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j Topics in Regulatory Economicsan d Policy SeriesMichael A. Crew, EditorGraduate School of ManagementRutgers UniversityNewark, New Jersey, U.S.A.Previously published books in the series:Hillman, J., and R. Braeutigam:Price Level Regulation for Diversified Public UtilitiesEinhorn, M.:Price Caps and Incentive Regulation in TelecomnmnicationsCrew, M. :Competition and the Regulation in TelecomnmnicationsCrew, M., and P. Kleindorfer:Competition and Innovation in Postal ServicesThompson, H.:Regulatory Finance: Financial Foundations oj-Rate of Return RegulationCrew, M. , and P. Kleindorfer:Economic Innovations in Public Utility RegulationCrew, M. , and P. Kleindorfer:The Economics of Postal ServiceCrew, M., and P. Kleindorfer:Regulation and the Nature of Postal and Delivery ServicesOren, S. and S. Smith.:Service Opportunities for Electric Utilities: Creating Differentiated ProductsKolbe, A. L., W. B. Tye, and S. C. Myers:Regulatory Risk: Economic Principles and Applications to Natural Gas PipelinesPecbman. C.:Regulating Power: The Economics of Electricity in the Information AgeGordon, R. L.:Regulation and Economic Analysis: A Critique Over 1Wo CenturiesBlackmon, G.:Incentive Regulation and the Regulations of IncentivesCrew, M.:Incentive Regulation for Public UtilitiesCrew, M.:Commercialization of Postal and Delivery ServiceSAbbott, T. A.:Health Care Policy and RegulationGoff, B.:Regulation and Macroeconomic Performance

THE ECONOMICS OF THE ANTITRUST PROCESS

edited byMalcolm B. Coate Federal Trade Commission

and Andrew N. K1eit Louisiana State University

..... " LUWER ACADEMIC PUBUSHERS BostoniDordrechtlLondon /qq;;,


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ReferencesBaseman, Kenneth C., Warren-Boulton, P. R., and G. A. Woroch. 1995. "MicrolOd PlayaHardball: Use of Exclusionary Pricing and T""lm.ical Incompatibility to MaintainMonopoly Power in Markets for Operating System Software." AMmut Bulktin40(2):265-315.Berlot, Ed. 1994. Letter to Editor. Byte 19(8):18.Easterbrook, Frank H. 1986. "On Identii)'ing Exolusionary Conduot." Notre Dame Law

Review 61(5):912-980.Flynn, Ida M. and AnnM. McHo . . 1991. Understanding Operating Systems. PacificGrove,

CA: Brooks/Cole Publishing Company.Fryer, Bronwyn. 1995. "Tho Sof\ware Police." Wired 3(5):88-96.IcllibiAh, Daniel and Susan L. Knepper. 1991. TheMaki:ng ofMWrosojt. Rocklin, CA: Prima

Publisbing.Mat.hillen, Tozjo. 1994. "Noven's Newest DOS." Byte 19(7):241.Ordover,Janusz A. and Solto C. Panzar. 1982. "On the Nonlinear Pricingof Inputs." Inu,....tional Economic Revi.... 23(3):659-675.Posner, Richard A. and Prank H. Easterbrook. 1980. Antitrust: Cases, Economic Notes IJIId

Other Malerials. SainI Paul, MN: West Publisbing Company.Rohm, Wendy G. 1994. "Ob No, Mr. Bill! The Inside Story of the U.S. Government',

Aotitrust Case Against Microsoft." Wired 2(4):90ff.Salop, Steven C. and David T. Soheffirum. 19&7. "Cost IWsing Strategies." Jo1lrMl of

Industrial Economics 36(1):19-34.Scherer, F. M. 1992. "Schumpeler and Plausible Capitalism."JOIlT1UlI ofEconomicLitera1UT'30(3):1416-1433.Scbulman, Aodrew. 1994. Uno:uJkorit.ed Window. 95. San Mateo, CA: IDG BookaWorldwide.Sohumpoler, Jo.eph A. 1950. Capitalism, Soci41ism andDemocracy (third ed.). N_ Yort:

Harper and Row.Wallaee, lames and Jim Erickson. 1992. Hard Dri>e: Bill Gates and 1M Making oj 1M

Microsoft Empire. New York: lohn Wiley and Sons.

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Chapter 10Predatory Pricing in the Retail Trade:The Waf-Mart Case

Donald J. Boudreaux 1

1. IntroductionIn 1987, Wal-Mart began selling pharmaceuticals in Faulkner County, Arkansas.Consistent with its overall retai1 strategy, Wal-Mart sought to sell a high volume ofpharmaceuticals at low lDHtgins. Wal-Mart's explicit policy was to never beundersold on a pharmacy item. Although the manager of each local Wal-MartpbB.rmacy had no autlwrity to raise prices above those set at WaI-MJU1.'sheadquarters, each manager was permitted to lower prices to beat those charged byrival retailers eVen if these prices were lowered below the wholesale prices paid byWal -Mart for the individual items it retailed.

