Predatory pricing
Predatory pricing, also known as price slashing, is a commercial pricing strategy which involves reducing the retail prices to a level lower than competitors to eliminate competition. Selling at lower prices than a competitor is known as undercutting. This is where an industry dominant firm with sizable market power will deliberately reduce the prices of a product or service to loss-making levels to attract all consumers and create a monopoly. For a period of time, the prices are set unrealistically low to ensure competitors are unable to effectively compete with the dominant firm without suffering a substantial loss. The aim is to force existing or potential competitors within the industry to abandon the market so that the dominant firm may establish a stronger market position and create further barriers to entry. Once competition has been driven from the market, consumers are forced into a monopolistic market where the dominant firm can safely increase prices to recoup its losses.
The critical difference between predatory pricing and other market strategies is the potential for consumer harm in the long-term. Despite the initial buyer's market created through firms' competing for consumer preference, as the price war favours the dominant firm, consumers will be forced to accept fewer options and higher prices for the same goods and services in the monopolistic market. If the strategy is executed successfully, predatory pricing can cause consumer harm and is, therefore, considered anti-competitive in many jurisdictions, making the practice illegal under numerous competition laws.
Concept
Predatory pricing is split into a two-stage strategy.The first stage of predatory pricing involves the dominant firm offering goods and services at below-cost rate which, in turn, leads to a reduction in the firm's immediate short-term profits. This drop in price forces the market price for those goods or services to readjust to this lower price, putting smaller firms and industry entrants at risk of exiting the industry. The principle behind this strategy is that, unlike new entrants and current players, the dominant firm has the size and capital to sustain short-term loss in profits, thus forcing a game of survival that the dominant firm is likely to win.
The second stage is the recoupment, during which the dominant firm readjusts its product and service prices to approach monopoly prices to recover its losses in the long-term. This price adjustment can put consumers under pressure, as they are now forced to accept the higher price without any fair-priced competition, thus resulting in consumer harm. This is what differentiates predatory pricing from normal competitive pricing. Under EU law, the European Commission can account for recoupment as a factor when determining whether predatory pricing is abusive. This is because predatory pricing can only be considered economically effective if a firm can recover its short-term losses from pricing below the average variable cost., AKZO Chemie BV v Commission of the European Communities ECR I-03359, para 71 However, recoupment is not a precondition for establishing whether predatory pricing is an abuse of dominance under Article 102 TFEU. Assessing other factors, such as barriers to entry, can suffice in demonstrating how predatory pricing can lead to foreclosure of competitors from the market.
The use of predatory pricing to gain a foothold in a market in one territory while maintaining high prices in the suppliers' home market creates a risk that the loss-making product will find its way back to the home market and drive down prices there. This can result in negative effects on the home market and cause harm to domestic supplies and producers. Due to this, countries often have laws and regulations to prevent dumping and other forms of predatory pricing strategies that may distort trade.
Legal features
1. The principal aspect of predatory pricing is that the seller in the market has a certain economic or technical strength which distinguishes it from price discrimination, where competition exists amongst both buyers and sellers.2. The geographic market for predatory pricing is the country's domestic market which differentiates it from "dumping". Dumping refers to the practice of selling commodities in overseas markets at a lower price than within the domestic market. Though it can be determined that both concepts have similarities in terms of "low-cost sales" and "exhaustion of competitors", numerous differences have been noted:
The scopes of application of the two are different. Predatory pricing applies to domestic trade, while dumping applies to international trade.
The identification standards of the two are different. Predatory pricing is based on cost, while dumping is based on the price applicable to the normal trading of similar domestic products.
The laws applicable to both are different. Predatory pricing mainly falls under domestic laws, while dumping falls to international treaties or the laws of other countries.
The consequences of the two are different. Legal sanctions for predatory pricing are compensatory damages or administrative penalties, while dumping involves the levying of anti-dumping duties.
3. The objective performance of predatory pricing is that a company temporarily sells goods or services below cost to eliminate competitors from a certain market and create exclusivity. The predatory pricing company can then sell goods and services at monopoly prices to compensate for the losses from initial low price sales.
4. A dominant firm's subjective intention may be to eliminate competition to gain a monopoly advantage. Under EU law, if a dominant firm prices above AVC but below Average Total Costs, proving intention can be useful evidence for finding predatory pricing. However, the difficulty is faced when distinguishing between an intention to eliminate competitors and an intention to win the competition. Thus, the European Commission does not have to establish an undertaking's subjective intention to prove that Article 102 applies, as abuse is an objective rather than a subjective concept.
