1. IntroductionPredatory pricing one of the oldest conspiracy methods that competing largebusinesses may inflict. The law that started regulating this malign form ofcompetition is dating back to 19th century nevertheless it is still complexand controversial. After all, competing on price is the core essence ofcompetition and firms should not be deterred passing the efficiency – thatthey have achieved – on to the price of a product. The law on predatorypricing is enforced on the very thin ice where underneath is sheercompetition and above is abusing practice and it is important not to breakin. A firm has to raise itself an anxious question if it is dominant andthen to face a dilemma where both a price rise and a price cut might beconsidered to be abusive. The dominant firm might simply argue that it iscompeting – as it should do – whereas the complainant will argue that ithas departed from beneficial competition and is guilty of abusivebehavior[1].
1.2 EliminationIn this assignment I have concentrated on EC law dealing with abuse of adominant position in relation to predatory pricing. I made some referancesto UK law as it gives some helphul guidelines in the enforcment of EC law.Even more, some helpful insight on this issue I found in the practise of USantitrus authorities (e.g. as for today, the rule of ’recoupment’ has notbeen aplied yet by ECJ but its incidense is not a distant future).
1.3 MethodAll kinds of sources used in this assignment, such as official EU officialpublications, literature and articles on this topic, will be evaluated interms of relevance and validity. The size of this paper does not allow meto go into deep analysis, but hopefully I will provide myself with helpfulinsights into this subject.
1.4 Formulation of the problemIn order to show to what extent a dominant undertaking may engage inpredatory pricing practice it is important to define what is considered bypredatory pricing.To the extent that single market integration has lifted previous legal andinstitutional restrictions to entry into a national market, the dominantfirms in that market have no other choice but rely on strategic behaviour;one of this kind is predatory behaviour towards existing and potentialcompetitors. It has been aimed at new entrants and firms already operatingin the markets. This usually takes two forms[2].Firstly, there can be restriction of access to a complimentary asset by adominant firm. This asset can be characterised by essential importance inreaching the end customer, and most importantly – cannot be duplicated –either because it is in scarce supply or it has a form of statutory ormonopoly. The monopolist controlling an essential complementary assetnaturally will have an incentive to prevent the access of competing firmsby introducing disadvantageous terms. This may be expressed by refusal tosupply an asset, setting supranormal charges, use of vertical restrains(e.g. exclusive dealing agreements)Secondly, and of the most importance to this paper, there can beexclusionary pricing. That is, a dominant firm may preclude the entry ofrivals into the given market directly through its pricing behaviour, bysetting prices for its products in the market below the level of economicrationality so it is not worth for a rival to compete. This can be done byintroducing non-linear pricing structures such as selective discounts andfidelity rebates (which reward customers in exchange for not purchasingfrom rivals). The other form includes predatory pricing, where the dominantfirm adopts an aggressive prising strategy as a response to entry. Evenmore, the dominant firm may implicitly imply of its predatory intents to
potential rival. Due to the constrain of limits to this paper, Iinvestigate only predatory price-cutting (selling at a loss). Other prisingpractices as selective price-cutting to retain customers (but not at loss)and vertical margin squeezing are excluded.2 Predatory price-cuttingThus, the idea of predatory prising is simple enough: that a dominant firmthat has been charging for its products supra-competitively reduced pricesto a loss making level when faced with competition from an existingcompetitor or a new entrant on the market and then having disciplined thecompetitors the dominant firm raises its prices again, accumulatingsupranormal profits until the next wave of attacks[3].
2.1 Justifications for predatory pricingIn principle, any competing firm may seek to meet possible competitionthrough conduct which is meant to signal unequivocally that entry would bemet with aggressive retaliation, or that its advantage is such that therival would not be able to compete effectively, were it to enter. Mainlythese signals are expressed in pricing behaviour in the market. Theimportant economic issue is when and under what circumstances thesestrategies may be deemed justifiable and pro competitive. Unlikeinvestment in capacity, R&D or advertising, which may provide thecompetitive advantage, pricing is a strategic weapon. This weapon is usefulof its rapid application whereas other means might require considerableamount of time. Pricing strategy is one of the most viable instruments thatundertakings have in their disposition and they should not be deprived ofpossibility of inflicting it, even if it is predatory.