Predictably - in light of antitrust's history of being used by firms to bludgeoA their more successful rivals (Bau:mol and Ordover (1985); McChesney and Shughart (1995 - WaI-MJU1. was sued in 1991 by three local ph.amuicies for attempting to monopolim the market for pharmaceuticals and health and beauty aids in FaulknerCounty. This suit, American Drugs, Inc. v. Wal-Man Stores, Inc. (hereinafter'Wal-Mal1 Stores"), was brought in Arkansas state rout! under Arkansas's UnfliirPractices Act, a 1937 statute reminiscent of the Robinson-Patman Act. AltlwughWaI-MJU1. lost in a bench trial, it narrowly prevailed on appeal to the ArkansasSupreme Court which found that Wal-Ma rt's pricing practices could not reasonablyhave been intended to destroy rompetition (as is ""luired by the Act).
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Apart from the attention it received in the popular and business press, Wal-MartStores raises a host of interesting economic and antitrust issues. I explore some ofthese issues below. In particular, I ask what it means to assert that a retailer intendsto monopolize an appropriately defined retail market through predatory pricing:when, if ever, are such attempts sensible? Can a retailer attempting to monopolizethrough a predatory-pricing strategy ever hope to do so by pricing some, though notall. of its retail itetnS below invoice cost'? Perhaps most fundamentally, 1 askwhether it can make any sense to distinguish predatory from non-predatory costs, asis now don e wit h the AreOOa-Tumer test. I also explore the still -largely-une xploredquestion of the incentives of manufacturers or wholesalers to take steps to keepretailing competitive. I begin, however, with a fuller acoount of the Wal-MartStores litigation.

2. The titigationThree local pharmacies in Faulkner County (American Drugs, Balcer Drugs, andMayflower Family Pb.annacy) jointly b'Ued Wal-Mart under an ArIo1nsas statutedesigned to prohibit predatory pricing. Because plaintiffs sought, in addition tod a m a ~ e s , to enjoin Wal-Mart 's pricing practices, the case was removed to chancerycourt.

Wal-Mart was accused of violating the statute in two distinct ways. The firstwas a straightforward predatory-pricing allegation based On the AreOOa-Turner(1975) test: the plaintiffs accused Wal-Mart of attempting to monopolize theFaulkner County retail market for pharntaceuticals aod health and beauty aidsthrough its policy of retailing a handful of its pharntaceutical item s at prices belowthe invoice costs Wal-Mart paid for these itetnS. Plaintiffs' exper t ecooomisttestified that the invoice cost of any pharmaceutical item is less thsn the averagevariable cost (AVe) of selling this item. It follows that Wal-Mart's below-invoiceprices on a handful of items were also below Ave. Moreover, this experteconomist argued that failure to maximize profits on any aingle product violates theAreeda-Turner test and is, thereby, evidence of predatory intent. Under this logic,the fact that below-invoice prices on pharntaceuticals items might increase WalMart's profits on other items is irrelevant for a predatory-pricing inquiry.3

Second, Wal-Mart was accused of trapping gullible consumers wbo, lured ontoWal-Mart's premises by the promise of exceptionally law prices on select items,would also purchase items with exceptionally high retail mark ups. The plaintiff'spleadings against Wal-Mart lumped the second allegation in with the first; it is as ifthe plaintiffs and their attorneys saw no difference between the two allegations. Ido not here address the allegation of 'Iow-price luring' because it i. not really anallegation of predation, an d the trial decision as well as the appellate opinion turned

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eXClusively on the plausibility of the claim that Wal-Mart attempted to monopolizethe relevant market through predatory-pricing practices.In partiCUlar, Wal-Mart allegedly violated the following statutory prov ision:It shall be unlawful for any .. corporation .. engaged in businesswithin this state, to sell, offer for sale, or advertise for sale lilly article orproduct . at less than cost thereof to the vendor . . for the purposeof injuring competitors aod destroying competition. 4

Thus, a successful plaintiff must prove three separate facts: (1) that the defen dantpriced (or offered to sell) a llood 'a t less than cost tu ' the defendant; (2) that suchbelow-cost pricing was done for the purpose of injuring competitors, and (3) thatsuch below-cost pricing was done for the purp ose of destroying competition.

The plaintiffs presented undJsputed evidence that Wal-Mart occa.sionaJly pricedindividnal pha.rmaceutic,oJ it ems beloW these items' iovoice costs. Indeed, Wal-Martadmitted this much. Wal-Mart, however, dmied that its practice of pricing abendful of itetnS below invoice amouoted to unlawful belaw-cost sales. Wal-Ma rtinsisted that the televant product is not any individoal item; rather. the relevantproduct is a market basket of PharmJlceuticals. Because there was no allegation thatWal-Mart ever sold any bundle of pharmaceuticalsat an aggregate price belaw cost - in fact, the Faulkner County Wal- Mart's pha.rmacy was continually profitab leduring the entire period of the alleged predation - if the relevant product wasdefined as a market-basket of pharmaceuticals, then Wal-Mart would win the caseoutright.

