Archives For predatory pricing

These days, lacking a coherent legal theory presents no challenge to the would-be antitrust crusader. In a previous post, we noted how Shaoul Sussman’s predatory pricing claims against Amazon lacked a serious legal foundation. Sussman has returned with a new post, trying to build out his fledgling theory, but fares little better under even casual scrutiny.

According to Sussman, Amazon’s allegedly anticompetitive 

conduct not only cemented its role as the primary destination for consumers that shop online but also helped it solidify its power over brands.

Further, the company 

was willing to go to great lengths to ensure brand availability and inventory, including turning to the grey market, recruiting unauthorized sellers, and even selling diverted goods and counterfeits to its customers.

Sussman is trying to make out a fairly convoluted predatory pricing case, but once again without ever truly connecting the dots in a way that develops a cognizable antitrust claim. According to Sussman: 

Amazon sold products as a first-party to consumers on its platform at below average variable cost and [] Amazon recently began to recoup its losses by shifting the bulk of the transactions that occur on the website to its marketplace, where millions of third-party sellers pay hefty fees that enable Amazon to take a deep cut of every transaction.

Sussman now bases this claim on an allegation that Amazon relied on  “grey market” sellers on its platform, the presence of which forces legitimate brands onto the Amazon Marketplace. Moreover, Sussman claims that — somehow — these brands coming on board on Amazon’s terms forces those brands raise prices elsewhere, and the net effect of this process at scale is that prices across the economy have risen. 

As we detail below, Sussman’s chimerical argument depends on conflating unrelated concepts and relies on non-public anecdotal accounts to piece together an argument that, even if you squint at it, doesn’t make out a viable theory of harm.

Conflating legal reselling and illegal counterfeit selling as the “grey market”

The biggest problem with Sussman’s new theory is that he conflates pro-consumer unauthorized reselling and anti-consumer illegal counterfeiting, erroneously labeling both the “grey market”: 

Amazon had an ace up its sleeve. My sources indicate that the company deliberately turned to and empowered the “grey market“ — where both genuine, authentic goods and knockoffs are purchased and resold outside of brands’ intended distribution pipes — to dominate certain brands.

By definition, grey market goods are — as the link provided by Sussman states — “goods sold outside the authorized distribution channels by entities which may have no relationship with the producer of the goods.” Yet Sussman suggests this also encompasses counterfeit goods. This conflation is no minor problem for his argument. In general, the grey market is legal and beneficial for consumers. Brands such as Nike may try to limit the distribution of their products to channels the company controls, but they cannot legally prevent third parties from purchasing Nike products and reselling them on Amazon (or anywhere else).

This legal activity can increase consumer choice and can lead to lower prices, even though Sussman’s framing omits these key possibilities:

In the course of my conversations with former Amazon employees, some reported that Amazon actively sought out and recruited unauthorized sellers as both third-party sellers and first-party suppliers. Being unauthorized, these sellers were not bound by the brands’ policies and therefore outside the scope of their supervision.

In other words, Amazon actively courted third-party sellers who could bring legitimate goods, priced competitively, onto its platform. Perhaps this gives Amazon “leverage” over brands that would otherwise like to control the activities of legal resellers, but it’s exceedingly strange to try to frame this as nefarious or anticompetitive behavior.

Of course, we shouldn’t ignore the fact that there are also potential consumer gains when Amazon tries to restrict grey market activity by partnering with brands. But it is up to Amazon and the brands to determine through a contracting process when it makes the most sense to partner and control the grey market, or when consumers are better served by allowing unauthorized resellers. The point is: there is simply no reason to assume that either of these approaches is inherently problematic. 

Yet, even when Amazon tries to restrict its platform to authorized resellers, it exposes itself to a whole different set of complaints. In 2018, the company made a deal with Apple to bring the iPhone maker onto its marketplace platform. In exchange for Apple selling its products directly on Amazon, the latter agreed to remove unauthorized Apple resellers from the platform. Sussman portrays this as a welcome development in line with the policy changes he recommends. 

