Predation

1. Predation Monopolization & Predatory Behavior Predatory Pricing & Economic Theory Legal Treatment of Alleged Predation

2. Monopolization & Predatory Behavior • Object: • enhance market power through predatory acts • convince rivals to exit market, not enter or compete • once clear, exploit market power

3. Means of Predation • classic form: predatory price cutting • impose losses on rivals until they "cry uncle" • modern extension: raising rivals costs • exclusion • exclusive contracts to deny essential facilities • upstream integration • monopolize inputs to raise cost to downstream competitors • advertising (allegedly) to raise entry costs • "frivolous" legal challenges • old but notable: sabotage/espionage • doubly illegal but part of some A-T cases

4. Recent Cases of Alleged Predation • Classic: American Airlines & Fare Wars • Entry followed by price cuts on specific routes • A common feature of modern airline markets • not limited to American Airlines • Q: were fare cuts limited to affected routes or was did they extend to other routes • Also: Matsushita vs. Zenith (1986) • novel claim: predation was collusive

5. Recent Cases of Alleged Predation • Raising Rivals Costs • Airline Computer Reservation Systems • United & American developed CRS that favored their flights over independents • DOJ claimed this was upstream integration into an input market (CRSs) designed to preserve/expand market power

6. Recent Cases of Alleged Predation • Sabotage: • $1 billion verdict in UST-Conwood (2003) • case involved UST agents removing Conwood displays at tobacco retailers • Sun Microsystems vs. Microsoft (ongoing) • Sun owns Java & licenses it to developers • Java is/was a perceived threat to Windows OS • MS development tools allegedly "pollute" Java code so it bombs on non Windows platforms

7. Predatory Price Cutting • Forms & Intent • impose losses on firms • as long as you stay you will make losses, so leave or • merge or be doomed to making losses • "discipline" rivals in a cartel • "grim strategy" in pricing games • make rival think you will resort to huge punishment if rival does not cooperate

8. Economics of Predatory Pricing • Elements: • pricing below cost with intent to gain market power • pricing designed to impose losses on rivals • must ascertain costs: which costs are relevant? • common claim: costs of rival (incorrect) • to distinguish between normal competitive behavior: P < AVC may be predatory • "Areeda-Turner rule" endorsed by current S. Court Justice Beyer (in prior case) • But: still must distinguish between predation & promotion (free giveaways are common entry schemes)

9. Economics of Predatory Pricing • Problems with the Strategy • Predator is generally larger than the rival •  costs incurred exceed costs imposed • easier to manage with locally targeted cuts, but disparity presumably remains • rival's optimal strategy might be to shut down temporarily and not incur any operating losses

10. Economics of Predatory Pricing • Problems with the Strategy (cont'd) • Suppose aim is to induce firm to exit • Exit likely if assets are highly mobile • target firm sees losses in widgets so switches to making gadgets • But if assets are mobile, easy entry occurs when the predator increases price • Conclude: asset mobility is a wash for predator

11. Economics of Predatory Pricing • Problems with the Strategy (cont'd) • Suppose assets are highly immobile • P < AVC  rational rival shuts down • Immobility  assets can't be shifted elsewhere • Problem: assets remain in the market; available to restart production when predator raises price

12. Economics of Predatory Pricing • Potential Remedies for Predators • Develop a reputation for irrationality • Make rivals fear predator s.t. they believe predator will cut P even if it is not in own best interest •  lower likelihood of entry •  greater likelihood that merger offers accepted • OK, but basing theories on irrationality hypotheses is not good economics

13. Legal Treatment of Predatory Pricing • Predation often alleged and accepted by courts • Economist's skepticism has altered court's practice in recent years • Two Prong Test: • 1) What is likelihood that predation could be profitable? • 2) Apply Areeda-Turner only if (1) is found likely • Failure to establish that predation could be profitable (item 1) has stopped recent cases when in past court would have been confused

14. Matsushita v Zenith (1986) • Fairly typical case of alleged predation... • Typical in that economists think the allegation of predatory pricing was a “howler” • Atypical in that: • Alleged predation was collusive • Court accepted the expert economist’s claim that the alleged predation would have led to significant losses that could not be recouped

15. M v Z: Zenith’s Claims • Main Allegation • 7 Japanese TV manufacturers engaged in collusive predation • Specific Claims • 1. Over a 10 year period, prices were about 60% of costs, predatory • 2. Firms agreed to minimum export prices and restricted distribution channels, collusive • 3. Losses in U.S. financed by “War Chest“ from monopolistic pricing in Japan

16. M v Z: Plaintiffs' Defense (1) • 1. One can view the losses of below-cost pricing as an investment that yields future returns when competitors exit and price increases to monopoly levels. • What is the rate of return on this investment? Negative! It is almost impossible to recoup a decade of losses at 40 cents on the dollar with future monopoly profits. • Hence, the predation alleged by Zenith is not a rational investment.

17. M v Z: Plaintiffs' Defense (2) • 2. Cartel theory  incentive to cheat • Cheating occurred here, but the cheating was not consistent with a predatory agreement. • P < C  cheaters want to reduce output • let others suffer the losses from predation • individual Japanese firms were undercutting the minimum prices to sell more TVs

18. M v Z: Plaintiffs' Defense (3) • 3. War Chest • The existence of profits in one market is irrelevant to the strategy in other markets • A "War Chest" would be employed only on project with have positive net present value • Predation in this market was shown to be an unprofitable project • Similarly, if predation were a positive net present value project, it could be financed independent of the profits earned elsewhere • The "War Chest" is irrelevant.

19. M v Z: The Court's Response • 11 years of evidence at Fed District Court • Then, case dismissed on summary judgment! • --Judge ruled that the facts presented by Zenith, if true, were inconsistent with rational predation, and a “full trial” unnecessary • --Economic theory implied claim of predation was false • Ping-pong appeals to S. Court, which accepted the District Court's reliance on economics • Cases can now be dismissed if it can be established that alleged predation had no chance of being profitable

20. Cartel Dumping Model • PW – world price (competitive) • PDom – domestic, cartelized price • QT – total production by domestic firms • QDom – production allocated to dom mkt • (QT – QDom) – output “dumped” into export market

21. Cartel Dumping Model

22. Cartel Dumping Model • Japanese TV firms were domestic cartel, supported by MITI and trade barriers • Who was harmed by their strategy? • How is this similar to Addyston Pipe?