The trial court, however, accepted the plaintiffs' argument that the statole Wasaimed at below-cost pricing of individoal itetnS and could not sensibly be inletpretedto mean 'below-cost pricing of a market basket of goods.' I later discuss this issuein more depth.

The trial court then, having concluded that Wal-Mart did indeed price below cost, asked wbether or not such pricing Was intended to injure competitors and destroy competition. Recognizing that direct evidence of i firm's intent is virtually nonexistent, the trial court understandably sought to decipher intentby examining tru. facts aod circumstances surro unding Wal-M art's cba1lenged pricing ptactices.

The court listed six circumstances that in combination strongly suggested to itthat Wal-Mart's below-cost pricing was meant to harm competitors aod destroycompetition. These six circumstances are:

The number and frequency of below-cost sales. The extent of below-cost sales. Wal-Mart'. stated pricing policy - 'meet or beat the competition withoutregard to oost Wal-Mart's stated purpose of below-cost sales - to attract Ii disproportionatenumber of customers to Wal-Mart. 5

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The in-store price comparison of products sold by competitors, includingplaintiffs. Th e disparity in prices between Faulkner County prices of the relevantproduct-lines and other msikets with more or less competition.

With no additiODll! comment, the trial court concluded that the combinationofthese six circumstances prove d that Wal-Mart priced with the requisite predatoryintent. Therefore, Wal-Mart was ordered to stop charging below-invoice prices forits plw.tma

In shorl, a bare I!Illjority of Arkansas's Supreme Court understood that evidenceof below-invoice pricing, even combined with local variations in prices, bas aplausible pro-competitive explanation. As such, any inference of predatory intentfrom these facts alone is invalid.

Th e high court discussed three additional reasons wbyan inference of predatoryintent is inappropriate in this case. The first is that the plaintiffs "all continued into1993 making a profit.ll Although it is not necessary that an alleged predatoractually destroy a rival in order to violate the statute - below-rostpr i= combined

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with predatory intent is sufficient- failure to destroy a rival is nevertheless evidenceagainst an allegation of predatory intent. Presul!lllbly, a fum with pockets as deepas Wal-Mart could well have crushed eacb of the plaintiffs bad it been so inclined.Second, the market was served by several other pharmacies in addition to WatMart and the plaintiffs.12 Many of these other pharmacies were national retsilers.Recouping its predatory expenses would bave required that Wal-Mart cbaq:emonopoly prices after rivals bad been destroyed. Ability to Cbarge monopoly prices,bowever, required either that Wal-Mart successfully prey on all of its rivals _including nations! mail-order houses - or that WaJ-Mart successfully conspire tocartelize the market with those rivals against whom it did no t prey. No aIlegationawere I!Illde of either of these additions! tactics. The lesson bere is that aIlegatiDDBof predation against only a subset of rivals should be sufficient grounds for dismissalif the statute requires that the plaintiff prove an intent by the defendant to destroycompetition.

Third, the Arkansas Supreme Court took explicit notice of the statute',depression-era origins. As the ""urt pointed out, the legislature declared the statuteto be "an emergency measure' aimed at avoidin! bankruptcies whicb would'increas[e] the prevailing condition of depression. , I Regardless of the prudentialmerits of assisting macroeconomic recovery througb legislation aimed at stemmingbelow-cost pricing, the court wisely ruled that this statute should not generally beavailable for use by plaintiffs dismayed by rivals' loss-leading policies. Arkansas'.high court implicitly recognized what the United States Supreme Court explicitlyspelled ou t nearly a decade earlier in the Matsushita decision: 'cutting price in ordto increase business is often the very essence of competition. Thus, mistakeninferences in [predatory-pricing cases] are especially costf ' because they chil1 thevery conduct the antitrust laws are designed to protect. , I

3. Broader Economic IssuesStepping back from the details of the Wal-Man Stores ruling, it is interesting toinvestigate more generally some of the economic iSb1JeS raised by this litigation. Ifocus on four. Fint, is predation possible when a firm Cbarges prices below costson only a handful of items that it and its rivals sell? Second, uuder what conditiOl1llwill manufacturers wbo distribute through a suspected predator take steps to policeagainst this downstream predation? Third, does monopolization at one stage ofproduction necessarily harm finns upstream or downstream from the monopolist ifbargaining between the upstream and downstream monopolists is possible? In arecent article, Hove.nkamp (1991) argnes that it does not. I argne below thecontrary. Fourth and most fundamentally, does it make sense to distinguishpredatory from non-predstory prices on the basis of costs?

