INST Committee Report

Predatory Pricing

       Predatory behaviour occurs when a firm temporarily lowers its prices or expands output or capacity in an attempt to deter new competitors from entering the market or to drive out or discipline competitors who are already there. In all three cases, the predator incurs temporary losses in the expectation of, at the very least, recouping them by raising prices later and from an increased market share. Prior to the 1980s, most economists regarded predation as extremely rare because the barriers to entry in most markets were thought to be low. Consequently, it was believed that the subsequent high prices required to recoup the losses suffered in the predatory period would not be sustainable in the face of new entrants. Moreover, predation would be very expensive; the “prey” would be aware that the period of lower prices would be costly for the predator and might hold on in the hope of eventual profits (in the case of efficient capital markets), or to see the predator attempt to buy it out. Only in the extremely rare event that the predator had greater and better access to external capital would a predatory campaign pay off; although even a takeover or merger would generally be a more successful way of monopolizing the market.

       Recent economic research, however, challenges this long-held position on the grounds that predation may be a more frequent occurrence than previously thought. Some believe the practice, although still infrequent, is not rare.

       Predatory pricing is a criminal offence under paragraph 50(1)(c) of the Competition Act. Several elements must be established before an offence is proven. The alleged predator must be engaged in a business and have adopted a policy of selling products at prices that are unreasonably low. Both the “policy” requirement and the “unreasonably low” price requirement have raised difficult issues of interpretation. With respect to a policy, one of the following four requirements must be met:

 In section 50, where we have the vague wording “at prices unreasonably low”, we don’t have much jurisprudence … to give an interpretation of it. [Douglas West, University of Alberta, 59:10:40]

  [W]ith predatory pricing … [E]very case in Canada has failed because cost isn’t properly defined. [Robert Russell, Borden, Ladner & Gervais, 59:10:35]

       The Committee was told that, as simple as the above definition seems, predatory pricing and behaviour are much more complicated to establish in practice. The firm’s broad scope in pricing its services (in the case where its marginal cost can approach zero) makes it extremely difficult to distinguish predatory pricing from aggressive price competition. In the case of perishable goods, whose marginal cost is often as close to zero as you can get, selling below cost is a perfectly legitimate business practice.

       Indeed, modern thinking even questions whether the hard-to-define marginal cost concept is the appropriate test of predatory pricing. The Committee was told to consider the case of Amazon.com; founded in 1995, the firm has yet to price above cost. Amazon.com is pricing less than its cost, but it is not engaged in predatory pricing. Through low prices, it is investing in a future market share as a new innovator. So there is a temporal aspect to pricing that may not be properly accounted for in the current cost test of predatory pricing.

       This example of below-cost pricing which is not predatory pricing was further extended to apply to simple goods such as a razor and razor blades or a number of other complementary products. Apparently, pricing razors below their accounting measures of cost makes good economic sense when it leads to greater sales of razor blades and ultimately greater profit. In this case, what should be compared to today’s price is the following: today’s average variable cost minus the present value of the firm’s expected increased gross margin per unit in the future that is attributable to the low pricing policy. Needless to say, when the investigator has gathered this last bit of information, the “prey” will have given up the struggle. Clearly, economic theory, as a practical guide to enforcement of predatory pricing, leaves something to be desired.

[W]e create penalties, and the whole point of enforcement is to discourage people from doing bad things. … So a few successful cases on predatory pricing, no matter how long they take, might create the right kinds of incentives to get … the right enforcement stance on predatory pricing. We don’t need regulatory powers from the Commissioner to do that. [Roger Ware, Queen’s University, 59:12:15]

       The VanDuzer Report was sceptical of both the legal framework and its economic underpinnings:

    A consensus of competition law experts supports the VanDuzer Report’s proposed solution:

     The VanDuzer Report suggests other advantages of shifting the prohibition under section 79:

       However, the Commissioner of Competition, the Canadian Bar Association and a number of other stakeholders oppose this suggested change because they believe the criminal status best deters egregious anticompetitive conduct; they favour more enforcement resources, believing the double layer of protection (paragraph 50(1)(c) and section 79)