But news reports last month indicate the FTC is reviewing this deal for potential antitrust violations. One is reminded of Ronald Coase’s famous lament that he “had gotten tired of antitrust because when the prices went up the judges said it was monopoly, when the prices went down they said it was predatory pricing, and when they stayed the same they said it was tacit collusion.” It seems the same is true for Amazon and its relationship with the grey market.

Amazon’s incentive to remove counterfeits

What is illegal — and explicitly against Amazon’s marketplace rules  — is selling counterfeit goods. Counterfeit goods destroy consumer trust in the Amazon ecosystem, which is why the company actively polices its listings for abuses. And as Sussman himself notes, when there is an illegal counterfeit listing, “Brands can then file a trademark infringement lawsuit against the unauthorized seller in order to force Amazon to suspend it.”

Sussman’s attempt to hang counterfeiting problems around Amazon’s neck belies the actual truth about counterfeiting: probably the most cost-effective way to stop counterfeiting is simply to prohibit all third-party sellers. Yet, a serious cost-benefit analysis of Amazon’s platforms could hardly support such an action (and would harm the small sellers that antitrust activists seem most concerned about).

But, more to the point, if Amazon’s strategy is to encourage piracy, it’s doing a terrible job. It engages in litigation against known pirates, and earlier this year it rolled out a suite of tools (called Project Zero) meant to help brand owners report and remove known counterfeits. As part of this program, according to Amazon, “brands provide key data points about themselves (e.g., trademarks, logos, etc.) and we scan over 5 billion daily listing update attempts, looking for suspected counterfeits.” And when a brand identifies a counterfeit listing, they can remove it using a self-service tool (without needing approval from Amazon). 

Any large platform that tries to make it easy for independent retailers to reach customers is going to run into a counterfeit problem eventually. In his rush to discover some theory of predatory pricing to stick on Amazon, Sussman ignores the tradeoffs implicit in running a large platform that essentially democratizes retail:

Indeed, the democratizing effect of online platforms (and of technology writ large) should not be underestimated. While many are quick to disparage Amazon’s effect on local communities, these arguments fail to recognize that by reducing the costs associated with physical distance between sellers and consumers, e-commerce enables even the smallest merchant on Main Street, and the entrepreneur in her garage, to compete in the global marketplace.

In short, Amazon Marketplace is designed to make it as easy as possible for anyone to sell their products to Amazon customers. As the WSJ reported

Counterfeiters, though, have been able to exploit Amazon’s drive to increase the site’s selection and offer lower prices. The company has made the process to list products on its website simple—sellers can register with little more than a business name, email and address, phone number, credit card, ID and bank account—but that also has allowed impostors to create ersatz versions of hot-selling items, according to small brands and seller consultants.

The existence of counterfeits is a direct result of policies designed to lower prices and increase consumer choice. Thus, we would expect some number of counterfeits to exist as a result of running a relatively open platform. The question is not whether counterfeits exist, but — at least in terms of Sussman’s attempt to use antitrust law — whether there is any reason to think that Amazon’s conduct with respect to counterfeits is actually anticompetitive. But, even if we assume for the moment that there is some plausible way to draw a competition claim out of the existence of counterfeit goods on the platform, his theory still falls apart. 

There is both theoretical and empirical evidence for why Amazon is likely not engaged in the conduct Sussman describes. As a platform owner involved in a repeated game with customers, sellers, and developers, Amazon has an incentive to increase trust within the ecosystem. Counterfeit goods directly destroy that trust and likely decrease sales in the long run. If individuals can’t depend on the quality of goods on Amazon, they can easily defect to Walmart, eBay, or any number of smaller independent sellers. That’s why Amazon enters into agreements with companies like Apple to ensure there are only legitimate products offered. That’s also why Amazon actively sues counterfeiters in partnership with its sellers and brands, and also why Project Zero is a priority for the company.

