 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

 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

 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

 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”)

 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

 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)

 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

 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

 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

 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)

 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..

 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’<costs  correct rule  a firm with Π < 0 might be a predator (a firm with Π > 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

 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

 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

 No presumption of harm to consumers in the predation test  a negative effect on consumer surplus is expected  presumption of anticompetitive 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

 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

 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

 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

 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.