of charging excessive prices for face masks in the lead-up to the declaration of a national state of disaster. The commission has submitted that, between December 2019 and March 2020, Babelegi hiked prices by at least 888%. In an unprecedented move, the commission requested an award of treble damages against Babelegi — an onerous punitive measure that has been adopted in the United States but has not found its way into South African law. The Tribunal’s decision in this matter is imminent.
On the same day that the Babelegi case was heard, the commission announced its referral of a second COVID-19-related excessive pricing complaint to the tribunal – this time against Dis-Chem Pharmacies (Dis-Chem), a national pharmaceutical wholesale distributor and retailer. According to the commission, its investigations revealed that Dis-Chem was another firm to have exploited customers in respect of face masks, increasing its prices by as much as 261% between February and March 2020. The case was argued on 4 and 6 May 2020, with the commission seeking the maximum possible penalty against Dis-Chem. Again, a decision by the Tribunal is imminent.
The commission has recently announced its referral of two further COVID-19-related excessive pricing complaints to the Tribunal. This follows its finding that Sicuro Safety and Hennox Supplies increased their prices for face masks by more than 969% and 956%, respectively. It is anticipated that further details will be released in the lead up to the Tribunal hearings.
In tandem with the above prosecutions, the commission has been active in investigating and reaching settlement agreements with other firms accused of COVID-19-related excessive pricing. The first of these agreements was confirmed as an order of the Tribunal on 20 April 2020. The counterparty was Centrum Pharmacy (Centrum), a Boksburg-based firm alleged to have excessively priced face masks. The commission found that Centrum had, during March 2020, levied an average mark-up of 150% on the face masks it sold to customers. As part of the settlement, Centrum agreed to donate essential products to the value of ZAR2 5410 to two old-age homes in Boksburg.
The second settlement agreement in the context of COVID-19-related excessive pricing was confirmed as an order of the Tribunal on 23 April 2020. The counterparty here was Main Hardware, a firm operating a Johannesburg-based hardware store that is alleged to have inflated the prices of surgical gloves sold to its customers in March 2020. The commission found that, during this period, Main Hardware had levied a mark-up of 96.53% on its surgical gloves — representing an increase of 19.75% on its mark-up prior to the COVID-19 national disaster. As part of the settlement, Main Hardware agreed to refund all of its customers that purchased surgical gloves at inflated prices the amount paid in excess of a 10% margin.
On 1 May 2020, the Tribunal announced its approval of a third settlement agreement in the context of COVID-19-related excessive pricing. This follows investigations by the commission into Evergreens Fresh Market (Evergreens), a supplier of fresh produce in Kempton Park, which revealed that Evergreens had earned an average margin of approximately 33.4% on hand sanitizers during March 2020. The commission found this to be unreasonable, taking the view that a reasonable margin on hand sanitizers would be between 20% and 25%. As part of the settlement, Evergreens agreed to donate hand sanitizers to the value of ZAR1 800 to a provincial hospital.
The fourth settlement agreement to be confirmed by the Tribunal in respect of COVID-19-related excessive pricing was announced on 6 May. This time, the implicated firm was Matus, a distributor of personal protective gear with its major branches in Johannesburg, Cape Town and Durban. Matus was accused of excessive pricing in respect of face masks. The firm admitted to having increased its gross profit margins during February and March 2020, but did not admit to having contravened any law by doing so. The stated reason for settling with the commission was to avoid protracted litigation. In terms of the settlement agreement, Matus agreed to pay a fine of nearly ZAR6 million and to make a ZAR5 million contribution to the Solidarity Fund for COVID-19.
In a media release announcing its settlement with Matus, the commission indicated that it had also concluded further excessive pricing settlement agreements with numerous small independent retailers – mostly pharmacies and hardware stores. It is anticipated that further details of these settlements will be made public once confirmed by the Tribunal.
Most recently, on 7 May, three further settlement agreements in respect of COVID-19-related excessive pricing were announced as being confirmed by the Tribunal. The first two involved the Nelspruit and Pretoria branches of the Van Heerden Pharmacy Group (Van Heerden Pharmacy), which were found by the commission to have hiked their prices for face masks and hand sanitizers, respectively, during February and March 2020. In terms of the settlement relating to its Nelspruit branch, Van Heerden Pharmacy agreed to pay a fine of ZAR30 000. The Pretoria branch settlement, on the other hand, requires Van Heerden Pharmacy to donate ZAR3 875 to the Solidarity Fund for COVID-19.