Sussman relies on private, anecdotal claims while engaging in speculation that is entirely unsupported by public data 

Much of Sussman’s evidence is “[b]ased on conversations [he] held with former employees, sellers, and brands following the publication of [his] paper”, which — to put it mildly — makes it difficult for anyone to take seriously, let alone address head on. Here’s one example:

One third-party seller, who asked to remain anonymous, was willing to turn over his books for inspection in order to illustrate the magnitude of the increase in consumer prices. Together, we analyzed a single product, of which tens of thousands of units have been sold since 2015. The minimum advertised price for this single product, at any and all outlets, has increased more than 30 percent in the past four years. Despite this fact, this seller’s margins on this product are tighter than ever due to Amazon’s fee increases.

Needless to say, sales data showing the minimum advertised price for a single product “has increased more than 30 percent in the past four years” is not sufficient to prove, well, anything. At minimum, showing an increase in prices above costs would require data from a large and representative sample of sellers. All we have to go on from the article is a vague anecdote representing — maybe — one data point.

Not only is Sussman’s own data impossible to evaluate, but he bases his allegations on speculation that is demonstrably false. For instance, he asserts that Amazon used its leverage over brands in a way that caused retail prices to rise throughout the economy. But his starting point assumption is flatly contradicted by reality: 

To remedy this, Amazon once again exploited brands’ MAP policies. As mentioned, MAP policies effectively dictate the minimum advertised price of a given product across the entire retail industry. Traditionally, this meant that the price of a typical product in a brick and mortar store would be lower than the price online, where consumers are charged an additional shipping fee at checkout.

Sussman presents no evidence for the claim that “the price of a typical product in a brick and mortar store would be lower than the price online.” The widespread phenomenon of showrooming — when a customer examines a product at a brick-and-mortar store but then buys it for a lower price online — belies the notion that prices are higher online. One recent study by Nielsen found that “nearly 75% of grocery shoppers have used a physical store to ‘showroom’ before purchasing online.”

In fact, the company’s downward pressure on prices is so large that researchers now speculate that Amazon and other internet retailers are partially responsible for the low and stagnant inflation in the US over the last decade (dubbing this the “Amazon effect”). It is also curious that Sussman cites shipping fees as the reason prices are higher online while ignoring all the overhead costs of running a brick-and-mortar store which online retailers don’t incur. The assumption that prices are lower in brick-and-mortar stores doesn’t pass the laugh test.

Conclusion

Sussman can keep trying to tell a predatory pricing story about Amazon, but the more convoluted his theories get — and the less based in empirical reality they are — the less convincing they become. There is a predatory pricing law on the books, but it’s hard to bring a case because, as it turns out, it’s actually really hard to profitably operate as a predatory pricer. Speculating over complicated new theories might be entertaining, but it would be dangerous and irresponsible if these sorts of poorly supported theories were incorporated into public policy.

In 2014, Benedict Evans, a venture capitalist at Andreessen Horowitz, wrote “Why Amazon Has No Profits (And Why It Works),” a blog post in which he tried to explain Amazon’s business model. He began with a chart of Amazon’s revenue and net income that has now become (in)famous:

Source: Benedict Evans

A question inevitably followed in antitrust circles: How can a company that makes so little profit on so much revenue be worth so much money? It must be predatory pricing!

Predatory pricing is a rather rare anticompetitive practice because the “predator” runs the risk of bankrupting itself in the process of trying to drive rivals out of business with below-cost pricing. Furthermore, even if a predator successfully clears the field of competition, in developed markets with deep capital markets, keeping out new entrants is extremely unlikely.

Nonetheless, in those rare cases where plaintiffs can demonstrate that a firm actually has a viable scheme to drive competitors from the market with prices that are “too low” and has the ability to recoup its losses once it has cleared the market of those competitors, plaintiffs (including the DOJ) can prevail in court.

In other words, whoa if true.

Khan’s Predatory Pricing Accusation

In 2017, Lina Khan, then a law student at Yale, published “Amazon’s Antitrust Paradox” in a note for the Yale Law Journal and used Evans’ chart as supporting evidence that Amazon was guilty of predatory pricing. In the abstract she says, “Although Amazon has clocked staggering growth, it generates meager profits, choosing to price below-cost and expand widely instead.”

But if Amazon is selling below-cost, where does the money come from to finance those losses?

