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United Kingdom Competition Appeals Tribunal


You are here: BAILII >> Databases >> United Kingdom Competition Appeals Tribunal >> Napp Pharmaceutical Holdings Ltd & Ors v Office of Communications [2002] CAT 1 (15 January 2002)
URL: http://www.bailii.org/uk/cases/CAT/2002/1.html
Cite as: [2002] Comp AR 13, [2002] CAT 1, (2002) 64 BMLR 165, [2002] ECC 13

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IN THE COMPETITION COMMISSION
APPEAL TRIBUNAL
Case No. 1001/1/1/01
New Court Carey Street London WC2A 2JT
15 January 2002
Before:
SIR CHRISTOPHER BELLAMY
(President)
MR BARRY COLGATE
PROFESSOR PETER GRINYER
BETWEEN:
NAPP PHARMACEUTICAL HOLDINGS LIMITED AND SUBSIDIARIES
Applicant
and
DIRECTOR GENERAL OF FAIR TRADING
Respondent
Mr Nicholas Green QC (instructed by Messrs Herbert Smith) appeared for the Applicant
Mr Peter Roth QC and Mr Jon Turner (instructed by The Director of Legal Services, Office of Fair Trading) appeared for the Respondent
JUDGMENT (Non-confidential version):
Note: Excisions in this judgment relate to commercially confidential information: Section 56 and Schedule 8, paragraph 4(3) of the Competition Act 1998.
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TABLE OF CONTENTS
Paragraph
I            INTRODUCTION ..........................................................................................1..
The statutory framework ...................................................................................2..
General background ........................................................................................11..
II          THE DECISION AND DIRECTIONS
The Administrative procedure ........................................................................23..
The Director’s findings on dominance ...........................................................27..
The Director’s findings on abuse ....................................................................32..
Discounts to hospitals .............................................................................33..
Excessive prices ......................................................................................56..
The Penalty .....................................................................................................70..
The Directions .................................................................................................71..
III        THE PROCEDURE BEFORE THE TRIBUNAL .....................................72..
IV         THE BURDEN AND STANDARD OF PROOF ........................................91..
V          OTHER PROCEDURAL ISSUES ............................................................114..
VI         DOMINANCE
Relevant market ............................................................................................148..
Dominant position .........................................................................................153..
VII       ABUSE: DISCOUNTS TO HOSPITALS .................................................170..
A: ARGUMENTS OF THE PARTIES
Napp’s arguments .........................................................................................171..
The Director’s arguments .............................................................................199..
B: THE RELEVANT LAW .........................................................................207..
C: FINDINGS
Preliminary analysis ......................................................................................217..
Napp’s “net revenue” defence ......................................................................231..
Clarification of terms ............................................................................232..
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Paragraph
The follow-on effect as alleged by Napp ..............................................239..
Conceptual problems with Napp’s net revenue test ..............................258..
The effect of Napp’s hospital pricing policy on competition ...............267..
Asymmetry: Napp’s advantages over its competitors ..........................289..
The market since 1 March 2000 ...........................................................301..
Intention to eliminate competition ........................................................307..
Conclusion on Napp’s net revenue defence ..................................................334..
Napp’s other arguments ................................................................................340..
Conclusion ....................................................................................................352..
VIII      ABUSE: EXCESSIVE PRICES
A: ARGUMENTS OF THE PARTIES ........................................................353..
B: LAW ........................................................................................................386..
C: FINDINGS ..............................................................................................389..
The abuse as found in the Decision ..............................................................390..
Napp’s defence based on the PPRS ..............................................................406..
The Director’s alleged “change of case” .......................................................428..
Conclusion ....................................................................................................442..
IX         THE PENALTY
A: INTENTIONALLY OR NEGLIGENTLY .............................................443..
Arguments of the parties .......................................................................443..
Law .......................................................................................................452..
Findings on intentionally or negligently ...............................................459..
B: THE AMOUNT OF THE PENALTY ....................................................473..
The Director’s Guidance .......................................................................473..
The Director’s approach in the Decision ..............................................481..
Arguments of the parties .......................................................................487..
Findings ................................................................................................497..
General observations ....................................................................497..
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Paragraph
The issue of duration in relation to hospital pricing .....................504..
The gain at Step 3 .........................................................................507..
Aggravation at Step 4 ...................................................................512..
Factors affecting the amount of the penalty in the present case ...517..
The Tribunal’s assessment of the penalty .....................................535..
Interest on the penalty ...................................................................542..
X          THE DIRECTIONS
The letter of 4 May 2001 ..............................................................................544..
Arguments of the parties ...............................................................................548..
Findings ........................................................................................................553..
XI         ORDERS MADE .........................................................................................563..
Note: For simplicity, this judgment will refer throughout to Articles 81 and 82 of the EC Treaty, whether in citations from judgments or otherwise, notwithstanding that the original citation referred to Articles 85 and 86 of the EC Treaty which were renumbered as Articles 81 and 82 by the Treaty of Amsterdam with effect from 1 May 1999.
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I – INTRODUCTION
(i) the decision by the Director General of Fair Trading (“the Director”) dated 30 March 2001 (“the Decision”) which found that Napp had abused a dominant position in the supply of sustained release morphine tablets and capsules in the United Kingdom, contrary to the Chapter II prohibition of the Competition Act 1998, and imposed a penalty of £3.21 million; and
(ii) the directions made by the Director dated 4 May 2001 (“the Directions”) regulating the prices at which Napp’s sustained release morphine products are to be sold.
Earlier decisions of this Tribunal on 22 May, 10 July and 8 August 2001 have previously dealt with interim relief and various interlocutory matters: see [2001] CompAR 1, 21 and 33.
The statutory framework
“18.–(1) … [A]ny conduct on the part of one or more undertakings which amounts to the abuse of a dominant position in a market is prohibited if it may affect trade within the United Kingdom.
(2)  Conduct may, in particular, constitute such an abuse if it consists in–
(a)    directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions;
(b)    limiting production, markets or technical development to the prejudice of consumers;
(c)    applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;
(d)    making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of the contracts.
(3)  In this section–
“dominant position” means a dominant position within the United Kingdom; and “the United Kingdom” means the United Kingdom or any part of it.
(4)  The prohibition imposed by subsection (1) is referred to in this Act as “the Chapter II prohibition”.”
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9.       The powers of this Tribunal to determine appeals under section 46 are set out in paragraph 3 of Schedule 8 of the Act, which provides:
“3.–(1) The tribunal must determine the appeal on the merits by reference to the grounds of appeal set out in the notice of appeal.
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(2) The tribunal may confirm or set aside the decision which is the subject of the appeal, or any part of it, and may–
(a)    remit the matter to the Director,
(b)    impose or revoke, or vary the amount of, a penalty,
(c)    grant or cancel an individual exemption or vary any conditions or obligations imposed in relation to the exemption by the Director,
(d)    give such directions, or take such other steps, as the Director could himself have given or taken, or
(e)    make any other decision which the Director could himself have made.
(3)  Any decision of the tribunal on an appeal has the same effect, and may be enforced in the same manner, as a decision of the Director.
(4) If the tribunal confirms the decision which is the subject of the appeal it may nevertheless set aside any finding of fact on which the decision was based.”
General Background
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4
II – THE DECISION AND DIRECTIONS The Administrative procedure
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Napp under section 26 of the Act, required notably the production of minutes of meetings of directors of members of the Napp group and all documents prepared for those meetings relating to the pricing of MST tablets for the period from 1 January 1997, as well as a great deal of other specified documents and information.
The Director’s findings on dominance
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Table 2: Napp’s market share (unit volumes) of sustained release morphine tablets/capsules 1997-2000
Hospital and Community sales (unit volumes)
1997
1998
1999
2000
Q1 2001
MST CONTINUS
89.2
89.6
90.6
91.0
91.6
MXL
5.2
5.9
5.1
4.2
3.9
Napp total
94.4
95.5
95.7
95.2
95.5
ORAMORPH SR
4.9
3.6
3.0
2.0
0.0
MORCAP
0.6
0.7
0.5
0.5
0.6
ZOMORPH
0.1
0.2
0.8
2.3
3.9
TOTAL
100.0
100.0
100.0
100.0
100.0
Table 3: Shares of supply (unit volumes) of sustained release morphine tablets/capsules to the community 1997-2000
Community sales (unit volumes)
1997
1998
1999
2000
Q1 2001
MST CONTINUS
91.7
91.0
91.4
91.5
92.0
MXL
5.0
5.6
5.1
4.2
4.0
Napp total
96.7
96.6
96.5
95.7
96.0
ORAMORPH SR
2.6
2.4
2.3
1.8
0.0
MORCAP
0.7
0.8
0.5
0.5
0.6
ZOMORPH
0.0
0.2
0.7
2.0
3.4
TOTAL
100.0
100.0
100.0
100.0
100.0
Table 4: Shares of supply (unit volumes) of sustained release morphine tablets/capsules to hospitals 1997-2000
Hospital sales (unit volumes)
1997
1998
1999
2000
Q1 2001
MST CONTINUS
71.5
77.2
83.2
87.2
89.0
MXL
6.2
8.0
6.8
4.7
3.7
Napp total
77.7
85.2
90.0
91.9
92.7
ORAMORPH SR
22.0
14.4
8.1
3.6
0.0
MORCAP
0.3
0.4
0.2
0.2
0.0
ZOMORPH
0.0
0.0
1.7
4.3
7.3
TOTAL
100.0
100.0
100.0
100.0
100.0
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(i) regulatory barriers to entry, that is to say the need for any new competitor to obtain the necessary manufacturing, marketing or import authorisations required under the Medicines Act 1968 and other legislation governing medicinal products (paragraphs 102 and 103);
(ii) what the Director describes as Napp’s “strong and persistent first mover advantage” (paragraphs 104 to 113); and
(iii) what the Director describes as “the strategic barrier to entry in hospital sales” created by the pricing behaviour of Napp in the hospital segment of the market (paragraphs 114 to 118).
The Director’s findings on abuse
“(a) while charging high prices to customers in the community segment of the market, supplied sustained release morphine tablets and capsules to hospitals at discounts which have the object and effect of hindering competition in the market for the supply of sustained release morphine tablets and capsules in the UK. The pricing behaviour of Napp has to be considered as a whole, but the particular aspects in
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which, in the circumstances of the present case, its discounting behaviour is abusive under section 18 of the Act are as follows:
(i) selectively supplying sustained release morphine tablets and capsules to customers in the hospital segment at lower prices than to customers in the community segment;
(ii) more particularly, targeting competitors, both by supplying at higher discounts to hospitals where it faced (or anticipated) competition and by supplying at higher discounts on those strengths of sustained release morphine tablets and capsules where it faced competition; and
(iii) supplying sustained release morphine tablets and capsules to hospitals at excessively low prices.
Moreover Napp has engaged in the above conduct with the intention of eliminating competition.
(b) charged excessive prices to customers in the community segment of the market for the supply of sustained release morphine tablets and capsules in the UK.
In doing so, Napp has abused its dominant position in the market for the supply of sustained release morphine tablets and capsules in the UK.”
Discounts to hospitals
9
Table 5: Napp’s average variable cost on MST tablets and average hospital prices, March to May 2000
Strength
Direct Costs (£)
NHS list price, excl. VAT (£)
Average hospital price (£)
5mg
 
4.30
 
10mg
7.17
15mg
12.57
30mg
...
17.22
...
60mg
33.58
100mg
53.16
200mg
 
106.34
 
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“[the] lack of sales was primarily due to predatory pricing in the hospital sector of the market and in 1999 we have had to adjust our sales strategy to compete on price. As a result we are now in a position of having to almost give away product to compete with Napp in the hospital market. Of course we are losing money and as a small company I
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am not sure that we can continue this policy, reluctant as I am to be ‘bullied’ out of the market by our much larger competitor.” (paragraph 116)
(i) Napp’s sales to hospitals at discounted prices, although apparently below direct cost, were incrementally profitable because of the compensating margins to be earned on the “follow-on” sales in the community segment (paragraphs 148, 149 and 192).
(ii) What was true for Napp was true for its competitors, who could equally earn compensating margins in the community sector (paragraph 148).
(iii) The market was not foreclosed (paragraphs 167 to 169).
