Transcript Document

An Introduction to
Predation
Eric Emch, OECD
[email protected]
Introduction
• Single-firm conduct is the most challenging
area of antitrust analysis.
– Primary challenge is distinguishing
predation/foreclosure (bad) from intense
competition (good)
– Overly aggressive intervention can discourage intense
competition, with high costs to society
• Goals of this talk
– To identify and discuss key questions of economic
theory in the context of existing legal rules re:
predation
– Review economics of actual cases related to predation
2
Outline of Talk
I. Unified theory vs. single firm “boxes”
II. Predation: classic story and its critique
III. Predation: modern game theoretic analysis
IV. Legal tests
V. Recent cases
3
Is There Unified Theory of
Single Firm Conduct?
• Not in practice. Some possibilities that
have been floated:
– “No economic sense” test
– “Equally efficient competitor” test
– Welfare test
• But, none of these are perfect, and there is
no consensus on a single framework
4
Some Legal “Boxes” For Single
Firm Conduct (In US)
• Price Predation: Price below cost + recoupment
• Tying: In the United States, “per se illegal.” In practice,
structured rule of reason
• Refusals to deal: US DOJ advocates “no economic sense” test
in Trinko brief, some of which is adopted by Supreme Court
• Bundling: “Ortho test” of bundling as effective predation
• Exclusive dealing: Extent of “market access”
5
Price Predation: “Classic” Story
• Dominant firm prices product very low with the express
purpose of driving competitors out of business
• Dominant firm outlasts competitors during loss period
(“long purse”). Once competitors exit, predator raises
price to recoup losses and make extra profits
• Consumer and total welfare harmed
• But does this make sense…?
6
Critique of Classic Story
• Predator, with larger market share and capturing even more
with low prices, should incur more losses than prey
• Financial markets should be willing to fund prey for this
reason. Prey can “wait it out.”
• Consumer inventory behavior: won’t consumers stock up in
the predatory period and make recouping losses more
difficult?
• Selten’s “chain store paradox”: Predatory strategy unwinds
via backwards induction from final period
• For critiques, see, e.g., Easterbrook (Chicago Law Review
1981), McGee (JLE 1958)
7
“Post-Chicago” View
• Predation may be more targeted, and therefore less
costly, than Chicago view assumes
• Chicago view assumes complete information, no
principal-agent problems
• Under incomplete information on various
dimensions, predation can be a rational strategy
8
Predation As “Signaling”
• Predation signals efficient incumbent or aggressive
posture; incomplete information means that this
costly signal may induce exit/lack of entry and
ultimately be profitable
– Kreps and Wilson (Journal of Economic Theory 1982)
– Milgrom and Roberts (Econometrica 1982)
• Also, “signal-jamming” predation; “test market”
predation
9
Predation as Exploitation of
Principal-Agent Problems
• Bolton-Scharfstein (AER, 1990)
• Basic logic: a bank will not give a firm
unconditional funding, due to principal-agent
problems in financing
• Predation leads to poor firm performance which
leads to a cutback in external financing, which
may lead to exit
10
What is a “Principal-Agent” Problem?
•
•
•
•
A broad category of contract design problems in which one party, the
"principal," writes a contract to induce another party, "the agent," to achieve
some outcome he likes.
For instance, owners of a firm want to write a contract to induce managers
to maximize profits. One might think that the optimal solution to this
problem is simply to write a contract that says: “if you achieve x profit, the
maximum possible, you are compensated with y dollars, otherwise you get
zero.” Problem with this contract is future uncertainty. Who knows if x
profit is achievable? Suppose the agent does everything right and still
doesn't achieve x profit? Why would the agent sign such a contract?
Problems arise due to hidden actions and hidden information that manifest
themselves after the contract is written.
Generally, principal agent problems highlight inefficiencies due to an
inability to write what is called a "complete contingent contract," a contract
that specifies payoffs depending on all possible states of the world
11
Bolton/Scharfstein Model of Predation
• Two firms, A & B. B depends on external financing
• Two periods with possible profit realizations π1 (low)
and π2 (high) each period.
• Firms incur fixed cost F each period
• B and financier sign contract at time zero that specifies
period 1 payment and probability of period 2 financing
as a function of period 1 reported profits
• Optimal contract terminates period 2 financing upon
low reported period 1 profits
• Possibility of predation changes optimal contract, and
predation still sometimes occurs in equilibrium
12
Where Are We Now?
• Consensus that welfare-reducing predation can
happen
• Semi-consensus that classic price predation is
probably rare and difficult to identify
• Difficulties in identification, and balancing type I
vs. type II errors, lead courts to rely on pricecost tests + recoupment criteria
13
Legal Test
• Brooke Group Test in US, other
jurisdictions use similar criteria
• Part 1: Finding Price Below Cost
• Part 2: Finding Likelihood of Future
Recoupment of Losses
14
Price-Cost Tests
• Areeda-Turner test (P<AVC presumptively illegal)
• Bolton, Baumol test (P<AIC presumptively illegal)
• Joskow-Klevorick test (P<ATC presumptively illegal)
• Problem is that none of these is either necessary or sufficient for
harm from predation
• Areeda-Turner probably most popular in United States
• EC Article 82 Discussion Paper advocates P<AAC presumption of
predation. AAC<P<ATC, may be predation but no presumption
15
Price-Cost Tests (2)
Profit-Maximizing
Price
P=AIC
P=ATC
Price
P=AVC
•16
Problems with Price-Cost Tests
• Price below even marginal cost not always
predatory
– Introductory prices to promote consumer learning
– Two-sided markets: price below “cost” on one side of
market may be efficient
– Network effects/scale economies may make below
cost pricing efficient during initial periods
• Price above cost may be predatory in some sense if
strategy involves profit sacrifice and recoupment
17
Recoupment Criterion
• Are market conditions susceptible to
recouping losses?