In her article, Khan hinted at two potential explanations: (1) Amazon is using profits from the cloud computing division (AWS) to cross-subsidize losses in the retail division or (2) Amazon is using money from investors to subsidize short-term losses:

Recently, Amazon has started reporting consistent profits, largely due to the success of Amazon Web Services, its cloud computing business. Its North America retail business runs on much thinner margins, and its international retail business still runs at a loss. But for the vast majority of its twenty years in business, losses—not profits—were the norm. Through 2013, Amazon had generated a positive net income in just over half of its financial reporting quarters. Even in quarters in which it did enter the black, its margins were razor-thin, despite astounding growth.

Just as striking as Amazon’s lack of interest in generating profit has been investors’ willingness to back the company. With the exception of a few quarters in 2014, Amazon’s shareholders have poured money in despite the company’s penchant for losses.

Revising predatory pricing doctrine to reflect the economics of platform markets, where firms can sink money for years given unlimited investor backing, would require abandoning the recoupment requirement in cases of below-cost pricing by dominant platforms.

Below-Cost Pricing Not Subsidized by Investors

But neither explanation withstands scrutiny. First, the money is not from investors. Amazon has not raised equity financing since 2003. Nor is it debt financing: The company’s net debt position has been near-zero or negative for its entire history (excluding the Whole Foods acquisition):

Source: Benedict Evans

Amazon does not require new outside financing because it has had positive operating cash flow since 2002:

Notably for a piece of analysis attempting to explain Amazon’s business practices, the text of Khan’s 93-page law review article does not include the word “cash” even once.

Below-Cost Pricing Not Cross-Subsidized by AWS

Source: The Information

As Priya Anand observed in a recent piece for The Information, since Amazon started breaking out AWS in its financials, operating income for the North America retail business has been significantly positive:

But [Khan] underplays its retail profits in the U.S., where the antitrust debate is focused. As the above chart shows, its North America operation has been profitable for years, and its operating income has been on the rise in recent quarters. While its North America retail operation has thinner margins than AWS, it still generated $2.84 billion in operating income last year, which isn’t exactly a rounding error compared to its $4.33 billion in AWS operating income.

Below-Cost Pricing in Retail Also Known as “Loss Leader” Pricing

Okay, so maybe Amazon isn’t using below-cost pricing in aggregate in its retail division. But it still could be using profits from some retail products to cross-subsidize below-cost pricing for other retail products (e.g., diapers), with the intention of driving competitors out of business to capture monopoly profits. This is essentially what Khan claims happened in the Diapers.com (Quidsi) case. But in the retail industry, diapers are explicitly cited as a loss leader that help retailers to develop a customer relationship with mothers in the hopes of selling them a higher volume of products over time. This is exactly what the founders of Diapers.com told Inc Magazine in a 2012 interview (emphasis added):

We saw brick-and-mortar stores, the Wal-Marts and Targets of the world, using these products to build relationships with mom and the end consumer, bringing them into the store and selling them everything else. So we thought that was an interesting model and maybe we could replicate that online. And so we started with selling the loss leader product to basically build a relationship with mom. And once they had the passion for the brand and they were shopping with us on a weekly or a monthly basis that they’d start to fall in love with that brand. We were losing money on every box of diapers that we sold. We weren’t able to buy direct from the manufacturers.

An anticompetitive scheme could be built into such bundling, but in many if not the overwhelming majority of these cases, consumers are the beneficiaries of lower prices and expanded output produced by these arrangements. It’s hard to definitively say whether any given firm that discounts its products is actually pricing below average variable cost (“AVC”) without far more granular accounting ledgers than are typically  maintained. This is part of the reason why these cases can be so hard to prove.

A successful predatory pricing strategy also requires blocking market entry when the predator eventually raises prices. But the Diapers.com case is an explicit example of repeated entry that would defeat recoupment. In an article for the American Enterprise Institute, Jeffrey Eisenach shares the rest of the story following Amazon’s acquisition of Diapers.com:

Amazon’s conduct did not result in a diaper-retailing monopoly. Far from it. According to Khan, Amazon had about 43 percent of online sales in 2016 — compared with Walmart at 23 percent and Target with 18 percent — and since many people still buy diapers at the grocery store, real shares are far lower.

