Predatory Pricing By Kevin Hinde. Predatory Pricing  Firms who have market power in more than one market may set prices below cost in one period in order.

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Presentation transcript:

Predatory Pricing By Kevin Hinde

Predatory Pricing  Firms who have market power in more than one market may set prices below cost in one period in order to drive out rivals and restrict entry. Having done so, it once again raises price.  Predation will be considered a strategy if the present value of profits earnt after rivals have exited is greater than the present value of losses from predation.

Legal Rules for dealing with Predation  The following broad judgements, taken from EC Court decisions  P < AVCPredation can be assumed  AVC<P<ATCEvidence on costs may indicate predation but authorities need evidence that a dominant undertaking was looking to eliminate a competitor  P > ATCEvidence does not indicate predation

Predatory Pricing: Stage 1 D P QO c=LRAC Qpred SRAC Vic SRMC vic Qc Ppred

Predatory Pricing: Stage 1 Loss D P QO SRAC Vic SRMC vic c=LRAC Ppred QpredQc

Predatory Pricing: Stage 1 Gain D P QO SRAC Vic SRMC vic c=LRAC Ppred QpredQc

Predatory Pricing: Stage 1 Net Loss to society D P QO SRAC Vic SRMC vic c=LRAC Ppred QpredQc

Predatory Pricing  In the second stage the predator can embark upon monopoly pricing.  Note predation requires  capital markets to be imperfect  target firms are unable to lend money to whether the storm  consumer coalitions to fail  here the problem is that there are large transaction costs in negotiating contracts.  that merger is not a possible alternative (but then again this would may be viewed as anti- competitive)

The Chain Store Paradox  An incumbent ‘Chain Store’ faces 20 entrants in 20 towns.  Each entrant must decide whether or not to enter.  The incumbent must decide whether to fight or share the market.  What will happen?  The answer depends on how we encompass information.

The Chain Store Paradox In Entrant Out (5, 1) Incumbent Fight Co-operate (0, 0) (2, 2)

The Chain Store Paradox In Entrant Out (a, 0) Incumbent Fight Co-operate (-1, b-1) (0, b) In Entrant Out (a, 0) Incumbent Fight Co-operate (0, b-1) (-1, b) Weak Incumbent Strong Incumbent Incumbent: a > 1 Entrant: 0 1

The Chain Store Paradox  Note that the incumbent is weak in that they earn more from co-operating than fighting (0 > -1)  If the incumbent is weak, and the entrant knows this, then the backward induction argument applies and co-operation develops.  Hence the incentive to gain a reputation even if the incumbent are weak.  The overall profitability of predation does not depend on its profitability in a single period.  Note that predation emerges as an equilibrium strategy because information is imperfect.

Examples  UK  Stagecoach and Darlington Traction Company 1995  News International  Napp Pharmaceuticals Napp Pharmaceuticals  EC  Tetra Pak (Go to page 173) Tetra Pak (Go to page 173)

Possible Examples: News International,  The OFT has looked at price cutting of The Times on three previous occasions.  In 1993 and 1994 Sir Bryan Carsberg, DGFT, accepted that the price cuts at that time appeared to be a legitimate commercial strategy.  In 1996 no action was taken because at that stage it appeared that the price cuts would not be sustained for a long period.  John Bridgeman, present DGFT, said recently  'I have concluded that NI deliberately made a loss on The Times during the period between June 1996 and January 1998 when the Monday edition was sold for 10p, and that this affected competition in the national daily newspaper market. Competitors alleged that they had been forced to cut prices or lose sales and that investment had been reduced accordingly.’

 Darlington Council announced that it was to sell it bus operations Darlington Transport Company in July 1994 and invited bids.  Stagecoach, who had no presence in the area acquired Busways on the day they announced that they were going to bid for DTC.  By September 1995 Darlington Council announced that it was to sell to to Yorkshire Traction.  when the bid result was announced, Stagecoach advertised for qualified drivers in the local press and announced that it was going to run on all routes covered by DTC.  In addition to making this pre-commitment to a labour strategy Stagecoach announced a short period of price cutting (indeed, initially zero prices at certain times). Unsurprisingly, DTC exited in November Possible Examples: North East Buses, 1995.

Any Questions?