Price abuses

1. Predation
2. Rebates
3. Price discrimination
4. Excessive prices
5. Price squeeze

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 Predatory pricing
A firm (“predator”) sets low prices for a certain period
in order for a rival (“prey”) to incur losses and exit
the industry.
Two main elements of predatory behaviour:
1. short-term loss for the predator (sacrifice of current
profits)
2. expectation of recoupment: higher prices and profits
when rival exits (existence of market power a
necessary condition to raise prices)
Practical problems in identifying predation: are low
prices predation (bad) or strong competition (good)?
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 A phenomenon in search of a theory
McGee (1958): we should not expect predation to occur:
1. Criticism to “deep pocket” arguments: why should
the prey not be able to obtain further funds?
2. Predation inefficient (destroys industry profits):
merging with rivals would be more profitable
Yamey (1972)'s counter-objections:
1. Predation discourages entry (merging with an
entrant would invite further entry)
2. Predation allows to buy rivals at lower prices
But: no rigorous foundation to predation until the 80s.
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 Recent models of predation
The predator exploits imperfect information of the
entrant (or its investors) to deter entry or force exit.
Three types of models:
1. Reputation: if an incumbent faces a stream of
(successive) entrants, a price war with early
entrants creates a reputation for being “strong”,
and discourages entry from later entrants
2. Signaling: entrant does not know if incumbent is
weak (high cost) or strong (low cost), and observes
incumbent’s price before entering. I chooses low
price (limit pricing) to discourage entry.
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 Recent models of predation, II
3. Predation in imperfect financial markets: it
formalises the “deep pocket” argument. Idea:
(i) Asymmetric information (lenders have little
knowledge of the industry; moral hazard) makes
capital markets imperfect
(ii) If capital markets are imperfect, a firm's assets
(e.g., cash and retained earnings) determine its
ability to raise external funds
(iii) By behaving aggressively, the incumbent
reduces the prey's assets, limits its ability to raise
capital, and obliges it to exit
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 Predation: practice
Problem: how to distinguish predatory pricing (bad)
from fierce price competition (good) ?

Two main ingredients for predation:

1. Sacrifice of profits in the short-run
2. Ability to recoup in the long-run

Proposed rule: two-tier approach

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 Practice, II: Two-tier test for predation
1. Is there enough market power for recoupment?
If predator is dominant, go to 2.
Else, dismiss case
2. Is there sacrifice of profits?
P>AverageTotalCost (ATC): always lawful
P<AverageVariableCost (AVC): presumed
unlawful (burden of proof on defendant)
AVC<P<ATC: presumed lawful (burden of proof
on plaintiff)

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 Practice, III: remarks
Low predation standards decrease incentives to compete
for non-dominant firms
Many possible reasons for P<AVC (introductory price
offers, switching costs, learning, network effects):
 a prohibition of below-cost pricing (laws in many
EU countries) makes no sense;
 but not applicable defence for dominant firms
Intent relevant if confirms existence of predatory scheme
No need to prove ex-post damage to consumers
Meeting rivals’ prices: not acceptable defence if P<AVC
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 Rebates
Discounts applicable where a customer exceeds a
specified target for sales in a defined period

Differences, according to ‘target’:

Conditional on purchase growth;
on buying only (or in a certain %) from supplier;
on buying over a given threshold (quantity discounts)

And if individualised (3rd degree PD) or not

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 Rebates in antitrust law
EU case law: bad because exclusionary
1. and 2. are per se illegal if used by a dominant firm (“amount
to exclusive dealing”)
3. illegal if individualised
Michelin II case (2003): also standardised quantity rebates are
illegal
US case law: usually lawful
competition on the merits; burden to prove they are
anticompetitive on plaintiff (high standard)
But: LePage (and Dentsply) signal a change?

