Predatory pricing has a long history in competition law dating back to the US Standard Oil case in 1911. Allegations of predation also featured in the more recent Microsoft case. In recent years there have also been allegations of predation in the airline industry in the US, Canada and Australia and several instances of alleged predation in bus transport in the UK.
Allegations of predation tend to greatly exceed the number of proven cases. This is due in part to the fact that predation is complex and rather difficult to prove. However, small firms have a clear incentive to allege predation by larger rivals in order to obtain protection against what is simply vigorous competition.
Price competition involving price cutting or discounting is a normal part of competitive business behaviour. Predatory pricing involves a policy of price-cutting by a dominant firm designed to eliminate competition so that the firm may reap higher profits at a later stage by charging higher prices once a competitor has been eliminated. In order to be successful this requires entry barriers to keep prevent new entry since otherwise it would not be possible for the predator to raise prices once its rival has been eliminated.
Until the early 1980s economic analysis indicated that predatory pricing was not a rational profit maximising strategy for firms to engage in, and consequently instances of actual predatory pricing were considered extremely unlikely and rare, if they could happen at all. However, this view depended on assumptions of perfect information and certainty. Game theory has shown that, once these assumptions are relaxed, predatory pricing is rational under certain conditions. The main requirements are that the predator be a multi-market firm and that its pricing behaviour is capable of being misinterpreted by an entrant as normal competition.
Predatory behaviour need not involve cutting price, i.e. it could involve someother form of deliberate loss making strategy. Equally all price-cutting is not predatory. It is not essential for losses to be incurred in order for prices to be predatory. Clearly however it becomes much harder to establish predation where in fact a firm does not incur actual losses.
Areeda and Turner argued in a highly influential article that predation only arises when prices are held below marginal cost. Recognising that, in practice, measuring marginal cost may be extremely difficult, they argued that average variable costs could be used instead. The Areeda-Turner rule is designed to restrain firms pricing behaviour as little as possible reflecting the authors’ view that predation is a rare phenomenon. It is therefore arguably overly restrictive. Nevertheless it has had significant influence in US cases.
The main EU case on predation is Akzo. The E.C.J. in that case held that prices below average variable cost were predatory. It went on to state that prices below average total costs ‘must be regarded as abusive if they are determined as part of a plan for eliminating a competitor.’ (Emphasis added). Thus the ECJ was clearly prepared to accept that predation could occur in circumstances which did not satisfy the requirements of the Areeda-Turner rule if there was evidence of intent on the part of the alleged predator. Drawing inferences based on intent is fraught with risk.
A number of alternative rules using different measures of cost or output changes have been suggested. A more general definition of predation proposed by Ordover and Willig ‘is any business strategy that is profitable only because of the long-run benefits of eliminating one or more competitors.’
Phlips has proposed applying theory to test for predation. Predation turns a profitable entry opportunity for an entrant into an unprofitable one. To discover whether such a profitable opportunity for entry exists, i.e., whether there is room for an additional firm in the market, it is necessary to find out whether the entrant would make a positive profit in a non-cooperative post-entry equilibrium. In other words, without the price cut, was there room in the market for an additional firm under normal competition. A practical difficulty is that the firms concerned are the source of the information that is required to undertake such an analysis. Both the alleged predator and the alleged victim may seek to manipulate the data to assist their own case. Nevertheless this type of analysis has been applied.
Phlips identified a number of conditions that must be simultaneously met in order for predation to occur:
© CompEcon Limited 2002.
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