Transcript 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
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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 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
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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 > 0 probably 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?
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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 anticompetitive 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
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A firm invest in process innovation knowing a firm is
considering entry: let be Xi the 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.