Predatory Pricing. Response of Members of the Unilateral Conduct Committee of the ABA Section of Antitrust Law 1

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1 Predatory Pricing Response of Members of the Unilateral Conduct Committee of the ABA Section of Antitrust Law 1 This questionnaire seeks information on ICN members analysis and treatment of predatory pricing claims. Predatory pricing typically involves a practice by which a firm temporarily charges low prices in order to limit or eliminate competition, and thereby allows the firm to raise prices subsequently. This questionnaire concerns only treatment of single product discounts; rather than pricing practices involving multiple products (including bundling, tying, and related prices). Unless otherwise stated, the questions concern conduct by a dominant firm or firm with significant market power. Respondents should feel free not to answer questions concerning aspects of your law or policy that are not well developed. Answers should be based on agency practice, legal guidelines, relevant case law, etc., rather than speculation. Analysis (elements and evidence) 1. Please provide the main relevant texts (in English if available) of your jurisdiction s laws and guidelines on predatory pricing. There is no separate statute in the United States governing predatory pricing. The US Supreme Court (the Supreme Court ) has identified two statutory sources for a predatory pricing claim. First, Section 2 of the Sherman Act provides: Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $100,000,000 if a corporation, or, if any other person, $1,000,000, or by imprisonment not exceeding 10 years, or by both said punishments, in the discretion of the court. 2 Second, Section 2 of the Clayton Act (as amended by the Robinson-Patman Act) provides: It shall be unlawful for any person engaged in commerce, in the course of such commerce, either directly or indirectly, to discriminate in price 1 2 This response was drafted by Daniel Crane, Ron Davis and Sarah Friedman on behalf of the ABA Section of Antitrust Law s Unilateral Conduct Committee, a nongovernmental advisor to the ICN Unilateral Conduct Working Group. However, please note that this is not an official ABA submission, as it has not been reviewed, approved or endorsed by the ABA Section of Antitrust Law. 15 U.S.C.A

2 between different purchasers of commodities of like grade and quality... where the effect of such discrimination may be substantially to lessen competition or tend to create a monopoly in any line of commerce, or to injure, destroy, or prevent competition with any person who either grants or knowingly receives the benefit of such discrimination, or with customers of either of them. 3 The Supreme Court has held that a claim of monopolization (or conspiracy to monopolize or attempted monopolization) under Section 2 of the Sherman Act or as an instance of primary line price discrimination under the Robinson-Patman Act are effectively identical and require the same legal showings Please list your jurisdiction s criteria for an abuse of dominance/monopolization based on predatory pricing. Plaintiff must show that defendant priced below an appropriate measure of cost and that the below-cost pricing either created market power that allowed actual recoupment or that it created a reasonable prospect or dangerous probability that the predator would acquire market power and recoup. 5 The Supreme Court has never defined the appropriate measure of cost in antitrust cases. However, some commentators and lower courts believe that, in light of the Supreme Court s most recent predatory pricing decision (Brooke Group), only prices below some measure of incremental cost can be predatory. 6 For the remainder of this questionnaire, the answers about the approach to predatory pricing in the United States will differ somewhat from those in other jurisdictions for two reasons. First, since most predatory pricing cases are privately initiated and heard in the federal or state courts rather than in a specialized antitrust tribunal like the Federal Trade Commission, antitrust enforcement agencies have relatively little influence over the definition of predatory pricing in the United States. Second, most predatory pricing rules are created in the lower federal courts, particularly the thirteen federal circuit courts of appeal, and not in the Supreme Court, which hears relatively few antitrust cases. Since the circuit courts of appeal do not have to follow each other s precedents, there is a wide variety of authority in the United States on the predatory pricing offense, and in particular on the appropriate measure of cost question U.S.C. 13. Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 220 (1993). Brooke Group, 509 U.S. at See Daniel A. Crane, The Paradox of Predatory Pricing, 91 Cornell L. Rev. 1 (2005)

