Low prices and anti-competitive action

Over at Anti-Dismal, Paul Walker states the following when discussing anti-competitive action against Intel:

The whole point of market power is to raise prices, and thus profits. But how can Intel be accused of anti-competitive behavior when it was giving “hidden discounts” to computer makers? A real anti-competitive monopolist, with real market power, acting in a truly anti-competitive way, would be in a position to raise prices, not lower them.

However, they are being attacked for predatory pricing – which means the “high prices” we are discussing have to be compared to the appropriate counterfactual.

At some level prices have been falling because of improving technology – so looking at the CPI figure is not exactly what we want to do.  We want to look at what Intel is supposedly doing to cause the complaint of predatory pricing.  Now Intel is suspected of predatory pricing because it is giving kickbacks (and so effectively lower input costs) to people who use their chips.

If doing this is sufficient to prevent the entry of some competitors (because of significant fixed costs of entry – something that seems descriptive of the micro-chip industry, both from setting up factories and getting downstream firms to integrate your product), and thereby keep prices higher than they would have been in the case with competition, then it is a legitimate complaint.

Another way of viewing it is – has Intel set itself up in such a way that it credibly commits to the threat of a new entrant.  If we can make this case predatory pricing could exist.

Now I am not saying that the this is necessarily what is happening – but in a global industry with only 2 (maybe 3 😛 ) firms it is definitely worth looking into.  Personally I believe that there could be economies of scale, or that it makes sense to have a “benchmark chip” which Intel currently has patent over.  But there is a genuine case for an anti-trust case study here.

  • Matt. Never really bought the predatory pricing story, for reasons that go back to McGee (1958). As Louis Plips [Competition Policy: A Game-Theoretic Perspective, Cambridge: Cambridge University Press, 1995, p. 204] points out that predatory pricing is a real possibility only when the following five conditions are simultaneously met: 1) The aggressor is a multimarket firm (possibly a multiproduct firm). 2) The predator attacks after entry has occurred in one of its markets. 3) The attack takes the form of a price cut in one of the predator’s markets, which brings this price below a current non-cooperative Nash equilibrium price at which the entry value is positive for the entrant (possibly below a discriminatory current Nash equilibrium price with the same property). 4) The price cut makes the entry value negative (in present value terms) in the market in which predation occurs. 5) Yet the victim is not sure that the price cut is predatory. The price cut could be interpreted by the entrant as implying that its entry value is negative under normal competition. In other words, the victim entertains the possibility that there is no room for it in the market under competitive conditions. The most obvious point here is that these conditions are unlikely to be met.

  • @Paul Walker

    Hi Paul,

    That is true for strict predatory pricing – but not in the case where the firm is preventing entry.

    Effectively, if the fixed costs are high enough a firm can set prices at a level that is above the competitive level but still precludes entry.

    It sounds like a pain to prove – especially when there is so much noise in the data given the rapid technological change in the industry. However, it is still easily conceivable that Intel is preventing entry – which is anticompetitive.

    While I can see why you might believe that the current situation isn’t anticompetitive – I think it is useful to point out two things:

    1) It could be anticompetitive,
    2) The falling prices over the past decade don’t preclude anticompetitive behaviour – in fact they aren’t really related.

  • But what is there that is damaging to consumers about what they have done? Look at the falling price of microchips and computers, we have never had it so good! Showing actual harm to consumers would be hard. I think part of the problem with the Europeans is that they are trying to protect a competitor rather than protecting competition. Those things are different.

  • There was a neat survey a while back comparing American and European IO economists on the plausibility of predatory pricing arguments; Europeans were far more likely to buy them. Aiginger et al, if I recall correctly.

  • @Eric Crampton

    Do American and European Industrial Organization Economists Differ?, Aiginger, Karl_et al. Review of Industrial Organization, December 2001, v. 19, iss. 4, pp. 383-405

    Abstract:
    This paper compares results from two surveys among American and European industrial organisation (IO) economists on various IO and broader economic issues. Although differences between the two groups are generally rather small, some systematic differences seem to exist. These differences are more pronounced when judgments about the efficacy of government policies and the workings of the market are concerned than when judgments about methodology and the present and future state of the IO field are concerned. American IO economists tend to exhibit more confidence in the market’s capability to allocate resources than their European counterparts.

  • Richard A. Epstein (James Parker Hall Distinguished Service Professor of Law at the University of Chicago) writes at the IEA blog on Monopolization gone haywire. He says

    […] his academic at least can raise two doubts about the Commission’s attack on rebates.

    First, no claim of consumer harm can look just at individual cases. It must look at overall market conditions. Here the Intel rebates lowered prices for the 80 per cent of consumers that used its products. What consumer harm could outweigh those particular gains in either the short or the long run? Without these rebates Intel’s share of the market would fall and that of Advanced Micro Devices (AMD), the complainant in this case, would rise from its 12 per cent share. Suppose AMD’s share doubled, Intel would still serve about 2/3rds of the market. Where is the net harm when more consumers are helped than hurt by the rebate?

