1. Competition Policy Predation

2. Exclusion  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

3. Predatory Pricing  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

4. Predation is as old as antitrust laws  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

5. A Theory of Predation  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”)

6. Weak points of predation arguments  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

7. Counter-objections to McGee (’58)  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 high 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)

8. Counter-objections to McGee (’58)  3.The “small pocket” assumption is is the most challenging point: 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

9. Predation in Imperfect Financial Markets  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

10. Reputation Models  The behaviour of an Incumbent towards a current competitor is likely to have an impact on future (potential) competitors as well  A price-war today may be due to the attempt to create a reputation of being a strong and aggressive incumbent in order to discourage entry tomorrow

11. The Chain Store example  The Chain store example: in each market the incumbent faces a potential entrant  Entrant enters one at a time  Timing of the game:  1) In the first market the potential entrant decides to enter or not  2) If entry occurs the incumbent decides to fight entry or to accomodate it  Then the same game is repetaed for all the markets

12. The Chain Store example A weak incumbent has costs as high as the entrant If the game was played only once it would not fight entry (it would be unprofitable) The same result applies even if the game is played for a finite number of times (finite horizon), as long as it is certain that the incumbent is weak

13. The Chain Store example Case with 2 entrants: whatever happened in the first market, in the second one the Incumbent will accomodate, as the Incumbent would incur losses from fighting and there is no reason to build a reputation as the game ends But then if the only reason to fight entry is to deter entry in a future period, in the first period there is no incentive to fight: both I and E would correctly anticipates that in the second period I accomodates and Entry occurs

14. The Chain Store paradox The result is a paradox (the Chain store paradox) as predation would never be observed In reality one can imagine good reason for the incumbents to prey one entrant to build a reputation and deter future entrants If some uncertainty is introduced in the game predation will occur!

15. Asymmetric Information With imperfect information about the cost of the incumbent there is a small probability that the incumbent is not weak, but rather strong: his cost are so low that it can charge a price below the entrant cost and make some profits Then, a weak incumbent may exploit the Entrants’ uncertainty and fight entry in order to let them believe that the Incumbent is strong rather than weak

16. Reputation with asymmetric information  Predation A weak incumbent will fight entry at the start of the game and continue to fight to establish a reputation and discourage future entry Only in the last periods of the game the I will accomodate as the closer the end of the game the lower the expected gains from pretending of being strong In any period of the game the decision to fight reinforces the Incumbent reputation with a sacrifice of current profits to deter entry and increase future profit  Predation