2.5.3 Vertical Price Squeeze

To be able to implement a vertical price squeeze, a firm must be vertically integrated, and control an essential wholesale input to the retail service. A firm implementing a price squeeze offers to supply this essential input to its retail competitors only at a price greatly in excess of its costs.

The key elements of a price squeeze are:

The firm demands a price for the essential facility that is so high that it is not possible for an equally-efficient retail-stage competitor to operate profitably (or even survive) given the level of retail prices, and
The firm does not charge its own downstream operation this high price.

In the extreme, the firm might demand a price for the essential input that is higher than the full retail price of the service.

A vertical price squeeze can only succeed if the essential input has no effective substitutes. If such substitutes are available, the price squeeze will simply encourage entrants to use the substitute to produce competing retail services.

A price squeeze has a similar effect to a refusal to supply an essential facility. By charging a high price for the essential input, a vertically integrated firm can reduce the effectiveness of its competitors, or in the extreme force them out of the market (see Figure 1).

Figure 1: Example of a Vertical Price Squeeze

In the figure, an incumbent firm owns an essential input, on which an entrant depends in order to provide service to its customers. Both firms have the same costs at the retail stage of the market. The incumbent obtains the essential input at incremental cost, but charges the entrant a price substantially greater than incremental cost. As a result, the entrant’s total costs exceed the retail price for the service, and it is forced to exit the market.

In 2003, Deutsche Telekom (DT) was found to have abused its dominant position by committing a price squeeze, contrary to Article 82 of the European Commission Treaty. DT offered local access services at the retail level to end-users and at the wholesale level on an unbundled basis to competitors. DT was thus active in both upstream and downstream markets. Beginning in 1998, DT had been legally obligated to provide competitors with wholesale access to its local loops.

In its decision finding that DT had abused its dominant position, the European Commission found that DT charged new entrants higher fees for wholesale access to the local loop than what DT charged its retail subscribers for fixed line subscriptions. The Commission assessed the margin between DT’s wholesale access prices and the weighted average price of its corresponding retail services for access (analog, ISDN, and ADSL). Given that wholesale access prices were higher than the weighted average of the corresponding retail prices charged to end-users, the Commission determined that the price margin was insufficient for new entrants to compete with DT. The Commission concluded that DT’s pricing practices constituted a price squeeze. The Commission further concluded that DT’s pricing for local access services deterred new competitors from entering the local access market and reduced the choice of telecommunications service providers for consumers and suppressed price competition. DT unsuccessfully appealed this decision to the European Court of First Instance (CFI). For more details about the DT abuse of dominance case, please see the Practice Note "Vertical Price Squeeze Charge against Deutsche Telekom". A link to this Practice Note is set out below.