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Slide 1

Predatory Pricing

Janusz A. Ordover
Professor of Economics, New York University

DOJ/FTC Hearings on Single-Firm Conduct and Antitrust Law

June 22, 2006


Slide 2

How to Analyze Challenged Conduct
for Monopolization?

  • The slogan is: "Antitrust should protect competition, but not competitors"

    • But what does it mean in practice?

  • Irrespective, at least as a predicate, any monopolization claim must establish a direct and causal link between the conduct at issue and significant harm to competition in a well-defined relevant market (or markets)
  • But how should a decision-maker delineate conduct that does harm "competition" by harming scarce rivals from standard, day-to-day market interactions?

 


Slide 3

Sacrifice and Welfare Test Coincide

  • The prescriptions from the profit sacrifice tests consistent with social welfare in many market settings
  • Seeking profits is generally conducive to economic welfare: hence coincidence not surprising
  • When incumbent can extract maximum profits from the market without distorting consumer choices, a choice of profit sacrificing strategy that harms competition is presumptively inimical to welfare
  • Examples include a choice of product design or the price for access to a bottleneck input or raising rival's cost of competing
  • But when profit maximization leaves surplus un-extracted, even absent competition, there could be exclusion seemingly even without sacrifice

Slide 4

Example: Inferior Source of Supply

  • An incumbent may have an incentive to exclude a rival when there exists an inferior alternative source of supply to its monopolized product
  • Consumers demand a system with two components A and B and are willing to pay up to $100
  • An entrant can produce standalone component B' at a lower cost than incumbent. Incumbent profits increase by withdrawing its component B and charging a compensatory (=ECPR+) price for A
  • Not an optimal strategy if another firm can offer A'. Then max price for A+B =willingness to pay for A' + B' < 100
  • With these facts, incumbent has an incentive to foreclose the more efficient B' in order to drive it irreversibly out of the market
  • However, if incumbent could force A' exit it would rather do that!
  • In this example, profit sacrifice could be gauged against the profits under ECPR+

Slide 5

Example: Discounting

  • Assume that, like in Ortho v. Abbott, a consumer demands a package of five products
  • Abbott has a monopoly on three and two are competitive
  • Abbott's bundled price for five tests is allegedly less than the price for three tests plus the incremental cost of the two competitive tests
  • Abbott can extract full surplus from the buyer, without foreclosing Ortho from the competitive tests
  • Clear profit sacrifice (but the case is not clear as to the non-coincident market that strategy would affect)

Slide 6

Example (Virgin v. BA)

  • Consumer needs 10 distinct products and is willing to pay $100 for each. It costs the incumbent $80 to make each product. An entrant can make any one (but only one) product for $70 and hence more efficient

      Alternative 1: Each product priced separately. Result: 9 products sell for $100 and one for $80 - a penny

      Alternative 2: Incumbent announces policy "Buy any 9 products and get 10th free." Entrant decides whether to sink $z to come in. If it does, competition ensues; if it does not, incumbent sets the price

      Equilibrium: E does not come in and I sets price of $ 111.10 per product


Slide 7

Example of Quantity-Forcing Contracts


Slide 8

Plenty to Focus on

Business strategies that have a "commitment" value are a more relevant focus for antitrust concerns with predation

  • commitment to discount (Virgin v. BA)
  • commitment to a product design (IBM cases)
  • commitment to defend lucrative market ("new era" tying models)
  • commitment to create network economies ("aggressive" prices for market penetration)
  • commitment to raising rival's cost of competing

Slide 9

To Sum up

  • The sacrifice test protects conduct that is part of competition, even if it harms and weakens competitors
  • The sacrifice test is quite general in its applicability to diverse circumstances
  • The sacrifice test is well-defined, though sometimes takes some work to sort out
    • Essential to keep track of the benchmark against which profits to be calculated
    • Benchmark is the profits that would be earned under competitive circumstances if rival were to remain viable