Competition Policy

Competition Policy Predation, Monopolisation, Abusive practices

Exclusion • Exclusionary practices: deter entry or forcing exit of a rival • Legal concept. Monopolisation (US) – Abuse of dominant position in the UE • Difficult to identify exclusionary pract. – not easily distinguished from competitive actions that benefit consumers EX. Price reductions by an incumbent following entry (to be followed by price increase after exclusion) • New attention after privatization and liberalizationresult in public utility sectors: an incumbent facing potential entrants

Predatory Pricing • A firm sets low prices with an anti-competitive aim: forcing a rival out of the market or pre-empt a potential entrant • Low prices increase welfare only in the short runonce the prey has succumbed the predator will increase priceswelfare will be reduced in the long run as competition is eliminated from the industry • Two main elements to indentify PP: 1) A loss in the short run 2) Enough market power by the predator to let him increase prices and profits in the long run • Cautios approach needed by antitrust agenciesavoid the risk that firms with market power keep prices higher not to be charged with predatory behaviour

Predation is as old as antitrust laws • Old phenomenon: The Sherman act was also introduced because small firms complained that big firms implemented predation: setting low prices to drive them out of the market • Some claims were unfounded: some firms charged low prices because they were more effcient, exploiting scale and scope economies • But some predatory pricing existed

A Theory of Predation • The main explanation of predation has been “Deep Pocket” predation: a big firm may drive out a small firm with a price-war causing losses to both but the small one has not the financial resources to resist a price-war (a “small pocket”)

Weak points of predation arguments • Mc Gee (1958) criticized predation theory on four main grounds: • 1.Due to its larger market share a large firm will suffer greater losses than a small one • 2.Predation is rational only if the predator raises prices, after the prey exits from the marketbut the small firm has invested in assets that are sunk costs it can re-enter after the price increase or sell the assets to another firm becoming a new rival less Π for the predator • 3. Predation theory assumes that the predator has a “small pocket”, rather tha explaining it  the financially constrained firm can explain the problem to its creditors to obtain funds • Predation is inefficient as it destroys profitsbetter to merge with the rival to preserve high profits

Counter-objections to McGee (’58) • 1. The incumbent can price-discriminate and decrease price only in those markets where the small firm is competingthe predator can preserve high margin on most units and reduce the cost of predation • 2. Enter-Exit-Re-entering can imply sunk costs (one cannot close plants, fire workers and then re-start the activity without costs) • 2.bis as to selling assets to other firms an incumbent that has successfully preyed once will discourage other firms to enter (reputation argument)

Counter-objections to McGee (’58) • 3.This is the most challenging points: if the small firm could obtain funding from banks, predation cannot be successfull and anticipating the result the incumbent will avoid it • 4. Merger as ana alternative a)New competitors will be attracted by the perspective of being bought (merger not a cheap option)b)Antitrust laws may not allow the merger c) Predation and mergers are not mutually exclusive options aggressive pricing might result in the prey being sold at lower prices

Predation in Imperfect Financial Markets • Weak point of deep pocket predation: limited access to funding by the entrantIf capital markets were perfect a profitable firm would find a financial sponsor • With imperfect capital markets? Limited access to funding is endogenous predation affects the risk of lending money reducing financial resources available • Key point: imperfect information by lendershidden action moral hazard (the bank cannot know if the money is used efficiently)find an optimal contract, ex: credit related to a given amount of assets • Competiton between an incumbent and the new entrantpredation reduces the prob. That the entrant gets funding: it reduces its profits, its savings and then its own assets needed to get credit

How to deal with predatory pricing • Two main elements. 1) sacrifice of short-run profits 2)Increasing profits in the long run by exploiting market powerlegal treatment built on these elements • Test of prdation as follows:1)Market analysis to assess dominancewithout dominance dismiss the case 2) with dominanceanalyse price-cost relationship • P>ATC (average total cost): lawful without exc. • AVC <P< ATC: presumed to be lawfulburden of proof on the plaintiff • P<AVC: presumed to be unlawfulburden of proof on the defendant

Ability to increase prices (dominance) • Necesssary ingredient of predation is the ability to increase prices after exclusionassess the degree of market power • EU law P.P. included in the abuse of a dominant position a firm with a market share below 40% not accused of PP • In the US the isssue is less clear: risk to accuse an oligopolistic firm that decrease prices as part of the competitive process • EX. A firm with 20% reduces prices and steals customers to a dominant firm (60% market share) and to a small rival (5% market share)

Ability to increase prices (dominance) • A non dominant firm may price below cost for some reasons: compensate for switching costs, network externalitiesreach a critical mass of consumers, learning curves, reach economies of scale…product complementarity with another market (more important for the firm..) • The same arguments cannot be applied to a dominant firm • The market power test should catch only dominant firms at the risk of neglecting a non-dominant predator (left unpunished) small price to pay compared to a more “inclusive” test that could wrongly involve most oligopolists..

