Monday, 31 December 2001
111 Yale L.J. 941 (2002)
This Essay has refocused the predatory pricing debate on ex ante incentives--i.e., the incentives for entry and limit pricing before the predatory period--instead of the traditional focus of high prices after the predatory period. Ideally, a monopoly incumbent should price reasonably low, and in the event that it prices high, other firms should enter the market. The difficulty arises when the entrants have higher costs than the incumbent and expect to be out-competed upon entry. Consumers would then be worse off than if the monopoly firm did not exist, because they would have to pay higher prices than entrants would charge if they entered.
Monopolies that cut prices dramatically in response to entry are exclusionary because the behavior discourages entry. This observation holds even if they are only matching rivals' prices, and even if they are charging prices that exceed their costs. If courts view such behavior as monopolization under section 2 of the Sherman Act, monopolies will price lower than they do now under the Brooke Group rule.
Likewise, it is exclusionary for an incumbent monopoly to respond to entry by substantially improving product quality, as when a monopoly airline increases flight frequency. This behavior is no less exclusionary when the product remains priced above cost, as in the AMR Corp. case. If such behavior constitutes monopolization under section 2 of the Sherman Act, monopolies will provide higher-quality products than they do now under the Brooke Group rule.
The courts have two choices about how to recognize above-cost price cuts and quality enhancements as exclusionary. The Supreme Court could simply overrule Brooke Group. A more moderate approach in the lower courts would distinguish the monopoly cases at issue in this Essay from oligopoly cases like Brooke Group. As this Essay has pointed out, a monopoly typically has substantial advantages that allow it to drive out entrants without incurring losses, a possibility that is less plausible in oligopoly cases like Brooke Group.
This Essay's predation rule essentially makes the market more contestable. A contestable market behaves like a competitive market even when only one incumbent serves the market, because competitors wait in the wings to enter if the incumbent prices high. The great advantage of a contestable market is that low prices are ensured by the decisions of market participants. No regulator needs to know the costs of other firms, and, in fact, firms do not need to know other firms' costs. The market price is never high, because if it were, competitors would enter and drive it down. Certainly, recognizing a new category of above-cost predation would not make markets perfectly contestable, but it would make markets more contestable.
This Essay's arguments are strongest in the core case, with homogeneous products, a cost advantage for the incumbent, and a clear understanding of what constitutes substantial entry. Substantial administrative difficulties arise when products are differentiated by quality or other characteristics, when entrants are difficult to identify, or when it is difficult to tell whether the incumbent is reacting after rather than before the entrant has materialized. This Essay only briefly mentioned some of these complexities but suggested as an example that if the overall deal offered by an entrant seems comparable to a twenty percent discount on the incumbent's product, the entrants would qualify as substantial and warrant some protection. Such a standard, however, is easier to state than to implement carefully. The variety of potential administrative difficulties is daunting indeed, but the same is true in other antitrust cases. How is the court to know, for example, whether a merger will or will not be anticompetitive?
The Essay has not dealt further with administrative complexities, because to do so in advance would yield limited insights. Such questions are best faced as they come before the courts. Hopefully, this Essay has at least made clear that low prices can harm consumers and also lower total welfare even if prices exceed cost--a possibility that one sees most clearly by focusing on ex ante incentives to enter the market.
The principal substantive objection to the rule proposed here is that it protects inefficient entrants. Why would we want inefficient firms in the market, and what business is it of antitrust to protect them? The best answer is that consumers often need inefficient entrants. Recall that the entrant only receives any protection if it is a "substantial entrant," which I suggest operationalizing as one pricing at least twenty percent below the incumbent. Only entrants who provide substantial benefits to consumers receive any protection. From the vantage point of overall wealth maximization, the advantages of this rule are ambiguous if the incumbent does not charge low enough limit prices to bar all entry, because some less efficient firms may enter. Consumer benefits are more certain, however, since limit pricing is encouraged; and at any given incumbent price level, entry is encouraged. Conditional upon entry, the entrant has a strong incentive to price twenty percent below the incumbent instead of ducking just under the monopoly price umbrella. Courts that favor total welfare maximization over maximizing consumer benefits could modify the proposed rule appropriately.