Transcript Competition Policy

Competition Policy
Predation
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
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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 high
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.The “small pocket” assumption is is the
most challenging point: 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
Reputation Models
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The behaviour of an Incumbent towards
a current competitor is likely to have an
impact on future (potential) competitors
as well
A price-war today may be due to the
attempt to create a reputation of being
a strong and aggressive incumbent in
order to discourage entry tomorrow
The Chain Store example
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The Chain store example: in each market the
incumbent faces a potential entrant
Entrant enters one at a time
Timing of the game:
1) In the first market the potential entrant
decides to enter or not
2) If entry occurs the incumbent decides to
fight entry or to accomodate it
Then the same game is repetaed for all the
markets
The Chain Store example
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A weak incumbent has costs as high as the
entrant
If the game was played only once it would not
fight entry (it would be unprofitable)
The same result applies even if the game is
played for a finite number of times (finite
horizon), as long as it is certain that the
incumbent is weak
The Chain Store example
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Case with 2 entrants: whatever happened in
the first market, in the second one the
Incumbent will accomodate, as the Incumbent
would incur losses from fighting and there is no
reason to build a reputation as the game ends
But then if the only reason to fight entry is to
deter entry in a future period, in the first
period there is no incentive to fight: both I and
E would correctly anticipates that in the second
period I accomodates and Entry occurs
The Chain Store paradox
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The result is a paradox (the Chain store
paradox) as predation would never be
observed
In reality one can imagine good reason for the
incumbents to prey one entrant to build a
reputation and deter future entrants
If some uncertainty is introduced in the game
predation will occur!
Asymmetric Information
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With imperfect information about the cost of
the incumbent there is a small probability
that the incumbent is not weak, but rather
strong: his cost are so low that it can charge a
price below the entrant cost and make some
profits
Then, a weak incumbent may exploit the
Entrants’ uncertainty and fight entry in order to
let them believe that the Incumbent is strong
rather than weak
Reputation with asymmetric
informationPredation
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A weak incumbent will fight entry at the start
of the game and continue to fight to establish a
reputation and discourage future entry
Only in the last periods of the game the I will
accomodate as the closer the end of the game
the lower the expected gains from pretending
of being strong
In any period of the game the decision to
fight reinforces the Incumbent reputation
with a sacrifice of current profits to deter entry
and increase future profitPredation