Judgments concerning follow-on cartel damages cases are few and far between.

Practitioners in the field therefore have limited case law to draw on to understand the standards of evidence when it comes to important economic issues such as the assessment of overcharge and pass-on. On 8 February the High Court handed down its ruling in Granville vs LG Display, only the third cartel damages judgment in the UK, providing rich reference material for how courts think about these issues.

In this article we draw out the main points to be learned on how the court assessed overcharge and pass-on and what this may mean for the economic evidentiary burden in future such cases. In sum, its findings demonstrate the pragmatic view that courts can take in assessing economic evidence and the importance of economic theory in assisting even non-specialist courts to evaluate the facts at hand.

Background of the case

Granville brought its claim against LG Display arising from a worldwide cartel in the market for LCD panels (the display modules in electronic devices) in the early 2000s. The European Commission (EC) found that a number of producers of LCDs had infringed Article 101 TFEU by implementing an agreement on the sales prices of LCD panels for PC and TV applications (EC Decision COMP/39.309). They were fined a total of almost €650m.

Frontier advised LG Display, the sole defendant that had neither settled nor become insolvent. LG Display is a South Korean company, which was, at the time of the infringement, the world’s largest supplier of LCD panels for TVs, PC monitors and notebooks. It sold panels mainly to major manufacturers of consumer electronics, but also to smaller, more localised computer makers, including Granville, the claimant in this case.

Granville manufactured, assembled and retailed computer packages under the brands of “Time” and “Tiny” during the infringement period. Granville claimed that it had suffered damage as a result of having paid higher prices for LCD panels due to the existence of the infringement, as the panels were a key input in notebooks and PC monitors.

Granville went into administration in mid-2005, towards the end of the infringement period, and the claim was brought by its liquidators. This meant that witness evidence from the claimants was not available and disclosure of factual evidence and data was incomplete. This heavily influenced the economic analysis which could be undertaken, particularly with respect to pass-on.

A broad sword or careful scalpel? Varying approaches for measuring overcharge

The first battleground between the claimants’ and the defendants’ experts was the estimation of overcharge – the amount that the claimant overpaid on its purchases of LCD panels as a result of the infringement.

Lesson #1: Overcharge analysis needs to fit the facts

The central challenge when estimating overcharge is to determine the “but-for” prices (or counterfactual) that the claimants would have paid absent the infringement. By definition, but-for prices are not observed, but must be estimated using available data. A crucial starting point when considering what might be an appropriate statistical or econometric analysis is to review the factual evidence of the market dynamics around the time of the infringement. The purpose of such an exercise is to identify how prices would have been determined under competitive conditions, with the aim of ensuring that these dynamics have been properly captured.

Basic economic principles imply that production costs will be a key driver of LCD panel prices. In addition, market analysis from the time preceding and during the infringement characterised the market for LCD panels as being subject to large supply-demand dynamics, known as the “crystal cycle”. Prices swung around a trend line, with cycles of excess demand followed by excess capacity.

The descriptions and evidence of the infringement presented by the EC documented how the cartel participants set prices in reference to their future expectations of this crystal cycle (see for instance §99 of the EC Decision), which, data showed, continued throughout the infringement. Any good economic model of a counterfactual must take these kinds of dynamics into account. Not doing so would risk attributing swings in prices which would also have occurred under competitive conditions to the impact of the infringement.

The approach that Frontier took was to model the but-for prices during the infringement as a function of production costs, capacity, demand (proxied by semiconductor revenues) and a selection of other variables accounting for panel size, resolution and country of purchase. All these factors appeared, based on the data, to drive prices of LCD panels. The but-for prices were modelled using what is known as the ‘temporal comparator’ approach.