3 Perhaps the most influential source of authority on predatory pricing in the United States is not the decision of any particular circuit court but rather Phillip Areeda and Donald Turner s seminal article, Predatory Pricing and Related Practices Under Section 2 of the Sherman Act, 88 Harv. L. Rev. 697 (1975). That article has been cited on many occasions by the Supreme Court and lower courts and its average variable cost definition of the appropriate measure of cost has been adopted by a number of lower courts. Although it is not uniformly the law of the land, Areeda and Turner s average variable cost test is as close to a uniform rule as we have. 3. Please explain the circumstances under which a firm s pricing is, or may be, considered predatory in your jurisdiction, by responding to the following questions: As part of your analysis, does the price have to be below one or more measures of cost? /No YES If yes, please identify which of the following measures is/are used, as applicable: Cost benchmark/measure Used? Comment No Below marginal cost (the cost of producing one more unit of output) The Areeda-Turner article discussed above identified marginal cost as the appropriate measure conceptually, but advocated use of average variable cost as a more workable surrogate Below average variable cost (cost that varies with output) Below average avoidable cost (all costs that can be avoided by not producing some or all output) Several courts have explicitly adopted an average variable cost test. 7 The possibility of an average avoidable cost test was discussed in the Justice Department s enforcement action against American Airlines See, e.g., Northeastern Telephone Co. v. American Tel. & Tel. Co., 651 F.2d 76 (2d Cir.1981). U.S. v. AMR Corp., 335 F.3d 1109 (10 th Cir. 2003)

4 Below average long run incremental cost (average variable costs and productspecific fixed costs) Below average total cost (cost including variable, fixed and sunk non-recoverable costs) Other measure of cost (Please identify) The United States Court of Appeals for the Seventh Circuit has adopted long run incremental cost. 9 The United States Court of Appeals for the Eleventh Circuit has adopted average total cost. 10 A recent decision of the Ninth Circuit, however, calls this holding into question in light of the Supreme Court s Brooke Group decision. 11 (b) For each cost measure employed, please provide the definition of the measure used in your jurisdiction. As per the Areeda-Turner test: Variable costs, as the name implies, are costs that vary with changes in output. They typically include such items as materials, fuel, labor directly used to produce the product, indirect labor such as foremen, clerks, and custodial help, utilities, repair and maintenance, and per unit royalties and license fees. The average variable cost is the sum of all variable costs divided by output. 12 There has been no judicial effort to articulate a precise test for average avoidable cost, but the test has been championed by economist Will Baumol MCI Communications Corp. v. American Tel. and Tel. Co., 708 F.2d 1081 (7 th Cir. 1982). McGahee v. N. Propane Gas Co., 858 F.2d 1487, 1500 (11th Cir.1988). Cascade Health Solutions v. PeaceHealth, 2007 WL (9 th Cir. 2007) ( At least one circuit has held that average total cost, not average variable cost, is the appropriate baseline for determining predation. See McGahee v. N. Propane Gas Co., 858 F.2d 1487, 1500 (11th Cir.1988). However, such an approach is inconsistent with the Supreme Court's instruction in Brooke Group that predatory prices are those below some measure of incremental cost. Brooke Group, 509 U.S. at 223, 113 S.Ct (quoting Cargill, 479 U.S. at n. 12, 107 S.Ct. 484) (emphasis added). ). Areeda & Turner, 88 Harv. L. Rev. at 700. For an explanation of the average avoidable cost test, see William J. Baumol, Predation and the Logic of the Average Variable Cost Test, 39 J. L. & Econ. 49 (1996)

5 The Seventh Circuit defined long-run incremental cost as follows: Longrun incremental cost, by contrast [to average variable cost], measures all the costs of adding a new product or service- fixed as well as variable costs (and capital as well as operating items). Essentially, the LRIC approach assumes that all costs become variable in the long run. Hence, a number of the criticisms that have been levelled against the choice of a short-run marginal cost standard are not applicable to the use of long-run incremental cost. 14 (c) Is the same cost measure applied in all cases? /No The same cost measure is applied in all cases within a particular circuit and is not applied on a industry-by-industry basis. However, some circuits use multiple cost-measures, and different presumptions and burdenshifting within a single case. For example, the Sixth Circuit holds that a price above average variable cost is presumptively lawful, but that a plaintiff may be able to rebut that showing and prove that a price between average variable cost and average total cost is predatory if it is capable of excluding rivals given the structure of the market. 15 (ii) If different cost measures can be applied, for example on the basis of industry, please explain and provide examples, as available. If more than one cost measure can be applied in any individual case, please explain why and whether, in practice, this has raised issues. (d) If price must be shown to be below cost, for which of the dominant firm s sales must this be shown? Is the only relevant comparison between the cost measure and the dominant firm s average price for all of its sales in the relevant market? /No There is a line of authority holding that revenues and costs must be compared on the dominant firm s entire product line MCI, 708 F.2d at Spirit Airlines, Inc. v. Northwest Airlines, Inc., 431 F.3d 917 (6 th Cir. 2005). Taylor Publ g Co. v. Jostens, Inc., 216 F.3d 465, (5th Cir. 2000); Stearns Airport Equip. v. FMC Corp., 170 F.3d 518, 529 (5th Cir. 1999); Int. Travel Arrangers v. NWA, Inc., 991 F.2d 1389, (8th Cir. 1993); Morgan v. Ponder, 892 F.2d 1355, 1362 (8th Cir. 1989); Janich Bros., Inc. v. Am. Distilling Co., 570 F.2d 848, 856 (9th Cir. 1977)