2.3 Proving of predatory pricingThe main problem with predation is that this strategy may be detected bycompetition authorities. And sometimes it might be legal and sometimesillegal. If firms could be sure that predatory pricing was always detectedand proved illegal, then such strategy would never be used. However, the
proving of predatory pricing is quite complicated and there is no singlesatisfactory test or technique that a firm is predating.The best-known test is the Areeda-Turner rule, were by prices which arebelow a firm’s average variable cost (‘AVC’) are deemed to be predatory. Infact, there are situations in which pricing below marginal cost islegitimate, and therefore this test may not be considered safe. To solvethis problem, from 1993 the US Supreme Court has established the recoupmenttest[4] that relegated the Areeda-Turner test to ancillary role. But as wecan see the EU competition authorities have declined to adopt the Areeda-Turner test, according to which pricing above AVC should be presumedlawfull. Other two rules have been used. Namely, AKZO rule an IncrementalCost standard.AKZO testThe crucial problem is the need to identify an appropriate measure of thefirm’s cost – to be compared with the prices. This always contentious issuein predation cases, where there is a sort ‘indistinguishability problem’(the dominant firm will always argue that its pricing conduct is in factcompatible with keen competition), and therefore much hinges on the levelof cost. These types of difficulties are well exemplified by the case ofAKZO[5] (the largest European supplier of bleaching agents), which wasinvestigated following a complaint that its conduct threatened to force outbusiness a smaller UK competitor, Engineering and Chemical Supplies Ltd(ECS). The Commission here decided that pricing above average variable cost(‘AVC’) but below average total cost (‘ATC’) could be abusive were the wasevidence of an intention on the part of the dominant firm to eliminate acompetitor[6]. The Commission suggested that even a price above ATC mightbe predatory when assessed in its particular market context. As the ECJruled on the appeal by AKZO, the prices were predatory because there was no
evidence that they were necessary in order to match competitors’ offers andthat there was evidence of an intention to drive ECS out of the market.Now, rises the question was is meant by “matching competitors’ offers”.Clear application of AKZO test is seen in Wanadoo[7] case and can be citedas a general rule: ‘Community case law applies two tests to establishwhether an abuse in the form of predatory predatory pricing has beencommitted: where variable costs are not covered, an abuse is automaticallypresumed; where variable costs are covered, but total costs are not, thepricing is deemed to constitute an abuse if it forms part of a plan toeliminate competitors.’Legitimisation for predatory pricingIn the EC law, there are no clear guidelines on what would be legitimatemeet competition by predatory pricing. Some helpful and more elaboratedinsight can be drawn from UK legislation. UK Competition Act of 1998 is ingreat conformity with EC regime this enables UK competition authorities toapply Community competition law when making decisions under the Act[8]. Inthis Act, Section 4 of the Guideline Assessment of Individual Agreementsand Conduct [9] deals with predation. The Guideline is more sophisticatedthan the case law of ECJ. Here we can find some possible justifications[10]even when pricing below AVC: – Loss leading were cutting the price of one product may increase sales complimentary products; – Short run promotions often involve selling below AVC for a limited period and are widely used in many markets. However, a series of short term promotions could, taken together, amount to a predatory strategy; – Prices that mach inefficient entrant. Some markets are able to support only one or two undertakings because, for example, there are significant economies of scale. The dominant firm would then have the choice of remaining in the market, and incurring losses, or exiting
the market, perhaps leaving the market to be supplied by a less efficient new entrant. – Mistakes in determining the correct market price. In some cases an undertaking may find itself selling at below its variable costs because of unanticipated increases in input costs, or unanticipated reductions in demand.; – Low prices that are attributable to network externalities. There are some services (such as telecommunications networks) where the addition of more customers adds to the value of the service sold to other customers. In these circumstances, it can be profitable for the undertaking to sell part of the service to customers at below average variable cost; – The undertaking is making an incremental profit. If the particular action being complained about is incrementally profitable, it is unlikely that it is predatory. The competition authorities still need to be convinced, however, that the reduction in losses will shortly result in the undertaking covering its average variable costs.Indeed, the Commission gives attribute to these justifications. In TetraPak II case[11] the Commission did not merely rely on the AKZO presumptionwere prices are below AVC, but said that, that it had ‘gatheredsufficiently clear and unequivocal data to be able to conclude that, salesat loss were the result of a deliberate policy aimed at eliminatingcompetition’[12]. Commission declined to accept justification thatefficient multi-national company could have indulged in behavior so opposedto the logic of economic profitability trough management error. Nor did itcould find any exceptional circumstances, independent of Tetra Pak’s freewill, that forced it to make losses. The Commission concluded that therewere no such circumstances and that prices were simply part of an ‘evictionstrategy’[13]Recoupment testAs it was pointed out above in US law the proving of price predation hingeson the fact that predator should have the ability to recoup any losses
