Predatory Pricing under the Areeda-Turner Test

21 Pages Posted: 9 Apr 2014 Last revised: 16 Mar 2015

Herbert J. Hovenkamp

University of Iowa - College of Law

Date Written: March 15, 2015

Abstract

Few works of legal scholarship have had the impact enjoyed by Areeda and Turner's 1975 article on predatory pricing. Proof of predatory pricing under the Areeda-Turner test requires two things. The plaintiff must show a market structure such that the predator could rationally foresee "recouping the losses through higher profits earned in the absence of competition." This requirement, typically called "recoupment," requires the plaintiff to show that, looking from the beginning of the predation campaign, the predator can reasonably anticipate that the costs of predation will be more than offset by the present value of a future period of monopoly profits, making the strategy a sound investment. Second, the plaintiff must show that the defendant's prices over substantial sales were below a relevant measure of cost, presumptively average variable cost (AVC) or, in some cases, marginal costs over a relatively short run.

The effects of Areeda and Turner's predation test occurred in two waves, both devastating for plaintiffs. For the first fifteen years the courts focused overwhelmingly on price-cost relationship, and it quickly became clear that proving predatory pricing under an AVC test is extremely difficult. The second wave occurred after the Supreme Court's formulation of the recoupment requirement in the Brooke Group case. Few plaintiffs have won a case, and the incidence of classical predatory pricing claims has declined dramatically.

That so many courts embraced the Areeda-Turner AVC test might seem surprising, given that contemporary assessments from economists were quite negative. The criticisms can be grouped into three categories. Even assuming that short run marginal cost is a useful legal test for predatory pricing, AVC is a reasonable surrogate for marginal cost only in equilibrium. "Classic" predatory pricing is not an equilibrium strategy, however, but rather a nonsustainable high output strategy. In this range AVC and MC diverge, making the Areeda-Turner test a "defendant's paradise."

The AVC test is particularly underdeterrent in markets characterized by high fixed costs, which are also the markets that are most conducive to predation. Because strictly defined AVC excludes fixed costs, many nonsustainable pricing strategies are identified as legal, even though many of these might be considered anticompetitive under a more holistic approach.

The most fundamental critique of the Areeda-Turner test is that, whether or not AVC is a workable surrogate for short run marginal cost, short-run measures are deficient because they exclude other types of strategic pricing behavior. Longer run strategies may involve fully sustainable pricing.

Most recent antitrust complaints about exclusionary pricing have sought to avoid Areeda-Turner by focusing on more complex pricing strategies, such as market share or bundled discounts. Plaintiffs have had some but limited success in convincing courts to analogize these practices to exclusive dealing or tying rather than pricing as such. This permits condemnation even on prices above cost. But these cases also present serious problems of complexity that the courts have not yet addressed, particularly when more than two goods are in a bundle or they can be used in varying proportions.

What the Areeda-Turner test promised in exchange for its deficiencies was a query that narrowed the fact finder's focus and was easier to administer. While the test largely succeeded on the first of these, ease of administration has proven elusive. The test nonetheless survives. First, it tends to keep predatory pricing cases out of court and away from juries, two properties that make it attractive to judges. Second, no one has produced something better. A superior test would have to correct for Areeda-Turner’s false negatives without going too far in the other direction. Second, it would have to be administrable by the full range of tribunals authorized to hear predatory pricing cases, which today includes jury trials.

Keywords: antitrust, competition, monopolization, predatory pricing, AVC test, price discrimination, recoupment, Areeda-Turner, strategic pricing

Suggested Citation

Hovenkamp, Herbert J., Predatory Pricing under the Areeda-Turner Test (March 15, 2015). U Iowa Legal Studies Research Paper No. 15-06. Available at SSRN: https://ssrn.com/abstract=2422120 or http://dx.doi.org/10.2139/ssrn.2422120

Herbert J. Hovenkamp (Contact Author)

University of Iowa - College of Law ( email )

407 Boyd Law Building
Iowa City, IA 52242
United States
319-335-9079 (Phone)

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