(iv) Napp’s discounts to hospitals were the inevitable result of the necessity to meet competition (paragraph 197).
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Excessive prices
“if it is above that which would exist in a competitive market and where it is clear that high profits will not stimulate successful new entry within a reasonable period. Therefore, to show that prices are excessive, it must be demonstrated that (i) prices are higher than would be expected in a competitive market, and (ii) there is no effective competitive pressure to bring them down to competitive levels, nor is there likely to be.”
57.     According to the Director, Napp’s prices can be shown to be above the competitive level, first, by assessing “whether the difference between costs actually incurred and the price actually charged is excessive”: Case 27/76 United Brands v Commission [1978] ECR 207 (“United Brands”). In the Decision, the Director has sought to do this by showing the profit margins Napp earns on community sales and comparing these with the margins Napp earns on sales of other products, and on sales of MST to other markets (paragraph 204).
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excessive (paragraph 206). Napp does not dispute the Director’s figures, but does not accept his conclusion.
—   Comparisons of the prices for MST tablets with those of Napp’s competitors (paragraphs 207 to 212)
—  Comparison of prices for MST tablets over time (paragraphs 213 to 216)
—   Comparison of the prices of MST charged to hospitals and the community respectively (paragraphs 217 to 220)
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—  Comparison with Napp’s export prices (paragraphs 218, 219, 221 and 222)
—   Comparisons of Napp’s profitability on sales to hospitals and the community (paragraphs 223 to 226)
—  Comparison of Napp’s margins with those of its competitors (paragraphs 226 to 229)
16
manufactures MST tablets, while its competitors contract out the manufacture, and the possibility that Napp’s operations may be more efficient, the Director has calculated Napp’s gross profit margin, using the average costs of its next most profitable competitor, in order to ensure that any comparison is made on the basis most favourable to Napp. Even when calculated on this basis, according to the Director, Napp’s prices imply margins of 80.5 per cent compared to [...] [less than 70] per cent for the next most profitable competitor. This further supports the conclusion that Napp’s prices to the community are excessive and not subject to normal competitive constraints (paragraphs 228 and 229).
The penalty
The Directions
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III – PROCEDURE BEFORE THE TRIBUNAL
18
19
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87.      Following the hearing, further written submissions were made, at the Tribunal’s request, principally as regards (i) the relevance or admissibility of the documents disclosed pursuant to the Tribunal’s request of 31 August 2001; and (ii) whether Napp’s prices fell below direct costs in 1998 or earlier (see the letters of the parties of 5, 15, 17 and 22 October 2001).
88.      We comment, for the benefit of those conducting future appeals, that the procedure in this case did not go entirely according to the plan envisaged in the Tribunal’s Guide to Appeals under the Competition Act, probably for three reasons: the notice of appeal was not as focussed as we would have wished, the Director sought to introduce a good deal of material and argument that was not in the Decision, and some of the supplementary materials supplied by Napp on such matters as the Human Rights Act and PCGs/PCTs were not in a form which we could easily absorb. We entirely appreciate the difficulties of the subject matter, the pressure of time, and the fact that all concerned are on a learning curve as regards the procedures to be followed in appeals under the Act, but we hope that the principles of the Guide can be closely followed in future cases.
89.      Napp requests the Tribunal to:
-    set aside the Decision in whole or in part;
-    set aside or vary the Directions;
-     to set aside or reduce the penalty;
-    declare that Napp’s conduct does not infringe the Chapter II prohibition;
-    order the Director to pay Napp’s costs of and incidental to the appeal;
-    order such further or other relief as the Tribunal may consider appropriate.
90.      The Director requests the Tribunal to:
-    dismiss Napp’s appeal;
-    order Napp to pay his costs;
-    order, pursuant to Rule 27 of the Tribunal’s Rules, that interest be payable on the penalty.
IV - THE BURDEN AND STANDARD OF PROOF
91.      This is the first appeal under the Act against an infringement decision, so we address at the outset the issue of the burden and standard of proof where penalties are imposed under section 36 of the Act.
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“Right to a Fair Trial
1.   In the determination of his civil rights and obligations or of any criminal charge against him, everyone is entitled to a fair and public hearing within a reasonable time by an independent and impartial tribunal established by law. Judgment shall be pronounced publicly ...
2.   Everyone charged with a criminal offence shall be presumed innocent until proved guilty according to law.
3.   Everyone charged with a criminal office has the following minimum rights:
(a)    to be informed promptly, in a language which he understands and in detail, of the nature and cause of the accusation against him;
(b)    to have adequate time and facilities for the preparation of his defence;
(c)    to defend himself in person or through legal assistance of his own choosing or, if he has not sufficient means to pay for legal assistance, to be given it free when the interests of justice so require;
(d)    to examine or have examined witnesses against him and to obtain the attendance and examination of witnesses on his behalf under the same conditions as witnesses against him;
...”
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on him throughout. However, that does not necessarily prevent the operation of certain evidential presumptions for example, that sales below direct cost are presumed to be abusive: see R v Lambert [UKHL] 37 [2001] 3 WLR 206, paragraphs 34, 87 et seq, and 150 et seq.
23
attendance and examination of witnesses on his behalf under the same conditions as witnesses against him” (Article 6(3)(d)).
24
we must apply in deciding whether infringements of the Chapter I or Chapter II prohibitions are proved is the civil standard, commonly known as the preponderance or balance of probabilities, notwithstanding that the civil penalties imposed may be intended by the Director to have a deterrent effect.
25
financial penalties. It is for the Director to satisfy us in each case, on the basis of strong and compelling evidence, taking account of the seriousness of what is alleged, that the infringement is duly proved, the undertaking being entitled to the presumption of innocence, and to any reasonable doubt there may be.
110.   That approach does not in our view preclude the Director, in discharging the burden of proof, from relying, in certain circumstances, from inferences or presumptions that would, in the absence of any countervailing indications, normally flow from a given set of facts, for example that dominance may be inferred from very high market shares (Case 85/76 Hoffman-La Roche v Commission [1979] ECR 461, paragraph 41); that sales below average variable costs may, in the absence of rebuttal, be presumed to be predatory (see the opinion of Advocate General Fennelly in Cases C-395/96P and 396/96P Compagnie Maritime Belge v Commission [2000] ECR I-1442 at paragraph 127); or that an undertaking’s presence at a meeting with a manifestly anti-competitive purpose implies, in the absence of explanation, participation in the cartel alleged: Montecatini v Commission, cited above, at paragraphs 177 to 181.
26
suffisance de droit), but there is no doubt that, in general, those Courts require convincing proof that the alleged infringements have been committed in the form of a “firm, precise and consistent body of evidence”: see Cases 29 and 30/83 CRAM and Rheinzink v Commission cited above, paragraphs 16 to 20; Cases C-89/85 etc Ahlström Osakeyhtiö and others v Commission [1993] ECR I-1307, paragraph 127. We have no reason to suppose that the standard of proof we propose to follow is any different from that followed in practice by the courts in Luxembourg.
V – OTHER PROCEDURAL ISSUES
The Director’s witness statements
27
“It is our intention that the tribunal should be primarily concerned with the correctness or otherwise of the conclusions contained in the appealed decision and not with how the decision was reached or the reasoning expressed in it. That will apply unless defects in how the decision was reached or the reasoning make it impracticable for the tribunal fairly to determine the correctness or otherwise of the conclusions or of any directions contained in the decision. Wherever possible, we want the tribunal to decide a case on the facts before it, even where there has been a procedural error, and to avoid remitting the case to the director general. We intend to reflect that policy in the tribunal rules.
This is an important aspect of our policy, and I shall explain the rationale behind our approach. The Bill provides for a full appeal on the merits of the case, which is an essential part of ensuring the fairness and transparency of the new regime. It enables undertakings to appeal the substance of the decision including in those cases where it is believed that a failure on the part of the director general to follow proper procedures has led him to reach an incorrect conclusion. The fact that the tribunal will be reconsidering the decision on the merits will enable it to remedy the consequences of any defects in the director general’s procedures.”
28
Napp’s principal submission that nothing may be relied on before the Tribunal unless it was relied on in the administrative procedure.
29
the follow-on effect alleged by Napp. Although largely relating to events before the alleged period of infringement, Napp relies strongly on Mr Penrose’s evidence on at least one point, namely that it was BIL rather than Napp which initiated price cutting after 1994. We see no proper basis for excluding Mr Penrose’s evidence, although it is not essential to our analysis of Napp’s conduct during the period of infringement.
The documents disclosed following the Tribunal’s request of 31 August 2001
30
as we could see without referring to any documents tending to show what matters Napp had actually taken into account at the material time. We therefore asked for documents relating to the objectives, strategy or policy considerations taken into account by Napp in setting its prices in the periods referred to in the Decision to be drawn to our attention. The documents concerned were promptly supplied without objection on Napp’s part.
The “Ermakov” issue
132.   Napp now argues on the basis of R v Westminster City Council ex parte Ermakov [1996] 2 All ER 302 (CA), followed for example in Nash v Chelsea Royal College of Art (Burnton J, [2001] EWHC Admin 538), that the Director should not be permitted to change the reasons for his Decision before the Tribunal, nor add supplementary reasons, given in particular that the Director is a specialist decision maker. In Ermakov, the Court of Appeal decided that, in certain proceedings under the Housing Act 1996, the decision maker should be held to the reasons given in his original decision, in the interests of fairness and efficient decision making: see Hutchison LJ at pp. 315 to 317.
31
the safeguards it provides, largely devoid of purpose; the function of this Tribunal is not to try a wholly new case. If the Director wishes to make a new case, the proper course is for the Director to withdraw the decision and adopt a new decision, or for this Tribunal to remit.
Human Rights and general issues of unfairness
32
33
commercial confidentiality had been claimed by third parties pursuant to Rule 14(6)(a) and Rule 30(1)(c) of the Director’s Rules. A Schedule listing all the documents in the Director’s possession, identifying those which had not been disclosed in whole or part, was supplied to Napp. Upon the lodging of the appeal, the Director disclosed further documents to named external advisers of Napp, who gave undertakings to observe the confidentiality of the documents in question. Material relating to the discounting of products other than oral sustained release morphine was disclosed by the Director in the defence. The witness statements of Mr Hartley and Mr Penrose before the Tribunal contained a great deal of further material about the commercial strategies pursued in relation to Zomorph and Oramorph, respectively.
34
VI – DOMINANCE Relevant market
35
36
Dominant position
“relates to a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market by affording it the power to behave to an appreciable extent independently of its competitors, its customers and ultimately of consumers.”
“The existence of a dominant position may derive from several factors which, taken separately, are not necessarily determinative but among these factors a highly important one is the existence of very large market shares.”
And at paragraph 41:
“Furthermore although the importance of the market shares may vary from one market to another the view may legitimately be taken that very large shares are in themselves, and save in exceptional circumstances, evidence of the existence of a dominant position.”
37
38
39
portfolio based approach of the PPRS is to be preferred, when it comes to determining whether the price of MST is excessive for the purposes of the Chapter II prohibition. But those arguments which in any event we reject at paragraphs 406 et seq below, go to the question of abuse, and not to the prior question of the existence of a dominant position.
“If anti-competitive conduct is required of undertakings by national legislation or if the latter creates a legal framework which itself eliminates any possibility of competitive activity on their part, Articles 81 and 82 do not apply. In such a situation, the restriction of competition is not attributable, as those provisions implicitly require, to the autonomous conduct of the undertakings ... Articles 81 and 82 may apply, however, if it is found that the national legislation does not preclude undertakings from engaging in autonomous conduct which prevents, restricts or distorts competition ...”
(paragraph 130).
VII – ABUSE: DISCOUNTS TO HOSPITALS
40
hospital segment of the market is the only viable point of entry into the market as a whole. Hence the alleged abuse in the hospital segment, while a discrete abuse and significant in its own right, is also, says the Director, a means to an end, namely the preservation of Napp’s prices and market share in the much larger community segment of the market. Although we analyse the two abuses separately, the connection between the hospital and community segments must be borne in mind throughout this judgment.