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3.1 Single Good or Market Basket?The trial court in WalMart Stores rejected Wal-Mart's argument that below-invoicepricing of a handful of items does not lUIlDunt to below-cost pricing of the kind thestatute aims to prohibit. Claiming to read the statote according to its plain mesning,the trial court noted that "the Act' applies to 'any article or product' and not'market basket' or 'overall product line' cost. ,I S While it is lnle that the statuteprohibits below-cost pricing of 'any article or product,' the trial-court's .reasoningbegs the question of how to define 'article' or 'product.' The statute itself does notdefine these terms. Although it may appesr superficially that the words 'any articleor product' means, literally, any individual article or product, well-acceptedpriociples of statutory construction require that words be interpreted in accordancewith the overall intention of the statute.16 The statute claims tu promotecompetition. It follows, then, that the interpretation of 'any article or product'should accord with the statut e's pro-competition purpose. 17So, it s appropriate to ask which interpretation best promotes the statute 's pm competitive goal: the trial-court's literal 'individual item' interpretation, or WalMart's 'market basket' interpretation. I f it is possible to monopolize a market bypricing a handful of items below cost, then the court's literal interpretation isjustified . But because success at predetion is impossible UDless the predator's belowcost prices threaten rivals' existence -- otherwise competition persists - below-costpricing of a mere handful of all items comprising the relevant product market isunlikely to promote monopolization. Hence, the proper interpretation of the statutein this case requires that the relevant items be defined as a 'market basket' of allpharmac


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in its contracts with the renegade retailer on minimum resale prices above predatorylevels.Other upstream strategies include refusing to deal with a suspected downstreampredator, charging higher wholesale prices to the suspected predator than thosecharged to the predator' s rivals (or otherwise giving the prey discounts on productsand special assistance with retailing efforts), and threatening a downstream predatorwith maximum RPM or sales quotas if the downstream stage becomesmonopolized. 22While minimum RPM directly blocks a retailer's ability to sell below cost thoseitems covered by RPM contracts, these other strategies raise the costs of attemptedmonopolization. Refusals to deal might do so in one of two ways. First, themanufacturer of the predatorially priced product might refuse to sell this product tothe suspect retailer. The retailer must then find a less-desirable item to use in pricepredation. 23 Second, because a monopolist retailer harms several manufacturers,an individual manufacturer suspicious of a retailer 's motives might pull its productseven if this firm's products are not those on which the retailer is chargingpredatorially low prices. If he manufacturer's brand is important enough to theretail trade that any retailer not carrying this brand is at a substantial competitivedisadvantage, then refusals to deal by this manufacturer can play an important rolein policing against downstream monopolization. (I address below the ince1llives ofupstream firms to police.) For example, if Coca-Cola believes that Kroger is aserious threat to monopolize grocery retailing in a particular (and appropriatelydefined) geographic market, then Coca-Cola could thresten to pu ll its products fro mKroger if Kroger continues its monopolizing efforts. Coca-Cola may do so whetherKroger charges predatorially low retail prices on Coca-Cola products or on otheritems. tThe same is true for price discrimination. Rather than refuse to deal, amanufacturer might charge higher wholesale prices to the monopolizing retailer.Rivals of the predator are thereby advantaged relative to the predator and are, hence,better able to survive a predatory price war.Finally, the threat of maximum RPM or sales quotas makes predation lessattractive to retailers. Mwmum RPM or sales quotas can force a monopolistretailer to price competitively. Consequently, a retailer that succeeds in oustingrivals will be unable to recoup its predation losses through monopoly pricing.Predation, therefore, is less attractive as a business strategy to the extent thatmaximum RPM or sales quotas are available to manufacturers. 24

Of course, as suggested above, free-rider problems may well frustrate effortsby suppliers to police against downstream monopolization. I do not here investigatein full the details of market arrangements that promote downstream policing bymanufacturers. I am content now to suggest the possibility, and to make a fewgeneral remarks. One obvious implication of this discussion is that a retailer whodistributes exclusively one manufacturer's products is in no position to predatorially

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price in a way antagonistic to the manufacturer's interest. If, say, an independentlyowned Texaco service station sought to monopolize the retail market for Texacogasoline in a particular town, Texaco could quite easily thwart this retailer'.scheme.25 Free-rider problems do not here exist, and Texaco could be certainthat whatever retaliation it takes against the retailer would have a substantial effecton the ret ailer's ability to successfully conduct business.

But manufacturer policing against retailer monopolization becomes less effectivewith increases in the number of different manufacturers whose products are hand ledby a predatory retailer. The reason is twofold. First , free-rider problems mightblock policing efforts. Even if a manufacturer could effectively threaten to penali zea predatory retailer, efforts to free-ride on the policing efforts of other similarlysituated manufacturers might block all policing efforts. Second, a manufacturer mayhave inadequate clout to punish a predatory retailer. When retailers carry theproducts of several manufacturers, only manufacturers whose goods are essential toretailing success have sufficient clout to police effectively against monopolizingefforts by retailers.26 A supermarket contractually bound to sell okra at a priceno lower than invoice cost is unlikely to be dissuaded from pursuing itsmonopolizing ways. Io contrast, a supermarket contractually prohibited fromcharging a predatory price on Coca-Cola may well find that i t cannot now as easilymonopolize the retail grocery trade as it would were it able to sell Coca-Cola atpredatorially low prices.

A corollary of this second consideration is that policing by manufacturers ismore likely when retail success depends upon being a "full-service" retailer - thatis, when consumers punish retailers who do not carry consistently adequate stocksof a minimally wide range of retail goods. Io such situations, anyone manufacturerwill more likely be able to stymie a retailer's predatory success by refusing to dealwith a retailer (or by dealing only on unfavorable terms)27 .