In other words, the relationship between prices and explanatory factors was estimated during a period of time which was believed to be ‘uncontaminated' by the infringement (in the present case, due to data constraints, this largely included the years after the infringement) and, on the assumption that the same relationship holds during the infringement period, the overcharge is then estimated as the difference between the but-for prices and actual observed prices during the infringement period. The resultant overcharge estimate was about 2% for notebook panels and 5% for PC monitor panels.

The claimants’ expert did not seek to control for any of these market dynamics. The expert’s approach was to simply measure the trend in prices preceding the infringement, by fitting a curve to the price data, and to assume that trend would continue during the infringement. The claimants’ central overcharge estimate was 70% for all LCD panel applications.

There are a number of issues with this approach:

• First, the estimated counterfactual was unrealistic: if extended to the present day the claimants’ model would imply that LCD panel prices should now be close to zero.
• Second, the estimated counterfactual in no way reflected the realities of the market and failed to control for important drivers of prices under competitive conditions.
• Third and as a consequence, this approach risked falsely attributing price swings caused by the crystal cycle to the infringement, thereby overestimating the overcharge (as illustrated in Figure 1 below).

Source: Frontier Economics

Note: For illustrative purposes only, not based on real data

Judge Pelling, hearing the case, was critical of the approach taken by the claimants’ expert: "Of the two methods offered, it is the multiple regression analysis technique used by [the defendants’ experts] that at least attempts to control for the actual effect during the infringement period of production costs, supply and demand whereas [the claimants’ expert] proceeds on the assumption that actual changes in these metrics during the infringement period can be ignored by assuming they did not alter".

Consequently, he ruled in favour of Frontier’s econometric approach as a superior way of estimating the counterfactual controlling for all relevant factors impacting prices under competitive conditions.

A Rubin’s Vase: the evidence on pass-on

The second key area of contention between the claimants and the defendants was the level of pass-on – how much of the claimed overcharge on LCD panels the claimants were able to pass on by charging their downstream customers higher prices for PC packages. The court concluded that pass-on was likely to be at the higher end, agreeing in most part with the defendants’ reasoning. There are two further lessons to be learned from this.

Lesson #2: Economic reasoning and indirect evidence can suffice where there is a dearth of data

An empirical analysis of downstream pass-on requires a time series of data evidencing the prices the claimants paid for the cartelised input (LCD panels) and the prices charged to downstream customers (businesses and consumers buying PC packages and notebooks).

This data did not exist in the current case because (i) the claimants had long ago been liquidated; and (ii) dozens of new PC specifications are released every year. As such, identifying the impact of a change in LCD prices would require data on the specification of each package sold and the input price of each component, to be able to control for changes in prices unrelated to LCD panels.

Consequently, neither expert was able to conduct an empirical analysis to support the analysis of pass-on. The lack of data allowing the experts to “[trace] the change in cost of the LCD panels from the claimants’ purchases through to a change in sales price to the end consumer” underpinned the claimants’ assumption that none of the overcharge was passed on. In other words, because it was not possible to see the pass-on, the claimants presumed it did not happen.

The High Court rejected this explicitly, noting that “[w]here documentary evidence is limited, such an approach would effectively make it impossible to demonstrate pass-on”. The judgment then goes on to recognise that where data is limited, defendants may rely instead on a combination of economic reasoning and evidence of “internal policies and approaches”. Notably, this sort of evidence may not permit precise quantification of the rate of pass-on. Nevertheless, the court took a pragmatic approach in the current case, recognising that a “broad brush or broad axe” approach may be appropriate.

Lesson #3: Economic theory can act as a guiding hand in interpreting factual evidence

Given the lack of data, the assessment of pass-on in Granville vs. LG Display ultimately turned on the available factual evidence of market characteristics and Granville’s business model and pricing approach. This evidence was deployed to “[narrow] of the range of uncertainty concerning downstream pass-on”. The claimants’ core approach was to consider Granville’s pricing strategy, while the defendants adopted an economic framework.

Ultimately the High Court favoured the economic approach, illustrating the importance of economic theory in aiding the interpretation of factual evidence.

