South Africa’s Second Price Gouging Case: Dis-Chem Penalised For Excessive Pricing re Face Masks*
On 14 July 2020, the South African Competition Tribunal published its written reasons in relation to its decision to penalize Dis-Chem (a large pharmaceutical chain in South Africa) for contravening section 8(1)(a) of the Competition Act by charging excessive prices for a variety of surgical face-mask products.
The Tribunal’ latest price gouging decision follows closely on the heels of the Tribunal’s decision in Babelegi, which was the first decision price gouging decision in South Africa during the Covid-19 pandemic (in terms of which the Tribunal also imposed a penalty on Babelegi based on a finding that Babelegi charged excessive prices for face masks during the pandemic). Babelegi was a firm which -pre-Covid 19 had a market share of less than 5%.
Turning to the Dis-Chem case, the price increases at play for three different face-masks were 261%, 43% and 25% respectively, on 9 March 2020 as the Covid-19 pandemic gripped South Africa, but before the Minister of Trade and Industry published the commonly referred to ‘Price Gouging Regulations’ (Regulations). The Regulations, promulgated, on 19 March 2020, essentially place a reverse onus on dominant firms (in relation to a defined list of “essential goods”) to demonstrate why any price increases post the proclamation of the Regulations, which were not directly and proportionally linked to a corresponding cost increase, are not “excessive”.
Although the Competition Commission (SACC) had initially framed its case in terms of the Regulations, the Tribunal confirmed that the Regulations did not apply retroactively. Accordingly, the Tribunal proceeded to analysis the complaint in terms of section 8(1)(a) of the Act read together with the factors set out in section 8(3) of the Act in order to determine whether a price is excessive. This is noteworthy as the principles underpinning the Dis-Chem decision are applicable regardless of whether the Regulations are, or remain in, force and may well apply to cases beyond the Covid-19 pandemic.
In terms of the recently amended Competition Act, an “excessive price” is defined as a price which has “no reasonable relation to the economic value of the product”. If there is a prima facie case of excessive pricing, the onus shifts to the respondent to demonstrate that the price is not excessive.
The Tribunal held that in order to demonstrate an “excessive price”, what the complainant must show is a price which “on the face of it was utterly exorbitant”. The respondent would then need to show that the increase was reasonable.
The crux of the case, however, largely turns on whether Dis-Chem is in fact considered “dominant”. Dominance, generally, is determined with reference to whether a firm is able to exert a substantial degree of “market power”. In terms of South Africa’s Competition Act, a firm is irrebuttably presumed to be dominant if it has market shares in excess of 45%. A firm can still be found to be dominant, however, with market shares less than 45% if it can be established that the firm is able to exert “market power”. “Market power” is specifically defined in the Act as “the power of a firm to control prices or to exclude competition, or to behave to an appreciable extent independently of its competitors, customers or suppliers”.
The Commission argued that defining the relevant market was not necessary. Rather, the fact that Dis-Chem was able to materially increase its prices in the context of a global health crisis independently of its competitors, customers or suppliers, meant that Dis-Chem was able to exert “market power” and was therefore “dominant”.
The Tribunal confirmed that the assessment of “market power” may be conducted with reference to the prevailing market conditions without having to specifically define the market. In essence, the Tribunal asked itself what advantages the global-health crisis conferred to the respondent (in this case Dis-Chem) that it would not enjoy absent the crisis?
At the time of the relevant price increase, the public were encouraged to wear surgical face-masks. The Tribunal rejected, therefore the argument raised by Dis-Chem that cloth face-masks are a suitable substitute. Dis-Chem had argued that barriers to entry were low as face-masks where easy to produce from a supply-side. The product market was broadly defined as the market for surgical face masks.
Turning to the geographic market definition, the Tribunal suggested that the geographic market must be narrowed (based on customers reluctance to travel far during the pandemic) despite Dis-Chem applying a national pricing strategy. The Tribunal ultimately did not define the geographic market. Instead, its assessment essentially refers back to that relating to the tests for market power. In essence, the Tribunal held that because there were concerns among consumers about supply shortages, consumers would not be prepared to “shop around” for better options fearing they may miss out altogether. The Tribunal mentioned that applying the well known “hypothetical monopolist test”, that Dis-Chem would have been able to profitably raise its prices by more than 5% and, therefore, was essentially in its own market (the Tribunal did not define the precise geographic boundaries of the market even though these was evidence put up suggesting that there were many suppliers of surgical face masks within a very small geographic radius of Dis-Chem’s largest outlets). Accordingly, this case was not determined by narrowing the geographic market.
Turning to the economic tests utilized or considered by the Tribunal, the following is summarized:
- The relevant “benchmark” price used was the price immediately before the Covid-19 pandemic compared to the prices thereafter.
- The relevant complaint period was held to be 1-31 March 2020.
- That the empirical evidence assessed pointed to an increase in prices in March (compared to prices prevailing in January and February) without a direct link to cost increases. Consequently, the Tribunal found that the gross-margins increased “exponentially” during the complaint period.
- The Tribunal rejected the argument that for multi-product retailers, profit margins ought to be assessed with reference to “net” as opposed to “gross” margins. In other words, the Tribunal precluded any cross-subsidization type defences.
The Tribunal found that had it not been for the surge demand for surgical face-masks as a result of the health crisis posed by Covid-19, Dis-Chem would not have been able to increase the prices to the extent it did. Further, the Tribunal found Dis-Chem enjoyed and exerted market power by substantially increasing its prices and profit margins for face-masks and therefore the SACC had established a prima facie case of excessive pricing which shifted the burden of proof to Dis-Chem to show its price increases were “reasonable”.