The retail pharmacy market seems to be especially of this type. Each majordrug manufacturer is the exclusive producer of several patented drugs; failure of aretailer to carry anyone of these drugs might substantially disadvantage a retailpharmacy relative to its rivals. Although retail pharmacies in Faulkner County eachcarried the products of dozens of manufacturers, failure to stock one particula rproduct from anyone of these manufacturers might exl'ose a pharmacy to seriousmarket discipline: if a customer asks for, say, Suprax,28 and the pharmacy doesnot carry Suprax, this pharmacy may well suffer a substantial diminution ofcustomer patronage if there is nO good substitute for Suprax produced by any otherpharmaceutical manufacturer. Thus, the clout of each pharmaceutical supplier topolice against retail monopolization is argusbly strong enough to render untenableany inference of predatory intent on the part of Wal-Mart. Putting aside otherreasons why Wal-Mart's actions were not plausibly predatory, each drugmanufacturer would plausibly have had incentives to police against monopolizati onof pharmaceutical retailing.

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I assumed away, in the above discussion, existing antitrust prohibitions. Undera legal regime with no antitrust restrictions, it is possible in many circumstances and plausible in some - that policing by upstream suppliers against retailers willadequately thwart downstream monopolization attempts. Matters are different underthe existing antitrust regime. While antitrust law does not now discourage allvarieties of policing efforts - unilateral refusals to deal and sales quotas areexamples of supplier strategies available under existing law - many other policingmethods are illegal. For example, the proscription against both minimum andmaximum RPM bloclcs what may well be the single most effective tool potentiaIl9'available to upstream suppliers to keep retail markets free of predators.2Similarly, the Clayton Act (as modified by Robinson-Patman) prevents suppliersfrom assisting with differentially lower wholesale prices the prey of a suspectedretail predator. Indeed, Sherman Act 1 prohibitions against collusion may obstructcooperation among suppliers to coordinate and share the costs of discipliningpredatory retailers. Whatever benefits are served by existing antitrust laws must beweighed against these (as well as other, better-known)30 costs.3. 3 Hovenkamp on Vertical AgreementsThe claim that firms at one stage of production might discipline monopolists at otherstages is not new (e.g., Kleit and Coate (1993, although I am unaware of anyargument that such discipline might obstruct predation. Typically, this claim is madein the context of a buyer with some monopsony power forcing down prices chargedby a supplier garnering monopoly power through merger. I f the buyer hassubstantial bargaining power, there is less need to worry about monopolization at thesupply stage. A handful of recent antitrust decisions explicitly rely upon this insightto strike down attempts to block mergers. For example, in U.S. v. Country LakeFoods,31 a U.S. District Court refused to condemn a merger of fluid-milkprocessors. Although this merger resulted in high concentration among fluid-milksuppliers, the court focused on the fact that the three largest customers of thesesuppliers purchase 90 % of these suppliers' output of fluid milk. The court waspersuaded by the defendant's claim that the dominance and sophistication of itsbuyers would stifle any attempt by the defendant to behave anticompetitivelyfollowing the merger.

A similar conclusion was reached in U. S. v. Syufy,32 although in this casea merger among buyers was challenged. In Syufy, Judge Alex Kozinski rebuffed thegovernment's efforts to block a merger of u.s Vegas movie exhibitors. JudgeKozinski held that the substantial market power of movie producers is sufficient tocheck any monopoly power that might exist among u.s Vegas theaters.Hovenkamp challenges the logical bases of these rulings. After rightly pointingout that "[t]irms generally prefer neither to purchase from monopolists nor to sellto them," Hovenkamp argues -- contrary to CountryLake Foods, Syufy, and similar

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rulings - that this fact does not imply that firms at one stage of production haveincentives to destroy monopoly power at another. Hovenkamp 's conclusion isinspired by the Coase Theorem, which "suggests that vertically related firms wouldprefer to share the profits of monopoly rather than to compete them away.Vertically related firms tend to make bargains that maximize joilll profits."(Hovenkamp (1991, 1371) (original emphasis).) Hovenkamp concludes from thisfact that monopolist suppliers do not necessarily wish to sell to competitive retailers,and that monopolist buyers do not necessarily wish to purchase from competitivesuppliers. Rather than eliminate monopoly power at stage n of the productionprocess, a monopolist at stage m will allow the monopoly at stage n to persist if themonopolist at stage n shares its monopoly profits with the monopolist at stage m.

