1. Competition Policy Predation, Monopolisation, Abusive practices

2. Exclusion  Exclusionary practices: deter entry or forcing exit of a rival  Legal concept. Monopolisation (US) – Abuse of dominant position in the UE  Difficult to identify exclusionary pract. – not easily distinguished from competitive actions that benefit consumers  EX. Price reductions by an incumbent following entry (to be followed by price increase after exclusion)  New attention after privatization and liberalization  result in public utility sectors: an incumbent facing potential entrants

3. Predatory Pricing  A firm sets low prices with an anti-competitive aim: forcing a rival out of the market or pre-empt a potential entrant  Low prices increase welfare only in the short run  once the prey has succumbed the predator will increase prices  welfare will be reduced in the long run as competition is eliminated from the industry  Two main elements to indentify PP: 1) A loss in the short run 2) Enough market power by the predator to let him increase prices and profits in the long run  Cautios approach needed by antitrust agencies  avoid the risk that firms with market power keep prices higher not to be charged with predatory behaviour

4. Predation is as old as antitrust laws  Old phenomenon: The Sherman act was also introduced because small firms complained that big firms implemented predation: setting low prices to drive them out of the market  Some claims were unfounded: some firms charged low prices because they were more effcient, exploiting scale and scope economies  But some predatory pricing existed

5. A Theory of Predation  The main explanation of predation has been “Deep Pocket” predation: a big firm may drive out a small firm with a price-war causing losses to both  but the small one has not the financial resources to resist a price-war (a “small pocket”)

6. Weak points of predation arguments  Mc Gee (1958) criticized predation theory on four main grounds:  1.Due to its larger market share a large firm will suffer greater losses than a small one  2.Predation is rational only if the predator raises prices, after the prey exits from the market  but the small firm has invested in assets that are sunk costs  it can re-enter after the price increase or sell the assets to another firm becoming a new rival  less Π for the predator  3. Predation theory assumes that the predator has a “small pocket”, rather tha explaining it  the financially constrained firm can explain the problem to its creditors to obtain funds  Predation is inefficient as it destroys profits  better to merge with the rival to preserve high profits

7. Counter-objections to McGee (’58)  1. The incumbent can price-discriminate and decrease price only in those markets where the small firm is competing  the predator can preserve high margin on most units and reduce the cost of predation  2. Enter-Exit-Re-entering can imply sunk costs (one cannot close plants, fire workers and then re-start the activity without costs)  2.bis as to selling assets to other firms  an incumbent that has successfully preyed once will discourage other firms to enter (reputation argument)

8. Counter-objections to McGee (’58)  3.This is the most challenging points: if the small firm could obtain funding from banks, predation cannot be successfull and anticipating the result the incumbent will avoid it  4. Merger as ana alternative a)New competitors will be attracted by the perspective of being bought (merger not a cheap option)b)Antitrust laws may not allow the merger c) Predation and mergers are not mutually exclusive options  aggressive pricing might result in the prey being sold at lower prices

9. Predation in Imperfect Financial Markets  Weak point of deep pocket predation: limited access to funding by the entrant  If capital markets were perfect a profitable firm would find a financial sponsor  With imperfect capital markets? Limited access to funding is endogenous  predation affects the risk of lending money reducing financial resources available  Key point: imperfect information by lenders  hidden action  moral hazard (the bank cannot know if the money is used efficiently)  find an optimal contract, ex: credit related to a given amount of assets  Competiton between an incumbent and the new entrant  predation reduces the prob. That the entrant gets funding: it reduces its profits, its savings and then its own assets needed to get credit

10. How to deal with predatory pricing  Two main elements. 1) sacrifice of short-run profits 2)Increasing profits in the long run by exploiting market power  legal treatment built on these elements  Test of prdation as follows:1)Market analysis to assess dominance  without dominance dismiss the case 2) with dominance  analyse price-cost relationship  P>ATC (average total cost): lawful without exc.  AVC <P< ATC: presumed to be lawful  burden of proof on the plaintiff  P<AVC: presumed to be unlawful  burden of proof on the defendant

11. Ability to increase prices (dominance)  Necesssary ingredient of predation is the ability to increase prices after exclusion  assess the degree of market power  EU law  P.P. included in the abuse of a dominant position  a firm with a market share below 40% not accused of PP  In the US the isssue is less clear: risk to accuse an oligopolistic firm that decrease prices as part of the competitive process  EX. A firm with 20% reduces prices and steals customers to a dominant firm (60% market share) and to a small rival (5% market share)

12. Ability to increase prices (dominance)  A non dominant firm may price below cost for some reasons: compensate for switching costs, network externalities  reach a critical mass of consumers, learning curves, reach economies of scale…product complementarity with another market (more important for the firm..)  The same arguments cannot be applied to a dominant firm  The market power test should catch only dominant firms at the risk of neglecting a non-dominant predator (left unpunished)  small price to pay compared to a more “inclusive” test that could wrongly involve most oligopolists..

