Allocating Costs in Ninth Circuit Predatory Pricing Cases: Marsann Co. v. Brammall, Inc. and its Problematic Progeny, Inglis v. Continental Baking and Thales v. Matsushita
| Author | H.E. Frech,C. Paul Wazzan |
| DOI | 10.1177/0003603X0905400305 |
| Published date | 01 September 2009 |
| Date | 01 September 2009 |
| Subject Matter | Economics |
Allocating costs in Ninth Circuit
predatory pricing cases:
Marsann Co. v. Brammall, Inc.
and its problematic progeny,
Inglis v. Continental Baking
and Thales v. Matsushita
BY C. PAUL WAZZAN* AND H.E. FRECH III**
I.
INTRODUCTION
Predatory pricing remains an active area in antitrust law, and cases
continue to be brought before federal and state courts, causing the
economics of predatory pricing to be revisited with some frequency.1
*
LECG, LLC, Los Angeles, California.
**
Department of Economics, University of California, Santa Barbara.
AUTHORS’ NOTE: This paper was presented at the Industrial Organization Society meet-
ings in Arlington, Virginia, May 17, 2008. Thanks are due the participants, especially
to John Connor, for helpful comments. Thanks are also due to Clement Krouse, Michael
Beauregard, Jonathan Tomlin and William Comanor for helpful critiques of earlier ver-
sions of this paper and to an anonymous referee for helpful comments. C. Paul Wazzan
and H.E. Frech III were economic experts for Thales in Thales v. Matsushita.
1
Daniel Crane indicates that “hundreds” of predatory cases have been
filed since the restrictive Supreme Court decisions. Daniel A. Crane, The Per-
verse Effects of Predatory Pricing Law, 28 REG. 26 (2005). For a list of reported
cases since 1993, see Daniel A. Crane, The Paradox of Predatory Pricing, 91 COR-
NELL L. REV. 1, 26 n.118 (2005).
© 2009 by Federal Legal Publications, Inc.
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Recent cases include Bay Guardian Co., Inc. v. NT Media LLC2; Kinetic
Concepts, Inc. v. Hillenbrand Industries, Inc.3; LePage’s Inc. v. 3M Co.4;
and United States v. AMR Corp.5 A key concept in these cases is
whether prices were set below some measure of costs, a threshold
issue in predatory pricing analysis.6 Despite the fact that the Supreme
Court has recently given considerable attention to predatory pricing,
it has still not resolved splits in the circuit courts regarding the
appropriate measure for determining when a price is “below cost.”7
The Supreme Court has declined in three recent, important cases,
Brooke Group,8 Cargill,9 and Matsushita,10 to determine the appropriate
measure of cost below which prices must be set in order to be
condemned as predatory. In Brooke Group, the Court merely required
that prices be below “some measure of incremental cost.”11 This article
2
Bay Guardian Co., Inc. v. NT Media LLC, No. 04-435584 (Cal. Sup. Ct.
filed Oct. 19, 2004).
3
Kinetic Concepts, Inc. v. Hillenbrand Indus., Inc., 262 F. Supp. 2d 722,
725–26 (W.D. Tex. 2003).
4
LePage’s Inc. v. 3M Co., 324 F.3d 141, 145 (3d Cir. 2003).
5
United States v. AMR Corp., 335 F.3d 1109, 1115 (10th Cir. 2003).
6
See, e.g., Brooke Group Ltd. v. Brown & Williamson Tobacco Corp.,
509 U.S. 209, 222 n.1 (1993).
7
The treatment of prices above average variable cost, but below aver-
age total cost varies greatly. In the Sixth and Ninth Circuits, the plaintiff has
the burden of proving such prices are predatory, in the Eighth Circuit such
prices are presumptively illegal, in the Tenth Circuit such prices are presump-
tively lawful absent other evidence of predation, and in the Eleventh Circuit
prices above average variable cost create circumstantial evidence of preda-
tory intent. In the Third, Fourth, Seventh and the District of Columbia Cir-
cuits, there is no established rule. See R. O. Zerbe, Jr., & M. T. Mumford, Does
Predatory Pricing Exist? Economic Theory and the Courts after Brooke Group, 41
ANTITRUST BULL. 949, 949 n.4 (1996).
8
Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S.
209 (1993).
9
Cargill v. Monfort, 479 U.S. 104 (1986).
10
Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574
(1986).
11
Brooke Group, 509 U.S. at 223.
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will briefly discuss the economics of predatory pricing and will focus
on how the developing case law in the Ninth Circuit on the
measurement of costs potentially leads to improper decisions from an
economic perspective. We use Thales v. Matsushita as a case study.12 It
is our understanding that the other circuits have not taken up the
issues raised here.