– Entry barriers
– Few firms left to reap profits
– Inelastic demand
• Is this a market structure screen? Or a
test for consumer harm?
18
US v. American Airlines (2001)
• American’s response to low-cost carrier (LCC) entry at its
Dallas hub (DFW) is low fares and more capacity. This is good
for consumers on these routes in the short-run. Is this
competition or exclusion?
• US Says that American Airlines has monopoly power on many
DFW routes. Alleges predation on 8 nonstop city-pair routes
out of DFW against LCC’s Vanguard, Sunjet and Western
Pacific.
• Says American Airlines matched lower fares of some entrant
LCCs and expanded capacity in an attempt to drive
competitors from DFW and establish a “reputation” for
predation
• Capacity increases were alleged to be beyond what would have
made economic sense, but for competitor exit.
– Internal memos from American made this argument
– Government’s economic expert Professor Barry reached the same
conclusion
19
AMERICAN AIRLINES
PRICING AND CAPACITY ON
DALLAS ROUTES BEFORE,
DURING AND AFTER
PREDATORY PERIODS
DFW-ICT
50,000
120
45,000
100
40,000
35,000
80
30,000
25,000
60
20,000
Total setas
Average fare
40
15,000
10,000
20
5,000
0
0
May-95
Sep-96
Dec-96
Jun-98
Jun-99
Jun-94
Jun-95
Oct-96
Jul-97
Jul-98
DFW-MCI
120000
140
120
100000
100
80000
80
60000
60
40000
40
20000
20
0
0
Dec-94
Dec-95
Sep-96
May-98
Sep-99
Jan-94
Feb-95
Jan-96
Oct-96
Jun-98
Total setas
Average fare
DFW-COS
70000
180
160
60000
140
50000
120
40000
100
30000
80
60
20000
40
10000
20
0
0
May-95
Oct-97
Mar-99
Jun-94
Jul-95
Apr-98
Total setas
Average fare
US v. American Airlines (cont.)
• DOJ advances four price-cost tests that the various
route-episodes fail
• Tests 1 and 4 compare incremental costs and benefits of
capacity additions, assuming constant price (essentially:
is p<AIC for capacity expansion); Tests 2 and 3 measure
overall profitability of route after capacity additions,
including allocated overhead costs.
• American Airlines, in contrast, emphasizes price vs.
short-run AVC, more narrowly defined (not including
overall plane costs, for example)
24
Decision: US v. American Airlines
• Court rules for American in Summary Judgment
phase
– Focusing on American’s cost measure, rules that
American’s price was “above cost,” and thus fails
Brooke Group test
– Says that straightforward comparison of price to AVC
on a route is the appropriate test for price predation,
and there is no separate test for “capacity predation”
– In addition, rules that American would be entitled to
summary judgement regardless because it never
undercut competitors’ prices
• US appeals but fails to overturn decision
25
Conclusion
• Lack of clear economic (and legal) consensus about
how to judge predation, exclusionary acts
• Extreme care is required in prosecuting, since these
“bad acts” (e.g., low prices, new marketing strategies)
are hard to distinguish from intense competition,
which antitrust laws are expressly designed to
encourage
• Articulating clear standards is important for
consistency, continued evolution of thinking
• Nevertheless, narrow focus on particular price-cost
tests could miss instances of predatory behaviour
26
Some References
•
•
•
•
•
•
•
•
•
•
Motta, Massimo, Competition Policy: Theory and Practice, Cambridge University Press, 2004 (in
particular Section 7.2: “Predatory Pricing.”)
DG Competition discussion paper on the application of Article 82 of the Treaty to exclusionary abuses
(Brussels, December 2005)
Easterbrook, F. (1981). “Predatory Strategies and Counterstrategies,” University of Chicago Law Review
48:263-337.
Kreps, D. and R.Wilson, 1982, “Reputation and Imperfect Information,” Journal of Economic Theory 27:
253-279.
Bolton, G. and D. Scharfstein, 1990, “A Theory of Predation Based on Agency Problems in Financial
Contracting,” American Economic Review, 80: 93-106.
Milgrom, P. and J. Roberts, 1982, “Predation, Reputation and Entry Deterrence.”Journal of Economic
Theory 27: 280-312.
David Genesove & Wallace Mullin, 2006, “Predation and its Rate of Return: The Sugar Industry 18871914,” RAND Journal of Economics 37(1): 47-69.
Scott Morton, F, 1997 “Entry and Predation: British Shipping Cartels 1879-1929.” Journal of Economics
and Management Strategy 6:679-724.
Jung, Y.J. , J. Kagel,and D. Levin, 1994, "On the Existence of Predatory Pricing: An Experimental Study of
Reputation and Entry Deterrence in the Chain-Store Game," RAND Journal of Economics 25(1): 72-93 .
United States of America v. AMR Corporation, American Airlines, Inc., and American Eagle Holding
Corporation. 140 F. Supp. 2d 1141 (2001).
27