Private Enforcement of predation cases

From the Autumn 2012 Research Bulletin, by Morten Hviid, Professor in Law

With the number of private actions for amages increasing in the UK, we offer a word of caution about cases alleging predation. The article highlights possible misuse of such cases and explains the importance of establishing that the victim is at least an as-efficient firm as the predator.

A lot of the public discussion of private enforcement focuses on the good it can bring to enforcement of competition rules, the deterrence of violations and the compensation of those harmed by the violations.  The current debate has been much less vocal when it comes to the potential adverse effects private actions can have on competition.  The ability of private competition actions to soften competition is probably best illustrated through the history of private actions alleging predation brought by horizontal rivals. 

Recall that simple predation involves one firm setting an unreasonably low price, usually taken to be below some measure of average or marginal cost.  While this harms competitors, it clearly also benefits consumers, at least in the short run.  From a public enforcement perspective, the authority has to weigh up the evidence quite carefully to ensure that it is not stifling legitimate competition which benefits consumers.  In particular, the authority has to ensure that it does not fall into the trap of protecting competitors rather than competition. 

From a private enforcement perspective, the relevant forum for such a case, be it a general or a specialist court, must by the same token ensure that the claimant has actually suffered an injury which competition law is designed to guard against.  To use American terminology, the claimant should have suffered an antitrust injury. 

There are basically two very different stories which can be told about how private actions alleging predation can have anticompetitive effects.  One relates to horizontal agreements or collective dominance where the actions are used as a signal to rivals. The second relates to single firm dominance where the action is used partly to extract rent from the dominant firm and partly to reduce future competitive pressure from this firm. 

The first story explains how an allegation of predation can be a facilitating practice by enabling one party to a price fixing conspiracy (or a tacit understanding of not competing) to signal its displeasure of a low price charged by rival.  Here litigation is used as a signalling device.  The strategy is to initiate the case and then drop it once the rival gets the message and increases its price.  Where the rival has been slow on the uptake, a settlement could be used to provide side-payments to the injured party.  Note that the losers here are consumers who will face higher prices.  For those who think this is entirely fantastic, the empirical analysis provided in a paper by Daniel Crane[1] suggest otherwise.  While no-win-no-fee is a common way to finance antitrust actions in the US, Professor Crane finds that a surprising number of predation cases employ non-incentive based payment of the legal team.  This would be consistent with an ex ante aim of settling or dropping the case.  Using predation litigation as an anticompetitive signal to a rival can be a difficult strategy to counter because denying the claimant the opportunity to pursue a case interferes with very basic legal rights.  What this does highlight is the importance of monitoring both litigated, settled and dropped cases, especially where these involve horizontal rivals.

The second story is one of rent extraction by a weaker firm.  There is an old, long-standing, debate in industrial economics about whether firms are big (dominant) because they are bad or because they are efficient.  What is certainly uncontroversial is that a persistently more efficient firm would become dominant over time.  We would like firms to price at or close to their average costs to ensure that consumers get the best deal possible which is consistent with the financial survival of the firm.  At that price, an inefficient firm would make a loss and would be forced to leave.  That is competition for you.  If the courts are not careful, however, such a firm might think it would have a case to bring alleging predation.  Is this realistic?  This depends entirely on what we believe about the ability of the courts to assess the conflicting claims about the costs of the dominant firm.  As costs are generally estimated using some empirical method, such (statistical) measurement errors are inevitable as are legitimate disagreement among experts about these. In this case, even a dominant firm who is sure it is not pricing below its relevant measure of average costs may still be wrongfully convicted. This creates an incentive to settle or more dangerously, where the incentive to pursue the case is high, to price safely above average costs, to the joy of inefficient rivals but to the detriment of consumers.  What might provide such incentives for the claimant to pursue a case?  There are at least three sources:  courts with low levels of expertise in evaluating economic evidence; limited liability possibly combined with being in receivership; and generous or multiple damages.

Keys to identifying predation in private actions.

The first key element to assessing a claim of predation is that the excluded (harmed) firm is as-efficient-as or more-efficient-than the alleged predator.  If this is not the case, then finding predation sets a dangerous precedent about how hard firms are allowed to compete.  Competition law is about protecting competition.  Finding predation where the claimant is inefficient does not serve that purpose.  To establish the standing to bring a case, the claimant should be required to establish that it is an as-efficient firm.

The second key element is recoupment.  This not only goes to the credibility of the price being set in order to predate[2], but also has another important role to play.  The counter-factual to predation is the oligopoly price level which would emerge in the absence of the alleged predation.  Consider predation against an as- or more-efficient rival.  During the period of predation, the net loss to the predator is the same as the gain in consumer surplus except for three effects: the consumer gains the dead-weight-gain triangle between the counter-factual price and the average costs; the predator loses an extra small amount on the marginal sales to those who would not have purchased at a price equal to the average cost but who do purchase at the predatory price below these costs; and the part of the foregone industry profit from predation, which is lost by the target for the predation.  The first two are both second order effects and can be ignored in an approximation,[3] but the last effect is not, especially if the target is as- or more-efficient. As a first approximation, the loss which has to be recouped is less than the initial consumer gain.  During the period of recoupment, the consumer loss exceeds the predator’s gain by the dead-weight-loss relative to the counter-factual price.  This dead-weight-loss is a second order effect and hence to a first approximation the gain to the predator equals the loss to the consumers.  Putting the two together, as a first approximation, if there is no recoupment, there is no consumer detriment.  To put it differently, as a first approximation, recoupment is a necessary but not sufficient condition for consumer harm. Thus recoupment also serves as a check on whether or not the ones we really care about in the competition analysis, the consumers, are likely to be harmed.

Until recently we did not, as far as one can tell from case law, have any private predation cases in the UK.  This changed with the decision by the Competition Appeals Tribunal in the Cardiff Bus case.  Why are some economists worried about the decision in this case?  Because it ticks all the wrong boxes.  The claimant did not demonstrate that it was an as-efficient firm which ought to be the test of standing, nor did the defendant appear to challenge the standing of the claimant.  The analysis of recoupment which the CAT inherited from the OFT decision is at least questionable as such cost analysis so often is.  The OFT analysis of costs seems to suggest that prices in order not to be predatory should have been at least 72% higher than they were.[4]  In the context of the case, that would have meant that prices on bus routes where there was an entrant should have been higher than where there was no entrant.  Or put differently, even the non –predatory prices did not cover the estimated costs.  The claimant was in liquidation so it is not clear who would have covered the costs of the case had the claimant lost.  Finally, the award of exemplary damages will raise future estimates of the amount a claimant can expect to recover if successful in a predation case.  Dominant firms in the UK now have a legitimate fear[5] of predatory cases even where they are simply engaging in hard-nosed competition.  The concern is that this fear may lead not only to settlement in future cases even where the case does not have any merit but also to a softening of competition.  Whether this hard lesson from US cases will be learned in the UK is something we will need to look out for.

[1] Crane, D.A., 2005, “The Paradox of Predatory Pricing”, Cornell Law Review 91:1, 1-66.

[2] It serves to corroborate any claim about the intent of the alleged predator.  Most statements used to identify “intent” are basically cheap-talk without this corroborating evidence.

[3] How good this and subsequent approximations are depend on the curvature of the demand function.

[4] OFT in paragraph 7.206 of their decision finds that “revenue would have had to rise by 72 per cent to equal avoidable costs.”

[5] Even if the cases in which exemplary damages can be awarded may be limited to cases where the dominant firm is also small, this is not absolutely settled.

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