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 Rebates
At first sight, some types of rebates may appear similar
to exclusive dealing
However, contrary to ED, rebates are not an ex-ante
commitment: I offers a price schedule, but E can
match it. More difficult to formalise why rebates can
exclude efficient entrants
[Note: like ED, rebates may also have efficiency effects:
they can give incentives to retailers to sell more; they
avoid double marginalisation… see discussion of
Michelin, II]

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 Anticompetitive rebates (Karlinger-Motta, 2006)
Network industry: consumers buy only if network size above a
threshold (reached by I, but not by E yet)
Networks E and I identical (but E is more efficient); E has no fixed
costs.
One large buyer and many small ones; to reach minimum size, E
needs at least 1 large and 1 small buyer.
The game
First: I and E simultaneously announce price schedules
Then: Each of the buyers decides supplier
Prices: linear, two-part tariffs, or with quantity discounts

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 Results
(1) If linear pricing, both exclusionary and entry equilibria
exist
Intuition: Buyers’ miscoordination. (Shows that network
industries are prone to competitive problems)
(2) If rebates are possible, under certain conditions only
the exclusionary equilibrium exists
Intuition: I gives some rents to the large buyer and compensates
losses with small buyers. Getting the large buyer suffices to
keep off E. Note: E does not have the same scope because I
would enjoy monopoly if excludes, E will not.
Comments: 1) Purely quantitative discounts manage to
exclude entrants; 2) Exclusion is achieved despite I and
E making simultaneous offers!
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 Price discrimination
Types of price discrimination

The (ambiguous) welfare effects of price

discrimination

Parallel imports: not justified the EU per se

prohibition of clauses which prevent parallel
imports.

Price discrimination as monopolisation device

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 Price discrimination
It is a pervasive phenomenon: examples

Three types of price discrimination (PD):

1st degree (perfect) PD
2nd degree PD: self-selection of consumers
3rd degree PD: when different observable
characteristics

Two main ingredients of price discrimination

- ability to “sort out” different consumers and charge
them different prices
- no arbitrage opportunities
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 Welfare effects of PD
PD is not always bad: the extreme case of 1st degree
PD, under which the first-best is attained (but:
unrealistic example)

Quantity discounts (2nd degree PD). If consumers are

charged according to T+pq, the unit price (p+T/q)
decreases with the number of units bought.
Welfare increases because the fixed fee is used to
extract surplus, allowing for a lower variable
component than under linear pricing

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 3rd degree PD and parallel imports
Suppose h and l are two EU countries (h=rich; l=poor)
with different demands.
Transport costs set to zero for simplicity.
(Possible re-interpretation: consumer groups rather
than countries.)
If price discrimination across countries is allowed, the
firm chooses prices so as to max profits in each
market: it will set ph>pl.

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 Parallel imports, II
If PD was prohibited (i.e., the firm cannot prevent parallel
imports), then two cases may arise:
1) Under uniform pricing, sales in both markets. In this
case: d > u , but Wd<Wu.
2) Under uniform pricing, one market is not served: the
firm may prefer to set ph even if this implies no sales
in country l. (This happens when country l is relatively
unimportant, for instance.)
In this case: h >u and Wh >Wu.

General result: PD welfare detrimental if qPD does not

increase.
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 Parallel imports, III
EU policy: per se prohibition of clauses that prevent
parallel imports
Ratio: EU integration (one of the fundamental objectives
of EU competition law) means equal prices across
member states
Objections:
• this policy may decrease welfare
• it may lead firms not to serve some countries (in
example above, one market only is served under
uniform pricing)
• equity not an issue: under PD, ‘poorer’ citizens pay less
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 Further remarks
PD and investments. Since PD increases the firms’
profits, the uniform pricing policy may have long-run
negative effects (on investments, innovations etc.)
PD and market power. Both small and large firms will
have incentives to discriminate prices across countries.
But in the former case welfare effects are less relevant.
To the extent that PD will induce firms to invest more,
allowing ‘small’ firms to engage in PD may foster
competition.
Sensible to use a safe harbour: PD allowed for firms
below a certain market share (not the current policy!).

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 PD as monopolisation device
PD may also affect market structure, i.e. be used by an
incumbent to exclude rivals.
For instance, we have seen that discriminatory offers
help exclude entrants
Rebates and selective discounts are other possible forms
of PD which may lead to exclusion (Karlinger-Motta,
2006).
But an obligation to dominant firms not to discriminate
(transparent pricing) may have adverse effects (helps a
dominant firm to solve the commitment problem).
Also, PD may increase welfare if exclusion not an issue.

