The concept of predatory pricing

Question: Discuss The Treatment Of The Concept Of Predatory Pricing Under Article 82 EC.

Introduction

Predatory Pricing is an area of law which is problematic. The lack of clarity in case law creates variant approaches from the relevant authorities. It also offers great controversy for theorists, with many competing views as to the strategic credibility and rationality of the concept. Throughout this essay the treatment of Predatory Pricing will occur through the existing case law.

What Is Predatory Pricing?

“Predatory Pricing is the practice whereby an undertaking prices its product so low that competitors cannot live with the price and are driven from the market”. Predatory pricing is an abuse of a dominant position under Article 82, often resulting in fines for the concerned undertaking. In order for predatory pricing to be proven, it needs to be shown to have the intention of removing competition, which is also an area of controversy, with many believing it should be the effect which is analysed. According to Bork, there are three techniques to predation; price cutting in which “the losses during the war will be proportionally higher for the predator than the victim”. The second being disruption of distribution patterns and finally the misuse of government processes. This discussion will be based upon the primary technique : Price Cutting.

“However finding predatory pricing is often difficult for competition authorities as they find it difficult to distinguish this practice from price competition.”

The Areeda- Turner Test

In 1975, a test was put forward for identifying predatory pricing. The test stated

“a price lower than reasonably anticipated short -run marginal cost is predatory, whilst a price equal to or higher than reasonably anticipated short- run marginal cost is not predatory”. However, there are problems with this test, as highlighted in AKZO, in that it is very difficult to ascertain the difference between fixed and variable categories. As stated by Jones and Sufrin “The longer the time period, the more costs that become variable”.

The Akzo Case

AKZO was the first EU case in which predatory pricing was discussed. AKZO was a multinational corporation which produced benzoyl peroxide, for use within the plastics sector. AKZO's competitor (one of), ECS, decided to expand upon it's use of the aforementioned product into the plastics sector, capturing one of AKZO'S largest clients as a result. The retaliation was to offer large discounts to ECS' flour customers. An appeal was subsequently raised by ECS, citing predatory pricing as an abuse of dominant position. The Commission, in this instance, found predatory pricing was occurring to force ECS from the plastics sector. AKZO were fined ECU 10 million and were also ordered to terminate the infringement.

AKZO appealed, stating that since there prices were not below Average Variable Costs (AVC) and that consequently, citing, the Areeda- Turner Test, that there was no abuse. This appeal was thrown out, with the courts stating that;

“Moreover, prices below average total costs, that is to say, plus variable costs, but above average variable costs, must be regarded as abusive if they are determined as part of a plan for eliminating a competitor”.

This judgement provided new definition for predatory pricing. It was contrary to the criteria laid down in the Areeda- Turner Test, clearly distinguishing the courts' approach from the test.

Consequently as a result of this judgement a new test was created. This test was;

  • “Prices below AVC are presumed to be predatory.

  • Prices above AVC but below Average Total Costs are not presumed predatory, but can be presumed predatory if they are part of a plan to eliminate a competitor”.

Problems With The Akzo Test

Cost apportionment can be difficult. “In AKZO the parties both submitted varying calculations of AKZO's cost”, demonstrating the problem. The difficulty lies in calculating fixed and variable costs. An example would be the issue of labour, some could argue this as a fixed cost, as the number of staff and wages offered are not variable. However, a converse argument exists, dependent on the same factors having to fluctuate as a result of a recession for example.

There are also significant reasons as to why pricing below AVC can be rational, demonstrating further problems with the criteria laid down in AKZO.

Primarily is signalling. Pricing below AVC, can prevent potential competitors from joining the market. This is because it can signal to potential competitors that low prices needs to be offered in order for a market share to be ascertained. Effectively it prevents further competitors, which is rational for any undertaking that wishes to maintain or improve their position.

