GCLC lunch talk
2 November 2004
Pricing abuses under art. 82
A closer look at predation
Benoît Durand
Chief Economist Team
DG Competition
Disclaimer: The views expressed in this presentation do not necessarily reflect an official position
of the European Commission or any of its commissioners.
Pricing abuses
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Excessive pricing
Fidelity rebates
Margin squeeze
Predatory pricing
Predatory prices: the current
legal test
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AKZO
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Price below AVC are predatory
 (“must be regarded as abusive”)
Price below ATC (and above AVC) are
predatory if intent is shown
 (“must be regarded as abusive if [.] part
of a plan”)
Probable recoupment?
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Tetra Pak II
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No need to show probable recoupment
(“not necessary to demonstrate [.]
reasonable prospect of recouping losses”)
Only reason for a firm to price below cost
is to eliminate competition
Early economic critique (I)

The Chicago School’s critique
 A price war is more costly for the dominant
firm
 Below cost pricing is thus only temporary
 The prey recognizes this and fights back
 If in need, the prey has access to credit
market to resist aggressive pricing (“deep
pockets”)
Early economic critique (II)
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Why would a dominant firm lower its price
below cost if it has no chances of recouping
its losses?
Predatory pricing is thus irrational and
therefore it rarely occurs
Skepticism echoed in the US supreme court
decision Brooke Group (1994)
Modern economic theories
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Predation is a rational strategy; but
need dynamic framework
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Sacrifice profit in the short-run (pricing
below what would be optimal)
Exclude or discipline rivals, or prevent
entry => injure competition
Then recoup initial losses once competition
is eliminated
Strategic approach to
predation
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Introducing asymmetric and imperfect
information => predation is a profit
maximizing strategy
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Financial predation
Signaling models
 Reputation
 Limit pricing
Financial predation (I)
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Akin to “long purse” (“deep pockets”)
story, but somewhat different
The focus is on the prey’s financial
situation
Does the prey have also “deep pockets”?
 If prey relies on external funds for entry or
expansion, predation is possible. Why?
=> Capital market imperfection
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Financial predation (II)
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Lenders have imperfect information
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Cannot verify precisely whether the borrowed
money is used efficiently
By threatening to cut off funding when the prey’s
performance is poor, the lenders attempt to regain
control
But lenders have no ability to recognize
predatory episodes from cost inefficiencies or
mismanagement etc…
Lenders rely on retained earnings (internal
assets) to grant additional funds
Financial predation (III)
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The predator observes the prey’s
dependence on capital markets
Aggressive behavior to affect the prey’s
short-run profitability
The prey’s cost of capital will rise as
investors reduce or withdraw financial
support
The prey exits or scales down operation
Reputation effect (I)
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A “weak” incumbent fights aggressively a new
entrant
 Lowers price; expands capacity etc…
 Sacrifices current profits
Invest in building a reputation for “toughness”
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Asymmetric information => future entrants do
not know whether the incumbent will be
aggressive
 Current aggressive behavior is observed by future
entrants => signal
Reputation effect (II)
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Reputation acts as additional barriers to entry
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Markets where aggressive behavior occurs
But also in related markets where incumbent is
active
Recoupment may occur in several markets

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This is maybe very profitable when reputation
affects many markets
American Airlines case=> DoJ allegation
Limit pricing: cost signaling (I)
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The cost of the incumbent firm is private
information (not observed by rivals)
The incumbent charges low price to signal
low cost of production

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Thanks to new product development, technical
innovation, new management etc…
But is the incumbent bluffing? May be sacrificing
current profits.
Limit pricing: cost signaling (II)
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Based on beliefs rivals will have to
decide between
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Staying but face a likely more cost-efficient
opponent => low expected profit
Leaving the market => other less
profitable opportunities if incumbent is
bluffing
Predation is harmful when rivals exit
when in fact they should have stayed
More economics?
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Current legal test presumes below cost
pricing is illegal for dominant firms

Analytically unsatisfactory – firms are irrational in
this framework
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Not a powerful test – alone does not allow to
separate legitimate pricing from predatory pricing
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Does not address early economic critique
Pricing below cost occurs also for market expansion
reasons
Use modern economic theories?
Competition or predation?
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But modern theories => “fuzzy resemblance”
between competition and predation
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Aggressive behavior maybe perfectly legitimate
 Why would an incumbent firm accommodate
entry?
 In reputation game, no other choice but being
tough, otherwise may induce further entry
Which criteria permit to tell when aggressive
conduct is detrimental to welfare?
Which way forward?

Bolton, Brodley & Riordan (2000)
proposal for the US post Brooke
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Facilitating market structure
Scheme of predation & supporting
evidence
Probable recoupment
Pricing below cost
Business justification
The way forward
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Need to build a coherent theory of predation
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Probable recoupment
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Bring evidence that competition (exclusion or discipline
rivals) has been injured by predation allowing the dominant
firm to recoup
Can be exceedingly difficult to show
Evidence of pricing below cost
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Use economist tool kit to explain firm’s conduct
Fit the theory to the facts
Which cost measure?
Can also be very difficult to demonstrate
Dominant firm’s defense
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Below-cost pricing for other reasons than predation