The Role of Recoupment in Predatory Pricing Analyses.

• Author: Hemphill, C. Scott

1. INTRODUCTION

   Predatory pricing is a classic problem in antitrust enforcement. As with other areas of antitrust regulation, successful enforcement requires a court to identify and deter anti-competitive conduct, without deterring good conduct in the process. But predatory price cuts are particularly hard to distinguish from vigorous competition. And a court that bans a given price cut improvidently may chill the very conduct, price competition, which antitrust laws try to promote.

   U.S. antitrust doctrine is extremely skeptical about predatory pricing, and federal courts are currently very hostile toward predatory pricing claims. This hostility has two aspects, the first doctrinal and the second a matter of underlying economic theory. Doctrinally, courts apply a stringent two-part test to predatory pricing claims: the allegedly predatory price must fall below (some appropriate measure of) the predator's cost, and the predator must have a reasonable probability of "recoupment" of predatory losses through higher prices later on.(1) As a matter of economic theory, the courts' approach reflects an underlying economic view that predatory pricing is "rarely tried, and even more rarely successful,"(2) and thus claims should rarely succeed.

   This Note explores weaknesses in the current doctrinal approach to predatory pricing claims, as well as the underlying economic theory that seems to animate it, by focusing on the "recoupment" element of the current predatory pricing test. For decades, the attention of courts and commentators has been focused on the price-cost test in predatory pricing doctrine, rather than the recoupment test.(3) This Note is an attempt to identify the proper role of recoupment in predatory pricing doctrine. The primary burden of this Note is to identify and address problems in recoupment doctrine as currently employed. Doing so necessarily entails an examination of the proper level of skepticism toward predatory pricing claims.

   In principle, two different types of examination could demonstrate a predator's probable recoupment: the structural features of the market in question, or the conduct of the predator. Structural examinations are a valuable tool for identifying markets likely to be vulnerable to predation. Yet some discussions of recoupment prioritize conduct analysis. The first contribution of this Note is to show how the inclusion of conduct in recoupment analyses generates perverse results, previously ignored by commentators and courts.

   Even if it generates perverse results, a conduct-centered recoupment analysis might be a useful way to dismiss most predatory pricing claims. And indeed, some commentators and most courts do see predatory pricing as rare and generally low-cost when it occurs. However, economic theory and empirical work over the past twenty years suggest that predatory pricing occurs more often, and is more frequently successful when it does occur, than courts have typically assumed. A second contribution of this essay is to direct attention to the structure-focused recoupment test as a doctrinal vehicle to evaluate this newer economic theory and evidence.

   The Note is organized as follows: Part II summarizes current predatory pricing doctrine and describes the goals that an optimal doctrine should serve. Part III introduces a structural recoupment screen. Part IV describes how the inclusion of conduct in recoupment analyses produces perverse results. Part V considers the objection that current recoupment doctrine is valuable as a means to dismiss all claims, identifies the "Chicago-school." views underlying that approach, and suggests additional factors that might undercut the Chicago school's conclusions. Part VI evaluates the consistency of the optimal recoupment screen--narrow in the sense that it excludes conduct, deep in that it includes a robust set of structural factors--with existing court doctrine as described in the Brooke Group opinion. Part VII concludes.

2. THE BROOKE GROUP STATUS QUO AND THE MINIMIZATION OF ERRORS

   1. The Brooke Group Status Quo

      As the term is used here, predatory pricing occurs when a firm sells a product below cost in order to enjoy higher profits later due to reduced future competition.(4) Predatory pricing presents an antitrust problem to the extent that an incumbent firm's anti-competitive behavior causes long-term injury to consumers. As noted in the introduction, predatory pricing is a particularly difficult problem in antitrust law, since a predatory price reduction is hard to distinguish from vigorous competition.