As a matter of economics, predatory pricing is a particular type of
strategic behavior. Pricing is considered predatory when it is below
the short-run profit maximizing price, and it is designed to influence
a rival’s behavior.13 In the extreme, the rival is induced to leave the
market, or a potential entrant is discouraged from entering. Less
extreme outcomes include less aggressive competition, higher costs
for the rival, or a reduction in innovation. The predator expects to
recover its costs from this strategy by earning more in the future
because of less vigorous rivals, or perhaps no rivals at all.
While the definition of predatory pricing is straightforward, one
practical difficulty lies in determining what the short-run profit
maximizing price would be absent predatory pricing. Typically, the
short-run profit maximizing price can be defined relative to some
benchmark of cost (e.g., marginal cost, average variable cost, average
total cost). Unfortunately, the calculations of these various cost
measures are typically not straightforward.
12
Thales Avionics, Inc. v. Matsushita Avionics Sys. Corp., Case No. SA
CV 04-424-JVS (MLGx) (C.D. Cal. June 7, 2005).
13
For a statement of the strategic nature of predation, see William S.
Comanor & H.E. Frech III, Predatory Pricing and the Meaning of Intent, 38
ANTITRUST BULL. 294–95 (1993) and DENNIS W. CARLTON & JEFFREY M. PERLOFF,
MODERN INDUSTRIAL ORGANIZATION 352–53 (4th ed. 2005). For a more detailed
analysis, see Patrick Bolton, Joseph F. Brodley & Michael H. Riordan, Preda-
tory Pricing: Strategic Theory and Legal Policy, 88 GEO. L.J. 223 (2000), Zerbe &
Mumford, supra note 7, at 4. See also Kenneth G. Elzinga & David E. Mills,
Predatory Pricing and Strategic Theory, 89 GEO. L.J. 2475 (2001) and Patrick
Bolton, Joseph F. Brodley, & Michael H. Riordan, Predatory Pricing: Response to
Critique and Further Elaboration, 89 GEO. L.J. 2495 (2001). For an excellent per-
spective on the changing view of predation in the economic literature and
how that relates to issues of judicial economy and administratability, see
Bruce H. Kobayashi, The Law and Economics of Predatory Pricing (George
Mason Univ. Law & Econ. Research Paper Series No. 08-41, Nov. 2008).
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A. The Areeda-Turner test
The modern preeminence of costs in predatory pricing analysis
dates from a 1975 article by Phillip Areeda and Donald Turner. They
wanted to avoid too easily condemning low prices as predatory and
deterring aggressive price cutting. So Areeda and Turner suggested a
simple cost-based test: prices below marginal costs would be
presumed to be predatory.14 Areeda and Turner were aware that this
test did not exactly fit the economic definition of predation, but they
thought that the test would be administrable and would avoid
chilling competition.15 Areeda and Turner reasoned that a firm would
not set price this low, incurring short-term losses, unless it had
predatory intentions. Further, they suggested that marginal costs
could be approximated by average variable costs.16 Any observed
pricing below that level would be presumed to be predatory.
Symmetrically, any observed pricing above that level would be
presumed not to be predatory. The Areeda-Turner approach was
adopted by various courts in relatively short order.17 The rule has
recently been used to provide a sort of safe harbor for low, but above-
marginal-cost pricing.18
Of course the definition of “average variable costs” is open to
interpretation and depends on the economics of the relevant sales, as
described above. Moreover, the Areeda-Turner metric produces only
14
Phillip Areeda & Donald F. Turner, Predatory Pricing and Related Issues
Under Section 2 of the Sherman Act, 88 HARV. L. REV. 697–733 (1975). See also
McGahee v. N. Propane Gas Co., 858 F.2d 1487, 1504 (11th Cir. 1988); Ne. Tel.
Co. v. AT&T, 651 F.2d 76, 87–88 (2d Cir. 1981); Chillicothe Sand & Gravel Co.
v Martin Marietta Corp., 615 F.2d 427, 432 (7th Cir. 1980); Janich Bros. v. Am.
Distilling Co., 570 F.2d 848, 858 (9th Cir. 1977); Int’l Air Indus. v. Am. Excel-
sior Co., 517 F.2d 714, 724 (5th Cir. 1975).
15
See Kobayashi, supra note 13, at 60 for a recent defense of this position.
16
Areeda & Turner, supra note 14, at 10. See also Cascade Health Solu-
tions v. PeaceHealth, 502 F.3d 895 (9th Cir. 2007). The Cascade approach is con-
sistent with the views of Areeda and Turner. See Cascade, 502 F.3d at 811, 712.
17
See, e.g., LOUIS PHLIPS, COMPETITION POLICY: A GAME-THEORETIC PER-
SPECTIVE 231 (1995).
18
See Cascade, 502 F.3d at 913, 914.
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a presumption, not an outcome. Further analysis is necessary.
A number of alternative methods to determining the existence of
predatory pricing have been suggested as alternatives or
supplements.19
B. Controversies
The Areeda-Turner rule has been controversial, spawning a
number of competing tests. Williamson proposed an output-based
rule for response to entry-raising output when...
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