    Second, AMD, as a nondominant firm, could of course offer rebates (or larger rebates) for its products to increase its market share. Now price competition increases, which is all to the good. The EC’s Kroes has gathered the scalp of yet another large American company by intoning the phrase “abuse of a dominant position”. But in so doing she has converted Article 82 into an anticompetitive provision, just as her critics have long feared.

  • Owen

    But if the result of anti-competitive policies is higher prices for consumers than would otherwise be the case, then there is not much point to having them then is there?

    Forcing producers to charge higher prices in order to not be anti-competitive just doesnt make much sense to me.

  • Thanks for all the comments guys. Sorry for the slack response time, retail sales data = very busy Matt.

    @Paul Walker

    “But what is there that is damaging to consumers about what they have done?”

    The damage is relative to the appropriate counterfactual – the fact is that the European commission does believe prices are higher (and thereby quantity is lower) than it would be in the counterfactual case. The fact that prices have fallen and quantity has risen does not invalidate their counterfactual.

  • @Eric Crampton

    @Paul Walker

    Very interesting

  • @Paul Walker

    My concern lies with the framing of the issue. We know prices have fallen and quantity has risen – but this is virtually irrelevant for analysing whether things are anti-competitive!

    There is a case for predatory prices – one I don’t fully buy either in this example – but it does exist. When we have only 2-3 firms in a global industry and their are significant fixed costs (and costs of entry in specific markets) there is significant potential for anti-competitive behaviour – so I’ve got no problem with a European Commission having a peak.

  • @Owen

    Forcing producers to charge higher prices now, to accommodate entry, and eventually lead to lower prices than we have now is the purpose of the policy. The result is still lower prices – we just have anti-competitive behaviour that prevents entry into some markets. That is the thinking of the European Commission here.

  • @Matt Nolan

    Just what counterfactual must these people be using? As Richard Epstein notes

    ” First, no claim of consumer harm can look just at individual cases. It must look at overall market conditions. Here the Intel rebates lowered prices for the 80 per cent of consumers that used its products. What consumer harm could outweigh those particular gains in either the short or the long run? Without these rebates Intel’s share of the market would fall and that of Advanced Micro Devices (AMD), the complainant in this case, would rise from its 12 per cent share. Suppose AMD’s share doubled, Intel would still serve about 2/3rds of the market. Where is the net harm when more consumers are helped than hurt by the rebate?

    Second, AMD, as a nondominant firm, could of course offer rebates (or larger rebates) for its products to increase its market share. Now price competition increases, which is all to the good. The EC’s Kroes has gathered the scalp of yet another large American company by intoning the phrase “abuse of a dominant position”. But in so doing she has converted Article 82 into an anticompetitive provision, just as her critics have long feared.”

    Exactly what counterfactual could show net harm to consumers? And if AMD offered rebates we get more price competition, as Epstein says. Where is the harm to consumers? This looks a lot like ADM are using antitrust as weapon against a more efficient competitor. As I said above, I think part of the problem with the Europeans is that they are trying to protect a competitor rather than protecting competition.

  • What would Hayek say

    Quick test for the the counterfactual claim – Has Intel increased market share? Since we can’t use price, we should be able to consider whether the tactics by Intel resulting in an increase in market share and therefore (drawing a long bow) increased its potential ability to harm consumers

    Just refreshed and saw Paul Walkers comment, so i’ll stop and just agree with his comment of 2pm 🙂

  • @Paul Walker

    @What would Hayek say

    The very essence of what we are looking at here depends on how we think Intel’s choices have influenced entry. As long as the commission believes that, in some markets, Intel’s behaviour has prevented, delayed, or reduced entry then it is anticompetitive.

    Off the top of my head there are two ways it could work in this case:

    1) They could note that the industry has increasing returns to scale over some level (not enough to satisfy market demand), and given product specificity they know that if they can get a high enough market share they get a cost advantage over any competitor. In this case the temporary incentives to shift which leads to higher long run prices.

    2) The subsidies weren’t just to increase demand for Intel products – but were directly meant to interfere with AMD’s current contractual relationships. If Intel was paying to directly create barriers (rather than simply subsidising per unit) this could be anti-competitive.

    Now I can buy the first reason in the current industry, and the second reason matches some of the descriptions I’ve heard.

    If I had to apply value judgments I would ultimately weigh against anti-competitive behaviour myself – but I trust the analysis of the European Commission more than my implicit feelings.

    As I can see scope for anti-competitive behaviour, I thought it was worth raising why this could be the case 🙂

  • I’m still not convinced about so called predatory pricing being a bad thing.

    Presumably if a firm has a degree of market power then it has the ability to extract rents via the fact that pricing under imperfect competition leads to a DWL.

