Following "Akzo 1985" European Competition Commission antitrust duty, (Official Journal L 374, 31/12/1985, p 1-27), explain the circumstances under which the elimination of a competitor by under-cutting its price is considered as unfair.

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Industrial Economics

7th February 2004

Russell Manley

Following "Akzo 1985" European Competition Commission antitrust duty, (Official Journal L 374, 31/12/1985, p 1-27), explain the circumstances under which the elimination of a competitor by under-cutting its price is considered as unfair.

"Predatory pricing schemes are rarely tried and are even more rarely successful."

There is still much debate on the subject of Predation or Predatory Pricing. Economic analysis and antitrust laws have largely developed separately from one another. In more recent times antitrust laws have been following the more extensive research into this subject and hopefully a more cohesive unambiguous definition of predatory pricing and the associated legalities can be presented. It is the most difficult area of competition and antitrust policy and as highlighted later there are disagreements between decisions on different cases and about general principle. The first issue to assess is whether predation exists. Often it can be confused with a competitive response to the threat of new entrants and therefore analysis will take place of its existence in theory and practice. Then analysis will take place on the welfare effects of predation and the legal ramifications to see why exactly it should be unlawful. Finally, we will look at if it is possible to differentiate between predation and competitive behaviour and throughout we will look at the previous and current legal cases and outcomes to identify when predation is actually illegal, and more precisely when a successful case can be brought against a predator.

Predation is in essence a simple concept that unfortunately is easy to show in theory and nigh on impossible to prove in practice. If an incumbent monopolist (I) cannot prevent entry into the market then it has the alternative of inciting or forcing the exit of rivals or new entrants (E) to gain monopoly power. This process is known as predatory pricing. This type of pricing involves pricing below cost to force out competitors and once this has been done, the monopolist will then increase the price to gain the monopoly profit ( PM ). The best way to illustrate predation is through examples. KLM was the market leader in flights between London and Amsterdam. EasyJet (EJ) then started flying on the same route and as their business plan/policy dictated, they ran it on very low cost and therefore very low price. KLM as market leader (40%) responded by cutting their prices that led to losses for EJ. It can be assumed at this point that KLM had the explicit desire to induce exit of EJ from the London to Amsterdam market. This could be done in one of two ways, dependant on the costs of KLM and EJ. "Limit" pricing would be KLM pricing below EJ cost but above their own costs. This is legal and just results from greater efficiencies and economies of scope and scale. If however, they priced below EJ cost and below their own cost then that would be predatory pricing and is considered illegal under Article 86, Treaty of Rome1. EJ having faced this price undercutting has choices that they can make immediately and in subsequent periods but this is based entirely on the information that it has regarding KLM's costs.

The first question that EJ must attempt to answer is whether the threat of predatory pricing is credible, as this will determine the outcome and profits/losses in subsequent periods of the game. The game has 2 periods and there is an incumbent monopolist (I) and a new entrant (E).

In t = 1 I decides to set price (p) ??low, high?

If p = low I and E make a loss = -L

If p = high I and E make duopoly profit = PD

Therefore, E has the decision to stay or exit the market d ??stay, exit? at end of the period.
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In t = 2 If d = exit then I earns monopoly profit = PM

If d = stay then same decision as period 1

The Nash perfect equilibrium is then for I to set the price high at t = 1, E then stays and at t = 2, I sets the price high again.

Extensive form of the game of perfect information:

I

High Low

E E

High Low High Low

I I I I

High Low High High Low High

(2PD , 2PD ...

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