The third of the 7 May settlements involved Mandini Pharmacy, a KZN-based operator that is alleged to have inflated the prices of the face masks it sold during March 2020. In terms of the settlement, Mandini Pharmacy agreed to donate essential goods amounting to ZAR 300 to a local child welfare organisation.
The nature and, in particular, the amounts of the recent settlements by the commission are certainly out of line with what one would expect when there has been an alleged abuse of dominance. Abuse of dominance settlements ordinarily entail exponentially larger fines against much larger firms. This raises the question of whether this departure from the norm is a justifiable response to the unprecedented circumstances we are currently experiencing, or whether it is perhaps an indicator that the commission’s attack on price gouging has been a misdirected one.
The details of further settlement agreements confirmed by the Tribunal are expected to be released in the coming days and will no doubt be of great interest to the legal and business communities.
A question of dominance
The commission’s approach to market power
In the Babelegi and Dis-Chem cases, the commission argued that the respondent firms were dominant in the market for the sale of face masks by virtue of their temporary market power demonstrated by their high pricing. The firms responded by, inter alia, denying that they were dominant or that they possessed market power.
Similarly, in the Centrum, Main Hardware and Evergreens settlement agreements (being the only agreements of those mentioned above to be made publicly available at the time of the writing of this article) it was recorded that:
“…the mere ability to raise prices is indicative of market power as it demonstrates a lack of constraints such that there is an ability to control prices and/or behave independently of competitors or customers … States of disaster often provide the conditions for temporary market power to be held by market participants that may not otherwise have market power outside of the disaster period. The removal of constraints may occur for several reasons, many of which are conceptually related to a narrowing of the geographic market for products as a result of disruptions to the normal functioning of markets. Due to the national lockdown, the scope of the geographic market is narrow as citizens’ movements are heavily restricted.”
In essence, the commission’s stance is that the charging of high prices as a result of market narrowing is, in and of itself, indicative of an ability to act independently of competitors, customers or suppliers. Accordingly, high prices demonstrate market power, which, in turn, gives rise to dominance.
The COVID-19 national disaster has, of course, resulted in commercial disruptions; and these have certainly had a narrowing effect on many markets. With restrictions on travel, markets that rely on conventional distribution methods have shrunk geographically. Similarly, restrictions on the operation of certain businesses have reduced the number of participants in particular markets. Nevertheless, it is questionable whether this, coupled with high prices, is indicative of market power.
Market power requires that a firm is able to behave independently of its competitors, customers or suppliers. Accordingly, competitor, customer and supplier dynamics can each serve as a separate basis for market power. The question to be asked, however, is whether high prices alone provide sufficient insight into these dynamics to enable a firm’s independence from its competitors, customers or suppliers to be assessed. The commission argues in the affirmative, but its approach is vulnerable to scrutiny.
With well over 1000 COVID-19 complaints having already reached the commission, the apparent evidence, albeit largely untested, is that suppliers of essential products are elevating prices in relative unison. Accordingly, they are acting in concert rather than independently of each other. This means that they cannot, at least on the basis of high prices insofar as they are purported to be a signal of competitor dynamics, be regarded as having market power. For market power to be established on the basis of competitor dynamics, it must be shown that the impugned firms would have been able to elevate their prices even in the absence of their competitors doing so. This requires an analysis that extends beyond prevailing prices and that accounts for the particular market conditions within which each firm operates.
There will, of course, be circumstances where markets are indeed constrained and the firms operating within them may even have large market shares, but this does not necessarily mean that they can charge elevated prices in the absence of a similar approach by their competitors. If within a particular market there is sufficient supply, a firm charging significantly higher prices than its competitors will fail to attract customers and will be unable to sustain those prices. Of course, this relies on supply being sufficient relative to demand, which will not always be the case, particularly in times of national disaster. However, in the current circumstances, providers of essential products are encouraged to continue operating and markets for essential products are therefore materially constrained mostly from a geographical perspective. What this means is that different geographical markets for the same product may experience very different supply and demand conditions. These conditions need to be considered on a case-by-case basis in order to determine whether a firm has market power.
