Predatory Pricing

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


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


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


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


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.




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








all computers.

TR

MR








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.








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)


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


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

Predatory Pricing

Documents

Transcript of Predatory Pricing