Predatory pricing: who's crying wolf?

Darren Horrigan
19 August 2008
Page 1 of 2 : single page

Photo credit: Killanoodle

Smaller businesses often accuse their larger competitors of predatory pricing, but big companies say they are just discounting to benefit consumers. Darren Horrigan wades into the murky waters of competition law and finds out where the sharks really come from.

Of all the dastardly deeds big business can perpetrate against small business – and there are many – predatory pricing has always been regarded as one of the darkest in this land of the fair go.

John Cummings knows what it’s like to do business against the big boys. He is part owner of three independent supermarkets in Perth and chairman of the National Association of Retail Grocers of Australia – representing 4500 independent retailers.

“We all know that Woolworths and Coles publish weekly specials which apply across all stores state wide,” he says. “Woolworths, in several instances, has recently been publishing a separate brochure, under-cutting their own state-wide specials to damage a local independent grocer. Is it predatory pricing? We can’t be sure because we can’t know whether Woolworths is selling those products below cost. Only the ACCC can establish that.”

The Rudd Government has announced changes to trade practices law aimed at making it easier for small businesses to fight predatory pricing. So why are large retailers the only ones praising the decision?

What is it?

Predatory pricing is when companies with deep pockets reduce prices below cost to drive smaller or weaker competitors out of the market. Economics textbooks say the practice is near irresistible to large firms with many products or markets, because they can offset losses in one area with profits made from others.

In the short term, predatory pricing is good for consumers – prices fall. However, once the stronger company gains market dominance or the weaker company folds, the predator increases prices, recoups its losses and basks in its ower. That’s the theory.

Predatory pricing is illegal in Australia because it prevents or reduces competition. The trouble is, it has been impossible to prove, tangled in a knot of meddling politicians, timid bureaucrats, mercenary lobbyists and gobbledegook legislation.

Australia is now in the grip of yet another fierce debate over predatory pricing as our Federal Government is changing the laws that govern this misunderstood and, some say, mythical practice. Fear and loathing is rife.

Prehistoric predator

Business folklore says predatory pricing was fathered in the 1880s by arch-capitalist John D Rockefeller, the son of a bigamist and snake-oil salesman. Three parts genius and one part pirate, Rockefeller built his Standard Oil Company into a vertically integrated colossus that, at its zenith, controlled 90% of all the oil refined in America. Standard Oil owned the oil fields, the refineries, the wagons, the warehouses, the barrels, the factories that made the barrels and the forests that supplied the timber.

Rockefeller devoured his competition by cutting prices, driving opponents into bankruptcy and buying out what was left. He turned predatory pricing into an art form and became the richest man ever, worth US$318 billion in today’s dollars, according to a Forbes Magazine article.

So predatory pricing pays? Well, sort of. The United States Supreme Court broke up Standard Oil in 1911 for anti-competitive practices. But there is a learned body of opinion that claims Rockefeller did nothing more than outsmart and out-risk his competition.

I fought the law and the lawyers won

In Australia, predatory pricing is as transparent as one of old John D’s barrels of oil. The complexity of this area of competition law – governed by Section 46 of the Trade Practices Act – is best illustrated in the landmark predatory pricing case Australian Competition and Consumer Commission v Boral. This seven-year saga started in 1998 when the ACCC sued Boral for supplying masonry products below cost to eliminate a new entrant to the Melbourne market, C&M Bricks. The story is complicated, but a simple example illustrates the issue. In 1993, when C&M Bricks started up, size 15.01 concrete blocks sold for between 85–90c each. By mid-1994 Boral was offering the same blocks for as low as 62c each.

The judge in the initial trial said the issue of Boral’s market power had to be considered in the broader market for construction materials, not just masonry products. Since Boral did not have considerable power in the wider market, it had not acted unlawfully. The ACCC appealed to the Full Federal Court, which narrowed the definition to just masonry products. The court held that Boral had a substantial degree of power in this market and priced below its cost of production to put off new entrants.

Boral went to the High Court, which found there wasn’t enough evidence to support the Full Federal Court’s findings on market power and taking advantage of that power. The High Court ruled that Boral had displayed an anti-competitive purpose prohibited by Section 46, however an anti-competitive purpose on its own was not enough. The court said the ACCC had to prove that Boral had a substantial degree of market power and that Boral took advantage of that power to crush C&M.

Defining ‘market power’

The High Court wigs found that Section 46 has three elements: it prohibits a company that has substantial market power from taking advantage of that power for a prohibited purpose, such as eliminating a competitor.

In regard to taking advantage, the High Court found that Boral set prices as low as it needed to win business in a highly competitive market, but no lower. The court interpreted ‘market power’ to mean a company could raise prices without losing business. In theory, Woolworths can’t raise prices without losing business to Coles and vice versa. So in theory, neither has market power.

Lawyers say the lessons from ACCC v Boral are clear. Financial power does not necessarily equate to market power. Aggressive price-cutting is not necessarily an abuse of market power. And seeking to harm or exclude a competitor is not, of itself, unlawful.

“One of the great slogans of competition laws since the 1980s is that such laws are designed to protect competition, not competitors,” says Stephen Corones, professor of law at Queensland University of Technology and author of Competition Law in Australia. “Competition is not necessarily harmed if a competitor is harmed. The thinking behind it is that a small inefficient competitor should not be able to invoke competition law to protect itself from a more efficient rival.

“It is now well established that the policy objective of Section 46 of the Trade Practices Act is not to protect small business competitors, but rather to promote competition and economic efficiency for the benefit of consumers.

“The difficulty with Section 46 is deciding when healthy competition, even aggressive competition, crosses the boundary and becomes anti-competitive. It is a matter over which eminent judges reach starkly opposing views.”