Sacrifice of short-run profits • Theory just states that the incumbent makes less profits than it would have made in the short-run it does not state if these profits are negative or not • Difficult to apply theory literally..: compute the optimal price P* and prove that the actual price P’<P*not feasible in practice (managers cannot know P*…) • Alternative: show firms are making negative profits P’<costs correct rule a firm with Π < 0 might be a predator (a firm with Π > 0probably not) • Another possibility: find documents prooving managers have sacrificed profits to exclude rivals but these documents cannot substitute an objective proof if rivals are inefficient the incumbent might be entiteld to reduce prices as a response to entrynormal competitive process • P < cost might not allow to catch all possible predation cases

Which definition of cost? • To assess if Π < 0, one should find a measure of cost • Areeda & Turner (1974): the best would be MC as with P<MC profits are not maximized • But MC difficult to assess from firm accountsuse then AVC: 1) P> AVC is presumed to be lawful 2) P <AVC presumed unlawful • Courts and some scholars rule out P.P. only if P> ATCif firms do not cover sunk cost are not in equilibrium • However the last standard is a very stringent oneif an incumbent invest and thinks to recover sunk costs through a monopoly price, then a new firm enters the market and normal competition leads the incumbent to reduce pricesthis is not P.P. • Use AIC (Average Incremental Cost): the cost for the added output needed to cover the additional predatory sales (include both variable and fixed cost) it may be difficult to measure

Testing Predatory Pricing • Intent (existence of a predatory scheme): evidence due to internal documents that proove the intent of exclusion (evidence hard to dismiss…) • No Need to proove success of predation: control for market power to see the ability of the incumbent to recover lossess in the long run, but from an ex-ante point of view if ex post predation was unsuccessfull due to miscalculations or the prey resulted to be tougher the expected the abuse remains

Testing Predatory Pricing • No presumption of harm to consumers in the predation test a negative effect on consumer surplus is expected presumption of anti-competitive effects: if due to miscalculation low prices were not follwed by higher prices in the long run and predation failed the abuse remain (even if consumers by chance got benefits) • The alleged predator can have an efficiency defence for its below-cost prices

Testing Predatory Pricing • Matching the competitor prices as a defence: observing the incumbent reducing prices after entry may be part of the competitive process but not if P < AVC • Price below cost: not a general rule: in many countries below cost pricing,retail discounts…are forbidden as a result of regulation due to lobbying by small bussiness and shop-keepers aiming to contrast competition by chain-storesHowever in this case price-below cost is forbidden for any firm independently of market power No foundation for such an approach as it protects competitors not competition and it also damages consumers

Non-Price Monopolisation: Strategic Investment • A dominant firm might use investment (Capacity, R&D, advertisment..) in strategic way to exclude competitors from the industry or avoid new entries • 1)it is very difficult to distinguish “innocent” investments from “strategic” ones 2) As investment has a positive effect on welfare one should be cautios to discourage firmsonly in exceptional cases a firm should be accused and the burden of proof should be on the plaintiff • Basic mechanism as in PP: a firm invest more than it is profitable expecting profit increase in the long run

Strategic Investment • A firm invest in process innovation knowing a firm is considering entry: let be Xithe optimal (innocent) investment to reduce costswelcome efect of increased competition • A firm may also use strategic investment XP (predatory): it adopts a new technology so costly and so effcient that the new entrant expects not to be able to compete with the incumbent and observing XP it will not enterthe expectation of monopolistic profits makes XP profitable • Remarks:1) Even if XP was feasible to deter entry it may not be profitable (due to high sunk costs it is better to accomodate entry).2) Even if XP has been decided to pre-empt entry, not necessarily it is anti-competitivea)the lower the costs the lower the monopolistic price b) there is no benchmarke to distinguish XP from Xi

Strategic Investment • It was different for PP because there was a benchmark: a firm pricing below AVC • Most investment are irreversiblecredible commitentconsumers will benefit from the investment even after predation endsthe welfare loss from over-investment would be lower than with PP. • Although excessive investment is possible in theory it may be difficult to identify it in practice.

Competition Policy