In determining whether a price increase is “reasonable”, the Tribunal appears to disfavour any economic assessment to the inquiry. Instead the Tribunal suggests that any price increase (presumably irrespective of the percentage increment) in relation to an item essential for the public’s health is unreasonable. Following the Tribunal’s earlier finding that the price increases were substantial, the Tribunal held that Dis-Chem’s price increases during the pandemic were “utterly unreasonable and reprehensible”.
As an aside, the Tribunal suggests that the price increase of any good in South Africa between 47%-261% would affect the public interest adversely. In the context of a health crisis where those increases related to essential goods, the price increase has a particular impact on poor customers.
Accordingly, the Tribunal found that Dis-Chem had engaged in excessive pricing in contravention of the Act and imposed a penalty of R1.2 million (which was calculated based on approximately twice the turnover which Dis-Chem derived from face-masks during the complaint period).
The Tribunal’s decision in Dis-Chem provides more analysis and considerations to market definition than the case of Babelegi although the central features and findings in both cases are the same. Due to the Covid-19 pandemic, both Dis-Chem and Babelegi charged higher prices to consumer in relation to products considered essential to the health and well-being of the public and because these price increase were nor justified with reference to cost increases, the prices were considered “excessive”.
The Tribunal (as part of its assessment under the geographic market definition analysis) provides an important qualifier to intervening in matters arising from short-term market conditions. In particular, the Tribunal stated that “material price increases of life essential items such as surgical masks, even in the short run, in a health disaster such as the Covid-19 outbreak, warrants our intervention”. This is an important caveat as the Tribunal appears to recognize that intervening in competition law matters based on short term market conditions may have unintended consequences and that ordinarily competition authorities should allow the market to “self-regulate”.
While opportunistic and exploitative behaviour during a time of crisis may indeed warrant scrutiny, one does question whether these decisions fall into the classic “hard cases make bad law” dictum coined by US Supreme Court Justice, OW Holmes.
Different standards of law and economics should not apply to firms simply based on the type of product that they produce or sell. To punish a firm because it supplies essential healthcare products may indeed be a noble public interest objective, but caution must be had to using mechanisms such as the Competition Act to achieve these outcomes if the economic principles and justifications do not stack up.
While the Tribunal was at pains to point out in Dis-Chem that context matters, it is less clear precisely what context matters in excessive pricing cases going forward. Are the market dynamics due to the Covid-19 pandemic an outlier unlikely to repeat itself in history and that the Tribunal’s recent price gouging decisions should be assessed in that context? Or, does the Tribunal’s decision effectively mean that any firm who is able to profitably increase a price by 5% has market power (and is, therefore, dominant) and, therefore, any such price increase (unless linked proportionately to a cost increase) is prima facie excessive? When will the Tribunal intervene in excessive price cases and when will it allow the normal forces of supply and demand and the hallmark features of a dynamic competition to rectify any market abnormalities?
While the Tribunal suggests that a 47% increase and above would be excessive for “any good” in South Africa, the Tribunal does not provide much guidance on where to the draw the line. The Tribunal rejected the US’s guidance which refers to a 10% increase (in the context of a price increase of an essential good). Previously the Competition Appeal Court in the Sasol judgment suggested (without setting a firm benchmark) that a price which is less than 25% more than the economic value of the product cannot be said to be excessive.
While the Tribunal does make cursory mention of the prices of other competitors, the Tribunal seems to err in one important regard. Excessive price cases and indeed the assessment of market power should not be conducted with reference to the overall demand shock in the market but with reference to the firm’s ability to act independently of other competitors in the same prevailing market conditions. A comparison therefore between pre-market shock and post-market shock insofar as the shock applies to the whole market, is somewhat irrelevant.
If the overall demand for face-masks increased and all face-mask suppliers are able to profitably increase their prices for face-masks during the relevant period, it can hardly be said that every face-mask supplier is “dominant” during that period. If all ice-cream suppliers raise their prices in summer versus winter that would clearly not be a result of ice-cream suppliers having market power during the summer months only. The Tribunal’s analysis in Dis-Chem does not seem to answer this issue and in fact lends credence to such an outcome which would clearly not be supported by any credible economic justification.
The Tribunal does not deal with another important aspect relating to principles of supply and demand more generally. The Tribunal recognizes that there were (and are) a shortage of supply for face-masks. It was the shortage of supply (be it actual or potential) which in fact led to “panic buying” and higher demand and therefore higher prices. To suggest that the poorest customers are most likely to be harmed due to price increases following demand shocks is correct. However, all customers (including the poorest) are likely to be harmed if the supply shortage cannot be addressed and is perpetuated by the on-going health crisis. The most sensible way to encourage entry into the supply side market for face-masks is to allow such firms to earn short term profits which it would not otherwise enjoy. Without the upside incentive, new entry into the supply side market is unlikely and the only disciplining safeguard left in the market is quasi-price regulation by the competition authorities. The forces of competition in such instances are, therefore, precluded from being allowed to operate to restore the market to competitive levels. The Tribunal, however, recognizes in the Dis-Chem decision that in certain instances it should in fact play the role of a price regulator.
So where does that leave us? Firstly, it seems very likely that the Dis-Chem decision will be taken on appeal. Until such time as the Tribunal’s decision is altered (if at all), firms selling goods which are considered “essential” in the fight against Covid-19 should take particular cognizance of this decision. Secondly, the price gouging regulations published by the Minister are essentially rendered nugatory by the Tribunal’s approach to excessive pricing cases. Thirdly, regardless of the size of the firm pre-Covid, if a firm is able to increase its prices unilaterally as a result of a demand shock following the Covid health, there is a significant risk that the Tribunal will consider such a firm to possess market power and hence unless such price increase is justified with reference to cost increases, potentially liable to an administrative penalty (and possibly follow-on civil damages).