13. Sacrifice of short-run profits  Theory just states that the incumbent makes less profits than it would have made in the short-run  it does not state if these profits are negative or not  Difficult to apply theory literally..: compute the optimal price P* and prove that the actual price P’<P*  not feasible in practice (managers cannot know P*…)  Alternative: show firms are making negative profits  P’ 0 probably not )  Another possibility: find documents prooving managers have sacrificed profits to exclude rivals  but these documents cannot substitute an objective proof  if rivals are inefficient the incumbent might be entiteld to reduce prices as a response to entry  normal competitive process  P < cost might not allow to catch all possible predation cases

14. Which definition of cost?  To assess if Π < 0, one should find a measure of cost  Areeda & Turner (1974): the best would be MC as with P<MC profits are not maximized  But MC difficult to assess from firm accounts  use then AVC: 1) P> AVC is presumed to be lawful 2) P <AVC presumed unlawful  Courts and some scholars rule out P.P. only if P> ATC  if firms do not cover sunk cost are not in equilibrium  However the last standard is a very stringent one  if an incumbent invest and thinks to recover sunk costs through a monopoly price, then a new firm enters the market and normal competition leads the incumbent to reduce prices  this is not P.P.  Use AIC (Average Incremental Cost): the cost for the added output needed to cover the additional predatory sales (include both variable and fixed cost)  it may be difficult to measure

15. Testing Predatory Pricing  Intent (existence of a predatory scheme): evidence due to internal documents that proove the intent of exclusion (evidence hard to dismiss…)  No Need to proove success of predation: control for market power to see the ability of the incumbent to recover lossess in the long run, but from an ex-ante point of view  if ex post predation was unsuccessfull due to miscalculations or the prey resulted to be tougher the expected the abuse remains

16. Testing Predatory Pricing  No presumption of harm to consumers in the predation test  a negative effect on consumer surplus is expected  presumption of anti- competitive effects: if due to miscalculation low prices were not follwed by higher prices in the long run and predation failed the abuse remain (even if consumers by chance got benefits)  The alleged predator can have an efficiency defence for its below-cost prices

17. Testing Predatory Pricing  Matching the competitor prices as a defence: observing the incumbent reducing prices after entry may be part of the competitive process but not if P < AVC  Price below cost: not a general rule: in many countries below cost pricing,retail discounts…are forbidden as a result of regulation due to lobbying by small bussiness and shop-keepers aiming to contrast competition by chain-stores  However in this case price-below cost is forbidden for any firm independently of market power  No foundation for such an approach as it protects competitors not competition and it also damages consumers

18. Non-Price Monopolisation: Strategic Investment  A dominant firm might use investment (Capacity, R&D, advertisment..) in strategic way to exclude competitors from the industry or avoid new entries  1)it is very difficult to distinguish “innocent” investments from “strategic” ones 2) As investment has a positive effect on welfare one should be cautios to discourage firms  only in exceptional cases a firm should be accused and the burden of proof should be on the plaintiff  Basic mechanism as in PP: a firm invest more than it is profitable expecting profit increase in the long run

19. Strategic Investment  A firm invest in process innovation knowing a firm is considering entry: let be X i the optimal (innocent) investment to reduce costs  welcome efect of increased competition  A firm may also use strategic investment X P (predatory): it adopts a new technology so costly and so effcient that the new entrant expects not to be able to compete with the incumbent and observing X P it will not enter  the expectation of monopolistic profits makes X P profitable  Remarks:1) Even if X P was feasible to deter entry it may not be profitable (due to high sunk costs it is better to accomodate entry).2) Even if X P has been decided to pre-empt entry, not necessarily it is anti-competitive  a)the lower the costs the lower the monopolistic price b) there is no benchmarke to distinguish X P from X i

20. Strategic Investment  It was different for PP because there was a benchmark: a firm pricing below AVC  Most investment are irreversible  credible commitent  consumers will benefit from the investment even after predation ends  the welfare loss from over-investment would be lower than with PP.  Although excessive investment is possible in theory it may be difficult to identify it in practice.