Implementation conditions
1. Sacrificing short-term profitsThe economic theory of predatory pricing involves a company pricing its goods and services to generate less revenue in the short term, thus, eliminating competitors and increasing market power. The theory does not explicitly state that profits must be negative in order for this to be achieved. In anti-monopoly law enforcement, determining the level of pricing that constitutes predatory pricing can be difficult in operation. The generally acceptable standard is that during a period of predatory prices, the predator's profit will be negative where the price is lower than the initial cost. However, with this the question arises as to what kind of cost should be used as a reference. The use of a price that is lower than the cost may make certain predatory pricing practices not legally binding.
According to the theory of industrial organization, some predatory pricing practices may not necessarily lead to negative short-term profits. However, in this particular case, the company's ability to make low-cost profits can indicate that the company is a highly efficient company compared to its competitors. This does not necessarily indicate that such instances will lead to reduced benefits in the long-term as non-entry of entrants does not necessarily reduce welfare, and entry of entrants does not necessarily improve it. Consequently, anti-monopoly law ignores this and does not result in major welfare losses.
2. The ability of incumbent company to raise prices
An important condition for predatory pricing is that, after excluding competitors, a dominant firm can raise prices to compensate for their short-term losses. To achieve this, market power can be an important factor. However, under EU law, market power is not necessary to establish predatory pricing, since other factors such as barriers to entry can indicate an abuse of a dominant position.
It is also important to note the barriers to entry impact on a dominant firm's ability to raise the price of their goods and services. On the exclusion of these barriers, other firms could theoretically enter any market where an incumbent firm is enjoying economic profits, thereby preventing the dominant firm from sufficiently raising prices high enough to recoup the costs of lowering price.
Theories for controlling predatory pricing
It can be difficult to identify when normal price competition turns into anti-competitive predatory pricing. Therefore, various rules and economic tests have been established to identify predatory pricing.No rule
According to Easterbrook, predatory pricing is rare and should not be considered a central concern. Introducing laws against predation, especially because it is rare, could lead to generating false positive errors, which would restrict the rule. The main point of the argument is that government intervention is dispensable, as predation is unlikely to succeed and creates a deterrent effect on its own. The deterrent effect results from selling goods and services below the costs, which causes losses without the gain in market power. In this case, the market power does not increase due to the market share holder weathering the predatory strategy. Thus, the firm punished itself by taking losses without gaining market share. As a consequence, this acts a deterrent for other firms. An additional argument against the implementation of rules is the inability of courts or competition authorities to differentiate predatory from competitive prices.Short-term loss rules and the Areeda-Turner test
In 1975, Phillip Areeda and Donald Turner developed a short-run cost-based test, widely referred to as the 'Areeda-Turner rule'. The rules are based on short term focus due to the long run focus being too speculative and inefficient. The Areeda-Turner rule suggests prices at or above reasonable expected average variable costs are presumed to be lawful, but prices below AVC are presumed to be unlawful and anti-competitive.In EU law, the approach to testing for predatory pricing under Article 102 of the Treaty on the Functioning of the European Union has been explained in a number of important cases.
In ECS/AKZO, the European Commission did not adopt the Areeda-Turner rule. The Court of Justice upheld this decision for the inclusion of other factors to be taken into consideration alongside a cost-based analysis. Instead, the Court in AKZO suggested that if a dominant firm sets prices below AVC, the predatory pricing is presumed to be abusively predatory due to the assumed intention to eliminate competitors rather than maximize profits. However, a strategy would not be presumed predatory were a dominant firm to set prices above AVC but below ATC unless evidence were provided to show dominant firm's plan to eliminate competition. Additionally, if a dominant firm sets prices above ATC, the firm is most commonly not found guilty of predatory pricing, though, still may be proven anti-competitive if potential for substantial consumer harm is discovered. The AKZO test was reaffirmed in Tetra Pak II, and France Télécom.
In Post Danmark I, the Court of Justice developed upon AKZO by stating that prices above average incremental costs but below ATC would not likely be ruled abusive under Article 102 of the TFEU if there was no evidence the dominant firm deliberately intended to eliminate competition.