Hovenkamp's conclusion is incorrect. Maximizing joint profits requires thatall stages of the production process, save one, perfo rm competitively. AlthoughHovenkamp correctly suggests that vertically related monopolists may haveincentives to cooperate, such cooperation will result in one or the other pricingcompetitively. Failure to cooperate in this way among vertically related monopolists- or failure of one monopolist to compel the other to behave competitively - result sin the "double marginalization" problem. When two or more vertically related firmseach skim off monopoly profits, each taking the outputs and demands of all othervertically related firms as given, aggregate monopoly profits in this industry arelower than if only one stage of the production process behaves monopolistically.33

Of course, competitors as well as monopolists want their vertically relatedbrethren to behave competitively. But unfortunately for firms in competitiveindustries, free-rider problems may prohibit them from challenging the exercise ofmonopoly power by a buyer or supplier. In contrast, firms with monopoly powerhave not only unsullied interests in the competitive behavior of each of theirvertically related firms, they also are more likely than competitors to possesseffective means of forcing vertically related firms to behave competitively.

One or the other of two vertically related monopolists might, with sufficientbargaining skills, force the other to behave competitively. I f no one firm can prevailon the other to behave competitively, a vertical merger may result.34 In eithercase, vertically related monopolists have both the incentive and the ability to solvethe double-marginaIization problem by getting rid of monopoly effects at all but onestage of production.3.4 'Predatory'versus 'Non-predatory' PricesUntil now, I have not questioned the use of some measure of cost (e.g., AVe) todistinguish predatory from non-predatory prices. However, cost-based distinctions,most notably the Areeda-Turner test, are biased in favor of false-positive findings - i.e., falsely identifying low prices as predatory prices.35

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A price is predalnry if it is reasonably intended In secure a monopoly. But thesymptoms of predation are strikingly similar In those of healthy competition. Torelieve courts of the impossible task of divining defeodants' intent, Areeda-Tumer(1975) constructed a cost-based test that allegedly offers courts an objective way Inidentify predation. Under the Areeda-Tumer test, prices above average lntal cost(ATe) are per se legal, prices lower than ATe but not below AV e arepresumptively non-predalnry, and prices below AV e are presumptively predalnry.

While the Areeda-Tumer test improved courts' treatment of predation claimsby abifting attention away from bell igerent language often found in internal companymemoranda (Elzinga and Mills (1994, this test is fundamentally flawed. The legaltreatment of predation would be further improved if aU pricing practices were perse legal. No one should bave stsnding In sue for predation based upon a defeodant'slow prices. The reasons are fourfold: (1) misidentifying competitively low pricesas predalnry chills competitive behavior; (2) costs are inherently difficult In measurebecause they are only imperfectly proxied by accounting data;36 (3) firms willalmost never pursue monopolization through below-cost pricing; and (4) therelationship between price and cost at any moment says nothing about predalnryintent or likelihood of predatory success.The first two reasons are widely recognized and will not be discuased further.Although much has been written about the third reason (Easterbrook (1981a, sti1Imore can be said. But saying more requires first an understsnding of the fourthreason - that is, why the relationship between price and cost yields no informationabout predatory intent .The Areeda-Tumer test rests squarely on the belief that P


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There are, though, seveml well-known reasons for doubting that predation evertakes the form of below-(:ost pricing (Easterbrook (1981.. To these well-knownreasons, I add others suggested by the realization thet a would-be predator typicallyhas available investment opportunities thet can substitote for beIow-


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S. The: trial court reported all an undisputed fact that Wal-Mart's purpose was tD attract a Irdiaproportionatc number of c:ustomcn to Wal-Mart." But thi. concluaionwail utUustified. Wal-Mart' . exccutive. never testified that Wal-Mart lIOugbt tD au.mct a ~ d i s p r o p o r t i o n a t c number of cuatolllMa, " nor wu any offered (0 IUpport thia finding. Apparently, the lrial judge miauaed an innocen.t atAtcment from tho teat.imony of Wal-Mart". expert e:conomiat aa the basi. for :finding that Wal-Mart acughtto attract d'Uproportionateaumfuo of customers. At trial, W a l ~ M . r t a expert explained why b i g b ~ v o t u m e retailers might price aome: items below invoice cost. The context ofthia testimony makes cte.ar tha[ Wal-Mart'. witn.ei& WI. not tcltlfYiJli about Wal-Matt'. fonnaI company policy. Rather, the witneill meant only to explain that beJO"N..mvolcc pricing

i.a way to help attract a number of cuatom.rs into the store who otherwiae would not come to the stole.

6. Wal-Man Stores, Inc. v. American Drugs, Inc., 819 S.W. 2d 30 (1995). Plaintiff" petitio. forrebearing was denied.7. -"The lndividuaJ itemt acid below cost. the frequency of hofiC. salea, the duration of those Ales. andthe extent of auch salea an:. not revealed in the chancery c o u r t ~ s opinion. And that i.a a critic:al poinl inthi. caN." [d., at 34.8. Id., at 34.9.ld., at 34-5.

. 110.ld. at 35. ;11. [d. at 36. Indeed, 000 pJaintiffvinuaUy admitted at trial that WalwMart cauaed him tD behave mol'lleffillliently:

Q. [from Wal-Mart's attorney1 Your grou proflt in the yeat tha' Wal-Mart went into busin. . . against you in the pharmacy, your gro .. ptotil. increased by $1I0,OOOdollara. Do you ICe that? A. I may have done. lot of bell tighten.ltia during that yc.at.