       The Committee has reservations about this last position, because there is simply insufficient case law to validate the deterrent effect of paragraph 50(1)(c). The Committee cannot just ignore the predatory pricing provision’s inactive and ineffectual history, which includes only two contested cases (both of which are more than two decades old). Moreover, the Committee is unsure about a court being the right venue for the intricate economic analysis needed to discern between predatory and aggressive, pro-competitive pricing; the Competition Tribunal appears better able to judge this behaviour. In any event, a consensus has formed on the use of the abuse of dominant position provision as a vehicle for bringing a predatory pricing case before the legal authorities — a provision that requires that the alleged predator has “market power” and that the practice in question would “prevent or lessen competition substantially.” For these reasons, the Committee recommends:

Price Maintenance

       Price maintenance is the practice whereby a firm attempts to either set or influence upward the minimum price at which another firm further down the manufacturer-wholesaler-retailer distribution chain can sell its product. Although resale price maintenance is not a pervasive practice throughout the business sector, it is one of the most common pricing restraints found in the marketplace. It may take place either vertically, for example between a wholesale supplier and a retailer that resells the supplier’s products, or horizontally, for example between competitors who agree to impose resale price maintenance on those who resell their products.

      Since 1951, following the recommendations of the MacQuarrie Commission, price maintenance has been a criminal offence under section 61 of the Act. Thus, it is illegal for any person engaged in a business to try to “influence upward or discourage the reduction” of the price at which someone else engaged in a business sells the product by “any agreement, threat, promise or like means.” In 1960, the law was amended to add the current defences to the related offence of refusing to supply a customer because of the customer’s low pricing policy. These defences are listed in subsection 61(10) as:

• using products supplied as loss leaders (the “Loss Leader Defence”);
• using products supplied not for the purpose of selling them for a profit but to attract customers to buy a rival’s products (the “Bait and Switch Defence”);
• engaging in misleading advertising in respect of the products supplied; and
• not providing the level of service that purchasers of the products might reasonably expect (the “Service Defence”).

      On the other hand, requests, discussions, moral suasion, or suggestions to this end are considered to be much the same as setting a suggested list price and are permissible (subsection 61(3)). Similarly, under subsection 61(4), if the suggested price appears in an advertisement, it must be expressed in such a way that it is clear to any person who looks at the advertisement that the product may be sold at a lower price; otherwise the supplier will be found to have attempted to influence the price upward.  

      The Committee is more easily convinced of the economic rationale for prohibiting horizontal price maintenance. Where suppliers agree among themselves to set the resale price of their products, price competition among downstream competitors is precluded. Where the resale price is the more visible of the two, the maintenance of that price may facilitate collusion among suppliers. By subtracting the retailer and wholesaler profit margins from the minimum fixed retail price, manufacturers in effect fix their own prices of the product. The Committee was also made aware that resale price maintenance could facilitate the work of a retailer cartel. History suggests that this had long been the case of pharmaceutical retailers whereby drug stores pressured manufacturers of the products they carried to impose resale price maintenance.

       Vertical price maintenance is less obviously an anticompetitive act. The classical example of such price maintenance is where a supplier requires someone to whom it sells, perhaps a retailer but also a wholesaler, to maintain prices at a particular level as a way of encouraging that retailer or wholesaler to engage in competition on something other than price. A higher retail margin thus encouraged the retailer to engage in providing a high level of service to clients or to ensure that the brand image associated with the product is maintained and not sullied in any way.

       From the consumer’s perspective, vertical price maintenance results in more services, which we would regard as good, but higher prices, which we would view as bad. The Committee was told that, on balance, the decision of how to market a product and how to design a distribution system should be left up to the manufacturer. Prohibiting resale price maintenance under the per se rule is effectively regulating the manufacturer’s decisions on how best to maximize the sale of his products. By way of an analogy, we do not prohibit by law high levels of advertising even when such advertising raises prices; for the same reason we should not prohibit vertical price maintenance under a per se rule. So to the extent that there are efficiency justifications for price maintenance, the per se criminal prohibition in the Act is over-inclusive.