A. ARGUMENTS OF THE PARTIES
Napp’s arguments
41
hospital price plus the sale of “follow on” units to the community segment at the community price) is profitable. Such transactions cover not only Napp’s average variable costs, but also Napp’s average total cost: see Table 2.2 of document A107. Even assuming that one unit of hospital sales led to the sale of only 0.25 follow-on units in the community, Napp would still be covering its average total costs: see Table 2.3 of document A107. Even at the reduced NHS prices required by the Directions, the hospital prices currently charged for MST would be profitable for Napp (i.e. cover average total costs), once the follow-on sales are taken into account, so long as one unit sold in a hospital generated at least 0.30 units of follow-on sales in the community sector: Table 2.4 of document A107. It would require a linkage of only 0.04 follow-on units for Napp to cover its direct costs.
“Napp considers that it makes sense to discount MST substantially to win hospital contracts, to take account of the fact that there is some linkage, albeit one that it is difficult to quantify, between sales in hospitals and sales in the community. Given that, under the PPRS, Napp can charge prices for its community sales which generate a profit margin of some [...] [in excess of 80]%, Napp does not need to stimulate many sales in the community to justify a substantial discount of its prices to the hospital sector. Thus Napp can afford to discount its prices to hospitals substantially, even on the basis of a fairly modest assumed linkage between hospitals and community sales, and the hospital sales will still be profitable.
In short, we did not believe that, by discounting our prices to the extent that we did to win hospital contracts, we would be making losses; instead we believed that, if we were successful in winning contracts, we would thereby make extra sales, because we could expect to sell extra units of MST in the community segment, by virtue of the “linkage” referred to in paragraph (ii) above. We assumed that all bidders were
42
evaluating the opportunities in the same way, and were willing to offer discounts on the same basis.”
“Moreover, I have at all material times believed that Napp’s discounts to hospitals represented a fair and normal means of competition: Napp was keen to win hospital contracts, in recognition of the follow on benefits which they bring, in terms of community sales. I believed that other suppliers would also recognise those benefits and, indeed, I believed that that was why other firms (first Farmitalia, then Boehringer Ingelheim and now Link) were offering such low prices to hospitals.”
43
183.   That the benefit of such linked sales is available to Link is confirmed, says Napp, by a letter to the OFT by Mr Steven Mountain, the managing director of Link dated 3rd November 2000 (OFT document 255) where he says:
“Proof of this link [sc. between hospital and community] can be seen in the sales of Zomorph capsules over the last year where the ratio of hospital sales volumes to community sales volumes is 1:4. Link only has a hospital sales team. We do not call or advertise to GPs at all, and so the only way that there are any sales of Zomorph capsules into the community is through hospital influence via referral and the other methods outlined above.
The MST ratio is currently 1:8 and so it can be seen following conversions that a hospital has an immediate and direct influence over around 50% of community usage. The ratio for Zomorph capsules sales will rise further over time as hospital influence filters through to the community…
We do not dispute Napp’s second point that Napp makes money overall out of loss leading into hospital. For every 1 pack they sell into hospital we can see that immediately they would sell 4 into the community, and in the long term 8. …”
44
treatment when making prescribing decisions. These effects, says Napp, were already being felt by January 2000, just as BIL was leaving the market, and have been successfully exploited by Link, as shown by Mr Mountain’s letter of 3 November 2000 and the evidence of Mr Hartley. Napp particularly criticises the Director for failing to take account of Mr Mountain’s letter in the Decision, despite Napp’s comments on that letter at the second oral hearing during the administrative procedure. In fact, Link’s sales have grown substantially since May 2000, another fact not taken into account by the Director. Napp states, however, “for the avoidance of doubt” that it is not suggested that the linkage is entirely automatic, in the sense that no further effort is required on behalf of the supplier. According to its skeleton argument, what Napp means by ‘automatic’ is that “a supplier need expend no more effort than one would reasonably expect of a competent supplier” (paragraph 85).
45
and not in danger of going out of business. APS Berk, Lanacher and CeNeS are potential new entrants. BIL’s statements as to why it left the market are self-serving and dubious.
192.   Napp accepts “that it is well established that GP’s prescribing decisions are influenced by hospital prescribing” (notice of appeal, paragraph 3.27). However, in choosing a brand of oral sustained release morphine, GP’s will not, according to Napp, be influenced to any substantial degree by the mere fact that a new brand of oral sustained release morphine is used in hospitals. According to the Internet Survey, and the evidence of Dr. Forster (document A26, paragraph 20) most patients are initiated by the GP, without the involvement of the hospital doctor, and the GP will go mainly by his own experience. Although accepting that the influence of hospital prescribing habits is likely to be more important in the case of new drugs (document A26, paragraph 26), Napp submits that there is no evidence to quantify to what extent the sale of a new brand of oral sustained release morphine to hospital will itself contribute to the establishment of a “reputation” for that brand in the community segment of the market, nor to what extent the making of hospital sales is better than other available means of establishing such a reputation (e.g. direct promotion and marketing of the brand to GP’s and community nurses, and general promotional activities, such as the sponsoring of medical conferences and the sponsoring of training for healthcare professionals). Napp submits that, even for new entrants, hospital sales do not represent the only means by which a new entrant may establish a reputation in the community segment of the market.
46
not expect Napp to retaliate in hospitals nor lower their prices in the community. Nor can the Director be permitted to prove an anti-competitive intent on the basis of the material disclosed in response to the Tribunal’s request, since that material was not relied on in the Decision, and predates the period of infringement.
The Director’s arguments
47
market share in the community segment. Pursuant to AKZO, the burden is on Napp to rebut the presumption of abuse to which its below-cost sales give rise. According to the Director, Napp’s arguments based on ‘follow-on effect’ and ‘linkages’ fail to rebut that presumption.
48
49
B. THE RELEVANT LAW
207.   In Case 85/76 Hoffman-La Roche v Commission [1979] ECR 461, which concerned a system of loyalty rebates operated by the dominant firm which made it difficult for competitors to enter the market, the Court of Justice stated at paragraph 91:
“The concept of abuse is an objective concept relating to the behaviour of an undertaking in a dominant position which is such as to influence the structure of a market where, as a result of the very presence of the undertaking in question, the degree of competition is weakened and which, through recourse to methods different from those which condition normal competition in products or services on the basis of the transactions of commercial operators, has the effect of hindering the maintenance of the degree of competition still existing in the market or the growth of that competition.”
“A finding that an undertaking has a dominant position is not in itself a recrimination but simply means that, irrespective of the reasons for which it has such a dominant position, the undertaking concerned has a special responsibility not to allow its conduct to impair genuine undistorted competition on the common market.”
209.   In AKZO (Case C-62/86 AKZO Chemie v Commission [1991] ECR I-3359), where the dominant firm offered prices discounted below cost in order to force a competitor out of business, the Court held:
“[70] Article 82 prohibits a dominant undertaking 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. From that point of view, however, not all competition by means of price can be regarded as legitimate.
[71] Prices below average variable costs (that is to say, those which vary depending on the quantities produced) by means of which a 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, since each sale generates a loss, namely the total amount of the fixed costs (that is to say, those which remain constant regardless of the quantities produced) and, at least, part of the variable costs relating to the unit produced.
[72] 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.”
50
210.   AKZO was followed in Case T-83/91 Tetra Pak v Commission [1994] ECR II-755), on appeal, Case 333/94P Tetra Pak v Commission [1996] ECR I-5951 (“Tetra Pak II”). The Court of First Instance, applying the criteria set out in AKZO, found that certain of Tetra Pak’s prices were below direct variable costs, and in one case below average variable cost (paragraph 151), and had no other economic rationale other than ousting Tetra Pak’s principal competitor (paragraphs 147 to 151, and 188 to 192 of its judgment). On the subsequent appeal the Court of Justice held at paragraphs 41 to 44:
“41. In AKZO this Court did indeed sanction the existence of two different methods of analysis for determining whether an undertaking has practised predatory pricing. First, prices below average variable costs must always be considered abusive. In such a case, there is no conceivable economic purpose other than the elimination of a competitor, since each item produced and sold entails a loss for the undertaking. Secondly, prices below average total costs but above average variable costs are only to be considered abusive if an intention to eliminate can be shown.
42. At paragraph 150 of the judgment under appeal, the Court of First Instance carried out the same examination as did this Court in AKZO. For sales of non-aseptic cartons in Italy between 1976 and 1981, it found that prices were considerably lower than average variable costs. Proof of intention to eliminate competitors was therefore not necessary. In 1982, prices for those cartons lay between average variable costs and average total costs. For that reason, in paragraph 151 of its judgment, the Court of First Instance was at pains to establish – and the appellant has not criticised it in that regard – that Tetra Pak intended to eliminate a competitor. ...
44. Furthermore, it would not be appropriate, in the circumstances of the present case, to require in addition proof that Tetra Pak had a realistic chance of recouping its losses. It must be possible to penalise predatory pricing whenever there is a risk that competitors will be eliminated. The Court of First Instance found, at paragraphs 151 and 191 of its judgment, that there was such a risk in this case. The aim pursued, which is to maintain undistorted competition, rules out waiting until such a strategy leads to the actual elimination of competitors.”
51
“[146] As has already been pointed out, it has been consistently held that whilst the fact that an undertaking is in a dominant position cannot deprive it of entitlement to protect its own commercial interests if they are attacked; and whilst such an undertaking must be allowed the right to take such reasonable steps as it deems appropriate to protect those interests, such behaviour cannot be allowed if its real purpose is to strengthen this dominant position and thereby abuse it (in particular, BPB Industries and British Gypsum v Commission).”
The Court of First Instance held that the purpose of the practice was to eliminate the conference’s only competitor, and that, in any event, the response by Cewal to the situation which it faced was not reasonable and proportionate (paragraphs 147 and 148).
“127. Apparently, therefore, sales below average variable (or short-run marginal: AKZO, paragraph 70) costs are in effect presumed to be abusive. While it is usually rational to sell above average variable costs, because that permits some return on capital, where the market will not bear a higher price, it is not usually rational to sell below average variable costs. Marginal costs need not be incurred and business has no interest in incurring them so as to make a loss. A dominant firm would be permitted, however, to rebut this presumption by showing that such pricing was not part of a plan to eliminate its competitor.”
“132. I would, on the other hand, accept that, normally, non-discriminatory price cuts by a dominant undertaking which do not entail below-cost sales should not be regarded as being anti-competitive. In the first place, even if they are only short lived, they benefit consumers and, secondly, if the dominant undertaking’s competitors are equally or more efficient, they should be able to compete on the same terms. Community competition law should thus not offer less efficient undertakings a safe haven against vigorous competition even from dominant undertakings. Different considerations may, however, apply where an undertaking which enjoys a position of dominance approaching a monopoly, particularly on a market where price cuts can be implemented with relative autonomy from costs, implements a policy of selective price cutting with the demonstrable aim of eliminating all competition. In those circumstance, to accept that all selling above cost was automatically acceptable could enable the undertaking in question to eliminate all competition by pursuing a selective
52
pricing policy which in the long run would permit it to increase prices and deter potential future entrants for fear of receiving the same targeted treatment.”
“137. In all these circumstances, the Court of First Instance committed no error of law in finding that the response of Cewal members to the entrance of G&C was not ‘reasonable and proportionate’. To my mind, Article 86 cannot be interpreted as permitting monopolists or quasi-monopolists to exploit the very significant market power which their superdominance confers so as to preclude the emergence either of a new or additional competitor. Where an undertaking, or group of undertakings whose conduct must be assessed collectively, enjoys a position of such overwhelming dominance verging on monopoly, comparable to that which existed in the present case at the moment when G&C entered the relevant market, it would not be consonant with the particularly onerous special obligation affecting such a dominant undertaking not to impair further the structure of the feeble existing competition for them to react, even to aggressive price competition from a new entrant, with a policy of targeted, selective price cuts designed to eliminate that competitor. Contrary to the assertion of the appellants, the mere fact that such prices are not pitched at a level that is actually (or can be shown to be) below total average (or long-run marginal) costs does not, to my mind, render legitimate the application of such a pricing policy.”
113.    It is, moreover, established that, in certain circumstances, abuse may occur if an undertaking in a dominant position strengthens that position in such a way that the degree of dominance reached substantially fetters competition (Europemballage and Continental Can, paragraph 26).