Trial record, at 1634.12. The court lumped thi. second rcaaon in with the rU'lt. WaJ-MilI't Stares, at 36. 'I'beie reuotU a r e ~ h o w e v e r ~ distinct. Failure to run the plaintiffs from the market i. evidence supporting the claim chat thedefendant - oapcci.ally one . . wealthy Wal-Mart - never acted with a specific deaign tD banbupl theplabniff.. Thc llXiat.ence of other eatahliahed rlvali i.. evidence a,ainal the proposition hat the defendantacted with an intent to destroy competition gencnll y in the market. It .a more coady to run many rivalafrom an i.ndustry than tD bankrupt only a mw. Ort what may be the I I lmC thing, an induatry with acvcra.lfinna wggeats that the optimal-aize firm 10: that induatry minimlzea ill coats at an output level fat below100II market demand. MainIaining a mooopoly in . " industry .haracteriud by OIUply inc.,...;",g .0 ....and whcn the optimal number of minimum--co&l firma it two or more, la unUkcJy to be profitable.13.ld., at 36.14. MlflSushiUJ Elecrric lndusrrial Co. y. Zmilh lWdio Corp., 475 u.s. 574,594 (1986; Powell,S. ).

15. Trial court opinion, at S.16. Otherwiae. e.g., no store could ever give away ,oodi a, priz.ca in promotional c;ampaigna. Onprinciples of statutory COnst.n.K:tioD, ICe Sutherland (992).17. See alao. e.g., Westem UrtianF1nanciaJ Services, Inc. v. First DakI C o r p . ~ el aJ. 25 Cal. R p t r ~ 2 d 3 4 1 (Dec. 14,1993). W. . . .m Uoionaued V"'" D,.. C"'!'. underCallfurnio', Uafak Pnwticc. ata"'te (whichj, aimilar. though GOt identical, to the ArkallSl. atatute at iHue in WaJ-Mmt Starn). The cb.a:tge WI.predatory pricing of money-U'anafer service. . In Wutem Union thc< California appd1atc court ltate d thatthe proper definition of the product in queation must accord with the atatutc', pro-compctition inten.tioD.18. SpcDjilor(l950); Bark (1954); M""hlup and Tabe r (1960); and Blair and Ka..nnan (1983). Sullivalland Hovenbmp (1989. 368) IUm up: "Any finn, even a monopoliit. is bu t off if aU other firma in th6d1at.ribution chain are behaving competitively."19. n e labels "downst.ream" and upstream'" ate aroltrary in many ~ I C ' ! "down.st.ream" fuma Cd oftenbe n:.caa' .t uplJlream IUpp1icrs of serviccs (e.g., retailers .upplying retail ICt'Vices to "do'\tlJlitt'e.am"manu(acture"'). See Krattorunaker and Salop (1986,226-27).20. For a general model &howing how a sophiaticated . l ler whose salea are large portion of an iDpu1marketmight encourage compc


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26. Of course. policing by manufaetutera might still be pouib1c even when the predatory retailer carrietthe products of thousand. of d i f f c r e n t m a n u f & , N m ' $ ~ if he producuof one Or two oftheae JmtJlUwctureraarc ~ e u c n t i a l ' to ~ t a i t i n g IUCCess (e.g., .. Kellogg" breakfa31 cereals arguably are to the retail grocerytrade). then a threat to pull such products might be tufficient to discipline the :reWler.27. More generally. policing by a manufacturer A more likely the fewer the number of compelins'brands retailer carriel of ln y product the .tacking of which i. critical to retail IUCCCII.23. Suprax. manufaelU:d exclusively by LederJe Co., i, .n antibiotic prescribed by phy.icia.nsfur earinfections.

29. It is weD understoodthat the l a w ~ & prohibition of rnaximumIU"M weaUo.a mppWta* abilitica to bc pdlstributors from exttaoting monopoly profita from cOlWuncra. Sec Easterbrook (1981b) and Blair andKaSCtman (198l). The .rgument here build. upon thia insight: if' maximum RPM Were legal, a fUpptierbehaving pt:eda.torially today has le u chance of oocouping itt predation loasea t om o.m )W (even if it drivuan rivals from the market) because of the threat of maximum RPM. Therefore, predation today is Ie. .likely.30. Schwartz (1986) offers a particularly persuaaive indict.tnont of the Robinson-Patman Act - the fcde.n:lversion of the atate Ratutc underwhicb Wa.I-Mart WiiI81.led in WoJ-Man Szor u. Afte-r aurveyit.1s: a varlfiyof real-world comlequencea of R o b i n s o n - P a t m a ~ Schwart2. concludel that ..What i. c1eac i. that the Ac:lhaa produeed numerous perver:ie relUla ..- [at 756].31. 754 F. Supp. 669 (D. MllUl. 1990).32.903 F.2d 659 (9Jh Ca . 1990).33. See Kaserman and Mayo (1995, 306..()7): "Th.uB, with a separate mODopoIiat .t each of lb. twoRlcceuive l tagu ofproduction, consumeaare worse off than they were with a lingle monopoly at eitherR ap or an intc:gntte-d monopoUst that eonlfols hom lUges. Fi.o.al output price is higher, and quantity i.alower.-In addition. the sum of profits of the two separate monopoliab ill le u dum the proota that QQUJd beearned by a single vertical monopolist.34.10. at l07. s... aloo Klein, Cmwford, and Akhlan (1978).35. The A:ceeda-Tu.mer test bu been ACcuaed by earlier critic. of bias in favor of faJ.se-.negadn .findings.See, e.B., Scherer and Rosa (1990), 472-479. None of these earlier critio;:s question the IIOUDdocu of c o a t ~ baaed distinctions between predatory and Don-pNdatory pricCI.36. Boudreaux. Elzinga, and.Mill. (1995) relate an example from a re.ceot a01ib:ust 98 & oftbe exorbitanteomp1exity of estimating o;:Oil.a from A C data.31. Idei rufOning waa uaed by the p l a i n U f f J ~ expert economial in the Wal-Matt case. s. . TrialRIloord, 111844, 1855.38. 1b t s, bccau&e the ococlauic.tlpattial-cquilibrium model (llke aU useful model.) doca DOt explaineverything, it iJ illegitimate to cooolude th.t actiOml i.nc:onsiste01 with what the model doci explain areneccasarily irntLional, inefficient, or IIOCwly noxious.