6 A. If no, over which of the dominant firm s sales can cost be compared? (e) Could a firm s price above average total cost ever be found to be predatory? /No No. Given the Supreme Court s holding that predation requires pricing below an appropriate measure of cost, pricing above average total cost is always lawful. It should be noted that there have been calls for a predation standard that would not require cost-revenue comparisons in all circumstances. For example, Aaron Edlin has argued for the following rule: In markets where an incumbent monopoly enjoys significant advantages over potential entrants, but another firm enters and provides buyers with a substantial discount, the monopoly should be prevented from responding with substantial price cuts or significant product enhancements until the entrant has had a reasonable time to recover its entry costs and become viable, or until the entrant's share grows enough so that the monopoly loses its dominance. 17 However, current law requires a showing of below-cost pricing for a predatory pricing claim to be sustained. If so, please explain the instances in which this might occur, and identify whether this has been the basis for actual enforcement. (f) If prices do not have to be below a cost benchmark to be considered predatory, please explain the circumstances under which the firm s prices are considered predatory. 4. To be unlawful, must the alleged predatory pricing occur in the market in which the firm holds a dominant position/substantial market power? /No No. Because attempted monopolization is also recognized as an offense, it is theoretically possible that a firm that was not yet dominant in a market could be liable for predatory pricing if it engaged in a scheme to obtain dominance through predation. However, in light of the requirement that the alleged predator s conduct have created a dangerous probability of success that the market would become monopolized, it is unlikely that a firm without a large market share could be liable for predatory pricing. 17 Aaron Edlin, Stopping Above-Cost Predatory Pricing, 111 Yale L.J (2002)

7 If no, please explain. 5. Apart from the cost criteria referenced in question 3 above, must other objective criteria, such as the duration or continuity of the pricing behavior, be demonstrated for a finding of liability under a predatory pricing theory? /No As discussed below, recoupment is also relevant. There is no legal requirement that the predation be of any particular duration. If so, please explain. For example, if the behavior must be sustained over a certain time period, why, and for what period? 6. On what type of evidence do you rely to prove predatory pricing? Please explain, including examples as appropriate. Are cost data used? /No. If so, are cost data from the firm used? /No Cost data are obtained from the dominant firm, and usually also the firm s rivals, under the United States liberal discovery rules. (b) Are there circumstances when cost data of other firms can be used? /No. If so, please specify the circumstances. There is no rule on when cost data of other firms can be used, but most courts would probably allow comparisons to other firms if evidence regarding the defendant s own cost structure were lacking. (c) What other data or information is used, if any? Please provide examples as relevant. There is a debate in lower court opinions about whether fact-finders (juries or courts) should look at accounting costs or economic costs See, e.g., D.E. Rogers Associates, Inc. v. Gardner-Denver Co., 718 F.2d 1431 (6 th Cir. 1983) (discussing difference between economic and accounting approaches to cost in predatory pricing context)

8 7. Does pricing below a particular cost benchmark create a presumption of predatory pricing? /No. Pricing below average variable cost is generally presumed to be predatory. 19 Note, however, that this does not relieve that plaintiff of the requirement of showing that the predatory pricing did result in monopoly or was dangerously probable to do so. If yes, is this presumption rebuttable or irrebuttable? Please explain. Although some courts refer to pricing below average variable cost as conclusively presumed to be unlawful, they probably do not mean that statement to be applied strictly. Areeda and Turner s original article discussed various scenarios when a firm might rationally price below average variable cost for some period of time without excluding competitors. (b) If the presumption is rebuttable, what must be shown to rebut the presumption? There is no exhaustive catalog. One scenario is where a price turns out to be below average variable cost because of changed circumstances or mistaken assumptions by the dominant firm. Some courts qualify the predation test by holding that what counts is not actual financial results but whether the defendant priced below its reasonably anticipated average variable cost Is there a safe harbor from a finding of predatory pricing for pricing above a particular cost benchmark? /No If yes, please explain, including the terms of the safe harbor. As noted earlier, there is variation in the lower courts on what the benchmark is, but the consensus view seems to be that any price above some measure of incremental cost is not predatory Irvin Industries, Inc. v. Goodyear Aerospace Corp.,974 F.2d 241, 245 (2d Cir. 1992) (holding that predatory pricing is presumed to occur when a seller prices below reasonably anticipated average variable cost ). E.g., Kelco Disposal, Inc. v. Browning-Ferris Industries of Vermont, Inc., 845 F.2d 404, 409 (2d Cir. 1988)