114.    Furthermore, the actual scope of the special responsibility imposed on a dominant undertaking must be considered in the light of the specific circumstances of each case which show that competition has been weakened (Case C-333/94 P Tetra Pak v Commission [1996] ECR I-5951, paragraph 24).”
After referring to the specific circumstances of the maritime transport sector, the Court continued:
“117 It follows that, where a liner conference in a dominant position selectively cuts its prices in order deliberately to match those of a competitor, it derives a dual benefit. First, it eliminates the principal, and possibly the only, means of competition open to the competing undertaking. Second, it can continue to require its users to pay higher prices for the services which are not threatened by that competition.
53
...
119.    It is sufficient to recall that the conduct at issue here is that of a conference having a share of over 90% of the market in question and only one competitor. The appellants have, moreover, never seriously disputed, and indeed admitted at the hearing, that the purpose of the conduct complained of was to eliminate G&C from the market.
120.    The Court of First Instance did not, therefore, err in law, in holding that the Commission’s objections to the effect that the practice known as ‘fighting ships’, as applied against G&C constituted an abuse of a dominant position were justified. ...”
“it is necessary to consider all the circumstances, particularly the criteria and rules governing the grant of the discount, and to investigate whether, in providing an advantage not based on any economic service justifying it, the discount tends to remove or restrict the buyer’s freedom to choose his sources of supply, to bar competitors from access to the market, to apply dissimilar conditions to equivalent transactions with other trading parties or to strengthen the dominant position by distorting competition (Hoffman-La Roche, paragraph 90; Michelin, paragraph 73). The distortion of competition arises from the fact that the financial advantage granted by the undertaking in a dominant position is not based on any economic consideration justifying it, but tends to prevent the customers of that dominant undertaking from obtaining their supplies from competitors (Michelin, paragraph 71). One of the circumstances may therefore consist in the fact that the practice in question takes place in the context of a plan by the dominant undertaking aimed at eliminating a competitor (AKZO, paragraph 72; Compagnie Maritime Belge Transports, paragraphs 147 and 148).”
C. FINDINGS
Preliminary analysis
54
view it is relevant to take facts arising before 1 March 2000 into account for the purpose, but only for the purpose, of throwing light on facts and matters in issue on and after that date.
219.   In these circumstances, there is no doubt in our minds that, from 1 March 2000, Napp had ‘a special responsibility not to allow its conduct to impair genuine undistorted competition’, as held by the Court of Justice in Michelin [1983] ECR 3451, at paragraph 57. It is well established that such a special responsibility may deprive a dominant undertaking of the right to adopt a course of conduct that would be unobjectionable if adopted by a non-dominant undertaking (Case T-111/96 ITT Promedia v Commission [1998] ECR II-2937, paragraph 139), but the actual scope of that special responsibility must be considered in the light of the specific circumstances of each case: Compagnie Maritime Belge [2000] ECR I-1365 at paragraph 114. We for our part accept and follow the opinion of Mr Advocate General Fennelly in Compagnie Maritime Belge, cited above, that the special responsibility of a dominant undertaking is particularly onerous where it is a case of a quasi-monopolist enjoying “dominance approaching monopoly”, “superdominance” or “overwhelming dominance verging on monopoly” [2000] ECR I-1365 at paragraphs 132 and 137. In our view, Napp’s high and persistent market shares put Napp into the category of “dominance approaching monopoly” – i.e. superdominance – and the issue of abuse in this case has to be addressed in that specific context.
55
Oramorph in 1994, BIL offered higher discounts to hospitals, which Napp matched. Each time BIL came back with a higher discount, Napp matched again. As a result, by 1996 Napp’s discounts to hospitals were some [...] [in excess of 90] per cent if Napp was the sole supplier. For the purposes of this judgment we are prepared to assume that the policy of offering higher discounts to hospitals was originally initiated by BIL. Similarly, it is unnecessary for us to make any finding on whether there were occasions on which Napp undercut BIL. For the purposes of this judgment, it is sufficient to find that Napp pursued a policy of matching BIL’s prices.
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56
statement, at paragraph 191 of the Decision, that such prices are well below direct costs, by up to [...] [in between 30 to 50] per cent, and do not even cover raw material costs.
“[71] Prices below average variable costs (that is to say, those which vary depending on the quantities produced) by means of which a 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, since each sale generates a loss, namely the total amount of the fixed costs (that is to say, those which remain constant regardless of the quantities produced) and, at least, part of the variable costs relating to the unit produced.”
“Prices below average variable costs must always be considered abusive. In such a case, there is no conceivable economic purpose other than the elimination of a competitor, since each item produced and sold entails a loss for the undertaking.
...
For sales of non-aseptic cartons in Italy between 1976 and 1981 ... prices were considerably lower than average variable costs. Proof of intention to eliminate competitors was therefore not necessary.”
57
on the foregoing facts alone, that Napp has abused its dominant position in offering prices below average variable costs to hospitals contrary to the Chapter II prohibition, as the Director found in the Decision, without it being necessary to find that Napp had a specific intention to eliminate competition. In view of the fact that the AKZO approach was laid down in a case where the dominant undertaking had only 50 per cent of the market, it seems to us that it is only in the most exceptional of circumstances that a similar approach should not be applied in cases of “superdominance” where the undertaking concerned has around 95 per cent of the market.
Napp’s “net revenue” defence
58
Clarification of terms
— The narrow follow-on effect alleged by Napp
233.   As appears from paragraphs 148 and 149 of the Decision, Napp’s case before the Director was that the Internet Survey (document A18) showed that on average in about 15 per cent of cases the brand of oral sustained release morphine prescribed by the GP in the community is determined by the hospital doctor’s choice of brand. Using a multiplier of 9 (since the community sector is 9 times the size of the hospital sector), Napp concluded that each sale in the hospital would lead to the sale of 1.35 ‘follow-on’ units in the community segment. On the basis of the various calculations carried out by Napp’s economic consultants, Nera (document A29), Napp then argued that its hospital sales were profitable if one took into account this ‘follow-on effect’. In other words, if one took the net revenue, from both the hospital sale and the ‘follow-on’ community sale combined, Napp was making a profit overall. Napp described this ‘follow-on’ effect as ‘largely mechanistic’ (see e.g. paragraph 34 of Napp’s outline notes of oral submissions on the second Rule 14 notice). Napp distinguished this ‘mechanistic’ follow-on effect from the more broadly based and largely unquantifiable ‘reputational links’, which occur when the use of a particular brand of oral sustained release morphine in a hospital tends to establish that brand in the minds of GPs. The ‘follow-on effect’ thus relied on by Napp seems to have been understood by the Director as referring to a situation where a patient has been initiated on a particular brand in the hospital (i.e. there has been a supply in the hospital), and the GP then repeats the prescription when the same patient comes out of the hospital: see footnote 67 to paragraph 111 of the Decision.
59
linkages’ or simply ‘linkages’ in a wider sense that in our view approximates more to the broader notion of ‘hospital influence’.
— Hospital influence
60
The follow-on effect as alleged by Napp
61
in hospital (i.e. there is a hospital sale), and where there is merely a hospital recommendation (but not necessarily a hospital sale). In Nera’s report of 16 October 2000 (A19) Nera makes it clear that they are referring to “approximately 14.6 per cent of patients [who] consume a brand of SRM heavily influenced by the brand chosen originally by the hospital doctor (“follow-on linkages”) (p.1), by reference to “a branded prescription or referral letter” (p.4) [emphasis added by the Tribunal].
62
“it had not located any documents which discussed follow on linkages and which suggested that on their face or from their context that such linkages are or should be taken into account in setting hospital tender prices.”
Contrary to Napp’s suggestion in argument, we do not find that the documents enclosed with that letter give rise to any inference that, in setting its tender prices, Napp took account of a follow-on effect in the narrow sense alleged by Napp.
63
showing that such a rationale did in fact form the basis of the company’s policy at the material time. In the present case, Napp did not choose to do so, either in answer to the allegations made by the Director, or in the notice of appeal.
64
Conceptual problems with Napp’s net revenue test
65
if those loss-making hospital sales also have the effect of excluding competitors, the very conduct which is profitable to Napp on a net revenue basis has at the same time the effect of eliminating competition. That in turn, protects Napp’s revenues in the community segment. To then argue that the below-cost pricing in the hospital segment is justified by the revenues from the community segment is the equivalent of saying that anti-competitive behaviour which protects Napp’s virtual monopoly can be justified on the basis of the profits made from the monopoly which the anti-competitive behaviour is designed to protect. The argument is circular, as the Director points out at paragraphs 151 and 195 of the Decision.
263.   The second conceptual weakness in Napp’s argument is its contention that hospital and community prices are ‘system prices’. In our view that argument depends on establishing that what is being sold to the buyer is indeed a ‘system’, as might, at least theoretically, be the case of the sale of razors and razor blades, or photocopiers and toner cartridges. However, as Canon KK v Green Cartridge Co [1997] AC 728 (HL) makes clear, an essential aspect of the legitimate use of system pricing is that the buyer is in a position to evaluate the life-time, or system-wide costs, and so make a rational choice between competing possibilities (see the speech of Lord Hoffmann at pages 737 to 738). Here, that is not the case. During the period of infringement in this case, there were two separate groups of buyers, the hospital authorities, and the GPs respectively, rather than a single
66
buyer. Neither group of buyers was motivated to any significant extent to take account of the cost implications, for the other group, of his decisions, or had the information to do so rationally. In this case, it seems to us, what Napp has done is exploit not the connection, but the disconnection between purchasing decisions taken by the different component parts of the NHS, thereby maintaining widely different prices to the different purchasers concerned. That, in our view, is the exact opposite of “system pricing” as it is properly understood.
67
hospital pricing policy on competition, the alleged ‘asymmetry’ between Napp and its competitors, and finally, Napp’s intentions. To those matters we now turn.
The effect of Napp’s hospital pricing policy on competition
68
“The overall strategic importance of obtaining hospital usage was obvious, and was commonly accepted in the industry. It meant that the key pain management specialists (clinicians and nurses) would be endorsing our product in particular whenever clinicians referred out patients by brand, or specialist nurses, in constant contact with hospital practices, gave prescribing advice to GPs this could potentially have a major influence on the GPs prescribing habits.” (paragraph 34)
“The reality is that hospital influence on the community prescribing is incredibly strong”
and that
“the influence of the hospital in this market is profound”.
Among the reasons Mr Mountain gives are that palliative care teams working in the community have been trained in hospitals, GPs invariably follow the hospitals’ advice in referral letters, and GPs will be anxious to secure consistency of treatment as between primary and secondary care.
“Link depends entirely on achieving a successful ‘conversion’ of a hospital to Zomorph as the basis for establishing a reputation and sales in the surrounding community segment of the market. This can only really be appreciated when one considers the way in which we inform GPs and retail pharmacists about our product.” (paragraph 28)
Mr Hartley goes on to explain that Link’s strategy is first of all to secure a hospital contract. Once that contract has been won, Link does not market directly in the community segment but seeks to persuade the hospital authorities to inform GPs, retail pharmacists and others that the switch to Zomorph has taken place, explaining the advantages, and if possible recommending that it should be prescribed as “Zomorph capsules”. In addition Link’s team spends time at the hospitals carrying out training for the personnel who will be using Zomorph on a day-to-day basis.
69
expensive and fruitless, and we reject any suggestion by Napp to the contrary. We have no reason to doubt the statement of Mr Mountain in his letter to the OFT of 3 November 2000 where he said, with reference to hospitals,
“There is only one way into this market and Napp have the key to the gate”
70
additional hurdle to be overcome by a new entrant, who already faces the development and promotional costs associated with launching a new product, as well as the need to overcome Napp’s strong first mover advantages, and the other barriers to entry we have already mentioned.
“The unique barrier that we face as a company trying to become known in this market place is Napp’s practice of offering extreme discounts to hospitals making their product almost free. At the levels of discount in question the average hospital spend on MST tablets comes to something under £500 a year.”
71
adding Napp’s share of the hospital segment to that part of the community segment which is directly foreclosed by the follow-on effect of hospital prescriptions (or referral letters) which directly refer to MST. That alone gives a direct foreclosure of some 24 to 27 per cent of the relevant market (paragraphs 160 and 167 of the Decision).
