Strategic Pricing:
Theory, Practice and Policy
Professor John W. Mayo
mayoj@georgetown.edu
Hurricane Charlie ….and
Dennis, Katrina and Rita
• What about a $10 bag of ice?
Price Gouging H.R. 1252
(Passed U.S. House of Representatives, 284-141)
• “It shall be unlawful for any person to sell, at
wholesale or retail in an area during a period of
emergency, gasoline…at a price that –
(A) is unconscionable excessive;
and
(B) indicates that the seller is taking unfair
advantage of the circumstances to increase
prices unreasonably.”
The “Spirit” of Pricing!!!
4
The “Spirit” of Pricing
• What is the pricing policy of Spirit Airlines?
• Is this smart business strategy?
• What are the potential strategic responses?
• Is it a troublesome practice that should be
controlled or halted by regulation or legislation?
5
Oh Say Can you See?
• What happened to the price of American flags in
the wake of the 9/11 terrorists attacks on
Washington and New York?
6
Policy toward Pricing
• Price collusion
• Monopoly pricing
• Price leadership
• Predatory pricing
U.S. Policy deterrents to Price fixing
• Sherman Act, section 1 – felony, up to $1 million,
10 years in jail
• Case Law – Per Se violation
• Trenton Potteries (1927) : “The aim of every price-fixing
agreement, if effective, is the elimination of one form of
competition. The power to fix prices, whether reasonably
exercised or not, involves the power to control the market and to
fix arbitrary and unreasonable prices. The reasonable price fixed
today may ..become the unreasonable price of tomorrow..”
•
• Corporate Leniency Policy
Article 101
• 1.
The following shall be prohibited as incompatible with the common
market: all agreements between undertakings, decisions by associations of
undertakings and concerted practices which may affect trade between
Member States and which have as their object or effect the prevention,
restriction or distortion of competition within the common market, and in
particular those which:
• (a) directly or indirectly fix purchase or selling prices or any other
trading conditions;
• (b) limit or control production, markets, technical development, or
investment;
• (c) share markets or sources of supply;
• (d) apply dissimilar conditions to equivalent transactions with other
trading parties, thereby placing them at a competitive disadvantage;
• (e) make the conclusion of contracts subject to acceptance by the other
parties of supplementary obligations which, by their nature or according
to commercial usage, have no connection with the subject of such
contracts.
• 3. The provisions of paragraph 1 may, however, be declared
inapplicable in the case of:
• - any agreement or category of agreements between
undertakings,
• - any decision or category of decisions by associations of
undertakings,
• - any concerted practice or category of concerted practices,
• which contributes to improving the production or distribution
of goods or to promoting technical or economic progress,
while allowing consumers a fair share of the resulting
benefit, and which does not:
• (a) impose on the undertakings concerned restrictions which are not indispensable to
the attainment of these objectives;
• (b) afford such undertakings the possibility of eliminating competition in respect of a
substantial part of the products in question.
10
European Commission Cartel Fines
(Million Euros)
11
Large Company fines imposed by the European
Commission
Firm
Fine (euros)
Year
ThyssenKrupp1
(IP/07/209)
479 669 850
2007
Hoffmann-La Roche AG
(IP/01/1625)
462 000 000
2001
Siemens AG1 (IP/07/80)
396 562 500
2007
ENI SpA1 (IP/06/1647)
272 250 000
2006
Lafarge SA1 (IP/02/1744) 249 600 000
2002
BASF AG2 (IP/01/1625)
236 845 000
2001
Otis1 (IP/07/209)
224 932 950
2007
Heineken NV1
(IP/07/509)
219 275 000
2007
Arkema1 (IP/06/698)
219 131 250
2006
Solvay1 (IP/06/560)
167 062 000
2006
1
Appeal filed with the Court of First Instance
Monopoly and Competition
$
mc
ac
cs
D
mr
What are the objections to monopoly?
Do these translate into policy against monopoly pricing?
Monopolization requires “abuse” in both
Europe and the U.S.
“The offense of monopoly under Section 2 of
the Sherman Act has two elements: (1) the
possession of monopoly power in the relevant
market and (2) the willful acquisition or
maintenance of that power as distinct from
growth or development as a consequence of a
superior product, business acumen or
historical accident”
United States v. Grinnell Corp. 384 U.S. 563,
570-571 (1966)
Price Leadership
• What is the legal treatment of Price Leadership?
• “[T]he fact that competitors may see proper, in the
exercise of their own judgment, to follow the
prices of another manufacturer, does not
establish any suppression of competition or show
sinister domination.”
• U.S. v. International Harvester Co. (1927)
15
• Delta Airlines cuts its reimbursement to travel
agents. Other airlines follow suit…Travel agents
sue.
Predatory Pricing
What is “predatory pricing”?
Simple story: Large firm cuts prices drives smaller firms from
market then raises prices to monopoly levels
McGee (Journal of Law and Economics) -re-examines
Standard Oil case. Predatory pricing is not rational. Why
engage in predation when merger is cheaper.
More recent literature suggests that:
1. predatory pricing may reduce sales price if then merge
2. Predation may be for demonstration effect
3. McGee assumes merger to monopoly is legal
Predation requires (necessary conditions):
1. Initial Market power
2. Low Barriers to Exit
3. High barriers to entry
Predatory pricing:
1. Areeda-Turner (Harvard Law Review, 1975)
a. p<mc
b. p<mc up to minAC then p<ATC
c. p<avc
Price
MC ATC
AVC
D
Quantity
Predation – the demonstration effect or “I’ll
Teach that SOB a lesson”
Price
FOB
Distance from plant
Pricing of Concrete construction Blocks