9 9. Is recoupment (obtaining additional profits that more than offset profit sacrifices stemming from predatory pricing) required for a finding of liability under predatory pricing rules in your jurisdiction? /No Actual recoupment is not required, but a dangerous probability of recoupment is required. If so: Is this assessment conducted separately from the analysis of the firm s market power and the predation? /No No. (b) What factors are employed in assessing recoupment in your jurisdiction? Market structure is the most important factor. This includes the concentration of the market and barriers to entry. It is very difficult to prove a dangerous probability of recoupment. The plaintiff must show that the below-cost pricing was capable of driving rivals from the market, and the plaintiff must present evidence that the market is susceptible to sustained monopoly pricing following the victim s exit. 21 (c) Is there a specific recoupment calculation or amount to be shown? /No If so, what is this? The present value of the recoupment must meet or exceed the present value of the cost of predation. (d) Is there a relevant time period for recoupment? /No If so, what is it? There is no exact time period, but in the Matsushita decision 22 the Supreme Court held that an allegation of a predation scheme that Antitrust Law Developments Volume I (6th ed.). Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574 (1986)

10 lasted for many years was inherently implausible since it would take a very long time to recoup. (e) Is it possible for recoupment to occur in a market different than the one in which the predatory pricing took place? /No There is no clear answer. If so, please explain and provide relevant examples. (f) What degree of likelihood of recoupment is required (e.g., possibility or probability)? The standard is that the predation must create a dangerous probability or reasonable prospect of recoupment. Please provide examples of the recoupment standard of likelihood employed as part of your recoupment assessment. The leading case on recoupment is the Brooke Group case (cited above) where the Supreme Court concluded that Brown & Williamson did not have a dangerous probability of recouping its costs of predation given the oligopoly structure of the market and that fact that for every dollar invested in predation the predation would have to yield nine dollars of supracompetitive prices for Brown & Williamson to be able to recoup. 10. Is the firm s intent relevant in predatory pricing cases? /No. If so, please describe the relevant type(s) of intent, and the evidence used to show the required intent, providing available examples. Whether intent is relevant depends on whether the case is one for monopolization, in which case only general intent is required, or attempted monopolization, in which case specific intent is required. General intent can usually be inferred from outcome of the action (i.e., monopolization) itself so there is usually no need to prove the state of mind of the dominant firm in a case where it has actually obtained or maintained a monopoly through predation. However, in a case alleging only attempted monopolization, plaintiff must prove that the defendant specifically intended to achieve the unlawful outcome

11 (b) If objective conditions for predatory pricing -- for example, pricing exceeding a certain cost benchmark or recoupment are not demonstrated, does intent matter? /No No. If so, please explain. 11. In addition to proving below-cost pricing, must effects, such as market foreclosure or consumer harm, be demonstrated to establish liability? /No No. If likelihood of recoupment is shown, no further requirement of foreclosure or consumer harm is necessary. If yes, please explain the elements assessed (e.g., exit or delayed entry of competitors, price increases, prevention or delay of price decreases) and the types of evidence required to do so. Justifications and Defenses 12. What type of justifications or defenses, if any, are permitted for predatory pricing, e.g., an efficiency, meeting competition or objective necessity defense? Please explain and provide examples, as relevant. Meeting competition is a recognized defense. What is the standard of proof applicable to these defenses? Who bears the burden of proof? What evidence is required to demonstrate that these defenses or justifications are met? Defendant bears the burden of sustaining a meeting competition defense. Also, promotional discounts are not unlawful and a defendant could conceivably argue that claimed predatory pricing was actually a promotional discount. However, a promotional price must be of limited duration, but there is no definitive rule separating the legitimate promotional period from the longer period necessary to qualify as predatory Antitrust Law Developments Volume I 285 (6th ed.)

