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Predatory pricing case study
Predatory pricing case study- AKZO Nobel Chemicals & Akcros Chemicals v Commission
On September 7th 2007 The European Court of first instance (CFI) made judgement on the case of AKZO, which has had a great impact on the way in which businesses organise their counselling in the future with regard to legal professional privilege and also abuses of competition law through predatory pricing, it is the latter which will be discussed in this essay. The commission found AKZO to be in a dominant position and that they had infringed Article 82 by pursuing a course of predation against ECS which was with the aim to drive them from the plastics sector. The ECU fined AKZO and ordered it to terminate the infringement. This meant AKZO had to refrain from offering or applying prices which would result in customers in respect of who's business it was competing with ECS paying prices dissimilar to those applied to comparable customers. This finding was based on threats made by AKZO and its eliminatory intent, which was found by a Reg. 17 Article 14 (3) investigation of Akzo's premises. This form of abuse that was uncovered is known as predatory pricing, and there has been much discussion about the test which was set out in this case which later went to appeal, where it was argued an objective test should be made. The court referred to Hoffman La-Roche where the concept of abuse was based on the behaviour of a dominant undertaking who wants to influence the market's structure by weakening the degree of competition due to methods outside of competition laws and policies. The decision did not lay down specific rules however about the point in which low prices become predatory which has proven problematic as it was suggested that even prices above average total cost (ATC) could be predatory.
In France Telecom v Commission it was decided by the (CFI) that “ dominant undertakings had no absolute right to align their prices with competitors” following the Akzo case and the reaffirmation in Tetra Pak II on the matter of predatory pricing. This is where a price reduction is made by a dominant undertaking for a short period of time, which is intended to harm competition and drive rivals out of the market if they do not have ‘deep pockets' and therefore restricting entry for further competitors. This reduction is made to a level below cost, which is a loss they are able to sustain but weaker competitors cannot stay in the market and once they have been driven out then then raise their prices again. It was first declared that not all price competition is legitimate in the Court of Justice decision in AKZO. In this case a formula was set out using the test abuse from Hoffman-LA Roche, whereby a firm is seen to be acting in a predatory manner if their present value of profit after the exit of their rivals in the market is higher than the loss they sustained from predatory pricing. The formula to calculate whether pricing is predatory is if prices are below average variable cost (AVC) predatory pricing is then presumed, as there is no profit maximising reason for them. This then presumes that pricing below AVC is abusive, this was later followed in the case of Tetra Pak. If prices are below AVC and (ATC) the dominant undertaking is acting in a predatory manner if there is evidence that a price reduction in this manner was part of a plan to eliminate competition. There is a grey area however when prices are between the two, which contrasts other statements within the case because it would suggest some form of rationality. A positive aspect of competition is that of consumer choice and low pricing, in a highly competitive market businesses will be encouraged to lower prices and attract customers in order to gain market share a good example of this is airlines which have a low fare policy which forces competitors to enhance their efficiency. Low prices are essentially good for customers but the problem arises in determining when there id too much of a good thing and when does low pricing become predatory?
Under Article 86 a prohibition is made when a dominant tenement eliminates a competitor to strengthen itself. In AKZO the ECJ held that their intention was not to pursue a general policy of favourable prices but to adopt a strategy that would damage ECS. The selectivity in price showed AKZO was targeting a particular competitor. In practice this test is difficult to apply in looking at which costs should be considered and gather information on this as it will be ever changing, and also it is difficult to prove the intentions of the dominant tenement. Reliance on intention is also problematic in the sense that all undertakings may be said to be trying to eliminate competitors by the fact that they are all participating in the struggle for custom in the market place.
So in a competitive situation most firms will try to eliminate competitors, and predatory pricing deterrents can discourage innocent firms from lowering prices. From the case law the only type of price competition which may be treated as legitimate by the courts is meeting, but not beating competitors prices, but surely this is what the market needs for consumers to be guaranteed the best prices and in order for there to be no dominant positions created in the market. For to “force a company to maintain non competitive prices would be to turn the Antitrust laws on its head”. So could meeting competition be a valid defence?
Surely the idea that any business would willingly sell at a loss for a long period of time in the hope that some day they will recoup the loss is a bit far fetched, surely the sheer expense and uncertainty of success would deter firms from trying this tactic. This shows that many problems have followed after the test was set out. Central to the meeting competition defence is how far may the dominant tenement is free to defend their position against smaller rivals. In the United Brands case the ECJ stated that a company can protect its own commercial interests if they are attacked and can take such steps at it deems appropriate to protect its interests but such behaviour can be countered if its actual sole purpose is to strengthen its dominant position and abuse it. This means however that the ability of smaller retailers is restricted in competing with legitimate lower cost selling by larger competitors as it would be against the law for the smaller retailer with a bigger wholesale price than that of their competitor to reduce their prices to levels charged by the competitor because the effect would be selling below cost.
Both the EC and The Commission now consider that dominant firms bear special responsibility to safeguard the low degree of competition that is left. In the Michelin case the ECJ held that the dominant firms special responsibility was to not further diminish the degree of competition remaining, but in Compagnie Martime Belge “The mere fact that the aim of that price competition was to drive a competitor from the market cannot render legitimate competition”. However the suggestion that the commission may initiate proceedings if prices were below ATC does not reflect the courts judgement in AKZO, but this was possibly more of a question of selective price cutting known as price discrimination.
