PREDATORY PRICING
10/2/2010 1
AGENDA
• Introduction to predatory pricing
• External favorable conditions
• Other related phenomenon
• Traditional concept & Types of predation
• Areda Turner test
• Chain store paradox
• Laws and standpoints
• Examples
10/2/2010 FMS MBA MS - PREDATORY PRICING 2
Predatory Pricing- What is it ?
• Predatory pricing is the practice of selling at a very low price to wipe out competition
• Strategy adopted to enhance market power . To establish a de facto monopoly
• In short term it means sharp discounting by reducing price margins
• Game of the big fish
• Used to send a false signal to new entrants
10/2/2010 3FMS MBA MS - PREDATORY PRICING
Predatory Pricing- Economical outlook
FC-Fixed Cost-Do not vary with production
VC-variable Cost- vary with production
Total Cost- FC + VC
If price is below Average variable cost, its predatory and not rational
10/2/2010 4FMS MBA MS - PREDATORY PRICING
Favorable conditions• Market Conditions
Enough dominance to control a large market share.
• Barriers to entry and re-entry
if not, the victims or other prospective rivals would without delay enter again. It can be in form of huge investments, regulations , patents, tech needs etc.
• Excess capacity of competitors have to be small
10/2/2010 5FMS MBA MS - PREDATORY PRICING
Favorable conditions continued
• Financial requirements
You need to have deep pockets todo this. Adequate financialreserves to back it up. Can siphonfrom other parallels. Good marketimage may get to borrowings.
• Recoupment
The predator must havereasonable expectations forrecouping incurred losses andgetting additional benefits tomake sense
• No close substitute to yourproduct10/2/2010 6FMS MBA MS - PREDATORY PRICING
Other Related Phenomenon
Non Price predation – increase competitors price by unfair means, exploiting government regulations,
playing with add spends or with Fixed cost innovation
Cross Subsidization- the loss incurred by predatory pricing in one zone is compensated in other zone by
high pricing
Cartel Formation- organizations join hands to agree & coordinate prices
10/2/2010 7FMS MBA MS - PREDATORY PRICING
Traditional Concept
Financially powerful firm decides to ruin the smaller and newer competitors
Predator firm reduces the price of the product less than its cost of production
Prey firm follows suit and incur losses
Predator firm enjoys monopoly when prey firm exits
Types of Predation
Type 1 – Predation aimed at attaining a monopoly by driving out one’s competition
Type 2 – Predation designed to obtain monopoly power by compelling competitor to cooperate the predatory firm
Conditions to be met
The predator must sell its product at a price which is below its own cost of production
The intended predatee must be eliminated from the market as a result of this activity
The price cutting firm must have predatory intent
Time profile of profits resulting from predation
Models followed by Predators
Financial Market Predation Model
Reputation Predation Model
Cost Signaling Model of Predation
The Areda-Turner Test
The Areda-Turner Test
An example: Microsoft
charged firms one price
if they install Windows
on only some of their
computers. It charged a
lower price if they put
Windows on all
computers.
The Areda-Turner Test
An example: Microsoft
charged firms one price
if they Windows on only
some of their computers.
It charged a lower price
if they put Windows on
all computers.
Units
Price
Per
Unit TR MR
8 50 400
9 40 360 -40
10 30 300 -60
The Areda-Turner Test
An example: Microsoft
charged firms one price
if they Windows on only
some of their computers.
It charged a lower price
if they put Windows on
all computers.
TR
MR
The Areda-Turner Test
An example: Microsoft
charged firms one price
if they Windows on only
some of their computers.
It charged a lower price
if they put Windows on
all computers.
TR
MR
When a firm put Windows
on all its computers,
Microsoft was essentially
operating in the range of a
negative MR. That makes
no economic sense.
The Areda-Turner Test
An example: Microsoft
charged firms one price
if they Windows on only
some of their computers.
It charged a lower price
if they put Windows on
all computers.
TR
MR
When a firm put Windows
on all its computers,
Microsoft was essentially
operating in the range of a
negative MR. That makes
no economic sense.
Consider the problems of
Anti-Windows, a new
software system. If it
wants to sell to the
customer, the price is the
cost of Anti-Windows
plus the extra cost of
installing fewer copies of
Windows. This is
predatory pricing.
The Chain Store Paradox: Effectiveness of predatory pricing ??
• An incumbent ‘Chain Store’ faces 20 entrants in 20 towns.
• Each entrant must decide whether or not to enter.
• The incumbent must decide whether to fight or share the market.
• What will happen?
• The answer depends on how we encompass information.
The Chain Store Paradox
In
Incumbent
Entrant Out
(5, 0)
Incumbent
Fight Co-operate
(0, 0) (2, 2)
The Chain Store Paradox
In
Entrant
Out
(a, 0)
Incumbent
Fight Co-operate
(-1, b-1) (0, b)
In
Entrant
Out
(a, 0)
Incumbent
Fight Co-operate
(0, b-1) (2, b)
Weak Incumbent Strong Incumbent
Incumbent: a > 1 Entrant: b > 1
The Chain Store Paradox
Note that the incumbent is weak in that they earn more from co-operating than fighting (0 > -1)
If the incumbent is weak, and the entrant knows this, then the backward induction argument applies and co-operation develops.