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39. Or, if there is an cconoroio;:al1y relevant d i f f e r e ~ between theae two mean.a, thla difference it notexposed by the convontionalmod el withjn Which predatory pricing ill analyzed. Again. bclo'llt":M pricingwithin the modeJ: ia read u evidence of predation for no Ml80n other than that below-(:o" pricing iI~ j & t e n z . with WrtlUil of profil-maJtimizing bchaviora identified wit hin the model. M o r e o v c t ~ even ifpredation Were the only reuon a real-world firm would ever charge priCCI below AVC, nothing in theconventional model augpsls that b e l o w ~ o a t pricing il more or le.alikely than other fonna of inVCltmcnLI(e.g product-quatity improvements) to result jn monopolies40. For the record, I do not. believe that non-price predation, appropriate.ly defined. ocQUra with any&cqueno;:y in reality. My intuition il buutesscd by the recent retcarch of Lopatka and Kleit ( 1 9 9 S ) ~ Moreover. to the extent that non"Pr1ce predation docl tlICO;:Ut, traditional tort. eonuact, and o;:riminal....wn:mcdie. are adequate. to combat it.

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Refer"""",An:cda, Phillip and Donald F. Turner. 1975. "Predatory Pricing and Relate

Seetion 2 of the Sherman Act." Harvard Law Review 88(4);697-733.Baumol, William 1. and Janusz A. Ordaver. 1985. "U ofAntitrust to Subvert Competition."

Journal ofLaw and Economics 28(2);247-265.Blair, Roger D. and David L. Kaserman. 1981. 'TheAlbrtchlRule and ConsumerWelfa.rc :

An Economic Analysis." University ofFlorida Law Review 33(4):461-484.Blair, Roger D. and David L. Kasennan. 1983. The Law and Economics of Vertical

Integration and ConJrol. New York: Academic Press.Bork. Robert H. 1954. 'Vertical Integmtion IUld the Shenrnm Act: The Legal History of an

Economic Misconception.' University of Chicago Law Review 22(1):157-201.Boudreaux, Donald J Kenneth G. Elzinga, and David E. Mills. 1995. "From Fruit Pie& toCigarettes: The Supreme Court's Predation Odyssey ... Supreme Court Economic Review4(1);57-93.EAsterbrook, Frank H. 1981. 'Predatory Strategies and Counterstrategies. University ofChicago La w Re';.. . 48(2);263-337.Easterbrook, Frank H. 1981b. 'Maximum Price Fixing." University of Chicago Law Review48(4):886-910.Elzinga, Kenneth G. and David E. Mills. 1989. "Testing for Predation; Is Recoupment

Fea.ible?" Anlirrus/ Bulletin 34(4);869-893.Elzinga, Kenneth G. and David E. Mills. 1994. 'Ttumping the Areeda-Tumer Test: Tbe

Recoupment Standard in Brooke Group." Antitrust Law Journal 62(3);559-584.Hovenl:amp, Herbert. 1985. Economics and FederalAnlirrustLaw. St. Paul: Weat PublishingCo.Hovenkamp, Herbert 1991. 'Mergers and Buyers." Virginia Law Review 77(7):1369-1383.Ksaerman, David L. and John W. Mayo. 1995. Government and Business. Fort Wottll:

Dryden Press.Klein, Benjamin, Robert A. Crawford, and Armen A. Alew. 1978. 'Verticallntegration,

Appropriable Rents. and the Competitive Contracting Process." Journal of Law IIIldEconomics :/-1(:/-):297-326.

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K1eit, Andrew N. and MalCOM B. Coate. 1993. "Are Judges Leading Economic Theory?Sunk Casts, the Tbreat of Entry and the Competitive Process.' SoUlhern Ecozwmi

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