In the end, Quidsi proved to be a bad investment for Amazon: After spending $545 million to buy the firm and operating it as a stand-alone business for more than six years, it announced in April 2017 it was shutting down all of Quidsi’s operations, Diapers.com included. In the meantime, Quidsi’s founders poured the proceeds of the Amazon sale into a new online retailer — Jet.com — which was purchased by Walmart in 2016 for $3.3 billion. Jet.com cofounder Marc Lore now runs Walmart’s e-commerce operations and has said publicly that his goal is to surpass Amazon as the top online retailer.

Sussman’s Predatory Pricing Accusation

Earlier this year, Shaoul Sussman, a law student at Fordham University, published “Prime Predator: Amazon and the Rationale of Below Average Variable Cost Pricing Strategies Among Negative-Cash Flow Firms” in the Journal of Antitrust Enforcement. The article, which was written up by David Dayen for In These Times, presents a novel two-part argument for how Amazon might be profitably engaging in predatory pricing without raising prices:

  1. Amazon’s “True” Cash Flow Is Negative

Sussman argues that the company has been inflating its free cash flow numbers by excluding “capital leases.” According to Sussman, “If all of those expenses as detailed in its statements are accounted for, Amazon experienced a negative cash outflow of $1.461 billion in 2017.” Even though it’s not dispositive of predatory pricing on its own, Sussman believes that a negative free cash flow implies the company has been selling below-cost to gain market share.

2. Amazon Recoups Losses By Lowering AVC, Not By Raising Prices

Instead of raising prices to recoup losses from pricing below-cost, Sussman argues that Amazon flies under the antitrust radar by keeping consumer prices low and progressively decreasing AVC, ostensibly through using its monopsony power to offload costs on suppliers and partners (although this point is not fully explored in his piece).

But Sussman’s argument contains errors in both legal reasoning as well as its underlying empirical assumptions.

Below-cost pricing?

While there are many different ways to calculate the “cost” of a product or service, generally speaking, “below-cost pricing” means the price is less than marginal cost or AVC. Typically, courts tend to rely on AVC when dealing with predatory pricing cases. And as Herbert Hovenkamp has noted, proving that a price falls below the AVC is exceedingly difficult, particularly when dealing with firms in dynamic markets that sell a number of differentiated but complementary goods or services. Amazon, the focus of Sussman’s article, is a useful example here.

When products are complements, or can otherwise be bundled, firms may also be able to offer discounts that are unprofitable when selling single items. In business this is known as the “razor and blades model” (i.e., sell the razor handle below-cost one time and recoup losses on future sales of blades — although it’s not clear if this ever actually happens). Printer manufacturers are also an oft-cited example here, where printers are often sold below AVC in the expectation that the profits will be realized on the ongoing sale of ink. Amazon’s Kindle functions similarly: Amazon sells the Kindle around its AVC, ostensibly on the belief that it will realize a profit on selling e-books in the Kindle store.

Yet, even ignoring this common and broadly inoffensive practice, Sussman’s argument is odd. In essence, he claims that Amazon is concealing some of its costs in the form of capital leases in an effort to conceal its below-AVC pricing while it works to simultaneously lower its real AVC below the prices it charges consumers. At the end of this process, once its real AVC is actually sufficiently below consumers prices, it will (so the argument goes) be in the position of a monopolist reaping monopoly profits.

The problem with this argument should be immediately apparent. For the moment, let’s ignore the classic recoupment problem where new entrants will be drawn into the market to win some of those monopoly prices based on the new AVC that is possible. The real problem with his logic is that Sussman basically suggests that if Amazon sharply lowers AVC — that is it makes production massively more efficient — and then does not drop prices, they are a “predator.” But by pricing below its AVC in the first place, consumers in essence were given a loan by Amazon — they were able to enjoy what Sussman believes are radically low prices while Amazon works to actually make those prices possible through creating production efficiencies. It seems rather strange to punish a firm for loaning consumers a large measure of wealth. Its doubly odd when you then re-factor the recoupment problem back in: as soon as other firms figure out that a lower AVC is possible, they will enter the market and bid away any monopoly profits from Amazon.