72
of about 400. Although Link’s share of the hospital segment has grown since the Director’s investigation started from 1.7 per cent in 1999 to 4.3 per cent in 2000 and 7.3 per cent in the first quarter of 2001, that is no doubt partly due to BIL’s departure. We regard Link’s position as little more than a toehold – acquired at considerable loss over several years – in the face of Napp’s share of 93 per cent in that segment. Link’s share of the total market (hospital and community segments together) was just under 4 per cent by the first quarter of 2001, while Napp still had over 95 per cent of the total.
73
pharmaceutical product coming out of patent to maintain both its existing price and a virtual monopoly market share for prolonged periods. On the contrary, in our view, after patent expiry, one would normally expect some fall in price, or market share, or both, as competitive forces come to bear on the previously patented product. In the present case, that has not happened, either to Napp’s prices, or to its market share, in the community segment. It has not happened to Napp’s market share in the hospital segment. Even allowing for the fact that in this case Napp’s actual or potential competitors represent branded, rather than generic, entry, in our judgment the overwhelming inference from the totality of the evidence is that Napp’s prices in the community segment, and its market shares in both the hospital and community segments, have been protected, at least in part, by the foreclosure effects of Napp’s hospital discount policy. Nor do we doubt that that was Napp’s intention: see paragraphs 307 et seq below.
Asymmetry: Napp’s advantages over its competitors
74
segment can be made up on subsequent sales in the community segment, Napp submits that there was in fact a level playing field between itself and its competitors.
“[The data] shows that even where and when Zomorph succeeds in gaining access to hospitals, this has a minimal impact on its market penetration among GPs.”
In relation to Oramorph the same report comments (p. 18):
“there are only limited linkages between hospital and community sales of SRM. Most of the community market that is currently “captive” to MST cannot be won simply by winning some hospital contracts.”
75
“This is utterly mistaken. Where patients were prescribed Oramorph SR in the hospital, we made every effort to maximise the chances that patients would continue to be prescribed it subsequently in the community, but we could never be sure this would actually happen or to what extent. In many cases we found there was no significant follow-on effect.”
“This is why Napp aggressively defend the hospital business, and as a monopoly supplier why their pricing is predatory.”
“on the contrary it is only the application by Link of the various methods described above, which include, above all, harnessing the reputation of the hospital specialists and the PCG officials to communicate with GPs, nurses and retail pharmacists in the community that achieves vital sales growth” (paragraph 37).
76
launch of Zomorph in 1997. It cannot be known how long Link could have stayed in the market had it not been for the present proceedings (and see paragraph 44 above).
299.   Among the reasons why the potential availability of the “links” mentioned by Mr Mountain do not give rise to a level playing field are the following: (i) Napp has an established flow of profits from the community segment which can subsidise the losses on its hospital business, whereas a new entrant has to start from scratch without that advantage; (ii) Napp is in a position to impose its hospital prices on new entrants, thereby forcing them to incur losses on sales to hospitals over and above the normal costs of development and promotion associated with entering a new market; (iii) Napp as the incumbent supplier benefits from the existence of hospital switching costs which new entrants have to overcome; (iv) the low level of purchases by individual hospitals means that switching costs may prove an insuperable barrier to a new entrant; (v) with its established reputation Napp no longer has to incur additional costs of promotion in order to benefit from hospital influence in the community segment, whereas its rivals have to invest heavily; (vi) Napp has higher prices in the community segment than its rivals and thus can more easily recoup its losses in the hospital segment; (vii) any “linkage” is likely to be more reliable and predictable in the case of MST than other products because of Napp’s established reputation; (viii) according to the Internet Survey, 30 per cent of patients with a hospital prescription or referral letter may be switched by their GP to another brand, which is most likely to be MST; (ix) where Napp has procured a sole contract, that will be an additional barrier to a new entrant; and (x) Napp has the benefit of its established position in the community segment in the large proportion of cases where a patient is initiated by a GP without the intervention of a hospital or a referral letter.
The market since 1 March 2000
77
78
1999, to 91.9 per cent in 2000 and to 92.7 per cent in Q1 2001. That picture does not suggest to us that there was any material weakening of Napp’s dominance during the period of the infringement, nor that the playing field became materially more level in the period since 1 March 2000.
Intention to eliminate competition
79
80
“I can only say to you from my position that we always had a consistent strategy within the company. As you well know, we were facing aggressive pricing discounts by our competitors and they were constantly lowering their prices in the hospitals, apart from also having lower prices in the community, but they aggressively undercut our prices in hospitals and that has always been the case with the competitors that we have faced. Our strategy over the years to my mind has been absolutely consistent and you will see it, I think, repeatedly in the documents, that our strategy was to match those prices.” (Transcript, Day 1, p.19.)
When asked about the absence of documents since 1997, he said:
MR BROGDEN ... “I do not know whether I am right or wrong on this, but I can only attempt to explain it by the sense that our strategy over the years has not changed, and our strategy in terms of matching the prices that Boehringer created within the hospital market has, to some extent been perpetuated with Link also continuing to aggressively undercut our prices. In that sense there is ...
THE PRESIDENT: So in relation to Link you have been following, broadly speaking, the same strategy that you followed with Boehringer?
A. Yes, sir, broadly speaking, we have been following the same strategy. There are differences, but those are not of our making, and not our strategy.
Q. But the strategy has remained consistent throughout?
A. The strategy has remained consistent throughout, sir. If I may just say ...
Q. Of course.
A. ... because there is an important difference, the one thing that Boehringer seemed to do to my knowledge over the years was consistently submit tenders for the regional health authority contracts. These are the big contracts. It seems, as we have learned from our experience of late, that they [Link] have not consistently done that, but our approach has always been consistent in the sense of trying to match prices and submit tenders to hospitals.” (Day 1, p 19)
“The tribunal may admit or exclude evidence, whether or not the evidence was available to the respondent when the disputed decision was taken and notwithstanding any enactment or rule of law relating to the admissibility of evidence in proceedings before a court.”
In the light of that Rule, in our view it is open to the Director to rely on the documents disclosed to the Tribunal even though they were not relied upon by the Director in the Decision (i) as evidence tending to rebut assertions made by Napp in the course of this appeal and (ii) as secondary support for the finding already made by the Director in the Decision, that Napp’s intention was to eliminate
81
competition. Napp has had a very full opportunity to comment on the documents in question. We do not see any unfairness to Napp if we permit the Director to rely on them.
“The launch of SRM-Rotard in tablet strengths of 10mg, 30mg, 60mg and 100mg, in identical colours to MST CONTINUS Tablets, is clearly the most important issue with which we now have to deal... We have agreed internally that we will match (beat, if necessary) their prices to hospitals and hospices.”
“Farmitalia’s approach has been to concentrate on hospitals and hospices by offering extremely low prices, which we have been forced to match in order to retain this important and influential business.” (year-end report for December 1992).
and that:
“an aggressive pricing policy is essential to prevent the adoption and acceptance of new competitors.” (June 1993 mid-year report)
“The effect, however, would be to deflate the vital element of Boehringer’s promotional strategy and limit their opportunities to give Oramorph SR early success. It would also reaffirm that this is our market and any “would be” competitor may hurt us but will gain nothing for themselves.”
“The above action is both immediate and uncompromising as a response to Boehringer’s threat, and will hopefully signal to them that we are NOT leaving this market open to them...”
“Clearly the 90% discount option would send an unequivocal message to Boehringer that there was no place for them in this market. We do not of course know what their
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intentions are and can only assume that they would not be prepared to lose money in order to penetrate the market.”
Mr Smailes’ proposal was to “offer 80% discount prices and review the situation in the light of the outcome.” Mr Brogden responded to Mr Smailes’ memo on 20 June 1994 in the following terms:
“I know there is a school of thought that argues that we should ‘stuff Boehringer’ by quoting substantial discounts, eg, 90%. However, I don’t want to simply win the battle and lose the war by getting stuck with such low prices that our hospital sales have no absolute value (other than referral). It’s the usual difficult balancing act. I’d be inclined to accept the proposal of 80% made by Chris providing that the contracts come up in such a sequence as to allow us to drop our price if we should fall at the first hurdle. If three significant contracts have to be completed at the same time then I would consider moving to 85%. Incidentally, Arthur, these judgments have to be made in relation to the cost of goods and you should encourage Chris to include these in future.”
“Chris I’d be inclined not to prevaricate. Simply match the prices.”
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“The projected decline in cash sales for the tablets is in part due to the continued need for aggressive contract pricing to match Boehringer’s (Oramorph SR) ...”
“1. Perhaps understandably, they [BIL] felt hospital/hospice endorsement was very important to their market entry and aggressively undercut our own contract prices. As you appreciate, hospital endorsement (usage) can influence greatly the general practitioner and to prevent them gaining this foothold we also reduced our contract prices. They have now stabilised at the ludicrous figures you see in the table and whilst they are still half our price, the total value of the purchases by an individual hospital are so small as to largely negate any desire or reason for a hospital to move away from MST CONTINUS.
2. The above strategy [by BIL] was coupled with lower basic NHS price than MST. There are two reasons. Firstly, many hospitals appreciate the influence that their choice of drug has on the community general practitioner and believe therefore that they have a responsibility to make their choice of product with some regard to what the wider community will have to pay. Thus Boehringer use the lower Basic NHS price to persuade the hospital pharmacist – “not only will you pay less, but by following you the community, general practitioner will also pay less”. Secondly, of course, the lower basic NHS price is simply placed in front of the general practitioner as a money saving device against the practice budgets.”
“Our morphine preparations have done considerably better than anticipated. This reflects the introduction of MXL once-a-day morphine ... We have been very successful in containing our competitors though not without a continued erosion of prices when trying to keep them out of the hospital market.”
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“to reaffirm that this is our market and that any ‘would be’ competitor may hurt us but gain nothing for themselves.”
and
“to send an unequivocal message to Boehringer that there is no place for them in this market.”
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96 per cent of the community segment, Mr Manners makes no reference to any internal documents which support his description of Napp’s hospital pricing policy. Those we have seen in the course of these proceedings confirm that it was not simply a case of “making extra sales”, but of a consistent policy of excluding competitors from the hospital segment.
Conclusion on Napp’s net revenue defence
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or gain market share in, the hospital segment and, ultimately, in the community segment of the market, were placed at a significant competitive disadvantage by Napp’s hospital discounting policy; (c) Napp’s intention was, so far as possible, to eliminate competition by preventing or hindering market entry into both the hospital and the community segments; (d) Napp’s primary motivation was not to make “extra sales”, nor to make “an incremental profit” in recognition of the “follow-on benefits” accruing from hospital contracts, but to deny to its competitors a key means of entering the market for oral sustained release morphine in the United Kingdom through the gateway of the hospital segment.
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over 90 per cent of the market may commit an abuse if it selectively cuts prices deliberately to match those of a competitor, even if it is not shown that the undertaking has priced below total costs. In that case the dominant undertaking had eliminated the principal, and possibly the only means of competition open to its sole rival, thereby maintaining higher prices in the area not threatened by competition. There was a market share of over 90 per cent, and an intention to eliminate competition (paragraphs 117 and 118 of the judgment). As Mr Fennelly pointed out in his opinion (at paragraphs 135 and 137) it was a case of a superdominant undertaking which had selectively targeted competitors with discriminatory price cuts, implemented with relative autonomy from costs, with the aim of eliminating all competition.
Napp’s other arguments
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[...] [in excess of 90] per cent are not normal in hospital tenders; (ii) that such discounts have been granted selectively only where Napp has been faced by a competitor; and (iii) that the resulting difference between what the hospital pays and the normal NHS list price is exceptional – in some cases over 2000 per cent – as the Director finds at paragraphs 198 to 200 of the Decision (see Section VIII below). Perhaps more significantly, we do not regard it as “normal” for prices to hospitals to remain below direct costs for many years. For the reasons already given, we find that the below-cost pricing in question was not a ‘normal’ commercial response but the response of a superdominant undertaking aiming to eliminate competition. Nothing in the structure of the NHS compelled Napp to act as it did.
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90
“selectively supplying sustained release morphine tablets and capsules to customers in the hospital segment at lower prices than to customers in the community segment.”