12 Enforcement 13. Please provide the following information for the past ten years (as information is available): The number of predatory pricing cases your agency reviewed (investigated beyond a preliminary phase). Within the last ten years, the federal antitrust agencies (Department of Justice and Antitrust Division) have only initiated one enforcement action alleging predatory pricing the Justice Department s 1999 lawsuit against American Airlines. (b) The number of these cases that resulted in an agency decision that the conduct violates antitrust rules; (ii) a settlement with relief. None. (c) The number of agency decisions issued, if any, that held that the practice did not violate your jurisdiction s predatory pricing rules (i.e., clearance decisions ). None. (d) Each of the number of agency decisions or settlements that were challenged in court and, of those, either (ii) overturned by court decision or (iii) confirmed by court decision. The only case brought, the American Airlines case, resulted in a 2003 decision by the United States Court of Appeals for the Tenth Circuit holding that the Government failed to establish that American priced below incremental cost. 14. Does your jurisdiction allow private cases challenging predatory pricing? /No.. Please provide a short description of representative examples, as available. A probably unique aspect of the American system is that there are far more private antitrust cases than public ones. This is particularly true for unilateral pricing offenses, that are almost never enforced by the Government but give rise to many private suits. A 2005 study found that between 1993 and 2005, there were at least 57 private predatory pricing

13 cases initiated in the federal courts alone. 24 That number is based on reported decisions and only includes federal cases, so the actual number is probably much higher. 15. Is predatory pricing a civil and/or a criminal violation of your jurisdiction s antitrust laws? It is theoretically a criminal offense under Section 2 of the Sherman Act, but today predatory pricing would never be prosecuted criminally. (b) If both, what are the differences in the criteria applied to these categories? On what basis does the agency choose to bring a criminal or civil case? 16. As relevant, please provide a short English summary of the leading predatory pricing decisions/cases in your jurisdiction, including information on the method used to calculate costs, to the extent applicable, and, if possible, a link to the English translation, an executive summary or press release of the case. As discussed above, Brooke Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), established the general requirements for proving that pricing is predatory: (1) below cost pricing, and (2) probable recoupment via supracompetitive prices. However, the Court has never held what precise measure of cost is dispositive for this purpose. 25 The most important predatory pricing case of the last decade is the Justice Department s enforcement action against American Airlines, which resulted in a decision by the United States Court of Appeals for the Tenth Circuit that the Government failed to prove pricing below an appropriate measure of cost. The Government alleged that American priced below cost in four city-pair airline markets, all connected to American s hub at Dallas/Fort Worth International Airport ( DFW ). Significantly, the court noted that economic literature in the past decade had rehabilitated the theory of predatory pricing after the Chicago School s attack on the theory during the 1970s and 80s. The court stated that it would not approach predatory pricing claims with the incredulity that once prevailed. Nonetheless, the court held that none of the four cost measures proposed by the Government corresponded with incremental cost, since all of them included some component of fixed cost or costs that could not be avoided even in American abandoned a particular route. The American Airlines decision is found at 335 F.3d See Daniel A. Crane, The Paradox of Predatory Pricing, 91 Cornell L. Rev. 1 (2005). Antitrust Law Developments Volume I 273 & 75 (6th ed.)

14 17. Please provide any additional comments that you would like to make on your experience with predatory pricing rules and their enforcement in your jurisdiction, including, as appropriate but not limited to: Whether there have there been or you expect there to be major developments or significant changes in the criteria by which you assess predatory pricing, explaining these developments as relevant. The Supreme Court has declined to decide what the appropriate measure of cost is on a number of occasions. Sooner or later, it is likely that it will have to rule on what the appropriate measure of cost should be, thus creating a uniform rule for all of the circuits. The Ninth Circuit s PeaceHealth decision may be en route to the Supreme Court and could provide a vehicle for such a decision. (b) Whether there are significant policy and/or practical considerations that may lead to greater or lesser agency enforcement against predatory pricing pursuant to unilateral conduct rules in your jurisdiction, e.g., concern with the risks of false positives/false negatives, the existence of related laws such as a general ban on below-cost pricing, limited evidence of consumer harm, and/or difficulties in obtaining reliable cost data (please provide explanation as relevant). This is a very big question. Since the 1970s there has been a very active debate about predatory pricing rules. Chicago School skepticism about predation claims has largely prevailed since the 1980s. Post-Chicago theories, which often rely on signaling or reputation effects and gametheoretic assumptions, are beginning to make inroads in the courts. Neo- Chicagoans are beginning to rebut the claims of the post-chicagoans. A majority of the members of the Supreme Court seem, for now at least, committed to the Chicago School views, so it is likely that a fair amount of antipathy to predatory pricing claims will remain for some time