Sussman’s Technical Analysis Is Flawed

While there are issues with Sussman’s general theory of harm, there are also some specific problems with his technical analysis of Amazon’s financial statements.

Capital Leases Are a Fixed Cost

First, capital leases should be not be included in cost calculations for a predatory pricing case because they are fixed — not variable — costs. Again, “below-cost” claims in predatory pricing cases generally use AVC (and sometimes marginal cost) as relevant cost measures.

Capital Leases Are Mostly for Server Farms

Second, the usual story is that Amazon uses its wildly-profitable Amazon Web Services (AWS) division to subsidize predatory pricing in its retail division. But Amazon’s “capital leases” — Sussman’s hidden costs in the free cash flow calculations — are mostly for AWS capital expenditures (i.e., server farms).

According to the most recent annual report: “Property and equipment acquired under capital leases was $5.7 billion, $9.6 billion, and $10.6 billion in 2016, 2017, and 2018, with the increase reflecting investments in support of continued business growth primarily due to investments in technology infrastructure for AWS, which investments we expect to continue over time.”

In other words, any adjustments to the free cash flow numbers for capital leases would make Amazon Web Services appear less profitable, and would not have a large effect on the accounting for Amazon’s retail operation (the only division thus far accused of predatory pricing).

Look at Operating Cash Flow Instead of Free Cash Flow

Again, while cash flow measures cannot prove or disprove the existence of predatory pricing, a positive cash flow measure should make us more skeptical of such accusations. In the retail sector, operating cash flow is the appropriate metric to consider. As shown above, Amazon has had positive (and increasing) operating cash flow since 2002.

Your Theory of Harm Is Also Known as “Investment”

Third, in general, Sussman’s novel predatory pricing theory is indistinguishable from pro-competitive behavior in an industry with high fixed costs. From the abstract (emphasis added):

[N]egative cash flow firm[s] … can achieve greater market share through predatory pricing strategies that involve long-term below average variable cost prices … By charging prices in the present reflecting future lower costs based on prospective technological and scale efficiencies, these firms are able to rationalize their predatory pricing practices to investors and shareholders.

“’Charging prices in the present reflecting future lower costs based on prospective technological and scale efficiencies” is literally what it means to invest in capex and R&D.

Sussman’s paper presents a clever attempt to work around the doctrinal limitations on predatory pricing. But, if courts seriously adopt an approach like this, they will be putting in place a legal apparatus that quite explicitly focuses on discouraging investment. This is one of the last things we should want antitrust law to be doing.

This blurb published yesterday by Competition Policy International nicely illustrates the problem with the growing focus on unilateral conduct investigations by the European Commission (EC) and other leading competition agencies:

EU: Qualcomm to face antitrust complaint on predatory pricing

Dec 03, 2015

The European Union is preparing an antitrust complaint against Qualcomm Inc. over suspected predatory pricing tactics that could hobble smaller rivals, according to three people familiar with the probe.

Regulators are in the final stages of preparing a so-called statement of objections, based on a complaint by a unit of Nvidia Corp., that asked the EU to act against predatory pricing for mobile-phone chips, the people said. Qualcomm designs chipsets that power most of the world’s smartphones, licensing its technology across the industry.

Qualcomm would add to a growing list of U.S. technology companies to face EU antitrust action, following probes into Google, Microsoft Corp. and Intel Corp. A statement of objections may lead to fines, capped at 10 percent of yearly global revenue, which can be avoided if a company agrees to make changes to business behavior.

Regulators are less advanced with another probe into whether the company grants payments, rebates or other financial incentives to customers in returning for buying Qualcomm chipsets. Another case that focused on complaints that the company was charging excessive royalties on patents was dropped in 2009.