Recoupment is also not considered in the judgement whereby the dominant firm may not be able to recoup its losses if there are new entrants to the market, but again recoupment possibly should not carry great weight as it would have to be shown that the price elasticity was that great that although customers were accustomed to low prices they would be willing to put up with higher pricing in the future.
The significance of this case and the cases that have followed are that developments have been made in relation to the principal community competition law rules, as application of Article 82 has had a reduced focus on exploitative abuses and looked at exclusionary and anti competitive abuses instead which will damage more long term competition. With this said it is a very fine line between unlawful and legitimate competition activity, and in the future a clearer distinction should be established. The AKZO test currently still applies despite these criticisms which is possibly due to a high dependence on economic theory in this area.
For instance what about a new economy market? Low pricing attracts customers in large quantities which results in that firm ‘winning the competition in that market' Also companies such as Microsoft have high fixed costs and low variable costs due to replication of a new product on the market once they have developed it. Wanadoo became an important case in this area as the commission altered the fundamentals of predatory pricing rules to take into account the new market, which was upheld in France Telecom v Commission.
Further criticisms that follow that concern the outcome of law which has stemmed from this judgement is that Article 82 requires ‘a dominant position at the time of predatory pricing' and it will not catch cases where a firm becomes dominant as a result of predatory pricing, instead enforcers should focus on large financial resources instead of market share to establish dominance in predatory pricing. Examples of this are Hoffman-La-Roche with a market share of 47%, United Brands 40-45% and Grundig with a share of 33% and no dominance.
There are also problems with a costs based test, the AKZO case itself reflects this by the fact that each party submitted to the court different calculations of their costs and there was no correlation between labour costs and quantity produced. Below cost tests are also very rigid and may in the future be replaced by a rule of reasoning role of inquiry into all economic circumstances, or even a below cost test. This cautious approach has been reflected by decisions in the Irish Sugar and Microsoft cases but this has lead to further criticisms of the commission for “chilling competition”. Anti competitive litigation aims to intimidate price cutting rivals but because predatory pricing is hard to distinguish from legitimate price competition which is healthy for the market, and requires a high standard of proof, which may be hard to obtain.
In defining different notions of cost the law has become uncertain and inconsistent with many different models that followed such as examples from America from Areeda & Turner where prices below average cost are predatory and Baumol who looks at average avoidable cost. New tests would suggest that the AKZO test is now inappropriate for today's economy and a better approach may be taken in looking at the commission's Deutsche post decision relying on incremental cost. The AKZO test is unsatisfactory as it favours industries such as the transport sector and research based industries where variable costs are low. Another criticism is that of time to recover from loss, in the OFTEL decision it was stated “ It is perfectly possible for a service to make a loss in the first year without the pricing being judged predatory in competition law terms, provided the product improves within a reasonable period, but what constitutes a reasonable period? Is it the economic life cycle of the activity? Or the period an investor would expect to see a return? The courts need to decide this by looking at what is a reasonable rate of return and should take into account reasonably anticipated future costs
To decide whether this case has set the right tone in prosecuting predatory pricing legitimate business justifications as a defence have to be considered. OFT guidelines show that not all below cost pricing is predatory and the test in AKZO does not fit a number of situations. And even the OFT itself has admitted “ It may be acceptable for an undertaking in a dominant position to sell at a loss in certain circumstances. These circumstances may include the current economic climate where firms can sell below cost at a loss in the downturn to maintain customer relationships and stay in business if the firm believes that the excess capacity is temporary and that the start up costs incurred in the future when full scale production resumes will be much greater than if the firm ceases production now even though staying in business it is not meeting its variable costs or if the goods that need selling are perishable as in these cases below cost pricing is used to minimise loss. Also what about short term promotions which aim to attract customers and are loyalty inducing with regards to new products as a ‘payment' for switching products to the new product. From this the sensible deduction to make would be to see if the practice makes commercial sense in a situation where there is no competitor.
Problems can also arise when a new entrant to the market is weak and cooperation in price would mean that they will gain more than trying to fight the dominant undertaking and this could lead to cartels or mergers are created which can also be seen as harmful to competition. Examples of this are Stagecoach and the Times newspaper.
To conclude predatory pricing is anti competitive and operates against good competition and consumers interests. From The AKZO case it can be seen that some forms of price reductions are acceptable but persistent below cost selling is not acceptable. There are still some loop holes in relation to the test where some instances of predatory pricing do not meet the criteria and escape the test, which need to be considered in the future. Problems have arose from the fact that legitimate pro competitive reasons for selling below cost are not incorporated, there is also as of yet no test to see if below cost selling is likely to distort the mark, there is also no valid measure of cost, rebates and discounts from suppliers to retailers are also not taken into account however it has shown that exclusion of just as efficient competition as the dominant firm will not be permitted following the AKZO test and this has created some clarity by building a test with formula's for almost every situation. This case remains significant today as the case law has followed the precedent it has set and it is still being used today.
From this case and the cases that follow it has been made clear that there is no absolute right to align prices with competitors and any behaviour which persistently appears to be predatory will face heavy fines if confirmed by this test, which acts as a strong deterrent to dominant parties.
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