      In early predatory pricing analyses, courts distinguished price cuts mainly by examining whether the alleged predator's price was set below (some measure of) cost during the period of predation. The Supreme Court recently reexamined predatory pricing claims in Brooke Group Ltd. v. Brown & Williamson Tobacco Corp.(5) The Brooke Group opinion had two notable features which have been incorporated in subsequent lower-court opinions.(6) First, in doctrinal terms the Court used both a price-cost test(7) and a second requirement, the "demonstration that the competitor had a reasonable prospect ... of recouping its investment in below-cost prices."(8) A few courts, further parsing the recoupment prong, have discerned two components within it: a threshold inquiry into whether the price is capable of producing the intended effect on its target, and an assessment of whether the result is likely to injure competition.(9) Second, the opinion solidified the Court's emerging economic view that predatory pricing is "rarely tried, and even more rarely successful."(10) This attitude of "extreme skepticism"(11) has been embraced by lower courts.

      Since Brooke Group, predatory pricing claims have been almost impossible to win. Under U.S. antitrust law, both private plaintiffs and the U.S. government can bring actions against alleged predators. When private plaintiffs bring cases, lower courts almost always grant summary judgment to defendants or dismiss on the pleadings.(12) Courts disposing of plaintiffs' claims often rely on recoupment alone,(13) or recoupment in combination with other doctrinal bases.(14) No case since Brooke Group has progressed to a successful final judgment: The three cases in which plaintiffs resisted summary judgment(15) were later settled outside of court.(16)

      Probably due to the difficulty of winning a case, the U.S. government seldom brings predatory pricing claims.(17) One recent action brought by the Department of Justice, against American Airlines for predation at its Dallas-Ft. Worth hub does include allegations of predatory pricing as part of broader allegations of monopolization and attempted monopolization under Section 2 of the Sherman Act.(18) More typically, when the United States brings cases involving conduct that arguably includes predatory pricing, it avoids an explicit predatory pricing allegation, instead trying to reach related conduct under the general Section 2 standard. United States v. Microsoft arguably fits this pattern.(19) The failure of private plaintiffs, combined with the reluctance of the U.S. government to bring claims, has reinforced the conclusion that Brooke Group sounded the "death knell" of federal predatory pricing claims.(20)

   2. Minimizing Errors

      It is no coincidence that the current doctrine is hostile to predatory pricing at the same time that courts view predatory pricing as exceedingly unlikely. At base, this is a natural response. As Joskow and Klevorick have pointed out, courts should set legal rules to minimize error costs.(21) If predatory pricing is exceedingly unlikely, then "false positives"--the risk that a court will find predation to have occurred when it didn't--are an important danger. A very stringent predatory pricing rule will tend to reduce false positives.

      However, two points are worth noting here.(22) First, a very stringent predatory pricing rule will tend to increase "false negatives" even as it reduces false positives: When overall enforcement is low, real predators will escape without attracting judicial notice. Second, the discussion so far has focused only on the level of enforcement; we might also care about the shape of enforcement. That is, we should prefer rules that are especially likely to prevent the costliest false negatives (and false positives)--for example, by always catching predators who make the most socially harmful price cuts.

      Any recoupment test will incur some error costs; the goal is to find a screen (or set of screens) that minimizes those costs. To understand whether recoupment is likely to succeed--that is, whether an investment in below-cost pricing will pay off for a would-be predator--there are two kinds of inquiries a court could undertake. It could look at industry structure, asking whether there are barriers to entry that will allow the predator to profit from its ill-gotten monopoly once the competitor has been eliminated (or co-opted). Alternately, a court could focus on the conduct of the predator. A simple, perhaps simplistic, way to analyze conduct would be to add up the predator's losses in the period of predation, add up the likely profits after the period of predation has ended, and see which is larger.

      As we will see, this simplistic scheme is one possible description of current doctrine. But before examining this, it is useful to understand what a structural analysis of recoupment entails, and the extent to which it is already used in predatory pricing cases.

3. STRUCTURAL SCREENS

   1. Traditional Structural Screens: The A.A. Poultry Farms Example

      A structural approach to recoupment focuses on identifiable elements of the economic environment in which predation is alleged to have taken place. For example, how much would it cost for an outsider to enter the business? How large a market share does the alleged predator have, compared to its competitors? These questions make no reference whatsoever to the...