Although the Director has, in the Decision, rightly criticised the extent of the differential between Napp’s prices in the hospital and community segments, it does not seem to us that, in the Decision, the Director has alleged that supplying the hospital segment at lower prices than the community segment is, of itself, an abuse. The Director has not addressed to us any detailed argument on this issue, nor made specific reference to subparagraph (i) of paragraph 236. If and in so far as the word “selectively” in subparagraph (i) is intended to add anything, the “selective” nature of Napp’s discounts is already referred to in subparagraphs (ii) and (iii) of paragraph 236. It seems to us, therefore, that sufficient grounds have not been shown for upholding paragraph 236(a)(i) of the Decision if and in so far as that subparagraph is intended to identify an element of the abuse not otherwise covered by the rest of paragraph 236(a).
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Conclusion
VIII — ABUSE: EXCESSIVE PRICES
A: ARGUMENTS OF THE PARTIES Napp’s arguments in the notice of appeal
353.   The essence of Napp’s case is summarised in the notice of appeal as follows:
“Napp has not charged excessive prices for MST. The price of MST is set in accordance with the PPRS, and is a reasonable price, having regard to the objects of the PPRS, and the fact that its terms are calculated, inter alia, to provide an appropriate incentive to Napp and to other companies to invest in R&D to secure a new generation of drugs for supply to the NHS.” (paragraph 4.1(ii)(a))
Napp relies very largely on Nera’s report of 29 May 2001, Napp: Analysis of OFT Decision on Excess Pricing for MST (A 106) and a paper of 24 May 2001 prepared by Napp entitled Evidence on Other Therapeutic Markets, (A 112).
“… over the life cycle of the product as a whole, provides pharmaceutical firms … with the appropriate incentive to invest in such R&D, education, training and promotion to the extent that consumers collectively are willing to fund such investment. Any such competitive price will take account of the ex ante uncertainty as to whether a particular product will succeed.” (notice of appeal, paragraph 5.21)
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incorrect to suggest, at paragraph 130 of the Decision that the limits set by the PPRS are “not restrictive”. The pharmaceutical industry is a relatively high risk industry because of the amount of R&D required and the uncertainty of finding successful drugs. Napp’s overall rates of return are well within reasonable limits for an industry of this kind.
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MST was, secondly, considering Napp’s expected volume of sales, and, thirdly, assessing how much profit Napp needs to make in order to fund its ongoing research activities.
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strength enables it to attract a premium over other brands, as the Director accepts. Nothing in the Director’s analysis serves to show that MST’s legitimate brand premium is excessive, or by how much. In addition, Napp points out that the Director has miscalculated the price of Morcap SR. Further the Director has misunderstood the nature of Napp’s export sales. Napp is merely a contract manufacturer and has no involvement or risk in the marketing of the product outside the United Kingdom. Comparisons with Napp’s other NHS products are not meaningful either.
The Director’s arguments in the defence
“16. In essence, the Director General’s case is that Napp charges excessively low and/or discriminatory prices in the hospital segment and thereby sustains very high prices and market share in the community segment of the market. These two aspects are accordingly interlinked. Napp’s pricing practices have the effect of placing significant obstacles against the successful entry of competitors, and in consequence serve to preserve its quasi-monopoly position in the community segment of the market and enable it to continue to charge prices for MST higher than could be sustained in the absence of that quasi-monopoly position ie competitive prices …
17. Accordingly, the Director General does not seek to condemn the prices in the community segment in isolation; in other words, if his case should fail as regards the exclusionary character of Napp’s pricing practice in the hospital segment, he does not contend that the prices in the community segment violate the Chapter II prohibition simply because of their absolute level.”
“As stated above, it is the Director General’s case that Napp’s conduct has had the effect of excluding competitors from the hospital segment, thereby foreclosing the essential gateway for entry to the community segment. As a result Napp has retained its quasi-monopoly position in the community segment and has been able to charge quasi-monopoly prices. In those circumstances, the charging of prices, which are
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higher than Napp would be able to charge in a competitive market, constitutes an abuse.”
The Director relies on United Brands, at pages 301 and 302 of that judgment.
96
Napp’s submissions on the Director’s alleged change of case
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lower its community prices. Napp might have decided that it was more profitable to maintain its community prices for some time, even though this would have lost market share, before responding with lower community prices. Napp suggests that any reduction in its community prices would most likely have occurred after 30 March 2001.
98
The Director’s response to the alleged change of case
99
“The essential significance of Napp’s exclusionary conduct (both before and after 1 March 2000) to the finding of excessive prices is that it provides a solid basis on which to conclude that, in the absence of such conduct, there would have been effective price competition in this market as from 1 March 2000.”
B: LAW
“directly or indirectly imposing unfair ... selling prices”.
100
“248 The imposition by an undertaking in a dominant position directly or indirectly of unfair purchase or selling prices is an abuse to which exception can be taken under Article 82 of the Treaty.
249     It is advisable therefore to ascertain whether the dominant undertaking has made use of the opportunities arising out of its dominant position in such a way as to reap trading benefits which it would not have reaped if there had been normal and sufficiently effective competition.
250     In this case charging a price which is excessive because it has no reasonable relation to the economic value of the product supplied would be such an abuse.
251     This excess could, inter alia, be determined objectively if it were possible for it to be calculated by making a comparison between the selling price of the product in question and its cost of production, which would disclose the amount of the profit margin; however the Commission has not done this since it has not analysed UBC’s costs structure.
252     The questions therefore to be determined are whether the difference between the costs actually incurred and the price actually charged is excessive, and, if the answer to this question is in the affirmative, whether a price has been imposed which is either unfair in itself or when compared to competing products.
253     Other ways may be devised – and economic theorists have not failed to think up several – of selecting the rules for determining whether the price of a product is unfair”
C: FINDINGS
The abuse as found in the Decision
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“if it is above that which would exist in a competitive market and where it is clear that high profits will not stimulate successful new entry within a reasonable period. Therefore, to show that prices are excessive, it must be demonstrated that (i) prices are higher than would be expected in a competitive market, and (ii) there is no effective competitive pressure to bring them down to competitive levels, nor is there likely to be.”
—    Napp’s prices in the community segment are typically around [...] [between 30 to 50] per cent higher than its competitors.
—    Apart from certain across-the-board reductions applying to the pharmaceutical industry as a whole under the PPRS, Napp’s price in the community segment has remained the same since the launch of MST in 1980, (save, as we understand it, for one increase in 1983) notwithstanding the expiry of its formulation patent in 1992.
—    Napp’s list price (less wholesale discount) in the community segment of the market is on average over 1400 per cent higher than its price in the hospital segment of the market for 10mg, 30mg, 60mg, and 100 mg tablets, where Napp faces competition.
—    At Napp’s highest level of discount, the list price in the community segment is on some tablets over 2000 per cent higher than Napp’s hospital prices.
—    Napp’s prices in the community segment are over 500 per cent higher than its prices for export on a contract manufacture basis. As we understand it, MST faces competition in export markets.
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—    Napp’s gross profit margin on sales to the community segment is [...] [in excess of 80] per cent, compared with a margin of around [...] [between 30 and 50] per cent on Napp’s other products sold to the NHS.
—    Napp’s gross profit margin of [...] [in excess of 80] per cent on sales to the community segment compares with a gross profit margin of [...] [less than 70] per cent for Napp’s next most profitable competitor. If Napp’s manufacturing margin is recalculated on the basis of the costs of its next most profitable competitor, Napp’s gross margin becomes [...] [less than 90] per cent compared with that competitor’s [...] [less than 70] per cent.
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5mg               4.30                   3.76
10mg             7.17                   6.27
15mg           12.57                 11.00
30mg           17.22                 15.07
60mg           33.58                 29.38
100mg          53.16                 46.52
...
...
r ~\ ...
200mg        106.34                 93.05
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most profitable competitor. In addition, Napp faced no competitive pressure on its prices in the community segment, had no patent protection, and enjoyed a market share of 96 per cent throughout.
Napp’s defence based on the PPRS
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cannot be judged without knowing the size of Napp’s initial investment in that product and its expected volume of sales; (ii) that the PPRS is a sufficient control over the price of MST; and (iii) that the Director has failed to take into account the need for “portfolio” pricing: see paragraphs 353 to 361 above.
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“—Secure the provision of safe and effective medicines for the NHS at reasonable prices.
Promote a strong and profitable pharmaceutical industry capable of such sustained research and development as should lead to the future availability of new and improved medicines.
Encourage the efficient and competitive development and supply of medicines to pharmaceutical markets to this and other countries.”
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which we are required to consider when deciding whether there is an abuse of a dominant position under section 18 of the Act. In our view, it is not appropriate, when deciding whether an undertaking has abused a dominant position by charging excessive prices in a particular market, to take into account the reasonableness or otherwise of its profits on other, unspecified, markets comprised in some wider but undefined “portfolio” unrelated to the market in which dominance exists.
“The PPRS does not guarantee a company a particular level of sales, or a particular level of profit associated with those sales, for a number of reasons…”
“… a company facing competing products may not be in a strong position to increase prices as a way of generating additional revenue, unless it has other products in its portfolio facing little therapeutic competition.”
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the remarks of Advocate General Reischl in Coditel II, nor the Monopolies and Mergers Commission Report The Supply of Recorded Music, seem to us to be relevant to the present case.
109
the public interest arguments may be for the PPRS, those arguments do not seem to us to be relevant to the justification of an excessive price in circumstances where it is the undertaking’s own anti-competitive activities which have, to a material extent, prevented any significant competitive pressure being brought to bear on the price in question. To seek to justify such a price on the basis of the PPRS is in our view to move wholly outside the objectives of the PPRS and to bring the PPRS into potential conflict with the Act.
“These margins [in the community segment] result from a lack of competition in the community segment which, in turn, results from the anti-competitive effects of Napp’s discounting behaviour in the hospital segment.” (paragraph 151)
“Napp cannot therefore justify a policy of loss leading [in the hospital sector] except in so far as cutting hospital prices below AVC denies a competitor the opportunity to establish itself in the community sector and thereby allows Napp to continue to earn high margins in that sector.” (paragraph 194)
“That Napp can earn high compensating margins in the community segment ... is because its discount policy in the hospital segment has hindered competition in the community segment. ... The object and effect of the low pricing in the hospital segment is indeed to protect and take advantage of Napp’s near monopolist position [in the community segment].” (paragraph 195)
“It is only in the community segment where buyers are less price sensitive and where there is an absence of effective price competition, partly as a consequence of Napp’s conduct, that Napp can sustain a premium of 40 per cent on competitors.” (paragraph 211)
“That Napp has sustained these higher margins without stimulating successful new entry is due, at least in part, to its exclusionary pricing policies in the hospital segment of the market.” (paragraph 228)
“Napp has maintained excessively high margins on the sale of MST in the community segment of the market without effective competition from successful new entry. This is due, at least in part, to Napp’s exclusionary pricing practices in the hospital segment.” (paragraph 232)
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“The lack of successful entry in this case is in part due to Napp’s exclusionary practices in the hospital segment of the market.” (paragraph 225)
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The Director’s alleged “change of case”
112
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Conclusion
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IX — THE PENALTY
A: INTENTIONALLY OR NEGLIGENTLY
Arguments of the parties
“(i) Napp has at all material times believed that the PPRS was effective to prevent it from charging excessive prices and that, provided that Napp observed the terms of the PPRS, its pricing of MST to the NHS would not be regarded as excessive.
(ii) Napp has at all material times believed that it was normal and acceptable commercial practice for a supplier of a leading brand of a pharmaceutical product, facing competition from new entrants, and with no patent protection, to maintain the NHS list price of its product, and to offer differential discounts to different buyers according to their willingness to pay, in the manner and to the extent that Napp has offered discounts against the list price of MST.
(iii) Napp did not believe that, by offering substantial discounts against the list price of MST to hospital buyers, it would thereby incur incremental losses. It believed that sales of MST to hospital buyers would result in incremental profits to Napp, when account was taken of the effects which hospital sales could be expected to have in maintaining or increasing sales of MST in the community segment of the market. Prior to the commissioning of the Internet Survey at document A18, Napp did not, however, seek to quantify the extent of any such linkages between hospital and community sales. Napp believed that it was normal commercial practice to offer discounts to hospitals which took account of linkages between hospital and community sales. Nor did Napp have any reason to believe
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otherwise: Napp observed that other firms were offering discounts which were suggestive that those other firms were also competing on that basis. Napp did not believe that it could expect to secure greater linkages between hospital and community sales than other suppliers of oral sustained release morphine.”