Secondly is reputation. A strong reputation can strengthen an undertaking's position in a market. If an undertaking, X, has a reputation for offering low prices, it is more likely that competitors will be hesitant to lower it's prices, because they know that X will follow to limit their competitor's success, if they have such a reputation. Effectively a strong reputation can prevent other undertakings from trying to take control of pricing within the market.

Furthermore is the theory of deep pockets, the ability to absorb losses. It is more logical and economically sensible to minimise losses and sell goods at a lower price than to have stock unsold. Examples of where this would occur are the creation of a new line of clothing or product, where the old stock becomes redundant.

In addition to the rationality reasons, it is also very difficult to ascertain intention of the concerned undertaking. Predatory pricing, is known as an abuse, and therefore if undertakings are practicing this concept it is unlikely that they would declare this intention, through the minutes of meetings for example. The effect of doing so would make it more apparent to the relevant authority that predatory pricing was the strategic plan as occurred in Wanadoo. It is for this reason that intention is difficult to ascertain, because undertakings, if they have negative intentions, are likely to hide them. AKZO demonstrates this point as there was no express declaration in regards to removal of competition.

Cases such as Tetra Pak II and France Telecom have reaffirmed and applied the test laid down in AKZO and consequently it can be argued that the case law on this area as a result of AKZO is resultantly misguided and incorrect.

Predatory Pricing And Dominance On Different Markets

The issue as to whether an undertaking can be guilty of predatory pricing where the dominance is on a different market was the centre of Tetra Pak II.

In Tetra Pak there were two separate markets, one was for aseptic cartons, and the other was non- aseptic cartons. They were held to be independent of each other and thus separate markets.

“It was held, however that Tetra Pak had abused it's dominant position on the aseptic market by it's conduct on the non-aseptic market which was designed to obtain a competitive advantage over the non- aseptic market”.

While in this circumstance, it seems fair and reasonable to impose a fine upon Tetra Pak, it is as of yet unclear how this principle will be applied in cases with similar circumstances. There is potential for injustice if distinguishable cases follow this judgment. This aspect requires further definition as to what will constitute “special circumstances”, so as to create clarity and certainty for undertakings and the relevant authorities.

Alternatives To The Akzo Test:

In Deutsche Post an alternative was created. The standard which was applied was the Long Run Incremental Costs (LRIC) Standard.

Deutsche Post had a statutory monopoly over basic letter post in Germany, it also offered over the counter services and a mail order parcel market. UPS brought a claim to the Deutsche Post were using revenue from it's letter post monopoly to predatory pricing in the mail order sector. In determining the value of the mail -order service, the commission stated:

“This means that, when establishing whether incremental costs incurred in providing mail order parcel service are covered, the additional costs of producing that service, incurred solely as a result of providing that service, must be distinguished from the common fixed costs, which are not incurred solely as a result of this service”

Recoupment

Tetra Pak II was the primary case in which the question of whether an undertaking was able to recuperate it losses was part of the test for predatory pricing. The Court of First Instance (CFI) held that recoupment was not a necessary part of the test for predatory pricing stating that:

“It would not be appropriate … to require in addition proof that Tetra Pak had realistic chance of recouping its losses”.

The court were not willing in this case, to apply recoupment as a criteria for predatory pricing, however whether this approach was restricted to the individual circumstances of this case remains to be seen.

There is much debate about whether recoupment should be part of the test for predatory pricing.

Lang and Donoghue are primarily against the enforcement of this as criteria. They state “predatory pricing by a dominant company may have anti-competitive effects even if the dominant company does not or could not recoup it's losses”

On the contrary, Attorney General Fenelly is of the view that recoupment should be part of the test for predatory pricing.

In a competition discussion paper it was further reiterated that “The commission does therefore not consider that it is necessary to provide further separate proof of recoupment in order to find an abuse” .

In France Telecom the community courts cited paragraph 44 of Tetra Pak II and came to the conclusion “The Commission was therefore right to take the view that proof of recoupment of losses was not a precondition to making a finding of predatory pricing”.