incurred. This standard had already played a major in the 1986 MatsushitaElectric Industrial vs. Zenith Radio case[14]. In this case the SupremeCourt, interestingly, acquitted seven Japanese firms from accusations ofdumping and predatory pricing in the USA because of the impossibility torecoup losses aft6erwards, in spite of the fact that both geographic pricediscrimination and injury to US producers had been found. O other hand theUK law does not give clear guidelines[15] to what extent recoupment must beproved in EC law. It says that it would not necessarily be required toestablish the feasibility of recoupment where the dominant firm abuses inthe market in which it is dominant; however the issue would arise were thedominant firm cuts its prices in a neighbouring market in which it is notdominant. Nor the ECJ has adopted a requirement of recoupment under Article82. In AKZO V Commission the Court acknowledged the significance ofrecoupment in paragraph 71 of its judgement. However it did not expresslyincorporate the need of recoupment as part of the offence. According to theCourt, it must possible to penalise predatory pricing whenever there is arisk that competitors will be eliminated. The aim pursued, which is tomaintain undistorted competition, rules out waiting until such a strategyleads to the actual elimination of competition[16]This gives a notion that firms inflicting predatory pricing in Europeshould not explicitly rely on recoupment clause even though it is a weightyargument in US law. But of course, the possibility that in future caseswere the evidence of intention to eliminate competition is less clear-cutand were a predator is not super-dominant, the Court might require proof ofthe possibility of recoupment[17].Prove of intentionIt is an important clause were selling below ATC is found predatory only
when there is an evidence to eliminate competition. Though, the intentionto eliminate competition is quite difficult to prove. After all, the wholeidea about competition is how to eliminate competitors. In EC law practice,the requirement of intention means that evidence of a ‘smoking gun’ shouldbe produced, for example written memoranda, email. In Compagnie MaritimeBelge v Commission[18], which deals with selective price cutting, the ECJfound the evidence of ‘smoking gun’ were appellants had admitted theirpractice the ‘fighting ship method’. That is, when facing a cheapercompetitor, the conference would hold a meeting to undercut him, and ensurethat conference members scheduled their sailing at around the sane time asthose of competitors in order to win over its customers. But not all thecompanies will be as obliging as AKZO, which had committed its plans topaper. In these situations the requisite element of intention can beinferred from the surrounding evidence, such as the duration, continuityand scale of losses made. As the Commission pointed out in Tetra PackII[19] it ‘gathered sufficiently clear and unequivocal data to be able toconclude that, in that country at least, sales at a loss were the result ofa deliberate policy aimed at eliminating competition’.AKZO rule exemptionIt may not always be appropriate to apply the standards of AVC and ATC. Insome industries fixed costs are very high but variable costs are law. Anobvious example is telecommunication industry where much of the cost (ATC)attributed to establishing infrastructure, maintaining it and the cost(AVC) of providing one unit of a product (telephony calls, transmittingdata) is very law and sometimes close to zero. So, if the AVC standardwere to be applied there would hardly ever be predatory pricing; and theATC standard would require proof of the predator’s intention to eliminate
competition. In this situation an alternative rule is needed. TheCommission stated in Notice on the Application of the Competition Rules toAccess Agreements[20] that instead of AKZO standards a standard based onlong-run incremental cost (‘LRIC’) might be preferable[21]. Again, moreelaborate explanation is given in the UK law[22]. Here LRIC is defined as ameasure that takes in to account the total long run cost (that is, bothcapital and operating cost) of supplying a specified additional unit ofoutput (‘the increment’). To put it differently, it provides for a‘combinatorial’ approach towards the assessment of cost, whereby a firm’slong-run incremental cost is combined with its ‘stand-alone cost’ and thefirm has to demonstrate two things:– First, that its individual prices are set at the level or above LRIC. – Secondly, that the combined prices of services in groups that share common costs cover both LRIC and the common costs of supplying those services.This rule no the basis of incremental cost we can find in the Commission’sproceeding against Deutsche Post AG (DPAG)[23]. The Commission found thatfor a period of 5 years DPAG in every sale in the mail-order businessrepresented a loss which comprises all the service provision cost and atleast part of the additional costs (postal services) of providing thissideline service. In such circumstances, every additional sale not onlyentitled the loss of at least part of these additional costs, but made nocontribution toward covering the carrier’s mail-ordering business cost[24]. By remaining in the market without any foreseeable improvement in revenue,DPAG was considered to have restricted the activities of competitors whichwere in position to provide the service at a price that would cover theircost.