The claimants’ approach

The claimants’ central argument was that Granville would have been unable to pass on any overcharge because of its specific business model:

• Granville’s competitive strategy: Granville sought to beat its competitors by offering higher-specification PC packages at the same price; promotions were a key feature of its pricing strategy.
• Psychologically attractive pricing: Granville adopted a strategy of choosing optically appealing price points (e.g. £499 rather than £500).
• Cover sales: Granville’s retail staff were incentivised to sell extended warranties and upgrades alongside PC packages. Extended warranties were said to have achieved 100% margins, accounting for about 10% of Granville’s revenues on PC packages (and, as such, well over 10% of total profits).

In summary, the claimants argued that Granville’s approach was to select a price for PC packages which was based on psychologically enticing pricing points and the offerings of its competitors; margins were not a key consideration. The competitive conditions on the market meant that there was no flexibility for Granville to pass on price increases due to the risk of losing sales of PC packages and associated high-margin warranties and upgrades.

The economic approach

Fundamentally, economic theory indicates that where there is competition, market-wide cost shocks tend to be passed on – and the more competitive the market, the higher the likely rate of pass-on. In addition, enduring increases in variable costs are more likely to affect pricing decisions and to be passed on. Finally, markets where prices can be changed easily and at little cost facilitate a high level of pass-on.

All of these factors obtained with respect to the present case, as is clear from Judge Pelling’s reasoning supporting a finding of a high level of pass-on:

• The circumstances of the infringement in question were such that it affected a per-unit variable cost and most likely impacted the entire market in which the claimants were active. Crucially, this meant competitors would also have faced (and passed on) the LCD cost increases. Thus the claimants would not have lost significant market share by passing on the overcharge.
• The markets in which the claimants were active were highly competitive, which meant that margins would have been constrained. “This is apparent from the margins referred to in the [claimants’ documentary disclosure] and is apparent too from the emphasis placed internally on the desirability of selling extended warranties in order to enhance overall margin”. Under such circumstances, the claimants would have had very limited ability to absorb cost increases.
• Finally, the nature of the market and the frequently changing product specifications meant there must have been very low costs to altering prices.

While both claimants’ and defendants’ expert evidence essentially revolved around much the same set of facts and evidence, there was a firm difference of opinion over how to interpret the evidence, resulting in polar opposite pass-on findings. Ultimately, what proved to be pivotal was the use of economic theory to understand the evidence and what it meant for the rate of pass-on: Judge Pelling concluded that “[he was] satisfied that in the circumstances of this case the economic theory set out by [the defendants’ experts] points strongly toward it being more probable than not that the claimants’ managers would have sought to pass on such cost increases”.

Conclusion

The defendants in Granville v. LG Display proved their case on three points which both conflicted with the claimants’ arguments and were determinative as to damages:

• Econometric analysis which reflects economic principles and the facts of the market is a superior approach for determining overcharge compared to simply ‘curve-fitting’ – an econometric approach was better suited than a time trend to model the dynamics of pricing in the LCD market.
• The likelihood of pass-on can be considered in the round given the evidence available and documentary or other evidence showing an explicit tracing of cost changes through to pricing is not required – the claimants’ approach was a counsel of perfection applied to downstream pass-on which was not applied to upstream pass-on. If it was not possible to directly trace a specific cost increase to a retail price change, then the overcharge they paid themselves should also have been zero.
• Economic analysis can play a key part in the assessment of pass-on – the claimants’ approach to downstream pass-on was to treat it solely as an accounting issue, with no reference to economics. Judge Pelling quite properly ruled that economics is relevant to pass-on, and that companies in highly competitive markets are likely to pass on at least a substantial part of any incremental cost increase to their customers.

As a result of these three factors, the claimants won only around 7% of their original £60m claim. This case therefore carries important lessons for future litigants on both sides of follow-on claims and will doubtless be much referenced over the next few years.