(paragraph 5.58 of the notice of appeal, as substituted.)
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of the Act. Paragraph 7.3 of the Director’s Guidance as to the Appropriate Amount of the Penalty (OFT 423) (“the Director’s Guidance”) states that “Mitigating factors include: … infringements which are committed negligently rather than intentionally.”
Law
117
118
Findings on intentionally or negligently
Discounts to hospitals
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negligently”. As we have just held, the Director was not, at this stage of the analysis, obliged to specify whether he considered the infringement to be intentional or merely negligent.
“243. Napp was similarly aware of the strategic importance of the hospital segment for new competitors and potential entrants. It must therefore have been aware that its discounts to hospitals would have the effect of reducing the ability of competitors to gain market share in the hospital and community segments of the market, and could lead them to exit the market altogether. That this was Napp’s intention is shown the more clearly by the fact that its prices to hospitals were below direct cost and by its having adjusted discounts on particular products and in respect of supplies to particular hospital regions according to the amount of competition it faced.
244. The Director is satisfied therefore that Napp’s conduct had as its object the restriction of competition. He is equally satisfied that Napp was aware that its actions would be, or, at the very least, would be reasonably be likely to be, restrictive of competition, but was still prepared to carry them out. Furthermore, contrary to Napp’s representations, Napp cannot have been unaware of the exceptional magnitude of the discounts it was offering to hospitals or of the asymmetry between its position in the market and that of its competitors. It must therefore have been aware that it would not be possible for competitors to engage in similar pricing behaviour over the long term.”
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infringement. We do not regard sustained pricing below direct cost by a superdominant enterprise enjoying a virtual monopoly 20 years after the launch of the product as in any sense “normal competition” or “legitimate commercial usage”, as those terms are understood in Community or domestic competition law.
Excessive prices
“246. Napp has maintained high prices in the community segment of the relevant market in the full knowledge of its own very high market share, its profit margins on such sales, its competitors’ prices, the preference for its brand on the part of the GPs, and their lack of price sensitivity. The Director therefore considers that Napp’s infringement in respect of its excessive prices to the community was, for the purposes of section 36 of the Act, intentional or, at the very least, negligent.”
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above the levels that would prevail in conditions of normal competition. In this case Napp knew that it had a virtual monopoly in the community segment. Napp also knew that the price of MST was not subject to competitive pressure in the community segment. Napp, however, maintained the price of MST knowing that that price was (i) around 40 per cent above that of its competitors; (ii) on average over 1400 per cent above its price to hospitals on 10mg, 30mg, 60mg and 100mg tablets; and (iii) up to [...] [in excess of 500] per cent above its export prices on those tablets. Napp also knew that its gross profit margin was some [...] [in excess of 80]per cent, well above its average NHS margin.
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to 427 above. Moreover the fact that the Director’s case has developed in the course of the proceedings does not alter the fact that, objectively speaking, Napp maintained prices in the community segment that it at least ought to have known were well above competitive levels and protected from competition. We do not accept that the question of “intentionally or negligently” under section 36(3) of the Act depends on whether or not the undertaking was told by the Director how to conduct its business. In the present case reference to United Brands, at paragraphs 248 to 253 of the judgment, cited above, would or should have put Napp on notice of the possibility that it was reaping trading benefits in the community segment “which it could not have reaped if there had been normal and sufficient competition”.
B: THE AMOUNT OF THE PENALTY
The Director’s Guidance
“The twin objectives of the Director’s policy on financial penalties are to impose penalties on infringing undertakings which reflect the seriousness of the infringement and to ensure that the threat of penalties will deter undertakings from engaging in anti-competitive practices. The Director therefore intends, where appropriate, to impose financial penalties which are severe, in particular in respect of agreements between undertakings which fix prices or share markets and other cartel activities, as well as serious abuses of a dominant position, which the Director considers are among the most serious infringements caught under the Act. The deterrent is not aimed solely at the undertakings which are subject to the decision, but also at other undertakings which might be considering activities that are contrary to the Chapter I and Chapter II prohibitions.”
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“2.3 The starting point for determining the level of financial penalty which will be imposed on an undertaking is calculated by applying a percentage rate to the “relevant turnover” of the undertaking, up to a maximum of 10%. The “relevant turnover” is the turnover of the undertaking in the relevant product market and relevant geographic market affected by the infringement in the last financial year. This may include turnover generated outside the United Kingdom if the relevant geographic market for the relevant product is wider than the United Kingdom.
2.4 The actual percentage rate which will be applied to the “relevant turnover” will depend upon the nature of the infringement. The more serious the infringement, the higher the percentage rate is likely to be. Price-fixing or market-sharing agreements and other cartel activities are among the most serious infringements caught under the Chapter I prohibition. Conduct which infringes the Chapter II prohibition and which by virtue of the undertaking’s dominant position and the nature of the conduct has, or is likely to have a particularly serious effect on competition, for example, predatory pricing, is also one of the most serious infringements under the Act. The starting point for such activities and conduct will be calculated by applying a percentage likely to be at or near 10% of the “relevant turnover” of the infringing undertakings.”
“2.8 The penalty figure reached after the calculations in steps 1 and 2 may be adjusted as appropriate to achieve the policy objectives, outlined in paragraph 1.8 above, in particular, of imposing penalties on infringing undertakings in order to deter undertakings from engaging in anti-competitive practices. The deterrent is not aimed solely at the undertakings which are subject to the decision, but also at other undertakings which might be considering activities which are contrary to the Chapter I and Chapter II prohibitions. Considerations at this stage may include, for example, the Director’s estimate of the gain made or likely to be
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made by the infringing undertaking from the infringement. Where relevant, the Director’s estimate would account for any gains which might accrue to the undertaking in other product or geographic markets as well as the “relevant” market under consideration. The assessment of the need to adjust the penalty will be made on a case by case basis for each individual infringing undertaking.
2.9 This step may result in a substantial adjustment of the financial penalty calculated at the earlier steps. The consequence may be that the penalty which is imposed is much larger than would otherwise have been imposed. The result of any one of steps 2 or 3 above or 4 below may well be to take the penalty over 10% of the “relevant turnover” identified at step 1, but the overall cap on penalties is 10% of the “section 36(8) turnover” referred to in step 5 below and must not be exceeded.”
“3. The turnover of an undertaking for the purposes of section 36(8) is:
(1)    the applicable turnover for the business year preceding the date when the infringement ended;
(2)    where the length of the infringement is more than 12 months, in addition the amount of the applicable turnover for the business year preceding that identified under paragraph (1) which bears the same proportion to the applicable turnover for that business year as the period by which the length of infringement exceeds 12 months bears to 12 months; and
(3)    where the length of the infringement is more than 24 months, in addition the amount of the applicable turnover for the business year preceding that identified under paragraph (2) which bears the same proportion to the applicable turnover for that business year as the period by which the length of infringement exceeds 24 months bears to 12 months;
save that the amount added under paragraph (2) or (3) shall not exceed the amount of the applicable turnover for the preceding business year in question.”
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The Director’s approach in the Decision
“249. The relevant product market affected by the infringements is the supply of sustained release morphine tablets and capsules in the UK. Napp’s turnover in the relevant product market in the year ending 31 December 2000 was £[...] million. The Director has taken this as the relevant turnover for the purposes of calculating the starting point.
250.    The actual percentage rate applied to the relevant turnover depends upon the nature of the infringement. The more serious the infringement, the higher the percentage rate is likely to be.
251.    Napp has supplied sustained release morphine tablets and capsules to hospitals at significant discounts with the object and effect of preventing competitors from increasing their share of the relevant market and deterring new entry. Napp has further targeted its discounts at those areas where it faced or expected competition. The Director considers that Napp’s discount policy directly restricted competition in at least a quarter of the relevant market and indirectly impaired competition in the whole of the relevant market. These discounts have therefore seriously disadvantaged Napp’s competitors in competing for hospital sales and thereby further restricted and diminished competition in the hospital segment of the market. Furthermore, the hospital segment of the market is of considerable strategic importance for competitors wishing to increase sales in the larger community segment of the market. Hence Napp’s discounts to hospitals have restricted and diminished competition in both the hospital and the community segments of the market.
252.    Napp faces very little competition in the community segment of the market and the barriers to entry are high. Napp’s prices to the community are typically some 40% higher than those of its competitors and, in most cases, over 1000% higher than the prices it charges to hospitals. They are also between [...] [in excess of 100%] and [...] [less than 700%] higher than its prices for export. In addition, its gross profit margins on community sales are in excess of [...][80%] compared to average NHS margins of around 40%. The result of Napp’s conduct is a serious distortion of competition, and a considerable excess cost to the NHS and so to the taxpayer.
253.    Sustained release morphine tablets and capsules are supplied for use in the final product market, rather than as an intermediate good, and the cost is borne by the taxpayer. The effects are therefore widespread.
254.    The Director therefore concludes that, contrary to Napp’s submissions, Napp has committed a serious infringement of the Chapter II prohibition and has taken as the starting point for determining the penalty 8% of the relevant turnover.”
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“257. The penalty figure reached after the calculations in steps 1 and 2 may be adjusted as appropriate to achieve the Director’s policy objectives of reflecting the seriousness of the infringement and deterrence. As regards the latter, the deterrent is not aimed solely at the infringing undertaking but also at other undertakings which might be considering activities contrary to the Act.
258.    The Director considers that it is appropriate to make an adjustment to the penalty in order in particular to achieve his policy objective of deterrence. To achieve this objective, the Director has decided that in the present case the basis for the adjustment should be his estimate of Napp’s gain from the infringements.
259.    It is impossible to estimate with certainty how much lower Napp’s profits would have been, or would now be, on sales of sustained release morphine tablets and capsules in the UK in the absence of the infringements. It is however clear that prices in the community segment of the market are, and have been throughout the period of the infringement, excessive and typically 40% higher than the prices charged by Napp’s competitors. Moreover, it could be expected that were it not for the infringements, not only would Napp’s community prices have been lower but the volume and value of its sales in the market as a whole would also have been, and would now be, lower. However, it is likely that Napp’s revenues from hospital sales, representing on average 15% of the market by volume and less than 1% by value, have been less than they would otherwise have been.
260.    On the basis of these findings, the Director estimates that Napp’s likely gain from the infringements is, at the very least, £2m. The Director considers that this figure probably underestimates Napp’s gain from the infringements but is satisfied that it is appropriate in this case to adjust the penalty by this amount in order to meet the Director’s policy objectives on penalties. In reaching this conclusion, the Director has had regard both to Napp’s turnover on the relevant market and to the fact that Napp’s profits are subject to taxation. Following Step 3, the penalty is therefore adjusted to £2.92m.”
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“265. The final amount of any penalty imposed under section 36 may not exceed 10% of the turnover of the undertaking calculated in accordance with the Competition Act 1998 (Determination of Turnover for Penalties) Order. The UK turnover of Napp Pharmaceutical Holdings Limited in 2000 amounted to £51.2 and in 1999 to £53.9m. The length of the infringement exceeds 12 months by 30 days, so that the turnover for the purposes of section 36(8) of the Act is £51.2m + 30/365 of £53.9m, i.e. £55.6m. The calculated penalty does not exceed 10% of this figure.”
