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Predatory pricing: who’s crying wolf?

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 is 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 power. 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 are 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.

The Rudd Government claims it will, once and for all, give Australian businesses the competition laws they deserve. But like Santa Claus, the Resurrection, and multiple orgasms, there are those who have faith and those who do not.

Increasing small business protection?

The Government says its reforms to the Trade Practices Act will reduce anti-competitive behavior by big business bullies [see Recent Reforms, below]. The Minister for Competition Policy and Consumer Affairs Chris Bowen claims the new rules will make it easier to prosecute businesses engaging in anti-competitive behavior.

The amendments will ensure that victims of predatory pricing will not need to prove that the predator has the ability to recoup its losses after instigating a below-cost pricing strategy, the Minister says. The new laws will clarify the meaning of the term ‘take advantage’ in response to concerns that the present meaning has prevented Section 46 from capturing anti-competitive behavior. And they will remove the uncertainty created by the fundamentally different concepts of market power and market share.

At the Competition Law Conference in Sydney in May this year, ACCC Chairman Graeme Samuel welcomed the proposed reforms to Section 46.

With these changes the ACCC considers that the balance has been adequately struck between ensuring that businesses are exposed to the rigours of competition while being protected from the possible anti-competitive consequences associated with firms gaining power from that competitive process, he said. Having long expressed their frustration at the inability of the predatory pricing provisions of the Trade Practices Act, and the lack of successful cases, small businesses are having some of those concerns now addressed.

Dissenting views

The Minister’s and Chairman’s pronouncements are a load of bollocks to Queensland Senator Barnaby Joyce. He is furious about the proposed new legislation, claiming it is a backward step in small businesses and consumers’ battle against predatory pricing.

This should bring tears of happiness to the major retailers and the major oil companies and anybody else who wants to squash small business, Joyce says.

Joyce became a small business poster boy in 2007 when he introduced an amendment to the Howard Government’s planned changes to the Trade Practices Act to remove the infamous definition of market power. The Birdsville Amendment (so named because Joyce was visiting the outback Queensland town when he had the idea) was designed to overcome this definition, which made predatory pricing almost impossible to prove.

The purpose of the Birdsville Amendment was to outlaw the destruction of competition by predatory pricing which required the corner store or shopping mall butcher to jump through hoops to mount a case against the large retailer, Joyce says. Your local independent fuel retailer, for instance, had to prove that the large oil multinationals across the street could raise prices without losing customers before they could take the case any further.

Joyce says after the Birdsville Amendment, to make a case of predatory pricing a company only had to prove:

  • Its competitor had a substantial market share
  • The competitor engaged in a sustained campaign of selling below cost to remove competition.

Under the Rudd Government’s amendments, Australia is going back to the old definition of market power.

Under the old position, big business has been extremely capable of stopping any case ever getting legs, Joyce says. In fact, since 2003, under this definition of market power, not one case has been successful.

“This should bring tears of happiness to the major retailers and the major oil companies and anybody else who wants to squash small business”

Joyce calls the Government’s new approach to predatory pricing an attempt to find a comfortable position on a barbed-wire fence. He is not alone.

Putting the loophole back

One of the strongest voices for small businesses in recent years has been Craig Kelly, president of the Southern Sydney Retailers Association. Kelly says the flip back to market power definition brings back a loophole that allows big retailers to escape prosecution for predatory pricing.

He is stunned some sections of the small business community think the new Government has dished them a better deal.

The changes weaken the existing laws to prevent predatory pricing and anyone who claims otherwise is either ignorant or deceiving the public, Kelly says. It is exactly what Coles and Woolworths wanted and they are laughing at the stupidity of small businesses for accepting the changes.

We have never had effective laws against predatory pricing in this country. Attempts to fix our preposterous fair trading laws have failed. These amendments will be detrimental to small businesses and return us to the old, ineffective laws. The result is the Australian consumer will remain an economic hostage to Coles and Woolworths.

Cummings adds it is nigh impossible for a smaller business to gather the evidence needed to launch legal action against a suspected predator.

For a small business to take such a matter to court is simply out of the question, he says. No small business can afford $1 million and a decade-long wait until the case reaches the High Court. In the grocery industry, market hyper-concentration has made it impossible for small players to make a case against a multi-billion dollar competitor.

Big retailers: discounting is legit

Large companies were petrified by the Joyce amendment, convinced it would strangle discounting as a legitimate business tactic. Woolworths CEO Michael Luscombe outlined these fears when he told the National Press Club last year that the Howard Government’s changes to the Trade Practices Act had introduced new legal uncertainties to the retail business.

Woolworths does not believe in or engage in, predatory pricing, Luscombe said. It’s a matter which I take very seriously with each and every Woolworths manager. But surely Woolworths must have the right to match competitors’ prices? With these new laws, we are concerned some may allege that legitimate competitive activity has an inappropriate purpose. Our market share, under the new rules, exposes our company to these claims. In addition to employing an army of shop assistants, he continues, We will need an army of lawyers to work out whether we can mark down bread at the end of the day.

Big business is more cheerful now. Having spent years forensically monitoring successive tweaks to the Trade Practices Act, it has welcomed the Federal Government’s new measures as a sensible way to keep everyone happy.

Finding the way out

Australian businesses believe the problem with predatory pricing is finding a definition and set of fair safeguards everyone accepts. Consumers want value for money; politicians want to avoid offending vested interests and voters; and lawmakers want consistent, clear legislation.

The goal remains: to construct a firm yet fair legal framework that protects small businesses from becoming roadkill while allowing big business to do what it wants most – amass big profits. In Australia, we seem no closer to that end today than when JD Rockefeller tapped his first barrel of Texas tea.

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