“Predatory pricing” complaints by competitors of successful innovators are typically aimed at hobbling efficient rivals and reducing aggressive competition.  If and when successful, such rent-seeking complaints attenuate competitive vigor (thereby disincentivizing innovation) and tend to raise prices to consumers – a result inimical with antitrust’s overarching goal, consumer welfare promotion.  Although I admittedly am not privy to the facts at issue in the Qualcomm predatory pricing investigation, Nvidia is not a firm that fits the model of a rival being decimated by economic predation (given its overall success and its rapid growth and high profitability in smartchip markets).  In this competitive and dynamic industry, the likelihood that Qualcomm could recoup short-term losses from predation through sustainable monopoly pricing following Nvidia’s exit from the market would seem to be infinitesimally small or non-existent (even assuming pricing below average variable cost or average avoidable cost could be shown).  Thus, there is good reason to doubt the wisdom of the EC’s apparent decision to issue a statement of objections to Qualcomm regarding predatory pricing for mobile phone chips.

The investigation of (presumably loyalty) payments and rebates to buyers of Qualcomm chipsets also is unlikely to enhance consumer welfare.  As a general matter, such financial incentives lower costs to loyal customers, and may promote efficiencies such as guaranteed purchase volumes under favorable terms.  Although theoretically loyalty payments might be structured to effectuate anticompetitive exclusion of competitors under very special circumstances, as a general matter such payments – which like alleged “predatory” pricing typically benefit consumers – should not be a high priority for investigation by competition agencies.  This conclusion applies in spades to chipset markets, which are characterized by vigorous competition among successful firms.  Rebate schemes in dynamic markets of this sort are almost certainly a symptom of creative, welfare-enhancing competitive vigor, rather than inefficient exclusionary behavior.

A pattern of investigating price reductions and discounting plans in highly dynamic and innovative industries, exemplified by the EC’s Qualcomm investigations summarized above, is troubling in at least two respects.

First, it creates regulatory disincentives to aggressive welfare-enhancing competition aimed at capturing the customer’s favor.  Companies like Qualcomm, after being suitably chastised, may well “take the cue” and decide to avoid future trouble by “playing nice” and avoiding innovative discounting, to the detriment of future consumers and industry efficiency.

Second, the dedication of enforcement resources to investigating discounting practices by successful firms that (based on first principles and industry conditions) are highly likely to be procompetitive points to a severe misallocation of resources by the responsible competition agencies.  Such agencies should seek to optimize the use of their scarce resources by allocating them to the highest-valued targets in welfare terms, such as anticompetitive government restraints on competition and hard-core cartel conduct.  Spending any resources on chasing down what is almost certainly efficient unilateral pricing conduct not only sends a bad signal to industry (see point one), it suggests that agency priorities are badly misplaced.  (Admittedly, a problem faced by the EC and many other competition authorities is that they are required to respond to third party complaints, but the nature of that response and the resources allocated could be better calibrated to the likely merit of such complaints.  Whether the law should be changed to grant such competition authorities broad prosecutorial discretion to ignore clearly non-meritorious complaints (such as the wide discretion enjoyed by U.S. antitrust enforcers) is beyond the scope of this commentary, and merits separate treatment.)

A proper application of decision theory and its error cost approach could help the EC and other competition enforcers avoid the problem of inefficiently chasing down procompetitive unilateral conduct.  Such an approach would focus intensively on highly welfare inimical conduct that lacks credible efficiencies (thus minimizing false positives in enforcement) that can be pursued with a relatively low expenditure of administrative costs (given the lack of credible efficiency justifications that need to be evaluated).  As indicated above, a substantial allocation of resources to hard core cartel conduct, bid rigging, and anticompetitive government-imposed market distortions (including poorly designed regulations and state aids) would be consistent with such an approach.  Relatedly, investigating single firm conduct, which is central to spurring a dynamic competitive process and is often misdiagnosed as anticompetitive (thereby imposing false positive costs), should be deemphasized.  (Obviously, even under a decision-theoretic framework, certain agency resources would continue to be devoted to mandatory merger reviews and other core legally required agency functions.)

As I noted in my prior post, two weeks ago the 13th Annual Conference of the International Competition Network (ICN) released two new sets of recommended best practices.  Having focused on competition assessment in my prior blog entry, I now turn to the ICN’s predatory pricing recommendations.

