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Why Intel Faces an Uphill Slog

By Andy Reinhardt Intel could have a tougher time defending itself in Europe than it would in the U.S., thanks to a pair of European court rulings. The most pertinent case was one issued against French tire maker Michelin by the European Commission in 2002, which was affirmed by the Luxembourg-based European Court of First Instance in September, 2003. The EC accused Michelin of abusing its market dominance by offering rebates and bonuses to dealers, the effect being to exclude other tiremakers.

The comparisons with the Intel-AMD situation are striking. Much of AMD's (AMD) argument is built on the allegedly predatory impact of Intel's (INTC) "market-development fund" rebates (often known as "Intel Inside") to PC makers, which are calculated based on sales volumes (see BW Online, 7/14/05, "The EU's Assault on Intel").

In the Michelin case, the company's rebates were found to be "loyalty inducing," thus abusive because of the way they were calculated. Dealers didn't get reimbursed for up to a year after they sold a tire. But because they didn't know how much rebate they would get 12 months later, they didn't know what to charge for tires -- and even ran the risk of selling at a loss. That, in turn, made it even more essential for them to hit their sales targets and obtain the largest rebates possible. The result: They bought more Michelins.

TOO BIG A SLICE? Antitrust experts have praised the decision because it provided some clarity for European companies and government bureaucrats about what kinds of rebates are permissible by dominant companies. In general, the rebates have to be tied as much as possible to the true underlying cost of providing the product or service, and any rebate linked to exclusive purchase requirements is generally unacceptable.

Also, rebates tied to incremental sales over a certain threshold are generally more acceptable than those that apply retroactively to all purchases, because rivals have an easier time competing in the incremental "slice" of the market. This applies in the Intel/AMD case because AMD argues that Intel generally will get 60% of the market as a baseline, and so AMD is really competing for the other 40% -- and that's where Intel's incentives really kick in.

The problem with the Michelin ruling is that it didn't adequately take into account economic arguments. For instance, Michelin offered evidence that despite the rebate plan, it had lost market share during the relevant period and that tire prices actually declined, to the benefit of consumers.

NEED FOR JUSTIFICATION. But the court ignored that argument, pointing out that it could be assumed prices would have been even lower, and competitors would have done better, in the absence of Michelin's rebate program. Legal experts say this is a weakness in the ruling that future defendants -- including, potentially, Intel -- will likely try to exploit.

Similarly, legal analysts from the Brussels office of law firm Cleary Gottlieb note in a white paper that the ruling used a very "formalistic" approach to Europe's Article 82, which is the equivalent to the U.S. Sherman Antitrust Act. The biggest problem, according to the law firm, was that it seemed to indicate rebates from dominant players generally aren't permissible unless they are clearly justified by economies of scale or other cost savings.

This seems too strict a test. Cleary Gottlieb says "any non-predatory price offered by a dominant firm that increases output should be presumed legal even in the absence of specific cost-savings attributable to the relevant transaction." As far as the Intel-AMD situation is concerned, AMD will, of course, argue that Intel's pricing was indeed predatory, and thus runs afoul of the law.

THE COST NEXUS. Another ruling with potential application to the Intel case was issued by the court in December 2003 against British Airways (BAB). It affirmed a decision by the EC that BA had abused its market dominance in British travel-agency services by offering graduated commissions to travel agents based on whether they reached certain sales targets.

BA claimed in its appeal of the EC's original decision that a finding under Article 82 required clear evidence that the markets in question were linked. BA admitted that it dominated travel agencies, but said that, since it doesn't dominate air travel in Britain, any market impact from its incentives to travel agencies was moot. The court rejected that reasoning, saying that influencing sales patterns among travel agents clearly affected the market for airline services.

The most important part of the ruling centered on the fact that there was no link between the amount of commission BA offered travel agents and BA's underlying costs. This is an Article 82 no-no. Dominant companies are free to give volume discounts when there's a correlation between what it costs to provide a product or service and how much is charged. Higher volumes usually cost less on a per-unit basis, so discounting is economically justified. But a discount unrelated to cost is not.

POTENTIAL VULNERABILITY. This latter point has big implications for the Intel-AMD situation because AMD alleges that Intel's discounts and rebates were tied to volume targets, not to Intel's economies of scale. As proof, AMD notes that Intel offers higher rebates retroactively if certain sales targets are met. That implies very little connection between cost and price, since the previously-purchased microprocessors -- regardless of what it cost Intel to make them -- get discounted only after more are bought.

But legal eagles have criticized the BA case on a number of grounds. First, the court found that BA's commission had a "fidelity-building" effect, and were thus unacceptable without acknowledging the fact that any economic incentive is likely to increase loyalty. Its failure to delineate this point more clearly is a potential vulnerability in future applications of the precedent or high court challenges.

Second, the court demurred on the question of whether the commission had to demonstrate a "concrete" impact from BA's behavior, rather than the easier test of "tending" to restrict competition. The problem here is that despite BA's commission program, it lost market share during the period in question. Had the court applied more rigorous economic analysis, it might have been forced to admit that while the behavior looked monopolistic and exclusionary, it clearly hadn't worked.

DOUBLE-BARREL CHARGES. This issue may not matter in the Intel case because the company has gained market share at AMD's expense, so its rebates seem to have had the desired effect.

Clearly, there are many other legal issues that will play out in any EC case against Intel. But it's no surprise why AMD is pinning more hopes on European justice than on action by U.S. antitrust authorities. Cleary Gottlieb notes that U.S. courts have generally held that absent predatory pricing or exclusive dealing requirements, there are no grounds for treating loyalty rebates as monopolization cases.

To make their case, AMD and the EC will rely on proving that Intel used both predatory pricing and exclusive dealing. For the time being, the bar to prove that in Europe is lower. But if the Michelin and BA cases are overturned or clarified, it's a whole new ballgame. Reinhardt is a correspondent in BusinessWeek's Paris bureau

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