In any vertical relationship, let's say between a manufacturer and a distributor, suppose the manufacturer owned the distributor? Then they could decide whatever terms and conditions they wanted that product to be sold under, including price, the quality of the sales personnel, their qualifications. The manufacturer could determine everything down to the lighting in the store. And we wouldn’t consider that to be anti-competitive. So why would we consider it to be anti-competitive if Sony tried to do some of those things at arm’s length? [Roger Ware, Queen’s University, 65:12:30]

In terms of vertical price maintenance, typically the example given would be ... Say, for example in the electronics industry, … You can sit down, you can go into a sound room, and you can listen to a whole bunch of different types of speakers. You can listen to a bunch of different types of CD players. You can get a real feel for the quality differences. But it costs … a lot of money to put that sound room in place. If somebody else could come along and free ride off that by locating down the street or a few blocks away, selling exactly the same products but at a substantially reduced price, … [the service providing store] wouldn’t be able to continue to provide the consumer with the benefit of that. [Paul Crampton, Davies, Ward, Phillips & Vineberg, 65:12:30]

So the pro-competitive aspect of it, of resale price maintenance is it provide dealers with a margin to invest in providing services, to expand the demand for the product. … when you expand the demand for the product, you increase aggregate wealth in the economy. So it’s pro-competitive in that sense. [Paul Crampton, Davies, Ward, Phillips & Vineberg, 65:12:30

In any vertical relationship, let's say between a manufacturer and a distributor, suppose the manufacturer owned the distributor? Then they could decide whatever terms and conditions they wanted that product to be sold under, including price, the quality of the sales personnel, their qualifications. The manufacturer could determine everything down to the lighting in the store. And we wouldn’t consider that to be anti-competitive. So why would we consider it to be anti-competitive if Sony tried to do some of those things at arm’s length? [Roger Ware, Queen’s University, 65:12:30]

You take price maintenance. We have a very strict law here. There’s no necessity for an agreement to be in place  …  The necessity for agreement in U.S. law allows the so called Colgate doctrine, which means: they can unilaterally sell, you won’t sell my product for less than, you just can’t have an agreement. … So price maintenance that would be unlawful in Canada occurs in the U.S. all the time. That’s a cross-border legal issue that I have to deal with monthly … [because] the law is different here. [Robert Russell, Borden, Ladner & Gervais, 65:11:15]

 [P]rice maintenance provision which deals with these vertical pricing arrangements you’re talking about is a very effective section for us. [R.W. McCrone, Competition Bureau, 64:09:40]  

       All witnesses, except Bureau officials, who commented on price maintenance had a recurring theme: vertical price maintenance should be decriminalized and horizontal price maintenance should be moved to the conspiracy provision. The Bureau, the lone dissenter, could only offer a higher success rate when prosecuting under a per se offence as its reason for departing from expert opinion. The Committee, however, must remind everyone that competition policy is not about winning and losing cases; it is about designing a framework whereby an efficient business sector can deliver products and services at competitive prices. Moreover, the Committee sees no social benefit in risking convictions of, and a “chilling effect” on, pro-competitive vertical price maintenance under the criminal section of the Act, when the civil section offers a more reasonable approach and a better result. In decriminalizing vertical price maintenance, competition experts suggested that shifting this act under the abuse of dominant position provision (section 79) would be the preferred route. In this way, the treatment of vertical price maintenance under the law will better conform to contemporary economic thinking.

The Committee understands that a section 79 review has two advantages: the practice would receive a full hearing on its likely economic effects and would also be subject to a lower burden of proof (from “beyond a reasonable doubt” to “on the balance of probabilities”). Another difference, which could be an advantage or a disadvantage depending on one’s perspective, is that section 79 will require an assessment of the market power of the individual firm engaging in price maintenance. According to the VanDuzer Report, the market power test is an advantage because economic factors can easily be identified for discerning anticompetitive from pro-competitive cases. Indeed, the VanDuzer Report suggests three economic indicators of anticompetitive vertical price maintenance:

[I]n the area of pricing practices … [y]ou’ve had the benefit of Professor VanDuzer’s detailed report, which has examined the fact that some of those laws are economically no longer really very modern. [Neil Campbell, McMillan Binch, 59:11:25]  

I would encourage you … to look at the decriminalization of the pricing practices … those laws are out of date and out of sync with good economics. [Neil Campbell, McMillan Binch, 59:12:40]

        At the same time, the VanDuzer Report is unsure if the section 79 market power test is appropriate for vertical price maintenance cases.