Aggressive price cutting is the essence of competitive behavior, and the application of antitrust enforcement to price cuts that are mislabeled as “predatory” threatens to chill such competition on the merits and deny consumers the benefits of lower prices.

Fortunately, the U.S. Supreme Court’s 1993 Brooke Group decision appropriately limited antitrust predatory pricing liability to cases where the defendant (1) priced below “an appropriate measure” of its costs and (2) had a “reasonable prospect of recouping” its investment in below cost pricing.  Brooke Group enhanced United States welfare by largely eliminating the risk of unwarranted predatory pricing suits, to the benefit of consumers and producers.  In particular, because courts generally have applied stringent cost measures (such as average variable cost, not the higher average total cost), findings of below cost pricing have been rare.  Consistent with decision theory, there is good reason to believe that whatever increase in antitrust “false negatives” (failure to challenge truly harmful behavior) it engendered has been greatly outweighed by the reduction in false positives (unwarranted challenges to procompetitive behavior).

The European Union’s test for antitrust predatory pricing is, by contrast, easier to satisfy.  Prices below average variable cost are presumed illegal, prices between average variable cost and average total cost are abusive if part of a plan to eliminate competitors (such prices would not be deemed predatory in the United States), and likelihood of recoupment need not be shown (enforcers presume that parties would not engage in below cost pricing if they did not think it would ultimately be profitable).  Europeans generally have been far more willing to carry out detailed case-specific predatory pricing evaluations, believing that they have the ability to get difficult analyses right.  Given the widespread adoption of the European approach to competition in much of the world, and the benefit for prosecutors of not having to prove recoupment, the European take on predatory pricing has seemed to be in the ascendancy.

Given this background, the ICN’s newly minted Recommended Practices on Predatory Pricing Analysis Pursuant to Unilateral Conduct Laws (RPPP) are a welcome breath of fresh air.  The RPPP are strongly grounded in economics, and they place great stress on the need to obtain solid evidence (rather than rely on mere theory) that predation is occurring in a particular case.  The following RPPP features are particularly helpful:

  • They stress up front the importance of focusing on the benefits of vigorous price competition to consumers;
  • They explain that a predatory strategy is rational only when a firm expects to acquire, maintain, or strengthen market power through its actions, which means that the predator expects not only to recoup its losses sustained during the predatory period, but also to enhance profits by holding its prices above what they otherwise would have been;
  • They urge that agencies use a sound economically-based theory of harm tied to a relevant market, and determine early on (before running difficult price-cost tests) whether the alleged predator’s prices are likely to cause competitive harm;
  • They advocate basing price-cost tests on the costs of the dominant firm, with concern centering on harm to equally efficient (not less efficient) competitors;
  • They provide an economically sophisticated summary of differences among potential measures of cost;
  • They recognize that to harm competition, low prices must deprive rivals of significant actual or potential sales in at least one market;
  • They stress that low barriers to entry and re-entry in the market render predation unlikely because recoupment is infeasible;
  • They call for examination of evidence relating to the rationale of a pricing strategy to distinguish between low pricing that harms competition and low pricing that reflects healthy competition;
  • They urge that agencies examine objective business justifications and defenses for low prices (such as promotional pricing and achieving scale economies); and
  • They support administrable and clearly communicated enforcement standards (an implicit nod to decision theory), the adoption of safe harbors that can be easily complied with, and agency cooperation early on with the alleged predator to understand the records it keeps and to facilitate price-cost comparisons.

Although the RPPP do not adopt the simple rules embodied in Brooke Group (which in my view would have been the optimal outcome), they reflect throughout a concern for economically rational evidence-based enforcement.  Such enforcement is based on a full appreciation of the welfare benefits of vigorous price competition, the possible procompetitive business justifications for price cutting, and the need for clear enforcement standards and safe harbors.

Overall, the RPPP demonstrate that the ICN remains capable of building consensus support for concise, economically-based antitrust enforcement principles, that take into account practical business justifications for certain practices.  As business deals increasingly take on a global dimension, the convergence of predatory pricing norms around a model suggested by the RPPP would be a most welcome, welfare-enhancing development.