Analyzing cost structures for determining possible predatory pricing: A case study

By using case study of fictional corporation Central European Railways, Inc. the paper shows the application of current analytical tests being applied within the EU competition policy in order to examine and identify possible predatory pricing. Predatory prices are set in such a way that excludes rivals from competition which potentially leads to weakening of the price mechanism and redistribution of wealth away from consumers to the dominant competitor. Therefore predatory pricing cannot be interpreted equally with excessive prices which only lead to enrichment of the dominant competitor at the expense of consumers.

European Court of Justice uses a set of procedures based on a modified Areeda-Turner test to evaluate possible predatory pricing: the first and second AKZO test. The first AKZO test uses the criteria of marginal costs which in practice are most often approximated by using average variable costs. The second AKZO test applies special price band defined by the average variable costs and average total costs. The prices below average total cost – which is the sum of the fixed and variable costs – but above average variable costs are regarded as abusive in that case if there is a plan to eliminate a competitor. In addition to these economic parameters there is an element of subjectivity which refers directly to the postulated competitive strategy of the dominant competitor.

Production at prices below average variable costs of each unit sold generates a loss totaling for all fixed costs and at least in a part of the variable costs. It is assumed that if the dominant competitor carries out production for such prices there is no other interest except for its effort to eliminate a competitor. This will then allow him to raise prices by taking advantage of his monopoly position. Thus the crucial question is which costs and how will they react to changes in the volume of production and the way in which the production volume should be measured. The railway passenger traffic may not only by measured by the volume of sales in monetary terms but also in diverse measurement units such as the number of passengers or other industry-specific measures. By using the case study of a railway carrier we provide a possible analytical approach of breaking down the cost structure by introducing an in-depth technical-economic analysis of the nature of the costs and linking the costs to their fundamental cost drivers.