Hence the incentive to gain a reputation if the incumbent are weak.
The overall profitability of predation does not depend on its profitability in a single period.
Even if the incumbent is strong , it gains more by willing to cooperate rather than preying the rival out
Economic research shows it rarely creates monopolies
Rivals of predators have both incentive and ability to withstand the predatory onslaught
Customers and suppliers of predators also often have incentive and ability to thwart predatory efforts
In a longer run customers can even reduce the sales of the monopolist
Retailers controlling the minimum sales price and the maximum selling price??
Courts skeptical
LAWS AND STANDPOINTS
USA
The American courts are highly influenced by Chicago school
Scholars of this school challenge the notion that predatory pricing is a means to monopoly
They don't say that predatory pricing is an impossible event
USA Supreme Court Rulings
Alleged predatory prices are below an appropriate measure of the defendant's cost and dangerous probability that the defendant would be able to recoup its investment in below cost price
Earlier proof of price discrimination with an exclusionary intent was sufficient to succeed a predatory pricing claim
Csourts recently agreed that predatory pricing is a rational strategy
American courts adopt a structural approach and significance is given to market concentration, capacity constraints of the competitors and entry barriers of the market
European Union
• Predation is an anticompetitive practice under abuse of dominance provision
• Europeans accept predatory pricing as a practical and profitable strategy(strategy theory).
• law is much influenced by Strategic theory which rests on the notions of asymmetric information or asymmetric access to financial resources.
• The theory explains how a dominant entity can use its market power to exclude its rivals and prolong its market power. The following rules prove the guilt:
(1) facilitating market structure,(2) a scheme of predation and supporting evidence,(3) probable recoupment, (4) price below cost and (5) absence of a business justification or efficiencies defence
CANADA
Predatory pricing is an offence under section 50 and a civil abuse of dominance under section 78 and 79 of the Competition act 1985
In Canada there is no requirement of dominance to charge a person under section 50 of the act but for fixing the civil liability you have to prove dominance of the entity.
Pricing is below marginal cost.
There is some prospect of recoupment or the firm is trying to build a reputation for predation in one market by engaging in predatory conduct in another market.
The competition bureau has clarified that recoupment is the essential ingredient of predatory pricing
The 2007 draft guidelines on predatory pricing enforcement [xvii] say that recoupment is achieved by "charging prices above competitive levels or achieving another anti-competitive objective
INDIAThe Monopolies and Restrictive Trade Practices Act, 1969 (MRTP Act) is the law regulating competition in India, under which predatory pricing is a restrictive trade practice under S. 2(o) and 33(j)
Competition Act 2002 says that "predatory price" means the sale of goods or provision of services, at a price which is below the cost,
It should be done with a view to reduce competition or eliminate the competitors
The act declares predatory pricing as a means of abuse of dominance, thus dominance is a precondition to sustain a predatory pricing claim under our law.
Though the competition act is not notified as of now
Under MRTP Act, dominance is not a pre-condition for predatory pricing rather the conduct and intent of the predator is material and needs to be proved with clear and cogent evidence
Conclusion –Different Countries Different Views
There is a clear difference of approach between the jurisdictions with respect to the requirement of dominance in predatory pricing claims
Dominance is not a formal condition in U.S, it matters for the purpose of showing probable recoupment
In EU dominance is a precondition but no need to prove recoupment as such
In Canada both dominance and recoupment are pre-requisites but the latter is presumed from the presence of former.
Conclusion (contd)
There are probabilities even for a non-dominant entity to adopt predatory pricing strategy to capture market
It is because of this reason under section 4(e) of our Act declares, uses of dominant position in one relevant market to enter into, or protect, other relevant market as a form of abuse of dominance
Thus our legislation explicitly addresses the lacuna that is not addressed by other three jurisdictions
BUNDLING
PURE BUNDLING
• Fixed proportions, fixed cost
• None of the products available individually
MIXED BUNDLING
• All products available individually
• Price of bundle less than price of individual sum
TYING
• To obtain product A, product B has to be purchased too
• Product B is available individually
MICROSOFT vs NETSCAPE
Monopoly in OS, bundled
Internet Explorer
with Windows
Netscape –Small Firm,
based solely on browser Netscape
MICROSOFT SECURITY PRODUCTS
Microsoft priced its products OneCare and Antigen almost 50% below the market leader
Microsoft loses money in most of its businesses, it primarily makes money on the operating system
Price advantage on Microsoft Antigen went up to 63%, even though it included five anti-virus engines
WALMART
• Walmart accused of predatory pricing on many occasions by various parties
• Corner goods discounts & extremely low prices on products like milk, butter, medicines
• Also accused of pressurizing suppliers to sell goods below cost, or at extremely low profits
Intel fined by EU $1.44 billion for illegally using its muscle to price out AMD
Intel gave special rebates to computer manufacturers if they didn’t use AMD chips in their products
Intel also made payments to manufacturers to delay or restrict use of AMD chips