Arguments of the parties
487. The essence of Napp’s case, advanced in the alternative, is that the penalty should be cancelled or substantially reduced for the following reasons, in addition to those already advanced. (i) The Director has not addressed his mind to whether the infringement was negligent or intentional. (ii) The infringement was novel, taking into account OFT 414 and Community case law. (iii) Napp had a legitimate expectation it would not be penalised as long as it observed the PPRS. (iv) Little if any loss was caused to consumers, in terms of them having to forego goods which they could have purchased under competitive conditions, or by restricting innovation. (v) The persistence of Napp’s infringement was in substantial part attributable to the Director’s delay in pursuing his investigation and his failure to state his case earlier. (vi) The Director has failed to justify increasing the penalty by £2 million to represent Napp’s “gain” from the infringement. (vii) Any “clawback” should not be from a date earlier than 13 March 2001, the date of the third Rule 14 Notice. (viii) Events prior to 1 March 2000, such as the exit of BIL, should not be taken into account in fixing any penalty. (ix) Napp did not initiate any “price war” with Farmitalia and BIL; it was hospital buyers who encouraged Napp to reduce its prices. (x) Napp could not have been expected to know that after the expiry of its patent it should have substantially reduced its list price for MST. (xi) It was reasonable for Napp to believe that provided it observed the terms of the PPRS its community prices would be regarded as reasonable. (xii) It is normal for suppliers of leading brands to maintain NHS list prices after patent expiry and offer differential discounts according to buyers’ willingness to pay. (xiii) The Department of Health as the ultimate buyer of MST was well aware of Napp’s costs and prices and of the prices of rival products. Department of Health officials do not agree with the Director’s assessment. (xiv) Napp fully co-operated with the Director’s investigations under the Act and earlier legislation. (xv) The Director was wrong to increase the level of penalty under step 4 by 10 per cent just because Napp continued to contest the case after the issue of the first Rule 14 Notice.
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129
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of community sales of 5.25 per cent. It is implausible that the reputation effect would account for only a further 1.75 per cent of the market (over 3 years) to make up Napp’s figure of 7 per cent. As to the Director’s assumptions, Napp says that the ratio of hospital to community sales suggests a high ‘linkage’ in favour of Link of about 1:2.8, which undermines the Director’s case on the lack of “follow-on effect”.
Findings
General observations
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to 31 March 2001. It is clear from that Order that Parliament intended that it is the overall turnover of the undertaking concerned, rather than its turnover in the products affected by the infringement, which is the final determinant for the amount of the penalty. As the Director points out in the Guidance, any other approach would mean that abuses by powerful companies in small relevant markets might not be appropriately sanctioned.
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The issue of duration in relation to hospital pricing
“The gain” at Step 3
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given case, what the gain is. That difficulty is illustrated by the present case. The Director did not disclose his original calculations which, according to him, showed a gain to Napp of £2 million. Since then, in the notice of appeal and the defence, and in a flurry of calculations and counter calculations exchanged between the parties in the days before the hearing, various different hypotheses and scenarios have been put forward by both sides. The Director’s final figure (still £2 million) is some 100 per cent above Napp’s final figure (some £1 million). The major difference between the parties are their different assumptions as to the rate at which Napp would have lost market share in the community segment if it had not priced below cost in the hospital segment from 1 March 2000 – 7 per cent over 3 years, according to Napp, and 25 per cent over 2 years, according to the Director.
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510.   Thirdly, and in our view more significantly, it seems to us that an arithmetical calculation of the ‘gain’ during the period of the infringement, of the kind carried out here, is likely to understate the real commercial gain from the infringing conduct, and thus risk being an ineffective penalty. In a case of predatory pricing, a significant part of the ‘gain’ made by the undertaking concerned is the deterrent effect it has on other undertakings which might have entered the market, or even other markets, where the dominant undertaking is active. That general effect, flowing from a general reputation for aggression, is not picked up in the calculations and is unquantifiable. Moreover the ‘gain’, as seen from the dominant undertaking’s point of view, is not merely the market share it would otherwise have lost in some period determined arbitrarily by reference to when the Director chose to take his Decision. The real ‘gain’ is the long-term strategic advantage of protecting a monopoly market share and the profits that flow from that for as many years as possible. For example, Napp’s calculations at Annex 26 to its skeleton argument show that Napp would have lost a minimal market share in the community segment up to the end of February 2001 if it had corrected its hospital prices on 1 March 2000, leading to a ‘gain’ after tax of just over £50,000. In our view it would be wholly unrealistic to fix a deterrent penalty by reference to that figure or anything resembling it, because such a figure does not reflect the real, but unquantifiable, commercial rationale behind Napp’s hospital pricing policy. That rationale was to protect and preserve its monopoly revenues from the community segment, of over £10 million a year, for as long as possible.
Aggravation under Step 4
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continuing with infringing conduct after a clear warning of the illegality of the conduct in question could be an aggravating circumstance. Otherwise, the temptation might be to continue the illegal conduct for as long as possible, in the hope that the resulting commercial gain would outweigh any subsequent penalty. Nor, in our view, does such a possibility of taking account of such an aggravating circumstance necessarily contravene the “rights of the defence”. The undertaking may still vigorously defend itself before the Director. The ‘aggravating circumstance’ is simply that continuing with conduct after an express warning of its illegality may be a worse offence than it would have been if no warning had been given.
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and instead proposed a direction to the effect that the NHS list price of MST in the community segment should be reduced by 20 per cent, with a floor price for MST sold in hospitals of 25 per cent of the reduced community price. Following further representations by Napp, the Directions, as finally made on 4 May 2001, imposed a reduction of 15 per cent in the NHS price of MST, plus a floor price for MST sold in hospitals of 20 per cent of that reduced community price.
Factors affecting the amount of the penalty in the present case
Hospital pricing: seriousness
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segment) that the predatory pricing is designed to protect or strengthen. Unless predatory pricing, and especially pricing below average variable cost, by dominant undertakings is rigorously penalised by competition law, new competitive entry may be thwarted, with the result that consumers never receive the benefit of competitive conditions, and the lower long-run price levels, wider choice and better quality which, in general, competition brings.
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affected by Napp’s conduct: paragraphs 281 to 283 above. Nonetheless, we are prepared to make some slight allowance, by way of mitigation, to take account of the fact that OFT 414 is not drafted quite as clearly as it could have been, and the fact that the Director’s case on follow-on effect and foreclosure has not been expressed entirely consistently.
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pricing policy about which Napp chose, whether rightly or wrongly, to remain silent in the course of the administrative procedure and the early stages of this appeal. We see no mitigation there.
Community pricing: seriousness
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533.   On the other hand, we see some mitigation in Napp’s favour. First, it was not until the adoption of the Directions that Napp finally knew the Director’s position as to the amount of reduction required to mitigate the “excess”. Secondly, the existence of the PPRS, while not in our view sufficient to prevent Napp’s infringement from being at least negligent, is in our view some mitigation. Although in our view Napp should have realised that the PPRS afforded no defence, it may not have been easy for Napp to come to terms with the fact that, as from 1 March 2000, the Chapter II prohibition imposes restraints on unfairly high prices charged by dominant undertakings, in addition to the constraints under the PPRS which, of course, applies to dominant and non-dominant firms alike. It is also true that the way the Director has characterised the abuse of excessive pricing before the Tribunal, linking it more explicitly to the abuse on hospital discounting, has to some extent “muddied the waters” as to the circumstances in which he (the Director) might consider the PPRS to be a defence to a charge of abuse of excessive pricing on pharmaceutical products. In addition there has been no decided case at Community level upholding an abuse of excessive pricing in circumstances comparable to the present case, and the principles upon which a price is to be judged “unfairly high” for the purposes of the Chapter II prohibition have not been considered in any previous decision of the Director or the Tribunal.
The Tribunal’s assessment of the penalty
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(the community segment). In addition, Napp’s prices in the community segment have been maintained well above the competitive level. If the objectives of the Act are to be achieved such conduct calls, in our judgment, for severe penalties. In those circumstances, absent any significant mitigating factors, we do not think that a penalty of £3 million, as a global figure, is outside the range of penalties that could reasonably be imposed, in a case such as the present, having regard to the permitted maximum of £5.56 million.
Interest on the penalty
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X — THE DIRECTIONS The letter of 4 May 2001
“At paragraph 236 of the Decision two elements of Napp’s conduct were found to infringe the Chapter II prohibition. First, Napp was found to have charged excessive prices to customers in the community segment of the market for the supply of sustained release morphine tablets and capsules in the United Kingdom (the relevant market). Second, Napp was found to have supplied sustained release morphine tablets to the hospital segment of the relevant market at discounts which have the object and effect of hindering competition in the relevant market.
The Director considers that these two elements of Napp’s pricing conduct are inter-related and must be considered as a whole in formulating directions which are appropriate to bring the infringement to an end. First, Napp’s ability to sustain high prices in the community depends in large part on the effect of Napp’s discounting behaviour to hospitals in hindering competition in the relevant market. Second, the fact that Napp’s prices in the community segment of the relevant market are significantly above those of its rivals contributes to Napp’s asymetrical advantage in bidding for hospital contracts.”
“The Director considers that an immediate reduction in the NHS list price is appropriate in order to mitigate Napp’s excessive prices in the community segment of the relevant market in the short to medium term. This reduction, coupled with a corresponding reduction in the ex-factory price of MST tablets sold to the community, will also reduce Napp’s ability to cross-subsidise discounts in the hospital segment of the relevant market.
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In the longer term, the Director considers that the best way to prevent Napp from pricing excessively is to maintain incentives, and to create opportunities, for competition to develop throughout the relevant market.
The Director considers that the appropriate level of reduction in the NHS list price would be fifteen per cent. This will significantly reduce the price of MST tablets to the community segment of the relevant market, while nevertheless allowing for a gap between the price of MST tablets and that of Napp’s competitors, thus maintaining incentives for competition to develop. This is consistent with Napp’s representations that a reasonable price premium on MST tablets should be allowed to reflect their current higher brand value relative to that of rival products.”
“Paragraph 2(d) of the directions provides that the price of each strength of MST tablet sold to hospitals in the UK shall not be less than twenty per cent of the NHS list price for that product strength of MST. The Director considers that this direction is appropriate in order to prevent Napp from restricting competition by supplying hospitals at excessively low prices.
The figure of twenty per cent represents the ratio between Napp’s average cost of supplying MST tablets to hospitals and the average NHS list price for those products arrived at following the fifteen per cent reduction required by the direction at paragraph 2(a). The calculation of Napp’s average cost of supplying MST tablets to hospitals for this purpose is based on the total delivered cost to Napp of supplying MST to hospitals in the UK over the period of March to May 2000. The calculation of Napp’s average NHS list price, to which the fifteen per cent reduction is then applied, is based on the volumes of MST tablets supplied to hospitals in the UK over the same period.
The direction at paragraph 2(d) does not impose on Napp an absolute prohibition on supplying hospitals at prices below the average cost. In order to do so, however, Napp would need to reduce further its NHS list price for the product thus limiting its ability to cross-subsidise discounts in the hospital segment and so, by weakening the asymmetry between Napp’s position and that of its competitors, increasing the opportunities for competition to develop.
In its representations, Napp has argued that in order to compete for hospital contracts it would have to reduce the list price of MST tablets to unnecessarily low levels. First, the Director does not consider that discounts to hospitals will remain at their current level following implementation of the direction. Second, MST tablets will maintain non-price advantages in competing for hospital contracts owing to Napp’s position of dominance on the relevant market.”
Arguments of the parties
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II prohibition or the Act itself; (iii) paragraph 6 of the Directions gives the Director power to obtain information to which he is not entitled under the Act; (iv) paragraph 2(d) of the Directions wrongly extends to private hospitals and hospices; (v) there is no basis for requiring Napp to renegotiate its hospital contracts in order to bring to an end any supposed infringement; (vi) there is no basis for concluding that a reduction of at least 15 per cent in the current NHS list price of MST is necessary in order to end Napp’s supposed infringement; (vii) there is no basis for concluding that it is appropriate to prohibit Napp from discounting its prices to hospitals to a level which falls below 20 per cent of the NHS list price in order to end Napp’s supposed infringement; (viii) by publishing the floor price in full the Director is distorting competition, since its rivals will know at precisely what level to undercut Napp, making up any losses from follow-on linkages, while Napp is prevented from acting likewise.
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Findings
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or lessens the need for the requirement to reduce by 15 per cent the list price of MST. That requirement is necessary in order to remedy the distinct infringement of excess pricing found in the Decision. As at the date of the Directions, 4 May 2001, Napp’s community prices were unfairly high, as we have found.
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XI — ORDERS MADE
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Christopher Bellamy                                       Barry Colgate                           Peter Grinyer
Delivered in open court                                                                                  15 January 2002
Charles Dhanowa Registrar
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