ConclusionsPricing strategy is one of the most viable instruments that undertakingshave in their disposition and they should not be deprived of possibility of
inflicting it, even if it is predatory. Although, the firms should take athorough consideration before perusing such strategy because it is notalways legitimate.To summarize it would be correct to say that: – Prices above ATC are not considered predatory with only exception were there is selective price cutting. – Prices between ATC and AVC are allowed under certain circumstances, such as meeting competition, excess capacity or obsolete products and never aimed to eliminate competitors. When there is no proof of this intention, or it is very vague, additional test of recoupment can be invoked by competition authorities – Prices below AVC are suspicious but might be justified in special situations, for example, when promoting a new product. – In specific industries were AVC is very law, bat capital cost is high the LRIC standard should be applied.To have a better view of this I made an attempt to depict it graphically inthe Figure No.1 List of References1. Brooke Group v Brown Williamson Tobacco decision (113 S. Ct. 2578) 2. C1-71-96-003-EN-C, Single market review. Subseries V, Impact on competition and scale effects, Volume 3 3. Case (475 U.S. 574) 4. Case C-62/86 AKZO v Commission [1991] ECR I-3359, [1993] 5 CMLR 215 5. Case C-333/94 P Tetra Pak International SA v Commission [1996] ECR I- 5951 6. Compagnie Maritime Belge v Commission, Case C-395/96 7. Commission Press Release IP/03/1025, 16 July 2003 8. OJ [1992] L 72/1, [1992] 4 CMLR 551, para 147 9. OJ [1992] L 72/1, [1992] 4 CMLR 551, para 149 10. OJ [1992] L 72/1, [1992] 4 CMLR 551, para 147 11. OJ [1998] C 265/2, [1998] 5 CMLR 821 12. OJ [1998] C 265/2, [1998] 5 CMLR 821, paras 113-115 13. OJ [2001] L 125/27, [2001] 5 CMLR 99 14. Office of Fair Trading, Guideline Assessment of Individual Agreements and Conduct, http://www.oft.gov.uk/NR/rdonlyres/6E8FFD45-5EA6-44CB- A569-197B3BEA9DB8/0/oft414.pdf 15. The Competition Act 1998: Assessment of Individual Agreements and Conduct (OFT Guideline 414) para 4.19 to 4.27 16. The Competition Act 1998: The application to the telecommunications sector (OFT Guideline 417) para 7.11. http://www.oft.gov.uk/NR/rdonlyres/967DA5EE-6D63-48E3-91D4-
D20A5D6263FF/0/oft417.pdf 17. Whish, Richard (2003): “Competition Law”, 5th edition, London: LexisNexis, p. 197 18. Wyatt and Dashwoods (2000): ”European Union Law”, 4th edition, London: Sweet & Maxwell, p.607 [pic]———————–[1] Whish, Richard (2003): “Competition Law”, 5th edition, London:LexisNexis, p. 197[2] C1-71-96-003-EN-C, Single market review. Subseries V, Impact oncompetition and scale effects, Volume 3[3] Whish, Richard (2003): “Competition Law”, 5th edition, London:LexisNexis, p. 703[4] Brooke Group v Brown Williamson Tobacco decision (113 S. Ct. 2578)[5] Case C-62/86 AKZO v Commission [1991] ECR I-3359, [1993] 5 CMLR 215[6] [1991] ECR I-3359, [1993] 5 CMLR 215, para 72[7] Commission Press Release IP/03/1025, 16 July 2003[8] Whish, Richard (2003): “Competition Law”, 5th edition, London:LexisNexis, p. 351[9] Office of Fair Trading, Guideline Assessment of Individual Agreementsand Conduct,[10] Ibid, para 4.8[11] Case C-333/94 P Tetra Pak International SA v Commission [1996] ECR I-5951[12] OJ [1992] L 72/1, [1992] 4 CMLR 551, para 147[13] OJ [1992] L 72/1, [1992] 4 CMLR 551, para 149[14] Case (475 U.S. 574)[15] The Competition Act 1998: Assessment of Individual Agreements andConduct (OFT Guideline 414) para 4.19 to 4.27[16] Wyatt and Dashwoods (2000): ”European Union Law”, 4th edition,London: Sweet & Maxwell, p.607[17] Whish, Richard (2003): “Competition Law”, 5th edition, London:LexisNexis, p. 708[18]Compagnie Maritime Belge v Commission, Case C-395/96[19] OJ [1992] L 72/1, [1992] 4 CMLR 551, para 147[20] OJ [1998] C 265/2, [1998] 5 CMLR 821[21] OJ [1998] C 265/2, [1998] 5 CMLR 821, paras 113-115[22] The Competition Act 1998: The application to the telecommunicationssector (OFT Guideline 417) para 7.11.[23] OJ [2001] L 125/27, [2001] 5 CMLR 99[24] Ibid. para 36———————–Figure 1
Predatory price-cutting
Long Run Incremental Cost rule (LRIC)
AKZO rule
loss-leading;short run promotions;prices that mach an inefficient entrant;mistakes in determining correct market price;network externalities;incremental profit.
AVC
ATC
Presumed to be Predatory unless
Predatory if proved to eliminate competitors
Recoupment proof
Still not clear
Proof by Course of behaviorbehavior
Documentary proof
Prove of intention to eliminate competitors
Price above ATC, no problem unless selective pricing proved
Predatory price
LRIC Period 1-5 years
Capital Cost
Operating cost for providing product n+1
Operating cost for providing product n
Legitimate price level
Dominant undertaking