    However, if predatory pricing leads to an equilibrium closer to the perfect competition paradigm then this is a good thing, no? If the counterfactual is that it is not close enough to the competitive market paradigm then this is simply imperfect competition and not a problem with predatory pricing.

  • @Dismal Soyanz

    But that ignores the endogeneity between entry decisions and prices. Now this doesn’t matter if there are no significant fixed costs.

    But when fixed costs are significant, keeping prices “down” now compared to the monopoly level can be seen as anti-competitive if it can prevent future competition that leads to lower prices.

    Now we need a reason for that to happen (as at first glance we still seem to have sufficient effective competition – or else the threat of entry would not be subgame perfect). Credit imperfections, asymmetric information (signaling namely) and the vertical structure of a market can both be discussed to allow for this.

    Furthermore, in the current case of Intel there is a suggestion that they are directly increasing the barrier to entry with the payments – not subsidising the per unit cost. This is even more obviously anti-competitive than the strict predatory pricing case.

    As a result, I can see scope for the European Commission to suggest there is anti-competitive behaviour here. We could have a counterfactual where Intel’s behaviour has made consumers worse off – even if prices have been falling and quantity has been rising (which is actually the result of technology anyway).

  • I can see the argument for payment not tied to the per unit cost being treated as some kind of corporate bribe, although the case would be lessened if the benefit of this flows through to lower costs for the consumer.

    One thing that strikes me is that if we start with a monopoly then go to a duopoly, would the resulting market output and price be less and more respectively than the predatory pricing situation? Given that predatory pricing requires a commitment to keep prices low (otherwise when they went back up sufficiently it would trigger entry) the predatory pricing must be maintained.

    I really shouldn’t be thinking about this – I have a stack of other work to do!

  • @Dismal Soyanz

    The strength of the effective competition depends on the barriers to entry. First we can have significant fixed costs – the higher the fixed costs the greater the market power the incumbent can use.

    Now you are completely right that if this is the only issue we can look past it – as the entrant will only come in if they can recoup fixed costs in the long-run anyway!

    However, if we have large fixed costs that have to be sunk, and the incumbent can make it believable that they would be willing to fight a price war in the case of entry, they can prevent commitment and the price charged can be in excess of the price that would be charged if the incumbent was willing to accommodate.

    If the EU commission believes that the subsidies are part of a signal to do this, or part of an investment in a credible commitment mechanism, then they can pull out the idea that they could be a form of predatory pricing.

  • ben

    If doing this is sufficient to prevent the entry of some competitors (because of significant fixed costs of entry – something that seems descriptive of the micro-chip industry, both from setting up factories and getting downstream firms to integrate your product), and thereby keep prices higher than they would have been in the case with competition, then it is a legitimate complaint.

    Most economists would disagree with you on that I think. Fixed costs are not usually considered a barrier to entry that antitrust should concern itself with – they properly regulate the entry of new firms. It is not helpful to have authorities encouraging entry for the sake of competition – doing so will almost certainly mean fixed costs are incurred with no commensurate benefit – if there was, entry would have (or can be anticipated to) occur.

    There is tremendous danger in what the EU is doing. Intel is in a dynamic industry and the cost of a regulatory mistake that seriously interferes with Intel and all other participatns now and into the future is potentially enormous because of the missing markets problem. Firms, especially in dynamic industries, of which microchips is the flagship, need to be free to innovate on all dimensions including price. It is ridiculous for the EU to jeopardise so much for such trivial gains. Property rights really matter in that sort of industry marked by large, long run investments.

    The EU could use some Schumpeter.

  • ben

    Now I am not saying that the this is necessarily what is happening – but in a global industry with only 2 (maybe 3 😛 ) firms it is definitely worth looking into.

    See Baumol’s 2002 book, the Free Market Innovation Machine. Baumol’s central argument is that the main reason by capitalism beats the hell out of every other economic system is that it is the only system which produces oligopoly. And oligopolies, with their deep pockets and market power, are ideal to engage in technilogical arms races against one another, the result being routinized and massive innovation. He shows oligopolies are responsible for the great majority of innovation (not invention) in modern economies, easly shading universities.

    Baumol gives us a good reason to like duopoly.

  • ben

    @Matt Nolan

    Forcing producers to charge higher prices now, to accommodate entry, and eventually lead to lower prices than we have now is the purpose of the policy. The result is still lower prices – we just have anti-competitive behaviour that prevents entry into some markets.

    That doesn’t make any sense to me. What entrant would not consider post-entry conditions? How do high prices before entry encourage entry if the entrant expects them to change? Isn’t it the changed price that matters?

    Is there a single example anywhere of anti-trust induced higher prices causing entry which actually lead to lower long term prices? The very fact any regulator that crazy is operating would convince me immediately that I should put my capital elsewhere!

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