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 Excessive Pricing
Art. 82 EC Treaty v. Sect. 2 Sherman Act
Very few cases in the EU
General Motors, United Brands, SACEM
Recent trends: more interventionist?
Liberalisation (most recent cases in postal services,
telecommunications, airlines…)
A tool to overcome situations where competition does not
work properly?
Role of National CAs (might increase with
decentralisation trends?), more subject to political
pressure towards price controls
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 Excessive prices: a typology
 
1. Exploitative abuse: too high 2. Exclusionary abuse: too
prices in final markets high prices in intermediate
markets

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 Exploitative excessive prices (final markets)
How to establish that prices are ‘excessive’?
ECJ: Unreasonable disproportion between price
and economic value of the good (General Motors)

Different methods to estimate the “economic value”

(i) Price ‘much higher’ (>100%?; >60%?) than
cost
(ii) Price ‘much higher’ than some benchmark

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 (i) Price ‘much higher’ than cost
(i) Price ‘much higher’ than
cost

Problems:
     How to establish the
‘highest fair’ price p*?
     How to compute costs?
(accounting principles)
     Costs may be high because
firm is dominant
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 (ii) Price ‘much higher’ than a benchmark

(ii.a) Price ‘much higher’ than in another benchmark

market

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(ii) Price ‘much higher’ than a benchmark, cont’d

(ii.b) Price ‘much higher’ than in a competitive

benchmark market

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 Excessive price or something else?

(ii)  amounts to prohibiting price discrimination

across markets (which may be different for
demand or for market structure reasons)

(i)  Since a dominant firm may not charge the

monopoly price, but a lower price p*, this amounts
to a de facto prohibition of exercising a dominant
position

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 Excessive prices in intermediate markets

Concern: excluding rivals, or putting them at disadvantage.

(Refusal-to-deal extreme case of excessive price)

Theory: a vertically integrated dominant firm may want to

foreclose (say, downstream) competitors, but:
Foreclosure not necessarily welfare detrimental
(!) Dis-incentive effect if firm cannot freely
decide its intermediate good prices      

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 Incentive effects

In this setting, excessive pricing = compulsory

licensing = ‘essential facilities doctrine’
     ex post: they improve welfare
     ex ante: they discourage firms’ incentives

Governments (or CAs) face a committment problem:

they should commit never to expropriate firms’
investments, so as to give firms the right incentives
to invest.
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 Policy implications
Prohibition of excessive pricing reduces profitability (and
increases legal uncertainty), thus discouraging investments
CAs not competent enough to establish ‘costs’
CAs’ role not to set prices
Problems of remedies: continuous monitoring? Structural
remedies?
Entry should reduce monopoly power; (and if legal barriers
exist, there should be sectoral regulation)
Even if it does not, intervention breaks commitment not to
expropriate firms economy-wide (dis-) incentive effects
Yet…
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 Conditions for ‘excessive pricing’ actions
The following conditions must simultaneously arise:
1.   There exist legal barriers to entry (and such barriers are not
justified by protection of investments, such as in IPRs)
2.   There is no way to eliminate those barriers
3.   No sectoral regulation
Such conditions are broadly consistent with past EU practice:
(SACEM, Belgacom/ITT Promedia, General Motors, British
Leyland) 
And if sector regulator exists, but it ‘is sleeping’…?
     CAs’ excessive prices action might stimulate the RAs to intervene
    EU cases in telecom industry, initiated by DG-COMP but later
picked up by NRAs.

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 Price (or margin) squeezes
Price (or margin) squeeze if a dominant
firm’s own downstream operation could
not trade profitably if it was charged the UI Cost c0
price offered to its competitors:
p-a<cI. a
Price squeeze if margin p-a is not
sufficient to allow a ‘reasonably Cost cI Cost cE
efficient’ service provider to
DI E
obtain a normal profit:
p-a<cr. p
Predation and excessive pricing
tests may not capture this practice.
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 Price squeeze: when is it likely?
Chicago School: no need for price squeeze, as upstream
firm can already get monopoly profit.
However, if downstream imperfect competition exists,
rationale for exclusion arises.
More general, price squeeze more likely if:
- monopoly (or near-) upstream
- no alternative sources of inputs
- imperfect downstream competition
- downstream products are close substitutes (else,
market demand for input would shrink)

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