Predatory Pricing In New Economy Markets

The concept of Predatory Pricing in a new economy market, is a concept the courts are not shy of applying. The courts, as witnessed in Wanadoo, were not willing to take a laissez faire approach to the conduct of Wanadoo in the developing market, the decision was then reapplied in France Telecom. Evidently the approach to such strategies is very narrow and the courts are reluctant to allow such behaviour in a new economy market.

Limit Pricing As An Aspect Of Predation

The Areeda-Turner Test received widespread criticism by economists for it's failure to incorporate limit pricing. AKZO did little to resolve this problem. Limit Pricing. Jones and Sufrin state this to be “a form of strategic entry deterrence aimed at potential entrants rather than existing competitors”. It is yet to be seen how this aspect of Predatory pricing will develop, or even how the courts will approach such a theory, because as of yet there is no case law relating to this issue.

The Compagnie Maritime Belge Case

This is the defining case on selective price cutting. In this case…. NEEED FACTS. It seems upon analysis of this case, which is based upon the judgment in CEWAL, that selective price cutting follows the theory that there needs to be the objective of the removal of competition.

Defences

There are many defences to the argument of Predatory Pricing. In Irish Sugar, the defence of “meeting” competition, in order to maintain their market position, was used. While the defence may have failed in that case, it did succeed partially in France Telecom, where the CFI stated:

“It must be pointed out first of all that the Commission is in no way disputing the right of an operator to align it's prices on those previously charged by a competitor”.

This defence was recognised in the Discussion Paper, where it was identified that a dominant undertaking had the right to minimise it's losses as a result of their competitor's actions.

The application of this defence, however, is limited. While it would be suitable where the alternatives were economically unsuitable or more widely anti- competitive, it would not apply where prices were below Average Alternative Costs (AAC). It is also stated that “the conditions are unlikely to be fulfilled even if prices are above AAC”.

Conclusions

The views of Bork suggest that Predatory Pricing is an irrational theory, offering a variety of reasons. The view of Ward Bowman is one which he endorses, where it is stated;

“ease of entry will be symmetrical with ease of exit. The easier it is to drive a firm from the market, the easier it will be for that firm or another to reenter once the predator begins to collect his monopoly profits”.

Consequently where one rival is removed, it would seem that the dominant undertaking will have to keep prices below Average Variable Costs to drive the new competitor out of the market, according to this view.

Predatory Pricing, upon analysis, whether rational or irrational, as a concept, seems largely flawed, a prime example would be the presumption of abuse where prices are below AVC, this many economists find to be unsuitable. It seems also to be against the concept of the Civil Justice System where a known maxim is “innocent until proven guilty”.

The Areeda- Turner test, the first test for Predatory Pricing, was criticised for being flawed. The reasons why are wide reaching, namely there is not mention of limit pricing, nor is there any definitive method to define how costs are calculated.

AKZO, the first community case on this concept, in itself was fallible, in that it also applied a costs based test which was not clearly defined, as to how to understand what is fixed and what is variable.

The consequences of these tests created is that the basis of Predatory Pricing as a concept is fallible. Cases such as France Telecom, Compagnie Maritime, Deutsche Post offer a no means extensive list of cases which relied upon one or both of these tests, the effect being a concept which is not fully developed.

Resultantly the Commission, having recognised this, suggest a reform of Article 82, which forms the basis of this whole concept and alternative abuses, such as price discrimination, for example.

“However, if the dominant company, for instance, had to expand capacity in order to predate, then also fixed or sunk investments made for this extra capacity, will have to be taken into account and will now filter into the AAC benchmark. In the latter case AAC will, for good reasons exceed AVC.”

It is apparent that the law on such an abuse, requires development. The commission Guidance, and Attorney General Fenelly acknowledge this and it seems appropriate to conclude on the words of Robert H. Bork where he states:

“This is a serious matter, for it means that the law now perceives threats to competition where none exists, and it follows that the law is destroying valuable business arrangements for no reason”.