Commentary: Predatory Pricing: Cleared for Takeoff

A federal judge's ruling makes it easier for big companies to shut rivals out

By Dan Carney

When a federal judge threw out the Justice Dept.'s "predatory pricing" case against American Airlines Inc. on Apr. 27, it wasn't even front-page news in most cities. But the ruling, which the Administration is not expected to appeal, will likely have an impact well beyond the airlines. "This case represented the department's best efforts to fashion a predatory-pricing doctrine for the New Economy," observes Washington antitrust attorney Robert A. Skitol.

Best--and for now, probably last. The suit's failure means the virtual end of predatory pricing as an antitrust issue for the foreseeable future. But that doesn't mean the problem will go away. Instead, the judge's ruling opens the door for dominant companies to wage bare-knuckles price wars against pesky smaller competitors. The consequences could be especially serious in New Economy industries such as software, chips, and computer hardware.

UNIMPRESSED. Here's why. To win a predatory-pricing case, trustbusters traditionally had to prove that a company sold products or services for less than its average variable cost. But Justice Dept. lawyers realized this would be almost impossible to do against American. Why? Because the airline industry, like high tech, has high fixed costs and low marginal costs. The big expense is buying equipment. Once a flight is scheduled, the marginal cost of providing a seat for an additional passenger is peanuts--plus a Coke, maybe.

So Justice attorneys argued that the test should be updated. Specifically, they suggested that U.S. District Judge J. Thomas Marten, based in Wichita, should determine whether there was any business justification for American's aggressive pricing, other than driving away competition.

Under that definition, trustbusters thought they had a great case. Every time a fledgling airline tried to get a toehold in the Dallas market, for example, American met its fares and added flights. As soon as the rival retreated, American jacked fares back up. Between Dallas and Kansas City, for instance, American's average one-way ticket was $108 before low-cost startup Vanguard Airlines Inc. entered the market in early 1995. That prompted American to cut fares to $80 and almost double the number of daily flights, to 14. When Vanguard gave up in December, 1995, American jacked up prices to $147 and scaled back the number of flights. Justice lawyers even had memos from American execs plotting the upstarts' demise.

Alas, Judge Marten would have none of this. Unimpressed, he stuck to the old definition of predatory pricing. "American priced its fares consistently above its average variable costs," Marten wrote. While Marten acknowledged that predatory pricing existed, he doubted that judges would be able to distinguish it from good, old-fashioned competition. "Identifying [predatory pricing] in the particular case without chilling aggressive, competitive pricing is far beyond the capacity of any antitrust tribunal," he wrote, quoting from a well-known antitrust treatise.

"SOLE SURVIVOR." Now that the average-variable-cost standard has been etched into law, it will be a lot easier for dominant companies to drive their rivals out of business. "This effectively means there can be no price predation" in industries with low variable costs, says New York University law professor Eleanor M. Fox. Beyond airlines, these industries are primarily found in New Economy sectors. Most of the cost of making software, chips, and prescription pills, for example, is in research and development. Once that money has been spent, the cost of making additional units is tiny. In these businesses, aggressive pricing can leave dominant companies "as the sole survivor," says analyst Roger Kay, of IDC in Framingham, Mass.

Indeed, Intel and Dell Computer have recently begun aggressively cutting prices. Nobody is accusing them of illegal predation. But in the wake of Marten's decision, they may be able to lower prices into previously unexplored territories.

Of course, low prices sound great for consumers. And they frequently are. But so is competition. Marten's ruling, by putting whole parts of the economy off-limits to predatory-pricing suits, could wind up costing some consumers a lot more than peanuts.

Carney covers legal affairs from Washington.

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