Similarly, high prices do not, in and of themselves, demonstrate an ability to act independently of customers. Independence, in this context, must be assessed by reference to the response of a firm’s customers to its price increases. A price hike may result in a firm losing a significant portion of its customer base. Customers may be lost not only in respect of the products that have become more expensive, but possibly also in respect of complementary and other products sold by the firm. Losses of this kind will likely arise where price hikes reduce foot traffic in stores. In such circumstances, high prices are certainly not indicative of market power on the basis of customer dynamics.
Competitor and customer dynamics define a firm’s pricing abilities and inform its decisions on the supply side of its business. This explains their overlapping influences on firm behavior. Supplier dynamics, on the other hand, feature more prominently on the buying side. Typically, one considers a firm to have market power on the basis of supplier dynamics if it has buyer power, which is the ability to influence the price, quantity or other characteristics of the products it purchases. With supplier dynamics being a buying-side factor, it is conceptually difficult to establish a link between a firm’s ability to charge high prices and any alleged independence from suppliers. Accordingly, high prices are not a reliable indicator of market power on the basis of supplier dynamics.
An augmented approach to market power
The above considerations reveal that a blanket approach to market power underpinned by the notion that high prices are a result of constrained markets and must, invariably, be indicative of market power should simply not suffice.
A firm charging high prices may well be dominant in the market in which it operates. Nevertheless, while market dominance enables a firm to charge high prices, high prices are not necessarily indicative of market dominance. The commission’s approach to excessive pricing in the context of the COVID-19 national disaster falters insofar as it fails to acknowledge this. And by doing so, it advocates a superficial approach to the dominance analysis, which neglects to account for broader market conditions.
A failure to properly consider the nature of the particular market within which each impugned firm operates may lead to a finding that a firm that, in reality, has no market power is dominant. This, from a legal perspective, is untenable. This is not to say that the firm in question is necessarily acting lawfully. As mentioned above, the firm may well be in violation of the Consumer Protection act’s prohibition on unfair pricing, or even the competition law prohibition against anti-competitive concerted practices. But it does mean that prosecuting the impugned firm on the basis of an abuse of dominance is an inappropriate line of attack.
Accordingly, dominance must be assessed robustly. This requires a methodology that is not misdirected due to assumptions that may not necessarily accord with the features of the particular market under study. In line with this approach, market power must be considered in the context of the supply and demand conditions characterising the market and not simply the prices charged by the impugned firm.
With the onset of the COVID-19 national disaster and the consequent passing of the regulations, the commission has zealously pursued firms implicated in alleged excessive pricing of essential products. The first prosecutions are already underway and numerous settlement agreements with other firms have been reached. Surprisingly though, it appears that the commission has been targeting small operators rather than the large firms the excessive pricing prohibition was intended to restrain.
This is concerning on two fronts. First, an important part of the commission’s mandate is to enable small firms to effectively participate in the South African economy, rather than hindering their ability to do so. Secondly, with the country facing a recession and the world experiencing an economic crisis, small firms that are already struggling financially may well collapse should they face financial penalties. This, in turn, will of course impede rather than improve competition. This is not to say that small firms should be permitted to opportunistically exploit the COVID-19 national disaster for selfish commercial gain against the interests of the everyday consumer in desperate need of essential products. However, the punitive outcomes should not only fall within the ambit of the empowering law but should also avoid crippling small businesses during potentially calamitous economic times.
The commission’s pursuit of small operators is based on the assumption that all firms charging high prices must, by virtue of their ability to do so, be dominant in their respective markets. However, this is not necessarily the case and a more detailed analysis, taking account of the particular market conditions within which a firm operates, is required in order to determine whether it is dominant. Again, this does not mean that elevated prices by non-dominant firms are morally acceptable or even legally permissible. This article simply advances the point that the act’s prohibition on excessive pricing is an inappropriate tool for dealing with potentially exploitative small businesses and the commission should revise its approach to such cases, if it is to have one at all.