       The Committee accepts all of the above reasoning. We believe that where the law can be modernized to better reflect conventional economic thinking, which in this case is able to properly distinguish between anticompetitive and pro-competitive incidences of vertical price maintenance, we should change the law. Given the recommended changes of section 79 (Chapter 6), reducing the bluntness of the Act in terms of vertical price maintenance should lessen the “chilling effect” on pro-competitive instances. The Committee, therefore, recommends:

Price Discrimination

       Price discrimination is a marketing practice whereby a supplier of goods or services charges different prices to different customers (whether other businesses or final consumers) and these price differentials do not accurately reflect differences in costs of serving the different customers. To be found discriminating on the basis of price, a firm has to meet the following conditions: (1) the firm must have market power to set prices (otherwise, consumers can choose to purchase from a competing supplier); (2) the firm must be able to identify classes of consumers with different price sensitivities; and (3) consumers have only a limited opportunity to resell to each other (otherwise, consumers would arbitrage these prices to the lower price offered).

       Price discrimination is a criminal act that extends only to “sales” of “articles” under paragraph 50(1)(a) of the Act and to promotional allowances under section 51. These provisions were introduced in 1935 in response to concerns of unfairness to small business, particularly in the grocery subsector, with the emergence of large retail discount and chain stores and following the Report of the Royal Commission on Price Spreads. Because paragraph 50(1)(a) only applies to “sales” of “articles,” leases and services are not covered. If the purchasers do not carry on business in the same market, such as the case where one is a final consumer and the other is a business, there is no offence. Volume or quantity discounts are exempted. There must be knowledge of each element of the offence. The supplier must have knowledge that the sale is discriminatory. Section 51 makes discrimination other than on the basis of price (i.e., differential access to promotional allowances) a criminal offence in some circumstances.

       Although price discrimination by definition means treating individuals or groups of consumers differently and may create an “unlevel playing field” when the product is an input into another product, it is not an inherently anticompetitive practice. It is often pro-competitive to charge different prices to different consumers when there are different costs attached to serving them (in the same way as volume and quantity discounts imply different costs and are not anticompetitive in and of themselves). Price discrimination may also result in additional sales, for example, to children and seniors who would not otherwise purchase the product. To the extent that the consumption of the good or service increases as a result, economic efficiency is being promoted.

When it comes to horizontal price maintenance, that ought to be dealt with under a new section 45. [Paul Crampton, Davies, Ward, Phillips & Vineberg, 59:12:25]

If I were to come to you and say “I’ll … come and pick the product up at your door, or I’ll warehouse the product, or I’ll perform some other function for you and save you money, if you give me a deal,” it’s arguable  … whether you could give me a discount in recognition of that pro-competitive initiative. It may be that I’m just a better negotiator. That maybe I’m going to do something for you in a different market. Buy more goods on a different market from you if you give me a better discount. What [the criminal offence] does is it just chills the negotiation process ... It would be a criminal offence for you to give me a better discount. So the whole competitive process that one would normally see between supplier and customer is chilled. [Paul Crampton, Davies, Ward, Phillips & Vineberg, 65:12:30]  

On price discrimination, we’re really weak in Canada compared to the U.S. because in the U.S. you can discriminate in price on the basis of volume. So you can, as a store for example, buy a product for less if you buy 100 than if you buy two. It’s completely arbitrary in our law. You can make a differentiation between one and two, or one and 5,000 — whatever you want — and set your price on that level. That’s the law in Canada. You don’t have to justify it on the basis of cost as a manufacturer. In the U.S. what you have to do is you can’t discriminate unless you can justify it. [Robert Russell, Borden, Ladner & Gervais, 65:11:15]

       Price discrimination is commonplace. For instance, a bank that offers students no-fee banking services in order to gain their loyalty later on in their lives is practising price discrimination. Many non-price techniques with similar aims to price discrimination could also be implemented to discriminate between consumers. Two classic examples are tied sales and multi-part pricing policies. The VanDuzer Report explains the tied selling technique:

There are questions as to whether the sections on predation and price discrimination, for example, should be decriminalized. People have been trying to address this for many years, and there are questions about the proper ambit of the abuse-of-dominance provision, among others.[Calvin Goldman, Davies, Ward & Beck, 59:10:50]  

        The VanDuzer Report concludes that:

The VanDuzer Report makes a very compelling case for decriminalizing price discrimination cases, and a consensus among competition experts has followed. The Committee, therefore, recommends:

The VanDuzer Report makes a very compelling case for decriminalizing price discrimination cases, and a consensus among competition experts has followed. The Committee, therefore, recommends: