Predatory Pricing Enforcement Guidelines

Table of Contents

• Preface
• Interpretation
• Executive Summary
• Part 1 - Predatory Pricing
• Part 2 - Enforcement Guidelines
• Appendix 1 - Case Studies

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Preface

The criminal sanction against predatory pricing has been part of Canada's competition law for over 50 years. Section 50(1)(c) of the Competition Act, as the provision is now known, rejects the concern that certain unfair pricing methods should not be used in the short run to diminish competition and the benefits which flow from it in the long run. This type of undesirable pricing behaviour is known as "predatory pricing."

Placing a criminal ban on a range of price competition, as section 50(l)(c) does, carries with it the risk that business persons may, because of uncertainty about the application of the law, refrain to some extent from engaging in price competition which would be healthy and beneficial. This is heightened by the globalization of markets and increased foreign competition. It is important to ensure that the enforcement policy for predatory pricing does not have a chilling effect on price competition. At the same time there has been little jurisprudence to guide lawyers and business persons as to when they might run afoul of the law.

Therefore, it was determined that, as part of our Program of Compliance, it would be helpful to publish guidelines to clarify the enforcement policy of the Director of Investigation and Research with respect to section 50(1)(c) to ensure that members of the public better understand the circumstances which may lead to an investigation under the Act.

These Guidelines address a number of key issues raised by the provision but they cannot anticipate all questions that may arise in the marketplace. They may be updated from time to time to account for future developments in law and policy.

Howard I. Wetston, Q.C.
Director of Investigation and Research
Bureau of Competition Policy
Consumer and Corporate Affairs Canada
March, 1992

Interpretation

These Guidelines supersede all previous statements made by the Director of Investigation and Research or other officials of the Bureau of Competition Policy that may differ from anything stated herein.

This document provides the general approach that is taken to the investigation of predatory pricing complaints under section 50(1)(c) of the Competition Act. It is not a binding statement of how discretion will be exercised in a particular situation. Guidance regarding a specific situation may be requested from the Bureau through its Program of Advisory Opinions. The Guidelines are also not intended to bind or affect in any way the discretion of the Attorney General in the prosecution of matters under the Act. Nor are they intended to be a substitute for the advice of legal counsel. They do not represent a significant change in enforcement policy or a restatement of the law. Final interpretation of the law is the responsibility of the courts.

For the sake of brevity the following terms are used throughout these Guidelines:

? "The Act" refers to the Competition Act, R.S.C. 1985, c.C-34, as am. R.S.C. 1985, c.27 (1st Supp.), ss. 187, 189; R.S.C. 1985, c.19 (2nd Supp.), Part II; R.S.C. 1985, c.34 (3rd Supp.), s.8; R.S.C. 1985, c.1 (4th Supp.), s.11; R.S.C. 1985, c.10 (4th Supp.), s. 18; S.C. 1990, c.37 ss. 27-32.

? "The Director" refers to the Director of Investigation and Research of the Bureau of Competition Policy, Consumer and Corporate Affairs Canada.

? "The Guidelines" refers to this publication, the Predatory Pricing Enforcement Guidelines.

? "Part" refers to a part of these Guidelines.

Executive Summary

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What Constitutes "Predatory Pricing"

In Part 1, the Guidelines discuss the meaning and significance of predatory pricing in the context of section 50(1)(c) of the Competition Act. In general terms, predatory pricing is a situation where a dominant firm charges low prices over a long enough period of time so as to drive a competitor from the market or deter others from entering and then raises prices to recoup its losses. While predatory pricing is frequently alleged, relatively few matters have led to formal inquiries by the Director or referral to the Attorney General for prosecution.

After presenting the basic elements of an offence under section 50(1)(c), Part 1 proceeds to a summary of the salient features of the jurisprudence in the two cases of record under this provision, Hoffman-La Roche and Consumers Glass. Although these cases do not provide a comprehensive analysis of the meaning of all of the elements of the provision, they do give general guidance on the circumstances that would lead to a finding of "unreasonably low" prices, the main issue in the assessment of predatory pricing complaints. This case law provides that while price/cost comparisons are an important element in determining unreasonably low prices, they are not necessarily determinative unless the price is clearly above cost.

Enforcement Guidelines

Part 2 outlines the approach taken by the Director in examining complaints of predatory pricing. The assessment of whether the prices under review are "unreasonably low" is the initial focus. This involves a two-stage analysis. The first stage is to determine whether the alleged predator has market power, the ability to unilaterally affect industry pricing. At the outset of an examination the Director often uses as a rough proxy a market share of 35 percent, below which it is unlikely an alleged predator possesses market power. Also considered is the total number of sellers in a market, the degree of size inequality among firms and the trend of market shares over time. These are preliminary indicators of market power.

A fuller appreciation of market power is obtained when the Director proceeds to the analysis of the conditions of entry in the market(s) under examination. If a number of factors combine to suggest that entry would be relatively difficult this would strengthen the Director's concern that the pricing behaviour of the alleged predator could cause harmful long-term anti-competitive effects in the market. The Guidelines present and discuss the two general categories of entry conditions which are the focus of analysis: cost advantages and sunk costs.

If a firm has market power, then the examination of unreasonably low prices proceeds to the second stage to consider the relationship of price to the underlying cost of production. Three rules of thumb are employed. First, a price at or above the average total cost of the alleged predator will not be regarded as "unreasonably low" by the Director, regardless of how much market power is possessed by the alleged predator. Second, a price set below the average variable cost of the alleged predator is likely to be regarded as "unreasonably low" by the Director, unless there is a clear justification, such as the need to sell off perishable inventory. Finally, if prices fall somewhere between average total cost and average variable cost (the "grey range"), a number of surrounding factors are considered, including the strength of demand, the existence of excess capacity and direct or indirect evidence of intent to use pricing for an anti-competitive purpose.

The next element considered in the Guidelines is whether the prices of the alleged predator constitute a "policy of selling". Here, the Director looks for evidence that the prices are part of a deliberate corporate program of pricing in the market and that they are in effect for a significant duration of time.

The Enforcement Guidelines conclude with a brief presentation of the meaning applied by the Director to the competitive impact of the offence described by the phrase "having the effect or tendency of substantially lessening competition or eliminating a competitor, or designed to have that effect".

Part 1 - Predatory Pricing

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1.1 Predatory Pricing Theory

The concept of predatory pricing is best illustrated by a dominant firm in a market setting its prices so low, over a long enough period of time, that it may drive one or more of its competitors from the market, or deter other companies from entering the market, or both. Following the exit of competitors from the market, or upon successfully deterring new entry, the predator is expected to raise prices significantly in an attempt, in the now less-competitive market it had created, to recover the costs incurred (i.e., losses or forgone profits) during the period of predation.

This is precisely the type of conduct that the Director seeks to identify in response to situations brought forward for examination under the statute. Although such pricing behaviour does confer some benefits to the purchasers in the market during the period of predation, those benefits will be transitory or short-term, and eventually outweighed by increased costs during the period of recoupment.

In the years since the enactment of the statute, enforcement experience and developments in economics have produced an analytical framework which helps to identify pricing behaviour which is truly harmful to competition, as distinct from that which does not require corrective action. As a result, predatory pricing, which is subject to the competition laws of many nations, has become a better understood phenomenon internationally in more recent times, and its treatment from a competition policy viewpoint now benefits from a more cohesive, analytical approach.

1.2 Enforcement Perspective

Historically, the Director has received few predatory pricing complaints which justified referral to the Attorney General of Canada for prosecution. In short, pricing behaviour of the sort prohibited by the statute has proven to be a rare rather than a common occurrence in Canada. For example, in the period 1980 to l990 the Director received some 550 complaints alleging an offence under the predatory pricing provisions. Of those complaints, only 23 resulted in formal inquiries under the Act, four were referred to the Attorney General, and only three resulted in the laying of charges 1.

In addition to section 50(1)(c), the Competition Act contains a non-criminal provision, section 79, which can be used to address abuses of market power by means of a broad range of anti-competitive acts, including predatory pricing behaviour. Section 79 gives the Competition Tribunal, a specialized body composed of judges and lay members, authority to impose remedies that are reasonable and necessary to overcome the effects of anti-competitive practices. Thus, given that predatory pricing may be dealt with under section 79 or section 50(1)(c), the Director will adopt an enforcement approach that is appropriate to the particular facts of each case. Where predatory pricing behaviour is used in conjunction with other types of anti-competitive acts, or where a more effective remedy can be obtained from the Competition Tribunal to correct the anti-competitive effects of the practices at issue in a particular case, the Director will generally choose to proceed under section 79 rather than under section 50(1)(c). The market power analysis set out in the following pages of these Guidelines can be readily applied to the statutory language of section 79 when addressing predatory pricing behaviour 2.

1.3 The Statutory Provision

Section 50(1)(c) of the Competition Act states:

"Everyone engaged in a business who ...

(c) engages in a policy of selling products at prices unreasonably low, having the effect or tendency of substantially lessening competition or eliminating a competitor, or designed to have such effect,

is guilty of an indictable offence and is liable to imprisonment for a term not exceeding two years."

As set out in section 1.1, the Competition Act's purpose "is to maintain and encourage competition in Canada" (emphasis added). Section 50(1)(c) of the Act is consistent with this purpose by prohibiting those forms of pricing behaviour which, though they may provide short-term benefits to buyers in a particular market, are designed to frustrate and interfere with the process of competition in the longer term, an outcome ultimately detrimental to consumers.

1.4 Elements of the Offence

The statute sets out a number of elements which must be satisfied for an offence to have been committed. The alleged predator must be shown to be "engaged in a business." The prices at issue must be "unreasonably low." They must be part of a "policy of selling". They must be shown to be "designed to" or to have "the effect or tendency of" bringing about one of two effects; to wit, "substantially lessening competition or eliminating a competitor". From an enforcement standpoint, all elements must be met, and no case can proceed without each element being satisfied. However, the threshold issue in a predatory pricing complaint is the reasonableness of the prices themselves.

1.5 Relevant Jurisprudence

The jurisprudence with respect to section 50(1)(c) is restricted to two contested cases, each of which has provided guidance in the formulation of the Director's enforcement policy.

In the Hoffman-La Roche 3 case, a conviction was obtained concerning a drug give-away policy which was designed to limit the entry of competitors. The Court stated categorically that: "(i)f an article is sold for more than cost, it can never be held to be unreasonable."4 At the same time, it made clear that one may not infer, simply from the relationship between prices and costs, whether or not a price is "unreasonably low". Rather, the Court held that even in instances of below-cost pricing there could be numerous other factors affecting that evaluation, including the duration of the prices, the competitive circumstances (i.e., whether the prices were offensive or defensive in nature) and the existence of legitimate long-term economic benefits accruing to the seller from such pricing. In essence, the Court recognized that while price/cost comparisons are an important ingredient, they are not necessarily determinative unless the price is clearly above cost.

A second key element dealt with in Hoffman-La Roche had to do with intent. The Court found that the accused's pricing policy was "designed" to be predatory from a number of factors, including the magnitude of the price cuts and the losses thereby incurred, the narrative contents of internal company records, and the absence of any other rationale for the price cuts. The Court did not have direct evidence of intent; rather, circumstantial evidence was sufficient to determine predatory intent.

Finally, the Court acknowledged that the many factors described as making up the offence of predatory pricing should not be treated as mutually exclusive, but are related and interdependent.

The second contested case, Consumers Glass 5, focussed on the question of whether or not the prices were "unreasonably low," and conflicting economic theories about what should constitute the appropriate price/cost comparison for purposes of determining reasonableness. The Court found that the accused's prices were at all times greater than average variable cost (but below average total cost) 6. In addition, the industry was suffering from chronic over-capacity. In light of these facts and because the accused was simply minimizing losses, the Court declined to convict. As in Hoffman-La Roche, Consumers Glass affirmed that, while price/cost comparisons are an important element in determining price reasonableness, the context within which prices are being applied is also of considerable importance.

An important theme of the judgement in Consumers Glass is that the law against predatory pricing should not interfere with legitimate competition. For example, the Court observed that it is possible for a competitor to be eliminated from the market without offending the law:

"The whole object of competition is to maximize profits by taking as much business as possible away from rivals, and so the mere fact one competitor lowers prices so as to take business away from a rival to the point that the rival might be forced from the marketplace cannot, by itself, determine whether predatory pricing was involved." 7

While the Guidelines reflect the law developed to date in these cases, it is apparent that the Courts have had limited opportunity to interpret this provision. Accordingly, the Guidelines are intended to supplement the jurisprudence by providing the Director's enforcement policy regarding the section.

Part 2 - Enforcement Guidelines

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2.1 General Remarks

The typical predatory pricing complaint received by the Director comes from an industry participant that says, in effect, that its competitor's prices are so low that they are going to drive it (and possibly others) from the market, following which the alleged predator will raise its prices and recoup the losses incurred during the period of alleged predation. In essence, the complainant lays out a set of suggested facts, and asks the Director to assess the likely outcome of the alleged predation.

The purpose of the assessment is to distinguish predatory pricing from otherwise vigorous and desirable price competition. The analysis emphasizes the presence of, or potential for, market power. Market power means the ability to maintain industry prices above competitive levels for a significant period of time. The analysis seeks to determine if, after a period of low pricing, the alleged predator would be able to raise prices and recoup losses (or forgone profits), unconstrained by competition in the future.

2.2 "Unreasonably Low" Prices - The Threshold Factor

A critical issue in a predatory pricing case is whether or not the prices which are the subject of the complaint can be said to be "unreasonably low". While it is true that they must also be part of a "policy" of pricing and that they must bring about, or be designed to bring about, one of the harmful effects described in the subsection, the reasonableness of the prices themselves is the threshold issue.

The jurisprudence makes it clear that the determination of price reasonableness is not a simple matter of comparing the alleged predator's prices and costs. Rather, it is important to know a great deal about the context within which the alleged predator and rival firms are competing with one another. Was the alleged predator responding to price cuts of a rival firm, or did the alleged predator initiate them? How long were the prices in effect in the market? Was there excess chronic capacity in the industry resulting in firms (including the alleged predator) offering prices which could fairly be described as loss-minimizing in an effort to remain viable and retain market share?

While precise price/cost data applicable to the alleged predator may not be readily available to the Director at the outset of a typical investigation, often much of the evidence needed to determine the likelihood of predation can be obtained, in whole or in part. The Director begins his analysis of a predatory pricing complaint by gathering evidence of the type which both Hoffman-La Roche and Consumers Glass considered in their overall determination of price reasonableness. In doing so, the Director attempts to evaluate whether or not the suggested prices are "unreasonably low" by undertaking a two stage analysis. First, by considering market characteristics, such as, seller concentration and the conditions of entry, which are indicative of the existence of, or the potential for building, market power. Second, by confirming that prices are indeed unreasonably low by evaluating the relationship between the alleged predator's prices and costs. The first stage analysis is undertaken to determine whether it is plausible that this pricing could achieve the anti-competitive effects described in section 50(1)(c) of the Act. If the Director concludes that this is unlikely, no further investigation occurs. In the alternative, the Director would proceed to the second stage, a price/cost analysis.

2.2.1 The First Stage - Market Power

2.2.1.1 Market Shares And Concentration

By its very nature, price predation presumes that the alleged predator possesses sufficient market power to unilaterally impose price levels on the market long enough to harm its rivals financially, and to recoup any losses incurred in that process once its rivals have been forced to exit the market. Therefore, it is very important for the Director to gain a good working understanding of the extent to which the alleged predator may be able to unilaterally affect industry pricing.

At the start, the market itself needs to be defined. This is done both with respect to the product(s) and to the geographical area(s) being contested and involves identifying all actual and potential sources of competition that may constrain the exercise of market power by the alleged predator. In general, the factors considered in defining the market include, on the demand side, the willingness of buyers to switch to substitute products or to the same product sold in other areas, and on the supply side, whether new entry would likely occur through the construction of facilities, the adaptation of existing facilities, or the sale of the product from distant areas. Further information on procedures followed by the Director in defining markets is contained in the Director's Merger Enforcement Guidelines, part 3, "Market Definition" (pp.7-14).

Next, at this preliminary stage of an examination, the Director generally uses the market share of the alleged predator as a tentative indicator of market power. It is unlikely that an alleged predator with a market share of less than 35 percent would have the ability to unilaterally affect industry pricing 8. The greater the market share or the more disparate the size inequality between the alleged predator and other competitors may be, the more likely the alleged predator has market power. This is less likely if the market is characterized by a relatively large, effective and vigorous competitive fringe of smaller firms vying with the alleged predator or where there have been significant recent changes in market shares and market rankings of the leading firms in the market. The closer the market moves towards being one characterized by a large dominant seller (i.e., the alleged predator) with few vigorous competitors, the more likely it is that further examination will take place.

In all cases, the assessment of market shares and concentration is only the starting point of the Director's examination and so is not determinative in itself of a finding that market power exists. A conclusive finding depends on the assessment of the conditions of entry into an industry.

2.2.1.2 Conditions of Entry

General Approach -- In the context of a predatory pricing complaint, it is necessary to determine whether or not the alleged predator appears to have the power to recoup its initial losses by raising prices to above-normal levels once its target/rival has been driven from the market. This determination depends, to a considerable extent, on an assessment of the conditions surrounding effective entry to the industry, including potential for re-entry by any rivals forced out by the alleged predatory pricing behaviour, or expansion by existing firms. In this phase of the examination the Director tries to identify circumstances and conditions which may impede effective entry. The approach to entry conditions is discussed in more detail in the Director's Merger Enforcement Guidelines, part 4.6, "Barriers to Entry" pp. 33-36 and Appendix I.

Essentially, the Director tries to determine whether or not attempted recoupment by the alleged predator, through price increases following the exit of a rival or rivals, would, within two years, invite entry into the industry on a sufficient scale to ensure that price increases could not be sustained. This appears the appropriate period of time in most industries to put in place what is required to achieve a level of sales sufficient to effectively constrain a predator's price increases, post predation.

If a number of factors combine to suggest that entry to the industry would be less likely or more difficult, this would strengthen the Director's concern that the pricing behaviour of the alleged predator could have the potential to cause harmful long-term anti-competitive effects in the market. If, on the other hand, it would appear that entry or expansion would likely occur on a sufficient scale to constrain the ability of the alleged predator to recoup its initial losses at a later time, the Director would have less concern. Of course, whether or not the Director should consider the matter further will depend on the second stage analysis which determines if the alleged predator's prices reflect inherent cost advantages or are below its costs.

The assessment of the conditions of entry emphasizes an examination of whether entry is likely to be delayed or hindered by the presence of absolute cost differences or the need to make investments that are not likely to be recovered if entry is unsuccessful (known as "sunk cost" investments).

Cost Advantages -- Incumbent firms can gain important cost advantages relative to potential entrants through a variety of sources. One type of barrier might well be institutional in nature, such as tariffs or non-tariff barriers international trade.

Similarly, interprovincial barriers to trade and regulatory control over entry may present potential entrants with considerable, and in some cases insurmountable barriers to entry. For example, the necessity to obtain approval from a government regulatory body, as a condition of entry to a market or industry, might well pose a barrier, both in terms of the cost associated with seeking such approval and the anticipated financial consequences of an unsuccessful application.

A scarcity of production inputs, or a lack of access to necessary technology, could also represent an important cost disadvantage to potential entrants. In some cases, necessary inputs and technology may well be controlled by existing industry members, including the alleged predator. The firms may be integrated to such an extent that they significantly control the sources of raw materials used in the down-stream production processes, or possess patent rights to products and processes necessary to the most efficient production of the goods in question. Such controls, however legitimately they have been obtained, may nevertheless represent obstacles to the effective entry of competitors into the markets involved.

Sunk Costs -- Entry to many industries involves various start-up costs that cannot reasonably be expected to be recovered in the event the new business might fail. Such costs are referred to as sunk and may result from either the need to make investments in market specific assets, the need to overcome product differentiation-related advantages enjoyed by incumbent firms, or to overcome disadvantages presented by the strategic behaviour of incumbent firms.

Sunk costs can impede entry in two ways. First, they may be so significant relative to total entry costs and expected rates of return that they deter entry altogether, or prolong the time required to become an effective competitor. Second, though they may fall short of absolute deterrence, they may lead business to decide on entry at a reduced scale, in an effort to minimize financial risk. This latter circumstance may in turn result in entry which, because it is at a sub-optimal level, does not represent effective competition to the existing market participants.

A common form of sunk costs involves the need to invest in market specific assets; for example, in some manufacturing industries the highly sophisticated, specialized equipment dedicated to the production of unique products may have little or no appreciable value outside the specific application for which they are intended. Where such sunk costs represent a significant part of the investment needed for entry or expansion, they are viewed by potential entrants as being higher risk investments than, for example, a fleet of trucks or simple warehouse facilities, which have broader market end uses and could be disposed of on favourable terms in the event that the contemplated entry proved to be unsuccessful.

The presence of significant economies of scale or scope in an industry are two types of production conditions which also can potentially hinder entry by increasing the importance of operating at optimal size and product mix. Economies of scale means that unit costs are lower the more that is produced. Economies of scope refers to the joint production of two or more products being cheaper than producing each product singly and separately.

Entry at the level that would take advantage of available scale or scope economies may, in some cases, carry with it capital costs which are relatively high in relation to the financial resources of the entrant. This may pose a barrier in some cases when a large proportion of these costs are sunk. In addition, the contemplated scale of operations may be so large that, even if capital barriers are not a factor, the time required for investment and development may effectively hinder entry.

Sub-optimal entry, though it may permit the entrant to reduce the capital outlay and shorten the entry period, may simply result in the entrant being relatively ineffectual, because of cost disadvantages, in serving as a check on the ability of the predator to impose higher price levels on the market.

In any given industry there may be a number of well established buyer/seller relationships which promote product differentiation advantages. To some extent these relationships may be determined by price, but it may also be the case that even while price may be a major factor, other non-price factors such as technical service, reputation, geographic proximity, and even strong personal bonds may weigh heavily in the buyer's purchasing decisions. Where such non-price factors appear to an entrant to be significant in terms of quickly attaining the level of sales required to succeed, they may well pose a significant hindrance which would not be present, for example, in an industry where sales levels depended only on successful competition within a tendering process which was exclusively price-driven.

Another type of entry impediment involves strategic behaviour. This refers to conduct that firms would not adopt but for the adverse effect it is expected to have on its rivals or potential entrants. Strategy of this nature may allow firms to build or entrench market power. Here, in assessing whether the alleged predator's ability to raise prices during the post predatory period will be constrained by effective entry, the Director will focus on whether entry will be impeded or delayed by actions such as the following:

#149; incumbents having signalled through responses to past entry initiatives that existing excess capacity will be employed to depress prices in response to an attempt to enter;

? excessive investment in R&D, or advertising by incumbents;

? existing exclusive dealing or tying arrangements.

Further examples of sunk costs can be found in the Director's Merger Enforcement Guidelines, Appendix I.

2.2.2 The second stage - Price/Cost Comparisons

If a firm has market power, the Director then addresses the question of whether the price is at a level low enough to be considered "unreasonable". To do this the Director uses a price/cost comparison test which assumes that, absent unusual circumstances, a firm will continue to operate only if it makes a contribution to its fixed costs of operation. The Director performs the price/cost comparison based on two considerations. First, a price set at or above the average total cost of the alleged predator will not be regarded as "unreasonably low" by the Director, regardless of how much market power is possessed by the alleged predator. Second, a price set below the average variable cost of the alleged predator is likely to be regarded as "unreasonably low" by the Director, unless there is a clear justification such as the need to sell off perishable inventory.

For the above purposes, average variable cost includes the costs of labour, materials, energy, promotional allo wances, use-related plant depreciation and all other costs that vary with the levels of output. Average total cost is the sum of average variable cost and average fixed costs; that is, costs associated with investment in real plant and machinery and any other fixed assets which do not vary with output produced. Whenever possible the analysis will be based on reasonably anticipated, rather than book (historical) average variable costs. This distinction recognizes that price may sometimes fall below average variable costs for unanticipated reasons such as a shortage of materials or a labour strike. Some industries have well-developed costing methodologies which identify forecast-based costs, such as, prospective incremental costs. Where this is an accepted industry standard, it will be used by the Director in preference to book average variable cost.

With regard to prices set somewhere between average total cost and average variable cost (the "grey range"), the Director's conclusion about their reasonableness will depend on the surrounding circumstances. For example, a price in the "grey range" may be reasonable in circumstances of declining demand or substantial excess capacity in the market, even if it is associated with the exit of other firms. On the other hand, a price within this range would be regarded as unreasonable if there was proof that the accused was ignoring opportunities to raise prices in the face of increasing demand, or there was direct evidence of the firm's intent to use pricing for an anti-competitive purpose.

While a complainant may be able to provide valuable evidence at the outset about the alleged predator's pricing behaviour (it is not uncommon for the Director to be provided with copies of price lists, price change announcements, bulletins, etc.), and compare that to the complainant's own cost structure, it will seldom be completely evident to the Director what the exact relationship is between the alleged predator's prices and costs. For this reason the two stage approach to the investigation of the "unreasonably low" element of section 50(1)(c) is particularly helpful. However, where the evidence sought in the first stage is insufficient, that does not mean that the Director may not infer the likelihood of unreasonably low prices from the totality of the circumstances, including such factors as evidence of predatory intent or the manner and extent of elimination or exclusion of competitors by pricing practices.

2.3 "Policy of Selling"

It is not sufficient for the Director to conclude, based on the factors outlined above, that an offence has been committed only if the alleged predator's prices are "unreasonably low". In addition, the Director must be able to conclude from the evidence that the alleged predator is engaged in a "policy of selling" at such prices.

In this regard, the Director will be looking for evidence that the alleged predatory prices are not competitive expedients 9 of brief duration, that they are not simply defensive reactions to the pricing initiatives or behaviour of other firms, or that they are not randomly occurring events attributable to specific business circumstances extant in the market at any given point in time.

The Director will be looking for evidence to determine whether the prices in question have resulted from, and are part of, a deliberate corporate program of pricing in the market, that the prices are applicable throughout the market being contested by the complainant firm(s), and that their applicability is of sufficient duration to constitute a price offering in the context of the given market.10

Thus, complaints made about a particular price which applies to one, or relatively few, market transactions are unlikely to satisfy this test. Similarly, prices which may have applied generally in the market, but for a relatively short period of time, are likely to (but will not necessarily) fall short of representing the sort of "policy of selling" contemplated in section 50(1)(c). On the other hand, in markets in which the bulk of purchasing is done over a short period of time, such as seasonal markets and those in which infrequent large tender calls constitute a significant portion of market transactions, the Director may well conclude that prices applicable over a short duration may be reflective of a "policy of selling" as contemplated in the statute.

2.4 The Competitive impact

If the Director's examination concludes that the alleged predator is engaged in a "policy of selling at prices unreasonably low", then the Director goes on to assess whether the remaining element of the offence is satisfied. As observed by the Court in Hoffman-La Roche, it is recognized that the analysis and evidence relevant to these alternatives will often be similar to what has already been considered with respect to showing unreasonably low prices.

The statute bans unreasonably low pricing behaviour "having the effect or tendency of substantially lessening competition or eliminating a competitor, or designed to have that effect". This part of the statute clearly contemplates a number of separate and different scenarios, each of which will be examined by the Director seeking answers to the following questions:

(a) Has the pricing behaviour had the effect of substantially lessening competition?

(b) Has it had the effect of eliminating a competitor?

(c) Does the pricing behaviour have the tendency to substantially lessen competition?

(d) Does it have the tendency to eliminate a competitor?

(e) Is there evidence that the pricing behaviour is or was designed to substantially lessen competition or eliminate a competitor?

In practical terms, questions (a) and (b) are addressed in circumstances where the objectionable pricing behaviour has already brought about demonstrable and measurable harmful economic effects. In considering substantial lessening of competition, the Director seeks confirmation that the effect of the pricing policy is to preserve or add to market power and that there is little opportunity for competition in the future because entry barriers are maintained or raised. In determining whether a competitor has been eliminated, the Director would want to be satisfied that a competing firm has gone out of business or is otherwise no longer in a position to constrain the ability of the alleged predator to raise prices.

Questions (c) and (d) are addressed in cases where the objectionable pricing behaviour has not been in place for a period of time sufficient to yet fully bring about these effects, and the Director is required to assess the likelihood that they will result over time.

Question (e) relates to situations in which there is evidence available with respect to harmful design or intent of the alleged predator in the pursuit of its pricing behaviour. Here, the Director examines a number of factors, including the magnitude of the price cuts and the losses thereby incurred, the absence of any other rationale for the price cuts and documentary and oral evidence which describe the intent of the alleged predator in carrying out these actions. This information will be considered in conjunction with an assessment of the ability of a party to realize an anti-competitive design. For example, evidence which may suggest an intent to lessen competition or eliminate a competitor, which is not backed up by the market power to realize these goals, is less likely to be pursued.

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Appendix 1 - Case Studies

The following case studies illustrate how the Director would react in hypothetical fact situations. By focussing on the key elements set out earlier in these Guidelines, it is hoped that the reader will derive a better understanding of when and why the Director is likely to take enforcement action in particular cases.

Case I

Fact Set:

It has been alleged by one of its competitors that Company A, a national wholesale distributor of a major brand of consumer electronics products, has been employing a policy of predatory pricing for the purpose of driving one or more of its rivals from the market. While there is no dominant distributor in the market, there are several well-entrenched firms similar to Company A, one of whom has more than a 35 percent share of the market. Company A, the third largest distributor, has 17 percent of the market at present, a decline of about 3 percent over the past two years.

Typically, each distributor of these electronics products is a relatively large multi-product firm, supplying a wide range of electronics goods to the retail market. In no case would the electronics products in question account for more than 20 percent of the total offerings of a given firm.

Each distributor maintains regional warehouse and delivery facilities in several Canadian cities, and employs commissioned sales agents operating in the field.

The customers in the market are retail outlets ranging in size from small independent stores to large national chains. The various competing brands of the products are somewhat differentiated in terms of both styling and operating features, but the major determining factor on the demand side of the market is price; that is, the retailer's purchasing decisions about competing brands offering more or less the same quality features are, historically, price-driven.

Company A, being aware of the complaint made to the Director by its competitor, has provided the Director with information which confirms that it recently lowered its prices considerably with respect to the electronics products in question. On the cost side, Company A provided information which indicates that the reduced prices have at all times been greater than its average total cost in respect of the products. Furthermore, it provided evidence showing that the short-run effect of the price reduction has been to secure additional market share at the expense of several of its competitors, some of whom have held firm in respect of their own pricing policies.

Discussion:

The conditions of entry into this type of distribution business are relatively easy. There are no institutional barriers present and sunk costs are not a major factor in the start-up cost considerations of potential entrants.

There is no dominant firm in the market, and little brand loyalty on the part of buyers, all of whom are price-driven in their purchasing decisions, and willing and able to switch from one supplier to another on reasonably short notice.

On the basis of the price/cost comparison alone, this is not a complaint which the Director would pursue further. Even if the prices were in the "grey range" (between average total cost and average variable cost) it is unlikely that this case would be pursued. There is no evidence of anti-competitive intent evident in the behaviour of Company A, which in any event lacks significant market power over output and prices with a market share well under 35 percent and in a market with relatively easy entry .

On its face, the pricing behaviour of Company A looks like an attempt to recapture lost market share through price competition in a highly fluid and dynamic market.

While the price behaviour may well lead to reduced sales volumes and profits for some of Company A's competitors, it does not appear likely that it will result in a substantial lessening of competition or the elimination of a competitor through the employment of unreasonably low prices.

The basic facts of this case study are typical of a great many of the complaints received annually by the Bureau. The pricing behaviour of Company A in this case study is precisely the kind of competitive behaviour that the Director would not want to see discouraged by an erroneous perception that such behaviour may run the risk of contravening the predatory pricing provisions of the Act.

Case II

Fact Set:

Company A is a manufacturer of a product which is sold directly to large wholesalers serving the home construction industry. Five years ago there were several manufacturers of the product, but at present the market is served by only three firms. Companies B and C both allege that Company A has begun using a predatory pricing strategy to drive one or both of them from the market.

With a share of about 40 percent of sales of the product, Company A is the largest manufacturer. Companies B and C each have about 30 percent of product sales.

All of the firms are operating at well below their respective production capacities, as a result of declining demand brought on by the growth in market acceptance of several close substitute products. These substitute products employ different materials and are generally lower-priced than those offered by Companies A, B and C.

The conditions of entry into the industry are described as relatively easy. The raw materials are in abundant supply and available at competitively determined prices. Sunk costs do not represent a significant factor since the capital equipment used in the production process can, for the most part, be put to alternative uses within the industry, there is little product differentiation and no evidence of strategic behaviour on the part of incumbents.

Prices have been declining in the industry for more than one year but, in the face of continuing sales volumes lost to the close substitute products, Company A has now lowered its price to a level just above its average variable cost. In a memorandum to its sales staff, and a price announcement to its customers, Company A explained that it was lowering its price to make the product "more competitive within the construction industry."

Discussion:

In the circumstances, the Director would not consider the price of Company A to be unreasonably low, and would not proceed further with an investigation or inquiry. On the facts, the rationale for the price change by Company A was clearly the protection of its existing market share, which it saw as being eroded not by the market initiatives of its direct rivals, but by those of the suppliers of close substitute products. In effect, Company A was engaging in rational loss-minimizing behaviour. Even if that behaviour were to result in the elimination of Company B or C from the market, the Director's view would remain that, since the prices themselves were not unreasonably low, the case would not warrant further investigative work.

Case III

Fact Set:

Company A is the largest of several vertically-integrated firms supplying a range of semi-manufactured products used as inputs by numerous Canadian fabricators who produce a wide variety of goods sold in both consumer and industrial markets. The company has a market share in excess of 40 percent, while its nearest rival's share is about 12 percent, with the remaining firms accounting for less that 10 percent each.

There has been steady market growth each year and demand is projected to increase considerably over the next ten years in the industry. With no close substitutes in the market for their products, most firms are known to be considering investing in the expansion or modernization of their production facilities over the next two years.

The vertically-integrated firms control, for the most part, the sources of raw materials used in their production processes. In effect, their manufacturing units are seen as captive customers for the raw materials which they control, and little third party trade takes place in respect of these raw materials. The equipment used in their production process is highly specialized and accounts for a large proportion of start-up costs resulting in sunk costs being a significant entry factor. In addition, economies of scale play an important role on the production side. Most, but not all, of the market participants enjoy significant scale economies in the operation of their regional plants.

The customer side of the market is characterized by numerous buyers, both large and small, all engaged in the manufacture of finished goods. The products supplied by Company A and its competitors represent input costs to the buyers, and they are extremely price-conscious in their purchasing behaviour. Quality being equal, they will switch from one supplier to another when provided with even a small price incentive to do so. Price cutting by one firm in the industry has tended, in the past, to be matched quickly by other suppliers. For the most part, however, prices and market shares have tended to be fairly stable in recent times.

Company A has shattered this stability by reducing its prices across the board by over 25 percent. Two of its smallest competitors have independently claimed to the Bureau that the ostensible purpose of this price-cutting behaviour on the part of Company A is to cripple or drive them from the market, whereupon they expect that prices would rise to levels higher than those prevailing before the price cut. Each of the complainants had been seriously contemplating expansion of production facilities to bring them closer to realizing the scale economies enjoyed by the larger firms in the industry. However, with the recent deep decline in prices, these plans have been put "on hold".

According to the complainants, current market prices are very close to, if not below, their average variable cost of production, and they estimated that these prices would be below the average total cost of all firms in the industry, including those of Company A.

Discussion:

The industry is characterized by relatively difficult conditions of entry, and the alleged predator occupies a dominant position within the market and possesses the market power to influence industry output and prices. The price cutting behaviour of Company A is contrary to what one would expect in the face of increasing market demand with no external stimulus to trigger the behaviour.

On these grounds alone, the Director would be concerned enough to examine the matter vis-à-vis the price/cost relationship of Company A. If it was determined through further investigation that Company A's prices probably fall within the "grey range" vis-à-vis costs and, insofar as the available information is consistent with an intent to lessen competition, the Director would likely conclude that Company A's prices are "unreasonably low". The closer the prices are to Company A's average variable cost, the greater would be the likelihood the Director would find them objectionable.

This case study involves difficult judgement calls. Some of the market effects of the pricing behaviour are already evident, in that two competitors have forestalled their expansion plans in the face of suddenly uneconomic market prices. Should prices remain at their present levels for a significant period of time, there appears to be the real prospect that one or more firms may be forced from the market.

With little chance of quick, effective entry to the market, the possibility for recoupment of losses on the part of Company A appears strong. Even if no competitor is forced to exit the market, the Director would want to know if Company A has cut prices in this manner as a strategic behaviour to demonstrate the extent of its market power. Should the company decide in the near future to raise its prices back to previous levels, or even higher, it may have already conditioned its competitors to accept its role as undisputed price leader and deterred them from expanding their facilities in a way which would have enabled them to be more effective competitors in the future.

For all of these reasons, the Director would have reasonable grounds to initiate an inquiry to determine the facts. This would involve a careful scrutiny of the alleged predator's price/cost information and the evidence of anti-competitive intent. If prices are shown to be below anticipated average variable or incremental cost, then the matter would likely be pursued. If, on the other hand, there is confirmation that prices are in the grey area, the Director would evaluate the available direct and circumstantial evidence of intent to injure competition before pursuing the matter further.

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1. In one case, the accused was acquitted(R. v. Consumers Glass Co. (1981), 124 D.L.R. (3d) 274) and in another (R. v. Bristol-Myers Canada Limited) charges were withdrawn at the preliminary hearing. The third case (R v. École de conduite Tecnic Aubé Inc. et al.) is still before the courts. The Hoffman-La Roche case commenced prior to 1980. It is discussed in part 1.5 below.

2. Section 36 of the Competition Act provides a right of private action. In 1989, the Supreme Court of Canada upheld the constitutional validity of this provision(General Motors of Canada Ltd. v. City National Leasing (20 avril 1989), 58 D.L.R. (4th) 255; Quebec Ready-Mix Inc. v. Rocois Construction Inc. (1989), 60 D.L.R. (4th) 124). Individuals or corporations may wish to explore this avenue of redress if they are of the view that damage has been suffered as a result of conduct contrary to the criminal provisions of the Act, including section 50(1)(c). The Director would appreciate being informed of any such actions.

3. R. v. Hoffman-La Roche, (1980), 109 D.L.R. (3d) 5; affirmed (1981) 125 D.L.R. (3d) 607.

4. Id.at 41.

5. Consumers Glass. , supra note 1.

6. See part 2.2.2, for an explanation of these terms.

7. Consumers Glass Co. , supra note 1, at 293.

8. An exception would be where a firm has a market share of less than 35 percent but is able to build and entrench market power through strategic behaviour. Strategic behaviour is an example of sunk cost impediments to entry discussed in Part 2.2.1.2 - Conditions Of Entry.

9. This is the interpretation of "policy" taken by the Court in The Queen v. The Producers Dairy Limited (1966, unreported), Ont. C.A.

10. The Court in Hoffman-La Roche found that to construe any particular course of pricing action as a "policy of selling" it must be established that such course of action was planned and deliberate conduct by responsible employees of the company.